Using simulation has few drawbacks since individual cash flows generally are
independent and positively correlated.
The interest rate on commercial paper normally exceeds the prime rate.
The term knomrepresents the effective annual rate of interest.
Not to be confused with the probability that the borrower will be unable to meet the
obligations of principal and interest payments, default risk is the possibility of the
borrower violating one of the many covenants within the bond agreement.
As a company increases its financial leverage, improvements in ROE and EPS result
from the fact that it pays more for the use of borrowed money than it earns from the
money.
The agency problem is generally the most prevalent in companies where ownership is
held by only a few people.
Offsetting profits and losses to save on taxes is often the only reason behind successful
mergers.
Cash held for precautionary demand is to take advantage of unexpected opportunities.
Any exchange rate is determined by the supply of and demand for currencies, which is
derived from each country’s demand for the other country’s products and investments.
Projects with negative NPVs contribute only minimal positive amounts to shareholder
wealth.
Horizontal mergers can create economies of scale.
Holding companies enable a parent to control a subsidiary without owning all of its
stock. As a general rule, 25% ownership of a widely held company virtually guarantees
control.
A firm can avoid excess funds at regional banking facilities by using zero balance
accounts, or ZBAs.
Determine how much $1,000 deposited in a savings account paying 8% compounded
annually will be worth after 5 years.
A.$5,526
B.$784
C.$1,400
D.$1,469
Match the following:
1>Expansion option A. Usually requires little early commitment and should be planned
whenever possible
2>Abandonment option B. Ability to quit midway through a project method
3>Pure play method C. Develops a risk-adjusted return for a new venture using the beta
of a publicly traded company in the same field.
4>Accounting beta D. Develops a risk adjusted return for a division using internal data
and the capital asset pricing model.
Roy, who has just turned 40, would like to have an annual annuity of $20,000 paid over
a 20-year period, the first payment occurring on his 66th birthday. How much must Roy
save each year (end of year) for the next 25 years to have this annuity, if the investment
will earn 12 percent compounded annually?
A.$16,000
B.$19,046
C.$1,120
D.$944.10
Assume a municipal bond is issued by the State of New York. Its yield is stated at 6%.
A taxable corporate bond of equivalent quality is yielding 9%. You are in the 35% tax
bracket and your son is in the 10% tax bracket. Which would be the correct investment
strategy for both you and your son?
A.You and your son should acquire the municipal bond.
B.Your son should acquire the municipal bond, but you should acquire the corporate
bond.
C.You and your son should acquire the corporate bond.
D.Your son should acquire the corporate bond, but you should acquire the municipal
bond.
The first break in the MCC usually occurs because:
A.debt costs more as more is raised because the firm appears riskier to investors.
B.equity capital is more expensive when raised from outside sources.
C.the firm runs out of money.
D.it becomes impossible to sell more preferred stock.
When an account is determined to be uncollectible, “writing off” the bad debt usually
involves:
A.reducing the receivables balance and the bad debt reserve by the amount of the
account.
B.writing a letter to the customer demanding payment.
C.”expensing” the amount deemed uncollectible.
D.All of the above
What is the most you should pay to receive the following cash flows if you require a
return of 12 percent?
A.$58,580
B.$104,135
C.$68,105
D.None of the above
A model of what management expects a business to become in the future expressed in
words and financial projections is a:
A.cost ratio.
B.cash budget.
C.business plan.
D.stretch plan.
Which of the following statements is false?
A.Beta is meaningful only if an investor holds a well-diversified portfolio.
B.You can completely eliminate risk if you hold a well-diversified portfolio.
C.A portfolio composed of only one stock will not be well diversified.
D.A wise investor diversifies to capture the high average return of stocks while
avoiding as much risk as possible.
E.All of the above statements are correct.
Firms often perform scenario analyses in conjunction with finalizing business plans.
Explain the concept and the role it plays in addressing risk in planning.
How is taxation different in the corporate and proprietorship forms of business? Explain
double taxation.
A difficulty with evaluating mutually exclusive projects is the possibility of unequal
lives. Explain why this is a problem and how the replacement chain method addresses
it.
Assume the following partially completed financial plan ($000):
The firm pays 8% interest on all of its debt and is subject to a 40% tax rate. Complete
the plan.
The Valentine Company has the following capital accounts stated at market value and
component capital costs.
What is Valentine’s WACC?
What is the market risk premium?
What are the advantages and disadvantages of more rather than less financial leverage?
Joshua Trucking has chosen a new software package tied to satellite global positioning
system (GPS), in order to monitor its fleet. The software will be outdated after three
years and replaced. The software vendor has given Joshua Trucking the choice of
buying the software for $65,000 or leasing it for an annual payment of $25,000. To
attract customers, the GPS vendor allows lease payments at year-end. The firm has
decided to purchase the vendor’s service contract under either option. Assume that
depreciation is on a straight-line basis, Joshua Trucking’s cost of obtaining funds is nine
percent, and the firm is in the 34 percent tax bracket. Should it borrow and buy or lease
the GPS software?
What are the two different types of risk in the context of leverage?
What are some of the practical reasons for capital rationing?