1. A taxable gain occurs when an asset is sold for more than its book value. For capital budgeting purposes, the taxes on the sale _______________________.
A.are treated as a reduction in cash and added to operating cash flow
B.are treated as a noncash event similar to depreciation
C.are treated as a reduction in cash and deducted from the book value of the asset
D.are treated as a reduction in cash and deducted from the taxable gain
E.are treated as a reduction in cash and are deducted from the sale price


2. The purpose of scenario analysis is
A.to evaluate all possible cash flow forecasts
B.to evaluate all possible contingencies and prepare for the occurrence of each
C.to analyze highly negative NPV projects more closely
D.to assess the reasonableness of the cash flows that form the basis for an NPV calculation
E.to gauge the effectiveness of a capital budgeting project after it is already operating


3.
Suppose you are evaluating a project for The Ultimate recreational tennis rackets, guaranteed to correct that wimpy backhand. You estimate the sales price of The Ultimate to be $400 and sales to be 1,000 units in year 1, 1,250 units in year 2, and 1,325 units in year 3. In addition, you figure the project has a life of 3 years. Variable costs amount to $225 per unit and fixed costs are $100,000 per year. The project requires an initial investment of $165,000 which is depreciated straight-line to zero over the three year life of the project. The actual market value of the initial investment after year 3 is $35,000. Initial net working capital (NWC) investment is $75,000 and NWC will maintain a level equal to 20% of sales each year thereafter. The tax rate is 34% and the required return on the project is determined to be 10%.
R-1 9-2

What is operating cash flow (OCF) for the project in year 2?
A.$26,400
B.$68,200
C.$97,075
D.$101,210
E.$105,738



4. Given the following information and assuming straight-line depreciation to zero, what is the NPV of this project? Initial investment = $400,000; life = 5 years; revenues = $150,000 per year; salvage = $30,000 in year 5; tax rate = 34%; discount rate = 14%.
A.-$149,841
B.-$33,117
C.$0
D.$19,800
E.$43,538


5. You discover that the engine-oil additive your scientists developed three years ago makes a great men's after shave when diluted properly using certain chemicals. How should you treat the original $125,000 of R&D expenditures that went into developing the engine-oil additive in your present capital budgeting decision of whether or not to begin production of the after shave?
A.Treat it as a cash outflow three years ago for the current project, that is, find the future value today of the $125,000 spent three years ago
B.The full $125,000 should be treated as initial investment today
C.As a cash inflow since the formula has obviously increased in value over the years
D.As an opportunity cost if the formula cannot presently be sold to another manufacturer
E.As a sunk cost since that R&D expenditure has no bearing on today's decision


6. The equity risk that arises from the nature of the firm's operating activities is called _________.
A.business risk
B.systematic risk
C.unsystematic risk
D.financial risk
E.diversifiable risk


7. Indirect bankruptcy costs include the costs of avoiding a bankruptcy filing incurred by a financially distressed firm.
A.True
B.False


8. Which of the following statements is correct?
A.Decisions regarding a firm's debt and equity can be called capital budgeting decisions
B.The asset beta is a measure of the unsystematic risk of a firm's assets
C.In a purely capital restructuring, the composition of the assets of the firm will change
D.The value of the overall firm will not change as a result of a capital restructuring unless the NPV of the restructuring is negative
E.The use of personal leverage by an investor to alter the degree of financial leverage of a firm is called homemade leverage


9.
Suppose you are evaluating a project for The Ultimate recreational tennis rackets, guaranteed to correct that wimpy backhand. You estimate the sales price of The Ultimate to be $400 and sales to be 1,000 units in year 1, 1,250 units in year 2, and 1,325 units in year 3. In addition, you figure the project has a life of 3 years. Variable costs amount to $225 per unit and fixed costs are $100,000 per year. The project requires an initial investment of $165,000 which is depreciated straight-line to zero over the three year life of the project. The actual market value of the initial investment after year 3 is $35,000. Initial net working capital (NWC) investment is $75,000 and NWC will maintain a level equal to 20% of sales each year thereafter. The tax rate is 34% and the required return on the project is determined to be 10%.
R-1 9-2

Given the $75,000 initial investment in NWC, what change occurs in NWC in year 1?
A.There are no changes in NWC in year 1
B.There is a $5,000 increase in NWC
C.There is a $5,000 decrease in NWC
D.There is an $80,000 increase in NWC
E.There is an $80,000 decrease in NWC



10. A firm has a WACC of 16%, a cost of debt of 10% and a cost of equity of 22%. What is the firm's debt-to-equity ratio? Ignore taxes.
A.0.25
B.0.50
C.0.75
D.1.00
E.1.25


11. A firm just issued $1,000,000 worth of bonds with a yield-to-maturity of 7.5%. The total market value of the firm after the issue was $6,000,000. What was the market value of the firm before the issue if the firm's tax rate is 40%?
A.$5.0 million
B.$5.2 million
C.$5.6 million
D.$6.0 million
E.$6.4 million


12. An unlevered firm just issued $5,000,000 worth of bonds with a yield-to-maturity of 7.5%, using the proceeds to repurchase stock. The firm was worth $5,000,000 before the issue. What is the debt-to-equity ratio after the bond issue (based on market values) if the firm's tax rate is 40%?
A.1.00
B.1.50
C.2.00
D.2.50
E.3.00


13. An investor owns 100 shares of stock in a firm with a debt/equity ratio of 1.0. The investor prefers a debt/equity ratio of zero. If the market price per share is $60, what should the investor do?
A.Borrow $1,500 and buy 25 new shares
B.Borrow $3,000 and buy 50 new shares
C.Borrow $6,000 and buy 100 new shares
D.Sell 50 shares and lend $3,000
E.Sell 100 shares and lend $6,000


14. A firm with no debt has 200,000 shares outstanding valued at $20 each. Its cost of equity is 12%. The firm is considering adding $1,000,000 in debt to its capital structure. The coupon rate would be 8% and the firm's tax rate is 34%. What would the firm be worth after adding the debt?
A.$4.033 million
B.$4.180 million
C.$4.340 million
D.$4.660 million
E.$5.000 million


15. Which of the following would alter the capital structure of a firm? (All else equal.)
A.A firm sells bonds and uses the proceeds to buy back stock
B.A firm refunds a bond issue by issuing new bonds
C.A firm uses the proceeds of a sale of bonds to pay off bank debt
D.A firm pays all of its earnings out to stockholders in the form of dividends, retaining nothing
E.A firm makes an interest payment on its bonds


16. The optimal capital structure is that mixture of debt and equity which
I. maximizes the value of the firm
II. minimizes the firm's weighted average cost of capital
III. maximizes the market price of the firm's bonds
A.I only
B.III only
C.I and II only
D.I and III only
E.I, II and III


17. After ten years as a general auto mechanic in a local garage, Joe decides he is tired of working for others, especially since business is typically slow and he works partially on commission. So, he decides to open his own garage. After estimating the cash flows for his new garage, he finds a large, positive NPV. Which of the following is most likely true about his analysis?
A.The discount rate he used must be too high
B.Unless he can find a true source of value in his new venture, he probably made a mistake in estimating his cash flows
C.He has likely been overly optimistic about the future and has underestimated future cash flows
D.His estimates of initial outlays must be off
E.His analysis is probably correct provided there is adequate competition in the auto repair business


18. Your company currently sells oversized golf clubs. The Board of Directors wants you to look at replacing them with a line of super-sized clubs. Which of the following is NOT a relevant cash flow?
A.$300,000 drop in sales from terminating the oversized line of clubs
B.$750,000 in land you own that may be used for the project
C.$200,000 spent on Research and Development last year on oversized clubs
D.$350,000 you will pay to Fred Singles to promote your new clubs
E.$125,000 you will receive by selling the existing production equipment which must be replaced


19. A project costs $20,000, will be depreciated straight-line to zero over its 3-year life, will require a net working capital investment of $5,000 up front, has a tax rate of 34% and a required return of 10%. The fixed assets will be sold for $2,000 at the end of year three. The project generates OCF of $13,000. What is the project's NPV?
A.$10,724
B.$11,033
C.$12,077
D.$13,426
E.$15,942


20. Which of the following describe(s) relevant cash flows for the purpose of performing capital budgeting analysis?
I. Cash flows must be incremental
II. Cash flows must be after-tax
III. EBIT + DEPN - Taxes
IV. Changes in net working capital
A.I and III only
B.I, II, and III only
C.I and IV only
D.II, III, and IV only
E.I, II, III, and IV



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