1) Refer to Exhibit 3.1. What is the firm’s days sales outstanding? Assume a 360-day
year for this calculation.
a. 48.17
b. 50.71
c. 53.38
d. 56.19
e. 59.14
2) Refer to Exhibit 3.1. What is the firm’s inventory turnover ratio?
a. 4.17
b. 4.38
c. 4.59
d. 5.82
e. 5.07
3) Careco Company and Audaco Inc are identical in size and capital structure. However,
the riskiness of their assets and cash flows are somewhat different, resulting in Careco
having a WACC of 10% and Audaco a WACC of 12%. Careco is considering Project X,
which has an IRR of 10.5% and is of the same risk as a typical Careco project. Audaco
is considering Project Y, which has an IRR of 11.5% and is of the same risk as a typical
Audaco project.
Now assume that the two companies merge and form a new company, Careco/Audaco
Inc. Moreover, the new company’s market risk is an average of the pre-merger
companies’ market risks, and the merger has no impact on either the cash flows or the
risks of Projects X and Y. Which of the following statements is CORRECT?
a.If evaluated using the correct post-merger WACC, Project X would have a negative
NPV
b.After the merger, Careco/Audaco would have a corporate WACC of 11%. Therefore,
it should reject Project X but accept Project Y
c.Careco/Audaco’s WACC, as a result of the merger, would be 10%
d.After the merger, Careco/Audaco should select Project Y but reject Project X. If the
firm does this, its corporate WACC will fall to 10.5%
e.If the firm evaluates these projects and all other projects at the new overall corporate
WACC, it will probably become riskier over time
4) 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$30$30
Expected growth (constant)6%4%
Required return12%10%
a.Stock Y has a higher dividend yield than Stock X
b.One year from now, Stock X’s price is expected to be higher than Stock Y’s price
c.Stock X has the higher expected year-end dividend
d.Stock Y has a higher capital gains yield
e.Stock X has a higher dividend yield than Stock Y
5) Which of the following statements is CORRECT?
a.One advantage of sensitivity analysis relative to scenario analysis is that it explicitly
takes into account the probability of specific effects occurring, whereas scenario
analysis cannot account for probabilities
b.Well-diversified stockholders do not need to consider market risk when determining
required rates of return
c.Market risk is important, but it does not have a direct effect on stock prices because it
only affects beta
d.Simulation analysis is a computerized version of scenario analysis where input
variables are selected randomly on the basis of their probability distributions
e.Sensitivity analysis is a good way to measure market risk because it explicitly takes
into account diversification effects
6) Which of the following is NOT commonly regarded as being a credit policy
variable?
a.Collection policy
b.Credit standards
c.Cash discounts
d.Payments deferral period
e.Credit period
7) For markets to be in equilibrium, that is, for there to be no strong pressure for prices
to depart from their current levels,
a.The past realized rate of return must be equal to the expected future rate of return; that
is,
b.The required rate of return must equal the past realized rate of return; that is, r =
c.The expected rate of return must be equal to the required rate of return; that is, = r
d.All of the above statements must hold for equilibrium to exist; that is = r =
e.None of the above statements is correct
8) Refer to Exhibit 21.1. What’s the difference in the projected ROEs under the
restricted and relaxed policies?
a.1.20%
b.1.50%
c.1.80%
d.2.16%
e.2.59%
9) Assume that Congress recently passed a provision that will enable Barton’s Rare
Books (BRB) to double its depreciation expense for the upcoming year but will have no
effect on its sales revenue or tax rate. Prior to the new provision, BRB’s net income
after taxes was forecasted to be $4 million. Which of the following best describes the
impact of the new provision on BRB’s financial statements versus the statements
without the provision? Assume that the company uses the same depreciation method for
tax and stockholder reporting purposes.
a.Net fixed assets on the balance sheet will decrease
b.The provision will reduce the company’s net cash flow
c.The provision will increase the company’s tax payments
d.Net fixed assets on the balance sheet will increase
e.The provision will increase the company’s net income
10) CMS Corporation’s balance sheet as of today is as follows:
Long-term debt (bonds, at par)$10,000,000
Preferred stock2,000,000
Common stock ($10 par)10,000,000
Retained earnings 4,000,000
Total debt and equity$26,000,000
The bonds have a 4.0% coupon rate, payable semiannually, and a par value of $1,000.
They mature exactly 10 years from today. The yield to maturity is 12%, so the bonds
now sell below par. What is the current market value of the firm’s debt?
a.$5,276,731
b.$5,412,032
c.$5,547,332
d.$7,706,000
e.$7,898,650
11) Century Roofing is thinking of opening a new warehouse, and the key data are
shown below. The company owns the building that would be used, and it could sell it
for $100,000 after taxes if it decides not to open the new warehouse. The equipment for
the project would be depreciated by the straight-line method over the project’s 3-year
life, after which it would be worth nothing and thus it would have a zero salvage value.
No new working capital would be required, and revenues and other operating costs
would be constant over the project’s 3-year life. What is the project’s NPV? (Hint: Cash
flows are constant in Years 1-3.)
WACC10.0%
Opportunity cost$100,000
Net equipment cost (depreciable basis)$65,000
Straight-line deprec. rate for equipment33.333%
Sales revenues, each year$123,000
Operating costs (excl. deprec.), each year$25,000
Tax rate35%
a.$10,521
b.$11,075
c.$11,658
d.$12,271
e.$12,885
12) Tashakori Trucking, a U.S.-based company, is considering expanding its operations
into a foreign country. The required investment at Time = 0 is $10 million. The firm
forecasts total cash inflows of $4 million per year for 2 years, $6 million for the next 2
years, and then a possible terminal value of $8 million. In addition, due to political risk
factors, Tashakori believes that there is a 50% chance that the gross terminal value will
be only $2 million and a 50% chance that it will be $8 million. However, the
government of the host country will block 20% of all cash flows. Thus, cash flows that
can be repatriated are 80% of those projected. Tashakori’s cost of capital is 15%, but it
adds one percentage point to all foreign projects to account for exchange rate risk.
Under these conditions, what is the project’s NPV?
a.$1.01 million
b.$2.77 million
c.$3.09 million
d.$5.96 million
e.$7.39 million
13) Monar Inc.’s CFO would like to decrease its cash conversion cycle by 10 days
(based on a 365 day year). The company carries average inventory of $750,000. Its
annual sales are $10 million, its cost of goods sold is 75% of annual sales, and its
average collection period is twice as long as its inventory conversion period. The firm
buys on terms of net 30 days, and it pays on time. The CFO believes he can reduce the
average inventory to $647,260 with no effect on sales. By how much must the firm also
reduce its accounts receivable to meet its goal in the reduction of the cash conversion
cycle?
a.$123,630
b.$130,137
c.$136,986
d.$143,836
e.$151,027
14) Which of the following statements is CORRECT? Assume that the project being
considered has normal cash flows, with one outflow followed by a series of inflows.
a.One drawback of the regular payback for evaluating projects is that this method does
not properly account for the time value of money
b.If a project’s payback is positive, then the project should be rejected because it must
have a negative NPV
c.The regular payback ignores cash flows beyond the payback period, but the
discounted payback method overcomes this problem
d.If a company uses the same payback requirement to evaluate all projects, say it
requires a payback of 4 years or less, then the company will tend to reject projects with
relatively short lives and accept long-lived projects, and this will cause its risk to
increase over time
e.The longer a project’s payback period, the more desirable the project is normally
considered to be by this criterion
15) If it takes $0.71 U.S. dollars to purchase one Swiss franc, how many Swiss francs
can one U.S. dollar buy?
a.0.50
b.0.71
c.1.00
d.1.41
e.2.81
16) Amram Company’s current ratio is 1.9. Considered alone, which of the following
actions would reduce the company’s current ratio?
a. Use cash to reduce accounts payable
b. Borrow using short-term notes payable and use the proceeds to reduce accruals
c. Borrow using short-term notes payable and use the proceeds to reduce long-term debt
d. Use cash to reduce accruals
e. Use cash to reduce short-term notes payable
17) Which of the following statements is CORRECT?
a.Other things held constant, a callable bond should have a lower yield to maturity than
a noncallable bond
b.Once a firm declares bankruptcy, it must then be liquidated by the trustee, who uses
the proceeds to pay bondholders, unpaid wages, taxes, and lawyer fees
c.Income bonds must pay interest only if the company earns the interest. Thus, these
securities cannot bankrupt a company prior to their maturity, and this makes them safer
to the issuing corporation than “regular” bonds
d.A firm with a sinking fund that gave it the choice of calling the required bonds at par
or buying the bonds in the open market would generally choose the open market
purchase if the coupon rate exceeded the going interest rate
e.One disadvantage of zero coupon bonds is that the issuing firm cannot realize any tax
savings from the debt until the bonds mature
18) Companies Heidee and Leaudy have the same tax rate, sales, 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 a lower times interest earned (TIE) ratio
b. Company Heidee has a lower equity multiplier
c. Company Heidee has more net income
d. Company Heidee pays more in taxes
e. Company Heidee has a lower ROE
19) Other things held constant, which of the following alternatives would increase a
company’s cash flow for the current year?
a. Increase the number of years over which fixed assets are depreciated for tax purposes
b. Pay down the accounts payables
c. Reduce the days’ sales outstanding (DSO) without affecting sales or operating costs
d. Pay workers more frequently to decrease the accrued wages balance
e. Reduce the inventory turnover ratio without affecting sales or operating costs
20) Suppose the U.S. Treasury announces plans to issue $50 billion of new bonds.
Assuming the announcement was not expected, what effect, other things held constant,
would that have on bond prices and interest rates?
a. Prices and interest rates would both rise
b. Prices would rise and interest rates would decline
c. Prices and interest rates would both decline
d. There would be no changes in either prices or interest rates
e. Prices would decline and interest rates would rise
21) For managerial purposes, i.e., making decisions regarding the firm’s operations, the
standard financial statements as prepared by accountants under Generally Accepted
Accounting Principles (GAAP) are often modified and used to create alternative data
and metrics that provide a somewhat different picture of a firm’s operations. Related to
these modifications, which of the following statements is CORRECT?
a.The standard statements make adjustments to reflect the effects of inflation on asset
values, and these adjustments are normally carried into any adjustment that managers
make to the standard statements
b.The standard statements focus on accounting income for the entire corporation, not
cash flows, and the two can be quite different during any given accounting period.
However, for valuation purposes we need to discount cash flows, not accounting
income. Moreover, since many firms have a number of separate divisions, and since
division managers should be compensated on their divisions’ performance, not that of
the entire firm, information that focuses on the divisions is needed. These factors have
led to the development of information that is focused on cash flows and the operations
of individual units
c.The standard statements provide useful information on the firm’s individual operating
units, but management needs more information on the firm’s overall operations than the
standard statements provide
d.The standard statements focus on cash flows, but managers are less concerned with
cash flows than with accounting income as defined by GAAP
e.The best feature of standard statements is that, if they are prepared under GAAP, the
data are always consistent from firm to firm. Thus, under GAAP, there is no room for
accountants to “adjust” the results to make earnings look better
22) Which of the following statements is CORRECT?
a. If a firm has the highest price/earnings ratio of any firm in its industry, then, other
things held constant, this suggests that the board of directors should fire the president
b. If a firm has the highest market/book ratio of any firm in its industry, then, other
things held constant, this suggests that the board of directors should fire the president
c. Other things held constant, the higher a firm’s expected future growth rate, the lower
its P/E ratio is likely to be
d. The higher the market/book ratio, then, other things held constant, the higher one
would expect to find the Market Value Added (MVA)
e. If a firm has a history of high Economic Value Added (EVA) numbers each year, and
if investors expect this situation to continue, then its market/book ratio and MVA are
both likely to be below average
23) Baltimore Baking is preparing its cash budget and expects to have sales of $30,000
in January, $35,000 in February, and $35,000 in March. If 20% of sales are for cash,
40% are credit sales paid in the month after the sale, and another 40% are credit sales
paid 2 months after the sale, what are the expected cash receipts for March?
a.$24,057
b.$26,730
c.$29,700
d.$33,000
e.$36,300
24) Two constant growth stocks are in equilibrium, have the same price, and have the
same required rate of return. Which of the following statements is CORRECT?
a.If one stock has a higher dividend yield, it must also have a lower dividend growth
rate
b.If one stock has a higher dividend yield, it must also have a higher dividend growth
rate
c.The two stocks must have the same dividend growth rate
d.The two stocks must have the same dividend yield
e.The two stocks must have the same dividend per share
25) A new firm is developing its business plan. It will require $565,000 of assets, and it
projects $452,800 of sales and $354,300 of operating costs for the first year.
Management is quite sure of these numbers because of contracts with its customers and
suppliers. It can borrow at a rate of 7.5%, but the bank requires it to have a TIE of at
least 4.0, and if the TIE falls below this level the bank will call in the loan and the firm
will go bankrupt. What is the maximum debt-to-assets ratio the firm can use? (Hint:
Find the maximum dollars of interest, then the debt that produces that interest, and then
the related debt ratio.)
a. 47.33%
b. 49.82%
c. 52.45%
d. 55.21%
e. 58.11%
26) Consider projects S and L. Both have normal cash flows, and the projects have the
same risk, hence both are evaluated with the same WACC, 10%. However, S has a
higher IRR than L. Which of the following statements is CORRECT?
a.If Project S has a positive NPV, Project L must also have a positive NPV
b.If the WACC falls, each project’s IRR will increase
c.If the WACC increases, each project’s IRR will decrease
d.If Projects S and L have the same NPV at the current WACC, 10%, then Project L, the
one with the lower IRR, would have a higher NPV if the WACC used to evaluate the
projects declined
e.Project S must have a higher NPV than Project L
27) Which of the following is most likely to be true for a portfolio of 40 randomly
selected stocks?
a.The riskiness of the portfolio is the same as the riskiness of each stock if it was held in
isolation
b.The beta of the portfolio is less than the average of the betas of the individual stocks
c.The beta of the portfolio is equal to the average of the betas of the individual stocks
d.The beta of the portfolio is larger than the average of the betas of the individual stocks
e.The riskiness of the portfolio is greater than the riskiness of each of the stocks if each
was held in isolation
28) Which of the following statements is CORRECT?
a.The discounted payback method recognizes all cash flows over a project’s life, and it
also adjusts these cash flows to account for the time value of money
b.The regular payback method was, years ago, widely used, but virtually no companies
even calculate the payback today
c.The regular payback is useful as an indicator of a project’s liquidity because it gives
managers an idea of how long it will take to recover the funds invested in a project
d.The regular payback does not consider cash flows beyond the payback year, but the
discounted payback overcomes this defect
e.The regular payback method recognizes all cash flows over a project’s life
29) Which of the following statements is CORRECT?
a.The IRR method can never be subject to the multiple IRR problem, while the MIRR
method can be
b.One reason some people prefer the MIRR to the regular IRR is that the MIRR is
based on a generally more reasonable reinvestment rate assumption
c.The higher the WACC, the shorter the discounted payback period
d.The MIRR method assumes that cash flows are reinvested at the crossover rate
e.The MIRR and NPV decision criteria can never conflict
30) If the price of money (e.g., interest rates and equity capital costs) increases due to
an increase in anticipated inflation, the risk-free rate will also increase. If there is no
change in investors’ risk aversion, then the market risk premium (rM – rRF) will remain
constant. Also, if there is no change in stocks’ betas, then the required rate of return on
each stock as measured by the CAPM will increase by the same amount as the increase
in expected inflation.
31) The calculated cost of trade credit can be reduced by paying late.
32) Two disadvantages of a proprietorship are (1) the relative difficulty of raising new
capital and (2) the owner’s unlimited personal liability for the business’ debts.
33) It is possible for a firm to have a positive beta, even if the correlation between its
returns and those of another firm is negative.
34) The NPV and IRR methods, when used to evaluate two independent and equally
risky projects, will lead to different accept/reject decisions and thus capital budgets if
the projects’ IRRs are greater than their cost of capital.