1) Owners equity increases each period by the amount of the corporation’s positive net
cash flow.
2) Only a firm’s financial decisions affect its stock prices.
3) The price of a computer today is $400 and inflation is 5% per year. Therefore, in two
years the price of the computer is expected to be $440.
4) A quote of .7645 euros per dollar in New York is an example of a direct quote.
5) Increases in working capital needs should be included as part of the initial outlay of a
project, but decreases in working capital for a project should not be considered because
they are not guaranteed.
6) The sum of the present values of an investment’s expected future cash flows is
known as the investment’s intrinsic value.
7) Additional investment in working capital, even if it may be recovered at the end of a
project, must be included in capital budgeting analysis because of the time value of
money.
8) A general partnership, unlike a limited partnership, is an entity that legally functions
separate and apart from its owners.
9) The cost of trade credit varies directly with the size of the cash discount and
inversely with the length of time between the end of the discount period and the final
due date.
10) How managers choose to finance the business affects the company’s risk, and as a
result, the rate of return stockholders receive on their investments.
11) Part of the U.S. Government’s huge deficit is financed by foreign countries, such as
China, which is a savings surplus unit.
12) Financial management deals with the maintenance and creation of economic value
or wealth.
13) The T-bill return is used in the CAPM model as the risk free rate.
14) The amount of the preferred stock dividend is generally fixed either as a dollar
amount or as a percentage of the par value.
15) The higher the dividend payout ratio, the more a company must rely on external
financing.
16) Forward contracts benefit only the customer due to a reduction in uncertainty.
17) For a project with multiple sign reversals in its cash flows, the net present value can
be the same for two entirely different discount rates.
18) The income statement describes the financial position of a firm on a given date.
19) Borrowing money causes a corporation’s return on operating assets to decrease
because of the interest that must be paid.
20) If two projects are mutually exclusive then the IRR is more important than the NPV
in deciding the project that should be chosen.
21) The primary goal of a publicly owned corporation is to ________.
A) maximize dividends per share
B) maximize shareholder wealth
C) maximize earnings per share after taxes
D) minimize shareholder risk
22) You bought a racehorse that has had a winning streak for six years, bringing in
$250,000 at the end of each year before dying of a heart attack. If you paid $1,155,720
for the horse 4 years ago, what was your annual return over this 4-year period?
A) 8%
B) 33%
C) 18%
D) 12%
23) Investors generally don’t like risk. Therefore, a typical investor
A) will not be induced to take on any risk
B) will only take on the least risk possible
C) will only take on additional risk if he expects to be compensated in the form of
additional return
D) will only accept a zero return if the risk is zero
24) If a firm were to experience financial insolvency, the legal system provides an order
of hierarchy for the payment of claims. Assume that a firm has the following
outstanding securities: mortgage bonds, common stock, debentures, and preferred stock.
Rank the order in which investors that own mortgage bonds would have their claim
paid?
A) first
B) second
C) third
D) fourth
25) Which of the following sources of short-term financing is likely to have the lowest
interest rate?
A) accounts receivable loan (pledging of accounts receivable)
B) line of credit
C) line of credit with a compensating balance
D) commercial paper
26) Blammo, Inc. has a target capital structure of 30% debt and 70% equity. The firm is
planning to invest in a project that will necessitate raising new capital. New debt will be
issued at a before-tax yield of 14%, with a coupon rate of 10%. The equity will be
provided by internally generated funds so no new outside equity will be issued. If the
required rate of return on the firm’s stock is 22% and its marginal tax rate is 35%,
compute the firm’s cost of capital.
A) 18.00%
B) 18.13%
C) 19.68%
D) 15.55%
27) The real rate of return is the return earned above the
A) default risk premium
B) risk-adjusted return
C) inflation risk premium
D) variability of returns measured by standard deviation
28) The cost of external equity capital is greater than the cost of retained earnings
because of
A) flotation costs on new equity
B) increasing marginal tax rates
C) higher dividends
D) greater risk for shareholders
29) What is the primary advantage of a firm that is able to issue commercial paper to
finance its short-term assets?
A) Commercial paper provides greater flexibility in terms of repayment
B) Interest rates on commercial paper are generally lower than rates on bank loans
C) Commercial paper does not need to be repaid
D) Commercial paper is guaranteed by the Federal Government
30) TransSystems Inc. has a total equity of $560,000; sales of $2,250,000; total assets
of $995,000; and current liabilities of $310,000. What is TransSystems Inc.’s debt ratio?
A) 55.4%
B) 43.7%
C) 31.2%
D) 66.7%
31) The Clydesdale Corporation has an optimal capital structure consisting of 70
percent debt and 30 percent equity. The marginal cost of capital is calculated to be
14.75 percent. Total earnings available to common stockholders for the coming year
total $1,200,000. Investment opportunities are:
a.According to the residual dividend theory, what should the firm’s total dividend
payment be?
b.If the firm paid a total dividend of $675,000, and restricted equity financing to
internally generated funds, which projects should be selected? Assume the marginal
cost of capital is constant.
32) LPD Logistics, Inc.’s projected sales for the first six months of 2010 are given
below.
Jan.$300,000April$350,000
Feb.$350,000May$500,000
Mar.$475,000June$400,000
20% of sales are collected in the month of the sale, 75% are collected in the month
following the sale, and 5% are written off as uncollectible. Cost of goods sold is 80% of
sales. Purchases are made the month prior to the sales and are paid during the month the
purchases are made (i.e. goods sold in March are bought and paid for in February).
Total other cash expenses are $35,000/month. The company’s cash balance as of
February 1, 2010 will be $30,000. Excess cash will be used to retire short-term
borrowing (if any). LPD has no short term borrowing as of February 28, 2010 . Assume
that the interest rate on short-term borrowing is 1% per month. The company must have
a minimum cash balance of $20,000 at the beginning of each month. What is LPD’s
projected total disbursements for April?
A) $422,918
B) $435,686
C) $398,833
D) $375,655
33) Haroldson Inc. common stock is selling for $22 per share. The last dividend was
$1.20, and dividends are expected to grow at a 6% annual rate. Flotation costs on new
stock sales are 5% of the selling price. What is the cost of Haroldson’s retained
earnings?
A) 5.73%
B) 11.45%
C) 11.78%
D) 12.09%
34) Which of the following actions would improve a firm’s liquidity?
A) purchasing inventories for cash
B) purchasing inventory on trade credit
C) purchasing inventory with long-term debt
D) buying machinery with long-term debt
35) Which of the following conclusions would be TRUE if you earn a higher rate of
return on your investments?
A) The greater the present value would be for any lump sum you would receive in the
future
B) The lower the present value would be for any lump sum you would receive in the
future
C) Your rate of return would not have any effect on the present value of any sum to be
received in the future
D) The greater the present value would be for any annuity you would receive in the
future
36) Johnson Production Company paid a dividend yesterday of $3.50 per share. The
dividend is expected to grow at a constant rate of 10% per year. The price of KayCee’s
common stock today is $40 per share. If KayCee decides to issue new common stock,
flotation costs will equal $4.00 per share. KayCee’s marginal tax rate is 35%. Based on
the above information, the cost of new common stock is
A) 26.41%
B) 20.09%
C) 19.63%
D) 17.55%
37) Different discounted cash flow evaluation methods may provide conflicting
rankings of investment projects when
A) the size of investment outlays differ
B) the projects are mutually exclusive
C) the accounting policies differ
D) the internal rate of return equals the cost of capital
38) The yield to maturity on a bond is the rate of return that equates the present value of
the bond’s future cash flows with the bond’s
A) face value
B) market value
C) liquidation value
D) book value
39) Marble Corp. has a beta of 2.5 and a standard deviation of returns of 20%. The
return on the market portfolio is 15% and the risk free rate is 4%. What is the risk
premium on the market?
A) 5%
B) 6%
C) 9.00%
D) 11%
40) KLE Holdings is considering a capital budgeting project with a life of 7 years that
requires an initial outlay of $277,400. The probability distribution for annual
incremental cash flows is as follows:
a.The risk-adjusted required rate of return for this project is 12%. Calculate the
risk-adjusted net present value of the project and the project’s IRR.
b.Should the project be accepted?
41) Progressive Corporation issued callable bonds. The bonds are most likely to be
called if
A) interest rates decrease
B) interest rates increase
C) Shafer Corporation needs additional financing
D) Shafer Corporation’s stock price increases dramatically
42) LPD Logistics, Inc.’s projected sales for the first six months of 2010 are given
below.
Jan.$300,000April$350,000
Feb.$350,000May$500,000
Mar.$475,000June$400,000
20% of sales are collected in the month of the sale, 75% are collected in the month
following the sale, and 5% are written off as uncollectible. Cost of goods sold is 80% of
sales. Purchases are made the month prior to the sales and are paid during the month the
purchases are made (i.e. goods sold in March are bought and paid for in February).
Total other cash expenses are $35,000/month. The company’s cash balance as of
February 1, 2010 will be $30,000. Excess cash will be used to retire short-term
borrowing (if any). LPD has no short term borrowing as of February 28, 2010 . Assume
that the interest rate on short-term borrowing is 1% per month. The company must have
a minimum cash balance of $20,000 at the beginning of each month. What is LPD’s
projected gross profit for April?
A) ($50,000)
B) $70,000
C) $100,000
D) $110,550
43) A “Dutch auction” was used by Google to raise money in 2004. A Dutch auction
involves
A) selling bonds in Europe
B) allowing investors to submit bids saying how many shares they’d like to buy and at
what price
C) allowing investment banking firms to submit bids on how many shares they are
willing to sell and at what price
D) hiring a Dutch firm to sell a company’s securities at auction
44) Bond A has a current yield of 6% and Bond B has a current yield of 8%. If the
market price of both bonds is the same, then the yield to maturity on Bond B must be
higher than the yield to maturity on Bond A.
45) The accuracy of the percent of sales forecast method is impaired if
A) scale economies are present for assets
B) assets must be purchased in discrete quantities
C) asset needs are independent of sales level
D) all of the above impair the accuracy of the percent of sales forecast method
46) Suppose a corporation can change its depreciation method so that its tax payments
will decrease by $5,000 this year but increase by $5,000 next year.
A) The change will have no impact on the value of the company because its cash flow
over time will be the same
B) The change will decrease the value of the company because investors don’t like
changes in accounting methods
C) The change will decrease the value of the company because lower tax payments this
year result from lower reported income
D) The change will increase the value of the company because the value of the cash
savings this year exceeds the cost of the cash payments next year
47) A financial manager is considering two projects, A and B. A is expected to add $2
million to profits this year while B is expected to add $2 million to profits this year
while B is expected to add $1 million to profits this year. Which of the following
statements is MOST correct?
A) The manager should select project A because it maximizes profits
B) The manager should select the project that maximizes long-term profits, not just one
year of profits
C) The manager should select project A or he is irrational
D) The manager should select the project that causes the stock price to increase the
most, which could be A or B
48) Two bonds are identical except for their maturity. The bonds have a coupon rate that
is greater than their yield to maturity. Which of the following is TRUE when
comparing the two bonds?
A) The longer maturity bond has a greater premium (is priced farther above par)
B) The longer maturity bond has a smaller premium (is priced above par but closer to
par)
C) The longer maturity bond has a greater discount (is priced farther below par)
D) The longer maturity bond has a smaller discount (is priced below par but closer to
par)
49) A Johnson corporation bond is currently selling for $850. The bond matures in 20
years, has a face value of $1,000, and a yield to maturity of 10.55%. The bond’s coupon
rate is
A) 10%
B) 11%
C) 12%
D) 13%
50) If the NPV (Net Present Value) of a project with multiple sign reversals is positive,
then the project’s required rate of return ________ its calculated IRR (Internal Rate of
Return).
A) must be less than
B) must be greater than
C) could be greater or less than
D) cannot be determined without actual cash flows
51) Beauty Inc. plans to maintain its optimal capital structure of 40 percent debt, 10
percent preferred stock, and 50 percent common equity indefinitely. The required return
on each component source of capital is as follows: debt–8 percent; preferred stock–12
percent; common equity–16 percent. Assuming a 40 percent marginal tax rate, what
after-tax rate of return must the firm earn on its investments if the value of the firm is to
remain unchanged?
A) 12.40 percent
B) 12.00 percent
C) 11.12 percent
D) 10.64 percent
52) Which of the following is an example of both a capital market and a primary market
transaction?
A) The U.S. Government sells 3-month Treasury Bills
B) Microsoft common stock owned by an individual investor is sold to another investor
C) Ford Motor Company sells a new issue of common stock to raise funds through a
public offering
D) No transactions occur in both primary and capital markets at the same time
53) 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
54) gat, Inc. has issued a $1,000 par 4% annual coupon bond that is to mature in 18
years. If your required rate of return is 6.5%, what price would you be willing to pay for
the bond?
55) Security A has an expected rate of return of 29.8 percent and a beta of 3.1 . Security
B has a beta of 1.70. If the Treasury bill rate is 5 percent, what is the expected rate of
return for Security B?
56) What is direct foreign investment? What are the additional risks that a multinational
corporation must consider before undertaking direct investment in a foreign country?
57) Complete the following balance sheet using the information given. Round account
balances to the nearest dollar.
58) The current direct quote in New York is .01075 dollars per yen. Suppose the current
direct quote in Tokyo is 91 yen per dollar. What is the appropriate indirect quote in New
York? What will arbitrageurs do to eliminate the differential rates in these markets?
59) 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.
60) Prepare a balance sheet using the information given below. Make sure to identify
current assets, net fixed assets, total assets, current liabilities, long-term debt, total
equity, and total liabilities and equity.
