1) Which of the following statements is CORRECT? Assume that all projects being
considered have normal cash flows and are equally risky.
a.If a project’s IRR is equal to its WACC, then under all reasonable conditions, the
project’s IRR must be negative
b.If a project’s IRR is equal to its WACC, then under all reasonable conditions the
project’s NPV must be zero
c.There is no necessary relationship between a project’s IRR, its WACC, and its NPV
d.When evaluating mutually exclusive projects, those projects with relatively long lives
will tend to have relatively high NPVs when the cost of capital is relatively high
e.If a project’s IRR is equal to its WACC, then, under all reasonable conditions, the
project’s NPV must be negative
2) Companies A and C each reported the same earnings per share (EPS), but Company
A’s stock trades at a higher price. Which of the following statements is CORRECT?
a. Company A trades at a higher P/E ratio
b. Company A probably has fewer growth opportunities
c. Company A is probably judged by investors to be riskier
d. Company A must have a higher market-to-book ratio
e. Company A must pay a lower dividend
3) Dyer Furniture is expected to pay a dividend of D1 = $1.25 per share at the end of
the year, and that dividend is expected to grow at a constant rate of 6.00% per year in
the future. The company’s beta is 1.15, the market risk premium is 5.50%, and the
risk-free rate is 4.00%. What is Dyer’s current stock price?
a.$28.90
b.$29.62
c.$30.36
d.$31.12
e.$31.90
4) Jerome Corporation’s bonds have 15 years to maturity, an 8.75% coupon paid
semiannually, and a $1,000 par value. The bond has a 6.50% nominal yield to maturity,
but it can be called in 6 years at a price of $1,050. What is the bond’s nominal yield to
call?
a.5.01%
b.5.27%
c.5.54%
d.5.81%
e.6.10%
5) Which of the following statements is CORRECT?
a.If you were restricted to investing in publicly traded common stocks, yet you wanted
to minimize the riskiness of your portfolio as measured by its beta, then according to
the CAPM theory you should invest an equal amount of money in each stock in the
market. That is, if there were 10,000 traded stocks in the world, the least risky possible
portfolio would include some shares of each one
b.If you formed a portfolio that consisted of all stocks with betas less than 1.0, which is
about half of all stocks, the portfolio would itself have a beta coefficient that is equal to
the weighted average beta of the stocks in the portfolio, and that portfolio would have
less risk than a portfolio that consisted of all stocks in the market
c.Market risk can be eliminated by forming a large portfolio, and if some Treasury
bonds are held in the portfolio, the portfolio can be made to be completely riskless
d.A portfolio that consists of all stocks in the market would have a required return that
is equal to the riskless rate
e.If you add enough randomly selected stocks to a portfolio, you can completely
eliminate all of the market risk from the portfolio
6) Fireside Inc. has the following data. What is the firm’s cash conversion cycle?
Inventory conversion period =38 days
Average collection period =19 days
Payables deferral period =20 days
a.33 days
b.37 days
c.41 days
d.45 days
e.49 days
7) Vang Corp.’s stock price at the end of last year was $33.50 and its earnings per share
for the year were $2.30. What was its P/E ratio?
a. 13.84
b. 14.57
c. 15.29
d. 16.06
e. 16.86
8) On its 2012 balance sheet, Barngrover Books showed $510 million of retained
earnings, and exactly that same amount was shown the following year in 2013.
Assuming that no earnings restatements were issued, which of the following statements
is CORRECT?
a.Dividends could have been paid in 2013, but they would have had to equal the
earnings for the year
b.If the company lost money in 2013, they must have paid dividends
c.The company must have had zero net income in 2013
d.The company must have paid out half of its earnings as dividends
e.The company must have paid no dividends in 2013
9) Which of the following statements is CORRECT?
a.Although short-term interest rates have historically averaged less than long-term rates,
the heavy use of short-term debt is considered to be an aggressive strategy because of
the inherent risks associated with using short-term financing
b.If a company follows a policy of “matching maturities,” this means that it matches its
use of common stock with its use of long-term debt as opposed to short-term debt
c.Net working capital is defined as current assets minus the sum of payables and
accruals, and any decrease in the current ratio automatically indicates that net working
capital has decreased
d.If a company follows a policy of “matching maturities,” this means that it matches its
use of short-term debt with its use of long-term debt
e.Net working capital is defined as current assets minus the sum of payables and
accruals, and any increase in the current ratio automatically indicates that net working
capital has increased
10) Under normal conditions, which of the following would be most likely to increase
the coupon rate required to enable a bond to be issued at par?
a.Adding a call provision
b.The rating agencies change the bond’s rating from Baa to Aaa
c.Making the bond a first mortgage bond rather than a debenture
d.Adding a sinking fund
e.Adding additional restrictive covenants that limit management’s actions
11) Projects S and L, whose cash flows are shown below, are mutually exclusive,
equally risky, and not repeatable. Hooper Inc. is considering which of these two projects
to undertake. If the decision is made by choosing the project with the higher IRR, how
much value will be forgone? Note that under certain conditions choosing projects on the
basis of the IRR will not cause any value to be lost because the project with the higher
IRR will also have the higher NPV, so no value will be lost if the IRR method is used.
WACC:10.25%
Year01234
CFS-$2,050 $750 $760 $770 $780
CFL-$4,300$1,500$1,518$1,536$1,554
a.$134.79
b.$141.89
c.$149.36
d.$164.29
e.$205.36
12) Squire Inc.’s 5-year bonds yield 6.75%, and 5-year T-bonds yield 4.80%. The real
risk-free rate is r* = 2.75%, the inflation premium for 5-year bonds is IP = 1.65%, the
default risk premium for Squire’s bonds is DRP = 1.20% versus zero for T-bonds, and
the maturity risk premium for all bonds is found with the formula MRP = (t – 1) 0.1%,
where t = number of years to maturity. What is the liquidity premium (LP) on Squire’s
bonds?
a.0.49%
b.0.55%
c.0.61%
d.0.68%
e.0.75%
13) On 12/31/2013, Heaton Industries Inc. reported retained earnings of $675,000 on its
balance sheet, and it reported that it had $172,500 of net income during the year. On its
previous balance sheet, at 12/31/2012, the company had reported $555,000 of retained
earnings. No shares were repurchased during 2013. How much in dividends did Heaton
pay during 2013?
a.$47,381
b.$49,875
c.$52,500
d.$55,125
e.$57,881
14) Which of the following statements is CORRECT?
a.Only incremental cash flows are relevant in project analysis, the proper incremental
cash flows are the reported accounting profits, and thus reported accounting income
should be used as the basis for investor and managerial decisions
b.It is unrealistic to believe that any increases in net working capital required at the start
of an expansion project can be recovered at the project’s completion. Working capital
like inventory is almost always used up in operations. Thus, cash flows associated with
working capital should be included only at the start of a project’s life
c.If equipment is expected to be sold for more than its book value at the end of a
project’s life, this will result in a profit. In this case, despite taxes on the profit, the
end-of-project cash flow will be greater than if the asset had been sold at book value,
other things held constant
d.Changes in net working capital refer to changes in current assets and current
liabilities, not to changes in long-term assets and liabilities. Therefore, changes in net
working capital should not be considered in a capital budgeting analysis
e.If an asset is sold for less than its book value at the end of a project’s life, it will
generate a loss for the firm, hence its terminal cash flow will be negative
15) 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.
ExpectedStandard
StockReturnDeviationBeta
A10%20%1.0
B10%10%1.0
C12%12%1.4
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’s coefficient of variation is greater than 2.0
b.Portfolio AB’s required return is greater than the required return on Stock A
c.Portfolio ABC’s expected return is 10.66667%
d.Portfolio ABC has a standard deviation of 20%
e.Portfolio AB has a standard deviation of 20%
16) Assume that all interest rates in the economy decline from 10% to 9%. Which of the
following bonds would have the largest percentage increase in price?
a.A 1-year bond with a 15% coupon
b.A 3-year bond with a 10% coupon
c.A 10-year zero coupon bond
d.A 10-year bond with a 10% coupon
e.An 8-year bond with a 9% coupon
17) Kelly Enterprises’ stock currently sells for $35.25 per share. The dividend is
projected to increase at a constant rate of 4.75% per year. The required rate of return on
the stock, rs, is 11.50%. What is the stock’s expected price 5 years from now?
a.$40.17
b.$41.20
c.$42.26
d.$43.34
e.$44.46
18) Langton Inc. is considering Projects S and L, whose cash flows are shown below.
These projects are mutually exclusive, equally risky, and not repeatable. The CEO
believes the IRR is the best selection criterion, while the CFO advocates the MIRR. If
the decision is made by choosing the project with the higher IRR rather than the one
with the higher MIRR, how much, if any, value will be forgone. In other words, what’s
the NPV of the chosen project versus the maximum possible NPV? Note that (1) “true
value” is measured by NPV, and (2) under some conditions the choice of IRR vs. MIRR
will have no effect on the value lost.
WACC:7.00%
Year01234
CFS-$1,100$550$600$100 $100
CFL-$2,750$725$725$800$1,400
a.$185.90
b.$197.01
c.$208.11
d.$219.22
e.$230.32
19) Calculate the required rate of return for Everest Expeditions Inc., assuming that (1)
investors expect a 4.0% rate of inflation in the future, (2) the real risk-free rate is 3.0%,
(3) the market risk premium is 5.0%, (4) the firm has a beta of 1.00, and (5) its realized
rate of return has averaged 15.0% over the last 5 years.
a.10.29%
b.10.83%
c.11.40%
d.12.00%
e.12.60%
20) Which of the following statements is CORRECT?
a.The time to maturity does not affect the change in the value of a bond in response to a
given change in interest rates
b.You hold two bonds. One is a 10-year, zero coupon, bond and the other is a 10-year
bond that pays a 6% annual coupon. The same market rate, 6%, applies to both bonds.
If the market rate rises from the current level, the zero coupon bond will experience the
smaller percentage decline
c.The shorter the time to maturity, the greater the change in the value of a bond in
response to a given change in interest rates
d.The longer the time to maturity, the smaller the change in the value of a bond in
response to a given change in interest rates
e.You hold two bonds. One is a 10-year, zero coupon, issue and the other is a 10-year
bond that pays a 6% annual coupon. The same market rate, 6%, applies to both bonds.
If the market rate rises from the current level, the zero coupon bond will experience the
larger percentage decline
21) Which of the following statements is CORRECT?
a.The capital structure that maximizes the stock price is also the capital structure that
maximizes earnings per share
b.The capital structure that maximizes the stock price is also the capital structure that
maximizes the firm’s times interest earned (TIE) ratio
c.Increasing a company’s debt ratio will typically reduce the marginal costs of both debt
and equity financing; however, this still may raise the company’s WACC
d.If Congress were to pass legislation that increases the personal tax rate but decreases
the corporate tax rate, this would encourage companies to increase their debt ratios
e.The capital structure that maximizes the stock price is also the capital structure that
minimizes the weighted average cost of capital (WACC)
22) The capital budget of Creative Ventures Inc. is $1,000,000. The company wants to
maintain a target capital structure that is 30% debt and 70% equity. The company
forecasts that its net income this year will be $800,000. If the company follows a
residual dividend policy, what will be its total dividend payment?
a. $100,000
b. $200,000
c. $300,000
d. $400,000
e. $500,000
23) An option that gives the holder the right to sell a stock at a specified price at some
future time is
a.a put option
b.an out-of-the-money option
c.a naked option
d.a covered option
e.a call option
24) Refer to Exhibit 3.1. What is the firm’s dividends per share?
a. $2.62
b. $2.91
c. $3.20
d. $3.53
e. $3.88
25) The Jameson Company just paid a dividend of $0.75 per share, and that dividend is
expected to grow at a constant rate of 5.50% per year in the future. The company’s beta
is 1.15, the market risk premium is 5.00%, and the risk-free rate is 4.00%. What is
Jameson’s current stock price, P0?
a.$18.62
b.$19.08
c.$19.56
d.$20.05
e.$20.55
26) Wiley’s Wire Products 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:11.00%
Year0123
Cash flows-$800$350$350$350
a.8.86%
b.9.84%
c.10.94%
d.12.15%
e.13.50%
27) Which of the following bonds would have the greatest percentage increase in value
if all interest rates fall by 1%?
a.20-year, 10% coupon bond
b.20-year, 5% coupon bond
c.1-year, 10% coupon bond
d.20-year, zero coupon bond
e.10-year, zero coupon bond
28) A stock just paid a dividend of D0 = $1.50. The required rate of return is rs =
10.1%, and the constant growth rate is g = 4.0%. What is the current stock price?
a.$23.11
b.$23.70
c.$24.31
d.$24.93
e.$25.57
29) Which of the following statements is CORRECT?
a. Capital market instruments include both long-term debt and common stocks
b. An example of a primary market transaction would be your uncle transferring 100
shares of Wal-Mart stock to you as a birthday gift
c. The NYSE does not exist as a physical location; rather, it represents a loose
collection of dealers who trade stocks electronically
d. If your uncle in New York sold 100 shares of Microsoft through his broker to an
investor in Los Angeles, this would be a primary market transaction
e. While the two frequently perform similar functions, investment banks generally
specialize in lending money, whereas commercial banks generally help companies raise
large blocks of capital from investors
30) Which of the following items is NOT included in current assets?
a.Short-term, highly liquid, marketable securities.
b.Accounts receivable
c.Inventory
d.Bonds
e.Cash
31) If a firm has set up a revolving credit agreement with a bank, the risk to the firm of
being unable to obtain funds when needed is lower than if it had an informal line of
credit.
32) Provided a firm does not use an extreme amount of debt, financial leverage
typically affects both EPS and EBIT, while operating leverage only affects EBIT.
33) If a profitable firm finds that it simply must ‘stretch” its accounts payable, then this
suggests that it is undercapitalized, i.e., that it needs more working capital to support its
operations.
34) The concept of permanent current operating assets reflects the fact that some
components of current assets do not shrink to zero even when a business is at its
seasonal or cyclical low. Thus, permanent current operating assets represent a minimum
level of current assets that must be financed.
35) Because of improvements in forecasting techniques, estimating the cash flows
associated with a project has become the easiest step in the capital budgeting process.