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Principles of Finance, 6e
Besley/Brigham
Chapter 17
Cengage Learning Testing, Powered by Cognero
Page 1
© 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license
1. The practice of evaluating the information contained in financial statements, industry reports, and economic factors to
determine the intrinsic value of a firm is called
a.
Asset valuation.
b.
Technical analysis.
c.
Price theory.
d.
Fundamental analysis.
e.
Industry analysis.
ANSWER:
d
POINTS:
1
DIFFICULTY:
Easy
ACCREDITING STANDARDS:
Blooms Taxonomy-5 - Knowledge
Business Program-6 - Reflective Thinking
DISC-FIN-09 - Investments
Time Estimate-a - 5 min.
TOPICS:
Fundamental Analysis
2. Factors that fundamentalists examine to determine future stock price movements include:
I.
Company conditions
II.
Industry conditions
III.
Economic & market conditions
IV.
Supply/demand relationships
a.
I, II, and IV
b.
I and II
c.
II and III
d.
I, II, and III
e.
II, III, and IV
ANSWER:
d
POINTS:
1
DIFFICULTY:
Easy
ACCREDITING STANDARDS:
Blooms Taxonomy-5 - Knowledge
Business Program-6 - Reflective Thinking
DISC-FIN-09 - Investments
Time Estimate-a - 5 min.
TOPICS:
Fundamental Analysis
3. The means by which the Federal Reserve influences economic conditions in the United States is called ____.
a.
Deficit spending
b.
Fiscal policy
c.
Monetary policy
d.
Gross domestic product
e.
Business cycle
ANSWER:
c
POINTS:
1
Principles of Finance, 6e
Besley/Brigham
Chapter 17
Cengage Learning Testing, Powered by Cognero
Page 3
e.
Stock prices.
ANSWER:
b
POINTS:
1
DIFFICULTY:
Easy
ACCREDITING STANDARDS:
Blooms Taxonomy-5 - Knowledge
Business Program-6 - Reflective Thinking
DISC-FIN-09 - Investments
Time Estimate-a - 5 min.
TOPICS:
Economic Indicators
7. Industries that tend to be directly related to business cycles such that they perform best during expansions and worst
during contractions are called ____.
a.
Defensive industries
b.
Industry life cycles
c.
Countercyclical industries
d.
Growth industries
e.
Cyclical industries
ANSWER:
e
POINTS:
1
DIFFICULTY:
Easy
ACCREDITING STANDARDS:
Blooms Taxonomy-5 - Knowledge
Business Program-6 - Reflective Thinking
DISC-FIN-09 - Investments
Time Estimate-a - 5 min.
TOPICS:
Industry Characteristics
8. What are the stages of a typical industry life cycle?
a.
Introductory stage, expansionary or contractionary stage (depending on the business cycle), mature stage.
b.
Speculative, expanding growth, declining growth.
c.
If the industry is cyclical then it will not follow a life cycle because it expands and contracts with the business
cycle.
d.
Introductory stage, Expansion stage, Mature stage.
e.
Introductory stage, Expansion stage, Stable stage.
ANSWER:
d
POINTS:
1
DIFFICULTY:
Easy
ACCREDITING STANDARDS:
Blooms Taxonomy-5 - Knowledge
Business Program-6 - Reflective Thinking
DISC-FIN-09 - Investments
Time Estimate-a - 5 min.
TOPICS:
Industry Life Cycle
9. All of the following variables must be estimated when using the dividend discount model for stock valuation except the
Principles of Finance, 6e
Besley/Brigham
Chapter 17
Cengage Learning Testing, Powered by Cognero
Page 4
© 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license
distributed with a certain product or service or otherwise on a password-protected website for classroom use.
a.
Future dividends.
b.
Growth rate of the company.
c.
Risk free rate.
d.
Appropriate required rate of return.
ANSWER:
c
POINTS:
1
DIFFICULTY:
Easy
ACCREDITING STANDARDS:
Blooms Taxonomy-5 - Knowledge
Business Program-6 - Reflective Thinking
DISC-FIN-09 - Investments
Time Estimate-a - 5 min.
TOPICS:
Dividend Discount Model
10. Financial statement analysis should be included in investment analysis because
a.
A firm's business conditions can be compared with similar firms to determine whether its current operations
are average or above or below average.
b.
We can predict earnings and dividends by forecasting the future financial conditions.
c.
We can use the accounting statements and information regarding current and forecasted business conditions to
form expectations regarding the risk of the firm's future operations.
d.
Only a and b are valid reasons.
e.
a, b and c are all valid reasons.
ANSWER:
e
POINTS:
1
DIFFICULTY:
Easy
ACCREDITING STANDARDS:
Blooms Taxonomy-5 - Knowledge
Business Program-6 - Reflective Thinking
DISC-FIN-09 - Investments
Time Estimate-a - 5 min.
TOPICS:
Financial Statement Analysis
11. If the stock market is semi-strong efficient, which of the following statements is correct?
a.
All stocks should have the same expected returns; however, they may have different realized returns.
b.
In equilibrium, stocks and bonds should have the same expected returns.
c.
Investors can outperform the market if they have access to information which has not yet been publicly
revealed.
d.
If the stock market has been performing strongly over the past several months, stock prices are more likely to
decline than increase over the next several months.
e.
None of the above statements is correct.
ANSWER:
c
RATIONALE:
Statement c is correct; the semi-strong form of the EMH states that current market prices
reflect all publicly available information. Thus, if an investor had access to information
which has not yet been publicly revealed then he could outperform the market.
POINTS:
1
Principles of Finance, 6e
Besley/Brigham
Chapter 17
14. Technical analysts would argue that the stock market is ____ form efficient.
a.
Weak
b.
Semistrong
c.
Strong
d.
None of the above, because most technicians would argue the stock market is not efficient.
ANSWER:
d
POINTS:
1
DIFFICULTY:
Moderate
ACCREDITING STANDARDS:
Blooms Taxonomy-5 - Knowledge
Business Program-6 - Reflective Thinking
DISC-FIN-09 - Investments
Time Estimate-a - 5 min.
TOPICS:
Technical Analysis
15. Titanium World Inc., which is a firm that makes specialized golf clubs, plans to pay a dividend of $2 per share at the
end of this year; the following year's dividend is expected to be $3 per share; the dividend the year after is expected to be
$5; and, after that point, dividends should increase at a constant rate of 10 percent each year forever. The appropriate
discount rate for Titanium World is 15 percent. What is the per share value of Titanium World's stock?
a.
$70.19
b.
$110.00
c.
$62.89
d.
$79.62
e.
$80.72
ANSWER:
d
RATIONALE:
The next four dividends are: = $2.00 = $3.00 = $5.00 = $5.00(1.10) = $5.50
The stock price in Year 3 is: Therefore, the current price is:
Financial calculator solution:
1.
Input into the cash flow register CF0 = 0, CF1 = 2, CF2 = 3, CF3 = 115,
and I = 15.
2.
Press NPV, and the result is 79.62.
POINTS:
1
DIFFICULTY:
Easy
ACCREDITING STANDARDS:
Blooms Taxonomy-2 - Application
Business Program-3 - Analytic
DISC-FIN-09 - Investments
Time Estimate-a - 5 min.
TOPICS:
Dividend Discount Model
Principles of Finance, 6e
Besley/Brigham
Chapter 17
stock price?
a.
$21.27
b.
$10.76
c.
$22.40
d.
$17.33
e.
$18.75
ANSWER:
e
RATIONALE:
The next four dividends are:
D1 = $1.25
D2 = $1.25(1.10)
= $1.3750
D3 = $1.25(1.10)2
= $1.5125
D4 = $1.25(1.10)3
= $1.6638
D5 = $1.6638(1.08)
= $1.7969
The stock price in Year 4 is: Therefore, the current price is:
Financial calculator
solution:
1.
Input into the cash flow register CF0 = 0, CF1 =1.25, CF2 = 1.3750,
CF3 = 1.5125, CF4 = 27.3338, and I = 15.
2.
Press NPV, and the result is 18.75.
POINTS:
1
DIFFICULTY:
Easy
ACCREDITING STANDARDS:
Blooms Taxonomy-2 - Application
Business Program-3 - Analytic
DISC-FIN-09 - Investments
Time Estimate-a - 5 min.
TOPICS:
Dividend Discount Model
17. Hurricane Shutters Inc. paid a dividend of $1.30 yesterday. The next dividend will be in one year and is expected to be
$1.50. After that, dividends are expected to grow at a constant 15 percent forever. The discount rate for Hurricane Shutters
Inc. is 25 percent. What should be the market price of the stock?
a.
$17.25
Principles of Finance, 6e
Besley/Brigham
Chapter 17
Cengage Learning Testing, Powered by Cognero
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© 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license
d.
2.0
e.
There is not enough information to answer this question.
ANSWER:
c
RATIONALE:
EPS = $4,000,000/200,000 shares = $20.00 P/E = $50.00/$20.00 = 2.5x
POINTS:
1
DIFFICULTY:
Easy
ACCREDITING STANDARDS:
Blooms Taxonomy-2 - Application
Business Program-3 - Analytic
DISC-FIN-09 - Investments
Time Estimate-a - 5 min.
TOPICS:
P/E Multiple
23. Big Joe's Burgers has a P/E ratio of 12 and a beta equal to 3. The risk-free rate is 8 percent and the return to the market
has been 14 percent. The firm has an EPS of $5.00. What should be the current market price of Big Joe's stock?
a.
$120.00
b.
$96.00
c.
$44.40
d.
$60.00
e.
$55.20
ANSWER:
d
RATIONALE:
P0 = $5.00 × 12 = $60.00
POINTS:
1
DIFFICULTY:
Easy
ACCREDITING STANDARDS:
Blooms Taxonomy-2 - Application
Business Program-3 - Analytic
DISC-FIN-09 - Investments
Time Estimate-a - 5 min.
TOPICS:
P/E Multiple
24. If the industry P/E ratio normally varies from 15 to 20, which of the following prices is most appropriate for a
company that has an EPS equal to $3?
a.
$57.60
b.
$40.00
c.
$188.20
d.
$43.20
e.
Not enough information is given to answer this question.
ANSWER:
a
RATIONALE:
Plow
= $3.00 × 15 = $45.00
Phigh
= $3.00 × 20 = $60.00
The price should fall in the range of $45 to $60.
POINTS:
1
DIFFICULTY:
Easy
Principles of Finance, 6e
Besley/Brigham
Chapter 17
Cengage Learning Testing, Powered by Cognero
Page 12
d.
$570,000
e.
$220,000
ANSWER:
c
RATIONALE:
EVA
= EBIT(1 − T) − (WACC × Invested capital)
= $3,000,000(1 − 0.40) − (0.14 × $7,000,000)
= $1,800,000 − $980,000 = $820,000
POINTS:
1
DIFFICULTY:
Easy
ACCREDITING STANDARDS:
Blooms Taxonomy-2 - Application
Business Program-3 - Analytic
DISC-FIN-09 - Investments
Time Estimate-a - 5 min.
TOPICS:
EVA
27. Using the following financial data, determine the maximum dividends per share that can be paid to stockholders
before the firm's value would be threatened. Base your answer on the economic value added model.
EBIT
$ 7,000,000
Total Capital
$12,000,000
Shares Outstanding
2,000,000
Marginal Tax Rate
30%
Debt/Assets Ratio
50%
WACC
15%
Cost of Debt
11%
a.
$0.15
b.
$0.85
c.
$1.55
d.
$1.79
e.
$2.60
ANSWER:
c
RATIONALE:
EVA
= EBIT(1 − T) − (WACC × Invested capital)
= $7,000,000(1 − 0.30) − (0.15 × $12,000,000)
= $4,900,000 − $1,800,000 = $3,100,000
DPS
= $3,100,000/2,000,000 = $1.55
POINTS:
1
DIFFICULTY:
Easy
ACCREDITING STANDARDS:
Blooms Taxonomy-2 - Application
Business Program-3 - Analytic
DISC-FIN-09 - Investments
Time Estimate-a - 5 min.
TOPICS:
EVA
28. Using the following financial data, determine the maximum dividends per share that can be paid to stockholders
before the firm's value would be threatened. Base your answer on the economic value added model.
Principles of Finance, 6e
Besley/Brigham
Chapter 17
Cengage Learning Testing, Powered by Cognero
Page 13
EBIT
$6,000,000
Total Capital
$8,000,000
Shares Outstanding
1,000,000
Marginal Tax Rate
35%
Debt/Assets Ratio
60%
WACC
20%
Cost of Debt
10%
a.
$0.50
b.
$0.70
c.
$2.00
d.
$2.30
e.
$3.10
ANSWER:
d
RATIONALE:
EVA
= EBIT(1 − T) − (WACC × Invested capital)
= $6,000,000(1 − 0.35) − (0.20 × $8,000,000)
= $3,900,000 − $1,600,000 = $2,300,000
DPS
= $2,300,000/1,000,000 = $2.30
POINTS:
1
DIFFICULTY:
Easy
ACCREDITING STANDARDS:
Blooms Taxonomy-2 - Application
Business Program-3 - Analytic
DISC-FIN-09 - Investments
Time Estimate-a - 5 min.
TOPICS:
EVA
29. Using the following financial data, determine the maximum dividends per share that can be paid to stockholders
before the firm's value would be threatened. Base your answer on the economic value added model.
EBIT
$3,000,000
Total Capital
$5,000,000
Shares Outstanding
1,250,000
Marginal Tax Rate
40%
Debt/Assets Ratio
75%
WACC
18%
Cost of Debt
13%
a.
$1.15
b.
$0.92
c.
$0.90
d.
$0.72
e.
$0.24
ANSWER:
d
RATIONALE:
EVA
= EBIT(1 − T) − (WACC × Invested capital)
= $3,000,000(1 − 0.40) − (0.18 × $5,000,000)
Principles of Finance, 6e
Besley/Brigham
Chapter 17
© 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license
31. F Minus Notes is a publicly traded company. The last dividend paid was $4 per share. Dividends are paid annually,
and they are expected to increase 5 percent per year for the next five years, then increase 10 percent per year thereafter.
The discount rate associated with F Minus Notes common stock is 20 percent. What should be the current price of F
Minus Notes stock?
a.
$36.21
b.
$33.13
c.
$47.55
d.
$50.72
e.
$31.59
ANSWER:
a
RATIONALE:
The next six dividends are:
= $4.00(1.05)
= $4.2000
= $4.00(1.05)2
= $4.4100
= $4.00(1.05)3
= $4.6305
= $4.00(1.05)4
= $4.8620
= $4.00(1.05)5
= $5.1051
= $5.1051(1.10)
= $5.6156
The stock price in Year 5 is: Therefore, the current price is:
Financial
calculator solution:
1.
Input into the cash flow register CF0 = 0, CF1 = 4.20, CF2 = 4.41, CF3
= 4.6305, CF4 = 4.8620, CF5 = 61.2611, and I = 20.
2.
Press NPV, and the result is 36.21.
POINTS:
1
DIFFICULTY:
Moderate
ACCREDITING STANDARDS:
Blooms Taxonomy-2 - Application
Business Program-3 - Analytic
DISC-FIN-09 - Investments
Time Estimate-a - 5 min.
TOPICS:
Dividend Discount Model
Principles of Finance, 6e
Besley/Brigham
Chapter 17
RATIONALE:
The next three dividends are:
= $2.50(1.15)
= $2.87500
= $2.50(1.15)2
= $3.30625
= $2.50(1.15)3
= $3.80219
Because the dividend remains constant after Year 2, the dividend payment becomes a
perpetuity. Thus the value of the stock in Year 2 is: The current
price is: Financial calculator solution:
1.
Input into the cash flow register CF0 = 0, CF1 = 2.87500, CF2 =
22.31625, and I = 20.
2.
Press NPV, and the result is 17.89.
POINTS:
1
DIFFICULTY:
Moderate
ACCREDITING STANDARDS:
Blooms Taxonomy-2 - Application
Business Program-3 - Analytic
DISC-FIN-09 - Investments
Time Estimate-a - 5 min.
TOPICS:
Dividend Discount Model
33. Candy Apple Cakes' stock has a current market value of $40.50. The company just paid a dividend equal to $1.50 per
share, which is expected to grow at a constant rate forever into the future. If Candy Apple's marginal investors require a
rate of return equal to 12 percent, what is the rate at which dividends are expected to grow in the future?
a.
8.3%
b.
12.0%
c.
4.0%
d.
8.0%
e.
There is not enough information to answer this question.
ANSWER:
d
RATIONALE:
POINTS:
1
DIFFICULTY:
Easy
ACCREDITING STANDARDS:
Blooms Taxonomy-2 - Application
Business Program-3 - Analytic
DISC-FIN-09 - Investments
Principles of Finance, 6e
Besley/Brigham
Chapter 17
Debt/Assets Ratio
70%
Cost of Equity
16%
Cost of Debt
10%
a.
$1.07
b.
$1.14
c.
$1.20
d.
$2.28
e.
$2.40
ANSWER:
b
RATIONALE:
WACC
= 0.70[(1 − 0.40)10%] + (1 − 0.70)(16%) = 9.0%
EVA
= EBIT(1 − T) − (WACC × Invested capital)
= $5,000,000(1 − 0.40) − (0.09 × $8,000,000)
= $3,000,000 − $720,000 = $2,280,000
DPS
= $2,280,000/2,000,000 = $1.14
POINTS:
1
DIFFICULTY:
Moderate
ACCREDITING STANDARDS:
Blooms Taxonomy-2 - Application
Business Program-3 - Analytic
DISC-FIN-09 - Investments
Time Estimate-a - 5 min.
TOPICS:
EVA
37. Using the following financial data, determine the maximum dividends per share that can be paid to stockholders
before the firm's value would be threatened. Base your answer on the economic value added model.
EBIT
$4,500,000
Total Capital
$6,000,000
Shares Outstanding
1,500,000
Marginal Tax Rate
60%
Debt/Assets Ratio
50%
Cost of Equity
24%
Cost of Debt
15%
a.
$1.20
b.
$0.90
c.
$0.60
d.
$0.36
e.
$0.24
ANSWER:
c
RATIONALE:
WACC
= 0.50[(1 − 0.60)15%] + (1 − 0.50)(24%) = 15.0%
EVA
= EBIT(1 − T) − (WACC × Invested capital)
= $4,500,000(1 − 0.60) − (0.15 × $6,000,000)
= $1,800,000 − $900,000 = $900,000
Principles of Finance, 6e
Besley/Brigham
Chapter 17
