Weighted average cost

1. A key difference between replacement and expansion project analyses is that with replacement, the incremental cash flows are measured as the net difference between projected cash flows from the current productive assets and cash flows of the proposed new productive assets.

True / False

2. The weighted average cost of capital increases if the total funds required call for an amount of equity in excess of what can be obtained as retained earnings.

True / False

3. The post-audit is a simple process in which actual results are compared to forecasted results and any discrepancy indicates a change in factors that are completely under management’s control.

True / False

4. Short-term financing might be riskier than long-term financing because, during periods of tight credit, the firm might not be able to rollover (renew) its debt.

True / False

5. Effective capital budgeting can improve the timing of asset acquisition and the quality of assets purchased, thereby providing an opportunity to purchase and install assets before they are needed.

True / False

6. One of the major advantages of debt financing is the tax benefit received due to the payment of interest expense.

True / False

7. Conflicts between two mutually exclusive projects, where the NPV method chooses one project but the IRR method chooses the other, should generally be resolved in favor of the project with the higher NPV.

True / False

8. The optimal capital structure is that capital structure that strikes a balance between risk and return such that the firm’s stock price is maximized.

True / False

9. Superior analytical techniques, such as NPV, used in combination with adjustments to the average required rate of return, can always overcome the problem of poor cash flow estimation in decision making.

True / False

10. Synchronization of cash flows is an important cash management technique and effective synchronization can actually increase a firm’s profitability.

True / False

11. The present value of the expected net cash inflows for a project will most likely exceed the present value of the expected net profit after tax for the same project because

a. Income is reduced by taxes paid, but cash flow is not.

b. There is a greater probability of realizing the projected cash flow than the forecasted income.

c. Income is reduced by dividends paid, but cash flow is not.

d. Income is reduced by depreciation charges, but cash flow is not.

e. Cash flow reflects any change in net working capital, but sales do not.

12. (2 Points) If a firm is operating at its optimal capital structure, then its weighted average cost of capital must be __________ and its value must be __________.

a. maximized; maximized

b. minimized; minimized

c. maximized; minimized

d. minimized; maximized

13. Which of the following is not one of the four primary factors that influence capital structure decisions?

a. The firm’s business risk.

b. The firm’s tax position.

c. The firm’s financial flexibility.

d. The firm’s inventory valuation method.

e. The firm’s managerial attitude.

14. Which of the following statements related to Financial Statement Forecasting is correct?

a. One of the key steps in the development of pro forma financial statements is to identify those assets and liabilities which increase spontaneously with net income.

b. The first, and most critical, step in constructing a set of pro forma financial statements is establishing the sales forecast.

c. Pro forma financial statements as discussed in the text are used primarily to assess a firm’s historical performance.

d. All else equal, if a firm operates at full capacity, the greater its payout ratio, the less additional funds that will be needed for a particular growth in sales.

e. The projected balance sheet forecasting method produces accurate results when fixed assets are lumpy and when economies of scale are present.

15. Which of the following statements related to Capital Budgeting Techniques is correct?

a. Because discounted payback takes account of the required rate of return, a project’s discounted payback is normally shorter than its regular payback.

b. The NPV and IRR methods use the same basic equation, but in the NPV method the discount rate is specified, and the equation is solved for NPV, while in the IRR method the NPV is set equal to zero and the discount rate is found.

c. If the required rate of return is less than the crossover rate for two mutually exclusive projects’ NPV profiles, a NPV/IRR conflict will not occur.

d. If you are choosing between two projects which have the same life, and if their NPV profiles cross, then the smaller project will probably be the one with the steeper NPV profile.

e. If the required rate of return is relatively high, this will favor larger, longer-term projects over smaller, shorter-term alternatives because it is good to earn high rates on larger amounts over longer periods.

16. (3 Points) Allyson, who is the CFO of Mundane Minerals & Mining (MMM), is trying to decide whether to issue debt or common stock to finance the capital budgeting projects she has evaluated as acceptable (that is, the projects have positive net present values, NPV). Because MMM is a relatively small company, Allyson believes that the type of capital she uses to finance the projects will send a signal to investors. As a result, which of the following actions would you recommend Allyson take?

a. Issue equity, because investing in positive NPV projects is not in the best interests of the firm, and the existing stockholders will want to share such “bad news” with new stockholders.

b. Issue equity so as to dilute ownership and share the increase in wealth that results from investing in positive NPV projects with new stockholders.

c. Issue debt, because debt is riskier than common stock, thus the value of existing stockholders’ stock will increase more than if new equity is issued.

d. Issue debt, because investing in positive NPV projects increases the value of the firm, and the existing stockholders probably prefer not to share such good fortune with new stockholders.

e. Investors do not care which source of funds the firm uses as long as the funds are invested in positive NPV projects; therefore, it shouldn’t matter which type of capital is used.

17.  Which of the following is not a common type of short-term financing?

a. Commercial paper.

b. Accruals.

c. Trade credit.

d. Corporate bonds.

e. Bank loans.

18. (30 Points) Complete the Electrics, Inc. assignment.  Refer to the Electrics, Inc. Case Document (focus on the last page of the case document), and the Excel template attached