2012 Winter FINA520 Final ExamName___________________________________Total=60 Points (1 point per each question)MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.1) In order to maximize firm value, management should invest in new assets when cash flows fromthe assets are discounted at the firm's ________ and result in a positive NPV.1)A) rate of return on equity B) internal rate of returnC) cost of capital D) cost of debt used to finance the project2) The investor's required rate of return differs from the firm's cost of capital due to the: 2)A) tax deductibility of interest. B) time value of money.C) firm's beta. D) CAPM.3) The weights used to determine the relative importance of the firm's sources of capital shouldreflect:3)A) book values in accord with generally accepted accounting principles.B) current market values.C) current market values for bonds, common stock, and preferred stock and book values forretained earnings.D) subjective adjustments for firm risk.4) Which of the following best describes a firm's cost of capital? 4)A) The coupon rate on preferred stockB) The average cost of the firm's assetsC) The average yield to maturity on debtD) The rate of return that must be earned on its investments in order to satisfy the firm'sinvestors5) A firm's capital structure consists of which of the following? 5)A) Preferred stock B) BondsC) Common stock D) All of the above6) Which of the following must be adjusted for the firm's tax rate when estimating the weightedaverage cost of capital WACC?6)A) Cost of common equity B) Cost of debtC) Cost of preferred stock D) All of the above7) Which of the following would NOT be considered in calculating a firm's cost of capital? 7)A) common stock B) BondsC) Accounts payable D) Preferred Stock8) Which of the following reasons causes bonds to be a less expensive form of capital for a public firmthan the issuance of common stock? Bondholders:8)A) bear less risk than common stockholders bear.B) investors pay a lower tax rate on bond interestC) have prior voting rights over common stockholders.D) receive greater returns than common stockholders.19) The cost of capital is: 9)A) the required rate of return for new capital investments which have typical or average risk.B) the rate of return the firm must earn on its investments in order to satisfy the required rate ofreturn of the firm's investors.C) the opportunity cost of using funds to invest in new projects.D) all of the above.10) Cost of capital is: 10)A) the average cost of the firm's assets.B) the coupon rate of debt.C) the rate of return that must be earned on additional investment if firm value is to remainunchanged.D) a minimum rate of return set by the board of directors.11) Which of the following is a correct formula for calculating the cost of capital? 11)A) WACC = weighted after-tax cost of debt + weighted cost of preferred stock + weighted costof common stockB) WACC = (after-tax cost of debt + cost of preferred stock + cost of common stock )/3C) WACC = weighted after-tax cost of debt + weighted after-tax cost of preferred stock +weighted after-tax cost of common stockD) WACC = weighted cost of debt + weighted cost of preferred stock + weighted cost ofcommon stockUse the following information to answer the following question(s).The following data concerning Grafton Computer Peripherals' capital structure is available.$ millions Book Values Market ValuesAccountsPayable &Accruals $100Short-termnotes 50 50Long-termdebt 150 200Preferred Stock 25 50Common Stock 200 500Total $525 $80012) The percentage of common stock in Grafton's weighted average cost of capital is: 12)A) 20%. B) 62.5%. C) 6.25%. D) 38.1%.13) The percentage of debt in Grafton's weighted average cost of capital is: 13)A) 31.25%. B) 57.14%. C) 38.1%. D) 25%.14) The percentage of preferred stock in Grafton's weighted average cost of capital is: 14)A) 6.25%. B) 5.9%. C) 62.5%. D) 4.76%.15) The total capital that should be used in computing the weights for Grafton's WACC is: 15)A) $525. B) $800. C) $750. D) $425.216) J & B, Inc. has $5 million of debt outstanding with a coupon rate of 12%. Currently, the yield tomaturity on these bonds is 14%. If the firm's tax rate is 40%, what is the after-tax cost of debt to J &B?16)A) 5.6% B) 12.0% C) 8.4% D) 14.0) The expected dividend is $2.50 for a share of stock priced at $25. What is the cost of commonequity if the long-term growth in dividends is projected to be 8%?17)A) 25% B) 8% C) 18% D) 10) Sonderson Corporation is undertaking a capital budgeting analysis. The firm's beta is 1.5. The rateon six-month T-bills is 5%, and the return on the S&P 500 index is 12%. What is the appropriatecost of common equity in determining the firm's cost of capital?18)A) 17.7% B) 19.9% C) 15.5% D) 13.1) Most firms use Treasury securities with maturities of ________ to determine the appropriaterisk-free rate to use in the CAPM.19)A) 10 years B) 90 days C) 180 days D) 30 years20) The cost of preferred stock is equal to: 20)A) the preferred stock dividend divided by the net market price.B) (1 - tax rate) times the preferred stock dividend divided by net price.C) the preferred stock dividend divided by market price.D) the preferred stock dividend divided by its par value.21) The most expensive source of capital is usually: 21)A) preferred stock. B) debt.C) new common stock. D) retained earnings.22) When calculating the weighted average cost of capital, which of the following has to be adjustedfor taxes?22)A) Preferred stock B) Common stockC) Debt D) Retained earnings23) Which of the following is NOT used to calculate the cost of debt? 23)A) Number of years to maturity B) Face value of the debtC) Risk-free rate D) Market price of the debt24) Which of the following is a valid issue in implementing the dividend growth model? The model: 24)A) is too complex to be used to estimate value.B) does not require an accurate estimate of the rate of growth in future dividends.C) is based upon the assumption that dividends are expected to grow at a constant rate forever.D) both A and C.25) An increase in ________ will increase the cost of common equity. 25)A) the risk-free rate B) the expected growth rate of dividendsC) a drop in the stock price D) both A and B326) Bender and Co. is issuing a $1,000 par value bond that pays 9% interest annually. Investors areexpected to pay $918 for the 10-year bond. What is the after-tax cost of debt if the firm is in the34% tax bracket?26)A) 6.83% B) 9.00% C) 15.68% D) 10.35') Busing Manufacturing has a new bond issue that will net the firm $1,069,000. The bonds have a$1,000,000 par value, pay interest annually at a 12% coupon rate, and mature in 10 years. The firmhas a marginal tax rate of 34%. The after-tax cost of the debt issue is:27)A) 3.68%. B) 6.58%. C) 7.15%. D) 7.92%.28) Alpha has an outstanding bond issue that has a 7.75% semiannual coupon, a current maturity of 20years, and sells for $967.97. The firm's income tax rate is 40%. What should Alpha use as anafter-tax cost of debt for cost of capital purposes?28)A) 2.42% B) 8.08% C) 4.85% D) 4.04%Use the following information to answer the following question(s).The current market price of an existing debt issue is $1,125. The bonds have a $1,000 par value, pay interest annually at a12% coupon rate, and mature in 10 years. The firm has a marginal tax rate of 34%.29) The before-tax cost of this debt issue is: 29)A) 12%. B) 13%. C) 9.97%. D) 7.92%.30) The after-tax cost of this debt issue is: 30)A) 12%. B) 7.92%. C) 6.58%. D) 3.39%.31) The firm's optimal capital structure is the mix of financing sources that: 31)A) maximizes after-tax earnings.B) minimizes the risk of financial distress.C) maximizes the total value of the firm's debt and equity.D) all of the above.32) A firm's capital structure consists of which of the following? 32)A) The amount of debt and preferred stock that a firm utilizesB) The amount of debt that a firm utilizesC) The amount of debt, preferred stock, and common stock that a firm utilizesD) None of the above33) The primary objective of capital structure management is to find the combination of fundingsources that will minimize the33)A) WACC. B) cost of equity.C) probability of financial distress. D) interest rate.34) Which of the following is NOT a component of a firm's capital structure? 34)A) Accounts payableB) Common stockC) BondsD) Preferred stockE) Retained earnings435) Merrimac Brewing company's total assets equal $18 million. The book value of Merrimac's equityis $6 million. The market value of Merrimac's equity is $10 million. It's Debt to Value ratio is .5.What is the book value of Merrimac's interest- bearing debt?35)A) $15 million B) $10 million C) $20 million D) $5 million36) Merrimac Brewing company's total assets equal $18 million. The book value of Merrimac's equityis $6 million. The market value of Merrimac's equity is $10 million. It's Debt to Value ratio is .5.What is Merrimac's Debt Ratio?36)A) .33 B) .75 C) .67 D) .2537) Cornucopia's liabilities and equity are shown below:AccountsPayable $500,000AccruedExpenses 250,000Short-termNote at 5% 300,000Long-TermDebt 1,250,000CommonEquity, BookValue 2,500,000CommonEquity, MarketValue 6,000,000Cornucopia's debt ratio is ________.37)A) .30 B) .32 C) .21 D) .4838) Cornucopia's liabilities and equity are shown below:AccountsPayable $500,000AccruedExpenses 250,000Short-termNote at 5% 300,000Long-TermDebt 1,250,000CommonEquity, BookValue 2,500,000CommonEquity, MarketValue 6,000,000Cornucopia's debt to value ratio is ________.38)A) .48 B) .30 C) .21 D) .32539) Fibonacci Property Management's balance sheet shows total liabilities of $5 million and total assetsof $13 million. Interest bearing liabilities total $3 million (book value). The market value ofFibonnacci's equity is $21 million. Fibonacci's debt ratio is ________.39)A) .24 B) .125 C) .23 D) .3840) Fibonacci Property Management's balance sheet shows total liabilities of $5 million and total assetsof $13 million. Interest bearing liabilities total $3 million (book value). The market value ofFibonnacci's equity is $21 million. Fibonacci's Debt to Value ratio is ________.40)A) .24 B) .38 C) .125 D) .2341) Tremont Inc.'s Total Assets =$25 million. The balance sheet shows Accounts payable and accrualstotaling $7 million, common stock and retained earnings total $10 million. There is no preferredstock. What is the book value of interest bearing debt?41)A) $18 million B) $15 million C) $7 million D) $8 million42) Which of the following should be excluded from a firm's capital structure? 42)A) Long-term debt B) Short-term bank notesC) Common equity D) Non-interest bearing debt43) A company that earns a rate of return on its investments lower than the interest rate on its debt issaid to have:43)A) unfavorable financial leverage. B) favorable financial leverage.C) negative financial leverage. D) a sub-optimal capital structure.44) A company whose rate of return on investments is higher than the interest rate on its debt is saidto have:44)A) negative financial leverage. B) favorable financial leverage.C) a sub-optimal capital structure. D) unfavorable financial leverage.45) The Modigliani and Miller Capital Structure Theorem, in its original form: 45)A) provided important insights into capital structure policy.B) concludes that how a firm is financed is not important.C) uses unrealistic assumptions.D) all of the above.46) The inclusion of bankruptcy risk in firm valuation: 46)A) causes the cost of capital curve to be downward sloping regardless of capital structure.B) causes cost of capital curve to be linear.C) acknowledges that a firm has an upper limit to debt financing.D) has no consequences for practical management of capital structure policy.47) Which of the following is the most important factor that affects a firm's financing mix? 47)A) The number of shares that are outstandingB) The amount of EPSC) The predictability of cash flowsD) The amount of operating income648) When the impact of taxes is considered, as the firm takes on more debt 48)A) there will be no change in total cash flows.B) the weighted average cost of capital will increase.C) cash flows will increase because taxes will decrease.D) both taxes and total cash flow to stockholders and bondholders will decrease.49) The original form of the Modigliani and Miller Capital Structure Theorem 49)A) ignores transaction costs.B) ignores the relationship between firm value and cost of capital.C) ignores the effect of taxes.D) both A and C are true.50) Optimal capital structure is: 50)A) the mix of all items that appear on the right-hand side of the company's balance sheet.B) the funding mix that will maximize the company's common stock price.C) the mix of securities that will maximize EPS.D) the mix of funds that will minimize the firm's beta.51) An optimal capital structure is achieved: 51)A) when a firm's break-even point is achieved.B) when a firm's expected EPS are maximized.C) when a firm's expected profits are maximized.D) when a firm's weighted average cost of capital is minimized.52) From the information below, select the optimal capital structure for Mountain High Corp. 52)A) Debt = 70%; Equity = 30%; EPS = $3.31; Stock price = $30.00B) Debt = 80%; Equity = 20%; EPS = $3.42; Stock price = $30.40C) Debt = 60%; Equity = 40%; EPS = $3.18; Stock price = $31.20D) Debt = 40%; Equity = 60%; EPS = $2.95; Stock price = $26.50E) Debt = 50%; Equity = 50%; EPS = $3.05; Stock price = $28.9053) An optimal capital structure is achieved: 53)A) when a firm's expected stock price is maximized.B) when a firm's break-even point is achieved.C) when a firm's expected EPS are maximized.D) when a firm's expected profits are maximized.54) An optimal capital structure is achieved: 54)A) when a firm's expected profits are maximized.B) when a firm's break-even point is achieved.C) when a firm's expected stock price is maximized.D) when a firm's expected EPS are maximized.55) If interest expense lowers taxes, why does the WACC not decrease indefinitely with the additionof more debt?55)A) Increasing debt too much can result in a greater likelihood of firm failure (financial distress).B) The tax shield effect of debt will result in a lower cost of equity.C) A firm's common stock price will not be affected by the amount of debt a firm uses.D) Too much common equity increases the probability of bankruptcy.756) Capital structure theory suggests that companies may put the interests of ________ ahead of theinterests of ________.56)A) There are no potential conflicts t arising from the way a firm manages its capital structure.B) Existing shareholders, IRSC) Stockholders, bondholdersD) Potential stockholders, existing stockholders57) The inclusion of financial distress costs in firm valuation: 57)A) provides a rationale for a saucer-shaped cost of capital curve.B) acknowledges that a firm is insulated from the impact of high debt financing.C) causes the cost of capital to rise in a linear fashion as more debt is added to the capitalstructure.D) eliminates conflicts between bondholders and stockholders.58) The theory that managers may prefer internal sources of funds to the lowest cost source of funds isknown as:58)A) pecking order theory. B) tradeoff theory.C) the Modigliani and Miller Proposition. D) financial stress avoidance theory.59) The Tradeoff Theory of capital structure theory indicates that: 59)A) there is a range of capital structures, rather than a single capital structure, that is optimal.B) the higher the firm's financial leverage, the higher the probability the firm will be unable tomeet the financial obligations included in its debt contracts, which could ultimately lead tofirm failure.C) the tax shield on debt positively affects firm value, indicating that there is some benefit tofinancial leverage as opposed to an all-equity capitalization.D) all of the above.60) The Tradeoff Theory view of capital structure management says that the cost of capital curve is: 60)A) a straight line. B) saucer-shaped.C) s-shaped. D) v-shaped.8