1) McCurdy Co.’s Class Q bonds have a 12-year maturity, $1,000 par value, and a
5.75% coupon paid semiannually (2.875% each 6 months), and those bonds sell at their
par value. McCurdy’s Class P bonds have the same risk, maturity, and par value, but the
P bonds pay a 5.75% annual coupon. Neither bond is callable. At what price should the
annual payment bond sell?
a.$943.98
b.$968.18
c.$993.01
d.$1,017.83
e.$1,043.28
2) Which of the following statements is CORRECT?
a.The capital structure that minimizes a firm’s weighted average cost of capital is also
the capital structure that maximizes its stock price
b.The capital structure that minimizes the firm’s weighted average cost of capital is also
the capital structure that maximizes its earnings per share
c.If a firm finds that the cost of debt is less than the cost of equity, increasing its debt
ratio must reduce its WACC
d.Other things held constant, if corporate tax rates declined, then the Modigliani-Miller
tax-adjusted tradeoff theory would suggest that firms should increase their use of debt
e.A firm can use retained earnings without paying a flotation cost. Therefore, while the
cost of retained earnings is not zero, its cost is generally lower than the after-tax cost of
debt
3) Which of the following is NOT normally regarded as being a good reason to
establish an ESOP?
a.To enable the firm to borrow at a below-market interest rate
b.To make it easier to grant stock options to employees
c.To help prevent a hostile takeover
d.To help retain valued employees
e.To increase worker productivity
4) Other things held constant, which of the following events is most likely to encourage
a firm to increase the amount of debt in its capital structure?
a.The costs that would be incurred in the event of bankruptcy increase
b.Management believes that the firm’s stock has become overvalued
c.Its degree of operating leverage increases
d.The corporate tax rate increases
e.Its sales become less stable over time
5) Cheers Inc. operates as a partnership. Now the partners have decided to convert the
business into a regular corporation. Which of the following statements is CORRECT?
a. Assuming Cheers is profitable, less of its income will be subject to federal income
taxes
b. Cheers will now be subject to fewer regulations
c. Cheers’ shareholders (the ex-partners) will now be exposed to less liability
d. Cheers’ investors will be exposed to less liability, but they will find it more difficult
to transfer their ownership
e. Cheers will find it more difficult to raise additional capital
6) NNR Inc.’s balance sheet showed total current assets of $1,875,000 plus $4,225,000
of net fixed assets. All of these assets were required in operations. The firm’s current
liabilities consisted of $475,000 of accounts payable, $375,000 of 6% short-term notes
payable to the bank, and $150,000 of accrued wages and taxes. Its remaining capital
consisted of long-term debt and common equity. What was NNR’s total
investor-provided operating capital?
a.$4,694,128
b.$4,941,188
c.$5,201,250
d.$5,475,000
e.$5,748,750
7) Which of the following statements is CORRECT?
a. One disadvantage of operating as a corporation rather than as a partnership is that
corporate shareholders are exposed to more personal liability than partners
b. There is no good reason to expect a firm’s bondholders and stockholders to react
differently to the types of new asset investments a firm makes
c. Bondholders are generally more willing than stockholders to have managers invest in
risky projects with high potential returns as opposed to safer projects with lower
expected returns
d. Stockholders are generally more willing than bondholders to have managers invest in
risky projects with high potential returns as opposed to safer projects with lower
expected returns
e. Relative to sole proprietorships, corporations generally face fewer regulations, which
makes raising capital easier for corporations
8) Which of the following statements is CORRECT?
a.If their maturities and other characteristics were the same, a 5% coupon bond would
have more interest rate price risk than a 10% coupon bond
b.A 10-year coupon bond would have more reinvestment rate risk than a 5-year coupon
bond, but all 10-year coupon bonds have the same amount of reinvestment rate risk
c.A 10-year coupon bond would have more interest rate price risk than a 5-year coupon
bond, but all 10-year coupon bonds have the same amount of interest rate price risk
d.If their maturities and other characteristics were the same, a 5% coupon bond would
have less interest rate price risk than a 10% coupon bond
e.A zero coupon bond of any maturity will have more interest rate price risk than any
coupon bond, even a perpetuity
9) Which of the following statements is CORRECT?
a.If a stock has a required rate of return rs = 12% and its dividend is expected to grow at
a constant rate of 5%, this implies that the stock’s dividend yield is also 5%
b.The stock valuation model, P0 = D1/(rs – g), can be used to value firms whose
dividends are expected to decline at a constant rate, i.e., to grow at a negative rate
c.The price of a stock is the present value of all expected future dividends, discounted at
the dividend growth rate
d.The constant growth model cannot be used for a zero growth stock, where the
dividend is expected to remain constant over time
e.The constant growth model is often appropriate for evaluating start-up companies that
do not have a stable history of growth but are expected to reach stable growth within
the next few years
10) Which of the following will cause an increase in net working capital, other things
held constant?
a.A cash dividend is declared and paid
b.Merchandise is sold at a profit, but the sale is on credit
c.Long-term bonds are retired with the proceeds of a preferred stock issue
d.Missing inventory is written off against retained earnings
e.Cash is used to buy marketable securities
11) Which of the following statements is CORRECT?
a.The income statement for a given year, say 2012, is designed to give us an idea of
how much the firm earned during that year
b.The focal point of the income statement is the cash account, because that account
cannot be manipulated by “accounting tricks”
c.The reported income of two otherwise identical firms cannot be manipulated by
different accounting procedures provided the firms follow Generally Accepted
Accounting Principles (GAAP)
d.The reported income of two otherwise identical firms must be identical if the firms
are publicly owned, provided they follow procedures that are permitted by the
Securities and Exchange Commission (SEC)
e.If a firm follows Generally Accepted Accounting Principles (GAAP), then its reported
net income will be identical to its reported net cash flow
12) Firms U and L both have a basic earning power ratio of 20% and each has the same
amount of assets. Firm U is unleveraged, i.e., it is 100% equity financed, while Firm L
is financed with 50% debt and 50% equity. Firm L’s debt has a before-tax cost of 8%.
Both firms have positive net income. Which of the following statements is CORRECT?
a.Firm L has a lower ROA than Firm U
b.Firm L has a lower ROE than Firm U
c.Firm L has the higher times interest earned (TIE) ratio
d.Firm L has a higher EBIT than Firm U
e.The two companies have the same times interest earned (TIE) ratio
13) Below is the common equity section (in millions) of Fethe Industries’ last two
year-end balance sheets:
20122011
Common stock$2,000$1,000
Retained earnings 2,000 2,340
Total common equity$4,000$3,340
The company has never paid a dividend to its common stockholders. Which of the
following statements is CORRECT?
a.The company’s net income in 2011 was higher than in 2012
b.The company issued common stock in 2012
c.The market price of the company’s stock doubled in 2012
d.The company had positive net income in both 2011 and 2012, but the company’s net
income in 2009 was lower than it was in 2011
e.The company has more equity than debt on its balance sheet
14) A 10-year bond pays an annual coupon, its YTM is 8%, and it currently trades at a
premium. Which of the following statements is CORRECT?
a.If the yield to maturity remains at 8%, then the bond’s price will decline over the next
year
b.The bond’s coupon rate is less than 8%
c.If the yield to maturity increases, then the bond’s price will increase
d.If the yield to maturity remains at 8%, then the bond’s price will remain constant over
the next year
e.The bond’s current yield is less than 8%
15) Which of the following statements is CORRECT?
a.The primary difference between EVA and accounting net income is that when net
income is calculated, a deduction is made to account for the cost of common equity,
whereas EVA represents net income before deducting the cost of the equity capital the
firm uses
b.MVA gives us an idea about how much value a firm’s management has added during
the last year
c.MVA stands for market value added, and it is defined as follows:
MVA = (Shares outstanding)(Stock price) + Book value of common equity
d.EVA stands for economic value added, and it is defined as follows:
EVA = EBIT(1 – T) – (Investor-supplied op. capital) (A – T cost of capital)
e.EVA gives us an idea about how much value a firm’s management has added over the
firm’s life
16) You have been hired as a consultant by Feludi Inc.’s CFO, who wants you to help
her estimate the cost of capital. You have been provided with the following data: rRF =
4.10%; RPM = 5.25%; and b = 1.30. Based on the CAPM approach, what is the cost of
common from reinvested earnings?
a.9.67%
b.9.97%
c.10.28%
d.10.60%
e.10.93%
17) Analysts following Armstrong Products recently noted that the company’s operating
net cash flow increased over the prior year, yet cash as reported on the balance sheet
decreased. Which of the following factors could explain this situation?
a.The company issued new long-term debt
b.The company cut its dividend
c.The company made a large investment in a profitable new plant
d.The company sold a division and received cash in return
e.The company issued new common stock
18) A U.S.-based company, Stewart, Inc., arranged a 2-year, $1,000,000 loan to fund a
project in Mexico. The loan is denominated in Mexican pesos, carries a 10.0% nominal
rate, and requires equal semiannual payments. The exchange rate at the time of the loan
was 5.75 pesos per dollar, but it dropped to 5.10 pesos per dollar before the first
payment came due. The loan was not hedged in the foreign exchange market. Thus,
Stewart must convert U.S. funds to Mexican pesos to make its payments. If the
exchange rate remains at 5.10 pesos per dollar through the end of the loan period, what
effective interest rate will Stewart end up paying on the loan?
a.10.36%
b.11.50%
c.17.44%
d.20.00%
e.21.79%
19) Lofland’s has $20 million in current assets and $10 million in current liabilities,
while Smaland’s current assets are $10 million versus $20 million of current liabilities.
Both firms would like to “window dress” their end-of-year financial statements, and to
do so each plans to borrow $10 million on a short-term basis and to then hold the
borrowed funds in their cash accounts. Which of the statements below best describes
the results of these transactions?
a. The transaction would improve both firms’ financial strength as measured by their
current ratios
b. The transactions would raise Lofland’s financial strength as measured by its current
ratio but lower Smaland’s current ratio
c. The transactions would lower Lofland’s financial strength as measured by its current
ratio but raise Smaland’s current ratio
d. The transaction would have no effect on the firm’ financial strength as measured by
their current ratios
e. The transaction would lower both firm’ financial strength as measured by their
current ratios
20) If D0 = $1.75, g (which is constant) = 3.6%, and P0 = $32.00, what is the stock’s
expected total return for the coming year?
a.8.37%
b.8.59%
c.8.81%
d.9.03%
e.9.27%
21) Which of the following statements is NOT correct?
a. After a 3-for-1 stock split, a company’s price per share should fall, but the number of
shares outstanding will rise
b. Investors can interpret a stock repurchase program as a signal that the firm’s
managers believe the stock is undervalued
c. Companies can repurchase shares to distribute large inflows of cash, say from the
sale of a division, to stockholders without paying cash dividends
d. Stockholders pay no income tax on dividends if the dividends are used to purchase
stock through a dividend reinvestment plan
e. Stock repurchases can be used by a firm as part of a plan to change its capital
structure
22) Currently, Bruner Inc.’s bonds sell for $1,250. They pay a $120 annual coupon,
have a 15-year maturity, and a $1,000 par value, but they can be called in 5 years at
$1,050. Assume that no costs other than the call premium would be incurred to call and
refund the bonds, and also assume that the yield curve is horizontal, with rates expected
to remain at current levels on into the future. What is the difference between this bond’s
YTM and its YTC? (Subtract the YTC from the YTM.)
a.2.11%
b.2.32%
c.2.55%
d.2.80%
e.3.09%
23) Which of the following statements is CORRECT?
a.If a firm is found guilty of cannibalization in a court of law, then it is judged to have
taken unfair advantage of its customers. Thus, cannibalization is dealt with by society
through the antitrust laws
b.If cannibalization exists, then the cash flows associated with the project must be
increased to offset these effects. Otherwise, the calculated NPV will be biased
downward
c.If cannibalization is determined to exist, then this means that the calculated NPV if
cannibalization is considered will be higher than the NPV if this effect is not recognized
d.Cannibalization, as described in the text, is a type of externality that is not against the
law, and any harm it causes is done to the firm itself
e.If a firm is found guilty of cannibalization in a court of law, then it is judged to have
taken unfair advantage of its competitors. Thus, cannibalization is dealt with by society
through the antitrust laws
24) Data on Liu Inc. for the most recent year are shown below, along with the inventory
conversion period (ICP) of the firms against which it benchmarks. The firm’s new CFO
believes that the company could reduce its inventory enough to reduce its ICP to the
benchmarks’ average. If this were done, by how much would inventories decline? Use a
365-day year.
Cost of goods sold =$85,000
Inventory =$20,000
Inventory conversion period (ICP) =85.88
Benchmark inventory conversion period (ICP) =38.00
a.$7,316
b.$8,129
c.$9,032
d.$10,036
e.$11,151
25) Which of the following statements is CORRECT?
a.A conservative financing policy is one where the firm finances part of its fixed assets
with short-term capital and all of its net working capital with short-term funds
b.If a company receives trade credit under terms of 2/10 net 30, this implies that the
company has 10 days of free trade credit
c.One cannot tell if a firm has a conservative, aggressive, or moderate current asset
financing policy without an examination of its cash budget
d.If a firm has a relatively aggressive current asset financing policy vis–vis other firms
in its industry, then its current ratio will probably be relatively high
e.Accruals are an expensive but commonly used way to finance working capital
26) Which of the following statements is CORRECT?
a.If a coupon bond is selling at a discount, its price will continue to decline until it
reaches its par value at maturity
b.If interest rates increase, the price of a 10-year coupon bond will decline by a greater
percentage than the price of a 10-year zero coupon bond
c.If a bond’s yield to maturity exceeds its annual coupon, then the bond will trade at a
premium
d.If a coupon bond is selling at a premium, its current yield equals its yield to maturity
e.If a coupon bond is selling at par, its current yield equals its yield to maturity
27) Aziz Industries has sales of $100,000 and accounts receivable of $11,500, and it
gives its customers 30 days to pay. The industry average DSO is 27 days, based on a
365-day year. If the company changes its credit and collection policy sufficiently to
cause its DSO to fall to the industry average, and if it earns 8.0% on any cash freed-up
by this change, how would that affect its net income, assuming other things are held
constant?
a. $267.34
b. $281.41
c. $296.22
d. $311.81
e. $328.22
28) Reed Enterprises is considering a project that has the following cash flow and
WACC data. What is the project’s NPV? Note that a project’s expected NPV can be
negative, in which case it will be rejected.
WACC:10.00%
Year0123
Cash flows-$1,050$450$460$470
a.$92.37
b.$96.99
c.$101.84
d.$106.93
e.$112.28
29) Which of the following statements is CORRECT?
a.The capital structure that minimizes the interest rate on debt also maximizes the
expected EPS
b.The capital structure that minimizes the required return on equity also maximizes the
stock price
c.The capital structure that minimizes the WACC also maximizes the price per share of
common stock
d.The capital structure that gives the firm the best credit rating also maximizes the stock
price
e.The capital structure that maximizes expected EPS also maximizes the price per share
of common stock
30) Which of the following statements is CORRECT?
a.If investors become more risk averse but rRF does not change, then the required rate
of return on high-beta stocks will rise and the required return on low-beta stocks will
decline, but the required return on an average-risk stock will not change
b.An investor who holds just one stock will generally be exposed to more risk than an
investor who holds a portfolio of stocks, assuming the stocks are all equally risky. Since
the holder of the 1-stock portfolio is exposed to more risk, he or she can expect to earn
a higher rate of return to compensate for the greater risk
c.There is no reason to think that the slope of the yield curve would have any effect on
the slope of the SML
d.Assume that the required rate of return on the market, rM, is given and fixed at 10%.
If the yield curve were upward sloping, then the Security Market Line (SML) would
have a steeper slope if 1-year Treasury securities were used as the risk-free rate than if
30-year Treasury bonds were used for rRF
e.If Mutual Fund A held equal amounts of 100 stocks, each of which had a beta of 1.0,
and Mutual Fund B held equal amounts of 10 stocks with betas of 1.0, then the two
mutual funds would both have betas of 1.0. Thus, they would be equally risky from an
investor’s standpoint, assuming the investor’s only asset is one or the other of the mutual
funds
31) Jessie’s Bobcat Rentals’ operations provided a negative net cash flow last year, yet
the cash shown on its balance sheet increased. Which of the following statements could
explain the increase in cash, assuming the company’s financial statements were
prepared under generally accepted accounting principles?
a.The company had high depreciation expenses
b.The company repurchased some of its common stock
c.The company dramatically increased its capital expenditures
d.The company retired a large amount of its long-term debt
e.The company sold some of its fixed assets
32) Morales Publishing’s tax rate is 40%, its beta is 1.10, and it uses no debt. However,
the CFO is considering moving to a capital structure with 30% debt and 70% equity. If
the risk-free rate is 5.0% and the market risk premium is 6.0%, by how much would the
capital structure shift change the firm’s cost of equity?
a.1.53%
b.1.70%
c.1.87%
d.2.05%
e.2.26%
33) Which of the following statements is CORRECT?
a.Call options generally sell at a price less than their exercise value
b.If a stock becomes riskier (more volatile), call options on the stock are likely to
decline in value
c.Call options generally sell at prices above their exercise value, but for an
in-the-money option, the greater the exercise value in relation to the strike price, the
lower the premium on the option is likely to be
d.Because of the put-call parity relationship, under equilibrium conditions a put option
on a stock must sell at exactly the same price as a call option on the stock
e.If the underlying stock does not pay a dividend, it makes good economic sense to
exercise a call option as soon as the stock’s price exceeds the strike price by about 10%,
because this permits the option holder to lock in an immediate profit
34) Stocks A and B have the following data. Assuming the stock market is efficient and
the stocks are in equilibrium, which of the following statements is CORRECT?
AB
Required return10%12%
Market price$25$40
Expected growth7%9%
a.These two stocks must have the same dividend yield
b.These two stocks should have the same expected return
c.These two stocks must have the same expected capital gains yield
d.These two stocks must have the same expected year-end dividend
e.These two stocks should have the same price
35) If D1 = $1.25, g (which is constant) = 4.7%, and P0 = $26.00, what is the stock’s
expected dividend yield for the coming year?
a.4.12%
b.4.34%
c.4.57%
d.4.81%
e.5.05%
36) Megan Ross holds the following portfolio:
StockInvestmentBeta
A$150,0001.40
B50,0000.80
C100,0001.00
D75,0001.20
Total$375,000
What is the portfolio’s beta?
a.1.06
b.1.17
c.1.29
d.1.42
e.1.56
37) You have been hired by the CFO of Lugones Industries to help estimate its cost of
common equity. You have obtained the following data: (1) rd = yield on the firm’s
bonds = 7.00% and the risk premium over its own debt cost = 4.00%. (2) rRF = 5.00%,
RPM = 6.00%, and b = 1.25. (3) D1 = $1.20, P0 = $35.00, and g = 8.00% (constant).
You were asked to estimate the cost of common based on the three most commonly
used methods and then to indicate the difference between the highest and lowest of
these estimates. What is that difference?
a.1.13%
b.1.50%
c.1.88%
d.2.34%
e.2.58%
38) Laramie Trucking’s CEO is considering a change to the company’s capital structure,
which currently consists of 25% debt and 75% equity. The CFO believes the firm
should use more debt, but the CEO is reluctant to increase the debt ratio. The risk-free
rate, rRF, is 5.0%, the market risk premium, RPM, is 6.0%, and the firm’s tax rate is
40%. Currently, the cost of equity, rs, is 11.5% as determined by the CAPM. What
would be the estimated cost of equity if the firm used 60% debt? (Hint: You must first
find the current beta and then the unlevered beta to solve the problem.)
a.10.95%
b.11.91%
c.12.94%
d.14.07%
e.15.29%
39) Suppose a foreign investor who holds tax-exempt Eurobonds paying 9% is
considering investing in an equivalent-risk domestic bond in a country with a 28%
withholding tax on interest paid to foreigners. If 9% after-tax is the investor’s required
return, what before-tax rate would the domestic bond need to pay to provide the
required after-tax return?
a.9.00%
b.10.20%
c.11.28%
d.12.50%
e.13.57%
40) The overriding goal of inventory management is to ensure that the firm never
suffers a stock-out, i.e., never runs out of an inventory item.
41) A stock’s beta measures its diversifiable risk relative to the diversifiable risks of
other firms.
42) It is possible that two firms could have identical financial and operating leverage,
yet have different degrees of risk as measured by the variability of EPS.
43) Trade credit can be separated into two components: free trade credit, which is credit
received after the discount period ends, and costly trade credit, which is the cost of
discounts not taken.
44) Credit policy for multinational firms is generally more risky due in part to the
additional consideration of exchange rates and also due to uncertainty regarding the
credit worthiness of many foreign customers.
45) The corporate valuation model cannot be used unless a company doesn’t pay
dividends.
46) Stock dividends and stock splits should, at least conceptually, have the same effect
on shareholders’ wealth.