A firms cost of capital is typically measured on a pre-tax basis.

______ 2. Because interest expense that a firm pays on outstanding bonds is tax deductible, this has the effect of

increasing the cost of debt financing for the firm.

______ 3. ABC Corporation has both preferred stock and common stock outstanding. Payment of preferred

stock dividends, therefore, has priority over payment of common stock dividends.

______ 4. The cost to a corporation of using new common stock financing is typically lower than the cost to

the firm of using new preferred stock financing.

______ 5. Market value weights use accounting values to measure the proportion of each type of capital

in the firms capital structure.

______ 6. The Weighted Average Cost of Capital (WACC) typically increases as the volume of new capital

raised within a given time period increases.

______ 7. Leverage results from the use of fixed-cost assets or funds to magnify the returns to the firms owners.

______ 8. Generally, increases in the use of leverage by a firm result in decreases in both the firms return and

risk levels.

______ 9. Fixed Costs vary directly with the level of sales and are a function of volume, not time.

______ 10. The level of debt or financial leverage that is acceptable in one industry or line of business can be very

risky in another industry.

______ 11. In general, non-U.S. companies have less debt in their capital structures than U.S.-based firms.

______ 12. Accepting an independent project does not eliminate other projects from consideration for a firm.

______ 13. If a firm has unlimited funds for capital investment purposes, then it will typically

approve all independent projects that provide an acceptable rate of return.

______ 14. If the payback period for a given project is greater than the firms maximum acceptable

payback period, then the firm should accept and implement the project.

______ 15. A major weakness of the payback period method is that the appropriate acceptable payback period

is a subjectively determined number.

B. MULTIPLE CHOICE QUESTIONS

For each question, enter the letter of the best response on the blank preceding the question.

______ 16. In general, a firm should invest only in capital budgeting projects that exceed the firms

Current Ratio for the current fiscal year.

Shareholders Equity balance listed on the firms most recent balance sheet.

cost of capital.

Net Income listed on the firms most recent income statement.

______ 17. Each of the following is a possible type of long-term financing that could be included in the

Weighted Average Cost of Capital (WACC) for a corporation EXCEPT

Accounts Payable

Long-Term Debt

Preferred Stock

Common Stock

______ 18. The weights in the Weighted Average Cost of Capital (WACC) formula must

be non-negative.

sum to 1.0 or 100%.

include some portion of debt financing.

A and B and C.

A and B.

______ 19. _____________________ weights reflect a firms desired capital structure proportions. These

weights are based on the optimal capital structure that the firm hopes to achieve.

Book value

Target

Market value

Appraised value

______ 20. A firms operating breakeven point is

the level of sales necessary to cover all operating expenses.

the point at which the firms Operating Profit (i.e., its Earnings Before Interest and Taxes or

EBIT) is equal to $0.

dependent on the market price per share of the firms common stock.

A and B.

______ 21. Typically lenders (i.e., those who provide debt financing to a firm) demand a relatively lower

rate of return on the financing they provide because

in bankruptcy, lenders have a relatively higher priority claim against the earnings or assets

of the firm.

shareholders always favor the use of more debt in the firms capital structure.

there is generally little demand to borrow funds, even in a growing economy.

B and C.

______ 22. An outlay of funds that is expected to produce benefits over a time period longer than one year

for a firm is a(n)

operating expenditure.

capital expenditure.

working capital expenditure.

Account Payable.

______ 23. Possible motive(s) a firm may have when making a capital expenditure could be

to expand operations.

to replace or renew fixed assets.

to offer credit terms of sale to its customers.

A and B.

A and B and C.

______ 24. Each of the following is a step in the capital budgeting process for a firm EXCEPT

decision-making.

payment of dividends to the firms common shareholders.

review and analysis.

proposal generation.

______ 25. For mutually exclusive projects being considered by a firm,

the projects have the same function.

the projects are competing with one another.

acceptance of one of the projects eliminates the other projects from further consideration.

A and B and C.

______ 26. Mason Manufacturing Company needs to increase its production capacity. This could be

accomplished by

expanding its own production plant.

acquiring another company that has excess production capacity.

contracting with an outside company for production services.

buying back shares of its outstanding common stock for the Treasury.

A and B and C.

______ 27. Each of the following is an advantage of the payback period method of capital

budgeting EXCEPT

it considers accounting profits, rather than cash flows.

it is quite simple and intuitive.

it considers cash flows rather than accounting profits.

it gives implicit consideration to the timing of cash flows.

______ 28. The discount rate used in Net Present Value (NPV) analysis, is

the firms cost of financing.

the minimum return that must be earned on a project to satisfy the firms investors.

always equivalent to the firms dividend yield.

A and B and C.

A and B.

______ 29. Williamson Quality Windows, Inc. has analyzed two mutually exclusive conveyor

systems for its production facility. System A has a Net Present Value (NPV) of

$1.5 million; System B has a NPV of $2 million. Given this information the firm should

choose both System A and System B, as both have a positive NPV.

choose System A, as it is more conservative.

choose System B, as it has a higher NPV.

reject both System A and System B, as neither has an NPV higher than $10 million.

______ 30. When companies evaluate investment opportunities using the Profitability Index (PI),

the decision rule they follow is to

invest in a project when the Profitability Index is less than 1.0.

invest in a project when the Profitability Index is greater than 1.0.

invest in a project when the Profitability Index is a negative value.

invest in a project when the Profitability Index is greater than 0, but less than 1.0.