1) One of the key attributes that makes a firm a good candidate for an LBO is that it has
a relatively high level of debt and a low level of liquid assets.
2) A stock split is usually taxable to a firm as it restructures the capital.
3) The IRR method assumes the cash flows are reinvested at the internal rate of return
rather than the required rate of return.
4) Risk-free rate of interest is equal to the sum of the real rate of interest plus an
inflation premium.
5) In general, non-U.S. companies have much higher debt ratios than their U.S.
counterparts because financial markets are much more developed in the United States
than elsewhere.
6) A congeneric merger is a merger combining firms in unrelated businesses.
7) The constant-growth model uses the market price as a reflection of the expected
risk-return preference of investors in the market place.
8) If net present value of a project is greater than zero, the firm will earn a return greater
than its cost of capital. The acceptance of such a project would enhance the wealth of
the firm’s owners.
9) At the end of the term of the lease agreement, the terminal value of an asset, if any, is
realized by the lessee.
10) Recaptured depreciation is the portion of the sale price that is in excess of the initial
purchase price.
11) Common stock can be either privately owned by private investors or publicly
owned by public investors.
12) Time-series analysis evaluates the performance of various firms at the same point in
time using financial ratios.
13) Due to its secondary position relative to equity, suppliers of debt capital face greater
risk and therefore must be compensated with higher expected returns than suppliers of
equity capital.
14) A firm has an operating profit of $300,000, interest of $35,000, and a tax rate of 40
percent. The firm has an after-tax cost of debt of 5 percent and a cost of equity of 15
percent. The firm’s target capital structure is set at a mix of 40 percent debt and 60
percent equity. Assuming this as the optimum capital structure, the value of the firm is
________.
A) $1.4 million
B) $2.2 million
C) $1.8 million
D) $6.0 million
15) A combination of two or more companies that results in a firm maintaining the
identity of one of the firms is ________.
A) amalgamation
B) consolidation
C) merger
D) a holding company
16) Which of the following represents an advantage for holding companies?
A) They are easy to analyze for investment purposes
B) They are facilitated with reduced federal corporate taxes due to the holding company
status
C) They are exempted from double taxation
D) They permit a firm to control a large amount of assets with relatively small dollar
investment
17) Table 11.5
Nuff Folding Box Company, Inc. is considering purchasing a new gluing machine. The
gluing machine costs $50,000 and requires installation costs of $2,500. This outlay
would be partially offset by the sale of an existing gluer. The existing gluer originally
cost $10,000 and is four years old. It is being depreciated under MACRS using a
five-year recovery schedule and can currently be sold for $15,000. The existing gluer
has a remaining useful life of five years. If held until year 5, the existing machine’s
market value would be zero. Over its five-year life, the new machine should reduce
operating costs (excluding depreciation) by $17,000 per year. Training costs of
employees who will operate the new machine will be a one-time cost of $5,000 which
should be included in the initial outlay. The new machine will be depreciated under
MACRS using a five-year recovery period. The firm has a 12 percent cost of capital and
a 40 percent tax on ordinary income and capital gains.
The net present value of the project is ________. (See Table 11.5)
A) $3,815
B) $2,445
C) $5,614
D) $7,500
18) In developing the cash flows for an expansion project, the analysis is the same as
the analysis for replacement projects where ________.
A) all cash flows from the old assets are equal
B) prior cash flows are irrelevant
C) all cash flows from the old asset are zero
D) cash inflows equal cash outflows
19) Table 15.2
The company earns 5 percent on current assets and 15 percent on fixed assets. The
firm’s current liabilities cost 7 percent to maintain and the average annual cost of
long-term funds is 20 percent.
The firm would like to increase its current ratio. This goal would be accomplished most
profitably by ________. (See Table 15.2)
A) increasing accounts payable
B) decreasing inventory
C) increasing accounts receivable
D) decreasing cash and cash equivalents
20) Table 11.3
Cuda Marine Engines, Inc. must develop the relevant cash flows for a replacement
capital investment proposal. The proposed asset costs $50,000 and has installation costs
of $3,000. The asset will be depreciated using a five-year recovery schedule. The
existing equipment, which originally cost $25,000 and will be sold for $10,000, has
been depreciated using an MACRS five-year recovery schedule and three years of
depreciation has already been taken. The new equipment is expected to result in
incremental before-tax net profits of $15,000 per year. The firm has a 40 percent tax
rate.
The incremental depreciation expense for year 1 is ________. (See Table 11.3)
A) $2,250
B) $7,600
C) $7,000
D) $7,950
21) Which of the following is true of leverage?
A) It refers to the effects that operating and financial fixed costs have on the returns that
shareholders earn
B) It is associated with risks which are out of the control of managers
C) It includes the effect of operating fixed costs on the returns of shareholders and not
the financial fixed costs
D) It is used to evaluate the profitability associated with various levels of sales
22) The aggressive financing strategy is risky in two aspects: a firm operates with a
possibility of ________, and a firm has only a limited amount of ________ capacity.
A) insolvency; short-term borrowing
B) interest rate swings; short-term borrowing
C) low earnings; long-term borrowing
D) fixed interest rate; long-term borrowing
23) Which of the following is a strength of payback period?
A) a disregard for cash flows after the payback period
B) only an implicit consideration of the timing of cash flows
C) merely a subjectively determined number
D) a measure of risk exposure
24) A field warehouse is ________.
A) a warehouse outside the metropolitan area
B) a warehouse on the borrower’s premises
C) a central warehouse storing the merchandise of several businesses
D) a warehouse located near the lender
25) What is the NPV for a project if its cost of capital is 0 percent and its initial
after-tax cost is $5,000,000 and it is expected to provide after-tax operating cash
inflows of $1,800,000 in year 1, $1,900,000 in year 2, $1,700,000 in year 3, and
$1,300,000 in year 4?
A) $1,700,000
B) $371,764
C) $137,053
D) $6,700,000
26) The modified DuPont formula relates the firm’s return on total assets (ROA) to its
________.
A) return on equity (ROE)
B) operating leverage multiplier
C) net profit margin
D) total asset turnover
27) Tangshan Mining borrowed $100,000 for one year under a line of credit with a
stated interest rate of 7.5 percent and a 15 percent compensating balance. Normally, the
firm keeps a balance of about $10,000 in its checking account. Based on this
information, the effective annual interest rate on the loan is ________.
A) 7.89%
B) 8.05%
C) 8.89%
D) 7.29%
28) The four basic sources of long-term funds for a firm are ________.
A) current liabilities, long-term debt, common stock, and preferred stock
B) current liabilities, long-term debt, common stock, and retained earnings
C) long-term debt, paid-in capital in excess of par, common stock, and retained earnings
D) long-term debt, common stock, preferred stock, and retained earnings
29) Credit Scoring Policy
Jia’s Jewelry uses the credit scoring technique to evaluate retail applications. The
financial and credit characteristics considered and weights indicating their relative
importance in the credit decision are shown above. The firm’s credit standards are to
accept all applicants with credit scores of 85 or more, to extend limited credit to
applicants with scores ranging from 75 to 84, and to reject all applicants below 75. The
firm is currently processing two applicants. The scores of each applicant on each of the
financial and credit characteristics are summarized above. Would you recommend either
of these applicants for credit extension?
30) Due to growing demand for computer software, the Shine Company has had a very
successful year and expects its earnings per share to grow by 25 percent to reach $5.50
for this year. Estimate the price of the company’s common stock assuming the industry’s
price/earning ratio is 12.
31) You have been given a choice between two retirement policies as described below.
Policy A: You will receive equal annual payments of $10,000 beginning 35 years from
now for 10 years.
Policy B: You will receive one lump-sum of $100,000 in 40 years from now.
Which policy would you choose? Assume rate of interest is 6 percent.
32) Table 11.4
Degnan Dance Company, Inc., a manufacturer of dance and exercise apparel, is
considering replacing an existing piece of equipment with a more sophisticated
machine. The following information is given.
The firm pays 40 percent taxes on ordinary income and capital gains.
Calculate the book value of the existing asset being replaced. (See Table 11.4)
33) To expand its business, the Kingston Outlet factory would like to issue a bond with
par value of $1,000, coupon rate of 10 percent, and maturity of 10 years from now.
What is the value of the bond if the required rate of return is 1> 8 percent, 2> 10
percent, and 3> 12 percent?