1) The term structure of interest rates usually indicates that longer terms to maturity
have higher expected returns.
2) The YLD% shown in Wall Street Journal stock quotes stands for the stock’s dividend
yield and is calculated by dividing the amount of the dividend by the stock’s opening
price on the first day of the year.
3) As long as a firm has a positive level of retained earnings, it can pay a dividend.
4) Saving surplus units include individuals and governments, but not corporations.
5) The current yield for a bond is constant over time because the coupon rate is fixed.
6) A security with a beta of one has a required rate of return equal to the overall market
rate of return.
7) A corporation with $1 million in retained earnings at the end of the year could easily
pay a dividend of $500,000.
8) If a U.S. company enters into a purchase agreement with a European company and
the contract is denominated in euros, then direct exchange rate risk exists for both
companies.
9) One of the attractive features of commercial paper is an active secondary market.
10) Stock repurchases do not alter a company’s capital structure since all of the
purchased shares are retired and no longer outstanding.
11) Individuals, corporations, and governments can be either savings deficit units or
savings surplus units.
12) The value of a bond is inversely related to changes in the investor’s present required
rate of return.
13) The market rewards the patient investor, for between 1926 and 2008, there has
never been a time when an investor lost money if she held an all-stock portfolio for ten
years.
14) If the future value of an annuity is known, then the present value of the annuity can
be found using the present value of a lump sum formula, even if the amount of each
annuity payment is unknown.
15) A firm’s income statement reports the results from operating the business for a
period of time, while the firm’s balance sheet provides a snapshot of the firm’s financial
position at a specific point in time.
16) Since stock dividends do not require payment in cash, their impact on a
corporation’s share price can be only positive (if there is an information effect) or
neutral, but not negative.
17) For many industries accounts receivable comprise as much as 25 percent of total
assets.
18) How managers choose to finance the business affects the company’s risk, and as a
result, the rate of return stockholders receive on their investments.
19) The computation of return on equity, or ROE, does not include retained earnings as
part of common equity because retained earnings includes all net income for the
company since its inception and analysts are trying to calculate the return for just the
current year.
20) Ratios are used to standardize financial information, thereby making it easier to
interpret.
21) Using the percent of sales method and assuming that no excess capacity exists, a
20% increase in sales will result in
A) a 20% increase in total assets
B) a 20% increase in total liabilities
C) a 20% increase in retained earnings
D) a 20% increase in the company’s profit margin
22) Butler Automotive developed a new diagnostic testing procedure that is expected to
increase sales by $10,000 per month. As more drivers bring in their vehicles, Butler
expects to also do more oil changes and brake repairs. As a result, inventory levels of
oil and brake parts must be increased by $5,000. Revenues from oil changes and brake
jobs are expected to increase by $4,000 per month. An example of a synergistic effect
from the new diagnostic testing procedure is the
A) increase in inventory levels of oil and brake parts
B) increase in revenue of $10,000 per month for the diagnostic testing
C) increase in revenues from oil changes and brake jobs of $4,000 per month
D) increase in all activities totaling $19,000 per month
23) Flashbinder Guitars, Inc. is considering a lockbox system that will increase its
check processing cost by $.15 per check. The company estimates an average check size
of $1,700 and expects the lockbox to reduce check collection time by 3 days. What
annual before-tax yield must Flashbinder Guitars, Inc. earn on its marketable securities
for the lockbox system to be beneficial?
A) 1.825%
B) 1.118%
C) 1.074%
D) 0.735%
24) All of the following are likely to result in the use of less debt in a company’s capital
structure EXCEPT
A) desire to maintain financial flexibility
B) desire to maintain a high credit rating
C) insufficient internal funds
D) a decrease in a company’s marginal tax rate
25) The inventory loan agreement in which the lender can increase his or her security
interest by having specific items of inventory identified in the loan agreement is called
A) a floating lien agreement
B) a chattel mortgage agreement
C) a field warehouse agreement
D) inventory identification agreement
26) According to the perfect markets approach to dividend policy
A) other things equal, the greater the payout ratio, the greater the share price of the firm
B) the price of a share of stock is unrelated to dividend policy
C) the firm should retain earnings so stockholders will receive a capital gain
D) the firm should pay a dividend only after current equity financing needs have been
met
27) Based on the information in Table 4-1, the accounts receivable turnover is
A) 10.00
B) 11.11
C) 8.11
D) 9.50
28) Cabell Corp. bonds pay an annual coupon rate of 10%. If investors’ required rate of
return is now 12% on these bonds, they will be priced at
A) par value
B) a premium to par value
C) a discount to par value
D) Cannot be determined without knowing the number of years to maturity
29) You must add one of two investments to an already well- diversified portfolio.
Security ASecurity B
Expected Return = 14%Expected Return = 14%
Standard Deviation ofStandard Deviation of
Returns = 15.8%Returns = 19.7%
Beta = 1.8Beta = 1.5
If you are a risk-averse investor, which one is the better choice?
A) Security A
B) Security B
C) Either security would be acceptable
D) cannot be determined with information given
30) Which of the following is an example of both a capital market and a primary market
transaction?
A) The U.S. Government sells 3-month Treasury Bills
B) Microsoft common stock owned by an individual investor is sold to another investor
C) Ford Motor Company sells a new issue of common stock to raise funds through a
public offering
D) No transactions occur in both primary and capital markets at the same time
31) Exchange rate changes tend to reflect international differences in inflation rates.
What is the name of this theory?
A) the purchasing power parity theory
B) the IMF effect
C) interest rate parity theory
D) the law of one price
32) Which of the following financial ratios is the best measure of the operating
effectiveness of a firm’s management?
A) times interest earned
B) net profit margin
C) operating return on assets
D) operating efficiency quotient
33) Project Alpha has an internal rate of return (IRR) of 15 percent. Project Beta has an
IRR of 14 percent. Both projects have a required return of 12 percent. Which of the
following statements is MOST correct?
A) Both projects have a positive net present value (NPV)
B) Project Alpha must have a higher NPV than Project Beta
C) If the required return were less than 12 percent, Project Beta would have a higher
IRR than Project Alpha
D) Project Beta has a higher profitability index than Project Alpha
34) Lithium, Inc. is considering two mutually exclusive projects, A and B. Project A
costs $95,000 and is expected to generate $65,000 in year one and $75,000 in year two.
Project B costs $120,000 and is expected to generate $64,000 in year one, $67,000 in
year two, $56,000 in year three, and $45,000 in year four. Lithium, Inc.’s required rate
of return for these projects is 10%. The modified internal rate of return for Project B is
A) 17.84%
B) 18.52%
C) 19.75%
D) 22.80%
35) Smith Manufacturing Inc. expects the following results in year one of a new
project:
Revenue$400,000
Cash Expenses150,000
Depreciation90,000
EBIT$160,000
Taxes48,000
Net Income$112,000
The annual change in operating cash flow is equal to
A) $298,000
B) $202,000
C) $160,000
D) $250,000
36) How is preferred stock affected by a decrease in the required rate of return?
A) The value of a share of preferred stock increases
B) The dividend increases
C) The dividend decreases
D) The dividend yield increases
37) Andre owns a corporate bond with a coupon rate of 8% that matures in 10 years.
Ruth owns a corporate bond with a coupon rate of 12% that matures in 25 years. If
interest rates go down, then
A) the value of Andre’s bond will decrease and the value of Ruth’s bond will increase
B) the value of both bonds will increase
C) the value of Ruth’s bond will decrease more than the value of Andre’s bond due to
the longer time to maturity
D) the value of both bonds will remain the same because they were both purchased in
an earlier time period before the interest rate changed
38) Your company is considering the replacement of an old delivery van with a new one
that is more efficient. The old van cost $40,000 when it was purchased 5 years ago. The
old van is being depreciated using the simplified straight-line method over a useful life
of 8 years. The old van could be sold today for $7,000. The new van has an invoice
price of $80,000, and it will cost $6,000 to modify the van to carry the company’s
products. Cost savings from use of the new van are expected to be $28,000 per year for
5 years, at which time the van will be sold for its estimated salvage value of $18,000.
The new van will be depreciated using the simplified straight-line method over its
5-year useful life. The company’s tax rate is 35%. Working capital is expected to
increase by $5,000 at the inception of the project, but this amount will be recaptured at
the end of year five. What is the tax effect of selling the old machine?
A) a savings of $2,800
B) a savings of $2,450
C) additional taxes paid of $2,450
D) a tax savings of $1,400
39) A small company struggling to reach profitability just announced a major new
government contract that will validate its technology and generate revenue for the next
several years. The announcement of the contract will
A) cause the stock price to increase because rcs (the required return) is likely to
increase
B) cause the stock price to decrease because the government usually pays below market
price for the goods and services it purchases
C) cause the stock price to increase because rcs (the required return) is likely to
decrease and g (the growth rate in future dividends) is likely to increase
D) have no effect on the stock price because the company has not yet paid any
dividends
40) You believe in the power of compounding and decide to save $1 per day by
avoiding the purchase of a soda. You deposit the $1 at the end of each day in a bank
account that pays 8% interest compounded daily. You are going to take a trip in 20
years with the money you have accumulated. How much money will you have in 20
years, assuming 365 days per year?
A) $7,500
B) $12,438
C) $18,032
D) $22,456
41) A bond with a $1,000 face value and a 10 percent annual coupon rate matures in 15
years.
a.Determine the value of the bond to a friend of yours with a required rate of return of
13%.
b.A zero coupon bond with similar risk is selling for $180. The bond has a face value of
$1,000 and matures in 15 years. Your friend asks you which bond she should invest in,
the zero coupon bond or the bond in part (a). Which bond do you recommend, and
why? Assume the market price of the bond in part (a) is $820.
42) Manfred Manufacturing is involved in the production of machine parts. The
company uses 600,000 pounds of steel annually. The current purchasing cost for steel is
$3.20 per pound. The carrying cost for inventory is 10 percent of the purchase price.
The cost of ordering steel is $800 per order. The company has decided to maintain a
safety stock of 15,000 pounds. The delivery time per order is 6 days. The company
works 365 days a year.
a.Determine the optimal EOQ.
b.How many orders will be placed annually?
c.What is the average inventory?
d.What is the inventory order point? (That is, at what level of inventory should a new
order be placed?)
e.What is the company’s total inventory costs for the year?
43) According to the residual theory of dividends
A) dividends are a residual after investment financing needs have been met
B) earnings remaining after payment of preferred stock dividends should be paid to
common stockholders
C) dividend payments are a constant percentage of earnings per share
D) a dividend is the residual above the payout ratio
44) Investment firms, such as Goldman Sachs, assist the transfer of capital by
A) facilitating indirect transfers from savers (investing public) to borrowers
(corporations needing capital)
B) selling indirect securities to savers and using the funds to buy common stock for
corporations needing funds
C) selling direct securities
D) selling common stock for corporate clients in the secondary market
45) As part of its expansion project, A.J. Industries Equipment Division has expanded
its office space by 200 square feet. The company’s administrative overhead is allocated
based on the square footage of each business segment. Although the total administrative
overhead for the company will remain the same, the Equipment Division will be
charged more for administrative overhead. For the Equipment Division expansion
project, the administrative overhead is an example of a(n)
A) incremental cash flow
B) sunk cost
C) opportunity cost
D) incremental opportunity cash flow
46) The primary weakness of EBIT-EPS analysis is that
A) it ignores the implicit cost of debt financing
B) it double counts the cost of debt financing
C) it applies only to firms with large amounts of debt in their capital structure
D) it may only be used by firms that are profitable this year
47) Your company buys supplies on credit terms of 2/10 net 45. Suppose the company
makes a purchase of $20,000 today. Which of the following payment options makes the
most sense as a general rule?
A) Pay the bill as soon as possible to keep the supplier happy
B) Pay the bill on day 45 due to the time value of money
C) Pay the bill on day 10 to get the discount
D) Either pay the bill on day 10 to get the discount, or wait until day 45
48) You won the lottery and can receive either (1) $60,000 today, or (2) $10,000 one
year from today plus $25,000 two years from today plus $35,000 three years from
today. You plan to use the money to pay for your child’s college education in 15 years.
You should
A) take the $60,000 today because of the time value of money regardless of current
interest rates
B) take option two because you get $70,000 rather than $60,000 regardless of current
interest rates
C) take the $60,000 today only if the current interest rate is at least 16.67%
D) take the $60,000 today if you can earn 6.81% per year or more on your investments
49) WineCellars Inc. currently has a weighted average cost of capital of 12%.
WineCellars has been growing rapidly over the past several years, selling common
stock in each year to finance its growth. However, due to difficult economic times this
year, WineCellars decides to cut its dividend and increase its retained earnings so that
the common equity portion of its capital structure will include only retained earnings
and no new common stock will be sold. WineCellars weighted average cost of capital
this year should be
A) zero, since no new stock will be sold
B) less than 12%
C) equal to 12%
D) greater than 12%
50) You bought a racehorse that has had a winning streak for six years, bringing in
$250,000 at the end of each year before dying of a heart attack. If you paid $1,155,720
for the horse 4 years ago, what was your annual return over this 4-year period?
A) 8%
B) 33%
C) 18%
D) 12%
51) A new machine can be purchased for $1,200,000. It will cost $35,000 to ship and
$15,000 to modify the machine. A $12,000 recently completed feasibility study
indicated that the firm can employ an existing factory owned by the firm, which would
have otherwise been sold for $180,000. The firm will borrow $750,000 to finance the
acquisition. Total interest expense for 5-years is expected to approximate $350,000.
What is the investment cost of the machine for capital budgeting purposes?
A) $2,180,000
B) $1,780,000
C) $1,442,000
D) $1,430,000
52) The real rate of return is the return earned above the
A) default risk premium
B) risk-adjusted return
C) inflation risk premium
D) variability of returns measured by standard deviation
53) Over the period 1926 to 2011 the standard deviation of returns has been the greatest
for which of the following?
A) treasury bills
B) corporate bonds
C) common stocks
D) common stocks of small firms
54) Quincy Fathows & Co. plans to issue commercial paper for the first time in its
85-year history. The firm plans to issue $400,000 in 120-day maturity notes. The paper
will carry a 13% quarterly compounded rate with discounted interest and will cost
Quincy Fathows $8,000 in advance to issue.
a.What is the effective cost of credit to Quincy Fathows?
b.What other factors should the firm consider in analyzing whether or not to issue the
commercial paper?
55) Which of the following would be an example of the ‘speculative motive” for a firm
holding cash balances?
A) make dividend payments
B) anticipating a strike
C) purchase of inventory
D) take advantage of an anticipated decline in the price of raw materials