1) Advocates of mark-to-market accounting believe that this method works best during
periods of great market uncertainty.
2) The put-call parity holds only if an investor plans to hold the options to maturity.
3) If the stock prices follow a random walk, successive stock prices fluctuate above and
below a normal long-run price.
4) A reduction in inventory levels from year-end to year-end would be considered a
source of cash.
5) Cash flow from operations = (revenues – cash expenses) (1 – tax rate) + (depreciation
tax rate).
6) Maximizing profits is the same as maximizing the value of the firm.
7) Boards of directors are often portrayed as active supporters of top management.
8) Since 1926 the average annual difference between the returns on value and growth
stocks has been 3.8%.
9) By using options a firm can protect against increase in raw material prices, while
continuing to benefit from price decreases.
10) Beta measures a stock’s sensitivity to market risks.
11) Current yield overstates the return of premium bonds since investors who buy a
bond at a premium face a capital loss over the life of the bond.
12) As the number of inventory orders per year increases, the total order costs increase.
13) The required risk premium for any investment is given by the security market line:
Risk premium on investment = beta expected market risk premium.
14) In June 2003 Oracle Corp announced a $5.1 billion cash tender offer for its rival
PeopleSoft.
15) Costs of financial distress are costs arising from bankruptcy or distorted business
decisions before bankruptcy.
16) A stream of equal cash payments lasting forever is termed:
A.an annuity
B.an annuity due
C.an installment plan
D.a perpetuity
17) According to accrual accounting, when goods are not sold until the period after they
were produced, then the cost of goods sold:
A.will be recognized in the first period
B.will be recognized in the second period
C.will be recognized when payment is received
D.will be split between both periods
18) ABC Corp. has an ROE of 20% and a current dividend payout ratio of 40%. Which
of the following changes will allow its earnings to grow at a 15% rate?
A.A decrease in the dividend payout ratio to 35% while holding ROE constant
B.A two-percentage-point decrease in ROE while holding dividend payout ratio
constant
C.A decrease in dividend payout ratio to 25% while holding ROE constant
D.An increase in dividend payout ratio to 50% and an increase in ROE to 25%
19) If the shareholders of an acquired firm capture all of the merger’s gain, then the:
A.cost of the merger is zero
B.NPV of the merger is zero
C.EPS will increase
D.acquiring firm retains all merger benefits
20) Technical analysts are most likely to be successful in a market that is considered:
A.semistrong-form efficient
B.not to be strong-form efficient
C.not to be weak-form efficient
D.to follow a random walk
21) According to MM II, if the expected return on assets decreases, what happens to the
expected return on equity?
A.Depends on the firm’s capital structure
B.Decreases
C.Stays constant
D.Increases
22) When a firm’s debt-equity ratio is 1.0, the firm:
A.has too much long-term debt in relation to leases
B.has less long-term debt than equity
C.is nearing insolvency
D.has as much in long-term liabilities as in equity
23) If a $1,000 convertible bond with a market value of $950 has a conversion ratio of
25 when the firm’s stock is selling for $36 per share, then:
A.the bond will be converted immediately
B.the bond is violating its “price floor”
C.conversion now would give the investor a profit of $900
D.the conversion value of the bond is $900
24) The cost of capital:
A.is the expected rate of return on capital investment
B.is an opportunity cost determined by the risk-free rate of return
C.is the interest rate that the firm pays on a loan from a bank or insurance company
D.for risky investments is normally higher than the firm’s borrowing rate
25) An implicit cost of increasing the proportion of debt in a firm’s capital structure is
that:
A.the firm’s asset beta will increase
B.shareholders will demand a higher rate of return
C.the tax shield will not apply to the added debt
D.the equity-to-value ratio will decrease
26) Capital budgeting projects typically assume that all cash flows transpire at the end
of the year. The reason for this is that:
A.less tax liability results from this practice
B.balance sheets are prepared at the end of the year
C.it is easier for the analyst in this manner
D.most corporations collect their cash at the end of the year
27) The company cost of capital may be an inappropriate discount rate for a capital
budgeting proposal if:
A.it calculates a negative NPV for the proposal
B.the proposal has a different degree of risk
C.the company has unique risk
D.the company expects to earn more than the risk-free rate
28) A deficiency of standard measures of liquidity is that the measures:
A.ignore a firm’s reserve borrowing capacity
B.fail to include accounts receivable as an asset
C.give inventories equal weighting in the quick ratio
D.do not include the current portions of long-term debt
29) If a borrower promises to pay you $1,900 9 years from now in return for a loan of
$1,000 today, what effective annual interest rate is being offered?
A.5.26%
B.7.39%
C.9.00%
D.10.00%
30) Which of the following statements is correct for a firm that currently has total costs
of carrying and ordering inventory that are 50% higher than total carrying costs?
A.Current order size is greater than optimal
B.Current order size is less than optimal
C.Per unit carrying costs are too high
D.The optimal order size is currently being used
31) For the consumer, a credit card:
A.transports money forward in time
B.provides liquidity
C.is a convenient way to pay
D.all of these
32) Which of the following statements is true regarding the trade-off theory?
A.Target debt ratios are similar among firms in the same industry
B.Riskier firms tend to rely mostly on debt financing
C.Riskier firms should have high target debt ratios
D.Less risky firms ought to have a greater amount of debt financing
33) Which of the following statements best explains the fact that cyclical firms tend to
have high betas?
A.Their earnings are not stable
B.Their stocks are overpriced
C.Their earnings are less diversifiable
D.Their profit margins are small
34) The primary difficulty in the allocation of overhead costs to prospective projects is
that the:
A.allocation will reduce the project’s NPV
B.discount rate is unknown
C.costs may not represent an incremental expense
D.expenses may have been previously allocated
35) What is the tax liability for an individual with $52,000 of income, which includes
$2,000 of dividends, if the tax rate is 15% on income up to $25,350 and 28% on income
over $25,350?
A.$11,704.50
B.$11,264.50
C.$14,000.00
D.$14,560.00
36) Research has shown all of the following to be true of the way corporations
determine dividends except:
A.Firms have short-run target payout ratios
B.Firms have long-run target payout ratios
C.The focus is more on dividend changes rather than absolute dividends
D.Managers try to avoid dividend changes that may need to be reversed
37) A potential downfall of using dividends as the plug item is that:
A.it may give shareholders mixed signals
B.dividends are constant within a planning horizon
C.the firm may have to borrow cash to pay dividends
D.shareholders may receive an excessive return
38) If the balance sheet of a firm indicates that total assets exceed current liabilities plus
shareholders’ equity, then the firm has:
A.no retained earnings
B.long-term debt
C.no accumulated depreciation
D.current assets
39) Suppose that:
What arbitrage gains can be achieved if the bank quotes a rate of 75 yen per Swiss
francs?
A.8%
B.9%
C.10%
D.11%
40) Under the terms of a sight draft, the buyer’s bank:
A.is instructed to make immediate payment
B.treats the invoice like a postdated check
C.forwards the acceptance to the seller until due
D.treats the purchase as a conditional sale
41) When underwriters offer a firm commitment on a stock issue, they:
A.employ their best efforts in selling the stock
B.guarantee the proceeds to the issuing firm
C.agree to purchase the venture capitalists’ shares
D.assure purchasers that the stock will appreciate
42) Which combination of positions will tend to protect the owner from downside risk?
A.Buy the stock and buy a call option
B.Sell the stock and buy a call option
C.Buy the stock and buy a put option
D.Buy the stock and sell a put option
43) What is the cash conversion cycle for a firm with a receivables period of 40 days, a
payables period of 30 days, and an inventory period of 60 days?
A.10 days
B.50 days
C.70 days
D.130 days
44) When two firms merge, the value of the acquiring firm will change by the:
A.gain from the merger
B.NPV minus the cost of the merger
C.NPV of the merger
D.cost of the merger
45) Your car loan requires payments of $200 per month for the first year and payments
of $400 per month during the second year. The annual interest rate is 12% and
payments begin in one month. What is the present value of this 2-year loan?
A.$6,246.34
B.$6,389.78
C.$6,428.57
D.$6,753.05
46) Assume your firm has an unused machine that originally cost $75,000, has a book
value of $20,000, and is currently worth $25,000. Ignoring taxes, the correct
opportunity cost for this machine in capital budgeting decisions is:
A.$75,000
B.$25,000
C.$20,000
D.$5,000
47) If a stock’s price decreased during the past week, what is the most likely prediction
about this week’s price change?
A.Price will reverse last week’s loss and go up
B.Price will continue last week’s decline
C.Price will stand still until new information is released
D.Either direction of price change is equally likely
48) Your retirement account has a current balance of $50,000. What interest rate would
need to be earned in order to accumulate a total of $1,000,000 in 30 years, by adding
$6,000 annually?
A.5.02%
B.7.24%
C.9.80%
D.10.07%
49) What is the break-even probability in the following case? A customer wishes to
purchase a $2,000 item that has been marked up 50% over cost and the probability of
collection is only 65%. Assume all cash flows are discounted to present value.
A.55.67%
B.66.67%
C.77.67%
D.88.67%
50) Why is limited liability such an important aspect to investors?
51) Compute the total tax liability, the average tax rate, and the marginal tax rate for the
following corporation: $1,000,000 in taxable income; 15% tax up to $50,000, 25% up
to $75,000, 34% up to $100,000, 39% over $100,000.
52) In the year ending October 2007, Walmart paid out $1,929 million as debt interest.
How much more tax would Walmart have paid if the firm had been entirely
equity-financed? What would be the present value of Walmart’s interest tax shield if the
company planned to keep its borrowing permanently at the 2007 level? Assume an
interest rate of 6% and a corporate tax rate of 35%.
53) Knowing the value of compounding, you consider the opportunity to invest for 10
years in a Japanese investment that will return 12% annually. The U.S. alternative for a
10-year investment appears to offer 7% annually. The spot exchange rate is 96/$. What
other concern should you have?
54) What are the popular tactics for increasing net float?
55) Discuss why corporations typically exhibit separation of ownership and
management, as distinguished from sole proprietorships or partnerships.
56) In 1987 RJR Nabisco, the food and tobacco giant, had $5 billion of A-rated debt
outstanding. In that year the company was taken over, and $19 billion of debt was
issued and used to buy back equity. The debt ratio skyrocketed, and the debt was
downgraded to a BB rating. The holders of the previously issued debt were furious, and
one filed a lawsuit claiming that RJR had violated an implicit obligation not to
undertake major financing changes at the expense of existing bondholders. Why did
these bondholders believe they had been harmed by the massive issue of new debt?
What type of explicit restriction would you have wanted if you had been one of the
original bondholders?
57) What is an interest rate swap, and what might motivate a borrower to arrange for
one with a bank?
58) (Expansion Option) Now suppose that Hit or Miss Sports from the previous
problem can expand production if the project is successful. By paying its workers
overtime, it can increase production by 25,000 units; the variable cost of each ball will
be higher, however, equal to $35 per unit. By how much does this option to expand
production increase the NPV of the project?
59) A firm can invest 10 million in its German subsidiary and receive a return of 4.3
million annually for 3 years. The spot rate is 1.6/$, the U.S. rate of inflation is expected
to be 4% annually, and the German rate is expected to be 3% annually. If the
appropriate risk-adjusted cost of capital in dollars is 14%, does the project appear to
have a positive NPV?
