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## Finance Finale

 A firm has a cost of equity of 10 percent, a cost of preferred of 9 percent, and an aftertax cost of debt of 5 percent. Given this, which one of the following will decrease the firm’s weighted average cost of capital? Issuing new debt The cost of preferred sock is equal to the stock’s dividend yield. All else constant, an increase in a firm’s cost of debt will result in an increase in the firm’s cost of capital The cost of capital for a project depends primarily on the Use of the funds. The weighted average cost of capital is defined as the weight average of a firm’s cost of equity and its aftertax cost of debt. Woven Goods is considering adding a new line of baskets to its product line-up. Which of the following are relevant cash flows for this project?I. increased revenue from existing goods if these baskets are added to the lineupII. revenue from the new line of basketsIII. money spent to date investigating the availability of woven basketsIV. cost of expanding the showroom to make space for the new baskets I, II, and IV only Payback ignores the time value of money A net present value of zero implies that an investment is earning a return that exactly matches the requirement The IRR decision rule states that a project should be accepted if its IRR: exceeds the required rate. An indicator that a project has a rate of return that exceeds its required return is: a positive NPV The most valuable alternative that is forfeited if a particular investment is undertaken is called: an opportunity cost The payback period is the period of time it takes an investment to generate sufficient cash flows to: recover the investment’s initial cost A proposed project will increase a firm’s accounts payable. This increase: is a cash inflow at time zero a cash outflow at the end of the project. The change in a firm’s future cash flows that results from adding a new project are referred to as _____ cash flows. incremental The NPV rule states that you should accept an investment if the NPV: is positive The discount rate that causes the net present value of a project to equal zero is called the: internal rate of return. A sunk cost is: a cost that has already been incurred and cannot be recouped. The hypothesis that stock market,s such as the NYSE, are efficient is called the: efficient markets hypothesis The lower the standard deviation of a security, the ______ the expected rate of return and the ______ the risk. lower; lower What is used as the risk-free rate of return? U.S. Treasury bills If the financial markets are efficient then: stock prices should only respond to unexpected news and events. The historical returns on large-company stocks, as reported by Ibbotson and Sinquefield, are based on: the stocks of the 500 companies included in the S&P 500 index. Weak form market efficiency state that the value of a security is based on: historical price information only. Standard deviation measure the _____ of a security’s returns over time. volatility A bell-shaped frequency distribution that is defined by its average and standard deviation is called a: normal distribution Over the period of 1926-2006: long-term government bonds underperformed long-term corporate bonds. Which of the following statement are correct?I. The risk-free rate of return has a zero risk premiumII. The reward for bearing risk is called the standard deviationIII. Based on historical returns, there are rewards for bearing risk.IV. In general, the higher the risk, the higher the expected return. I, III, and IV only The distribution of returns for which stocks of the period of 1926-2006 produces the widest bell curve (or distribution)? small-company stocks Systematic risk is a risk that affects a large number of assets What must total to 100 percent? portfolio weights and probabilities of occurrence for the various economic states The concept of investing in a variety of diverse assets to reduce risk is referred to as: the principle of diversification An example of systematic risk? Inflation exceeding market expectations Diversifying a portfolio across various sectors and industries will tend to: reduce the firm-specific risk The goal of diversification is to eliminate: unsystematic risk An example of unsystematic risk? an unexpected increase in the sales of a firm A U.S. Treasur bill has a beta of ___ while the overall market has a beta of ____. 0; 1 The difference between beta and standard deviation is best described as: Beta measures the risk investors are compensated for, while standard deviation measures both systematic and unsystematic risk. The amount of systematic risk present in a particular risk asset relative to that in an average risk asset (or the market in general) is called the: beta coefficient
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## Corporate Finance Homework Solutions Chapter 2

 P2-4During the year just ended, Shering Distributors, Inc., had pretax earnings from operations of \$490,000. In addition, during the year it received \$20,000 in income from the interest on bonds it held in Zig Manufacturing and received \$20,000 in income from dividends on its 5% common stock holding in Tank Industries, Inc. Shering is in the 40% tax bracket and is eligible for a 70% dividend exclusion on its Tank Industries stock. A. Calculate the firm’s tax on it operating earnings only.B. Find the tax and the after-tax amount attributable to the interest income from Zig Manufacturing bonds.C. Find the tax and the after- tax amount attributable to the dividend income from tank industries inc, common stock.D. Compare, contrast and discuss the after tax amt resulting from the interest income and dividend income calculated in parts A and B.E-What is the firm’s total liability for the year? A) 490,000* .40= 196000B) 20,000* .40= 8000 20,000-8,000= 12,000C) 20,000* (1-.7)= 6,000 6000 * .40= 2,400 20,000-2,400= 17,600D) The tax amount after taxes for interest received is lower than the tax amount after taxes for the dividends received because of the tax exclusion on the dividend. This leaves you with more after tax profit for the dividends rather than the after tax profit for the interest. E) Total tax liability= 196,000+ 8000+2400)= 206,400 P2-5Michaels Corporation expects earnings before interest and taxes to be \$50,000 for the current period. Assuming an ordinary tax rate of 35%, computer the firm’s earnings after taxes and earnings available for common stockholders (earnings after taxes and preferred stock dividends, if any) under the following conditions:a) The firm pays \$12,000 in interest.b) The firm pays \$12,000 in preferred stock dividends. EBIT= 50000T= 35%a) 12000 in interest b) 12000 in dividendsEBIT= 50000 50000- iexp (12000) (0)=EBT 38000 50000-T (13300) (17500)=NI 24,700 32500-PD 0 (12000)=ETC 24700 20,500
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