1) The primary sources of collateral for secured loans are accounts receivable and
inventory.
2) Stocks that plot above the security market line are underpriced because their
expected returns exceed their risk-adjusted required returns.
3) For companies in competitive markets, the evolution and introduction of new
products may serve more to preserve market share than to expand it.
4) Although interest rates are generally higher on long-term debt, using more long-term
debt rather than short-term debt can reduce the risk of illiquidity and decrease
uncertainty related to interest rate changes.
5) Other things held equal, a bond with a call provision is worth more to investors than
a bond without a call provision.
6) International expansion often occurs because it is generally easier for firms to expand
the market for their products rather than to develop new products.
7) A certificate of deposit that pays 9.8% compounded monthly is better than a similar
certificate of deposit that pays 10% compounded only once per year.
8) Traditional financial forecasting takes the sales forecast as given and forecasts the
corresponding expenses, assets, and liabilities of the firm.
9) Forward contracts benefit only the customer due to a reduction in uncertainty.
10) Total asset turnover is equal to accounts receivable turnover plus inventory turnover
plus fixed asset turnover.
11) A project’s standing alone risk allows for diversification within a sole firm.
12) The purpose of finished goods inventory is to uncouple the production and sales
functions so that it is not necessary to produce the goods before a sale can occur.
13) Discretionary financing needed can be positive or zero, but not negative.
14) Both compensating balances and discounting interest increase the effective interest
rate on a loan.
15) Using the constant growth dividend valuation model and assuming dividends will
growth a constant rate forever, the increase in the value of the stock each year should be
equal to the
A) growth rate in dividends, g
B) required return on the stock, rcs
C) dividend yield plus the capital gains yield
D) dividend yield
16) Exchange rate risk is highest for companies with
A) international trade contracts denominated in the foreign currency
B) investment portfolios that contain foreign securities
C) direct foreign investments in foreign subsidiaries
D) international trade contracts denominated in the domestic currency
17) Assume that an investor is offered a choice of a risk-free government bond that is
expected to return 3.5% or a high-risk corporate stock. According to one of the
principles of finance, what would induce the investor to purchase the corporate stock?
A) a return that is substantially lower than 3.5%
B) cash dividends
C) a return that is substantially higher than 3.5%
D) none of the above
18) Blammo, Inc. has a target capital structure of 30% debt and 70% equity. The firm is
planning to invest in a project that will necessitate raising new capital. New debt will be
issued at a before-tax yield of 14%, with a coupon rate of 10%. The equity will be
provided by internally generated funds so no new outside equity will be issued. If the
required rate of return on the firm’s stock is 22% and its marginal tax rate is 35%,
compute the firm’s cost of capital.
A) 18.00%
B) 18.13%
C) 19.68%
D) 15.55%
19) Maynard Inc. preferred stock pays an annual dividend of $7 per share. Which of the
following statements is true for an investor with a required return of 9%?
A) The value of the preferred stock is $7 because the dividend is fixed at $7 each year
B) The value of the preferred stock is $63.00 per share
C) The value of the preferred stock is $77.78 per share
D) The value of the preferred stock is $6.30 per share because of the 9% required return
20) California Retailing Inc. has sales of $4,000,000; the firm’s cost of goods sold is
$2,500,000; and its total operating expenses are $600,000. What is California
Retailing’s EBIT?
A) $850,000
B) $875,000
C) $900,000
D) $1,300,000
21) The difference between the capital gains tax rate and the income tax rate is an
incentive for
A) firms never to split their stock
B) firms to declare more stock dividends
C) firms to pay more earnings as dividends
D) firms to retain more earnings
22) California Retailing Inc. has sales of $4,000,000; the firm’s cost of goods sold is
$2,500,000; and its total operating expenses are $600,000. The firm’s interest expense is
$250,000, and the corporate tax rate is 40%. What is California Retailing’s net income?
A) $288,000
B) $350,000
C) $377,000
D) $390,000
23) The four basic determinants of business risk include all of the following EXCEPT
A) the stability of the domestic economy
B) the level of fixed cost used in the company’s production process
C) sensitivity to the business cycle
D) competitive pressures in the firm’s industry
24) Which of the following relationships is true regarding the costs of issuing the
following securities?
A) common stock > bonds > preferred stock
B) preferred stock > common stock > bonds
C) bonds > common stock > preferred stock
D) common stock > preferred stock > bonds
25) A U.S.-based multinational corporation (MNC) currently has an investment
portfolio that includes Japanese securities valued at 10,000,000 yen. The company also
owes its Japanese suppliers 12,000,000 yen. Which of the following statements is
MOST correct?
A) The MNC is not exposed to exchange rate risk because it holds both assets and
liabilities denominated in yen
B) The MNC will be exposed to exchange rate losses if the yen declines in value
relative to the dollar
C) The MNC will be exposed to exchange rate losses if the yen increases in value
relative to the dollar
D) The MNC can avoid exchange rate risk by paying its Japanese liabilities with dollars
26) The category of securities with the highest historical risk premium is
A) large company stocks
B) small company stocks
C) government bonds
D) small company corporate bonds
27) Flashbinder Guitars, Inc. is negotiating with the bank for a lockbox system that is
expected to reduce check collection time by 4 days. Flashbinder Guitars’ average check
size is $1,200 and any funds freed up by the new system will be invested in a money
market account that is currently paying 2.5% annually. What is the most Flashbinder
Guitars should be willing to pay the bank for the lockbox service, assuming the bank
charges a per-check processing fee?
A) 20.500 cents
B) 29.767 cents
C) 30.726 cents
D) 32.877 cents
28) You invest $1,000 at a variable rate of interest. Initially the rate is 4% compounded
annually for the first year, and the rate increases one-half of one percent annually for
five years (year two’s rate is 4.5%, year three’s rate is 5.0%, etc.). How much will you
have in the account after five years?
A) $1,276
B) $1,359
C) $1,462
D) $1,338
29) Based on the information in Table 4-1, and assuming the company’s stock price is
$30 per share, the P/E ratio is
A) 3.09
B) 4.83
C) 9.85
D) 10.99
30) Dickerson Corporation’s common stock is currently selling for $38. Last year’s
dividend was $4.00 per share. Investors expect dividends to grow at an annual rate of 7
percent indefinitely. Flotation costs of 4% will be incurred when new stock is sold.
a.What is the cost of internal common equity?
b.What is the cost of new common equity?
31) Keystone Corporation 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 new common
stock be for Keystone Corp.?
A) 11.33%
B) 11.51%
C) 11.60%
D) 11.79%
E) 12.53%
32) Activities of the investment banker include
A) assuming the risk of selling a security issue
B) selling new securities to the ultimate investors
C) providing advice to firms issuing securities
D) all of the above
33) A firm’s cost of capital is influenced by
A) the current ratio
B) par value of common stock
C) capital structure
D) net income
34) Miller’s preferred stock is selling at $54 on the market and pays an annual dividend
of $4.20 per share.
a.What is the expected rate of return on the stock?
b.If an investor’s required rate of return is 9%, what is the value of the stock to that
investor?
c.Considering the investor’s required rate of return, does this stock seem to be a
desirable investment?
35) You are currently earning 12% compounded semiannually. Your investment
company is switching all accounts to daily compounding. What rate will give you the
same effective annual rate of return as you are receiving now?
A) 10.83%
B) 10.97%
C) 11.66%
D) 11.89%
36) 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 30,000 euros. The spot exchange rate today
is .6233 euros per dollar. If the U.S. importer does not hedge the position, which of the
following spot exchange rates in 90 days will yield the highest returns?
A) 0.6833 euros per dollar
B) 0.6499 euros per dollar
C) $1.4844 per euro
D) $1.5387 per euro
37) Wendy purchased 800 shares of Genetics Stock at $3 per share on 1/1/12. Wendy
sold the shares on 12/31/12 for $3.45. Genetics stock has a beta of 1.9, the risk-free rate
of return is 4%, and the market risk premium is 9%. Wendy’s holding period return is
A) 15.0%
B) 16.5%
C) 17.6%
D) 21.1%
38) Alice Kitchen’s, Inc. bonds have a 10% coupon rate with semiannual coupon
payments. They have 12 and 1/2 years to maturity and a par value of $1,000. Compute
the value of Alice’s bonds if investors’ required rate of return is 8%.
A) $1,156.22
B) $1,239.33
C) $1,137.10
D) $1,084.44
39) LEE Corporation intends to purchase equipment for $1,500,000. The equipment has
a 5-year useful life and will be depreciated on a straight-line basis. Addition of the
equipment requires additional working capital of $20,000. The $20,000 is expected to
be recaptured at the end of the project. LEE’s marginal tax rate is 40%. Use of the
equipment is expected to change the company’s reported EBIT by $600,000 in year one,
$700,000 in year two, $550,000 in year three, $200,000 in year four, and $100,000 in
year five. Due to changing market conditions, the equipment did have a salvage value
of $100,000 at the end of year five.
a.Calculate the initial outlay and the incremental free cash flows over the life of the
project.
b.If the risk-adjusted discount rate for this project is 20%, calculate the project’s net
present value and internal rate of return and comment on the acceptability of the
project.
40) Variable costs include all of the following EXCEPT
A) property taxes
B) direct labor
C) sales commissions
D) annual rent
41) At what rate must $287.50 be compounded annually for it to grow to $650.01 in 14
years?
A) 6 percent
B) 5 percent
C) 7 percent
D) 8 percent
42) Which of the following strategies may be used to alter a firm’s capital structure
toward a higher percentage of debt compared to equity?
A) stock dividend
B) stock split
C) maintain a low dividend payout ratio
D) stock repurchase
43) If two firms have the same current dividend and the same expected growth rate,
their stocks must sell at the same current price or else the market will not be in
equilibrium
A) false, because the required return could be different
B) true, because we are using a dividend valuation model
C) true if markets are semi-strong form efficient
D) true if investors are risk-averse
44) You are considering investing in a project with the following year-end after-tax cash
flows:
Year 1: $57,000
Year 2: $72,000
Year 3: $78,000
If the initial outlay for the project is $185,000, compute the project’s internal rate of
return.
A) 3.98%
B) 5.54%
C) 11.89%
D) 14.74%
45) Flotation costs
A) include the fees paid to the investment bankers, lawyers, and accountants involved
in selling a new security issue
B) encourage firms to pay large dividends
C) are encountered whenever a firm fails to pay a dividend
D) are incurred when investors fail to cash their dividend check
46) The “bird-in-the-hand dividend theory” supports which view of the effect of
dividend policy on company value?
A) A firm’s dividend policy is irrelevant
B) High dividends increase stock values
C) Low dividends increase stock values
D) Constant dividends increase stock values
47) Which of the following is a disadvantage of the use of current liabilities to finance
assets?
A) greater risk of illiquidity
B) less flexibility
C) higher interest costs
D) the hedging principle
48) Which of the following has the most significant influence on return on equity?
A) common dividends
B) principal payments
C) accruals
D) operating income
49) Dazzly Diamond Corp. called for credit at the Home Alone Bank of Paris, TX. The
terms included a $35,000 maximum loan with interest of 1 percent over prime, and the
agreement also requires a 15% compensating balance throughout the year. The prime
rate is currently 12 percent.
a.If Dazzly Diamond Corp. maintains a balance in its account of $5,250 to $6,000, what
is the effective cost of credit through the line-of-credit agreement where the maximum
amount of the loan is used?
b.Recompute the effective cost of credit to Dazzly Diamond if it will have to borrow the
compensating balance and the maximum amount possible under the agreement.
50) The disadvantage of the IRR method is that
A) the IRR deals with cash flows
B) the IRR gives equal regard to all returns within a project’s life
C) the IRR will always give the same project accept/reject decision as the NPV
D) the IRR requires long, detailed cash flow forecasts
51) Which of the following should NOT be considered when calculating a firm’s
WACC?
A) after-tax YTM on a firm’s bonds
B) after-tax cost of accounts payable
C) cost of newly issued preferred stock
D) cost of newly issued common stock
52) How is preferred stock similar to bonds?
A) Dividend payments to preferred shareholders (much like bond interest payments to
bondholders) are tax deductible
B) Investors can sue the firm if preferred dividend payments are not paid (much like
bondholders can sue for non-payment of interest payments)
C) Preferred stockholders receive a dividend payment (much like interest payments to
bondholders) that is usually fixed
D) Preferred stock is not like bonds in any way
53) Changes in the general economy, like changes in interest rates or tax laws represent
what type of risk?
A) company-unique risk
B) market risk
C) unsystematic risk
D) diversifiable risk
54) Which of the following statements concerning Economic Value Added (EVA) is
MOST correct?
A) the higher the cost of capital, the higher the EVA, other things being held constant
B) EVA can be negative even if operating profits are positive
C) A company with positive net income will have positive EVA
D) Higher operating return on assets will result in lower EVA for a company with a debt
ratio over 50%
55) Alarm Systems Corporation’s preferred stock pays a dividend of $3.60 and sells for
$28.00. Alarm Systems Corporation has a marginal tax rate of 35%. What is the cost of
preferred financing?
56) The treasurer for Chic Man Clothing must decide how much money the company
needs to borrow in July. The balance sheet for June 30, 2010 is presented below:
Chic Man Clothing Balance Sheet
June 30, 2010
The company expects sales of $400,000 for July. The company has observed that 25%
of its sales is for cash and that the remaining 75% is collected in the following month.
The company plans to purchase $345,000 of new clothing. Usually 70% of purchases is
for cash and the remaining 30% of purchases is paid in the following month. Salaries
are $135,000 per month, lease payments are $35,000 per month, and depreciation
charges are $20,000 per month. The company plans to purchase a new van for $60,000
in July and sell its marketable securities for $123,000. If the company must maintain a
minimum cash balance of $25,000, how much money must the company borrow in
July?
57) Agri-Industries purchased some agricultural land at the edge of a large metropolitan
area for $250,000 five years ago. In order to have the land classified as agricultural for
property tax purposes, the company has been leasing the property to neighboring
farmers. The before-tax return from leasing the property is $12,000 per year. This
company’s corporate tax rate is 35 percent. If the company sells the land for $400,000
today, what is the internal rate of return on this investment?
58) Worthington, Inc. is planning to issue $7,500,000 in 120-day maturity notes
carrying a rate of 11 percent per year. Worthington’s commercial paper will be placed at
a cost of $35,000. What is the effective cost of credit to Worthington?
59) JKE, Inc. has a break even sales level of $10,000,000 and has fixed costs of
$4,000,000 per year. The selling price per unit is $200. What is the variable cost per
unit?
60) I301 Motors has several investment projects under consideration, all with positive
net present values. However, due to a shortage of trained personnel, a limit of
$1,250,000 has been placed on the capital budget for this year. Which of the projects
listed below should be included in this year’s capital budget? Explain your answer.
61) Due to a number of lawsuits related to toxic wastes, a major chemical company has
recently experienced a market revaluation. The firm has bonds outstanding that were
issued 8 years ago at their par value of $1,000. These bonds have 12 years to maturity
and a coupon rate of 6 percent, with interest paid semiannually. The required return on
these bonds has increased to 14 percent. What is the current value of one of these
bonds?