1) For a given constant required rate of return, the greatest portion of a preferred
stockholder’s return comes from increases in the price of preferred stock.
2) Three basic factors that determine which sources of short-term financing a firm uses
are the effective cost of financing, the availability of credit, and the influence of the use
of a particular credit source on the cost and availability of other sources of financing.
3) We typically expect to find rapidly growing firms to have high payout ratios.
4) The portfolio beta is simply the sum of the betas of the individual stocks in the
portfolio.
5) Reducing the probability of bankruptcy is a benefit of diversification.
6) According to the CAPM, systematic risk is the only relevant risk for capital
budgeting purposes.
7) Federal tax law is irrelevant to corporate dividend policy because dividends are not
tax deductible.
8) Common stock does not mature.
9) Carrying inventory reduces the costs associated with periodic bad debt losses.
10) Higher bankruptcy costs will result in optimal capital structures using more
long-term debt financing.
11) Trend analysis is the forecasting of the firm’s financial ratios for a future time
period by using its own ratios from previous periods.
12) The Capital Asset Pricing Model may be used to estimate the cost of retained
earnings.
13) Motives for holding stocks of cash include transaction, precautionary, and
speculative.
14) Economic Value Added attempts to measure a firm’s economic profit rather than its
accounting profit.
15) The firm financed completely with equity capital has a cost of capital equal to the
required return on common stock.
16) Financial ratios that are higher than industry averages may indicate problems that
are as detrimental to the firm as ratios that are too low.
17) The cash budget represents a detailed plan of future cash flows.
18) You are 21 years old today. Your grandparents set up a trust fund that will pay you
$25,000 per year for 20 years, starting on your 65th birthday to supplement your
retirement. If the trust can earn 7.5% per year, how much will your grandparents need
to put in the trust fund today (rounded to the nearest ten dollars)?
A) $11,370
B) $22,310
C) $5,250
D) $17,450
19) Which of the following investments has the highest effective annual return (EAR)?
(Assume that all CDs are of equal risk.)
A) a bank CD that pays 7.00 percent interest compounded daily
B) a bank CD that pays 7.10 percent compounded monthly
C) a bank CD that pays 7.30 percent annually
D) a bank CD that pays 7.25 percent compounded semiannually
20) The goal of the firm should be
A) maximization of profits (net income per share)
B) maximization of shareholder wealth
C) maximization of market share
D) maximization of sales
21) Fixed assets are often estimated incorrectly by the percent of sales method because
A) fixed assets remain constant and the percent of sales method assumes all assets
increase proportionally with sales
B) fixed asset are very expensive
C) fixed assets are typically purchased in “lumps” and therefore do not increase
proportionally with sales
D) fixed assets are part of the capital budgeting process
22) In which of the following cases will the agency problem between shareholders and
managers be the greatest?
A) 100% of the common stock is owned by the founder of the company who decided to
retire and hired a manager to run his business for him
B) The Johnson family owns 50% of the common stock of the company. The other 50%
is owned by 5 mutual funds
C) The common stock of the company is owned by many diverse shareholders, with no
shareholder owning more than 1% of the outstanding stock
D) All top managers in the company own significant amounts of stock and stock
options
23) Table 4-5
Yen Inc.
Balance Sheet
Yen Inc.
Income Statement
For the year ended December 31, 2010
What was Yen’s return on common equity for 2010?
A) 50.0%
B) 85.0%
C) 121.4%
D) 24.3%
24) Investment A has an expected return of 14% with a standard deviation of 4%, while
investment B has an expected return of 20% with a standard deviation of 9%. Therefore
A) a risk averse investor will definitely select investment A because the standard
deviation is lower
B) a rational investor will pick investment B because the return adjusted for risk (20% –
9%) is higher than the return adjusted for risk for investment A ($14% – 4%)
C) it is irrational for a risk-averse investor to select investment B because its standard
deviation is more than twice as big as investment A’s, but the return is not twice as big
D) rational investors could pick either A or B, depending on their level of risk aversion
25) Propell Inc. is considering the purchase of a new machine that will cost $178,000,
plus an additional $12,000 to ship and install. The new machine will have a 5-year
useful life and will be depreciated using the straight-line method. The machine is
expected to generate new sales of $85,000 per year and is expected to increase
operating costs by $10,000 annually. Propell’s income tax rate is 40%. What is the
projected incremental cash flow of the machine for year 1?
A) $54,800
B) $60,200
C) $66,350
D) $68,200
26) The time necessary for a deposited check to clear through the commercial banking
system causes which of the following types of floats?
A) mail
B) processing
C) transit
D) disbursing
27) Table 4-5
Yen Inc.
Balance Sheet
Yen Inc.
Income Statement
For the year ended December 31, 2010
What was Yen’s operating profit margin for 2010?
A) 26.50%
B) 21.34%
C) 14.29%
D) 11.67%
28) When comparing inventory turnover ratios, other things being equal
A) a lower inventory turnover is preferred in order to keep inventory costs low
B) a higher inventory turnover is preferred to improve liquidity
C) higher inventory turnover results from old or obsolete inventory increasing the
inventory balance on the balance sheet
D) higher inventory turnover results from an increase in the selling price of the product
29) An example of a secondary market transaction involving a capital market security is
A) a new issue of a security with a very short maturity
B) a new issue of a security with a very long maturity
C) the transfer of a previously-issued security with a very short maturity
D) the transfer of a previously-issued security with a very long maturity
30) A company calculates its discretionary financing needed and determines this
amount of capital cannot be raised at a reasonable cost. Which of the following would
reduce the amount of discretionary financing needed?
A) reduce the company’s net profit margin
B) reduce the company’s sales growth rate
C) increase the company’s dividend payout ratio
D) increase the proportion of the company’s sales that are made on credit
31) If a project is acceptable using the NPV criteria, it will also be acceptable when
using the profitability index and IRR criteria.
32) The Sarbanes-Oxley Act, or SOX
A) holds corporate advisors strictly accountable in a legal sense for any instances of
misconduct
B) pretexts the interests of shareholders by providing greater protection against
accounting fraud and financial misconduct
C) reduces the cost of financial reporting by standardizing reporting requirements
D) accomplishes both A and B
33) Which of the following is considered a spontaneous source of financing?
A) short-term notes payable
B) accounts payable
C) long-term notes payable
D) preferred stock
34) Asymmetric Frames Corp had a return on equity of 15%. The corporation’s earnings
per share was $6.00, its dividend payout ratio was 40% and its profit-retention rate was
60%. If these relationships continue, what will be United Financial Corp’s internal
growth rate?
A) 6.0%
B) 8.6%
C) 9.0%
D) 15.6%
35) A project’s equivalent annual annuity (EAA) is the annuity cash flow that yields the
same present value as the project’s NPV.
36) According to the hedging principle, which of the following assets should be
financed with permanent sources of financing?
A) seasonal expansions of inventory
B) seasonal increases in accounts receivable
C) levels of inventory and accounts receivable the firm maintains throughout the year
D) none of the above
37) Calculate the internal rate of return on the following projects:
a.Initial outlay of $60,500 with an after-tax cash flow of $11,897 per year for eight
years.
b.Initial outlay of $647,000 with an after-tax cash flow of $118,000 per year for ten
years.
c.Initial outlay of $25,400 with an after-tax cash flow $11,788 per year for three years.
38) CraftCo, Inc.’ projected sales for the first six months of 2012 are given below:
Jan.$500,000April$490,000
Feb.$740,000May$740,000
Mar.$380,000June$610,000
40% of sales are collected in cash at time of sale, 50% are collected in the month
following the sale, and the remaining 10% are collected in the second month following
the sale. Cost of goods sold is 60% 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 $40,000/month. The company’s cash balance as of February 28, 2012
will be $25,000. Excess cash will be used to retire short-term borrowing (if any).
CraftCo, Inc. has no short term borrowing as of February 28, 2012 . Assume that the
interest rate on short-term borrowing is 1% per month. The company must have a
minimum cash balance of $15,000 at the beginning of each month. What is CraftCo,
Inc.’ earnings before interest and taxes for April 2012?
A) $156,000
B) $142,000
C) $133,000
D) $ 93,000
39) Assume that you have $100,000 invested in a stock whose beta is .85, $200,000
invested in a stock whose beta is 1.05, and $300,000 invested in a stock whose beta is
1.25 . What is the beta of your portfolio?
A) 0.97
B) 1.02
C) 1.12
D) 1.21
40) Premium Lodging, Inc., is financed entirely with 3 million shares of common stock
selling for $50 a share. Capital of $10 million is needed for this year’s capital budget.
Additional funds can be raised with new stock (ignore dilution) or with 11 percent
12-year bonds. Premium Lodging’s tax rate is 35 percent.
a.Calculate the financing plan’s EBIT indifference point.
41) The Boyles Ceramics, Inc. established a line of credit with a local bank. The
maximum amount that can be borrowed under the terms of the agreement is $1,000,000
at an annual rate of 8 percent. A compensating balance averaging 25 percent of the
amount borrowed is required. Prior to the agreement, Boyles had no deposit with the
bank. Shortly after signing the agreement, Boyles needed $240,000 to pay off a note
that was due. It borrowed the $240,000 from the bank by drawing on the line of credit.
What is the effective annual cost of credit?
A) 12.50%
B) 11.11%
C) 10.67%
D) 8.85%
42) 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
43) A financial advisor tells you that you can make your child a millionaire if you just
start saving early. You decide to put an equal amount each year into an investment
account that earns 7.5% interest per year, starting on the day your child is born. How
much would you need to invest each year (rounded to the nearest dollar) to accumulate
a million for your child by the time he is 35 years old? (Your last deposit will be made
on his 34th birthday.)
A) $6,525
B) $7,910
C) $12,500
D) $20,347
44) 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%
45) Crawley, Inc. has a line of credit with HNC Bank that allows the company to
borrow up to $800,000 at an interest rate of 12 percent. However, Crawley, Inc. must
keep a compensating balance of 18 percent of any amount borrowed on deposit at the
bank. Crawley, Inc. does not normally keep a cash balance account with HNC Bank.
What is the effective annual cost of credit?
A) 12.40%
B) 12.83%
C) 14.63%
D) 15.47%
46) You inherit $300,000 from your parents and want to use the money to supplement
your retirement. You receive the money on your 65th birthday, the day you retire. You
want to withdraw equal amounts at the end of each of the next 20 years. What constant
amount can you withdraw each month and have nothing remaining at the end of 20
years if you are earning 7% interest compounded monthly?
A) $1,200
B) $1,829
C) $2,326
D) $2,943
47) Alarm Systems Corporation’s preferred stock pays a dividend of $3.60 and sells for
$28.00. Alarm Systems Corporation has a marginal tax rate of 35%. What is the cost of
preferred financing?
48) Bay Land, Inc. has the following distribution of returns:
Assuming that these returns are normally distributed, what is the probability that Bay
Land, Inc. will return less than 7.25%? Show all work, and clearly explain and state
your answer.
49) Using the 2012 financial statements for DRE Corporation and this additional
information, prepare a pro forma income statement and balance sheet for the year
2013 . Determine the discretionary financing needed (DFN) and assume that if the DFN
is positive, the company will increase long-term debt, and if DFN is negative, the
company will pay back some long-term debt.
Sales for next year (2013) are expected to increase by $300,000 to $1,800,000. The firm
is running efficiently and at full capacity so that all assets and spontaneous liabilities are
expected to increase proportionally with sales. The dividend payout ratio for 2013 will
be 40%.
DRE Corporation
2012 Financial Statements
50) An investment will pay $500 in three years, $700 in five years and $1000 in nine
years. If your opportunity rate is 6%, what is the present value of this investment?
51) Given the anticipated rate of inflation (i) of 2.13% and the real rate of interest (R)
of 3.1%, find the nominal rate of interest (r).
52) The common stock of Cranberry Inc. is selling for $26.75 on the open market. Next
year’s dividend is expected to be $3.68, and the growth rate of this company is
estimated to be 5.5%. If Richard Dean, an average investor, is considering purchasing
this stock at the market price, what is his expected rate of return?
53) Glenna Gayle common stock sells for $55, and dividends paid last year were $1.35.
Flotation costs on issuing stock will be 8% of the market price. The dividends are
predicted to have a 10% growth rate. What is the cost of internal equity, and new equity,
respectively for Glenna Gayle?
54) One of the causes of the recent financial crisis in the United States has been
excessive risk taking due to underestimation of risk. How does this relate to financial
leverage? Can overestimation of risk also be detrimental?
55) Given the information below, calculate the company’s cash balance at the end of the
year.
