1) Refer to Exhibit 3.1. What is the firm’s TIE?
a. 1.94
b. 2.15
c. 2.39
d. 2.66
e. 2.93
2) You are considering two mutually exclusive, equally risky, projects. Both have IRRs
that exceed the WACC. Which of the following statements is CORRECT? Assume that
the projects have normal cash flows, with one outflow followed by a series of inflows.
a.If the cost of capital is greater than the crossover rate, then the IRR and the NPV
criteria will not result in a conflict between the projects. The same project will rank
higher by both criteria
b.If the cost of capital is less than the crossover rate, then the IRR and the NPV criteria
will not result in a conflict between the projects. The same project will rank higher by
both criteria
c.For a conflict to exist between NPV and IRR, the initial investment cost of one project
must exceed the cost of the other
d.For a conflict to exist between NPV and IRR, one project must have an increasing
stream of cash flows over time while the other has a decreasing stream. If both sets of
cash flows are increasing or decreasing, then it would be impossible for a conflict to
exist, even if one project is larger than the other
e.If the two projects’ NPV profiles do not cross, then there will be a sharp conflict as to
which one should be selected
3) Refer to Exhibit 3.1. What is the firm’s EPS?
a. $5.84
b. $6.15
c. $6.47
d. $6.80
e. $7.14
4) Reynolds Construction’s value of operations is $750 million based on the corporate
valuation model. Its balance sheet shows $50 million of short-term investments that are
unrelated to operations, $100 million of accounts payable, $100 million of notes
payable, $200 million of long-term debt, $40 million of common stock (par plus
paid-in-capital), and $160 million of retained earnings. What is the best estimate for the
firm’s value of equity, in millions?
a.$429
b.$451
c.$475
d.$500
e.$525
5) The YTMs of three $1,000 face value bonds that mature in 10 years and have the
same level of risk are equal. Bond A has an 8% annual coupon, Bond B has a 10%
annual coupon, and Bond C has a 12% annual coupon. Bond B sells at par. Assuming
interest rates remain constant for the next 10 years, which of the following statements is
CORRECT?
a.Since the bonds have the same YTM, they should all have the same price, and since
interest rates are not expected to change, their prices should all remain at their current
levels until maturity
b.Bond C sells at a premium (its price is greater than par), and its price is expected to
increase over the next year
c.Bond A sells at a discount (its price is less than par), and its price is expected to
increase over the next year
d.Over the next year, Bond A’s price is expected to decrease, Bond B’s price is expected
to stay the same, and Bond C’s price is expected to increase
e.Bond A’s current yield will increase each year
6) Suppose that during the coming year, the risk free rate, rRF, is expected to remain the
same, while the market risk premium (rM – rRF), is expected to fall. Given this forecast,
which of the following statements is CORRECT?
a.The required return on all stocks will remain unchanged
b.The required return will fall for all stocks, but it will fall more for stocks with higher
betas
c.The required return for all stocks will fall by the same amount
d.The required return will fall for all stocks, but it will fall less for stocks with higher
betas
e.The required return will increase for stocks with a beta less than 1.0 and will decrease
for stocks with a beta greater than 1.0
7) Stock X has a beta of 0.6, while Stock Y has a beta of 1.4. Which of the following
statements is CORRECT?
a.Stock Y must have a higher expected return and a higher standard deviation than
Stock X
b.If expected inflation increases but the market risk premium is unchanged, then the
required return on both stocks will fall by the same amount
c.If the market risk premium declines but expected inflation is unchanged, the required
return on both stocks will decrease, but the decrease will be greater for Stock Y
d.If expected inflation declines but the market risk premium is unchanged, then the
required return on both stocks will decrease but the decrease will be greater for Stock Y
e.A portfolio consisting of $50,000 invested in Stock X and $50,000 invested in Stock
Y will have a required return that exceeds that of the overall market
8) Refer to Exhibit 3.1. What is the firm’s P/E ratio?
a. 12.0
b. 12.6
c. 13.2
d. 13.9
e. 14.6
9) Refer to Exhibit 15.4. Now assume that AJC is considering changing from its
original capital structure to a new capital structure with 50% debt and 50% equity. If it
makes this change, its resulting market value would be $820,000. What would be its
new stock price per share?
a.$58
b.$59
c.$60
d.$61
e.$62
10) Quinlan Enterprises stock trades for $52.50 per share. It is expected to pay a $2.50
dividend at year end (D1 = $2.50), and the dividend is expected to grow at a constant
rate of 5.50% a year. The before-tax cost of debt is 7.50%, and the tax rate is 40%. The
target capital structure consists of 45% debt and 55% common equity. What is the
company’s WACC if all the equity used is from reinvested earnings?
a.7.07%
b.7.36%
c.7.67%
d.7.98%
e.8.29%
11) Which of the following statements is CORRECT?
a.WACC calculations should be based on the before-tax costs of all the individual
capital components
b.Flotation costs associated with issuing new common stock normally reduce the
WACC
c.If a company’s tax rate increases, then, all else equal, its weighted average cost of
capital will decline
d.An increase in the risk-free rate will normally lower the marginal costs of both debt
and equity financing
e.A change in a company’s target capital structure cannot affect its WACC
12) Refer to Exhibit 3.1. What is the firm’s ROA?
a. 2.70%
b. 2.97%
c. 3.26%
d. 3.59%
e. 3.95%
13) Which of the following statements is CORRECT?
a.One way to increase EVA is to achieve the same level of operating income but with
more investor-supplied capital
b.If a firm reports positive net income, its EVA must also be positive
c.One drawback of EVA as a performance measure is that it mistakenly assumes that
equity capital is free
d.One way to increase EVA is to generate the same level of operating income but with
less investor-supplied capital
e.Actions that increase reported net income will always increase net cash flow
14) The Anderson Company has equal amounts of low-risk, average-risk, and high-risk
projects. The firm’s overall WACC is 12%. The CFO believes that this is the correct
WACC for the company’s average-risk projects, but that a lower rate should be used for
lower-risk projects and a higher rate for higher-risk projects. The CEO disagrees, on the
grounds that even though projects have different risks, the WACC used to evaluate each
project should be the same because the company obtains capital for all projects from the
same sources. If the CEO’s position is accepted, what is likely to happen over time?
a.The company will take on too many low-risk projects and reject too many high-risk
projects
b.Things will generally even out over time, and, therefore, the firm’s risk should remain
constant over time
c.The company’s overall WACC should decrease over time because its stock price
should be increasing
d.The CEO’s recommendation would maximize the firm’s intrinsic value
e.The company will take on too many high-risk projects and reject too many low-risk
projects
15) Consider the following average annual returns for Stocks A and B and the Market.
Which of the possible answers best describes the historical betas for A and B?
YearsMarketStock AStock B
1 0.030.160.05
2-0.050.200.05
3 0.010.180.05
4-0.100.250.05
5 0.060.140.05
a.bA > +1; bB = 0.
b.bA = 0; bB = -1.
c.bA < 0; bB = 0.
d.bA < -1; bB = 1.
e.bA > 0; bB = 1.
16) Which of the following statements is CORRECT?
a. The financial manager’s proper goal should be to attempt to maximize the firm’s
expected cash flows, since that will add the most to the individual shareholders’ wealth
b. The financial manager should seek that combination of assets, liabilities, and capital
that will generate the largest expected projected after-tax income over the relevant time
horizon, generally the coming year
c. The riskiness inherent in a firm’s earnings per share (EPS) depends on the
characteristics of the projects the firm selects, and thus on the firm’s assets. However,
EPS is not affected by the manner in which those assets are financed
d. Potential agency problems can arise between managers and stockholders, because
managers hired as agents to act on behalf of the owners may instead make decisions
favorable to themselves rather than the stockholders
e. Large, publicly owned firms like IBM and GE are controlled by their management
teams. Ownership is generally widely dispersed; hence managers have great freedom in
how they run the firm. Managers may operate in stockholders’ best interests, but they
also may operate in their own personal best interests. As long as they stay within the
law, there is no way to either force or motivate managers to act in the stockholders’ best
interests
17) Stock A has a beta of 0.7, whereas Stock B has a beta of 1.3. Portfolio P has 50%
invested in both A and B. Which of the following would occur if the market risk
premium increased by 1% but the risk-free rate remained constant?
a.The required return on both stocks would increase by 1%
b.The required return on Portfolio P would remain unchanged
c.The required return on Stock A would increase by more than 1%, while the return on
Stock B would increase by less than 1%
d.The required return for Stock A would fall, but the required return for Stock B would
increase
e.The required return on Portfolio P would increase by 1%
18) Which of the following statements is CORRECT?
a.The slope of the Security Market Line is beta
b.Any stock with a negative beta must in theory have a negative required rate of return,
provided rRF is positive
c.If a stock’s beta doubles, its required rate of return must also double
d.If a stock’s returns are negatively correlated with returns on most other stocks, the
stock’s beta will be negative
e.If a stock has a beta of to 1.0, its required rate of return will be unaffected by changes
in the market risk premium
19) McPherson Company must purchase a new milling machine. The purchase price is
$50,000, including installation. The machine has a tax life of 5 years, and it can be
depreciated according to the following rates. The firm expects to operate the machine
for 4 years and then to sell it for $12,500. If the marginal tax rate is 40%, what will the
after-tax salvage value be when the machine is sold at the end of Year 4?
YearDepreciation Rate
10.20
20.32
30.19
40.12
50.11
60.06
a.$8,878
b.$9,345
c.$9,837
d.$10,355
e.$10,900
20) Bartlett Company’s target capital structure is 40% debt, 15% preferred, and 45%
common equity. The after-tax cost of debt is 6.00%, the cost of preferred is 7.50%, and
the cost of common using reinvested earnings is 12.75%. The firm will not be issuing
any new stock. You were hired as a consultant to help determine their cost of capital.
What is its WACC?
a.8.98%
b.9.26%
c.9.54%
d.9.83%
e.10.12%
21) Hunter Manufacturing Inc.’s December 31, 2012, balance sheet showed total
common equity of $2,050,000 and 100,000 shares of stock outstanding. During 2013,
Hunter had $250,000 of net income, and it paid out $100,000 as dividends. What was
the book value per share at 12/31/13, assuming that Hunter neither issued nor retired
any common stock during 2013?
a.$20.90
b.$22.00
c.$23.10
d.$24.26
e.$25.47
22) Tierney Enterprises is constructing its cash budget. Its budgeted monthly sales are
$5,000, and they are constant from month to month. 40% of its customers pay in the
first month and take the 2% discount, while the remaining 60% pay in the month
following the sale and do not receive a discount. The firm has no bad debts. Purchases
for next month’s sales are constant at 50% of projected sales for the next month. “Other
payments,” which include wages, rent, and taxes, are 25% of sales for the current
month. Construct a cash budget for a typical month and calculate the average net cash
flow during the month.
a.$1,092
b.$1,150
c.$1,210
d.$1,271
e.$1,334
23) Which of the following statements is CORRECT?
a.If a 10-year, $1,000 par, 10% coupon bond were issued at par, and if interest rates
then dropped to the point where rd = YTM = 5%, we could be sure that the bond would
sell at a premium above its $1,000 par value
b.Other things held constant, a corporation would rather issue noncallable bonds than
callable bonds
c.Other things held constant, a callable bond would have a lower required rate of return
than a noncallable bond
d.Reinvestment rate risk is worse from an investor’s standpoint than interest rate price
risk if the investor has a short investment time horizon
e.If a 10-year, $1,000 par, zero coupon bond were issued at a price that gave investors a
10% yield to maturity, and if interest rates then dropped to the point where rd = YTM =
5%, the bond would sell at a premium over its $1,000 par value
24) Weston Clothing Company is considering manufacturing a new style of shirt, whose
data are shown below. The equipment to be used would be depreciated by the
straight-line method over its 3-year life and would have a zero salvage value, and no
new working capital would be required. Revenues and other operating costs are
expected to be constant over the project’s 3-year life. However, this project would
compete with other Weston’s products and would reduce their pre-tax annual cash
flows. What is the project’s NPV? (Hint: Cash flows are constant in Years 1-3.)
WACC10.0%
Pre-tax cash flow reduction for other products (cannibalization)$5,000
Investment cost (depreciable basis)$80,000
Straight-line deprec. rate33.333%
Sales revenues, each year for 3 years$67,500
Annual operating costs (excl. deprec.)$25,000
Tax rate35.0%
a.$3,636
b.$3,828
c.$4,019
d.$4,220
e.$4,431
25) Consider the following information and then calculate the required rate of return for
the Universal Investment Fund, which holds 4 stocks. The market’s required rate of
return is 13.25%, the risk-free rate is 7.00%, and the Fund’s assets are as follows:
StockInvestmentBeta
A$ 200,000 1.50
B$ 300,000-0.50
C$ 500,000 1.25
D$1,000,000 0.75
a.9.58%
b.10.09%
c.10.62%
d.11.18%
e.11.77%
26) Which of the following statements is CORRECT?
a.The market value of a bond will always approach its par value as its maturity date
approaches. This holds true even if the firm has filed for bankruptcy
b.Rising inflation makes the actual yield to maturity on a bond greater than a quoted
yield to maturity that is based on market prices
c.The yield to maturity on a coupon bond that sells at its par value consists entirely of a
current interest yield; it has a zero expected capital gains yield
d.On an expected yield basis, the expected capital gains yield will always be positive
because an investor would not purchase a bond with an expected capital loss
e.The yield to maturity for a coupon bond that sells at a premium consists entirely of a
positive capital gains yield; it has a zero current interest yield
27) If expectations for long-term inflation rose, but the slope of the SML remained
constant, this would have a greater impact on the required rate of return on equity, rs,
than on the interest rate on long-term debt, rd, for most firms. Therefore, the percentage
point increase in the cost of equity would be greater than the increase in the interest rate
on long-term debt.
28) Interest paid by a corporation is a tax deduction for the paying corporation, but
dividends paid are not deductible. This treatment, other things held constant, tends to
encourage the use of debt financing by corporations.
29) Calculating a currency cross rate involves determining the exchange rate for two
currencies by using a third currency as a base.
30) If a firm utilizes debt financing, an X% decline in earnings before interest and taxes
(EBIT) will result in a decline in earnings per share that is larger than X.
31) Listed below are some provisions that are often contained in bond indentures.
Which of these provisions, viewed alone, would tend to reduce the yield to maturity
that investors would otherwise require on a newly issued bond?
32) Both the regular and the modified IRR (MIRR) methods have wide appeal to
professors, but most business executives prefer the NPV method to either of the IRR
methods.
33) Even if the correlation between the returns on two securities is +1.0, if the securities
are combined in the correct proportions, the resulting 2-asset portfolio will have less
risk than either security held alone.
34) In general, firms should use their weighted average cost of capital (WACC) to
evaluate capital budgeting projects because most projects are funded with general
corporate funds, which come from a variety of sources. However, if the firm plans to
use only debt or only equity to fund a particular project, it should use the after-tax cost
of that specific type of capital to evaluate that project.
35) To estimate the cash flow from operations, depreciation must be added back to net
income because it is a non-cash charge that has been deducted from revenue.
36) If a company announces a change in its dividend policy from a zero target payout
ratio to a 100% payout policy, this action could be expected to increase the value of
long-term options (say 5-year options) on the firm’s stock.