1) In your first job with TBL Inc. your task is to consider a new project whose data are
shown below. What is the project’s Year 1 cash flow?
Sales revenues$22,250
Depreciation$8,000
Other operating costs$12,000
Tax rate35.0%
a.$8,903
b.$9,179
c.$9,463
d.$9,746
e.$10,039
2) Stewart Inc.’s latest EPS was $3.50, its book value per share was $22.75, it had
215,000 shares outstanding, and its debt-to-assets ratio was 46%. How much debt was
outstanding?
a. $3,393,738
b. $3,572,356
c. $3,760,375
d. $3,958,289
e. $4,166,620
3) Hazel Morrison, a mutual fund manager, has a $40 million portfolio with a beta of
1.00. The risk-free rate is 4.25%, and the market risk premium is 6.00%. Hazel expects
to receive an additional $60 million, which she plans to invest in additional stocks.
After investing the additional funds, she wants the fund’s required and expected return
to be 13.00%. What must the average beta of the new stocks be to achieve the target
required rate of return?
a.1.68
b.1.76
c.1.85
d.1.94
e.2.04
4) Suppose that Federal Reserve actions have caused an increase in the risk-free rate,
rRF. Meanwhile, investors are afraid of a recession, so the market risk premium, (rM –
rRF), has increased. Under these conditions, with other things held constant, which of
the following statements is most correct?
a.The required return on all stocks would increase, but the increase would be greatest
for stocks with betas of less than 1.0
b.Stocks’ required returns would change, but so would expected returns, and the result
would be no change in stocks’ prices
c.The prices of all stocks would decline, but the decline would be greatest for high-beta
stocks
d.The prices of all stocks would increase, but the increase would be greatest for
high-beta stocks
e.The required return on all stocks would increase by the same amount
5) During the coming year, Gold & Gold wants to increase its free cash flow by $180
million, which should result in a higher EVA and stock price. The CFO has made these
projections for the upcoming year:
EBIT is projected to equal $850 million.
Gross capital expenditures are expected to total to $360 million versus depreciation of
$120 million, so its net capital expenditures should total $240 million.
The tax rate is 40%.
There will be no changes in cash or marketable securities, nor will there be any changes
in notes payable or accruals.
What increase in net working capital (in millions of dollars) would enable the firm to
meet its target increase in FCF?
a.$72
b.$90
c.$108
d.$130
e.$156
6) Which of the following statements is CORRECT?
a. If two firms differ only in their use of debti.e., they have identical assets, sales,
operating costs, and tax ratesbut one firm has a higher debt ratio, the firm that uses
more debt will have a higher profit margin on sales
b. If one firm has a higher debt ratio than another, we can be certain that the firm with
the higher debt ratio will have the lower TIE ratio, as that ratio depends entirely on the
amount of debt a firm uses
c. A firm’s use of debt will have no effect on its profit margin on sales
d. If two firms differ only in their use of debti.e., they have identical assets, sales,
operating costs, interest rates on their debt, and tax ratesbut one firm has a higher debt
ratio, the firm that uses more debt will have a lower profit margin on sales
e. The debt ratio as it is generally calculated makes an adjustment for the use of assets
leased under operating leases, so the debt ratios of firms that lease different percentages
of their assets are still comparable
7) Which of the following statements is CORRECT? Assume that the project being
considered has normal cash flows, with one outflow followed by a series of inflows.
a.The higher the WACC used to calculate the NPV, the lower the calculated NPV will
be
b.If a project’s NPV is greater than zero, then its IRR must be less than the WACC
c.If a project’s NPV is greater than zero, then its IRR must be less than zero
d.The NPVs of relatively risky projects should be found using relatively low WACCs
e.A project’s NPV is generally found by compounding the cash inflows at the WACC to
find the terminal value (TV), then discounting the TV at the IRR to find its PV
8) A firm’s new president wants to strengthen the company’s financial position. Which
of the following actions would make it financially stronger?
a. Increase inventories while holding sales and cost of goods sold constant
b. Increase accounts receivable while holding sales constant
c. Increase EBIT while holding sales constant
d. Increase accounts payable while holding sales constant
e. Increase notes payable while holding sales constant
9) Which of the following statements is NOT CORRECT?
a.Credit policy has an impact on working capital because it influences both sales and
the time before receivables are collected
b.The cash budget is useful to help estimate future financing needs, especially the need
for short-term working capital loans
c.If a firm wants to generate more cash flow from operations in the next month or two,
it could change its credit policy from 2/10 net 30 to net 60
d.Managing working capital is important because it influences financing decisions and
the firm’s profitability
e.A company may hold a relatively large amount of cash and marketable securities if it
is uncertain about its volume of sales, profits, and cash flows during the coming year
10) Which of the following statements is correct?
a. If a company uses the residual dividend model to determine its dividend payments,
dividends payout will tend to increase whenever its profitable investment opportunities
increase
b. The stronger management thinks the clientele effect is, the more likely the firm is to
adopt a strict version of the residual dividend model
c. Large stock repurchases financed by debt tend to increase earnings per share, but they
also increase the firm’s financial risk
d. A dollar paid out to repurchase stock is taxed at the same rate as a dollar paid out in
dividends. Thus, both companies and investors are indifferent between distributing cash
through dividends and stock repurchase programs
e. The tax code encourages companies to pay dividends rather than retain earnings
11) Which of the following is NOT associated with (or does not contribute to) business
risk? Recall that business risk is affected by a firm’s operations.
a.Sales price variability
b.The extent to which operating costs are fixed
c.The extent to which interest rates on the firm’s debt fluctuate
d.Input price variability
e.Demand variability
12) Which of the following statements is CORRECT?
a.Under current laws and regulations, corporations must use straight-line depreciation
for all assets whose lives are 3 years or longer
b.If firms use accelerated depreciation, they will write off assets slower than they would
under straight-line depreciation, and as a result projects’ forecasted NPVs are normally
lower than they would be if straight-line depreciation were required for tax purposes
c.If they use accelerated depreciation, firms can write off assets faster than they could
under straight-line depreciation, and as a result projects’ forecasted NPVs are normally
lower than they would be if straight-line depreciation were required for tax purposes
d.If they use accelerated depreciation, firms can write off assets faster than they could
under straight-line depreciation, and as a result projects’ forecasted NPVs are normally
higher than they would be if straight-line depreciation were required for tax purposes
e.Since depreciation is not a cash expense, and since cash flows and not accounting
income are the relevant input, depreciation plays no role in capital budgeting
13) The Gergen Group’s 5-year bonds yield 6.85%, and 5-year T-bonds yield 4.75%.
The real risk-free rate is r* = 2.80%, the default risk premium for Gergen’s bonds is
DRP = 0.85% versus zero for T-bonds, the liquidity premium on Gergen’s bonds is LP =
1.25%, and the maturity risk premium for all bonds is found with the formula MRP = (t
– 1) 0.1%, where t = number of years to maturity. What is the inflation premium (IP) on
5-year bonds?
a.1.40%
b.1.55%
c.1.71%
d.1.88%
e.2.06%
14) Jane Doe, who has substantial personal wealth and income, is considering the
possibility of starting a new business in the chemical waste management field. She will
be the sole owner, and she has enough funds to finance the operation. The business will
have a relatively high degree of risk, and it is expected that the firm will incur losses for
the first few years. However, the prospects for growth and positive future income look
good, and Jane plans to have the firm pay out all of its income as dividends to her once
it is well established. Which of the legal forms of business organization would probably
best suit her needs?
a. Proprietorship, because of ease of entry
b. S corporation, to gain some tax advantages and also to obtain limited liability
c. Partnership, but only if she needs additional capital
d. Regular corporation, because of the limited liability
e. In this situation, the various forms of organization seem equally desirable
15) Which of the following statements is CORRECT? (Assume that the risk-free rate is
a constant.)
a.The effect of a change in the market risk premium depends on the slope of the yield
curve
b.If the market risk premium increases by 1%, then the required return on all stocks will
rise by 1%
c.If the market risk premium increases by 1%, then the required return will increase by
1% for a stock that has a beta of 1.0
d.The effect of a change in the market risk premium depends on the level of the
risk-free rate
e.If the market risk premium increases by 1%, then the required return will increase for
stocks that have a beta greater than 1.0, but it will decrease for stocks that have a beta
less than 1.0
16) Harper Corp.’s sales last year were $395,000, and its year-end receivables were
$42,500. Harper sells on terms that call for customers to pay 30 days after the purchase,
but many delay payment beyond Day 30. On average, how many days late do
customers pay? Base your answer on this equation: DSO – Allowed credit period =
Average days late, and use a 365-day year when calculating the DSO.
a. 7.95
b. 8.37
c. 8.81
d. 9.27
e. 9.74
17) The indenture contains covenants that prevent the use of additional debt.
a.1, 4, 6
b.1, 2, 3, 4, 6
c.1, 2, 3, 4, 5, 6
d.1, 3, 4, 5, 6
e.1, 3, 4, 6
18) If a firm’s expected growth rate increased then its required rate of return would
a.decrease
b.fluctuate less than before
c.fluctuate more than before
d.possibly increase, possibly decrease, or possibly remain constant
e.increase
19) Stock A has a beta of 0.8, Stock B has a beta of 1.0, and Stock C has a beta of 1.2.
Portfolio P has 1/3 of its value invested in each stock. Each stock has a standard
deviation of 25%, and their returns are independent of one another, i.e., the correlation
coefficients between each pair of stocks is zero. Assuming the market is in equilibrium,
which of the following statements is CORRECT?
a.Portfolio P’s expected return is equal to the expected return on Stock A
b.Portfolio P’s expected return is less than the expected return on Stock B
c.Portfolio P’s expected return is equal to the expected return on Stock B
d.Portfolio P’s expected return is greater than the expected return on Stock C
e.Portfolio P’s expected return is greater than the expected return on Stock B
20) Which of the following statements is CORRECT?
a.Diversifiable risk can be reduced by forming a large portfolio, but normally even
highly-diversified portfolios are subject to market (or systematic) risk
b.A large portfolio of randomly selected stocks will have a standard deviation of returns
that is greater than the standard deviation of a 1-stock portfolio if that one stock has a
beta less than 1.0
c.A large portfolio of stocks whose betas are greater than 1.0 will have less market risk
than a single stock with a beta = 0.8
d.If you add enough randomly selected stocks to a portfolio, you can completely
eliminate all of the market risk from the portfolio
e.A large portfolio of randomly selected stocks will always have a standard deviation of
returns that is less than the standard deviation of a portfolio with fewer stocks,
regardless of how the stocks in the smaller portfolio are selected
21) Which of the following statements about dividend policies is correct?
a. One reason that companies tend to avoid stock repurchases is that dividend payments
are taxed at a lower rate than gains on stock repurchases
b. One advantage of dividend reinvestment plans is that they allow shareholders to
avoid paying taxes on the dividends that they choose to reinvest
c. One key advantage of a residual dividend policy is that it enables a company to
follow a stable dividend policy
d. The clientele effect suggests that companies should follow a stable dividend policy
e. Modigliani and Miller argue that investors prefer dividends to capital gains because
dividends are more certain than capital gains. They call this the “bird-in-the hand”
effect
22) Jenna holds a diversified $100,000 portfolio consisting of 20 stocks with $5,000
invested in each. The portfolio’s beta is 1.12. Jenna plans to sell a stock with b = 0.90
and use the proceeds to buy a new stock with b = 1.80. What will the portfolio’s new
beta be?
a.1.286
b.1.255
c.1.224
d.1.194
e.1.165
23) Which of the following statements is CORRECT?
a.The WACC is calculated using a before-tax cost for debt that is equal to the interest
rate that must be paid on new debt, along with the after-tax costs for common stock and
for preferred stock if it is used
b.An increase in the risk-free rate is likely to reduce the marginal costs of both debt and
equity
c.The relevant WACC can change depending on the amount of funds a firm raises
during a given year. Moreover, the WACC at each level of funds raised is a weighted
average of the marginal costs of each capital component, with the weights based on the
firm’s target capital structure
d.Beta measures market risk, which is generally the most relevant risk measure for a
publicly-owned firm that seeks to maximize its intrinsic value. However, this is not true
unless all of the firm’s stockholders are well diversified
e.The bond-yield-plus-risk-premium approach to estimating the cost of common equity
involves adding a risk premium to the interest rate on the company’s own long-term
bonds. The size of the risk premium for bonds with different ratings is published daily
in The Wall Street Journal
24) Wells Water Systems recently reported $8,250 of sales, $4,500 of operating costs
other than depreciation, and $950 of depreciation. The company had no amortization
charges, it had $3,250 of outstanding bonds that carry a 6.75% interest rate, and its
federal-plus-state income tax rate was 35%. In order to sustain its operations and thus
generate sales and cash flows in the future, the firm was required to spend $750 to buy
new fixed assets and to invest $250 in net operating working capital. How much free
cash flow did Wells generate?
a.$1,770.00
b.$1,858.50
c.$1,951.43
d.$2,049.00
e.$2,151.45
25) Which of the following statements is CORRECT?
a.Portfolio diversification reduces the variability of returns on an individual stock
b.Risk refers to the chance that some unfavorable event will occur, and a probability
distribution is completely described by a listing of the likelihood of unfavorable events
c.The SML relates a stock’s required return to its market risk. The slope and intercept of
this line cannot be controlled by the firms’ managers, but managers can influence their
firms’ positions on the line by such actions as changing the firm’s capital structure or the
type of assets it employs
d.A stock with a beta of -1.0 has zero market risk if held in a 1-stock portfolio
e.When diversifiable risk has been diversified away, the inherent risk that remains is
market risk, which is constant for all stocks in the market
26) Frederickson Office Supplies recently reported $12,500 of sales, $7,250 of
operating costs other than depreciation, and $1,250 of depreciation. The company had
no amortization charges and no non-operating income. It had $8,000 of bonds
outstanding that carry a 7.5% interest rate, and its federal-plus-state income tax rate was
40%. How much was the firm’s taxable income, or earnings before taxes (EBT)?
a.$3,230.00
b.$3,400.00
c.$3,570.00
d.$3,748.50
e.$3,935.93
27) Stocks A and B have the following data. Assuming the stock market is efficient and
the stocks are in equilibrium, which of the following statements is CORRECT?
AB
Price$25$25
Expected growth (constant)10%5%
Required return15%15%
a.Stock A has a higher dividend yield than Stock B
b.Currently the two stocks have the same price, but over time Stock B’s price will pass
that of A
c.Since Stock A’s growth rate is twice that of Stock B, Stock A’s future dividends will
always be twice as high as Stock B’s
d.The two stocks should not sell at the same price. If their prices are equal, then a
disequilibrium must exist
e.Stock A’s expected dividend at t = 1 is only half that of Stock B
28) Fitzgerald Computers is considering a new project whose data are shown below.
The required equipment has a 3-year tax life, after which it will be worthless, and it will
be depreciated by the straight-line method over 3 years. Revenues and other operating
costs are expected to be constant over the project’s 3-year life. What is the project’s Year
1 cash flow?
Equipment cost (depreciable basis)$65,000
Straight-line depreciation rate33.333%
Sales revenues, each year$60,000
Operating costs (excl. deprec.)$25,000
Tax rate35.0%
a.$28,115
b.$28,836
c.$29,575
d.$30,333
e.$31,092
29) A new company to produce state-of-the-art car stereo systems is being considered
by Jagger Enterprises. The sales price would be set at 1.5 times the variable cost per
unit; the VC/unit is estimated to be $2.50; and fixed costs are estimated at $120,000.
What sales volume would be required in order to break even, i.e., to have an EBIT of
zero for the stereo business?
a.86,640
b.91,200
c.96,000
d.100,800
e.105,840
30) Which of the following statements is CORRECT?
a.When calculating the cost of preferred stock, companies must adjust for taxes,
because dividends paid on preferred stock are deductible by the paying corporation
b.Because of tax effects, an increase in the risk-free rate will have a greater effect on the
after-tax cost of debt than on the cost of common stock as measured by the CAPM
c.If a company’s beta increases, this will increase the cost of equity used to calculate the
WACC, but only if the company does not have enough reinvested earnings to take care
of its equity financing and hence must issue new stock
d.Higher flotation costs reduce investors’ expected returns, and that leads to a reduction
in a company’s WACC
e.When calculating the cost of debt, a company needs to adjust for taxes, because
interest payments are deductible by the paying corporation
31) Lucy’s Music Emporium opened its doors on January 1, 2012, and it was granted
permission to use the same depreciation calculations for shareholder reporting and
income tax purposes. The company planned to depreciate its fixed assets over 20 years,
but in December 2012 management realized that the assets would last for only 15 years.
The firm’s accountants plan to report the 2012 financial statements based on this new
information. How would the new depreciation assumption affect the company’s
financial statements?
a.The firm’s net liabilities would increase
b.The firm’s reported net fixed assets would increase
c.The firm’s EBIT would increase
d.The firm’s reported 2012 earnings per share would increase
e.The firm’s cash position in 2012 and 2013 would increase
32) Suppose a carton of hockey pucks sell in Canada for 105 Canadian dollars, and 1
Canadian dollar equals 0.71 U.S. dollars. If purchasing power parity (PPP) holds, what
is the price of hockey pucks in the United States?
a.$14.79
b.$63.00
c.$74.55
d.$85.88
e.$147.88
33) Kasper Film Co. is selling off some old equipment it no longer needs because its
associated project has come to an end. The equipment originally cost $22,500, of which
75% has been depreciated. The firm can sell the used equipment today for $6,000, and
its tax rate is 40%. What is the equipment’s after-tax salvage value for use in a capital
budgeting analysis? Note that if the equipment’s final market value is less than its book
value, the firm will receive a tax credit as a result of the sale.
a.$5,558
b.$5,850
c.$6,143
d.$6,450
e.$6,772
34) Sherrie Hymes holds a $200,000 portfolio consisting of the following stocks. The
portfolio’s beta is 0.875.
StockInvestmentBeta
A$50,0000.50
B50,0000.80
C50,0001.00
D50,0001.20
Total$200,000
If Sherrie replaces Stock A with another stock, E, which has a beta of 1.50, what will
the portfolio’s new beta be?
a.1.07
b.1.13
c.1.18
d.1.24
e.1.30
35) While developing a new product line, Cook Company spent $3 million two years
ago to build a plant for a new product. It then decided not to go forward with the
project, so the building is available for sale or for a new product. Cook owns the
building free and clearthere is no mortgage on it. Which of the following statements is
CORRECT?
a.If the building could be sold, then the after-tax proceeds that would be generated by
any such sale should be charged as a cost to any new project that would use it
b.This is an example of an externality, because the very existence of the building affects
the cash flows for any new project that Rowell might consider
c.Since the building was built in the past, its cost is a sunk cost and thus need not be
considered when new projects are being evaluated, even if it would be used by those
new projects
d.If there is a mortgage loan on the building, then the interest on that loan would have
to be charged to any new project that used the building
e.Since the building has been paid for, it can be used by another project with no
additional cost. Therefore, it should not be reflected in the cash flows for any new
project
36) Which of the following statements is CORRECT?
a. All else equal, increasing the debt ratio will increase the ROA
b. The use of debt financing will tend to lower the basic earning power ratio, other
things held constant
c. A firm that employs financial leverage will have a higher equity multiplier than an
otherwise identical firm that has no debt in its capital structure
d. If two firms have identical sales, interest rates paid, operating costs, and assets, but
differ in the way they are financed, the firm with less debt will generally have the
higher expected ROE
e. Holding bonds is better than holding stock for investors because income from bonds
is taxed on a more favorable basis than income from stock
37) Data on Mertz Co. for the most recent year are shown below, along with the
payables deferral period (PDP) for the firms against which it benchmarks. The firm’s
new CFO believes that the company could delay payments enough to increase its PDP
to the benchmarks’ average. If this were done, by how much would payables increase?
Use a 365-day year.
Cost of goods sold =$75,000
Payables =$5,000
Payables deferral period (PDP) =24.33
Benchmark payables deferral period =30.00
a.$764
b.$849
c.$943
d.$1,048
e.$1,164
38) Assume that the risk-free rate, rRF, increases but the market risk premium, (rM –
rRF), declines, with the net effect being that the overall required return on the market,
rM, remains constant. Which of the following statements is CORRECT?
a.The required return will decline for stocks that have a beta less than 1.0 but will
increase for stocks that have a beta greater than 1.0
b.Since the overall return on the market stays constant, the required return on each
individual stock will also remain constant
c.The required return will increase for stocks that have a beta less than 1.0 but decline
for stocks that have a beta greater than 1.0
d.The required return of all stocks will fall by the amount of the decline in the market
risk premium
e.The required return of all stocks will increase by the amount of the increase in the
risk-free rate
39) Projects S and L are equally risky, mutually exclusive, and have normal cash flows.
Project S has an IRR of 15%, while Project L’s IRR is 12%. The two projects have the
same NPV when the WACC is 7%. Which of the following statements is CORRECT?
a.If the WACC is 6%, Project S will have the higher NPV
b.If the WACC is 13%, Project S will have the lower NPV
c.If the WACC is 10%, both projects will have a negative NPV
d.Project S’s NPV is more sensitive to changes in WACC than Project L’s
e.If the WACC is 10%, both projects will have positive NPVs
40) Because “present value” refers to the value of cash flows that occur at different
points in time, a series of present values of cash flows should not be summed to
determine the value of a capital budgeting project.
41) If an individual investor buys or sells a currently outstanding stock through a
broker, this is a primary market transaction.
42) “Restrictive covenants” are designed primarily to protect bondholders by
constraining the actions of managers. Such covenants are spelled out in bond
indentures.
43) Accruals are ‘spontaneous,” but unfortunately, due to law and economic forces,
firms have little control over the level of these accounts.
44) A zero coupon bond is a bond that pays no interest and is offered (and subsequently
sells initially) at par. These bonds provide compensation to investors in the form of
capital appreciation.
45) On average, a firm collects checks totaling $250,000 per day. It takes the firm
approximately 4 days from the day the checks were mailed until they result in usable
cash for the firm. Assume that (1) a lockbox system could be employed which would
reduce the cash conversion procedure to 2 1/2 days and (2) the firm could invest any
additional cash generated at 6% after taxes. The lockbox system would be a good buy if
it costs $25,000 annually.
46) If a stock’s expected return as seen by the marginal investor exceeds this investor’s
required return, then the investor will buy the stock until its price has risen enough to
bring the expected return down to equal the required return.