Q26. A bakery company is considering one capital budgeting project involving the replacement of a sophisticated brick oven, and another capital

Q26. A bakery company is considering one capital budgeting project involving the replacement of a sophisticated brick oven, and another capital budgeting project involving research and development into synthetic food substitutes. Which of the following statements is MOST correct concerning the risk-adjusted discount rate(s) for the projects?

   a. The rate will likely be higher for the replacement project because the likelihood of success is higher.

   b. The rate will likely be higher for the research and development project because of the uncertainty involved with research and development projects.

   c. The rate should be the same for both projects because they are being considered by one company with the same common shareholders.

   d. The rate should be higher for the replacement project because the company is more certain of the returns from a project similar to their existing business.

Q27. If bankruptcy costs and/or shareholder under diversification are an issue, what measure of risk is relevant when evaluating project risk in capital budgeting?

   a. total project risk

   b. contribution-to-firm risk

   c. systematic risk

   d. capital rationing risk

Q28. Which of the following should be included in the initial outlay?

   a. taxable gain on the sale of old equipment being replaced

   b. first year depreciation expense on any new equipment purchased

   c. preexisting firm overhead reallocated to the new project

   d. increased investment in inventory and accounts receivable

Q29. If depreciation expense in year one of a project increases for a highly profitable company

   a. net income decreases and incremental free cash flow decreases.

   b. net income increases and incremental free cash flow increases.

   c. the book value of the depreciating asset increases at the end of year one.

   d. net income decreases and incremental free cash flow increases.

Q30. Accounting profits, adjusted for taxes and differences in accounting methods, provide the best measure of relevant cash flows for capital budgeting purposes.

   a. True

   b. False

Q31. The primary weakness of EBIT-EPS analysis is that

   a. it ignores the implicit cost of debt financing.

   b. it double counts the cost of debt financing.

   c. it applies only to firms with large amounts of debt in their capital structure.

   d. it may only be used by firms that are profitable this year.

Q32. A high degree of variability in a firm's earnings before interest and taxes refers to

   a. business risk.

   b. financial risk.

   c. financial leverage.

   d. operating leverage.

Q33. A Bristal Boats, Inc. reports sales of $4,000,000, variable costs of $500,000, fixed operating costs of $1,250,000, and interest expense of $350,000. The corporation's EBIT is $3,250,000 and its marginal tax rate is 30%. If the corporation is able to increase its sales by 25%, then

   a. its EBIT will increase by 25% and its EPS will increase by 25%.

   b. its EBIT will increase by more than 25% and its EPS will increase by less than 25%.

   c. its EBIT and EPS will both increase, but less than 25% due to fixed costs and taxes.

   d. its EBIT will increase by more than 25% and its EPS will increase by more than the percentage increase in EBIT.

Q34. Kohler Manufacturing typically achieves one of three production levels in any given year: 8 million pounds of steel, 10 million pounds of steel, or 16 million pounds of steel. In tracking some of its costs, Kohler's controller discovered one cost that was $10 per pound at a production level of 8 million pounds, $8 per pound at a production level of 10 million pounds, and $5 per pound at a production level of 16 million pounds. This is an example of a

   a. variable cost.

   b. fixed cost.

   c. semivariable cost.

   d. semifixed cost.

Q35. Dakota Oil, Inc. reported that its sales and EBIT increased by 10%, but its EPS increased by 30%. The much larger change in earnings per share could be the result of

   a. high operating leverage.

   b. high financial leverage.

   c. a high percentage of credit sale collections from prior years.

   d. high fixed costs of production.

Q36. Financial leverage is distinct from operating leverage since it accounts for

   a. use of debt and preferred stock.

   b. variability in fixed operating costs.

   c. variability in sales.

   d. changes in EBIT.

Q37. The "threat hypothesis"

   a. reduces management's tendency to spend freely.

   b. encourages management to use debt to further their own interests.

   c. increases the agency problem.

   d. increases agency monitoring costs.

Q38. Raising funds internally is effectively increasing the investment of the firm's existing common shareholders.

   a. True

   b. False

Q39. Optimal capital structure is

   a. the mix of permanent sources of funds used by the firm in a manner that will maximize the company's common stock price.

   b. the mix of all items that appear on the right-hand side of the company's balance sheet.

   c. the mix of funds that will minimize the firm's cost of equity capital.

   d. the mix of funds that will maximize the firm's interest tax shield.

Q40. Which of the following is a fixed cost?

   a. insurance

   b. direct material

   c. direct labor

   d. freight costs on products

Q41. According to the clientele effect

   a. companies should have dividend payout ratios of either 100% or 0%.

   b. companies should avoid making capricious changes in their dividend policies.

   c. companies should change their dividend policies to please their target group of investors.

   d. even if capital markets are perfect, dividend policy still matters.

Q42. Which of the following strategies may be used to alter a firm's capital structure toward a higher percentage of debt compared to equity?

   a. stock dividend

   b. stock split

   c. maintain a low dividend payout ratio

   d. stock repurchase

Q43. Concentric Corporation has 10 million shares of stock outstanding. Concentric's after-tax profits are $140 million and the corporation's stock is selling at a price-earnings multiple of 18, for a stock price of $252 per share. Concentric's management issues a 40% stock dividend. What is the effect on an investor who owns 100 shares of Concentric before the dividend if Concentric's price-earnings multiple remains the same after the dividend is paid?

   a. The investor will own 140 shares worth $25,200.

   b. The investor will own 140 shares worth $35,280.

   c. The investor will own 100 shares worth $25,200.

   d. The investor will own 100 shares worth $35,280.

Q44. A firm that maintains a "stable dollar dividend per share" will generally not increase the dividend unless

   a. a stock split occurs.

   b. the firm merges with another profitable firm.

   c. the firm is sure that a higher dividend level can be maintained.

   d. the P/E ratio has increased steadily over the past 5 years.

Q45. A corporation announces a significant increase in its annual dividend and its stock price increases on the news. This could be explained most directly by

   a. residual dividend theory.

   b. bird-in-the-hand theory.

   c. perfect capital markets.

   d. MM"s indifference theorem.

Q46. Which of the following will result from a stock repurchase?

   a. Earnings per share will rise.

   b. Number of shares will increase.

   c. Corporate cash is conserved.

   d. Ownership is diluted.

Q47. The problem with the constant dividend payout ratio is

   a. investors may come to expect a specified amount.

   b. the dollar amount of the dividend fluctuates from year to year.

   c. management is reluctant to cut the dividend even if there are low profits that year.

   d. management cannot decrease the dividend when times are tough.

Q48. Which of the following factors would most likely be present if a company increases its dividend payout ratio significantly?

   a. a high debt/equity ratio (i.e), use of a large amount of financial leverage.

   b. a quick ratio that is significantly below the industry average

   c. current shareholders cannot participate in a new offering and desire to maintain ownership control

   d. the variability of expected future earnings decreases

Q49. According to the perfect markets approach to dividend policy

   a. other things equal, the greater the payout ratio, the greater the share price of the firm.

   b. the price of a share of stock is unrelated to dividend policy.

   c. the firm should retain earnings so stockholders will receive a capital gain.

   d. the firm should pay a dividend only after current equity financing needs have been met.

Q50. The difference between the capital gains tax rate and the income tax rate is an incentive for

   a. firms never to split their stock.

   b. firms to declare more stock dividends.

   c. firms to pay more earnings as dividends.

   d. firms to retain more earnings.