Chapter 15 Multiple Choice Quiz

. The process of planning expenditures that will influence the operation of a firm over a number of years is called

A. investment.

B. capital budgeting.

C. net present valuation.

D. dividend valuation.

. Which of the following is not an example of a capital investment project?

A. Replacement of worn out equipment

B. Expansion of production facilities

C. Development of employee training programs

D. All of the above are examples of capital investment projects.

. A firm is considering three investment projects which we will refer to as A, B, and C. Each project has an initial cost of $10 million. Investment A offers an expected rate of return of 16%, B of 8%, and C of 12%. The firm's cost of capital is 6% if it borrows $10 million, 10% if it borrows $20 million, and 15% if it borrows $30 million. Which project(s) should the firm invest in?

A. Just A, because it offers the highest rate of return and is the only investment that has a rate of return higher than 15%

B. All three should be undertaken, because the rate of return on B is above 6%, on C is above 10%, and on A is above 15%.

C. Only A and C should be undertaken because both have rates of return that are greater than 10%.

D. None of the above is correct.

. Which of the following is not an appropriate way to measure cash flows?

A. Treat depreciation as a negative cash flow

B. Consider only incremental costs and revenues

C. Consider only after-tax cash flows

D. All of the above are appropriate ways to measure cash flows.

. The net present value of a project is equal to

A. the present value of all net cash flows that result from the project.

B. the present value of all revenues minus the present value of all costs that result from the project.

C. the present value of all future net cash flows that result from the project minus the initial investment required to start the project.

D. All of the above are correct.

. The net present value method and the internal rate of return method will always yield the same decision when

A. a single project is evaluated.

B. mutually exclusive projects are evaluated.

C. a limited number of projects must be selected from a large number of opportunities.

D. All of the above are correct.

. Which of the following is not a form of capital as the term is used in economics?

A. Houses owned by individuals

B. Factories owned by businesses

C. Education

D. Money

. In cases where capital must be rationed, a firm should rank projects according to their

A. net present values.

B. internal rates of return.

C. profitability indexes.

D. external rates of return.

. Which of the following is an internal source of investment funding?

A. Issuing bonds

B. Sale of stocks

C. Undistributed profits

D. All of the above are internal sources.

. A firm can borrow at an interest rate of 10%. Its marginal tax rate is 40%. What is its cost of debt?

A. 10%

B. 14%

C. 6%

D. None of the above is correct.

. The method of raising funds for capital investment that involves the greatest risk to the firm is

A. borrowing by selling bonds.

B. relying on retained profits.

C. issuing common stock.

D. raising the dividend rate.

. Which of the following sources of funds for capital investment involves a tax adjustment to determine the cost of capital?

A. Retained profits

B. Issuing debt

C. Issuing common stock

D. All of the above involve a tax adjustment.

. Assume that the risk-free interest rate is 6% and that a firm can issue bonds at an interest rate of 9%. Assume further that the difference between the average yield on stocks and the average yield on corporate bonds is 4%. What is the risk premium associated with the firm's cost of equity capital?

A. 15%

B. 13%

C. 7%

D. 4%

. Assume that investors require a rate of return of 10% to invest in a firm that pays a dividend of $2 per year. The price of the firm's stock is currently based on the assumption that the firm's dividend will remain constant. By how much will the price of the firm's stock increase if the firm begins to grow at a rate of 2% per year and is expected to continue to do so indefinitely?

A. $25

B. $20

C. $10

D. $5

. The beta coefficient is associated with

A. the capital asset pricing model.

B. the dividend valuation model.

C. the risk-free rate plus premium model.

D. the tax-adjusted cost of debt.

. Assume that the risk-free rate is 5% and that the rate of return on a balanced portfolio of common stocks is 9%. If a firm has a beta coefficient of 2, then its risk premium is

A. 18%

B. 10%

C. 8%

D. 4%

. A firm must raise $10 million dollars in funding for a capital investment project. $2 million will be raised by issuing debt with an interest rate of 10% while the remainder will be raised by issuing stocks that will yield a return of 12%. The firm's marginal tax rate is 30%. What is the firm's composite cost of capital?

A. 15%

B. 12%

C. 11%

D. 10%

. The debt to equity ratio that is selected by a firm depends

A. on the attitude of the firm towards risk.

B. the cost of debt and the cost of equity capital.

C. the nature of the firm's business.

D. All of the above are correct.

. The review of projects after they have been implemented is called

A. capital budgeting.

B. a postaudit.

C. blame spreading.

D. context correlation.

. According to the Gitman and Forrester study published in 1977, the two most commonly used capital budgeting techniques are

A. net present value and profitability index.

B. internal rate of return and payback period.

C. net present value and average rate of return.

D. profitability index and average rate of return.

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