FINAN 3040 Exam Review
37. Seven years ago, you purchased a new packaging machine for $90,000 and depreciated it straight-line over a 10-year life. Today, you sold the machine for $35,000. If your tax rate is 25%, what is the after-tax cash flow from the sale of the machine? A) $33,000 B) $26,250 C) $24,819 D) $8,000
A) $33,000 After tax CF = selling price - (gain on sale x tax rate) Depreciation = $90,000/10 = $9,000 Book value = (original cost - accumulated depreciation) = $90,000 - (7 x 9,000) = $27,000 Gain on sale = (selling price - book value) = $35,000 - $27,000 = $8,000 After tax cash flow = $35,000 - ($8,000 x 0.25) = $33,000
21. How much should you pay for a $1,000 bond with a 10% coupon, annual payments, and 5 years to maturity if the interest rate is 12%? A) $927.90 B) $981.40 C) $1,000.00 D) $1,075.82
A) $927.90 N= 5, IY= 12, PV = CPT -927.90, PMT = 100, FV = 1,000 PMT = face value x coupon rate = $1,000 x 0.1 = $100
7. Approximately how much must you have saved by retirement if you want to withdraw $100,000 for 25 years if your account earns 9% annually and the first withdrawal occurs one year after retiring? A) $982,258 B) $887,320 C) $1,128,433 D) $925,667
A) $982,258 N = 25 IY = 9 PMT = 100,000 FV = 0 PV = CPT, -982,258
14. Using a discount rate of 8%, how much more is a perpetuity of $800 worth than a 30-year annuity of the same amount?A)$994 B) $876 C) $723 D) $919
A) $994 PVperp = PMT/r = $800/0.08 = $10,000 N = 30, IY = 8, PV = -9,006.23, PMT = 800, FV = 0 Difference = $10,000 - $9,006.23 = 993.77
33. What is the net effect on a firm's cash flow of a $100,000 increase in accounts receivable, $250,000 increase in inventory and $75,000 increase in accounts payable? A) -$275,000 B) -$425,000 C) -$225,000 D) $75,000
A) -$275,000 Investments in WC decrease cash flows, while reductions in WC increase cash flows. WC reductions include current liabilities, accounts payable. WC investments include current assets, Accounts receivable, inventory. CF = WC reductions - WC investments CF = $75,000 - $100,000 - $250,000 = -$275,000
16. If the effective annual rate of interest is known to be 16.08% on a debt that has quarterly payments, what is the annual percentage rate? A) 15.19% B) 16.02% C) 14.50% D) 12.02%
A) 15.19% EAR = 16.08 m = 4 APR = 15.19 2nd, 2 EFF = 16.08, C/Y = 4, NOM = CPT 15.19
41. Suppose marginal tax rates are 18% for income below $50,000, 22% from $50,000 to $60,000, and 25% for income above $60,000. What is the average tax rate for an individual that earned $72,000? A) 19.72% B) 21.67% C) 20.28% D) 18.76%
A) 19.72% Calculating marginal tax rates is a simple weighted average: $50,000 x 0.18 = $9,000 $10,000 x 0.22 = 2,200 (72,000 - 60,000) x 0.25 = 3,000 Average tax rate = (9,000 + 2,200 + 3,000)/72,000 = 0.1972 = 19.72%
48. TJ Maxx (beta 0.67) is evaluating a project in the airline industry (beta 1.70). If the risk-free rate is 1.9% and the market risk premium is 11%, what is the required rate of return on this project? A) 20.60% B) 17.37% C) 9.27% D) 8.00%
A) 20.60% Use the project beta if its risk is different than that of the company. Kp = Rf + Bp(MRP) Kp = 1.9 + 1.70(11) = 20.60%
54. Wayfair [W] has 90 million shares of common stock outstanding which currently sell at $86 per share. W has a beta of 1.85. If the risk-free rate is 1.8% and the expected return on the market is 12.2%, what is W's cost of equity? A) 21.04% B) 24.37% C) 22.57% D) 25.90%
A) 21.04% Kw = Rf + Bw(Km -Rf) Kw = 1.8 +1.85(12.2 - 1.8) = 21.04%
9. A struggling college student only has $5,000 in her bank account. What interest rate must she earn on her account if she wants to accumulate $1 million in 35 years by adding $10,000 annually? A) 5.34% B) 7.85% C) 9.67% D) 6.42%
A) 5.34% N = 35 PV = -5,000 PMT = -10,000 FV = 1,000,000 IY = CPT, 5.34
55. Dick's Sporting Goods [DKS] has 110 million shares of common stock outstanding which currently sell at $39 per share. DKS also has 1.3 million outstanding bonds that mature in 14 years. The bonds have a face value of $1,000, pay an annual coupon of 9% and currently sell at 110. DKS has a beta of 0.59 and a tax rate of 21%. If the risk-free rate is 1.85% and the market risk premium is 12%, what is DKS's WACC? A) 8.24% B) 7.05% C) 5.71% D) 6.98%
A) 8.24% (in millions) MVe = $39 x 110 = $4,290 MVd = $1,100 x 1.3 = $1,430 V = MVe + MVd = $4,290 + $1,430 =$5,720 We = MVe/V = 0.75 = 75% Wd = 1-0.75 = 25% Re = Rf + B(MRP) = 1.85 + 0.59(12) = 8.93% N = 14, IY = CPT 7.8, PV = -1,100, PMT = 90, FV = 1,000 WACC = (We x Re) + (Wd x Rd x (1- tax)) WACC = (0.75 x 0.0893) + (0.25 x 0.078 x (1-0.21)) = 8.24%
22. A bond has a coupon rate of 8%, pays interest annually, sells for $962, and matures in 3 years. What is its yield to maturity? A) 9.52% B) 4.78% C) 12.17% D) 5.48%
A) 9.52% N= 3, IY = CPT 9.52, PV = -962, PMT = 80, FV = 1,000
43. When using CAPM to find required rates of return, why is diversifiable risk ignored? A) Only systematic risk is rewarded. B) There is no method for quantifying diversifiable risk. C) Beta includes a component to compensate for diversifiable risk. D) Diversifiable risk is compensated by the market risk premium.
A) Only systematic risk is rewarded. Firm specific can be diversified away. Only market risk (systematic risk) is rewarded
51. If a firm with no current liabilities has a long-term debt to equity ratio of 1, then: A) The firm has a total debt ratio of 0.5. B) The firm has more equity than debt. C) The firm has no diversifiable risk. D) The firm has a high cost of equity.
A) The firm has a total debt ratio of 0.5. L-T debt/Equity = 1 0.5 L-T debt/0.5 Equity = 1
47. The project cost of capital is: A) not necessarily related to the company cost of capital. B) greater than the company cost of capital because the project has specific risk. C) less than the company cost of capital. D) equal to the company cost of capital.
A) not necessarily related to the company cost of capital. The project cost of capital depends on the risk of the project and not the risk of the company.
42. A stock's beta measures the: A) sensitivity of the stock's returns to those of the market portfolio. B) market risk premium on the stock. C) difference between the return on the stock and the return on the market portfolio. D) average return on the stock.
A) sensitivity of the stock's returns to those of the market portfolio. A measure of the volatility of an individual firm's stock returns compared to the risk of the entire market. 𝛽 indicates whether a stock moves in the same direction as the market, and how volatile or risky it is compared to the market.
49. A company's nominal pre-tax cost of debt is represented by the: A) yield to maturity on outstanding bonds. B) coupon rate of current bonds. C) return calculated by CAPM. D) company's beta.
A) yield to maturity on outstanding bonds. Cost of debt: (total amount of interest on debt) / (total amount of debt)
35. Cookie Castle [CKC] issued $1,000,000 of debt with a cost of debt of 8%. If CKC has a 25% tax rate and intends to maintain the debt continuously, what is the present value of the perpetual debt tax shield? A)$250,000 B)$170,000 C)$320,000 D)$20,000
A)$250,000 PV of perpetual debt tax shield = debt x tax rate = $1,000,000 x 0.25 = $250,000
10. Cleveland signed a contract that will provide four annual cash inflows of $41,000, $11,000, $35,000, and $56,000 respectively with the first payment of $41,000 occurring three years from today. What is the contract worth today at a discount rate of 6%? A) $106,559 B) $108,769 C) $199,999 D) $112,555
B) $108,769 CF0: 0 C01: 0 F01: 2 C02: 41,000 F02: 1 C03: 11,000 F03: 1 C04: 35,000 F04: 1 C05: 56,000 F05: 1 I: 6 NPV: 108,769
45. What is the beta of a 3-stock portfolio consisting of $10,000 of Stock A with a beta of 0.90, $8,000 of Stock B with a beta of 1.05, and $2,000 of Stock C with a beta of 1.70? A) 1.00 B) 1.04 C) 1.17 D) 1.22
B) 1.04 Portfolio value = $10,000 + $8,000 + $2,000 = $20,000 Weight of stock A = $10,000/$20,000 = 0.5 Weight of stock B = $8,000/$20,000 = 0.4 Weight of stock C = $2,000/$20,000 = 0.1 Beta = (0.5 x 0.9) + (0.4 x 1.05) + (0.1 x 1.7) = 1.04
11. You want your 10-year-old child to have a million dollars in the future. Today you deposit $25,000 in an account that earns 8.5%. The money will be distributed to your child when the total reaches $1 million. How old will your child be when the money is distributed? A) 59 B) 55 C) 45 D) 61
B) 55 IY = 8.5 PV = -25,000 PMT = 0 FV = 1,000,000 N = CPT 45.22 45.22 + 10 = 55.22
34. In what manner does depreciation expense affect investment projects? A) It reduces taxes by the amount of the depreciation expense. B) It reduces taxable income by the amount of the depreciation expense. C) It reduces cash flows by the amount of the depreciation expense. D) It increases cash flows by the amount of the depreciation expense.
B) It reduces taxable income by the amount of the depreciation expense. Cash inflow - cash expenses - depreciation
19. When an investor purchases a $1,000 par value bond that was quoted at 97.162, the investor: A) receives $971.62 upon the maturity date of the bond. B) pays 97.162% of face value for the bond. C) pays $10,971.62 for a $10,000 face value bond. D) receives 97.162% of the stated coupon payments.
B) pays 97.162% of face value for the bond. 97.162/100 = 97.162%
27. The ratio of net present value to initial investment is known as the: A) net present value. B) profitability index. C) internal rate of return. D) payback period.
B) profitability index. NPV/Initial investment = profitability index
32. Investments in working capital: A) do not matter because the cash is generally recovered when the project ends. B) reduce project NPV. C) increase NPV because they make the project more valuable. D) are simply accounting entries and do not affect NPV.
B) reduce project NPV. Cash flow associated with investments in working capital is the negative of the change in working capital. Just like investment in plant and equipment, investment in working capital produces a negative cash flow.
24. When a fixed-rate bond has its rating upgraded from B to A, then: A) the bond's current yield increases. B) the bond's price increases. C) the bond's face value decreases. D) the bond's coupon rate increases.
B) the bond's price increases. As a bond's rating is upgraded, its price increases and current yield decreases.
25. If a project's expected rate of return exceeds its opportunity cost of capital, one would expect: A) the NPV to be zero. B) the project to have a positive NPV. C) the profitability index to be negative. D) the opportunity cost of capital to be too low.
B) the project to have a positive NPV. Higher opportunity cost of capital lowers NPV, so if the expected rate of return is higher than opportunity cost of capital, then NPV should be positive
5. The primary distinction between securities sold in the primary and secondary markets is: A) the riskiness of the securities. B) whether the securities are new or already exist. C) the price of the securities. D) the profitability of the issuing corporation.
B) whether the securities are new or already exist. Primary Markets: This is where securities are created. Here, firms sell (float) new stocks and bonds to the public for the first time. Secondary Markets: This is where investors buy and sell securities that have already been issued and owned.
29.A polisher costs $10,000 and will cost $20,000 a year to operate and maintain. If the discount rate is 10% and the polisher will last for 5 years, what is the equivalent annual cost?A)$17,163 B)$22,638 C)$19,411 D)$22,188
B)$22,638 CF0: -10,000 C01: -20,000 F01: 5 I: 10 NPV: -85,815.74 N = 5, IY = 10, PV = -85,815.74, PMT = CPT 22,638, FV = 0
38. What is the annual depreciation tax shield for a $100,000 annual depreciation expense if the tax rate is 21%? A) $79,000 B) $15,500 C) $21,000 D) $25,000
C) $21,000 Depreciation tax shield = (depreciation x tax rate) = $100,000 x 0.21 = $21,000
8. You just won the lottery. You will receive $50,000 per year for 10 years with the first payment being made 5 years from today. If the discount rate is 7%, what is the present value of your winnings? A) $277,152.33 B) $310,547.48 C) $250,385.83 D) $291,662.95
C) $250,385.83 CF0: 0 C01: 0 F01: 5 C02: 50,000 F02: 10 I: 7 NPV: 250,385.83
6. Assume the total expense for your current year in college equals $20,000. How much would your parents have needed to invest 21 years ago in an account paying 8% compounded annually to cover this amount? A) $1,728.08 B)$2,952.46 C) $3,973.12 D) $1,600.00
C) $3,973.12 N = 21 I/Y = 8 PMT = 0 FV = 20,000 PV = CPT, -3,973.12
12. You just bought a new car. You paid $5,000 down at time zero. You will then make payments of $500 per month for the next 48 months. At the end of 48 months you will make a balloon payment of $10,000. Based on this payment schedule and an interest rate of 6%, what is the value (present value) of your car today? A) $51,338.12 B) $37,987.54 C) $34,161.14 D) $29,481.27
C) $34,161.14 CF0: -$5,000 C01: -$500 F01: 47 C02: -$10,500 F02: 1 I = 6/2 = 0.5 NPV = -34,161.14
28. What is the profitability index for a project costing $40,000 and returning $15,000 annually for 4 years at an opportunity cost of capital of 12%? A) 0.861 B) 0.500 C) 0.139 D) 0.320
C) 0.139 CF0: -40,000 C01: 15,000 F01: 4 I: 12 NPV: 5,560.24 PI = 5,560.24/40,000 = 0.139
46. A project has a beta of 1.24, the risk-free rate is 3.8%, and the market rate of return is 9.2%. What is the project's expected rate of return? A) 11.41% B) 15.21% C) 10.50% D) 14.61%
C) 10.50% Kp = Rf + Bp(Km - Rf) Kp = 3.8 + 1.24(9.2 - 3.8) = 10.50%
50. A firm has 12,500 shares of stock outstanding that sell for $42 each. The book value of equity is $400,000. The firm has also issued $250,000 face value of debt that is currently quoted at 101.2. What value should be used as the weight of equity when computing WACC? A) 72.09% B) 61.54% C) 67.48% D) 69.74%
C) 67.48% MVe = $42 x 12,500 = $525,000 MVd = $250,000 x 1.012 = $253,000 V = MVe + MVd = $525,000 + $253,000 = $778,000 We = MVe / V = $525/$788 = 67.48%
23. What is the coupon rate for an annual coupon bond with 3 years to maturity, a price of $1,026, and a yield to maturity of 7.5%? A) 9.25% B) 6.67% C) 8.50% D) 7.42%
C) 8.50% N = 3, IY = 7.5, PV = -1,026, PMT = 85, FV = 1,000 PMT = 85/1,000 = 8.5%
17. What is the effective annual interest rate on a 9% APR automobile loan that has monthly payments? A) 9.00% B) 8.65% C) 9.38% D) 9.81%
C) 9.38% APR = 9 m = 12 EAR = 9.38 2nd, 2 NOM = 9, C/Y = 12, EFF = CPT, 9.38
4. A primary market would be utilized when: A) shares of common stock are exchanged. B) a commission must be paid on the transaction. C) securities are initially issued. D) investors buy or sell existing securities.
C) securities are initially issued. Primary Markets: This is where securities are created. Here, firms sell (float) new stocks and bonds to the public for the first time. These transactions increase the total financial assets in the economy. Where financial assets are "born."
52. Debt provides a tax shield for the company because: A) the amount of debt reduces taxable income. B) the amount of interest reduces the total taxes payable. C) the amount of interest reduces taxable income. D) the amount of debt reduces the total taxes payable.
C) the amount of interest reduces taxable income. Interest Tax Shield: Aka Debt Tax Shield. The annual reduction in income taxes that results from the allowable deduction from interest expense.
2. Corporate managers are expected to make corporate decisions that are in the best interest of: A) top corporate management. B) the corporation's board of directors. C) the corporation's shareholders. D) all corporate employees.
C) the corporation's shareholders. Shareholders must be the top priority of management.
36. When a depreciable asset is ultimately sold, the after-tax cash flow from the sale is: A) not used in capital budgeting. B) reduced by the book value of the asset. C) the total sales price minus tax. D) the same as the after-tax accounting amount.
C) the total sales price minus tax. Proceeds from sale - (Gain on sale x tax rate)
30.What is the equivalent annual cost for a project that requires a $40,000 investment at time zero, and a $10,000 annual expense during each of the next 4 years, if the opportunity cost of capital is 12%? A)$21,356 B)$25,237 C)$23,169 D)$20,000
C)$23,169 CF0: -40,000 C01: -10,000 F01: 4 I: 12 NPV = -70,373.49 N = 4, IY = 12, PV = -70,373.49, PMT = CPT 23,169.38, FV = 0
26. What is the NPV of a project that costs $100,000 and returns $50,000 annually for 3 years if the opportunity cost of capital is 14%? A) $33,749 B) $14,473 C) $13,398 D) $16,082
D) $16,082 CF0: -100,000 C01: 50,000 F01: 3 I: 14 NPV: 16,082
13. The present value of an ordinary annuity is $1600 when valued at 10%. How much would the value change if this was an annuity due? A) $1,440 B) $178 C) $82 D) $160
D) $160 PVad = PVa(1 +r) = $1,600(1.10) = $1,760 $1,760 - $1,600 = 160 Shortcut: PVa x r = $1,600 x 0.10 = $160
53. Dell Technologies [DELL] has 700 million shares of common stock outstanding which currently sell at $55 per share. It also has $10 billion in book value debt currently quoted at 101. What value should be used as the weight on debt when computing DELL's WACC? A) 79.22% B) 19.41% C) 28.63% D) 20.78%
D) 20.78% (in millions) MVe = $55 x 700 = $38,500 MVd = $10,000 x 1.01 = $10,100 V = MVe +MVd = $38,500 + $10,100 = $48,600 Wd = MVd/V = $10,100/$48,600 = 20.78%
15. What is the expected real rate of interest for an account that offers a 12% nominal rate of return when the rate of inflation is 6% annually? A) 5.00% B) 9.46% C) 6.00% D) 5.66%
D) 5.66% Real rate = ((1 + nominal rate)/(1+ inflation rate)) -1 1.12/1.06 - 1 = 5.66%
44. The 4-week T Bill rate is 2% and the market risk premium is 8%. If you have a portfolio consisting of 50% of the risk-free asset and 50% in the market, what is the expected return on your portfolio? A) 2% B) 4% C) 5% D) 6%
D) 6% return on the market = (market risk premium + risk-free rate) = 8% + 2% = 10% Return on the portfolio = (0.5 x 2%) + (0.5 x 10%) = 6%
3. Which one of the following can best be characterized as an agency problem? A) Having a higher than industry average rate of defects on the firm's products. B) Differing opinions among directors as to the merits of paying a higher dividend. C) Management dispute over which accounting firm to use. D) Differing incentives between managers and owners.
D) Differing incentives between managers and owners. Agency problem: Differing incentives between managers and shareholders. Managers are bound ethically to act in the shareholders' best interest but may be tempted to act in their own interests rather than those of the shareholders.
1. Which of the following appears to be the most appropriate goal for corporate management? A) Maximizing the company's market share. B) Minimizing the company's liabilities. C) Maximizing the current profits of the company. D) Maximizing market value of the company's shares.
D) Maximizing the market value of the company's shares. Maximize Shareholder Wealth Aka maximize the value of the firm's common stock. Shareholders must be the top priority of management.
31. When is it appropriate to include sunk costs in the evaluation of a project? A) If they are considered to be overhead costs. B) If they improve the project's NPV. C) Whenever they are relatively large. D) Never.
D) Never. When calculating cash flows, do not include: Sunk Costs, e.g., prior R&D costs
20. Assume a bond is currently selling at par value. What will happen in the future if the yield on the bond is lower than the coupon rate? A) The coupon rate of the bond will increase. B) The coupon payments will be adjusted to the new discount rate. C) The par value of the bond will decrease. D) The price of the bond will increase.
D) The price of the bond will increase. Bond's interest rate is higher than current rates in the market = Premium. A bond trading above its face value.
18. The coupon rate of a bond equals: A) the annual interest divided by the current market price. B) its yield to maturity. C) the yield to maturity when the bond sells at a discount. D) a defined percentage of its face value.
D) a defined percentage of its face value. Coupon rate = PMT/FV The coupon rate merely tells us what coupon payment the bond will produce. T he coupon rate is only used to calculate the coupon payment.
39. A firm invests $10 million in a new stamping machine. It depreciates the machine straight-line over 5 years. The tax rate is 21% and the discount rate is 8%. What is the PV of the depreciation tax shield? A) $3,000,000 B) $634,978 C) $2,579,497 D)$1,676,938
D)$1,676,938 Annual depreciation = (initial investment/years) = $10,000,000/5 = $2,000,000 Annual depreciation tax shield = (depreciation x tax rate) = $2,000,000 x 0.21 = $420,000 Then use TVM worksheet to find PV of depreciation tax shield. N = 5, IY = 8, PV = CPT -1,676,938, PMT = 420,000, FV = 0
40. What is the NPV of an 8-year project that costs $200,000, has annual revenues of $75,000 and cash expenses of $25,000? Assume the investment is depreciated straight-line over 8 years, the corporate tax rate is 21%, and the discount rate is 13%. A)$13,411 B)$14,182 C)$15,560 D)$14,745
D)$14,745 Depreciation = (initial investment / years) = $200,000/8 = $25,000 Operating CF: Revenue $75,000 Expenses -$25,000 Depreciation -$25,000 Pre tax profit = $25,000 (Revenue - expenses - depreciation) Tax @ 21% -$5,250 Net income (after tax) = $19,750 Add back depreciation $25,000 Operating CF = $44,750 CF0: -200,000 C01: 44,750 F01: 8 I: 13 NPV: 14,745
