1) Private equity funds tend to focus their investments in situations where promised
returns are very high and the need for funds is brief.
2) Another name for an asset’s expected rate of return is holding-period return.
3) The retained earnings balance on IBM’s balance sheet at the end of 2010 is equal to
IBM’s 2010 net income minus dividends paid in 2010.
4) An investment earning simple interest is preferred over an investment earning
compound interest because the simplicity adds value.
5) A call provision entitles a company to repurchase its preferred stock from holders at
stated prices over a given time period.
6) A corporation may lower its cost of capital by shifting a portion of its total financing
from a higher cost source of capital, such as common equity, to a lower cost source of
capital, such as debt.
7) Economic value added includes a charge for the cost of equity that is not included on
financial statements prepared according to GAAP.
8) Because the NPV and PI methods both yield the same accept/reject decision, a
company attempting to rank capital budgeting projects for funding consideration can
use either method and get the same results.
9) There is no legal distinction made between the assets of the business and the personal
assets of any of the owners in the limited partnership.
10) How managers choose to finance the business does not affect the rate of return to
shareholders because the rate of return is based on how the company uses the assets it
has, not whether or not they paid for the assets with debt or equity.
11) The most important reasons firms hold cash balances are the transaction and
precautionary motives.
12) If the interest rate is positive, then the present value of an annuity due will be less
than the present value of an ordinary annuity.
13) Stocks listed on the New York Stock Exchange must be traded exclusively on the
NYSE in order to maintain the high standards set by the exchange.
14) If a bond has a market value that is higher than its par value, then the required
return on the bond must be less than the bond’s coupon rate.
15) The appropriate measure for risk according to the capital asset pricing model is
A) the standard deviation of a firm’s cash flows
B) alpha
C) the standard deviation of a firm’s stock returns
D) beta
16) The simulation approach provides us with
A) a single value for the risk-adjusted net present value
B) an approximation of the systematic risk level
C) a probability distribution of the project’s net present value or internal rate of return
D) a graphic exposition of the year-by-year sequence of possible outcomes
17) Which of the following statements regarding a line of credit is true?
A) The purpose for which the money is being borrowed must be stated by the borrower
B) A line of credit agreement usually fixes the interest rate that will be applied to any
extensions of credit
C) A line of credit agreement is a legal commitment on the part of the bank to provide
the stated credit
D) Such agreements usually cover the borrower’s fiscal year
18) The MAX Corporation is planning a $4,000,000 expansion this year. The expansion
can be financed by issuing either common stock or bonds. The new common stock can
be sold for $60 per share. The bonds can be issued with a 12 percent coupon rate. The
firm’s existing shares of preferred stock pay dividends of $2.00 per share. The
company’s corporate income tax rate is 46 percent. The company’s balance sheet prior
to expansion is as follows:
MAX Corporation
a.Calculate the indifference level of EBIT between the two plans.
b.If EBIT is expected to be $3 million, which plan will result in higher EPS?
19) The financial manager most directly responsible for producing the company’s
financial statements and directing its cost accounting functions is the
A) chief financial officer
B) controller
C) treasurer
D) vice president – financer
20) A company is going to issue a $1,000 par value bond that pays a 7% annual coupon.
The company expects investors to pay $942 for the 20-year bond. The expected
flotation cost per bond is $42, and the firm is in the 34% tax bracket. Compute the
following:
a.The yield to maturity on the firm’s bonds
b.The firm’s after-tax cost of existing debt
c.The firm’s after-tax cost of new debt
21) You have been depositing money at the end of each year into an account drawing
8% interest. What is the balance in the account at the end of year four if you deposited
the following amounts?
YearEnd of Year Deposit
1$350
2$500
3$725
4$400
A) $1,622
B) $2,207
C) $2,384
D) $2,687
22) Which of the following should NOT be included as investment costs in evaluating a
capital asset?
A) interest payments and other financing cash flows that result from raising funds to
finance a project
B) employee training expenses
C) shipping expenses
D) installation expenses
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) Which of the following bond provisions will make a bond more desirable to
investors, other things being equal?
A) The bond is convertible
B) The bond is callable
C) The coupon rate is lower
D) The bond is subordinated
25) A limited partnership provides limited liability to
A) all general partners
B) only limited partners responsible for day to day management of the firm
C) only to limited partners who do not participate in the management of the business
D) all partners
26) Since 1973 the exchange rates between the major currencies of the world are
A) on a floating exchange rate system
B) on an arbitrage exchange rate system
C) on a fixed exchange rate system
D) on a spot exchange rate system
27) Cost of capital is commonly used interchangeably with all of the following terms
EXCEPT
A) the firm’s required rate of return
B) the hurdle rate for new investments
C) the internal rate of return for new investments
D) the firm’s opportunity cost of funds
28) Concentric Corporation has 10 million shares of stock outstanding. Concentric’s
after-tax profits are $140 million and the corporation’s stock is selling at a
price-earnings multiple of 18, for a stock price of $252 per share. Concentric’s
management issues a 40% stock dividend. What is the effect on an investor who owns
100 shares of Concentric before the dividend if Concentric’s price-earnings multiple
remains the same after the dividend is paid?
A) The investor will own 140 shares worth $25,200
B) The investor will own 140 shares worth $35,280
C) The investor will own 100 shares worth $25,200
D) The investor will own 100 shares worth $35,280
29) Your son is born today and you want to make him a millionaire by the time he is 50
years old. You deposit $10,700 in an investment account and want to know what annual
interest rate must you earn in order to have the account value equal to $1,000,000 on
your son’s 50th birthday.
A) 17.8%
B) 12.4%
C) 9.5%
D) 6.2%
30) Solar Confectionary develops a new candy bar and plans to sell each bar for $1.
Solar predicts that 1 million candy bars will be sold in the first year if the new candy
bar is produced and sold, and includes $1 million of incremental revenues in its capital
budgeting analysis. A senior executive in the company believes that 1 million candy
bars will be sold, but lowers the estimate of incremental revenue to $700,000. What
would explain this change?
A) cannibalization of 300,000 of Solar Confectionary’ other candy bars
B) excessive marketing costs to sell the 1 million candy bars
C) a lower discount rate
D) a higher selling price for the new candy bars
31) AFB, Inc. requires an investment in equipment of $600,000 to replace existing
equipment. The existing equipment will produce after-tax salvage value of $70,000. Net
working capital requirements are increased by $50,000. What is the total cash outflow
at time zero?
A) $720,000
B) $650,000
C) $530,000
D) $580,000
32) 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
33) 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
34) Bensen Co. paid a dividend of $5.25 on its common stock yesterday. The company’s
dividends are expected to grow at a constant rate of 8.5% indefinitely. The required rate
of return on this stock is 15.5%. You observe a market price of $78.50 for the stock.
Should you purchase this stock?
A) No, the market price is above the intrinsic value of the stock
B) Yes, the market price is below the intrinsic value of the stock
C) No, the growth rate in dividends is too far below the required return
D) Yes, but only if you can keep the stock for at least 5 years
35) You are considering the purchase of a share of Ranch’s common stock. You expect
to sell it at the end of 1 year for $32.00. You will also receive a dividend of $2.50 at the
end of the year. Ranch just paid a dividend of $2.25. If your required return on this
stock is 12%, what is the most you would be willing to pay for it now?
A) $28.57
B) $33.05
C) $20.83
D) $30.80
36) An inventory loan agreement in which the inventories pledged as collateral are
physically separated from the firm’s other inventory and placed under the control of a
third-party is called
A) a floating lien agreement
B) a chattel mortgage agreement
C) a field warehouse agreement
D) a securitized inventory loan arrangement
37) Redrock Inc. is a household products firm that is considering developing a new
detergent. In evaluating whether to go ahead with the new detergent project, which of
the following statements is MOST correct?
A) The company will produce the detergent in a building that they already own. The
cost of the building is therefore zero and should be excluded from the analysis
B) The company will need to use some equipment that it could have leased to another
company. This equipment lease could have generated $200,000 per year in after-tax
income. The $200,000 should be excluded because the equipment can no longer be
leased
C) The company will need to hire 10 new workers whose salaries and benefits will total
$400,000 per year. Labor costs are not part of capital budgeting and should be excluded
D) The company will produce the detergent in a building that it renovated 2 years ago
for $300,000. The $300,000 should be excluded from the analysis
38) Which of the following would NOT be found in a cash budget?
A) interest expense
B) taxes
C) depreciation
D) cash sales
39) You observe Thundering Herd Common Stock selling for $40.00 per share. The
next dividend is expected to be $4.00, and is expected to grow at a 5% annual rate
forever. If your required rate of return is 12%, should you purchase the stock?
A) yes, because the present value of the expected future cash flows is greater than $40
B) no, because the present value of the expected future cash flows is less than $40
C) yes, because the present value of the expected future cash flows is less than $40
D) no, because the present value of the expected future cash flows is greater than $40
40) 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
41) Which of the following statements is MOST correct concerning the relationship
between a company’s cash budget and its income statement?
A) If net income is positive for 3 or more months in a row, then cash flow must be
positive
B) If net income is positive, then cash flow must be positive
C) If net income is positive, then cash flow could be positive or negative, but if net
income is negative, cash flow must also be negative
D) Cash flow could be positive whether net income is positive or negative
42) You want $20,000 in 5 years to take your spouse on a second honeymoon. Your
investment account earns 7% compounded semiannually. How much money must you
put in the investment account today? (round to the nearest $1).
A) $14,178
B) $12,367
C) $15,985
D) $13,349
43) Balon Plastics, Inc. is financed entirely with 3 million shares of common stock
selling for $20 a share. Capital of $4 million is needed for this year’s capital budget.
Additional funds can be raised with new stock (ignore dilution) or with 13 percent
10-year bonds. The firm’s tax rate is 40 percent.
a.Calculate the financing plan’s EBIT indifference point.
b.The expected level of EBIT is $10,320,000 with a standard deviation of $2,000,000.
What is the probability that EBIT will be above the indifference point?
c.Does the “indifference point” calculated in question (a) above truly represent a point
where stockholders are indifferent between stock and debt financing? Explain your
answer.
44) Hyper Retail Outlets sell goods on terms of net 40. The store’s average monthly
sales (all on credit) are $70,000. Hyper pledges all of its receivables to the bank, which
advances 80% of the face value of the receivables at a rate of 2.5% above prime. The
bank also charges a 1% processing fee on all receivables pledged. Hyper borrows the
full amount possible, and the current prime rate is 5%. What is the annual percentage
rate (APR) of using this source of financing for one full year?
A) 23.5%
B) 22.5%
C) 21.8%
D) 19.1%
45) You are going to add one of the following three projects to your already
well-diversified portfolio.
PROJECT 1PROJECT 2
StandardStandard
ProbabilityReturnDeviationBetaProbabilityReturnDeviationBeta
50% Chance22%12%1.130% Chance36%19.5%0.8
50% Chance-4%40% Chance10.5%
30% Chance-20%
PROJECT 3
Standard
ProbabilityReturnDeviationBeta
10% Chance28%12%2.0
70% Chance18%
20% Chance-8%
Assume the risk-free rate of return is 2% and the market risk premium is 8%. If you are
a risk averse investor, which project should you choose?
A) Project 1
B) Project 2
C) Project 3
D) Either Project 2 or Project 3 because the higher expected return on project 3 offsets
its higher risk
46) Bonneau Sunglass Co. is considering the factoring of its receivables. The firm has
credit sales of $500,000 per month and has an average receivables balance of
$1,000,000 with 60-day credit terms. The factor has offered to extend credit equal to
85% of the receivables factored less interest on the loan at a rate of 2% per month. The
15% difference in the advance and face value of all receivables factored consists of a
2% factoring fee plus a 13% reserve, which the factor maintains. In addition, if
Bonneau decides to factor its receivables, it will sell them all, so that it can reduce its
credit costs by $2,000 a month.
a.What is the cost of borrowing the maximum amount of credit available to Bonneau
through the factoring agreement?
b.What considerations other than cost should be accounted for by Bonneau in
determining whether or not to enter the factoring agreement?
47) If a project is acceptable using the NPV criteria, it will also be acceptable when
using the profitability index and IRR criteria.
48) Brett’s Gift Box estimates that it will sell 30,000 porcelain figurines next year.
Because porcelain figurines are so easily damaged, the average per unit carrying cost of
the figurines is $25. The per order cost of ordering is $800. Assume that Brett wants a
safety stock of 75 figurines. If Brett reorders the figurines based on the economic order
quantity, what is Brett’s average inventory of porcelain figurines?
A) 768
B) 854
C) 628
D) 700
49) Which of the following premiums is NOT factored into the price of a long-term
Treasury bond?
A) a real risk-free interest rate
B) a maturity premium
C) a default-risk premium
D) an inflation-risk premium
50) P.D. Corporation is considering the purchase of a high-speed lathe that has an
invoice price of $250,000. The cost to ship the lathe to P.D.’s factory is $10,000, and the
existing facilities will require modifications that are expected to cost $20,000. The
machine will be depreciated on a straight-line basis over its useful life of 10 years,
assuming no salvage value. P.D. Corporation is planning on paying for the lathe using a
line of credit at the bank that has an interest rate of 6 percent per year. The lathe is
expected to increase production and sales. Sales are expected to increase by $100,000
per year. Inventory and accounts receivable balances are expected to increase by
$10,000 and $20,000 respectively. Expenses to operate the lathe are $25,000 per year.
P.D.’s marginal tax rate is 40%.
a.Calculate the initial outlay required to fund this project.
b.Calculate the incremental after-tax cash flow in year one of the project.
51) Terminal warehouse agreements
A) are particularly useful where large bulky items are used as collateral
B) give the lender a lien against all inventories while only removing representative
items
C) remove control of the inventory from the borrower
D) are less costly than field warehouse agreements
52) Which of the following is an advantage of using private placements for debt?
A) reduced costs from the elimination of the registration statement for the SEC,
investment-banking underwriting fees and distribution costs
B) lower interest costs
C) fewer and less burdensome restrictive covenants
D) the possibility of future SEC registration
53) Which item would constitute poor collateral for an inventory loan?
A) lumber
B) vegetables
C) grain
D) chemicals