1) Which of the following statements is CORRECT?
a.The payback method is generally regarded by academics as being the best single
method for evaluating capital budgeting projects
b.The discounted payback method is generally regarded by academics as being the best
single method for evaluating capital budgeting projects
c.The net present value method (NPV) is generally regarded by academics as being the
best single method for evaluating capital budgeting projects
d.The modified internal rate of return method (MIRR) is generally regarded by
academics as being the best single method for evaluating capital budgeting projects
e.The internal rate of return method (IRR) is generally regarded by academics as being
the best single method for evaluating capital budgeting projects
2) Merriwether Building has operating income of $20 million, a tax rate of 40%, and no
debt. It pays out all of its net income as dividends and has a zero growth rate. The
current stock price is $40 per share, and it has 2.5 million shares of stock outstanding. If
it moves to a capital structure that has 40% debt and 60% equity (based on market
values), its investment bankers believe its weighted average cost of capital would be
10%. What would its stock price be if it changes to the new capital structure?
a.$40
b.$48
c.$52
d.$54
e.$60
3) Which of the following statements is CORRECT?
a.If two projects are mutually exclusive, then they are likely to have multiple IRRs
b.If a project is independent, then it cannot have multiple IRRs
c.Multiple IRRs can occur only if the signs of the cash flows change more than once
d.If a project has two IRRs, then the smaller one is the one that is most relevant, and it
should be accepted and relied upon
e.For a project to have more than one IRR, then both IRRs must be greater than the
WACC
4) The LeMond Corporation just purchased a new production line. Assume that the firm
planned to depreciate the equipment over 5 years on a straight-line basis, but Congress
then passed a provision that requires the company to depreciate the equipment on a
straight-line basis over 7 years. Other things held constant, which of the following will
occur as a result of this Congressional action? Assume that the company uses the same
depreciation method for tax and stockholder reporting purposes.
a.LeMond’s tax liability for the year will be lower
b.LeMond’s taxable income will be lower
c.LeMond’s net fixed assets as shown on the balance sheet will be higher at the end of
the year
d.LeMond’s cash position will improve (increase)
e.LeMond’s reported net income after taxes for the year will be lower
5) Assume that the risk-free rate is 6% and the market risk premium is 5%. Given this
information, which of the following statements is CORRECT?
a.If a stock has a negative beta, its required return must also be negative
b.An index fund with beta = 1.0 should have a required return less than 11%
c.If a stock’s beta doubles, its required return must also double
d.An index fund with beta = 1.0 should have a required return greater than 11%
e.An index fund with beta = 1.0 should have a required return of 11%
6) To help estimate its cost of common equity, Maxwell and Associates recently hired
you. You have obtained the following data: D0 = $0.90; P0 = $27.50; and g = 7.00%
(constant). Based on the DCF approach, what is the cost of common from reinvested
earnings?
a.9.29%
b.9.68%
c.10.08%
d.10.50%
e.10.92%
7) Recession, inflation, and high interest rates are economic events that are best
characterized as being
a.company-specific risk factors that can be diversified away
b.among the factors that are responsible for market risk
c.risks that are beyond the control of investors and thus should not be considered by
security analysts or portfolio managers
d.irrelevant except to governmental authorities like the Federal Reserve
e.systematic risk factors that can be diversified away
8) Refer to Exhibit 3.1. What is the firm’s equity multiplier?
a. 3.33
b. 3.50
c. 3.68
d. 3.86
e. 4.05
9) You have a portfolio P that consists of 50% Stock X and 50% Stock Y. Stock X has a
beta of 0.7 and Stock Y has a beta of 1.3. The standard deviation of each stock’s returns
is 20%. The stocks’ returns are independent of each other, i.e., the correlation
coefficient, r, between them is zero. Given this information, which of the following
statements is CORRECT?
a.The required return on Portfolio P is equal to the market risk premium (rM – rRF)
b.Portfolio P has a beta of 0.7
c.Portfolio P has a beta of 1.0 and a required return that is equal to the riskless rate, rRF
d.Portfolio P has the same required return as the market (rM)
e.Portfolio P has a standard deviation of 20%
10) Based on the corporate valuation model, the value of Weidner Co.’s operations is
$1,200 million. The company’s balance sheet shows $80 million in accounts receivable,
$60 million in inventory, and $100 million in short-term investments that are unrelated
to operations. The balance sheet also shows $90 million in accounts payable, $120
million in notes payable, $300 million in long-term debt, $50 million in preferred stock,
$180 million in retained earnings, and $800 million in total common equity. If Weidner
has 30 million shares of stock outstanding, what is the best estimate of the stock’s price
per share?
a.$24.90
b.$27.67
c.$30.43
d.$33.48
e.$36.82
11) Which of the following statements is correct?
a. One nice feature of dividend reinvestment plans (DRIPs) is that they reduce the taxes
investors would have to pay if they received cash dividends
b. Empirical research indicates that, in general, companies send a negative signal to the
marketplace when they announce an increase in the dividend, and as a result share
prices fall when dividend increases are announced. The reason is that investors interpret
the increase as a signal that the firm has relatively few good investment opportunities
c. If a company wants to raise new equity capital rather steadily over time, a new stock
dividend reinvestment plan would make sense. However, if the firm does not want or
need new equity, then an open market purchase dividend reinvestment plan would
probably make more sense
d. Dividend reinvestment plans have not caught on in most industries, and today about
99% of all companies with DRIPs are utilities
e. Under the tax laws as they existed in 2008, a dollar received for repurchased stock
must be taxed at the same rate as a dollar received as dividends
12) Weatherall Enterprises has no debt or preferred stockit is an all-equity firmand has a
beta of 2.0. The chief financial officer is evaluating a project with an expected return of
14%, before any risk adjustment. The risk-free rate is 5%, and the market risk premium
is 4%. The project being evaluated is riskier than an average project, in terms of both its
beta risk and its total risk. Which of the following statements is CORRECT?
a.The project should definitely be rejected because its expected return (before risk
adjustment) is less than its required return
b.Riskier-than-average projects should have their expected returns increased to reflect
their higher risk. Clearly, this would make the project acceptable regardless of the
amount of the adjustment
c.The accept/reject decision depends on the firm’s risk-adjustment policy. If
Weatherall’s policy is to increase the required return on a riskier-than-average project to
3% over rS, then it should reject the project
d.Capital budgeting projects should be evaluated solely on the basis of their total risk.
Thus, insufficient information has been provided to make the accept/reject decision
e.The project should definitely be accepted because its expected return (before any risk
adjustments) is greater than its required return
13) 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.If Project A has a higher IRR than Project B, then Project A must also have a higher
NPV
b.The IRR calculation implicitly assumes that all cash flows are reinvested at the
WACC
c.The IRR calculation implicitly assumes that cash flows are withdrawn from the
business rather than being reinvested in the business
d.If a project has normal cash flows and its IRR exceeds its WACC, then the project’s
NPV must be positive
e.If Project A has a higher IRR than Project B, then Project A must have the lower NPV
14) Which of the following statements is correct?
a. If a company has an established clientele of investors who prefer a high dividend
payout, and if management wants to keep stockholders happy, it should not follow the
strict residual dividend policy
b. If a firm follows a strict residual dividend policy, then, holding all else constant, its
dividend payout ratio will tend to rise whenever the firm’s investment opportunities
improve
c. If Congress eliminates taxes on capital gains but leaves the personal tax rate on
dividends unchanged, this would motivate companies to increase their dividend payout
ratios
d. Despite its drawbacks, following the residual dividend policy will tend to stabilize
actual cash dividends, and this will make it easier for firms to attract a clientele that
prefers high dividends, such as retirees
e. One advantage of dividend reinvestment plans is that they enable investors to avoid
paying taxes on the dividends they receive
15) Young & Liu Inc.’s free cash flow during the just-ended year (t = 0) was $100
million, and FCF is expected to grow at a constant rate of 5% in the future. If the
weighted average cost of capital is 15%, what is the firm’s value of operations, in
millions?
a.$948
b.$998
c.$1,050
d.$1,103
e.$1,158
16) Perry Inc.’s bonds currently sell for $1,150. They have a 6-year maturity, an annual
coupon of $85, and a par value of $1,000. What is their current yield?
a.7.39%
b.7.76%
c.8.15%
d.8.56%
e.8.98%
17) Data for Atwill Corporation is shown below. Now Atwill acquires some risky assets
that cause its beta to increase by 30%. In addition, expected inflation increases by
2.00%. What is the stock’s new required rate of return?
Initial beta1.00
Initial required return (rs)10.20%
Market risk premium, RPM6.00%
Percentage increase in beta30.00%
Increase in inflation premium, IP2.00%
a.14.00%
b.14.70%
c.15.44%
d.16.21%
e.17.02%
18) The last dividend paid by Wilden Corporation was $1.55. The dividend growth rate
is expected to be constant at 1.5% for 2 years, after which dividends are expected to
grow at a rate of 8.0% forever. The firm’s required return (rs) is 12.0%. What is the best
estimate of the current stock price?
a.$37.05
b.$38.16
c.$39.30
d.$40.48
e.$41.70
19) Hutchinson Corporation has zero debtit is financed only with common equity. Its
total assets are $410,000. The new CFO wants to employ enough debt to bring the
debt/assets ratio to 40%, using the proceeds from the borrowing to buy back common
stock at its book value. How much must the firm borrow to achieve the target debt
ratio?
a. $155,800
b. $164,000
c. $172,200
d. $180,810
e. $189,851
20) The Lincoln Company sold a $1,000 par value, noncallable bond several years ago
that now has 20 years to maturity and a 7.00% annual coupon that is paid semiannually.
The bond currently sells for $925 and the company’s tax rate is 40%. What is the
component cost of debt for use in the WACC calculation?
a.4.28%
b.4.46%
c.4.65%
d.4.83%
e.5.03%
21) The last dividend paid by Coppard Inc. was $1.25. The dividend growth rate is
expected to be constant at 15% for 3 years, after which dividends are expected to grow
at a rate of 6% forever. If the firm’s required return (rs) is 11%, what is its current stock
price?
a.$30.57
b.$31.52
c.$32.49
d.$33.50
e.$34.50
22) Which of the following statements is CORRECT?
a.Most sinking funds require the issuer to provide funds to a trustee, who saves the
money so that it will be available to pay off bondholders when the bonds mature
b.A sinking fund provision makes a bond more risky to investors at the time of issuance
c.Sinking fund provisions never require companies to retire their debt; they only
establish “targets” for the company to reduce its debt over time
d.If interest rates have increased since a company issued bonds with a sinking fund, the
company is less likely to retire the bonds by buying them back in the open market, as
opposed to calling them in at the sinking fund call price
e.Sinking fund provisions sometimes turn out to adversely affect bondholders, and this
is most likely to occur if interest rates decline after the bond has been issued
23) The Besnier Company had $250 million of sales last year, and it had $75 million of
fixed assets that were being operated at 80% of capacity. In millions, how large could
sales have been if the company had operated at full capacity?
a.$312.5
b.$328.1
c.$344.5
d.$361.8
e.$379.8
24) Computer Consultants Inc. is considering a project that has the following cash flow
and WACC data. What is the project’s MIRR? Note that a project’s MIRR can be less
than the WACC (and even negative), in which case it will be rejected.
WACC:10.00%
Year0123
Cash flows-$1,000$450$450$450
a.9.32%
b.10.35%
c.11.50%
d.12.78%
e.14.20%
25) If you randomly select stocks and add them to your portfolio, which of the
following statements best describes what you should expect?
a.Adding more such stocks will increase the portfolio’s expected rate of return
b.Adding more such stocks will reduce the portfolio’s beta coefficient and thus its
systematic risk
c.Adding more such stocks will have no effect on the portfolio’s risk
d.Adding more such stocks will reduce the portfolio’s market risk but not its
unsystematic risk
e.Adding more such stocks will reduce the portfolio’s unsystematic, or diversifiable,
risk
26) Howes Inc. purchases $4,562,500 in goods per year from its sole supplier on terms
of 2/15, net 50. If the firm chooses to pay on time but does not take the discount, what
is the effective annual percentage cost of its non-free trade credit? (Assume a 365-day
year.)
a.20.11%
b.21.17%
c.22.28%
d.23.45%
e.24.63%
27) Considered alone, which of the following would increase a company’s current ratio?
a. An increase in accounts payable
b. An increase in net fixed assets
c. An increase in accrued liabilities
d. An increase in notes payable
e. An increase in accounts receivable
28) Its retained earnings is the actual cash that the firm has generated through
operations less the cash that has been paid out to stockholders as dividends. Retained
earnings are kept in cash or near cash accounts and, thus, these cash accounts, when
added together, will always be equal to the firm’s total retained earnings.
29) From an investor’s perspective, a firm’s preferred stock is generally considered to be
less risky than its common stock but more risky than its bonds. However, from a
corporate issuer’s standpoint, these risk relationships are reversed: Bonds are the most
risky for the firm, preferred is next, and common is least risky.
30) As a firm’s sales grow, its current assets also tend to increase. For instance, as sales
increase, the firm’s inventories generally increase, and purchases of inventories result in
more accounts payable. Thus, spontaneous liabilities that reduce AFN arise from
transactions brought on by sales increases.
31) The constant growth DCF model used to evaluate the prices of common stocks is
conceptually similar to the model used to find the price of perpetual preferred stock or
other perpetuities.
32) The exercise value is the positive difference between the current price of the stock
and the strike price. The exercise value is zero if the stock’s price is below the strike
price.
33) Floating-rate debt is advantageous to investors because the interest rate moves up if
market rates rise. Since floating-rate debt shifts interest rate risk to companies, it offers
no advantages to issuers.
34) If a firm has a large percentage of accounts over 30 days old, this is proof positive
that its receivables manager is not doing a good job.
35) Since 70% of the preferred dividends received by a corporation are excluded from
taxable income, the component cost of equity for a company that pays half of its
earnings out as common dividends and half as preferred dividends should, theoretically,
be
Cost of equity = rs(0.30)(0.50) + rps(1 – T)(0.70)(0.50).