Question I

1. Which of the following statements is correct?

a. Cost of equity is higher than cost of debt

b. Cost of debt is higher than cost of equity

c. Cost of capital does not capture risk of firm investment

d. Both a and c.

2. Firms should use their weighted average cost of capital (WACC) when they are funding their capital projects with a variety of sources. However, when the firm plans on using only debt or only equity to fund a particular project, it should use the after-tax cost of the specific source of capital to evaluate that project.

a. True

b. False

3. Which of the following is not considered a capital component for the purpose of calculating the weighted average cost of capital as it applies to capital budgeting?

a. Long-term debt.

b. Common stock.

c. Short-term debt used to finance seasonal current assets.

d. Preferred stock.

e. All of the above are considered capital components for WACC and capital budgeting purposes.

4. Which of the following events is likely to encourage a company to raise its target debt ratio?

a. A decrease in the corporate tax rate.

b. A decrease in the firm's business risk

d. An increase in bankruptcy costs

e. An increase in the firm's intangible asset

5. A decrease in a firm's willingness to pay dividends is likely to result from an increase in its

a. Earnings stability.

b. Access to capital markets.

c. Profitable investment opportunities.

d. Collection of accounts receivable.

e. Stock price.

6. Intel Corp is expecting to receive a remittance of Euro 2,00,0000 six months from now. The firm may consider the following to hedge against the currency risk.

a. Buy call options on Euro

b. Buy put options on Euro.

c. Buy put options on Dollar

d. Both a and c

7. Which of the following statements is most correct?

a. All else equal, if a bond's yield to maturity increases, its price will fall.

b. All else equal, if a bond's yield to maturity increases, its price will increase

c. If a bond's yield to maturity exceeds the coupon rate, the bond will sell at a premium over par.

d. All of the answers above are correct.

e. None of the answers above is correct.

8. WACC reflects both financial and business risk of the firm.

a. True

b. False

9. Spencer Inc. has the following information for the current year: Net income = $600; Net operating profit after taxes (NOPAT) = $500; Total assets = $4,000; Short-term investments = $500; Stockholders equity = $2,000; Debt = $1,000; and Total net operating capital = $2500. If Spencer's cost of capital is 10%, what is its Economic value added (EVA)?

a. $250

b. $300

c. $350

d. $375

e. $400

10. Petersen Co. has a capital budget of $1,200,000. The company wants to maintain a target capital structure that is 60 percent debt and 40 percent equity. The company forecasts that its net income this year will be $600,000. If the company follows a residual distribution policy (with all distributions in the form of dividends), what will be its payout ratio?

a. 0%

b. 20%

c. 40%

d. 60%

e. 80%