1) Cornwall Corporation is planning to raise $1,000,000 to finance a new plant. Which
of the following statements is CORRECT?
a.If debt is used to raise the million dollars, but $500,000 is raised as first mortgage
bonds on the new plant and $500,000 as debentures, the interest rate on the first
mortgage bonds would be lower than it would be if the entire $1 million were raised by
selling first mortgage bonds
b.If two tiers of debt are used (with one senior and one subordinated debt class), the
subordinated debt will carry a lower interest rate
c.If debt is used to raise the million dollars, the cost of the debt would be lower if the
debt were in the form of a fixed-rate bond rather than a floating-rate bond
d.If debt is used to raise the million dollars, the cost of the debt would be higher if the
debt were in the form of a mortgage bond rather than an unsecured term loan
e.The company would be especially eager to have a call provision included in the
indenture if its management thinks that interest rates are almost certain to rise in the
foreseeable future
2) Stephenson Co.’s 15-year bond with a face value of $1,000 currently sells for $850.
Which of the following statements is CORRECT?
a.The bond’s current yield exceeds its yield to maturity
b.The bond’s yield to maturity is greater than its coupon rate
c.The bond’s current yield is equal to its coupon rate
d.If the yield to maturity stays constant until the bond matures, the bond’s price will
remain at $850
e.The bond’s coupon rate exceeds its current yield
3) Last week, Weschler Paint Corp. completed a 3-for-1 stock split. Immediately prior
to the split, its stock sold for $150 per share. The firm’s total market value was
unchanged by the split. Other things held constant, what is the best estimate of the
stock’s post-split price?
a. $50.00
b. $52.50
c. $55.13
d. $57.88
e. $60.78
4) Sheridan Films is considering some new equipment whose data are shown below.
The equipment has a 3-year tax life and would be fully depreciated by the straight-line
method over 3 years, but it would have a positive pre-tax salvage value at the end of
Year 3, when the project would be closed down. Also, some new working capital would
be required, but it would be recovered at the end of the project’s life. Revenues and
other operating costs are expected to be constant over the project’s 3-year life. What is
the project’s NPV?
WACC10.0%
Net investment in fixed assets (depreciable basis)$70,000
Required new working capital$10,000
Straight-line deprec. rate33.333%
Sales revenues, each year$75,000
Operating costs (excl. deprec.), each year$30,000
Expected pretax salvage value$5,000
Tax rate35.0%
a.$20,762
b.$21,854
c.$23,005
d.$24,155
e.$25,363
5) Suppose Stackpool Inc. had inventory in Britain valued at 240,000 pounds one year
ago. The exchange rate for dollars to pounds was 1£ = 2 U.S. dollars. This year the
exchange rate is 1£ = 1.82 U.S. dollars. The inventory in Britain is still valued at
240,000 pounds. What is the gain or loss in inventory value in U.S. dollars as a result of
the change in exchange rates?
a.-$240,000
b.-$43,200
c.$0
d.$43,200
e.$47,473
6) The current price of a stock is $22, and at the end of one year its price will be either
$27 or $17. The annual risk-free rate is 6.0%, based on daily compounding. A 1-year
call option on the stock, with an exercise price of $22, is available. Based on the
binomial model, what is the option’s value? (Hint: Use daily compounding.)
a.$2.43
b.$2.70
c.$2.99
d.$3.29
e.$3.62
7) Barnette Inc.’s free cash flows are expected to be unstable during the next few years
while the company undergoes restructuring. However, FCF is expected to be $50
million in Year 5, i.e., FCF at t = 5 equals $50 million, and the FCF growth rate is
expected to be constant at 6% beyond that point. If the weighted average cost of capital
is 12%, what is the horizon value (in millions) at t = 5?
a.$719
b.$757
c.$797
d.$839
e.$883
8) Which of the following statements concerning the cash budget is CORRECT?
a.Cash budgets do not include financial items such as interest and dividend payments
b.Cash budgets do not include cash inflows from long-term sources such as the issuance
of bonds
c.Changes that affect the DSO do not affect the cash budget
d.Capital budgeting decisions have no effect on the cash budget until projects go into
operation and start producing revenues
e.Depreciation expense is not explicitly included, but depreciation’s effects are reflected
in the estimated tax payments
9) Which of the following statements is CORRECT?
a.If rates fall after its issue, a zero coupon bond could trade at a price above its par
value
b.If rates fall rapidly, a zero coupon bond’s expected appreciation could become
negative
c.If a firm moves from a position of strength toward financial distress, its bonds’ yield
to maturity would probably decline
d.If a bond is selling at a premium, this implies that its yield to maturity exceeds its
coupon rate
e.If a coupon bond is selling at par, its current yield equals its yield to maturity
10) An investor who writes standard call options against stock held in his or her
portfolio is said to be selling what type of options?
a.Put
b.Naked
c.Covered
d.Out-of-the-money
e.In-the-money
11) Pascarella Inc. is revising its payables policy. It has annual sales of $50,735,000, an
average inventory level of $15,012,000, and average accounts receivable of
$10,008,000. The firm’s cost of goods sold is 85% of sales. The company makes all
purchases on credit and has always paid on the 30th day. However, it now plans to take
full advantage of trade credit and to pay its suppliers on the 40th day. The CFO also
believes that sales can be maintained at the existing level but inventory can be lowered
by $1,946,000 and accounts receivable by $1,946,000. What will be the net change in
the cash conversion cycle, assuming a 365-day year?
a.-26.6 days
b.-29.5 days
c.-32.8 days
d.-36.4 days
e.-40.5 days
12) Reynolds Paper Products Corporation follows a strict residual dividend policy. All
else equal, which of the following factors would be most likely to lead to an increase in
the firm’s dividend per share?
a. The company increases the percentage of equity in its target capital structure
b. The number of profitable potential projects increases
c. Congress lowers the tax rate on capital gains. The remainder of the tax code is not
changed
d. Earnings are unchanged, but the firm issues new shares of common stock
e. The firm’s net income increases
13) Sommers Co.’s bonds currently sell for $1,080 and have a par value of $1,000. They
pay a $100 annual coupon and have a 15-year maturity, but they can be called in 5 years
at $1,125. What is their yield to maturity (YTM)?
a.8.56%
b.9.01%
c.9.46%
d.9.93%
e.10.43%
14) Which of the following statements is CORRECT?
a. One of the disadvantages of incorporating a business is that the owners then become
subject to liabilities in the event the firm goes bankrupt
b. Sole proprietorships are subject to more regulations than corporations
c. In any type of partnership, every partner has the same rights, privileges, and liability
exposure as every other partner
d. Sole proprietorships and partnerships generally have a tax advantage over many
corporations, especially large ones
e. Corporations of all types are subject to the corporate income tax
15) Refer to Exhibit 3.1. What is the firm’s ROE?
a. 8.54%
b. 8.99%
c. 9.44%
d. 9.91%
e. 10.41%
16) Companies generate income from their “regular” operations and from other sources
like interest earned on the securities they hold, which is called non-operating income.
Lindley Textiles recently reported $12,500 of sales, $7,250 of operating costs other than
depreciation, and $1,000 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
Lindley’s operating income, or EBIT?
a.$3,462
b.$3,644
c.$3,836
d.$4,038
e.$4,250
17) Companies Heidee and Leaudy have the same total assets, sales, operating costs,
and tax rates, and they pay the same interest rate on their debt. However, company
Heidee has a higher debt ratio. Which of the following statements is CORRECT?
a. If the interest rate the companies pay on their debt is less than their basic earning
power (BEP), then Company Heidee will have the higher ROE
b. Given this information, Leaudy must have the higher ROE
c. Company Leaudy has a higher basic earning power ratio (BEP)
d. Company Heidee has a higher basic earning power ratio (BEP)
e. If the interest rate the companies pay on their debt is more than their basic earning
power (BEP), then Company Heidee will have the higher ROE
18) Whaley & Whaley has the following data. What is the firm’s cash conversion cycle?
Inventory conversion period =41 days
Average collection period =31 days
Payables deferral period =38 days
a.31 days
b.34 days
c.37 days
d.41 days
e.45 days
19) Assume that in recent years both expected inflation and the market risk premium
(rM – rRF) have declined. Assume also that all stocks have positive betas. Which of the
following would be most likely to have occurred as a result of these changes?
a.The required returns on all stocks have fallen, but the fall has been greater for stocks
with higher betas
b.The average required return on the market, rM, has remained constant, but the
required returns have fallen for stocks that have betas greater than 1.0
c.Required returns have increased for stocks with betas greater than 1.0 but have
declined for stocks with betas less than 1.0
d.The required returns on all stocks have fallen by the same amount
e.The required returns on all stocks have fallen, but the decline has been greater for
stocks with lower betas
20) Refer to Exhibit 3.1. What is the firm’s BEP?
a. 6.00%
b. 6.32%
c. 6.65%
d. 6.98%
e. 7.33%
21) Fairweather Corporation purchases merchandise on terms of 2/15, net 40, and its
gross purchases (i.e., purchases before taking off the discount) are $800,000 per year.
What is the maximum dollar amount of costly trade credit the firm could get, assuming
it abides by the supplier’s credit terms? (Assume a 365-day year.)
a.$53,699
b.$56,384
c.$59,203
d.$62,163
e.$65,271
22) Last year Baron Enterprises had $350 million of sales, and it had $270 million of
fixed assets that were used at 65% of capacity last year. In millions, by how much could
Baron’s sales increase before it is required to increase its fixed assets?
a.$170.09
b.$179.04
c.$188.46
d.$197.88
e.$207.78
23) Refer to Exhibit 15.2. What would the stock price be if VF issued the new debt and
immediately used the proceeds to repurchase stock?
a.$49.43
b.$50.70
c.$52.00
d.$53.33
e.$56.00
24) Chandler Co.’s 5-year bonds yield 7.00%, and 5-year T-bonds yield 5.15%. The real
risk-free rate is r* = 3.0%, the inflation premium for 5-year bonds is IP = 1.75%, the
liquidity premium for Chandler’s bonds is LP = 0.75% versus zero for T-bonds, 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 default risk premium (DRP) on
Chandler’s bonds?
a.0.99%
b.1.10%
c.1.21%
d.1.33%
e.1.46%
25) Andrews Corporation buys on terms of 2/8, net 45 days, it does not take discounts,
and it actually pays after 58 days. What is the effective annual percentage cost of its
non-free trade credit? (Use a 365-day year.)
a.14.34%
b.15.10%
c.15.89%
d.16.69%
e.17.52%
26) A firm is considering a new project whose risk is greater than the risk of the firm’s
average project, based on all methods for assessing risk. In evaluating this project, it
would be reasonable for management to do which of the following?
a.Increase the estimated NPV of the project to reflect its greater risk
b.Reject the project, since its acceptance would increase the firm’s risk
c.Ignore the risk differential if the project would amount to only a small fraction of the
firm’s total assets
d.Increase the cost of capital used to evaluate the project to reflect its
higher-than-average risk
e.Increase the estimated IRR of the project to reflect its greater risk
27) Bonds for two companies were just issued: Short Corp.’s bonds will mature in 5
years, and Long Corp.’s bonds will mature in 15 years. Both bonds promise to pay a
semiannual coupon, they are not callable or convertible, and they are equally liquid.
Further, assume that the Treasury yield curve is based only on expectations about future
inflation, i.e., that the maturity risk premium is zero for T-bonds. Under these
conditions, which of the following statements is correct?
a.If the Treasury yield curve is downward sloping, Long’s bonds must under all
conditions have the lower yield
b.If the yield curve for Treasury securities is upward sloping, Long’s bonds must under
all conditions have a higher yield than Short’s bonds
c.If the yield curve for Treasury securities is flat, Short’s bond must under all conditions
have the same yield as Long’s bonds
d.If Long’s and Short’s bonds have the same default risk, their yields must under all
conditions be equal
e.If the Treasury yield curve is upward sloping and Short has less default risk than
Long, then Short’s bonds must under all conditions have the lower yield
28) Suppose Acme Industries correctly estimates its WACC at a given point in time and
then uses that same cost of capital to evaluate all projects for the next 10 years, then the
firm will most likely
a.become less risky over time, and this will maximize its intrinsic value
b.accept too many low-risk projects and too few high-risk projects
c.become more risky and also have an increasing WACC. Its intrinsic value will not be
maximized
d.continue as before, because there is no reason to expect its risk position or value to
change over time as a result of its use of a single cost of capital
e.become riskier over time, but its intrinsic value will be maximized
29) The CAPM is a multi-period model that takes account of differences in securities’
maturities, and it can be used to determine the required rate of return for any given level
of systematic risk.
30) The primary reason that the NPV method is conceptually superior to the IRR
method for evaluating mutually exclusive investments is that multiple IRRs may exist,
and when that happens, we don’t know which IRR is relevant.
31) Individuals and corporations can buy or sell forward currencies to hedge their
exchange rate exposure. Essentially, the process involves simultaneously selling the
currency expected to appreciate in value and buying the currency expected to
depreciate.
32) As the text indicates, a firm’s financial risk has identifiable market risk and
diversifiable risk components.
33) In theory, capital budgeting decisions should depend solely on forecasted cash
flows and the opportunity cost of capital. The decision criterion should not be affected
by managers’ tastes, choice of accounting method, or the profitability of other
independent projects.
34) Any change in its beta is likely to affect the required rate of return on a stock, which
implies that a change in beta will likely have an impact on the stock’s price, other things
held constant.