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Which of the following statements is CORRECT?
a.Any forecast of financial requirements involves determining how much money the
firm will need, and this need is determined by adding together increases in assets and
spontaneous liabilities and then subtracting operating income.
b.The AFN equation for forecasting funds requirements requires only a forecast of the
firm's balance sheet. Although a forecasted income statement may help clarify the
results, income statement data are not essential because funds needed relate only to the
balance sheet.
c.Dividends are paid with cash taken from the accumulated retained earnings account,
hence dividend policy does not affect the AFN forecast.
d.A negative AFN indicates that retained earnings and spontaneous capital are far more
than sufficient to finance the additional assets needed.
e.If assets and spontaneously generated liabilities are not projected to grow at the same
rate as sales, then the AFN method will provide more accurate forecasts than the
projected financial statement method.
Operating leases often have terms that include
a.maintenance of the equipment by the lessor.
b.full amortization over the life of the lease.
c.very high penalties if the lease is cancelled.
d.restrictions on how much the leased property can be used.
e.much longer lease periods than for most financial leases.
Your girlfriend plans to start a new company to make a new type of cat litter. Her father
will finance the operation, but she will have to pay him back. You are helping her, and
the issue now is how to finance the company, with equity only or with a mix of debt and
equity. The price per unit will be $10.00 regardless of how the firm is financed. The
expected fixed and variable operating costs, along with other information, are shown
below. How much higher or lower will the firm's expected EPS be if it uses some debt
rather than only equity, i.e., what is EPSL - EPSU?
a.$0.54
b.$0.60
c.$0.67
d.$0.75
e.$0.83
Which of the following statements is CORRECT?
a.The slope of the SML is determined by the value of beta.
b.The SML shows the relationship between companies' required returns and their
diversifiable risks. The slope and intercept of this line cannot be influenced by a firm's
managers, but the position of the company on the line can be influenced by its
managers.
c.Suppose you plotted the returns of a given stock against those of the market, and you
found that the slope of the regression line was negative. The CAPM would indicate that
the required rate of return on the stock should be less than the risk-free rate for a
well-diversified investor, assuming investors expect the observed relationship to
continue on into the future.
d.If investors become less risk averse, the slope of the Security Market Line will
increase.
e.If a company increases its use of debt, this is likely to cause the slope of its SML to
increase, indicating a higher required return on the stock.
Interstate Transport has a target capital structure of 50% debt and 50% common equity.
The firm is considering a new independent project that has a return of 13% and is not
related to transportation. However, a pure-play proxy firm has been identified that has a
beta of 1.38. Both firms have a marginal tax rate of 40%, and Interstate's before-tax cost
of debt is 12%. The risk-free rate is 10% and the market risk premium is 5%. The firm
should:
a.Reject the project; its return is less than the firm's required rate of return on the project
of 16.9%.
b.Accept the project; its return is greater than the firm's required rate of return on the
project of 12.05%.
c.Reject the project; its return is only 13%.
d.Accept the project; its return exceeds the risk-free rate and the before-tax cost of debt.
e.Be indifferent between accepting or rejecting; the firm's required rate of return on the
project equals its expected return.
Below are the returns for the past five years for Stock S and for the overall market:
What is the estimated beta of Stock S?
a.1.4320
b.1.5036
c.1.5788
d.1.6577
e.1.7406
Firms U and L each have the same amount of assets, investor-supplied capital, and both
have a return on investors' capital (ROIC) of 12%. Firm U is unleveraged, i.e., it is
100% equity financed, while Firm L is financed with 50% debt and 50% equity. Firm
L's debt has an after-tax cost of 8%. Both firms have positive net income and a 35% tax
rate. Which of the following statements is CORRECT?
a.The two companies have the same times interest earned (TIE) ratio.
b.Firm L has a lower ROA than Firm U.
c.Firm L has a lower ROE than Firm U.
d.Firm L has the higher times interest earned (TIE) ratio.
e.Firm L has a higher EBIT than Firm U.
Which of the following statements is CORRECT?
a.If a company with a high beta merges with a low-beta company, the best estimate of
the new merged company's beta is 1.0.
b.Logically, it is easier to estimate the betas associated with capital budgeting projects
than the betas associated with stocks, especially if the projects are closely associated
with research and development activities.
c.The beta of an "average stock," which is also "the market beta," can change over time,
sometimes drastically.
d.If a newly issued stock does not have a past history that can be used for calculating
beta, then we should always estimate that its beta will turn out to be 1.0. This is
especially true if the company finances with more debt than the average firm.
e.During a period when a company is undergoing a change such as increasing its use of
leverage or taking on riskier projects, the calculated historical beta may be drastically
different from the beta that will exist in the future.
Last year Jandik Corp. had $295,000 of assets (which is equal to its total invested
capital), $18,750 of net income, and a debt-to-total-capital ratio of 37%. Now suppose
the new CFO convinces the president to increase the debt-to-total-capital ratio to 48%.
Sales, total assets, and total invested capital will not be affected, but interest expenses
would increase. However, the CFO believes that better cost controls would be sufficient
to offset the higher interest expense and thus keep net income unchanged. By how
much would the change in the capital structure improve the ROE?
a.2.13%
b.2.35%
c.2.58%
d.2.84%
e.3.12%
Companies HD and LD have the same total assets, total investor-supplied capital,
operating income (EBIT), tax rate, and business risk. Company HD, however, has a
much higher debt ratio than LD. Also, both companies' returns on investors' capital
(ROIC) exceed their after-tax costs of debt, rd(1 - T). Which of the following statements
is CORRECT?
a.HD should have a higher return on assets (ROA) than LD.
b.HD should have a higher times interest earned (TIE) ratio than LD.
c.HD should have a higher return on equity (ROE) than LD, but its risk, as measured by
the standard deviation of ROE, should also be higher than LD's.
d.Given that ROIC > rd(1 - T), HD's stock price must exceed that of LD.
e.Given that ROIC > rd(1 - T), LD's stock price must exceed that of HD.
Which of the following statements is CORRECT?
a.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.
b.The CAPM has been thoroughly tested, and the theory has been confirmed beyond
any reasonable doubt.
c.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.
d.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.
e.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.
Which of the following statements is CORRECT?
a.Even though Firm A's current ratio exceeds that of Firm B, Firm B's quick ratio might
exceed that of A. However, if A's quick ratio exceeds B's, then we can be certain that
A's current ratio is also larger than B's.
b.Suppose a firm wants to maintain a specific TIE ratio. It knows the amount of its debt,
the interest rate on that debt, the applicable tax rate, and its operating costs. With this
information, the firm can calculate the amount of sales required to achieve its target TIE
ratio.
c.Since the ROA measures the firm's effective utilization of assets without considering
how these assets are financed, two firms with the same EBIT must have the same ROA.
d.Suppose all firms follow similar financing policies, face similar risks, have equal
access to capital, and operate in competitive product and capital markets. However,
firms face different operating conditions because, for example, the grocery store
industry is different from the airline industry. Under these conditions, firms with high
profit margins will tend to have high asset turnover ratios, and firms with low profit
margins will tend to have low turnover ratios.
e.Klein Cosmetics has a profit margin of 5.0%, a total assets turnover ratio of 1.5 times,
no debt and therefore an equity multiplier of 1.0, and an ROE of 7.5%. The CFO
recommends that the firm borrow funds using long-term debt, use the funds to buy back
stock, and raise the equity multiplier to 2.0. The size of the firm (assets) would not
change. She thinks that operations would not be affected, but interest on the new debt
would lower the profit margin to 4.5%. This would probably not be a good move, as it
would decrease the ROE from 7.5% to 6.5%.
Dentaltech Inc. projects the following data for the coming year. If the firm follows the
residual dividend model and also maintains its target capital structure, what will its
dividend payout ratio be?
a.37.2%
b.39.1%
c.41.2%
d.43.3%
e.45.5%
