Exam4 Spring2011

Topics: Net present value, Corporate finance, Internal rate of return Pages: 10 (3006 words) Published: November 15, 2014
Fourth Examination – Finance 3320 – Spring 2011 (Moore)

R-Number:____________________Printed Name:____________________

Ethical conduct is an important component of any profession. The Texas Tech University Code of Student Conduct is in force during this exam. Students providing or accepting unauthorized assistance will be assigned a score of zero (0) for this piece of assessment. Using unauthorized materials during the exam will result in the same penalty. Ours’ should be a self-monitoring profession. It is the obligation of all students to report violations of the honor code in this course. By signing below, you are acknowledging that you have read the above statement and agree to abide by the stipulated terms.

Student’s Signature:______________________________

Clearly Fill in the appropriate bubble on the Scantron form for each of the following questions. Choose the BEST response. There is only one answer per question.

1.Schalheim Sisters Inc. has always paid out all of its earnings as dividends, hence the firm has no retained earnings. This same situation is expected to persist in the future. The company uses the CAPM to calculate its cost of equity, its target capital structure consists of common stock, preferred stock, and debt. Which of the following events would REDUCE its WACC? a.The market risk premium declines.

b.The flotation costs associated with issuing new common stock increase. c.The company’s beta increases.
d.Expected inflation increases.
e.The flotation costs associated with issuing preferred stock increase.

2.Duval Inc. uses only equity capital, and it has two equally-sized divisions. Division A’s cost of capital is 10.0%, Division B’s cost is 14.0%, and the corporate (composite) WACC is 12.0%. All of Division A’s projects are equally risky, as are all of Division B's projects. However, the projects of Division A are less risky than those of Division B. Which of the following projects should the firm accept?

a.A Division B project with a 13% return.
b.A Division B project with a 12% return.
c.A Division A project with an 11% return.
d.A Division A project with a 9% return.
e.A Division B project with an 11% return.

3.Which of the following statements is CORRECT?

a.When calculating the cost of preferred stock, a company needs to adjust for taxes, because preferred stock dividends are deductible by the paying corporation. b.All else equal, an increase in a company’s stock price will increase its marginal cost of retained earnings, rs. c.All else equal, an increase in a company’s stock price will increase its marginal cost of new common equity, re. d.Since the money is readily available, the after-tax cost of retained earnings is usually much lower than the after-tax cost of debt. e.If a company’s tax rate increases but the YTM on its noncallable bonds remains the same, the after-tax cost of its debt will fall.

4.Which of the following statements is CORRECT?
a.Since debt capital can cause a company to go bankrupt but equity capital cannot, debt is riskier than equity, and thus the after-tax cost of debt is always greater than the cost of equity. b.The tax-adjusted cost of debt is always greater than the interest rate on debt, provided the company does in fact pay taxes. c.If a company assigns the same cost of capital to all of its projects regardless of each project’s risk, then the company is likely to reject some safe projects that it actually should accept and to accept some risky projects that it should reject. d.Because no flotation costs are required to obtain capital as retained earnings, the cost of retained earnings is generally lower than the after-tax cost of debt. e.Higher flotation costs tend to reduce the cost of equity capital.

5.A company’s perpetual preferred stock currently sells for $92.50 per share, and it pays an $8.00 annual dividend. If the company were to sell a new preferred issue, it would...
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