B3 - Weighted Average

Question 1

Which one of the following factors might cause a firm to increase the debt in its financial structure?

a. an increase in the corporate income tax rate
b. a decrease in the times interest earned ratio
c. increased economic uncertainty
d. an increase in the price/earnings ratio

Answer 1

a - an increase in the corporate income tax rate might cause a firm to increase the debt in its financial structure because interest is tax deductible, while dividends are not tax deductible

Question 2

The cost of debt most frequently is measured as:

a. actual interest rate plus a risk premium
b. actual interest rate
c. actual interest rate minus tax savings
d. actual interest rate adjusted for inflation

Answer 2

c

Question 3

If brewer corp’s bonds are currently yielding 8% in the marketplace, why would the firm’s cost of debt be lower?

a. additional debt can be issued more cheaply than the original debt
b. there is a mixture of old and new debt
c. market interest rates have increased
d. interest is deductible for tax purposes

Answer 3

D - because interest expense is a tax deduction, teh cost to brewer is lower than the market yield rate on debt

Question 4

What is the primary disadvantage of using ROI rather than RI to evaluate the performance of investment center managers?

a. ROI does NOT necessarily reflect the company’s cost of capital
b. ROI may lead to rejecting projects that yield positive cash flows
c. ROI does NOT reflect all economic gains
d. ROI is a percentage, while RI is a dollar amount

Answer 4

b.

Question 5

the imputed interest rate used in the residual income approach for performance measurement and evaluation can BEST be characterized as:

a. average ROI that has been earned by the company over a particular time period
b. average ROA employed over a particular time period
c. average prime lending rate for the year being evaluated
d. historical weighted average cost of capital for the company

Answer 5

D - historical weighted average cost of capital is usually used as the largest or hurdle rate in the residual income approach

Question 6

Which of the following terms represents the residual income that remains after the cost of all capital, including equity capital, has been deducted?
market value-added, free cash flow, net operating capital, economic value added

Answer 6

Economic value-added

is a residual income technique used for capital budgeting and performance evaluation. it represents the residual (excess) income of project earnings in excess of the cost of capital (including cost of equity) associated with invested capital