1) If a firm is privately owned, and its stock is not traded in public markets, then we
cannot measure its beta for use in the CAPM model, we cannot observe its stock price
for use in the DCF model, and we don’t know what the risk premium is for use in the
bond-yield-plus-risk-premium method. All this makes it especially difficult to estimate
the cost of equity for a private company.
2) If debt financing is used, which of the following is CORRECT?
a.The percentage change in net operating income will be equal to a given percentage
change in net income
b.The percentage change in net income relative to the percentage change in net
operating income will depend on the interest rate charged on debt
c.The percentage change in net income will be greater than the percentage change in net
operating income
d.The percentage change in sales will be greater than the percentage change in EBIT,
which in turn will be greater than the percentage change in net income
e.The percentage change in net operating income will be greater than a given
percentage change in net income
3) Refer to Exhibit 9.1. Based on the CAPM, what is the firm’s cost of common stock?
a.11.15%
b.11.73%
c.12.35%
d.13.00%
e.13.65%
4) Sylvester Media is analyzing an average-risk project, and the following data have
been developed. Unit sales will be constant, but the sales price should increase with
inflation. Fixed costs will also be constant, but variable costs should rise with inflation.
The project should last for 3 years, it will be depreciated on a straight-line basis, and
there will be no salvage value. This is just one of many projects for the firm, so any
losses can be used to offset gains on other firm projects. The marketing manager does
not think it is necessary to adjust for inflation since both the sales price and the variable
costs will rise at the same rate, but the CFO thinks an adjustment is required. What is
the difference in the expected NPV if the inflation adjustment is made vs. if it is not
made?
WACC10.0%
Net investment cost (depreciable basis)$200,000
Units sold50,000
Average price per unit, Year 1$25.00
Fixed op. cost excl. deprec. (constant)$150,000
Variable op. cost/unit, Year 1$20.20
Annual depreciation rate33.333%
Expected inflation4.00%
Tax rate35.0%
a.$13,286
b.$13,985
c.$14,721
d.$15,457
e.$16,230
5) Refer to Exhibit 3.1. What is the firm’s market-to-book ratio?
a. 0.56
b. 0.66
c. 0.78
d. 0.92
e. 1.08
6) Charlie and Lucinda each have $50,000 invested in stock portfolios. Charlie’s has a
beta of 1.2, an expected return of 10.8%, and a standard deviation of 25%. Lucinda’s
has a beta of 0.8, an expected return of 9.2%, and a standard deviation that is also 25%.
The correlation coefficient, r, between Charlie’s and Lucinda’s portfolios is zero. If
Charlie and Lucinda marry and combine their portfolios, which of the following best
describes their combined $100,000 portfolio?
a.The combined portfolio’s beta will be equal to a simple weighted average of the betas
of the two individual portfolios, 1.0; its expected return will be equal to a simple
weighted average of the expected returns of the two individual portfolios, 10.0%; and
its standard deviation will be less than the simple average of the two portfolios’ standard
deviations, 25%
b.The combined portfolio’s expected return will be greater than the simple weighted
average of the expected returns of the two individual portfolios, 10.0%
c.The combined portfolio’s standard deviation will be greater than the simple average of
the two portfolios’ standard deviations, 25%
d.The combined portfolio’s standard deviation will be equal to a simple average of the
two portfolios’ standard deviations, 25%
e.The combined portfolio’s expected return will be less than the simple weighted
average of the expected returns of the two individual portfolios, 10.0%
7) Which of the following statements is CORRECT?
a.If the risk-free rate rises, then the market risk premium must also rise
b.If a company’s beta is halved, then its required return will also be halved
c.If a company’s beta doubles, then its required return will also double
d.The slope of the security market line is equal to the market risk premium, (rM – rRF)
e.Beta is measured by the slope of the security market line
8) The firm’s target capital structure should be consistent with which of the following
statements?
a.Minimize the cost of debt (rd)
b.Obtain the highest possible bond rating
c.Minimize the cost of equity (rs)
d.Minimize the weighted average cost of capital (WACC)
e.Maximize the earnings per share (EPS)
9) Refer to Exhibit 15.1. Assume that PP is considering changing from its original
capital structure to a new capital structure with 35% debt and 65% equity. This results
in a weighted average cost of capital equal to 9.4% and a new value of operations of
$510,638. Assume PP raises $178,723 in new debt and purchases T-bills to hold until it
makes the stock repurchase. What is the stock price per share immediately after issuing
the debt but prior to the repurchase?
a.$45.90
b.$48.12
c.$51.06
d.$53.33
e.$58.75
10) Which of the following statements is CORRECT?
a.All else equal, an increase in interest rates will have a greater effect on the prices of
short-term than long-term bonds
b.All else equal, an increase in interest rates will have a greater effect on higher-coupon
bonds than it will have on lower-coupon bonds
c.If a bond’s yield to maturity exceeds its coupon rate, the bond’s price must be less than
its maturity value
d.If a bond’s yield to maturity exceeds its coupon rate, the bond’s current yield must be
less than its coupon rate
e.If two bonds have the same maturity, the same yield to maturity, and the same level of
risk, the bonds should sell for the same price regardless of the bond’s coupon rates
11) Stocks A and B have the following data. Assuming the stock market is efficient and
the stocks are in equilibrium, which of the following statements is CORRECT?
AB
Price$25$40
Expected growth7%9%
Expected return10%12%
a.The two stocks could not be in equilibrium with the numbers given in the question
b.A’s expected dividend is $0.50
c.B’s expected dividend is $0.75
d.A’s expected dividend is $0.75 and B’s expected dividend is $1.20
e.The two stocks should have the same expected dividend
12) When working with the CAPM, which of the following factors can be determined
with the most precision?
a.The beta coefficient, bi, of a relatively safe stock
b.The most appropriate risk-free rate, rRF
c.The expected rate of return on the market, rM
d.The beta coefficient of “the market,” which is the same as the beta of an average stock
e.The market risk premium (RPM)
13) Wansley Enterprises is considering a new project. The company has a beta of 1.0,
and its sales and profits are positively correlated with the overall economy. The
company estimates that the proposed new project would have a higher standard
deviation and coefficient of variation than an average company project. Also, the new
project’s sales would be countercyclical in the sense that they would be high when the
overall economy is down and low when the overall economy is strong. On the basis of
this information, which of the following statements is CORRECT?
a.The proposed new project would increase the firm’s corporate risk
b.The proposed new project would increase the firm’s market risk
c.The proposed new project would not affect the firm’s risk at all
d.The proposed new project would have less stand-alone risk than the firm’s typical
project
e.The proposed new project would have more stand-alone risk than the firm’s typical
project
14) Which of the following actions will best enable a company to raise additional equity
capital?
a. Declare a stock split
b. Begin an open-market purchase dividend reinvestment plan
c. Initiate a stock repurchase program
d. Begin a new-stock dividend reinvestment plan
e. Refund long-term debt with lower cost short-term debt
15) Which of these items will not generally be affected by an increase in the debt ratio?
a.Total risk
b.Financial risk
c.Market risk
d.The firm’s beta
e.Business risk
16) Shirley Paul’s 2-stock portfolio has a total value of $100,000. $37,500 is invested in
Stock A with a beta of 0.75 and the remainder is invested in Stock B with a beta of 1.42.
What is her portfolio’s beta?
a.1.17
b.1.23
c.1.29
d.1.35
e.1.42
17) Which of the following is NOT a situation that might lead a firm to increase its
holdings of short-term marketable securities?
a.The firm is going from its peak sales season to its slack season, so its receivables and
inventories will experience a seasonal decline
b.The firm is going from its slack season to its peak sales season, so its receivables and
inventories will experience seasonal increases
c.The firm has just sold long-term securities and has not yet invested the proceeds in
operating assets
d.The firm just won a product liability suit one of its customers had brought against it
e.The firm must make a known future payment, such as paying for a new plant that is
under construction
18) Which of the following statements is NOT CORRECT?
a.Accruals are “free” in the sense that no explicit interest is paid on these funds
b.A conservative approach to working capital management will result in most, if not all,
permanent current operating assets being financed with long-term capital
c.The risk to a firm that borrows with short-term credit is usually greater than if it
borrowed using long-term debt. This added risk stems from the greater variability of
interest costs on short-term debt and possible difficulties with rolling over short-term
debt
d.Bank loans generally carry a higher interest rate than commercial paper
e.Commercial paper can be issued by virtually any firm so long as it is willing to pay
the going interest rate
19) Companies Heidee and Leaudy have the same sales, tax rate, interest rate on their
debt, total assets, and basic earning power. Both companies have positive net incomes.
Company Heidee has a higher debt ratio and, therefore, a higher interest expense.
Which of the following statements is CORRECT?
a. Company Heidee has more net income
b. Company Heidee pays less in taxes
c. Company Heidee has a lower equity multiplier
d. Company Heidee has a higher ROA
e. Company Heidee has a higher times interest earned (TIE) ratio
20) The primary operating goal of a publicly-owned firm interested in serving its
stockholders should be to
a. Maximize the stock price per share over the long run, which is the stock’s intrinsic
value
b. Maximize the firm’s expected EPS
c. Minimize the chances of losses
d. Maximize the firm’s expected total income
e. Maximize the stock price on a specific target date
21) Avery Corporation’s target capital structure is 35% debt, 10% preferred, and 55%
common equity. The interest rate on new debt is 6.50%, the yield on the preferred is
6.00%, the cost of common from reinvested earnings is 11.25%, and the tax rate is 40%.
The firm will not be issuing any new common stock. What is Avery’s WACC?
a.8.15%
b.8.48%
c.8.82%
d.9.17%
e.9.54%
22) Companies Heidee and Leaudy are virtually identical in that they are both
profitable, and they have the same total assets (TA), Sales (S), return on assets (ROA),
and profit margin (PM). However, Company Heidee has the higher debt ratio. Which of
the following statements is CORRECT?
a. Company Heidee has a lower operating income (EBIT) than Company LD
b. Company Heidee has a lower total assets turnover than Company Leaudy
c. Company Heidee has a lower equity multiplier than Company Leaudy
d. Company Heidee has a higher fixed assets turnover than Company Leaudy
e. Company Heidee has a higher ROE than Company Leaudy
23) Which of the following statements is CORRECT?
a.If a firm reports a loss on its income statement, then the retained earnings account as
shown on the balance sheet will be negative
b.Since depreciation is a source of funds, the more depreciation a company has, the
larger its retained earnings will be, other things held constant
c.A firm can show a large amount of retained earnings on its balance sheet yet need to
borrow cash to make required payments
d.Common equity includes common stock and retained earnings, less accumulated
depreciation
e.The retained earnings account as shown on the balance sheet shows the amount of
cash that is available for paying dividends
24) Returns for the Alcoff Company over the last 3 years are shown below. What’s the
standard deviation of the firm’s returns? (Hint: This is a sample, not a complete
population, so the sample standard deviation formula should be used.)
YearReturn
2010 21.00%
2009-12.50%
2008 25.00%
a.20.08%
b.20.59%
c.21.11%
d.21.64%
e.22.18%
25) Weber Interstate Paving Co. had $450 million of sales and $225 million of fixed
assets last year, so its FA/Sales ratio was 50%. However, its fixed assets were used at
only 65% of capacity. If the company had been able to sell off enough of its fixed assets
at book value so that it was operating at full capacity, with sales held constant at $450
million, how much cash (in millions) would it have generated?
a.$74.81
b.$78.75
c.$82.69
d.$86.82
e.$91.16
26) Which of the following statements is correct?
a. One advantage of dividend reinvestment plans is that they enable investors to
postpone paying taxes on the dividends credited to their account
b. Stock repurchases can be used by a firm that wants to increase its debt ratio
c. Stock repurchases make sense if a company expects to have a lot of profitable new
projects to fund over the next few years, provided investors are aware of these
investment opportunities
d. One advantage of an open market dividend reinvestment plan is that it provides new
equity capital and increases the shares outstanding
e. One disadvantage of dividend reinvestment plans is that they increase transactions
costs for investors who want to increase their ownership in the company
27) Suppose Yates Inc., a U.S. exporter, sold a consignment of antique American
muscle-cars to a Japanese customer at a price of 143.5 million yen, when the exchange
rate was 140 yen per dollar. In order to close the sale, Yates agreed to make the bill
payable in yen, thus agreeing to take some exchange rate risk for the transaction. The
terms were net 6 months. If the yen fell against the dollar such that one dollar would
buy 154.4 yen when the invoice was paid, what dollar amount would Yates actually
receive after it exchanged yen for U.S. dollars?
a.$1,075,958
b.$1,025,000
c.$1,000,000
d.$975,610
e.$929,404
28) As a consultant to Basso Inc., you have been provided with the following data: D1
= $0.67; P0 = $27.50; and g = 8.00% (constant). What is the cost of common from
reinvested earnings based on the DCF approach?
a.9.42%
b.9.91%
c.10.44%
d.10.96%
e.11.51%
29) Which of the following events would make it more likely that a company would
choose to call its outstanding callable bonds?
a.Market interest rates rise sharply
b.Market interest rates decline sharply
c.The company’s financial situation deteriorates significantly
d.Inflation increases significantly
e.The company’s bonds are downgraded
30) Refer to Exhibit 3.1. What is the firm’s EBITDA coverage?
a. 3.29
b. 3.46
c. 3.64
d. 3.82
e. 4.01
31) Which of the following statements is CORRECT?
a. One of the disadvantages of a sole proprietorship is that the proprietor is exposed to
unlimited liability
b. It is generally easier to transfer one’s ownership interest in a partnership than in a
corporation
c. One of the advantages of the corporate form of organization is that it avoids double
taxation
d. One of the advantages of a corporation from a social standpoint is that every
stockholder has equal voting rights, i.e., “one person, one vote”
e. Corporations of all types are subject to the corporate income tax
32) Which of the following statements is CORRECT?
a.The more depreciation a firm has in a given year, the higher its EPS, other things held
constant
b.Typically, a firm’s DPS should exceed its EPS
c.Typically, a firm’s EBIT should exceed its EBITDA
d.If a firm is more profitable than average (e.g., Google), we would normally expect to
see its stock price exceed its book value per share
e.If a firm is more profitable than most other firms, we would normally expect to see its
book value per share exceed its stock price, especially after several years of high
inflation
33) Stocks X and Y have the following data. Assuming the stock market is efficient and
the stocks are in equilibrium, which of the following statements is CORRECT?
XY
Price$25$25
Expected dividend yield5%3%
Required return12%10%
a.Stock X pays a higher dividend per share than Stock Y
b.One year from now, Stock X should have the higher price
c.Stock Y has a lower expected growth rate than Stock X
d.Stock Y has the higher expected capital gains yield
e.Stock Y pays a higher dividend per share than Stock X
34) The Cavendish Company recently issued new common stock and used the proceeds
to pay off some of its short-term notes payable. This action had no effect on the
company’s total assets or operating income. Which of the following effects would occur
as a result of this action?
a. The company’s debt ratio increased
b. The company’s current ratio increased
c. The company’s times interest earned ratio decreased
d. The company’s basic earning power ratio increased
e. The company’s equity multiplier increased
35) Which of the following would indicate an improvement in a company’s financial
position, holding other things constant?
a. The current and quick ratios both increase
b. The inventory and total assets turnover ratios both decline
c. The debt ratio increases
d. The profit margin declines
e. The EBITDA coverage ratio declines
36) Suzanne’s Cleaners is considering a project that has the following cash flow data.
What is the project’s payback?
Year012345
Cash flows-$1,100$300$310$320$330$340
a.2.31 years
b.2.56 years
c.2.85 years
d.3.16 years
e.3.52 years
37) One of the functions of NYSE specialists is to facilitate trading by keeping an
inventory of shares of the stocks in which they specialize, buying when investors want
to sell and selling when they want to buy. They change the bid and ask prices of the
securities so as to keep supply and demand in balance.
38) For a firm that makes heavy use of net float, being able to forecast collections and
disbursement check clearings is essential.
39) The cost of debt, rd, is normally less than rs, so rd(1 – T) will normally be much less
than rs. Therefore, as long as the firm is not completely debt financed, the weighted
average cost of capital (WACC) will normally be greater than rd(1 – T).
40) Recently, Hale Corporation announced the sale of 2.5 million newly issued shares
of its stock at a price of $21 per share. Hale sold the stock to an investment banker, who
in turn sold it to individual and institutional investors. This is a primary market
transaction.
41) We would generally find that the beta of a single security is more stable over time
than the beta of a diversified portfolio.
42) The cost of common equity obtained by retaining earnings is the rate of return the
marginal stockholder requires on the firm’s common stock.