MANAGERIAL FINANCE: FIN 350
Spring Semester 2019
Chapter Nine: The Cost of Capital
Chapter Twelve: Leverage and Capital Structure (pages as listed on course syllabus)
Chapter Ten: Capital Budgeting Techniques
Instructions: You may complete the Assignment by typing in the answers of your choice into the Microsoft Word
file. Thank you!
A. TRUE / FALSE QUESTIONS
Enter “True” or “False” on the blank preceding each question.
______ 1. In general, a firm should invest only in projects that have a rate of return that is lower than the
firm’s cost of capital.
______ 2. The firm’s cost of capital is measured on a pre-tax basis.
______ 3. Typically, the after-tax cost of long-term debt for a firm is greater than the cost of preferred
stock or common stock.
______ 4. There are two forms of common stock financing for a firm: 1) Retained Earnings; and
2) new issues of common stock.
______ 5. A firm’s “Weighted Average Cost of Capital” (WACC) typically increases as the volume
of new capital raised within a given time period increases.
______ 6. Breakeven analysis is used to determine the level of operations necessary to cover
all operating costs.
______ 7. An increase in either the firm’s fixed costs (FC) or its variable costs (VC) will cause the
firm’s operating breakeven point (OBP) in “units” to decrease.
______ 8. In general, non-U.S. companies have much higher levels of indebtedness than do
firms headquartered in the U.S.
______ 9. ABC Company, Inc. is considering two “independent” capital budgeting projects. If the firm
accepts one of these independent projects, then the other independent project will be eliminated
______ 10. The “Net Present Value” (NPV) capital budgeting method measures how long (in years and months)
that it takes to recover a project’s initial investment, based on the project’s cash inflows.
______ 11. If a project’s payback period is greater than the maximum acceptable payback period, then
the project should be accepted.
______ 12. A weakness of the “payback period” capital budgeting method is that the appropriate or
maximum payback period is a subjectively determined value.
______ 13. When using the “Net Present Value” (NPV) method of capital budgeting analysis, a firm will
undertake a given project only if the present value of the cash flows generated by the
investment is less than the initial cost of the investment at t = 0.
______ 14. In “Net Present Value” (NPV) analysis, the discount rate or interest rate used to discount the project’s
cash flows back to the present time is the minimum return that must be earned on a project to
satisfy the firm’s investors.
______ 15. When using the “Profitability Index” (PI) analysis method, the decision rule is to invest in a
project that has a Profitability Index value less than 1.0 .
B. MULTIPLE CHOICE QUESTIONS
For each question, enter the letter of the best response on the blank preceding the question.
______ 16. The process of evaluating and selecting long-term investments for the firm is known as
______ 17. Each of the following is a typical source of long-term capital for a firm EXCEPT
______ 18. When calculating a firm’s “Weighted Average Cost of Capital” (WACC), the cost of each type
of capital is weighted by
the firm’s beta value.
the current inflation rate in the economy.
the bank’s prime lending rate.
its proportion in the firm’s capital structure.
______ 19. The “weights” in the “Weighted Average Cost of Capital” (WACC) formula
must sum to 1.0 or 100%.
must be non-negative.
must include at least three different types of financing.
A and B and C.
A and B.
______ 20. __________________ results from the use of fixed-cost assets or fixed-cost funds to magnify the
returns to the firm’s owners.
The Co-efficient of Variation (CV)
______ 21. At the “Operating Breakeven Point” (OBP),
“Operating Profit” (EBIT) is equal to zero.
“Gross Profit” equals “Net Profit.”
“Total Assets” equals “Total Sales Revenue.”
“Debt” financing equals “Equity” financing.
______ 22. _______________ costs vary directly with the level of “Sales” and are a function of volume,
rather than time.
______ 23. Each of the following is an example of a “fixed” cost for a manufacturing firm EXCEPT
“Rent Expense” for the distribution warehouse.
“Property Tax Expense” for the corporate office.
“Insurance Expense” for the firm’s fleet of semi trucks.
“Shipping Cost” for products sold to the customers.
______ 24. Each of the following is a possible source of equity financing for a corporation EXCEPT
______ 25. A(n) ____________________ expenditure is an outlay made by a firm that is expected to
produce benefits within one year.
______ 26. For “independent” capital budgeting projects,
accepting one project does not eliminate the other projects from consideration.
each project has cash flows that are unrelated to one another.
if one project is done, then the other project must be done, also.
A and B and C.
A and B.
______ 27. A firm that needs increased production capacity could obtain it by
A. expanding its current manufacturing plant.
B. acquiring another company that has suitable manufacturing facilities for the
products which the acquiring firm wishes to have made.
C. contracting with an outsider firm to manufacture the needed products
D. A and/or B and/or C.
E. A and/or B.
______ 28. Typically, firms operate under _____________________, with only a specified
amount of funds (i.e., a finite amount) available for capital expenditures in a given year.
parallel investment cycles
______ 29. Each of the following is an advantage or benefit of using the payback period method to
analyze a capital budgeting decision EXCEPT
it is a simple and intuitive method.
it explicitly takes into account the “time value of money” in its calculations.
it considers cash flows, rather than accounting profits.
it is easy to use as a supplement or in conjunction with other capital budgeting methods.
______ 30. Seymore Distribution, Inc. is considering the purchase of one new semi tractor.
Option A has a “Net Present Value” (NPV) of $10,599; Option B has a NPV of $15,100.
With Option A and Option B being mutually exclusive, the firm should choose _________,
as this choice will add more value to the firm.
both Option A and Option B
neither Option A nor Option B
C. CALCULATION SECTION
Instructions: In this section, please show all calculations. Partial credit will be given wherever possible,
when your calculations are shown and they are completed correctly.
31.—33. A firm is evaluating a capital budgeting proposal which has an initial investment at t = 0 of $55,000.
This project has the following has inflows: $20,000 in Year 1; $25,000 in Year 2; and $12,000
in Year 3. What is the payback period for this project?
34.—39. Assume that you are a financial analyst for Tangshan Mining Company and are given the following
information about the firm’s new project: the project’s initial after-tax cost at t = 0 is $8,000,000 and
the project is expected to provide after-tax operating cash inflows as follows:
a. Calculate the payback period for this project.
1. If the maximum acceptable payback period is 3 years, should this project be accepted? Why or
b. Assume that the firm’s “Weighted Average Cost of Capital” (WACC) is 6%. Calculate the
“Net Present Value” (NPV) for the above project.
1. Based on your NPV calculations above, should this project be accepted? Why or why not?
40.—41. Calculate the after-tax cost of debt for a firm, which has a 21% marginal tax rate and a pre-tax cost of
debt of 7%.
42.—43. A firm has a beta of 1.5. The market return equals 9% and the risk-free rate of return equals
4%. Calculate the estimated cost of common-stock equity funding.
44.—45. Smith Electronics, Inc. has determined its cost of each source of capital and its optimal capital
structure, which is composed of the following sources and target market value proportions:
Source of Capital
Common Stock Equity
Target Market Proportions
Calculate the “Weighted Average Cost of Capital” (WACC) for Smith Electronics using the information
46.—49. Wheaten Enterprises, Inc. has fixed operating costs of $125,000; the selling price per unit of
its product is $175, and its variable cost per unit for this product is $100.
a. Calculate the firm’s operating breakeven point in units.
b. What is the firm’s breakeven point in sales dollars?
50. American Apparel, Inc. has fixed annual operating costs of $325,000. The average selling price per
unit is $45.00 and the variable cost per unit is $34.00. Based on this information, calculate the
breakeven sales level in units.
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