Fama’s Llamas has a weighted average cost of capital of 10.5 percent. The company’s
cost of equity is 15.5 percent, and its pretax cost of debt is 8.5 percent. The tax rate is
34 percent. What is the company’s target debt-equity ratio?
A. 0.89
B. 0.92
C. 0.98
D. 1.01
E. 1.02
You are considering a new product launch. The project will cost $630,000, have a 5-
year life, and have no salvage value; depreciation is straight-line to zero. Sales are
projected at 160 units per year, price per unit will be $24,000, variable cost per unit will
be $12,000, and fixed costs will be $283,000 per year. The required return is 11 percent
and the relevant tax rate is 34 percent. Based on your experience, you think the unit
sales, variable cost, and fixed cost projections given here are probably accurate to
within ±9 percent. What is the worst case NPV?
A. $3,417,907
B. $2,654,241
C. $888,618
D. $3,102,134
E. $3,458,020
Which one of the following stocks is correctly priced if the risk-free rate of return is 3.2
percent and the market rate of return is 11.76 percent?
A. A
B. B
C. C
D. D
E. E
Ratios that measure a firm’s financial leverage are known as _____ ratios.
A. asset management
B. long-term solvency
C. short-term solvency
D. profitability
E. book value
A proposed project has fixed costs of $9,800, depreciation expense of $2,700, and a
sales quantity of 2,100 units. The total variable costs are $5,607. What is the
contribution margin per unit if the projected level of sales is the accounting break-even
point?
A. $3.28
B. $4.07
C. $5.95
D. $6.16
E. $7.11
Allison has developed a set of procedures for determining the amount of each raw
material that she needs to have in inventory if she is to keep her firm’s assembly lines
operating efficiently. These procedures are commonly referred to by which one of the
following terms?
A. first-in, first-out method
B. the Baumol model
C. net working capital planning
D. economic order procedures
E. materials requirements planning
What is the times interest earned ratio for 2009?
A. 9.63
B. 10.12
C. 12.59
D. 14.97
E. 16.05
You need $25,000 today and have decided to take out a loan at 7 percent for five years.
Which one of the following loans would be the least expensive? Assume all loans
require monthly payments and that interest is compounded on a monthly basis.
A. interest-only loan
B. amortized loan with equal principal payments
C. amortized loan with equal loan payments
D. discount loan
E. balloon loan where 50 percent of the principal is repaid as a balloon payment
The unlevered cost of capital refers to the cost of capital for a(n):
A. private entity.
B. all-equity firm.
C. governmental entity.
D. private individual.
E. corporate shareholder.
Which one of the following statements correctly describes your situation as the holder
of a European call option?
A. You are obligated to buy if the option is exercised.
B. You have a right to sell.
C. You have a right to buy but only on the expiration date.
D. You are obligated to sell if the option is exercised.
E. You have a right to buy at any time before the option expires.
Which one of the following would make a project unacceptable?
A. cash inflow for net working capital at time zero
B. requiring fixed assets that would have no salvage value
C. an equivalent annual cost that exceeds that of an alternative project
D. lack of revenue generation
E. a depreciation tax shield that exceeds the value of the interest expense
Stock in Country Road Industries has a beta of 0.97. The market risk premium is 10
percent while T-bills are currently yielding 5.5 percent. Country Road’s most recent
dividend was $1.70 per share, and dividends are expected to grow at a 7 percent annual
rate indefinitely. The stock sells for $32 a share. What is the estimated cost of equity
using the average of the CAPM approach and the dividend discount approach?
A. 13.94 percent
B. 14.06 percent
C. 14.21 percent
D. 14.38 percent
E. 14.50 percent
The subjective approach to project analysis:
A. is used only when a firm has an all-equity capital structure.
B. uses the WACC of firm X as the basis for the discount rate for a project under
consideration by firm Y.
C. assigns discount rates to projects based on the discretion of the senior managers of a
firm.
D. allows managers to randomly adjust the discount rate assigned to a project once the
project’s beta has been determined.
E. applies a lower discount rate to projects that are financed totally with equity as
compared to those that are partially financed with debt.
Consider an asset that costs $176,000 and is depreciated straight-line to zero over its 11-
year tax life. The asset is to be used in a 7-year project; at the end of the project, the
asset can be sold for $22,000. The relevant tax rate is 30 percent. What is the aftertax
cash flow from the sale of this asset?
A. $31,800
B. $32,600
C. $33,300
D. $34,100
E. $34,600
When Chris balanced her business checkbook, she had an adjusted bank balance of
$11,418. She had 2 outstanding deposits worth $879 each and 11 checks outstanding
with a total value of $3,648. What is the amount of the collection float on this account?
A. -$1,890
B. $1,758
C. $3,648
D. $5,406
E. $6,012
Which one of the following is the electronic system used by the NYSE for directly
transmitting orders to specialists?
A. OTCDOT
B. SuperDOT
C. Instinet
D. Internet
E. Floornet
According to CAPM, the amount of reward an investor receives for bearing the risk of
an individual security depends upon the:
A. amount of total risk assumed and the market risk premium.
B. market risk premium and the amount of systematic risk inherent in the security.
C. risk free rate, the market rate of return, and the standard deviation of the security.
D. beta of the security and the market rate of return.
E. standard deviation of the security and the risk-free rate of return.
The common stock of Air United, Inc., had annual returns of 15.6 percent, 2.4 percent,
-11.8 percent, and 32.9 percent over the last four years, respectively. What is the
standard deviation of these returns?
A. 13.29 percent
B. 14.14 percent
C. 16.50 percent
D. 17.78 percent
E. 19.05 percent
Anytime Ted analyzes a proposed project, he always assigns a much higher probability
of success to the project than is warranted by the information he has gathered. Ted
suffers from which one of the following?
A. frame dependence
B. overconfidence
C. gambler’s fallacy
D. confirmation bias
E. overoptimism
You are considering the following two mutually exclusive projects. Both projects will
be depreciated using straight-line depreciation to a zero book value over the life of the
project.
Neither project has any salvage value.
Should you accept or reject these projects based on IRR analysis?
A. accept Project A and reject Project B
B. reject Project A and accept Project B
C. accept both Projects A and B
D. reject both Projects A and B
E. You cannot make this decision based on internal rate of return analysis.
Assume the spot rate on the Canadian dollar is C$1.1847. The risk-free nominal rate in
the U.S. is 5 percent while it is only 4 percent in Canada. What one-year forward rate
will create interest rate parity?
A. C$1.1362
B. C$1.1429
C. C$1.1734
D. C$1.1799
E. C$1.1961
Collection float:
A. is more desirable to firms than disbursement float.
B. is totally eliminated by the installation of a lockbox system.
C. exists when a firm’s available balance exceeds its book balance.
D. can be avoided by collecting payments electronically at the time of sale.
You own nine convertible bonds. These bonds have a 7 percent coupon, a $1,000 face
value, and mature in 6 years. The bonds are convertible into shares of common stock at
a conversion price of $25. How many shares of stock will you receive if you convert all
of your bonds?
A. 285
B. 300
C. 350
D. 360
E. 400
Suppose the following bond quote for the Beta Company appears in the financial page
of today’s newspaper. Assume the bond has a face value of $1,000 and the current date
is April 15, 2009. What is the yield to maturity on this bond?
A. 6.64 percent
B. 8.96 percent
C. 10.23 percent
D. 12.47 percent
E. 13.27 percent
If an acquisition does not create value and the market is smart, then the:
A. earnings per share of the acquiring firm must be the same both before and after the
acquisition.
B. earnings per share can change but the stock price of the acquiring firm should remain
constant.
C. price per share of the acquiring firm should increase because of the growth of the
firm.
D. earnings per share will most likely increase while the price-earnings ratio remains
constant.
E. price-earnings ratio should remain constant regardless of any changes in the earnings
per share.
Your coin collection contains fifty-four 1941 silver dollars. Your grandparents
purchased them for their face value when they were new. These coins have appreciated
at a 10 percent annual rate. How much will your collection be worth when you retire in
2060?
A. $3,611,008
B. $3,987,456
C. $4,122,394
D. $4,421,008
E. $4,551,172
The internal growth rate of a firm is best described as the:
A. minimum growth rate achievable assuming a 100 percent retention ratio.
B. minimum growth rate achievable if the firm maintains a constant equity multiplier.
C. maximum growth rate achievable excluding external financing of any kind.
D. maximum growth rate achievable excluding any external equity financing while
maintaining a constant debt-equity ratio.
E. maximum growth rate achievable with unlimited debt financing.
A call option contract:
A. obligates both the buyer and the seller.
B. obligates the buyer but not the seller.
C. grants rights to the buyer and obligates the seller.
D. grants rights to the seller and obligates the buyer.
E. grants rights to both the buyer and the seller but does not obligate either party.
You own eight call option contracts on Swift Water Tours stock with a strike price of
$15. When you purchased the shares the option price was $0.30 and the stock price was
$15.25. What is the total intrinsic value of these options if the stock is currently selling
for $16.08 a share?
A. -$83
B. -$1.08
C. $0
D. $108
E. $864
The counter area on the floor of the NYSE where a specialist operates is called a:
A. pit.
B. hot spot.
C. seat.
D. post.
E. DOT.
A purely financial merger:
A. increases the risk that the merged firm will default on its debt obligations.
B. has no effect on the risk level of the firm’s debt.
C. reduces the value of the option to go bankrupt.
D. has no effect on the equity value of a firm.
E. reduces the risk level of the firm and increases the value of the firm’s equity.
Why might a borrower select an interest-only loan instead of an amortized loan, which
would be cheaper?
Draw the following two graphs, one above the other: In the top graph, plot firm value
on the vertical axis and total debt on the horizontal axis.
045 = [ROE × (1 – 0.
Firms can frequently create synergy by merging and sharing complementary resources
with another firm.
Using the dividend growth model, explain why a firm would be hesitant to reduce the
growth rate of its dividends.
Why might firms forego discounts offered by their suppliers even though it is costly to
do so? What steps might a firm pursue to be able to take these discounts?
Suppose your boss comes to you and asks you to re-evaluate a capital budgeting
project. The first evaluation was in error, he explains, because it ignored flotation costs.
To correct for this, he asks you to evaluate the project using a higher cost of capital
which incorporates these costs. Is your boss’ approach correct? Why or why not?
You want to invest in an index fund which directly correlates to the overall U.S. stock
market. How can you determine if the market risk premium you are expecting to earn is
reasonable for the long-term?
Explain why a low-priced, low trading volume stock is more apt to present limits to
arbitrage than is a high-priced, high trading volume stock.
Inflation has remained low for the past three years but you have come to the conclusion
that trend is ending and inflation will increase significantly over the next 18 months.
Assume you have reached this conclusion prior to other investors reaching the same
conclusion. What adjustments should you make to your bond portfolio in light of your
conclusions?
Explain why financial mergers tend to benefit bondholders more than shareholders.