Finance Multiple Choice Questions
Subject: Business / Finance
1.(TCO D) A stock just paid a dividend of D0 = $1.50. The required rate of return is rs = 10.1%, and the constant growth rate is g = 4.0%. What is the current stock price? (Points : 10)
2.(TCO D) If D1 = $1.25, g (which is constant) = 5.5%, and P0 = $44, what is the stock’s expected total return for the coming year? (Points : 10)
3.(TCO D) Molen Inc. has an outstanding issue of perpetual preferred stock with an annual dividend of $7.50 per share. If the required return on this preferred stock is 6.5%, at what price should the preferred stock sell? (Points : 10)
4.(TCO E) Which of the following is NOT a capital component when calculating the weighted average cost of capital (WACC) for use in capital budgeting? (Points : 10)
5.(TCO E) The MacMillen Company has equal amounts of low-risk, average-risk, and high-risk projects. The firm’s overall WACC is 12%. The CFO believes that this is the correct WACC for the company’s average-risk projects, but that a lower rate should be used for lower-risk projects and a higher rate for higher-risk projects. The CEO disagrees, on the grounds that even though projects have different risks, the WACC used to evaluate each project should be the same because the company obtains capital for all projects from the same sources. If the CEO’s position is accepted, what is likely to happen over time?(Points : 10)
The company will take on too many high-risk projects and reject too many low-risk projects.
The company will take on too many low-risk projects and reject too many high-risk projects.
Things will generally even out over time, and, therefore, the firm’s risk should remain constant over time.
The company’s overall WACC should decrease over time because its stock price should be increasing.
The CEO’s recommendation would maximize the firm’s intrinsic value.
6.(TCO D) Scanlon Inc.’s CFO hired you as a consultant to help her estimate the cost of capital. You have been provided with the following data: rRF = 4.10%; RPM = 5.25%; and b = 1.30. Based on the CAPM approach, what is the cost of common from retained earnings? (Points : 10)
7.(TCO F) Cornell Enterprises is considering a project that has the following cash flow and WACC data. What is the project’s NPV? Note that a project’s expected NPV can be negative, in which case it will be rejected.
Year 0 1 2 3
Cash flows -$1,050 $450 $460 $470 (Points : 10)
8.(TCO F) Maxwell Feed & Seed is considering a project that has the following cash flow data. What is the project’s IRR? Note that a project’s IRR can be less than the WACC (and even negative), in which case it will be rejected.
Year 0 1 2 3 4 5
Cash flows -$9,500 $2,000 $2,025 $2,050 $2,075 $2,100 (Points : 10)
9.(TCO F) Fernando Designs is considering a project that has the following cash flow and WACC data. What is the project’s discounted payback?
Year 0 1 2 3
Cash flows -$900 $500 $500 $500 (Points : 10)
10.(TCO H) TexMex Food Company is considering a new salsa whose data are shown below. The equipment to be used would be depreciated by the straight-line method over its three-year life and would have a zero salvage value, and no new working capital would be required. Revenues and other operating costs are expected to be constant over the project’s three-year life. However, this project would compete with other TexMex products and would reduce their pre-tax annual cash flows. What is the project’s NPV? (Hint: Cash flows are constant in years 1-3.)
Pre-tax cash flow reduction for other products (cannibalization)
Investment cost (depreciable basis)
Straight-line deprec. rate
Sales revenues, each year for three years
Annual operating costs (excl. deprec.)