Question 1

Beige Inc. has to choose from three projects whose internal rates of return (IRRs) are more than the marginal cost of capital (MCC). Beige should choose those projects that _____.

Accepted Answer

Beige should choose the projects that maximize the excess of internal rate of return (IRR) over marginal costs, as this will generate the highest return on investment. Choosing projects that minimize the marginal cost of capital (A), maximize dividend payout (C), or minimize the rate of return to investors (E) may not necessarily lead to the highest returns for the company. Maximizing cash flow from investment in projects (D) could be a consideration, but the projects' IRRs would still need to be taken into account.

Question 2

Allison Engines Corporation has established a target capital structure of 40 percent debt and 60 percent common equity. The firm expects to earn $150,000 in after-tax income during the coming year, and it will retain 40 percent of those earnings. What is the break point of retained earnings?

Accepted Answer

The break point of retained earnings is calculated by dividing the retained earnings by the equity portion of the target capital structure. Retained earnings are 40% of $150,000, which is $60,000. The equity portion is 60%, so the break point is $60,000 / 0.60 = $100,000.

Question 3

The cost of debt to the firm is adjusted for _____.

Accepted Answer

The cost of debt to the firm is adjusted for taxes because interest payments made on debt are tax deductible. As such, the after-tax cost of debt is lower than the before-tax cost.

Question 4

Which of the following is true of the change in the weighted average cost of capital of a firm?

Accepted Answer

A decrease in the weighted average cost of capital, which means a lower cost of financing for the firm, results in a higher net present value (NPV) of future cash flows and increases the value of the firm. This is because the firm can invest in more profitable projects and generate higher returns on its investments with a lower cost of capital. Conversely, an increase in the weighted average cost of capital decreases the NPV of future cash flows and the value of the firm.

Question 5

The marginal cost of capital _____ as more capital is raised during a given period.

Accepted Answer

As more capital is raised during a given period, the marginal cost of capital is likely to increase. This is because as a company raises more capital, there may be diminishing returns to additional funding sources, and lenders may require higher interest rates or other costs to compensate for increased risk. Additionally, as the company becomes more heavily leveraged, it may become riskier for investors, driving up the cost of equity.

Question 6

Omega Inc.'s net income is expected to be $600,000 and the firm's payout ratio is 60 percent. The firm's common stock ratio is 30 percent and it has no preferred stock outstanding. Which of the following is the retained earnings break point for Omega Inc.?

Accepted Answer

The answer of Omega Inc.'s net income is expected to...

Question 7

The value of any asset-real or financial-is based on _____ and _____.

Accepted Answer

The value of any asset, whether it is real or financial, is based on the cash flow expected to be generated by the asset and the rate of return required by investors. Investors will only be interested in buying an asset if it generates enough cash flow to cover the rate of return they require. Therefore, the value of the asset will depend on the amount of cash flow it generates and the rate of return required by investors.

Question 8

The next year's net income of Byron Corporation is projected to be $21,000, and its payout ratio is 30 percent. Its target capital structure is 40 percent debt and 60 percent common equity. What is the retained earnings break point?

Accepted Answer

The answer of The next year's net income of Byron...

Question 9

Everything else equal, an asset's value is directly related to:

Accepted Answer

An asset's value is most directly related to the cash flow it is expected to generate. Other factors may also contribute to an asset's value, such as the risk associated with the investment or the rate of return investors require, but ultimately, the cash flow the asset is expected to produce is the primary driver of its value. This is because the value of an asset is fundamentally based on the future benefits it can provide to its owner.

Question 10

Which of the following statements is true of marginal cost of capital?

Accepted Answer

The answer of Which of the following statements is true...

Question 11

Alpha Inc. combines the marginal cost of capital (MCC) and the investment opportunity schedules (IOS) on a graph. Which of the following areas on the graph shows the maximum excess of returns over costs?

Accepted Answer

The area above the WACC (Weighted Average Cost of Capital) but below the IOS (Investment Opportunity Schedule) represents the projects where the returns exceed the costs, maximizing excess returns over costs.

Question 12

A graph of a firm's acceptable capital projects ranked in the order of the projects' internal rates of return is called the firm's _____.

Accepted Answer

An investment opportunity schedule shows the acceptable capital projects of a firm ranked according to their internal rates of return (IRRs), allowing the firm to choose the most profitable projects to invest in. Marginal cost of capital schedule refers to the cost of additional capital raised by the firm, modified internal rate of return schedule considers the reinvestment rate assumption, internal project classification schedule does not exist, and optimal capital budget schedule refers to the combination of selected projects that maximizes the firm's value.

Question 13

A firm's weighted average cost of capital (WACC) is:

Accepted Answer

The firm's WACC is determined by the financial markets because it represents the cost of the funds that investors provide to the firm. The WACC is the weighted average of the cost of debt and equity financing and reflects the returns that investors require for providing capital to the firm. The board of directors may use the WACC to make capital budgeting decisions, but they do not set the WACC. The WACC is not regulated by the IRS, and it is not the same as the firm's IRR or the total NPV of its projects.

Question 14

A firm should continue to invest in capital budgeting projects until its marginal cost of capital is:

Accepted Answer

A firm should continue to invest in projects until the marginal cost of capital equals the marginal return generated by the last project, ensuring that each additional investment yields a return at least equal to its cost.

Question 15

If a project's _____ exceeds the firm's cost of capital, its NPV will be positive.

Accepted Answer

If a project's IRR exceeds the firm's cost of capital, it indicates that the project is expected to generate returns greater than the cost of financing it, resulting in a positive NPV.

Question 16

The rates of return, or costs, that a firm must pay to raise funds to invest in capital budgeting projects are determined by:

Accepted Answer

The rates of return or costs that a firm must pay to raise funds to invest in capital budgeting projects are primarily determined by the investors who purchase the firm's stocks and bonds. The investors demand a certain rate of return or cost of capital to invest in the firm, which in turn affects the firm's cost of capital for investing in capital budgeting projects. Thus, choice (B) is the correct option.

Question 17

The investment opportunity schedule (IOS) plotted on a graph shows:

Accepted Answer

The investment opportunity schedule (IOS) plotted on a graph shows the amount of investment at different rates of return for a firm. It helps in determining which investment options are best for the company and at what cost. Option A is incorrect because IOS does not provide information on the capital financing components of a firm. Option C is incorrect because the net present values of different projects of a firm are shown on a different type of graph called the net present value profile. Option D is incorrect because the IOS does not provide information on the average cost of capital of a firm. Option E is incorrect because the IOS does not provide information on the weighted average capital.

Quiz 11: The Cost of Capital

Beige Inc. has to choose from three projects whose internal rates of return (IRRs) are more than the marginal cost of capital (MCC) . Beige should choose those projects that _____.