1) One reason for the difference between profits and cash is that the cost of capital
equipment is spread over the forecast life.
2) If you are not better informed than the highly paid professionals in banks and other
institutions, you should use derivatives for hedging, not for speculation.
3) Weighted-average cost of capital is the expected rate of return on a portfolio of all
the firm’s securities, adjusted for tax savings due to interest payments.
4) In proxy contests, outsiders compete with the firm’s existing management and
directors for control of the corporation.
5) The primary aim of financial planning is to obtain better forecasts of future cash
flows and earnings.
6) The liquidation value of a firm is equal to the book value of the firm.
7) A merger must have the approval of at least 51% of the shareholders of each firm.
8) A company that pays out a $2 million cash dividend will see a $2 million decrease in
working capital.
9) Households hold more than half of U.S. corporate equities.
10) Privately placed securities may be difficult to remarket.
11) When calculating IRR with a trial and error process, discount rates should be raised
when NPV is positive.
12) Limiting the size of dividends paid is an example of a protective covenant.
13) The difference in interest rates between countries is believed to be equal to the
expected change in spot exchange rates.
14) The law of one price implies that the same commodity should be sold at the same
price in all countries.
15) Corporate financing comes ultimately from:
A.savings by households and foreign investors
B.cash generated from the firm’s operations
C.the financial markets and intermediaries
D.the issue of shares in the firm
16) A decrease in which of the following terms will cause an increase in the call value
of an option?
A.Interest rates
B.Time to maturity
C.Exercise price
D.Volatility of the stock
17) Which of the following is representative of how depreciation expense is handled in
the face of inflation?
A.It increases annually with the rate of inflation
B.It decreases annually in nominal terms
C.The depreciable base is not altered by inflation
D.The real value of the depreciation is fixed
18) What rate of return should an investor expect for a stock that has a beta of 0.8 when
the market is expected to yield 14% and Treasury bills offer 6%?
A.9.2%
B.11.2%
C.12.4%
D.12.8%
19) If two merged firms are shown to have a higher combined market value than the
sum of the individual market values, then:
A.economic gains are said to have taken place
B.the firms were previously underpriced
C.the merger provides diversification to investors
D.there is no cost involved in the merger
20) When a new issue goes wrong and the stock price crashes:
A.investors can only blame their bad luck
B.investors should sell the shares as soon as possible
C.investors may sue the company executives for mismanagement
D.investors may sue the underwriters for overhyping the issue
21) The conversion ratio for a convertible bond equals the:
A.ratio of bond value to stock price at conversion
B.number of bonds necessary to convert into one share of stock
C.number of shares of stock that can be exchanged for one bond
D.floor value beneath which the bond price cannot fall
22) The standard deviations of individual stocks are generally higher than the standard
deviation of the market portfolio because individual stocks:
A.offer higher returns
B.have more systematic risk
C.have no diversification of risk
D.do not have unique risk
23) Ignoring the risk of theft, cash balances cannot spoil, yet managers are concerned
with carrying costs. Why?
A.Embezzlement is a real risk in most firms
B.Higher balances require additional supervisors
C.Cash balances are idle and face an opportunity cost
D.All of these
24) If the price of a stock falls on 4 consecutive days of trading, then stock prices:
A.cannot be following a random walk
B.can still be following a random walk
C.are almost certain to increase today
D.are almost certain to decrease today
25) Which of the following are real assets?
A.A patent
B.A share of stock issued by Bank of New York
C.An IOU (“I owe you”) from your brother-in-law
D.A mortgage loan taken out to help pay for a new home
26) Show the effect of the following transactions on cash, net working capital, and the
current ratio. Assume that the current ratio exceeds 1.0 to begin.
a. The firm borrows $1,000 short term and pays $500 in accounts payable.
b. The firm factors $1,000 in receivables at a 5% discount.
c. The firm issues $1,000 in long-term bonds, using the proceeds to pay $800 in
payables and purchase $200 in marketable securities.
27) When an outside group acquires a firm, primarily through the use of borrowed
funds, the acquisition is known as a:
A.management buyout
B.tender offer
C.leveraged buyout
D.successful proxy fight
28) An investor was expecting an 18% return on her portfolio with beta of 1.25 before
the market risk premium decreased from 8 to 6%. Based on this change, what return
will now be expected on the portfolio?
A.15.5%
B.20.5%
C.22.5%
D.26.0%
29) What is the most likely value of the PVGO for a stock with current price of $50,
expected earnings of $6 per share, and a required return of 20%?
A.$10
B.$20
C.$25
D.$30
30) Which statement is true concerning the one-year after-tax return on the following
stocks, assuming a 40% tax rate on dividends and a 20% tax rate on capital gains: Stock
A is purchased for $50, offers a 5% dividend yield, and is sold for $56; stock B is
purchased for $60, offers no dividend yield, but is sold after one year for $70.
A.Stock A’s after-tax return is higher by 1.27%
B.Stock B’s after-tax return is higher by .73%
C.Stock A’s after-tax return is higher by .27%
D.Stock B’s after-tax return is higher by .58%
31) If a corporation’s management, with its superior knowledge of proposed
investments, considers a security issue to be underpriced, it may react by:
A.forgoing the security issuance and investment
B.lowering the price of the existing shares to equal the new shares
C.increasing the number of shares to be sold
D.adopting shelf registration, which automatically raises the issue price
32) Bank lines of credit must be judiciously requested because the lines often:
A.accrue interest regardless of whether funds are borrowed
B.require payment of a commitment fee to establish
C.appear as a liability on the firm’s balance sheet
D.have a negative impact on the firm’s credit history
33) Which of the following adjustment techniques would be preferred to account for
additional project risk?
A.Increase the discount rate
B.Adjust expected cash flows downward
C.Increase the beta
D.Adjust the market risk premium
34) One way in which financing decisions are easier than investment decisions is:
A.it is more difficult to lose money through foolish financing decisions
B.financial markets are not competitive due to regulations
C.it is easier to make a lot of money through smart financing decisions
D.all of these
35) One advantage of debt financing over equity financing is:
A.tax-deductible dividends
B.tax-deductible interest
C.tax-deductible principal repayment
D.tax-free interest income
36) The idea that investors in common stock may expect a lower total return when
prices are relatively stable suggests that:
A.investors are irrational
B.risk premiums may have a normal magnitude
C.real rates of return will be lower during periods of price stability
D.stocks should be avoided when inflation is low
37) If the correlation of prices between two stocks is 0.35, then the price of one stock
would be expected to:
A.rise when the other stock price falls
B.rise by 35% when the other stock price is unchanged
C.fall when the other stock price falls
D.fall by 35% when the other stock price is unchanged
38) A stock with a beta greater than 1.0 would be termed:
A.an aggressive stock, expected to increase more than the market increases
B.a defensive stock, expected to decrease more than the market increases
C.an aggressive stock, expected to decrease more than the market increases
D.a defensive stock, expected to increase more than the market decreases
39) The opportunity to abandon a project loses some of its value when:
A.fixed costs are high
B.markets are extremely competitive
C.the future is relatively certain
D.secondary markets exist and are active
40) In the case of a merger that is stock financed, the assumed merger cost may be
incorrect if the:
A.value of the acquired firm’s shares changes after the merger announcement
B.value of the acquiring firm’s shares changes after the merger announcement
C.long-term interest rates increase
D.merger is either horizontal or vertical
41) Which of the following statements is not characteristic of mutual funds?
A.They are financial institutions
B.They raise money by selling shares to investors
C.They pool the savings of many investors
D.They offer professional management
42) Preferred stockholders:
A.have full voting rights
B.receive a fixed dividend
C.have priority over debtholders if the company goes out of business
D.all of these
43) When debt is risky under MM II:
A.bondholders shift more of the risk to equityholders
B.equityholders shift more of the risk to bondholders
C.the value of the interest tax shield is at its highest
D.there is more overall risk in the firm
44) A perpetuity of $5,000 per year beginning today is said to offer a 15% interest rate.
What is its present value?
A.$33,333.33
B.$37,681.16
C.$38,333.33
D.$65,217.39
45) The true value of a security is:
A.the value of that security at some future date
B.the sum of all future dividends
C.the amount that a fundamental analyst will pay
D.the price that incorporates all currently available information
46) Which of the following changes will decrease a firm’s internal growth rate?
A.A decrease in dividends with a given net income
B.An increase in net income with a given dividend payout ratio
C.A decrease in the plowback ratio
D.A decrease in assets with a set dividend
47) A loan officer states, “Thousands of dollars can be saved by switching to a 15-year
mortgage from a 30-year mortgage.” Calculate the difference in payments on a 30-year
mortgage at 9% interest versus a 15-year mortgage with 8.5% interest. Both mortgages
are for $100,000 and have monthly payments. What is the difference in total dollars that
will be paid to the lender under each loan?
48) What are the reasons felt by financial executives regarding their firms’ reluctance to
cut the dividend?
49) How should the gains and costs of mergers to the acquiring firm be measured?
50) Describe agency problems in general, and offer at least three examples from
corporations.
51) Show how leverage increases financial risk by calculating the EPS and return on
shares for a firm with $1 million in 10% debt. The firm also has 50,000 shares
outstanding that sell for $40 each. Three states of the economy are possible: a slump
under which the firm would have operating income of $150,000, a normal state under
which the firm will earn $420,000, and a boom under which the firm will earn
$600,000. The firm pays no taxes.
52) How are financial planning models constructed?