2024 – True or False Please indicate whether each statement is true or false 2 points

True or False: Please indicate whether each statement is true or false. (2 points per question)

1. The primary function of the capital budget is to forecast the funds required for future investments that must be raised through external funding, that is, by selling stock or bonds.

2. When considering two mutually exclusive projects, the financial manager should always select that project whose internal rate of return is the highest provided the projects have the same initial cost.

3. Corporate risk does not take into consideration the effects of stockholder’s diversification; it is measured by a project’s effect on the firm’s earnings variability.

4. The beta risk of a project is that part of the project’s that cannot be eliminated by diversification. Investors are not concerned about this type of since it cannot be diversified.

5. The cost of debt is equal to one minus the marginal tax rate multiplied by the coupon rate on outstanding debt.

6. The cost of debt, rd, is always less than rs, so rd(1 – T) will certainly be less than rs. Therefore, since a firm cannot be 100% debt financed, the weighted average cost of capital will always be greater than rd(1 – T).

7. The fact that interest is tax deductible makes corporate debt less expensive than common of preferred stock.

8. If the firm’s actual debt ratio is below its target level, expansion capital should be raised by issuing equity in order to preserve the firm’s borrowing capacity.

9. On a 2-for-1 stock split, the shares outstanding are doubled, and the stock’s par value is halved.

10. A firm with a current ratio equal to four will have its current ratio increase if both current assets and current liabilities increase by the same amount.

11. The sale of common stock for cash will increase the current assets for a firm.

12. If you receive some goods on April 1 with the terms 3/20, net 30, June 1 dating, it means that you will receive a 3 percent discount if the bill is paid on or before June 20 and that the full amount must be paid 30 days after receipt of the goods.

13. Collections float offsets disbursement float. If a firm’s collections float is greater than its disbursement float then a firm is said to operate with positive net float.

14. When a firm pledges its accounts receivable, if a customer that purchased goods from the firm does not pay, the selling firm must take the loss.

15. Breakeven analysis can involve determining the magnitude of the firm’s profit or losses at output levels on and around the point where revenues equal costs.

16. Assume a project has normal cash flows (i.e., initial cash flow is negative, and all other cash flows are positive). Which of the following statements is most correct?

17. Which of the following statements is correct?

18. Which of the following is not a cash flow that results from the decision to accept a project?

19. According to the text, the financial staff’s role in the forecasting process centers on

20. The firm’s weighted average cost of capital (WACC) is

21. Which of the following statements is correct?

22. The firm’s target capital structure is consistent with which of the following?

23. Which of the following statements is correct?

24. The portion of the firm’s earnings that has been reinvested in the firm rather than paid out in dividends is called

25. The average length of time required to convert a firm’s receivables into cash is called the __________.

27. Which of the following would cause average inventory holdings to decrease, other things held constant?

28. The Danser Company expects to have sales of $30,000 in January, $33,000 in February, and $38,000 in March. If 20 percent of sales are for cash, 40 percent are credit sales paid in the month following the sale, and 40 percent are credit sales paid 2 months following the sale, what are the cash receipts from sales in March?

29. A firm is offered trade credit terms of 3/15, net 45. The firm does not take the discount, and it pays after 67 days. What is the approximate annual cost of not taking the discount?

30. The degree of financial leverage for ABC Inc. is 2.5, and the degree of financial leverage for XYZ Corporation is 1.5. According to this information, which firm is considered to have greater financial risk?

31. Given the following net cash flows, determine the IRR of the project (5 points):

32. Your company is considering a machine that will cost $1,000 at Time 0 and which can be sold after 3 years for $100. To operate the machine, $200 must be invested at Time 0 in inventories; these funds will be recovered when the machine is retired at the end of Year 3. The machine will produce sales revenues of $900/year for 3 years; variable operating costs (excluding depreciation) will be 50 percent of sales. Operating cash inflows will begin 1 year from today (at Time 1). The machine will have depreciation expenses of $500, $300, and $200 in Years 1, 2, and 3, respectively. The company has a 40 percent tax rate, enough taxable income from other assets to enable it to get a tax refund from this project if the project’s income is negative, and a 10 percent required rate of return. Inflation is zero. What is the project’s NPV? (5 points)

33. Hamilton Company’s 8 percent coupon rate, quarterly payment, $1,000 par value bond, which matures in 20 years, currently sells at a price of $686.86. The company’s tax rate is 40 percent. Based on the simple interest rate, not the EAR, what is the firm’s component cost of debt for purposes of calculating the WACC? (5 points)

34. Copybold Corporation is a start-up firm considering two alternative capital structures–one is conservative and the other aggressive. The conservative capital structure calls for a D/A ratio = 0.25, while the aggressive strategy call for D/A = 0.75. Once the firm selects its target capital structure it envisions two possible scenarios for its operations: Feast or Famine. The Feast scenario has a 60 percent probability of occurring and forecast EBIT in this state is $60,000. The Famine state has a 40 percent chance of occurring and the EBIT is expected to be $20,000. Further, if the firm selects the conservative capital structure its cost of debt will be 10 percent, while with the aggressive capital structure its debt cost will be 12 percent. The firm will have $400,000 in total assets, it will face a 40 percent marginal tax rate, and the book value of equity per share under either scenario is $10.00 per share. What is the coefficient of variation of expected EPS under the aggressive capital structure plan? (5 points)

35. Flavortech Inc. expects EBIT of $2,000,000 for the coming year. The firm’s capital structure consists of 40 percent debt and 60 percent equity, and its marginal tax rate is 40 percent. The cost of equity is 14 percent, and the company pays a 10 percent rate on its $5,000,000 of long-term debt. One million shares of common stock are outstanding. In its next capital budgeting cycle, the firm expects to fund one large positive NPV project costing $1,200,000, and it will fund this project in accordance with its target capital structure. If the firm follows a residual dividend policy and has no other projects, what is its expected dividend payout ratio? (5 points)

36. On average, a firm sells $2,500,000 in merchandise a month. Its cost of goods sold equals 80 percent of sales, and it keeps inventory equal to one-half of its monthly cost of goods on hand at all times. If the firm analyzes its accounts using a 360-day year, what is the firm’s inventory conversion period? (5 points)

37. You need to borrow $25,000 for one year. Your bank offers to make the loan, and it offers you three choices: (1) 15 percent simple interest, annual compounding; (2) 13 percent simple interest, daily compounding (360-day year); (3) 9 percent add-on interest, 12 end-of-month payments. The first two loans would require a single payment at the end of the year, the third would require 12 equal monthly payments beginning at the end of the first month. What is the difference between the highest and lowest effective annual rate? (5 points)

38. Trident Food Corporation Trident Food Corporation generated the following income statement for the most recent fiscal year, which ended December 31, 2010: