Corporate Finance Assignment
Section 1: Multiple Choice (30 questions; 30 marks). Select the best alternative for each of the following statements.
1. When analyzing two mutually exclusive capital budgeting projects, the NPV and IRR capital budgeting methods can result in different ranking decisions. On a NPV profile (a chart showing the NPV at different discount rates) of these two projects, the cross-over rate is the point at which:
a) the market risk premium equals the asset risk premium.
b) the IRR and NPV for a single project are equal.
c) the IRR for two projects are equal.
d) the NPV for two projects are equal.
e) none of the above.
2. Lan Electronics is considering expanding into another line of business. There are five potential business opportunities available. Each line of business has the same expected return. The betas of the various business lines are provided below. Which of the expansion alternatives would be the best choice for Lan Electronics?
a) copper mines, 1.63 d) toy manufacturing, 0.79
b) machinery construction, 1.00 e) janitorial services, 0.95
c) natural gas exploration, 1.75
3. LH Enterprises borrowed $44 million in the Eurocurrency market 8 months ago at an interest rate of LIBOR plus 111. The LIBOR at that time was 2.83%. The loan is repayable today. How much does LH Enterprises owe?
a) $44,000,000 d) $45,733,600
b) $45,245,200 e) $45,155,733
c) $44,830,133
4. Which of the following is not a source of financing (capital) for a company?
a) assets d) bonds
b) common shares e) all of the above are sources
c) preferred shares
5. Parrish Corp is evaluating a capital budgeting project that has an initial cost of $850 million. The companys cost of capital is 13.8% and the NPV of the project is +$26,352. This means that:
a) the project generates a return of $26,352 to Parrish Corp.
b) the project return of $26,352 is not sufficient given the projects cost of $850 million.
c) the projects expected return is less than 13.8%.
d) the projects expected return is greater than 13.8%.
e) the project is not acceptable.
6. The IRR for a capital budgeting project is:
a) based on the market risk premium.
b) equivalent to the firms cost of capital.
c) the discount rate that makes the firms cost of capital equal to zero.
d) the discount rate that makes the projects NPV equal to zero.
e) the point where the projects NPV profile intersects with the firms cost of capital.
7. The interest expense for a company is equal to its operating income (EBIT). The companys tax rate is 40%. The companys times-interest earned ratio is equal to:
a) 2 d) 1.20
b) 1 e) none of the above.
c) 0.60
8. The cost of capital is the:
a) cost of raising a marginal dollar of financing.
b) cost of the liabilities and equity on the firms balance sheet.
c) cost of the funds used to acquire the new assets that appear on the firms balance sheet.
d) cost of the assets that appear on the firms balance sheet in the OCS weights.
e) cost of raising a marginal dollar of financing in the OCS weights.
9. If inventory decreases on a balance sheet, how would this be treated on a statement of cash flows?
a) It would be a use of cash, since the firm is buying inventory and using cash.
b) It would be a source of cash, since the firm is selling inventory.
c) It would be a use of cash, since the firm is selling inventory it purchased with cash.
d) It would be a source of cash, since the firm is buying inventory that it can resell for cash.
e) There would be no impact.
10. Consider the following statements regarding the retained earnings account.
1) Retained earnings reflects the sum of the firms net income over its life less all cash dividends paid.
2) Retained earnings is the link between the income statement and the balance sheet.
3) Usually, retained earnings changes every fiscal year.
4) Retained earnings represents funds that are currently available for financing purposes.
Which of the above statements are correct?
a) 1 and 2, only. b) 3 and 4, only. c) 2, 3, and 4, only. d) 1, 2, and 3, only. e) 1, 2, 3, and 4.
11. Winn Shopping Centers is planning to use long-term debt to finance the expansion of their business. For capital budgeting purposes, which of the following should be recognized as part of the cash flows?
a) the after-tax interest payments, but not the principal repayments.
b) the principal repayments, but not the after-tax interest payments.
c) neither the after-tax interest payments, nor the principal repayments.
d) both the after-tax interest payments, and the principal repayments.
12. Which of the following is not a financial intermediary in the financial markets?
a) Chartered banks.
b) Life insurance companies.
c) Government of Canada.
d) Pension Plans.
e) All of the above are financial intermediaries.
13. Lambe Enterprises is evaluating five capital budgeting projects. The firm has unlimited funds. Projects 1 and 2 are independent and Projects 3, 4 and 5 are mutually exclusive. The projects are listed below with their expected returns.
Expected
Project
Type
Return (%)
1
Independent
14%
2
Independent
12%
3
Mutually exclusive
10%
4
Mutually exclusive
16%
5
Mutually exclusive
15%
A ranking of the projects on the basis of their returns from the best to the worst according to their acceptability to the firm would be:
a) 4, 5, 1, 2, and 3.
b) 4, 1, and 2.
c) 3, 2, 1, 5, and 4.
d) 4, 5, 1, and 3.
e) none of the projects are acceptable.
14. A companys accounts receivable turnover ratio is decreasing, the companys average collection period (ACP):
a) is increasing
b) is decreasing
c) could be moving in either direction.
d) there is no impact.
15. Consider the following four financial events:
1) an increase in cost of goods sold.
2) issuing a long-term debenture.
3) a reduction in accounts receivable.
4) a reduction in the line of credit.
Which of the above financial events represent a use of cash for a company?
a) 1 and 3, only. d) 1, 3, and 4, only.
b) 2 and 4, only. e) 1, 2, 3, and 4.
c) 1 and 4, only.
16. The NPV and IRR methods of capital budgeting can sometimes result in different rankings for mutually exclusive capital budgeting projects. Consider the following statements that may explain the reasons the different rankings can occur.
1. Differences can result because of differences in the size and timing of the cash inflows for the projects.
2. Differences in rankings can occur because time value of money is not explicitly considered in one of the capital budgeting methods.
3. Differences in ranking can occur because one of the methods does not consider all of the cash flows associated with a project.
4. Differences in ranking can occur due to different re-investment rate assumptions regarding the projects cash inflows.
Which of the above explanations are correct?
a) 1 and 4, only.
b) 2 and 3, only.
c) 2, 3, and 4, only.
d) 1, 3, and 4, only.
e) 1, 2, 3, and 4.
17. Crowner Enterprises is evaluating two independent projects. Project A has incremental capital cost $369,000 and is expected to have a useful life of five years. After-tax cash inflows are expected to be $112,700 per year. Project B has an incremental cost of $550,000 and a useful life of four years. After-tax cash inflows are expected to be $181,080 per year. The company has sufficient funds to invest in both projects if required. Crowner should:
a) invest in both projects if the companys cost of capital is 15% or less.
b) invest in Project B only if the companys cost of capital is 15% or less.
c) invest in both projects if the companys cost of capital is 12% or less.
d) invest in Project A only if the companys cost of capital is 12% or less.
e) invest in neither project if the companys cost of capital is 12% or less.
18. Bond A has a coupon rate of 10% and matures in 2 years. Bond B also has a coupon rate of 10% and matures in 22 years. Both bonds are rated A. If yields on debt securities in the market decrease:
a) the fall in the market price of bond A would exceed the fall in the market price of bond B.
b) the fall in the market price of bond B would exceed the fall in the market price of bond A.
c) the rise in the market price of bond A would exceed the rise in the market price of bond B.
d) the rise in the market price of bond B would exceed the rise in the market price of bond A.
e) the change in the market price of bond A would equal the change in the market price of bond B.
19. The type of risk depicted in the above example is , and investors rationally demand a
a) default risk, a default risk premium
b) default risk, a maturity risk premium
c) inflation, a liquidity premium
d) interest rate risk, a maturity risk premium
e) reinvestment rate risk, an expectations premium
20. What is the primary goal of financial management?
a) To increase the companys earnings.
b) To maximize the companys cash flow.