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1. When we compute the annual cash flows for a project, we calculate the tax amount as ____________.

Multiple Choice

• EBT(T_C) after deducting interest expenses

• (EBT Depreciation)(T_C)

• (EBIT + Depreciation Change in NWC Capital spending)(T_C)

• EBIT(T_C) excluding interest expenses

• (EBIT Depreciation Change in NWC Capital spending)(T_C)

2. _______________ will increase the company's aftertax cost of debt.

Multiple Choice

• A decrease in a company's debt-equity ratio

• A decrease in a company's tax rate

• An increase in the credit rating of a company's bonds

• An increase in a company's beta

• A decrease in the market rate of interest

3. Richmond Tours has a capital structure of 60 percent common stock, 5 percent preferred stock, and 35 percent debt. The firm pays out 30% of net income as dividend. Its beta is 1.21 and pays taxes at the rate of 21 percent.

Based on the above, pick the correct statement from below.

Multiple Choice

• The aftertax cost of debt will be greater than the current yield-to-maturity on the company's outstanding bonds.

• The company's cost of preferred is most likely less than the company's actual cost of debt.

• The cost of equity is unaffected by a change in the company's tax rate.

• The cost of equity can only be estimated using the capital asset pricing model.

• The weighted average cost of capital will remain constant as long as the company's capital structure remains constant.

4. You are the financial manager of One Beach, Inc. It is a national restaurant chain that has a cost of capital of 13%. The restaurant chain is cosidering opening a high end restaurant that is expected to have a cost of capital of 14.5% or higher. If the high-end restaurant can be opened, its NPV will be $600 when discounted at 13%. What would be your best decision for this high-end restaurant project?

Multiple Choice

• The project should be accepted immediately.

• The project should be financed solely with debt in order for the project to have a positive NPV.

• The project should probably be put on hold until its cost of capital can be lowered.

• The project should be permanently rejected.

• The project should probably be expanded.

5. If a company uses its WACC as the discount rate for all of the projects it undertakes, chances are that it will ______________.

Multiple Choice

• accept all positive net present value projects

• increase the average risk level of the company over time

• reject all high-risk projects

• reject all negative net present value projects

• favor low-risk projects over high-risk projects

6. Pick the correct statement from below.

Multiple Choice

• The subjective approach assigns a discount rate to each project based on other companies in the same category as the project.

• Overall, a company makes better decisions when it uses the subjective approach than when it uses its WACC as the discount rate for all projects.

• Companies will correctly accept or reject every project if they adopt the subjective approach.

• Mandatory projects should only be accepted if they produce a positive NPV when the overall company WACC is used as the discount rate.

• The pure play approach should only be used with low-risk projects.

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