1) Tibbs Inc. had the following data for the year ending 12/31/12: Net income = $300;
Net operating profit after taxes (NOPAT) = $400; Total assets = $2,500; Short-term
investments = $200; Stockholders’ equity = $1,800; Total debt = $700; and Total
operating capital = $2,300. What was its return on invested capital (ROIC)?
a.14.91%
b.15.70%
c.16.52%
d.17.39%
e.18.26%
2) Which one of the following would NOT result in incremental cash flows and thus
should NOT be included in the capital budgeting analysis for a new product?
a.A new product will generate new sales, but some of those new sales will be from
customers who switch from one of the firm’s current products
b.A firm must obtain new equipment for the project, and $1 million is required for
shipping and installing the new machinery
c.A firm has spent $2 million on R&D associated with a new product. These costs have
been expensed for tax purposes, and they cannot be recovered regardless of whether the
new project is accepted or rejected
d.A firm can produce a new product, and the existence of that product will stimulate
sales of some of the firm’s other products
e.A firm has a parcel of land that can be used for a new plant site or be sold, rented, or
used for agricultural purposes
3) Suppose 90-day investments in Britain have a 6% annualized return and a 1.5%
quarterly (90-day) return. In the U.S., 90-day investments of similar risk have a 4%
annualized return and a 1% quarterly (90-day) return. In the 90-day forward market, 1
British pound equals $1.65. If interest rate parity holds, what is the spot exchange rate?
a.1 pound = $1.8000
b.1 pound = $1.6582
c.1 pound = $1.0000
d.1 pound = $0.8500
e.1 pound = $0.6031
4) To help them estimate the company’s cost of capital, Smithco has hired you as a
consultant. You have been provided with the following data: D1 = $1.45; P0 = $22.50;
and g = 6.50% (constant). Based on the DCF approach, what is the cost of common
from reinvested earnings?
a.11.10%
b.11.68%
c.12.30%
d.12.94%
e.13.59%
5) Which of the following statements is CORRECT? Assume that the project being
considered has normal cash flows, with one cash outflow at t = 0 followed by a series of
positive cash flows.
a.A project’s MIRR is always less than its regular IRR
b.If a project’s IRR is greater than its WACC, then its MIRR will be greater than the
IRR
c.To find a project’s MIRR, we compound cash inflows at the regular IRR and then find
the discount rate that causes the PV of the terminal value to equal the initial cost
d.To find a project’s MIRR, the textbook procedure compounds cash inflows at the
WACC and then finds the discount rate that causes the PV of the terminal value to equal
the initial cost
e.A project’s MIRR is always greater than its regular IRR
6) If 1.64 Canadian dollars can purchase one U.S. dollar, how many U.S. dollars can
you purchase for one Canadian dollar?
a.0.37
b.0.61
c.1.00
d.1.64
e.3.28
7) Refer to Exhibit 3.1. What is the firm’s profit margin?
a. 1.40%
b. 1.56%
c. 1.73%
d. 1.93%
e. 2.12%
8) Suppose you believe that Basso Inc.’s stock price is going to increase from its current
level of $22.50 sometime during the next 5 months. For $3.10 you can buy a 5-month
call option giving you the right to buy 1 share at a price of $25 per share. If you buy this
option for $3.10 and Basso’s stock price actually rises to $45, what would your pre-tax
net profit be?
a.-$3.10
b.$16.90
c.$17.75
d.$22.50
e.$25.60
9) After an intensive research and development effort, two methods for producing
playing cards have been identified by the Turner Company. One method involves using
a machine having a fixed cost of $10,000 and variable costs of $1.00 per deck of cards.
The other method would use a less expensive machine (fixed cost = $5,000), but it
would require greater variable costs ($1.50 per deck of cards). If the selling price per
deck of cards will be the same under each method, at what level of output will the two
methods produce the same net operating income (EBIT)?
a.5,000 decks
b.10,000 decks
c.15,000 decks
d.20,000 decks
e.25,000 decks
10) Last month, Standard Systems analyzed the project whose cash flows are shown
below. However, before the decision to accept or reject the project took place, 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:10.00%New WACC:11.25%
Year0123
Cash flows-$1,000$410$410$410
a.-$18.89
b.-$19.88
c.-$20.93
d.-$22.03
e.-$23.13
11) Which of the following statements is CORRECT?
a.The higher the correlation between the stocks in a portfolio, the lower the risk
inherent in the portfolio
b.An investor can eliminate almost all risk if he or she holds a very large and well
diversified portfolio of stocks
c.Once a portfolio has about 40 stocks, adding additional stocks will not reduce its risk
by even a small amount
d.An investor can eliminate almost all diversifiable risk if he or she holds a very large,
well-diversified portfolio of stocks
e.An investor can eliminate almost all market risk if he or she holds a very large and
well diversified portfolio of stocks
12) Which of the following statements is CORRECT?
a.One advantage of the NPV over the IRR is that NPV assumes that cash flows will be
reinvested at the WACC, whereas IRR assumes that cash flows are reinvested at the
IRR. The NPV assumption is generally more appropriate
b.One advantage of the NPV over the MIRR method is that NPV takes account of cash
flows over a project’s full life whereas MIRR does not
c.One advantage of the NPV over the MIRR method is that NPV discounts cash flows
whereas the MIRR is based on undiscounted cash flows
d.Since cash flows under the IRR and MIRR are both discounted at the same rate (the
WACC), these two methods always rank mutually exclusive projects in the same order
e.One advantage of the NPV over the IRR is that NPV takes account of cash flows over
a project’s full life whereas IRR does not
13) Olivia Hardison, CFO of Impact United Athletic Designs, plans to have the
company issue $500 million of new common stock and use the proceeds to pay off
some of its outstanding bonds. Assume that the company, which does not pay any
dividends, takes this action, and that total assets, operating income (EBIT), and its tax
rate all remain constant. Which of the following would occur?
a.The company would have to pay less taxes
b.The company’s taxable income would fall
c.The company’s interest expense would remain constant
d.The company would have less common equity than before
e.The company’s net income would increase
14) Spence Company is considering a project that has the following cash flow data.
What is the project’s IRR? Note that a project’s IRR can be less than the WACC or
negative, in both cases it will be rejected.
Year01234
Cash flows-$1,050$400$400$400$400
a.14.05%
b.15.61%
c.17.34%
d.19.27%
e.21.20%
15) Which of the following statements is CORRECT?
a.If the maturity risk premium (MRP) is greater than zero, then the yield curve must
have an upward slope
b.Because long-term bonds are riskier than short-term bonds, yields on long-term
Treasury bonds will always be higher than yields on short-term T-bonds
c.If the maturity risk premium (MRP) equals zero, the yield curve must be flat
d.The yield curve can never be downward sloping
e.If inflation is expected to increase in the future, and if the maturity risk premium
(MRP) is greater than zero, then the yield curve will have an upward slope
16) Last year Rosenberg Corp. had $195,000 of assets, $18,775 of net income, and a
debt-to-total-assets ratio of 32%. Now suppose the new CFO convinces the president to
increase the debt ratio to 48%. Sales and total assets will not be affected, but interest
expenses would increase. However, the CFO believes that better cost controls would be
sufficient to offset the higher interest expense and thus keep net income unchanged. By
how much would the change in the capital structure improve the ROE?
a. 4.36%
b. 4.57%
c. 4.80%
d. 5.04%
e. 5.30%
17) Whitestone Products is considering a new project whose data are shown below. The
required equipment has a 3-year tax life, and the accelerated rates for such property are
33.33%, 44.45%, 14.81%, and 7.41% for Years 1 through 4. Revenues and other
operating costs are expected to be constant over the project’s 10-year expected
operating life. What is the project’s Year 4 cash flow?
Equipment cost (depreciable basis)$70,000
Sales revenues, each year$42,500
Operating costs (excl. deprec.)$25,000
Tax rate35.0%
a.$11,904
b.$12,531
c.$13,190
d.$13,850
e.$14,542
18) Marshall Inc. recently hired your consulting firm to improve the company’s
performance. It has been highly profitable but has been experiencing cash shortages due
to its high growth rate. As one part of your analysis, you want to determine the firm’s
cash conversion cycle. Using the following information and a 365-day year, what is the
firm’s present cash conversion cycle?
Average inventory =$75,000
Annual sales =$600,000
Annual cost of goods sold =$360,000
Average accounts receivable =$160,000
Average accounts payable =$25,000
a.120.6 days
b.126.9 days
c.133.6 days
d.140.6 days
e.148.0 days
19) Refer to Exhibit 15.3. Now assume that BB is considering changing from its
original capital structure to a new capital structure with 45% debt and 55% equity. This
results in a weighted average cost of capital equal to 10.4% and a new value of
operations of $576,923. Assume BB raises $259,615 in new debt and purchases T-bills
to hold until it makes the stock repurchase. What is the stock price per share
immediately after issuing the debt but prior to the repurchase?
a.$14.42
b.$19.36
c.$23.91
d.$28.85
e.$35.62
20) Refer to Exhibit 15.1. PP is considering changing its capital structure to one with
30% debt and 70% equity, based on market values. The debt would have an interest rate
of 8%. The new funds would be used to repurchase stock. It is estimated that the
increase in risk resulting from the added leverage would cause the required rate of
return on equity to rise to 12%. If this plan were carried out, what would be PP’s new
value of operations?
a.$484,359
b.$487,805
c.$521,173
d.$560,748
e.$584,653
21) Which of the following statements is CORRECT?
a.Suppose a firm is operating its fixed assets at below 100% of capacity, but it has no
excess current assets. Based on the AFN equation, its AFN will be larger than if it had
been operating with excess capacity in both fixed and current assets
b.If a firm retains all of its earnings, then it cannot require any additional funds to
support sales growth
c.Additional funds needed (AFN) are typically raised using a combination of notes
payable, long-term debt, and common stock. Such funds are non-spontaneous in the
sense that they require explicit financing decisions to obtain them
d.If a firm has a positive free cash flow, then it must have either a zero or a negative
AFN
e.Since accounts payable and accrued liabilities must eventually be paid off, as these
accounts increase, AFN as calculated by the AFN equation must also increase
22) Your friend is considering adding one additional stock to a 3-stock portfolio, to
form a 4-stock portfolio. She is highly risk averse and has asked for your advice. The
three stocks currently held all have b = 1.0, and they are perfectly positively correlated
with the market. Potential new Stocks A and B both have expected returns of 15%, are
in equilibrium, and are equally correlated with the market, with r = 0.75. However,
Stock A’s standard deviation of returns is 12% versus 8% for Stock B. Which stock
should this investor add to his or her portfolio, or does the choice not matter?
a.Stock A
b.Stock B
c.Neither A nor B, as neither has a return sufficient to compensate for risk
d.Add A, since its beta must be lower
e.Either A or B, i.e., the investor should be indifferent between the two
23) Which of the following is a primary market transaction?
a. You sell 200 shares of Johnson & Johnson stock on the NYSE through your broker
b. Johnson & Johnson issues 2,000,000 shares of new stock and sells them to the public
through an investment banker
c. You buy 200 shares of Johnson & Johnson stock from your younger brother. You just
give him cash and he gives you the stockthe trade is not made through a broker
d. One financial institution buys 200,000 shares of Johnson & Johnson stock from
another institution. An investment banker arranges the transaction
e. You invest $10,000 in a mutual fund, which then uses the money to buy $10,000 of
Johnson & Johnson shares on the NYSE
24) Which of the following statements is CORRECT?
a.Suppose the returns on two stocks are negatively correlated. One has a beta of 1.2 as
determined in a regression analysis using data for the last 5 years, while the other has a
beta of -0.6. The returns on the stock with the negative beta must have been negatively
correlated with returns on most other stocks during that 5-year period
b.Suppose you are managing a stock portfolio, and you have information that leads you
to believe the stock market is likely to be very strong in the immediate future. That is,
you are convinced that the market is about to rise sharply. You should sell your
high-beta stocks and buy low-beta stocks in order to take advantage of the expected
market move
c.You think that investor sentiment is about to change, and investors are about to
become more risk averse. This suggests that you should re-balance your portfolio to
include more high-beta stocks
d.If the market risk premium remains constant, but the risk-free rate declines, then the
required returns on low-beta stocks will rise while those on high-beta stocks will
decline
e.Paid-in-Full Inc. is in the business of collecting past-due accounts for other
companies, i.e., it is a collection agency. Paid-in-Full’s revenues, profits, and stock price
tend to rise during recessions. This suggests that Paid-in-Full Inc.’s beta should be quite
high, say 2.0, because it does so much better than most other companies when the
economy is weak
25) Which of the following statements is CORRECT?
a. If a firm increases its sales and cost of goods sold while holding its inventories
constant, then, other things held constant, its inventory turnover ratio will decrease
b. A reduction in inventories held would have no effect on the current ratio
c. An increase in inventories would have no effect on the current ratio
d. If a firm increases its sales and cost of goods sold while holding its inventories
constant, then, other things held constant, its inventory turnover ratio will increase
e. A reduction in the inventory turnover ratio will generally lead to an increase in the
ROE
26) The NPV method’s assumption that cash inflows are reinvested at the cost of capital
is generally more reasonable than the IRR’s assumption that cash flows are reinvested at
the IRR. This is an important reason why the NPV method is generally preferred over
the IRR method.
27) Projected free cash flows should be discounted at the firm’s weighted average cost
of capital to find the value of its operations.
28) “Stretching” accounts payable is a widely accepted, entirely ethical, and costless
financing technique.
29) A poison pill is also known as a corporate restructuring.
30) The SML relates required returns to firms’ systematic (or market) risk. The slope
and intercept of this line can be influenced by a manager’s actions.
31) Conflicts between two mutually exclusive projects occasionally occur, where the
NPV method ranks one project higher but the IRR method ranks the other one first. In
theory, such conflicts should be resolved in favor of the project with the higher positive
IRR.
32) One of the necessary steps in the financial planning process is a forecast of financial
statements under each alternative version of the operating plan in order to analyze the
effects of different operating procedures on projected profits and financial ratios.
33) One of the effects of ceasing to take trade credit discounts is that the firm’s accounts
payable will rise, other things held constant.
34) Debt management ratios show the extent to which a firm’s managers are attempting
to magnify returns on owners’ capital through the use of financial leverage.