FiltersDone

Question type

Essay

Multiple Choice

Short Answer

True False

Matching

Exam 11: The Cost of Capital

Show Answer

Share

---

All types

Filters

Study FlashcardsPractice ExamLearn

Question 31

True/False

Review LaterAdd Note

Review Later

Sensitivity analysis is a risk analysis technique in which key variables are changed and the resulting changes in the NPV and IRR are observed.

A) True
B) False

Correct Answer

verified

Show Answer

Question 32

Multiple Choice

Review LaterAdd Note

Review Later

Which of the following statements is correct?

A) A relatively risky future cash outflow should be evaluated using a relatively low discount rate.
B) If a firm's managers want to maximize the value of the stock, they should concentrate exclusively on projects' market, or beta, risk.
C) If a firm evaluates all projects using the same required rate of return to determine NPVs, then the riskiness of the firm as measured by its beta will probably decline over time.
D) If a firm has a beta which is less than 1.0, say 0.9, this would suggest that its assets' returns are negatively correlated with the returns of most other firms' assets.
E) The above statements are all false.

F) A) and D)
G) A) and C)

Correct Answer

verified

Show Answer

Question 33

Multiple Choice

Review LaterAdd Note

Which of the following is not a cash flow that results from the decision to accept a project?

If the firm is being operated so as to maximize shareholder wealth, and if our basic assumptions concerning the relationship between risk and return are true, then which of the following should be true?

Rucker Truck Line (RTL) is evaluating whether the fleet of trucks it owns should be replaced.If the trucks are replaced, current operating revenues and expenses will not change, except for depreciation expenses.Annual depreciation will increase from $150,000 to $175,000.Based on this information, how will the change in depreciation expense affect the incremental operating cash flows RTL examines when making its capital budgeting decision about replacing the trucks? RTL's marginal tax rate is 40 percent.

The cost of capital may be different for a foreign project than for an equivalent domestic project because foreign projects may be more or less risky.

Exhibit 10-1 You have been asked by the president of your company to evaluate the proposed acquisition of a new special- purpose truck. The truck's basic price is $50,000, and it will cost another $10,000 to modify it for special use by your firm. The truck falls into the MACRS three-year class, and it will be sold after three years for $20,000. Use of the truck will require an increase in net working capital (spare parts inventory) of $2,000. The truck will have no effect on revenues, but it is expected to save the firm $20,000 per year in before-tax operating costs, mainly labor. The firm's marginal tax rate is 40 percent. -Refer to Exhibit 10-1.What is the terminal (nonoperating) cash flow at the end of Year 3?

Sensitivity analysis measures the stand-alone risk of a project by showing how much the project's NPV is affected by a small change in one of the input variables, such as sales.Other things held constant, with the independent variable graphed on the horizontal axis, the steeper the graph of the relationship line, the less risky the project.

Which of the following statements is correct?

If an investment project would make use of land which the firm currently owns, the project should be charged with the opportunity cost of the land.

If a firm uses its weighted average cost of capital (WACC) to evaluate all capital budgeting projects, which of the following could occur?

Carolina Insurance Company, an all-equity life insurance firm, is considering the purchase of a fire insurance company.If the purchase is made, Carolina will be 50 percent larger than before.Currently, Carolina's stock has a beta of 1.2 and the return required is 15.2 percent.The fire insurance company is expected to generate a return of 20 percent with a beta of 2.5.If the risk-free rate is 8 percent and the market risk premium is 6 percent, should Carolina make the investment?

Replacement analysis involves the decision of whether to replace an existing asset that is still productive with a new asset.

If an asset being considered for acquisition has beta of zero, its purchase will have no effect on the firm's market risk.

Exhibit 10-1 You have been asked by the president of your company to evaluate the proposed acquisition of a new special- purpose truck. The truck's basic price is $50,000, and it will cost another $10,000 to modify it for special use by your firm. The truck falls into the MACRS three-year class, and it will be sold after three years for $20,000. Use of the truck will require an increase in net working capital (spare parts inventory) of $2,000. The truck will have no effect on revenues, but it is expected to save the firm $20,000 per year in before-tax operating costs, mainly labor. The firm's marginal tax rate is 40 percent. -Refer to Exhibit 10-1.What is the initial investment outlay for the truck? (That is, what is the Year 0 net cash flow?)

How do most firms deal with the risks of projects when making capital budgeting decisions?

When evaluating a new project, the firm should consider all of the following factors except:

Which of the following statements is most correct?

If a project is small relative to the total firm, and if its returns are not highly correlated with the returns on the firm's other assets, then the project may not be very risky in either the within-firm (corporate) or the market risk sense, even if the returns on the project are highly uncertain and thus the project has a high degree of stand-alone risk.

An evaluation of four independent capital budgeting projects by the director of capital budgeting for Ziker Golf Company yielded the following results: $\quad$$\quad$$\quad$$\quad$$\quad$$\text { Internal rate of }$ $\begin{array}{ccc} \underline{\text { Project }}& \underline{\text { of return, IRR }} &\underline{\text { Risk level }}\\\mathrm{L} & 19.0 \% & \text { Average } \\\mathrm{E} & 15.0 & \text { High } \\\mathrm{M} & 12.0 & \text { Low } \\\mathrm{Q} & 11.0 & \text { Average }\end{array}$ The firm's weighted average cost of capital is 12 percent.Ziker Golf generally evaluates projects that are riskier than average by adjusting its required rate of return by 4 percent, whereas projects with less-than-average risk are evaluated by adjusting the required rate of return by 2 percent.Which project(s) should the firm purchase?