Assume that a firm currently has EBIT of $2,000,000, a degree of total leverage of 5,
and a degree of financial leverage of 1.875. If sales decline by 20% next year, then what
will be the firm’s expected EBIT in one year?
a.$361,000
b.$380,000
c.$400,000
d.$420,000
e.$441,000
Stock HB has a beta of 1.5 and Stock LB has a beta of 0.5. The market is in
equilibrium, with required returns equaling expected returns. Which of the following
statements is CORRECT?
a.If expected inflation remains constant but the market risk premium (rM – rRF)
declines, the required return of Stock LB will decline but the required return of Stock
HB will increase.
b.If both expected inflation and the market risk premium (rM – rRF) increase, the
required return on Stock HB will increase by more than that on Stock LB.
c.If both expected inflation and the market risk premium (rM – rRF) increase, the
required returns of both stocks will increase by the same amount.
d.Since the market is in equilibrium, the required returns of the two stocks should be the
same.
e.If expected inflation remains constant but the market risk premium (rM – rRF)
declines, the required return of Stock HB will decline but the required return of Stock
LB will increase.
An option that gives the holder the right to sell a stock at a specified price at some time
in the future is called a(n)
a.Call option.
b.Put option.
c.Out-of-the-money option.
d.Naked option.
e.Covered option.
Each stock’s rate of return in a given year consists of a dividend yield (which might be
zero) plus a capital gains yield (which could be positive, negative, or zero). Such
returns are calculated for all the stocks in the S&P 500. A weighted average of those
returns, using each stock’s total market value, is then calculated, and that average return
is often used as an indicator of the “return on the market.”
a.True
b.False
Your firm has $500 million of investor-supplied capital, its return on investors’ capital
(ROIC) is 15%, and it currently has no debt in its capital structure (i.e., wd = 0). The
CFO is contemplating a recapitalization where it would issue debt at an after-tax cost of
10% and use the proceeds to buy back some of its common stock, such that the
percentage of common equity in the capital structure (wc) is 1 – wd. If the company
goes ahead with the recapitalization, its operating income, the size of the firm (i.e., total
assets), total investor-supplied capital, and tax rate would remain unchanged. Which of
the following is most likely to occur as a result of the recapitalization?
a.The ROA would increase.
b.The ROA would remain unchanged.
c.The return on investors’ capital would decline.
d.The return on investors’ capital would increase.
e.The ROE would increase.
Stock X has a beta of 0.5 and Stock Y has a beta of 1.5. Which of the following
statements must be true, according to the CAPM?
a.If you invest $50,000 in Stock X and $50,000 in Stock Y, your 2-stock portfolio
would have a beta significantly lower than 1.0, provided the returns on the two stocks
are not perfectly correlated.
b.Stock Y’s realized return during the coming year will be higher than Stock X’s return.
c.If the expected rate of inflation increases but the market risk premium is unchanged,
the required returns on the two stocks should increase by the same amount.
d.Stock Y’s return has a higher standard deviation than Stock X.
e.If the market risk premium declines, but the risk-free rate is unchanged, Stock X will
have a larger decline in its required return than will Stock Y.
Suppose 6 months ago a Swiss investor bought a 6-month U.S. Treasury bill at a price
of $9,708.74, with a maturity value of $10,000. The exchange rate at that time was
1.420 Swiss francs per dollar. Today, at maturity, the exchange rate is 1.324 Swiss
francs per dollar. What is the annualized rate of return to the Swiss investor?
a.7.93%
b.7.13%
c.6.42%
d.5.78%
e.5.20%
Inflation, recession, and high interest rates are economic events that are best
characterized as being
a.systematic risk factors that can be diversified away.
b.company-specific risk factors that can be diversified away.
c.among the factors that are responsible for market risk.
d.risks that are beyond the control of investors and thus should not be considered by
security analysts or portfolio managers.
e.irrelevant except to governmental authorities like the Federal Reserve.
Last year, Martyn Company had $500,000 in taxable income from its operations,
$50,000 in interest income, and $100,000 in dividend income. Using the corporate tax
rate table given below, what was the company’s tax liability for the year?
a.$177,973
b.$187,340
c.$197,200
d.$207,060
e.$217,413
A company expects sales to increase during the coming year, and it is using the AFN
equation to forecast the additional capital that it must raise. Which of the following
conditions would cause the AFN to increase?
a.The company previously thought its fixed assets were being operated at full capacity,
but now it learns that it actually has excess capacity.
b.The company increases its dividend payout ratio.
c.The company begins to pay employees monthly rather than weekly.
d.The company’s profit margin increases.
e.The company decides to stop taking discounts on purchased materials.
You recently sold 100 shares of Microsoft stock to your brother at a family reunion. At
the reunion your brother gave you a check for the stock and you gave your brother the
stock certificates. Which of the following best describes this transaction?
a.This is an example of a direct transfer of capital.
b.This is an example of a primary market transaction.
c.This is an example of an exchange of physical assets.
d.This is an example of a money market transaction.
e.This is an example of a derivative market transaction.
Which of the following are reasons why companies move into international operations?
a.To take advantage of lower production costs in regions where labor costs are
relatively low.
b.To develop new markets for the firm’s products.
c.To better serve their primary customers.
d.Because important raw materials are located abroad.
e.All of the above.
Louisiana Enterprises, an all-equity firm, is considering a new capital investment.
Analysis has indicated that the proposed investment has a beta of 0.5 and will generate
an expected return of 7%. The firm currently has a required return of 10.75% and a beta
of 1.25. The investment, if undertaken, will double the firm’s total assets. If rRF is 7%
and the market risk premium is 3%, should the firm undertake the investment?
a.Yes; the expected return of the asset (7%) exceeds the required return (6.5%).
b.Yes; the beta of the asset will reduce the risk of the firm.
c.No; the expected return of the asset (7%) is less than the required return (8.5%).
d.No; the risk of the asset (beta) will increase the firm’s beta.
e.No; the expected return of the asset is less than the firm’s required return, which is
10.75%.
Appalachian Airlines began operating in 2010. The company lost money the first year
but has been profitable ever since. The company’s taxable income (EBT) for its first
five years is listed below. Each year the company’s corporate tax rate has been 40%.
Assume that the company has taken full advantage of the Tax Code’s carry-back,
carry-forward provisions and that the current provisions were applicable in 2010. How
much did the company pay in taxes in 2013?
a.$ 688,500
b.$ 765,000
c.$ 800,000
d.$ 930,000
e.$1,023,000