Multiple choice questions on project evaluation, dividend Policy and bond valuation.

1. Harmon industries is considering adding a new store. As a final step in reviewing the proposed project, the CFO wants to take into account two real options that are attached to the proposed project. First, there is a timing option. One year from now, the company will have a much better idea of whether the county will raise or lower its property taxes. The firm might want to wait a year to decide whether it makes sense to proceed with their proposed project because the county taxes could significantly affect the project's cash flows. Second, there is an abandonment option. After two years, the company will have the option to shut down the store if it is determined that the store is losing money and will continue to lose money. Which of the following statements is most correct?

a.         In this case, the option to delay the project actually takes value away from the project.

b.        The abandonment option is likely to increase the project's expected cash flows.

c.         The abandonment option is likely to increase the project's risk.

d.        An abandonment and investment timing option cannot exist for the same project.

e.         In this case, the option to delay the project is likely to increase the project's risk.

2. Business risk is concerned with the operations of the firm. Which of the following is NOT associated with (or not a part of)usiness risk?

a.         Demand variability

b.        Sales price variability

c.         The extent to which operating costs are fixed

d.        Changes in required returns due to financing decisions

e.         The ability to change prices as costs change

3. Brandi Co. has an unlevered beta of 1.10. The firm currently has no dept, but is considering changing its capital structure to be 30% dept and 70% equity. If its corporate tax rate is 40%, what is Brandi's levered beta?

a.         1.2549

b.        1.3829

c.         1.5764

d.        1.6235

e.         1.7458

4. Ronaldo Inc. has a capital budget of $1,000,000, but it wants to maintain a target capital structure of 60% dept and 40% equity. The company forecasts this year's net income to be $600,000. If the company follows a residual dividend policy, what will be its dividend payout ratio?

a.         16.67%

b.        20.00%

c.         25.00%

d.        33.33%

e.         35.00%

5. Which of the following actions would tend to reduce conflicts of interest between stockholders and bondholders?

a.         Including restrictive covenants in the company's bond indenture (which is the contract between the company and its bondholders).

b.        Compensating managers with more stock options and less cash income.

c.         The passage of laws that make it harder for hostile takeovers to succeed.

d.        A government regulation that banned the use of convertible bonds.

e.         Have the firm use only long-term dept. e.g., dept that matures in 30 years or more rather than in less than one year.