Which of the following is NOT a way risk management can be used to increase the
value of a firm?
a.Risk management can increase debt capacity.
b.Risk management can help a firm maintain its optimal capital budget.
c.Risk management can reduce the expected costs of financial distress.
d.Risk management can help firms minimize taxes.
e.Risk management can allow managers to defer receipt of their bonuses and thus
postpone tax payments.
Corporations face the following tax schedule:
Company Z has $80,000 of taxable income from its operations, $5,000 of interest
income, and $30,000 of dividend income from preferred stock it holds in other
corporations. What is Company Z’s tax liability?
a.$17,328
b.$18,240
c.$19,200
d.$20,210
e.$21,221
Which of the following statements is CORRECT?
a.Hedge funds are legal in Europe and Asia, but they are not permitted to operate in the
United States.
b.Hedge funds are legal in the United States, but they are not permitted to operate in
Europe or Asia.
c.Hedge funds have more in common with investment banks than with any other type of
financial institution.
d.Hedge funds have more in common with commercial banks than with any other type
of financial institution.
e.Hedge funds are not as highly regulated as most other types of financial institutions.
The justification for this light regulation is that only ‘sophisticated investors” (i.e., those
with high net worths and high incomes) are permitted to invest in these funds, and these
investors supposedly can do any necessary “due diligence” on their own rather than
have it done by the SEC or some other regulator.
Other things held constant, if the expected inflation rate decreases and investors also
become more risk averse, the Security Market Line would be affected as follows:
a.The y-axis intercept would decline, and the slope would increase.
b.The x-axis intercept would decline, and the slope would increase.
c.The y-axis intercept would increase, and the slope would decline.
d.The SML would be affected only if betas changed.
e.Both the y-axis intercept and the slope would increase, leading to higher required
returns.
Which of the following statements is CORRECT?
a.If a lower level person in a firm does something illegal, like “cooking the books,” to
understate costs and thereby artificially increase profits because he or she was ordered
to do so by a superior, the lower level person cannot be prosecuted but the superior can
be prosecuted.
b.There are many types of unethical business behavior. One example is where
executives provide information that they know is incorrect to outsiders. It is illegal to
provide such information to federally regulated banks, but it is not illegal to provide it
to stockholders because they are the owners of the firm.
c.If someone deliberately understates costs and thereby causes reported profits to
increase, this can cause the stock priceto rise above its intrinsic value. The stock will
probably fall in the future. Both those who participated in the fraud and the firm itself
can be prosecuted.
d.Ethical behavior is not influenced by training and auditing procedures. People are
either ethical or they are not, and this is what determines ethical behavior in business.
e.Ethics is not an important consideration in business and in business schools.
Which of the following is a primary market transaction?
a.You sell 200 shares of IBM stock on the NYSE through your broker.
b.You buy 200 shares of IBM stock from your brother. The trade is not made through a
broker; you just give him cash and he gives you the stock.
c.IBM issues 2,000,000 shares of new stock and sells them to the public through an
investment banker.
d.One financial institution buys 200,000 shares of IBM stock from another institution.
An investment banker arranges the transaction.
e.IBM sells 2,000,000 shares of treasury stock to its employees when they exercise
options that were granted in prior years.
Thomson Media is considering some new equipment whose data are shown below. The
equipment has a 3-year tax life and would be fully depreciated by the straight-line
method over 3 years, but it would have a positive pre-tax salvage value at the end of
Year 3, when the project would be closed down. Also, additional net operating working
capital would be required, but it would be recovered at the end of the project’s life.
Revenues and other operating costs are expected to be constant over the project’s 3-year
life. What is the project’s NPV?
a.$20,762
b.$21,854
c.$23,005
d.$24,155
e.$25,363
Temple Corp. is considering a new project whose data are shown below. The equipment
that would be used has a 3-year tax life, would be depreciated by the straight-line
method over its 3-year life, and would have a zero salvage value. No change in net
operating working capital would be required. Revenues and other operating costs are
expected to be constant over the project’s 3-year life. What is the project’s NPV?
a.$15,740
b.$16,569
c.$17,441
d.$18,359
e.$19,325
Which of the following is most CORRECT?
a.Firms that use “off-balance-sheet” financing, such as leasing, would show lower debt
ratios if the effects of their leases were reflected in their financial statements.
b.Capitalizing a lease means that the firm issues equity capital in proportion to its
current capital structure, in an amount sufficient to support the lease payment
obligation.
c.The fixed charges associated with a lease can be as high as, but never greater than, the
fixed payments associated with a loan.
d.Capital, or financial, leases generally provide for maintenance by the lessor.
e.A key difference between a capital lease and an operating lease is that with a capital
lease, the lease payments provide the lessor with a return of the funds invested in the
asset plus a return on the invested funds, whereas with an operating lease the lessor
depends on the residual value to realize a full return of and on the investment.
A highly risk-averse investor is considering adding one additional stock to a 3-stock
portfolio, to form a 4-stock portfolio. 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.Either A or B, i.e., the investor should be indifferent between the two.
b.Stock A.
c.Stock B.
d.Neither A nor B, as neither has a return sufficient to compensate for risk.
e.Add A, since its beta must be lower.
Exhibit 16.1
Zorn Corporation is deciding whether to pursue a restricted or relaxed working capital
investment policy. The firm’s annual sales are expected to total $3,600,000, its fixed
assets turnover ratio equals 4.0, and its debt and common equity are each 50% of total
assets. EBIT is $150,000, the interest rate on the firm’s debt is 10%, and the tax rate is
40%. If the company follows a restricted policy, its total assets turnover will be 2.5.
Under a relaxed policy its total assets turnover will be 2.2.
Refer to Exhibit 16.1. Assume now that the company believes that if it adopts a
restricted policy, its sales will fall by 15% and EBIT will fall by 10%, but its total assets
turnover, debt ratio, interest rate, and tax rate will all remain the same. In this situation,
what’s the difference between the projected ROEs under the restricted and relaxed
policies?
a.2.24%
b.2.46%
c.2.70%
d.2.98%
e.3.27%
Swim Suits Unlimited is in a highly seasonal business, and the following summary
balance sheet data show its assets and liabilities at peak and off-peak seasons (in
thousands of dollars):
From this data we may conclude that
a.Swim Suits’ current asset financing policy calls for exactly matching asset and
liability maturities.
b.Swim Suits’ current asset financing policy is relatively aggressive; that is, the
company finances some of its permanent assets with short-term discretionary debt.
c.Swim Suits follows a relatively conservative approach to current asset financing; that
is, some of its short-term needs are met by permanent capital.
d.Without income statement data, we cannot determine the aggressiveness or
conservatism of the company’s current asset financing policy.
e.Without cash flow data, we cannot determine the aggressiveness or conservatism of
the company’s current asset financing policy.