: Financial management

| June 6, 2016

Firms should use their weighted average cost of capital (WACC) when they are funding their capital projects from a variety of financing sources. However, when the firm plans on using only a single debt or equity source to fund a particular project, it should use the after-tax cost of that specific source of capital to evaluate that project.



If a proposed investment has an NPV of zero, it means that you can expect to get a zero percent return from it if it is adopted.




Conflicts between two mutually exclusive projects, where the NPV method chooses one project but the IRR method chooses the other, should generally be resolved in favor of the project with the higher NPV.




Question 5 >

Whenever a firm goes into debt, it is using financial leverage.




Three factors affecting a firm’s business risk are the variability of demand for the firm’s products, variability of the products’ sales prices, and the extent to which operating costs are fixed.




Question 7 1 pts

As a firm’s sales grow its current asset accounts tend to increase. For instance, as sales increase the firm’s inventories increase and its level of accounts payable will increase. Thus, spontaneously generated funds will arise from transaction accounts that increase as sales increase.




Question 8 1 pts An increase in a current asset must be accompanied by a corresponding increase in a current liability.

An increase in a current asset must be accompanied by a corresponding increase in a current liability.




If a firm takes actions that reduce its days sales outstanding (DSO), then, other things held constant, this will lengthen its cash conversion cycle (CCC).




Suppose the RiskFree Rate is 8%, the Expected Return this year on the S&P 500 stock market index is 13%, and the stock of Joe’s Junkyard has a Beta of 1.4. Given these conditions what is the required rate of return for Joe’s stock?






To raise money to finance the capital budget projects you’ve been evaluating, your firm plans to borrow money at an interest rate of 14%, before-tax. If your firm’s effective tax rate is 40%, what is the aftertax cost in percent of the new loan?







Here is a condensed version of your firm’s balance sheet:

Total liabilities………………$30,000,000

Preferred stock…………….$10,000,000

Common Stock…………….$60,000,000

Total assets…$100,000,000 Total liabilities & equity…$100,000,000

If your firm’s aftertax cost of debt is 6%, the cost of preferred stock is 10%, and the cost of common stock is 11%, what is the Weighted Average Cost of Capital (WACC)?




Some other value .


Michigan Mattress Company is considering the purchase of land and the construction of a new plant. The land, which would be bought immediately (at t = 0), has a cost of $100,000 and the building, which would be erected at the end of the first year (t = 1), would cost $500,000. It is estimated that the firm’s after-tax cash flow will be $100,000 starting at the end of the second year, and that this incremental inflow would increase at a 10 percent rate annually over the next 10 years. What is the approximate payback period?

two years

four years

six years

eight years

ten years


Lloyd Enterprises has a project which has the following cash flows:

Year Cash Flow

0 -$200,000
1 50,000
2 100,000
3 150,000
4 40,000
5 25,000

The cost of capital is 10 percent. What is the project’s discounted payback?

Sometime in the first year

Sometime in the second year

Sometime in the third year

Sometime in the fourth year

Sometime in the fifth year


Which of the following events is likely to encourage a company to raise its target debt ratio?

An increase in the corporate tax rate.

An increase in the personal tax rate.

An increase in the company’s operating leverage.


Question 16 2 pts

A firm can use retained earnings without paying a flotation cost. Therefore, while the cost of retained earnings is not zero, the cost of retained earnings is generally lower than the after-tax cost of debt financing.

The capital structure that minimizes the firm’s cost of capital is also the capital structure that maximizes the firm’s stock price.

The capital structure that minimizes the firm’s cost of capital is also the capital structure that maximizes the firm’s earnings per share.

If a firm finds that the cost of debt financing is currently less than the cost of equity financing, an increase in its debt ratio will always reduce its cost of capital.


Enterprises has total assets of $300 million and EBIT of $45 million. The company currently has no debt in its capital structure. The company is contemplating a recapitalization where it will issue debt at 10 percent and use the proceeds to buy back shares of the company’s common stock. If the company proceeds with the recapitalization, its operating income, total assets, and tax rate will remain the same. Which of the following will occur as a result of the recapitalization?

The company’s ROA and ROE will increase

The company’s ROA and ROE will decrease.

The company’s ROA will decrease and ROE will increase

The company’s ROA will increase and ROE will decrease

Can’t tell without knowing more information.

If you constructed a set of pro forma financial statements for 2014 and found that projected Total Assets exceeded projected Total Liabilities and Equity by $11,250, you would know that:

your forecasting method is inaccurate

your forecasting assumptions or calculations must be in error, because projected Assets and projected Liabilities and Equity must always balance

you must arrange for $11,250 in additional financing

your firm will have $11,250 of excess funds available in 2014


Considering each action independently and holding other things constant, which of the following actions would reduce a firm’s need for additional capital?

An increase in the dividend payout ratio.

A decrease in the profit margin.

A decrease in the days sales outstanding.

An increase in expected sales growth.

Consider the following condensed Income Statement:






Gross Profit


Sales growth in 2014 is expected to be 15%

If COGS is assumed to vary directly with sales, then Gross Profit for 2014 will be:






Kenney Corporation recently reported the following income statement for 2013 (numbers are in millions of dollars):



Total operating costs






Earnings before tax (EBT)


Taxes (40%)


Net income available to common shareholders


The company forecasts that its sales will increase by 10 percent in 2014 and its operating costs will increase in proportion to sales. The company’s interest expense is expected to remain at $200 million, and the tax rate will remain at 40 percent. The company plans to pay out 50 percent of its net income as dividends, the other 50 percent will be additions to retained earnings. What is the forecasted addition to retained earnings for 2014?







Question 22 2 pts Other things held constant, which of the following will cause an increase in net working capital?

Cash is used to buy marketable securities

A cash dividend is declared and paid

Merchandise is sold at a profit, but the sale is on credit

Long-term bonds are retired with the proceeds of a preferred stock issue

Missing inventory is written off against retained earnings


Paul Stone can get 3/15, net 65 from his suppliers. Paul would like to delay paying the suppliers as long as possible because his cash account balance is very low, but his Dad, a famous financial expert, recommends that he borrow from his local bank at 10% and pay early to take advantage of the discount. Which of the following should Paul do?

Pay within 15 days, borrowing from the bank, if necessary, to get the money.

Pay on the 16th day

Pay on the 65th day

Send a hit man after his Dad


Stone’s Stones and Rocks buys on terms of 2/10, net 30 from its suppliers. If it pays on the 8th day, taking the discount, what is the percent cost of the trade credit that it receives?





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