1) In order to maximize shareholder value, a corporation must earn a higher rate of
return on a dollar that is retained in the corporation than the shareholders can earn by
investing the dollar elsewhere.
2) Preferred stock and common stock issued by the same firm will have the same
required return because the riskiness of the firm’s cash flows is the same for both
securities.
3) Higher bankruptcy costs will result in optimal capital structures using more
long-term debt financing.
4) Three of the most common options that can add value to a capital budgeting project
are the option to delay the project, the option to expand the project, and the option to
abandon the project.
5) The trade-off associated with holding large amounts of cash and marketable
securities is increased liquidity offset by a reduction in the overall rate of return.
6) The independence hypothesis allows for bankruptcy and agency costs.
7) Short-term debt provides a more flexible form of financing than long-term debt.
8) In a private placement, the securities are offered and sold to a limited number of
investors.
9) Security markets are considered to be perfect when firms can issue securities at no
cost and the investor incurs no brokerage commissions.
10) Preferred dividends are paid with before-tax dollars because the dividend rate is
known, whereas common stock dividends are paid with after-tax dollars.
11) Interest expenses are not included as incremental free cash flows because the cost of
funds is recognized as cash flows are discounted back to present value.
12) Total risk equals systematic risk plus unsystematic risk.
13) Intangible assets such as copyrights and goodwill are not included on the balance
sheet because they are impossible to value objectively.
14) A corporate treasurer is typically responsible for cash management, credit
management, and raising capital.
15) The initial outlay includes the cost of purchasing the asset and getting is
operational, but this excludes any training costs for employees which should be
included as part of differential cash flows over the life of the project.
16) The vast majority of corporate bond business takes place over the counter.
17) Assume you are to receive a 10-year annuity with annual payments of $1000. The
first payment will be received at the end of Year 1, and the last payment will be
received at the end of Year 10. You will invest each payment in an account that pays 9
percent compounded annually. Although the annuity payments stop at the end of year
10, you will not withdraw any money from the account until 25 years from today, and
the account will continue to earn 9% for the entire 25-year period. What will be the
value in your account at the end of Year 25 (rounded to the nearest dollar)?
A) $48,359
B) $35,967
C) $48,000
D) $55,340
18) Nelson Industries has a higher debt ratio than Butler, Inc., and Nelson also has a
higher times interest earned ratio than Butler. If Nelson and Butler both have the same
amount of total assets, then
A) Nelson must have higher operating income than Butler
B) if both companies have the same operating income, Butler must be paying a higher
interest rate on its long-term debt than Nelson is paying
C) Nelson may have more non-interest bearing liabilities, such as accounts payable,
than Butler has
D) if both companies have the same operating income, a mistake was made in the
calculations because the company with a higher debt ratio must have a lower times
interest earned ratio
19) Exchange rate risk
A) arises from the fact that the spot exchange rate on a future date is a random variable
B) applies only to certain types of international businesses
C) has been phased out due to recent international legislation
D) has been reduced by the adoption of floating exchange rates
20) All of the following business organizations provide limited liability to their owners
EXCEPT
A) general partnership
B) S-type corporation
C) corporation
D) limited liability company
21) Banker’s acceptances have the following characteristics EXCEPT
A) typically maturities of 1 to 5 years
B) fully taxable at the federal, state, and local levels
C) are sold on a discount basis and payable to the bearer
D) are not “issued” in predetermined denominations
22) A bond issued by Liberty, Inc. 10 years ago has a coupon rate of 8% and a face
value of $1,000. The bond will mature in 15 years. What is the value to an investor with
a required return of 12.5%?
A) $800
B) $750.86
C) $658.94
D) $701.52
23) A one-sign-reversal project should be accepted if it
A) generates an internal rate of return that is higher than the profitability index
B) produces an internal rate of return that is greater than the firm’s discount rate
C) results in an internal rate of return that is above a project’s equivalent annual annuity
D) results in a modified internal rate of return that is higher than the internal rate of
return
24) The Net Present Value (or NPV) criteria for capital budgeting decisions assumes
that expected future cash flows are reinvested at ________, and the Internal Rate of
Return (or IRR) criteria assumes that expected future cash flows are reinvested at
________.
A) the firm’s discount rate; the internal rate of return
B) the internal rate of return; the internal rate of return
C) the internal rate of return; the firm’s discount rate
D) Neither criteria assumes reinvestment of future cash flows
25) Charlie Corporation has two bonds outstanding. Both bonds mature in 10 years,
have a face value of $1,000, and have a yield to maturity of 8%. One bond is a zero
coupon bond and the other bond has a coupon rate of 8%. Which of the following
statements is true?
A) Both bonds must sell for the same price if markets are in equilibrium
B) The zero coupon bond must have a higher price because of its greater capital gain
potential
C) The zero coupon bond must sell for a lower price than the bond with an 8% coupon
rate
D) All rational investors will prefer the 8% bond because it pays more interest
26) DAS, Inc. is preparing its financial forecast for next year and its discretionary
financing needed is negative. This means that
A) sales growth must be negative
B) the predicted change in total assets must be negative
C) the predicted change in spontaneous liabilities and retained earnings must be greater
than the predicted change in total assets
D) the dividend payout ratio must be greater than the predicted growth rate in sales
27) You purchased 3,000,000 Indian rupees in London at an exchange rate of 54.86 to
the dollar and simultaneously sold the rupees in Bahrain at an exchange rate of 55.12 to
the dollar. What is the name for such a transaction?
A) trend trading
B) arbitrage
C) currency swapping
D) exchange rate hedging
28) A company is technically insolvent when
A) cash outflows in a given period are greater than cash inflows
B) earnings before interest payments are less than the interest payments
C) it lacks the necessary liquidity to promptly pay its current debt obligations
D) current ratio is less than 1.0
29) Two considerations that cause a corporation’s cost of capital to be different than its
investors’ required returns are
A) corporate taxes and flotation costs
B) individual taxes and corporate taxes
C) individual taxes and dividends
D) corporate taxes and the earned income tax credit
30) Which of the following transactions will increase a corporation’s operating return
on assets?
A) sell stock and use the money to pay off some long-term debt
B) sell 10-year bonds and use the money to pay off current liabilities
C) negotiate a new contract that lowers raw material costs by 10%
D) increase sales by 10%
31) Table 4-4
Wes Donnell, Inc.
Balance Sheet
Wes Donnell, Inc.
Income Statement
For the year ended December 31, 2010
In addition to the information contained in Table 4-4, you know that the current ratio for
2010 is 4 and that the corporation paid $11,600 in dividends in 2010. What is Wes
Donnell’s total asset balance for 2010?
A) $42,500
B) $36,500
C) $38,500
D) $26,900
32) Grandview Inc. will issue new common stock to finance an expansion. The existing
common stock just paid a $1.50 dividend, and dividends are expected to grow at a
constant rate 8% indefinitely. The stock sells for $45, and flotation expenses of 5% of
the selling price will be incurred on new shares. What is the cost of retained earnings
for Grandview?
A) 11.33%
B) 11.51%
C) 11.60%
D) 11.79%
E) 12.53%
33) Shackleford Corporation net income this year is $800,000. The company generally
retains 35% of net income for reinvestment. The company’s common equity currently
has a book value of $5,000,000. They just paid a dividend of $1.37, and the required
rate of return on this stock is 12%. Compute the value of this stock if dividends are
expected to continue growing indefinitely at the company’s internal growth rate.
A) $22.61
B) $11.42
C) $15.63
D) $4.35
34) Coyote Inc. operates three divisions. One division involves significant research and
development, and thus has a high-risk cost of capital of 15%. The second division
operates in business segments related to Coyote’s core business, and this division has a
cost of capital of 10% based upon its risk. Coyote’s core business is the least risky
segment, with a cost of capital of 8%. The firm’s overall weighted average cost of
capital of 11% has been used to evaluate capital budgeting projects for all three
divisions. This approach will
A) favor projects in the core business division because that division is the least risky
B) favor projects in the related businesses division because the cost of capital for this
division is the closest to the firm’s weighted average cost of capital
C) favor projects in the research and development division because the higher risk
projects look more favorable if a lower cost of capital is used to evaluate them
D) not favor any division over the other because they all use the same company-wide
weighted average cost of capital
35) A zero coupon bond pays no annual coupon interest payments. When it matures at
the end of 7.5 years it pays out $1,000. If investors wish to earn 2.35% per year on this
bond investment, what is the current price of the bond? (Round to the nearest dollar.)
A) $533
B) $561
C) $875
D) $840
36) The break-even model enables the manager of the firm to
A) calculate the minimum price of common stock for certain situations
B) set appropriate equilibrium thresholds
C) determine the quantity of output that must be sold to cover all operating costs
D) determine the optimal amount of debt financing to use
37) Glacier Inc. preferred stock has a 5% stated dividend percentage, and a $100 par
value. What is the value of the stock if your required rate of return is 6% per year?
A) $83.33
B) $94.05
C) $100.00
D) $30.00
38) Given that short-term interest rates typically fluctuate less than long-term rates,
interest rate risk is least for
A) treasury bills
B) common stock
C) long-term government bonds
D) medium-term corporate bonds
39) Siskiyou Corp. has cash of $75,000; short-term notes payable of $100,000; accounts
receivables of $275,000; accounts payable of $135,000: inventories of $350,000; and
accrued expenses of $75,000. What is the firm’s net working capital?
A) $390,000
B) $175,000
C) $700,000
D) $210,000
40) In general the greater a firm’s reliance upon short-term debt or current liabilities
A) the lower will be its liquidity
B) the greater will be its liquidity
C) liquidity will remain constant
D) there will be no effect on liquidity
41) Two bonds are identical except for their maturity. The bonds have a coupon rate that
is greater than their yield to maturity. Which of the following is true when comparing
the two bonds?
A) The longer maturity bond has a greater premium (is priced farther above par)
B) The longer maturity bond has a smaller premium (is priced above par but closer to
par)
C) The longer maturity bond has a greater discount (is priced farther below par)
D) The longer maturity bond has a smaller discount (is priced below par but closer to
par)
42) The Western State Company’s common stock is expected to pay a $2.00 dividend in
the coming year. If investors require a 17% return and the growth rate in dividends is
expected to be 8%, what will the market price of the stock be?
A) $11.76
B) $24.00
C) $23.11
D) $22.22
43) Simpson Conglomerates borrows $12,000 for a short-term purpose. The loan will
be repaid after 120 days, with Simpson paying a total of $12,400. What is the
approximate cost of credit using the APY, or annual percentage yield, calculation?
A) 4.33%
B) 10.34%
C) 12.25%
D) 12.46%
44) The three basic types of issues addressed by the study of finance are
A) capital budgeting, capital structure decisions, and working capital management
B) capital budgeting, working capital management, and investment analysis
C) capital structure decisions, working capital management, and sustained profitability
D) capital budgeting, investment analysis, and cash management
45) Table 4-4
Wes Donnell, Inc.
Balance Sheet
Wes Donnell, Inc.
Income Statement
For the year ended December 31, 2010
In addition to the information contained in Table 4-4, you know that the current ratio for
2010 is 4 and that the corporation paid $11,600 in dividends in 2010. What is Wes
Donnell’s cash balance for 2010?
A) $2,500
B) $13,600
C) $4,000
D) $6,500
46) Visionary TV Corporation bonds are currently priced at $1,088. They have a par
value of $1,000 and 12 years to maturity. They pay an annual coupon rate of 6%. What
is the yield to maturity on this bond?
A) 6.7%
B) 6.1%
C) 5.4%
D) 5.0%
47) Investors want a return that satisfies the following expectations:
A) A return for delaying consumption
B) An additional return for taking on risk
C) An additional return for accepting dividends rather than capital gains
D) Both A and B
48) Two sisters each open IRAs in 2011 and plan to invest $3,000 per year for the next
30 years. Mary makes her first deposit on January 1, 2011, and will make all future
deposits on the first day of the year. Jane makes her first deposit on December 31, 2011,
and will continue to make her annual deposits on the last day of each year. At the end of
30 years, the difference in the value of the IRAs (rounded to the nearest dollar),
assuming an interest rate of 7% per year, will be
A) $19,837
B) $12,456
C) $6,300
D) $210
49) Suppose a U.S. importer purchases an Italian product today but will not pay for it
for 90 days. The cost of the product today is 85,000 euros. The spot exchange rate today
is .7559 euros per dollar. How much is the cost today in dollars?
A) $58,062
B) $56,153
C) $65,683
D) $64,252
50) Which of the statements below are true?
A) The sole proprietorship and the general partnership both feature unlimited liability
B) A corporation is the business form that is typically the most complicated (legally) to
establish
C) The corporation and the limited partnership both provide at least some owners with
limited liability
D) all of the above
51) Based on the information in Table 4-2, the times interest earned ratio is
A) 11.48
B) 5.25
C) 4.88
D) 8.65
52) Your parents are complaining about the price of items today compared to what they
cost years ago. If an automobile that cost $12,000 in 1980 costs $40,000 in 2010,
calculate the annual growth rate in the automobile’s price.
53) The cash budget for Parker Processed Meats, Inc. is given below for the fourth
quarter of 2010:
Parker Processed Meats, Inc.
Cash Budget for the Three Months Ending December 31, 2010
The expected sales for the period are as follows:
Oct.: $116,000 Nov.: $127,000 Dec.: $95,000
The total depreciation expense for the period will be $12,000.
An interest payment on outstanding debt of $13,000 will be made in December. Using
the information given above, construct a pro forma income statement for the final
quarter of 2010
54) The effective interest rate on short-term loans from Bank A is 12.5 percent per year.
Bank B claims that their interest rate is only 11 percent per year. However, Bank B
charges interest on a discount basis. Which bank is charging the lowest effective rate of
interest on a one-year loan?
55) John won the lottery on Monday and can take either $50,000 per year for 20 years,
or $500,000 today. Bill won the same lottery on Tuesday and has the same options for
receiving the cash. A well respected financial advisor is hired by both John and Bill.
The advisor recommends that John take the $50,000 per year for 20 years but advises
Bill to take the $500,000 up front payment. How is it possible to give different advice to
two clients regarding the exact same cash flows?
56) Discuss whether the standard deviation of a portfolio is, or is not, a weighted
average of the standard deviations of the assets in the portfolio. Fully explain your
answer.
57) The Meacham Tire Company is considering two mutually exclusive projects with
useful lives of 3 and 6 years. The after-tax cash flows for projects S and L are listed
below.
The required rate of return on these projects is 14 percent. What decision should be
made? As part of your answer, calculate the NPV assuming a replacement chain for
Project S, and also calculate the equivalent annual annuity for each project.
58) Brett’s, Inc. expects to have $35 million in credit sales during the coming year. In
spite of a national distributing system, all remittances are sent to the home office. A
proposed system can eliminate 3 days of float, releasing funds which, when invested,
will earn 6.5 percent. What annual savings can Brett’s, Inc. expect if the system is
implemented? Use a 365-day year.