1) The basic earning power ratio (BEP) reflects the earning power of a firm’s assets
after giving consideration to financial leverage and tax effects.
2) When deciding whether or not to take a trade discount, the cost of borrowing from a
bank or other source should be compared to the cost of trade credit to determine if the
cash discount should be taken.
3) If the current price of a stock is below the strike price, then an option to buy the
stock is worthless and will have a zero value.
4) You have funds that you want to invest in bonds, and you just noticed in the financial
pages of the local newspaper that you can buy a $1,000 par value bond for $800. The
coupon rate is 10% (with annual payments), and there are 10 years before the bond will
mature and pay off its $1,000 par value. You should buy the bond if your required
return on bonds with this risk is 12%.
5) The maturity of most bank loans is short term. Bank loans to businesses are
frequently made as 90-day notes which are often rolled over, or renewed, rather than
repaid when they mature. However, if the borrower’s financial situation deteriorates,
then the bank may refuse to roll over the loan.
6) If the required rate of return on a bond (rd) is greater than its coupon interest rate and
will remain above that rate, then the market value of the bond will always be below its
par value until the bond matures, at which time its market value will equal its par value.
(Accrued interest between interest payment dates should not be considered when
answering this question.)
7) If investors prefer firms that retain most of their earnings, then a firm that wants to
maximize its stock price should set a low payout ratio.
8) If the yield curve is upward sloping, then short-term debt will be cheaper than
long-term debt. Thus, if a firm’s CFO expects the yield curve to continue to have an
upward slope, this would tend to cause the current ratio to be relatively low, other
things held constant.
9) The primary advantage to using accelerated rather than straight-line depreciation is
that with accelerated depreciation the present value of the tax savings provided by
depreciation will be higher, other things held constant.