1) Which of the following statements is CORRECT?
a.Preferred stock is normally expected to provide steadier, more reliable income to
investors than the same firm’s common stock, and, as a result, the expected after-tax
yield on the preferred is lower than the after-tax expected return on the common stock
b.The preemptive right is a provision in all corporate charters that gives preferred
stockholders the right to purchase (on a pro rata basis) new issues of preferred stock
c.One of the disadvantages to a corporation of owning preferred stock is that 70% of the
dividends received represent taxable income to the corporate recipient, whereas interest
income earned on bonds would be tax free
d.One of the advantages to financing with preferred stock is that 70% of the dividends
paid out are tax deductible to the issuer
e.A major disadvantage of financing with preferred stock is that preferred stockholders
typically have supernormal voting rights
2) If the expected dividend growth rate is zero, then the cost of external equity capital
raised by issuing new common stock (re) is equal to the cost of equity capital from
retaining earnings (rs) divided by one minus the percentage flotation cost required to
sell the new stock, (1 – F). If the expected growth rate is not zero, then the cost of
external equity must be found using a different formula.
3) Stock LB has a beta of 0.5 and Stock HB has a beta of 1.5. The market is in
equilibrium, with required returns equaling expected returns. Which of the following
statements is CORRECT?
a.If both expected inflation and the market risk premium (rM – rRF) increase, the
required return on Stock HB will increase by more than that on Stock LB
b.If both expected inflation and the market risk premium (rM – rRF) increase, the
required returns of both stocks will increase by the same amount
c.Since the market is in equilibrium, the required returns of the two stocks should be the
same
d.If expected inflation remains constant but the market risk premium (rM – rRF)
declines, the required return of Stock HB will decline but the required return of Stock
LB will increase
e.If expected inflation remains constant but the market risk premium (rM – rRF)
declines, the required return of Stock LB will decline but the required return of Stock
HB will increase
4) The slope of the SML is determined by the value of beta.
5) Which of the following are the factors for the Fama-French model?
a.The excess market return, a debt factor, and a book-to-market factor
b.The excess market return, a size factor, and a debt
c.A debt factor, a size factor, and a book-to-market factor
d.The excess market return, an industrial production factor, and a book-to-market factor
e.The excess market return, a size factor, and a book-to-market factor
6) Suppose it takes 1.82 U.S. dollars today to purchase one British pound in the foreign
exchange market, and currency forecasters predict that the U.S. dollar will depreciate
by 12.0% against the pound over the next 30 days. How many dollars will a pound buy
in 30 days?
a.1.12
b.1.63
c.1.82
d.2.04
e.3.64
7) Daniel Sawyer, the CEO of the Sawyer Group, is initiating planning for the
company’s operations next year, and he wants you to forecast the firm’s additional funds
needed (AFN). The firm is operating at full capacity. Data for use in your forecast are
shown below. Based on the AFN equation, what is the AFN for the coming year?
Dollars are in millions.
Last year’s sales = S0$350Last year’s accounts payable$40
Sales growth rate = g30%Last year’s notes payable$50
Last year’s total assets = A0*$500Last year’s accruals$30
Last year’s profit margin = PM5%Target payout ratio60%
a.$102.8
b.$108.2
c.$113.9
d.$119.9
e.$125.9
8) Field Industries’ outstanding bonds have a 25-year maturity and $1,000 par value.
Their nominal yield to maturity is 9.25%, they pay interest semiannually, and they sell
at a price of $850. What is the bond’s nominal (annual) coupon interest rate?
a.6.27%
b.6.60%
c.6.95%
d.7.32%
e.7.70%
9) Newsome Inc. buys on terms of 3/15, net 45. It does not take the discount, and it
generally pays after 60 days. What is the nominal annual percentage cost of its non-free
trade credit, based on a 365-day year?
a.25.09%
b.27.59%
c.30.35%
d.33.39%
e.36.73%
10) Which of the following statements is NOT CORRECT?
a.Foreign bonds and Eurobonds are two important types of international bonds
b.Foreign bonds are bonds sold by a foreign borrower but denominated in the currency
of the country in which the issue is sold
c.The term Eurobond applies only to foreign bonds denominated in U.S. currency
d.A foreign bond might pay a higher nominal interest rate than a U.S. bond
e.Any bond sold outside the country of the borrower is called an international bond
11) Company A has a beta of 0.70, while Company B’s beta is 1.20. The required return
on the stock market is 11.00%, and the risk-free rate is 4.25%. What is the difference
between A’s and B’s required rates of return? (Hint: First find the market risk premium,
then find the required returns on the stocks.)
a.2.75%
b.2.89%
c.3.05%
d.3.21%
e.3.38%
12) DeYoung Devices Inc., a new high-tech instrumentation firm, is building and
equipping a new manufacturing facility. Assume that currently its equipment must be
depreciated on a straight-line basis over 10 years, but Congress is considering
legislation that would require the firm to depreciate the equipment over 7 years. If the
legislation becomes law, which of the following would occur in the year following the
change?
a.The firm’s reported net income would increase
b.The firm’s operating income (EBIT) would increase
c.The firm’s taxable income would increase
d.The firm’s net cash flow would increase
e.The firm’s tax payments would increase
13) Last year Altman Corp. had $205,000 of assets, $303,500 of sales, $18,250 of net
income, and a debt-to-total-assets ratio of 41%. The new CFO believes the firm has
excessive fixed assets and inventory that could be sold, enabling it to reduce its total
assets to $152,500. Sales, costs, and net income would not be affected, and the firm
would maintain the 41% debt ratio. By how much would the reduction in assets
improve the ROE?
a. 4.69%
b. 4.93%
c. 5.19%
d. 5.45%
e. 5.73%
14) Pet World 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 (and even
negative), in which case it will be rejected.
Year012345
Cash flows-$9,500$2,000$2,025$2,050$2,075$2,100
a.2.08%
b.2.31%
c.2.57%
d.2.82%
e.3.10%
15) Which of the following statements is CORRECT?
a.Subordinated debt has less default risk than senior debt
b.Convertible bonds have lower coupon rates than non-convertible bonds of similar
default risk because they offer the possibility of capital gains
c.Junk bonds typically provide a lower yield to maturity than investment-grade bonds
d.A debenture is a secured bond that is backed by some or all of the firm’s fixed assets
e.Junior debt is debt that has been more recently issued, and in bankruptcy it is paid off
after senior debt because the senior debt was issued first
16) Which of the following would be most likely to lead to a decrease in a firm’s
dividend payout ratio?
a. Its access to the capital markets increases
b. Its R&D efforts pay off, and it now has more high-return investment opportunities
c. Its accounts receivable decrease due to a change in its credit policy
d. Its stock price has increased over the last year by a greater percentage than the
increase in the broad stock market averages
e. Its earnings become more stable
17) Stocks A, B, and C are similar in some respects: Each has an expected return of
10% and a standard deviation of 25%. Stocks A and B have returns that are independent
of one another; i.e., their correlation coefficient, r, equals zero. Stocks A and C have
returns that are negatively correlated with one another; i.e., r is less than 0. Portfolio AB
is a portfolio with half of its money invested in Stock A and half in Stock B. Portfolio
AC is a portfolio with half of its money invested in Stock A and half invested in Stock
C. Which of the following statements is CORRECT?
a.Portfolio AC has an expected return that is greater than 25%
b.Portfolio AB has a standard deviation that is greater than 25%
c.Portfolio AB has a standard deviation that is equal to 25%
d.Portfolio AC has a standard deviation that is less than 25%
e.Portfolio AC has an expected return that is less than 10%
18) Puckett Inc. risk-adjusts its WACC to account for project risk. It uses a WACC of
8% for below-average risk projects, 10% for average-risk projects, and 12% for
above-average risk projects. Which of the following independent projects should
Puckett accept, assuming that the company uses the NPV method when choosing
projects?
a.Project B, which has below-average risk and an IRR = 8.5%
b.Project C, which has above-average risk and an IRR = 11%
c.Without information about the projects’ NPVs we cannot determine which project(s)
should be accepted
d.All of these projects should be accepted
e.Project A, which has average risk and an IRR = 9%
19) LIBOR is an acronym for London Interbank Offer Rate, which is an average of
interest rates offered by London banks to smaller U.S. corporations.
20) If you were evaluating two mutually exclusive projects for a firm with a zero cost
of capital, the payback method and NPV method would always lead to the same
decision on which project to undertake.
21) The higher the firm’s flotation cost for new common equity, the more likely the firm
is to use preferred stock, which has no flotation cost, and reinvested earnings, whose
cost is the average return on the assets that are acquired.
22) Consider the balance sheet of Wilkes Industries as shown below. Because Wilkes
has $800,000 of retained earnings, the company would be able to pay cash to buy an
asset with a cost of $200,000.
Cash$ 50,000Accounts payable$ 100,000
Inventory200,000Accruals 100,000
Accounts receivable 250,000Total CL$ 200,000
Total CA$ 500,000Debt200,000
Net fixed assets$ 900,000Common stock200,000
_________Retained earnings 800,000
Total assets$1,400,000Total L & E$1,400,000
23) If you plotted the returns of a company against those of the market and found that
the slope of your line was negative, the CAPM would indicate that the required rate of
return on the stock should be less than the risk-free rate for a well-diversified investor,
assuming that the observed relationship is expected to continue in the future.
24) An individual stock’s diversifiable risk, which is measured by its beta, can be
lowered by adding more stocks to the portfolio in which the stock is held.