1) Taylor Inc., the company you work for, is considering a new project whose data are
shown below. What is the project’s Year 1 cash flow?
Sales revenues, each year$62,500
Depreciation$8,000
Other operating costs$25,000
Interest expense$8,000
Tax rate35.0%
a.$25,816
b.$27,175
c.$28,534
d.$29,960
e.$31,458
2) Which of the following statements is CORRECT?
a.There is no reason to think that changes in the personal tax rate would affect firms’
capital structure decisions
b.A firm with high business risk is more likely to increase its use of financial leverage
than a firm with low business risk, assuming all else equal
c.If a firm’s after-tax cost of equity exceeds its after-tax cost of debt, it can always
reduce its WACC by increasing its use of debt
d.Suppose a firm has less than its optimal amount of debt. Increasing its use of debt to
the point where it is at its optimal capital structure will decrease the costs of both debt
and equity financing
e.In general, a firm with low operating leverage also has a small proportion of its total
costs in the form of fixed costs
3) Which of the following statements is CORRECT?
a.Call options give investors the right to sell a stock at a certain strike price before a
specified date
b.Options typically sell for less than their exercise value
c.LEAPS are very short-term options that were created relatively recently and now
trade in the market
d.An option holder is not entitled to receive dividends unless he or she exercises their
option before the stock goes ex dividend
e.Put options give investors the right to buy a stock at a certain strike price before a
specified date
4) Garden-Grow Products is considering a new investment whose data are shown
below. The equipment would be depreciated on a straight-line basis over the project’s
3-year life, would have a zero salvage value, and would require some additional
working capital that would be recovered at the end of the project’s life. Revenues and
other operating costs are expected to be constant over the project’s life. What is the
project’s NPV? (Hint: Cash flows are constant in Years 1 to 3.)
WACC10.0%
Net investment in fixed assets (basis)$75,000
Required new working capital$15,000
Straight-line deprec. rate33.333%
Sales revenues, each year$75,000
Operating costs (excl. deprec.), each year$25,000
Tax rate35.0%
a.$23,852
b.$25,045
c.$26,297
d.$27,612
e.$28,993
5) Harvey’s Industrial Plumbing Supply’s target capital structure consists of 40% debt
and 60% equity. Its capital budget this year is forecast to be $650,000. It also wants to
pay a dividend of $225,000. If the company follows the residual dividend policy, how
much net income must it earn to meet its capital requirements, pay the dividend, and
keep the capital structure in balance?
a. $584,250
b. $615,000
c. $645,750
d. $678,038
e. $711,939
6) Orono Corp.’s sales last year were $435,000, its operating costs were $362,500, and
its interest charges were $12,500. What was the firm’s times interest earned (TIE) ratio?
a. 4.72
b. 4.97
c. 5.23
d. 5.51
e. 5.80
7) Bonds A and B are 15-year, $1,000 face value bonds. Bond A has a 7% annual
coupon, while Bond B has a 9% annual coupon. Both bonds have a yield to maturity of
8%, which is expected to remain constant for the next 15 years. Which of the following
statements is CORRECT?
a.One year from now, Bond A’s price will be higher than it is today
b.Bond A’s current yield is greater than 8%
c.Bond A has a higher price than Bond B today, but one year from now the bonds will
have the same price
d.Both bonds have the same price today, and the price of each bond is expected to
remain constant until the bonds mature
e.Bond B has a higher price than Bond A today, but one year from now the bonds will
have the same price
8) Last year Vaughn Corp. had sales of $315,000 and a net income of $17,832, and its
year-end assets were $210,000. The firm’s total-debt-to-total-assets ratio was 42.5%.
Based on the DuPont equation, what was Vaughn’s ROE?
a. 14.77%
b. 15.51%
c. 16.28%
d. 17.10%
e. 17.95%
9) Emerson Inc.’s would like to undertake a policy of paying out 45% of its income. Its
latest net income was $1,250,000, and it had 225,000 shares outstanding. What
dividend per share should it declare?
a. $2.14
b. $2.26
c. $2.38
d. $2.50
e. $2.63
10) Nichols Inc. is considering a project that has the following cash flow data. What is
the project’s IRR? Note that a project’s IRR can be less than the WACC or negative, in
both cases it will be rejected.
Year012345
Cash flows-$1,250$325$325$325$325$325
a.9.43%
b.9.91%
c.10.40%
d.10.92%
e.11.47%
11) Lincoln Industries’ current ratio is 0.5. Considered alone, which of the following
actions would increase the company’s current ratio?
a. Use cash to reduce long-term bonds outstanding
b. Borrow using short-term notes payable and use the cash to increase inventories
c. Use cash to reduce accruals
d. Use cash to reduce accounts payable
e. Use cash to reduce short-term notes payable
12) Branch Corp.’s total assets at the end of last year were $315,000 and its net income
after taxes was $22,750. What was its return on total assets?
a. 7.22%
b. 7.58%
c. 7.96%
d. 8.36%
e. 8.78%
13) David Rose Inc. forecasts a capital budget of $500,000 next year with forecasted
net income of $400,000. The company wants to maintain a target capital structure of
30% debt and 70% equity. If the company follows the residual dividend policy, how
much in dividends, if any, will it pay?
a. $42,869
b. $45,125
c. $47,500
d. $50,000
e. $52,500
14) Hart Corp. is considering a project that has the following cash flow data. What is
the project’s IRR? Note that a project’s IRR can be less than the WACC or negative, in
both cases it will be rejected.
Year0123
Cash flows-$1,000$425$425$425
a.12.55%
b.13.21%
c.13.87%
d.14.56%
e.15.29%
15) Refer to Exhibit 9.1. Which of the following is the best estimate for the weight of
debt for use in calculating the firm’s WACC?
a.18.67%
b.19.60%
c.20.58%
d.21.61%
e.22.69%
16) Based on the information below for Benson Corporation, what is the optimal capital
structure?
a.Debt = 50%; Equity = 50%; EPS = $3.05; Stock price = $28.90
b.Debt = 60%; Equity = 40%; EPS = $3.18; Stock price = $31.20
c.Debt = 80%; Equity = 20%; EPS = $3.42; Stock price = $30.40
d.Debt = 70%; Equity = 30%; EPS = $3.31; Stock price = $30.00
e.Debt = 40%; Equity = 60%; EPS = $2.95; Stock price = $26.50
17) Portfolio P has $200,000 consisting of $100,000 invested in Stock A and $100,000
in Stock B. Stock A has a beta of 1.2 and a standard deviation of 20%. Stock B has a
beta of 0.8 and a standard deviation of 25%. Which of the following statements is
CORRECT? (Assume that the stocks are in equilibrium.)
a.Stock B has a higher required rate of return than Stock A
b.Portfolio P has a standard deviation of 22.5%
c.More information is needed to determine the portfolio’s beta
d.Portfolio P has a beta of 1.0
e.Stock A’s returns are less highly correlated with the returns on most other stocks than
are B’s returns
18) If the spot rate of the Israeli shekel is 5.51 shekels per dollar and the 180-day
forward rate is 5.97 shekels per dollar, then the forward rate for the Israeli shekel is
selling at a ____ to the spot rate.
a.premium of 8%
b.premium of 18%
c.discount of 18%
d.discount of 8%
e.premium of 16%
19) McCann Publishing has a target capital structure of 35% debt and 65% equity. This
year’s capital budget is $850,000 and it wants to pay a dividend of $400,000. If the
company follows a residual dividend policy, how much net income must it earn to meet
its capital budgeting requirements and pay the dividend, all while keeping its capital
structure in balance?
a. $904,875
b. $952,500
c. $1,000,125
d. $1,050,131
e. $1,102,638
20) Suppose you believe that Florio Company’s stock price is going to decline from its
current level of $82.50 sometime during the next 5 months. For $5.10 you could buy a
5-month put option giving you the right to sell 1 share at a price of $85 per share. If you
bought this option for $5.10 and Florio’s stock price actually dropped to $60, what
would your pre-tax net profit be?
a.-$5.10
b.$19.90
c.$20.90
d.$22.50
e.$27.60
21) Albrecht Inc. is a no-growth firm whose sales fluctuate seasonally, causing total
assets to vary from $320,000 to $410,000, but fixed assets remain constant at $260,000.
If the firm follows a maturity matching (or moderate) working capital financing policy,
what is the most likely total of long-term debt plus equity capital?
a.$260,642
b.$274,360
c.$288,800
d.$304,000
e.$320,000
22) Which of the following statements is CORRECT?
a.If a company pays more in dividends than it generates in net income, its retained
earnings as reported on the balance sheet will decline from the previous year’s balance
b.Dividends paid reduce the net income that is reported on a company’s income
statement
c.If a company uses some of its bank deposits to buy short-term, highly liquid
marketable securities, this will cause a decline in its current assets as shown on the
balance sheet
d.If a company issues new long-term bonds during the current year, this will increase its
reported current liabilities at the end of the year
e.Accounts receivable are reported as a current liability on the balance sheet.
23) Which of the following statements is NOT CORRECT?
a.All else equal, bonds with longer maturities have more interest rate (price) risk than
bonds with shorter maturities
b.If a bond is selling at its par value, its current yield equals its yield to maturity
c.If a bond is selling at a premium, its current yield will be greater than its yield to
maturity
d.All else equal, bonds with larger coupons have greater interest rate (price) risk than
bonds with smaller coupons
e.If a bond is selling at a discount to par, its current yield will be less than its yield to
maturity
24) In recent years Constable Inc. has suffered losses, and its stock currently sells for
only $0.50 per share. Management wants to use a reverse split to get the price up to a
more “reasonable” level, which it thinks is $25 per share. How many of the old shares
must be given up for one new share to achieve the $25 price, assuming this transaction
has no effect on total market value?
a. 47.50
b. 49.88
c. 50.00
d. 52.50
e. 55.13
25) Which of the following statements is CORRECT?
a.Under current laws and regulations, corporations must use straight-line depreciation
for all assets whose lives are 5 years or longer
b.Corporations must use the same depreciation method for both stockholder reporting
and tax purposes
c.Using accelerated depreciation rather than straight line normally has the effect of
speeding up cash flows and thus increasing a project’s forecasted NPV
d.Using accelerated depreciation rather than straight line normally has no effect on a
project’s total projected cash flows nor would it affect the timing of those cash flows or
the resulting NPV of the project
e.Since depreciation is a cash expense, the faster an asset is depreciated, the lower the
projected NPV from investing in the asset
26) The capital budget forecast for the Santano Company is $725,000. The CFO wants
to maintain a target capital structure of 45% debt and 55% equity, and it also wants to
pay dividends of $500,000. If the company follows the residual dividend policy, how
much income must it earn, and what will its dividend payout ratio be?
Net Income Payout
a. $ 898,750 55.63%
b. $ 943,688 58.41%
c. $ 990,872 61.34%
d. $1,040,415 64.40%
e. $1,092,436 67.62%
27) Which of the following statements is CORRECT?
a.On an expected yield basis, the expected capital gains yield will always be positive
because an investor would not purchase a bond with an expected capital loss
b.On an expected yield basis, the expected current yield will always be positive because
an investor would not purchase a bond that is not expected to pay any cash coupon
interest
c.If a coupon bond is selling at par, its current yield equals its yield to maturity
d.The current yield on Bond A exceeds the current yield on Bond B; therefore, Bond A
must have a higher yield to maturity than Bond B
e.If a bond is selling at a discount, the yield to call is a better measure of return than the
yield to maturity
28) Which of the following statements is CORRECT?
a. The New York Stock Exchange is an auction market with a physical location
b. Capital market transactions involve only the purchase and sale of equity securities,
i.e., common stocks
c. If an investor sells shares of stock through a broker, then this would be a primary
market transaction
d. Consumer automobile loans are evidenced by legal documents called “promissory
notes,” and these individual notes are traded in the money market
e. While the distinctions are blurring as investment banks are today buying commercial
banks, and vice versa, investment banks generally specialize in lending money, whereas
commercial banks generally help companies raise capital from other parties
29) Which of the following statements is CORRECT?
a. It is generally more expensive to form a proprietorship than a corporation because,
with a proprietorship, extensive legal documents are required
b. Corporations face fewer regulations than sole proprietorships
c. One disadvantage of operating a business as a sole proprietorship is that the firm is
subject to double taxation, at both the firm level and the owner level
d. One advantage of forming a corporation is that equity investors are usually exposed
to less liability than in a regular partnership
e. If a regular partnership goes bankrupt, each partner is exposed to liabilities only up to
the amount of his or her investment in the business
30) If the inflation rate in the United States is greater than the inflation rate in Britain,
other things held constant, the British pound will
a.Depreciate against the U.S. dollar
b.Remain unchanged against the U.S. dollar
c.Appreciate against other major currencies
d.Appreciate against the dollar and other major currencies
e.Appreciate against the U.S. dollar
31) Last year Mason Inc. had a total assets turnover of 1.33 and an equity multiplier of
1.75. Its sales were $195,000 and its net income was $10,549. The CFO believes that
the company could have operated more efficiently, lowered its costs, and increased its
net income by $5,250 without changing its sales, assets, or capital structure. Had it cut
costs and increased its net income in this amount, by how much would the ROE have
changed?
a. 5.66%
b. 5.95%
c. 6.27%
d. 6.58%
e. 6.91%
32) Which of the following is NOT one of the steps taken in the financial planning
process?
a.Monitor operations after implementing the plan to spot any deviations and then take
corrective actions
b.Determine the amount of capital that will be needed to support the plan
c.Develop a set of forecasted financial statements under alternative versions of the
operating plan in order to analyze the effects of different operating procedures on
projected profits and financial ratios
d.Consult with key competitors about the optimal set of prices to charge, i.e., the prices
that will maximize profits for our firm and its competitors
e.Forecast the funds that will be generated internally. If internal funds are insufficient to
cover the required new investment, then identify sources from which the required
external capital can be raised
33) In Japan, 90-day securities have a 4% annualized return and 180-day securities have
a 5% annualized return. In the United States, 90-day securities have a 4% annualized
return and 180-day securities have an annualized return of 4.5%. All securities are of
equal risk, and Japanese securities are denominated in terms of the Japanese yen.
Assuming that interest rate parity holds in all markets, which of the following
statements is most CORRECT?
a.The yen-dollar spot exchange rate equals the yen-dollar exchange rate in the 180-day
forward market
b.The yen-dollar exchange rate in the 90-day forward market equals the yen-dollar
exchange rate in the 180-day forward market
c.The spot rate equals the 90-day forward rate
d.The spot rate equals the 180-day forward rate
e.The yen-dollar spot exchange rate equals the yen-dollar exchange rate in the 90-day
forward market
34) Which of the following statements is CORRECT? Assume that the project being
considered has normal cash flows, with one outflow followed by a series of inflows.
a.The lower the WACC used to calculate a project’s NPV, the lower the calculated NPV
will be
b.If a project’s NPV is less than zero, then its IRR must be less than the WACC
c.If a project’s NPV is greater than zero, then its IRR must be less than zero
d.The NPV of a relatively low-risk project should be found using a relatively high
WACC
e.A project’s NPV is found by compounding the cash inflows at the IRR to find the
terminal value (TV), then discounting the TV at the WACC
35) Lancaster Corp. is considering two equally risky, mutually exclusive projects, both
of which have normal cash flows. Project A has an IRR of 11%, while Project B’s IRR
is 14%. When the WACC is 8%, the projects have the same NPV. Given this
information, which of the following statements is CORRECT?
a.If the WACC is 9%, Project A’s NPV will be higher than Project B’s
b.If the WACC is 6%, Project B’s NPV will be higher than Project A’s
c.If the WACC is greater than 14%, Project A’s IRR will exceed Project B’s
d.If the WACC is 9%, Project B’s NPV will be higher than Project A’s
e.If the WACC is 13%, Project A’s NPV will be higher than Project B’s
36) No conflict will exist between the NPV and IRR methods, when used to evaluate
two equally risky but mutually exclusive projects, if the projects’ cost of capital exceeds
the rate at which the projects’ NPV profiles cross.
37) The minimum growth rate that a firm can achieve with no access to external capital
is called the firm’s sustainable growth rate. It can be calculated by using the AFN
equation with AFN equal to zero and solving for g.
38) The major advantage of a regular partnership or a corporation as a form of business
organization is the fact that both offer their owners limited liability, whereas
proprietorships do not.
39) If a firm’s suppliers stop offering discounts, then its use of trade credit is more
likely to increase than to decrease, other things held constant.
40) Since investors tend to dislike risk and like certainty, the more volatile a stock, the
less valuable will be an option to purchase the stock, other things held constant.
41) The longer its customers normally hold inventory, the longer the credit period
supplier firms normally offer. Still, suppliers have some flexibility in the credit terms
they offer. If a supplier lengthens the credit period offered, this will shorten the
customer’s cash conversion cycle but lengthen the supplier firm’s own CCC.
42) Other things held constant, an increase in the cost of capital will result in a decrease
in a project’s IRR.
43) An informal line of credit and a revolving credit agreement are similar except that
the line of credit creates a legal obligation for the bank and thus is a more reliable
source of funds for the borrower.
44) As a rule, managers should try to always use the free component of trade credit but
should use the costly component only if the cost of this credit is lower than the cost of
credit from other sources.
45) The realized return on a stock portfolio is the weighted average of the expected
returns on the stocks in the portfolio.