Which of the following statements is CORRECT?
a.The sustainable growth rate is the maximum achievable growth rate without the firm
having to raise external funds. In other words, it is the growth rate at which the firm’s
AFN equals zero.
b.If a firm’s assets are growing at a positive rate, but its retained earnings are not
increasing, then it would be impossible for the firm’s AFN to be negative.
c.If a firm increases its dividend payout ratio in anticipation of higher earnings, but
sales and earnings actually decrease, then the firm’s actual AFN must, mathematically,
exceed the previously calculated AFN.
d.Higher sales usually require higher asset levels, and this leads to what we call AFN.
However, the AFN will be zero if the firm chooses to retain all of its profits, i.e., to have
a zero dividend payout ratio.
e.Dividend policy does not affect the requirement for external funds based on the AFN
equation.
Consider the following information for three stocks, A, B, and C. The stocks’ returns are
positively but not perfectly positively correlated with one another, i.e., the correlations
are all between 0 and 1.
Portfolio AB has half of its funds invested in Stock A and half in Stock B. Portfolio
ABC has one third of its funds invested in each of the three stocks. The risk-free rate is
5%, and the market is in equilibrium, so required returns equal expected returns. Which
of the following statements is CORRECT?
a.Portfolio AB has a standard deviation of 20%.
b.Portfolio AB’s coefficient of variation is greater than 2.0.
c.Portfolio AB’s required return is greater than the required return on Stock A.
d.Portfolio ABC’s expected return is 10.66667%.
e.Portfolio ABC has a standard deviation of 20%.
Casey Communications recently issued new common stock and used the proceeds to
pay off some of its short-term notes payable. This action had no effect on the company’s
total assets or operating income. Which of the following effects would occur as a result
of this action?
a.The company’s current ratio increased.
b.The company’s times interest earned ratio decreased.
c.The company’s basic earning power ratio increased.
d.The company’s equity multiplier increased.
e.The company’s total debt to total capital ratio increased.
Last year Blease Inc had a total assets turnover of 1.33 and an equity multiplier of 1.75.
Its sales were $295,000 and its net income was $10,600. The firm finances using only
debt and common equity and its total assets equal total invested capital. The CFO
believes that the company could have operated more efficiently, lowered its costs, and
increased its net income by $10,250 without changing its sales, assets, or capital
structure. Had it cut costs and increased its net income by this amount, how much
would the ROE have changed?
a.6.55%
b.7.28%
c.8.09%
d.8.90%
e.9.79%
Which of the following is most likely to occur as you add randomly selected stocks to
your portfolio, which currently consists of 3 average stocks?
a.The diversifiable risk of your portfolio will likely decline, but the expected market
risk should not change.
b.The expected return of your portfolio is likely to decline.
c.The diversifiable risk will remain the same, but the market risk will likely decline.
d.Both the diversifiable risk and the market risk of your portfolio are likely to decline.
e.The total risk of your portfolio should decline, and as a result, the expected rate of
return on the portfolio should also decline.
Which of the following items should a company report directly in its monthly cash
budget?
a.Its monthly depreciation expense.
b.Cash proceeds from selling one of its divisions.
c.Accrued interest on zero coupon bonds that it issued.
d.New shares issued in a stock split.
e.New shares issued in a stock dividend.
You observe the following information regarding Companies X and Y:
Company X has a higher expected return than Company Y.
Company X has a lower standard deviation of returns than Company Y.
Company X has a higher beta than Company Y.
Given this information, which of the following statements is CORRECT?
a.Company X has more diversifiable risk than Company Y.
b.Company X has a lower coefficient of variation than Company Y.
c.Company X has less market risk than Company Y.
d.Company X’s returns will be negative when Y’s returns are positive.
e.Company X’s stock is a better buy than Company Y’s stock.
A company currently sells 75,000 units annually. At this sales level, its EBIT is $4
million, and its degree of total leverage is 2.0. The firm’s debt consists of $15 million in
bonds with a 9.5% coupon. The company is considering a new production method
which will entail an increase in fixed costs but a decrease in variable costs, and will
result in a degree of operating leverage of 600. The president, who is concerned about
the stand-alone risk of the firm, wants to keep the degree of total leverage at 2.0. If
EBIT remains at $4 million, what dollar amount of bonds must be retired to accomplish
this?
a.$5,640,625
b.$5,937,500
c.$6,250,000
d.$6,578,947
e.$6,907,895
Recycler Battery Corporation (RBC) issued zero coupon bonds 5 years ago at a price of
$214.50 per bond. RBC’s zeros had a 20-year original maturity, with a $1,000 par value.
The bonds were callable 10 years after the issue date at a price 7% over their accrued
value on the call date. If the bonds sell for $240 in the market today, what annual rate of
return should an investor who buys the bonds today expect to earn on them?
a.9.01%
b.9.48%
c.9.98%
d.10.48%
e.11.00%
Which of the following statements is most CORRECT?
a.Preferred stock generally has a higher component cost of capital to the firm than does
common stock.
b.By law in most states, all preferred stock must be cumulative, meaning that the
compounded total of all unpaid preferred dividends must be paid before any dividends
can be paid on the firm’s common stock.
c.From the issuer’s point of view, preferred stock is less risky than bonds.
d.Whereas common stock has an indefinite life, preferred stocks always have a specific
maturity date, generally 25 years or less.
e.Unlike bonds, preferred stock cannot have a convertible feature.
Bob has a $50,000 stock portfolio with a beta of 1.2, an expected return of 10.8%, and a
standard deviation of 25%. Becky also has a $50,000 portfolio, but it has a beta of 0.8,
an expected return of 9.2%, and a standard deviation that is also 25%. The correlation
coefficient, r, between Bob’s and Becky’s portfolios is zero. If Bob and Becky marry
and combine their portfolios, which of the following best describes their combined
$100,000 portfolio?
a.The combined portfolio’s expected return will be less than the simple weighted
average of the expected returns of the two individual portfolios, 10.0%.
b.The combined portfolio’s beta will be equal to a simple weighted average of the betas
of the two individual portfolios, 1.0; its expected return will be equal to a simple
weighted average of the expected returns of the two individual portfolios, 10.0%; and
its standard deviation will be less than the simple average of the two portfolios’ standard
deviations, 25%.
c.The combined portfolio’s expected return will be greater than the simple weighted
average of the expected returns of the two individual portfolios, 10.0%.
d.The combined portfolio’s standard deviation will be greater than the simple average of
the two portfolios’ standard deviations, 25%.
e.The combined portfolio’s standard deviation will be equal to a simple average of the
two portfolios’ standard deviations, 25%.
Which of the following actions would be likely to shorten the cash conversion cycle?
a.Adopt a new manufacturing process that speeds up the conversion of raw materials to
finished goods from 20 days to 10 days.
b.Change the credit terms offered to customers from 3/10, net 30 to 1/10, net 50.
c.Begin to take discounts on inventory purchases; we buy on terms of 2/10, net 30.
d.Adopt a new manufacturing process that saves some labor costs but slows down the
conversion of raw materials to finished goods from 10 days to 20 days.
e.Change the credit terms offered to customers from 2/10, net 30 to 1/10, net 60.
The capital intensity ratio is generally defined as follows:
a.Sales divided by total assets, i.e., the total assets turnover ratio.
b.The percentage of liabilities that increase spontaneously as a percentage of sales.
c.The ratio of sales to current assets.
d.The ratio of current assets to sales.
e.The amount of assets required per dollar of sales, or A0*/S0.
Which of the following statements is CORRECT?
a.An option’s value is determined by its exercise value, which is the market price of the
stock less its strike price. Thus, an option can’t sell for more than its exercise value.
b.As a stock’s price increases, the premium portion of an option on that stock increases
because the difference between the stock price and the fixed strike price increases.
c.If the company is consistently profitable, its call options will always be in the money.
d.The market value of an option depends in part on the option’s length of time until
expiration and on the variability of the underlying stock’s price.
e.The potential loss on an option decreases as the option sells at higher and higher
prices because the profit margin becomes larger.
To estimate the cash flow from operations, depreciation must be added back to net
income because it is a non-cash charge that has been deducted from revenue in the net
income calculation.
a.True
b.False
Which of the following statements is CORRECT?
a.If interest rates increase, a 10-year zero coupon bond’s price will drop by a greater
percentage than will a 10-year, 8% coupon bond.
b.One nice thing about zero coupon bonds is that individual investors do not have to
pay any taxes on a zero coupon bond until it matures, even if they are not holding the
bonds as part of a tax-deferred account.
c.If a bond with a sinking fund provision has a yield to maturity greater than its coupon
rate, the issuing company would prefer to comply with the sinking fund by calling the
bonds in at par rather than buying the bonds back in the open market.
d.Because of the IRS’s tax treatment of zero coupon bonds, pension funds and other
tax-exempt entities rarely, if ever, invest in zero coupon bonds.
e.Interest must be paid on a zero coupon bond’s accrued value, but while the first year’s
interest is taxable at the ordinary income tax rate, subsequent years are taxed at the
long-term capital gains rate (since they are received after more than a year).
Koy Corporation’s 5-year bonds yield 7.00%, and 5-year T-bonds yield 5.15%. The real
risk-free rate is r* = 3.0%, the inflation premium for 5-year bonds is IP = 1.75%, the
liquidity premium for Koy’s bonds is LP = 0.75% versus zero for T-bonds, and the
maturity risk premium for all bonds is found with the formula MRP = (t – 1) x 0.1%,
where t = number of years to maturity. What is the default risk premium (DRP) on
Koy’s bonds?
a.0.60%
b.1.10%
c.1.50%
d.2.25%
e.3.00%
An option that gives the holder the right to buy a stock at a specified price at some time
in the future is called a(n)
a.Call option.
b.Put option.
c.Out-of-the-money option.
d.Naked option.
e.Covered option.