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Exam 18: Financial and Operating Leverage: Analysis and Calculation

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Question 41

Multiple Choice

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Louisiana Enterprises, an all-equity firm, is considering a new capital investment. Analysis has indicated that the proposed investment has a beta of 0.5 and will generate an expected return of 7%. The firm currently has a required return of 10.75% and a beta of 1.25. The investment, if undertaken, will double the firm's total assets. If rRF is 7% and the market risk premium is 3%, should the firm undertake the investment?

A) Yes; the expected return of the asset (7%) exceeds the required return (6.5%) .
B) Yes; the beta of the asset will reduce the risk of the firm.
C) No; the expected return of the asset (7%) is less than the required return (8.5%) .
D) No; the risk of the asset (beta) will increase the firm's beta.
E) No; the expected return of the asset is less than the firm's required return, which is 10.75%.

F) A) and B)
G) B) and D)

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Question 42

Multiple Choice

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Maxvill Motors has annual sales of $15,000. Its variable costs equal 60% of its sales and its fixed costs equal $1,000. If the company's sales increase 10%, what will be the percentage increase in the company's earnings before interest and taxes (EBIT) ?

A) 13.89%
B) 14.59%
C) 13.23%
D) 12.60%
E) 12.00%

F) B) and C)
G) C) and E)

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Question 43

Multiple Choice

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Given the following returns on Stock J and the "market" during the last three years, what is the beta coefficient of Stock J? (Hint: Think rise over run.) $\begin{array} { c r r } \text { Year }& \text { Stock J }& \underline { \text { Market } } \\1 & -13.85 \% & -8.63 \% \\2 & 22.90 \% & 12.37 \% \\3 & 35.15 \% & 19.37 \%\end{array}$

For a 10-year deposit, what annual rate payable semiannually will produce the same effective rate as 4% compounded continuously?

You place $1,000 in an account that pays 7% interest compounded continuously. You plan to hold the account exactly 3 years. Simultaneously, in another account you deposit money that earns 8% compounded semiannually. If the accounts are to have the same amount at the end of the 3 years, how much of an initial deposit do you need to make now in the account that pays 8% interest compounded semiannually?

Mulroney Corp. is considering two mutually exclusive projects. Both require an initial investment of $10,000, and their risks are average for the firm. Project X has an expected life of 2 years with after-tax cash inflows of $5,300 and $7,000 at the end of Years 1 and 2, respectively. Project Y has an expected life of 4 years with after-tax cash inflows of $3,500 at the end of each of the next 4 years. The firm's WACC is 8%. Use the replacement chain to determine the NPV of the most profitable project.

Refer to Exhibit 7A.1. What is the nominal dollar value of the interest tax savings to the firm in the third year of the issue?