1) Which of the following should not influence a firm’s dividend policy decision?
a. A strong preference by most shareholders for current cash income versus capital
gains
b. Constraints imposed by the firm’s bond indenture
c. The fact that much of the firm’s equipment has been leased rather than bought and
owned
d. The fact that Congress is considering changes in the tax law regarding the taxation of
dividends versus capital gains
e. The firm’s ability to accelerate or delay investment projects
2) Zacher Co.’s stock has a beta of 1.40, the risk-free rate is 4.25%, and the market risk
premium is 5.50%. What is the firm’s required rate of return?
a.11.36%
b.11.65%
c.11.95%
d.12.25%
e.12.55%
3) Last year National Aeronautics had a FA/Sales ratio of 40%, comprised of $250
million of sales and $100 million of fixed assets. However, its fixed assets were used at
only 75% of capacity. Now the company is developing its financial forecast for the
coming year. As part of that process, the company wants to set its target Fixed
Assets/Sales ratio at the level it would have had had it been operating at full capacity.
What target FA/Sales ratio should the company set?
a.28.5%
b.30.0%
c.31.5%
d.33.1%
e.34.7%
4) Which one of the following would NOT result in incremental cash flows and thus
should NOT be included in the capital budgeting analysis for a new product?
a.Revenues from an existing product would be lost as a result of customers switching to
the new product
b.Shipping and installation costs associated with a machine that would be used to
produce the new product
c.The cost of a study relating to the market for the new product that was completed last
year. The results of this research were positive, and they led to the tentative decision to
go ahead with the new product. The cost of the research was incurred and expensed for
tax purposes last year
d.It is learned that land the company owns and would use for the new project, if it is
accepted, could be sold to another firm
e.Using some of the firm’s high-quality factory floor space that is currently unused to
produce the proposed new product. This space could be used for other products if it is
not used for the project under consideration
5) The risk-free rate is 6%; Stock A has a beta of 1.0; Stock B has a beta of 2.0; and the
market risk premium, rM – rRF, is positive. Which of the following statements is
CORRECT?
a.Stock B’s required rate of return is twice that of Stock A
b.If Stock A’s required return is 11%, then the market risk premium is 5%
c.If Stock B’s required return is 11%, then the market risk premium is 5%
d.If the risk-free rate remains constant but the market risk premium increases, Stock A’s
required return will increase by more than Stock B’s
e.If the risk-free rate increases but the market risk premium stays unchanged, Stock B’s
required return will increase by more than Stock A’s
6) Stock A has a beta of 0.8 and Stock B has a beta of 1.2. 50% of Portfolio P is
invested in Stock A and 50% is invested in Stock B. If the market risk premium (rM –
rRF) were to increase but the risk-free rate (rRF) remained constant, which of the
following would occur?
a.The required return would decrease by the same amount for both Stock A and Stock B
b.The required return would increase for Stock A but decrease for Stock B
c.The required return on Portfolio P would remain unchanged
d.The required return would increase for Stock B but decrease for Stock A
e.The required return would increase for both stocks but the increase would be greater
for Stock B than for Stock A
7) Bae Inc. has the following income statement. How much net operating profit after
taxes (NOPAT) does the firm have?
Sales$2,000.00
Costs1,200.00
Depreciation 100.00
EBIT$ 700.00
Interest expense 200.00
EBT$ 500.00
Taxes (35%) 175.00
Net income$ 325.00
a.$370.60
b.$390.11
c.$410.64
d.$432.25
e.$455.00
8) Bonds A, B, and C all have a maturity of 15 years and a yield to maturity of 9%.
Bond A’s price exceeds its par value, Bond B’s price equals its par value, and Bond C’s
price is less than its par value. Which of the following statements is CORRECT?
a.Bond A has the most interest rate risk
b.If the yield to maturity on the three bonds remains constant, the prices of the three
bonds will remain the same over the next year
c.If the yield to maturity on each bond increases to 8%, the prices of all three bonds will
decline
d.Bond C sells at a premium over its par value
e.If the yield to maturity on each bond decreases to 6%, Bond A will have the largest
percentage increase in its price
9) The following data apply to Garber Industries, Inc. (GII):
The company plans on distributing $50 million as dividend payments. What will the
intrinsic per share stock price be immediately after the distribution?
a. $6.32
b. $6.65
c. $7.00
d. $7.35
e. $7.72
10) Which of the following statements is CORRECT?
a.A portfolio with a large number of randomly selected stocks would have more market
risk than a single stock that has a beta of 0.5, assuming that the stock’s beta was
correctly calculated and is stable
b.If a stock has a negative beta, its expected return must be negative
c.A portfolio with a large number of randomly selected stocks would have less market
risk than a single stock that has a beta of 0.5
d.According to the CAPM, stocks with higher standard deviations of returns must also
have higher expected returns
e.If the returns on two stocks are perfectly positively correlated (i.e., the correlation
coefficient is +1.0) and these stocks have identical standard deviations, an equally
weighted portfolio of the two stocks will have a standard deviation that is less than that
of the individual stocks
11) Which of the following statements is CORRECT?
a.Call options generally sell at a price greater than their exercise value, and the greater
the exercise value, the higher the premium on the option is likely to be
b.Call options generally sell at a price below their exercise value, and the greater the
exercise value, the lower the premium on the option is likely to be
c.Call options generally sell at a price below their exercise value, and the lower the
exercise value, the lower the premium on the option is likely to be
d.Because of the put-call parity relationship, under equilibrium conditions a put option
on a stock must sell at exactly the same price as a call option on the stock
e.If the underlying stock does not pay a dividend, it does not make good economic
sense to exercise a call option prior to its expiration date, even if this would yield an
immediate profit
12) Companies can issue different classes of common stock. Which of the following
statements concerning stock classes is CORRECT?
a.All common stocks, regardless of class, must have the same voting rights
b.All firms have several classes of common stock
c.All common stock, regardless of class, must pay the same dividend
d.Some class or classes of common stock are entitled to more votes per share than other
classes
e.All common stocks fall into one of three classes: A, B, and C
13) You observe the following information regarding Companies X and Y:
Company X has a higher expected return than Company Y.
Company X has a lower standard deviation of returns than Company Y.
Company X has a higher beta than Company Y.
Given this information, which of the following statements is CORRECT?
a.Company X has a lower coefficient of variation than Company Y
b.Company X has less market risk than Company Y
c.Company X’s returns will be negative when Y’s returns are positive
d.Company X’s stock is a better buy than Company Y’s stock
e.Company X has more diversifiable risk than Company Y
14) If the returns of two firms are negatively correlated, then one of them must have a
negative beta.
15) Braddock Construction Co.’s stock is trading at $20 a share. Call options that expire
in three months with a strike price of $20 sell for $1.50. Which of the following will
occur if the stock price increases 10%, to $22 a share?
a.The price of the call option will increase by more than $2
b.The price of the call option will increase by less than $2, and the percentage increase
in price will be less than 10%
c.The price of the call option will increase by less than $2, but the percentage increase
in price will be more than 10%
d.The price of the call option will increase by more than $2, but the percentage increase
in price will be less than 10%
e.The price of the call option will increase by $2
16) Heidee Corp. and Leaudy Corp. have identical assets, sales, interest rates paid on
their debt, tax rates, and EBIT. However, Heidee uses more debt than Leaudy. Which of
the following statements is CORRECT?
a. Heidee would have the higher net income as shown on the income statement
b. Without more information, we cannot tell if Heidee or Leaudy would have a higher
or lower net income
c. Heidee would have the lower equity multiplier for use in the DuPont equation
d. Heidee would have to pay more in income taxes
e. Heidee would have the lower net income as shown on the income statement
17) Which of the following is NOT normally regarded as being a barrier to hostile
takeovers?
a.Targeted share repurchases
b.Shareholder rights provisions
c.Restricted voting rights
d.Poison pills
e.Abnormally high executive compensation
18) Suppose Stan holds a portfolio consisting of a $10,000 investment in each of 8
different common stocks. The portfolio’s beta is 1.25. Now suppose Stan decided to sell
one of his stocks that has a beta of 1.00 and to use the proceeds to buy a replacement
stock with a beta of 1.35. What would the portfolio’s new beta be?
a.1.17
b.1.23
c.1.29
d.1.36
e.1.43
19) Which of the following rules is CORRECT for capital budgeting analysis?
a.Only incremental cash flows, which are the cash flows that would result if a project is
accepted, are relevant when making accept/reject decisions
b.Sunk costs are not included in the annual cash flows, but they must be deducted from
the PV of the project’s other costs when reaching the accept/reject decision
c.A proposed project’s estimated net income as determined by the firm’s accountants,
using generally accepted accounting principles (GAAP), is discounted at the WACC,
and if the PV of this income stream exceeds the project’s cost, the project should be
accepted
d.If a product is competitive with some of the firm’s other products, this fact should be
incorporated into the estimate of the relevant cash flows. However, if the new product is
complementary to some of the firm’s other products, this fact need not be reflected in
the analysis
e.The interest paid on funds borrowed to finance a project must be included in estimates
of the project’s cash flows
20) Patterson Co. is considering a project that has the following cash flow and WACC
data. What is the project’s NPV? Note that a project’s expected NPV can be negative, in
which case it will be rejected.
WACC:10.00%
Year0123
Cash flows-$950$500$400$300
a.$54.62
b.$57.49
c.$60.52
d.$63.54
e.$66.72
21) Scott Enterprises is considering a project that has the following cash flow and
WACC data. What is the project’s NPV? Note that if a project’s expected NPV is
negative, it should be rejected.
WACC:11.00%
Year01234
Cash flows-$1,000$350$350$350$350
a.$77.49
b.$81.56
c.$85.86
d.$90.15
e.$94.66
22) Stock A has an expected return of 12%, a beta of 1.2, and a standard deviation of
20%. Stock B also has a beta of 1.2, but its expected return is 10% and its standard
deviation is 15%. Portfolio AB has $300,000 invested in Stock A and $100,000 invested
in Stock B. The correlation between the two stocks’ returns is zero (that is, rA,B = 0).
Which of the following statements is CORRECT?
a.The stocks are not in equilibrium based on the CAPM; if A is valued correctly, then B
is overvalued.
b.The stocks are not in equilibrium based on the CAPM; if A is valued correctly, then B
is undervalued.
c.Portfolio AB’s expected return is 11.0%.
d.Portfolio AB’s beta is less than 1.2.
e.Portfolio AB’s standard deviation is 17.5%.
23) A security analyst obtained the following information from Prestopino Products’
financial statements:
Retained earnings at the end of 2011 were $700,000, but retained earnings at the end of
2012 had declined to $320,000.
The company does not pay dividends.
The company’s depreciation expense is its only non-cash expense; it has no
amortization charges.
The company has no non-cash revenues.
The company’s net cash flow (NCF) for 2012 was $150,000.
On the basis of this information, which of the following statements is CORRECT?
a.Prestopino had negative net income in 2012
b.Prestopino’s depreciation expense in 2012 was less than $150,000
c.Prestopino had positive net income in 2012, but its income was less than its 2011
income
d.Prestopino’s NCF in 2012 must be higher than its NCF in 2011
e.Prestopino’s cash on the balance sheet at the end of 2012 must be lower than the cash
it had on the balance sheet at the end of 2011
24) Mark’s Manufacturing’s average age of accounts receivable is 45 days, the average
age of accounts payable is 40 days, and the average age of inventory is 69 days.
Assuming a 365-day year, what is the length of its cash conversion cycle?
a.63 days
b.67 days
c.70 days
d.74 days
e.78 days
25) You are considering three different bonds for your portfolio. Each bond has a
10-year maturity and a yield to maturity of 10%. Bond X has an 8% annual coupon,
Bond Y has a 10% annual coupon, and Bond Z has a 12% annual coupon. Which of the
following statements is CORRECT?
a.Bond X has the greatest reinvestment rate risk
b.If market interest rates decline, all of the bonds will have an increase in price, and
Bond Z will have the largest percentage increase in price
c.If market interest rates remain at 10%, Bond Z’s price will be 10% higher one year
from today
d.If market interest rates increase, Bond X’s price will increase, Bond Z’s price will
decline, and Bond Y’s price will remain the same
e.If the bonds’ market interest rates remain at 10%, Bond Z’s price will be lower one
year from now than it is today
26) Refer to Exhibit 3.1. What is the firm’s debt-to-assets ratio?
a. 45.93%
b. 51.03%
c. 56.70%
d. 63.00%
e. 70.00%
27) Carolina Company is considering Projects S and L, whose cash flows are shown
below. These projects are mutually exclusive, equally risky, and are not repeatable. If
the decision is made by choosing the project with the higher IRR, how much value will
be forgone? Note that under some conditions choosing projects on the basis of the IRR
will cause $0.00 value to be lost.
WACC:7.75%
Year01234
CFS-$1,050$675$650
CFL-$1,050$360$360$360$360
a.$11.45
b.$12.72
c.$14.63
d.$16.82
e.$19.35
28) Which of the following statements is CORRECT?
a.The after-tax cost of debt that should be used as the component cost when calculating
the WACC is the average after-tax cost of all the firm’s outstanding debt
b.Suppose some of a publicly-traded firm’s stockholders are not diversified; they hold
only the one firm’s stock. In this case, the CAPM approach will result in an estimated
cost of equity that is too low in the sense that if it is used in capital budgeting, projects
will be accepted that will reduce the firm’s intrinsic value
c.The cost of equity is generally harder to measure than the cost of debt because there is
no stated, contractual cost number on which to base the cost of equity
d.The bond-yield-plus-risk-premium approach is the most sophisticated and objective
method for estimating a firm’s cost of equity capital
e.The cost of capital used to evaluate a project should be the cost of the specific type of
financing used to fund that project, i.e., it is the after-tax cost of debt if debt is to be
used to finance the project or the cost of equity if the project will be financed with
equity
29) Dixon Food’s stock has a beta of 1.4, while Clark Caf’s stock has a beta of 0.7.
Assume that the risk-free rate, rRF, is 5.5% and the market risk premium, (rM – rRF),
equals 4%. Which of the following statements is CORRECT?
a.If the market risk premium increases but the risk-free rate remains unchanged,
Dixon’s required return will increase because it has a beta greater than 1.0 but Clark’s
required return will decline because it has a beta less than 1.0
b.Since Dixon’s beta is twice that of Clark’s, its required rate of return will also be twice
that of Clark’s
c.If the risk-free rate increases while the market risk premium remains constant, then
the required return on an average stock will increase
d.If the market risk premium decreases but the risk-free rate remains unchanged,
Dixon’s required return will decrease because it has a beta greater than 1.0 and Clark’s
will also decrease, but by more than Dixon’s because it has a beta less than 1.0
e.If the risk-free rate increases but the market risk premium remains unchanged, the
required return will increase for both stocks but the increase will be larger for Dixon
since it has a higher beta
30) McGaha Enterprises expects earnings and dividends to grow at a rate of 25% for the
next 4 years, after the growth rate in earnings and dividends will fall to zero, i.e., g = 0.
The company’s last dividend, D0, was $1.25, its beta is 1.20, the market risk premium is
5.50%, and the risk-free rate is 3.00%. What is the current price of the common stock?
a.$26.77
b.$27.89
c.$29.05
d.$30.21
e.$31.42
31) McGlothin Inc. is considering a project that has the following cash flow data. What
is the project’s payback?
Year0123
Cash flows-$1,150$500$500$500
a.1.86 years
b.2.07 years
c.2.30 years
d.2.53 years
e.2.78 years
32) VR Corporation has the opportunity to invest in a new project, the details of which
are shown below. What is the Year 1 cash flow for the project?
Sales revenues, each year$42,500
Depreciation$10,000
Other operating costs$17,000
Interest expense$4,000
Tax rate35.0%
a.$16,351
b.$17,212
c.$18,118
d.$19,071
e.$20,075
33) Which of the following statements is CORRECT?
a.A callable 10-year, 10% bond should sell at a higher price than an otherwise similar
noncallable bond
b.Corporate treasurers dislike issuing callable bonds because these bonds may require
the company to raise additional funds earlier than would be true if noncallable bonds
with the same maturity were used
c.Two bonds have the same maturity and the same coupon rate. However, one is
callable and the other is not. The difference in prices between the bonds will be greater
if the current market interest rate is above the coupon rate than if it is below the coupon
rate
d.The actual life of a callable bond will always be equal to or less than the actual life of
a noncallable bond with the same maturity. Therefore, if the yield curve is upward
sloping, the required rate of return will be lower on the callable bond
e.Two bonds have the same maturity and the same coupon rate. However, one is
callable and the other is not. The difference in prices between the bonds will be greater
if the current market interest rate is below the coupon rate than if it is above the coupon
rate
34) A firm wants to strengthen its financial position. Which of the following actions
would increase its current ratio?
a. Use cash to increase inventory holdings
b. Reduce the company’s days’ sales outstanding to the industry average and use the
resulting cash savings to purchase plant and equipment
c. Use cash to repurchase some of the company’s own stock
d. Borrow using short-term debt and use the proceeds to repay debt that has a maturity
of more than one year
e. Issue new stock and then use some of the proceeds to purchase additional inventory
and hold the remainder as cash
35) The projected cash flow for the next year for Minesuah Inc. is $100,000, and FCF is
expected to grow at a constant rate of 6%. If the company’s weighted average cost of
capital is 11%, what is the value of its operations?
a.$1,714,750
b.$1,805,000
c.$1,900,000
d.$2,000,000
e.$2,100,000
36) Heath and Logan Inc. forecasts the free cash flows (in millions) shown below. The
weighted average cost of capital is 13%, and the FCFs are expected to continue growing
at a 5% rate after Year 3. Assuming that the ROIC is expected to remain constant in
Year 3 and beyond, what is the Year 0 value of operations, in millions?
Year:123
Free cash flow:-$15$10$40
a.$315
b.$331
c.$348
d.$367
e.$386
37) Which of the following is most likely to occur as you add randomly selected stocks
to your portfolio, which currently consists of 3 average stocks?
a.The expected return of your portfolio is likely to decline
b.The diversifiable risk will remain the same, but the market risk will likely decline
c.Both the diversifiable risk and the market risk of your portfolio are likely to decline
d.The total risk of your portfolio should decline, and as a result, the expected rate of
return on the portfolio should also decline
e.The diversifiable risk of your portfolio will likely decline, but the expected market
risk should not change
38) Taylor Inc. estimates that its average-risk projects have a WACC of 10%, its
below-average risk projects have a WACC of 8%, and its above-average risk projects
have a WACC of 12%. Which of the following projects (A, B, and C) should the
company accept?
a.Project C, which is of above-average risk and has a return of 11%
b.Project A, which is of average risk and has a return of 9%
c.None of the projects should be accepted
d.All of the projects should be accepted
e.Project B, which is of below-average risk and has a return of 8.5%
39) Adams Inc. has the following data: rRF = 5.00%; RPM = 6.00%; and b = 1.05.
What is the firm’s cost of common from reinvested earnings based on the CAPM?
a.11.30%
b.11.64%
c.11.99%
d.12.35%
e.12.72%
40) Which of the following is NOT a capital component when calculating the weighted
average cost of capital (WACC) for use in capital budgeting?
a.Accounts payable
b.Common stock raised by reinvesting earnings
c.Common stock raised by new issues
d.Preferred stock
e.Long-term debt
41) The cost of capital used in capital budgeting should reflect the average cost of the
various sources of long-term funds a firm uses to acquire assets.
42) If investors are risk averse and hold only one stock, we can conclude that the
required rate of return on a stock whose standard deviation is 0.21 will be greater than
the required return on a stock whose standard deviation is 0.10. However, if stocks are
held in portfolios, it is possible that the required return could be higher on the stock
with the low standard deviation.
43) If Firm A’s business is to obtain savings from individuals and then invest them in
financial assets issued by other firms or individuals, Firm A is a financial intermediary.
44) The firm’s cost of external equity raised by issuing new stock is the same as the
required rate of return on the firm’s outstanding common stock.
45) For a project with one initial cash outflow followed by a series of positive cash
inflows, the modified IRR (MIRR) method involves compounding the cash inflows out
to the end of the project’s life, summing those compounded cash flows to form a
terminal value (TV), and then finding the discount rate that causes the PV of the TV to
equal the project’s cost.
46) The current ratio and inventory turnover ratios both help us measure the firm’s
liquidity. The current ratio measures the relationship of a firm’s current assets to its
current liabilities, while the inventory turnover ratio gives us an indication of how long
it takes the firm to convert its inventory into cash.