## Question

"For a given level of financial leverage, holding other factors constant, a higher firm overall market risk results in a higher common stock market risk." True or false.

Select one:

a. True

b. False

2.

What is the future value of $50 with an interest rate of 12% compounded continuously for 5 years?

Select one:

a. 86.87

b. 95.21

c. $91.11

d. 88.20

e. 93.65

3.

If you receive a constant payment of $400 at the end of every year forever, what is the present value of this cash flow stream if the interest rate is 12%?

Select one:

a. $3,333.33

b. $2,555.55

c. $1,111.11

d. $4,444.44

4.

"If the tax rate of the firm is lower, the after-tax cost of debt and thus the WACCCOMP are also lower, other things held constant." True or false?

Select one:

a. True

b. False

5.

"Holding investment decision constant, a higher debt ratio raises the risk for the debt, resulting in a higher beta for the debt. However, since the assets are held constant, the beta for the assets is unchanged; therefore, the beta for the equity must be lower." True or false?

Select one:

a. False

b. True

6.

"If a firm issues common stocks to replace an like amount of debt, the debt ratio is lower, which increases the total value of the firm." True or false?

Select one:

a. True

b. False

7.

The company has the following market values of debt and equity:

Market value of debt: $50

Market value of equity: $80

Therefore, the total market value of the assets is $130.

The firm has 10 shares outstanding; therefore, the current price per share is $8. The managers are considering an investment project with in initial cost of 40. They believe that the project should be worth $50. The company announces that it will issue new common stocks to obtain $40. However, due to information asymmetry between the management and the investors, as soon as the firm makes the announcement, investors believe that the firm’s common stock must be overvalued and consequently bid down the price to $8.5 per share. However, the new common stock issuance would increase the total value of equity that lowers the debt ratio. Investors feel that the debt is thus safer than before; therefore, the interest rate for the debt drops and the value increases to $53.

What is the total value of the firm right after the firm completes the stock issuance?

Select one:

a. $172.53

b. $148.00

c. $160.09

d. $156.02

e. $178.00

8.

"If a high percentage of a firm's costs is fixed and hence do not decline when demand falls, the firm has a low operating leverage, which decreases its business risk." True or false?

Select one:

a. False

b. True

9.

What is the expected price of the stock with following information?

Dividend per share just paid: $2

Expected growth rate: 5%

Beta: 1.2

10-year Treasury bond yield: 2%

Market risk premium: 6%

Select one:

a. $52.00

b. $49.00

c. $50.00

d. $51.00

e. $48.00

10.

"The reduction in debt ratio is more valuable to investors if the reduction moves the firm closer to the optimal capital structure than if the reduction moves the firm away from the optimal capital structure." True or false?

Select one:

a. True

b. False

11.

The firm has a debt obligation of 100 due at t=1. The current asset value is 97; that is, the firm is under financial distress. The management believes that the asset value is most likely to remain at 97 at t=1 and the firm would go under. The firm has an investment project at the present time that requires 10 as initial investment. The value of the project has a 70% chance to become 12 (that is, a gain of 2) and a 30% chance to become 9 (that is, a loss of 1). The WACC for the project is 5 percent. What is the expected cash flow at t=1 for debt-holders if the firm undertakes the project?

Select one:

a. $99.8

b. $98.1

c. $-4

d. $97.3

e. $100

12.

"For a given stream of positive cash flows in the future, the higher the discount rate (interest rate), the lower the present value of this stream." True or false?

Select one:

a. False

b. True

13.

The company has the following market values of debt and equity:

Market value of debt: $40

Market value of equity: $60

Therefore, the total market value of the assets is $100.

There are 10 common shares outstanding and the book value of the debt is $40. The management expects the following asset values and their probabilities to occur at time

$130, 60%

$80, 20%

$30, 20%

Assume that the market value of the debt remains at $40 as long as the firm is solvent, that is, as long as at time 1 the firm is able to pay off the debt at the book value of $40.

What is the expected rate of return on the common stock?

Select one:

a. 4.91%

b. 3.33%

c. 2.52%

d. 4.20%

14.

"Under some conditions of the firm, the management may have the incentive to accept a negative-NPV project." True or false?

Select one:

a. False

b. True

15.

"Due to information asymmetry, investor tend to believe that the management would issue common stock only if it is under-priced." True or false?

Select one:

a. True

b. False

16.

Assume that the firm’s optimal debt ratio is 25%. The following required rates of return are estimated based on this debt ratio:

Cost of debt: 8%

Cost of common stock: 16%

If the tax rate is 40%, what is the firm’s weighted average cost of capital?

Select one:

a. 13.2%

b. 11.8%

c. 12.3%

d. 11%

e. 13.9%

17.

"According to the packing order hypothesis, new stock offerings result in an increase in stock price and according to the signalling hypothesis, new stock offerings also result in an increase in stock price." True or false?

Select one:

a. True

b. False

18.

" Holding other factors constant, a higher level of debt increases the firm's interest tax savings and thus increases the net income." True or false?

Select one:

a. True

b. False

19.

What is the NPV of the project with the following cash flows?

Year 0: -$400

Year 1: $200

Year 2: $200

Year 3: $300

The WACC for the project is 11%.

Select one:

a. $176.03

b. $161.86

c. $167.30

d. $157.55

e. $173.90

20.

"Debt-holders bear the default risk; therefore, the cost of debt is always higher than the cost of common stock." True or false?

Select one:

a. True

b. False

21.

The firm has a debt obligation of 100 due at t=1. The current asset value is 97; that is, the firm is under financial distress. The management believes that the asset value is most likely to remain at 97 at t=1 and the firm would go under. The firm has an investment project at the present time that requires 10 as initial investment. The value of the project has a 60% chance to become 17 (that is, a gain of 7) and a 40% chance to become 3 (that is, a loss of 7). The WACC for the project is 20 percent. What is the expected cash flow at t=1 for shareholders if the firm undertakes the project?

Select one:

a. $3.3

b. $1.6

c. $2.0

d. $3.8

e. $2.4

22.

"To reach the optimal trade-off between profitability and risk, the firm must employ the best capital budgeting techniques to select projects such that the projects selected as a whole has the largest internal rate of return (IRR)." True or false?

Select one:

a. False

b. True

23.

"If the firm wants to keep the rating of its bonds at medium grade, that is, between A and BBB, the TIE ratio needs to be at least 5, that is, EBIT is five times of the interest expenses." True or false?

Select one:

a. False

b. True

24.

"In general, unless the firm is already at a high debt ratio, more risky projects and a higher debt ratio increase the firm’s profitability over time, and thus E(D1) and the growth rate g." True or false?

Select one:

a. True

b. False

25.

What is the IRR of the project with the following cash flows?

Year 0: -$400

Year 1: $200

Year 2: $200

Year 3: $300

Select one:

a. 31.45%

b. 35.90%

c. 33.76%

d. 37.32%

26.

What is the true IRR of the project with the following cash flows if the firm would be able to reinvest the cash inflows at a rate of return equal to 8%?

Year 0: -$400

Year 1: $200

Year 2: $200

Year 3: $300

Select one:

a. 19.88%

b. 21.09%

c. 23.27%

d. 25.88%

e. 27.93%

27.

"If the risk of the project is higher than that of the firm as a whole, the cost of equity of the project is lower than that of the firm." True or false?

Select one:

a. True

b. False

28.

"Increasing the debt ratio by issuing new debt to buy back stocks is effectively using cheaper-cost capital to replace higher-cost capital." True or false?

Select one:

a. False

b. True

29.

The company has the following market values of debt and equity:

Market value of debt: $50

Market value of equity: $50

Therefore, the total market value of the assets is $100.

The firm has 10 shares outstanding; therefore, the current price per share is $5. The managers are considering an investment project with an initial cost of 30. They believe that the project should be worth $40. The company announces that it will issue new common stocks to obtain $30. However, due to information asymmetry between the management and the investors, as soon as the firm makes the announcement, investors believe that the firm’s common stock must be overvalued and consequently bid down the price to $4.5 per share. However, the new common stock issuance would increase the total value of equity that lowers the debt ratio. Investors feel that the debt is thus safer than before; therefore, the interest rate for the debt drops and the value increases to $57.

Sometime later, if investors recognize $95 as the true value of the firm’s original assets and $40 as the true value of the project, what would the rate of return for the new stockholders be? Assume that the value of debt stays at $57.

Select one:

a. 5.54%

b. 7.51%

c. $4.00%

d. 4.83%

e. 6.67%

30.

YYI Company has an investment project at the present time that requires 10 as initial investment. The value of the project has a 50% chance to become 17 (that is, a gain of 7) and equal chance to become 2 (that is, a loss of 8) at time 1. The WACC for the project is 20 percent. What is the NPV of the project?

Select one:

a. $3.21

b. -$3.28

c. -$3.77

d. $2.67

e. -$2.08

31.

"The reduction of debt ratio, regardless the original level of debt, transfer wealth from stockholders to debt-holders, holding other factors constant." True or false?

Select one:

a. False

b. True

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