d076 Lesson checks

A company called Bobby's Books is considering purchasing a new bookbinding machine. The company calculates the hurdle rate of the project to be 9% and the IRR to be 11%. Should the company purchase the bookbinding machine? a) No, because the old bookbinding machine still works. b) Yes, because the IRR exceeds the cost of capital. c) No, because the hurdle rate is lower than the IRR. d) Yes, because newer models of equipment are always profitable investments. - b) Yes, because the IRR exceeds the cost of capital. When the IRR of a project is greater than the hurdle rate (the required rate of return, or cost of capital), it indicates that the company should accept the project. A firm has paid off its short-term loans more quickly in the past couple of years. What might this trend indicate about the firm's financial ratios? a) Its liquidity ratio is increasing. b) Its profitability ratio is decreasing. c) Its leverage ratio is decreasing. d) Its activity ratio is increasing. - a) Its liquidity ratio is increasing. Liquidity is a measure of the ability of a firm to convert short-term assets into cash. Paying off short- term loans quickly is an indication that a firm is quite liquid, so the firm's liquidity ratio would be increasing. A large corporation is looking to merge with another large corporation. Which financial institution can help them do this? a) Central bank b) Private equity institution c) Investment bank d) Pension fund - c) Investment bank Investment banks facilitate complex financial deals, like mergers. A local start-up company just hit its five-year anniversary and is planning an initial public offering sometime this year. In order to issue public stock, which market will the company use? a) Futures and options market b) Dealer market c) Primary market d) Secondary market - c) Primary market When a company issues stock for the first time to raise capital, shares must initially be sold through a primary market. Alphabet Co. has $50,000 to spend on capital investment projects for the next year. It will do as many projects as it has cash for. Alphabet Co. calculates the potential incremental cash flows and costs of the projects as well as the NPV, IRR, and PI for each project. How should the company decide which projects to invest in if it wants to maximize the total amount of value created? a) It should choose the projects with the highest PIs until all capital has been used. b) It should choose the projects with the highest costs until all capital has been used. c) It should choose the projects with the highest NPVs until all capital has been used. d) It should choose the projects with the highest IRRs until all capital has been used. - a) It should choose the projects with the highest PIs until all capital has been used. By choosing the projects with the highest PI, Alphabet Co. will be able to use its limited capital effectively to create the most overall value for the firm. An investor just purchased a bond for $973 that has a par value of $1,000. What type of bond is this? a) A premium bond b) A discount bond c) A par bond d) A preferred bond - b) A discount bond When the market price is less than the par price of a bond, you know that the YTM is currently higher than the coupon rate of that particular bond, so it is being sold at a discount. BigDog and SmallDog are two companies that have an identical return on equity. One difference between the two companies is that BigDog has 40% of assets financed by debt while SmallDog has 100% of assets financed by equity. What can you conclude about BigDog and SmallDog? a) SmallDog has a smaller ROA than BigDog. b) SmallDog has a smaller ROE than BigDog. c) SmallDog has a higher ROA than BigDog. d) SmallDog has a higher ROE than BigDog. - c) SmallDog has a higher ROA than BigDog. Since SmallDog has no debt, the leverage multiplier of SmallDog is smaller than that of BigDog. Since both companies have the same ROE, SmallDog must have a higher ROA. Endothon Company has decided to move its production from the United States to a foreign country. Which situation below would constitute an unethical action by the company? a) Telling current employees about the decision early on b) Monitoring public perception of the company c) Lowering costs while keeping prices the same for customers d) Saving money by paying inadequate wages to workers overseas - d) Saving money by paying inadequate wages to workers overseas Other countries may not have laws that protect workers, such as minimum wage laws. Five years ago, Ahmed decided he was going to save up to purchase a car with cash. The car he wants is priced at $15,000. He saved $245 a month in an account that gave him enough interest to have $15,000 in five years. Today, he pulled out $15,000 from his account to buy the car, but the price of the car is now $16,562. Which component of the required rate of return did Ahmed forget to consider? a) Opportunity cost b) Risk c) Inflation d) Interest rate - c) Inflation The price of the car simply went up by $1,562 due to inflation. How are non-incremental cash flows different from incidental cash flows? a) All non-incremental cash flows should be included. It is unclear if a company will incur a cost regardless of whether it adopts a specific project, so that cost should be counted as a cost of the project.