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Multiple choice questions

1. A company planning to market a new model of motor scooter analyzes the effect of changes in the selling price of the motor scooter, the number of units that will be sold, the cost of making the motor scooter, the effect on Net Working Capital, and the cost of capital for the project. They predict that the break-even point for sales price for the motor scooter is $2480. What does this mean?
A. The maximum that the motor scooter can sell for and still make the project have a positive net present value (NPV) is $2480.
B. If the motor scooter is sold for $2480, then the net present value (PNV) for the product will be zero.
C. The predicted selling price of the motor scooter is $2480.
D. If the motor scooter is sold for $2480 then the project will make a profit.

2. Praetorian Industries will pay a dividend of $2.50 per share this year and has an equity cost of capital of 8%. Praetorian's stock is currently trading at$84 per share. By comparing Praetorian with similar firms, an investor expects that its dividend will grow by up to 5% per year. What is the best next step that the investor should take regarding Praetorian's stock?
A. Revise her estimate of Praetorian's dividend growth.
B. Sell any Praetorian stock that she owns.
C. Short Praetorian's stock.
D. Revise Praetorian's equity cost of capital.

3. Which of the following statements is false?
A. Consider the case of a new firm that is identical to an existing publicly traded company. If these firms will generate identical cash flows, the Law of One Price implies that we can use the value of the existing company to determine the value of the new firm.
B. Even two firms in the same industry selling the same types of products, while similar in many respects, are likely to be of different size or scale
C. A valuation multiple is a ratio of some measure of the firm's scale to the value of the firm.
D. In the method of comparables, we estimate the value of the firm based on the value of other, comparable firms or investments that we expect will generate very similar cash flows in the future.

4. Which of the following statements is FALSE?
A. We cannot use the general dividend discount model to value the stock of a firm with rapid or changing growth.
B. The dividend-discount model values the stock based on a forecast of the future dividends paid to shareholders.
C. As firms mature, their growth slows to rates more typical of established companies
D. The simplest forecast for the firm's future dividends states that they will grow at a constant rate, i.e., forever.

5. Which of the following statements is FALSE?
A. The firm's weighted average cost of capital denotes r WACC is the cost of capital that reflects the risk of the overall business, which is the combined risk of the firm's equity and debt.
B. We interpret r WACC as the expected return the firm must pay to investors to compensate them for the risk of holding the firm's debt and equity together.
C. When using the discounted free cash flow model we should use the firm's equity cost of capital
D. Intuitively, the difference between the discounted free cash flow model and the dividend discount model is that in the divided- discount model the firm's cash and debt are included indirectly through the effect of interest income and expenses on earnings in the dividend-discount model

6. A company spends $20 million researching whether it is possible to create a durable plastic from the process waste from feedstock preparation. How should the $20 million best be considered?
A. As a sunk cost
B. As a capital cost
C. As an opportunity cost
D. As affixed overhead expense

7. Which of the following statements is FALSE?
A. Trailing earnings are the earnings over the previous 12 months.
B. Forward earnings are the expected earnings over the coming 12 months.
C. For valuation purposes, the trailing price earnings ratio is generally preferred, since it is based on actual not expected earnings.
D. We can estimate the value of a firm's shares by multiplying its current earnings per share by the average price-earnings ratio of comparable firms.

8. Which of the following statements is FALSE?
A. Investments in plant, property, and equipment are directly listed as expense when calculating earnings.
B. We begin the capital budgeting process by determining the incremental earnings of a project.
C. The marginal corporate tax rate is the tax rate the firm will pay on an incremental dollar of pretax income.
D. The opportunity cost of using a resource is the value it could have provided in its best alternative use.

Solution Preview

1. A company planning to market a new model of motor scooter analyzes the effect of changes in the selling price of the motor scooter, the number of units that will be sold, the cost of making the motor scooter, the effect on Net Working Capital, and the cost of capital for the project. They predict that the break-even point for sales price for the motor scooter is $2480. What does this mean?
A. The maximum that the motor scooter can sell for and still make the project have a positive net present value (NPV) is $2480.
B. If the motor scooter is sold for $2480, then the net present value (PNV) for the product will be zero.
C. The predicted selling price of the motor scooter is $2480.
D. If the motor scooter is sold for $2480 then the project will make a profit.
At this point the cost equals the revenues: B. If the motor scooter is sold for $2480, then the net present value (PNV) for the product will be zero.

2. Praetorian Industries will pay a dividend of $2.50 per share this year and has an equity cost of capital of 8%. Praetorian's stock is currently trading at$84 per share. By comparing Praetorian with similar firms, an investor expects that its dividend will grow by up to 5% per year. What is the best next step that the investor should take regarding Praetorian's stock?
A. Revise her estimate of Praetorian's dividend growth.
B. Sell any Praetorian stock that she owns.
C. Short Praetorian's stock.
D. Revise Praetorian's equity cost of capital.
Because of the expected ...

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