1) The DuPont formula allows a firm to break down its return into the net profit margin,
which measures the firm’s profitability on sales, and its total asset turnover, which
indicates how efficiently the firm has used its assets to generate sales.
2) The pecking order explanation of capital structure states that a hierarchy of financing
exists for firms, in which retained earnings are employed first, followed by debt
financing and finally by external equity financing.
3) The effect of financial leverage is such that an increase in a firm’s earnings before
interest and taxes (EBIT) results in a more than proportional increase in the firm’s
earnings per share (EPS), while a decrease in the firm’s EBIT results in a less than
proportional decrease in EPS.
4) Dividend payments change directly with changes in earnings per share.
5) As the typical cash budget shows cash flows only on a monthly basis, the
information provided by the cash budget is not necessarily adequate for ensuring
solvency.
6) The payback period of a project that costs $1,000 initially and promises after-tax
cash inflows of $300 each year for the next three years is 0.333 years.
7) The cost of common stock equity capital represents the return required by existing
shareholders on their investment.
8) The availability of funds for capital expenditures does not affect a firm’s capital
budgeting decisions.
9) While operating leverage results only in a magnification of returns, financial
leverage results only in a magnification of risk.
10) The higher the degree of financial leverage (DFL), the greater the leverage a given
financing plan has, and the steeper its slope when plotted on EBIT-EPS axes.
11) An attractive candidate for acquisition through leveraged buyout must have a good
position in its industry with a solid profit history and reasonable expectation for growth.
12) Table 4.2
Magna Fax, Inc.
Balance Sheet
For the Years Ended December 31, 2014 and 2015
The credit manager at First National Bank has just received the income statement and
balance sheet for Magna Fax, Inc. for the year ended December 31,2015. (See Table
4.2.) The bank requires the firm to report its earnings performance and financial
position quarterly as a condition of a loan agreement. The bank’s credit manager must
prepare two key financial statements based on the information sent by Magna Fax, Inc.
This will be passed on to the commercial loan officer assigned to this account, so that
he may review the financial condition of the firm.
(a)Prepare a statement of retained earnings for the year ended December 31, 2015
(b)Prepare a summary of cash inflows and cash outflows for the year ended December
31, 2015
(c)Prepare a statement of cash flows for the year ended December 31, 2015, organized
by cash flow from operating activities, cash flow from investment activities, and cash
flow from financing activities.
13) From a corporation’s point of view, a disadvantage of issuing preferred stock is
________.
A) that it increases financial leverage
B) that it has to give fixed payments as well as voting rights to the holders
C) its excellent merger security
D) that the dividends are not tax-deductible
14) Which of the following forms of organizations is the easiest to form?
A) sole proprietorships
B) limited liability corporation
C) limited partnership
D) S-corporations
15) Bonds are ________.
A) a series of perpetual short-term debt instruments
B) a form of equity financing that pays interest
C) long-term debt instruments used to raise large sums of money
D) a hybrid form of financing used to raise large sums of money from a diverse group
of lenders
16) As randomly selected securities are combined to create a portfolio, the ________
risk of the portfolio decreases until 10 to 20 securities are included. The portion of the
risk eliminated is ________ risk, while that remaining is ________ risk.
A) diversifiable; nondiversifiable; total
B) relevant; irrelevant; total
C) total; diversifiable; nondiversifiable
D) total; nondiversifiable; diversifiable
17) Many holders of convertible bonds will not convert when the firm’s common stock
price exceeds the conversion price. To protect itself against this behavior, the firm
includes a ________ on the convertible security.
A) warrant
B) option
C) call feature
D) striking price
18) A firm’s final sales forecast is usually a function of ________.
A) its net income
B) the salesperson’s estimates of demand
C) internal and external factors in combination
D) its accounts receivable
19) ________ is a guide to a firm’s value if it is assumed that investors value the
earnings of a given firm in the same way they do the average firm in the industry.
A) Liquidation value
B) Book value
C) The P/E multiple
D) The present value of the dividends
20) Table 10.4
A firm must choose from six capital budgeting proposals outlined below. The firm is
subject to capital rationing and has a capital budget of $1,000,000; the firm’s cost of
capital is 15 percent.
Using the internal rate of return approach to ranking projects, which project(s) should
the firm accept? (See Table 10.4)
A) 1, 2, 3, 4, and 5
B) 1, 2, 3, and 5
C) 2, 3, 4, and 6
D) 1, 3, 4, and 6
21) Which of the following is true of a leveraged buyout?
A) It is a type of a strategic merger
B) It is used to increase market share, which is used to maximize shareholder wealth
C) It aims at developing monopoly control over the markets
D) It involves the use of a large amount of debt to purchase a firm
22) Table 11.5
Nuff Folding Box Company, Inc. is considering purchasing a new gluing machine. The
gluing machine costs $50,000 and requires installation costs of $2,500. This outlay
would be partially offset by the sale of an existing gluer. The existing gluer originally
cost $10,000 and is four years old. It is being depreciated under MACRS using a
five-year recovery schedule and can currently be sold for $15,000. The existing gluer
has a remaining useful life of five years. If held until year 5, the existing machine’s
market value would be zero. Over its five-year life, the new machine should reduce
operating costs (excluding depreciation) by $17,000 per year. Training costs of
employees who will operate the new machine will be a one-time cost of $5,000 which
should be included in the initial outlay. The new machine will be depreciated under
MACRS using a five-year recovery period. The firm has a 12 percent cost of capital and
a 40 percent tax on ordinary income and capital gains.
The tax effect of the sale of the existing asset is ________. (See Table 11.5)
A) a tax liability of $2,340
B) a tax benefit of $1,500
C) a tax liability of $3,320
D) a tax liability of $5,320
23) Which of the following is the responsibility of a finance manager?
A) processing purchase orders and invoices
B) ensuring accounts payable are paid on time
C) preparing the monthly income statement
D) analyzing the capital needs of the firm
24) If an investor buys a 100-share call option for $250 with an exercise price of $60
and the underlying price per share of the stock at expiration is $66, what is the amount
of profit or loss, ignoring brokerage fees?
A) There would be a profit of $350
B) There would be a profit of $600
C) There would be a profit of $250
D) There would be a loss of $250
25) Tangshan Mining is considering the acquisition of Zhengsen Mining at a cash price
of $6,000,000. The primary motivation for Tangshan’s purchase of Zhengsen is for a
special piece of drilling equipment that it believes will generate after-tax cash flows of
$2,000,000 per year during the next 5 years. Zhengsen Mining has liabilities of
$9,000,000 and Tangshan estimates that it can sell the remaining assets $6,500,000.
Tangshan will use a 15 percent cost of capital for evaluating the acquisition. Based on
this information, what is the net value of the special drilling equipment? Calculate the
net value of a second alternative that would allow Tangshan to purchase a better quality
asset for $12,000,000 that would provide a $2,600,000 in after-tax inflows for the next
5 years. Which alternative would you choose?
A) $1,795,700, $3,284,400, both
B) $1,500,000, $4,500,000, both
C) ($1,795,700), ($3,284,400), neither
D) ($1,795,700), ($4,500,000), neither
26) ________ is the process of evaluating and selecting long-term investments that are
consistent with a firm’s goal of maximizing owners’ wealth.
A) Recapitalizing assets
B) Capital budgeting
C) Ratio analysis
D) Securitization
27) The degree of financial leverage is the ratio of ________ to percentage change in
EBIT.
A) operating profit
B) percentage change in sales
C) percentage change in EPS
D) long-term debt
28) A preferred approach for risk adjustment of capital budgeting cash flows, from a
practical viewpoint, is ________.
A) sensitivity analysis
B) simulation analysis
C) scenario analysis
D) risk-adjusted discount rates
29) The ________ is created by a number of institutions and arrangements that allow
the suppliers and demanders of long-term funds to make transactions.
A) forex market
B) capital market
C) money market
D) commodities market