1) Murray Inc. is considering Projects S and L, whose cash flows are shown below.
These projects are mutually exclusive, equally risky, and not repeatable. The CEO
wants to use the IRR criterion, while the CFO favors the NPV method. You were hired
to advise Murray on the best procedure. If the wrong decision criterion is used, how
much potential value would Murray lose?
WACC:6.00%
Year01234
CFS-$1,025$380$380$380$380
CFL-$2,150$765$765$765$765
a.$188.68
b.$198.61
c.$209.07
d.$219.52
e.$230.49
2) HHH Inc. reported $12,500 of sales and $7,025 of operating costs (including
depreciation). The company had $18,750 of investor-supplied operating assets (or
capital), the weighted average cost of that capital (the WACC) was 9.5%, and the
federal-plus-state income tax rate was 40%. What was HHH’s Economic Value Added
(EVA), i.e., how much value did management add to stockholders’ wealth during the
year?
a.$1,357.13
b.$1,428.56
c.$1,503.75
d.$1,578.94
e.$1,657.88
3) Gardner Electric has a beta of 0.88 and an expected dividend growth rate of 4.00%
per year. The T-bill rate is 4.00%, and the T-bond rate is 5.25%. The annual return on
the stock market during the past 4 years was 10.25%. Investors expect the average
annual future return on the market to be 12.50%. Using the SML, what is the firm’s
required rate of return?
a.11.34%
b.11.63%
c.11.92%
d.12.22%
e.12.52%
4) Consider two projects, X and Y. Project X’s IRR is 19% and Project Y’s IRR is 17%.
The projects have the same risk and the same lives, and each has constant cash flows
during each year of their lives. If the WACC is 10%, Project Y has a higher NPV than
X. Given this information, which of the following statements is CORRECT?
a.The crossover rate must be greater than 10%
b.If the WACC is 8%, Project X will have the higher NPV
c.If the WACC is 18%, Project Y will have the higher NPV
d.Project X is larger in the sense that it has the higher initial cost
e.The crossover rate must be less than 10%
5) Projects S and L are both normal projects with an initial cost of $10,000, followed by
a series of positive cash inflows. Project S’s undiscounted net cash flows total $20,000,
while L’s total undiscounted flows are $30,000. At a WACC of 10%, the two projects
have identical NPVs. Which project’s NPV is more sensitive to changes in the WACC?
a.Project L
b.Both projects are equally sensitive to changes in the WACC since their NPVs are
equal at all costs of capital
c.Neither project is sensitive to changes in the discount rate, since both have NPV
profiles that are horizontal
d.The solution cannot be determined because the problem gives us no information that
can be used to determine the projects’ relative IRRs
e.Project S
6) The current price of a stock is $50, the annual risk-free rate is 6%, and a 1-year call
option with a strike price of $55 sells for $7.20. What is the value of a put option,
assuming the same strike price and expiration date as for the call option?
a.$7.33
b.$7.71
c.$8.12
d.$8.55
e.$9.00
7) Refer to Exhibit 21.1. If the firm adopts a restricted policy, how much lower would
its interest expense be than under the relaxed policy?
a.$8,418
b.$8,861
c.$9,327
d.$9,818
e.$10,309
8) $35.50 per share is the current price for Foster Farms’ stock. The dividend is
projected to increase at a constant rate of 5.50% per year. The required rate of return on
the stock, rs, is 9.00%. What is the stock’s expected price 3 years from today?
a.$37.86
b.$38.83
c.$39.83
d.$40.85
e.$41.69
9) 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.
10) Which of the following statements is CORRECT?
a.If a coupon bond is selling at a discount, then the bond’s expected capital gains yield
is negative
b.If a bond is selling at a discount, the yield to call is a better measure of the expected
return than the yield to maturity
c.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
d.If a coupon bond is selling at par, its current yield equals its yield to maturity
e.If a coupon bond is selling at a premium, then the bond’s current yield is zero
11) Which of the following statements is NOT CORRECT?
a. When a corporation’s shares are owned by a few individuals and are not traded on
public markets, we say that the firm is “closely, or privately, held”
b. “Going public” establishes a firm’s true intrinsic value, and it also insures that a
highly liquid market will always exist for the firm’s shares
c. When stock in a closely held corporation is offered to the public for the first time, the
transaction is called “going public,” and the market for such stock is called the new
issue market
d. Publicly owned companies have shares owned by investors who are not associated
with management, and public companies must register with and report to a regulatory
agency such as the SEC
e. It is possible for a firm to go public and yet not raise any additional new capital at the
time
12) If its yield to maturity declined by 1%, which of the following bonds would have
the largest percentage increase in value?
a.A 1-year bond with an 8% coupon
b.A 10-year bond with an 8% coupon
c.A 10-year bond with a 12% coupon
d.A 10-year zero coupon bond
e.A 1-year zero coupon bond
13) Last year Tiemann Technologies reported $10,500 of sales, $6,250 of operating
costs other than depreciation, and $1,300 of depreciation. The company had no
amortization charges, it had $5,000 of bonds that carry a 6.5% interest rate, and its
federal-plus-state income tax rate was 35%. This year’s data are expected to remain
unchanged except for one item, depreciation, which is expected to increase by $750. By
how much will net after-tax income change as a result of the change in depreciation?
The company uses the same depreciation calculations for tax and stockholder reporting
purposes.
a.-463.13
b.-487.50
c.-511.88
d.-537.47
e.-564.34
14) One drawback of switching from a partnership to the corporate form of organization
is the following:
a. It subjects the firm to additional regulations
b. It cannot affect the amount of the firm’s operating income that goes to taxes
c. It makes it more difficult for the firm to raise additional capital
d. It makes the firm’s investors subject to greater potential personal liabilities
e. It makes it more difficult for the firm’s investors to transfer their ownership interests
15) Silverman Co. is considering Projects S and L, whose cash flows are shown below.
These projects are mutually exclusive, equally risky, and not repeatable. If the decision
is made by choosing the project with the higher MIRR rather than the one with the
higher NPV, how much value will be forgone? Note that under some conditions
choosing projects on the basis of the MIRR will cause $0.00 value to be lost.
WACC:8.75%
Year01234
CFS-$1,100$375$375$375$375
CFL-$2,200$725$725$725$725
a.$32.12
b.$35.33
c.$38.87
d.$40.15
e.$42.16
16) Projects A and B have identical expected lives and identical initial cash outflows
(costs). However, most of one project’s cash flows come in the early years, while most
of the other project’s cash flows occur in the later years. The two NPV profiles are
given below:
Which of the following statements is CORRECT?
a.More of Project B’s cash flows occur in the later years
b.We must have information on the cost of capital in order to determine which project
has the larger early cash flows
c.The NPV profile graph is inconsistent with the statement made in the problem
d.The crossover rate, i.e., the rate at which Projects A and B have the same NPV, is
greater than either project’s IRR
e.More of Project A’s cash flows occur in the later years
17) Frosty Corporation has the following data, in thousands. Assuming a 365-day year,
what is the firm’s cash conversion cycle?
Annual sales =$45,000
Annual cost of goods sold =$31,500
Inventory =$4,000
Accounts receivable =$2,000
Accounts payable =$2,400
a.25 days
b.28 days
c.31 days
d.35 days
e.38 days
18) Ivan Knobel holds a well-diversified portfolio that has an expected return of 11.0%
and a beta of 1.20. He is in the process of buying 1,000 shares of Syngine Corp at $10 a
share and adding it to his portfolio. Syngine has an expected return of 13.0% and a beta
of 1.50. The total value of Ivan’s current portfolio is $90,000. What will the expected
return and beta on the portfolio be after the purchase of the Syngine stock?
a.10.64%; 1.17
b.11.20%; 1.23
c.11.76%; 1.29
d.12.35%; 1.36
e.12.97%; 1.42
19) Which of the following statements is correct?
a. Capital gains earned in a share repurchase are taxed less favorably than dividends;
this explains why companies typically pay dividends and avoid share repurchases
b. Very often, a company’s stock price will rise when it announces that it plans to
commence a share repurchase program. Such an announcement could lead to a stock
price decline, but this does not normally happen
c. Stock repurchases increase the number of outstanding shares
d. The clientele effect is the best explanation for why companies tend to vary their
dividend payments from quarter to quarter
e. If a company has a 2-for-1 stock split, its stock price should roughly double
20) LeCompte Learning Solutions is considering making a change to its capital
structure in hopes of increasing its value. The company’s capital structure consists of
debt and common stock. In order to estimate the cost of debt, the company has
produced the following table:
Percent financedPercent financedDebt-to-equityBondBefore-tax
with debt (wd)with equity (wc)ratio (D/S)Ratingcost of debt
0.100.900.10/0.90 = 0.11AAA 7.0%
0.200.800.20/0.80 = 0.25AA7.2
0.300.700.30/0.70 = 0.43A8.0
0.400.600.40/0.60 = 0.67BBB8.8
0.500.500.50/0.50 = 1.00BB9.6
The company uses the CAPM to estimate its cost of common equity, rs. The risk-free
rate is 5% and the market risk premium is 6%. LeCompte estimates that if it had no
debt its beta would be 1.0. (Its “unlevered beta,” bU, equals 1.0.) The company’s tax
rate, T, is 40%.
On the basis of this information, what is LeCompte’s optimal capital structure, and what
is the firm’s cost of capital at this optimal capital structure?
a.wc = 0.9; wd = 0.1; WACC = 14.96%
b.wc = 0.8; wd = 0.2; WACC = 10.96%
c.wc = 0.7; wd = 0.3; WACC = 7.83%
d.wc = 0.6; wd = 0.4; WACC = 10.15%
e.wc = 0.5; wd = 0.5; WACC = 10.18%
21) Assume that the risk-free rate remains constant, but the market risk premium
declines. Which of the following is most likely to occur?
a.The required return on a stock with beta > 1.0 will increase
b.The return on “the market” will remain constant
c.The return on “the market” will increase
d.The required return on a stock with beta < 1.0 will decline
e.The required return on a stock with beta = 1.0 will not change
22) Refer to Exhibit 3.1. What is the firm’s quick ratio?
a. 0.49
b. 0.61
c. 0.73
d. 0.87
e. 1.05
23) Grandin Inc. is evaluating its dividend policy. It has a capital budget of $625,000,
and it wants to maintain a target capital structure of 60% debt and 40% equity. The
company forecasts a net income of $475,000. If it follows the residual dividend policy,
what is its forecasted dividend payout ratio?
a. 40.61%
b. 42.75%
c. 45.00%
d. 47.37%
e. 49.74%
24) Which of the following statements is CORRECT?
a. The main method of transferring ownership interest in a corporation is by means of a
hostile takeover
b. Two key advantages of the corporate form over other forms of business organization
are unlimited liability and limited life
c. A corporation is a legal entity that is generally created by a state; its life and existence
is separate from the lives of its individual owners and managers
d. Limited liability of its stockholders is an advantage of the corporate form of
organization, but corporations have more trouble raising money in financial markets
because of the complexity of this form of organization
e. Although its stockholders are insulated by limited legal liability, the corporation’s
legal status does not protect the firm’s managers in the same way; i.e., bondholders can
sue its managers if the firm defaults on its debt, even if the default is the result of poor
economic conditions
25) Which of the following items should a company report directly in its monthly cash
budget?
a.Cash proceeds from selling one of its divisions
b.Accrued interest on zero coupon bonds that it issued
c.New shares issued in a stock split
d.New shares issued in a stock dividend
e.Its monthly depreciation expense
26) LeCompte Corp. has $312,900 of assets, and it uses only common equity capital
(zero debt). Its sales for the last year were $620,000, and its net income after taxes was
$24,655. Stockholders recently voted in a new management team that has promised to
lower costs and get the return on equity up to 15%. What profit margin would
LeCompte need in order to achieve the 15% ROE, holding everything else constant?
a. 7.57%
b. 7.95%
c. 8.35%
d. 8.76%
e. 9.20%
27) Gere Furniture forecasts a free cash flow of $40 million in Year 3, i.e., at t = 3, and
it expects FCF to grow at a constant rate of 5% thereafter. If the weighted average cost
of capital is 10% and the cost of equity is 15%, what is the horizon value, in millions at
t = 3?
a.$840
b.$882
c.$926
d.$972
e.$1,021
28) Which of the following statements is CORRECT?
a.When fixed assets are added in large, discrete units as a company grows, the
assumption of constant ratios is more appropriate than if assets are relatively small and
can be added in small increments as sales grow
b.Firms whose fixed assets are “lumpy” frequently have excess capacity, and this should
be accounted for in the financial forecasting process
c.For a firm that uses lumpy assets, it is impossible to have small increases in sales
without expanding fixed assets
d.There are economies of scale in the use of many kinds of assets. When economies
occur the ratios are likely to remain constant over time as the size of the firm increases.
The Economic Ordering Quantity model for establishing inventory levels demonstrates
this relationship
e.When we use the AFN equation, we assume that the ratios of assets and liabilities to
sales (A0*/S0 and L0*/S0) vary from year to year in a stable, predictable manner
29) A product sells for $750 in the United States. The exchange rate is $1 to 1.65 Swiss
francs. If purchasing power parity (PPP) holds, what is the price of the product in
Switzerland?
a.123.75 Swiss francs
b.454.55 Swiss francs
c.750.00 Swiss francs
d.1,237.50 Swiss francs
e.1,650.00 Swiss francs
30) Which of the following statements is CORRECT?
a.The discounted payback method eliminates all of the problems associated with the
payback method
b.When evaluating independent projects, the NPV and IRR methods often yield
conflicting results regarding a project’s acceptability
c.To find the MIRR, we discount the TV at the IRR
d.A project’s NPV profile must intersect the X-axis at the project’s WACC
e.The IRR method appeals to some managers because it gives an estimate of the rate of
return on projects rather than a dollar amount, which the NPV method provides
31) The relative profitability of a firm that employs an aggressive current asset
financing policy will improve if the yield curve changes from upward sloping to
downward sloping.
32) If a firm finances with only debt and common equity, and if its equity multiplier is
3.0, then its debt ratio must be 0.667.
33) The “apparent,” but not the “true,” financial position of a company whose sales are
seasonal can differ dramatically, depending on the time of year when the financial
statements are constructed.
34) The Eurodollar market is essentially a long-term market; most loans and deposits in
this market have maturities longer than one year.
35) Due to advanced communications technology and the standardization of general
procedures, working capital management for multinational firms is no more complex
than it is for large domestic firms.
36) When estimating the cost of equity by use of the bond-yield-plus-risk-premium
method, we can generally get a good idea of the interest rate on new long-term debt, but
we cannot be sure that the risk premium we add is appropriate. This problem leaves us
unsure of the true value of rs.
37) For capital budgeting and cost of capital purposes, the firm should always consider
reinvested earnings as the first source of capitali.e., use these funds firstbecause
reinvested earnings have no cost to the firm.