1) Two key components of a prudent capital structure are the debt maturity composition
and the debt to equity composition.
2) Shareholder selection committees select potential board of director nominees
ensuring that board members will monitor management sufficiently to protect
shareholder interests.
3) Total asset turnover is equal to accounts receivable turnover plus inventory turnover
plus fixed asset turnover.
4) An increase in financial leverage will increase the absolute value of EPS, everything
else equal.
5) Capital budgeting decisions are based on free cash flow because free cash flow better
reflects when money is received and available for reinvestment than account profits.
6) The corporation is a legal entity separate from its owners; thus it is possible for the
corporation to continue even upon the death of one or more shareholders.
7) Free cash flows represent the benefits generated from accepting a capital-budgeting
proposal.
8) A company that sells preferred stock and uses the money to pay off a loan is
decreasing its amount of financial leverage.
9) Limited liability companies are more flexible than S-type Corporations because
limited liability companies operate under state laws.
10) Accrued expenses represent a spontaneous form of financing.
11) A company decreases the risk of insolvency by financing long-term assets with
short-term debt.
12) Commercial paper is an example of spontaneous financing because it is generated
by the day-to-day operations of a company.
13) A mortgage bond is secured by a lien on real property.
14) The forward exchange rate quoted today should be equal to the spot rate in the
future.
15) The increase in owners equity for a given period is equal to
A) positive net cash flow minus dividends
B) net income minus dividends
C) sales minus dividends
D) gross profit minus distributions to shareholders
16) Dakota Oil, Inc. reported that its sales and EBIT increased by 10%, but its EPS
increased by 30%. The much larger change in earnings per share could be the result of
A) high operating leverage
B) high financial leverage
C) a high percentage of credit sale collections from prior years
D) high fixed costs of production
17) If depreciation expense in year one of a project increases for a highly profitable
company
A) net income decreases and incremental free cash flow decreases
B) net income increases and incremental free cash flow increases
C) the book value of the depreciating asset increases at the end of year one
D) net income decreases and incremental free cash flow increases
18) Beta is a statistical measure of
A) unsystematic risk
B) total risk
C) the standard deviation
D) the relationship between an investment’s returns and the market return
19) Your company needs to pay $10,000 for the overhaul of five trucks. A bank offers
you a loan at 18 percent per annum with a compensating balance requirement of 15
percent of the loan amount. You plan to borrow the money for 9 months and currently
do not have any account with this bank. What is the effective cost of the loan?
20) What is the internal rate of return’s assumption about how cash flows are
reinvested?
A) They are reinvested at the firm’s discount rate
B) They are reinvested at the required rate of return
C) They are reinvested at the project’s internal rate of return
D) They are only reinvested at the end of the project
21) The balance sheet for the Long Drive Golf Company on September 30, 2010 is
presented below:
Long Drive Golf Company Balance Sheet
September 30, 2010
The treasurer of the firm wants to issue $1,200,000 in long-term bonds to be used as
follows:
1>$240,000 to reduce accounts payable
2>$192,000 to retire notes payable
3>$128,000 to increase cash on hand
4>$640,000 to increase inventories
a.Assuming that the loan is obtained, construct a pro forma balance sheet for December
31, 2010, for Long Drive Golf Company that reflects the use of the funds provided.
b.Was the liquidity of Long Drive Golf Company improved by the loan?
22) Financial intermediaries
A) offer indirect securities
B) include the national and regional stock exchange
C) usually are underwriting syndicates
D) constitute the various secondary markets
23) You can buy a $50 savings bond today for $25 and redeem the bond in 10 years for
its full face value of $50. You could also put your money in a money market account
that pays 7% interest per year. Which option is better, assuming they are of equal risk?
A) The money market account is better because it pays more interest
B) The money market account is better because it requires a smaller investment
C) The savings bond is better because it earns a higher interest rate
D) The money market and savings bond both earn 7% interest, so they are equal in
value
24) Phillips Enterprises Inc. is expected to pay a dividend of $2.60 next year. Dividends
are expected to grow at a constant rate of 8% per year, and the stock price is currently
$20.00. New stock can be sold at this price subject to flotation costs of 15%. The
company’s marginal tax rate is 35%. Compute the cost of internal equity (retained
earnings) and the cost of external equity (new common stock), respectively.
A) 0, 21.00%
B) 8.00%, 23.29%
C) 21.00%, 23.29%
D) 23.00%, 25.48%
25) A firm that wants to know if it has enough cash to meet its bills would be most
likely to use which kind of ratio?
A) liquidity
B) leverage
C) efficiency
D) profitability
26) Discretionary financing needs will be lower if ________. Assume “all else equal.”
A) the dividend payout ratio is raised
B) the firm’s net profit margin increases
C) sales increase
D) fixed assets are currently at full capacity
27) Which of the following should NOT be considered when calculating a firm’s
WACC?
A) cost of preferred stock
B) after-tax cost of bonds
C) cost of common stock
D) cost of carrying inventory
28) The “percent of sales method” is a method of preparing pro forma financial
statements. All of the following would be examples of how the “percent of sales
method” is developed EXCEPT?
A) Forecast expenses by applying a percent of projected sales, using last year’s
expenses as a percent of last year’s sales
B) Forecast assets by applying a percent of projected sales, using current year’s assets as
a percent of current year’s sales
C) Approximate liabilities by applying a percent of projected sales, using the last
five-year average of liabilities as a percent of sales
D) Forecast retained earnings by applying a percent of projected sales, using current
year’s retained earnings as a percent of current year’s sales
29) In 2000 Jenson Inc. issued bonds with an 8 percent coupon rate and a $1,000 face
value. The bonds mature on March 1, 2025 . If an investor purchased one of these
bonds on March 1, 2012, determine the yield to maturity if the investor paid $1,100 for
the bond.
A) 7%
B) The yield to maturity is $900 ($1,000 interest less $100 capital loss)
C) The yield to maturity must be greater than 8% because the price paid for the bond
exceeds the face value
D) 5.4%
30) You are currently earning 12% compounded semiannually. Your investment
company is switching all accounts to daily compounding. What rate will give you the
same effective annual rate of return as you are receiving now?
A) 10.83%
B) 10.97%
C) 11.66%
D) 11.89%
31) A trade credit discount such as 2/10 net 40 means
A) a 2 percent penalty is due after 40 days
B) a 2 percent discount if payment is made within 10 days, otherwise, the total amount
is due in 40 days
C) a 2 percent discount for payment within 10 days, and a 3 percent penalty if payment
is made after 40 days
D) 10 percent discount for cash on delivery and a 2 percent discount for payment within
40 days
32) The relevant variable a financial manager uses to measure returns is
A) net income determined using generally accepted accounting principles
B) earnings per share minus dividends per share
C) cash flows
D) dividends
33) The direct quote in New York is .015 dollar per Pakistani Rupee. The direct quote in
Pakistan is 60 rupees per dollar. This imbalance in rates can be corrected by arbitrage. A
trader will ________ rupees in New York and ________ rupees in Pakistan, causing the
direct quote in New York to ________.
A) buy; sell; increase
B) buy; sell; decrease
C) sell; buy; decrease
D) sell; buy; increase
34) An income statement may be represented as follows:
A) Sales – Liabilities = Profits
B) Revenues – Liabilities = Net Income
C) Sales – Expenses = Retained Earnings
D) Sales – Expenses = Profits
35) A bottle of German wine costs $21 euros in Berlin. According to the purchasing
power parity theory, what would the bottle sell for in New York if it costs the New York
company $1.25 per bottle to transport the wine to the United States? Assume the
exchange rate is $1.32 per euro.
A) $40.54
B) $28.97
C) $27.22
D) $39.50
36) The cost of new preferred stock is equal to
A) the preferred stock dividend divided by the market price
B) the preferred stock dividend divided by its par value
C) (1 – tax rate) times the preferred stock dividend divided by net price
D) preferred stock dividend divided by the net selling price of preferred
37) Table 4-5
Yen Inc.
Balance Sheet
Yen Inc.
Income Statement
For the year ended December 31, 2010
What was the total amount of Yen’s common stock dividend for 2010?
A) $17,000
B) $12,800
C) $9,000
D) $8,000
38) The CAPM designates the risk-return tradeoff existing in the market, where risk is
defined in terms of beta.
39) Which of the following is the most relevant measure of risk for capital budgeting
purposes?
A) project standing alone risk
B) contribution-to-firm risk
C) symbiotic risk
D) unsystematic risk
40) Lasalle Industries is considering the purchase of a new machine that will cost
$250,000, plus an additional $10,000 to ship and install. The new machine will have a
5-year useful life and will be depreciated to zero using the straight-line method. The
machine is expected to have a salvage value of $30,000 at the end of year five.
LaSalle’s income tax rate is 40%. The additional net working capital from this project of
$50,000 is expected to return to its pre-project level upon termination. What is the
non-operating terminal cash flow of the machine?
A) -$32,000
B) $48,000
C) $68,000
D) $80,000
41) The balance sheet and income statement for Johnson and Breakwater is presented
below.
a.Compute the following ratios: Current ratio, Acid test ratio, Debt ratio, Total asset
turnover, Operating profit margin, Return on total investments, Times interest earned,
Inventory turnover.
b.All other things equal, compute the dollar amount of sales needed to achieve an 18%
return on total assets for the coming year.
c.Given Johnson’s inventory turnover ratio, find a way of computing the current level of
inventory given this ratio and assuming the current level of inventories is unknown. Set
up but do not solve.
42) 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?
43) Plimpton Sales presents income statements for the first three months of this year.
Revenues are $1,000,000 in January, $1,200,000 in February, and $1,400,000 in March,
while expenses total $800,000 in January, $900,000 February, and $1,000,000 in March.
Despite the positive net income, the controller believes Plimpton Sales needs to arrange
short-term financing of $300,000 to make payroll the next month. Which of the
following statements is MOST correct?
A) The controller must have made a mistake since the company’s net income for the
three months is $900,000
B) The company’s accounts receivable balance has decreased over the past three months
C) The company’s accounts payable balance has increased over the past three months
D) The company’s accounts receivable balance has increased and the accounts payable
balance has decreased over the past three months
44) Brown Inc. needs to borrow $250,000 for the next 6 months. The company has a
line of credit with a bank that allows the company to borrow funds with an 8% interest
rate subject to a 20% of loan compensating balance. Currently, Brown Inc. has no funds
on deposit with the bank and will need the loan to cover the compensating balance as
well as their other financing needs. What is the annual percentage rate for this financing
assuming discounted interest?
A) 14.29%
B) 12.98%
C) 11.67%
D) 10.53%
45) As production levels increase
A) variable costs per unit decrease
B) fixed costs per unit increase
C) fixed costs per unit stay the same and variable costs per unit increase
D) fixed costs per unit decrease and variable costs per unit stay the same
46) LEE Corporation intends to purchase equipment for $1,500,000. The equipment has
a 5-year useful life and will be depreciated on a straight-line basis. Addition of the
equipment requires additional working capital of $20,000. The $20,000 is expected to
be recaptured at the end of the project. LEE’s marginal tax rate is 40%. Use of the
equipment is expected to change the company’s reported EBIT by $600,000 in year one,
$700,000 in year two, $550,000 in year three, $200,000 in year four, and $100,000 in
year five. Due to changing market conditions, the equipment did have a salvage value
of $100,000 at the end of year five.
a.Calculate the initial outlay and the incremental free cash flows over the life of the
project.
b.If the risk-adjusted discount rate for this project is 20%, calculate the project’s net
present value and internal rate of return and comment on the acceptability of the
project.
47) Which of the following is an advantage of the sole proprietorship?
A) limited liability for its owners
B) double taxation for its owners
C) no significant legal requirements for starting the business
D) easily transferred ownership
48) Surf and Spray Inc. has a beta equal to 1.8 and a required return of 15% based on
the CAPM. If the market risk premium is 7.5%, the risk-free rate of return is
A) 4.1%
B) 3.4%
C) 2.0%
D) 1.5%
49) Messenger, Inc. bonds have a 4% coupon rate with semiannual coupon payments
and a $1,000 par value. The bonds have 11 years until maturity, and sell for $925. What
is the current yield for Messinger’s bonds?
A) 2.16%
B) 3.45%
C) 4.32%
D) 5.52%
50) Common-sized balance sheets
A) show data for companies in the same industry
B) show data for companies with approximately the same amount of assets
C) show each balance sheet account as a percentage of total sales
D) show each balance sheet account as a percentage of total assets
51) Which of the following is/are TRUE?
A) Most of the unsystematic risk is removed by the time a portfolio contains 30 stocks
B) Two points on the Characteristic Line are the T-bill and the market portfolio
C) The greater the total risk of an asset, the greater the expected return
D) All securities have a beta between 0 and 1
52) In finance, we assume that investors are generally
A) neutral to risk
B) averse to risk
C) fond of risk
D) none of the above