1) Ziebart Corp.’s EBITDA last year was $390,000 ( = EBIT + depreciation +
amortization), its interest charges were $9,500, it had to repay $26,000 of long-term
debt, and it had to make a payment of $17,400 under a long-term lease. The firm had no
amortization charges. What was the EBITDA coverage ratio?
a. 7.32
b. 7.70
c. 8.09
d. 8.49
e. 8.92
2) Which of the following statements is CORRECT?
a.The NPV method assumes that cash flows will be reinvested at the risk-free rate,
while the IRR method assumes reinvestment at the IRR
b.The NPV method assumes that cash flows will be reinvested at the WACC, while the
IRR method assumes reinvestment at the risk-free rate
c.The NPV method does not consider all relevant cash flows, particularly cash flows
beyond the payback period
d.The IRR method does not consider all relevant cash flows, particularly cash flows
beyond the payback period
e.The NPV method assumes that cash flows will be reinvested at the WACC, while the
IRR method assumes reinvestment at the IRR
3) Which of the following statements is CORRECT? Assume that the firm is a
publicly-owned corporation and is seeking to maximize shareholder wealth.
a.If a firm’s managers want to maximize the value of their firm’s stock, they should, in
theory, concentrate on project risk as measured by the standard deviation of the project’s
expected future cash flows
b.If a firm evaluates all projects using the same cost of capital, and the CAPM is used to
help determine that cost, then its risk as measured by beta will probably decline over
time
c.Projects with above-average risk typically have higher than average expected returns.
Therefore, to maximize a firm’s intrinsic value, its managers should favor high-beta
projects over those with lower betas
d.Project A has a standard deviation of expected returns of 20%, while Project B’s
standard deviation is only 10%. A’s returns are negatively correlated with both the
firm’s other assets and the returns on most stocks in the economy, while B’s returns are
positively correlated. Therefore, Project A is less risky to a firm and should be evaluated
with a lower cost of capital
e.If a firm has a beta that is less than 1.0, say 0.9, this would suggest that the expected
returns on its assets are negatively correlated with the returns on most other firms’
assets
4) Noncallable bonds that mature in 10 years were recently issued by Sternglass Inc.
They have a par value of $1,000 and an annual coupon of 5.5%. If the current market
interest rate is 7.0%, at what price should the bonds sell?
a.$829.21
b.$850.47
c.$872.28
d.$894.65
e.$917.01
5) Silvana Inc. projects the following data for the coming year. If the firm follows the
residual dividend policy and also maintains its target capital structure, what will its
payout ratio be?
a. 37.2%
b. 39.1%
c. 41.2%
d. 43.3%
e. 45.5%
6) Brodkey Shoes has a beta of 1.30, the T-bill rate is 3.00%, and the T-bond rate is
6.5%. The annual return on the stock market during the past 3 years was 15.00%, but
investors expect the annual future stock market return to be 13.00%. Based on the SML,
what is the firm’s required return?
a.13.51%
b.13.86%
c.14.21%
d.14.58%
e.14.95%
7) Which of the following statements is CORRECT?
a. “Window dressing” is any action that improves a firm’s fundamental, long-run
position and thus increases its intrinsic value
b. Borrowing by using short-term notes payable and then using the proceeds to retire
long-term debt is an example of “window dressing.” Offering discounts to customers
who pay with cash rather than buy on credit and then using the funds that come in
quicker to purchase additional inventories is another example of “window dressing”
c. Borrowing on a long-term basis and using the proceeds to retire short-term debt
would improve the current ratio and thus could be considered to be an example of
“window dressing”
d. Offering discounts to customers who pay with cash rather than buy on credit and then
using the funds that come in quicker to purchase additional inventories is an example of
“window dressing”
e. Using some of the firm’s cash to reduce long-term debt is an example of “window
dressing”
8) Bond A has a 9% annual coupon, while Bond B has a 7% annual coupon. Both bonds
have the same maturity, a face value of $1,000, and an 8% yield to maturity. Which of
the following statements is CORRECT?
a.Bond A trades at a discount, whereas Bond B trades at a premium
b.If the yield to maturity for both bonds remains at 8%, Bond A’s price one year from
now will be higher than it is today, but Bond B’s price one year from now will be lower
than it is today
c.If the yield to maturity for both bonds immediately decreases to 6%, Bond A’s bond
will have a larger percentage increase in value
d.Bond A’s current yield is greater than that of Bond B
e.Bond A’s capital gains yield is greater than Bond B’s capital gains yield
9) Suppose the debt ratio (D/TA) is 50%, the interest rate on new debt is 8%, the current
cost of equity is 16%, and the tax rate is 40%. An increase in the debt ratio to 60%
would decrease the weighted average cost of capital (WACC).
10) Stock A’s beta is 1.7 and Stock B’s beta is 0.7. Which of the following statements
must be true about these securities? (Assume market equilibrium.)
a.Stock B must be a more desirable addition to a portfolio than A
b.Stock A must be a more desirable addition to a portfolio than B
c.The expected return on Stock A should be greater than that on B
d.The expected return on Stock B should be greater than that on A
e.When held in isolation, Stock A has more risk than Stock B
11) Which of the following statements is NOT CORRECT?
a.The expected return on a corporate bond must be less than its promised return if the
probability of default is greater than zero
b.All else equal, senior debt has less default risk than subordinated debt
c.A company’s bond rating is affected by its financial ratios and provisions in its
indenture
d.Under Chapter 11 of the Bankruptcy Act, the assets of a firm that declares bankruptcy
must be liquidated, and the sale proceeds must be used to pay off its debt according to
the seniority of the debt as spelled out in the Act
e.All else equal, secured debt is less risky than unsecured debt
12) Brinkley Resources stock has increased significantly over the last five years, selling
now for $175 per share. Management feels this price is too high for the average investor
and wants to get the price down to a more typical level, which it thinks is $25 per share.
What stock split would be required to get to this price, assuming the transaction has no
effect on the total market value? Put another way, how many new shares should be
given per one old share?
a. 6.65
b. 6.98
c. 7.00
d. 7.35
e. 7.72
13) Which of the following statements is CORRECT?
a.Liquidity premiums are generally higher on Treasury than corporate bonds
b.The maturity premiums embedded in the interest rates on U.S. Treasury securities are
due primarily to the fact that the probability of default is higher on long-term bonds
than on short-term bonds
c.Default risk premiums are generally lower on corporate than on Treasury bonds
d.Reinvestment rate risk is lower, other things held constant, on long-term than on
short-term bonds
e.If the maturity risk premium were zero and interest rates were expected to decrease in
the future, then the yield curve for U.S. Treasury securities would, other things held
constant, have an upward slope
14) Below are the year-end balance sheets for Wolken Enterprises:
Assets:20132012
Cash$ 200,000$ 170,000
Accounts receivable864,000700,000
Inventories 2,000,000 1,400,000
Total current assets$3,064,000$2,270,000
Net fixed assets 6,000,000 5,600,000
Total assets$9,064,000$7,870,000
Liabilities and equity:
Accounts payable$1,400,000$1,090,000
Notes payable 1,600,000 1,800,000
Total current liabilities$3,000,000$2,890,000
Long-term debt2,400,0002,400,000
Common stock3,000,0002,000,000
Retained earnings 664,000 580,000
Total common equity$3,664,000$2,580,000
Total liabilities and equity$9,064,000$7,870,000
Wolken has never paid a dividend on its common stock, and it issued $2,400,000 of
10-year non-callable, long-term debt in 2012. As of the end of 2013, none of the
principal on this debt had been repaid. Assume that the company’s sales in 2012 and
2013 were the same. Which of the following statements must be CORRECT?
a.Wolken increased its short-term bank debt in 2013
b.Wolken issued long-term debt in 2013
c.Wolken issued new common stock in 2013
d.Wolken repurchased some common stock in 2013
e.Wolken had negative net income in 2013
15) Refer to Exhibit 15.3. BB is considering moving to a capital structure that is
comprised of 20% debt and 80% equity, based on market values. The debt would have
an interest rate of 7%. The new funds would be used to repurchase stock. It is estimated
that the increase in risk resulting from the additional leverage would cause the required
rate of return on equity to rise to 14%. If this plan were carried out, what would BB’s
new value of operations be?
a.$498,339
b.$512,188
c.$525,237
d.$540,239
e.$590,718
16) In the real world, dividends
a. are usually more stable than earnings
b. fluctuate more widely than earnings
c. tend to be a lower percentage of earnings for mature firms
d. are usually changed every year to reflect earnings changes, and these changes are
randomly higher or lower, depending on whether earnings increased or decreased
e. are usually set as a fixed percentage of earnings, e.g., at 40% of earnings, so if EPS =
$2.00, then DPS will equal $0.80. Once the percentage is set, then dividend policy is on
“automatic pilot” and the actual dividend depends strictly on earnings
17) If a stock’s dividend is expected to grow at a constant rate of 5% a year, which of
the following statements is CORRECT? The stock is in equilibrium.
a.The stock’s dividend yield is 5%
b.The price of the stock is expected to decline in the future
c.The stock’s required return must be equal to or less than 5%
d.The stock’s price one year from now is expected to be 5% above the current price
e.The expected return on the stock is 5% a year
18) The WACC for two mutually exclusive projects that are being considered is 8%.
Project K has an IRR of 20% while Project R’s IRR is 15%. The projects have the same
NPV at the 8% current WACC. However, you believe that money costs and thus your
WACC will also increase. You also think that the projects will not be funded until the
WACC has increased, and their cash flows will not be affected by the change in
economic conditions. Under these conditions, which of the following statements is
CORRECT?
a.You should delay a decision until you have more information on the projects, even if
this means that a competitor might come in and capture this market
b.You should recommend Project R, because at the new WACC it will have the higher
NPV
c.You should recommend Project K, because at the new WACC it will have the higher
NPV
d.You should recommend Project K because it has the higher IRR and will continue to
have the higher IRR even at the new WACC
e.You should reject both projects because they will both have negative NPVs under the
new conditions
19) Yesterday, Berryman Investments was selling for $90 per share. Today, the
company completed a 7-for-2 stock split. If the total market value was unchanged by
the split, what is the price of the stock today?
a. $23.21
b. $24.43
c. $25.71
d. $27.00
e. $28.35
20) Sawchuck Consulting has been profitable for the last 5 years, but it has never paid a
dividend. Management has indicated that it plans to pay a $0.25 dividend 3 years from
today, then to increase it at a relatively rapid rate for 2 years, and then to increase it at a
constant rate of 8.00% thereafter. Management’s forecast of the future dividend stream,
along with the forecasted growth rates, is shown below. Assuming a required return of
11.00%, what is your estimate of the stock’s current value?
Year0123456
Growth rateNANANANA50.00%25.00%8.00%
Dividends$0.000$0.000$0.000$0.250$0.375$0.469$0.506
a.$9.94
b.$10.19
c.$10.45
d.$10.72
e.$10.99
21) Based on the corporate valuation model, Bizzaro Co.’s value of operations is $300
million. The balance sheet shows $20 million of short-term investments that are
unrelated to operations, $50 million of accounts payable, $90 million of notes payable,
$30 million of long-term debt, $40 million of preferred stock, and $100 million of
common equity. Bizzaro has 10 million shares of stock outstanding. What is the best
estimate of the stock’s price per share?
a.$13.72
b.$14.44
c.$15.20
d.$16.00
e.$16.80
22) Tucker Electronic System’s current balance sheet shows total common equity of
$3,125,000. The company has 125,000 shares of stock outstanding, and they sell at a
price of $52.50 per share. By how much do the firm’s market and book values per share
differ?
a.$27.50
b.$28.88
c.$30.32
d.$31.83
e.$33.43
23) Heaton Corp. sells on terms that allow customers 45 days to pay for merchandise.
Its sales last year were $425,000, and its year-end receivables were $60,000. If its DSO
is less than the 45-day credit period, then customers are paying on time. Otherwise, they
are paying late. By how much are customers paying early or late? Base your answer on
this equation: DSO – Credit period = days early or late, and use a 365-day year when
calculating the DSO. A positive answer indicates late payments, while a negative
answer indicates early payments.
a. 6.20
b. 6.53
c. 6.86
d. 7.20
e. 7.56
24) Which of the following statements is CORRECT?
a.The CAPM has been thoroughly tested, and the theory has been confirmed beyond
any reasonable doubt
b.If two “normal” or “typical” stocks were combined to form a 2-stock portfolio, the
portfolio’s expected return would be a weighted average of the stocks’ expected returns,
but the portfolio’s standard deviation would probably be greater than the average of the
stocks’ standard deviations
c.If investors become more risk averse, then (1) the slope of the SML would increase
and (2) the required rate of return on low-beta stocks would increase by more than the
required return on high-beta stocks
d.An increase in expected inflation, combined with a constant real risk-free rate and a
constant market risk premium, would lead to identical increases in the required returns
on a riskless asset and on an average stock, other things held constant
e.A graph of the SML as applied to individual stocks would show required rates of
return on the vertical axis and standard deviations of returns on the horizontal axis
25) Which of the following statements is CORRECT?
a.Conservative firms generally use no short-term debt and thus have zero current
liabilities
b.A short-term loan can usually be obtained more quickly than a long-term loan, but the
cost of short-term debt is normally higher than that of long-term debt
c.If a firm that can borrow from its bank at a 6% interest rate buys materials on terms of
2/10 net 30, and if it must pay by Day 30 or else be cut off, then we would expect to see
zero accounts payable on its balance sheet
d.If one of your firm’s customers is ‘stretching” its accounts payable, this may be a
nuisance but it will not have an adverse financial impact on your firm if the customer
periodically pays off its entire balance
e.Under normal conditions, a firm’s expected ROE would probably be higher if it
financed with short-term rather than with long-term debt, but using short-term debt
would probably increase the firm’s risk
26) A stock is expected to pay a dividend of $0.75 at the end of the year. The required
rate of return is rs = 10.5%, and the expected constant growth rate is g = 6.4%. What is
the stock’s current price?
a.$17.39
b.$17.84
c.$18.29
d.$18.75
e.$19.22
27) The IRR of normal Project X is greater than the IRR of normal Project Y, and both
IRRs are greater than zero. Also, the NPV of X is greater than the NPV of Y at the cost
of capital. If the two projects are mutually exclusive, Project X should definitely be
selected, and the investment made, provided we have confidence in the data. Put
another way, it is impossible to draw NPV profiles that would suggest not accepting
Project X.
28) Suppose that 1 British pound currently equals 1.62 U.S. dollars and 1 U.S. dollar
equals 1.62 Swiss francs. What is the cross exchange rate between the pound and the
franc?
a.1 British pound equals 3.2400 Swiss francs
b.1 British pound equals 2.6244 Swiss francs
c.1 British pound equals 1.8588 Swiss francs
d.1 British pound equals 1.0000 Swiss francs
e.1 British pound equals 0.3810 Swiss francs
29) Which of the following statements is CORRECT?
a.A bond is likely to be called if its market price is below its par value
b.Even if a bond’s YTC exceeds its YTM, an investor with an investment horizon
longer than the bond’s maturity would be worse off if the bond were called
c.A bond is likely to be called if its market price is equal to its par value
d.A bond is likely to be called if it sells at a discount below par
e.A bond is likely to be called if its coupon rate is below its YTM
30) Which of the following statements is CORRECT?
a.If cash inflows from collections occur in equal daily amounts but most payments must
be made on the 10th of each month, then a regular monthly cash budget will be
misleading. The problem can be corrected by using a daily cash budget
b.Sound working capital policy is designed to maximize the time between cash
expenditures on materials and the collection of cash on sales
c.If a firm wants to generate more cash flow from operations in the next month or two,
it could change its credit policy from 2/10 net 30 to net 60
d.If a firm sells on terms of net 90, and if its sales are highly seasonal, with 80% of its
sales in September, then its DSO as it is typically calculated (with sales per day = Sales
for past 12 months/365) would probably be lower in October than in August
e.Depreciation is included in the estimate of cash flows (Cash flow = Net income =
Depreciation); hence depreciation is set forth on a separate line in the cash budget
31) Which of the following statements is CORRECT?
a.The optimal capital structure simultaneously maximizes EPS and minimizes the
WACC
b.The optimal capital structure minimizes the cost of equity, which is a necessary
condition for maximizing the stock price
c.The optimal capital structure simultaneously minimizes the cost of debt, the cost of
equity, and the WACC
d.The optimal capital structure simultaneously maximizes stock price and minimizes
the WACC
e.As a rule, the optimal capital structure is found by determining the debt-equity mix
that maximizes expected EPS
32) If investors become less averse to risk, the slope of the Security Market Line (SML)
will increase.
33) The text identifies three methods for estimating the cost of common stock from
reinvested earnings (not newly issued stock): the CAPM method, the DCF method, and
the bond-yield-plus-risk-premium method. However, only the DCF method is widely
used in practice.
34) Because of the put-call parity relationship, under equilibrium conditions a put
option on a stock must sell at exactly the same price as a call option on the stock,
provided the strike prices for the put and call are the same.
35) As the price of a stock rises above the strike price, the value investors are willing to
pay for a call option increases because both (1) the immediate capital gain that can be
realized by exercising the option and (2) the likely exercise value of the option when it
expires have both increased.
36) The internal rate of return is that discount rate that equates the present value of the
cash outflows (or costs) with the present value of the cash inflows.