1) Daylight Solutions is considering a recapitalization that would increase its debt ratio
and increase its interest expense. The company would issue new bonds and use the
proceeds to buy back shares of its common stock. The company’s CFO thinks the plan
will not change total assets or operating income, but that it will increase earnings per
share (EPS). Assuming the CFO’s estimates are correct, which of the following
statements is CORRECT?
a.If the plan reduces the WACC, the stock price is also likely to decline
b.Since the plan is expected to increase EPS, this implies that net income is also
expected to increase
c.If the plan does increase the EPS, the stock price will automatically increase at the
same rate
d.Under the plan there will be more bonds outstanding, and that will increase their
liquidity and thus lower the interest rate on the currently outstanding bonds
e.Since the proposed plan increases Daylight’s financial risk, the company’s stock price
still might fall even if EPS increases
2) Refer to Exhibit 9.1. What is the best estimate of the after-tax cost of debt?
a.4.64%
b.4.88%
c.5.14%
d.5.40%
e.5.67%
3) Martin Manufacturing is considering two normal, equally risky, mutually exclusive,
but not repeatable projects. Martin’s WACC is 10%. The two projects have the same
investment costs, but Project A has an IRR of 15%, while Project B has an IRR of 20%.
Assuming the projects’ NPV profiles cross in the upper right quadrant, which of the
following statements is CORRECT?
a.Since the projects are mutually exclusive, the firm should always select Project B
b.If the crossover rate is 8%, Project B will have the higher NPV
c.Only one project has a positive NPV
d.If the crossover rate is 8%, Project A will have the higher NPV
e.Each project must have a negative NPV
4) How would the Security Market Line be affected, other things held constant, if the
expected inflation rate decreases and investors also become more risk averse?
a.The x-axis intercept would decline, and the slope would increase
b.The y-axis intercept would increase, and the slope would decline
c.The SML would be affected only if betas changed
d.Both the y-axis intercept and the slope would increase, leading to higher required
returns
e.The y-axis intercept would decline, and the slope would increase
5) For a stock to be in equilibrium, that is, for there to be no long-term pressure for its
price to depart from its current level, then
a.the past realized return must be equal to the expected return during the same period
b.the required return must equal the realized return in all periods
c.the expected return must be equal to both the required future return and the past
realized return
d.the expected future returns must be equal to the required return
e.the expected future return must be less than the most recent past realized return
6) Poder Inc. is considering a project that has the following cash flow data. What is the
project’s payback?
Year0123
Cash flows-$750$300$325$350
a.1.91 years
b.2.12 years
c.2.36 years
d.2.59 years
e.2.85 years
7) Current Design Co. is considering two mutually exclusive, equally risky, and not
repeatable projects, S and L. Their cash flows are shown below. The CEO believes the
IRR is the best selection criterion, while the CFO advocates the NPV. If the decision is
made by choosing the project with the higher IRR rather than the one with the higher
NPV, how much, if any, value will be forgone, i.e., what’s the chosen NPV versus the
maximum possible NPV? Note that (1) “true value” is measured by NPV, and (2) under
some conditions the choice of IRR vs. NPV will have no effect on the value gained or
lost.
WACC:7.50%
Year01234
CFS-$1,100$550$600$100 $100
CFL-$2,700$650$725$800$1,400
a.$138.10
b.$149.21
c.$160.31
d.$171.42
e.$182.52
8) Corner Jewelers, Inc. recently analyzed the project whose cash flows are shown
below. However, before the company decided to accept or reject the project, the Federal
Reserve changed interest rates and therefore the firm’s WACC. The Fed’s action did not
affect the forecasted cash flows. By how much did the change in the WACC affect the
project’s forecasted NPV? Note that a project’s expected NPV can be negative, in which
case it should be rejected.
Old WACC:8.00%New WACC:11.25%
Year0123
Cash flows-$1,000$410$410$410
a.-$59.03
b.-$56.08
c.-$53.27
d.-$50.61
e.-$48.08
9) Which of the following statements is CORRECT?
a.An example of an externality is a situation where a bank opens a new office, and that
new office causes deposits in the bank’s other offices to decline
b.The NPV method automatically deals correctly with externalities, even if the
externalities are not specifically identified, but the IRR method does not. This is another
reason to favor the NPV
c.Both the NPV and IRR methods deal correctly with externalities, even if the
externalities are not specifically identified. However, the payback method does not
d.Identifying an externality can never lead to an increase in the calculated NPV
e.An externality is a situation where a project would have an adverse effect on some
other part of the firm’s overall operations. If the project would have a favorable effect
on other operations, then this is not an externality
10) You recently sold 100 shares of your new company, XYZ Corporation, 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 statements best
describes this transaction?
a. This is an example of an exchange of physical assets
b. This is an example of a primary market transaction
c. This is an example of a direct transfer of capital
d. This is an example of a money market transaction
e. This is an example of a derivatives market transaction
11) A lockbox plan is most beneficial to firms that
a.have widely dispersed manufacturing facilities
b.have a large marketable securities portfolio and cash to protect
c.receive payments in the form of currency, such as fast food restaurants, rather than in
the form of checks
d.have customers who operate in many different parts of the country
e.have suppliers who operate in many different parts of the country
12) Which of the following statements is NOT a disadvantage of the regular payback
method?
a.Ignores cash flows beyond the payback period
b.Does not directly account for the time value of money
c.Does not provide any indication regarding a project’s liquidity or risk
d.Does not take account of differences in size among projects
e.Lacks an objective, market-determined benchmark for making decisions
13) Which of the following statements is most correct, holding other things constant,
for XYZ Corporation’s traded call options?
a.The higher the strike price on XYZ’s options, the higher the option’s price will be
b.Assuming the same strike price, an XYZ call option that expires in one month will
sell at a higher price than one that expires in three months
c.If XYZ’s stock price stabilizes (becomes less volatile), then the price of its options
will increase
d.If XYZ pays a dividend, then its option holders will not receive a cash payment, but
the strike price of the option will be reduced by the amount of the dividend
e.The price of these call options is likely to rise if XYZ’s stock price rises
14) Suppose International Digital Technologies decides to raise a total of $200 million,
with $100 million as long-term debt and $100 million as common equity. The debt can
be mortgage bonds or debentures, but by an iron-clad provision in its charter, the
company can never raise any additional debt beyond the original $100 million. Given
these conditions, which of the following statements is CORRECT?
a.If the debt were raised by issuing $50 million of debentures and $50 million of first
mortgage bonds, we could be certain that the firm’s total interest expense would be
lower than if the debt were raised by issuing $100 million of debentures
b.In this situation, we cannot tell for sure how, or whether, the firm’s total interest
expense on the $100 million of debt would be affected by the mix of debentures versus
first mortgage bonds. The interest rate on each of the two types of bonds would increase
as the percentage of mortgage bonds used was increased, but the result might well be
such that the firm’s total interest charges would not be affected materially by the mix
between the two
c.The higher the percentage of debentures, the greater the risk borne by each debenture,
and thus the higher the required rate of return on the debentures
d.If the debt were raised by issuing $50 million of debentures and $50 million of first
mortgage bonds, we could be certain that the firm’s total interest expense would be
lower than if the debt were raised by issuing $100 million of first mortgage bonds
e.The higher the percentage of debt represented by mortgage bonds, the riskier both
types of bonds will be and, consequently, the higher the firm’s total dollar interest
charges will be
15) Stock A has a beta = 0.8, while Stock B has a beta = 1.6. Which of the following
statements is CORRECT?
a.If the marginal investor becomes more risk averse, the required return on Stock B will
increase by more than the required return on Stock A
b.An equally weighted portfolio of Stocks A and B will have a beta lower than 1.2
c.If the marginal investor becomes more risk averse, the required return on Stock A will
increase by more than the required return on Stock B
d.If the risk-free rate increases but the market risk premium remains constant, the
required return on Stock A will increase by more than that on Stock B
e.Stock B’s required return is double that of Stock A’s
16) Thornton Universal Sales’ cost of goods sold (COGS) average $2,000,000 per
month, and it keeps inventory equal to 50% of its monthly COGS on hand at all times.
Using a 365-day year, what is its inventory conversion period?
a.11.7 days
b.13.0 days
c.14.4 days
d.15.2 days
e.16.7 days
17) Franklin Corporation is expected to pay a dividend of $1.25 per share at the end of
the year (D1 = $1.25). The stock sells for $32.50 per share, and its required rate of
return is 10.5%. The dividend is expected to grow at some constant rate, g, forever.
What is the equilibrium expected growth rate?
a.6.01%
b.6.17%
c.6.33%
d.6.49%
e.6.65%
18) Serendipity Inc. is re-evaluating its debt level. Its current capital structure consists
of 80% debt and 20% common equity, its beta is 1.60, and its tax rate is 35%. However,
the CFO thinks the company has too much debt, and he is considering moving to a
capital structure with 40% debt and 60% equity. 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.-5.20%
b.-5.78%
c.-6.36%
d.-6.99%
e.-7.69%
19) Spontaneous funds are generally defined as follows:
a.A forecasting approach in which the forecasted percentage of sales for each item is
held constant
b.Funds that a firm must raise externally through short-term or long-term borrowing
and/or by selling new common or preferred stock
c.Funds that arise out of normal business operations from its suppliers, employees, and
the government, and they include immediate increases in accounts payable, accrued
wages, and accrued taxes
d.The amount of cash raised in a given year minus the amount of cash needed to finance
the additional capital expenditures and working capital needed to support the firm’s
growth
e.Assets required per dollar of sales
20) Sanchez Company has planned capital expenditures that total $2,000,000. The
company wants to maintain a target capital structure that is 35% debt and 65% equity.
The company forecasts that its net income this year will be $1,800,000. If the company
follows a residual dividend policy, what will be its total dividend payment?
a. $100,000
b. $200,000
c. $300,000
d. $400,000
e. $500,000
21) Refer to Exhibit 3.1. What is the firm’s book value per share?
a. $61.73
b. $64.98
c. $68.40
d. $72.00
e. $75.60
22) Merrell Enterprises’ stock has an expected return of 14%. The stock’s dividend is
expected to grow at a constant rate of 8%, and it currently sells for $50 a share. Which
of the following statements is CORRECT?
a.The stock’s dividend yield is 8%
b.The current dividend per share is $4.00
c.The stock price is expected to be $54 a share one year from now
d.The stock price is expected to be $57 a share one year from now
e.The stock’s dividend yield is 7%
23) Shulman Inc. has the following data, in thousands. Assuming a 365-day year, what
is the firm’s cash conversion cycle?
Annual sales =$45,000
Annual cost of goods sold =$30,000
Inventory =$4,500
Accounts receivable =$1,800
Accounts payable =$2,500
a.28 days
b.32 days
c.35 days
d.39 days
e.43 days
24) The required returns of Stocks X and Y are rX = 10% and rY = 12%. Which of the
following statements is CORRECT?
a.If Stock Y and Stock X have the same dividend yield, then Stock Y must have a lower
expected capital gains yield than Stock X
b.If Stock X and Stock Y have the same current dividend and the same expected
dividend growth rate, then Stock Y must sell for a higher price
c.The stocks must sell for the same price
d.Stock Y must have a higher dividend yield than Stock X
e.If the market is in equilibrium, and if Stock Y has the lower expected dividend yield,
then it must have the higher expected growth rate
25) Which of the following statements is CORRECT?
a.The NPV profile graph for a normal project will generally have a positive (upward)
slope as the life of the project increases
b.An NPV profile graph is designed to give decision makers an idea about how a
project’s risk varies with its life
c.An NPV profile graph is designed to give decision makers an idea about how a
project’s contribution to the firm’s value varies with the cost of capital
d.We cannot draw a project’s NPV profile unless we know the appropriate WACC for
use in evaluating the project’s NPV
e.An NPV profile graph shows how a project’s payback varies as the cost of capital
changes
26) Chambliss Corp.’s total assets at the end of last year were $305,000 and its EBIT
was 62,500. What was its basic earning power (BEP)?
a. 18.49%
b. 19.47%
c. 20.49%
d. 21.52%
e. 22.59%
27) Although a full liquidity analysis requires the use of a cash budget, the current and
quick ratios provide fast and easy-to-use measures of a firm’s liquidity position.
28) The cash budget and the capital budget are handled separately, and although they
are both important, they are developed completely independently of one another.
29) The Y-axis intercept of the SML indicates the required return on an individual asset
whenever the realized return on an average (b = 1) stock is zero.
30) If a firm busy on terms of 2/10 net 30, it should pay as early as possible during the
discount period.
31) The cash flows relevant for a foreign investment should, from the parent company’s
perspective, include the financial cash flows that the subsidiary can legally send back to
the parent company plus the cash flows that must remain in the foreign country.
32) A rapid build-up of inventories normally requires additional financing, unless the
increase is matched by an equally large decrease in some other asset.
33) If Miller and Modigliani had incorporated the costs of bankruptcy into their model,
it is unlikely that they would have concluded that 100% debt financing is optimal.
34) The risk to the firm of borrowing using short-term credit is usually greater than if it
used long-term debt. Added risk stems from (1) the greater variability of interest costs
on short-term than long-term debt and (2) the fact that even if its long-term prospects
are good, the firm’s lenders may not be willing to renew short-term loans if the firm is
temporarily unable to repay those loans.
35) The facts (1) that no explicit interest is paid on accruals and (2) that the firm can
control the level of these accounts at will makes them an attractive source of funding to
meet working capital needs.
36) Short-term financing is riskier than long-term financing since, during periods of
tight credit, the firm may not be able to rollover (renew) its debt. This is especially true
if the funds are used to finance long-term assets rather than short-term assets.