Question 1: GMX Resources, an independent oil and gas exploration and production company, has a tax rate of 38%. If it purchases $2,000,000 of drilling pipe, what is the after-tax cost of this expenditure?
- $760,000
- $1,240,000
- $2,000,000
- $2,760,000
Question 2: All else being equal, as debt replaces equity in a profitable company's capital structure, which of the following occurs?
- Interest expense increases, reducing taxable income and reducing taxes.
- Interest expense increases, reducing net income and earnings per share.
- Interest expense increases, reducing cash flows available to shareholders.
- Interest expense increases, reducing profitability and the wealth of shareholders.
Question 3: The most obvious leakage or capital market imperfection affecting the debt and equity choice is:
- bankruptcy risk.
- differential taxation of cash flows between debt and equity.
- the obligatory payment of interest and discretionary payment of dividends.
- the inability of bond rating agencies to perfectly foresee risk.
Question 4: Rather than just add up all the costs associated with a proposed investment, the with-and-without principle recognizes that some cash flows might not be incremental. Examples of nonincremental project costs are:
- sunk costs, additional revenues, and COGS of new products.
- sunk costs, allocation of overhead, and cannibalism of sales.
- sunk costs, allocation of overhead, and depreciation of new equipment.
- allocation of overhead, additional revenues, and costs.
Question 5: The typical corporate investment requires a large cash outlay followed by several years of cash inflows. To make these cash flows comparable, we do which of the following?
- Adjust both cash outflows and inflows for taxes.
- Subtract interest charges to reflect the time value of money.
- Adjust both outflows and inflows for the effects of depreciation.
- Apply time value of money concepts and compare present values.
Question 6: You receive an annual raise of $4,000. If you tax rate is 22%, how much will this increase your after-tax earnings?
- $880.00
- $3,120.00
- $4,000.00
- $4,880.00
Question 7: Which of the following is a problem associated with bankruptcy?
- It is embarrassing for managers to work at a firm that fails.
- Bankruptcy shifts assets to more highly valued uses.
- The costs associated with bankruptcy further reduce cash flows to shareholders.
- A company immediately ceases to be able to conduct business once it has filed for bankruptcy.
Question 8: When making investment decisions, we focus on after-tax cash flows because:
- taxes must be paid.
- those are the cash flows available to shareholders.
- taxes can have a significant effect on profits.
- tax rates differ across companies.
Question 9: If depreciation expense is a noncash charge, why do we consider it when determining cash flows?
- because depreciation expense reduces taxable income, so reduces the amount of taxes paid
- because depreciation expense offsets part of the initial cash outlay for depreciable assets
- because depreciation expense reduces net income
- because depreciation expense is a method for allocating costs
Question 10: The appropriate cash flows for evaluating a corporate investment decision are:
- incremental additional cash flows.
- marginal after-tax cash flows.
- incremental after-tax cash flows.
- investment after-tax cash flows.