Identify the choice that best completes the statement or answers the question.
Schalheim Sisters Inc. has always paid out all of its earnings as dividends; hence, the firm has no retained earnings. This same situation is expected to persist in the future. The company uses the CAPM to calculate its cost of equity, and its target capital structure consists of common stock, preferred stock, and debt. Which of the following events would REDUCE its WACC? a.
The market risk premium declines.
The flotation costs associated with issuing new common stock increase. c.
The company's beta increases.
Expected inflation increases.
The flotation costs associated with issuing preferred stock increase.
Duval Inc. uses only equity capital, and it has two equally-sized divisions. Division A's cost of capital is 10.0%, Division B's cost is 14.0%, and the corporate (composite) WACC is 12.0%. All of Division A's projects are equally risky, as are all of Division B's projects. However, the projects of Division A are less risky than those of Division B. Which of the following projects should the firm accept? a.
A Division B project with a 13% return.
A Division B project with a 12% return.
A Division A project with an 11% return.
A Division A project with a 9% return.
A Division B project with an 11% return.
2010 Fall Chapter 10
You are considering two mutually exclusive, equally risky, projects. Both have IRRs that exceed the WACC. Which of the following statements is CORRECT? Assume that the projects have normal cash flows, with one outflow followed by a series of inflows. a.
If the two projects' NPV profiles do not cross, then there will be a sharp conflict as to which one should be selected. b.
If the cost of capital is greater than the crossover rate, then the IRR and the NPV criteria will not result in a conflict between the projects. The same project will rank higher by both criteria. c.
If the cost of capital is less than the crossover rate, then the IRR and the NPV criteria will not result in a conflict between the projects. The same project will rank higher by both criteria. d.
For a conflict to exist between NPV and IRR, the initial investment cost of one project must exceed the cost of the other. e.
For a conflict to exist between NPV and IRR, one project must have an increasing stream of cash flows over time while the other has a decreasing stream. If both sets of cash flows are increasing or decreasing, then it would be impossible for a conflict to exist, even if one project is larger than the other.
2010 Fall, FIN 6100, Chapter 11, iClicker Questions
Which of the following is NOT a relevant cash flow and thus should not be reflected in the analysis of a capital budgeting project? a.
Changes in net working capital.
Shipping and installation costs.
Sunk costs that have been expensed for tax purposes.
Which of the following should be considered when a company estimates the cash flows used to analyze a proposed project? a.
The new project is expected to reduce sales of one of the company's existing products by 5%. b.
Since the firm's director of capital budgeting spent some of her time last year to evaluate the new project, a portion of her salary for that year should be charged to the project's initial cost. c.
The company has spent and expensed $1 million on R&D associated with the new project. d.
The company spent and expensed $10 million on a marketing study before its current analysis regarding whether to accept or reject the project. e.
The firm would borrow all the money used to finance the new project, and the interest on this debt would be $1.5 million per year.
Dalrymple Inc. is considering production of a new product. In evaluating whether to go ahead with the project, which of the following items should NOT be...
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