1) Additional Paid in Capital on the balance sheet equals the amount paid by investors
for the company’s common stock that exceeds the market price of the stock at the time
of purchase.
2) A typical decision rule used in simulation is to accept the project if the probability is
sufficiently high that the net present value is positive.
3) An opportunity cost is a relevant incremental cost for capital budgeting decisions.
4) The retention ratio is equal to 1 minus the dividend payout ratio.
5) A set of estimates which corresponds to the worst and best case outcomes is often
desired in preparing a financial forecast.
6) Marketable securities are near-cash assets because they can be converted into cash
quickly.
7) Short-term daily fluctuations in exchange rates are caused by supply and demand
conditions in the foreign exchange market.
8) To determine the periodic interest payments that a bond makes, multiply the bond’s
stated coupon rate by its par value and divide by the number of coupon payments per
year.
9) If two companies have the same net income and the same level of risk, they must
also have the same stock price or the market is not in equilibrium.
10) Corporate managers should accept investment projects that maximize profits in the
short run because of the time value of money.
11) The residual theory of dividends connects a firm’s dividend policy and its level of
capital investments.
12) A stock with a beta of 1.4 has 40% more variability in returns than the average
stock.
13) A firm’s dividend policy provides information pertaining to the firm’s payout ratio
and its stability.
14) Common stock cannot be worth less than its book value.
15) If a firm imposes a capital constraint on investment projects, the appropriate
decision criterion is to select the set of projects that has the highest positive net present
value subject to the capital constraint.
16) A project’s IRR is analogous to the concept of the yield to maturity for bonds.
17) It is common practice among the largest corporations to sell their securities directly
to investors.
18) If a firm were to earn exactly its cost of capital, we would expect the price of its
common stock to remain unchanged.
19) Which of the following has the least interest rate risk?
A) a six-month unsecured promissory note from International Harvester
B) an eight-year investment certificate from a federally insured bank
C) a 15-year U.S. Treasury bond
D) an AT&T bond maturing in 15 years
20) Southeast Wood Products, Inc. reports sales of $20,000,000 and inventory of
$4,000,000. Southeast’s inventory possesses significant economies of scale. Therefore,
if the firm’s sales increase by 10%, Southeast’s inventory will ________ and if
Southeast’s sales decrease by 10%, Southeast’s inventory will ________.
A) increase by more than 10%, increase by more than 10%
B) decrease by more than 10%, decrease by more than 10%
C) increase by more than 10%, decrease by less than 10%
D) increase by less than 10%, decrease by less than 10%
21) All of the following are rationales given for a stock dividend or split EXCEPT
A) the price will not fall proportionately to the share increase.
B) an optimum price range does not exist.
C) there is positive informational content associated with the announcement.
D) conservation of corporate cash.
22) Bill and Mary own a small chain of high fashion boutiques that represent almost
100% of their net worth. When considering capital budgeting projects for their
boutiques, the appropriate measure of risk is
A) project standing alone risk
B) systematic risk
C) contribution-to-firm risk
D) beta risk
23) How do interest rates affect the optimal order quantity Q*?
A) As interest rates increase, Q* decreases
B) As interest rates decrease, Q* decreases
C) As interest rates increase, Q* increases until it reaches a maximum, after which any
further increase in interest causes a decline in Q*
D) None of the above
24) All of the following measure liquidity EXCEPT
A) current ratio
B) inventory turnover
C) acid-test ratio
D) operating return on assets
25) Table 4-1
Stewart Company
Balance Sheet
The operating profit margin is
A) 47.5%
B) 37.5%
C) 26.4%
D) 32.8%
26) The objectives of a zero balance account system for the firm include
A) reduce disbursing float
B) achieve better control over its cash payments
C) increase cash balances in regional rather than national banks
D) all of the above are correct
27) The ________ is the premium to compensate for the price change expected to occur
over the life
of the bond or investment instrument.
A) inflation-risk premium
B) maturity premium
C) real risk-free interest rate premium
D) default-risk premium
28) Which of the following statements about investment banking in the United States is
MOST correct?
A) Investing banking is dominated by a few, very large, stand-alone investment banking
firms, such as Bear Stearns
B) The investment banking industry is dominated by large banks that are also
investment bankers
C) The top five banks involved in investment banking account for less than 25% of the
industry’s total market share
D) The investment banking industry became more competitive following the financial
crisis in 2007 and 2008
29) Lithium, Inc. is considering two mutually exclusive projects, A and B. Project A
costs $95,000 and is expected to generate $65,000 in year one and $75,000 in year two.
Project B costs $120,000 and is expected to generate $64,000 in year one, $67,000 in
year two, $56,000 in year three, and $45,000 in year four. The firm’s required rate of
return for these projects is 10%. The net present value for Project A is
A) $12,358
B) $16,947
C) $19,458
D) $26,074
30) A new project is expected to generate $800,000 in revenues, $250,000 in cash
operating expenses, and depreciation expense of $150,000 in each year of its 10-year
life. The corporation’s tax rate is 35%. The project will require an increase in net
working capital of $85,000 in year one and a decrease in net working capital of $75,000
in year ten. What is the free cash flow from the project in year one?
A) $298,000
B) $375,000
C) $380,000
D) $410,000
31) A bakery company is considering one capital budgeting project involving the
replacement of a sophisticated brick oven, and another capital budgeting project
involving research and development into synthetic food substitutes. Which of the
following statements is MOST correct concerning the risk-adjusted discount rate(s) for
the projects?
A) The rate will likely be higher for the replacement project because the likelihood of
success is higher
B) The rate will likely be higher for the research and development project because of
the uncertainty involved with research and development projects
C) The rate should be the same for both projects because they are being considered by
one company with the same common shareholders
D) The rate should be higher for the replacement project because the company is more
certain of the returns from a project similar to their existing business
32) If you want to have $5,000 in 10 years, how much money must you put in a savings
account today? (Assume that the savings account pays 4% and it is compounded daily;
round to the nearest $1).
A) $3,352
B) $3,370
C) $4,102
D) $4,207
33) Stock A has a beta of 1.2 and a standard deviation of returns of 14%. Stock B has a
beta of 1.8 and a standard deviation of returns of 18%. If the risk-free rate of return
increases and the market risk premium remains constant, then
A) the required return on stock B will increase more than the required return on stock A
B) the required returns on stocks A and B will both increase by the same amount
C) the required returns on stocks A and B will not change
D) the required return on stock A will increase more than the required return on stock B
34) The Missouri River Pendant Company uses commercial paper to satisfy part of its
short-term financing requirements. Next week, it intends to sell $18 million in 90-day
maturity paper on which it expects to have to pay discounted interest at an annual rate
of 7 percent per annum. In addition, Stoney River expects to incur a cost of
approximately $25,000 in dealer placement fees and other expenses of issuing the
paper. What is the effective annual cost of credit to Missouri River?
A) 7.7%
B) 7.5%
C) 7.3%
D) 7.1%
35) Assume that you have $100,000 invested in a stock that is returning 14%, $150,000
invested in a stock that is returning 18%, and $200,000 invested in a stock that is
returning 15%. What is the expected return of your portfolio?
A) 13.25%
B) 14.97%
C) 15.67%
D) 15.78%
36) Shasta Co. just paid a dividend of $1.65 (D0) on its common stock. This company’s
dividends are expected to grow at a constant rate of 3% indefinitely. If the required rate
of return on this stock is 11%, compute the current value per share of Shasta stock.
A) $20.63
B) $21.24
C) $15.00
D) $55.00
37) Table 4-1
Stewart Company
Balance Sheet
The fixed asset turnover ratio is
A) 1.69
B) 2.17
C) 4.39
D) 4.80
38) Assume that an investment is forecasted to produce the following returns: a 20%
probability of a 12% return; a 50% probability of a 16% return; and a 30% probability
of a 19% return. What is the standard deviation of return for this investment?
A) 5.89%
B) 16.1%
C) 2.43%
D) 15.7%
39) What is the present value of the following perpetuities?
a.$200 per year discounted at 6% annually
b.$500 per year discounted at 9% annually
c.$1,000 per year discounted at 5% annually
d.$550 per year discounted at 8% annually
40) Crandle’s common stock is currently selling for $79.00. It just paid a dividend of
$4.60 and dividends are expected to grow at a rate of 5% indefinitely. What is the
required rate of return on Crandle’s stock?
A) 11.11%
B) 11.76%
C) 12.2%
D) 14.21%
41) When reviewing the net present profile for a project
A) the higher the discount rate, the higher the NPV
B) the higher the discount rate, the higher the IRR
C) the IRR will always be a point on the horizontal axis line where NPV = 0
D) the IRR will always be a point on the horizontal axis equal to the required return
42) Which of the following statements concerning Economic Value Added (EVA) is
MOST correct?
A) the higher the cost of capital, the higher the EVA, other things being held constant
B) EVA can be negative even if operating profits are positive
C) A company with positive net income will have positive EVA
D) Higher operating return on assets will result in lower EVA for a company with a debt
ratio over 50%
43) Spontaneous sources of financing include
A) accounts payable and accrued expenses
B) notes payable and mortgages payable
C) long-term debt and capital leases
D) common stock and paid-in capital
44) Why do currency exchange rates throughout the world trade within a very narrow
range on any given day?
A) because of purchasing power parity
B) because of the international translation effect
C) because of arbitrage
D) because of the law of one price
45) Bill is a public accountant auditing Expo Corporation. Based on information in
Expo’s confidential records, Bill recommends the purchase of Expo stock to his brother.
A) Bill is involved in insider trading prohibited by the SEC
B) Bill’s brother has no direct connection to Expo Corporation and therefore his
purchase of the stock is not prohibited by insider trading laws
C) Bill is not an insider because he is not an officer or employee of Expo Corporation
D) If Bill told a non-relative who purchases Expo stock, no insider trading laws would
be violated
46) Which item would constitute poor collateral for an inventory loan?
A) lumber
B) vegetables
C) grain
D) chemicals
47) Standard Inc. has an annual interest expense of $40,000. If Standard’s
times-interest-earned ratio is 3.0, what is Standard’s Earnings Before Taxes (EBT)?
A) $47,000
B) $80,000
C) $120,000
D) $160,000
48) White Company stock has a beta of 2 and a required return of 23%, while Black
Company stock has a beta of 1.0 and a required return of 14%. The standard deviation
of returns for White Company is 10% more than the standard deviation for Black
Company. The risk free rate of return according to the CAPM is
A) 4%
B) 5%
C) 6%
D) impossible to determine with the information given
49) Which of the following represents the correct ordering of returns over the period
1926 to 2011 (from lowest to highest return)?
A) Treasury bills, long-term corporate bonds, common stocks, small firm common
stocks
B) small firm common stocks, common stocks, long-term corporate bonds, Treasury
bills
C) Treasury bills, common stocks, long-term corporate bonds, small firm common
stocks
D) long-term corporate bonds, Treasury bills, common stocks, small firm common
stocks
50) Crandal Dockworks is undergoing a major expansion. The expansion will be
financed by issuing new 15-year, $1,000 par, 9% annual coupon bonds. The market
price of the bonds is $1,070 each. Five Rivers flotation expense on the new bonds will
be $50 per bond. Crandal’s marginal tax rate is 35%. What is the yield to maturity on
the newly-issued bonds?
A) 6.95%
B) 7.99%
C) 8.17%
D) 9.82%
51) Bacon Signs Company preferred stock pays a perpetual annual dividend of 4.5% of
its $100 par value. If investors’ required rate of return on this stock is 12%, what is the
value per share?
A) $37.50
B) $31.82
C) $8.50
D) $45.00
52) Which of the following securities will likely have the highest liquidity premium?
A) U.S. Treasury Bond maturing in 2027
B) BBB-rated corporate bond maturing in 2020 actively traded on a major exchange
C) AAA-rated corporate bond maturing in 2015 not actively traded
D) U.S. Treasury Bill
53) You borrow $30,000 and agree to pay it off with one lump sum payment of $40,000
in 6 years. What annual rate of interest will you be charged?
54) Leigh Delight Candy, Inc. is choosing between two bonds in which to invest their
cash. One is being offered from Hershey’s and will mature in 10 years and pay $30 each
quarter. The other alternative is a Mars’ bond that will mature in 20 years and pay $30
each quarter. What would be the present value of each bond if the discount rate is 10%
compounded quarterly, and each bond pays $1,000 at maturity?
55) What is arbitrage? Assume that the dollar is quoted $1 = £0.625 in New York and
the pound sterling is quoted as £1 = $1.63 in London. Is there an arbitrage opportunity?
If so, what would an astute trader do? What will happen to the quotes as trades are
made at current prices?
56) Agri-Industries purchased some agricultural land at the edge of a large metropolitan
area for $250,000 five years ago. In order to have the land classified as agricultural for
property tax purposes, the company has been leasing the property to neighboring
farmers. The before-tax return from leasing the property is $12,000 per year. This
company’s corporate tax rate is 35 percent. If the company sells the land for $400,000
today, what is the internal rate of return on this investment?
57) Short-term United States Treasury Bills are widely used as proxies for risk-free
assets, yet the returns on these T-bills are consistently greater than zero. Is this
consistent with the concept of a risk-return tradeoff?
58) Define interest rate risk. How does a bond’s level of interest rate risk depend on its
maturity?
59) The balance sheet of the Emery Company is presented below:
Emery Company Balance Sheet
March 31, 2010
(Millions of Dollars)
For the year ending March 31, 2010, Jackson had sales of $58 million. The common
stockholders receive all net earnings of the firm in the form of cash dividends, leaving
no funds from earnings available to the firm for expansion (assume that depreciation
expense is just equal to the cost of replacing worn-out assets).
Construct a pro forma balance sheet for March 31, 2011 for an expected level of sales
of $75.4 million. Assume current assets and accounts payable vary as a percent of sales,
and fixed assets remain at the present level. Use notes payable as discretionary
financing.
60) Discuss the risk-return tradeoff experienced in working-capital management.
61) You have a choice between investing in a corporate bond or a municipal bond. The
corporate bond has an annual yield of 10 percent, while the municipal bond has an
annual yield of 7 percent. At what tax rate would you be indifferent between buying the
corporate bond or the municipal bond?
62) Toombes, Inc. is issuing new common stock at a market price of $55. Dividends last
year were $3.30 per share and are expected to grow at a rate of 6%. Flotation costs will
be 5% of the market price. What is Toombes’ cost of retained earnings, and new equity,
respectively?