Question

Which of the following statements is correct?

1) using MARCS depreciation will nojrmally decrease a projects forecasted NPV

2) Using straight-line depreciation will normally increase a projects forecasted NPV

3. The higher depreciation, the lower net income, and the lhigher cashflow

4) None of the above

Ace world's commomnn stock has a beta value of -0.5. if the rate of return on the market as a whole increases by 2% the rate of the return of Ace world stock will.

1. increase by 2%

2. Increase by 1%

3) Decrease by 2%

4*) Decrease by 1%

The difference in equity cost between retained earnings and new stock is primarily due to

1) Corporate tax code

2) agency poroblems

3) flotation cost

4) none of the above

Answer 1

1.Correct statement is The higher Depreciation,lower net income and the higher cash flow

Explanation:- For calculating net income , Depreciation is deducted and hence when Depreciation is higher then net income will be lower

But while calculating cash flow,tax shield on Depreciation is added to calculate the total cash inflow in any year and hence cash flow will be increased when Depreciation is higher

2.Expected return on stock as per CAPM = Risk free return + (market return-risk free return)* beta

Therefore when market return increases by 2% then expected return on stock will be increased by 2*beta =2*(-0.5)=-1% .

Therefore expected return of Ace world stock will

Decrease by 1%

3.Difference in equity cost between retained earnings and new stock is primarily due to

Floatation cost

Explanation:-When cost of equity is calculated for retained earnings then there is no floatation cost but when firm issues new stock then floatation cost is incurred