Exam Iii

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Fin 221 Spring 2011 Exam 3
Multiple Choice Identify the choice that best completes the statement or answers the question. 1. MAD Inc. is evaluating the following four independent, investment opportunities: Project A B C D Cost $300,000 150,000 200,000 400,000 IRR 14% 10% 13% 11%

MAD’s target capital structure is 60 percent debt and 40 percent equity. The yield to maturity on the company’s new debt will be 10 percent. MAD’s beta is 1.7, the risk free rate is 4% and the required market return is 12%. If the company’s tax rate is 30 percent, then which of the projects will be accepted? A) Projects A, B, C, and D B) Projects A, C, and D C) Project A D) Projects A and C 2. Which of the following will decrease the WACC of any given firm that earns taxable profit? A) An increase in the Beta of the common stock B) Issuing new equity instead of using retaining earnings for common equity financing. C) An increase in the Preferred Stock’s required return D) An increase in the expected dividend growth rate of the common stock, holding D1 (the dividend paid one period from now) constant. E) An increase in the firm’s marginal tax rate 3. Wooldridge furniture is replacing its old machine with a more efficient one. The old machine is being depreciated on a straight-line basis at a rate of $10,000 per year. The old machine has a current book value of $100,000 and a 10-year remaining useful and depreciation life. The new machine, which costs $910,000, will be depreciated for 10 years using simplified straight-line depreciation to zero. Introducing the more efficient machine is expected to increase revenues by $50,000 per year and reduce annual operating costs by $80,000. Compute the year 2 cash flow for this project. Assume Wooldridge has a marginal tax rate of 40%. A) $110,400 B) $49,520 C) $34,520 D) $122,250 4. Dumb & Dumber Development Company has two mutually exclusive investment projects to evaluate. Assume both projects can be repeated indefinitely. The following cash flows are associated with each project: Project A Cash Flow -$100,000 30,000 50,000 70,000 Project B Cash Flow -$70,000 30,000 30,000 30,000

Year 0 1 2 3

4 5

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30,000 10,000

The project types are equally risky and the firm’s cost of capital is 12 percent. What is the EAA of the higher valued project? (Round your final answer to the nearest whole dollar.) A) $7,433 B) $6,857 C) $11,325 D) $16,470 5. Moynihan Motors has a cost of capital of 10.25 percent. The firm has two normal projects of equal risk. Project A has an internal rate of return of 14 percent, while Project B has an internal rate of return of 12.25 percent. Which of the following statements is most correct? A) Both projects have a negative net present value. B) If the crossover rate (i.e., the rate at which the Project’s NPV profiles intersect) is 8 percent, Project A will have a higher net present value than Project B at the cost of capital given above. C) If the crossover rate (i.e., the rate at which the Project’s NPV profiles intersect) is 11 percent, Project B will have a higher net present value than Project A at the cost of capital given above. D) If the projects are mutually exclusive, the firm should always select Project A. 6. For the writer (seller) of a put stock option losses are A) limited because the stock price cannot fall below zero B) limited to the amount of the option premium C) unlimited because there is no boundary for the growth of stock prices D) none of the above is correct 7. If a company uses the same cost of capital for evaluating all projects, which of the following results is likely? A) Accepting only good, low-risk projects. B) Accepting no projects. C) Accepting poor, high-risk projects. D) Rejecting good, average-risk projects. 8. Flaherty Electric has a capital structure that consists of 70 percent equity and 30 percent debt. The company's long-term bonds have a before-tax yield to maturity of 8.4 percent. The company uses the DCF approach to...
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