Question 61 The market value of a firm that invests in projects providing a retu

Question

Question 61

The market value of a firm that invests in projects providing a return equal to its WACC should decrease over time.

Select one:

True

False

Question 62

A firm has $500 in debt at a cost of 7%, a 34% tax rate, a total firm value of $1.000, and an unlevered return of 11.5%. What is the WACC?

Select one:

a. 11.84%

b. 10.57%

c. 9.72%

d. 9.55%

e. 11.41%

Question 63

An increase in the corporate tax rate decreases the value of the depreciation tax shield, all else equal.

Select one:

True

False

Question 64

If a firm uses cash to purchase inventory, its quick ratio will remain unchanged.

Select one:

True

False

Question 65

For a project with an initial investment of $38,000 and cash inflows of $10,500 a year for five years, calculate NPV given a required return of 10%/year.

Select one:

a. $655

b. -$1,205

c. $1,803

d. $888

e. $1,103

Explanation / Answer

Q 61. False. As per Mogigliani and Miller Model, the market value of the company is not affected by the dividend decision of the company ie.paying returns equal to cost of capital of company.

Q 62 WACC = cost of debt (kd)* post tax debt /total value of firm + cost of quity (ke)* equity /total value of firm

kd = 7% (It is assumed to be post tax), ke = 0.115, post tax debt = 500*(1-.34) = 330 ,

value of firm = equity + post tax debt = $500+$330 = $830

Substituting the above into the formula,

WACC = .07*330/830+.115*500/830

= 0.027831+0.069277

= 9.72 % ie. Option (C)

Q 63 False, an increase in corporate rate tax will increase the value of depreciation shield.

Q 64 False, Quick ratio = Cash + Marketable securities + accounts receivable / current liabilities. Inventory, even though it is a current asset, is not considered a quick asset since it cannot be converted to cash within a very short time frame. Thus purchase of inventory using cash will not make the quick ratio remain unchanged .

Q 65 Calculation of NPV of a project.

Year Cashflow Present value factor discounted cash flow

xxxx -38,000 1 -38,000 (initial outflow)

1-5 10,500 3.791 39,805.5U (in-between flows)

NPV 1,805.5 ie. Option (C) (NPV = PV of outflows - PV of inflows)

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