FINA 3004 Final
Which of the following statements is correct?
The WACC measures the marginal cost of capital.
Which of the following is a use of cash?
The firm decreases its accrued wages and taxes.
Which of the following will increase the cost of equity?
The firm's share price falls 10%.
Solving for Rates You invested $1,000 in the stock market one year ago. Today, the investment is valued at $750. What return did you earn? What return would you need to get next year to break even overall?
-25%, +33.33% respectively
When computing the rate of return from selling an investment, the number of years between the present and future cash flows is an important factor in determining:
the annual rate earned
You borrow $3,500 and will pay back the entire amount in 5 years. You are charged 9% interest per year. How much interest do you pay on this loan?
$1,885.18
P/E Ratio and Stock Price International Business Machines (IBM) has earnings per share of $6.85 and a P/E ratio of 15.19. What is the stock price?
$104.05
Compute the future value in year 12 of a $2,000 deposit in year 3 and another $4,000 deposit at the end of year 5 using a 10% interest rate.
$12,510.77
Your current $155,000 mortgage calls for monthly payments over 25 years at an annual rate interest rate of 6%. If you pay an additional $50 each month beginning with the first payment, how much interest expense do you save by pre-paying?
$17,152.22
Future Value of an Annuity What is the future value of an $800 annuity payment over 15 years if the interest rates are 6 percent?
$18,620.78
Consider that you are 30 years old and have just changed to a new job. You have $91,000 in the retirement plan from your former employer. You can roll that money into the retirement plan of the new employer. You will also contribute $4,800 each year into your new employer's plan. If the rolled-over money and the new contributions both earn a 7% return, how much should you expect to have when you retire in 38 years?
$2,018,506.60
Margaret plans to deposit $500 on the first day of each of the next five years, beginning today. If she earns 4% compounded annually, how much will she have at the end of five years?
$2,816.49
Compounding with Different Interest Rates A deposit of $300 earns interest rates of 7 percent in the first year and 10 percent in the second year. What would be the second year future value?
$353.10
Jasmine has decided that she wants to build enough retirement wealth that, if invested at 6% per year, will provide her with $3,000 of monthly income for 30 years. To date, she has saved nothing but she still has 25 years until she retires. Jasmine believes that she can earn 9% on her investments until she retires. How much money does she need to contribute per month to reach her goal?
$446.32
Future Value of an Annuity What is the future value of a $1,000 annuity payment over 4 years if the interest rates are 8 percent?
$4506.11
P/E Model and Cash Flow Valuation Suppose that a firm's recent earnings per share and dividends per share are $3.00 and $1.50, respectively. Both are expected to grow at 10 percent. However, the firm's current P/E ratio of 20 seems high for this growth rate. The P/E ratio is expected to fall to 16 within five years. Compute a value for this stock by first estimating the dividends over the next five years and the stock price in five years. Then discount these cash flows using a 14 percent required rate.
$46.89
What is the present value of a $600 payment in one year when the discount rate is 8%?
$555.56
A deposit of $500 earns 5% the first year, 6% the second year and 7% the third year. What would be the third year future value?
$595.46
Future Value Given a 6 percent interest rate, compute the year 6 future value of deposits made in years 1, 2, 3, and 4 of $1,200, $1,400, $1,400, and $1,500.
$6,726.16
Assume you borrow $5,000 today and pay back the loan in one lump sum 4 years from today. You are charged 8% interest per year. What amount will you pay back and how much interest will you pay?
$6,802.44; $1802.44
You have been asked by the president of your company to evaluate the proposed acquisition of a new special-purpose truck for $250,000. The truck falls into the MACRS three-year class, and it will be sold after three years for $50,000. Use of the truck will require an increase in NWC (spare parts inventory) of $5,000. The truck will have no effect on revenues, but it is expected to save the firm $80,000 per year in before-tax operating costs, mainly labor. The firm's marginal tax rate is 40 percent. What will the operating cash flow for this project be during year 3?
$62,810
Value of Future Cash Flows A firm recently paid a $1.00 annual dividend. The dividend is expected to increase by 10 percent in each of the next four years. In the fourth year, the stock price is expected to be $100. If the required rate for this stock is 14 percent, what is its value?
$62.87
You are evaluating a project for The Ultimate recreational tennis racket, guaranteed to correct that wimpy backhand. You estimate the sales price of The Ultimate to be $300 per unit and sales volume to be 1,000 units in year 1; 1,250 units in year 2; and 1,325 units in year 3. The project has a 3-year life. Variable costs amount to $200 per unit and fixed costs are $50,000 per year. The project requires an initial investment of $150,000 in assets which will be depreciated straight-line to zero over the 3-year project life. The actual market value of these assets at the end of year 3 is expected to be $25,000. NWC requirements at the beginning of each year will be approximately 10% of the projected sales during the coming year. The tax rate is 30% and the required return on the project is 10%. What will the free cash flow for this project be in year 2?
$65,250
Jasmine has decided that she wants to build enough retirement wealth that, if invested at 6% per year, will provide her with $3,000 of monthly income for 30 years. To date, she has saved nothing but she still has 25 years until she retires. Jasmine believes that she can earn 6% on her investments until she retires. How much money does she need to contribute per month to reach her goal?
$722.05
Buying Stock with Commission At your discount brokerage firm, it costs $9.95 per stock trade. How much money do you need to buy 100 shares of Ralph Lauren (RL), which trades at $85.13?
$8,522.95
Stock Index Performance On November 27, 2007, The Dow Jones Industrial Average closed at 12,958.44, which was up 215.04 that day. What was the return (in percent) of the stock market that day?
+1.69
Sprint Nextel Corp stock ended the previous year at $25.00 per share. It paid a $2.57 per share dividend last year. It ended last year at $18.89. If you owned 650 shares of Sprint, what was your dollar return and percent return?
-$2,301; -14.16%
Determine the interest rate earned on a $800 deposit when $808 is paid back in one year.
1%
Analysts state that the required return from Plummet Soft Drinks stock is 25%, and the returns from Treasury bills and the market portfolio are 4% and 20% respectively. What is Plummets beta?
1.31
Portfolio Beta You have a portfolio with a beta of 1.25. What will be the new portfolio beta if you keep 80 percent of your money in the old portfolio and 20 percent in a stock with a beta of 1.75?
1.35
Portfolio Beta You own $1,000 of City Steel stock that has a beta of 1.5. You also own $5,000 of Rent-N-Co (beta = 1.8) and $4,000 of Lincoln Corporation (beta = 0.9). What is the beta of your portfolio?
1.4
You have just paid $1,135.90 for a bond which matures in 10 years, and pays interest every 6 months. If you require a nominal annual rate of 8%, what is the coupon rate on this bond?
10%
Your company is considering the purchase of a new machine. The original cost of the old machine was $100,000; it is now 5 years old, and it has a current market value of $40,000. The old machine is being depreciated over a 10-year life toward a zero estimated salvage value on a straight-line basis, resulting in a current book value of $50,000 and an annual depreciation expense of $10,000. The old machine can be used for 6 more years but has no market value after its depreciable life is over. Management is contemplating the purchase of a new machine whose cost is $80,000 and whose estimated salvage value is zero. Expected before-tax cash savings from the new machine are $13,000 a year over its full MACRS depreciable life. Depreciation is computed using MACRS over a 5-year life, and the cost of capital is 10 percent. Assume a 40 percent tax rate. What will the year 1 operating cash flow for this project be?
10,200
Crab Cakes Ltd. has 5 million shares of stock outstanding selling at $15 per share and an issue of $10 million in 10 percent, annual coupon bonds with a maturity of 25 years, selling at 97 percent of par ($1000). If Crab Cakes' weighted average tax rate is 30 percent, its next dividend is expected to be $1.00 per share, and all future dividends are expected to grow at 5 percent per year, indefinitely, what is its WACC?
11.16%
You hold the positions in the table below. What is the beta of your portfolio? If you expect the market to earn 10 percent and the risk-free rate is 4 percent, what is the required return of the portfolio?
11.68%
A small business owner visits his bank to ask for a loan. The owner states that she can repay a loan at $2,500 per month for the next 2 years and then $3,000 per month for another 2 years after that. If the bank is charging customers 6.5% APR, how much would it be willing to lend the business owner?
115,278.17
Solving for Rates What annual rate of return is earned on a $4,000 investment made in year 2 when it grows to $8,000 by the end of year eight?
12.25%
A firm has common stock with a market price of $25 per share and an expected dividend of $2 per share at the end of the coming year .The growth rate in dividends has been 5 percent. The cost of the firm's common stock equity is
13 percent
What will be the monthly payment on a loan of $895, amortized over 17 years, at an annual interest rate of 19%?
14.77 ± 2%
Due to poor spending habits, Ricky has accumulated $10,000 in credit card debt. He has missed several payments and now the annual interest rate on the card is 18.95%! If he pays $175 per month on the card, how long will it take Ricky to pay off the card?
148.50 months
Solving for Rates What annual rate of return is earned on a $200 investment when it grows to $850 in ten years?
15.57%
Solving for Time How many years will it take $1 million to grow to $3 million with an annual interest rate of 7 percent?
16.24 years
Dividend Growth Annual dividends of Pfizer, Inc. (PFE) grew from $0.38 in 2000 to $1.15 in 2007. What was the annual growth rate?
17.14%
If you invested $1,000 in Disney and $5,000 in Oracle and the two companies returned 15% and 18% respectively, what was your portfolio's return?
17.5%
How long will it take for the purchasing power of $1 to be cut in half if inflation is 4%?
17.67 years
What is the weighted average cost of capital after taxes if the desired capital structure is 40% debt and 60% equity and investors require a 10% pre-tax return from debt and 25% from equity and the tax rate is 30%?
18%
Calculate the price of a zero coupon bond that matures in 20 years if the market interest rate is 8.5%. (Assume annual compounding and a par value of $1,000.)
195.62
Dakota Corporation 15-year bonds have an equilibrium rate of return of 9%. For all securities, the inflation risk premium is 1.95% and the real interest rate is 3.65%. The security's liquidity risk premium is 0.35% and maturity risk premium is 0.95%. The security has no special covenants. Calculate the bond's default risk premium.
2.10%
IBM's stock price is $22, it is expected to pay a $2 dividend, and analysts expect the firm to grow at 10% per year for the next 5 years. TDI's stock price is $10, it is expected to pay a $1 dividend, and analysts expect the firm to grow at 12% per year for the next 5 years. What is the difference in the two firms' required rate of returns?
2.91%
Which of the following is an example of a capital structure?
20% debt and 80% equity
Five years ago, sales were $4 million. Today your company's sales are $10 million. What annual rate have sales been growing?
20.11%
A $7 million deposit earns 5% for 9 years. If the account loses 2% per year after that, how long will it take to be reduced back to $7 million?
21.74 years
KADS, Inc. has spent $400,000 on research to develop a new computer game. The firm is planning to spend $250,000 on a machine to produce the new game. Shipping and installation costs of the machine will be capitalized and depreciated; they total $50,000. The machine has an expected life of 3 years, a $75,000 estimated resale value, and falls under the MACRS 7-Year class life. Revenue from the new game is expected to be $500,000 per year, with costs of $200,000 per year. The firm has a tax rate of 35 percent, an opportunity cost of capital of 15 percent, and it expects net working capital to increase by $100,000 at the beginning of the project. What will the year 1 free cash flow for this project be?
210,004.50
One-year Treasury bills currently earn 3.75 percent. You expect that one year from now, one-year Treasury bill rates will increase to 4.15 percent. If the unbiased expectations theory is correct, what should the current rate be on two-year Treasury securities?
3.95%
Isaac realizes that he charged too much on his credit card and has racked up $7,000 in debt. If he can pay $275 each month and the card charges 17.55% APR (compounded monthly), how long will it take him to pay off the credit card? How much interest expense will Isaac pay during this time?
32.07 months; $3,819.25
A fast growing firm recently paid a dividend of $1.00 per share. The dividend is expected to increase at a rate of 15% rate for the next 3 years. Afterwards, a more stable 6% growth rate can be assumed. If a 10% discount rate is appropriate for this stock, what is its value?
33.54
Suppose the present value of a 65-year ordinary annuity is $490. If the discount rate is 7%, what must the annual cash flow be?
34.73 ± 2%
Future Value Given a 7 percent interest rate, compute the year 6 future value if deposits of $2,500 and $1,500 are made in years 2 and 3, respectively, and a withdrawal of $900 is made in year 4.
4,084.15
Compute the present value of a $2,500 deposit in year 4 and another $10,000 deposit at the end of year 8 if interest rates are 15%.
4,698.40
Suppose that Glamour Nails, Inc.'s capital structure features 30 percent equity, 70 percent debt, and that its before-tax cost of debt is 4 percent, while its cost of equity is 10 percent. If the appropriate weighted average tax rate is 34 percent, what will be Glamour Nails' WACC?
4.85%
A small business owner visits his bank to ask for a loan. The owner states that she can repay a loan at $1,250 per month for the next 3 years and then $500 per month for two years after that. If the bank is charging customers 12% APR, how much would it be willing to lend the business owner?
45,058.15
Discounting One Year What is the present value of a $500 payment in one year when the discount rate is 5 percent?
476.19
Constant Growth Stock Valuation Best Buy Co (BBY) paid a $0.27 dividend per share in 2003, which grew to $0.49 in 2007. This growth is expected to continue. What is the value of this stock at the beginning of 2007 when the required rate of return is 17.23 percent?
49.03
Annuity Interest Rate What's the interest rate of a 4-year, annual $1,000 annuity with present value of $3,500?
5.56%
Unbiased Expectations Theory One-year Treasury bills currently earn 5.50 percent. You expect that one year from now, one-year Treasury bill rates will increase to 5.75 percent. If the unbiased expectations theory is correct, what should the current rate be on two-year Treasury securities?
5.625%
JoJo's portfolio's return is 12%. She is invested in Cisco and IBM which had returns of 15% and 9% respectively. What percentage of JoJo's assets are invested in each firm?
50% in Cisco and 50% in IBM
Bond Prices and Interest Rate Changes A 5.5 percent coupon bond with 18 years left to maturity is priced to offer a 6.25 percent yield to maturity. You believe that in one year, the yield to maturity will be 5.75 percent. What is the change in price the bond will experience in dollars? (Assume semi-annual interest payments and $1,000 par value.)
53.48
Carrie D's has 6 million shares of common stock outstanding, 2 million shares of preferred stock outstanding, and 10 thousand bonds. If the common shares are selling for $15 per share, the preferred shares are selling for $28 per share, and the bonds are selling for 109 percent of par, what would be the weight used for equity in the computation of Carrie D's WACC?
57.36%
A firm is expected to pay a $2.00 dividend per share. The stock is selling in the market place for $50.00 per share. If investors are demanding 10% on this stock, what is this stock's growth rate?
6%
Risk Premium The annual return on the S&P 500 Index was 12.4 percent. The annual T-bill yield during the same period was 5.7 percent. What was the market risk premium during that year?
6.7%
Solving for Rates What annual rate of return is implied on a $700 loan taken next year when $800 must be repaid in year 3?
6.90%
Constant Growth Stock Valuation Target Corp (TGT) paid a $0.21 dividend per share in 2000, which grew to $0.52 in 2007. This growth is expected to continue. What is the value of this stock at the beginning of 2007 when the required rate of return is 14.77 percent?
62.97
The current market price of a share of HiTec, Inc. is $55. The firm is expected to continue growing at 3% in the foreseeable future. Flotation costs on new issues of equity will run $1.50 per share. If the next dividend is expected to be $2.50, what is the cost of new equity?
7.7%
If a 53-year ordinary annuity has a present value of $658, and if the interest rate is 11%, what is the amount of each annuity payment?
72.67 ± 2%
One Year Future Value What is the future value of $700 deposited for one year earning 4% interest rate annually?
728
If you presently have $6,000 invested at a rate of 15%, how many years will it take for you investment to triple? (round up to obtain a whole number of years if necessary.)
8
Time to Maturity A bond issued by a corporation on June 15, 2007, is scheduled to mature on June 15, 2017. If today is December 16, 2008, what is this bond's time to maturity? (Assume annual interest payments.)
8 years, 6 months
Bug-Off-the-Lot, a Volkswagen dealership is considering an expansion that will cost $75,000. The firm wishes to finance the expansion with one-third debt, 40% retained earnings, and the remainder with new equity. The firm pays no taxes. What is the marginal cost of capital if debt costs 12%, retained earnings cost 5%, and the cost of new equity is 8%?
8.15%
Pumpkin Pie Industries has 5 million shares of common stock outstanding, 1 million shares of preferred stock outstanding, and 10 thousand bonds. If the common shares are selling for $50 per share, the preferred shares are selling for $31 per share, and the bonds are selling for 98 percent of par ($1000), what would be the weights used in the calculation of Pumpkin Pie's WACC for common stock, preferred stock, and bonds, respectively?
85.97%, 10.67%, 3.38%
At your discount brokerage firm, it costs $9.95 per stock trade. How much money do you need to buy 200 shares of General Electric (GE), which trades at $45.19?
9,047.95
WC Inc. has a $10 million (face value), 10-year bond issue selling for 99 percent of par that pays an annual coupon of 9 percent. What would be WC's before-tax component cost of debt?
9.16%
A $1,000 investment has doubled to $2,000 in seven years. How much longer will it take for the investment to reach $5,000 if it continues to earn the same rate?
9.25 years
Suppose you sell a fixed asset for $90,000 when its book value is $95,000. If your company's marginal tax rate is 40%, what will be the effect on cash flows of this sale (i.e., what will be the after-tax cash flow of this sale)?
92,000
You are in possession of a bond that has three years remaining to maturity. The original maturity on the bond was 30 years. The bond has a $1,000 par value and a 9% coupon rate. If interest is paid annually and bonds with similar risk currently have an interest rate of 10%, what is the current value of the bond?
975
A firm is expected to pay a dividend of $2.00 next year and $3.75 the following year. Financial analysts believe the stock will be at their price target of $125.00 in two years. Compute the value of this stock with a required rate of return of 15%.
99.09
You are deciding among several different bank accounts. Which of the following will generate the highest effective annual rate (EAR)?
A 6% rate with monthly compounding
Which of the following statements is incorrect?
A NPV profile plots the relationship between the riskiness of a project and the associated NPVs.
You have developed the following data on three stocks:Stock Standard Deviation BetaA 0.15 0.79B 0.25 0.61C 0.20 1.29If you are a risk minimizer, you should chose Stock "___" if it is to be held in isolation and Stock "_____" if it is to be held as part of a well-delivered portfolio.
A; B
All of the following are reasons that one should be cautious in interpreting financial statements except ____________
All of these are reasons to be cautious in interpreting financial statements.
All of the following would be a result of changing to the MACRS method of depreciation except _______.
All of these.
Future Value At age 20 you invest $1,000 that earns 7 percent each year. At age 30 you invest $1,000 that earns 10 percent per year. In which case would you have more money at age 60?
At age 30 invest $1,000 at 10 percent.
Future Value At age 25 you invest $2,000 that earns 6 percent each year. At age 35 you invest $2,000 that earns 9 percent per year. In which case would you have more money at age 60?
At age 35 invest $2,000 at 9 percent.
Estee Lauder's upcoming dividend is expected to be $0.65 and its stock is selling at $45. The firm has a beta of 1.1 and is expected to grow at 10% for the foreseeable future. Compute Estee Lauder's required return using both CAPM and the constant growth model. Assume that the market portfolio will earn 11 percent and the risk-free rate is 4 percent.
CAPM: 11.7%; Constant Growth Model: 11.44%
Which of the following problems could not be addressed by using compounding or discounting techniques?
Calculating the length of time needed for the supply and demand for loanable funds to equate if interest rates are above the equilibrium level.
Which of the following statements is true?
Dealers play a crucial role by providing liquidity in thin markets.
When calculating operating cash flow for a project, one would calculate it as being mathematically equal to which of the following?
EBIT - Taxes + Depreciation
All of the following are secondary market transactions except ___________.
GE sells $30 million of new preferred stock
Jane Adams invests all her money in the stock of one firm. Which of the following must be true?
Her return will have more volatility than the return in the overall stock market.
Genuine Products Inc. requires a new machine. Two companies have submitted bids, and you have been assigned to the task of choosing one of the machines. Cash flow analysis indicates the following:Year Machine A Machine B0 -$2,000 -$2,0001 0 8322 0 8323 0 8324 3,877 832What is the internal rate of return for each machine?
IRRa= 18%; IRRb= 24%
Which of the following is most correct?
In an efficient market, investors will sell overvalued stock which will drive its price down.
Which of the following statements about Treasury bills is true?
Investors holding them do not receive periodic interest payments.
Which of the following statements is correct?
Long-term bonds have more interest rate risk than short-term bonds.
Which of the following statements is false?
Managers cannot act in the best interests of their shareholders unless they know their shareholders' average time preference for receiving their money and what risk a typical shareholder is prepared to assume.
Which of the following statements is incorrect?
Most sole proprietors raise money by borrowing from banks.
Which of the following statements is correct?
None of these statements is correct.
Which of the following is an example of aligning managers' personal interests with those of the owners?
Offer the managers an equity stake in the firm
An all-equity firm is considering the projects shown below. The T-bill rate is 3% and the market risk premium is 6%. If the firm uses its current WACC of 12% to evaluate these projects, which project(s), if any, will be incorrectly rejected?
Only Project A would be incorrectly rejected.
Suppose your firm is considering investing in a project with the cash flows shown below, that the required rate of return on projects of this risk class is 10 percent, and that the maximum allowable payback and discounted payback statistics for the project are 3 and 3.5 years, respectively. Use the payback decision to evaluate this project; should it be accepted or rejected?
Payback = 4.90 years; reject
Total Risk Rank the following three stocks by their level of total risk, highest to lowest. Rail Haul has an average return of 10 percent and standard deviation of 15 percent. The average return and standard deviation of Idol Staff are 15 percent and 25 percent; and of Poker-R-Us are 12 percent and 35 percent.
Poker-R-Us, Idol Staff, Rail Haul
All of the following are functions of the board of directors except ________.
Provide reports to the auditors
Sally is choosing between two bonds both of which mature in 15 years and have the same level of risk. Bond A is a municipal bond that yields 5.25%. Bond B is a corporate bond that yields 7.75%. If Sally is in the 30% tax bracket, which bond should she select and why?
Sally should select Bond B because the taxable equivalent yield of Bond A is less than the yield of Bond B.
Which of the following statements is correct?
Sole proprietorships are easy to start.
Which of the following indices best reflects the ten sectors of the economy?
Standard & Poor's 500
How are future values affected by changes in interest rates?
The higher the interest rate, the larger the future value will be.
Which of the following statements is not true with respect to the effect of inflation on interest rates?
The nominal rate is the real rate of interest plus last periods level of inflation and any other risk premiums.
Which of the following statements is correct?
The rate on a 10-year Corporate can never be less than the rate on a 10-year Treasury.
The relationship between risk and return in finance can be best described by which of the following statements?
The riskier the security, the greater the return the investors expect from it.
The yield to maturity on a bond with a current price equal to its par, or face, value will always equal its coupon interest rate.
True
When using the constant growth model for the valuation of common stock, the constant growth rate, g, has to be greater than the required return, Ks, in order for the model to be useful.
True
If you own 300 shares of Alaska Air at $15.88, 250 shares of Best Buy at $151.00, and 1,150 shares of Ford Motor at $3.51, what are the portfolio weights of each stock?
Weight of Alaska Air: 10.23%; Weight of Best Buy: 81.09%; Weight of Ford Motor: 8.67%
Which of the following is a situation in which you would want to use the constant growth model approach for estimating the component cost of equity?
When the firm's stock is expected to experience constant dividend growth.
Suppose your firm is considering two independent projects with the cash flows shown below. The required rate of return on projects of both of their risk class is 12 percent, and the maximum allowable payback and discounted payback statistic for the projects are 2.5 and 3 years, respectively.
accept both A and B
If a company reports a large amount of net income on its income statement during a year, the firm will have
any of these scenarios
Long-term financing used by corporations and government entities
bonds
Common stockholders' equity divided by number of shares of common stock outstanding is the formula for calculating
book value per share
A decrease in net working capital (NWC) is treated as a
cash inflow
We commonly measure the risk-return relationship using which of the following?
coefficient of variation
We call the process of earning interest on both the original deposit and on the earlier interest payments:
compounding
Agency problems exist in which forms of business ownership?
corporation
The bond's annual coupon rate divided by its market price is referred to as the __________.
current yield
Assume that you observe the following rates on long-term bonds:U.S. Treasury bonds = 4.15%AAA Corporate bonds = 6.2%BBB Corporate bonds = 7.15%The main reason for the differences in the interest rates is:
default risk premium
Compute Bond Price Compute the price of a 4.75 percent coupon bond with 15 years left to maturity and a market interest rate of 6.25 percent. (Assume interest payments are semi-annual and par value is $1,000.) Is this a discount or premium bond?`
discount
Compute Bond Price Compute the price of a 6 percent coupon bond with 10 years left to maturity and a market interest rate of 8.75 percent. (Assume interest payments are semi-annual and par value is $1,000.) Is this a discount or premium bond?
discount
Not all cash a company generates will be returned to the investors. Which of the following will NOT reduce the amount of capital returned to the investors?
dividends
This includes any capital gain (or loss) that occurred as well as any income that you received from a specific investment.
dollar return
All of the following are advantages to organizing as a corporation except ____.
double taxation
The key differences between debt and equity capital include all of the following EXCEPT ___________.
effect on operating leverage
Beta coefficient is an index of the degree of movement of an asset's return in response to a change in the risk- free asset.
false
Firms should use their weighted average cost of capital (WACC) when they are funding their capital projects with a variety of sources. However, when the firm plans on using only debt or only equity to fund a particular project, they should use the after-tax cost of the specific source of capital to evaluate that project.
false
For any interest rate and for any period of time , the more frequently interest is compounded , the greater the amount of money have to be invested today in order to accumulate a given future amount.
false
If two firms have the same current dividend and the same expected growth rate, their stocks must sell at the same current price or else the market will not be in equilibrium.
false
In reference to capital budgeting, risk is the chance that a project has a high degree of variability in the initial investment.
false
Interest rate risk can be avoided by buying long-term bonds with low coupon interest rates.
false
One of the benefits to a firm of being at or near its target capital structure is that financial flexibility becomes much less important.
false
T-bonds are money market securities, while T-bills and T-notes are traded in the capital market.
false
The before-tax cost of debt, which is lower than the after-tax cost, is used as the component cost of debt for purposes of developing the firm's WACC.
false
The purchase of additional machinery or a new factory is an example of the renewal type of capital expenditure.
false
Weak form efficiency means that insiders cannot gain an advantage using information no one else has access to.
false
A legal duty between two parties where one party must act in the interest of the other party.
fiduciary
The NPV method assumes that cash inflows are reinvested at the
firms cost of capital.
Cash flows available to pay the firm's stockholders and debt holders after the firm has made the necessary working capital investments, fixed asset investments, and developed the necessary new products to sustain the firm's ongoing operations is referred to as _________________.
free cash flows
Investment grade bonds include those bonds with ratings _____________.
from aaa to bbb
A NPV profile
graphs the NPV at a variety of discount rates.
A beta coefficient of -1 represents an asset that
has the same response as the market portfolio but in opposite direction
Stock valuation model dynamics make clear that higher growth rates lead to
high valuations
The four basic sources of long-term funds for the business firm are
long-term debt, common stock, preferred stock, and retained earnings.
You are trying to pick the least-expensive machine for your company. You have two choices: machine A, which will cost $50,000 to purchase and which will have OCF of -$3,500 annually throughout the machine's expected life of three years; and machine B, which will cost $75,000 to purchase and which will have OCF of -$4,900 annually throughout that machine's four-year life. Both machines will be worthless at the end of their life. If you intend to replace whichever type of machine you choose with the same thing when its life runs out, again and again out into the foreseeable future, and if your business has a cost of capital of 14 percent, which one should you choose?
machine a
You are considering the purchase of one of two machines used in your manufacturing plant. Machine A has a life of two years, costs $20,000 initially, and then $4,000 per year in maintenance costs. Machine B costs $25,000 initially, has a life of three years, and requires $3500 in annual maintenance costs. Either machine must be replaced at the end of its life with an equivalent machine. Which is the better machine for the firm? The discount rate is 14% and the tax rate is zero.
machine b
Inflation, recession, and high interest rates are economic events which are characterized as
market risk
In theory, the firm should maintain financial leverage consistent with a capital structure that ________.
maximizes owner wealth
The sale of an ordinary asset for its book value results in .
no tax benefit
If only one capital budgeting technique could be used to evaluate a project, which of the following would be the most preferred?
npv
In the Gordon model, the value of the common stock is the
present value of a constant, growing dividend stream.
This is the risk that an asset's sale price will be lower than its purchase price.
price risk
This is the concept that a unit's sales will follow an approximate bell-shaped curve versus a steady sales life.
product life cycle
The initial cash flows and operating cash inflows are referred to as the .
relevant cash flows
Your company has spent $200,000 on research to develop a new computer game. The firm is planning to spend $300,000 on a machine to produce the new game. Shipping and installation costs of the machine will be capitalized and depreciated; they total $25,000. The machine has an expected life of 3 years, a $50,000 estimated resale value, and falls under the MACRS 7-Year class life. Revenue from the new game is expected to be $400,000 per year, with costs of $150,000 per year. The firm has a tax rate of 35 percent, an opportunity cost of capital of 10 percent, and it expects net working capital to increase by $75,000 at the beginning of the project. What will the cash flows for this three-year project be?
see image
If a firm has already paid an expense or is obligated to pay one in the future, regardless of whether a particular project is undertaken, that expense is a
sunk cost
In calculating the cost of common stock equity, the model having the stronger theoretical foundation is
the capital asset pricing model.
The market price of outstanding issues often varies from par because
the market rate of interest has changed.
The higher an asset's beta,
the more responsive it is to changing market returns.
Comparing Bond Yields A client in the 33 percent marginal tax bracket is comparing a municipal bond that offers a 5 percent yield to maturity and a similar-risk corporate bond that offers a 6.25 percent yield. Which bond will give the client more profit after taxes?
the municipal bond
The cost of common stock equity is
the rate at which investors discount the expected dividends of the firm.
The standard deviation of an individual stock measures
total risk
A firm may face increases in the weighted average cost of capital either when retained earnings have been exhausted or due to increases in debt, preferred stock, and common equity costs as additional new funds are required.
true
Conflicts between two mutually exclusive projects, where the NPV method chooses one project but the IRR method chooses the other, should generally be resolved in favor of the project with the higher NPV.
true
The component costs of capital are market-determined variables in as much as they are based on investor's required returns.
true
The importance of the role of financial management is emphasized by examples of companies whose strategic financing decisions contributed to their demise, or to their success when economic conditions changed rapidly.
true
The internal rate of return is that discount rate which equates the present value of the cash outflows (or costs) with the present value of cash inflows.
true
The real rate of return is the compensation you require for delaying consumption.
true
The total leverage measures the combined effect of operating and financial leverage on the firm' s risk
true
When investors require higher rates of return for investments that demonstrate higher variability of returns, that is evidence of risk aversion.
true
The biggest disadvantage of the sole proprietorship is _________________.
unlimited liability
Possible shapes for the yield curve include all of the following except ___________.
vertical lines
An expected return from a portfolio
will lie somewhere between the highest and lowest expected returns from securities in the portfolio.
The ________________ is the percentage return an investor will earn if a bond is purchased at the current market price and held until maturity.
yield to maturity