"True/False The component costs of capital are market-determined variables in the sense that they are based on investors' required returns. ____ 2.

"True/FalseThe component costs of capital are market-determined variables in the sense that they are based on investors' required returns.____ 2. The before-tax cost of debt, which is lower than the after-tax cost, is used as the component cost of debt for purposes of developing the firm's WACC.____ 3. The cost of preferred stock to a firm must be adjusted to an after-tax figure because 70% of dividends received by a corporation may be excluded from the receiving corporation's taxable income.____ 4. The cost of common equity obtained by retaining earnings is the rate of return the marginal stockholder requires on the firm's common stock.____ 5. The cost of equity raised by retaining earnings can be less than, equal to, or greater than the cost of external equity raised by selling new issues of common stock, depending on tax rates, flotation costs, the attitude of investors, and other factors.____ 6. The firm's cost of external equity raised by issuing new stock is the same as the required rate of return on the firm's outstanding common stock.____ 7. For capital budgeting and cost of capital purposes, the firm should assume that each dollar of capital is obtained in accordance with its target capital structure, which for many firms means partly as debt, partly as preferred stock, and partly common equity.____ 8. Suppose the debt ratio (D/TA) is 50%, the interest rate on new debt is 8%, the current cost of equity is 16%, and the tax rate is 40%. An increase in the debt ratio to 60% would have to decrease the weighted average cost of capital (WACC).____ 9. Cost of equity = Since 70% of the preferred dividends received by a corporation are excluded from taxable income, the component cost of equity for a company that pays half of its earnings out as common dividends and half as preferred dividends should, theoretically, bers(0.30)(0.50) + rps(1 - T)(0.70)(0.50).____ 10. Conflicts between two mutually exclusive projects occasionally occur, where the NPV method ranks one project higher but the IRR method puts the other one first. In theory, such conflicts should be resolved in favor of the project with the higher IRR.____ 11. The internal rate of return is that discount rate that equates the present value of the cash outflows (or costs) with the present value of the cash inflows.____ 12. Under certain conditions, a project may have more than one IRR. One such condition is when, in addition to the initial investment at time = 0, a negative cash flow (or cost) occurs at the end of the project's life.____ 13. The NPV method's assumption that cash inflows are reinvested at the cost of capital is generally more reasonable than the IRR's assumption that cash flows are reinvested at the IRR. This is an important reason why the NPV method is generally preferred over the IRR method.____ 14. Both the regular and the modified IRR (MIRR) methods have wide appeal to professors, but most business executives prefer the NPV method to either of the IRR methods.____ 15. The primary reason that the NPV method is conceptually superior to the IRR method for evaluating mutually exclusive investments is that multiple IRRs may exist, and when that happens, we don't know which IRR is relevant.____ 16. The NPV and IRR methods, when used to evaluate two independent and equally risky projects, will lead to different accept/reject decisions and thus capital budgets if the projects' IRRs are greater than their cost of capital.____ 17. The regular payback method is deficient in that it does not take account of cash flows beyond the payback period. The discounted payback method corrects this fault.____ 18. Small businesses make less use of DCF capital budgeting techniques than large businesses. This may reflect a lack of knowledge on the part of small firms' managers, but it may also reflect a rational conclusion that the costs of using DCF analysis outweigh the benefits of these methods for very small firms.____ 19. An increase in the firm's WACC will decrease projects' NPVs, which could change the accept/reject decision for any potential project. However, such a change would have no impact on projects' IRRs. Therefore, the accept/reject decision under the IRR method is independent of the cost of capital.____ 20. Normal Projects S and L have the same NPV when the discount rate is zero. However, Project S's cash flows come in faster than those of L. Therefore, we know that at any discount rate greater than zero, L will have the higher NPV.Multiple ChoiceFor a typical firm, which of the following sequences is CORRECT? All rates are after taxes, and assume that the firm operates at its target capital structure.a.rs> re > rd > WACC. b.re > rs > WACC > rd. c.WACC > re > rs > rd. d.rd> re > rs > WACC. e.WACC > rd > rs > re. ____ 22. When working with the CAPM, which of the following factors can be determined with the most precision?a.The market risk premium (RPM). b.The beta coefficient, b, of a relatively safe stock.c.The most appropriate risk-free rate, rRF. d.The expected rate of return on the market, r.e.The beta coefficient of "the market," which is the same as the beta of an average stock.____ 23. 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.____ 24. Norris Enterprises, an all-equity firm, has a beta of 2.0. The chief financial officer is evaluating a project with an expected return of 14%, before any risk adjustment. The risk-free rate is 5%, and the market risk premium is 4%. The project being evaluated is riskier than an average project, in terms of both its beta risk and its total risk. Which of the following statements is CORRECT?a.The project should definitely be accepted because its expected return (before any risk adjustments) is greater than its required return.b.The project should definitely be rejected because its expected return (before risk adjustment) is less than its required return.c.Riskier-than-average projects should have their expected returns increased to reflect their higher risk. Clearly, this would make the project acceptable regardless of the amount of the adjustment.d.The accept/reject decision depends on the firm's risk-adjustment policy. If Norris' policy is to increase the required return on a riskier-than-average project to 3% over rs, then it should reject the project. e.Capital budgeting projects should be evaluated solely on the basis of their total risk. Thus, insufficient information has been provided to make the accept/reject decision.____ 25. Which of the following statements is CORRECT?a.In the WACC calculation, we must adjust the cost of preferred stock (the market yield) to reflect the fact that 70% of the dividends received by corporate investors are excluded from their taxable income.b.We should use historical measures of the component costs from prior financings that are still outstanding when estimating a company's WACC for capital budgeting purposes.c.The cost of new equity (re) could possibly be lower than the cost of retained earnings (rs) if the market risk premium, risk-free rate, and the company's beta all decline by a sufficiently large amount. d.Its cost of retained earnings is the rate of return stockholders require on a firm's common stock.e.The component cost of preferred stock is expressed as rp(1 - T), because preferred stock dividends are treated as fixed charges, similar to the treatment of interest on debt. ____ 26. O'Brien Inc. has the following data: rRF = 5.00%; RPM = 6.00%; and b = 1.10. What is the firm's cost of equity from retained earnings based on the CAPM?a.11.83%b.13.22%c.11.25%d.8.93%e.11.60%____ 27. Assume that Kish Inc. hired you as a consultant to help estimate its cost of capital. You have obtained the following data: D0= $0.90; P0 = $30.00; and g = 7.00% (constant). Based on the DCF approach, what is the cost of equity from retained earnings?a.9.60%b.7.66%c.11.33%d.8.37%e.10.21%____ 28. Sapp Trucking's balance sheet shows a total of noncallable $45 million long-term debt with a coupon rate of 7.00% and a yield to maturity of 6.00%. This debt currently has a market value of $50 million. The balance sheet also shows that the company has 10 million shares of common stock, and the book value of the common equity (common stock plus retained earnings) is $65 million. The current stock price is $21.00 per share; stockholders' required return, rs, is 14.00%; and the firm's tax rate is 40%. The CFO thinks the WACC should be based on market value weights, but the president thinks book weights are more appropriate. What is the difference between these two WACCs?a.1.74%b.2.07%c.2.25%d.2.23%e.2.16%Assume that you have been hired as a consultant by CGT, a major producer of chemicals and plastics, including plastic grocery bags, styrofoam cups, and fertilizers, to estimate the firm's weighted average cost of capital. The balance sheet and some other information are provided below.AssetsCurrent assets$38,000,000 Net plant, property, and equipment$101,000,000 Total assets$139,000,000 Liabilities and EquityAccounts payable$10,000,000 Accruals$9,000,000 Current liabilities$19,000,000 Long-term debt (40,000 bonds, $1,000 par value)$40,000,000 Total liabilities$59,000,000 Common stock (10,000,000 shares)$30,000,000 Retained earnings$50,000,000 Total shareholders' equity$80,000,000 Total liabilities and shareholders' equity$139,000,000 The stock is currently selling for $15.00 per share, and its noncallable $1,000 par value, 20-year, 7.25% bonds with semiannual payments are selling for $1,150.00. The beta is 1.35, the yield on a 6-month Treasury bill is 3.50%, and the yield on a 20-year Treasury bond is 5.50%. The required return on the stock market is 11.50%, but the market has had an average annual return of 14.50% during the past 5 years. The firm's tax rate is 40%.____ 29. What is the best estimate of the after-tax cost of debt?a.4.15%b.4.47%c.4.11%d.3.57%e.3.65%____ 30. Which of the following statements is CORRECT? Assume that the project being considered has normal cash flows, with one outflow followed by a series of inflows.a.A project's NPV is found by compounding the cash inflows at the IRR to find the terminal value (TV), then discounting the TV at the WACC.b.The lower the WACC used to calculate it, the lower the calculated NPV will be.c.If a project's NPV is less than zero, then its IRR must be less than the WACC.d.If a project's NPV is greater than zero, then its IRR must be less than zero.e.The NPV of a relatively low-risk project should be found using a relatively high WACC.____ 31. Which of the following statements is CORRECT?a.One defect of the IRR method versus the NPV is that the IRR does not take account of cash flows over a project's full life.b.One defect of the IRR method versus the NPV is that the IRR does not take account of the time value of money.c.One defect of the IRR method versus the NPV is that the IRR does not take account of the cost of capital.d.One defect of the IRR method versus the NPV is that the IRR values a dollar received today the same as a dollar that will not be received until some time in the future.e.One defect of the IRR method versus the NPV is that the IRR does not take proper account of differences in the sizes of projects.____ 32. Which of the following statements is CORRECT?a.The shorter a project's payback period, the less desirable the project is normally considered to be by this criterion.b.One drawback of the payback criterion is that this method does not take account of cash flows beyond the payback period.c.If a project's payback is positive, then the project should be accepted because it must have a positive NPV.d.The regular payback ignores cash flows beyond the payback period, but the discounted payback method overcomes this problem.e.One drawback of the discounted payback is that this method does not consider the time value of money, while the regular payback overcomes this drawback.____ 33. Projects S and L both have an initial cost of $10,000, followed by a series of positive cash inflows. Project S's undiscounted net cash flows total $20,000, while L's total undiscounted flows are $30,000. At a WACC of 10%, the two projects have identical NPVs. Which project's NPV is more sensitive to changes in the WACC?a.Project S.b.Project L.c.Both projects are equally sensitive to changes in the WACC since their NPVs are equal at all costs of capital.d.Neither project is sensitive to changes in the discount rate, since both have NPV profiles that are horizontal.e.The solution cannot be determined because the problem gives us no information that can be used to determine the projects' relative IRRs.____ 34. Which of the following statements is CORRECT?a.For a project with normal cash flows, any change in the WACC will change both the NPV and the IRR.b.To find the MIRR, we first compound cash flows at the regular IRR to find the TV, and then we discount the TV at the WACC to find the PV.c.The NPV and IRR methods both assume that cash flows can be reinvested at the WACC. However, the MIRR method assumes reinvestment at the MIRR itself.d.If two projects have the same cost, and if their NPV profiles cross in the upper right quadrant, then the project with the higher IRR probably has more of its cash flows coming in the later years.e.If two projects have the same cost, and if their NPV profiles cross in the upper right quadrant, then the project with the lower IRR probably has more of its cash flows coming in the later years.____ 35. Resnick Inc. is considering a project that has the following cash flow data. What is the project's payback?Year0123Cash flows-$450$200$200$200a.2.39 yearsb.1.94 yearsc.1.71 yearsd.2.25 yearse.2.66 years____ 36. Susmel Inc. is considering a project that has the following cash flow data. What is the project's payback?Year0123Cash flows-$350$150$200$300a.1.98 yearsb.2.00 yearsc.1.50 yearsd.2.46 yearse.1.52 years____ 37. Mansi Inc. is considering a project that has the following cash flow data. What is the project's payback?Year0123Cash flows-$750$300$325$350a.2.19 yearsb.2.36 yearsc.2.69 yearsd.1.93 yearse.2.40 years____ 38. Lasik Vision Inc. recently analyzed the project whose cash flows are shown below. However, before Lasik decided to accept or reject the project, the Federal Reserve took actions that changed interest rates and therefore the firm's WACC. The Fed's action did not affect the forecasted cash flows. By how much did the change in the WACC affect the project's forecasted NPV? Note that a project's projected NPV can be negative, in which case it should be rejected.Old WACC:8.00%New WACC:8.50%Year0123Cash flows-$1,000$410$410$410"