1) If a firm adheres strictly to the residual dividend policy, the issuance of new common
stock would suggest that
a. the dividend payout ratio is increasing
b. no dividends were paid during the year
c. the dividend payout ratio is decreasing
d. the dollar amount of investments has decreased
e. the dividend payout ratio has remained constant
2) Sanders Enterprises arranged a revolving credit agreement of $9,000,000 with a
group of banks. The firm paid an annual commitment fee of 0.5% of the unused balance
of the loan commitment. On the used portion of the revolver, it paid 1.5% above prime
for the funds actually borrowed on a simple interest basis. The prime rate was 3.25%
during the year. If the firm borrowed $6,000,000 immediately after the agreement was
signed and repaid the loan at the end of one year, what was the total dollar annual cost
of the revolver?
a.$285,000
b.$300,000
c.$315,000
d.$330,750
e.$347,288
3) The value of Broadway-Brooks Inc.’s operations is $900 million, based on the
corporate valuation model. Its balance sheet shows $70 million in accounts receivable,
$50 million in inventory, $30 million in short-term investments that are unrelated to
operations, $20 million in accounts payable, $110 million in notes payable, $90 million
in long-term debt, $20 million in preferred stock, $140 million in retained earnings, and
$280 million in total common equity. If the company has 25 million shares of stock
outstanding, what is the best estimate of the stock’s price per share?
a.$23.00
b.$25.56
c.$28.40
d.$31.24
e.$34.36
4) Which of the following statements is CORRECT?
a.Lower beta stocks have higher required returns
b.A stock’s beta indicates its diversifiable risk
c.Diversifiable risk cannot be completely diversified away
d.Two securities with the same stand-alone risk must have the same betas
e.The slope of the security market line is equal to the market risk premium
5) Which of the following statements is CORRECT?
a.In comparing two projects using sensitivity analysis, the one with the steeper lines
would be considered less risky, because a small error in estimating a variable such as
unit sales would produce only a small error in the project’s NPV
b.The primary advantage of simulation analysis over scenario analysis is that scenario
analysis requires a relatively powerful computer, coupled with an efficient financial
planning software package, whereas simulation analysis can be done efficiently using a
PC with a spreadsheet program or even with just a calculator
c.Sensitivity analysis is a type of risk analysis that considers both the sensitivity of NPV
to changes in key input variables and the probability of occurrence of these variables’
values
d.As computer technology advances, simulation analysis becomes increasingly obsolete
and thus less likely to be used as compared to sensitivity analysis
e.Sensitivity analysis as it is generally employed is incomplete in that it fails to consider
the probability of occurrence of the key input variables
6) Which of the following statements is CORRECT?
a.If a bond’s yield to maturity exceeds its coupon rate, the bond will sell at par
b.All else equal, if a bond’s yield to maturity increases, its price will fall
c.If a bond’s yield to maturity exceeds its coupon rate, the bond will sell at a premium
over par
d.All else equal, if a bond’s yield to maturity increases, its current yield will fall
e.A zero coupon bond’s current yield is equal to its yield to maturity
7) An 8-year Treasury bond has a 10% coupon, and a 10-year Treasury bond has an 8%
coupon. Both bonds have the same yield to maturity. If the yield to maturity of both
bonds increases by the same amount, which of the following statements would be
CORRECT?
a.Both bonds would decline in price, but the 10-year bond would have the greater
percentage decline in price
b.The prices of both bonds would increase by the same amount
c.One bond’s price would increase, while the other bond’s price would decrease
d.The prices of the two bonds would remain constant
e.The prices of both bonds will decrease by the same amount
8) Warren Supply Inc. is evaluating its capital budget. The company finances with debt
and common equity, but because of market conditions, wants to avoid issuing any new
common stock during the coming year. It is forecasting an EPS of $3.00 for the coming
year on its 500,000 outstanding shares of stock. Its capital budget is forecasted at
$800,000, and it is committed to maintaining a $2.00 dividend per share. Given these
constraints, what percentage of the capital budget must be financed with debt?
a. 30.54%
b. 32.15%
c. 33.84%
d. 35.63%
e. 37.50%
9) Burnham Brothers Inc. has no retained earnings since it has always paid out all of its
earnings as dividends. This same situation is expected to persist in the future. The
company uses the CAPM to calculate its cost of equity, and its target capital structure
consists of common stock, preferred stock, and debt. Which of the following events
would REDUCE its WACC?
a.The flotation costs associated with issuing new common stock increase
b.The company’s beta increases
c.Expected inflation increases
d.The flotation costs associated with issuing preferred stock increase
e.The market risk premium declines
10) Fontana Painting had the following data for the most recent year (in millions). The
new CFO believes that the company could improve its working capital management
sufficiently to bring its NWC and CCC up to the benchmark companies’ level without
affecting either sales or the costs of goods sold. Fontana finances its net working capital
with a bank loan at an 8% annual interest rate, and it uses a 365-day year. If these
changes had been made, by how much would the firm’s pre-tax income have increased?
OriginalBenchmark
DataRelated CCCCCC
Sales$100,000
Cost of goods sold$ 80,000
Inventory (ICP)$ 20,000 91.2538.00
Receivables (DSO)$ 16,000 58.4020.00
Payables (PDP)$ 5,000 22.8130.00
126.8428.00
a.1,901
b.2,092
c.2,301
d.2,531
e.2,784
11) National Advertising just paid a dividend of D0 = $0.75 per share, and that dividend
is expected to grow at a constant rate of 6.50% per year in the future. The company’s
beta is 1.25, the required return on the market is 10.50%, and the risk-free rate is
4.50%. What is the company’s current stock price?
a.$14.52
b.$14.89
c.$15.26
d.$15.64
e.$16.03
12) Which of the following statements is CORRECT?
a.The after-tax cost of debt usually exceeds the after-tax cost of equity
b.For a given firm, the after-tax cost of debt is always more expensive than the after-tax
cost of non-convertible preferred stock
c.Retained earnings that were generated in the past and are reported on the firm’s
balance sheet are available to finance the firm’s capital budget during the coming year
d.The WACC that should be used in capital budgeting is the firm’s marginal, after-tax
cost of capital
e.The WACC is calculated using before-tax costs for all components
13) Which of the following statements is CORRECT?
a. If expected inflation increases, interest rates are likely to increase
b. If individuals in general increase the percentage of their income that they save,
interest rates are likely to increase
c. If companies have fewer good investment opportunities, interest rates are likely to
increase
d. Interest rates on all debt securities tend to rise during recessions because recessions
increase the possibility of bankruptcy, hence the riskiness of all debt securities
e. Interest rates on long-term bonds are more volatile than rates on short-term debt
securities like T-bills
14) Gretta’s portfolio consists of $700,000 invested in a stock that has a beta of 1.2 and
$300,000 invested in a stock that has a beta of 0.8. The risk-free rate is 6% and the
market risk premium is 5%. Which of the following statements is CORRECT?
a.The required return on the market is 10%
b.The portfolio’s required return is less than 11%
c.If the risk-free rate remains unchanged but the market risk premium increases by 2%,
Gretta’s portfolio’s required return will increase by more than 2%
d.If the market risk premium remains unchanged but expected inflation increases by
2%, Gretta’s portfolio’s required return will increase by more than 2%
e.If the stock market is efficient, Gretta’s portfolio’s expected return should equal the
expected return on the market, which is 11%
15) BLW Corporation is considering the terms to be set on the options it plans to issue
to its executives. Which of the following actions would decrease the value of the
options, other things held constant?
a.The exercise price of the option is increased
b.The life of the option is increased, i.e., the time until it expires is lengthened
c.The Federal Reserve takes actions that increase the risk-free rate
d.BLW’s stock price becomes more risky (higher variance)
e.BLW’s stock price suddenly increases
16) Which of the following statements is CORRECT?
a. Most businesses (by number and total dollar sales) are organized as partnerships or
proprietorships because it is easier to set up and operate in one of these forms rather
than as a corporation. However, if the business gets very large, it becomes
advantageous to convert to a corporation, mainly because corporations have important
tax advantages over proprietorships and partnerships
b. Due to limited liability, unlimited lives, and ease of ownership transfer, the vast
majority of U.S. businesses (in terms of number of businesses) are organized as
corporations
c. Most business (measured by dollar sales) is conducted by corporations in spite of
large corporations’ often less favorable tax treatment, due to legal considerations related
to ownership transfers and limited liability
d. Large corporations are taxed more favorably than sole proprietorships
e. Corporate stockholders are exposed to unlimited liability
17) Money markets are markets for
a. Foreign stocks
b. Consumer automobile loans
c. U.S. stocks
d. Short-term debt securities
e. Long-term bonds
18) Orwell Building Supplies’ last dividend was $1.75. Its dividend growth rate is
expected to be constant at 25% for 2 years, after which dividends are expected to grow
at a rate of 6% forever. Its required return (rs) is 12%. What is the best estimate of the
current stock price?
a.$41.58
b.$42.64
c.$43.71
d.$44.80
e.$45.92
19) In portfolio analysis, we often use ex post (historical) returns and standard
deviations, despite the fact that we are really interested in ex ante (future) data.
20) Shultz Business Systems is analyzing an average-risk project, and the following
data have been developed. Unit sales will be constant, but the sales price should
increase with inflation. Fixed costs will also be constant, but variable costs should rise
with inflation. The project should last for 3 years, it will be depreciated on a
straight-line basis, and there will be no salvage value. This is just one of many projects
for the firm, so any losses can be used to offset gains on other firm projects. What is the
project’s expected NPV?
WACC10.0%
Net investment cost (depreciable basis)$200,000
Units sold50,000
Average price per unit, Year 1$25.00
Fixed op. cost excl. deprec. (constant)$150,000
Variable op. cost/unit, Year 1$20.20
Annual depreciation rate33.333%
Expected inflation rate per year5.00%
Tax rate40.0%
a.$15,925
b.$16,764
c.$17,646
d.$18,528
e.$19,455
21) Rohter Galeano Inc. is considering how to set its dividend policy. It has a capital
budget of $3,000,000. The company wants to maintain a target capital structure that is
15% debt and 85% equity. The company forecasts that its net income this year will be
$3,500,000. If the company follows a residual dividend policy, what will be its total
dividend payment?
a. $205,000
b. $500,000
c. $950,000
d. $2,550,000
e. $3,050,000
22) Norton Electrical has quite a few positive NPV projects from which to choose. The
problem is that it has more of these projects than it can finance without issuing new
stock and the board of directors refuses to issue any new shares in the foreseeable
future. Norton’s projected net income is $150.0 million, its target capital structure is
25% debt and 75% equity, and its target payout ratio is 65%. The CFO now wants to
determine how the maximum capital budget would be affected by changes in capital
structure policy and/or the target dividend payout policy. Versus the current policy, how
much larger could the capital budget be if (1) the target debt ratio were raised to 75%,
other things held constant, (2) the target payout ratio were lowered to 20%, other things
held constant, and (3) the debt ratio and payout were both changed by the indicated
amounts.
Increase in Capital Budget
Increase Lower
Debt to 75% Payout to 20% Do both
a. $114.0 $73.3 $333.9
b. $120.0 $77.2 $351.5
c. $126.4 $81.2 $370.0
d. $133.0 $85.5 $389.5
e. $140.0 $90.0 $410.0
23) Getler Inc.’s projected capital budget is $2,000,000, its target capital structure is
40% debt and 60% equity, and its forecasted net income is $1,000,000. If the company
follows a residual dividend policy, how much dividends will it pay or, alternatively,
how much new stock must it issue?
Dividends Stock Issued
a. $514,425 $162,901
b. $541,500 $171,475
c. $570,000 $180,500
d. $600,000 $190,000
e. $0 $200,000
24) In your internship with Lewis, Lee, & Taylor Inc. you have been asked to forecast
the firm’s additional funds needed (AFN) for next year. The firm is operating at full
capacity. Data for use in your forecast are shown below. Based on the AFN equation,
what is the AFN for the coming year?
Last year’s sales = S0$200,000Last year’s accounts payable$50,000
Sales growth rate = g40%Last year’s notes payable$15,000
Last year’s total assets = A0*$135,000Last year’s accruals$20,000
Last year’s profit margin = PM20.0%Target payout ratio25.0%
a.-$14,440
b.-$15,200
c.-$16,000
d.-$16,800
e.-$17,640
25) Suppose a U.S. firm buys $200,000 worth of stereo speaker wire from a Mexican
manufacturer for delivery in 60 days with payment to be made in 90 days (30 days after
the goods are received). The rising U.S. deficit has caused the dollar to depreciate
against the peso recently. The current exchange rate is 5.50 pesos per U.S. dollar. The
90-day forward rate is 5.45 pesos/dollar. The firm goes into the forward market today
and buys enough Mexican pesos at the 90-day forward rate to completely cover its trade
obligation. Assume the spot rate in 90 days is 5.30 Mexican pesos per U.S. dollar. How
much in U.S. dollars did the firm save by eliminating its foreign exchange currency risk
with its forward market hedge?
a.$0
b.$1,834.86
c.$4,517.26
d.$5,712.31
e.$7,547.17
26) Which of the following statements is CORRECT?
a.To find the MIRR, we first compound cash flows at the regular IRR to find the TV,
and then we discount the TV at the WACC to find the PV
b.The NPV and IRR methods both assume that cash flows can be reinvested at the
WACC
However, the MIRR method assumes reinvestment at the MIRR itself
c.If two projects have the same cost, and if their NPV profiles cross in the upper right
quadrant, then the project with the higher IRR probably has more of its cash flows
coming in the later years
d.If two projects have the same cost, and if their NPV profiles cross in the upper right
quadrant, then the project with the lower IRR probably has more of its cash flows
coming in the later years
e.For a project with normal cash flows, any change in the WACC will change both the
NPV and the IRR
27) The two cardinal rules that financial analysts should follow to avoid capital
budgeting errors are: (1) in the NPV equation, the numerator should use income
calculated in accordance with generally accepted accounting principles, and (2) all
incremental cash flows should be considered when making accept/reject decisions.
28) Short-term marketable securities are held for two separate and distinct purposes: (1)
to provide liquidity as a substitute for cash and (2) as a non-operating investment.
Marketable securities held while awaiting reinvestment are not available for liquidity
purposes.
29) Variance is a measure of the variability of returns, and since it involves squaring the
deviation of each actual return from the expected return, it is always larger than its
square root, its standard deviation.
30) A firm that follows an aggressive current asset financing approach uses primarily
short-term credit and thus is more exposed to an unexpected increase in interest rates
than is a firm that uses long-term capital and thus follows a conservative financing
policy.
31) The use of accelerated versus straight-line depreciation causes net income reported
to stockholders to be lower, and cash flows higher, during every year of a project’s life,
other things held constant.