financial management questions

25 financial management questions

Multiple Choice Questions(Enter your answers on the enclosed answer sheet)

1) Zellars, Inc. is considering two mutually exclusive projects, A and B. Project A costs

$75,000 and is expected to generate $48,000 in year one and $45,000 in year two.

Project B costs $80,000 and is expected to generate $34,000 in year one, $37,000

in year two, $26,000 in year three, and $25,000 in year four. Zellars, Inc.’s required

rate of return for these projects is 10%. The net present value for Project A is:

a. $5,826

b. $6,347

c. $18,000

d. $9,458

2) Zellars, Inc. is considering two mutually exclusive projects, A and B. Project A costs

$75,000 and is expected to generate $48,000 in year one and $45,000 in year two.

Project B costs $80,000 and is expected to generate $34,000 in year one, $37,000

in year two, $26,000 in year three, and $25,000 in year four. Zellars, Inc.’s required

rate of return for these projects is 10%. The net present value for Project B is:

a. $18,097

b. $42,000

c. $34,238

d. $21,378

3) Zellars, Inc. is considering two mutually exclusive projects, A and B. Project A costs

$75,000 and is expected to generate $48,000 in year one and $45,000 in year two.

Project B costs $80,000 and is expected to generate $34,000 in year one, $37,000

in year two, $26,000 in year three, and $25,000 in year four. Zellars, Inc.’s required

rate of return for these projects is 10%. The internal rate of return for Project B is:

a. 18.64%

b. 16.77%

c. 20.79%

d. 26.74%

4) All of the following are criticisms of the payback period criterion except:

a. Time value of money is not accounted for.

b. It deals with accounting profits as opposed to cash flows.

c. Cash flows occurring after the payback are ignored.

d. None of the above; they are all criticisms of the payback period criteria.

5) A significant disadvantage of the payback period is that it:

a. Does not properly consider the time value of money.

b. Is complicated to explain.

c. Increases firm risk.

d. Provides a measure of liquidity.

Unit 3 Examination

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Introduction to Financial Management

6) A one-sign-reversal project should be accepted if it ________.

a. generates an internal rate of return that is higher than the profitability index

b. produces an internal rate of return that is greater than the firm’s discount rate

c. results in an internal rate of return that is above a project’s equivalent annual annuity

d. results in a modified internal rate of return that is higher than the internal rate of

return

7) A significant disadvantage of the internal rate of return is that it:

a. It does not give proper weight to all cash flows.

b. It is expressed as a percentage.

c. Does not fully consider the time value of money.

d. Can result in multiple rates of return (more than one IRR).

8) The recapture of net working capital at the end of a project will ________.

a. increase terminal year free cash flow

b. decrease terminal year free cash flow by the change in net working capital times the

corporate tax rate

c. increase terminal year free cash flow by the change in net working capital times the

corporate tax rate

d. have no effect on the terminal year free cash flow because the net working capital

change has already been included in a prior year

9) Determine the five-year equivalent annual annuity of the following project if the appropriate discount rate is 16%:

Initial Outflow = $150,000

Cash Flow Year 1 = $40,000

Cash Flow Year 2 = $90,000

Cash Flow Year 3 = $60,000

Cash Flow Year 4 = $0

Cash Flow Year 5 = $80,000

a. $9,872

b. $8,520

c. $7,058

d. $9,454

Unit 3 Examination

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Introduction to Financial Management

10) A project would be acceptable if:

a. The net present value is positive.

b. The payback is greater than the discounted equivalent annual annuity.

c. The equivalent annual annuity is greater than or equal to the firm’s discount rate.

d. The profitability index is greater than the net present value.

11) Which of the following methods of evaluating investment projects can properly evaluate projects of unequal lives?

a. The equivalent annual annuity.

b. The internal rate of return.

c. The payback.

d. The net present value.

12) Taste Good Chocolates develops a new candy bar and plans to sell each bar for $1.

Taste Good predicts that 1 million candy bars will be sold in the first year if the new

candy bar is produced and sold, and includes $1 million of incremental revenues in

its capital budgeting analysis. A senior executive in the company believes that 1 million candy bars will be sold, but
lowers the estimate of incremental revenue to

$700,000. What would explain this change?

a. excessive marketing costs to sell the 1 million candy bars

b. a lower discount rate

c. cannibalization of 300,000 of Taste Good Chocolates’ other candy bars

d. a higher selling price for the new candy bars

13) JW Enterprises is considering a new marketing campaign that will require the addition

of a new computer programmer and new software. The programmer will occupy an

office in JW’s current building and will be paid $8,000 per month. The software

license costs $1,000 per month. The rent for the building is $4,000 per month. JW’s

computer system is always on, so running the new software will not change the

current monthly electric bill of $900. The incremental expenses for the new marketing campaign are:

a. $8,000 per month.

b. $13,000 per month.

c. $13,900 per month.

d. $9,000 per month.

14) Increased depreciation expenses affect tax-related cash flows by

a. increasing taxable income, thus increasing taxes.

b. decreasing taxable income, thus reducing taxes.

c. pushing a corporation into a higher tax bracket.

d. decreasing taxable income, with no effect on cash flow since depreciation is a noncash expense.

Unit 3 Examination

139

Introduction to Financial Management

15) When terminating a project for capital budgeting purposes, the working capital outlay

required at the initiation of the project will

a. not affect the cash flow.

b. decrease the cash flow because it is an outlay.

c. increase the cash flow because it is recaptured.

d. decrease the cash flow because it is a historical cost.

16) 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

17) Which of the following is NOT considered in the calculation of incremental cash

flows?

a. tax saving due to increased depreciation expense

b. interest payments if new debt is issued

c. increased dividend payments if additional preferred stock is issued

d. both b and c

18) 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. Beta risk

c. Capital rationing risk

d. Contribution-to-firm risk

19) The average cost associated with each additional dollar of financing for investment

projects is ________.

a. the incremental return

b. the marginal cost of capital

c. CAPM required return

d. the component cost of capital

Unit 3 Examination

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Introduction to Financial Management

20) A firm with positive MVA is ________.

a. controlling operating expenses extremely well

b. using investments to produce what investors perceive to be positive net present

values

c. experiencing monetary volatility acceleration

d. likely to have an unhappy group of common stockholders

21) Two factors that cause the investor’s required rate of return to differ from the

company’s cost of capital are ________.

a. taxes and risk

b. taxes and transactions costs

c. transactions costs and risk

d. risk and opportunity cost differences

22) Royal Mediterranean Cruise Line’s common stock is selling for $22 per share. The

last dividend was $1.20, and dividends are expected to grow at a 6% annual rate.

Flotation costs on new stock sales are 5% of the selling price. What is the cost of

Royal’s retained earnings?

a. 12.09%

b. 11.45%

c. 11.78%

d. 5.73%

23) Cost of capital is

a. the average cost of the firm’s assets.

b. a hurdle rate set by the board of directors.

c. the coupon rate of debt.

d. the rate of return that must be earned on additional investment if firm value is to

remain unchanged.

Unit 3 Examination

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Introduction to Financial Management

24) Acme Conglomerate Corporation operates three divisions. One division involves significant research and development,
and thus has a high-risk cost of capital of 15%.

The second division operates in business segments related to Acme’s core business,

and this division has a cost of capital of 10% based upon its risk. Acme’s core business is the least risky segment, with
a cost of capital of 8%. The firm’s overall weight

ed average cost of capital of 11% has been used to evaluate capital budgeting projects for all three divisions. This
approach will

a. favor projects in the core business division because that division is the least risky.

b. favor projects in the research and development division because the higher risk projects look more favorable if a lower
cost of capital is used to evaluate them.

c. not favor any division over the other because they all use the same company-wide

weighted average cost of capital.

d. favor projects in the related businesses division because the cost of capital for this

division is the closest to the firm’s weighted average cost of capital.

25) Market value added is equal to

a. the current stock price per share minus the par value per share of stock.

b. the total market value of the company minus total invested capital.

c. the total market value of the company less retained earnings.

d. the total market value of the company minus the debt owed by the company.

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