Corporate Finance Test Notes

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Final Exam Corporate Finance FINC 650 1. 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. b. c. d. e. Long-term debt. Common stock. Short-term debt used to finance seasonal current assets. Preferred stock. All of the above are considered capital components for WACC and capital budgeting purposes.

2. A company has a capital structure which consists of 50 percent debt and 50 percent equity. Which of the following statements is most correct? a. b. c. d. The cost of equity financing is greater than the cost of debt financing. The WACC exceeds the cost of equity financing. The WACC is calculated on a before-tax basis. The WACC represents the cost of capital based on historical averages. In that sense, it does not represent the marginal cost of capital. e. The cost of retained earnings exceeds the cost of issuing new common stock.

3. Which of the following statements is most correct? a. Preferred stock does not involve any adjustment for flotation cost since the dividend and price are fixed. b. The cost of debt used in calculating the WACC is an average of the after-tax cost of new debt and of outstanding debt. c. The opportunity cost principle implies that if the firm cannot invest retained earnings and earn at least rs, it should pay these funds to its stockholders and let them invest directly in other assets that do provide this return. d. The cost of common stock, rs, is usually less than the cost of preferred stock. 4. Assume a project has normal cash flows (i.e., the initial cash flow is negative, and all other cash flows are positive). Which of the following statements is most correct? a. b. c. d. e. All else equal, a project's IRR increases as the cost of capital declines. All else equal, a project's NPV increases as the cost of capital declines. All else equal, a project's MIRR is unaffected by changes in the cost of capital. Answers a and b are correct. Answers b and c are correct.

5. Which of the following statements is most correct? a. The NPV method assumes that cash flows will be reinvested at the cost of capital while the IRR method assumes reinvestment at the IRR. b. The NPV method assumes that cash flows will be reinvested at the risk free rate while the IRR method assumes reinvestment at the IRR. c. The NPV method assumes that cash flows will be reinvested at the cost of capital while the IRR method assumes reinvestment at the risk-free rate. d. The NPV method does not consider the inflation premium. e. The IRR method does not consider all relevant cash flows, and particularly cash flows beyond the payback period. 6. Project A and B both have normal cash flows. Project A has an internal rate of return (IRR) of 15 percent. Project B has an IRR of 14 percent. Both projects have a cost of capital of 12 percent. Which of the following statements is most correct? a. Both projects have a positive net present value (NPV). b. Project A must have a higher NPV than Project B. c. If the cost of capital were less than 12 percent, Project B would have a higher IRR than Project A. d. Statements a and c are correct. e. Statements a, b, and c are correct. 7. Which of the following statements is most correct? a. If a project with normal cash flows has an IRR which exceeds the cost of capital, then the project must have a positive NPV. b. If the IRR of Project A exceeds the IRR of Project B, then Project A must also have a higher NPV. c. The modified internal rate of return (MIRR) can never exceed the IRR. d. Answers a and c are correct. e. None of the answers above is correct. 8. Which of the following is not an incremental cash flow that results from the decision to accept a project? a. b. c. d. e. Changes in working capital. Shipping and installation costs. Sunk costs. Opportunity costs. Cannibalization of existing products.

9. Risk in a project which has only negative cash flows can best be...
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