Objective type questions on bond valuation and WACC and project evaluation

1.  The Federal Reserve sells $50 billion of short-term U.S. Treasury securities to the public, other things held constant, what would be the most likely effect on short-term securities prices and interest rates?

1. Prices and interest rates will both rise.
2. Prices will rise and interest rates will decline.
3. Prices and interest rates will both decline.
4. Prices will decline and interest rates will rise.
5. There is no reason to expect a change in either price or interest rates.

2.   Your uncle would like to limit both interest rate (the risk that rising rates will cause the value of his bonds to decline) and his default risk, but he would still like to invest in corporate bonds. He is considering the following bonds. Which of these bonds would best meet his criteria?

1. AAA bonds with 10 years to maturity.
2. BBB perpetual bonds.
3. BBB bonds with 10 years maturity.
4. AAA bonds with 5 years maturity.
5. BBB bonds with 5 years maturity.

3.   Wagner Inc estimates that its average-risk project has a WACC of 10%, its below-average risk projects have a WACC of 8%, and its above-average risk projects have a WACC of 12%. Which of the following projects (A, B, and C) should the company accept?

1. Project A is of average risk and has a return of 9%?
2. Project B is of below-average risk and has a return of 8.5%?
3. Project C is of above-average risk and has a return of 11%?
4. None of the projects should be accepted.
5.   All of the projects should be accepted.

4.   The regular payback method has a number of disadvantages. Which of the following items is NOT a disadvantage of this method?

1. Lack of an objective, market-determined benchmark for making decisions.
2. Ignores cash flows beyond the payback period.
3. Does not directly account for the time value of money.
4. Does not provide any indication regarding a project's liquidity.
5. Does not directly account for differences in risk among projects.

5. The relative risk of a proposed project is best accounted for by

1. Adjusting the discount rate upward if the project is judged to have above average risk.
2. Adjusting the discount rate downward if the project is judged to have above average risk.
3. Reducing the NPV by 10% for risky projects.
4. Picking a risk factor equal to the average discount rate.
5. Ignoring it because project risk cannot be measured accurately.

6.  A firm is considered the purchase of an asset whose risk is greater than the firm's current risk, based on all methods for assessing risk. In evaluating this asset, it would be reasonable for the decision maker to

1. Increase the IRR of the asset to reflect its greater risk.
2. Increase the NPV of the asset to reflect the greater risk.
3. Reject the asset, since its acceptance would increase the firm's risk.
4. Ignore the risk differential if the project would amount to only a small fraction of the firm's total assets.
5. Increase the cost of capital used to evaluate the project to reflect the project's higher risk.

7.  Ridgefield Enterprises has total assets of $300 million. The company currently has no debt in its capital structure. The company's basic earning power is 15%. The company is contemplating a recapitalization where it will issue debt at 10% and use the proceeds to buy back shares of the company's common stock. If the company proceeds with the recapitalization, its operating income, total assets, and tax rate will remain the same. Which of the following will occur as a result of the recapitalization?

1. The company's ROA will increase.
2. The company's ROA will remain unchanged.
3. The company's basic earning power will decline.
4. The company's basic earning power will increase.
5. The company's ROE will increase.

8.  You are analyzing the value of an investment by calculating the present value of its expected cash flows. Which of the following would cause the investment to look better?

1. The discount rate decreases.
2. The cash flows are extended over a period of time, but the total amount of the cash flows remains the same.
3. The discount rate increases.
4. The riskiness of the project\'s cash flows increases.
5. The total amount of cash flows remains the same, but more of the cash flows are received in the later years and less is received in the earlier years.

9.  If the CEO of a firm were filling out a fitness report on a division manager (i.e., 'grading' the manager), which of the following situations would be likely to cause the manager to get a BETTER GRADE? In all cases, assume that things are held constant.

1. The division's total assets turnover ratio is below the average for other firms in the industry.
2. The division's DSO (day's sales outstanding) is 40, whereas the average for competitors is 30.
3. The division's inventory turnover is 6, whereas the average for competitors is 8.
4. The division's debt ratio is above the average for other firms in the industry.

The division's basic earning power ratio is above the average of other firms in the industry.