FNAN 522 MIDTERM EXAM 2025/2026 QUESTIONS WITH
ANSWERS GRADED A+
✔✔You are considering the following two projects and can take only one. Your cost of
capital is 11.9%. The cash flows for the two projects are as follows ($ million):
Project Year 0 Year 1 Year 2 Year 3 Year 4
A -$103 28 34 44 53
B -$103 53 44 34 24
What is the IRR of each project? Which project should you choose? - ✔✔IRR of Project
A = 17.7%, IRR of Project B = 21.7%.
✔✔You need a particular piece of equipment for your production process. An
equipment-leasing company has offered to lease the equipment to you for $10,600 per
year if you sign a guaranteed 5-year lease (the lease is paid at the end of each year).
The company would also maintain the equipment for you as part of the lease.
Alternatively, you could buy and maintain the equipment yourself. The cash flows from
doing so are listed below (the equipment has an economic life of 5 years). If your
discount rate is 7.9%, what should you do?
Year 0 Year 1 Year 2 Year 3 Year 4 Year 5
-$41,500 -$2,400 -$2,400 -$2,400 -$2,400 -$2,400 - ✔✔The NPV of the leasing
alternative is -$42,435. The NPV of the purchase alternative is -$51,108. Choose the
leasing alternative because it has the lowest NPV.
✔✔Your storage firm has been offered $102,000 in one year to store some goods for
one year. Assume your costs are $97,200, payable immediately, and the cost of capital
is 9.1%. Should you take the contract? - ✔✔The NPV will be −$3,708. No, you should
not take the contract, as the NPV of the contract is negative.
✔✔A company has $2 million in machinery expenses and $3 million in rent. It costs $30
per unit in labor costs to produce the good, which is sold for $50 per unit. What is the
break even point? - ✔✔250,000 units
✔✔A company produces 100,000 units that sell for $40. The company's variable costs
per unit is $25. The company's total fixed costs are $800,000. What is the company's
degree of operating leverage? - ✔✔2.14
✔✔Managers of publicly traded corporations are often compensated at least in part
based on firm profitability, and bondholders prefer to receive principal and interest
payments on time. Leverage can increase firm profitability and make more money
available for interest and principal payments, so it appears that mangers' interests and
bondholders' interests are well-aligned. Which of the following is true about conflicts
, between managers and bondholders? - ✔✔Managers may under invest in projects if it
appears that all proceeds will be absorbed by bondholders, hurting both shareholders
and bondholders.
✔✔If a company with stable earnings wanted to ensure that its managers' interests are
aligned with the company's shareholders, which of the following capital structures
should it use? - ✔✔A debt-heavy capital structure that maximizes returns to
shareholders by magnifying ROE, maximizing the tax shield, up to the point that these
benefits are higher than anticipated bankruptcy costs.
✔✔In a perfect market as proposed by Modigliani and Miller, which of the following
statements is true? - ✔✔As a company increases its leverage, total risk is conserved
and no extra value is created, The value of a company is independent of its capital
structure, Investment decisions are not affected by financing decisions.
✔✔Under the best capital structure of a company, the goal of it is to maximize: - ✔✔the
market value of the company.
✔✔When a company files Chapter 11 bankruptcy, which of the following statements
accurately describes an action the company's management can take? - ✔✔Acquire
financing and loans on favorable terms by giving the lenders first priority on earnings.
✔✔Which of the following factors explain why a company's capital structure is relevant
to its value in practice? - ✔✔Information asymmetry between the company's
management and it's investors, Bankruptcy costs, Agency costs.
✔✔Suppose a firm expects to have $50,000,000 in free cash flow and $1,000,000 in
interest expenses this year. If the firm's WACC is 12% and it's corporate tax rate is
35%, what is the expected value of the tax shield this year? - ✔✔$350,000
✔✔Managers of publicly traded corporations are often compensated at least in part
based on firm profitability, and shareholders prefer higher stock prices to lower stock
prices. Stock prices are determined at least in part based on firm profitability, so it
appears that mangers' interests and stockholders' interests are well-aligned. Which of
the following is true about conflicts between managers and shareholders? - ✔✔Instead
of returning free cash flow to investors in the form of dividends or stock buybacks,
managers may invest cash flows in projects that are not expected to yield adequate
returns in order to create some growth.
✔✔A company made $10 million in revenue, recorded $2 million in net income, and
paid $750,000 in dividends last year. What was the company's pay out ratio last year? -
✔✔37.5%
ANSWERS GRADED A+
✔✔You are considering the following two projects and can take only one. Your cost of
capital is 11.9%. The cash flows for the two projects are as follows ($ million):
Project Year 0 Year 1 Year 2 Year 3 Year 4
A -$103 28 34 44 53
B -$103 53 44 34 24
What is the IRR of each project? Which project should you choose? - ✔✔IRR of Project
A = 17.7%, IRR of Project B = 21.7%.
✔✔You need a particular piece of equipment for your production process. An
equipment-leasing company has offered to lease the equipment to you for $10,600 per
year if you sign a guaranteed 5-year lease (the lease is paid at the end of each year).
The company would also maintain the equipment for you as part of the lease.
Alternatively, you could buy and maintain the equipment yourself. The cash flows from
doing so are listed below (the equipment has an economic life of 5 years). If your
discount rate is 7.9%, what should you do?
Year 0 Year 1 Year 2 Year 3 Year 4 Year 5
-$41,500 -$2,400 -$2,400 -$2,400 -$2,400 -$2,400 - ✔✔The NPV of the leasing
alternative is -$42,435. The NPV of the purchase alternative is -$51,108. Choose the
leasing alternative because it has the lowest NPV.
✔✔Your storage firm has been offered $102,000 in one year to store some goods for
one year. Assume your costs are $97,200, payable immediately, and the cost of capital
is 9.1%. Should you take the contract? - ✔✔The NPV will be −$3,708. No, you should
not take the contract, as the NPV of the contract is negative.
✔✔A company has $2 million in machinery expenses and $3 million in rent. It costs $30
per unit in labor costs to produce the good, which is sold for $50 per unit. What is the
break even point? - ✔✔250,000 units
✔✔A company produces 100,000 units that sell for $40. The company's variable costs
per unit is $25. The company's total fixed costs are $800,000. What is the company's
degree of operating leverage? - ✔✔2.14
✔✔Managers of publicly traded corporations are often compensated at least in part
based on firm profitability, and bondholders prefer to receive principal and interest
payments on time. Leverage can increase firm profitability and make more money
available for interest and principal payments, so it appears that mangers' interests and
bondholders' interests are well-aligned. Which of the following is true about conflicts
, between managers and bondholders? - ✔✔Managers may under invest in projects if it
appears that all proceeds will be absorbed by bondholders, hurting both shareholders
and bondholders.
✔✔If a company with stable earnings wanted to ensure that its managers' interests are
aligned with the company's shareholders, which of the following capital structures
should it use? - ✔✔A debt-heavy capital structure that maximizes returns to
shareholders by magnifying ROE, maximizing the tax shield, up to the point that these
benefits are higher than anticipated bankruptcy costs.
✔✔In a perfect market as proposed by Modigliani and Miller, which of the following
statements is true? - ✔✔As a company increases its leverage, total risk is conserved
and no extra value is created, The value of a company is independent of its capital
structure, Investment decisions are not affected by financing decisions.
✔✔Under the best capital structure of a company, the goal of it is to maximize: - ✔✔the
market value of the company.
✔✔When a company files Chapter 11 bankruptcy, which of the following statements
accurately describes an action the company's management can take? - ✔✔Acquire
financing and loans on favorable terms by giving the lenders first priority on earnings.
✔✔Which of the following factors explain why a company's capital structure is relevant
to its value in practice? - ✔✔Information asymmetry between the company's
management and it's investors, Bankruptcy costs, Agency costs.
✔✔Suppose a firm expects to have $50,000,000 in free cash flow and $1,000,000 in
interest expenses this year. If the firm's WACC is 12% and it's corporate tax rate is
35%, what is the expected value of the tax shield this year? - ✔✔$350,000
✔✔Managers of publicly traded corporations are often compensated at least in part
based on firm profitability, and shareholders prefer higher stock prices to lower stock
prices. Stock prices are determined at least in part based on firm profitability, so it
appears that mangers' interests and stockholders' interests are well-aligned. Which of
the following is true about conflicts between managers and shareholders? - ✔✔Instead
of returning free cash flow to investors in the form of dividends or stock buybacks,
managers may invest cash flows in projects that are not expected to yield adequate
returns in order to create some growth.
✔✔A company made $10 million in revenue, recorded $2 million in net income, and
paid $750,000 in dividends last year. What was the company's pay out ratio last year? -
✔✔37.5%
