1) If D1 = $1.25, g (which is constant) = 5.5%, and P0 = $44, what is the stock’s
expected total return for the coming year?
a.7.54%
b.7.73%
c.7.93%
d.8.13%
e.8.34%
2) Which of the following statements is CORRECT?
a. If Firms X and Y have the same net income, number of shares outstanding, and price
per share, then their market-to-book ratios must also be the same
b. If Firms X and Y have the same P/E ratios, then their market-to-book ratios must also
be the same
c. If Firms X and Y have the same net income, number of shares outstanding, and price
per share, then their P/E ratios must also be the same
d. If Firms X and Y have the same earnings per share and market-to-book ratio, they
must have the same price earnings ratio
e. If Firm X’s P/E ratio exceeds that of Firm Y, then Y is likely to be less risky and also
to be expected to grow at a faster rate
3) Last year Urbana Corp. had $197,500 of assets, $307,500 of sales, $19,575 of net
income, and a debt-to-total-assets ratio of 37.5%. The new CFO believes a new
computer program will enable it to reduce costs and thus raise net income to $33,000.
Assets, sales, and the debt ratio would not be affected. By how much would the cost
reduction improve the ROE?
a. 9.32%
b. 9.82%
c. 10.33%
d. 10.88%
e. 11.42%
4) A lockbox plan is
a.used to identify inventory safety stocks
b.used to slow down the collection of checks our firm writes
c.used to speed up the collection of checks received
d.used primarily by firms where currency is used frequently in transactions, such as fast
food restaurants, and less frequently by firms that receive payments as checks
e.used to protect cash, i.e., to keep it from being stolen
5) Which of the following statements is CORRECT?
a.The cash budget and the capital budget are developed separately, and although they
are both important to the firm, one does not affect the other
b.Since depreciation is a non-cash charge, it neither appears on nor has any effect on the
cash budget
c.The target cash balance should be set such that it need not be adjusted for seasonal
patterns and unanticipated fluctuations in receipts, although it should be changed to
reflect long-term changes in the firm’s operations
d.The typical cash budget reflects interest paid on loans as well as income from the
investment of surplus cash. These numbers, as well as other items on the cash budget,
are expected values; hence, actual results might vary from the budgeted amounts
e.Shorter-term cash budgets, in general, are used primarily for planning purposes, while
longer-term budgets are used for actual cash control
6) Firms generally choose to finance temporary current operating assets with short-term
debt because
a.short-term interest rates have traditionally been more stable than long-term interest
rates
b.a firm that borrows heavily on a long-term basis is more apt to be unable to repay the
debt than a firm that borrows short term
c.the yield curve is normally downward sloping
d.short-term debt has a higher cost than equity capital
e.matching the maturities of assets and liabilities reduces risk under some
circumstances, and also because short-term debt is often less expensive than long-term
capital
7) Which of the following statements is correct?
a. The clientele effect can explain why so many firms change their dividend policies so
often
b. One advantage of adopting the residual dividend policy is that this policy makes it
easier for corporations to develop a specific and well-identified dividend clientele
c. New-stock dividend reinvestment plans are similar to stock dividends because they
both increase the number of shares outstanding but don’t change the firm’s total amount
of book equity
d. Investors who receive stock dividends must pay taxes on the value of the new shares
in the year the stock dividends are received
e. If a firm follows the residual dividend policy, then a sudden increase in the number of
profitable projects is likely to reduce the firm’s dividend payout
8) Connolly Co.’s expected year-end dividend is D1 = $1.60, its required return is rs =
11.00%, its dividend yield is 6.00%, and its growth rate is expected to be constant in the
future. What is Connolly’s expected stock price in 7 years, i.e., what is ?
a.$37.52
b.$39.40
c.$41.37
d.$43.44
e.$45.61
9) Trahern Baking Co. common stock sells for $32.50 per share. It expects to earn $3.50
per share during the current year, its expected dividend payout ratio is 65%, and its
expected constant dividend growth rate is 6.0%. New stock can be sold to the public at
the current price, but a flotation cost of 5% would be incurred. What would be the cost
of equity from new common stock?
a.12.70%
b.13.37%
c.14.04%
d.14.74%
e.15.48%
10) United Builders wants to maintain a target capital structure with 30% debt and 70%
equity. Its forecasted net income is $550,000, and because of market conditions, the
company will not issue any new stock during the coming year. If the firm follows the
residual dividend policy, what is the maximum capital budget that is consistent with
maintaining the target capital structure?
a. $673,652
b. $709,107
c. $746,429
d. $785,714
e. $825,000
11) Freeman Builders, Inc. buys on terms of 2/15, net 30. It does not take discounts, and
it typically pays 60 days after the invoice date. Net purchases amount to $720,000 per
year. What is the nominal annual percentage cost of its non-free trade credit, based on a
365-day year?
a.10.86%
b.12.07%
c.13.41%
d.14.90%
e.16.55%
12) Northwest Lumber had a profit margin of 5.25%, a total assets turnover of 1.5, and
an equity multiplier of 1.8. What was the firm’s ROE?
a. 12.79%
b. 13.47%
c. 14.18%
d. 14.88%
e. 15.63%
13) When evaluating a new project, firms should include in the projected cash flows all
of the following EXCEPT:
a.Previous expenditures associated with a market test to determine the feasibility of the
project, provided those costs have been expensed for tax purposes
b.The value of a building owned by the firm that will be used for this project
c.A decline in the sales of an existing product, provided that decline is directly
attributable to this project
d.The salvage value of assets used for the project that will be recovered at the end of the
project’s life
e.Changes in net working capital attributable to the project
14) With which of the following statements would most people in business agree?
a. The short-run profits of a corporation will almost always increase if the firm takes
actions the government has determined are in the nation’s best interests
b. Government agencies and firms almost always agree with one another regarding the
restrictions that should be placed on hiring and firing employees
c. Although people’s moral characters are probably developed before they get into a
business school, it is still useful for business schools to cover ethics, including giving
students an idea about the adverse consequences of unethical behavior to themselves,
their firms, and the nation
d. Developing a formal set of rules defining ethical and unethical behavior is not useful
for a large corporation. Such rules generally can’t be applied in many specific instances,
so it is better to deal with ethical issues on a case-by-case basis
e. Because of the courage it takes to blow the whistle, “whistle blowers” are generally
promoted more rapidly than other employees
15) Clifford Company is choosing between two projects. The larger project has an
initial cost of $100,000, annual cash flows of $30,000 for 5 years, and an IRR of
15.24%. The smaller project has an initial cost of $50,000, annual cash flows of
$16,000 for 5 years, and an IRR of 16.63%. The projects are equally risky. Which of the
following statements is CORRECT?
a.Since the smaller project has the higher IRR, the two projects’ NPV profiles will
cross, and the larger project will look better based on the NPV at all positive values of
WACC
b.If the company uses the NPV method, it will tend to favor smaller, shorter-term
projects over larger, longer-term projects, regardless of how high or low the WACC is
c.Since the smaller project has the higher IRR but the larger project has the higher NPV
at a zero discount rate, the two projects’ NPV profiles will cross, and the larger project
will have the higher NPV if the WACC is less than the crossover rate
d.Since the smaller project has the higher IRR and the larger NPV at a zero discount
rate, the two projects’ NPV profiles will cross, and the smaller project will look better if
the WACC is less than the crossover rate
e.Since the smaller project has the higher IRR, the two projects’ NPV profiles cannot
cross, and the smaller project’s NPV will be higher at all positive values of WACC
16) Which of the following could explain why a business might choose to operate as a
corporation rather than as a sole proprietorship or a partnership?
a. Corporations generally find it relatively difficult to raise large amounts of capital
b. Less of a corporation’s income is generally subjected to taxes than would be true if
the firm were a partnership
c. Corporate shareholders escape liability for the firm’s debts, but this factor may be
offset by the tax disadvantages of the corporate form of organization
d. Corporate investors are exposed to unlimited liability
e. Corporations generally face relatively few regulations
17) Which of the following statements is CORRECT?
a.If a firm lowered its fixed costs while increasing its variable costs, holding total costs
at the present level of sales constant, this would decrease its operating leverage
b.The debt ratio that maximizes EPS generally exceeds the debt ratio that maximizes
share price
c.If a company were to issue debt and use the money to repurchase common stock, this
action would have no impact on its basic earning power ratio. (Assume that the
repurchase has no impact on the company’s operating income.)
d.If changes in the bankruptcy code made bankruptcy less costly to corporations, this
would likely reduce the average corporation’s debt ratio
e.Increasing financial leverage is one way to increase a firm’s basic earning power
(BEP)
18) Which of the following statements is CORRECT?
a. Back before the SEC was created in the 1930s, companies would declare reverse
splits in order to boost their stock prices. However, this was determined to be a
deceptive practice, and it is illegal today
b. Stock splits create more administrative problems for investors than stock dividends,
especially determining the tax basis of their shares when they decide to sell them, so
today stock dividends are used far more often than stock splits
c. When a company declares a stock split, the price of the stock typically declinesby
about 50% after a 2-for-1 splitand this necessarily reduces the total market value of the
equity
d. If a firm’s stock price is quite high relative to most stockssay $500 per sharethen it
can declare a stock split of say 10-for-1 so as to bring the price down to something
close to $50. Moreover, if the price is relatively lowsay $2 per sharethen it can declare a
“reverse split” of say 1-for-25 so as to bring the price up to somewhere around $50 per
share
e. When firms are deciding on the size of stock splitssay whether to declare a 2-for-1
split or a 3-for-1 split, it is best to declare the smaller one, in this case the 2-for-1 split,
because then the after-split price will be higher than if the 3-for-1 split had been used
19) Which of the following statements is CORRECT?
a.The statement of cash flows shows how much the firm’s cashthe total of currency,
bank deposits, and short-term liquid securities (or cash equivalents)increased or
decreased during a given year
b.The statement of cash flows reflects cash flows from operations, but it does not reflect
the effects of buying or selling fixed assets
c.The statement of cash flows shows where the firm’s cash is located; indeed, it
provides a listing of all banks and brokerage houses where cash is on deposit
d.The statement of cash flows reflects cash flows from continuing operations, but it
does not reflect the effects of changes in working capital
e.The statement of cash flows reflects cash flows from operations and from borrowings,
but it does not reflect cash obtained by selling new common stock
20) Which of the following statements is CORRECT?
a.The tax-adjusted cost of debt is always greater than the interest rate on debt, provided
the company does in fact pay taxes
b.If a company assigns the same cost of capital to all of its projects regardless of each
project’s risk, then the company is likely to reject some safe projects that it actually
should accept and to accept some risky projects that it should reject
c.Because no flotation costs are required to obtain capital as reinvested earnings, the
cost of reinvested earnings is generally lower than the after-tax cost of debt
d.Higher flotation costs tend to reduce the cost of equity capital
e.Since debt capital can cause a company to go bankrupt but equity capital cannot, debt
is riskier than equity, and thus the after-tax cost of debt is always greater than the cost
of equity
21) Garner Inc. is considering a project that has the following cash flow data. What is
the project’s payback?
Year0123
Cash flows-$350$200$200$200
a.1.42 years
b.1.58 years
c.1.75 years
d.1.93 years
e.2.12 years
22) Meric Mining Inc. recently reported $15,000 of sales, $7,500 of operating costs
other than depreciation, and $1,200 of depreciation. The company had no amortization
charges, it had outstanding $6,500 of bonds that carry a 6.25% interest rate, and its
federal-plus-state income tax rate was 35%. How much was the firm’s net income after
taxes? Meric uses the same depreciation expense for tax and stockholder reporting
purposes.
a.$3,284.55
b.$3,457.42
c.$3,639.39
d.$3,830.94
e.$4,022.48
23) Poff Industries’ stock currently sells for $120 a share. You own 100 shares of the
stock. The company is contemplating a 2-for-1 stock split. Which of the following best
describes what your position will be after such a split takes place?
a. You will have 200 shares of stock, and the stock will trade at or near $60 a share
b. You will have 100 shares of stock, and the stock will trade at or near $60 a share
c. You will have 50 shares of stock, and the stock will trade at or near $120 a share
d. You will have 50 shares of stock, and the stock will trade at or near $60 a share
e. You will have 200 shares of stock, and the stock will trade at or near $120 a share
24) Which of the following statements is CORRECT?
a. If General Electric were to issue new stock this year it would be considered a
secondary market transaction since the company already has stock outstanding
b. Capital market transactions only include preferred stock and common stock
transactions
c. The distinguishing feature between spot markets versus futures markets transactions
is the maturity of the investments. That is, spot market transactions involve securities
that have maturities of less than one year, whereas futures markets transactions involve
securities with maturities greater than one year
d. Both Nasdaq “dealers” and NYSE ‘specialists” hold inventories of stocks
e. An electronic communications network (ECN) is a physical location exchange
25) Assume that investors have recently become more risk averse, so the market risk
premium has increased. Also, assume that the risk-free rate and expected inflation have
not changed. Which of the following is most likely to occur?
a.The required rate of return will decline for stocks whose betas are less than 1.0
b.The required rate of return on the market, rM, will not change as a result of these
changes
c.The required rate of return for each individual stock in the market will increase by an
amount equal to the increase in the market risk
d.The required rate of return on a riskless bond will decline
e.The required rate of return for an average stock will increase by an amount equal to
the increase in the market risk premium
26) You are on the staff of O’Hara Inc. The CFO believes project acceptance should be
based on the NPV, but Andrew O’Hara, the president, insists that no project should be
accepted unless its IRR exceeds the project’s risk-adjusted WACC. Now you must make
a recommendation on a project that has a cost of $15,000 and two cash flows: $110,000
at the end of Year 1 and -$100,000 at the end of Year 2. The president and the CFO both
agree that the appropriate WACC for this project is 10%. At 10%, the NPV is
$2,355.37, but you find two IRRs, one at 6.33% and one at 527%, and a MIRR of
11.32%. Which of the following statements best describes your optimal
recommendation, i.e., the analysis and recommendation that is best for the company
and least likely to get you in trouble with either the CFO or the president?
a.You should recommend that the project be rejected because, although its NPV is
positive, it has an IRR that is less than the WACC
b.You should recommend that the project be accepted because (1) its NPV is positive
and (2) although it has two IRRs, in this case it would be better to focus on the MIRR,
which exceeds the WACC. You should explain this to the president and tell him that the
firm’s value will increase if the project is accepted
c.You should recommend that the project be rejected. Although its NPV is positive it
has two IRRs, one of which is less than the WACC, which indicates that the firm’s value
will decline if the project is accepted
d.You should recommend that the project be rejected because, although its NPV is
positive, its MIRR is less than the WACC, and that indicates that the firm’s value will
decline if it is accepted
e.You should recommend that the project be rejected because its NPV is negative and
its IRR is less than the WACC
27) Fiske Roofing Supplies’ stock has a beta of 1.23, its required return is 11.75%, and
the risk-free rate is 4.30%. What is the required rate of return on the market? (Hint:
First find the market risk premium.)
a.10.36%
b.10.62%
c.10.88%
d.11.15%
e.11.43%
28) Other things held constant, the value of an option depends on the stock’s price, the
risk-free rate, and the
a.Variability of the stock price
b.Option’s time to maturity
c.Strike price
d.All of the above
e.None of the above
29) Setting up a lockbox arrangement is one way for a firm to speed up the collection of
payments from its customers.
30) The Y-axis intercept of the SML represents the required return of a portfolio with a
beta of zero, which is the risk-free rate.
31) A stock with a beta equal to -1.0 has zero systematic (or market) risk.
32) If a firm’s capital intensity ratio (A0*/S0) decreases as sales increase, use of the
AFN formula is likely to understate the amount of additional funds required, other
things held constant.
33) The time dimension is important in financial statement analysis. The balance sheet
shows the firm’s financial position at a given point in time, the income statement shows
results over a period of time, and the statement of cash flows reflects changes in the
firm’s accounts over that period of time.
34) On the balance sheet, total assets must always equal total liabilities and equity.
35) Two conditions are used to determine whether or not a stock is in equilibrium: (1)
Does the stock’s market price equal its intrinsic value as seen by the marginal investor,
and (2) does the expected return on the stock as seen by the marginal investor equal this
investor’s required return? If either of these conditions, but not necessarily both, holds,
then the stock is said to be in equilibrium.
36) Under certain conditions, a project may have more than one IRR. One such
condition is when, in addition to the initial investment at time = 0, a negative cash flow
(or cost) occurs at the end of the project’s life.
37) The cash conversion cycle (CCC) combines three factors: The inventory conversion
period, the average collection period, and the payables deferral period, and its purpose
is to show how long a firm must finance its working capital. Other things held constant,
the shorter the CCC, the more effective the firm’s working capital management.