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Financial Management 2017 - Quiz and Case Study Guides - Financial Management: Core Concepts, 3e (Brooks) - Quiz - Chapter 11

Financial Management 2016 - 2017

FINANCIAL MANAGEMENT 2017 - QUIZ AND CASE STUDY GUIDES

Financial Management: Core Concepts, 3e (Brooks)

Chapter 11   The Cost of Capital

 

 

 

Financial Management: Core Concepts, 3e (Brooks)

Chapter 11   The Cost of Capital

 

11.1   The Cost of Capital: A Starting Point

 

1) The ________ is the cost of each financing component multiplied by that component's percent of the total funding amount.

  1. A) NPV
  2. B) IRR
  3. C) cost of capital
  4. D) cost of debt

Answer:  C

Diff: 1

Topic:  11.1 The Cost of Capital: A Starting Point

AACSB:  3 Analytical Thinking

LO:  11.1 Understand the different kinds of financing available to a company: debt financing, equity financing, and hybrid equity financing.

 

2) The cost of capital is ________.

  1. A) the cost of debt in a firm that finances with both debt and equity
  2. B) the cost of each financing component multiplied by that component's percent of the total borrowed
  3. C) another name for the IRR
  4. D) All of the above

Answer:  B

Diff: 1

Topic:  11.1 The Cost of Capital: A Starting Point

AACSB:  3 Analytical Thinking

LO:  11.1 Understand the different kinds of financing available to a company: debt financing, equity financing, and hybrid equity financing.

 

3) ________ refers to the way a company finances itself through some combination of loans, bond sales, preferred stock sales, common stock sales, and retention of earnings.

  1. A) Capital structure
  2. B) Cost of capital
  3. C) Working capital management
  4. D) NPV

Answer:  A

Diff: 1

Topic:  11.1 The Cost of Capital: A Starting Point

AACSB:  3 Analytical Thinking

LO:  11.1 Understand the different kinds of financing available to a company: debt financing, equity financing, and hybrid equity financing.

Hmwrk Questions:  * Taken from "Prepping for Exams" questions at the end of the chapter.

 

4) Which of the following is not considered a part of the firm's capital structure?

  1. A) Long-term debt
  2. B) Retained earnings
  3. C) Inventory
  4. D) Preferred stock

Answer:  C

Diff: 1

Topic:  11.1 The Cost of Capital: A Starting Point

AACSB:  3 Analytical Thinking

LO:  11.1 Understand the different kinds of financing available to a company: debt financing, equity financing, and hybrid equity financing.

 

 

5) A firm's capital structure can be determined by examining which parts of the firm's balance sheet?

  1. A) The long-term assets
  2. B) The debt and equity
  3. C) The short-term assets and liabilities
  4. D) None of the above because a firm's capital structure is best observed on the income statement.

Answer:  B

Explanation:  B) Long-term assets speak to the question of capital budgeting, short-term assets and liabilities speak to net working capital decisions.

Diff: 1

Topic:  11.1 The Cost of Capital: A Starting Point

AACSB:  3 Analytical Thinking

LO:  11.1 Understand the different kinds of financing available to a company: debt financing, equity financing, and hybrid equity financing.

 

6) Of the following, which is NOT a source of funds for a company?

  1. A) Common shareholders
  2. B) Commercial banks
  3. C) Preferred stockholders
  4. D) All are sources of funds for companies.

Answer:  D

Diff: 1

Topic:  11.1 The Cost of Capital: A Starting Point

AACSB:  3 Analytical Thinking

LO:  11.1 Understand the different kinds of financing available to a company: debt financing, equity financing, and hybrid equity financing.

 

7) Which of the following would be classified as debt lenders for a firm?

  1. A) Preferred shareholders, banks, and nonbank lenders
  2. B) Nonbank lenders, common shareholders, and commercial banks
  3. C) Preferred shareholders, common shareholders, and suppliers
  4. D) Suppliers, nonbank lenders, and commercial banks

Answer:  D

Explanation:  D) Preferred stockholders are hybrid equity lenders, common shareholders are owners, and the rest of the choices may be considered a form of debt lender.

Diff: 2

Topic:  11.1 The Cost of Capital: A Starting Point

AACSB:  3 Analytical Thinking

LO:  11.1 Understand the different kinds of financing available to a company: debt financing, equity financing, and hybrid equity financing.

Hmwrk Questions:  * Taken from "Prepping for Exams" questions at the end of the chapter.

 

8) Which of the following would be classified as equity financing for a firm?

  1. A) Preferred shareholders, banks, and nonbank lenders
  2. B) Nonbank lenders, common shareholders, and commercial banks
  3. C) Preferred shareholders, common shareholders, and retained earnings
  4. D) Suppliers, nonbank lenders, and commercial banks

Answer:  C

Explanation:  C) Bank and nonbank lenders, as well as suppliers, are sources of debt lending.

Diff: 2

Topic:  11.1 The Cost of Capital: A Starting Point

AACSB:  3 Analytical Thinking

LO:  11.1 Understand the different kinds of financing available to a company: debt financing, equity financing, and hybrid equity financing.

 

9) When a company borrows money from a bank or sells bonds, it is called ________.

  1. A) capital structure financing
  2. B) stock financing
  3. C) equity financing
  4. D) debt financing

Answer:  D

Diff: 1

Topic:  11.1 The Cost of Capital: A Starting Point

AACSB:  3 Analytical Thinking

LO:  11.1 Understand the different kinds of financing available to a company: debt financing, equity financing, and hybrid equity financing.

 

10) Which of the items below is sometimes termed hybrid equity financing?

  1. A) Retained earnings
  2. B) Preferred stock
  3. C) Callable bonds
  4. D) Variable rate bonds

Answer:  B

Diff: 1

Topic:  11.1 The Cost of Capital: A Starting Point

AACSB:  3 Analytical Thinking

LO:  11.1 Understand the different kinds of financing available to a company: debt financing, equity financing, and hybrid equity financing.

11) Which of the statements below is NOT true?

  1. A) Preferred stock is a form of hybrid equity financing.
  2. B) Retained earnings are a form of hybrid equity financing.
  3. C) Common stock is a form of equity financing.
  4. D) Corporate bonds are a form of debt financing.

Answer:  B

Explanation:  B) Retained earnings are internal equity financing.

Diff: 1

Topic:  11.1 The Cost of Capital: A Starting Point

AACSB:  3 Analytical Thinking

LO:  11.1 Understand the different kinds of financing available to a company: debt financing, equity financing, and hybrid equity financing.

 

12) The weighted average cost of capital is ________.

  1. A) the average of the cost of each financing component, weighted by the proportion of each component
  2. B) the cost of capital for the firm as a whole
  3. C) made up of three financing components: the cost of debt, the cost of preferred stock, and the cost of equity
  4. D) All of the above

Answer:  D

Diff: 2

Topic:  11.1 The Cost of Capital: A Starting Point

AACSB:  3 Analytical Thinking

LO:  11.1 Understand the different kinds of financing available to a company: debt financing, equity financing, and hybrid equity financing.

 

13) Acme Supply Co. has a new project that will require the company to borrow $3,000,000. Acme has made an agreement with three lenders for the needed financing. First National Bank will give $1,500,000 and wants 10% interest on the loan. Lockup Bank will give $1,000,000 and wants 12% interest on the loan. Southern National Bank will give $500,000 and wants 13% interest on the loan. What is the weighted average cost of capital for this $3,000,000?

  1. A) 10.55%
  2. B) 11.17%
  3. C) 11.66%
  4. D) 12.16%

Answer:  B

Explanation:  B) WACC =  × 10% +  × 12% +  × 13% = 11.17%.

Diff: 2

Topic:  11.1 The Cost of Capital: A Starting Point

AACSB:  3 Analytical Thinking

LO:  11.1 Understand the different kinds of financing available to a company: debt financing, equity financing, and hybrid equity financing.

 

14) Michigan Manufacturing Inc. (MM) has a new project that will require the company to borrow $1,000,000. MM has made an agreement with three lenders for the needed financing. First National Bank will give $500,000 and wants 9% interest on the loan. Key West Bank will give $300,000 and wants 11% interest on the loan. Chase Bank will give $200,000 and wants 12% interest on the loan. What is the weighted average cost of capital for this $1,000,000?

  1. A) 10.67%
  2. B) 10.20%
  3. C) 10.00%
  4. D) 9.67%

Answer:  B

Explanation:  B) WACC =  × 9% +  × 11% +  × 12% = 10.20%.

Diff: 2

Topic:  11.1 The Cost of Capital: A Starting Point

AACSB:  3 Analytical Thinking

LO:  11.1 Understand the different kinds of financing available to a company: debt financing, equity financing, and hybrid equity financing.

 

15) The choice of the borrowing proportion makes up the capital budgeting of the firm.

Answer:  FALSE

Explanation:  The choice of the borrowing proportion makes up the capital structure of the firm.

Diff: 1

Topic:  11.1 The Cost of Capital: A Starting Point

AACSB:  3 Analytical Thinking

LO:  11.1 Understand the different kinds of financing available to a company: debt financing, equity financing, and hybrid equity financing.

 

16) When a company borrows from a bank or sells bonds, it is called equity financing.

Answer:  FALSE

Explanation:  When a company borrows from a bank or sells bonds, it is called debt financing.

Diff: 1

Topic:  11.1 The Cost of Capital: A Starting Point

AACSB:  3 Analytical Thinking

LO:  11.1 Understand the different kinds of financing available to a company: debt financing, equity financing, and hybrid equity financing.

 

17) When a company "borrows" money from the owners by selling common stock or using internal funds, it is called equity financing.

Answer:  TRUE

Diff: 1

Topic:  11.1 The Cost of Capital: A Starting Point

AACSB:  3 Analytical Thinking

LO:  11.1 Understand the different kinds of financing available to a company: debt financing, equity financing, and hybrid equity financing.

 

 

18) When estimating the cost of debt financing from bonds, a firm can use the yield-to-maturity as the before-tax cost of debt.

Answer:  TRUE

Diff: 1

Topic:  11.1 The Cost of Capital: A Starting Point

AACSB:  3 Analytical Thinking

LO:  11.1 Understand the different kinds of financing available to a company: debt financing, equity financing, and hybrid equity financing.

19) The textbook labels preferred stock as "hybrid equity financing." Identify and explain the features of preferred stock that give it the designation of "hybrid equity financing."

Answer:  Preferred stock is identified as a hybrid equity security because even though it is equity, it has features of debt as well. Like stock, it has no specific maturity and the principal is usually not repaid. Like debt, preferred stock does not ordinarily have voting rights but under certain conditions it may be converted to common stock. Preferred stock's annual dividend at a set rate is like the coupon payments on a bond.

Diff: 1

Topic:  11.1 The Cost of Capital: A Starting Point

AACSB:  3 Analytical Thinking

LO:  11.1 Understand the different kinds of financing available to a company: debt financing, equity financing, and hybrid equity financing.

 

11.2   Components of the Weighted Average Cost of Capital

 

1) In capital budgeting, the ________ is the appropriate discount rate to use when calculating the NPV of an average risk project.

  1. A) WACC
  2. B) IRR
  3. C) cost of debt
  4. D) cost of Equity

Answer:  A

Diff: 1

Topic:  11.2 Components of the Weighted Average Cost of Capital

AACSB:  3 Analytical Thinking

LO:  11.2 Understand the debt and equity components of the weighted average cost of capital (WACC) and explain the tax implications on debt financing and the adjustment to the WACC.

 

2) In capital budgeting, the appropriate decision rule for an average-risk project is to accept if the ________ is greater than the WACC.

  1. A) NPV
  2. B) IRR
  3. C) cost of equity
  4. D) cost of debt

Answer:  B

Diff: 1

Topic:  11.2 Components of the Weighted Average Cost of Capital

AACSB:  3 Analytical Thinking

LO:  11.2 Understand the debt and equity components of the weighted average cost of capital (WACC) and explain the tax implications on debt financing and the adjustment to the WACC.

 

 

3) The ________ is the return that the bank or bondholder demands on new borrowing.

  1. A) IRR
  2. B) WACC
  3. C) cost of equity
  4. D) cost of debt

Answer:  D

Diff: 1

Topic:  11.2 Components of the Weighted Average Cost of Capital

AACSB:  3 Analytical Thinking

LO:  11.2 Understand the debt and equity components of the weighted average cost of capital (WACC) and explain the tax implications on debt financing and the adjustment to the WACC.

4) The cost of debt could be which of the following?

  1. A) The required return on money borrowed as a long-term loan from a bank
  2. B) The required return on money borrowed from a venture capitalist
  3. C) The yield-to-maturity on money raised by selling bonds
  4. D) All of the choices above could be considered the cost of debt.

Answer:  D

Diff: 2

Topic:  11.2 Components of the Weighted Average Cost of Capital

AACSB:  3 Analytical Thinking

LO:  11.2 Understand the debt and equity components of the weighted average cost of capital (WACC) and explain the tax implications on debt financing and the adjustment to the WACC.

Hmwrk Questions:  * Taken from "Prepping for Exams" questions at the end of the chapter.

 

5) Which of the following would NOT be considered a cost of debt financing?

  1. A) The required return on a bank loan
  2. B) The required return on preferred stock
  3. C) The yield-to-maturity of a bond issue
  4. D) The required return on money borrowed from a venture capitalist

Answer:  B

Diff: 2

Topic:  11.2 Components of the Weighted Average Cost of Capital

AACSB:  3 Analytical Thinking

LO:  11.2 Understand the debt and equity components of the weighted average cost of capital (WACC) and explain the tax implications on debt financing and the adjustment to the WACC.

 

 

6) Your firm has just issued a 20-year $1,000.00 par value, 10% annual coupon bond for a net price of $964.00. What is the yield to maturity? Use a financial calculator to determine your answer.

  1. A) 10.60%
  2. B) 11.10%
  3. C) 10.44%
  4. D) 10.16%

Answer:  C

Explanation:  C)

Mode = P/Y = 1; C/Y = 1

Input          20                ?            -964         100           1,000

Key             N                I/Y        PV           PMT        FV

CPT             10.44%

Note that APR = EAR.

Diff: 2

Topic:  11.2 Components of the Weighted Average Cost of Capital

AACSB:  3 Analytical Thinking

LO:  11.2 Understand the debt and equity components of the weighted average cost of capital (WACC) and explain the tax implications on debt financing and the adjustment to the WACC.

7) Your firm has just issued a 20-year $1,000.00 par value, 6% coupon semiannual bond for a net price of $964.00. What is the yield to maturity? Use a financial calculator to determine your answer.

  1. A) 3.16%
  2. B) 7.33%
  3. C) 6.32%
  4. D) 6.00%

Answer:  C

Explanation:  C)

Mode = P/Y = 2; C/Y = 2

Input            40             ?             -964        30             1,000

Key               N              I/Y          PV          PMT         FV

CPT              6.32%

Diff: 3

Topic:  11.2 Components of the Weighted Average Cost of Capital

AACSB:  3 Analytical Thinking

LO:  11.2 Understand the debt and equity components of the weighted average cost of capital (WACC) and explain the tax implications on debt financing and the adjustment to the WACC.

 

 

8) Your firm has issued a 10-year $1,000.00 par value semiannual 10% coupon bond that sells for $1,000 in the market place. The proceeds from the sale of the bond issue are $975.00 per bond. What is your firm's yield to maturity on this new bond issue? Use a financial calculator to determine your answer.

  1. A) 5.15%
  2. B) 10.16%
  3. C) 10.30%
  4. D) 10.41%

Answer:  D

Explanation:  D)

Mode = P/Y = 2; C/Y = 2

Input            20              ?             -975         50           1,000

Key               N               I/Y         PV            PMT      FV

CPT               10.41%

Diff: 3

Topic:  11.2 Components of the Weighted Average Cost of Capital

AACSB:  3 Analytical Thinking

LO:  11.2 Understand the debt and equity components of the weighted average cost of capital (WACC) and explain the tax implications on debt financing and the adjustment to the WACC.

 

9) A/An ________ facilitates the issuing and sale of bonds and for this service is paid a fee.

  1. A) commercial banker
  2. B) investment banker
  3. C) dealer
  4. D) broker

Answer:  B

Diff: 1

Topic:  11.2 Components of the Weighted Average Cost of Capital

AACSB:  3 Analytical Thinking

LO:  11.2 Understand the debt and equity components of the weighted average cost of capital (WACC) and explain the tax implications on debt financing and the adjustment to the WACC.

10) An investment banker's fees are part of the ________ realized for issuing new debt or equity.

  1. A) flotation costs
  2. B) opportunity costs
  3. C) revenues
  4. D) benefits

Answer:  A

Diff: 1

Topic:  11.2 Components of the Weighted Average Cost of Capital

AACSB:  3 Analytical Thinking

LO:  11.2 Understand the debt and equity components of the weighted average cost of capital (WACC) and explain the tax implications on debt financing and the adjustment to the WACC.

 

 

11) Pricing preferred stock is most similar to pricing ________.

  1. A) constant growth common stock
  2. B) a perpetuity
  3. C) a zero-coupon bond
  4. D) a three-month Treasury bill

Answer:  B

Diff: 1

Topic:  11.2 Components of the Weighted Average Cost of Capital

AACSB:  3 Analytical Thinking

LO:  11.2 Understand the debt and equity components of the weighted average cost of capital (WACC) and explain the tax implications on debt financing and the adjustment to the WACC.

 

12) Your firm has preferred stock outstanding that pays a current dividend of $3.00 per year and has a current price of $39.50. You anticipate that the economy will grow steadily at a rate of 3.00% per year for the foreseeable future. What is the market required rate of return on your firm's preferred stock?

  1. A) 10.82%
  2. B) 10.59%
  3. C) 7.59%
  4. D) There is not enough information to answer this question.

Answer:  C

Explanation:  C) Rps =  =  = 7.59%.

Note: the growth rate in the economy is a red herring and has no bearing on the answer.

Diff: 3

Topic:  11.2 Components of the Weighted Average Cost of Capital

AACSB:  3 Analytical Thinking

LO:  11.2 Understand the debt and equity components of the weighted average cost of capital (WACC) and explain the tax implications on debt financing and the adjustment to the WACC.

Hmwrk Questions:  * Taken from "Prepping for Exams" questions at the end of the chapter.

13) Your firm has preferred stock outstanding that pays a current dividend of $2.00 per year and has a current price of $21.50. Currently, preferred stock makes up approximately 15% of your firm's long-term financing. What is the market required rate of return on your firm's preferred stock?

  1. A) 8.70%
  2. B) 9.00%
  3. C) 9.30%
  4. D) 15.00%

Answer:  C

Explanation:  C) Rps =  =  = 9.30%.

Diff: 3

Topic:  11.2 Components of the Weighted Average Cost of Capital

AACSB:  3 Analytical Thinking

LO:  11.2 Understand the debt and equity components of the weighted average cost of capital (WACC) and explain the tax implications on debt financing and the adjustment to the WACC.

 

 

14) The riskiness of a future cash flow is measured by ________ , and these are all components of the SML.

  1. A) the firm's standard deviation, correlation, and the market risk premium
  2. B) beta, the market risk premium, and the firm's standard deviation
  3. C) the market risk premium, beta, and correlation
  4. D) beta, the market risk premium, and the risk-free rate

Answer:  D

Diff: 2

Topic:  11.2 Components of the Weighted Average Cost of Capital

AACSB:  3 Analytical Thinking

LO:  11.2 Understand the debt and equity components of the weighted average cost of capital (WACC) and explain the tax implications on debt financing and the adjustment to the WACC.

 

15) Use the security market line to determine the required rate of return for the following firm's stock. The firm has a beta of 1.25, the required return in the market place is 10.50%, the standard deviation of returns for the market portfolio is 25.00%, and the standard deviation of returns for your firm is also 25.00%.

  1. A) 13.13%
  2. B) 10.50%
  3. C) 31.25%
  4. D) There is not enough information to answer this question.

Answer:  D

Explanation:  D) Re = E(ri) = rf + [E(rm) - rf] βi.

This problem lacks information about the risk-free rate of return, and so we cannot solve for Re.

Diff: 3

Topic:  11.2 Components of the Weighted Average Cost of Capital

AACSB:  3 Analytical Thinking

LO:  11.2 Understand the debt and equity components of the weighted average cost of capital (WACC) and explain the tax implications on debt financing and the adjustment to the WACC.

16) Use the security market line to determine the required rate of return for the following firm's stock. The firm has a beta of 0.80, the required return in the market place is 12.50%, and the risk-free rate of return is 3.50%.

  1. A) 13.50%
  2. B) 10.70%
  3. C) 7.20%
  4. D) 2.80%

Answer:  B

Explanation:  B) Re = Rf + β × (Rm - Rf) = 3.50% + 0.80 × (12.50% - 3.50%) = 10.70%.

Diff: 3

Topic:  11.2 Components of the Weighted Average Cost of Capital

AACSB:  3 Analytical Thinking

LO:  11.2 Understand the debt and equity components of the weighted average cost of capital (WACC) and explain the tax implications on debt financing and the adjustment to the WACC.

 

 

17) Which of the following is an advantage of the dividend growth approach over the SML in estimating the required return on equity?

  1. A) The dividend growth model uses market information but the SML does not.
  2. B) Dividend growth is known, whereas estimating beta for the SML is an art form.
  3. C) It is easy to fit flotation costs into the dividend growth model but not the SML.
  4. D) All are advantages of the dividend growth model for estimating the required return on equity.

Answer:  C

Explanation:  C) The dividend growth model solves for Re via Re =  + g, but the SML has no obvious method to adjust for flotation costs.

Diff: 2

Topic:  11.2 Components of the Weighted Average Cost of Capital

AACSB:  3 Analytical Thinking

LO:  11.2 Understand the debt and equity components of the weighted average cost of capital (WACC) and explain the tax implications on debt financing and the adjustment to the WACC.

 

18) Use the dividend growth model to determine the required rate of return for equity. Your firm intends to pay a dividend of $1.50 per share one year from today. Further, the recent stock price is $31.82 per share, and you anticipate a growth rate in dividends of 4.00% per year for the foreseeable future.

  1. A) 8.90%
  2. B) 8.71%
  3. C) 9.09%
  4. D) There is not enough information to answer this question.

Answer:  B

Explanation:  B) Re =  + g = Re =  + 0.04 = 8.71%.

Diff: 3

Topic:  11.2 Components of the Weighted Average Cost of Capital

AACSB:  3 Analytical Thinking

LO:  11.2 Understand the debt and equity components of the weighted average cost of capital (WACC) and explain the tax implications on debt financing and the adjustment to the WACC.

19) Use the dividend growth model to determine the required rate of return for equity. Your firm recently paid a dividend of $2.25 per share, has a recent price of $40.20 per share, and anticipates a growth rate in dividends of 3.00% per year for the foreseeable future.

  1. A) 8.76%
  2. B) 8.60%
  3. C) 8.44%
  4. D) There is not enough information to answer this question.

Answer:  A

Explanation:  A) Re =  + g = Re = $2.25 ∗ (1.03)/$40.20 + 0.03 = 8.76%.

Diff: 3

Topic:  11.2 Components of the Weighted Average Cost of Capital

AACSB:  3 Analytical Thinking

LO:  11.2 Understand the debt and equity components of the weighted average cost of capital (WACC) and explain the tax implications on debt financing and the adjustment to the WACC.

 

 

20) Use the dividend growth model to determine the required rate of return for equity. Your firm intends to issue new common stock. Your investment bankers have determined that the stock should be offered at a price of $45.00 per share and that you should anticipate paying a dividend of $1.50 in one year. If you anticipate a constant growth in dividends of 3.50% per year and the investment banking firm will take 7.00% per share as flotation costs, what is the required rate of return for this issue of new common stock?

  1. A) 7.19%
  2. B) 6.83%
  3. C) 7.08%
  4. D) There is not enough information to answer this question.

Answer:  C

Explanation:  C) Re =  + g =  + 0.035 = 0.03584 + 0.035 ≈ 7.08%.

Diff: 3

Topic:  11.2 Components of the Weighted Average Cost of Capital

AACSB:  3 Analytical Thinking

LO:  11.2 Understand the debt and equity components of the weighted average cost of capital (WACC) and explain the tax implications on debt financing and the adjustment to the WACC.

Hmwrk Questions:  * Taken from "Prepping for Exams" questions at the end of the chapter.

21) Use the dividend growth model to determine the required rate of return for equity. Your firm intends to issue new common stock. Your investment bankers have determined that the stock should be offered at a price of $20.00 per share and that you should anticipate paying a dividend of $0.75 in one year. If you anticipate a constant growth in dividends of 3.00% per year and the investment banking firm will take 8.00% per share as flotation costs, what is the required rate of return for this issue of new common stock?

  1. A) 6.83%
  2. B) 7.08%
  3. C) 7.19%
  4. D) 10.20%

Answer:  B

Explanation:  B) Re =  + g =  + 0.0300 = 0.04076 + 0.0300 ≈ 7.08%.

Diff: 3

Topic:  11.2 Components of the Weighted Average Cost of Capital

AACSB:  3 Analytical Thinking

LO:  11.2 Understand the debt and equity components of the weighted average cost of capital (WACC) and explain the tax implications on debt financing and the adjustment to the WACC.

 

 

22) The cost of retained earnings ________.

  1. A) is the loss of the dividend option for the owners
  2. B) is the cost of issuing new common stock without the flotation costs
  3. C) is the appropriate cost of capital for the shareholders
  4. D) All of the above

Answer:  D

Explanation:  D) Retained earnings are the portion of net income not paid out as dividends. Because the funds are kept by the firm, the managers have an obligation to meet the opportunity costs of the shareholders so the cost of retained earnings should be considered the cost of raising new equity without any additional flotation costs.

Diff: 2

Topic:  11.2 Components of the Weighted Average Cost of Capital

AACSB:  3 Analytical Thinking

LO:  11.2 Understand the debt and equity components of the weighted average cost of capital (WACC) and explain the tax implications on debt financing and the adjustment to the WACC.

 

23) When calculating the after-tax weighted average cost of capital (WACC), which of the following costs is adjusted for taxes in the equation?

  1. A) The before-tax cost of equity
  2. B) The before-tax cost of debt
  3. C) The before-tax cost of preferred stock
  4. D) The after-tax cost of debt

Answer:  B

Explanation:  B) WACCadj =  × Rd × (1 - Tc) +  × Rps +  × Re.

Diff: 1

Topic:  11.2 Components of the Weighted Average Cost of Capital

AACSB:  3 Analytical Thinking

LO:  11.2 Understand the debt and equity components of the weighted average cost of capital (WACC) and explain the tax implications on debt financing and the adjustment to the WACC.

24) Which of the following are tax-deductible expenses for corporations?

  1. A) Interest expenses
  2. B) Preferred stock dividends
  3. C) Common stock dividends
  4. D) All are tax-deductible for corporations.

Answer:  A

Diff: 1

Topic:  11.2 Components of the Weighted Average Cost of Capital

AACSB:  3 Analytical Thinking

LO:  11.2 Understand the debt and equity components of the weighted average cost of capital (WACC) and explain the tax implications on debt financing and the adjustment to the WACC.

 

 

25) Which of the following is the proper way to adjust the cost of debt to estimate the after-tax cost of debt?

  1. A) Rd÷ (1 + Tc)
  2. B) Rd÷ (1 - Tc)
  3. C) Rd× (1 - Tc)
  4. D) Rd× (1 + Tc)

Answer:  C

Diff: 1

Topic:  11.2 Components of the Weighted Average Cost of Capital

AACSB:  3 Analytical Thinking

LO:  11.2 Understand the debt and equity components of the weighted average cost of capital (WACC) and explain the tax implications on debt financing and the adjustment to the WACC.

 

26) For estimating NPV, the IRR is the appropriate discount rate to use for an average-risk project.

Answer:  FALSE

Explanation:  For estimating NPV, the WACC is the appropriate discount rate to use for an average-risk project.

Diff: 1

Topic:  11.2 Components of the Weighted Average Cost of Capital

AACSB:  3 Analytical Thinking

LO:  11.2 Understand the debt and equity components of the weighted average cost of capital (WACC) and explain the tax implications on debt financing and the adjustment to the WACC.

 

27) When evaluating an average-risk project using IRR, a firm should use the WACC as the hurdle rate.

Answer:  TRUE

Diff: 1

Topic:  11.2 Components of the Weighted Average Cost of Capital

AACSB:  3 Analytical Thinking

LO:  11.2 Understand the debt and equity components of the weighted average cost of capital (WACC) and explain the tax implications on debt financing and the adjustment to the WACC.

 

28) Flotation costs reduce the cost of borrowing funds for the firms.

Answer:  FALSE

Explanation:  Flotation costs INCREASE the cost of borrowing funds for the firms.

Diff: 1

Topic:  11.2 Components of the Weighted Average Cost of Capital

AACSB:  3 Analytical Thinking

LO:  11.2 Understand the debt and equity components of the weighted average cost of capital (WACC) and explain the tax implications on debt financing and the adjustment to the WACC.

29) When determining the cost of bond financing a firm must determine the net proceeds from the sale of the bond less the flotation cost charged by the investment banker to estimate the yield-to-maturity.

Answer:  TRUE

Diff: 1

Topic:  11.2 Components of the Weighted Average Cost of Capital

AACSB:  3 Analytical Thinking

LO:  11.2 Understand the debt and equity components of the weighted average cost of capital (WACC) and explain the tax implications on debt financing and the adjustment to the WACC.

 

 

30) Two techniques for determining the cost of equity include using:

  1. The Security Market Line, and 2. The Internal Rate of Return.

Answer:  FALSE

Explanation:  Two techniques for determining the cost of equity include using:

  1. The Security Market Line, and 2. The Dividend Growth Model.

Diff: 1

Topic:  11.2 Components of the Weighted Average Cost of Capital

AACSB:  3 Analytical Thinking

LO:  11.2 Understand the debt and equity components of the weighted average cost of capital (WACC) and explain the tax implications on debt financing and the adjustment to the WACC.

 

31) It is easier to incorporate the impact of flotation costs on the cost of equity capital in using the dividend growth model rather than the Security Market Line.

Answer:  TRUE

Diff: 2

Topic:  11.2 Components of the Weighted Average Cost of Capital

AACSB:  3 Analytical Thinking

LO:  11.2 Understand the debt and equity components of the weighted average cost of capital (WACC) and explain the tax implications on debt financing and the adjustment to the WACC.

 

32) The cost of retained earnings is the cost of issuing new common stock without flotation costs.

Answer:  TRUE

Diff: 1

Topic:  11.2 Components of the Weighted Average Cost of Capital

AACSB:  3 Analytical Thinking

LO:  11.2 Understand the debt and equity components of the weighted average cost of capital (WACC) and explain the tax implications on debt financing and the adjustment to the WACC.

 

33) To find the after-tax cost of debt for a corporation, one needs to multiply the before-tax cost of debt by (1 + Tc), where Tc = the corporate tax rate.

Answer:  FALSE

Explanation:  To find the after-tax cost of debt for a corporation, one needs to multiply the before-tax cost of debt by (1 - Tc), where Tc = the corporate tax rate.

Diff: 2

Topic:  11.2 Components of the Weighted Average Cost of Capital

AACSB:  3 Analytical Thinking

LO:  11.2 Understand the debt and equity components of the weighted average cost of capital (WACC) and explain the tax implications on debt financing and the adjustment to the WACC.

 

34) Theo has been assigned the task of determining the cost of capital for his division of the firm. His first step is to determine the cost of debt. The firm has $1,000 par value bonds outstanding that have an annual coupon rate of 8.00% and make semiannual payments. These bonds have twenty-three years remaining to maturity and currently sell for $1,133.42. What is the yield-to-maturity on these bonds? Use a financial calculator to determine your answer.

Answer:  Mode = P/Y = 2; C/Y = 2

Input            46              ?           -1,133.42         40          1,000

Key              N               I/Y       PV                   PMT     FV

CPT              6.84%

Diff: 2

Topic:  11.2 Components of the Weighted Average Cost of Capital

AACSB:  3 Analytical Thinking

LO:  11.2 Understand the debt and equity components of the weighted average cost of capital (WACC) and explain the tax implications on debt financing and the adjustment to the WACC.

 

35) Define flotation costs and explain how they are used when estimating a firm's yield-to-maturity.

Answer:  Flotation costs are the costs incurred to sell a security. They are the fees charged by the investment banker to facilitate the issuance and sale of the bond. To determine the yield-to-maturity of a new issue of bonds, it is proper to use the bond selling price less the flotation cost as the net proceeds to the firm. The net proceeds become the price used in the equation to determine the yield-to-maturity.

Diff: 2

Topic:  11.2 Components of the Weighted Average Cost of Capital

AACSB:  3 Analytical Thinking

LO:  11.2 Understand the debt and equity components of the weighted average cost of capital (WACC) and explain the tax implications on debt financing and the adjustment to the WACC.

 

36) Phillip Enterprises Inc. needs to determine its cost of equity capital. Use the following information to estimate the firm's cost of equity using both the security market line and the dividend growth model. The current market price of stock is $22.89, the risk-free rate is 4.00%, the required return on the market portfolio is 13.50%, the firm has a constant growth rate in dividends of 3.00% per year, current dividends are $2.00, and the firm's beta is 0.90.

Answer:  For the dividend growth model, Re =  + g =  + .03 = 12.00%

For the SML, E(ri) = rf + [E(rm) - rf] βi = 0.04 + (.135 - .04) × 0.90 = 12.55%.

At this point, the student may choose either answer or to average the two answers.

Diff: 3

Topic:  11.2 Components of the Weighted Average Cost of Capital

AACSB:  3 Analytical Thinking

LO:  11.2 Understand the debt and equity components of the weighted average cost of capital (WACC) and explain the tax implications on debt financing and the adjustment to the WACC.

 

11.3   Weighting the Components: Book Value or Market Value?

 

1) The ________ of an asset or liability is its cost carried on the balance sheet.

  1. A) market value
  2. B) book value
  3. C) hybrid value
  4. D) theoretical value

Answer:  B

Diff: 1

Topic:  11.3 Weighting the Components: Book Value or Market Value?

AACSB:  3 Analytical Thinking

LO:  11.3 Calculate the weights of the components using book values or market values.

 

2) Elway Electronics has debt with a market value of $350,000, preferred stock with a market value of $150,000, and common stock with a market value of $450,000. If debt has a cost of 8%, preferred stock a cost of 10%, common stock a cost of 12%, and the firm has a tax rate of 30%, what is the WACC?

  1. A) 8.64%
  2. B) 9.12%
  3. C) 9.33%
  4. D) 9.46%

Answer:  C

Explanation:  C) WACC =  × Rd × (1 - Tc) +  × Rps +  × Re.

WACC =  × 8% × (1 - .30) +  × 10% +  × 12% = 9.33%.

Diff: 2

Topic:  11.3 Weighting the Components: Book Value or Market Value?

AACSB:  3 Analytical Thinking

LO:  11.3 Calculate the weights of the components using book values or market values.

Hmwrk Questions:  * Taken from "Prepping for Exams" questions at the end of the chapter.

 

3) Rogers' Rotors has debt with a market value of $250,000, preferred stock with a market value of $50,000, and common stock with a market value of $750,000. If debt has a cost of 7%, preferred stock a cost of 9%, common stock a cost of 13%, and the firm has a tax rate of 30%, what is the WACC?

  1. A) 8.64%
  2. B) 9.12%
  3. C) 9.33%
  4. D) 10.88%

Answer:  D

Explanation:  D) WACC =  × Rd × (1 - Tc) +  × Rps +  × Re.

WACC =  × 7% × (1 - .30) +  × 9% +  × 13% = 10.88%.

Diff: 2

Topic:  11.3 Weighting the Components: Book Value or Market Value?

AACSB:  3 Analytical Thinking

LO:  11.3 Calculate the weights of the components using book values or market values.

 

4) The following information comes from the balance sheet of Roamer Enterprises. The value of common stock is $60,000, retained earnings equal $40,000, total common equity equals $100,000, preferred stock has a value of $10,000 and long-term debt totals $120,000. For purposes of estimating the firm's WACC, what are the weights of long-term debt, preferred stock, and equity?

  1. A) D/V = 52.17%, PS/V = 43.48%, and E/V = 4.35%
  2. B) D/V = 52.17%, PS/V = 4.35%, and E/V = 43.48%
  3. C) D/V = $120,000, PS/V = $10,000, and E/V =$100,000
  4. D) There is not enough information to answer this question.

Answer:  B

Explanation:  B) D/V = $120,000/$230,000 = 52.17%, P/V = $10,000/$230,000 = 4.35%,

E/V = $100,000/$230,000 = 43.48%.

Diff: 2

Topic:  11.3 Weighting the Components: Book Value or Market Value?

AACSB:  3 Analytical Thinking

LO:  11.3 Calculate the weights of the components using book values or market values.

 

5) The following information comes from the Galaxy Construction balance sheet. The value of common stock is $10,000, retained earnings equals $7,000, total common equity equals $17,000, preferred stock has a value of $3,000, and long-term debt totals $15,000. If the cost of debt is 8.00%, preferred stock has a cost of 10.00%, common stock has a cost of 12.00%, and the firm has a corporate tax rate of 30%, calculate the firm's WACC adjusted for taxes.

  1. A) 10.11%
  2. B) 10.00%
  3. C) 9.09%
  4. D) There is not enough information to answer this question.

Answer:  C

Explanation:  C) WACCadj =  × Rd × (1 - Tc) +  × Rps +  × Re.

WACCadj =  × 8% × (1 - .30) +  × 10% +  × 12% = 9.09%.

Diff: 3

Topic:  11.3 Weighting the Components: Book Value or Market Value?

AACSB:  3 Analytical Thinking

LO:  11.3 Calculate the weights of the components using book values or market values.

 

6) The following market information was gathered for the ACME corporation. The common stock is selling for $40.00 per share and there are 100,000 shares outstanding. Retained earnings equal $400,000, preferred stock has 1,000 shares outstanding selling at $120.00 per share, and 500 outstanding long-term bonds are selling for $1,035.00 each. For purposes of estimating the firm's WACC, what are the market value weights of long-term debt, preferred stock, and equity?

  1. A) D/V = 11.16%, PS/V = 2.59%, and E/V = 86.25%
  2. B) D/V = 10.27%, PS/V = 2.38%, and E/V = 87.34%
  3. C) D/V = 10.78%, PS/V = 3.08%, and E/V = 86.14%
  4. D) D/V = 33.33%, PS/V = 33.33%, and E/V = 33.33%

Answer:  A

Explanation:  A) E = $40 × 100,000 shares = $4,000,000, P = $120 × 1,000 shares = $120,000, D = $1,035 × 500 bonds = $517,500. E/V = $4,000,000/$4,637,500 = 86.25%, P/V = $120,000/$4,637,500 = 2.59%, D/V = $517,500/$4,637,500 = 11.16%.

Diff: 3

Topic:  11.3 Weighting the Components: Book Value or Market Value?

AACSB:  3 Analytical Thinking

LO:  11.3 Calculate the weights of the components using book values or market values.

 

7) The following market information was gathered for the Blender Corporation. The firm has 1,000 bonds outstanding, each selling for $1,100.00 with a required rate of return of 8.00%. Blenders has 5,000 shares of preferred stock outstanding, selling for $40.00 per share and 50,000 shares of common stock outstanding, selling for $18.00 per share. If the preferred stock has a required rate of return of 11.00% and the common stock requires a 14.00% return, and the firm has a corporate tax rate of 30%, calculate the firm's WACC adjusted for taxes.

  1. A) 6.77%
  2. B) 10.73%
  3. C) 9.53%
  4. D) There is not enough information to answer this question because there is no information provided about the amount of retained earnings held by the firm.

Answer:  C

Explanation:  C) E = $18 × 50,000 shares = $900,000, PS = $40 × 5,000 shares = $200,000, D = $1,100 × 1,000 bonds = $1,100,000.

E/V = $900,000/$2,200,000 = 0.40909, P/V = $200,000/$2,200,000 = 0.0909, D/V = $1,100,000/$2,200,000 = 0.5.

WACC =  × Rd × (1 - Tc) +  × Rps +  × Re = 0.5 × 8% × (1 - 0.30) + 0.0909 × 11% + 0.40909 × 14% = 9.53%.

Diff: 3

Topic:  11.3 Weighting the Components: Book Value or Market Value?

AACSB:  3 Analytical Thinking

LO:  11.3 Calculate the weights of the components using book values or market values.

 

8) Market values require multiplying the ________ of each component source of capital by the ________.

  1. A) price; quantity
  2. B) book value; quantity
  3. C) price; book value
  4. D) None of the above

Answer:  A

Diff: 1

Topic:  11.3 Weighting the Components: Book Value or Market Value?

AACSB:  3 Analytical Thinking

LO:  11.3 Calculate the weights of the components using book values or market values.

 

9) Investors ________ for estimating the WACC.

  1. A) are indifferent between using market and book value
  2. B) prefer book value to market value
  3. C) prefer market value to book value
  4. D) prefer a mix of book and market value

Answer:  C

Diff: 1

Topic:  11.3 Weighting the Components: Book Value or Market Value?

AACSB:  3 Analytical Thinking

LO:  11.3 Calculate the weights of the components using book values or market values.

 

10) Generally speaking, when the information is available, investors prefer to use ________ rather than ________ when evaluating a firm.

  1. A) past data; current data
  2. B) market values; book values
  3. C) current data; market values
  4. D) book values; market values

Answer:  B

Diff: 1

Topic:  11.3 Weighting the Components: Book Value or Market Value?

AACSB:  3 Analytical Thinking

LO:  11.3 Calculate the weights of the components using book values or market values.

 

11) The formula for the adjusted WACC =  × Rd +  × Rps +  × Re × (1 - Tc).

Answer:  FALSE

Explanation:  The formula for the adjusted WACC =  × Rd × (1 - Tc) +  × Rps +  × Re.

Diff: 2

Topic:  11.3 Weighting the Components: Book Value or Market Value?

AACSB:  3 Analytical Thinking

LO:  11.3 Calculate the weights of the components using book values or market values.

 

12) To estimate the market value of a publicly traded bond that has a broad market with frequent trading, it is usually best to multiply the number of bonds outstanding by the bond par value.

Answer:  FALSE

Explanation:  To estimate the market value of a publicly traded bond that has a broad market with frequent trading, it is usually best to multiply the number of bonds outstanding by the bond market price.

Diff: 2

Topic:  11.3 Weighting the Components: Book Value or Market Value?

AACSB:  3 Analytical Thinking

LO:  11.3 Calculate the weights of the components using book values or market values.

 

13) When possible, investors and analysts prefer to use book value to market value for estimating the WACC.

Answer:  FALSE

Explanation:  When possible, investors and analysts prefer to use MARKET value to BOOK value for estimating the WACC.

Diff: 2

Topic:  11.3 Weighting the Components: Book Value or Market Value?

AACSB:  3 Analytical Thinking

LO:  11.3 Calculate the weights of the components using book values or market values.

 

14) Equity is an attractive form of financing for a firm because it has additional tax advantages for the firm compared to debt.

Answer:  FALSE

Explanation:  DEBT is an attractive form of financing for a firm because it has additional tax advantages for the firm compared to EQUITY.

Diff: 2

Topic:  11.3 Weighting the Components: Book Value or Market Value?

AACSB:  3 Analytical Thinking

LO:  11.3 Calculate the weights of the components using book values or market values.

 

15) When estimating a weighted average cost of capital, a firm can use either book values or market values for estimating the value of the component sources of capital. Where would you find book values, and what value do they represent? How would you calculate market values? In general, would you prefer to use market or book values for estimating the WACC? Under what circumstances would you use book values?

Answer:  Book values for debt and equity are found on a firm's balance sheet and represent historical costs. Market values are calculated by multiplying the market price of the debt by the number of outstanding bonds and multiplying the number of outstanding shares of stock by the current market price. Market values represent the market's best estimate of the current value of future cash flows to be realized from owning debt or equity. In general we prefer to use market values because they are forward-looking rather than historical in nature. However, market values may not be available for privately held firms or for very small companies and then book value becomes the only practical, although inaccurate, alternative.

Diff: 2

Topic:  11.3 Weighting the Components: Book Value or Market Value?

AACSB:  3 Analytical Thinking

LO:  11.3 Calculate the weights of the components using book values or market values.

 

11.4   Using the Weighted Average Cost of Capital in a Budgeting Decision

 

1) Your firm has an average-risk project under consideration. You choose to fund the project in the same manner as the firm's existing capital structure. If the cost of debt is 9.00%, the cost of preferred stock is 12.00%, the cost of common stock is 16.00%, and the WACC adjusted for taxes is 14.00%, what is the NPV of the project, given the expected cash flows listed here?

 

Category

T0

T1

T2

T3

Investment

-$2,000,000

 

 

 

NWC

-$250,000

 

 

$250,000

Operating Cash Flow

 

$850,000

$850,000

$850,000

Salvage

 

 

 

$50,000

Total Incremental Cash Flow

-$2,250,000

$850,000

$850,000

$1,150,000

 

  1. A) -$74,121
  2. B) $499,604
  3. C) $2,175,879
  4. D) $2,479,604

Answer:  A

Explanation:  A) In this problem we have divided the T3 payment into two parts to facilitate ease of calculation. NPV = PV of cash inflows - the initial investment.

PMT = $850,000, FV = $1,150,000 - $850,000, N = 3, I% = 14.00%. PV = $2,175,879. Then, NPV = $2,175,879 - $2,250,000 = -$74,121.

Diff: 3

Topic:  11.4 Using the Weighted Average Cost of Capital in a Budgeting Decision

AACSB:  3 Analytical Thinking

LO:  11.4 Explain how the capital budgeting models use WACC.

 

2) Your firm has an average-risk project under consideration. You choose to fund the project in the same manner as the firm's existing capital structure. If the cost of debt is 9.00%, the cost of preferred stock is 12.00%, the cost of common stock is 16.00%, and the WACC adjusted for taxes is 14.00%, what is the IRR of the project given the expected cash flows listed here? Use a financial calculator to determine your answer.

 

Category

T0

T1

T2

T3

Investment

-$2,000,000

 

 

 

NWC

-$250,000

 

 

$250,000

Operating Cash Flow

 

$850,000

$850,000

$850,000

Salvage

 

 

 

$50,000

Total Incremental Cash Flow

-$2,250,000

$850,000

$850,000

$1,150,000

 

  1. A) About 12.13%
  2. B) About 14.00%
  3. C) About 24.95%
  4. D) There is not enough information to answer this question.

Answer:  A

Explanation:  A) In this problem we have divided the T3 payment into two parts to facilitate ease of calculation. To solve for the IRR, input the following values:

PMT = $850,000, FV = $300,000, N = 3, PV = -$2,250,000, and solve for I% to get the IRR = 12.125% or "about 12.13%."

Diff: 3

Topic:  11.4 Using the Weighted Average Cost of Capital in a Budgeting Decision

AACSB:  3 Analytical Thinking

LO:  11.4 Explain how the capital budgeting models use WACC.

 

3) Your firm has an average-risk project under consideration. You choose to fund the project in the same manner as the firm's existing capital structure. If the cost of debt is 9.50%, the cost of preferred stock is 10.00%, the cost of common stock is 12.00%, and the WACC adjusted for taxes is 11.50%, what is the NPV of the project, given the expected cash flows listed here?

 

Category

T0

T1

T2

T3

Investment

-$800,000

 

 

 

NWC

-$50,000

 

 

$50,000

Operating Cash Flow

 

$350,000

$350,000

$350,000

Salvage

 

 

 

$20,000

Total Incremental Cash Flow

-$850,000

$350,000

$350,000

$420,000

 

  1. A) $1,150,904
  2. B) $898,415
  3. C) $300,904
  4. D) $48,415

Answer:  D

Explanation:  D) NPV = PV of cash inflows - the initial investment.

PMT = $350,000, FV = $420,000 - $350,000, N = 3, I% = 11.50%. PV = $898,415. Then, NPV = $898,415 - $850,000 = $48,415.

Diff: 3

Topic:  11.4 Using the Weighted Average Cost of Capital in a Budgeting Decision

AACSB:  3 Analytical Thinking

LO:  11.4 Explain how the capital budgeting models use WACC.

Hmwrk Questions:  * Taken from "Prepping for Exams" questions at the end of the chapter.

 

 

4) Your firm has an average-risk project under consideration. You choose to fund the project in the same manner as the firm's existing capital structure. If the cost of debt is 9.50%, the cost of preferred stock is 10.00%, the cost of common stock is 12.00%, and the WACC adjusted for taxes is 11.50%, what is the IRR of the project, given the expected cash flows listed here? Use a financial calculator to determine your answer.

 

Category

T0

T1

T2

T3

Investment

-$800,000

 

 

 

NWC

-$50,000

 

 

$50,000

Operating Cash Flow

 

$350,000

$350,000

$350,000

Salvage

 

 

 

$20,000

Total Incremental Cash Flow

-$850,000

$350,000

$350,000

$420,000

 

  1. A) About 11.50%
  2. B) About 28.30%
  3. C) About 14.67%
  4. D) There is not enough information to answer this question.

Answer:  C

Explanation:  C) To solve for the IRR, input the following values: PMT = $350,000, FV = $70,000, N = 3, PV = -$850,000, and solve for I% to get the IRR = 14.666% or "about 14.67%."

Diff: 3

Topic:  11.4 Using the Weighted Average Cost of Capital in a Budgeting Decision

AACSB:  3 Analytical Thinking

LO:  11.4 Explain how the capital budgeting models use WACC.

 

5) Your firm has an average-risk project under consideration. You choose to fund the project in the same manner as the firm's existing capital structure. If the cost of debt is 11.00%, the cost of preferred stock is 12.00%, the cost of common stock is 17.00%, and the WACC adjusted for taxes is 15.00%, what is the NPV of the project, given the expected cash flows listed here?

 

Category

T0

T1

T2

T3

Investment

-$3,000,000

 

 

 

NWC

-$350,000

 

 

$350,000

Operating Cash Flow

 

$950,000

$950,000

$950,000

Salvage

 

 

 

$50,000

Total Incremental Cash Flow

-$3,350,000

$950,000

$950,000

$1,350,000

 

  1. A) -$917,930
  2. B) -$293,289
  3. C) $0
  4. D) $126,471

Answer:  A

Explanation:  A) NPV = PV of cash inflows - the initial investment.

PMT = $950,000, FV = $1,350,000 - $950,000, N = 3, I% = 15.00%. PV = $2,432,070. Then,
NPV = $2,432,070 -$ 3,350,000 = -$917,930.

Diff: 3

Topic:  11.4 Using the Weighted Average Cost of Capital in a Budgeting Decision

AACSB:  3 Analytical Thinking

LO:  11.4 Explain how the capital budgeting models use WACC.

 

 

6) Your firm has an average-risk project under consideration. You choose to fund the project in the same manner as the firm's existing capital structure. If the cost of debt is 11.00%, the cost of preferred stock is 12.00%, the cost of common stock is 17.00%, and the WACC adjusted for taxes is 15.00%, what is the IRR of the project, given the expected cash flows listed here? Use a financial calculator to determine your answer.

 

Category

T0

T1

T2

T3

Investment

-$3,000,000

 

 

 

NWC

-$350,000

 

 

$350,000

Operating Cash Flow

 

$1,200,000

$1,200,000

$1,200,000

Salvage

 

 

 

$50,000

Total Incremental Cash Flow

-$3,350,000

$1,200,000

$1,200,000

$1,600,000

 

  1. A) About 13.11%
  2. B) About 12.02%
  3. C) About 11.16%
  4. D) About 8.94%

Answer:  D

Explanation:  D) To solve for the IRR, input the following values: PMT = $1,200,000, FV = $400,000, N = 3, PV = -$3,350,000, and solve for I% to get the IRR = 8.943%, or "about 8.94%."

Diff: 3

Topic:  11.4 Using the Weighted Average Cost of Capital in a Budgeting Decision

AACSB:  3 Analytical Thinking

LO:  11.4 Explain how the capital budgeting models use WACC.

7) If all projects are assigned the same discount rate for purposes of evaluation, which of the following could occur?

  1. A) Low-risk projects could be rejected when in fact they are good investment choices.
  2. B) High-risk projects could be accepted when in fact they are poor investment choices.
  3. C) High-risk projects could be accepted when in fact they are good investment choices.
  4. D) All of the choices could occur when using a single discount rate for all projects.

Answer:  D

Diff: 2

Topic:  11.4 Using the Weighted Average Cost of Capital in a Budgeting Decision

AACSB:  3 Analytical Thinking

LO:  11.4 Explain how the capital budgeting models use WACC.

 

8) It is necessary to assign the appropriate cost of capital for each individual project that reflects that project's ________ when doing capital budgeting.

  1. A) life
  2. B) cash flows
  3. C) riskiness
  4. D) managers

Answer:  C

Diff: 1

Topic:  11.4 Using the Weighted Average Cost of Capital in a Budgeting Decision

AACSB:  3 Analytical Thinking

LO:  11.4 Explain how the capital budgeting models use WACC.

 

9) Takelmer Industries has a different WACC for each of three types of projects. Low-risk projects have a WACC of 8.00%, average-risk projects a WACC of 10.00%, and high-risk projects a WACC of 12%. Which of the following projects do you recommend the firm accept?

 

Project

Level of Risk

IRR

A

Low

9.50%

B

Average

8.50%

C

Average

7.50%

D

Low

9.50%

E

High

14.50%

F

High

17.50%

G

Average

11.50%

 

  1. A) A, B, C, D, G
  2. B) B, C, E, F, G
  3. C) A, D, E, F, G,
  4. D) A, B, C, D, E, F, G

Answer:  C

Diff: 2

Topic:  11.4 Using the Weighted Average Cost of Capital in a Budgeting Decision

AACSB:  3 Analytical Thinking

LO:  11.4 Explain how the capital budgeting models use WACC.

Hmwrk Questions:  * Taken from "Prepping for Exams" questions at the end of the chapter.

10) Johnson's Diner has an adjusted WACC of 10.08%. The company has a capital structure consisting of 70% equity and 30% debt, a cost of equity of 12.00%, a before-tax cost of debt of 8.00%, and a tax rate of 30%. Johnson is considering expanding by building a new diner in a distant city and considers the project to be riskier than his current operation. He estimates his existing beta to be 1.0, the required return on the market portfolio to be 12.00%, the risk-free rate to be 3.00%, and the beta for the new project to be 1.40. Given this information, and assuming the cost of debt will not change if Johnson undertakes the new project, what adjusted WACC should he use in his decision-making?

  1. A) 10.08%
  2. B) 12.60%
  3. C) 13.32%
  4. D) 14.16%

Answer:  B

Explanation:  B) Re = E(ri) = rf + [E(rm) - rf] βi = 3.00% + [12.00% - 3.00%] × 1.4 = 15.60%.

WACC =  × Rd × (1 - Tc) +  × Re = 0.30 × (8.00%) × (1 - .30) + 0.70 × (15.60%) = 12.60%.

Diff: 3

Topic:  11.4 Using the Weighted Average Cost of Capital in a Budgeting Decision

AACSB:  3 Analytical Thinking

LO:  11.4 Explain how the capital budgeting models use WACC.

 

 

11) Acme Business Connections (ABC) has an adjusted WACC of 8.56%. The company has a capital structure consisting of 60% equity and 40% debt, a cost of equity of 11.00%, a before-tax cost of debt of 7.00%, and a tax rate of 30%. ABC is considering expanding by building a new shop in a distant city and considers the project to be riskier than the current operation. ABC has an existing beta of 1.0, the required return on the market portfolio to be 11.00%, the risk-free rate to be 3.00%, and the beta for the new project to be 1.30. Given this information, and assuming the cost of debt will not change if ABC undertakes the new project, what adjusted WACC should be used in decision-making?

  1. A) 8.56%
  2. B) 9.84%
  3. C) 10.00%
  4. D) 11.24%

Answer:  C

Explanation:  C) Re = E(ri) = rf + [E(rm) - rf] βi = 3.00% + [11.00% - 3.00%] × 1.3 = 13.40%.

WACC =  × Rd × (1 - Tc) +  × Re = 0.40 × (7.00%) × (1 - .30) + 0.60 × (13.40%) = 10.00%.

Diff: 3

Topic:  11.4 Using the Weighted Average Cost of Capital in a Budgeting Decision

AACSB:  3 Analytical Thinking

LO:  11.4 Explain how the capital budgeting models use WACC.

 

12) The adjusted WACC is the correct discount rate to use when evaluating a firm's average-risk projects.

Answer:  TRUE

Diff: 1

Topic:  11.4 Using the Weighted Average Cost of Capital in a Budgeting Decision

AACSB:  3 Analytical Thinking

LO:  11.4 Explain how the capital budgeting models use WACC.

13) Using the WACC to evaluate all projects has the effect of making low-risk projects look MORE attractive and high-risk projects look LESS attractive.

Answer:  FALSE

Explanation:  Using the WACC to evaluate all projects has the effect of making low-risk projects look LESS attractive and high-risk projects look MORE attractive.

Diff: 1

Topic:  11.4 Using the Weighted Average Cost of Capital in a Budgeting Decision

AACSB:  3 Analytical Thinking

LO:  11.4 Explain how the capital budgeting models use WACC.

 

14) You have learned how to use NPV and IRR to evaluate projects as part of a capital budgeting decision-making process. How is WACC used in each of these capital-budgeting processes?

Answer:  When calculating the NPV of a project, the WACC is the appropriate required rate of return if the project is of average risk. It is also the starting point for making subjective adjustments to the required rate of return for projects of greater or lesser risk than average. When calculating the IRR, the WACC is the appropriate hurdle rate for determining if a project meets the investment criteria.

Diff: 2

Topic:  11.4 Using the Weighted Average Cost of Capital in a Budgeting Decision

AACSB:  3 Analytical Thinking

LO:  11.4 Explain how the capital budgeting models use WACC.

 

 

15) Using the WACC to evaluate all projects may lead managers into accepting high-risk projects that do not compensate adequately for risk and into rejecting low-risk projects that compensate fully for the level of risk but may not have particularly high rates of return. Describe the situations when using a WACC is not appropriate and how these incorrect decisions may be made.

Answer:  If managers could estimate the beta for every project and thereby a required rate of return for every project, then the capital budgeting process would always lead to good decision-making. Higher-risk projects would have a higher required return and lower-risk projects would have a lower required return. But assigning a "one-size-fits-all" WACC to every project could lead a manager to accept a project that has an IRR that is greater than the WACC (i.e., a positive NPV) but that is lower than its true required rate of return. Conversely, a manager might reject a low-risk project with an acceptable return for that level of risk because the IRR is less than the WACC (implying a negative NPV). In that case, the WACC would be a value that is too high to correctly evaluate the lower-risk project.

Diff: 2

Topic:  11.4 Using the Weighted Average Cost of Capital in a Budgeting Decision

AACSB:  3 Analytical Thinking

LO:  11.4 Explain how the capital budgeting models use WACC.

 

16) Michigan Industries has three projects under consideration. Project L is a lower-than-average-risk project, project A is an average-risk project, and project H is a higher-than-average-risk project. You have gathered the following information to determine if one or more of these projects has an acceptable rate of return for the firm.

 

  • Sources of financing 50% debt and 50% equity
  • Rd= 8.00% before taxes
  • Tax Rate = 30%
  • Average beta for Michigan Industries = 1.0
  • Rm= 13.00%
  • Rf= 4.00%
  • Adjusted WACC = 9.30%
  • Beta for project L = 0.80, for project A = 1.00, and for project H = 1.20
  • IRRL= 9.00%, IRRA = 10.00%, and IRRH = 11.00%

 

Calculate the required rate of return for each project and determine which, if any, projects are acceptable to the firm.

Answer:  Adjusted WACC for each project:

For project L, Re = Rf + β × (Rm - Rf) = 4.00% + 0.80 × (13.00% - 4.00%) = 11.20%

RL = 8.00% × (.50) × (1 -.30) + 11.20% × (.50) = 8.40%

IRRL = 9.00% is greater than RL = 8.40%. Therefore, this is an acceptable project.

 

For project A, Re = Rf + β × (Rm - Rf) = 4.00% + 1.00 × (13.00% - 4.00%) = 13.00%

RA = 8.00% × (.50) × (1 -.30) + 13.00% × (.50) = 9.30%

IRRA = 10.00% is greater than RA = 9.30%. Therefore, this is an acceptable project.

 

For project H, Re = Rf + β × (Rm - Rf) = 4.00% + 1.20 × (13.00% - 4.00%) = 14.80%

RH = 8.00% × (.50) × (1 -.30) + 14.80% × (.50) = 10.20%

IRRH = 11.00% is greater than RH = 10.20%. Therefore, this is an acceptable project.

Diff: 3

Topic:  11.4 Using the Weighted Average Cost of Capital in a Budgeting Decision

AACSB:  3 Analytical Thinking

LO:  11.4 Explain how the capital budgeting models use WACC.

 

11.5   Selecting Appropriate Betas for Projects

 

1) The appropriate capital budgeting decision rule is ________.

  1. A) to accept projects with an NPV greater than $0
  2. B) to reject projects with an IRR greater than the required rate of return
  3. C) to reject projects with an NPV greater than $0
  4. D) to reject projects with an IRR greater than the required payback period

Answer:  A

Diff: 1

Topic:  11.5 Selecting Appropriate Betas for Projects

AACSB:  3 Analytical Thinking

LO:  11.5 Determine a project's beta and its implications in capital budgeting problems.

2) Clearinghouse Publications is adding a new magazine project to the company portfolio and has the following information: the expected market return is 12%, the risk-free rate is 4%, and the expected return on the new project is 20%. What is the beta of the project?

  1. A) 1.00
  2. B) 1.50
  3. C) 1.75
  4. D) 2.00

Answer:  D

Explanation:  D) This problem requires the student to rearrange the SML equation; it is not specifically covered in the text.

Re = rf + [E(rm) - rf] β, and therefore, β =  =  = 2.00.

Diff: 2

Topic:  11.5 Selecting Appropriate Betas for Projects

AACSB:  3 Analytical Thinking

LO:  11.5 Determine a project's beta and its implications in capital budgeting problems.

Hmwrk Questions:  * Taken from "Prepping for Exams" questions at the end of the chapter.

 

3) Penney Fashions is adding a new line of shoes to the company portfolio and has the following information: the expected market return is 13%, the risk-free rate is 3%, and the expected return on the new project is 11%. What is the beta of the project?

  1. A) 0.60
  2. B) 0.70
  3. C) 0.80
  4. D) 0.90

Answer:  C

Explanation:  C) This problem requires the student to rearrange the SML equation; it is not specifically covered in the text.

Re = rf + [E(rm) - rf] β, and therefore, β =  =  = 0.80.

Diff: 2

Topic:  11.5 Selecting Appropriate Betas for Projects

AACSB:  3 Analytical Thinking

LO:  11.5 Determine a project's beta and its implications in capital budgeting problems.

 

4) Under which of the following circumstances is the pure play method of estimating a project's beta particularly useful?

  1. A) The firm is looking to expand its current business operations, doing essentially the same work.
  2. B) The firm is looking to expand its current business operations into a brand new area unlike any of its internal projects.
  3. C) The firm is looking to expand its current business operations. The work will be essentially the same as current operations but there is no obvious outside provider of the same service or product.
  4. D) The pure play method works equally effectively under each and all of these scenarios.

Answer:  B

Diff: 2

Topic:  11.5 Selecting Appropriate Betas for Projects

AACSB:  3 Analytical Thinking

LO:  11.5 Determine a project's beta and its implications in capital budgeting problems.

5) ________ refers to a method of matching a single project of a company to another company with a single business focus in an effort to assign an appropriate level of risk to the project.

  1. A) Ghosting
  2. B) Pure play
  3. C) Outside assignment
  4. D) Subjective assignment

Answer:  B

Diff: 1

Topic:  11.5 Selecting Appropriate Betas for Projects

AACSB:  3 Analytical Thinking

LO:  11.5 Determine a project's beta and its implications in capital budgeting problems.

 

6) Richard works for a firm that is expanding into a completely new line of business. He has been asked to determine an appropriate WACC for an average-risk project in the expansion division. Richard finds two publicly traded stand-alone firms that produce the same products as his new division. The average of the two firms' betas is 1.25. Further, he determines that the expected return on the market portfolio is 13.00% and the risk-free rate of return is 4.00%. Richard's firm finances 50% of its projects with equity and 50% with debt, and has a before-tax cost of debt of 9% and a corporate tax rate of 30%. What is the WACC for the new line of business?

  1. A) About 12.64%
  2. B) About 13.00%
  3. C) About 10.78%
  4. D) About 11.29%

Answer:  C

Explanation:  C) Re = rf + [E(rm) - rf] β = 4% + (13% - 4%) × 1.25 = 15.25%

WACC =  × Rd × (1 - Tc) +  × Re = 0.50 × (9.00%) × (1 - .30) + 0.50 × (15.25%) = 10.775%, or about 10.78%.

Diff: 3

Topic:  11.5 Selecting Appropriate Betas for Projects

AACSB:  3 Analytical Thinking

LO:  11.5 Determine a project's beta and its implications in capital budgeting problems.

 

7) Fortunately for investors, assigning a beta to individual projects is more of a science than an art.

Answer:  FALSE

Explanation:  Assigning a beta to individual projects is more of an art than a science.

Diff: 1

Topic:  11.5 Selecting Appropriate Betas for Projects

AACSB:  3 Analytical Thinking

LO:  11.5 Determine a project's beta and its implications in capital budgeting problems.

 

8) The simplest application of assigning a beta to an individual project is called a "pure play," in which a manager finds the beta of a firm whose sole business is similar to the project in question and assigns that beta to the project.

Answer:  TRUE

Diff: 1

Topic:  11.5 Selecting Appropriate Betas for Projects

AACSB:  3 Analytical Thinking

LO:  11.5 Determine a project's beta and its implications in capital budgeting problems.

9) In general, a subjective assessment of betas and projects is preferred to the pure play approach.

Answer:  FALSE

Explanation:  In general, a pure play approach to assigning betas to projects is preferred to a subjective assessment.

Diff: 1

Topic:  11.5 Selecting Appropriate Betas for Projects

AACSB:  3 Analytical Thinking

LO:  11.5 Determine a project's beta and its implications in capital budgeting problems.

 

10) Using beta as a risk measurement device has not caught on in the real world because finding the value is nearly impossible for most investors.

Answer:  FALSE

Explanation:  Most online investment information sources provide estimates of beta for publicly traded securities; e.g. finance.yahoo.com.

Diff: 1

Topic:  11.5 Selecting Appropriate Betas for Projects

AACSB:  3 Analytical Thinking

LO:  11.5 Determine a project's beta and its implications in capital budgeting problems.

 

11) Define "pure play" as it applies to assigning a beta to a project. Under what circumstances do you think the pure-play approach to assigning project betas would be particularly useful?

Answer:  Pure play is the art of determining the beta of an individual project by matching it to a publicly traded company whose sole business is similar to the project's. This technique is particularly useful when a company is looking to expand its business into an area where it has no internal projects that it can use for estimating the new project's beta.

Diff: 2

Topic:  11.5 Selecting Appropriate Betas for Projects

AACSB:  3 Analytical Thinking

LO:  11.5 Determine a project's beta and its implications in capital budgeting problems.

 

11.6   Constraints on Borrowing and Selecting Projects for the Portfolio

 

1) The best rule for choosing projects when a firm has a limited amount of funds is to accept the group of projects with the greatest combined ________.

  1. A) number of projects
  2. B) IRR
  3. C) NPV
  4. D) time to completion

Answer:  C

Diff: 1

Topic:  11.6 Constraints on Borrowing and Selecting Projects for the Portfolio

AACSB:  3 Analytical Thinking

LO:  11.6 Select optimal project combinations from a company's portfolio of acceptable projects.

 

2) Your firm has $2,000,000 available for investment in capital projects. Which combination of projects is the best, given this budget constraint?

 

Project

Initial Investment

NPV

A

$750,000

$100,000

B

$1,500,000

$125,000

C

$500,000

$75,000

D

$500,000

$35,000

 

  1. A) B, C
  2. B) A, B, C
  3. C) A, B, C, D
  4. D) A, C, D

Answer:  D

Diff: 2

Topic:  11.6 Constraints on Borrowing and Selecting Projects for the Portfolio

AACSB:  3 Analytical Thinking

LO:  11.6 Select optimal project combinations from a company's portfolio of acceptable projects.

Hmwrk Questions:  * Taken from "Prepping for Exams" questions at the end of the chapter.

 

3) What could happen to "unused" dollars after a firm has chosen capital projects but still has remaining unallocated funds?

  1. A) The remaining funds may be invested at the "going rate" of the company.
  2. B) The remaining funds, if internally generated, may be paid back to shareholders as a dividend.
  3. C) If the remaining funds are part of borrowing, then the firm may choose to borrow less money.
  4. D) All of the choices above are potential uses of unallocated funds.

Answer:  D

Diff: 2

Topic:  11.6 Constraints on Borrowing and Selecting Projects for the Portfolio

AACSB:  3 Analytical Thinking

LO:  11.6 Select optimal project combinations from a company's portfolio of acceptable projects.

 

 

4) Your firm has $4,000,000 available for investment in capital projects. Which combination of projects is the best, given this budget constraint?

 

Project

Initial Investment

NPV

A

$1,000,000

$150,000

B

$500,000

$200,000

C

$1,500,000

$175,000

D

$1,750,000

$135,000

 

  1. A) A, B, C
  2. B) A, B, D
  3. C) A, C, D
  4. D) B, C, D

Answer:  A

Diff: 2

Topic:  11.6 Constraints on Borrowing and Selecting Projects for the Portfolio

AACSB:  3 Analytical Thinking

LO:  11.6 Select optimal project combinations from a company's portfolio of acceptable projects.

5) On a practical basis a, manager should always accept all positive NPV projects even if this means exceeding a limited budget.

Answer:  FALSE

Explanation:  On a practical basis, a manager should accept the combination of positive NPV projects that maximizes the total NPV while still operating within budget.

Diff: 2

Topic:  11.6 Constraints on Borrowing and Selecting Projects for the Portfolio

AACSB:  3 Analytical Thinking

LO:  11.6 Select optimal project combinations from a company's portfolio of acceptable projects.

 

6) Unused capital budget funds are assumed to earn the same rate of return as the average IRR of accepted projects.

Answer:  FALSE

Explanation:  Unused capital budget funds are assumed to earn the same rate of return as the firm's "going rate." Or, excess funds may be returned to investors via dividends or lesser amounts of borrowing.

Diff: 2

Topic:  11.6 Constraints on Borrowing and Selecting Projects for the Portfolio

AACSB:  3 Analytical Thinking

LO:  11.6 Select optimal project combinations from a company's portfolio of acceptable projects.

 

7) Unused capital budget funds are assumed to earn the same rate of return as the average cost of capital for the firm. In other words they may be invested in $0.0 NPV projects. (Or, alternatively, excess funds may be returned to creditors and shareholders.)

Answer:  TRUE

Diff: 2

Topic:  11.6 Constraints on Borrowing and Selecting Projects for the Portfolio

AACSB:  3 Analytical Thinking

LO:  11.6 Select optimal project combinations from a company's portfolio of acceptable projects.

 

 

8) With an unlimited amount of funds, a firm could accept all positive NPV projects. However, with limited budgets, managers are forced to accept some positive NPV projects while rejecting others. What overall financial rule should managers follow when choosing the portfolio of projects to accept? Why?

Answer:  Managers should maximize the NPV of the portfolio of accepted projects. NPV measures the total financial benefit to existing shareholders. Other techniques are flawed in some fashion. For instance, IRR measures the return per dollar spent, but does not necessarily maximize the total return to shareholders.

Diff: 2

Topic:  11.6 Constraints on Borrowing and Selecting Projects for the Portfolio

AACSB:  3 Analytical Thinking

LO:  11.6 Select optimal project combinations from a company's portfolio of acceptable projects.

 

 

 

 

 

 

 

 

 

 -----

Key Contents: Financial Management and Corporate Finance
------
Financial Management: Core Concepts, 3rd Edition, 2016, Raymond Brooks, Oregon State University
Financial Management: Concepts and Applications, 2015, Stephen Foerster, Richard Ivey School of Business, University of Western Ontario
Financial Management: Principles and Applications, 12th Edition, 2015, Sheridan Titman, Arthur J. Keown
International Financial Management, 2nd Edition, 2012, Geert J Bekaert, Columbia University, Robert J. Hodrick, Columbia University
------
Corporate Finance, 4th Edition, 2017, Jonathan Berk, Stanford University, Peter DeMarzo, Stanford University
Corporate Finance: The Core, 4th Edition, 2017, Jonathan Berk, Stanford University, Peter DeMarzo, Stanford University
Excel Modeling in Corporate Finance, 5th Edition, 2015, Craig W. Holden, Indiana University
Fundamentals of Corporate Finance, 3rd Edition, 2015, Jonathan Berk, Stanford University, Peter DeMarzo, Stanford University, Jarrad Harford, University of Washington

-----

Fundamentals of Investing, 13th Edition, Scott B. Smart, Lawrence J. Gitman, Michael D. Joehnk, 2017
Multinational Business Finance, 14th Edition, David K. Eiteman, Arthur I. Stonehill, Michael H. Moffett, 2016
Personal Finance, 6th Edition, 2017, Jeff Madura, Emeritus Professor of Finance; Florida Atlantic University
Personal Finance: Turning Money into Wealth, 7th Edition, 2016, Arthur J. Keown, Virginia Polytechnic Instit. and State University
Foundations of Finance, 9th Edition, 2017, Arthur J. Keown, John H. Martin
Principles of Managerial Finance, 14th Edition, 2015, Lawrence J. Gitman, Chad J. Zutter
------
Part 1: Fundamental Concepts and Basic Tools of Finance
1. Financial Management
2. Financial Statements
3. The Time Value of Money (Part 1)
4. The Time Value of Money (Part 2)
5. Interest Rates
Part 2: Valuing Stocks and Bonds and Understanding Risk and Return
6. Financial Management Bonds and Bond Valuation
7. Stocks and Stock Valuation
8. Risk and Return
Part 3: Capital Budgeting
9: Capital Budgeting Decision Models
10: Cash Flow Estimation
11: The Cost of Capital
Part 4: Financial Planning and Evaluating Performance
12. Forecasting and Short-Term Financial Planning
13. Working Capital Management
14. Financial Ratios and Firm Performance
Part 5: Other Selected Finance Topics
15. Raising Capital
16. Capital Structure
17. Dividends, Dividend Policy, and Stock Splits
18. International Financial Management
Appendix 1 Future Value Interest Factors
Appendix 2 Present Value Interest Factors
Appendix 3 Future Value Interest Factors of an Annuity
Appendix 4 Present Value Interest Factors of an Annuity
Appendix 5 Answers to Prepping for Exam Questions
------
1. Overview of Financial Management
2. Sizing Up a Business: A Non-Financial Perspective
3. Understanding Financial Statements
4. Measuring Financial Performance
5. Managing Day-To-Day Cash Flow
6. Projecting Financial Requirements and Managing Growth
7. Time Value of Money Basics and Applications
8. Making Investment Decisions
9. Overview of Capital Markets: Long-Term Financing Instruments
10. Assessing the Cost of Capital: What Investors Require
11. Understanding Financing and Payout Decisions
12. Designing an Optimal Capital Structure
13. Measuring and Creating Value
14. Comprehensive Case Study: Wal-Mart Stores, Inc.

1. Overview of Financial Management
• 1.1: Financial Management and the Cash Flow Cycle
• 1.2: The Role of Financial Managers
• 1.3: A Non-Financial Perspective of Financial Management
• 1.4: Financial Management’s Relationship with Accounting and Other Disciplines
• 1.5: Types of Firms
• 1.6: A Financial Management Framework
• 1.7: Relevance for Managers
• 1.8: Summary
• 1.9: Additional Readings
• 1.10: End of Chapter Problems
2. Sizing Up a Business: A Non-Financial Perspective
• 2.1: Sizing Up The Overall Economy
o 2.1.1: GDP Components
o 2.1.2: Sector-Related Fluctuations
o 2.1.3: Inflation and Interest Rates
o 2.1.4: Capital Markets
o 2.1.5: Economic Size-Up Checklist
• 2.2: Sizing Up the Industry
o 2.2.1: Industry Life Cycles
o 2.2.2: The Competitive Environment
o 2.2.3: Opportunities and Risks
o 2.2.4: Industry Size-up Checklist
• 2.3: Sizing Up Operations Management and Supply Risk
• 2.4: Sizing Up Marketing Management and Demand Risk
• 2.5: Sizing Up Human Resource Management and Strategy
• 2.6: Sizing Up Home Depot: An Example
• 2.7: Relevance for Managers
• 2.8 Summary
• 2.9: Additional Readings and Information
• 2.10: End of Chapter Problems
3. Understanding Financial Statements
• 3.1: Understanding Balance Sheets
o 3.1.1: Understanding Assets
o 3.1.2: Understanding Liabilities
o 3.1.3: Understanding Equity
• 3.2: Understanding Income Statements
o 3.2.1: Understanding Revenues, Costs, Expenses, and Profits
o 3.2.2: Connecting a Firm’s Income Statement and Balance Sheet
• 3.3: Understanding Cash Flow Statements
o 3.3.1: Cash Flows Related to Operating Activities
o 3.3.2: Cash Flows from Investing Activities
o 3.3.3: Cash Flows from Financing Activities
• 3.4: Relevance for Managers
• 3.5: Summary
• 3.6: Additional Readings and Sources of Information
• 3.7: End of Chapter Problems
4. Measuring Financial Performance
• 4.1: Performance Measures
o 4.1.1: Return on Equity
o 4.1.2: Profitability Measures
o 4.1.3: Resource Management Measures
o 4.1.4: Liquidity Measures
o 4.1.5: Leverage Measures
o 4.1.6: Application: Home Depot
• 4.2: Reading Annual Reports
• 4.3: Relevance for Managers
• 4.4: Summary
• 4.5: Additional Readings and Sources of Information
• 4.6: End of Chapter Problems
5. Managing Day-To-Day Cash Flow
• 5.1: Cash Flow Cycles
• 5.2: Working Capital Management
o 5.2.1: Managing Inventory
o 5.2.2: Managing Accounts Receivable
o 5.2.3: Managing Accounts Payable
o 5.2.4: Application: Home Depot
• 5.2.4.1: Orange Computers and Little Orange Computers
• 5.2.4.2: Home Depot
• 5.3: Short-Term Financing
o 5.3.1: Bank Loans
o 5.3.2: Commercial Paper
o 5.3.3: Banker’s Acceptance
• 5.4: Relevance for Managers
• 5.5: Summary
• 5.6: Additional Readings
• 5.7: End of Chapter Problems

6. Projecting Financial Requirements and Managing Growth
• 6.1: Generating Pro Forma Income Statements
o 6.1.1: Establishing the Cost of Goods Sold and Gross Profit
o 6.1.2: Establishing Expenses
o 6.1.3: Establishing Earnings
• 6.2: Generating Pro Forma Balance Sheets
o 6.2.1: Establishing Assets
o 6.2.2: Establishing Liabilities and Equity
• 6.3: Generating Pro Forma Cash Budgets
o 6.3.1: Establishing Cash Inflows
o 6.3.2: Establishing Cash Outflows
o 6.3.3: Establishing Net Cash Flows
• 6.4: Performing Sensitivity Analysis
o 6.4.1: Sales Sensitivity
o 6.4.1: Interest Rate Sensitivity
o 6.4.3: Working Capital Sensitivity
• 6.5: Understanding Sustainable Growth and Managing Growth
• 6.6: Relevance for Managers
• 6.7: Summary
• 6.8: Additional Readings and Resources
• 6.9: Problems

7. Time Value of Money Basics and Applications
• 7.1: Exploring Time Value of Money Concepts
o 7.1.1: Future Values
o 7.1.2: Present Values
o 7.1.3: Annuities
o 7.1.4: Perpetuities
• 7.2: Applying Time Value of Money Concepts to Financial Securities
o 7.2.1: Bonds
o 7.2.2: Preferred Shares
o 7.2.3: Common Equity
• 7.3: Relevance for Managers
• 7.4: Summary
• 7.5: Additional Readings
• 7.6: End of Chapter Problems

8. Making Investment Decisions
• 8.1: Understanding the Decision-Making Process
• 8.2: Capital Budgeting Techniques
o 8.2.1: Payback
• 8.2.1.1: Strengths and Weaknesses of the Payback Method
o 8.2.2: Net Present Value
• 8.2.2.1: Strengths and Weaknesses of the Net Present Value Method
o 8.2.3: Internal Rate of Return
• 8.2.3.1: Strengths and Weaknesses of the Internal Rate of Return Method
• 8.2.3.2: Modified Internal Rate of Return
• 8.3: Capital Budgeting Extensions
o 8.3.1: Profitability Index
o 8.3.2: Equivalent Annual Cost and Project Lengths
o 8.3.3: Mutually Exclusive Projects and Capital Rationing
• 8.4: Relevance for Managers
• 8.5: Summary
• 8.6: Additional Readings
• 8.7: End of Chapter Problems

9. Overview of Capital Markets: Long-Term Financing Instruments
• 9.1: Bonds
o 9.1.1: Changing Bond Yields
o 9.1.2: Bond Features
o 9.1.3: Bond Ratings
• 9.2: Preferred Shares
• 9.3: Common Shares
o 9.3.1: Historical Returns
• 9.4: Capital Markets Overview
o 9.4.1: Private versus Public Markets
o 9.4.2: Venture Capital and Private Equity
o 9.4.3: Initial Offerings versus Seasoned Issues
o 9.4.4: Organized Exchanges versus Over-The-Counter Markets
o 9.4.5: Role of Intermediaries
• 9.5: Market Efficiency
o 9.5.1: Weak Form
o 9.5.2: Semi-strong Form
o 9.5.3: Strong Form
o 9.5.4: U.S. Stock Market Efficiency
• 9.6: Relevance for Managers
• Appendix: Understanding Bond and Stock Investment Information
• 9.7: Summary
• 9.8: Additional Readings
• 9.9: End of Chapter Problems

10. Assessing the Cost of Capital: What Investors Require
• 10.1: Understanding the Cost of Capital: An Example
• 10.2: Understanding the Implications of the Cost of Capital
• 10.3: Defining Risk
• 10.4: Estimating the Cost of Debt
• 10.5: Estimating the Cost of Preferred Shares
• 10.6: Estimating the Cost of Equity
o 10.6.1: Dividend Model Approach
o 10.6.2: Capital Asset Pricing Model
• 10.6.2.1: Risk-Free Rate
• 10.6.2.2: Market Risk Premium
• 10.6.2.3: Beta
• 10.7: Estimating Component Weights
• 10.8: Home Depot Application
• 10.9: Hurdle Rates
• 10.10: Relevance for Managers
• 10.11: Summary
• 10.12: Additional Readings
• 10.13: Problems
11. Understanding Financing and Payout Decisions
• 11.1: Capital Structure Overview
• 11.2: Understanding the Modigliani-Miller Argument: Why Capital Structure Does Not Matter
• 11.3: Relaxing the Assumptions: Why Capital Structure Does Matter
o 11.3.1: Understanding the Impact of Corporate Taxes
o 11.3.2: Understanding the Impact of Financial Distress
o 11.3.3: Combining Corporate Taxes and Financial Distress Costs
o 11.3.4: Impact of Asymmetric Information
• 11.4: Understanding Payout Policies
o 11.4.1: Paying Dividends
o 11.4.2: Repurchasing Shares
o 11.4.3: Do Dividend Policies Matter?
• 11.5: Relevance for Managers
• 11.6: Summary
• 11.7: Additional Resources
• 11.8: End of Chapter Problems
• Appendix: Why Dividend Policy Doesn’t Matter: Example

12. Designing an Optimal Capital Structure
• 12.1: Factor Affecting Financing Decisions: The FIRST Approach
o 12.1.1: Maximizing Flexibility
o 12.1.2: Impact on EPS: Minimizing Cost
• 12.1.2.1: A Simple Valuation Model
• 12.1.2.2: Earnings before Interest and Taxes Break-Even: What Leverage Really Means
• 12.1.2.3: Does Issuing Equity Dilute the Value of Existing Shares?
o 12.1.3: Minimizing Risk
o 12.1.4: Maintaining Shareholder Control
o 12.1.5: Optimal Training
• 12.2: Tradeoff Assessment: Evaluating FIRST Criteria
• 12.3: Relevance for Managers
• 12.4: Summary
• 12.5: Additional Resource
• 12.6: End of Chapter Problems

13. Measuring and Creating Value
• 13.1: An Overview of Measuring and Creating Value
• 13.2: Measuring Value: The Book Value Plus Adjustments Method
o 13.2.1: Pros and Cons of the Book Value of Equity Plus Adjustments Method
• 13.3: Measuring Value: The Discount Cash Flow Analysis Method
o 13.3.1: Estimating Free Cash Flows
o 13.3.2: Estimating the Cost of Capital
o 13.3.3: Estimating the Present Value of Free Cash Flows
o 13.3.4: Estimating the Terminal Value
o 13.3.5: Estimating the Value of Equity
o 13.3.6: Pros and Cons of the Free Cash Flow to the Firm Approach
• 13.4: Measuring Value: Relative Valuations and Comparable Analysis
o 13.4.1: The Price-Earnings Method
• 13.4.1.1: Pros and Cons of the Price-Earnings Approach
o 13.4.2: The Enterprise Value-to-EBITDA Method
• 13.4.2.1: Pros and Cons of the EV/EBITDA Approach
• 13.5: Creating Value and Value-Based Management
• 13.6: Valuing Mergers and Acquisitions
o 13.6.1: Valuing Comparable M&A Transactions
• 13.7: Relevance for Managers
• 13.8: Summary
• 13.9: Additional Readings
• 13.10: End of Chapter Problems

14. Comprehensive Case Study: Wal-Mart Stores, Inc.
• 14.1: Sizing Up Wal-Mart
o 14.1.1: Analyzing the Economy
o 14.1.2: Analyzing the Industry
o 14.1.3: Analyzing Walmart’s Strengths and Weaknesses in Operations, Marketing, Management, and Strategy
• 14.1.3.1: Analyzing Walmart’s Operations
• 14.1.3.2: Analyzing Walmart’s Marketing
• 14.1.3.3: Analyzing Walmart’s Management and Strategy
o 14.1.4: Analyzing Walmart’s Financial Health
• 14.2: Projecting Walmart’s Future Performance
o 14.2.1: Projecting Walmart’s Income Statement
o 14.2.2: Projecting Walmart’s Balance Sheet
o 14.2.3: Examining Alternate Scenarios
• 14.3: Assessing Walmart’s Long-Term Investing and Financing
o 14.3.1: Assessing Walmart’s Investments
o 14.3.2: Assessing Walmart’s Capital Raising and the Cost of Capital
• 14.4: Valuing Walmart
o 14.4.1: Measuring Walmart’s Economic Value Added
o 14.4.2: Estimating Walmart’s Intrinsic Value: The DCF Approach
o 14.4.3: Estimating Walmart’s Intrinsic Value: Comparable Analysis
o 14.4.4: Creating Value and Overall Assessment of Walmart
• 14.5: Relevance for Managers and Final Comments
• 14.6: Additional Readings and Sources of Information
• 14.7: End of Chapter Problems
------
Part 1: Introduction to Financial Management
Chapter 1: Getting Started - Principles of Finance
Chapter 2: Firms and the Financial Market
Chapter 3: Understanding Financial Statements, Taxes, and Cash Flows
Chapter 4: Financial Analysis - Sizing Up Firm Performance
Part 2: Valuation of Financial Assets
Chapter 5: Time Value of Money - The Basics
Chapter 6: The Time Value of Money - Annuities and Other Topics
Chapter 7: An Introduction to Risk and Return - History of Financial Market Returns
Chapter 8: Risk and Return - Capital Market Theory
Chapter 9: Debt Valuation and Interest Rates
Chapter 10: Stock Valuation
Part 3: Capital Budgeting
Chapter 11: Investment Decision Criteria
Chapter 12: Analyzing Project Cash Flows
Chapter 13: Risk Analysis and Project Evaluation
Chapter 14: The Cost of Capital
Part 4: Capital Structure & Dividend Policy
Chapter 15: Capital Structure Policy
Chapter 16: Dividend Policy
Part 5: Liquidity Management & Special Topics in Finance
Chapter 17: Financial Forecasting and Planning
Chapter 18: Working Capital Management
Chapter 19: International Business Finance
Chapter 20: Corporate Risk Management
------
PART I: INTRODUCTION TO FOREIGN EXCHANGE MARKETS AND RISKS
Chapter 1: Globalization and the Multinational Corporation
Chapter 2: The Foreign Exchange Market
Chapter 3: Forward Markets and Transaction Exchange Risk
Chapter 4: The Balance of Payments
Chapter 5: Exchange Rate Systems
PART II: INTERNATIONAL PARITY CONDITIONS AND EXCHANGE RATE DETERMINATION
Chapter 6: Interest Rate Parity
Chapter 7: Speculation and Risk in the Foreign Exchange Market
Chapter 8: Purchasing Power Parity and Real Exchange Rates
Chapter 9: Measuring and Managing Real Exchange Risk
Chapter 10: Exchange Rate Determination and Forecasting

PART III: INTERNATIONAL CAPITAL MARKETS
Chapter 11: International Debt Financing
Chapter 12: International Equity Financing
Chapter 13: International Capital Market Equilibrium
Chapter 14: Political and Country Risk

PART IV: INTERNATIONAL CORPORATE FINANCE
Chapter 15: International Capital Budgeting
Chapter 16: Additional Topics in International Capital Budgeting
Chapter 17: Risk Management and the Foreign Currency Hedging Decision
Chapter 18: Financing International Trade
Chapter 19: Managing Net Working Capital

PART V: FOREIGN CURRENCY DERIVATIVES
Chapter 20: Foreign Currency Futures and Options
Chapter 21: Interest Rate and Foreign Currency Swaps
------
PART 1: INTRODUCTION
1. The Corporation
2. Introduction to Financial Statement Analysis
3. Financial Decision Making and the Law of One Price
PART 2: TIME, MONEY, AND INTEREST RATES
4. The Time Value of Money
5. Interest Rates
6. Valuing Bonds
PART 3: VALUING PROJECTS AND FIRMS
7. Investment Decision Rules
8. Fundamentals of Capital Budgeting
9. Valuing Stocks
PART 4: RISK AND RETURN
10. Capital Markets and the Pricing of Risk
11. Optimal Portfolio Choice and the Capital Asset Pricing Model
12. Estimating the Cost of Capital
13. Investor Behavior and Capital Market Efficiency
PART 5: CAPITAL STRUCTURE
14. Capital Structure in a Perfect Market
15. Debt and Taxes
16. Financial Distress, Managerial Incentives, and Information
17. Payout Policy
PART 6: ADVANCED VALUATION
18. Capital Budgeting and Valuation with Leverage
19. Valuation and Financial Modeling: A Case Study
PART 7: OPTIONS
20. Financial Options
21. Option Valuation
22. Real Options

PART 8: LONG-TERM FINANCING
23. Raising Equity Capital
24. Debt Financing
25. Leasing
PART 9: SHORT-TERM FINANCING
26. Working Capital Management
27. Short-Term Financial Planning
PART 10: SPECIAL TOPICS
28. Mergers and Acquisitions
29. Corporate Governance
30. Risk Management
31. International Corporate Finance
------
PART 1: INTRODUCTION
1. The Corporation
2. Introduction to Financial Statement Analysis
3. Financial Decision Making and the Law of One Price
PART 2: TIME, MONEY, AND INTEREST RATES
4. The Time Value of Money
5. Interest Rates
6. Valuing Bonds
PART 3: VALUING PROJECTS AND FIRMS
7. Investment Decision Rules
8. Fundamentals of Capital Budgeting
9. Valuing Stocks
PART 4: RISK AND RETURN
10. Capital Markets and the Pricing of Risk
11. Optimal Portfolio Choice and the Capital Asset Pricing Model
12. Estimating the Cost of Capital
13. Investor Behavior and Capital Market Efficiency
PART 5: CAPITAL STRUCTURE
14. Capital Structure in a Perfect Market
15. Debt and Taxes
16. Financial Distress, Managerial Incentives, and Information
17. Payout Policy
PART 6: ADVANCED VALUATION
18. Capital Budgeting and Valuation with Leverage
19. Valuation and Financial Modeling: A Case Study
------
------
PART 1 INTRODUCTION
Chapter 1 Corporate Finance and the Financial Manager
Chapter 2 Introduction to Financial Statement Analysis
PART 2 INTEREST RATES AND VALUING CASH FLOWS
Chapter 3 Time Value of Money: An Introduction
Chapter 4 Time Value of Money: Valuing Cash Flow Streams
Chapter 5 Interest Rates
Chapter 6 Bonds
Chapter 7 Stock Valuation
PART 3 VALUATION AND THE FIRM
Chapter 8 Investment Decision Rules
Chapter 9 Fundamentals of Capital Budgeting
Chapter 10 Stock Valuation: A Second Look
PART 4 RISK AND RETURN
Chapter 11 Risk and Return in Capital Markets
Chapter 12 Systematic Risk and the Equity Risk Premium
Chapter 13 The Cost of Capital
PART 5 LONG-TERM FINANCING
Chapter 14 Raising Equity Capital
Chapter 15 Debt Financing
PART 6 CAPITAL STRUCTURE AND PAYOUT POLICY
Chapter 16 Capital Structure
Chapter 17 Payout Policy
PART 7 FINANCIAL PLANNING AND FORECASTING
Chapter 18 Financial Modeling and Pro Forma Analysis
Chapter 19 Working Capital Management
Chapter 20 Short-Term Financial Planning
PART 8 Special Topics
Chapter 21 Option Applications and Corporate Finance
Chapter 22 Mergers and Acquisitions
Chapter 23 International Corporate Finance  

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FINANCIAL MANAGEMENT AND CORPORATE FINANCE - COLLECTION 2017 (FREE DOWNLOAD)

Financial Management: Core Concepts, 3rd Edition, 2016, Raymond Brooks, Oregon State University
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Financial Management: Concepts and Applications, 2015, Stephen Foerster, Richard Ivey School of Business
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International Financial Management, 2nd Edition, 2012, Geert J Bekaert, Columbia University, Robert J. Hodrick
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Corporate Finance, 4th Edition, 2017, Jonathan Berk, Stanford University, Peter DeMarzo, Stanford University
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Free download - PPT 2 - Link
Free download - PPT 3 - Link

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Excel Modeling in Corporate Finance, 5th Edition, 2015, Craig W. Holden, Indiana University
Fundamentals of Corporate Finance, 3rd Edition, 2015, Jonathan Berk, Stanford University, Peter DeMarzo, 
Financial Management: Principles and Applications, 12th Edition, 2015, Sheridan Titman, Arthur J. Keown

 

Fundamentals of Investing, 13th Edition, Scott B. Smart, Lawrence J. Gitman, Michael D. Joehnk, 2017
Free download - PPT  - Link


Multinational Business Finance, 14th Edition, David K. Eiteman, Arthur I. Stonehill, Michael H. Moffett, 2016
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Personal Finance, 6th Edition, 2017, Jeff Madura, Emeritus Professor of Finance; Florida Atlantic University
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Personal Finance: Turning Money into Wealth, 7th Edition, 2016, Arthur J. Keown, 
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Foundations of Finance, 9th Edition, 2017, Arthur J. Keown, John H. Martin
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Principles of Managerial Finance, 14th Edition, 2015, Lawrence J. Gitman, Chad J. Zutter
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DOWNLOAD ALL TEST BANKs & CASE STUDY GUIDES - 2017

Corporate Finance, 4th Edition, 2017, Jonathan Berk, Stanford University, Peter DeMarzo, Stanford University - Test bank

Financial Management: Concepts and Applications, 2015, Stephen Foerster, Richard Ivey School of Business - Test bank

Financial Management: Core Concepts, 3rd Edition, 2016, Raymond Brooks, Oregon State University - Test bank

International Financial Management, 2nd Edition, 2012, Geert J Bekaert, Columbia University, Robert J. Hodrick - Test bank

Financial Management: Principles and Applications, 12th Edition, 2015, Sheridan Titman, Arthur J. Keown - Test bank

Corporate Finance: The Core, 4th Edition, 2017, Jonathan Berk, Stanford University, Peter DeMarzo - Test bank

Fundamentals of Investing, 13th Edition, Scott B. Smart, Lawrence J. Gitman, Michael D. Joehnk, 2017 - Test bank

Multinational Business Finance, 14th Edition, David K. Eiteman, Arthur I. Stonehill, Michael H. Moffett, 2016 - Test bank

Personal Finance, 6th Edition, 2017, Jeff Madura, Emeritus Professor of Finance; Florida Atlantic University - Test bank

Personal Finance: Turning Money into Wealth, 7th Edition, 2016, Arthur J. Keown - Test bank

Foundations of Finance, 9th Edition, 2017, Arthur J. Keown, John H. Martin - Test bank

Principles of Managerial Finance, 14th Edition, 2015, Lawrence J. Gitman, Chad J. Zutter - Test bank

 

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For Test Bankz, Quiz Answers and Case study Guides, email to: This email address is being protected from spambots. You need JavaScript enabled to view it.

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