1) A portfolio that combines two assets having perfectly positive correlation returns
cannot reduce the portfolio’s overall risk below the risk of the least risky asset.
2) An inverted yield curve is a downward-sloping yield curve that indicates that
short-term interest rates are generally higher than long-term interest rates.
3) Projects having higher cash inflows in the early years tend to be less sensitive to
changes in the cost of capital and are therefore often acceptable at higher discount rates
compared to projects with higher cash inflows that occur in the later years.
4) A line of credit is an agreement between a commercial bank and a business,
specifying the amount of unsecured short-term borrowing the bank will make available
to the firm over a given period of time.
5) Secured short-term financing has specific assets pledged as collateral.
6) The accrual method recognizes revenue at the point of sale and recognizes expenses
when incurred.
7) When a firm becomes bankrupt or is reorganized, the maximum claim of lessors
against the corporation is three years of lease payments.
8) In general, the greater the difference between the magnitude and/or timing of cash
inflows, the greater the likelihood of conflicting ranking between NPV and IRR.
9) The financial leverage multiplier is the ratio of a firm’s total assets to common stock
equity.
10) Money markets are markets for long-term funds such as bonds and equity.
11) Firms having stable and predictable revenues can more safely employ highly
leveraged capital structures than can firms with volatile patterns of sales revenue.
12) In general, low times interest earned ratio and fixed-payment coverage ratio are
associated with a high degree of financial leverage.
13) Holding all other factors constant, a firm that is subject to a greater level of business
risk should employ less total leverage than an otherwise equivalent firm that is subject
to a lesser level of business risk.
14) Since the net proceeds from sale of new common stock will be less than the current
market price, the cost of new issues will always be less than the cost of existing issues.
15) The probability that a firm will become bankrupt is largely dependent on its level of
both business and financial risk.
16) When making replacement decisions, the development of relevant cash flows is
complicated when compared to expansion decisions, due to the need to calculate
________ cash inflows.
A) conventional
B) opportunity
C) incremental
D) sunk
17) If you were to create a portfolio designed to reduce risk by investing equal
proportions in each of two different assets, which portfolio would you recommend?
(See Table 8.1)
A) Assets A and B
B) Assets A and C
C) none of the available combinations
D) cannot be determined
18) The difference by which the required discount rate exceeds the risk-free rate is
called the ________.
A) excess return
B) risk premium
C) inflation premium
D) maturity premium
19) If the CEO of a company were to pass away, what do you think would happen to
price of the stock?
A) It would decrease because of the perceived increased risk due of lack of near-term
leadership
B) It would increase because of the perceived increased risk due of lack of near-term
leadership
C) It would decrease because of the perceived decreased risk due of lack of near-term
leadership
D) It would increase because of the perceived decreased risk due of lack of near-term
leadership
20) A firm has interest expense of $145,000, preferred dividends of $25,000, and a tax
rate of 40 percent. The firm’s financial breakeven point is ________.
A) $ 25,000
B) $170,000
C) $186,667
D) $145,000
21) Bessey Aviation is considering leasing or purchasing a small aircraft to transport
executives between manufacturing facilities and the main administrative headquarters.
The firm is in the 40 percent tax bracket and its after-tax cost of debt is 7 percent. The
estimated after-tax cash flows for the lease and purchase alternatives are given below:
(a)Given the above cash outflows for each alternative, calculate the present value of the
after-tax cash flows using the after-tax cost of debt for each alternative.
(b)Which alternative do you recommend? Why?
22) Corporation A owns 15 percent of the stock of corporation B. Corporation B pays
corporation A $100,000 in dividends in 2002. Corporation A must pay tax on ________.
A) $100,000 of ordinary income
B) $ 30,000 of ordinary income
C) $ 70,000 of ordinary income
D) $ 70,000 of capital gain
23) A major assumption of breakeven analysis and one which causes severe limitations
in its use is that ________.
A) fixed costs really are fixed
B) total revenue is nonlinear
C) revenues and operating costs are linear
D) all costs are really semi-variable
24) In the DuPont system of analysis, the return on equity is equal to ________.
A) (net profit margin) (total asset turnover)
B) (stockholders’ equity) (financial leverage multiplier)
C) (return on total assets) (financial leverage multiplier)
D) (return on total assets) (total asset turnover)
25) Controlled disbursing ________.
A) reduces a firm’s average collection period
B) is a popular technique for effectively managing inventory to keep its level low
C) is a popular technique for increasing payment float
D) reduces a firm’s average payment period
26) The inflation risk premium on a bond is 2 percent, the U.S. T-bill rate is 5 percent,
the maturity risk premium on the bond is 3 percent, the default risk premium on the
bond is 2 percent, and the liquidity risk premium on the bond is 1 percent. Calculate its
nominal rate of return.
A) 16%
B) 13%
C) 11%
D) 9%
27) ________ is 100 percent minus total variable operating costs as a percentage of
total sales.
A) Profit margin
B) Contribution margin
C) Expense ratio
D) Fixed coverage ratio