bingning

Question 71

 

Which of the following statements about incremental cash flows in capital budgeting is most accurate?

A)    Since capital budgeting is based on cash flows rather than net accounting income, changes in noncash balance sheet accounts such as inventory are not relevant to the analysis.

B)   The cash flows for a project should include interest payments.

C)   Any cash flow that can be classified as a cash flow from financing is relevant in a capital budgeting project analysis.

D)   If an investment project would make use of property which the firm currently owns, the project should be charged with the opportunity cost (rental income) of the property.

 

The correct answer was D) If an investment project would make use of property which the firm currently owns, the project should be charged with the opportunity cost (rental income) of the property.

This statement is an example of an opportunity cost. Opportunity costs are cash flows that a firm is passing up by acquiring the asset in question. They include cash flows that could be generated from an asset the firm already owns if they are not used for the project in question.

The other statements are false. Project cash flows should reflect the effects of the project on other firm cash flows such as investment in inventory. Project cash flows do not consider financing costs, which are instead reflected in the project's required rate of return.

This question tested from Session 11, Reading 44, LOS b

 

Question 72

 

Justin Lopez, CFA, is the Chief Financial Officer of Waterbury Corporation. Lopez has just been informed that the U.S. Internal Revenue Code may be revised such that the maximum marginal corporate tax rate will be increased. Since Waterbury’s taxable income is routinely in the highest marginal tax bracket, Lopez is concerned about the potential impact of the proposed change. Assuming that Waterbury maintains its target capital structure, which of the following is least likely to be affected by the proposed tax change?

 

A)    Waterbury’s after-tax cost of noncallable, nonconvertible preferred stock.

B)   Waterbury’s after-tax cost of corporate debt.

C)   Waterbury’s weighted average cost of capital.

D)   Waterbury’s return on equity (ROE).

 

The correct answer was A) Waterbury’s after-tax cost of noncallable, nonconvertible preferred stock.

Corporate taxes do not affect the cost of preferred stock to the issuing firm. Waterbury’s after-tax cost of debt, and consequently, its weighted average cost of capital will decrease because the tax savings on interest will increase. Also, since taxes impact net income, Waterbury’s ROE will be affected by the change.

This question tested from Session 11, Reading 45, LOS g

 

Question 73

 

Which of the following is least likely to be considered a “best practice” regarding corporate governance?

 

A)    A majority of the board that is not affiliated with the firm’s management.

B)   Board members are limited to a six-year term.

C)   Use of a third party to tabulate votes and retain voting records.

D)   A code of ethics that is audited and improved periodically.

 

The correct answer was B) Board members are limited to a six-year term.

Anything beyond 2- or 3-year term limits on board membership has the potential to restrict the ability for shareholders to change the composition of the board if its members are not acting in the shareholders’ best interest.

This question tested from Session 11, Reading 48, LOS g

 

Question 74

 

Which of the following sources of liquidity is the most reliable?

 

A)    Uncommitted line of credit.

B)   Committed line of credit.

C)   Revolving line of credit.

D)   Overdraft line of credit.

 

The correct answer was C) Revolving line of credit.

A revolving line of credit is typically for a longer term than an uncommitted or committed line of credit and thus is considered a more reliable source of liquidity. With an uncommitted line of credit, the issuing bank may refuse to lend if conditions of the firm change. An overdraft line of credit is similar to a committed line of credit agreement between banks and firms outside of the U.S. Both committed and revolving lines of credit can be verified and can be listed in the footnotes to a firm’s financial statements as sources of liquidity.

This question tested from Session 11, Reading 46, LOS g

 

Question 75

 

Which of the following is least accurate regarding the net present value (NPV) and internal rate of return (IRR) capital budgeting techniques?

 

A)    The IRR is the discount rate that makes the net present value of a project’s cash flows zero.

B)   A project may have cash flows such that multiple IRRs exist.

C)   The crossover rate is the discount rate at which the NPVs of two projects are equal.

D)   If NPV and IRR project rankings conflict, the IRR method is preferred.

 

The correct answer was D) If NPV and IRR project rankings conflict, the IRR method is preferred.

When a ranking conflict occurs, the NPV method is preferred because it indicates the project that will provide the largest increase in the value of the firm.

This question tested from Session 11, Reading 44, LOS e, (Part 1)