1) One of the virtues of the percent-of-sales method is the precision of the estimate of
future financing needs.
2) Preferred stock is traded in the money market, while common stock is traded in the
capital market.
3) Financial theory assumes that individuals are risk averse.
4) The relevant risk to an investor is that portion of the variability of returns that cannot
be diversified away.
5) Depreciation is considered a fixed cost.
6) The just-in-time inventory control system is just a new approach to the EOQ model
which tries to produce the lowest average inventory possible.
7) In an efficient market, two investors may agree on the amount and timing of a bond’s
expected cash flows and also on the bond’s risk level, as measured by its debt rating,
and still determine two different values for the bond.
8) A set of estimates which corresponds to the worst and best case outcomes is often
desired in preparing a financial forecast.
9) Financial intermediaries issue their own indirect securities and use the proceeds to
purchase the direct securities of other economic units.
10) Two projects are mutually exclusive if the accept/reject decision for one project has
no impact on the accept/reject decision for the other project.
11) A rational investor will always prefer an investment with a lower standard deviation
of returns, because such investments are less risky.
12) An opportunity cost is a relevant incremental cost for capital budgeting decisions.
13) Each financial decision made by a corporate manager can be evaluated by its direct
impact on the corporation’s stock price.
14) An exchange rate of $1.6 per British Pound is an example of a direct quote in the
United States.
15) The modified internal rate of return represents the project’s internal rate of return
assuming that intermediate cash flows from the project can be reinvested at the project’s
required return.
16) Many firms today continue to use the payback method but also employ the NPV or
IRR methods especially when large projects are being analyzed.
17) A corporation has annual sales of $18 million, total assets of $4 million, a debt ratio
of 40%, depreciation expense of $200,000, and a tax rate of 40%. The corporation’s
total stockholders’ equity is equal to
A) $5,600,000
B) $2,800,000
C) $2,400,000
D) $1,800,000
18) The nominal interest rate is 7% and the expected inflation rate is 2%. Based on the
Fisher effect, the real rate of interest is
A) 5.0%
B) 6.86%
C) 5.1%
D) 4.9%
19) Which of the following is an unsecured short-term bank loan made for a specific
purpose?
A) mortgage bond
B) line of credit
C) revolving credit agreement
D) transaction loan
20) Your firm is considering an investment that will cost $750,000 today. The
investment will produce cash flows of $250,000 in year 1, $300,000 in years 2 through
4, and $100,000 in year 5. What is the investment’s discounted payback period if the
required rate of return is 10%?
A) 3.33 years
B) 3.16 years
C) 2.67 years
D) 2.33 years
21) LED Corp.’s common stock paid $2.50 in dividends last year (D0). Dividends are
expected to grow at a 12-percent annual rate forever. If LED’s current market price is
$40.00, and your required rate of return is 23 percent, should you purchase the stock?
A) No, the percentage return on the stock is too high, thus it is too risky
B) Yes, the stock is expected to return more than you require
C) No, the stock is overpriced
D) Not enough information is given
22) A commitment fee is
A) an amount paid on the unused portion of a loan in a private placement
B) an amount paid by an investment banker to ensure the sale of securities
C) paid by investors to guarantee that a company will borrow from them
D) paid by bondholders to secure the right to convert bonds into common stock
23) A corporation sells securities to an investment banking firm on January 1st. The
next day an international oil crisis causes stock prices to drop dramatically. The
corporation is immune from the drop in price of its stock due to which function of the
investment banking firm?
A) hedging
B) distributing
C) reinsurance
D) underwriting
24) The average cost associated with each additional dollar of financing for investment
projects is
A) the incremental return
B) the marginal cost of capital
C) CAPM required return
D) the component cost of capital
25) Premium Pie Company needs to purchase a new baking oven to replace an older
oven that requires too much energy to run. The industrial size oven will cost
$1,200,000. The oven will be depreciated on a straight-line basis over its six-year useful
life. The old oven cost the company $800,000 just four years ago. The old oven is being
depreciated on a straight-line basis over its expected ten-year useful life. (That is, the
old oven is expected to last six more years if it is not replaced now.) Due to changes in
fuel costs, the old oven may only be sold today for $100,000. The new oven will allow
the company to expand, increasing sales by $300,000 per year. Expenses will also
decrease by $50,000 per year due to the more energy efficient design of the new oven.
Premium Pie Company is in the 40% marginal tax bracket and has a required rate of
return of 10%.
a.Calculate the net present value and internal rate of return of replacing the existing
machine
b.Explain the impact on NPV of the following:
i.Required rate of return increases
ii.Operating costs of new machine are increased
iii.Existing machine sold for less
26) Creighton Industries is considering the purchase of a new strapping machine, which
will cost $150,000, plus an additional $10,500 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 generate new sales of $45,000 per year and is expected to
save $16,000 in labor and electrical expenses over the next 5-years. The machine is
expected to have a salvage value of $20,000. Creighton’s income tax rate is 35%.
Creighton uses a 12.5% discount rate for capital budgeting purposes. What is the
machine’s NPV?
A) $29,888
B) $25,062
C) $22,153
D) $27,894
27) Which of the following methods of evaluating investment projects can properly
evaluate projects of unequal lives?
A) the net present value
B) the payback
C) the internal rate of return
D) the equivalent annual annuity
28) Crandal Dockworks is undergoing a major expansion. The expansion will be
financed by issuing new 15-year, $1,000 par, 9% annual coupon bonds. The market
price of the bonds is $1,070 each. Crandal’s flotation expense on the new bonds will be
$50 per bond. Crandal’s marginal tax rate is 35%. What is the pre-tax cost of debt for
the newly-issued bonds?
A) 8.76%
B) 8.12%
C) 7.49%
D) 10.25%
29) 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
30) You are considering the purchase of a common stock that paid a dividend of $2.00
yesterday. You expect this stock to have a growth rate of 15 percent for the next 3 years,
resulting in dividends of D1=$2.30, D2=$2.645, and D3=$3.04. The long-run normal
growth rate after year 3 is expected to be 10 percent (that is, a constant growth rate after
year 3 of 10% per year forever). If you require a 14 percent rate of return, how much
should you be willing to pay for this stock?
A) $89.75
B) $83.65
C) $56.46
D) $62.57
31) A new project is expected to generate $800,000 in revenues, $250,000 in cash
operating expenses, and depreciation expense of $150,000 in each year of its 10-year
life. The corporation’s tax rate is 35%. The project will require an increase in net
working capital of $85,000 in year one and a decrease in net working capital of $75,000
in year ten. What is the free cash flow from the project in year one?
A) $298,000
B) $375,000
C) $380,000
D) $410,000
32) Financial analysis
A) uses historical financial statements and is thus useful only to assess past
performance
B) relies on generally accepted accounting principles to make comparisons between
companies valid
C) uses historical financial statements to measure a company’s performance and in
making financial projections of future performance
D) is accounting record-keeping using generally accepted accounting principles
33) You sell valuable artifacts from your household estate for $200,000 and want to use
the money to supplement your retirement. You receive the money on your 60th
birthday, the day you retire. You want to withdraw equal amounts at the end of each of
the next 25 years. What constant amount can you withdraw each year and have nothing
remaining at the end of 20 years if you are earning 7% interest per year?
A) $17,162
B) $28,318
C) $37,574
D) $49,113
34) Many preferred stocks have a feature that requires a firm to periodically set aside an
amount of money for the retirement of its preferred stock. What is the name of this
feature?
A) convertible
B) callable
C) cumulative
D) sinking fund
35) The two principal sources of financing for corporations are
A) debt and accounts payable
B) debt and equity
C) common equity and preferred equity
D) cash and common equity
36) The market value of a leveraged firm is equal to the market value of an unleveraged
firm
A) plus the present value of tax shields minus the present value of financial distress
costs plus the present value of agency costs
B) plus the present value of tax shields plus the present value of financial distress costs
plus the present value of agency costs
C) minus the present value of tax shields minus the present value of financial distress
costs minus the present value of agency costs
D) plus the present value of tax shields minus the present value of financial distress
costs minus the present value of agency costs
37) As a company accounts payable manager, which of the following credit terms are
most likely to entice you to take the cash discount?
A) 1/10 net 45
B) 2/10 net 60
C) 1/10 net 30
D) 2/10 net 90
38) Which of the following actions would improve a firm’s liquidity?
A) repurchasing stock
B) selling bonds and increasing cash
C) buying bonds
D) increasing the company’s dividend payments
39) 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
40) Operating leverage has to do with
A) borrowing money to finance a firm’s growth
B) using preferred stock to increase sales volume
C) the incurrence of fixed operating costs in the firm’s income stream
D) financing with fixed cost sources of capital
41) Adventure Outfitter Corp. can sell common stock for $27 per share and its investors
require a 17% return. However, the administrative or flotation costs associated with
selling the stock amount to $2.70 per share. What is the cost of capital for Adventure
Outfitter if the corporation raises money by selling common stock?
A) 27.00%
B) 18.89%
C) 18.33%
D) 17.00%
42) The Modigliani and Miller hypothesis does NOT work in the “real world” because
A) interest expense is tax deductible, providing an advantage to debt financing
B) higher levels of debt increase the likelihood of bankruptcy, and bankruptcy has real
costs for any corporation
C) both A and B
D) dividend payments are fixed and tax deductible for the corporation
43) AFB, Inc. stock is currently selling for $20 per share. The company completed a
5-for-1 stock split two days earlier. Two years ago, the company had a 2-for-1 stock
split. If the stock splits had not happened, the price of AFB, Inc. stock would, other
things being equal, be
A) $140.00 per share
B) $200.00 per share
C) $100.00 per share
D) $2.00 per share
44) ABC Corporation began operations on January 1st of this year with a cash balance
of $250,000. ABC had sales of $200,000 for the month of January, all on credit. ABC
allows its customers 30 days to pay. ABC’s expenses for January equal $150,000, and
ABC’s ending balance in accounts payable at January 31st is $50,000. In its cash budget
for January, ABC’s ending cash balance should be equal to
A) $300,000 because of GAAP accrual accounting rules
B) $150,000
C) $200,000
D) $100,000
45) Plato Industries’ projected sales for the first six months of 2012 are given below:
Jan.$250,000April$300,000
Feb.$340,000May$350,000
Mar.$280,000June$380,000
20% of sales are collected in cash at time of sale, 50% are collected in the month
following the sale, and the remaining 30% are collected in the second month following
the sale. Cost of goods sold is 85% of sales. Purchases are made in the month prior to
the sales, and payments for purchases are made in the month of the sale. Total other
cash expenses are $70,000/month. The company’s cash balance as of February 28, 2012
will be $10,000. Excess cash will be used to retire short-term borrowing (if any). Plato
has no short term borrowing as of February 28, 2012. Ignore any interest on short-term
borrowing. The company must have a minimum cash balance of $40,000 at the
beginning of each month. What is Plato Industries’ ending cash balance (before
borrowing) in March?
A) $12,000
B) $8,000
C) $3,000
D) ($28,000)
46) Which of the following securities will likely have the highest default risk premium?
A) U.S. Treasury Bond maturing in 2027
B) BBB-rated corporate bond maturing in 2020 actively traded on a major exchange
C) AAA-rated corporate bond maturing in 2015 not actively traded
D) U.S. Treasury Bill
47) AFB, Inc. purchases a new delivery van which is expected to increase cash flows
for the next 10 years. AFB can finance the purchase with a standard 48 month vehicle
loan, or by getting a 10 year loan from the bank. According to the hedging principle,
AFB should
A) use the 10-year financing in order to match the cash flow stream from the asset with
the financing repayments
B) use the 48 month loan since it matches the type of asset with the type of loan
C) use either type of financing, but hedge the risk in the options market
D) avoid using either loan and finance the truck with current cash reserves to avoid
interest expense
48) Which of the following is true of a zero coupon bond?
A) The bond makes no coupon payments
B) The bond sells at a premium prior to maturity
C) The bond has a zero par value
D) The bond has no value until the year it matures because there are no positive cash
flows until then
49) A new machine can be purchased for $1,800,000. It will cost $35,000 to ship and
$15,000 to fine-tune the machine. The new machine will replace an older version that is
fully depreciated and will be sold for $200,000. The firm’s income tax rate is 35%.
What is the initial outlay for capital budgeting purposes?
A) $1,580,000
B) $1,630,000
C) $1,650,000
D) $1,720,000
50) Welker Products sells small kitchen gadgets for $15 each. The gadgets have a
variable cost of $4 per unit, and Welker Products’ fixed operating costs are $220,000 per
year. Welker Products’ capital structure includes 55% debt and 45% equity. Annual
interest expense is $25,000, and the corporate tax rate is 35%.
a.Calculate the break-even point in units.
b.If Welker Products sells 25,000 units, calculate the firm’s EBIT and net income.
c.If sales increase ten percent from 25,000 units to 30,000 units, estimate the firm’s
expected EBIT and net income.
d.Does Kelly Products use operating leverage and/or financial leverage? Explain.
51) What are the most important types of current assets? List your answer in order of
declining liquidity.
52) Dave Company, Inc. is considering purchasing a new grinding machine with a
useful life of five years. The initial outlay for the machine is $165,000. The expected
cash inflows are as follows:
Given that the firm has a 10% required rate of return, what is the NPV?
53) NewLinePhone Corp. is very risky, with a beta equal to 2.8 and a standard deviation
of returns of 32%. The risk free rate of return is 3% and the market risk premium is 8%.
NewLinePhone’s marginal tax rate is 35%. Use the capital asset pricing model to
estimate NewLinePhone’s cost of retained earnings.
54) Blanton Corporation increased its financial leverage during 2010 by taking out a
loan and using the proceeds to buy back common stock. At the end of 2010, the
corporation reported higher earnings per share and higher return on equity. However, its
stock price declined. Discuss why this may happen.
55) The balance sheet of the Emery Company is presented below:
Emery Company Balance Sheet
March 31, 2010
(Millions of Dollars)
For the year ending March 31, 2010, Jackson had sales of $58 million. The common
stockholders receive all net earnings of the firm in the form of cash dividends, leaving
no funds from earnings available to the firm for expansion (assume that depreciation
expense is just equal to the cost of replacing worn-out assets).
Construct a pro forma balance sheet for March 31, 2011 for an expected level of sales
of $75.4 million. Assume current assets and accounts payable vary as a percent of sales,
and fixed assets remain at the present level. Use notes payable as discretionary
financing.
56) You purchased one share of Sophia Enterprises common stock for $30 today. If the
stock pays a dividend of $6.50 in one year, and sells for $32.50 at that time, what will
the dividend yield, growth rate, and total rate of return be for the year?
57) You want to invest in bonds. Explain whether or not each provision listed will make
the bonds more or less desirable as an investment: call provision, convertible bond
provision, subordinated debt
58) How could an analyst determine whether a company’s ratio is good or bad?