1) Marketing is crucial to capital budgeting success because the goal of a good capital
budgeting project is to maximize the company’s sales.
2) Because only the largest and most creditworthy companies are able to use
commercial paper, the interest rate on commercial paper is generally lower than the
prime rate.
3) The Beta of a T-bill is zero.
4) In order to reduce discretionary financing needed, a profitable company could
decrease its dividend payout ratio.
5) In terms of risk, preferred stock is safer than common stock because it has a prior
claim on assets and income.
6) As inflation pushes interest rates up, the cost of carrying inventory rises.
7) A rational investor will always prefer an investment with a lower standard deviation
of returns, because such investments are less risky.
8) To be included in a capital budgeting analysis, all incremental free cash flows must
be expensed on the company’s books, otherwise generally accepted accounting
principles will be violated.
9) Exchange-rate risk arises from the fact that the spot exchange rate on a future date is
unknown today.
10) Cumulative voting is advantageous to minority shareholders because it may allow
them to elect a member of the board of directors.
11) Individuals, corporations, and governments can be either savings deficit units or
savings surplus units.
12) Unlike market value, the intrinsic value of an asset is estimated independently of
risk.
13) A group of investment bankers organized to distribute large securities issues is
known as a syndicate.
14) When considering taxes, most investors prefer capital gains over dividend income.
15) Company A and Company B have the same gross profit margin and the same total
asset turnover, but company A has a higher return on equity. This may result from
A) Company B has more common stock
B) Company A has a lower debt ratio
C) Company A has lower selling and administrative expenses, resulting in a higher net
profit margin
D) Company A has lower cost of goods sold, resulting in a higher net profit margin
16) Which of the following is a fixed cost?
A) insurance
B) direct material
C) direct labor
D) freight costs on products
17) You hold a portfolio with the following securities:
PercentExpected
Securityof PortfolioBetaReturn
Able Corporation20%3.2036.0%
Baker Corporation40%1.6020.0%
Charlie Corporation40%.206.0%
What is the expected return for the market, according to the CAPM?
A) 14.0%
B) 13.8%
C) 12.0%
D) 10.0%
18) All of the following will improve a firm’s liquidity position EXCEPT
A) increase accounts receivable turnover
B) increase inventory turnover
C) increase the average collection period
D) increase long-term debt and invest the money in marketable securities
19) For the net present value (NPV) criteria, a project is acceptable if NPV is
________, while for the profitability index a project is acceptable if PI is ________.
A) greater than zero; greater than the required return
B) greater than or equal to zero; greater than zero
C) greater than one; greater than or equal to one
D) greater than or equal to zero; greater than or equal to one
20) ExxonMobil generates about $50 billion in cash annually from its operations and
invests about half of that on new exploration. Therefore, ExxonMobil is an example of
a(n)
A) savings surplus unit
B) savings deficit unit
C) investment banker
D) financial intermediary
21) The principle of risk-return tradeoff means that
A) higher risk investments must earn higher returns
B) an investor who takes more risk will earn a higher return
C) a rational investor will only take on higher risk if he expects a higher return
D) an investor who bought stock in a small corporation five years ago has more money
than an investor who bought U.S. Treasury bonds five years ago
22) The yield to maturity on a bond
A) is fixed in the indenture
B) is lower for higher risk bonds
C) is the required rate of return on the bond
D) is generally below the coupon interest rate.
23) CraftCo, Inc.’ projected sales for the first six months of 2012 are given below:
Jan.$500,000April$490,000
Feb.$740,000May$740,000
Mar.$380,000June$610,000
40% of sales are collected in cash at time of sale, 50% are collected in the month
following the sale, and the remaining 10% are collected in the second month following
the sale. Cost of goods sold is 60% of sales. Purchases are made in the month prior to
the sales, and payments for purchases are made in the month of the sale. Total other
cash expenses are $40,000/month. The company’s cash balance as of February 28, 2012
will be $25,000. Excess cash will be used to retire short-term borrowing (if any).
CraftCo, Inc. has no short term borrowing as of February 28, 2012 . Assume that the
interest rate on short-term borrowing is 1% per month. The company must have a
minimum cash balance of $15,000 at the beginning of each month. What is CraftCo,
Inc.’ projected cash balance at the end of March 2012?
A) $301,000
B) $329,000
C) $352,000
D) $361,000
24) Table 4-3
Emery Corporation
The current and acid-test ratios are, respectively
A) 2.37 and 1.39
B) 2.37 and 1.27
C) 2.18 and 1.39
D) 2.18 and 1.27
25) Hyper Retail Outlets sell goods on terms of net 40. The store’s average monthly
sales (all on credit) are $70,000. Hyper pledges all of its receivables to the bank, which
advances 80% of the face value of the receivables at a rate of 2.5% above prime. The
bank also charges a 1% processing fee on all receivables pledged. Hyper borrows the
full amount possible, and the current prime rate is 5%. What is the annual percentage
rate (APR) of using this source of financing for one full year?
A) 23.5%
B) 22.5%
C) 21.8%
D) 19.1%
26) Which of the following is NOT an acceptable method of measuring risk for capital
budgeting purposes?
A) modified internal rate of return
B) sensitivity analysis
C) using a risk-adjusted discount rate
D) proxy, or pure play method for estimating a project’s beta
27) Which of the following are characteristics of a limited partnership?
A) Limited partners may not participate in the management of the limited partnership
B) There must be one or more general partners
C) General partners have unlimited liability
D) all of the above
28) Which of the following statements is MOST correct concerning flotation costs?
A) Flotation costs are the same for common stock, preferred stock and bonds because
they reflect mainly printing costs and legal fees
B) Flotation costs are generally higher for bonds rather than stocks because the dollar
amounts involved are much higher, allowing for economies of scale
C) Flotation costs as a percentage of gross proceeds increase as the size of the security
issue increases
D) Flotation costs are higher for common stocks than for preferred stocks and bonds
due to the higher level of risk associated with owning common stock
29) Donner, Inc. will finance a proposed investment by issuing new securities while
maintaining its optimal capital structure of 60% debt and 40% equity. The firm can
issue bonds at a price of $950.00 before $15 flotation costs. The 10-year bonds will
have an annual coupon rate of 8% and a face value of $1,000. The company can issue
new equity at a before-tax cost of 16% and its marginal tax rate is 34%. What is the
appropriate cost of capital to use in analyzing this project?
A) 3.63%
B) 8.77%
C) 9.97%
D) 11.81%
30) What was the average annual rate of return on common stocks of small firms during
the period 1926 to 2011?
A) 15.4%
B) 18.6%
C) 11.9%
D) 9.5%
31) In perfect capital markets there
A) is no informational content assigned to a particular dividend policy
B) are no income taxes
C) are no flotation costs
D) all of the above
32) A financial analyst expects Crane Service Inc. to pay a dividend of $2 per share one
year from today, a dividend of $3 per share in years two, and estimates the value of the
stock at the end of year two to be $22. If your required return on Crane Service stock is
14 %, what is the most you would be willing to pay for the stock today if you plan to
sell the stock in two years?
A) $20.99
B) $26.75
C) $26.90
D) $27.00
33) One bank offers you 4% interest compounded semiannually. What is the equivalent
rate if interest is compounded quarterly?
A) 3.98%
B) 3.96%
C) 3.92%
D) 1.00%
34) New Jet Airlines plans to issue 14-year bonds with a par value of $1,000 that will
pay $60 every six months. The bonds have a market price of $1,220. Flotation costs on
new debt will be 4% of the selling price. If the firm has a 35% marginal tax bracket,
compute the following:
a.Yield to maturity of debt
b.After-tax cost of existing debt
c.After-tax cost of new debt
35) 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
36) Assume that you expect to hold a $40,000 investment for one year. It is forecasted
to have a year end value of $42,000 with a 30% probability; a year end value of
$48,000 with a 45% probability; and a year end value of $60,000 with a 25%
probability. What is the expected holding period return for this investment?
A) 50%
B) 25%
C) 23%
D) 18%
37) Assume that you went to Las Vegas and hit the jackpot for $5 million. Further
assume that you were offered a choice to receive the $5 million today, or receive it in
two years. According to one of the principles of finance, which would you take?
A) the $5 million in two years because you would be afraid of spending it all right away
B) the $5 million in two years because it would be worth more than if you would
receive it today
C) You would be indifferent as to when you would receive the $5 million
D) the $5 million today because it would be worth more than if you would receive it in
two years
38) An example of a primary market transaction is
A) a new issue of common stock by AT&T
B) a sale of some outstanding common stock of AT&T by an investor
C) AT&T repurchasing its own stock from a stockholder
D) all of the above
39) A well-diversified portfolio includes investments in 50 securities. The portfolio’s
systematic risk is likely to be about
A) 50% of the total risk
B) 40% of the total risk
C) 25% of the total risk
D) zero because risk is eliminated with a portfolio of 50 securities or more
40) Plato Industries’ projected sales for the first six months of 2012 are given below:
Jan.$250,000April$300,000
Feb.$340,000May$350,000
Mar.$280,000June$380,000
20% of sales are collected in cash at time of sale, 50% are collected in the month
following the sale, and the remaining 30% are collected in the second month following
the sale. Cost of goods sold is 85% of sales. Purchases are made in the month prior to
the sales, and payments for purchases are made in the month of the sale. Total other
cash expenses are $70,000/month. The company’s cash balance as of February 28, 2012
will be $10,000. Excess cash will be used to retire short-term borrowing (if any). Plato
has no short term borrowing as of February 28, 2012 . Ignore any interest on short-term
borrowing. The company must have a minimum cash balance of $40,000 at the
beginning of each month. What is Plato Industries’ total disbursement in May?
A) $367,500
B) $348,000
C) $425,500
D) $324,000
41) All of the following statements about balance sheets are TRUE EXCEPT
A) Assets – Liabilities = Shareholders’ Equity
B) assets are reported at historical cost
C) balance sheets show average asset balances over a one-year period
D) a balance sheet reports a company’s financial position at a specific point in time
42) LaMike owns 1,000 shares of DAS. Inc.’s common stock. The stock has a par value
of $1 per share and is currently selling for $80 per share. DAS declares a 20% stock
dividend. In a perfect capital market, after the dividend Sam will have
A) 1,200 shares selling for $66.67 each.
B) 1,020 shares selling for $80.80 each.
C) 1,200 shares selling for $96.00 each.
D) 1,020 shares selling for $64.00 each.
43) The DEF Company is planning a $64 million expansion. The expansion is to be
financed by selling $25.6 million in new debt and $38.4 million in new common stock.
The before-tax required rate of return on debt is 9 percent and the required rate of return
on equity is 14 percent. If the company is in the 35 percent tax bracket, what is the
firm’s cost of capital?
A) 8.92%
B) 9.89%
C) 11.50%
D) 10.74%
44) Assume that liquid funds can be invested to yield 4.5 percent. If annual remittance
checks total $2 billion, what is it worth for the firm to reduce float by 1 day?
A) $388,349
B) $246,575
C) $257,534
D) $24,658
45) You are working on your company’s cash budget for the coming year and you
believe there may be short periods of time where financing is required. Which of the
following sources of short-term financing is most certain to be available when needed?
A) trade credit
B) line of credit with a bank
C) revolving credit agreement with a bank
D) accounts receivable
46) Tempo Corp. will issue preferred stock to finance a new artillery line. The firm’s
existing preferred stock pays a dividend of $4.00 per share and is selling for $40 per
share. Investment bankers have advised Tempo that flotation costs on the new preferred
issue would be 5% of the selling price. Tempo’s marginal tax rate is 30%. What is the
relevant cost of new preferred stock?
A) 7.00%
B) 7.37%
C) 10.00%
D) 10.53%
E) 15.00%
47) 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
48) Stock repurchases may be used for all of the following EXCEPT
A) a means for providing an internal investment opportunity.
B) to improve earnings per share.
C) to decrease the corporation’s debt ratio.
D) to eliminate a minority ownership group of stockholders.
49) DXZ, Inc. currently produces one product which sells for $250 per unit. The
company’s fixed costs are $75,000 per year; variable costs are $205 per unit. A
salesman has offered to sell the company a new piece of equipment which will increase
fixed costs to $100,000. The salesman claims that the company’s break-even point will
not be altered if the company purchases this equipment. What will be the company’s
new variable cost per unit?
50) A bond will pay $5,000 at maturity in 9 years. It also makes semiannual interest
payments of $400 until maturity. If the discount rate is 7% compounded semiannually,
what should be the market price of the bond?
51) An investment promises to pay you the following amounts at the end of each of the
next 10 years: (1) $1,000, (2) $2,000, (3) $3,000, (4) $4,000, (5) – (10) $5,000 per year.
If you want to earn a return of 8% per year, how much will you be willing to pay for the
investment today?
52) Today is your 30th birthday and you must choose between two retirement options.
The first option will provide you with 10 equal annual payments of $100,000 beginning
on your 65th birthday. The second option will provide you with one payment of
$1,000,000 on your 70th birthday. If the interest rate is 6 percent per year and you are
assured of living to at least 80 years of age, which option is better?
53)
54) Betty borrows $60,000 at 12 percent compounded annually. The loan is to be repaid
in five equal annual end-of-year installments. How much must each loan payment be?
55) You are considering the purchase of Zee Company stock. You anticipate that the
company will pay dividends of $3.50 per share next year and $4.00 per share the
following year. You believe that you can sell the stock for $20.00 per share two years
from now. If your required rate of return is 10 percent, what is the maximum price that
you would pay for a share of Zee Company stock?
56) The economic order quantity (EOQ) model is well accepted. However, there are
weaknesses associated with several of its assumptions. What are these weaknesses?
57) The date today is January 1, 2010 . A one-year security maturing on 1/1/11 yields
3%. A two-year security maturing on 1/1/12 yields 6%. A three-year security maturing
on 1/1/13 yields 11%. Calculate the expected annual return on a two-year security
beginning 1/1/11 and maturing on 1/1/13 .
58) You borrow $25,000 to buy a car, and agree to make 48 monthly payments of
$607.39 to repay the loan. What annual rate of interest, which is being compounded
monthly, are you being charged?