test10 - Chapter 10Risk and Capital Budgeting MULTIPLE...

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Chapter 10—Risk and Capital Budgeting MULTIPLE CHOICE 1. Operating leverage describes the relationship between. .. a. EBIT and sales b. taxes and sales c. debt and equity d. fixed costs and variable costs ANS: A DIF: E REF: 10.1 Choosing the Right Discount Rate 2. Everything else being equal a higher corporate tax rate. .. a. will increase the WACC of a firm with debt and equity in its capital structure b. will not affect the WACC of a firm with debt in its capital structure c. will decrease the WACC of a firm with some debt in its capital structure d. will decrease the WACC of a firm with only equity in its capital structure ANS: C DIF: M REF: 10.1 Choosing the Right Discount Rate 3. Which of the following is considered a type of real options a. expansion option b. abandonment option c. flexibility option d. all of the above ANS: D DIF: E REF: 10.3 Real Options 4. A manager who wants to find out at which point a project’s profits and costs are equal will conduct a(n) a. sensitivity analysis b. scenario analysis c. breakeven analysis d. none of the above ANS: C DIF: E REF: 10.2 A Closer Look at Risk 5. The appropriate cost of capital for a project depends on . . . a. the type of assets used in the project (that is, whether they are current or fixed assets) b. the interest rate on the firm's outstanding long-term bonds c. the type of security issued to finance the project d. the risk associated with the project ANS: D DIF: M REF: 10.1 Choosing the Right Discount Rate 6. The following data have been computed for a firm: when sales are $20,000, EBIT is $5,000 and oper- ating leverage is 2.5. Suppose sales increase to $23,000; what is the new level of EBIT? a. $1,875 b. $6,875 c. $3,000 d. $8,435 ANS: B 2.5 = (change EBIT/$5000)/(3,000/20,000)
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change EBIT = $1,875 new EBIT = $6,875 DIF: H REF: 10.1 Choosing the Right Discount Rate 7. Bavarian Sausage, Inc. has a cost equity of 22% and a beta of 1.8. The expected market return is 14%. What is the risk-free rate? a. 4% b. 22% c. 8% d. 12% ANS: A .22 = Rf + 1.8(.14-Rf) Rf = .04 DIF: M REF: 10.1 Choosing the Right Discount Rate 8. Bavarian Sausage has a beta of 1.8. The risk free rate is 5% and the expected market risk premium is 12%. What is the company’s cost of equity? a. 17.0% b. 26.6% c. 21.6% d. 13.5% ANS: B E(Ri) = .05 + 1.8(.12) E(Ri) = .266 DIF: E REF: 10.1 Choosing the Right Discount Rate NARRBEGIN: Never-crash Airlines Never-crash Airline Never-crash Airline has a capital structure that consists of 30% debt and 70% equity. The company’s cost of debt is 7%. The company has a beta of 1.9. The risk free rate equals 4.5% and the expected re- turn on the market portfolio is 15%. NARREND 9. Assuming no taxes, what is Never-crash Airline’s WACC? a.
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This note was uploaded on 08/26/2011 for the course ECON 222 taught by Professor Min during the Spring '11 term at American University of Kuwait.

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test10 - Chapter 10Risk and Capital Budgeting MULTIPLE...

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