Finance Questions

: Analytic skills 37) Bill wants to buy a new boat in 7 years. He expects the new boat will cost $28,000. Bill has $18,000 in an investment account today. What rate of return must Bill earn on his investments to be able to buy the boat on time?

: 6.515% (FV = $28,000, PV = $18,000, N = 7, solve for i) Diff: 1 Keywords: Future Value, Present Value, Interest Rate, Time Value of Money

: Analytic skills 42) Jiffy Co. expects to pay a dividend of $3.00 per share in one year. The current price of Jiffy common stock is $60 per share. Flotation costs are $3.00 per share when Jiffy issues new stock. What is the cost of internal common equity (retained earnings) if the long-term growth in dividends is projected to be 8 percent indefinitely? A) 13 percent B) 14 percent C) 15 percent D) 16 percent

: A Diff: 1 Keywords: Cost of Retained Earnings

: Analytic skills 24) At what rate must $287.50 be compounded annually for it to grow to $650.01 in 14 years? A) 6 percent B) 5 percent C) 7 percent D) 8 percent

: A Diff: 1 Keywords: Future Value

: Analytic skills 19) At 6 percent compounded monthly, how long will it take to triple your money? A) 221 months B) 175 months C) 102 months D) 48 months

: A Diff: 1 Keywords: Future Value, Monthly Compounding

: Analytic skills 31) Based on the data contained in Table A, what is the break-even point in sales dollars? TABLE A Average selling price per unit $18.00 Variable cost per unit $13.00 Units sold 400,000 Fixed costs $650,000 Interest expense $ 50,000 A) $2,340,000 B) $1,850,000 C) $1,775,500 D) $700,000

: A Diff: 2 Keywords: Break-even Sales

: Analytic skills 10) The primary weakness of EBIT-EPS analysis is that A) it ignores the implicit cost of debt financing. B) it double counts the cost of debt financing. C) it applies only to firms with large amounts of debt in their capital structure. D) it may only be used by firms that are profitable this year.

: A Diff: 3 Keywords: EBIT-EPS Analysis

: Analytic skills 31) You hold a portfolio with the following securities: Percent Expected Security of Portfolio Beta Return Able Corporation 20% 3.20 36.0% Baker Corporation 40% 1.60 20.0% Charlie Corporation 40% .20 6.0% What is the expected return for the market, according to the CAPM? A) 14.0% B) 13.8% C) 12.0% D) 10.0%

: A Diff: 3 Keywords: Expected Return on the Market, CAPM, Security Market Line, Beta

: Analytic skills 29) Two factors that cause the investor's required rate of return to differ from the company's cost of capital are A) taxes and risk. B) transactions costs and risk. C) taxes and transactions costs. D) risk and opportunity cost differences.

: B Diff: 1 Keywords: Cost of Capital, Taxes, Transactions Costs

: Reflective thinking skills 28) Financing a portion of a firm's assets with securities bearing a fixed rate of return in hopes of increasing the return to stockholders refers to A) business risk. B) financial leverage. C) operating leverage. D) combined leverage.

: B Diff: 2 Keywords: Financial Leverage

: Analytic skills 21) The category of securities with the highest historical risk premium is A) large company stocks. B) small company stocks. C) government bonds. D) small company corporate bonds.

: B Diff: 1 Keywords: Risk Premium

: Reflective thinking skills 22) If you were to use the standard deviation as a measure of investment risk, which of the following has historically been the least risky investment? A) common stock of large firms B) U.S. Treasury bills C) common stock of small firms D) long-term government bonds

: B Diff: 1 Keywords: Standard Deviation, Risk, U.S. Treasury Bills

: Analytic skills 33) A company has preferred stock that can be sold for $21 per share. The preferred stock pays an annual dividend of 3.5% based on a par value of $100. Flotation costs associated with the sale of preferred stock equal $1.25 per share. The company's marginal tax rate is 35%. Therefore, the cost of preferred stock is A) 18.87%. B) 17.72%. C) 14.26%. D) 12.94%.

: B Diff: 2 Keywords: Cost of Preferred Stock, Net Proceeds, Flotation Costs

: Reflective thinking skills 30) If a corporation were to choose between issuing a debenture, a mortgage bond, or a subordinated debenture, everything else equal (such as coupon rate, maturity, etc.) which would sell for the greatest price? A) the debenture B) the mortgage bond C) the subordinated debenture D) All of the above types of bonds would sell for the same price.

: B Diff: 2 Keywords: Debenture, Mortgage Bond, Subordinated Debenture

: Analytic skills 12) The use of a call provision in addition to a sinking fund can effectively create a maturity date for preferred stock.

: TRUE Diff: 1 Keywords: Preferred Stock, Call Provision, Sinking Fund, Maturity Date

: Reflective thinking skills 3) A preferred stock that pays an annual dividend of $10, has a par value of $100, and has a required return of 5% will be valued at $200.

: TRUE Diff: 1 Keywords: Preferred Stock, Valuation

: Analytic skills 1) Variation in the rate of return of an investment is a measure of the riskiness of that investment.

: TRUE Diff: 1 Keywords: Rate of Return, Risk, Variability

: Reflective thinking skills 18) The relevant risk to an investor is that portion of the variability of returns that cannot be diversified away.

: TRUE Diff: 1 Keywords: Relevant Risk, Non-diversifiable Risk

: Analytic skills 3) In general, the required rate of return is a function of (1) the time value of money, (2) the risk of an asset, and (3) the investor's attitude toward risk.

: TRUE Diff: 1 Keywords: Required Rate of Return

: Analytic skills 1) In order to create value a corporation must earn a rate of return on its invested capital that is higher than the market's required rate of return on that invested capital.

: TRUE Diff: 1 Keywords: Required Rate of Return, Invested Capital

: Reflective thinking skills 1) The required rate of return for an asset is equal to the risk-free rate plus a risk premium.

: TRUE Diff: 1 Keywords: Required Rate of Return, Risk-free Rate, Risk Premium

: Analytic skills 3) Restrictive provisions in bond indenture agreements are designed to protect bondholders and lessen the agency problems between bondholders and stockholders.

: TRUE Diff: 1 Keywords: Restrictive Covenants, Indenture Agreements, Agency Problems

: Reflective thinking skills 17) In break-even analysis, semivariable costs are segregated into their fixed and variable components over the relevant range of output.

: TRUE Diff: 1 Keywords: Semivariable Costs, Break-Even Analysis

: Reflective thinking skills 19) Using simulation provides the financial manager with a probability distribution of an investment's net present value or internal rate of return.

: TRUE Diff: 1 Keywords: Simulation, Probability Distribution

: Analytic skills 4) The size disparity problem occurs when mutually exclusive projects of unequal size are being examined.

: TRUE Diff: 1 Keywords: Size Disparity, Mutually Exclusive Projects

: Reflective thinking skills 11) A well-diversified portfolio typically has systematic risk equal to about 40% of the portfolio's total risk.

: TRUE Diff: 1 Keywords: Systematic Risk, Diversification

: Reflective thinking skills 10) Total risk equals systematic risk plus unsystematic risk.

: TRUE Diff: 1 Keywords: Systematic Risk, Unsystematic Risk, Total Risk

: Analytic skills 3) If an old asset is sold for its depreciated, or book, value, then no taxes result and there is no tax effect from the sale.

: TRUE Diff: 1 Keywords: Tax Effect, Sale of Old Asset, Book Value

: Analytic skills 4) If the interest rate is positive, then the future value of an annuity due will be greater than the future value of an ordinary annuity.

: TRUE Diff: 1 Keywords: Time Value of Money, Annuity, Annuity Due

: Reflective thinking skills 7) The objective of capital structure management is to maximize the market value of the firm's common stock.

: TRUE Diff: 2 Keywords: Capital Structure Management

: Reflective thinking skills 6) Above the EBIT-EPS indifference point a more heavily levered financial plan will produce greater EPS.

: TRUE Diff: 2 Keywords: EBIT-EPS Indifference Point

: Analytic skills 5) Financial structure includes long- and short-term sources of funds.

: TRUE Diff: 2 Keywords: Financial Structure

: Reflective thinking skills 5) In an efficient market, a stock with a standard deviation of returns of 12% could have a higher expected return than a stock with a standard deviation of 10% because the beta for the higher standard deviation stock could be lower than the beta for the lower standard deviation stock.

: TRUE Diff: 2 Keywords: Risk-Return Trade Off, Beta, Standard Deviation

: Analytic skills 14) At an annual interest rate of 9%, an initial sum of money will double approximately every 8 years.

: TRUE Diff: 2 Keywords: Time Value of Money

: Analytic skills 14) ACME, Inc. expects its current annual $2.50 per share common stock dividend to remain the same for the foreseeable future. Therefore, the value of the stock to an investor with a required return of 12% is A) $3.00. B) $18.33. C) $20.83. D) $30.00.

: C Diff: 2 Keywords: Constant Growth Dividend Valuation Model

: Reflective thinking skills 28) Changes in capital spending are not incorporated directly into capital budgeting problems because the amounts are included in the operating cash flows through the inclusion of depreciation expense.

: FALSE Diff: 1 Keywords: Capital Spending, Free Cash Flows, Operating Cash Flow

: Reflective thinking skills 12) A firm's cost of capital is not affected by the composition of the right-hand side of the firm's balance sheet, but rather is determined by the firm's mix of assets.

: FALSE Diff: 1 Keywords: Capital Structure

: Reflective thinking skills 8) The stock valuation model D1/(rcs - g) requires the stock to grow at a rate greater than the required return; otherwise, the stock is worthless.

: FALSE Diff: 1 Keywords: Constant Growth Common Stock Valuation Model

: Reflective thinking skills 4) The firm's cost of capital is important when evaluation the firm's overall value, but should not be used to evaluate individual projects which have their own unique characteristics.

: FALSE Diff: 1 Keywords: Cost of Capital

: Reflective thinking skills 6) The yield-to-maturity is the discount rate that equates the present value of the interest and principal payments with the face value of the bond.

: FALSE Diff: 1 Keywords: Yield to Maturity

: Reflective thinking skills 16) Preferred stock and common stock issued by the same firm will have the same required return because the riskiness of the firm's cash flows is the same for both securities.

: FALSE Diff: 2 Keywords: Preferred Stock, Common Stock, Required Return

: Reflective thinking skills 20) The slope of the characteristic line of a security is that security's Beta.

: TRUE Diff: 1 Keywords: Characteristic Line, Beta

: Reflective thinking skills 10) Common stock does not mature.

: TRUE Diff: 1 Keywords: Common Stock, Maturity Date

: Reflective thinking skills 17) Corporations that are heavily committed to investments in fixed assets that are expected to produce cash flow over many years generally favor long-term debt to the extent that they borrow.

: TRUE Diff: 1 Keywords: Debt Maturity Composition, Capital Structure

: Reflective thinking skills 18) Reducing the probability of bankruptcy is a benefit of diversification.

: TRUE Diff: 1 Keywords: Diversification, Probability of Bankruptcy

: Reflective thinking skills 5) A project's equivalent annual annuity (EAA) is the annuity cash flow that yields the same present value as the project's NPV.

: TRUE Diff: 1 Keywords: Equivalent Annual Annuity

: Analytic skills 16) Whenever the internal rate of return on a project equals that project's required rate of return, the net present value equals zero.

: TRUE Diff: 1 Keywords: Internal Rate of Return, Net Present Value, Required Return

: Analytic skills 36) John Q. Enterprises is considering two potential investments. The probability distributions of annual end-of-year cash flows for the respective projects are: Project A Project B Probability Outcome Probability Outcome 0.25 $10,000 0.25 $12,000 0.50 $15,000 0.50 $15,000 0.25 $20,000 0.25 $18,000 Both projects will require an initial outlay of $45,000 and will have an estimated life of 6 years. Project A is considered a riskier investment and will have to have a risk-adjusted required rate of return of 15%, while Project B's risk-adjusted required rate of return is 12%. a. Determine the expected value of each project's annual cash flow. b. Determine each project's risk-adjusted net present value.

: Project A Project B a. $15,000 $15,000 b. $11,767.24 $16,671.11 Diff: 2 Keywords: Expected Incremental Cash Flows, Risk-adjusted Net Present Value

: Reflective thinking skills 37) The following information pertains to the Classic Burger Restaurant chain: Sales $600,000 Variable costs 300,000 Total contribution margin 300,000 Fixed costs 100,000 EBIT 200,000 Interest expense 50,000 Earnings before taxes 150,000 Taxes (30%) 45,000 Net income $105,000 a. If sales increase by 10%, what will be the new level of EPS if the firm has 100,000 shares outstanding? b. What is the percentage increase in EPS? Explain the difference between the percentage increase in sales and the percentage increase in EPS.

: a. Sales $600,000 x1.1= $660,000 Variable costs 300,000 x1.1= 330,000 Total contribution margin 300,000 330,000 Fixed costs 100,000 100,000 EBIT 200,000 230,000 Interest expense 50,000 50,000 Earnings before taxes 150,000 180,000 Taxes (30%) 45,000 54,000 Net income $105,000 $126,000 Earnings Per Share $10.50 $12.60 b. ($12.60 - $10.50)/$10.50 = .20 or 20%; A 10% increase in sales results in a 20% increase in EPS due to leverage. Classic Burger uses both operating leverage (fixed cost of operations) and financial leverage (debt financing reflected in interest expense). Diff: 2 Keywords: Operating Leverage, Financial Leverage, Combined Leverage, EPS

: Analytic skills 41) Bankers Corp has a very conservative Beta of .7, while Biotech Corp has a Beta of 2.1. Given that the T-bill rate is 5%, and the market is expected to return 15%, what is the expected return of Bankers Corp, Biotech Corp, and a portfolio composed of 60% of Bankers Corp and 40% Biotech Corp? a. Solve this problem first by weighting the Betas to calculate a portfolio Beta, and then using CAPM to calculate the portfolio expected return. b. Then solve the problem again by calculating the expected return of each asset and weighting those returns to calculate the portfolio expected return. c. Why is Biotech Corp's expected return NOT three times that of Bankers Corp?

: a. Bp = .6 × .7 + .4 × 2.1) = 1.26 Kp = .05 + 1.26(.15 - .05) = .05 + .126 = .176 b. KBankers = .05 + .7(.15 - .05) = .12 KBiotech = .05 + 2.1(.15-.05) = .26 Kp = (.6 × .12) + (.4 × .26) = .176 c. Beta is multiplied by the market risk premium only, so a stock with a beta three times that of another stock will have three times the risk premium, not three times the total return. Diff: 2 Keywords: Beta, Portfolio, Market Risk Premium, Security Market Line

: Analytic skills 25) You are considering the three securities listed below. Returns Probability Stock A Stock B Stock C 20% 2% -3% 5% 50% 10% 8% 8% 30% 15% 20% 12% a. Calculate the expected return for each security. b. Calculate the standard deviation of returns for each security. c. Compare Stock A with Stocks B and C. Is Stock A preferred over the others?

: a. RA = (.2)(2%)+(.5)(10%)+(.3)(15%) = 9.9% RB = (.2)(-3%)+(.5)(8%)+(.3)(20%) = 9.4% RC = (.2)(5%)+(.5)(8%)+(.3)(12%) = 8.6% b. Std.Dev.A = (2%-9.9%)2(.2)+(10%-9.9%)2(.5)+(15%-9.9%)2(.3) = 4.5% Std.Dev.B = (-3%-9.4%)2(.2)+(8%-9.4%)2(.5)+(20%-9.4%)2(.3) = 8.1% Std.Dev.C = (5%-8.6%)2(.2)+(8%-8.6%)2(.5)+(12%-8.6%)2(.3) = 2.5% c. Stock A dominates stock B because A has a higher expected return and a lower standard deviation. Stock A has a higher expected return than stock C, but also a higher standard deviation, so the choice between A and C depends on the level of risk aversion. Diff: 2 Keywords: Expected Return, Standard Deviation, Risk-Return Trade Off

: Reflective thinking skills 8) The less risky the bond (or the higher the bond rating) the lower will be the yield to maturity on the bond.

: TRUE Diff: 1 Keywords: Bond Rating, Yield to Maturity, Risk

: Analytic skills 10) A bond is a long-term promissory note issued by the firm.

: TRUE Diff: 1 Keywords: Bond, Promissory Note

: Reflective thinking skills 13) Financial structure is another term for capital structure.

: FALSE Diff: 1 Keywords: Capital Structure, Financial Structure

: Reflective thinking skills 3) Positive NPV projects may be rejected when capital must be rationed.

: TRUE Diff: 1 Keywords: Capital Rationing, NPV

: Analytic skills 17) Premium Lodging, Inc., is financed entirely with 3 million shares of common stock selling for $50 a share. Capital of $10 million is needed for this year's capital budget. Additional funds can be raised with new stock (ignore dilution) or with 11 percent 12-year bonds. Premium Lodging's tax rate is 35 percent. a. Calculate the financing plan's EBIT indifference point.

: a. = EBIT = $17,600,000 is the indifference level Diff: 3 Keywords: EBIT-EPS Analysis, Indifference Point

: Reflective thinking skills 21) A small company struggling to reach profitability just announced a major new government contract that will validate its technology and generate revenue for the next several years. The announcement of the contract will A) cause the stock price to increase because rcs (the required return) is likely to increase. B) cause the stock price to decrease because the government usually pays below market price for the goods and services it purchases. C) cause the stock price to increase because rcs (the required return) is likely to decrease and g (the growth rate in future dividends) is likely to increase. D) have no effect on the stock price because the company has not yet paid any dividends.

: C Diff: 1 Keywords: Required Return, Growth Rate, Stock Valuation

: Analytic skills 24) Which of the following statements concerning bonds and risk is true? A) Because the interest payments and maturing value are known, the only risk associated with investing in bonds is default risk. B) Zero coupon bonds are always more risky than bonds with high coupon rates because of the time value of money. C) Bonds are generally less risky than common stock because of the preference for debt over equity in the event of bankruptcy and liquidation. D) B-rated bonds are above average for risk, i.e., less risky than the average bond.

: C Diff: 1 Keywords: Risk, Bond Ratings, Default Risk

: Analytic skills 97) A significant advantage of the payback period is that it A) places emphasis on time value of money. B) allows for the proper ranking of projects. C) tends to reduce firm risk because it favors projects that generate early, less uncertain returns. D) gives proper weighting to all cash flows.

: C Diff: 2 Keywords: Payback Period

: Analytic skills 30) You estimate you'll need $200,000 per year for 25 years starting on your 65th birthday to live on during your retirement. Today is your 50th birthday and you want to make equal deposits into an account paying 9% interest per year, the first deposit today and the last deposit on your 64th birthday. How much must each deposit be (rounded to the nearest $10)? A) $99,920 B) $85,840 C) $61,385 D) $49,380

: C Diff: 3 Keywords: Annuity, Present Value, Future value

: Analytic skills 15) Why should firms that own and operate multiple businesses that have different risk characteristics use business-specific, or divisional costs of capital? A) Not all divisions have equal risk and the firm might accept projects whose returns are higher than are deemed appropriate. B) Not all business divisions have equal risk and the firm will likely become less risky in the future. C) Not all lines of business have equal risk and it is likely that the firm will accept projects whose returns are unacceptably low in relation to the risk involved. D) Use of the same weighted average cost of capital for all divisions may result in too much money being allocated to the least risky division.

: C Diff: 2 Keywords: Divisional Costs of Capital, Weighted Average Cost of Capital

: Reflective thinking skills 32) You are considering the purchase of a share of Ranch's common stock. You expect to sell it at the end of 1 year for $32.00. You will also receive a dividend of $2.50 at the end of the year. Ranch just paid a dividend of $2.25. If your required return on this stock is 12%, what is the most you would be willing to pay for it now? A) $28.57 B) $33.05 C) $20.83 D) $30.80

: D Diff: 2 Keywords: Common Stock Valuation, Dividend, Required Return

: Analytic skills 16) Today is your 21st birthday and your bank account balance is $25,000. Your account is earning 6.5% interest compounded daily. How much will be in the account on your 50th birthday? A) $159,795 B) $162,183 C) $163,823 D) $164,631

: D Diff: 2 Keywords: Future Value, Monthly Compounding

: Analytic skills 31) To compound $100 quarterly for 20 years at 8%, we must use A) 40 periods at 4%. B) 5 periods at 12%. C) 10 periods at 4%. D) 80 periods at 2%.

: D Diff: 2 Keywords: Future Value, Quarterly Compounding

: Analytic skills 74) In order to send your first child to Law School when the time comes, you want to accumulate $40,000 at the end of 18 years. Assuming that your savings account will pay 6% compounded annually, how much would you have to deposit if: a. You want to deposit an equal amount at the end of each year? b. You want to deposit one large lump sum today?

: a. $1,294.26 b. $14,013.75 Diff: 1 Keywords: Annuity, Present Value, Single Sum

: Reflective thinking skills 2) A bond with a coupon rate of 8% will also have a yield to maturity of 8%.

: FALSE Diff: 1 Keywords: Yield to Maturity, Coupon Rate

: Analytic skills 4) If two bonds have the same yield to maturity, they also have the same current yield.

: FALSE Diff: 1 Keywords: Yield to Maturity, Current Yield

: Analytic skills 3) If a bond is selling below its face value, then its yield to maturity must be less than the bond's coupon rate.

: FALSE Diff: 1 Keywords: Yield to Maturity, Face Value, Coupon Rate

: Reflective thinking skills 7) The initial outlay includes the immediate cash outflow necessary to purchase the asset and put it in operating order.

: TRUE Diff: 1 Keywords: Initial Outlay

: Analytic skills 1) Raising funds internally is effectively increasing the investment of the firm's existing common shareholders.

: TRUE Diff: 1 Keywords: Internal Financing, Shareholders

: Analytic skills 8) An acceptable project should have a net present value greater than or equal to zero and a profitability index greater than or equal to one.

: TRUE Diff: 1 Keywords: Net Present Value, Profitability Index

: Reflective thinking skills 22) If the net present value of a project is zero, then the profitability index will equal one.

: TRUE Diff: 1 Keywords: Net Present Value, Profitability Index, Decision Rules

: Reflective thinking skills 15) The net present value of a project will increase as the required rate of return is decreased (assume only one sign reversal).

: TRUE Diff: 1 Keywords: Net Present Value, Required Return

: Analytic skills 8) It is never appropriate to compare nominal rates unless they include the same number of compounding periods per year.

: TRUE Diff: 1 Keywords: Nominal Interest Rates, Compounding, Effective Annual Rate

: Analytic skills 20) Many firms today continue to use the payback method but also employ the NPV or IRR methods especially when large projects are being analyzed.

: TRUE Diff: 1 Keywords: Payback Period, NPV, IRR

: Analytic skills 68) Last year Gator Getters, Inc. had $50 million in total assets. Management desires to increase its plant and equipment during the coming year by $12 million. The company plans to finance 40 percent of the expansion with debt and the remaining 60 percent with equity capital. Bond financing will be at a 9 percent rate and will be sold at its par value. Common stock is currently selling for $50 per share, and flotation costs for new common stock will amount to $5 per share. The expected dividend next year for Gator is $2.50. Furthermore, dividends are expected to grow at a 6 percent rate far into the future. The marginal corporate tax rate is 34 percent. Internal funding available from additions to retained earnings is $4,000,000. a. What amount of new common stock must be sold if the existing capital structure is to be maintained? b. Calculate the weighted marginal cost of capital at an investment level of $12 million.

: a. Equity needed = $12 million × 0.6 = $7.2 million Less additions to R/E 4.0 million New common stock $3.2 million b. Kd = 9(1 - .34) = 5.94% Knc = $2.50/$45 + 0.06 = 11.56% MCC = 0.4 × 5.94% + 0.6 × 11.56% = 9.31% Diff: 2 Keywords: After-tax Cost of Debt, Cost of New Common Stock, Marginal Cost of Capital

: Analytic skills 42) Techno Robots produces a functioning toy robot. At a production and sales level of 10,000 robots, the firm has the following information: Selling price per unit = $15 Variable costs per unit = $8 EBIT = $17,500 a. What is the break-even point in units for the firm?

: a. QBE Sales = $15 × 10,000 robots = $150,000 Variable Costs = $8 × 10,000 robots = $80,000 EBIT = $150,000 - $80,000 - fixed costs = $17,500 Therefore, fixed costs = $52,500 Break Even = $52,500/($15 - $8) = 7,500 robots Diff: 2 Keywords: Break-even Point in Units

: Analytic skills 13) What is the present value of the following perpetuities? a. $200 per year discounted at 6% annually b. $500 per year discounted at 9% annually c. $1,000 per year discounted at 5% annually d. $550 per year discounted at 8% annually

: a. $3,333.33 b. $5,555.56 c. $20,000.00 d. $6,875.00 Diff: 1 Keywords: Perpetuity, Present Value

: Analytic skills 72) Frank Zanca is considering three different investments that his broker has offered to him. The different cash flows are as follows: End of Year A B C 1 300 400 2 300 3 300 4 300 300 600 5 300 6 300 7 300 8 300 600 Because Frank only has enough savings for one investment, his broker has proposed the third alternative to be, according to his expertise, "the best in town." However, Frank questions his broker and wants to calculate the present value of each investment. Assuming a 15% discount rate, what is Frank's best alternative?

: a. $856.49 b. $661.23 c. $887.02 So, investment C is best. Diff: 2 Keywords: Present Value, Annuity, Deferred Annuity, Uneven Cash Flow

: Analytic skills 41) ABC Corp. has estimated the following income statement for its next fiscal year. Sales $20,000,000 Variable costs 6,000,000 Revenue before fixed costs 14,000,000 Fixed costs 9,000,000 EBIT 5,000,000 Interest expense 900,000 Earnings before taxes 4,100,000 Taxes (35%) 1,435,000 Net income $2,665,000 a. What is the break-even point in sales dollars for the firm? b. If the average unit cost is $20, what is the break even point in units?

: a. $9,000,000/(1 - ($6,000,000/$20,000,000)) = $12,857,143 b. $12,857,143/$20 = 642,857 units Diff: 2 Keywords: Operating Leverage, Financial Leverage, Combined Leverage, Break-even Point

: Analytic skills 14) Balon Plastics, Inc. is financed entirely with 3 million shares of common stock selling for $20 a share. Capital of $4 million is needed for this year's capital budget. Additional funds can be raised with new stock (ignore dilution) or with 13 percent 10-year bonds. The firm's tax rate is 40 percent. a. Calculate the financing plan's EBIT indifference point. b. The expected level of EBIT is $10,320,000 with a standard deviation of $2,000,000. What is the probability that EBIT will be above the indifference point? c. Does the "indifference point" calculated in question (a) above truly represent a point where stockholders are indifferent between stock and debt financing? Explain your answer.

: a. (EBIT - 0)(1 - 0.4)/3,200,000 = (EBIT - 520,000)(1 - 0.4)/3,000,000 EBIT = $8,320,000 b. Z = (8.32 - 10.32)/2 = 1.00 to the left of the mean P(EBIT >= $8.32 million) = 1 - 0.16 = 0.84 c. No. Financial risk is ignored. Diff: 3 Keywords: EBIT-EPS Analysis, Indifference Point

: Reflective thinking skills 13) Balon Plastics, Inc. is trying to decide how best to finance a proposed $10,000,000 capital investment. Under Plan I, the project will be financed entirely with long-term 9 percent bonds. The firm currently has no debt or preferred stock. Under Plan II, common stock will be sold to net the firm $20 a share; presently, 1,000,000 shares are outstanding. The corporate tax rate for Roberts is 40 percent. a. Calculate the indifference level of EBIT associated with the two financing plans. b. Prepare an EBIT-EPS analysis chart, showing the intersection of the two financing plan lines. c. Which financing plan would you expect to cause the greatest change in EPS relative to a change in EBIT? Why? d. If EBIT is expected to be $3.1 million, which plan will result in a higher EPS?

: a. (EBIT)(1 - 0.4)/1,500,000 = (EBIT - $900,000)(1 - 0.4)/1,000,000 EBIT = $2,700,000 b. GRAPH SHOULD BE DRAWN BY STUDENT c. The bond plan will magnify changes in EPS since it increases financial leverage. d. Since $3.1 million EBIT is above the indifference point of $2.7 million, the bond plan will give a higher EPS. Diff: 3 Keywords: EBIT-EPS Analysis, Indifference Point

: Analytic skills 46) Stan's Cans, Inc. expects to earn $150,000 next year after taxes on sales of $2,200,000. Stan's manufactures only one size of garbage can. Stan sells his cans for $8 apiece and they have a variable cost of $2.40 apiece. Stan's tax rate is currently 34%. a. What are the firm's expected fixed costs for next year? b. What is the break-even point in units?

: a. ([P × Q] - [(V × Q) + F]) (1 - T) = $150,000 (2,200,000 - 660,000 - F)(.66) = $150,000 (1,540,000 - F)(.66) = $150,000 866,400 = .66F F = 1,312,727 b. Q = $1,312,727/($8 - $2.4) = 234,416 units Diff: 2 Keywords: Break-even Point, Fixed Costs

: Analytic skills 33) FYI bonds have a par value of $1,000. The bonds pay $40 in interest every six months and will mature in 10 years. a. Calculate the price if the yield to maturity on the bonds is 7, 8, and 9 percent, respectively. b. Explain the impact on price if the required rate of return decreases. c. Compute the coupon rate on the bonds. How does the relationship between the coupon rate and the yield to maturity determine how a bond's price will compare to it par value?

: a. 7% YTM price = $1,071.06 8% YTM price = $1,000.00 9% YTM price = $934.96 b. The price of the bond will increase. c. Coupon rate = ($40 × 2)/$1,000 = 8% A bond with a YTM above the coupon rate will sell at a discount (below par value). The investor will pay less than the par value for the bond, but will receive its par value at maturity. This built-in gain drives the investor's return up above the coupon rate. If the coupon rate equals the YTM, the bond will sell for its par value. If the YTM is below the coupon rate, the coupons are attractive thus an investor will pay more than the par value for the bond. Diff: 2 Keywords: Yield to Maturity, Intrinsic Value, Required Return, Coupon Rate

: Analytic skills 12) Any increase in interest payments caused by a project should be counted in the incremental cash flows.

: FALSE Diff: 1 Keywords: Interest Payments, Financing Cash Flows, Incremental Cash Flows

: Reflective thinking skills 1) In general, interest on bonds, like dividends on preferred stock, may be deferred until a later date at the discretion of management, making debt financing more appealing to corporate managers.

: FALSE Diff: 1 Keywords: Interest, Dividends

: Reflective thinking skills 8) $10,000 invested at 10% per year for 5 years earns interest equal to $6,105.10; therefore, $10,000 invested at 10% per year for 10 years will earn interest equal to $12,210.20 (2 times $6,105.10).

: FALSE Diff: 1 Keywords: Interest, Time Periods, Compounding

: Reflective thinking skills 13) When repaying an amortized loan, the interest payments increase over time due to the compounding process.

: FALSE Diff: 1 Keywords: Loan Amortization, Interest Payments

: Reflective thinking skills 14) Under majority voting a majority (>50%) shareholder will just be able to elect a simple majority of the board of directors.

: FALSE Diff: 1 Keywords: Majority Voting, Board of Directors

: Reflective thinking skills 9) The market risk premium remains constant over time because the risk free rate of return moves inversely with beta.

: FALSE Diff: 1 Keywords: Market Risk Premium, Capital Asset Pricing Model

: Analytic skills 1) The market price of a firm's common stock equals the sum of all equity accounts as reported in its balance sheet (common stock + paid-in capital + retained earnings) divided by the number of shares outstanding.

: FALSE Diff: 1 Keywords: Market Value of Equity

: Analytic skills 24) Mutually exclusive projects have more than one IRR.

: FALSE Diff: 1 Keywords: Mutually Exclusive Projects, IRR

: Reflective thinking skills 3) The mutually exclusive project with the highest positive NPV will also have the highest IRR.

: FALSE Diff: 1 Keywords: Mutually Exclusive Projects, NPV, IRR

: Reflective thinking skills 1) If two projects are mutually exclusive then the IRR is more important than the NPV in deciding the project that should be chosen.

: FALSE Diff: 1 Keywords: Mutually Exclusive, IRR, NPV

: Reflective thinking skills 45) A project with a NPV of zero should be rejected since even the returns on U.S. Treasury bill are greater than zero.

: FALSE Diff: 1 Keywords: NPV, Decision Rule

: Reflective thinking skills 46) NPV may be calculated on an Excel spreadsheet simply by entering the project's free cash flows into Excel's NPV function.

: FALSE Diff: 1 Keywords: NPV, Excel

: Reflective thinking skills 8) Finance theory suggests that the IRR criterion is the most favorable capital budgeting decision tool.

: FALSE Diff: 1 Keywords: NPV, IRR

: Analytic skills 10) The net present value profile clearly demonstrates that the NPV of a project increases as the discount rate increases.

: FALSE Diff: 1 Keywords: Net Present Value Profile, Discount Rate

: Reflective thinking skills 5) Two projects that have the same cost and the same expected cash flows will have the same net present value.

: FALSE Diff: 1 Keywords: Net Present Value, Discount Rate

: Reflective thinking skills 7) If a project is acceptable using the net present value criteria, then it will also be acceptable under the less stringent criteria of the payback period.

: FALSE Diff: 1 Keywords: Net Present Value, Payback Period

: Reflective thinking skills 8) If the increase in net working capital is recovered entirely at the end of the project then it may be ignored.

: FALSE Diff: 1 Keywords: Net Working Capital, Recovery of Net Working Capital

: Reflective thinking skills 27) Operating cash flow is equal to the change in EBIT less the change in interest expense, less the change in taxes, plus the change in depreciation.

: FALSE Diff: 1 Keywords: Operating Cash Flow, Interest Expense

: Reflective thinking skills 6) Operating leverage means financing a portion of a firm's earnings per share with debt.

: FALSE Diff: 1 Keywords: Operating Leverage

: Analytic skills 1) Operating leverage is easier to control and manage than financial leverage because operating leverage deals with the internal workings of the company while financing deals with outside parties.

: FALSE Diff: 1 Keywords: Operating Leverage, Financial Leverage

: Reflective thinking skills 11) The initial outlay for a new project is an example of an opportunity cost.

: FALSE Diff: 1 Keywords: Opportunity Cost

: Reflective thinking skills 3) The optimal capital structure occurs when operating leverage equals financial leverage.

: FALSE Diff: 1 Keywords: Optimal Capital Structure

: Reflective thinking skills 3) The best financial structure is determined by finding the debt and equity mix that maximizes the firm's cost of capital.

: FALSE Diff: 1 Keywords: Optimal Capital Structure, Cost of Capital

: Analytic skills 9) When solving time value of money problems on a financial calculator, you must select the "end mode" when you enter the final years cash flow.

: FALSE Diff: 1 Keywords: Ordinary Annuity, Financial Calculator

: Reflective thinking skills 2) The present value of a $100 perpetuity discounted at 5% is $5,000.

: FALSE Diff: 1 Keywords: Perpetuity

: Reflective thinking skills 25) Preferred dividends are paid with before-tax dollars because the dividend rate is known, whereas common stock dividends are paid with after-tax dollars.

: FALSE Diff: 1 Keywords: Preferred Dividends, Common Dividends, Taxes

: Reflective thinking skills 6) For a given constant required rate of return, the greatest portion of a preferred stockholder's return comes from increases in the price of preferred stock.

: FALSE Diff: 1 Keywords: Preferred Stock, Capital Gain

: Analytic skills 7) John has to pay $1,000 per month for his mortgage for another 5 years, but he is considering paying the mortgage off in one lump sum. John cannot calculate the present value of the payments using the annuity formulas because his payments are monthly and not once per year.

: FALSE Diff: 1 Keywords: Present Value, Annuity

: Reflective thinking skills 17) The required return of a preferred stockholder, rps, is higher than the cost of preferred stock for the corporation because stockholder's must pay federal taxes on their dividend income.

: FALSE Diff: 1 Keywords: Required Return on Preferred Stock, Cost of Preferred Stock

: Reflective thinking skills 2) An investor with a required return of 8% for stock A will purchase stock A if the expected return for stock A is less than or equal to 8%.

: FALSE Diff: 1 Keywords: Required Return, Expected Return

: Reflective thinking skills 8) Common stockholders demand a return on the price paid for their common stock, but since retained earnings on the balance sheet are merely "on paper" they do not require a return on earnings that have been retained.

: FALSE Diff: 1 Keywords: Required Return, Retained Earnings

: Reflective thinking skills 2) Cash flows is the most relevant variable to measure the returns on debt instruments, while GAAP net income is the most relevant variable to measure the returns on common stock.

: FALSE Diff: 1 Keywords: Return, Cash Flow, Net Income

: Reflective thinking skills 10) The risk-adjusted discount rate method implicitly assumes that distant cash flows have the same risk as near cash flows.

: FALSE Diff: 1 Keywords: Risk-Adjusted Discount Rate

: Analytic skills 1) Historically, investments with the highest returns have the lowest standard deviations because investors do not like risk.

: FALSE Diff: 1 Keywords: Risk-Return Trade Off

: Reflective thinking skills 14) The less-risky investment is always the more desirable choice.

: FALSE Diff: 1 Keywords: Risk/Return Tradeoff

: Reflective thinking skills 5) Shareholders, as owners of the corporation, face unlimited liability for the corporation's debts, while bondholders, as creditors, may only lose the value of their investment if the company goes bankrupt.

: FALSE Diff: 1 Keywords: Shareholders, Creditors, Limited Liability

: Reflective thinking skills 6) An investment earning simple interest is preferred over an investment earning compound interest because the simplicity adds value.

: FALSE Diff: 1 Keywords: Simple Interest, Compound Interest

: Reflective thinking skills 2) A rational investor will always prefer an investment with a lower standard deviation of returns, because such investments are less risky.

: FALSE Diff: 1 Keywords: Standard Deviation of Returns, Risk, Risk-Return Trade Off

: Reflective thinking skills 5) A project's standing alone risk allows for diversification within a sole firm.

: FALSE Diff: 1 Keywords: Standing Alone Risk, Diversification

: Analytic skills 4) Due to strict stock market controls, the most a stock's value can drop in one trading day is 5%.

: FALSE Diff: 1 Keywords: Stock Price Volatility

: Reflective thinking skills 4) Public perception and reputation do not affect stock prices, which are strictly a function of dividends and required returns.

: FALSE Diff: 1 Keywords: Stock Valuation Reputation

: Analytic skills 17) Adding gourmet coffee stations to my convenience store is expected to increase sales of my breakfast sandwiches; however, the sales of breakfast sandwiches should not be included in the evaluation of the gourmet coffee project because only relevant, incremental cash flows should be considered.

: FALSE Diff: 1 Keywords: Synergistic Effects

: Reflective thinking skills 12) Synergistic benefits from an investment project include cannibalism.

: FALSE Diff: 1 Keywords: Synergistic Effects, Cannibalism

: Analytic skills 13) Terminal cash flows are always positive because they result from the shutting down of a project with the sale of any assets with remaining value.

: FALSE Diff: 1 Keywords: Terminal Cash Flow

: Reflective thinking skills 2) The price of a computer today is $400 and inflation is 5% per year. Therefore, in two years the price of the computer is expected to be $440.

: FALSE Diff: 1 Keywords: Time Value of Money, Compounding, Inflation

: Reflective thinking skills 4) Timelines are used for simple time value of money problems, but cannot be used for more complex problems.

: FALSE Diff: 1 Keywords: Timelines

: Reflective thinking skills 5) A CEO concerned about variability of earnings per share may try to offset high operating leverage with a capital structure that is mostly debt in order to take advantage of the interest tax shield.

: FALSE Diff: 1 Keywords: Variability of EPS, Combined Leverage, Operating Leverage, Financial Leverage

: Reflective thinking skills 7) As the volume of production increases the variable cost-per unit of the product decreases.

: FALSE Diff: 1 Keywords: Variable Cost Per Unit

: Reflective thinking skills 12) If a common stockholder cannot personally attend the meeting of shareholders then their votes are lost.

: FALSE Diff: 1 Keywords: Voting Rights, Common Stock

: Reflective thinking skills 7) Once the weighted average cost of capital (WACC) is determined then all projects of average risk will be compared to the original WACC regardless of the size of the capital budget.

: FALSE Diff: 1 Keywords: Weighted Average Cost of Capital

: Analytic skills 11) Increases in working capital needs should be included as part of the initial outlay of a project, but decreases in working capital for a project should not be considered because they are not guaranteed.

: FALSE Diff: 1 Keywords: Working Capital Requirements, Initial Outlay

: Reflective thinking skills 11) A bond's yield to maturity varies from investor to investor because each investor has his or her own required return.

: FALSE Diff: 1 Keywords: Yield to Maturity, Required Return

: Reflective thinking skills 4) Higher bankruptcy costs will result in optimal capital structures using more long-term debt financing.

: FALSE Diff: 2 Keywords: Bankruptcy Costs, Optimal Capital Structure

: Reflective thinking skills 8) Companies that sell basic necessities face the highest levels of business risk because consumers will price shop aggressively for items they purchase on a regular basis.

: FALSE Diff: 2 Keywords: Business Risk

: Reflective thinking skills 4) Sales of consumer durable goods, such as appliances, are more sensitive to swings in the business cycle, and therefore companies in these industries face a higher level of operating risk.

: FALSE Diff: 2 Keywords: Business Risk, Operating Risk, Business Cycle

: Reflective thinking skills 5) Other things held equal, a bond with a call provision is worth more to investors than a bond without a call provision.

: FALSE Diff: 2 Keywords: Call Provision

: Analytic skills 5) When capital rationing exists, the divisibility of projects is ignored and projects are funded in order of their PI's or IRR's.

: FALSE Diff: 2 Keywords: Capital Rationing, PI, IRR

: Reflective thinking skills 6) According to the moderate view of capital structure theory, the cost of common equity is constant regardless of the debt financing level.

: FALSE Diff: 2 Keywords: Capital Structure Theory

: Reflective thinking skills 5) If the expected growth rate for dividends is zero, then the value of common stock will be equal to the current dividend.

: FALSE Diff: 2 Keywords: Constant Growth Dividend Valuation Model

: Dynamics of the global economy 3) Convertible bonds decrease in value whenever the price of the company's stock increases.

: FALSE Diff: 2 Keywords: Convertible Bonds

: Analytic skills 27) Because investors like dividends, the higher the company's dividend growth rate, the lower the company's cost of common equity.

: FALSE Diff: 2 Keywords: Cost of Common Equity, Dividend Growth Rate

: Reflective thinking skills 7) The current yield is greater than the coupon rate for a bond selling above par value.

: FALSE Diff: 2 Keywords: Current Yield, Coupon Rate, Premium Bond

: Reflective thinking skills 2) Since stockholders are able to reduce their exposure to risk by efficiently diversifying their holdings of securities, there is no reason for individual firms to seek diversification of their holdings of assets.

: FALSE Diff: 2 Keywords: Diversification, CAPM

: Reflective thinking skills 3) For a well-diversified investor, an investment with an expected return of 10% with a standard deviation of 3% dominates an investment with an expected return of 10% with a standard deviation of 5%.

: FALSE Diff: 2 Keywords: Expected Return, Standard Deviation, Risk-Return Trade Off, Well-diversified

: Reflective thinking skills 16) Fixed operating costs include charges incurred from the firm's use of debt financing.

: FALSE Diff: 2 Keywords: Fixed Operating Costs, Debt Financing

: Reflective thinking skills 49) Because the MIRR assumes reinvestment at the cost of capital while IRR assumes reinvestment at the project's IRR, the MIRR will always be less than the IRR.

: FALSE Diff: 2 Keywords: IRR, MIRR, Reinvestment Rate

: Reflective thinking skills 20) The independence hypothesis allows for bankruptcy and agency costs.

: FALSE Diff: 2 Keywords: Independence Hypothesis, Bankruptcy Costs, Agency Costs

: Reflective thinking skills 21) The independence hypothesis suggests that the cost of equity decreases as financial leverage increases.

: FALSE Diff: 2 Keywords: Independence Hypothesis, Cost of Equity, Financial Leverage

: Reflective thinking skills 3) A bond that matures in 5 years has less interest rate risk than a bond that matures in 25 years because regardless of changes in interest rates, the bond can be redeemed for face value 20 years earlier.

: FALSE Diff: 2 Keywords: Interest Rate Risk

: Reflective thinking skills 39) If a project has multiple internal rates of return, the lowest rate should be used for decision making purposes.

: FALSE Diff: 2 Keywords: Internal Rate of Return, Multiple IRRs

: Reflective thinking skills 1) Unlike market value, the intrinsic value of an asset is estimated independently of risk.

: FALSE Diff: 2 Keywords: Intrinsic Value, Risk

: Reflective thinking skills 7) Two projects are mutually exclusive if the accept/reject decision for one project has no impact on the accept/reject decision for the other project.

: FALSE Diff: 2 Keywords: Mutually Exclusive Projects

: Analytic skills 17) If a firm's production process requires high operating leverage (use of fixed costs), then the firm should finance its assets with debt, so that the cost of capital will be reduced and financing costs will remain fixed.

: FALSE Diff: 2 Keywords: Operating Leverage, Financial Leverage, Total Leverage

: Reflective thinking skills 19) If a project uses an asset the corporation already owns, the cost of that asset for capital budgeting purposes is zero to reflect the advantage the project has over projects that require the purchase of new assets.

: FALSE Diff: 2 Keywords: Opportunity Cost

: Analytic skills 7) The risk-return tradeoff that investors face on a day-to-day basis is based on realized rates of return because expected returns involve too much uncertainty.

: FALSE Diff: 2 Keywords: Realized Rate of Return, Expected Rate of Return

: Analytic skills 6) Joe borrowed $10,000 at 10% per year and promised to pay it back in equal annual installments at the end of each of the next 5 years. Joe's payment will be $2,100 [($10,000/5) + ($10,000 × 10%).

: FALSE Diff: 2 Keywords: Time Value of Money, Amortization Schedule

: Analytic skills 5) If the interest rate is positive, then the present value of an annuity due will be less than the present value of an ordinary annuity.

: FALSE Diff: 2 Keywords: Time Value of Money, Annuity, Annuity Due, Present Value

: Analytic skills 1) A return of 12% compounded annually is the same as a return of 1% per month.

: FALSE Diff: 2 Keywords: Time Value of Money, Compounding Periods

: Reflective thinking skills 15) A car manufacturer offers either $2,000 cash back or zero percent financing for 5 years. A rational consumer will always take the cash back because money received today is worth more than money received in the future.

: FALSE Diff: 2 Keywords: Time Value of Money, Present Value

: Analytic skills 22) Increases in inventory and accounts receivable expected to occur if a proposed advertising campaign is undertaken are examples of sunk costs.

: FALSE Diff: 2 Keywords: Working-Capital Requirements, Sunk Costs

: Analytic skills 70) Today is your 30th birthday and you must choose between two retirement options. The first option will provide you with 10 equal annual payments of $100,000 beginning on your 65th birthday. The second option will provide you with one payment of $1,000,000 on your 70th birthday. If the interest rate is 6 percent per year and you are assured of living to at least 80 years of age, which option is better?

: You must find the value of each option at the same point in time. The present value of the retirement annuity at age 65 is $780,169. The present value of the $1,000,000 at age 65 is $747,258. Therefore, the 10-year annuity is the better option. Comparable values at age 70 are $1,044,042 for the annuity and $1,000,000 for the lump sum. At age 74, the value of the annuity is $1,318,080 and the value of the lump sum is $1,262,477. Note that the ranking of the options does not change regardless of the date used. Diff: 2 Keywords: Annuity, Present Value

: Analytic skills 7) U.S Technologies preferred stock sells for $80 and pays $9 each year in dividends. What is the expected rate of return?

: rp = D/V = $9/805 = .1125 = 11.25% Diff: 1 Keywords: Preferred Stock Valuation, Expected Rate of Return

: Analytic skills 38)

the questions below using the following information on stocks A, B, and C. A B C Expected Return 20% 21% 10% Standard Deviation 12% 10% 10% Beta 1.8 2.2 0.8 Assume the risk-free rate of return is 3% and the expected market return is 12% a. Calculate the required return for stocks A, B, and C. b. Assuming an investor with a well-diversified portfolio, which stock would the investor want to add to his portfolio? c. Assuming an investor who will invest all of his money into one security, which stock will the investor choose? Answer: a. Stock A: 3% + (12% - 3%)(1.8) = 19.2% Stock B: 3% + (12% -3%)(2.2) = 22.8% Stock C: 3% + (12% - 3%)(0.8) =10.2% b. A well-diversified investor will select Stock A, which is the only stock with an expected return that exceeds its required return. c. Stock B is preferred because it has the highest expected return along with the lowest standard deviation of returns. Diff: 2 Keywords: Required Return, Security Market Line, Diversification, Risk-Return Trade Off

: Analytic skills 40) Welker Products sells small kitchen gadgets for $15 each. The gadgets have a variable cost of $4 per unit, and Welker Products' fixed operating costs are $220,000 per year. Welker Products' capital structure includes 55% debt and 45% equity. Annual interest expense is $25,000, and the corporate tax rate is 35%. a. Calculate the break-even point in units. b. If Welker Products sells 25,000 units, calculate the firm's EBIT and net income. c. If sales increase ten percent from 25,000 units to 30,000 units, estimate the firm's expected EBIT and net income. d. Does Kelly Products use operating leverage and/or financial leverage? Explain.

: a. Break-even = ($220,000/($15 - $4)) = 20,000 units b. Sales = 25,000 * $14 = $350,000 Variable Costs = 25,000 * $4 = $100,000 Fixed Costs = $220,000 EBIT = $350,000 - $100,000 - $220,000 = $30,000 EBT = $30,000 - $25,000 = $5,000 Net Income = $5,000 (1 - 0.35) = $3,250 c. Sales = 30,000 * $14 = $420,000 Variable Costs = 30,000 * $4 = $120,000 Fixed Costs = $220,000 EBIT = $420,000 - $120,000 - $220,000 = $80,000 EBT = $80,000 - $25,000 = $55,000 Net Income = $55,000 (1 - 0.35) = $35,750 d. EBIT increased by (80,000 - 30,000)/30,000 = 167% and Net Income increased by (35,750 — 3,250)3,25 = 1,000% Since EBIT increased by a higher percentage than sales (167% compared to 20%), the company uses operating leverage. Since the change in EPS is greater than the change in EBIT (1,000% compared to 167%), the company uses financial leverage. Diff: 2 Keywords: Break-even, Operating Leverage, Financial Leverage, Combined Leverage

: Analytic skills 87) P.D. Corporation is considering the purchase of a high-speed lathe that has an invoice price of $250,000. The cost to ship the lathe to P.D.'s factory is $10,000, and the existing facilities will require modifications that are expected to cost $20,000. The machine will be depreciated on a straight-line basis over its useful life of 10 years, assuming no salvage value. P.D. Corporation is planning on paying for the lathe using a line of credit at the bank that has an interest rate of 6 percent per year. The lathe is expected to increase production and sales. Sales are expected to increase by $100,000 per year. Inventory and accounts receivable balances are expected to increase by $10,000 and $20,000 respectively. Expenses to operate the lathe are $25,000 per year. P.D.'s marginal tax rate is 40%. a. Calculate the initial outlay required to fund this project. b. Calculate the incremental after-tax cash flow in year one of the project.

: a. Invoice price plus shipping plus modifications plus additional net working capital items: $250,000 + $10,000 + $20,000 + $10,000 + $20,000 = $310,000 b. (Sales — operating expenses — depreciation) (1-t) + Depreciation = ($100,000 - $25,000 — $28,000) (1-.4) + $28,000 = $56,200 Diff: 2 Keywords: Initial Outlay, Incremental After-Tax Cash Flows

: Analytic skills 115) A project that requires an initial investment of $340,000 is expected to have an after-tax cash flow of $70,000 per year for the first two years, $90,000 per year for the next two years, and $150,000 for the fifth year? Assume the required return for this project is 10%. a. What is the NPV of the project%? b. What is the IRR of the project? c. What is the MIRR of the project? d. What is the PI of the project? e. What decision would you make regarding this project if the required rate of return is 10%? f. What is the equivalent annual annuity using a 10% required rate of return?

: a. NPV = $3,715.34 b. IRR = 10.38% c. MIRR = 10.24% d. PI = 1.011 e. Accept the project because its NPV is positive, or because its IRR and MIRR are greater than the required return of 10%, or because the PI is greater than 1. f. The EAA = $980.10 Diff: 2 Keywords: NPV, IRR, MIRR, PI, Equivalent Annual Annuity

: Analytic skills 23) Consider the following two projects: Initial Outlay Net Cash Flow Each Period 1 2 3 4 Project A $4,000,000 $2,003,000 $2,003,000 $2,003,000 $2,003,000 Project B $4,000,000 0 0 0 $11,000,000 a. Calculate the net present value of each of the above projects, assuming a 14 percent discount rate. b. What is the internal rate of return for each of the above projects? c. Compare and explain the conflicting rankings of the NPVs and IRRs obtained in parts a and b above. d. If 14 percent is the required rate of return, and these projects are independent, what decision should be made? e. If 14 percent is the required rate of return, and the projects are mutually exclusive, what decision should be made?

: a. NPV of A = $1,836,166 NPV of B = $2,512,883 b. IRR of A = 35.0% IRR of B = 28.78% c. B has more distant cash flows, thus its IRR is less while its NPV is greater. This time disparity is one of IRR's ranking problems. d. If these projects are independent we would accept them both because they each have a positive NPV. e. If these projects are mutually exclusive we would select B because it has the highest positive NPV. Diff: 2 Keywords: IRR, NPV, Mutually Exclusive Projects, Independent Projects

: Analytic skills 114) Consider two mutually exclusive projects X and Y with identical initial outlays of $600,000 and useful lives of 5 years. Project X is expected to produce an after-tax cash flow of $180,000 each year. Project Y is expected to generate a single after-tax net cash flow of $1,015,000 in year 5. The discount rate is 14 percent. a. Calculate the net present value for each project. b. Calculate the IRR for each project. c. What decision should you make regarding these projects?

: a. NPV of A = $17,955 NPV of B = $23,242 b. IRR of A = 15.24% IRR of B = 14.87% c. B should be accepted because it is the mutually exclusive project with the highest positive NPV. Diff: 2 Keywords: NPV, IRR

: Analytic skills 26) Company K is considering two mutually exclusive projects. The cash flows of the projects are as follows: Year Project A Project B 0 -$2,000,000 -$2,000,000 1 500,000 2 500,000 3 500,000 4 500,000 5 500,000 6 500,000 7 500,000 5,650,000 a. Compute the NPV and IRR for the above two projects, assuming a 13% required rate of return. b. Discuss the ranking conflict. c. What decision should be made regarding these two projects?

: a. NPV of A = $211,305 NPV of B = $401,592.64 IRR of A = 16.33% IRR of B = 15.99% b. The later cash flow of B causes its lower IRR even though it has the higher NPV. c. B should be accepted because it is the mutually exclusive project with the highest positive NPV. Diff: 2 Keywords: NPV, IRR

: Analytic skills 85) Kelly Corporation is considering an investment proposal that requires an initial investment of $150,000 in equipment. Fully depreciated existing equipment may be disposed of for $40,000 pre-tax. The proposed project will have a five-year life, and is expected to produce additional revenue of $65,000 per year. Expenses other than depreciation will be $15,000 per year. The new equipment will be depreciated to zero over the five-year useful life, but it is expected to actually be sold for $20,000. Kelly has a 35% tax rate. a. What is the net initial outlay for the proposed project? b. What is the operating cash flow for years 1-4? c. What is the total cash flow at the end of year five (operating cash flow for year 5 plus terminal cash flow)?

: a. Net initial outlay = $150,000 — ($40,000*(1-.35)) = $124,000 b. Annual operating cash flows: First, depreciation expense will be $150,000/5 = $30,000 OCF = (Rev. — Exp.)(1-T) + TD = ($65,000 - $15,000) × (1 - .35) + (.35 × ($150,000/5)) = $32,500 + $10,500 = $43,000 c. Year 5 cash flow = $43,000 + .65($20,000) = $56,000 Diff: 2 Keywords: Initial Outlay, Incremental Operating Cash Flows, Terminal Cash Flow

: Analytic skills 116) The Bolster Company is considering two mutually exclusive projects: Year Initial Outlay NPV 0 -$100,000 -$100,000 1 31,250 0 2 31,250 0 3 31,250 0 4 31,250 0 5 31,250 200,000 The required rate of return on these projects is 12 percent. a. What is each project's payback period? b. What is each project's discounted payback period? c. What is each project's net present value? d. What is each project's internal rate of return? e. Fully explain the results of your analysis. Which project do you prefer, and why?

: a. Payback of A = 3.2 years Payback of B = 4.5 years b. Discounted Payback of A = 4.29 Discounted Payback of B = 4.88 b. NPV of A = $12,649.26 NPV of B = $13,485.37 c. IRR of A = 16.99% IRR of B = 14.87% d. B is preferred because it has the greatest positive NPV. Diff: 2 Keywords: Payback Period, Net Present Value, Internal Rate of Return

: Analytic skills 39) Voellers Upholstery Co. produces inexpensive leather chairs. The average selling price for one of the chairs is $400. The variable cost per chair is $250. Voellers' has average fixed costs per year of $450,000. a. What is the break-even point in units? b. What is the break-even point in dollar sales? c. What would be the operating profit or loss associated with the production and sale of (1) 3,000 chairs, (2) 4,000 chairs?

: a. QBE = $450,000/($400-$250) = 3,000 b. S = 3,000 × $400 = $1200,000 c. (1) 3,000 × $400 = $1,200,000 -3,000 × $250 = - 750,000 - 450,000 Operating Profit $ 0 (2) 4,000 × $400 = $1,600,000 -4,000 × $250 = -1,000,000 -450,000 Operating Profit $ 150,000 Diff: 2 Keywords: Break-even, Operating Profit

: Analytic skills 10) Miller's preferred stock is selling at $54 on the market and pays an annual dividend of $4.20 per share. a. What is the expected rate of return on the stock? b. If an investor's required rate of return is 9%, what is the value of the stock to that investor? c. Considering the investor's required rate of return, does this stock seem to be a desirable investment?

: a. R = D/V R = $4.20/54 R = 7.78% b. V = D/R V = $4.20/.09 V = $46.67 No, it is not a desirable investment because the current selling price exceeds the value to the investor. Diff: 2 Keywords: Preferred Stock Valuation, Expected Rate of Return, Required Rate of Return

: Analytic skills 17) A bond with a $1,000 face value and a 10 percent annual coupon rate matures in 15 years. a. Determine the value of the bond to a friend of yours with a required rate of return of 13%. b. A zero coupon bond with similar risk is selling for $180. The bond has a face value of $1,000 and matures in 15 years. Your friend asks you which bond she should invest in, the zero coupon bond or the bond in part (a). Which bond do you recommend, and why? Assume the market price of the bond in part (a) is $820.

: a. Value of Bond = $100 (PVIFA13%,15) + $1,000 (PVIF13%,15) = $806.13; Alternatively, using Excel, PV(Rate = .13, Nper = 15, Pmt = 100, Fv = 1000) = 806.13 b. Recommend the zero coupon bond. The yield to maturity on the zero coupon bond is 13.48%, which is higher than your friend's required return. The yield to maturity on the bond in part (a) must be less than 13% since the market price of the bond is more than $806.13. Diff: 2 Keywords: Yield to Maturity, Zero Coupon Bond, Bond Valuation

: Analytic skills 64) New Jet Airlines plans to issue 14-year bonds with a par value of $1,000 that will pay $60 every six months. The bonds have a market price of $1,220. Flotation costs on new debt will be 4% of the selling price. If the firm has a 35% marginal tax bracket, compute the following: a. Yield to maturity of debt b. After-tax cost of existing debt c. After-tax cost of new debt

: a. YTM = 9.18% (Using Yield Function in Excel with rate =.12, Pr = 122, Redemption = 100, Frequency = 2, and Basis = 0) b. After-tax cost of debt = 9.18% × (1-.35) = 5.97% c. After-tax cost of new debt = 9.73% × (1-.35) = 6.33% (The pre-tax cost is determined as in part a, except the Pr is 117.12, based on a net price of $1,220 less flotation costs of $48.80.) Diff: 2 Keywords: Yield to Maturity, After-tax Cost of Existing Debt, After-tax Cost of New Debt, Flotation Costs

: Analytic skills 32) Meacham Corp. wants to issue bonds with a 9% coupon rate, a face value of $1,000, and 12 years to maturity. Meacham estimates that the bonds will sell for $1,090 and that flotation costs will equal $15 per bond. Meacham Corp. common stock currently sells for $30 per share. Meacham can sell additional shares by incurring flotation costs of $3 per share. Meacham paid a dividend yesterday of $4.00 per share and expects the dividend to grow at a constant rate of 5% per year. Meacham also expects to have $12 million of retained earnings available for use in capital budgeting projects during the coming year. Meacham's capital structure is 40% debt and 60% common equity. Meacham's marginal tax rate is 35%. a. Calculate the after-tax cost of debt assuming Meacham's bonds are its only debt. b. Calculate the cost of retained earnings. c. Calculate the cost of new common stock. d. Calculate the weighted average cost of capital assuming Meacham's total capital budget is $30 million.

: a. YTM with Net Proceeds = $1,075 is 8.0%. After-tax cost of debt = 8.0%(1 - .35) = 5.2% b. (($4.00(1.05))/$30) + 5% = 19% c. (($4.00(1.05))/($30 - $3)) + 5% = 20.56% d. At $30 million, debt = $12 million and common equity = $18 million. Available retained earnings are $12 million, so new common stock will equal $6 million. WACC = (.4)(5.2%) + (.4)(19%) + (.2)(20.56%) = 13.79% Diff: 3 Keywords: Weighted Average Cost of Capital, Cost of Debt, Cost of Retained Earnings, Cost of New Common Stock, Capital Structure

: Analytic skills 43) Graystone bonds have a maturity value of $1,000. The bonds carry a coupon rate of 12 percent. Interest is paid semiannually. The bonds will mature in nine years. If the current market price is $976.50, a. what is the yield to maturity on the bond? b. what is the current yield on the bond?

: a. Yield to maturity = 12.44% b. Current yield = $120/$976.50 = 12.29% Diff: 1 Keywords: Yield to Maturity, Current Yield

: Analytic skills 74) The preferred stock of Wells Co. sells for $17 and pays a $1.75 dividend. The net price of the stock after issuance costs is $15.30. What is the cost of capital for new preferred stock?

: $1.75/$15.30 = 11.44% Diff: 1 Keywords: Cost of Preferred Stock

: Analytic skills 61) Your son will be attending an expensive university in 12 years. You deposit $5,000 per year for 12 years, beginning today. How much money will be in the college fund 12 years from now if the fund earns 8% per year?

: $102,476.48 Diff: 1 Keywords: Future Value, Annuity Due

: Analytic skills 75) Cindy wants $2.5 million for her retirement at age 65. Cindy is 25 years old today and plans to deposit equal amounts each year starting on her 26th birthday and ending on her 65th birthday. If her investments earn 6% per year, how much must each deposit be?

: $16,153.84 (FVA = $2.5 million, N = 40, I = 6%, solve for PMT) Diff: 1 Keywords: Time Value of Money, Payment, Future Value of an Annuity

: Analytic skills 63) Betty borrows $60,000 at 12 percent compounded annually. The loan is to be repaid in five equal annual end-of-year installments. How much must each loan payment be?

: $16,644.58, based on PVA = $60,000; N = 5; I = 12%; PMT = $16,644.58 Diff: 2 Keywords: Present Value, Annuity, Loan Amortization

: Analytic skills 65) Bob invested $2,000 in an investment fund on his 21st birthday. The fund pays 7% interest compounded semiannually. Bob is celebrating his 50th birthday today. Bob decides he wants to retire on his 60th birthday and he wants to withdraw $75,000 per year, the first withdrawal on his 60th birthday and the last withdrawal on his 90th birthday. Bob expects to receive $100,000 from his employer on his 55th birthday in recognition of his long service to the company. Assume Bob has not taken any money out of his investment fund since he initially funded it on his 21st birthday, and that he will deposit the $100,000 from his employer into the investment fund on his 55th birthday. The investment fund will be used to pay for Bob's retirement. If Bob makes no additional deposits into his investment fund, how much will be available for retirement at age 60? Since the amount in (a) is insufficient to meet his retirement goals, Bob decides to deposit equal annual amounts into the investment fund beginning on his 51st birthday and ending on his 59th birthday, so that he can meet his retirement goals. How much will each deposit be?

: $170,327 based on the future value of the $2,000 invested for 39 years being $29,267 at age 60 and the future value of the $100,000 from the employer invested for 5 years of $141,060. $63,893.50 based on the present value of an annuity due for 31 years, or $994,339 needed for retirement at age 60; this amount is the future value of a 9-year annuity due, yielding an annual payment of $63,893.50. Diff: 2 Keywords: Annuity Due, Annuity, Time Value of Money, Future Value, Present Value

: Analytic skills 76) A retirement home in Florida costs $200,000 today. Housing prices in Florida are increasing at a rate of 4% per year. Joe wants to buy the home in 8 years when he retires. Joe has $25,000 right now in a savings account paying 8% interest per year. Joe wants to make eight equal annual deposits into the savings account starting today. How much must each deposit be so Joe will have enough money in his savings account to buy the retirement home when he retires?

: $19,798.86; The future value of the home in 8 years is $273,713.80 (PV = $200,000, I = 4%, N = 8, solve for FV); The future value of the savings account in 8 years is $46,273.26 (PV = $25,000, I = 8%, N = 8, solve for FV); The difference of $227,440.54 is the additional amount Joe needs in 8 years. Since Joe is making equal annual deposits starting today, the $227,440.54 is the future value of an annuity due. The payment amount is $19,798.86 (FVA due = $227,440.54; N = 8, I = 8%, mode = BEG, solve for PMT).; Diff: 3 Keywords: Time Value of Money, Annuity, Annuity Due, Payment

: Analytic skills 64) You are currently 25 years of age. You have developed a lifetime budget that includes $50,000 at age 40 for a college fund for your kids and $25,000 per year for 20 years to supplement your retirement, the first payment on your 60th birthday and the last payment on your 79th birthday. You open an investment account on your 25th birthday that promises to pay 9% interest compounded annually. You want to deposit equal annual amounts into the account every year on your birthday, starting today (your 25th birthday) and continuing until you are 40 years old (i.e., the last deposit is made on your 40th birthday). How much will each deposit have to be if you want to meet your financial goals?

: $2,859.86, based on the present value of the retirement annuity at age 59 is $228,213.64; this amount discounted back to age 40 = $44,385.20; this amount is added to the $50,000 needed at age 40, for a total need at age 40 of $94,385.20; this amount is the future value of a 16 year annuity with an interest rate of 9% per year, yielding an annual payment of $2,859.86. Diff: 3 Keywords: Time Value of Money, Annuity, Present Value

: Analytic skills 62) If you wish to accumulate $200,000 in the child's college fund after 18 years, and can invest at a 7.5% annual rate, how much must you invest at the end of each year if the first deposit is made at the end of the first year?

: $5,605.79 Diff: 1 Keywords: Annuity, Annual Payment

: Analytic skills 19) Calculate the value of a bond that is expected to mature in 18 years with a $1,000 face value. The coupon rate is 4%, and the required rate of return is 8%. Interest is paid annually.

: $625.12 Diff: 1 Keywords: Intrinsic Value, Required Return

: Reflective thinking skills 71) A bond will pay $5,000 at maturity in 9 years. It also makes semiannual interest payments of $400 until maturity. If the discount rate is 7% compounded semiannually, what should be the market price of the bond?

: $7,967.68 Diff: 2 Keywords: Present Value, Annuity, semiannual Compounding, Bond

: Analytic skills 36) You just invested $50,000 into an account that earns 7 percent compounded annually. At the end of each year you can withdraw $4,971. How many years can you continue to make the withdrawals?

: 18 years Diff: 2 Keywords: Time Value of Money, Number of Periods

: Analytic skills 34) Your parents are complaining about the price of items today compared to what they cost years ago. If an automobile that cost $12,000 in 1980 costs $40,000 in 2010, calculate the annual growth rate in the automobile's price.

: 4.26%, based on PV = $12,000; FV = $42,000; N = 30; I = (42000/12000)(1/30) — 1 = 4.26%; Diff: 2 Keywords: Annual Growth Rate, Present Value, Future Value

: Analytic skills 43) Wheely Bike Manufacturers expects to produce and sell 9,000 made-to-order bicycles this year. Variable costs are 40 percent of sales while fixed costs total $600,000. At what price must each bicycle be sold for Wheely to earn EBIT of $450,000?

: 9,000P - (.40)(9,000)P - $600,000 = $450,000 9,000P — 3,600P - $600,000 = $450,000 5,400P = $1,050,000 P = $194.44 Diff: 2 Keywords: Break-even Analysis, EBIT, Selling Price

: Analytic skills 73) Gibson Industries is issuing a $1,000 par value bond with an 8% annual interest coupon rate that matures in 11 years. Investors are willing to pay $972, and flotation costs will be 9%. Gibson is in the 34% tax bracket. What will be the after-tax cost of new debt for the bond?

: 9.76% × (1 - .34) = 6.44% Diff: 2 Keywords: After-tax Cost of Debt, Flotation Costs

: Analytic skills 47) The Western Boot Company will produce 94,000 pairs of boots next year. Variable costs are 35 percent of sales, while fixed costs total $223,000. At what price must each pair of boots be sold for Western to obtain an EBIT of $1,391,500?

: 94,000P - (0.35)(94,000)P - 223,000 = 1,391,500 94,000P - 32,900P - 223,000 = 1,391,500 61,100P = 1,614,500 P = $26.42 Diff: 2 Keywords: Cost-Volume-Profit Analysis

: Analytic skills 16) Sunshine Candy Company's capital structure for the past year of operation is shown below. First mortgage bonds at 12% $2,000,000 Debentures at 15% 1,500,000 Common stock (1,000,000 shares) 5,000,000 Retained earnings 500,000 TOTAL $9,000,000 The federal tax rate is 50 percent. Sunshine Candy Company, home-based in Orlando, wants to raise an additional $1,000,000 to open new facilities in Tampa and Miami. The firm can accomplish this via two alternatives: (1) It can sell a new issue of 20-year debentures with 16 percent interest; or (2) 20,000 new shares of common stock can be sold to the public to net the candy company $50 per share. A recent study, performed by an outside consulting organization, projected Sunshine Candy Company's long-term EBIT level at approximately $6,800,000. Find the indifference level of EBIT (with regard to earnings per share) between the suggested financing plans.

: = = 50 EBIT - 23,250,000 = 51 EBIT - 31,875,000 EBIT = $8,625,000 is the indifference level Diff: 2 Keywords: EBIT-EPS Analysis, Indifference Point

: Analytic skills 33) Your daughter is born today and you want her to be a millionaire by the time she is 35 years old. You open an investment account that promises to pay 12% per year. How much money must you deposit each year, starting on her 1st birthday and ending on her 35th birthday, so your daughter will have $1,000,000 by her 35th birthday? A) $2,317 B) $3,455 C) $5,777 D) $9,450

: A Diff: 1 Keywords: Annuity, Payments

: Analytic skills 35) You sell valuable artifacts from your household estate for $200,000 and want to use the money to supplement your retirement. You receive the money on your 60th birthday, the day you retire. You want to withdraw equal amounts at the end of each of the next 25 years. What constant amount can you withdraw each year and have nothing remaining at the end of 20 years if you are earning 7% interest per year? A) $17,162 B) $28,318 C) $37,574 D) $49,113

: A Diff: 1 Keywords: Annuity, Payments

: Analytic skills 14) An investor currently holds the following portfolio: Amount Invested 4,000 shares of Stock H $8,000 Beta = 1.3 7,500 shares of Stock I $24,000 Beta = 1.8 12,500 shares of Stock J $48,000 Beta = 2.2 The beta for the portfolio is A) 1.99. B) 1.77. C) 1.45. D) 1.27.

: A Diff: 1 Keywords: Beta, Portfolio, Security Market Line

: Reflective thinking skills 3) Which type of value is shown on the firm's balance sheet? A) book value B) liquidation value C) market value D) intrinsic value

: A Diff: 1 Keywords: Book Value, Balance Sheet

: Analytic skills 22) The break-even point is equal to A) fixed costs divided by (sales price per unit — variable cost per unit). B) fixed costs divided by unit variable costs. C) fixed costs divided by selling price per unit. D) (sales price per unit — variable cost per unit) times the fixed costs.

: A Diff: 1 Keywords: Break-even Point, Fixed Costs, Variable Costs

: Reflective thinking skills 64) Which of the following should be included in an analysis of a new project's cash flows? A) any sales from existing products that would be lost if customers were expected to purchase a new product instead B) all financing costs C) all sunk costs D) no opportunity costs

: A Diff: 1 Keywords: Cannibalization, Financing Cash Flows, Sunk Costs, Opportunity Costs

: Reflective thinking skills 33) Which of the following would NOT be a part of a firm's capital structure? A) short-term notes payable B) long-term bonds C) preferred stock D) common stock

: A Diff: 1 Keywords: Capital Structure

: Reflective thinking skills 30) Two considerations that cause a corporation's cost of capital to be different than its investors' required returns are A) corporate taxes and flotation costs. B) individual taxes and corporate taxes. C) individual taxes and dividends. D) corporate taxes and the earned income tax credit.

: A Diff: 1 Keywords: Cost of Capital, Required Rate of Return, Taxes, Flotation Costs

: Analytic skills 19) Cumulative preferred stock A) requires dividends in arrears to be carried over into the next period. B) has a right to vote cumulatively. C) has a claim to dividends before bonds. D) has a higher required return than common stock.

: A Diff: 1 Keywords: Cumulative Preferred Stock

: Reflective thinking skills 50) Which of the following types of risk is diversifiable? A) unsystematic, or company-unique risk B) betagenic, or ecocentric risk C) systematic risk D) market risk

: A Diff: 1 Keywords: Diversifiable Risk, Unsystematic Risk

: Reflective thinking skills 34) Financial leverage has to do with A) the usage of fixed cost financial securities to finance a portion of a firm's assets. B) using common stock to finance a portion of a firm's assets. C) the incurrence of fixed operating costs in the firm's income stream. D) a high gross profit margin.

: A Diff: 1 Keywords: Financial Leverage

: Reflective thinking skills 26) Which of the following is a fixed cost? A) insurance B) direct material C) direct labor D) freight costs on products

: A Diff: 1 Keywords: Fixed Costs

: Analytic skills 28) Wendy purchased 800 shares of Genetics Stock at $3 per share on 1/1/12. Wendy sold the shares on 12/31/12 for $3.45. Genetics stock has a beta of 1.9, the risk-free rate of return is 4%, and the market risk premium is 9%. Wendy's holding period return is A) 15.0%. B) 16.5%. C) 17.6%. D) 21.1%.

: A Diff: 1 Keywords: Holding Period Return

: Analytic skills 70) Which of the following should NOT be included as investment costs in evaluating a capital asset? A) interest payments and other financing cash flows that result from raising funds to finance a project B) employee training expenses C) shipping expenses D) installation expenses

: A Diff: 1 Keywords: Incremental Cash Flows, Financing Cash Flows

: Reflective thinking skills 67) Which of the following expenses associated with a project should NOT be included in a capital budgeting analysis? A) additional allocated fixed overhead from corporate headquarters B) additional maintenance expenses associated with new equipment C) reengineering of a production line associated with a new project D) training sales staff on a new product

: A Diff: 1 Keywords: Incremental Cash Flows, Overhead, Initial Outlay

: Reflective thinking skills 30) Solar Confectionary develops a new candy bar and plans to sell each bar for $1. Solar predicts that 1 million candy bars will be sold in the first year if the new candy bar is produced and sold, and includes $1 million of incremental revenues in its capital budgeting analysis. A senior executive in the company believes that 1 million candy bars will be sold, but lowers the estimate of incremental revenue to $700,000. What would explain this change? A) cannibalization of 300,000 of Solar Confectionary' other candy bars B) excessive marketing costs to sell the 1 million candy bars C) a lower discount rate D) a higher selling price for the new candy bars

: A Diff: 1 Keywords: Incremental Revenues, Cannibalization

: Analytic skills 26) When the intrinsic value of an asset exceeds the market value A) the asset is undervalued to the investor. B) the asset is overvalued to the investor. C) market value and intrinsic value are always the same; therefore, this could not happen. D) liquidation value must be higher than book value.

: A Diff: 1 Keywords: Intrinsic Value, Market Value

: Reflective thinking skills 7) Harold considers investing in an LM Corp. bond and decides not to purchase the bond. Which of the following statements is MOST correct? A) The intrinsic value of the bond for the investor is less than the market value of the bond. B) The liquidation value of the bond is greater than the market value of the bond. C) The intrinsic value of the bond for the investor is less than the par value of the bond. D) The intrinsic value of the bond for the investor is greater than the book value of the bond.

: A Diff: 1 Keywords: Intrinsic Value, Market Value, Book Value, Par Value

: Analytic skills 61) The financial manager selecting one of two projects of differing risk should A) select the project with the larger risk-adjusted net present value. B) choose the project with the least relative risk. C) choose the project with greater return even if that project has greater risk. D) choose the project with less risk even though that project has less return.

: A Diff: 1 Keywords: Net Present Value

: Reflective thinking skills 44) Butler Automotive developed a new diagnostic testing procedure that is expected to increase sales by $10,000 per month. As more drivers bring in their vehicles, Butler expects to also do more oil changes and brake repairs. As a result, inventory levels of oil and brake parts must be increased by $5,000. Revenues from oil changes and brake jobs are expected to increase by $4,000 per month. An example of an increase in net working capital requirements from the new diagnostic testing procedure is the A) increase in inventory levels of oil and brake parts of $5,000. B) increase in revenue of $10,000 per month for the diagnostic testing. C) increase in revenues from oil changes and brake jobs of $4,000 per month. D) increase in all activities totaling $19,000 per month.

: A Diff: 1 Keywords: Net Working Capital

: Reflective thinking skills 35) Which of the following would be considered the firm's optimal capital structure? A) Stock Price = $25, Earnings Per Share = $10, Cost of Equity Capital = 15% B) Stock Price = $23, Earnings Per Share = $11, Cost of Equity Capital = 18% C) Stock Price = $24, Earnings Per Share = $12, Cost of Equity Capital = 17% D) Stock Price = $20, Earnings Per Share = $12, Cost of Equity Capital = 20%

: A Diff: 1 Keywords: Optimal Capital Structure, Maximize Shareholder Value

: Analytic skills 9) How is preferred stock affected by a decrease in the required rate of return? A) The value of a share of preferred stock increases. B) The dividend increases. C) The dividend decreases. D) The dividend yield increases.

: A Diff: 1 Keywords: Preferred Stock Valuation, Required Return

: Reflective thinking skills 19) Which of the following statements concerning the constant growth dividend valuation model is true? A) The required rate of return must exceed the growth rate. B) The dividend growth rate must be bigger than 8%. C) The growth rate must increase every year. D) The required rate of return must be equal to the growth rate for dividends.

: A Diff: 1 Keywords: Required Return, Constant Growth Dividend Valuation Model

: Analytic skills 12) Which of the following statements is true? A) The value of a bond is inversely related to changes in investors' present required rate of return. B) If interest rates decrease, the value of a bond will decrease. C) If interest rates increase, the value of a bond will increase. D) If interest rates remain constant, the value of premium bonds will increase over time.

: A Diff: 1 Keywords: Required Return, Intrinsic Value

: Analytic skills 16) Wendy purchased 800 shares of Robotics Stock at $3 per share on 1/1/09. Wendy sold the shares on 12/31/09 for $3.45. Genetics stock has a beta of 1.3, the risk-free rate of return is 3%, and the market risk premium is 8%. The required return on Genetics Stock is A) 13.4%. B) 16.5%. C) 17.6%. D) 21.1%.

: A Diff: 1 Keywords: Required Return, Security Market Line, Beta, Market Risk Premium

: Reflective thinking skills 34) Which of the following is NOT an acceptable method of measuring risk for capital budgeting purposes? A) modified internal rate of return B) sensitivity analysis C) using a risk-adjusted discount rate D) proxy, or pure play method for estimating a project's beta

: A Diff: 1 Keywords: Risk, Sensitivity Analysis, Risk-Adjusted Discount Rate, Pure Play Method

: Analytic skills 15) Which of the following changes will make the value of a stock go up, other things being held constant? A) The required return decreases. B) The required return increases. C) In general, investors become more risk averse. D) The growth rate of dividends decreases.

: A Diff: 1 Keywords: Risk/Return Tradeoff, Required Return, Stock Valuation

: Reflective thinking skills 7) The interest on corporate bonds is typically paid A) semiannually. B) annually. C) quarterly. D) monthly.

: A Diff: 1 Keywords: Semiannual Interest

: Analytic skills 37) The "threat hypothesis" A) reduces management's tendency to spend freely. B) encourages management to use debt to further their own interests. C) increases the agency problem. D) increases agency monitoring costs.

: A Diff: 1 Keywords: Threat Hypothesis, Agency Costs

: Analytic skills 25) Assuming two investments have equal lives, a high discount rate tends to favor A) the investment with large cash flow early. B) the investment with large cash flow late. C) the investment with even cash flow. D) neither investment since they have equal lives.

: A Diff: 1 Keywords: Time Value of Money, Discount Rate

: Analytic skills 25) Variable costs include all of the following EXCEPT A) property taxes. B) direct labor. C) sales commissions. D) annual rent.

: A Diff: 1 Keywords: Variable Cost

: Analytic skills 4) A corporate bond has a face value of $1,000 and a coupon rate of 5%. The bond matures in 15 years and has a current market price of $925. If the corporation sells more bonds it will incur flotation costs of $25 per bond. If the corporate tax rate is 35%, what is the after-tax cost of debt capital? A) 3.74% B) 4.45% C) 5.29% D) 6.78%

: A Diff: 2 Keywords: After-tax Cost of Debt, Flotation Costs, Bond Valuation

: Analytic skills 19) You have the choice of two equally risk annuities, each paying $5,000 per year for 8 years. One is an annuity due and the other is an ordinary annuity. If you are going to be receiving the annuity payments, which annuity would you choose to maximize your wealth? A) the annuity due B) the ordinary annuity C) Since we don't know the interest rate, we can't find the value of the annuities and hence we cannot tell which one is better. D) either one because they have the same present value

: A Diff: 2 Keywords: Annuity Due, Ordinary Annuity, Present Value

: Analytic skills 54) You bought a racehorse that has had a winning streak for six years, bringing in $250,000 at the end of each year before dying of a heart attack. If you paid $1,155,720 for the horse 4 years ago, what was your annual return over this 4-year period? A) 8% B) 33% C) 18% D) 12%

: A Diff: 2 Keywords: Annuity, Future Value, Rate of Return

: Analytic skills 23) You charged $1,000 on your credit card for Christmas presents. Your credit card company charges you 26% annual interest, compounded monthly. If you make the minimum payments of $25 per month, how long will it take ( to the nearest month) to pay off your balance? A) 94 months B) 79 months C) 54 months D) 40 months

: A Diff: 2 Keywords: Annuity, Loan Amortization, Time Value of Money

: Reflective thinking skills 28) A financial advisor tells you that you can make your child a millionaire if you just start saving early. You decide to put an equal amount each year into an investment account that earns 7.5% interest per year, starting on the day your child is born. How much would you need to invest each year (rounded to the nearest dollar) to accumulate a million for your child by the time he is 35 years old? (Your last deposit will be made on his 34th birthday.) A) $6,525 B) $7,910 C) $12,500 D) $20,347

: A Diff: 2 Keywords: Annuity, Payments

: Analytic skills 29) You are 21 years old today. Your grandparents set up a trust fund that will pay you $25,000 per year for 20 years, starting on your 65th birthday to supplement your retirement. If the trust can earn 7.5% per year, how much will your grandparents need to put in the trust fund today (rounded to the nearest ten dollars)? A) $11,370 B) $22,310 C) $5,250 D) $17,450

: A Diff: 2 Keywords: Annuity, Present Value

: Analytic skills 12) Stock A has a beta of 1.2 and a standard deviation of returns of 18%. Stock B has a beta of 1.8 and a standard deviation of returns of 18%. If the market risk premium increases, then A) the required return on stock B will increase more than the required return on stock A. B) the required returns on stocks A and B will both increase by the same amount. C) the required returns on stocks A and B will remain the same. D) the required return on stock A will increase more than the required return on stock B.

: A Diff: 2 Keywords: Beta, Security Market Line, Market Risk Premium

: Reflective thinking skills 27) A plant may remain operating when sales are depressed A) if the selling price per unit exceeds the variable cost per unit. B) to help the local economy. C) in an effort to cover at least some of the variable cost. D) unless variable costs are zero when production is zero.

: A Diff: 2 Keywords: Break-even Analysis

: Analytic skills 24) QuadCity Manufacturing, Inc. reported the following items: Sales = $6,000,000; Variable Costs of Production = $1,500,000; Variable Selling and Administrative Expenses = $550,000; Fixed Costs = $1,350,000; EBIT = $2,600,000; and the Marginal Tax Rate =35%. QuadCity's break-even point in sales dollars is A) $2,050,633. B) $2,197,500. C) $2,438,750. D) $2,785,000.

: A Diff: 2 Keywords: Break-even Point, Fixed Costs, Variable Costs

: Reflective thinking skills 30) Based on the data contained in Table A, what is the break-even point in units produced and sold? TABLE A Average selling price per unit $18.00 Variable cost per unit $13.00 Units sold 400,000 Fixed costs $650,000 Interest expense $ 50,000 A) 130,000 B) 140,000 C) 150,000 D) 180,000

: A Diff: 2 Keywords: Break-even Units

: Reflective thinking skills 10) A high degree of variability in a firm's earnings before interest and taxes refers to A) business risk. B) financial risk. C) financial leverage. D) operating leverage.

: A Diff: 2 Keywords: Business Risk

: Reflective thinking skills 9) Progressive Corporation issued callable bonds. The bonds are most likely to be called if A) interest rates decrease. B) interest rates increase. C) Shafer Corporation needs additional financing. D) Shafer Corporation's stock price increases dramatically.

: A Diff: 2 Keywords: Callable Bonds

: Analytic skills 95) Different discounted cash flow evaluation methods may provide conflicting rankings of investment projects when A) the size of investment outlays differ. B) the projects are mutually exclusive. C) the accounting policies differ. D) the internal rate of return equals the cost of capital.

: A Diff: 2 Keywords: Capital Budgeting Decisions, Size, Cash Flows vs Accounting Income

: Reflective thinking skills 36) Which of the following statements about combined (operating & financial) leverage is true? A) If a firm employs both operating and financial leverage, any percent change in sales will produce a larger percent change in earnings per share. B) A firm that is in a capital-intensive industry should use a higher level of financial leverage than a firm that employs low levels of operating leverage. C) Usage of both operating and financial leverage reduces a firm's risk. D) High operating leverage and high financial leverage offset one another, meaning that if sales increase by 10%, then EPS will also increase by 10%.

: A Diff: 2 Keywords: Combined Leverage

: Analytic skills 46) You observe Thundering Herd Common Stock selling for $40.00 per share. The next dividend is expected to be $4.00, and is expected to grow at a 5% annual rate forever. If your required rate of return is 12%, should you purchase the stock? A) yes, because the present value of the expected future cash flows is greater than $40 B) no, because the present value of the expected future cash flows is less than $40 C) yes, because the present value of the expected future cash flows is less than $40 D) no, because the present value of the expected future cash flows is greater than $40

: A Diff: 2 Keywords: Common Stock Valuation, Required Return

: Analytic skills 22) Using the constant growth dividend valuation model and assuming dividends will growth a constant rate forever, the increase in the value of the stock each year should be equal to the A) growth rate in dividends, g. B) required return on the stock, rcs. C) dividend yield plus the capital gains yield. D) dividend yield.

: A Diff: 2 Keywords: Constant Growth Dividend Valuation Model

: Analytic skills 33) Bensen Co. paid a dividend of $5.25 on its common stock yesterday. The company's dividends are expected to grow at a constant rate of 8.5% indefinitely. If the required rate of return on this stock is 15.5%, compute the current value per share of Bensen Co. stock. A) $81.38 B) $76.43 C) $56.23 D) $43.90

: A Diff: 2 Keywords: Constant Growth Dividend Valuation Model

: Reflective thinking skills 35) Dynamic Industries paid a dividend of $1.65 on its common stock yesterday. The dividends of Wallace Industries are expected to grow at 9% per year indefinitely. If the risk free rate is 3% and investors' risk premium on this stock is 8%, estimate the value of Wallace Industries stock 2 years from now. A) $106.84 B) $100.43 C) $91.81 D) $54.71

: A Diff: 2 Keywords: Constant Growth Dividend Valuation Model, Required Return, Risk Free Rate, Risk Premium

: Reflective thinking skills 22) Which of the following bond provisions will make a bond more desirable to investors, other things being equal? A) The bond is convertible. B) The bond is callable. C) The coupon rate is lower. D) The bond is subordinated.

: A Diff: 2 Keywords: Convertible Bonds

: Analytic skills 47) In general, the least expensive source of capital is A) debt. B) new common stock. C) preferred stock D) retained earnings.

: A Diff: 2 Keywords: Cost of Capital, Sources of Capital

: Analytic skills 35) Sentry Manufacturing paid a dividend yesterday of $5 per share (D0 = $4). The dividend is expected to grow at a constant rate of 8% per year. The price of Sentry Manufacturing's stock today is $29 per share. If Sentry Manufacturing decides to issue new common stock, flotation costs will equal $2.50 per share. Sentry Manufacturing's marginal tax rate is 35%. Based on the above information, the cost of new common stock is A) 28.38%. B) 24.12%. C) 26.62%. D) 31.40%.

: A Diff: 2 Keywords: Cost of New Common Stock

: Analytic skills 11) Valley Manufacturing Inc. just issued $1,000 par 20-year bonds. The bonds sold for $758.18 and pay interest semiannually. Investors require a rate of 9% on the bonds. What is the bonds' coupon rate? A) 6% B) 7% C) 8% D) 9%

: A Diff: 2 Keywords: Coupon Rate, Semiannual Interest, Intrinsic Value

: Reflective thinking skills 20) Minority shareholders have a greater chance of electing a member to the board of directors if the company uses A) cumulative voting. B) majority voting. C) minority voting. D) proxy voting.

: A Diff: 2 Keywords: Cumulative Voting

: Reflective thinking skills 36) ND Electric Company issued $1,000 bonds that have an annual coupon rate of 6.5%. The present market value of the bonds is $1,225. If the bonds have 17 years remaining until maturity, what is the current yield on ND Electric Company bonds? A) 5.3% B) 6.5% C) 7.2% D) 13.2%

: A Diff: 2 Keywords: Current Yield

: Reflective thinking skills 25) Which of the following statements is MOST correct concerning diversification and risk? A) Risk-averse investors often choose companies from different industries for their portfolios because the correlation of returns is less than if all the companies came from the same industry. B) Risk-averse investors often select portfolios that include only companies from the same industry group because the familiarity reduces the risk. C) Only wealthy investors can diversify their portfolios because a portfolio must contain at least 50 stocks to gain the benefits of diversification. D) Proper diversification generally results in the elimination of risk.

: A Diff: 2 Keywords: Diversification, Risk, Correlation

: Analytic skills 44) Bevel Building Products, Inc., whose common stock is currently selling for $12 per share, is expected to pay a $1.80 dividend, and sell for $14.40 one year from now. What are the dividend yield, growth rate, and total rate of return, respectively? A) 15% 20% 35% B) 10% 5% 15% C) 15% 12% 27% D) 20% 15% 35%

: A Diff: 2 Keywords: Dividend Yield, Growth Rate, Total Rate of Return

: Analytic skills 16) 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. A) false, because the required return could be different B) true, because we are using a dividend valuation model C) true if markets are semi-strong form efficient D) true if investors are risk-averse

: A Diff: 2 Keywords: Dividend, Growth Rate, Stock Valuation

: Reflective thinking skills 12) The EBIT-EPS indifference point A) identifies the EBIT level at which the EPS will be the same regardless of the financing plan. B) identifies the point at which the analysis can use EBIT and EPS interchangeably. C) identifies the level of earnings at which the management is indifferent about the payments of dividends. D) identifies the sales level at which EBIT equals EPS.

: A Diff: 2 Keywords: EBIT-EPS Indifference Point

: Reflective thinking skills 18) Assume that an investment is forecasted to produce the following returns: a 10% probability of a $1,400 return; a 50% probability of a $6,600 return; and a 40% probability of a $1,500 return. What is the expected amount of return this investment will produce? A) $4,040 B) $7,640 C) $12140 D) $1,540

: A Diff: 2 Keywords: Expected Return

: Reflective thinking skills 41) You hold a portfolio with the following securities: Expected Security Value Beta Return Driscol Corporation 20% 3.20 36.0% Evening Corporation 40% 1.60 20.0% Frolic Corporation 40% .20 6.0% What is the expected return for the portfolio? A) 17.60% B) 20.67% C) 23.54% D) 28.59%

: A Diff: 2 Keywords: Expected Return, Portfolio

: Reflective thinking skills 13) You are considering investing in a project with the following possible outcomes: Probability of Investment States Occurrence Returns State 1: Economic boom 18% 20% State 2: Economic growth 42% 16% State 3: Economic decline 30% 3% State 4: Depression 10% -25% Calculate the expected rate of return and standard deviation of returns for this investment, respectively. A) 8.72%, 12.99% B) 7.35%, 12.99% C) 3.50%, 1.69% D) 2.18%, 1.69%

: A Diff: 2 Keywords: Expected Return, Standard Deviation

: Analytic skills 10) You are considering a sales job that pays you on a commission basis or a salaried position that pays you $50,000 per year. Historical data suggests the following probability distribution for your commission income. Which job has the higher expected income? Probability of Commission Occurrence $15,000 .15 $35,000 .20 $48,000 .35 $67,000 .22 $80,000 .18 A) The salary of $50,000 is greater than the expected commission of $49,630. B) The salary of $50,000 is greater than the expected commission of $48,400. C) The salary of $50,000 is less than the expected commission of $50,050. D) The salary of $50,000 is less than the expected commission of $52,720.

: A Diff: 2 Keywords: Expected Value

: Reflective thinking skills 27) Financial leverage could mean financing some of a firm's assets with A) preferred stock. B) retained earnings. C) private equity capital. D) sales revenues.

: A Diff: 2 Keywords: Financial Leverage, Bonds

: Reflective thinking skills 30) Financial leverage is distinct from operating leverage since it accounts for A) use of debt and preferred stock. B) variability in fixed operating costs. C) variability in sales. D) changes in EBIT.

: A Diff: 2 Keywords: Financial Leverage, Operating Leverage

: Reflective thinking skills 48) The cost of external equity capital is greater than the cost of retained earnings because of A) flotation costs on new equity. B) increasing marginal tax rates. C) higher dividends. D) greater risk for shareholders.

: A Diff: 2 Keywords: Flotation Costs, Cost of New Common Stock, Cost of Retained Earnings

: Analytic skills 24) If you put $10,000 in an investment that returns 11 percent compounded monthly what would you have after 10 years (round to nearest $1)? A) $29,892 B) $27,559 C) $25,486 D) $22,489

: A Diff: 2 Keywords: Future Value, Monthly Compounding

: Analytic skills 11) You invest $1,000 at a variable rate of interest. Initially the rate is 4% compounded annually for the first year, and the rate increases one-half of one percent annually for five years (year two's rate is 4.5%, year three's rate is 5.0%, etc.). How much will you have in the account after five years? A) $1,276 B) $1,359 C) $1,462 D) $1,338

: A Diff: 2 Keywords: Future Value, Variable Interest Rate

: Reflective thinking skills 51) You purchased 500 shares of A.M.J. Inc. common stock one year ago for $50 per share. You received a dividend of $2 per share today and decide to take your profits by selling at $54.50 per share. What is your holding period return? A) 13.0% B) 9.0% C) 6.5% D) 4.0%

: A Diff: 2 Keywords: Holding Period Return, Dividends

: Reflective thinking skills 101) An independent project should be accepted if it A) produces a net present value that is greater than or equal to zero. B) produces a net present value that is greater than the equivalent IRR. C) has only one sign reversal. D) produces a profitability index greater than or equal to zero.

: A Diff: 2 Keywords: Independent Projects, Net Present Value

: Analytic skills 5) Your company is considering the replacement of an old delivery van with a new one that is more efficient. The old van cost $40,000 when it was purchased 5 years ago. The old van is being depreciated using the simplified straight-line method over a useful life of 8 years. The old van could be sold today for $7,000. The new van has an invoice price of $80,000, and it will cost $6,000 to modify the van to carry the company's products. Cost savings from use of the new van are expected to be $28,000 per year for 5 years, at which time the van will be sold for its estimated salvage value of $18,000. The new van will be depreciated using the simplified straight-line method over its 5-year useful life. The company's tax rate is 35%. Working capital is expected to increase by $5,000 at the inception of the project, but this amount will be recaptured at the end of year five. What is the initial outlay required to fund this replacement project? A) $81,200 B) $78,600 C) $74,500 D) $73,580

: A Diff: 2 Keywords: Initial Outlay, Tax Effect of Sale of Old Machine, Depreciation, Net Working Capital

: Analytic skills 14) If a firm were to experience financial insolvency, the legal system provides an order of hierarchy for the payment of claims. Assume that a firm has the following outstanding securities: mortgage bonds, common stock, debentures, and preferred stock. Rank the order in which investors that own mortgage bonds would have their claim paid? A) first B) second C) third D) fourth

: A Diff: 2 Keywords: Insolvency, Mortgage Bonds

: Analytic skills 38) Kinard's Kennels Inc. ROE is 20%. Their dividend payout ratio is 70%. The last dividend, just paid, was $2.00. If dividends are expected to grow by the company's internal growth rate indefinitely, what is the current value of Kinard's common stock if its required return is 18%? A) $17.67 B) $16.89 C) $14.92 D) $11.52

: A Diff: 2 Keywords: Internal Growth Rate, Constant Growth Dividend Valuation Model

: Analytic skills 53) Project Alpha has an internal rate of return (IRR) of 15 percent. Project Beta has an IRR of 14 percent. Both projects have a required return of 12 percent. Which of the following statements is MOST correct? A) Both projects have a positive net present value (NPV). B) Project Alpha must have a higher NPV than Project Beta. C) If the required return were less than 12 percent, Project Beta would have a higher IRR than Project Alpha. D) Project Beta has a higher profitability index than Project Alpha.

: A Diff: 2 Keywords: Internal Rate of Return, Net Present Value, Required Return

: Analytic skills 5) Alice Kitchen's, Inc. bonds have a 10% coupon rate with semiannual coupon payments. They have 12 and 1/2 years to maturity and a par value of $1,000. Compute the value of Alice's bonds if investors' required rate of return is 8%. A) $1,156.22 B) $1,239.33 C) $1,137.10 D) $1,084.44

: A Diff: 2 Keywords: Intrinsic Value, Semiannual Interest

: Reflective thinking skills 8) LRQ Inc. bonds on July 1, 2006. The bonds had a coupon rate of 5.5%, with interest paid semiannually. The face value of the bonds is $1,000 and the bonds mature on July 1, 2021. What is the intrinsic value of an LRQ Corporation bond on July 1, 2012 to an investor with a required return of 7%? A) $901.08 B) $902.27 C) $1,000.00 D) $1,104.28

: A Diff: 2 Keywords: Intrinsic Value, Semiannual Interest, Required Return, Coupon Rate

: Analytic skills 38) Your company has received a $50,000 loan from an industrial finance company. The annual payments are $6,202.70. If the company is paying 9 percent interest per year, how many loan payments must the company make? A) 15 B) 13 C) 12 D) 19

: A Diff: 2 Keywords: Loan Amortization, Loan Payments

: Analytic skills 56) DYI Construction Co. is considering a new inventory system that will cost $750,000. The system is expected to generate positive cash flows over the next four years in the amounts of $350,000 in year one, $325,000 in year two, $150,000 in year three, and $180,000 in year four. DYI's required rate of return is 8%. What is the net present value of this project? A) $104,089 B) $100,328 C) $96,320 D) $87,417

: A Diff: 2 Keywords: Net Present Value

: Analytic skills 79) A machine that costs $1,500,000 has a 3-year life. It will generate after tax annual cash flows of $700,000 at the end of each year. It will be salvaged for $200,000 at the end of year 3. If your required rate of return for the project is 13%, what is the NPV of this investment? A) $291,417 B) $400,000 C) $600,000 D) $338,395

: A Diff: 2 Keywords: Net Present Value

: Analytic skills 83) The advantages of NPV are all of the following EXCEPT A) it can be used as a rough screening device to eliminate those projects whose returns do not materialize until later years. B) it provides the amount by which positive NPV projects will increase the value of the firm. C) it allows the comparison of benefits and costs in a logical manner through the use of time value of money principles. D) it recognizes the timing of the benefits resulting from the project.

: A Diff: 2 Keywords: Net Present Value

: Reflective thinking skills 87) Southeast Compositions, Inc. is considering a project with the following cash flows: Initial Outlay = $126,000 Cash Flows: Year 1 = $44,000 Year 2 = $59,000 Year 3 = $64,000 Compute the net present value of this project if the company's discount rate is 14%. A) -$249,335 B) -$138,561 C) $239,209 D) $725,000

: A Diff: 2 Keywords: Net Present Value

: Reflective thinking skills 51) The capital budgeting manager for XYZ Corporation, a very profitable high technology company, completed her analysis of Project A assuming 5-year depreciation. Her accountant reviews the analysis and changes the depreciation method to 3-year depreciation. This change will A) increase the present value of the NCFs. B) decrease the present value of the NCFs. C) have no effect on the NCFs because depreciation is a non-cash expense. D) only change the NCFs if the useful life of the depreciable asset is greater than 5 years.

: A Diff: 2 Keywords: Net Present Value, Depreciation Expense

: Reflective thinking skills 96) The Net Present Value (or NPV) criteria for capital budgeting decisions assumes that expected future cash flows are reinvested at ________, and the Internal Rate of Return (or IRR) criteria assumes that expected future cash flows are reinvested at ________. A) the firm's discount rate; the internal rate of return B) the internal rate of return; the internal rate of return C) the internal rate of return; the firm's discount rate D) Neither criteria assumes reinvestment of future cash flows.

: A Diff: 2 Keywords: Net Present Value, Internal Rate of Return, Reinvestment Rate

: Analytic skills 24) CrochetCo is considering an investment in a project which would require an initial outlay of $350,000 and produce expected cash flows in years 1-5 of $95,450 per year. You have determined that the current after-tax cost of the firm's capital (required rate of return) for each source of financing is as follows: Cost of Long-Term Debt 7% Cost of Preferred Stock 11% Cost of Common Stock 15% long-term debt currently makes up 25% of the capital structure, preferred stock 15%, and common stock 60%. What is the net present value of this project? A) -$9,306 B) $2,149 C) $5,983 D) $11,568

: A Diff: 2 Keywords: Net Present Value, Weighted Average Cost of Capital

: Reflective thinking skills 32) You are considering buying some stock in Continental Grain. Which of the following are examples of non-diversifiable risks? I. Risk resulting from a general decline in the stock market. II. Risk resulting from a possible increase in income taxes. III. Risk resulting from an explosion in a grain elevator owned by Continental. IV. Risk resulting from a pending lawsuit against Continental. A) I and II B) III and IV C) I only D) II, III, and IV

: A Diff: 2 Keywords: Non-Diversifiable Risk, Systematic Risk

: Reflective thinking skills 32) Optimal capital structure is A) the mix of permanent sources of funds used by the firm in a manner that will maximize the company's common stock price. B) the mix of all items that appear on the right-hand side of the company's balance sheet. C) the mix of funds that will minimize the firm's cost of equity capital. D) the mix of funds that will maximize the firm's interest tax shield.

: A Diff: 2 Keywords: Optimal Capital Structure

: Analytic skills 56) Crandal Dockworks is undergoing a major expansion. The expansion will be financed by issuing new 15-year, $1,000 par, 9% annual coupon bonds. The market price of the bonds is $1,070 each. Crandal's flotation expense on the new bonds will be $50 per bond. Crandal's marginal tax rate is 35%. What is the pre-tax cost of debt for the newly-issued bonds? A) 8.76% B) 8.12% C) 7.49% D) 10.25%

: A Diff: 2 Keywords: Pre-tax Cost of Debt, Flotation Costs

: Analytic skills 14) Glacier Inc. preferred stock has a 5% stated dividend percentage, and a $100 par value. What is the value of the stock if your required rate of return is 6% per year? A) $83.33 B) $94.05 C) $100.00 D) $30.00

: A Diff: 2 Keywords: Preferred Stock Valuation

: Reflective thinking skills 10) Bacon Signs Company preferred stock pays a perpetual annual dividend of 4.5% of its $100 par value. If investors' required rate of return on this stock is 12%, what is the value per share? A) $37.50 B) $31.82 C) $8.50 D) $45.00

: A Diff: 2 Keywords: Preferred Stock Valuation, Perpetual Dividend

: Analytic skills 7) Whistle Corp. has a preferred stock that pays a dividend of $2.40. If you are willing to purchase the stock at $11, what is your required rate of return (round your answer to the nearest .1% and assume that there are no transaction costs)? A) 21.8% B) 11.0% C) 9.1% D) 20.1%

: A Diff: 2 Keywords: Preferred Stock, Required Return

: Analytic skills 25) If you want to have $5,000 in 10 years, how much money must you put in a savings account today? (Assume that the savings account pays 4% and it is compounded daily; round to the nearest $1). A) $3,352 B) $3,370 C) $4,102 D) $4,207

: A Diff: 2 Keywords: Present Value, Daily Compounding

: Analytic skills 26) You want $20,000 in 5 years to take your spouse on a second honeymoon. Your investment account earns 7% compounded semiannually. How much money must you put in the investment account today? (round to the nearest $1). A) $14,178 B) $12,367 C) $15,985 D) $13,349

: A Diff: 2 Keywords: Present Value, Semiannual Compounding

: Analytic skills 104) Your firm is considering an investment that will cost $920,000 today. The investment will produce cash flows of $450,000 in year 1, $270,000 in years 2 through 4, and $200,000 in year 5. The discount rate that your firm uses for projects of this type is 11.25%. What is the investment's profitability index? A) 1.21 B) 1.26 C) 1.43 D) 1.69

: A Diff: 2 Keywords: Profitability Index

: Analytic skills 64) Lithium, Inc. is considering two mutually exclusive projects, A and B. Project A costs $95,000 and is expected to generate $65,000 in year one and $75,000 in year two. Project B costs $120,000 and is expected to generate $64,000 in year one, $67,000 in year two, $56,000 in year three, and $45,000 in year four. Lithium, Inc.'s required rate of return for these projects is 10%. The profitability index for Project A is A) 1.27. B) 1.22. C) 1.17. D) 1.12.

: A Diff: 2 Keywords: Profitability Index

: Analytic skills 65) Lithium, Inc. is considering two mutually exclusive projects, A and B. Project A costs $95,000 and is expected to generate $65,000 in year one and $75,000 in year two. Project B costs $120,000 and is expected to generate $64,000 in year one, $67,000 in year two, $56,000 in year three, and $45,000 in year four. Lithium, Inc.'s required rate of return for these projects is 10%. The profitability index for Project B is A) 1.55. B) 1.48. C) 1.39. D) 1.33.

: A Diff: 2 Keywords: Profitability Index

: Analytic skills 70) Lithium, Inc. is considering two mutually exclusive projects, A and B. Project A costs $95,000 and is expected to generate $65,000 in year one and $75,000 in year two. Project B costs $120,000 and is expected to generate $64,000 in year one, $67,000 in year two, $56,000 in year three, and $45,000 in year four. Lithium, Inc.'s required rate of return for these projects is 10%. Which project would you recommend using the replacement chain method to evaluate the projects with different lives? A) Project B because its NPV is higher than Project A's replacement chain NPV of $47,623 B) Project A because its replacement chain NPV is $76,652, which exceeds the NPV for Project B C) Project A because its replacement chain NPV is $45,642, which is less than the NPV for Project B D) Both projects will be valued the same since they are now both four year projects.

: A Diff: 2 Keywords: Replacement Chain, Net Present Value

: Reflective thinking skills 16) Your firm is considering investing in one of two mutually exclusive projects. Project A requires an initial outlay of $3,500 with expected future cash flows of $2,000 per year for the next three years. Project B requires an initial outlay of $2,500 with expected future cash flows of $1,500 per year for the next two years. The appropriate discount rate for your firm is 12% and it is not subject to capital rationing. Assuming both projects can be replaced with a similar investment at the end of their respective lives, compute the NPV of the two chain cycle for Project A and three chain cycle for Project B. A) $2,232 and $85 B) $5,000 and $1,500 C) $2,865 and $94 D) $3,528 and $136

: A Diff: 2 Keywords: Replacement Chain, Net Present Value, Mutually Exclusive Projects

: Analytic skills 27) You determine that LMN common stock has an expected return of 24%. LMN has a Beta of 1.5. The risk-free rate is 5%, and the market expected return is 15%. Which of the following is most likely to happen? A) You and other investors will buy up LMN stock and its price will rise. B) You and other investors will sell LMN stock and its return will fall. C) You and other investors will buy up LMN stock and its return will rise. D) You and other investors will sell LMN stock and its price will fall.

: A Diff: 2 Keywords: Security Market Line, Required Return, Expected Return

: Analytic skills 24) A financial analyst expects Crane Service Inc. to pay a dividend of $2 per share one year from today, a dividend of $3 per share in years two, and estimates the value of the stock at the end of year two to be $22. If your required return on Crane Service stock is 14 %, what is the most you would be willing to pay for the stock today if you plan to sell the stock in two years? A) $20.99 B) $26.75 C) $26.90 D) $27.00

: A Diff: 2 Keywords: Stock Valuation, Present Value

: Analytic skills 77) A company is expanding and has already signed a lease on new office space that costs $10,000 per month. The company also needs a new information system and hired a consultant to recommend new software. The consultant was paid $5,000 for her recommendation. Now the company is trying to make a choice between three competing software products. In the capital budgeting decision to purchase new software, the monthly rent for the office space is ________ and the consultant's fee is ________. A) a sunk cost; a sunk cost B) an opportunity cost; a sunk cost C) incremental cash outflow; an opportunity cost D) a sunk cost; a part of the initial outlay

: A Diff: 2 Keywords: Sunk Costs

: Analytic skills 39) Which of the following is/are true? A) Most of the unsystematic risk is removed by the time a portfolio contains 30 stocks. B) Two points on the Characteristic Line are the T-bill and the market portfolio. C) The greater the total risk of an asset, the greater the expected return. D) All securities have a beta between 0 and 1.

: A Diff: 2 Keywords: Systematic Risk, Diversification

: Analytic skills 34) Blackjack Inc. wants to replace a 9-year-old machine with a new machine that is more efficient. The old machine cost $70,000 when new and has a current book value of $15,000. Blackjack can sell the machine to a foreign buyer for $14,000. Blackjack's tax rate is 35%. The effect of the sale of the old machine on the initial outlay for the new machine is A) ($14,350). B) ($13,650). C) ($9,100). D) $1,000.

: A Diff: 2 Keywords: Tax Effect, Sale of Old Machine, Book Value

: Reflective thinking skills 4) Your company is considering the replacement of an old delivery van with a new one that is more efficient. The old van cost $40,000 when it was purchased 5 years ago. The old van is being depreciated using the simplified straight-line method over a useful life of 8 years. The old van could be sold today for $7,000. The new van has an invoice price of $80,000, and it will cost $6,000 to modify the van to carry the company's products. Cost savings from use of the new van are expected to be $28,000 per year for 5 years, at which time the van will be sold for its estimated salvage value of $18,000. The new van will be depreciated using the simplified straight-line method over its 5-year useful life. The company's tax rate is 35%. Working capital is expected to increase by $5,000 at the inception of the project, but this amount will be recaptured at the end of year five. What is the tax effect of selling the old machine? A) a savings of $2,800 B) a savings of $2,450 C) additional taxes paid of $2,450 D) a tax savings of $1,400

: A Diff: 2 Keywords: Tax Effect, Sale of Old Machine, Depreciation

: Reflective thinking skills 19) Kohler Manufacturing typically achieves one of three production levels in any given year: 8 million pounds of steel, 10 million pounds of steel, or 16 million pounds of steel. In tracking some of its costs, Kohler's controller discovered one cost that was $10 per pound no matter what the production level for the year. This is an example of a A) variable cost. B) fixed cost. C) semivariable cost. D) semifixed cost.

: A Diff: 2 Keywords: Variable Cost, Variable Cost per Unit

: Reflective thinking skills 17) In 2000 Jenson Inc. issued bonds with an 8 percent coupon rate and a $1,000 face value. The bonds mature on March 1, 2025. If an investor purchased one of these bonds on March 1, 2012, determine the yield to maturity if the investor paid $1,100 for the bond. A) 7% B) The yield to maturity is $900 ($1,000 interest less $100 capital loss). C) The yield to maturity must be greater than 8% because the price paid for the bond exceeds the face value. D) 5.4%

: A Diff: 2 Keywords: Yield to Maturity, Bond Valuation

: Reflective thinking skills 23) While checking the Wall Street Journal bond listings you notice that the price of an AT&T bond is the same as the price of a K-Mart bond. Based on this information you know that A) the bond with the lower coupon rate will have the lower current yield. B) both bonds have the same yield to maturity. C) both bonds will have the same bond rating. D) the bond with the longest time to maturity will have the highest yield to maturity.

: A Diff: 2 Keywords: Yield to Maturity, Intrinsic Value, Current Yield

: Analytic skills 33) Cary's wonderful parents established a college savings plan for him when he was born. They deposited $50 into the account on the last day of each month. The account has earned 10% compounded monthly, tax-free. Now he's off to State U. What equal amount can they withdraw beginning today (his 18th birthday) and each year for three additional years to spend on his education, assuming that the account now earns 7% annually. A) $8,285 B) $8,865 C) $9,486 D) $30,028

: A Diff: 3 Keywords: Annuity, Monthly Compounding, Annuity Payment

: Analytic skills 43) Distant Thunder, Inc. paid a dividend of $5.00 per share on its common stock yesterday. Dividends are expected to grow at a constant rate of 10% for the next two years, at which point the dividends will begin to grow at a constant rate indefinitely. If the stock is selling for $50 today and the required return is 15%, what it the expected annual dividend growth rate after year two? A) 3.365% B) 3.878% C) 4.556% D) 5.000%

: A Diff: 3 Keywords: Constant Growth Dividend Valuation Model

: Reflective thinking skills 9) When using an EPS-EBIT chart to evaluate a pure debt financing and pure equity financing plan A) the debt financing plan line will graph with a steeper slope than the equity financing plan line. B) the debt financing plan line will have a lower level of EBIT at EPS = 0. C) the line of the two financing plans will intersect on the EBIT axis. D) the slope of the equity financing plan line will be steeper than the debt financing plan line below the intersection of the two lines.

: A Diff: 3 Keywords: EPS-EBIT Chart

: Reflective thinking skills 22) Your firm is considering an investment that will cost $920,000 today. The investment will produce cash flows of $450,000 in year 1, $270,000 in years 2 through 4, and $200,000 in year 5. The discount rate that your firm uses for projects of this type is 11.25%. What is the investment's equivalent annual annuity? A) $52,377 B) $42,923 C) $41,387 D) $40,399

: A Diff: 3 Keywords: Equivalent Annual Annuity

: Analytic skills 37) Shackleford Corporation net income this year is $800,000. The company generally retains 35% of net income for reinvestment. The company's common equity currently has a book value of $5,000,000. They just paid a dividend of $1.37, and the required rate of return on this stock is 12%. Compute the value of this stock if dividends are expected to continue growing indefinitely at the company's internal growth rate. A) $22.61 B) $11.42 C) $15.63 D) $4.35

: A Diff: 3 Keywords: Internal Growth Rate, Constant Growth Dividend Valuation Model

: Analytic skills 35) Two bonds are identical except for their maturity. The bonds have a coupon rate that is greater than their yield to maturity. Which of the following is true when comparing the two bonds? A) The longer maturity bond has a greater premium (is priced farther above par). B) The longer maturity bond has a smaller premium (is priced above par but closer to par). C) The longer maturity bond has a greater discount (is priced farther below par). D) The longer maturity bond has a smaller discount (is priced below par but closer to par).

: A Diff: 3 Keywords: Intrinsic Value, Yield to Maturity, Maturity

: Analytic skills 10) One bank offers you 4% interest compounded semiannually. What is the equivalent rate if interest is compounded quarterly? A) 3.98% B) 3.96% C) 3.92% D) 1.00%

: A Diff: 3 Keywords: Semiannual Compounding, Quarterly Compounding, Effective Annual Rate

: Analytic skills 34) You want to invest in bonds. Explain whether or not each provision listed will make the bonds more or less desirable as an investment: call provision, convertible bond provision, subordinated debt

: A call provision makes the bonds less desirable. A call provision protects the issuer in case interest rates drop. Thus, the bonds will only be called if it is advantageous for the issuer and not so for the bondholders. Convertible bonds are more desirable. Bonds may be converted at the option of the bondholder if the value of the stock that may be obtained from conversion is higher than the value of the bonds. Thus, the straight bond value sets a floor and the conversion feature may result in an increase in value above that floor. Subordinated debt is less desirable. Unsubordinated debt gets preference in the event of bankruptcy and liquidation. Diff: 2 Keywords: Call Provision

: Reflective thinking skills 10) I301 Motors has several investment projects under consideration, all with positive net present values. However, due to a shortage of trained personnel, a limit of $1,250,000 has been placed on the capital budget for this year. Which of the projects listed below should be included in this year's capital budget? Explain your answer. Project Initial Outlay NPV A $250,000 $325,000 B 250,000 350,000 C 100,000 700,000 D 375,000 112,500 E 375,000 75,000

: Accept B and C because their combined NPV ($1,050,000) is the greatest of any combination of projects that fit within the capital constraint. Diff: 2 Keywords: Capital Rationing, NPV

: Analytic skills 24) The Meacham Tire Company is considering two mutually exclusive projects with useful lives of 3 and 6 years. The after-tax cash flows for projects S and L are listed below. Year Cash Flow S Cash Flow L 0 -$60,000 -$115,000 1 38,000 28,500 2 25,000 49,500 3 35,000 26,850 4 22,600 5 18,750 6 23,500 The required rate of return on these projects is 14 percent. What decision should be made? As part of your answer, calculate the NPV assuming a replacement chain for Project S, and also calculate the equivalent annual annuity for each project.

: Accept Project S because its replacement chain NPV of $1,999.96 is positive and is greater than the NPV of Project L of $1,237.09. Also, the equivalent annual annuity for Project S is $514.30 while that of Project L is only $318.13. Diff: 2 Keywords: NPV, Replacement Chain, Equivalent Annual Annuity

: Analytic skills 44) JKE, Inc. has a break even sales level of $10,000,000 and has fixed costs of $4,000,000 per year. The selling price per unit is $200. What is the variable cost per unit?

: At break-even S-VC = FC $10,000,000 - VC = $4,000,000 VC = $6,000,000 Number of units sold = $10,000,000/$200 = 50,000 units Variable cost per unit = $6,000,000/50,000 = $120.00 Diff: 2 Keywords: Cost-Volume-Profit Analysis, Break-even Point in Sales, Variable Cost per Unit

: Reflective thinking skills 32) What method is used for calculation of the accounting beta? A) simulation B) regression analysis C) sensitivity analysis D) both A and C

: B Diff: 1 Keywords: Accounting Beta, Regression Analysis

: Reflective thinking skills 37) A stock's beta is a measure of its A) unsystematic risk. B) systematic risk. C) company-unique risk. D) diversifiable risk.

: B Diff: 1 Keywords: Beta, Systematic Risk

: Reflective thinking skills 11) Business risk refers to A) the risk associated with financing a firm with debt. B) the variability of a firm's expected earnings before interest and taxes. C) the uncertainty associated with a firm's CAPM. D) the variability of a firm's stock price.

: B Diff: 1 Keywords: Business Risk

: Reflective thinking skills 9) The four basic determinants of business risk include all of the following EXCEPT A) the stability of the domestic economy. B) the level of fixed cost used in the company's production process. C) sensitivity to the business cycle. D) competitive pressures in the firm's industry.

: B Diff: 1 Keywords: Business Risk

: Reflective thinking skills 36) What is the name given to the equation that financial managers use to measure an investor's required rate of return? A) the standard deviation B) the capital asset pricing model C) the coefficient of variation D) the MIRR

: B Diff: 1 Keywords: CAPM

: Reflective thinking skills 3) A major corporation is considering a capital budgeting project that involves the development of a new technology. The controller estimates the net present value to be negative, yet argues that the company should invest in the project. Which of the following statements is MOST correct? A) The controller should be fired for making such a poor decision. B) The controller may be considering the option to expand or modify the project in the future. C) The profitability index may be greater than one, giving an accept decision. D) Capital rationing may exist for the current year.

: B Diff: 1 Keywords: Capital Budgeting Options

: Analytic skills 3) The expected rate of return on a share of common stock whose dividends are growing at a constant rate (g) is which of the following, where D1 is the next dividend and Vc is the current value of the stock? A) (D1 + g)/Vc B) D1/Vc + g C) D1/g D) D1/g + Vc

: B Diff: 1 Keywords: Constant Growth Dividend Valuation Model, Expected Rate of Return

: Reflective thinking skills 23) Which of the following is the most relevant measure of risk for capital budgeting purposes? A) project standing alone risk B) contribution-to-firm risk C) symbiotic risk D) unsystematic risk

: B Diff: 1 Keywords: Contribution-To-Firm Risk

: Reflective thinking skills 22) If bankruptcy costs and/or shareholder under diversification are an issue, what measure of risk is relevant when evaluating project risk in capital budgeting? A) total project risk B) contribution-to-firm risk C) systematic risk D) capital rationing risk

: B Diff: 1 Keywords: Contribution-To-Firm Risk, Bankruptcy, Diversification

: Reflective thinking skills 23) The Johnson Corporation issues a bond which has a coupon rate of 10.20%, a yield to maturity of 10.55%, a face value of $1,000, and a market price of $850. Therefore, the annual interest payment is A) $101.75. B) $102. C) $105.50. D) $120.0.

: B Diff: 1 Keywords: Coupon Rate, Annual Interest

: Reflective thinking skills 53) Increased depreciation expenses affect tax-related cash flows by A) increasing taxable income, thus increasing taxes. B) decreasing taxable income, thus reducing taxes. C) decreasing taxable income, with no effect on cash flow since depreciation is a non-cash expense. D) pushing a corporation into a higher tax bracket.

: B Diff: 1 Keywords: Depreciation Expense, Tax-Related Cash Flow

: Reflective thinking skills 25) Market efficiency implies which of the following? A) book value = intrinsic value B) market value = intrinsic value C) book value = market value D) liquidation value = book value

: B Diff: 1 Keywords: Efficient Markets, Market Value, Intrinsic Value

: Analytic skills 9) Stock A has the following returns for various states of the economy: State of the Economy Probability Stock A's Return Recession 9% -72% Below Average 16% -15% Average 51% 16% Above Average 14% 35% Boom 10% 85% Stock A's expected return is A) 9.9%. B) 12.7%. C) 13.8%. D) 16.5%.

: B Diff: 1 Keywords: Expected Return

: Reflective thinking skills 31) Due to changes in regulatory requirements, the transactions costs associated with selling corporate securities increased by $1 per share. This change will A) cause the cost of capital to decrease. B) cause the cost of capital to increase. C) have no effect on the cost of capital because transactions costs are expensed immediately. D) cause the cost of capital to decrease only if investors may be billed for part of the increase in transactions costs.

: B Diff: 1 Keywords: Flotation Costs, Cost of Capital

: Analytic skills 31) An example of the growth factor in common stock is A) acquiring a loan to fund an investment in Asia. B) retaining profits in order to reinvest into the firm. C) issuing new stock to provide capital for future growth. D) two strong companies merging together to increase their economy of scale.

: B Diff: 1 Keywords: Growth Rate, Common Stock, Retained Profits

: Analytic skills 63) Incremental cash flows refer to A) the difference between after-tax cash flows and before-tax accounting profits. B) the new cash flows that will be generated if a project is undertaken. C) the cash flows of a project, minus financing costs. D) the cash flows that are foregone if a firm does not undertake a project.

: B Diff: 1 Keywords: Incremental Cash Flows

: Reflective thinking skills 27) Assuming no corporate taxes, the independence hypothesis suggests that a firm's weighted average cost of capital will A) remain constant regardless of capital structure because the cost of debt and the cost of equity are the same. B) remain constant because the cost of equity will be increasing as the amount of debt increases due to the increased risk. C) increase proportionally with the increase in the amount of debt a firm uses. D) decrease proportionally with the increase in the amount of debt a firm uses.

: B Diff: 1 Keywords: Independence Hypothesis, Weighted Average Cost of Capital

: Reflective thinking skills 47) Which of the following cash flows are NOT considered in the calculation of the initial outlay for a capital investment proposal? A) increase in accounts receivable B) cost of issuing new bonds if the project is financed by a new bond issue C) installation costs D) None of the above—all are considered.

: B Diff: 1 Keywords: Initial Outlay, Financing Cash Flows

: Reflective thinking skills 13) Asymmetric Frames Corp had a return on equity of 15%. The corporation's earnings per share was $6.00, its dividend payout ratio was 40% and its profit-retention rate was 60%. If these relationships continue, what will be United Financial Corp's internal growth rate? A) 6.0% B) 8.6% C) 9.0% D) 15.6%

: B Diff: 1 Keywords: Internal Growth Rate, Profit-Retention Rate

: Reflective thinking skills 109) A one-sign-reversal project should be accepted if it A) generates an internal rate of return that is higher than the profitability index. B) produces an internal rate of return that is greater than the firm's discount rate. C) results in an internal rate of return that is above a project's equivalent annual annuity. D) results in a modified internal rate of return that is higher than the internal rate of return.

: B Diff: 1 Keywords: Internal Rate of Return

: Reflective thinking skills 10) Which of the following statements concerning junk bonds is MOST correct? A) A rational investor will always prefer a AAA-rated bond to a junk bond. B) Junk bonds have higher interest rates than AAA-rated bonds because of the higher risk. C) Junk bonds may also be called low-yielding securities. D) Junk bonds are priced higher than AAA-rated bonds because junk bonds are more risky.

: B Diff: 1 Keywords: Junk Bonds

: Analytic skills 31) Advantages of using simulation include A) adjustment for risk in the resulting distribution of net present values. B) a range of possible outcomes presented. C) is good only for single period investments since discounting is not possible. D) graphically displays all possible outcomes of the investment.

: B Diff: 1 Keywords: Keywords: Simulation

: Analytic skills 43) The average cost associated with each additional dollar of financing for investment projects is A) the incremental return. B) the marginal cost of capital. C) CAPM required return. D) the component cost of capital.

: B Diff: 1 Keywords: Marginal Cost of Capital

: Analytic skills 14) Changes in the general economy, like changes in interest rates or tax laws represent what type of risk? A) company-unique risk B) market risk C) unsystematic risk D) diversifiable risk

: B Diff: 1 Keywords: Market Risk

: Reflective thinking skills 73) Arguments against using the net present value and internal rate of return methods include that A) they fail to use accounting profits. B) they require detailed long-term forecasts of the incremental benefits and costs. C) they fail to consider how the investment project is to be financed. D) they fail to use the cash flow of the project.

: B Diff: 1 Keywords: Net Present Value, Internal Rate of Return

: Analytic skills 39) Smith Manufacturing Inc. expects the following results in year one of a new project: Revenue $400,000 Cash Expenses 150,000 Depreciation 90,000 EBIT $160,000 Taxes 48,000 Net Income $112,000 The annual change in operating cash flow is equal to A) $298,000. B) $202,000. C) $160,000. D) $250,000.

: B Diff: 1 Keywords: Operating Cash Flow

: Reflective thinking skills 33) Which of the following statements about operating leverage is true? A) Operating leverage reduces a firm's risk. B) Operating leverage is the responsiveness of the firm's EBIT to fluctuations in sales. C) Operating leverage involves the usage of fixed cost financial securities in the operation of a business. D) Operating leverage is the responsiveness of the firm's EPS to fluctuations in sales.

: B Diff: 1 Keywords: Operating Leverage

: Analytic skills 24) Amalgamated Mining, Inc. has very high operating leverage due to the capital intensive nature of the steel business. The firm's CEO is concerned about the variability in the firm's EPS if sales should drop, and decides to take action. Which of the following will reduce the variability in the firm's EPS for a given change in sales? A) The CEO may increase the firm's financial leverage and hence reduce the variability by using non-shareholder money to support the business. B) The CEO may decrease the firm's financial leverage, thus lowering the firm's total leverage. C) The CEO may increase the firm's total leverage by raising money from the sale of common stock. D) The CEO may issue more corporate bonds and use the proceeds to pay off short-term liabilities.

: B Diff: 1 Keywords: Operating Leverage, Financial Leverage, Total Leverage

: Reflective thinking skills 32) AFB Systems is considering a new marketing campaign that will require the addition of a new computer programmer and new software. The programmer will occupy an office in AFB's current building and will be paid $8,000 per month. The software license costs $1,000 per month. The rent for the building is $4,000 per month. AFB's computer system is always on, so running the new software will not change the current monthly electric bill of $900. The incremental expenses for the new marketing campaign are A) $13,900 per month. B) $9,000 per month. C) $13,000 per month. D) $8,000 per month.

: B Diff: 1 Keywords: Overhead Costs, Incremental Expenses

: Reflective thinking skills 18) Preferred stock is similar to a bond in the following way A) preferred stock always contains a maturity date. B) both investments provide a stated income stream. C) both contain a growth factor similar to common stock. D) both provide interest payments.

: B Diff: 1 Keywords: Preferred Stock, Bonds

: Reflective thinking skills 21) Most preferred stocks have a feature that requires all past unpaid preferred dividend payments be paid before any common stock dividends can be paid. What is the name of this feature? A) participating B) cumulative C) provisional D) convertible

: B Diff: 1 Keywords: Preferred Stock, Cumulative, Dividends

: Reflective thinking skills 17) Preferred stock valuation usually treats the preferred stock as a A) capital asset. B) perpetuity. C) common stock. D) long-term bond.

: B Diff: 1 Keywords: Preferred Stock, Perpetuity

: Analytic skills 17) Your daughter is born today and you want her to be a millionaire by the time she is 40 years old. open an investment account that promises to pay 11.5% per year. How much money must you deposit today so your daughter will have $1,000,000 by her 35th birthday? A) $28,575 B) $22,150 C) $20,100 D) $18,940

: B Diff: 1 Keywords: Present Value

: Reflective thinking skills 19) If a shareholder cannot attend the corporation's annual meeting, the shares may still be voted using A) the preemptive right. B) a proxy. C) majority voting rules. D) the cumulative voting right.

: B Diff: 1 Keywords: Proxy

: Reflective thinking skills 20) A small biotechnology research corporation has been experiencing losses for the first three years of its existence, and thus has a negative balance in retained earnings. The corporation's stock price, however, is $1 per share. Which of the following statements is MOST correct? A) Investors are irrational to pay $1 per share when earnings per share have been negative for three years. B) Investors believe the stock is worth $1 per share because future earnings (and cash flows) are expected to be positive. C) The corporation's accountants must have made a mistake because retained earnings may not be negative. D) The required return on the stock will be small because the company has very few assets.

: B Diff: 1 Keywords: Required Return, Retained Earnings

: Reflective thinking skills 25) A bakery company is considering one capital budgeting project involving the replacement of a sophisticated brick oven, and another capital budgeting project involving research and development into synthetic food substitutes. Which of the following statements is MOST correct concerning the risk-adjusted discount rate(s) for the projects? A) The rate will likely be higher for the replacement project because the likelihood of success is higher. B) The rate will likely be higher for the research and development project because of the uncertainty involved with research and development projects. C) The rate should be the same for both projects because they are being considered by one company with the same common shareholders. D) The rate should be higher for the replacement project because the company is more certain of the returns from a project similar to their existing business.

: B Diff: 1 Keywords: Risk-Adjusted Discount Rate

: Reflective thinking skills 22) Tillamook Farms invests in a new kind of frozen dessert called polar cream that becomes very popular. So many new customers come to the store that the sales of existing ice cream products are increased. The extra sales revenue A) should not be counted as incremental revenue for the polar cream project because the sales come from existing products. B) are synergistic effects that should be counted as incremental revenues for the polar cream project. C) are cannibalized sales that should be excluded from the analysis. D) should be included in the analysis, but not the cost of the ice cream that is sold as that is a recurring expense.

: B Diff: 1 Keywords: Synergistic Effects, Incremental Revenues

: Analytic skills 20) WineCellars Inc. currently has a weighted average cost of capital of 12%. WineCellars has been growing rapidly over the past several years, selling common stock in each year to finance its growth. However, due to difficult economic times this year, WineCellars decides to cut its dividend and increase its retained earnings so that the common equity portion of its capital structure will include only retained earnings and no new common stock will be sold. WineCellars weighted average cost of capital this year should be A) zero, since no new stock will be sold. B) less than 12%. C) equal to 12%. D) greater than 12%.

: B Diff: 1 Keywords: Weighted Average Cost of Capital

: Reflective thinking skills 29) Which of the following should NOT be considered when calculating a firm's WACC? A) after-tax YTM on a firm's bonds B) after-tax cost of accounts payable C) cost of newly issued preferred stock D) cost of newly issued common stock

: B Diff: 1 Keywords: Weighted Average Cost of Capital

: Reflective thinking skills 16) The yield to maturity on a bond is the rate of return that equates the present value of the bond's future cash flows with the bond's A) face value. B) market value. C) liquidation value. D) book value.

: B Diff: 1 Keywords: Yield to Maturity

: Analytic skills 51) A six-year project for Little Egypt, Inc. results in additional accounts receivable of $150,000, additional inventory of $50,000, and additional accounts payable of $80,000 today. What is the change in the NPV of a project solely due to the additional net working capital (NWC) needs? Assume a 14% discount rate, and the recovery of net working capital at the end of the project. A) a decrease of $34,606 B) a decrease of $42,670 C) a decrease of $120,000 D) a decrease of $58,689

: B Diff: 2 Keywords: Additional Net Working Capital, NPV

: Analytic skills 72) Waterford Industries is considering the purchase of a new machine. It will replace an existing but obsolete machine that will be sold for $50,000. The existing machine is 8 years old, cost $200,000, had a 10-year useful life, and is being depreciated to zero using the straight-line method. Waterford's income tax rate is 35%. What is the after-tax salvage value of the old machine? A) $42,000 B) $46,500 C) $50,000 D) $53,500

: B Diff: 2 Keywords: After-Tax Salvage Value, Depreciation

: Analytic skills 13) Mountain Retreat and Resort is undergoing a major expansion. The expansion will be financed by issuing new 15-year, $1,000 par, 9% annual coupon bonds. The market price of the bonds is $1,070 each. The firm's flotation expense on the new bonds will be $50 per bond. The firm's marginal tax rate is 35%. What is the relevant cost of the new bonds for capital budgeting purposes? A) 5.14% B) 5.69% C) 8.45% D) 4.82%

: B Diff: 2 Keywords: After-tax Cost of Debt

: Analytic skills 6) TC, Inc. has $15 million of outstanding bonds with a coupon rate of 10 percent. The yield to maturity on these bonds is 12.5 percent. If the firm's tax rate is 30 percent, what is relevant cost of debt financing to Kendall, Inc.? A) 13.75 percent B) 8.75 percent C) 7.00 percent D) 3.75 percent

: B Diff: 2 Keywords: After-tax Cost of Debt, Yield to Maturity

: Analytic skills 34) You discover an antique in your attic that you purchased at an estate sale 10 years ago for $400. You auction it on eBay and receive $8,000 for your item. What annual rate of return did you earn? A) 200.00% B) 34.93% C) 30.47% D) 20.00%

: B Diff: 2 Keywords: Annual Rate of Return

: Reflective thinking skills 10) If the Beta for stock A equals zero, then A) stock A's required return is equal to the required return on the market portfolio. B) stock A's required return is equal to the risk-free rate of return. C) stock A has a guaranteed return. D) stock A's required return is greater than the required return on the market portfolio.

: B Diff: 2 Keywords: Beta, Required Rate of Return, Security Market Line

: Analytic skills 13) Stock A has a beta of 1.2 and a standard deviation of returns of 14%. Stock B has a beta of 1.8 and a standard deviation of returns of 18%. If the risk-free rate of return increases and the market risk premium remains constant, then A) the required return on stock B will increase more than the required return on stock A. B) the required returns on stocks A and B will both increase by the same amount. C) the required returns on stocks A and B will not change. D) the required return on stock A will increase more than the required return on stock B.

: B Diff: 2 Keywords: Beta, Security Market Line, Market Risk Premium, Risk-free Rate of Return

: Analytic skills 28) Potential applications of the break-even model include A) replacement for time-adjusted capital budgeting techniques. B) pricing policy. C) optimizing the cash-marketable securities position of a firm. D) all of the above.

: B Diff: 2 Keywords: Break-even Model, Pricing Policy

: Analytic skills 23) HomeCraft makes wooden play sets. The company pays annual rent of $400,000 per year and pays administrative salaries totaling $150,000 per year. Each play set requires $400 of wood, ten hours of labor at $70 per hour, and variable overhead costs of $100. Fixed advertising expenses equal $100,000 per year. Each play set sells for $3,200. What is Homecraft's break-even output level? A) 340 play sets B) 325 play sets C) 297 play sets D) 258 play sets

: B Diff: 2 Keywords: Break-even Output, Variable Costs, Fixed Costs

: Analytic skills 33) The break-even point in sales dollars is convenient if A) the firm sells a large amount of one product. B) the firm deals with more than one product. C) the price per unit is very low. D) depreciation expense is high.

: B Diff: 2 Keywords: Break-even Point in Sales Dollars

: Analytic skills 32) Rogue Tire Masters has fixed costs of $220,000. Tires sell for $95 each and have a unit variable cost of $45. What is Rogue's break-even point in units? A) 4,000 B) 4,400 C) 5,200 D) 5,500

: B Diff: 2 Keywords: Break-even Units

: Reflective thinking skills 8) The capital asset pricing model A) provides a risk-return trade off in which risk is measured in terms of the market volatility. B) provides a risk-return trade off in which risk is measured in terms of beta. C) measures risk as the coefficient of variation between security and market rates of return. D) depicts the total risk of a security.

: B Diff: 2 Keywords: Capital Asset Pricing Model, Beta, Risk-Return Trade Off

: Reflective thinking skills 29) One component of a firm's financial structure which is NOT a component of its capital structure is A) common stock. B) accounts payable. C) long-term debt. D) preferred stock.

: B Diff: 2 Keywords: Capital Structure, Financial Structure

: Analytic skills 41) If you expect NoDiv Corporation to sell for $75 per share in three years while paying no dividends along the way, and if your required rate of return is 16% per year, how much is the stock worth today? A) $42.68 B) $48.05 C) $51.10 D) $74.64

: B Diff: 2 Keywords: Common Stock Valuation, Present Value

: Analytic skills 34) Bensen Co. paid a dividend of $5.25 on its common stock yesterday. The company's dividends are expected to grow at a constant rate of 8.5% indefinitely. The required rate of return on this stock is 15.5%. You observe a market price of $78.50 for the stock. Should you purchase this stock? A) No, the market price is above the intrinsic value of the stock. B) Yes, the market price is below the intrinsic value of the stock. C) No, the growth rate in dividends is too far below the required return. D) Yes, but only if you can keep the stock for at least 5 years.

: B Diff: 2 Keywords: Constant Growth Dividend Valuation Model

: Analytic skills 45) Shasta Co. just paid a dividend of $1.65 (D0) on its common stock. This company's dividends are expected to grow at a constant rate of 3% indefinitely. If the required rate of return on this stock is 11%, compute the current value per share of Shasta stock. A) $20.63 B) $21.24 C) $15.00 D) $55.00

: B Diff: 2 Keywords: Constant Growth Dividend Valuation Model

: Reflective thinking skills 23) Nogrowth Corporation expects their dividend to stay at $0.50 per share each year into the foreseeable future. Therefore A) the stock will be valued at $0.50 times the number of years an investor plans to keep it. B) the value of the stock can be estimated as $0.50 divided by an investor's required rate of return. C) the value of the stock can not be determined using the dividend valuation model because the growth rate is zero. D) the value of the stock is positive only if the required return is negative.

: B Diff: 2 Keywords: Constant Growth Dividend Valuation Model

: Reflective thinking skills 16) Other things being equal, investors will value which of the following bonds the highest? A) callable bonds B) convertible bonds C) bonds that are both callable and convertible D) unsecured, callable bonds

: B Diff: 2 Keywords: Convertible Bonds, Callable Bonds

: Analytic skills 32) Adventure Outfitter Corp. can sell common stock for $27 per share and its investors require a 17% return. However, the administrative or flotation costs associated with selling the stock amount to $2.70 per share. What is the cost of capital for Adventure Outfitter if the corporation raises money by selling common stock? A) 27.00% B) 18.89% C) 18.33% D) 17.00%

: B Diff: 2 Keywords: Cost of Capital, Flotation Costs

: Analytic skills 40) Johnson Production Company paid a dividend yesterday of $3.50 per share. The dividend is expected to grow at a constant rate of 10% per year. The price of KayCee's common stock today is $40 per share. If KayCee decides to issue new common stock, flotation costs will equal $4.00 per share. KayCee's marginal tax rate is 35%. Based on the above information, the cost of new common stock is A) 26.41%. B) 20.09%. C) 19.63%. D) 17.55%.

: B Diff: 2 Keywords: Cost of New Common Stock, Flotation Costs

: Analytic skills 38) A company has preferred stock with a current market price of $18 per share. The preferred stock pays an annual dividend of 4% based on a par value of $100. Flotation costs associated with the sale of preferred stock equal $1.50 per share. The company's marginal tax rate is 40%. Therefore, the cost of preferred stock is A) 28.80%. B) 24.24%. C) 22.22%. D) 14.55%.

: B Diff: 2 Keywords: Cost of Preferred Stock, Net Proceeds, Flotation Costs

: Reflective thinking skills 55) Trinitron, Inc. purchased a new molding machine for $85,000. The company paid $8,000 for shipping and another $7,000 to get the machine integrated with the company's existing assets. Trinitron must maintain a supply of special lubricating oil just in case the machine breaks down. The company purchased a supply of oil for $4,000. The machine is to be depreciated on a straight-line basis over its expected useful life of 8 years. What will depreciation expense be during the first year? A) $13,000 B) $12,500 C) $11,625 D) $11,500

: B Diff: 2 Keywords: Depreciation Expense

: Reflective thinking skills 99) Your firm is considering an investment that will cost $750,000 today. The investment will produce cash flows of $250,000 in year 1, $300,000 in years 2 through 4, and $100,000 in year 5. What is the investment's discounted payback period if the required rate of return is 10%? A) 3.33 years B) 3.16 years C) 2.67 years D) 2.33 years

: B Diff: 2 Keywords: Discounted Payback Period

: Reflective thinking skills 26) Which of the following statements is MOST correct concerning diversification and risk? A) Diversification is mainly achieved by the selection of individual securities for each type of asset held in a portfolio. B) Diversification is mainly achieved by the asset allocation decision, not the selection of individual securities within each asset category. C) Large company stocks and small company stocks together in a portfolio lead to dramatic reductions in risk because their returns are negatively correlated. D) Asset allocation is important for pension funds but not for individual investors.

: B Diff: 2 Keywords: Diversification, Asset Allocation, Risk

: Analytic skills 40) Waterfront Solutions, Inc. paid a dividend of $5.00 per share on its common stock yesterday. Dividends are expected to grow at a constant rate of 4% for the next two years, at which point the stock is expected to sell for $56.00. If investors require a rate of return on Waterfront's common stock of 18%, what should the stock sell for today? A) $50.22 B) $48.51 C) $44.76 D) $40.22

: B Diff: 2 Keywords: Dividend Valuation Model

: Reflective thinking skills 47) Castle, Inc. paid a dividend yesterday of $2 per share. Castle management expects the dividend to increase next year to $3 annually. If the dividend is expected to stay at $3 per year for the foreseeable future, what is the value of the stock to an investor with a required rate of return of 10%? A) $7.50 B) $30.00 C) $32.00 D) $50.00

: B Diff: 2 Keywords: Dividend Valuation Model, Zero Growth

: Analytic skills 17) Determine the five-year equivalent annual annuity of the following project if the appropriate discount rate is 16%: Initial Outflow = $150,000 Cash Flow Year 1 = $40,000 Cash Flow Year 2 = $90,000 Cash Flow Year 3 = $60,000 Cash Flow Year 4 = $0 Cash Flow Year 5 = $80,000 A) $7,058 B) $8,520 C) $9,454 D) $9,872

: B Diff: 2 Keywords: Equivalent Annual Annuity

: Reflective thinking skills 71) Lithium, Inc. is considering two mutually exclusive projects, A and B. Project A costs $95,000 and is expected to generate $65,000 in year one and $75,000 in year two. Project B costs $120,000 and is expected to generate $64,000 in year one, $67,000 in year two, $56,000 in year three, and $45,000 in year four. Lithium, Inc.'s required rate of return for these projects is 10%. The equivalent annual annuity amount for project B, rounded to the nearest dollar, is A) $17,385. B) $20,936. C) $22,789. D) $26,551.

: B Diff: 2 Keywords: Equivalent Annual Annuity

: Analytic skills 29) What is the expected rate of return on a bond that matures in 5 years, has a par value of $1,000, a coupon rate of 11.5%, and is currently selling for $982? Assume annual coupon payments. A) 12.5% B) 12.0% C) 12.7% D) 13.4%

: B Diff: 2 Keywords: Expected Rate of Return, Yield to Maturity

: Analytic skills 9) Assume that you have $330,000 invested in a stock that is returning 11.50%, $170,000 invested in a stock that is returning 22.75%, and $470,000 invested in a stock that is returning 10.25%. What is the expected return of your portfolio? A) 15.6% B) 12.9% C) 18.3% D) 14.8%

: B Diff: 2 Keywords: Expected Return, Portfolio

: Analytic skills 8) Which of the following investments is clearly preferred to the others for an investor who is not holding a well-diversified portfolio? Investment σ A 18% 20% B 20% 20% C 20% 22% A) Investment A B) Investment B C) Investment C D) Cannot be determined without information regarding the risk-free rate of return.

: B Diff: 2 Keywords: Expected Return, Standard Deviation, Risk-Return Trade Off

: Analytic skills 21) Dakota Oil, Inc. reported that its sales and EBIT increased by 10%, but its EPS increased by 30%. The much larger change in earnings per share could be the result of A) high operating leverage. B) high financial leverage. C) a high percentage of credit sale collections from prior years. D) high fixed costs of production.

: B Diff: 2 Keywords: Financial Leverage, Operating Leverage

: Analytic skills 23) You decide you want your child to be a millionaire. You have a son today and you deposit $10,000 in an investment account that earns 7% per year. The money in the account will be distributed to your son whenever the total reaches $1,500,000. How old will your son be when he gets the money (rounded to the nearest year)? A) 82 years B) 74 years C) 60 years D) 49 years

: B Diff: 2 Keywords: Future Value

: Analytic skills 45) If you put $200 in a savings account at the beginning of each year for 10 years and then allow the account to compound for an additional 10 years, how much will be in the account at the end of the 20th year? Assume that the account earns 10% and round to the nearest $100. A) $8,300 B) $9,100 C) $8,900 D) $9,700

: B Diff: 2 Keywords: Future Value, Annuity, Single Sum

: Analytic skills 30) If Cathy deposits $12,000 into a bank account that pays 6% interest compounded quarterly, what will the account balance be in seven years? A) 18,001 B) 18,207 C) 19,112 D) 19,344

: B Diff: 2 Keywords: Future Value, Quarterly Compounding

: Analytic skills 74) Propell Inc. is considering the purchase of a new machine that will cost $178,000, plus an additional $12,000 to ship and install. The new machine will have a 5-year useful life and will be depreciated using the straight-line method. The machine is expected to generate new sales of $85,000 per year and is expected to increase operating costs by $10,000 annually. Propell's income tax rate is 40%. What is the projected incremental cash flow of the machine for year 1? A) $54,800 B) $60,200 C) $66,350 D) $68,200

: B Diff: 2 Keywords: Incremental Cash Flows, Depreciation Expense

: Analytic skills 62) QRW Corp. needs to replace an old lathe with a new, more efficient model. The old lathe was purchased for $50,000 nine years ago and has a current book value of $5,000. (The old machine is being depreciated on a straight-line basis over a ten-year useful life.) The new lathe costs $100,000. It will cost the company $10,000 to get the new lathe to the factory and get it installed. The old machine will be sold as scrap metal for $2,000. The new machine is also being depreciated on a straight-line basis over ten years. Sales are expected to increase by $8,000 per year while operating expenses are expected to decrease by $12,000 per year. QRW's marginal tax rate is 40%. Additional working capital of $3,000 is required to maintain the new machine and higher sales level. The new lathe is expected to be sold for $5,000 at the end of the project's ten-year life. What is the incremental free cash flow during year 1 of the project? A) $12,800 B) $14,400 C) $11,400 D) $15,200

: B Diff: 2 Keywords: Incremental Free Cash Flows

: Analytic skills 56) Trinitron, Inc. purchased a new molding machine for $85,000. The company paid $8,000 for shipping and another $7,000 to get the machine integrated with the company's existing assets. Trinitron, Inc. must maintain a supply of special lubricating oil just in case the machine breaks down. The company purchased a supply of oil for $4,000. The machine is to be depreciated on a straight-line basis over its expected useful life of 8 years. Trinitron is replacing an old machine that was purchased 6 years ago for $50,000. The old machine was being depreciated on a straight-line basis over a ten year expected useful life. The machine was sold for $15,000. Trinitron's marginal tax rate is 40%. What is the amount of the initial outlay? A) $89,000 B) $87,000 C) $91,000 D) $85,000

: B Diff: 2 Keywords: Initial Outlay

: Analytic skills 9) Which of the following statements is true? A) Short-term bonds have greater interest rate risk than do long-term bonds. B) Long-term bonds have greater interest rate risk than do short-term bonds. C) All bonds have equal interest rate risk. D) Interest rate risk is highest during periods of high interest rates.

: B Diff: 2 Keywords: Interest Rate Risk

: Reflective thinking skills 2) Suppose interest rates have been at historically low levels the past two years. A reasonable strategy for bond investors during this time period would be to A) invest in long-term bonds to reduce interest rate risk. B) invest in short-term bonds to reduce interest rate risk. C) buy only junk bonds which have higher interest rates. D) invest in long-term bonds to lock in a bond position for when interest rates increase in the future.

: B Diff: 2 Keywords: Interest Rate Risk, Bond Valuation

: Analytic skills 28) Biff deposited $9,000 in a bank account, and 10 years later he closes out the account, which is worth $18,000. What annual rate of interest has he earned over the 10 years? A) 6.45% B) 7.18% C) 9.10% D) 10.0%

: B Diff: 2 Keywords: Interest Rates, Time Value of Money

: Analytic skills 66) Lithium, Inc. is considering two mutually exclusive projects, A and B. Project A costs $95,000 and is expected to generate $65,000 in year one and $75,000 in year two. Project B costs $120,000 and is expected to generate $64,000 in year one, $67,000 in year two, $56,000 in year three, and $45,000 in year four. Lithium, Inc.'s required rate of return for these projects is 10%. The internal rate of return for Project A is A) 31.43%. B) 29.42%. C) 25.88%. D) 19.45%.

: B Diff: 2 Keywords: Internal Rate of Return

: Analytic skills 78) Given the following annual net cash flows, determine the internal rate of return to the nearest whole percent of a project with an initial outlay of $750,000. Year Net Cash Flow 1 $500,000 2 $150,000 3 $250,000 A) 9% B) 11% C) 13% D) 15%

: B Diff: 2 Keywords: Internal Rate of Return

: Analytic skills 94) You are considering investing in a project with the following year-end after-tax cash flows: Year 1: $57,000 Year 2: $72,000 Year 3: $78,000 If the initial outlay for the project is $185,000, compute the project's internal rate of return. A) 3.98% B) 5.54% C) 11.89% D) 14.74%

: B Diff: 2 Keywords: Internal Rate of Return

: Reflective thinking skills 85) The internal rate of return is A) the discount rate that makes the NPV positive. B) the discount rate that equates the present value of the cash inflows with the present value of the cash outflows. C) the discount rate that makes NPV negative and the PI greater than one. D) the rate of return that makes the NPV positive.

: B Diff: 2 Keywords: Internal Rate of Return

: Analytic skills 55) Jimmy just bought a new Ford SUV for his business. The price of the vehicle was $40,000. Jimmy made a $5,000 down payment and took out an amortized loan for the rest. The car dealership made the loan at 8% interest compounded monthly for five years. He is to pay back the principal and interest in equal monthly installments beginning one month from now. Determine the amount of Jimmy's monthly payment. A) $634.56 B) $709.67 C) $745.87 D) $809.33

: B Diff: 2 Keywords: Loan Amortization, Monthly Payment, Annuity

: Analytic skills 15) Your company is considering an investment in one of two mutually exclusive projects. Project one involves a labor intensive production process. Initial outlay for Project 1 is $1,495 with expected after tax cash flows of $500 per year in years 1-5. Project two involves a capital intensive process, requiring an initial outlay of $6,704. After tax cash flows for Project 2 are expected to be $2,000 per year for years 1-5. Your firm's discount rate is 10%. If your company is not subject to capital rationing, which project(s) should you take on? A) Project 1 B) Project 2 C) Projects 1 and 2 D) Neither project is acceptable.

: B Diff: 2 Keywords: Mutually Exclusive Projects, Net Present Value

: Analytic skills 63) Lithium, Inc. is considering two mutually exclusive projects, A and B. Project A costs $95,000 and is expected to generate $65,000 in year one and $75,000 in year two. Project B costs $120,000 and is expected to generate $64,000 in year one, $67,000 in year two, $56,000 in year three, and $45,000 in year four. Lithium, Inc.'s required rate of return for these projects is 10%. The net present value for Project B is A) $58,097. B) $66,363. C) $74,538. D) $112,000.

: B Diff: 2 Keywords: Net Present Value

: Analytic skills 93) If the NPV (Net Present Value) of a project with one sign reversal is positive, then the project's IRR (Internal Rate of Return) ________ the required rate of return. A) must be less than B) must be greater than C) could be greater or less than D) cannot be determined without actual cash flows

: B Diff: 2 Keywords: Net Present Value, Internal Rate of Return

: Analytic skills 59) Project LMK requires an initial outlay of $400,000 and has a profitability index of 1.5. The project is expected to generate equal annual cash flows over the next twelve years. The required return for this project is 20%. What is project LMK's net present value? A) $600,000 B) $150,000 C) $120,000 D) $80,000

: B Diff: 2 Keywords: Net Present Value, Profitability Index

: Reflective thinking skills 49) XYZ, Inc. has developed a project which results in additional accounts receivable of $400,000, additional inventory of $180,000, and additional accounts payable of $70,000. What is the additional investment in net working capital? A) $580,000 B) $510,000 C) $270,000 D) $150,000

: B Diff: 2 Keywords: Net Working Capital

: Reflective thinking skills 31) If a firm has no operating leverage and no financial leverage, then a 10% increase in sales will have what effect on EPS? A) EPS will remain the same. B) EPS will increase by 10%. C) EPS will decrease by 10%. D) EPS will increase by less than 10%.

: B Diff: 2 Keywords: Operating Leverage, Financial Leverage, Combined Leverage, EPS

: Reflective thinking skills 28) Which of the following statements is MOST correct concerning a corporation's optimal capital structure? A) The optimal capital structure maximizes the present value of the interest tax shield. B) The optimal capital structure occurs at the point where the market value of the levered firm is maximized. C) The optimal capital structure minimizes the present value of financial distress costs and agency costs. D) The optimal capital structure occurs where the present value of the interest tax shield equals the present value of the firm's bankruptcy costs.

: B Diff: 2 Keywords: Optimal Capital Structure, Interest Tax Shield, Financial Distress Costs, Agency Costs

: Reflective thinking skills 27) A 65 year-old man is retiring and can take either $500,000 in cash or an ordinary annuity that promises to pay him $50,000 per year for as long as he lives. Which of the following statements is MOST correct? A) Because of the time value of money, the man will always be better off taking the $500,000 up front. B) The higher the interest rate, the more likely the man will prefer the $500,000 lump sum. C) If the man expects to live more than 10 years, then he will prefer the annuity. D) If the man is certain the company will not default on its future payments, he should select the $50,000 per year.

: B Diff: 2 Keywords: Ordinary Annuity

: Analytic skills 12) Studio 55, Inc. has an issue of preferred stock that pays a dividend of $4.00. The preferred stockholders require a rate of return on this stock of 9%. At what price should the preferred stock sell for? Round off to the nearest $0.10. A) $36.00 B) $44.40 C) $62.50 D) $88.80

: B Diff: 2 Keywords: Preferred Stock Valuation

: Analytic skills 27) TellTrue Corporation has preferred stock which paid an annual dividend in 2009 of $5 per share. TellTrue also has common stock which paid a dividend in 2009 of $5. Which of the following statements is MOST correct concerning TellTrue stock? A) The price of the preferred stock should equal the price of the common stock since the dividends are the same. B) The price of the common stock could be higher than the price of the preferred stock if the common stock dividends are expected to grow in the future. C) The price of the preferred stock is expected to be higher than the price of the common stock because the required return on preferred stock is higher than the required return on common stock. D) If the required return on the preferred stock is the same as the required return on the common stock, then the price of preferred stock should equal the price of the common stock if markets are efficient.

: B Diff: 2 Keywords: Preferred Stock Valuation, Common Stock Valuation

: Reflective thinking skills 22) How is preferred stock similar to common stock? A) Preferred dividend payments usually have unlimited growth potential. B) Investors cannot sue a corporation for the non-payment of dividends. C) Both preferred and common stockholders have voting control of a firm. D) Preferred stock dividends and common stock dividends are fixed.

: B Diff: 2 Keywords: Preferred Stock, Common Stock

: Reflective thinking skills 4) You have a savings bond that will be worth $750 when it matures in 3 years, but you need cash today. If the current going rate of interest is 5%, what is your bond worth if you sell it today (rounded to the nearest dollar)? A) $675 B) $648 C) $625 D) $612

: B Diff: 2 Keywords: Present Value, Bond

: Analytic skills 28) If you want to have 1$2,500 in 57 months, how much money must you put in a savings account today? Assume that the savings account pays 4.5% and it is compounded quarterly (round to nearest $1). A) $8,459 B) $10,106 C) $10,387 D) $11,129

: B Diff: 2 Keywords: Present Value, Quarterly Compounding

: Analytic skills 9) An investment is expected to yield $300 in three years, $500 in five years, and $300 in seven years. What is the present value of this investment if our opportunity rate is 5%? A) $735 B) $864 C) $885 D) $900

: B Diff: 2 Keywords: Present Value, Uneven Cash Flows

: Analytic skills 30) Marble Corp. has a beta of 2.5 and a standard deviation of returns of 20%. The return on the market portfolio is 15% and the risk free rate is 4%. According to CAPM, what is the required rate of return on Collectible's stock? A) 37.5% B) 31.5% C) 26.5% D) 23.5%

: B Diff: 2 Keywords: Security Market Line, Beta, Required Rate of Return

: Reflective thinking skills 15) Put the following in order of their claim on assets of a firm, starting with the LAST to have a claim: A. Subordinated debentures B. Debentures (unsubordinated) C. Common Stock D. Preferred stock A) C, B, A, D B) C, D, A, B C) B, A, C, D D) D, C, B, A E) D, C, A, B

: B Diff: 2 Keywords: Subordinated Debentures, Debentures, Common Stock, Preferred Stock

: Analytic skills 78) As part of its expansion project, A.J. Industries Equipment Division has expanded its office space by 200 square feet. The company's administrative overhead is allocated based on the square footage of each business segment. Although the total administrative overhead for the company will remain the same, the Equipment Division will be charged more for administrative overhead. For the Equipment Division expansion project, the administrative overhead is an example of a(n) A) incremental cash flow. B) sunk cost. C) opportunity cost. D) incremental opportunity cash flow.

: B Diff: 2 Keywords: Sunk Costs, Overhead, Incremental Cash Flow

: Reflective thinking skills 35) A well-diversified portfolio includes investments in 50 securities. The portfolio's systematic risk is likely to be about A) 50% of the total risk. B) 40% of the total risk. C) 25% of the total risk. D) zero because risk is eliminated with a portfolio of 50 securities or more.

: B Diff: 2 Keywords: Systematic Risk, Well-diversified Portfolio

: Reflective thinking skills 21) U.S. Savings Bonds are sold at a discount. The face value of the bond represents its value on its future maturity date. Therefore A) the current price of a $50 face value bond that matures in 10 years will be greater than the current price of a $50 face value bond that matures in 5 years. B) the current price of a $50 face value bond that matures in 10 years will be less than the current price of a $50 face value bond that matures on 5 years. C) the current prices of all $50 face value bonds will be the same, regardless of their maturity dates because they will all be worth $50 in the future. D) the current price of a $50 face value bond will be higher if interest rates increase.

: B Diff: 2 Keywords: Time Value of Money, Present Value

: Reflective thinking skills 30) Kokapeli, Inc. has a target capital structure of 40% debt and 60% common equity, and has a 40% marginal tax rate. If the firm's yield to maturity on bonds is 7.5% and investors require a 15% return on the firm's common stock, what is the firm's weighted average cost of capital? A) 7.20% B) 10.80% C) 12.00% D) 12.25%

: B Diff: 2 Keywords: Weighted Average Cost of Capital

: Reflective thinking skills 9) Blammo, Inc. has a target capital structure of 30% debt and 70% equity. The firm is planning to invest in a project that will necessitate raising new capital. New debt will be issued at a before-tax yield of 14%, with a coupon rate of 10%. The equity will be provided by internally generated funds so no new outside equity will be issued. If the required rate of return on the firm's stock is 22% and its marginal tax rate is 35%, compute the firm's cost of capital. A) 18.00% B) 18.13% C) 19.68% D) 15.55%

: B Diff: 2 Keywords: Weighted Average Cost of Capital, After-tax Cost of Debt

: Analytic skills 22) Texas Transport has five possible investment projects for the coming year. Each project is indivisible. They are: Project Investment (million) IRR A $ 6 18% B $10 15% C $ 9 20% D $ 4 12% E $ 3 24% The firm's weighted marginal cost of capital schedule is 12 percent for up to $6 million of investment; 16 percent for between $6 million and $18 million of investment; and above $18 million the weighted cost of capital is 18 percent. The optimal capital budget is A) $12 million. B) $18 million. C) $23 million. D) $28 million.

: B Diff: 2 Keywords: Weighted Average Cost of Capital, Optimal Capital Budget

: Analytic skills 27) Which of the following causes a firm's cost of capital (WACC) to differ from an investor's required rate of return on the company's common stock? A) the fact that the risk free rate of interest has increased B) the incurrence of flotation costs when new securities are issued C) The market risk premium exceeds 12%. D) None of the above — the WACC and required return are the same.

: B Diff: 2 Keywords: Weighted Average Cost of Capital, Taxes, Flotation Costs

: Analytic skills 43) You must add one of two investments to an already well- diversified portfolio. Security A Security B Expected Return = 14% Expected Return = 14% Standard Deviation of Standard Deviation of Returns = 15.8% Returns = 19.7% Beta = 1.8 Beta = 1.5 If you are a risk-averse investor, which one is the better choice? A) Security A B) Security B C) Either security would be acceptable. D) cannot be determined with information given

: B Diff: 2 Keywords: Well-diversified Portfolio, Risk-Return Trade Off, Beta

: Analytic skills 25) Your grandparents deposit $2,000 each year on your birthday, starting the day you are born, in an account that pays 7% interest compounded annually. How much will you have in the account on your 21st birthday, just after your grandparents make their deposit? A) $101,802 B) $98,016 C) $86,058 D) $79,640

: B Diff: 3 Keywords: Annuity, Future Value

: Analytic skills 22) You are going to add one of the following three projects to your already well-diversified portfolio. PROJECT 1 PROJECT 2 Standard Standard Probability Return Deviation Beta Probability Return Deviation Beta 50% Chance 22% 12% 1.1 30% Chance 36% 19.5% 0.8 50% Chance -4% 40% Chance 10.5% 30% Chance -20% PROJECT 3 Standard Probability Return Deviation Beta 10% Chance 28% 12% 2.0 70% Chance 18% 20% Chance -8% Assume the risk-free rate of return is 2% and the market risk premium is 8%. If you are a risk averse investor, which project should you choose? A) Project 1 B) Project 2 C) Project 3 D) Either Project 2 or Project 3 because the higher expected return on project 3 offsets its higher risk.

: B Diff: 3 Keywords: Beta, Risk-Return Trade Off, Expected Return, Security Market Line, Required Return

: Analytic skills 15) An investor currently holds the following portfolio: Amount Invested 8,000 shares of Stock A $16,000 Beta = 1.3 15,000 shares of Stock B $48,000 Beta = 1.8 25,000 shares of Stock C $96,000 Beta = 2.2 If the risk-free rate of return is 2% and the market risk premium is 7%, then the required return on the portfolio is A) 14.91%. B) 15.93%. C) 21.91%. D) 23.93%.

: B Diff: 3 Keywords: Beta, Security Market Line, Portfolio, Required Return

: Analytic skills 19) White Company stock has a beta of 2 and a required return of 23%, while Black Company stock has a beta of 1.0 and a required return of 14%. The standard deviation of returns for White Company is 10% more than the standard deviation for Black Company. The risk free rate of return according to the CAPM is A) 4%. B) 5%. C) 6%. D) impossible to determine with the information given

: B Diff: 3 Keywords: CAPM, Security Market Line, Beta, Required Return

: Analytic skills 31) You plan to go to Asia to visit friends in three years. The trip is expected to cost a total of $10,000 at that time. Your parents have deposited $5,000 for you in a Certificate of Deposit paying 6% interest annually, maturing three years from now. Uncle Lee has agreed to pay for all remaining expenses. If you are going to put Uncle Lee's gift in an investment earning 10% over the next three years, how much must he deposit today, so you can visit your friends three years from today? A) $3,757 B) $3,039 C) $5,801 D) $3,345

: B Diff: 3 Keywords: Future Value, Present Value

: Analytic skills 10) You have been depositing money at the end of each year into an account drawing 8% interest. What is the balance in the account at the end of year four if you deposited the following amounts? Year End of Year Deposit 1 $350 2 $500 3 $725 4 $400 A) $1,622 B) $2,207 C) $2,384 D) $2,687

: B Diff: 3 Keywords: Future Value, Uneven Cash Flows

: Analytic skills 66) Bill starts a retirement fund at age 21 and plans on depositing equal annual amounts on each birthday, starting at age 21, and ending at age 60. He wants to have $2 million at age 60. John starts his fund on his 30th birthday. He wants to deposit equal annual amounts on each birthday starting on his 30th birthday and ending on his 60th birthday. John wants to have $2 million at age 60. If the investment funds earn 10% per year, calculate the amounts the Bill and John respectively will have to save each year (rounded to the nearest dollar) to meet their goals. Comment on the difference.

: Bill will need to make deposits of $4,519 per year, while John will need to make deposits of $10,992 per year. These amounts are based on the future value of the annuity in each case of $2,000,000, N = 40 for Bill and N = 31 for John, with I = 10%. The difference illustrates the importance of compounding and the need to begin saving early. John's annual deposits are more than twice Bill's deposits, even though the number of years is only 9 fewer, or less than 25% less. Diff: 2 Keywords: Annuity Due, Annuity, Time Value of Money, Future Value, Present Value

: Reflective thinking skills 2) Bellington, Inc. is considering the purchase of new, sophisticated machinery for a special three-year project. The machinery requires a special lubricating oil that probably will never be used, but must be available at all times should the machine break down. Bellington purchases $2,000 of lubricating oil to keep on hand just in case it is needed. At the end of the three-year project, it is expected the lubricating oil can be sold back to the distributor for $2,000. Which of the following statements is MOST correct? A) The lubricating oil is a sunk cost that should be excluded from the analysis. B) The $2,000 for the lubricating oil should be excluded from the analysis because it is recovered at the end of three years, so the final cost is zero. C) The $2,000 represents an additional investment in working capital that should be included in the capital budgeting analysis. D) The $2,000 for lubricating oil is simply an accounting entry and does not represent a real cash flow.

: C Diff: 1 Keywords: Additional Investment in Working Capital

: Analytic skills 36) You inherit $300,000 from your parents and want to use the money to supplement your retirement. You receive the money on your 65th birthday, the day you retire. You want to withdraw equal amounts at the end of each of the next 20 years. What constant amount can you withdraw each month and have nothing remaining at the end of 20 years if you are earning 7% interest compounded monthly? A) $1,200 B) $1,829 C) $2,326 D) $2,943

: C Diff: 1 Keywords: Annuity, Payments

: Analytic skills 20) If you invest $750 every six months at 8 percent compounded semiannually, how much would you accumulate at the end of 10 years? A) $10,065 B) $10,193 C) $22,334 D) $21,731

: C Diff: 1 Keywords: Annuity, semiannual Compounding, Future Value

: Reflective thinking skills 34) Most stocks have betas between A) -1.00 and 1.00. B) 0.00 and 1.00. C) 0.60 and 1.60. D) 1.00 and 2.00.

: C Diff: 1 Keywords: Beta

: Reflective thinking skills 29) Speculative, or non-investment-grade, bonds have an S&P bond rating of A) C or less. B) CCC or less. C) BB or less. D) BBB or less.

: C Diff: 1 Keywords: Bond Rating

: Analytic skills 6) Which of the following will cause the value of a bond to increase, other things held the same? A) investors' required rate of return increases. B) the company's debt rating drops from AAA to BBB. C) interest rates decrease. D) the bond is callable.

: C Diff: 1 Keywords: Bond Valuation, Required Return, Bond Ratings, Callable Bonds

: Reflective thinking skills 20) The break-even model enables the manager of the firm to A) calculate the minimum price of common stock for certain situations. B) set appropriate equilibrium thresholds. C) determine the quantity of output that must be sold to cover all operating costs. D) determine the optimal amount of debt financing to use.

: C Diff: 1 Keywords: Break-even Model

: Reflective thinking skills 22) Many preferred stocks have a provision that entitles a company to repurchase its preferred stock from their holders at stated prices over a given time period. What is the name of this provision? A) cumulative B) putable C) callable D) convertible

: C Diff: 1 Keywords: Callable Preferred Stock

: Analytic skills 35) Last National Bank is offering you a loan at 10%; payments on the loan are to be made monthly. Credit Onion is offering you a loan where payments are to be made semiannually; the rate on the loan is also 10%. Local Bank down the street is also offering a loan at 10% where the payments are made quarterly. Which loan has the lowest annual cost? A) Last National Bank's loan B) Local Bank's loan C) Credit Onion's loan D) All of the loans will have the same annual cost.

: C Diff: 1 Keywords: Compounding Periods, Bank Loan

: Reflective thinking skills 21) Bill and Mary own a small chain of high fashion boutiques that represent almost 100% of their net worth. When considering capital budgeting projects for their boutiques, the appropriate measure of risk is A) project standing alone risk. B) systematic risk. C) contribution-to-firm risk. D) beta risk.

: C Diff: 1 Keywords: Contribution-To-Firm Risk, Project Standing Alone Risk, Systematic Risk

: Reflective thinking skills 15) Cost of capital is A) the coupon rate of debt. B) a hurdle rate set by the board of directors. C) the rate of return that must be earned on additional investment if firm value is to remain unchanged. D) the average cost of the firm's assets.

: C Diff: 1 Keywords: Cost of Capital

: Reflective thinking skills 44) A firm's cost of capital is influenced by A) the current ratio. B) par value of common stock. C) capital structure. D) net income.

: C Diff: 1 Keywords: Cost of Capital

: Reflective thinking skills 16) Cost of capital is commonly used interchangeably with all of the following terms EXCEPT A) the firm's required rate of return. B) the hurdle rate for new investments. C) the internal rate of return for new investments. D) the firm's opportunity cost of funds.

: C Diff: 1 Keywords: Cost of Capital, Required Rate of Return, Hurdle Rate, Opportunity Cost of Funds

: Analytic skills 36) In general, which of the following rankings, from highest to lowest cost, is most accurate? A) cost of new common stock, cost of preferred stock, cost of debt, cost of retained earnings B) cost of debt, cost of preferred stock, cost of new common stock, cost of retained earnings C) cost of new common stock, cost of retained earnings, cost of preferred stock, cost of debt D) cost of preferred stock, cost of new common stock, cost of retained earnings, cost of debt

: C Diff: 1 Keywords: Cost of New Common Stock, Cost of Retained Earnings, Cost of Preferred Stock, Cost of Debt

: Analytic skills 49) How can investors reduce the risk associated with an investment portfolio without having to accept a lower expected return? A) Wait until the stock market rises. B) Increase the amount of money invested in the portfolio. C) Purchase a variety of securities; i.e., diversify. D) Purchase stocks that have exceptionally high standard deviations.

: C Diff: 1 Keywords: Diversification, Risk

: Analytic skills 10) In an efficient securities market the market value of a security is equal to A) its liquidation value. B) its book value. C) its intrinsic value. D) par value.

: C Diff: 1 Keywords: Efficient Markets, Liquidation Value, Book Value, Intrinsic Value

: Reflective thinking skills 8) Stock A has the following returns for various states of the economy: State of the Economy Probability Stock A's Return Recession 10% -30% Below Average 20% -2% Average 40% 10% Above Average 20% 18% Boom 10% 40% Stock A's expected return is A) 5.4%. B) 7.2%. C) 8.2%. D) 9.6%

: C Diff: 1 Keywords: Expected Return, Probability

: Reflective thinking skills 35) Which of the following statements about financial leverage is true? A) Financial leverage is the responsiveness of the firm's EBIT to fluctuations in sales. B) Financial leverage involves the incurrence of fixed operating costs in the firm's income stream. C) Financial leverage is the responsiveness of the firm's EPS to fluctuations in EBIT. D) Financial leverage reduces a firm's risk.

: C Diff: 1 Keywords: Financial Leverage

: Reflective thinking skills 20) Which of the following transactions will lower a company's financial leverage? A) A mortgage loan is obtained and the proceeds are used to pay off existing short-term debt. B) Preferred stock is sold and the proceeds are used to pay off existing short-term debt. C) Common stock is sold and the proceeds are used to pay off existing short-term debt. D) Short-term debt is obtained to get the company through a period of negative net income and cash flow.

: C Diff: 1 Keywords: Financial Leverage, Common Stock, Debt

: Analytic skills 6) Higher flotation costs will result in all of the following EXCEPT A) higher after-tax cost of debt. B) higher weighted average cost of capital. C) higher cost of retained earnings. D) higher cost of common equity when new common shares are sold.

: C Diff: 1 Keywords: Flotation Costs, Cost of Retained Earnings

: Reflective thinking skills 54) Which of the following differentiates the cost of retained earnings from the cost of newly-issued common stock? A) the cost of the pre-emptive rights held by existing shareholders B) the greater marginal tax rate faced by the now-larger firm C) the flotation costs incurred when issuing new securities D) the larger dividends paid to the new common stockholders

: C Diff: 1 Keywords: Flotation Costs, Cost of Retained Earnings, Cost of New Common Stock

: Reflective thinking skills 24) Mountain Recreation, Inc. is considering a new product line. The company currently manufactures several lines of snow skiing apparel. The new products, insulated ski bikinis, are expected to generate sales of $1.2 million per year for the next five years. They expect that during this five-year period, they will lose about $150,000 each year in sales on their existing lines of longer ski pants. The new line will require no additional equipment or space in the plant and can be produced in the same manner as the apparel products. The new project will, however, require that the company spend an additional $50,000 per year on insurance in case customers sue for frostbite. Also, a new marketing director would be hired to oversee the line at $75,000 per year in salary and benefits. Because of the different construction of the bikinis, an increase in inventory of $9,000 would be required initially. If the marginal tax rate is 35%, compute the incremental after tax cash flows for years 1-5. A) $634,500 per year B) $625,000 per year C) $601,250 per year D) $537,500 per year

: C Diff: 1 Keywords: Incremental After-Tax Cash Flows, Cannibalism, Additional Net Working Capital

: Reflective thinking skills 54) Which of the following statements is MOST correct? A) If a project's internal rate of return (IRR) exceeds the required return, then the project's net present value (NPV) must be negative. B) If Project A has a higher IRR than Project B, then Project A must also have a higher NPV. C) The IRR calculation implicitly assumes that all cash flows are reinvested at a rate of return equal to the IRR. D) A project with a NPV = 0 is not acceptable.

: C Diff: 1 Keywords: Internal Rate of Return, Net Present Value, Reinvestment Rate

: Reflective thinking skills 110) What is the internal rate of return's assumption about how cash flows are reinvested? A) They are reinvested at the firm's discount rate. B) They are reinvested at the required rate of return. C) They are reinvested at the project's internal rate of return. D) They are only reinvested at the end of the project.

: C Diff: 1 Keywords: Internal Rate of Return, Reinvestment Rate Assumption

: Reflective thinking skills 20) Mutually exclusive projects occur when A) projects have uneven cash flows. B) more than one firm can use the projects. C) a set of investment proposals perform essentially the same task. D) projects are independent.

: C Diff: 1 Keywords: Mutually Exclusive Projects

: Analytic skills 9) Under what condition would you NOT accept a project that has a positive net present value? A) If the project has a profitability index less than zero. B) If two or more projects are mutually inclusive. C) If the firm is limited in the capital it has available (capital rationing). D) If a project has more than one sign reversal.

: C Diff: 1 Keywords: Net Present Value, Capital Rationing

: Analytic skills 32) Operating leverage has to do with A) borrowing money to finance a firm's growth. B) using preferred stock to increase sales volume. C) the incurrence of fixed operating costs in the firm's income stream. D) financing with fixed cost sources of capital.

: C Diff: 1 Keywords: Operating Leverage, Fixed Operating Costs

: Reflective thinking skills 25) The optimal capital structure is the funds mix that will A) minimize the use of debt. B) achieve an equal proportion of debt, preferred stock, and common equity. C) minimize the firm's composite cost of capital. D) maximize total leverage.

: C Diff: 1 Keywords: Optimal Capital Structure

: Reflective thinking skills 86) All of the following are criticisms of the payback period criterion EXCEPT A) time value of money is not accounted for. B) cash flows occurring after the payback are ignored. C) it deals with accounting profits as opposed to cash flows. D) none of the above; they are all criticisms of the payback period criteria.

: C Diff: 1 Keywords: Payback Period

: Analytic skills 6) You have just purchased a share of preferred stock for $50.00. The preferred stock pays an annual dividend of $5.50 per share forever. What is the rate of return on your investment? A) 0.055 B) 0.010 C) 0.110 D) 0.220

: C Diff: 1 Keywords: Perpetuity, Preferred Stock

: Analytic skills 4) Maynard Inc. preferred stock pays an annual dividend of $7 per share. Which of the following statements is true for an investor with a required return of 9%? A) The value of the preferred stock is $7 because the dividend is fixed at $7 each year . B) The value of the preferred stock is $63.00 per share. C) The value of the preferred stock is $77.78 per share. D) The value of the preferred stock is $6.30 per share because of the 9% required return.

: C Diff: 1 Keywords: Preferred Stock Valuation

: Reflective thinking skills 5) Which of the following statements concerning preferred stock is MOST correct? A) Preferred stock is valued the same as zero coupon bonds because the cash flow patterns are similar. B) If a corporation issues 4% preferred stock with a par value of $100, the dividend will increase by 4% per year. C) Preferred stock dividends are typically the same each year, allowing a preferred stock to be valued as a perpetuity. D) Preferred stock dividends are calculated as a percentage of common stock dividends, although the preferred stock dividends must be paid first.

: C Diff: 1 Keywords: Preferred Stock Valuation, Dividends, Perpetuity

: Analytic skills 20) How is preferred stock similar to bonds? A) Dividend payments to preferred shareholders (much like bond interest payments to bondholders) are tax deductible. B) Investors can sue the firm if preferred dividend payments are not paid (much like bondholders can sue for non-payment of interest payments). C) Preferred stockholders receive a dividend payment (much like interest payments to bondholders) that is usually fixed. D) Preferred stock is not like bonds in any way.

: C Diff: 1 Keywords: Preferred Stock, Bonds

: Analytic skills 21) Preferred stock differs from common stock in that A) preferred stock usually has a maturity date. B) preferred stock investors have a higher required return than common stock investors. C) preferred stock dividends are fixed. D) common stock investors have a required return and preferred stock investors do not.

: C Diff: 1 Keywords: Preferred Stock, Dividends

: Analytic skills 20) The present value of a single future sum A) increases as the number of discount periods increases. B) is generally larger than the future sum. C) depends upon the number of discount periods. D) increases as the discount rate increases.

: C Diff: 1 Keywords: Present Value

: Analytic skills 22) The present value of $1,000 to be received in 5 years is ________ if the discount rate is 12.78%. A) $368 B) $494 C) $548 D) $687

: C Diff: 1 Keywords: Present Value, Discount Rate

: Reflective thinking skills 29) One method of accounting for systematic risk for a project involves identifying a publicly traded firm that is engaged in the same business as that project and using its required rate of return to evaluate the project. This method is referred to as A) the accounting beta method. B) scenario analysis. C) the pure play method. D) sensitivity analysis.

: C Diff: 1 Keywords: Pure Play Method

: Analytic skills 46) Salvage value would most likely NOT be considered by A) net present value. B) internal rate of return. C) payback. D) A and B.

: C Diff: 1 Keywords: Salvage Value, Payback Period

: Analytic skills 19) Coyote Inc. operates three divisions. One division involves significant research and development, and thus has a high-risk cost of capital of 15%. The second division operates in business segments related to Coyote's core business, and this division has a cost of capital of 10% based upon its risk. Coyote's core business is the least risky segment, with a cost of capital of 8%. The firm's overall weighted average cost of capital of 11% has been used to evaluate capital budgeting projects for all three divisions. This approach will A) favor projects in the core business division because that division is the least risky. B) favor projects in the related businesses division because the cost of capital for this division is the closest to the firm's weighted average cost of capital. C) favor projects in the research and development division because the higher risk projects look more favorable if a lower cost of capital is used to evaluate them. D) not favor any division over the other because they all use the same company-wide weighted average cost of capital.

: C Diff: 1 Keywords: Weighted Average Cost of Capital, Risk-Return Tradeoff

: Reflective thinking skills 26) If the market price of a bond decreases, then A) the yield to maturity decreases. B) the coupon rate increases. C) the yield to maturity increases. D) the coupon rate decreases.

: C Diff: 1 Keywords: Yield to Maturity, Coupon Rate

: Reflective thinking skills 15) The yield to maturity on a bond A) is fixed in the indenture. B) is lower for higher risk bonds. C) is the required rate of return on the bond. D) is generally below the coupon interest rate.

: C Diff: 1 Keywords: Yield to Maturity, Required Rate of Return

: Analytic skills 10) Donner, Inc. will finance a proposed investment by issuing new securities while maintaining its optimal capital structure of 60% debt and 40% equity. The firm can issue bonds at a price of $950.00 before $15 flotation costs. The 10-year bonds will have an annual coupon rate of 8% and a face value of $1,000. The company can issue new equity at a before-tax cost of 16% and its marginal tax rate is 34%. What is the appropriate cost of capital to use in analyzing this project? A) 3.63% B) 8.77% C) 9.97% D) 11.81%

: C Diff: 2 Keywords: After-tax Cost of Debt, Cost of New Common Stock, Weighted Average Cost of Capital

: Analytic skills 7) XRT, Inc. is issuing a $1,000 par value bond that pays 8.5% interest annually. Investors are expected to pay $1,100 for the 12-year bond. The firm will pay $50 per bond in flotation costs. What is the after-tax cost of new debt if the firm is in the 35% tax bracket? A) 8.23% B) 4.55% C) 4.70% D) 7.45%

: C Diff: 2 Keywords: After-tax Cost of Debt, Flotation Costs

: Analytic skills 47) How much money must you pay into an account at the beginning of each of 20 years in order to have $10,000 at the end of the 20th year? Assume that the account pays 12% per year, and round to the nearest $1. A) $1,195 B) $111 C) $124 D) $139

: C Diff: 2 Keywords: Annuity Due, Future Value, Annual Payment

: Analytic skills 59) How much would you be willing to pay (rounded to the nearest dollar) for a 20-year annuity due if the payments are $4,500 per year and you want to earn a rate of return equal to 5.5% per year? A) $84,500 B) $63,445 C) $56,734 D) $53,777

: C Diff: 2 Keywords: Annuity Due, Present Value

: Analytic skills 43) It is January 1st and Darwin Davis has just established an IRA (Individual Retirement Account). Darwin will put $1000 into the account on December 31st of this year and at the end of each year for the following 39 years (40 years total). How much money will Darwin have in his account at the end of the 40th year? Assume that the account pays 12% interest compounded annually and round to nearest $1000. A) $93,000 B) $766,000 C) $767,000 D) $850,000

: C Diff: 2 Keywords: Annuity, Future Value

: Reflective thinking skills 56) What is diversifying among different kinds of assets known as? A) portfolio funding B) capital asset classification C) asset allocation D) multi-diversification

: C Diff: 2 Keywords: Asset Allocation, Diversification

: Analytic skills 54) Assume that you have $100,000 invested in a stock whose beta is .85, $200,000 invested in a stock whose beta is 1.05, and $300,000 invested in a stock whose beta is 1.25. What is the beta of your portfolio? A) 0.97 B) 1.02 C) 1.12 D) 1.21

: C Diff: 2 Keywords: Beta, Portfolio

: Reflective thinking skills 38) If you hold a portfolio made up of the following stocks: Investment Value Beta Stock X $4,000 1.5 Stock Y $5,000 1.0 Stock Z $1,000 .5 What is the beta of the portfolio? A) 1.33 B) 1.24 C) 1.15 D) 1.00

: C Diff: 2 Keywords: Beta, Portfolio

: Reflective thinking skills 5) Cabell Corp. bonds pay an annual coupon rate of 10%. If investors' required rate of return is now 12% on these bonds, they will be priced at A) par value. B) a premium to par value. C) a discount to par value. D) Cannot be determined without knowing the number of years to maturity.

: C Diff: 2 Keywords: Bond Valuation, Premium Bond

: Analytic skills 8) In the present value bond valuation model, risk is generally incorporated into the A) maturity amount. B) timing of cash flows (assuming more risky cash flows are received early). C) discount rate or required return. D) cash flows (making some smaller if they are more risky).

: C Diff: 2 Keywords: Bond Valuation, Required Return

: Analytic skills 37) Mix Sweet Shop bakes and sells pies. Mix has annual fixed costs of $880,000 and a variable cost per pie of $7.50. Each pie sells for $15.50 each. The firm expects to sell 500,000 pies annually. What is the break-even point in sales dollars? A) $3,100,000 B) $2,875,000 C) $1,705,000 D) $1,625,000

: C Diff: 2 Keywords: Break-even Point in Sales Dollars

: Analytic skills 26) A firm that uses large amounts of debt financing in an industry characterized by a high degree of business risk would have ________ earnings per share fluctuations resulting from changes in levels of sales. A) no B) constant C) large D) small

: C Diff: 2 Keywords: Business Risk, Financial Leverage

: Analytic skills 51) GPS Inc. wishes to estimate its cost of retained earnings. The firm's beta is 1.3. The rate on 6-month T-bills is 2%, and the return on the S&P 500 index is 15%. What is the appropriate cost for retained earnings in determining the firm's cost of capital? A) 17.0% B) 19.5% C) 18.9% D) 22.1%

: C Diff: 2 Keywords: Capital Asset Pricing Model, Cost of Capital

: Reflective thinking skills 20) A corporate bond has a coupon rate of 9%, a face value of $1,000, and matures in 15 years. Which of the following statements is MOST correct? A) An investor with a required return of 10% will value the bond at more than $1,000. B) An investor who buys the bond for $900 and holds the bond until maturity will have a capital loss. C) An investor who buys the bond for $900 will have a yield to maturity on the bond greater than 9%. D) If the bond's market price is $900, then the annual interest payments on the bond will be $81.

: C Diff: 2 Keywords: Capital Gains, Maturity Value, Yield to Maturity

: Reflective thinking skills 8) You are in charge of one division of Yeti Surplus Inc. Your division is subject to capital rationing. Your division has 4 indivisible projects available, detailed as follows: Project Initial Outlay IRR NPV 1 2 million 18% 2,500,000 2 1 million 15% 950,000 3 1 million 10% 600,000 4 3 million 9% 2,000,000 If you must select projects subject to a budget constraint of 5 million dollars, which set of projects should be accepted so as to maximize firm value? A) Projects 1, 2 and 3 B) Project 1 only C) Projects 1 and 4 D) Projects 2, 3 and 4

: C Diff: 2 Keywords: Capital Rationing, Net Present Value

: Reflective thinking skills 45) JPR Company is financed 75 percent by equity and 25 percent by debt. If the firm expects to earn $30 million in net income next year and retain 40% of it, how large can the capital budget be before common stock must be sold? A) $7.5 million B) $12.0 million C) $15.5 million D) $16.0 million

: C Diff: 2 Keywords: Capital Structure, Capital Budget

: Analytic skills 25) Perrine Industrial Inc. just paid a dividend of $5 per share. Future dividends are expected to grow at a constant rate of 7% per year. What is the value of the stock if the required return is 16%? A) $33.44 B) $55.56 C) $59.44 D) $65.87

: C Diff: 2 Keywords: Constant Growth Dividend Valuation Model

: Analytic skills 48) LED Corp.'s common stock paid $2.50 in dividends last year (D0). Dividends are expected to grow at a 12-percent annual rate forever. If LED's current market price is $40.00, and your required rate of return is 23 percent, should you purchase the stock? A) No, the percentage return on the stock is too high, thus it is too risky. B) Yes, the stock is expected to return more than you require. C) No, the stock is overpriced. D) Not enough information is given.

: C Diff: 2 Keywords: Constant Growth Dividend Valuation Model, Required Rate of Return

: Analytic skills 11) Which of the following statements is true regarding convertible bonds? A) The holder has the right to sell these bonds back to the issuer if the bonds don't perform well. B) The holder can convert these bonds into an equal number of new bonds if they choose to do so. C) These bonds are convertible into common stock of the issuing firm at a prespecified price. D) These bonds have a variable interest rate.

: C Diff: 2 Keywords: Convertible Bonds

: Analytic skills 50) JPR Company's preferred stock is currently selling for $28.00, and pays a perpetual annual dividend of $2.00 per share. Underwriters of a new issue of preferred stock would charge $3 per share in flotation costs. The firm's tax rate is 40%. Compute the cost of new preferred stock for JPR. A) 4.80% B) 7.14% C) 8.00% D) 9.15%

: C Diff: 2 Keywords: Cost of New Preferred Stock, Flotation Costs

: Analytic skills 59) Grandview Inc. will issue new common stock to finance an expansion. The existing common stock just paid a $1.50 dividend, and dividends are expected to grow at a constant rate 8% indefinitely. The stock sells for $45, and flotation expenses of 5% of the selling price will be incurred on new shares. What is the cost of retained earnings for Grandview? A) 11.33% B) 11.51% C) 11.60% D) 11.79% E) 12.53%

: C Diff: 2 Keywords: Cost of Retained Earnings

: Analytic skills 34) Sentry Manufacturing paid a dividend yesterday of $5 per share (D0 = $4). The dividend is expected to grow at a constant rate of 8% per year. The price of Sentry Manufacturing's stock today is $29 per share. If Sentry Manufacturing decides to issue new common stock, flotation costs will equal $2.50 per share. Sentry Manufacturing's marginal tax rate is 35%. Based on the above information, the cost of retained earnings is A) 28.38%. B) 24.12%. C) 26.62%. D) 31.40%.

: C Diff: 2 Keywords: Cost of Retained Earnings

: Analytic skills 91) Compute the discounted payback period for a project with the following cash flows received uniformly within each year and with a required return of 8%: Initial Outlay = $100 Cash Flows: Year 1 = $40 Year 2 = $50 Year 3 = $60 A) 2.10 years B) 2.21 years C) 2.33 years D) 3.00 years

: C Diff: 2 Keywords: Discounted Payback Period

: Analytic skills 13) Lithium, Inc. is considering two mutually exclusive projects, A and B. Project A costs $95,000 and is expected to generate $65,000 in year one and $75,000 in year two. Project B costs $120,000 and is expected to generate $64,000 in year one, $67,000 in year two, $56,000 in year three, and $45,000 in year four. Lithium, Inc.'s required rate of return for these projects is 10%. The equivalent annual annuity amount for project A is A) $12,989. B) $13,357. C) $15,024. D) $18,532

: C Diff: 2 Keywords: Equivalent Annual Annuity

: Reflective thinking skills 9) Investment A has an expected return of 15% per year, while investment B has an expected return of 12% per year. A rational investor will choose A) investment A because of the higher expected return. B) investment B because a lower return means lower risk. C) investment A if A and B are of equal risk. D) investment A only if the standard deviation of returns for A is higher than the standard deviation of returns for B.

: C Diff: 2 Keywords: Expected Rate of Return, Standard Deviation, Risk-Return Trade Off

: Analytic skills 12) Rogue Recreation, Inc. has normally distributed returns with an expected return of 15% and a standard deviation of 5%, while Lake Tours, Inc. has normally distributed returns with an expected return of 15% and a standard deviation of 15%. Which of the following is true? A) Lake Tours' investors are not being adequately compensated for relevant risk. B) Rogue Rec is likely to experience returns larger than those of Lake Tours. C) Lake Tours is more likely to have negative returns than Rogue Rec. D) Rational investors will prefer Lake Tours, Inc. over Rogue Recreation, Inc.

: C Diff: 2 Keywords: Expected Return, Standard Deviation

: Reflective thinking skills 28) Using the dividend valuation method, an analyst determines the value of Company A's stock to be $10 and the value of Company B's stock to be $14. Based on this information, which of the following statements is most accurate? A) Company B must be riskier than Company A, and risk requires a reward. B) Other things being equal, if Company A and Company B have the same firm value, Company B must have more debt, thus leveraging its returns for the benefit of shareholders. C) Other things being equal, if Company A and Company B have the same firm value, Company A may have more shares of stock outstanding than Company B. D) Company B's required rate of return is higher than Company A's required return.

: C Diff: 2 Keywords: Free Cash Flow Valuation

: Analytic skills 44) If you put $10 in a savings account at the beginning of each month for 15 years, how much money will be in the account at the end of the 10th year? Assume that the account earns 12% compounded monthly and round to the nearest $1. A) $1,200 B) $2,323 C) $5,046 D) $3,485

: C Diff: 2 Keywords: Future Value, Annuity Due

: Analytic skills 30) Manny and Irene will be retiring in fifteen years and would like to buy a Mexican villa. The villa costs $500,000 today, and housing prices in Mexico are expected to increase by 6% per year. Manny and Irene want to make fifteen equal annual payments into an account, starting today, so there will be enough money to purchase the villa in fifteen years. If the account earns 10% per year, what is the amount of each deposit? A) $79,885 B) $72,623 C) $34,286 D) $32,947

: C Diff: 2 Keywords: Future Value, Annuity Payments, Annuity Due

: Analytic skills 32) Andre's wonderful parents established a college savings plan for him when he was born. They deposited $50 into the account on the last day of each month. The account has earned 10.9% compounded monthly, tax-free. How much can they withdraw on his 18th birthday to spend on his education? A) $27,560 B) $30,028 C) $33,307 D) $43,730

: C Diff: 2 Keywords: Future Value, Annuity, Monthly Compounding

: Analytic skills 22) What is the future value of $500 invested at 8.94% compounded quarterly for 12.5 years (round to nearest $1)? A) $670 B) $1,510 C) $1,617 D) $46,739

: C Diff: 2 Keywords: Future Value, Quarterly Compounding

: Analytic skills 23) If you put $2,000 in a savings account that yields 8% compounded semiannually, how much money will you have in the account in 20 years (round to nearest $10)? A) $6,789 B) $8,342 C) $9,602 D) $9,972

: C Diff: 2 Keywords: Future Value, semiannual Compounding

: Analytic skills 42) The prices for the National Gasworks Corporation for the second quarter of 2012 are given below. The price of the stock on April 1, 2012 was $130. Find the holding period return for an investor who purchased the stock on April 1, 2012 and sold it the last day of June 2012. Month End Price April $125.00 May 138.50 June 132.75 A) -4.2% B) -3.7% C) 2.1% D) 3.7%

: C Diff: 2 Keywords: Holding Period Return

: Analytic skills 27) Which of the following is FALSE concerning bonds? A) The indenture spells out the obligations of the bond issuer. B) Mortgage bonds are secured by assets such as real estate. C) Debentures are secured by specific assets other than real estate. D) Subordinated debentures are riskier than unsubordinated debentures.

: C Diff: 2 Keywords: Indenture, Mortgage Bonds, Debentures, Subordinated Debentures, Unsubordinated Debentures

: Analytic skills 69) Alloy Corp. is considering the acquisition of a new processing line. The processor can be purchased for $4,550,000. It will cost $65,000 to ship and $190,500 to install the processor. A recently completed feasibility study that was performed at a cost of $45,000 indicated that the processor would produce a positive NPV. Studies have shown that employee-training expenses will be $150,000. What is the total investment in the processing line for capital budgeting purposes? A) $4,550,000 B) $4,700,000 C) $4,955,500 D) $5,000,500

: C Diff: 2 Keywords: Initial Outlay, Sunk Costs

: Analytic skills 13) If market interest rates rise A) short-term bonds will decline in value more than long-term bonds. B) short-term bonds will rise in value more than long-term bonds. C) long-term bonds will decline in value more than short-term bonds. D) long-term bonds will rise in value more than short-term bonds.

: C Diff: 2 Keywords: Interest Rates, Intrinsic Value, Short-term Bonds, Long-term Bonds

: Analytic skills 105) Your firm is considering an investment that will cost $920,000 today. The investment will produce cash flows of $450,000 in year 1, $270,000 in years 2 through 4, and $200,000 in year 5. The discount rate that your firm uses for projects of this type is 11.25%. What is the investment's internal rate of return? A) 27.28% B) 21.26% C) 20.53% D) 15.98%

: C Diff: 2 Keywords: Internal Rate of Return

: Analytic skills 67) Lithium, Inc. is considering two mutually exclusive projects, A and B. Project A costs $95,000 and is expected to generate $65,000 in year one and $75,000 in year two. Project B costs $120,000 and is expected to generate $64,000 in year one, $67,000 in year two, $56,000 in year three, and $45,000 in year four. Lithium, Inc.'s required rate of return for these projects is 10%. The internal rate of return for Project B is A) 29.74%. B) 30.79%. C) 35.27%. D) 36.77%.

: C Diff: 2 Keywords: Internal Rate of Return

: Analytic skills 89) Your company is considering a project with the following cash flows: Initial Outlay = $3,000,000 Cash Flows Year 1-8 = $547,000 Compute the internal rate of return on the project. A) 6.38% B) 8.95% C) 9.25% D) 12.34%

: C Diff: 2 Keywords: Internal Rate of Return

: Analytic skills 106) Which of the following statements about the internal rate of return (IRR) is true? A) It has the most conservative and realistic reinvestment assumption. B) It never gives conflicting answers. C) It fully considers the time value of money. D) It is greater than the modified internal rate of return if the discount rate is higher than the IRR.

: C Diff: 2 Keywords: Internal Rate of Return

: Reflective thinking skills 107) A significant disadvantage of the internal rate of return is that it A) does not fully consider the time value of money. B) does not give proper weight to all cash flows. C) can result in multiple rates of return (more than one IRR). D) is expressed as a percentage.

: C Diff: 2 Keywords: Internal Rate of Return

: Reflective thinking skills 108) A significant disadvantage of the internal rate of return is that it A) does not fully consider the time value of money. B) does not give proper weight to all cash flows. C) may have an unrealistic reinvestment assumption. D) is expressed as a percentage.

: C Diff: 2 Keywords: Internal Rate of Return

: Reflective thinking skills 76) A project requires an initial investment of $389,600. The project generates free cash flow of $540,000 at the end of year 4. What is the internal rate of return for the project? A) 138.6% B) 38.6% C) 8.5% D) 6.9%

: C Diff: 2 Keywords: Internal Rate of Return

: Reflective thinking skills 8) Nunavet Ocean Cruises sold an issue of 12-year $1,000 par bonds to build new ships. The bonds pay 4.85% interest, semiannually. Today's required rate of return is 9.7%. How much should these bonds sell for today? Round off to the nearest $1. A) $771.86 B) $732.93 C) $660.45 D) $598.33

: C Diff: 2 Keywords: Intrinsic Value, Semiannual Interest

: Reflective thinking skills 20) D'Anthony borrowed $50,000 today that he must repay in 15 annual end-of-year installments of $5,000. What annual interest rate is D'Anthony paying on his loan? A) 2.222% B) 3.333% C) 5.556% D) 33.33%

: C Diff: 2 Keywords: Loan Amortization, Interest Rate, Annuity

: Analytic skills 88) Design Quilters is considering a project with the following cash flows: Initial Outlay = $126,000 Cash Flows: Year 1 = $44,000 Year 2 = $59,000 Year 3 = $64,000 If the appropriate discount rate is 11.5%, compute the NPV of this project. A) -$14,947 B) $2,892 C) $7,089 D) $41,000

: C Diff: 2 Keywords: Net Present Value

: Reflective thinking skills 103) Your firm is considering an investment that will cost $920000 today. The investment will produce cash flows of $450,000 in year 1, $270,000 in years 2 through 4, and $200,000 in year 5. The discount rate that your firm uses for projects of this type is 11.25%. What is the investment's net present value? A) $540,000 B) $378,458 C) $192,369 D) $112,583

: C Diff: 2 Keywords: Net Present Value

: Reflective thinking skills 75) When reviewing the net present profile for a project A) the higher the discount rate, the higher the NPV. B) the higher the discount rate, the higher the IRR. C) the IRR will always be a point on the horizontal axis line where NPV = 0. D) the IRR will always be a point on the horizontal axis equal to the required return.

: C Diff: 2 Keywords: Net Present Value Profile, IRR, NPV

: Reflective thinking skills 6) The net present value always provides the correct decision provided that A) cash flows are constant over the asset's life. B) the required rate of return is greater than the internal rate of return. C) capital rationing is not imposed. D) the internal rate of return is positive.

: C Diff: 2 Keywords: Net Present Value, Capital Rationing

: Reflective thinking skills 111) If the NPV (Net Present Value) of a project with multiple sign reversals is positive, then the project's required rate of return ________ its calculated IRR (Internal Rate of Return). A) must be less than B) must be greater than C) could be greater or less than D) cannot be determined without actual cash flows

: C Diff: 2 Keywords: Net Present Value, Internal Rate of Return, Multiple Sign Reversals

: Reflective thinking skills 102) What is the net present value's assumption about how cash flows are reinvested? A) They are reinvested at the IRR. B) They are reinvested at the APR. C) They are reinvested at the firm's discount rate. D) They are reinvested only at the end of the project.

: C Diff: 2 Keywords: Net Present Value, Reinvestment Rate Assumption

: Reflective thinking skills 29) Operating leverage refers to A) financing a portion of the firm's assets with securities bearing a fixed rate of return. B) the additional chance of insolvency borne by the common shareholder. C) the incurrence of fixed operating costs in the firm's income stream. D) a high degree of variable costs of production.

: C Diff: 2 Keywords: Operating Leverage

: Analytic skills 12) Valley Flights, Inc. has a capital structure made up of 40% debt and 60% equity and a tax rate of 30%. A new issue of $1,000 par bonds maturing in 20 years can be issued with a coupon of 9% at a price of $1,098.18 with no flotation costs. The firm has no internal equity available for investment at this time, but can issue new common stock at a price of $45. The next expected dividend on the stock is $2.70. The dividend for the firm is expected to grow at a constant annual rate of 5% per year indefinitely. Flotation costs on new equity will be $7.00 per share. The company has the following independent investment projects available: Project Initial Outlay IRR 1 $100,000 10% 2 $ 10,000 8.5% 3 $ 50,000 12.5% Which of the above projects should the company take on? A) Project 3 only B) Projects 1 and 2 C) Projects 1 and 3 D) Projects 1, 2 and 3

: C Diff: 2 Keywords: Optimal Capital Budget, After-tax Cost of Debt, Cost of New Common Stock

: Reflective thinking skills 19) All of the following are likely to result in the use of less debt in a company's capital structure EXCEPT A) desire to maintain financial flexibility. B) desire to maintain a high credit rating. C) insufficient internal funds. D) a decrease in a company's marginal tax rate.

: C Diff: 2 Keywords: Optimal Capital Structure, Financial Leverage

: Analytic skills 32) You own an ordinary annuity contract that will pay you $3,000 per year for 12 years. You need money to pay back a loan in 6 years, and you are afraid if you get the annuity payments annually you will spend the money and not be able to pay back your loan. You decide to sell your annuity for a lump sum of cash to be paid to you five years from today. If the interest rate is 8%, what is the equivalent value of your 12-year annuity if paid in one lump sum five years from today? A) $22,008 B) $18,000 C) $35,876 D) $38,880

: C Diff: 2 Keywords: Ordinary Annuity, Future Value, Present Value

: Reflective thinking skills 98) A significant disadvantage of the payback period is that it A) is complicated to explain. B) increases firm risk. C) does not properly consider the time value of money. D) provides a measure of liquidity

: C Diff: 2 Keywords: Payback Period

: Reflective thinking skills 48) Portfolio risk is typically measured by ________ while the risk of a single investment is measured by ________. A) standard deviation; beta B) security market line; standard deviation C) beta; standard deviation D) beta; slope of the characteristic line

: C Diff: 2 Keywords: Portfolio Risk, Beta, Standard Deviation

: Analytic skills 13) Lithium Lakes Industries preferred stock has a par value of $100 and pays a dividend of $6.00 per share. It presently sells for $87 per share. What do investors require as a rate of return on this stock? Round off to the nearest .10%. A) 14.5% B) 9.3% C) 6.9% D) 6.0%

: C Diff: 2 Keywords: Preferred Stock, Required Return

: Analytic skills 27) How much money must be put into a bank account yielding 6.42% (compounded annually) in order to have $1,671 at the end of 11 years (round to nearest $1)? A) $921 B) $886 C) $843 D) $798

: C Diff: 2 Keywords: Present Value

: Analytic skills 29) How much money do I need to place into a bank account that pays a 1.08% rate in order to have $500 at the end of 7 years? A) $332.54 B) $751.81 C) $463.78 D) $629.51

: C Diff: 2 Keywords: Present Value

: Analytic skills 40) What is the present value of an annuity of $120 received at the end of each year for 11 years? Assume a discount rate of 7%. The first payment will be received one year from today (round to nearest $1). A) $250 B) $400 C) $570 D) $900

: C Diff: 2 Keywords: Present Value, Annuity

: Analytic skills 8) A bond matures in 20 years, at which time it pays the owner $1,000. It also pays $70 at the end of each of the next 20 years. If similar bonds are currently yielding 7%, what is the market value of the bond? A) over $1,000 B) under $1,000 C) exactly $1,000 D) cannot be determined from the information given

: C Diff: 2 Keywords: Present Value, Bond

: Analytic skills 27) If you want to have $3,575 in 29 months, how much money must you put in a savings account today? Assume that the savings account pays 12% and it is compounded monthly (round to nearest $1). A) $3,147 B) $3,008 C) $2,679 D) $2,438

: C Diff: 2 Keywords: Present Value, Monthly Compounding

: Analytic skills 28) You hold a portfolio made up of the following stocks: Investment Value Beta Stock L $8,000 2.0 Stock M $18,000 1.5 Stock N $14,000 .4 If the market's expected return is 14%, and the risk free rate of return is 5%, what is the expected return of the portfolio? A) 17.010% B) 16.700% C) 15.935% D) 14.698%

: C Diff: 2 Keywords: Security Market Line, Beta, Expected Return, Portfolio

: Analytic skills 17) Based on the security market line, Robo-Tech stock has a required return of 14% and Friendly Insurance Company has a required return of 10%. Robo-Tech has a standard deviation of returns of 18%. Therefore A) Friendly must have a standard deviation of returns of less than 18% because Friendly is less risky than Robo-Tech. B) all rational investors will prefer Friendly over Robo-Tech. C) for a well-diversified investor, Friendly is less risky than Robo-Tech. D) the beta for Friendly must be greater than the beta for Robo-Tech because Friendly is the better buy for a risk-averse investor.

: C Diff: 2 Keywords: Security Market Line, Well-diversified, Beta, Risk

: Analytic skills 15) pr Corporation just issued $1,000 par 20-year bonds. The bonds sold for $936 and pay interest semiannually. Investors require a rate of 7.00% on the bonds. What is the amount of the semiannual interest payment on the bonds? A) $64.50 B) $55.00 C) $32.00 D) $21.75

: C Diff: 2 Keywords: Semiannual Interest, Required Return

: Reflective thinking skills 31) A company with a bond rating of BBB is more likely to have which of the following qualities compared to a company with a bond rating of B? A) greater reliance on equity financing B) high variability in past earnings C) little use of subordinated debt D) small firm size

: C Diff: 2 Keywords: Standard & Poor's, Bond Ratings

: Analytic skills 20) Assume that an investment is forecasted to produce the following returns: a 20% probability of a 12% return; a 50% probability of a 16% return; and a 30% probability of a 19% return. What is the standard deviation of return for this investment? A) 5.89% B) 16.1% C) 2.43% D) 15.7%

: C Diff: 2 Keywords: Standard Deviation

: Analytic skills 6) Stock W has the following returns for various states of the economy: State of the Economy Probability Stock W's Return Recession 9% -72% Below Average 16% -15% Average 51% 16% Above Average 14% 35% Boom 10% 85% Stock W's standard deviation of returns is A) 12%. B) 29%. C) 37%. D) 43%.

: C Diff: 2 Keywords: Standard Deviation

: Reflective thinking skills 5) Stock W has the following returns for various states of the economy: State of the Economy Probability Stock W's Return Recession 10% -30% Below Average 20% -2% Average 40% 10% Above Average 20% 18% Boom 10% 40% Stock W's standard deviation of returns is A) 10%. B) 14%. C) 17%. D) 20%

: C Diff: 2 Keywords: Standard Deviation

: Reflective thinking skills 30) You are going to invest all of your funds in one of three projects with the following distribution of possible returns: PROJECT 1 PROJECT 2 Standard Standard Probability Return Deviation Beta Probability Return Deviation Beta 50% Chance 22% 12% 1.1 30% Chance 36% 19.5% 1.0 50% Chance -4% 40% Chance 10.5% 30% Chance -20% PROJECT 3 Standard Probability Return Deviation Beta 10% Chance 28% 12% 1.2 70% Chance 18% 20% Chance -8% If you are a risk averse investor, which one should you choose? A) Project 1 B) Project 2 C) Project 3 D) either Project 1 or Project 2 because they have the same expected return

: C Diff: 2 Keywords: Standard Deviation, Risk/Return Trade Off, Expected Return, Non-diversified Portfolio

: Analytic skills 81) AFB Corp. needs to replace an old lathe with a new, more efficient model. The old lathe was purchased for $50,000 nine years ago and has a current book value of $5,000. (The old machine is being depreciated on a straight-line basis over a ten-year useful life.) The new lathe costs $100,000. It will cost the company $10,000 to get the new lathe to the factory and get it installed. The old machine will be sold as scrap metal for $2,000. The new machine is also being depreciated on a straight-line basis over ten years. Sales are expected to increase by $8,000 per year while operating expenses are expected to decrease by $12,000 per year. AFB's marginal tax rate is 40%. Additional working capital of $3,000 is required to maintain the new machine and higher sales level. The new lathe is expected to be sold for $5,000 at the end of the project's ten-year life. What is the project's terminal cash flow? A) $3,000 B) $5,000 C) $6,000 D) $8,000

: C Diff: 2 Keywords: Terminal Cash Flow

: Analytic skills 75) Lasalle Industries is considering the purchase of a new machine that will cost $250,000, plus an additional $10,000 to ship and install. The new machine will have a 5-year useful life and will be depreciated to zero using the straight-line method. The machine is expected to have a salvage value of $30,000 at the end of year five. LaSalle's income tax rate is 40%. The additional net working capital from this project of $50,000 is expected to return to its pre-project level upon termination. What is the non-operating terminal cash flow of the machine? A) -$32,000 B) $48,000 C) $68,000 D) $80,000

: C Diff: 2 Keywords: Terminal Cash Flow, Recapture of Net Working Capital, Salvage Value

: Analytic skills 26) You can buy a $50 savings bond today for $25 and redeem the bond in 10 years for its full face value of $50. You could also put your money in a money market account that pays 7% interest per year. Which option is better, assuming they are of equal risk? A) The money market account is better because it pays more interest. B) The money market account is better because it requires a smaller investment. C) The savings bond is better because it earns a higher interest rate. D) The money market and savings bond both earn 7% interest, so they are equal in value.

: C Diff: 2 Keywords: Time Value of Money, Interest Rates

: Analytic skills 26) Given the following information on S & G Inc.'s capital structure, compute the company's weighted average cost of capital. Type of Percent of Before-Tax Capital Capital Structure Component Cost Bonds 40% 7.5% Preferred Stock 5% 11% Common Stock (Internal Only) 55% 15% The company's marginal tax rate is 40%. A) 13.3% B) 7.1% C) 10.6% D) 10%

: C Diff: 2 Keywords: Weighted Average Cost of Capital

: Reflective thinking skills 55) Crandal Dockworks is undergoing a major expansion. The expansion will be financed by issuing new 15-year, $1,000 par, 9% annual coupon bonds. The market price of the bonds is $1,070 each. Five Rivers flotation expense on the new bonds will be $50 per bond. Crandal's marginal tax rate is 35%. What is the yield to maturity on the newly-issued bonds? A) 6.95% B) 7.99% C) 8.17% D) 9.82%

: C Diff: 2 Keywords: Yield to Maturity

: Reflective thinking skills 12) If a corporation were to choose between issuing a debenture, a mortgage bond, or a subordinated debenture, which would have the highest yield to maturity, everything else equal? A) the debenture B) the mortgage bond C) the subordinated debenture D) all of the above

: C Diff: 2 Keywords: Yield to Maturity, Debenture, Mortgage Bond, Subordinated Debenture

: Analytic skills 48) You are going to pay $800 into an account at the beginning of each of 20 years. The account will then be left to compound for an additional 20 years until the end of year 40, when it will turn into a perpetuity. You will receive the first payment from the perpetuity at the end of the 41st year. If the account pays 14%, how much will you receive from the perpetuity each year (round to nearest $1,000)? A) $140,000 B) $150,000 C) $160,000 D) $170,000

: C Diff: 3 Keywords: Annuity Due, Future Value, Perpetuity

: Analytic skills 51) You have been accepted to study international economy at the European Central Bank (ECB) in Frankfurt. You will need $10,500 every 6 months (beginning today) for the next three years to cover tuition and living expenses. Mom and Dad have agreed to pay for your education, and want to make one deposit today in a bank account earning 6% interest, compounded semiannually. How much must they deposit now so that you can withdraw $10,500 at the beginning of each semester over the next 3 years? A) $54,187 B) $55,797 C) $57,449 D) $56,639

: C Diff: 3 Keywords: Annuity Due, Present Value

: Reflective thinking skills 31) When deciding upon how much debt financing to employ, most practitioners would cite which of the following as the most important influence on the level of the debt ratio? A) providing a borrowing reserve B) maintaining desired bond rating C) ability to adequately meet financing charges D) exploiting advantages of financial leverage

: C Diff: 3 Keywords: Debt Ratio, Capital Structure

: Reflective thinking skills 45) Assume that you expect to hold a $40,000 investment for one year. It is forecasted to have a year end value of $42,000 with a 30% probability; a year end value of $48,000 with a 45% probability; and a year end value of $60,000 with a 25% probability. What is the expected holding period return for this investment? A) 50% B) 25% C) 23% D) 18%

: C Diff: 3 Keywords: Holding Period Return, Expected Return

: Analytic skills 46) Assume that you expect to hold a $20,000 investment for one year. It is forecasted to have a year end value of $21,000 with a 30% probability; a year end value of $24,000 with a 45% probability; and a year end value of $30,000 with a 25% probability. What is the standard deviation of the holding period return for this investment? A) 12.06% B) 14.36% C) 16.36% D) 33.45%

: C Diff: 3 Keywords: Holding Period Return, Standard Deviation

: Analytic skills 76) LaSalle Industries is considering the purchase of a new strapping machine, which will cost $150,000, plus an additional $10,500 to ship and install. The new machine will have a 5-year useful life and will be depreciated to zero using the straight-line method. The machine is expected to generate new sales of $45,000 per year and is expected to save $16,000 in labor and electrical expenses over the next 5-years. The machine is expected to have a salvage value of $20,000. LaSalle's income tax rate is 35%. What is the machine's IRR? A) 15.75% B) 18.86% C) 19.15% D) 20.03%

: C Diff: 3 Keywords: Incremental After-Tax Cash Flows, Internal Rate of Return, Initial Outlay, Depreciation Expense

: Analytic skills 23) ACME, Inc. reported the following income statement for 2009: Sales $2,500,000 Variable Costs 900,000 Fixed Operating Costs 700,000 EBIT 900,000 Interest Expense 200,000 EBT 700,000 Taxes (30%) 210,000 Net Income $490,000 Earnings Per Share $4.90 If ACME's sales next year increase by 20%, ACME's EBIT will increase A) 20%, showing no operating leverage. B) 20%, showing no financial leverage. C) over 35%, due to operating leverage. D) over 35%, due to operating leverage and financial leverage.

: C Diff: 3 Keywords: Operating Leverage, Financial Leverage, Earnings Per Share

: Reflective thinking skills 22) ACME, Inc. reported the following income statement for 2009: Sales $2,500,000 Variable Costs 900,000 Fixed Operating Costs 700,000 EBIT 900,000 Interest Expense 200,000 EBT 700,000 Taxes (30%) 210,000 Net Income $490,000 Earnings Per Share $4.90 If ACME's sales next year increase by 20%, what will ACME's earnings per share be? A) $5.76 B) $6.45 C) $7.14 D) $7.58

: C Diff: 3 Keywords: Operating Leverage, Financial Leverage, Earnings Per Share

: Analytic skills 33) Office Clean Corporation has a capital structure consisting of 30 percent debt and 70 percent common equity. Assuming the capital structure is optimal, what amount of total investment can be financed by a $35 million addition to retained earnings without selling new common stock?

: Capital budget = $35Million/.7 = $50Million Diff: 2 Keywords: Optimal Capital Structure, Total Capital Budget

: Analytic skills 25) The Dickerson PR Firm is considering two mutually exclusive projects with useful lives of 3 and 6 years. The after-tax cash flows for projects S and L are listed below. Year Cash Flow S Cash Flow L 0 -$60,000 -$51,500 1 40,000 13,000 2 20,000 19,000 3 17,000 11,000 4 20,000 5 10,000 6 8,000 Calculate the equivalent annual annuity for each project assuming a required return of 15%. What decision should be made?

: Choose Project S. Although the NPV of Project L (NPV = $1,269.21) is greater than the NPV of Project S (NPV = $1,083.26), this is due to the longer life of project L. The equivalent annual annuity for Project S is $474.44, while the equivalent annual annuity for Project L is only $335.37. Diff: 2 Keywords: NPV, Equivalent Annual Annuity

: Analytic skills 71) Toto and Associates' preferred stock is selling for $27.50 a share. The firm nets $25.60 after issuance costs. The stock pays an annual dividend of $3.00 per share. What is the cost of existing, and new, preferred stock respectively?

: Cost of existing preferred stock = $3.00/$27.50 = 10.91% Cost of new preferred stock = $3.00/$25.60 = 11.72% Diff: 2 Keywords: Cost of Existing Preferred Stock, Cost of New Preferred Stock

: Analytic skills 45) DXZ, Inc. currently produces one product which sells for $250 per unit. The company's fixed costs are $75,000 per year; variable costs are $205 per unit. A salesman has offered to sell the company a new piece of equipment which will increase fixed costs to $100,000. The salesman claims that the company's break-even point will not be altered if the company purchases this equipment. What will be the company's new variable cost per unit?

: Current break even point = $75,000/($250-$205) = 1,667 units $100,000/($250-VC) = 1,667 units 1,667 ($250 - VC) = $100,000 $416,750 - 1,667 VC = $100,000 -1,667 VC = -$316,750 VC = $190.01 Diff: 2 Keywords: Break-even Analysis, Variable Cost per Unit

: Analytic skills 36) Beta is a statistical measure of A) unsystematic risk. B) total risk. C) the standard deviation. D) the relationship between an investment's returns and the market return.

: D Diff: 1 Keywords: Beta

: Analytic skills 55) Which of the following statements is MOST correct regarding beta? A) Beta must be calculated using at least 5 years of monthly returns data to be accurate. B) Beta can only be measured properly using daily returns. C) Beta for a particular company remains constant over time. D) Even professionals may not agree on the measurement of beta.

: D Diff: 1 Keywords: Beta

: Analytic skills 52) Which of the following measures the average relationship between a stock's returns and the market's returns? A) coefficient of validation B) standard deviation C) geometric regression D) beta coefficient

: D Diff: 1 Keywords: Beta

: Reflective thinking skills 23) The appropriate measure for risk according to the capital asset pricing model is A) the standard deviation of a firm's cash flows. B) alpha. C) the standard deviation of a firm's stock returns. D) beta.

: D Diff: 1 Keywords: Beta, CAPM, Risk

: Reflective thinking skills 61) All else equal, an increase in beta results in A) an increase in the cost of retained earnings. B) an increase in the cost of newly issued common stock . C) an increase in the after-tax cost of debt. D) an increase in the cost of common equity, whether or not the funds come from retained earnings or newly issued common stock.

: D Diff: 1 Keywords: Beta, Cost of Common Equity

: Reflective thinking skills 28) Humongous Corporation is a multidivisional conglomerate. The Food Division is undergoing a capital budgeting analysis and must estimate the division's beta. This division has a different level of systematic risk than is typical for Humongous Corporation as a whole. The most appropriate method for estimating this beta is A) the regression coefficient from a time series regression of Humongous Corporation stock returns on a market index. B) to multiply the company's beta by the ratio of the Food Division's total assets/Humongous Corporation total assets. C) the regression coefficient from a time series regression of Food Division's net income on the Humongous Corporation's return on assets. D) the regression coefficient from a time series regression of Food Division's return on assets on a market index.

: D Diff: 1 Keywords: Beta, Time Series Regression

: Reflective thinking skills 65) It is important to consider a new project's affect on the cash flows of existing projects because of A) cannibalism. B) synergy. C) sunk costs. D) A and B above.

: D Diff: 1 Keywords: Cannibalism, Synergy

: Analytic skills 52) In capital budgeting analysis, when computing the weighted average cost of capital, the CAPM approach is typically used to find which of the following? A) market value weight of equity B) pretax component cost of debt C) after-tax component cost of debt D) component cost of internal equity

: D Diff: 1 Keywords: Capital Asset Pricing Model, Cost of Retained Earnings

: Analytic skills 7) Capital rationing may be imposed because of all of the following EXCEPT A) capital market conditions are poor. B) management has a fear of debt. C) stockholder control problems prevent issuance of additional stock. D) the company's stock price is at an historically high level.

: D Diff: 1 Keywords: Capital Rationing

: Reflective thinking skills 26) The Modigliani and Miller hypothesis suggests that capital structure doesn't matter. All of the following conditions need to be met for this hypothesis to be true EXCEPT A) corporate income is not subject to taxation. B) capital structure consists only of stocks and bonds. C) securities are traded in perfect or efficient markets. D) all corporate net income is paid out as dividends.

: D Diff: 1 Keywords: Capital Structure, Modigliani and Miller Hypothesis

: Reflective thinking skills 2) Which of the following affect an asset's value to an investor? I. Amount of an asset's expected cash flow II. The riskiness of the cash flows III. Timing of an asset's cash flows IV. Investor's required rate of return A) I, II, III B) I, III, IV C) I, II, IV D) I, II, III, IV

: D Diff: 1 Keywords: Cash Flow, Risk, Required Return

: Reflective thinking skills 25) Assume that a firm had such serious financial problems that it was about to be liquidated after a bankruptcy. All of the firm's assets are about to be sold in order to pay the following claims against the firm: bondholders, preferred stockholders, common stockholders, and federal income taxes. Of the claims mentioned, what priority would common stockholders have? A) first B) second C) third D) fourth

: D Diff: 1 Keywords: Common Stock Claims, Liquidation

: Reflective thinking skills 24) Consider the following four types of payments that could be made by a normal operating firm: interest, common dividends, income taxes, and preferred dividends. Compared to the other payments mentioned, where would you rank common dividend payments in terms of the order of payment if the firm is liquidating? A) first B) second C) third D) fourth

: D Diff: 1 Keywords: Common Stock Dividends

: Reflective thinking skills 29) All of the following affect the value of a share of common stock EXCEPT A) the dollar amount of the dividends. B) investors' required rate of return. C) the future growth rate for dividends. D) the stock and paid-in-capital amounts on the balance sheet.

: D Diff: 1 Keywords: Common Stock Valuation, Balance Sheet, Required Return, Dividends

: Reflective thinking skills 27) Which of the following features, or benefits, belong to a firm's common stockholders? A) limited liability B) ownership of the firm C) voting rights D) all of the above

: D Diff: 1 Keywords: Common Stock, Limited Liability, Voting Rights

: Analytic skills 60) Which of the following statements is MOST correct? A) Because the cost of debt is lower than the cost of equity, value-maximizing firms maintain debt ratios of close to 100%. B) Corporations that are 100% equity financed will have a much lower weighted average cost of capital because the lack of debt lowers their risk of bankruptcy. C) The source of capital with the lowest after-tax cost is preferred stock, because it is a hybrid security, part debt and part equity. D) The cost of a particular source of capital is equal to the investor's required rate of return after adjusting for the effects of both flotation costs and corporate taxes.

: D Diff: 1 Keywords: Cost of Capital, Flotation Costs, Transactions Costs

: Reflective thinking skills 45) If depreciation expense in year one of a project increases for a highly profitable company A) net income decreases and incremental free cash flow decreases. B) net income increases and incremental free cash flow increases. C) the book value of the depreciating asset increases at the end of year one. D) net income decreases and incremental free cash flow increases.

: D Diff: 1 Keywords: Depreciation Expense, Incremental Free Cash Flow, Taxes

: Reflective thinking skills 31) You are considering investing in Ford Motor Company. Which of the following are examples of diversifiable risk? I. Risk resulting from possibility of a stock market crash. II. Risk resulting from uncertainty regarding a possible strike against Ford. III. Risk resulting from an expensive recall of a Ford product. IV. Risk resulting from interest rates decreasing. A) I only B) I and IV C) I, II, III, IV D) II, III

: D Diff: 1 Keywords: Diversifiable Risk

: Reflective thinking skills 21) Which of the following methods of evaluating investment projects can properly evaluate projects of unequal lives? A) the net present value B) the payback C) the internal rate of return D) the equivalent annual annuity

: D Diff: 1 Keywords: Equivalent Annual Annuity

: Reflective thinking skills 66) Which of the following should be excluded in an analysis of a new project's cash flows? A) additional investment in fixed assets B) additional investment in accounts receivable C) additional investment in inventory D) additional interest expenses on debt financing

: D Diff: 1 Keywords: Financing Cash Flow

: Reflective thinking skills 21) As production levels increase A) variable costs per unit decrease. B) fixed costs per unit increase. C) fixed costs per unit stay the same and variable costs per unit increase. D) fixed costs per unit decrease and variable costs per unit stay the same.

: D Diff: 1 Keywords: Fixed Costs, Variable Costs

: Reflective thinking skills 48) Which of the following is NOT considered in the calculation of incremental cash flows? A) tax saving due to increased depreciation expense B) interest payments if new debt is issued C) increased dividend payments if additional preferred stock is issued D) B and C

: D Diff: 1 Keywords: Incremental Cash Flows, Financing Cash Flows

: Reflective thinking skills 21) The calculation of incremental free cash flows over a project's life should include A) labor and material saving. B) additional revenue. C) interest to bondholders. D) A and B.

: D Diff: 1 Keywords: Incremental Free Cash Flows

: Analytic skills 52) Which of the following should be included in the initial outlay? A) taxable gain on the sale of old equipment being replaced B) first year depreciation expense on any new equipment purchased C) preexisting firm overhead reallocated to the new project D) increased investment in inventory and accounts receivable

: D Diff: 1 Keywords: Initial Outlay

: Reflective thinking skills 71) A new machine can be purchased for $1,800,000. It will cost $35,000 to ship and $15,000 to fine-tune the machine. The new machine will replace an older version that is fully depreciated and will be sold for $200,000. The firm's income tax rate is 35%. What is the initial outlay for capital budgeting purposes? A) $1,580,000 B) $1,630,000 C) $1,650,000 D) $1,720,000

: D Diff: 1 Keywords: Initial Outlay, Tax Effect of Sale of Old Asset

: Analytic skills 37) Auto Loans R Them loans you $24,000 for four years to buy a car. The loan must be repaid in 48 equal monthly payments. The annual interest rate on the loan is 9 percent. What is the monthly payment? A) $500.92 B) $543.79 C) $563.82 D) $597.24

: D Diff: 1 Keywords: Loan Amortization, Payment, Monthly Compounding

: Analytic skills 72) The net present value method A) is consistent with the goal of shareholder wealth maximization. B) recognizes the time value of money. C) uses all of a project's cash flows. D) all of the above.

: D Diff: 1 Keywords: Net Present Value

: Reflective thinking skills 23) Many preferred stocks have a feature that requires a firm to periodically set aside an amount of money for the retirement of its preferred stock. What is the name of this feature? A) convertible B) callable C) cumulative D) sinking fund

: D Diff: 1 Keywords: Preferred Stock, Sinking Fund

: Analytic skills 1) Fred and Ethel are both considering buying a corporate bond with a coupon rate of 8%, a face value of $1,000, and a maturity date of January 1, 2025. Which of the following statements is MOST correct? A) Because both Fred and Ethel will receive the same cash flows if they each buy a bond, they both must assign the same value to the bond. B) If Fred decides to buy the bond, then Ethel will also decide to buy the bond, if markets are efficient. C) Fred and Ethel will only buy the bonds if the bonds are rated BBB or above. D) Fred may determine a different value for a bond than Ethel because each investor may have a different level of risk aversion, and hence a different required return.

: D Diff: 1 Keywords: Required Return, Bond Valuation

: Reflective thinking skills 54) Which of the following are included in the terminal cash flow? A) the expected salvage value of the asset B) any tax payments or receipts associated with the salvage value of the asset C) recapture of any working capital increase included in the initial outlay D) all of the above

: D Diff: 1 Keywords: Terminal Cash Flow

: Reflective thinking skills 35) Which of the following would be considered a variable cost in a manufacturing setting? A) rent B) administrative salaries C) insurance D) direct labor

: D Diff: 1 Keywords: Variable Manufacturing Costs, Direct Labor

: Reflective thinking skills 28) Which of the following should NOT be considered when calculating a firm's WACC? A) cost of preferred stock B) after-tax cost of bonds C) cost of common stock D) cost of carrying inventory

: D Diff: 1 Keywords: Weighted Average Cost of Capital

: Reflective thinking skills 14) A firm's weighted average cost of capital is determined using all of the following inputs EXCEPT A) the firm's capital structure. B) the amount of capital necessary to make the investment. C) the firm's after tax cost of debt. D) the probability distribution of expected returns.

: D Diff: 1 Keywords: Weighted Average Cost of Capital

: Analytic skills 25) Which of the following is NOT a definition of yield to maturity? A) discount rate that equates present value of future cash flows with a bond's price. B) investors' required rate of return on a bond investment. C) return that an investor will earn if they buy the bond for its market price and hold it until maturity. D) discount rate that equates present value of future cash flows with a bond's face value.

: D Diff: 1 Keywords: Yield to Maturity

: Reflective thinking skills 19) a Heights Inc. bonds have a coupon rate of 7%, a yield to maturity of 10%, a face value of $1,000, and mature in 10 years. Which of the following statements is MOST correct? A) An investor who purchases the bond today will earn a return of 10% if he sells the bond after one year. B) An investor who purchases the bond today will earn a return of 7% if he sells the bond after one year. C) An investor who purchases the bond today will earn a return of 17% per year if he holds the bond until it matures. D) An investor who purchases the bond today will earn a return of 10% per year if he holds the bond until it matures.

: D Diff: 1 Keywords: Yield to Maturity

: Analytic skills 8) All the following variables are used in computing the cost of debt EXCEPT A) maturity value of the debt. B) market price of the debt. C) number of years to maturity. D) risk-free rate.

: D Diff: 2 Keywords: After-tax Cost of Debt

: Analytic skills 46) How much money must you pay into an account at the end of each of 20 years in order to have $100,000 at the end of the 20th year? Assume that the account pays 6% per year, and round to the nearest $1. A) $1,840 B) $2,028 C) $2,195 D) $2,718

: D Diff: 2 Keywords: Annuity Due, Future Value, Annual Payment

: Analytic skills 50) A retirement plan guarantees to pay you or your estate a fixed amount for 25 years. At the time of retirement you will have $100,000 to your credit in the plan. The plan anticipates earning 7% interest annually over the period you receive benefits. How much will your annual benefits be assuming the first payment occurs one year from your retirement date? A) $6,182 B) $7,272 C) $8,101 D) $8,581

: D Diff: 2 Keywords: Annuity, Annual Payment, Present Value

: Analytic skills 56) You just graduated and landed your first job in your new career. You remember that your favorite finance professor told you to begin the painless job of saving for retirement as soon as possible, so you decided to put away $2,000 at the end of each year in a Roth IRA. Your expected annual rate of return on the IRA is 7.5%. How much will you accumulate at retirement after 40 years of investing (note: this may assume that you are even retiring early)? A) $94,426 B) $247,921 C) $1,088,632 D) $454,513

: D Diff: 2 Keywords: Annuity, Future Value, IRA

: Analytic skills 57) Congratulations! You are the proud winner of the multi-state Sour Ball Lottery. You are to receive $2,000,000 at the end of each year for the next 20 years. While the Lottery Commission refers to this as a $40,000,000 jackpot, if you choose the "cash option" they will give you much less than that; you can receive a lump sum payment today equal to the present value of the ordinary annuity instead of the 20 annual payments. If the discount rate that the Lottery Commission uses to determine the lump sum payoff is 7%, what is your payoff if you select the cash option? A) $26,945,332 B) $39,707,503 C) $42,977,401 D) $21,188,028

: D Diff: 2 Keywords: Annuity, Present Value

: Analytic skills 5) A bond issued by Liberty, Inc. 10 years ago has a coupon rate of 8% and a face value of $1,000. The bond will mature in 15 years. What is the value to an investor with a required return of 12.5%? A) $800 B) $750.86 C) $658.94 D) $701.52

: D Diff: 2 Keywords: Bond Valuation, Required Return, Coupon Rate

: Analytic skills 38) All of the following will make the break-even point increase, other things equal, EXCEPT A) fixed costs increase. B) the sales price per unit is decreased due to competition. C) variable costs increase due to higher direct labor cost. D) the number of units sold for the year decreased.

: D Diff: 2 Keywords: Break-even Point

: Reflective thinking skills 36) Mix Sweet Shop bakes and sells pies. Mix has annual fixed costs of $880,000 and a variable cost per pie of $7.50. Each pie sells for $15.50 each. The firm expects to sell 500,000 pies annually. What is the break-even point in pies? A) 190,440 B) 280,000 C) 200,000 D) 110,000

: D Diff: 2 Keywords: Break-even Units

: Analytic skills 20) Surf and Spray Inc. has a beta equal to 1.8 and a required return of 15% based on the CAPM. If the market risk premium is 7.5%, the risk-free rate of return is A) 4.1%. B) 3.4%. C) 2.0%. D) 1.5%.

: D Diff: 2 Keywords: CAPM, Security Market Line, Risk-free Rate of Return

: Analytic skills 21) Surf and Spray Inc. has a beta equal to 1.8 and a required return of 15% based on the CAPM. If the risk free rate of return is 4.2%, the expected return on the market portfolio is A) 21%. B) 19.2%. C) 13.4%. D) 10.2%.

: D Diff: 2 Keywords: CAPM, Security Market Line, Risk-free Rate of Return, Market Portfolio

: Analytic skills 41) The risk free rate of return is 3% and the expected return on the market portfolio is 14%. Oklahoma Oilco has a beta of 2.0 and a standard deviation of returns of 26%. Oilco's marginal tax rate is 35%. Analysts expect Oilco's net income to grow by 12% per year for the next 5 years. Using the capital asset pricing model, what is Oklahoma Oilco's cost of retained earnings? A) 18.6% B) 21.2% C) 22.8% D) 25.0%

: D Diff: 2 Keywords: Capital Asset Pricing Model, Cost of Retained Earnings

: Reflective thinking skills 37) The risk free rate of return is 2.5% and the market risk premium is 8%. Rogue Transport has a beta of 2.2 and a standard deviation of returns of 28%. Rogue Transport's marginal tax rate is 35%. Analysts expect Rogue Transport's dividends to grow by 6% per year for the foreseeable future. Using the capital asset pricing model, what is Rogue Transport's cost of retained earnings? A) 16.4% B) 17.7% C) 19.6% D) 20.1%

: D Diff: 2 Keywords: Capital Asset Pricing Model, Cost of Retained Earnings

: Reflective thinking skills 30) According to the moderate view of capital costs and financial leverage, as the use of debt financing increases A) the cost of capital continuously decreases. B) the cost of capital remains constant. C) the cost of capital continuously increases. D) there is an optimal level of debt financing.

: D Diff: 2 Keywords: Capital Structure Theory, Optimal Capital Structure

: Analytic skills 25) For a typical corporation, which of the following capital structures will result in the lowest weighted average cost of capital? A) 40% debt, 20% preferred stock, 40% common equity B) 50% debt, 10% preferred stock, 40% common equity C) 60% debt, 10% preferred stock, 30% common equity D) 60% debt, 15% preferred stock, 25% common equity

: D Diff: 2 Keywords: Capital Structure, Weighted Average Cost of Capital

: Reflective thinking skills 11) Basic tools of capital-structure management include A) EBIT-EPS analysis. B) comparative leverage ratios. C) capital budgeting techniques. D) both A and B.

: D Diff: 2 Keywords: Capital-Structure Management, EBIT-EPS Analysis, Comparative Leverage Ratios

: Analytic skills 39) Beaver Corporation stock is currently selling for $58.00. It is expected to pay a dividend of $5.00 at the end of the year. Dividends are expected to grow at a constant rate of 7.5% indefinitely. Compute the required rate of return on Beaver Corporation stock. A) 12.48% B) 15.65% C) 13.64% D) 16.12%

: D Diff: 2 Keywords: Constant Growth Dividend Valuation Model

: Reflective thinking skills 30) The Western State Company's common stock is expected to pay a $2.00 dividend in the coming year. If investors require a 17% return and the growth rate in dividends is expected to be 8%, what will the market price of the stock be? A) $11.76 B) $24.00 C) $23.11 D) $22.22

: D Diff: 2 Keywords: Constant Growth Dividend Valuation Model, Common Stock

: Analytic skills 6) Jackson Corp. common stock paid $2.50 in dividends last year (D0). Dividends are expected to grow at a 12-percent annual rate forever. If Jackson's current market price is $40.00, what is the stock's expected rate of return (nearest .01 percent)? A) 5.50% B) 11.00% C) 18.25% D) 19.00%

: D Diff: 2 Keywords: Constant Growth Dividend Valuation Model, Expected Rate of Return

: Analytic skills 26) Backford Company just paid a dividend yesterday of $2.25 per share. The company's stock is currently selling for $60 per share, and the required rate of return on Backford Company stock is 16%. What is the growth rate expected for Backford Company dividends assuming constant growth? A) 9.47% B) 9.89% C) 10.87% D) 11.81%

: D Diff: 2 Keywords: Constant Growth Dividend Valuation Model, Growth Rate

: Analytic skills 63) Haroldson Inc. common stock is selling for $22 per share. The last dividend was $1.20, and dividends are expected to grow at a 6% annual rate. Flotation costs on new stock sales are 5% of the selling price. What is the cost of Haroldson Inc.'s new common stock? A) 5.73% B) 11.45% C) 11.78% D) 12.09%

: D Diff: 2 Keywords: Cost of New Common Stock

: Analytic skills 58) Keystone Corporation will issue new common stock to finance an expansion. The existing common stock just paid a $1.50 dividend, and dividends are expected to grow at a constant rate 8% indefinitely. The stock sells for $45, and flotation expenses of 5% of the selling price will be incurred on new shares. What is the cost of new common stock be for Keystone Corp.? A) 11.33% B) 11.51% C) 11.60% D) 11.79% E) 12.53%

: D Diff: 2 Keywords: Cost of New Common Stock, Flotation Costs

: Analytic skills 46) The cost of new preferred stock is equal to A) the preferred stock dividend divided by the market price. B) the preferred stock dividend divided by its par value. C) (1 - tax rate) times the preferred stock dividend divided by net price. D) preferred stock dividend divided by the net selling price of preferred.

: D Diff: 2 Keywords: Cost of New Preferred Stock

: Analytic skills 57) Tempo Corp. will issue preferred stock to finance a new artillery line. The firm's existing preferred stock pays a dividend of $4.00 per share and is selling for $40 per share. Investment bankers have advised Tempo that flotation costs on the new preferred issue would be 5% of the selling price. Tempo's marginal tax rate is 30%. What is the relevant cost of new preferred stock? A) 7.00% B) 7.37% C) 10.00% D) 10.53% E) 15.00%

: D Diff: 2 Keywords: Cost of New Preferred Stock, Flotation Costs

: Reflective thinking skills 10) Bryant Inc. just issued $1,000 par 30-year bonds. The bonds sold for $1,107.20 and pay interest semiannually. Investors require a rate of 7.75% on the bonds. What is the bonds' coupon rate? A) 9.333% B) 7.750% C) 4.125% D) 8.675%

: D Diff: 2 Keywords: Coupon Rate, Semiannual Interest, Intrinsic Value

: Reflective thinking skills 9) Which of the following investments has the highest effective annual return (EAR)? (Assume that all CDs are of equal risk.) A) a bank CD that pays 7.00 percent interest compounded daily B) a bank CD that pays 7.10 percent compounded monthly C) a bank CD that pays 7.30 percent annually D) a bank CD that pays 7.25 percent compounded semiannually

: D Diff: 2 Keywords: Effective Annual Rate, Interest Rate

: Reflective thinking skills 11) If markets were entirely efficient (perfect), which of the following would we conclude? A) There would be no inflation. B) Book value would be the same as market value. C) No firms would ever default on their bonds. D) Market value and intrinsic value would be the same.

: D Diff: 2 Keywords: Efficient Markets, Market Value, Intrinsic Value

: Reflective thinking skills 2) TC Corp paid a dividend today of $5 per share. The dividend is expected to grow at a constant rate of 6.5% per year. If TC Corp stock is selling for $50.00 per share, the stockholders' expected rate of return is A) 11.50%. B) 13.56%. C) 15.49%. D) 16.50%.

: D Diff: 2 Keywords: Expected Rate of Return, Constant Growth Dividend Valuation Model

: Analytic skills 19) Assume that an investment is forecasted to produce the following returns: a 30% probability of a 12% return; a 50% probability of a 16% return; and a 20% probability of a 19% return. What is the expected percentage return this investment will produce? A) 33.3% B) 16.1% C) 9.5% D) 15.4%

: D Diff: 2 Keywords: Expected Return

: Analytic skills 10) Assume that you have $100,000 invested in a stock that is returning 14%, $150,000 invested in a stock that is returning 18%, and $200,000 invested in a stock that is returning 15%. What is the expected return of your portfolio? A) 13.25% B) 14.97% C) 15.67% D) 15.78%

: D Diff: 2 Keywords: Expected Return, Portfolio

: Analytic skills 11) Which of the following investments is clearly preferred to the others for a risk-averse investor? Investment σ A 14% 12% B 22% 20% C 18% 16% A) Investment A B) Investment B C) Investment C D) cannot be determined without additional information

: D Diff: 2 Keywords: Expected Return, Standard Deviation, Risk-Return Trade Off

: Analytic skills 10) Investment A has an expected return of 14% with a standard deviation of 4%, while investment B has an expected return of 20% with a standard deviation of 9%. Therefore A) a risk averse investor will definitely select investment A because the standard deviation is lower. B) a rational investor will pick investment B because the return adjusted for risk (20% - 9%) is higher than the return adjusted for risk for investment A ($14% - 4%). C) it is irrational for a risk-averse investor to select investment B because its standard deviation is more than twice as big as investment A's, but the return is not twice as big. D) rational investors could pick either A or B, depending on their level of risk aversion.

: D Diff: 2 Keywords: Expected Return, Standard Deviation, Risk-Return Trade Off

: Reflective thinking skills 25) A Bristal Boats, Inc. reports sales of $4,000,000, variable costs of $500,000, fixed operating costs of $1,250,000, and interest expense of $350,000. The corporation's EBIT is $3,250,000 and its marginal tax rate is 30%. If the corporation is able to increase its sales by 25%, then A) its EBIT will increase by 25% and its EPS will increase by 25%. B) its EBIT will increase by more than 25% and its EPS will increase by less than 25%. C) its EBIT and EPS will both increase, but less than 25% due to fixed costs and taxes. D) its EBIT will increase by more than 25% and its EPS will increase by more than the percentage increase in EBIT.

: D Diff: 2 Keywords: Financial Leverage, Combined Leverage, Operating Leverage

: Analytic skills 38) A new project is expected to generate $800,000 in revenues, $250,000 in cash operating expenses, and depreciation expense of $150,000 in each year of its 10-year life. The corporation's tax rate is 35%. The project will require an increase in net working capital of $85,000 in year one and a decrease in net working capital of $75,000 in year ten. What is the free cash flow from the project in year one? A) $298,000 B) $375,000 C) $380,000 D) $410,000

: D Diff: 2 Keywords: Free Cash Flow, EBIT, Depreciation Expense, Net Working Capital

: Analytic skills 21) Assume you are to receive a 10-year annuity with annual payments of $1000. The first payment will be received at the end of Year 1, and the last payment will be received at the end of Year 10. You will invest each payment in an account that pays 9 percent compounded annually. Although the annuity payments stop at the end of year 10, you will not withdraw any money from the account until 25 years from today, and the account will continue to earn 9% for the entire 25-year period. What will be the value in your account at the end of Year 25 (rounded to the nearest dollar)? A) $48,359 B) $35,967 C) $48,000 D) $55,340

: D Diff: 2 Keywords: Future Value, Annuity, Single Sum

: Analytic skills 36) You are analyzing the purchase of new equipment. Since you are not an expert on this type of equipment, you hire a consulting firm to make recommendations. The consultant charged you $1,500 and recommended the purchase of the latest model from ACME Corp. of America. The equipment costs $80,000, and it will cost another $10,000 to modify it for special use by your firm. The equipment will be depreciated on a straight-line basis over six years with no salvage value. You expect the equipment will be sold after three years for $28,000. Use of the equipment will require an increase in your company's net working capital of $4,000, but this $4,000 will be recovered at the end of year three. The use of the equipment will have no effect on revenues, but it is expected to save the firm $50,000 per year in before-tax operating costs. Your company's marginal tax rate is 35%. What is the incremental free cash flow for the first year of the project? A) $23,800 B) $29,850 C) $32,440 D) $37,750

: D Diff: 2 Keywords: Incremental Free Cash Flows

: Analytic skills 80) AFB Corp. needs to replace an old lathe with a new, more efficient model. The old lathe was purchased for $50,000 nine years ago and has a current book value of $5,000. (The old machine is being depreciated on a straight-line basis over a ten-year useful life.) The new lathe costs $100,000. It will cost the company $10,000 to get the new lathe to the factory and get it installed. The old machine will be sold as scrap metal for $2,000. The new machine is also being depreciated on a straight-line basis over ten years. Sales are expected to increase by $8,000 per year while operating expenses are expected to decrease by $12,000 per year. AFB's marginal tax rate is 40%. Additional working capital of $3,000 is required to maintain the new machine and higher sales level. The new lathe is expected to be sold for $5,000 at the end of the project's ten-year life. What is the incremental free cash flow during years 2 through 10 of the project? A) $13,600 B) $14,400 C) $15,800 D) $16,400

: D Diff: 2 Keywords: Incremental Free Cash Flows

: Analytic skills 40) Your company is considering the replacement of an old delivery van with a new one that is more efficient. The old van cost $40,000 when it was purchased 5 years ago. The old van is being depreciated using the simplified straight-line method over a useful life of 8 years. The old van could be sold today for $7,000. The new van has an invoice price of $80,000, and it will cost $6,000 to modify the van to carry the company's products. Cost savings from use of the new van are expected to be $28,000 per year for 5 years, at which time the van will be sold for its estimated salvage value of $18,000. The new van will be depreciated using the simplified straight-line method over its 5-year useful life. The company's tax rate is 35%. Working capital is expected to increase by $5,000 at the inception of the project, but this amount will be recaptured at the end of year five. What is the incremental free cash flow for year one? A) $18,875 B) $19,985 C) $22,305 D) $24,220

: D Diff: 2 Keywords: Incremental Free Cash Flows, Depreciation

: Analytic skills 73) Alloy Corp. is considering the acquisition of a new processing line. The processor can be purchased for $3,750,000; it will have a 10-year useful life. It will cost $165,000 to ship and $85,250 to install the processor. A recently completed feasibility study that was performed at a cost of $65,000 indicated that the processor would produce a positive NPV. The processor will be depreciated using the straight-line method to zero expected salvage value. Studies have shown that employee-training expenses will be $125,000. What will be the annual depreciation expense of the processing line for capital budgeting purposes? A) $375,000 B) $419,025 C) $390,000 D) $400,025

: D Diff: 2 Keywords: Initial Depreciation Value, Sunk Costs

: Analytic skills 60) QRW Corp. needs to replace an old lathe with a new, more efficient model. The old lathe was purchased for $50,000 nine years ago and has a current book value of $5,000. (The old machine is being depreciated on a straight-line basis over a ten-year useful life.) The new lathe costs $100,000. It will cost the company $10,000 to get the new lathe to the factory and get it installed. The old machine will be sold as scrap metal for $2,000. The new machine is also being depreciated on a straight-line basis over ten years. Sales are expected to increase by $8,000 per year while operating expenses are expected to decrease by $12,000 per year. QRW's marginal tax rate is 40%. Additional working capital of $3,000 is required to maintain the new machine and higher sales level. The initial outlay for the new machine is A) $113,000. B) $112,200. C) $111,000. D) $109,800.

: D Diff: 2 Keywords: Initial Outlay

: Analytic skills 35) You are analyzing the purchase of new equipment. Since you are not an expert on this type of equipment, you hire a consulting firm to make recommendations. The consultant charged you $1,500 and recommended the purchase of the latest model from ACME Corp. of America. The equipment costs $80,000, and it will cost another $10,000 to modify it for special use by your firm. The equipment will be depreciated on a straight-line basis over six years with no salvage value. You expect the equipment will be sold after three years for $28,000. Use of the equipment will require an increase in your company's net working capital of $4,000, but this $4,000 will be recovered at the end of year three. The use of the equipment will have no effect on revenues, but it is expected to save the firm $50,000 per year in before-tax operating costs. Your company's marginal tax rate is 35%. What is the initial outlay required to fund this project? A) $80,000 B) $84,000 C) $90,000 D) $94,000

: D Diff: 2 Keywords: Initial Outlay, Sunk Costs

: Analytic skills 59) AFB, Inc. is considering replacing an old machine with a new one. Two months ago their chief engineer completed a training seminar on the new machine's operation and efficiency. The $3,000 cost for this training session has already been paid. If the new machine is purchased, it would require $7,000 in installation and modification costs to make it suitable for operation in the factory. The old machine originally cost $80,000 five years ago and is being depreciated by $10,000 per year. The new machine will cost $100,000 before installation and modification. It will be depreciated by $12,000 per year. The old machine can be sold today for $12,000. The marginal tax rate for the firm is 40%. Compute the relevant initial outlay in this capital budgeting decision. A) $79,500 B) $97,800 C) $90,800 D) $87,800

: D Diff: 2 Keywords: Initial Outlay, Sunk Costs, Tax Effect on Sale of Old Asset

: Analytic skills 100) A significant advantage of the internal rate of return is that it A) provides a means to choose between mutually exclusive projects. B) provides the most realistic reinvestment assumption. C) avoids the size disparity problem. D) considers all of a project's cash flows and their timing.

: D Diff: 2 Keywords: Internal Rate of Return

: Analytic skills 57) DYI Construction Co. is considering a new inventory system that will cost $750,000. The system is expected to generate positive cash flows over the next four years in the amounts of $350,000 in year one, $325,000 in year two, $150,000 in year three, and $180,000 in year four. DYI's required rate of return is 8%. What is the internal rate of return of this project? A) 10.87% B) 11.57% C) 13.68% D) 15.13%

: D Diff: 2 Keywords: Internal Rate of Return

: Reflective thinking skills 84) The disadvantage of the IRR method is that A) the IRR deals with cash flows. B) the IRR gives equal regard to all returns within a project's life. C) the IRR will always give the same project accept/reject decision as the NPV. D) the IRR requires long, detailed cash flow forecasts.

: D Diff: 2 Keywords: Internal Rate of Return

: Reflective thinking skills 1) What is the value of a bond that has a par value of $1,000, a coupon of $120 (annually), and matures in 10 years? Assume a required rate of return of 7.02%. A) $1,198.45 B) $1,200.78 C) $1,284.38 D) $1,349.45

: D Diff: 2 Keywords: Intrinsic Value, Bond Valuation

: Analytic skills 6) Bart's Moving Company bonds have a 11% coupon rate. Interest is paid semiannually. The bonds have a par value of $1,000 and will mature 8 years from now. Compute the value of Bart's Moving Company bonds if investors' required rate of return is 9.5%. A) $1,197.27 B) $1,133.05 C) $1,098.99 D) $1,082.75

: D Diff: 2 Keywords: Intrinsic Value, Required Return, semiannual Coupon Rate, Bond Valuation

: Analytic skills 7) Master Craft Control Inc. has bonds that mature in 6 1/2 years with a par value of $1,000. They pay a coupon rate of 9% with semiannual payments. If the required rate of return on these bonds is 11% what is the bond's value? A) $1,026.73 B) $973.76 C) $1,022.74 D) $908.83

: D Diff: 2 Keywords: Intrinsic Value, Semiannual Interest

: Analytic skills 36) The market value of a leveraged firm is equal to the market value of an unleveraged firm A) plus the present value of tax shields minus the present value of financial distress costs plus the present value of agency costs. B) plus the present value of tax shields plus the present value of financial distress costs plus the present value of agency costs. C) minus the present value of tax shields minus the present value of financial distress costs minus the present value of agency costs. D) plus the present value of tax shields minus the present value of financial distress costs minus the present value of agency costs.

: D Diff: 2 Keywords: Leverage, Distress Costs, Tax Shields, Agency Costs

: Analytic skills 53) You have contracted to buy a house for $250,000, paying $30,000 down and taking out a fully amortizing loan for the balance, at a 5.7% annual rate for 30 years. What will your monthly payment be if they make equal monthly installments over the next 30 years (to the nearest dollar)? A) $1,035 B) $1,123 C) $1,189 D) $1,277

: D Diff: 2 Keywords: Loan Amortization, Monthly Payments

: Analytic skills 24) You decide to borrow $250,000 to build a new home. The bank charges an interest rate of 8% compounded monthly. If you pay back the loan over 30 years, what will your monthly payments be (rounded to the nearest dollar)? A) $1,123 B) $1,237 C) $1,687 D) $1,834

: D Diff: 2 Keywords: Loan Amortization, Payment

: Analytic skills 77) Raindrip Corp. can purchase a new machine for $1,875,000 that will provide an annual net cash flow of $650,000 per year for five years. The machine will be sold for $120,000 after taxes at the end of year five. What is the net present value of the machine if the required rate of return is 13.5%. A) $558,378 B) $513,859 C) $473,498 D) $447,292

: D Diff: 2 Keywords: Net Present Value

: Analytic skills 62) Lithium, Inc. is considering two mutually exclusive projects, A and B. Project A costs $95,000 and is expected to generate $65,000 in year one and $75,000 in year two. Project B costs $120,000 and is expected to generate $64,000 in year one, $67,000 in year two, $56,000 in year three, and $45,000 in year four. The firm's required rate of return for these projects is 10%. The net present value for Project A is A) $12,358. B) $16,947. C) $19,458. D) $26,074.

: D Diff: 2 Keywords: Net Present Value

: Reflective thinking skills 31) Redrock Inc. is a household products firm that is considering developing a new detergent. In evaluating whether to go ahead with the new detergent project, which of the following statements is MOST correct? A) The company will produce the detergent in a building that they already own. The cost of the building is therefore zero and should be excluded from the analysis. B) The company will need to use some equipment that it could have leased to another company. This equipment lease could have generated $200,000 per year in after-tax income. The $200,000 should be excluded because the equipment can no longer be leased. C) The company will need to hire 10 new workers whose salaries and benefits will total $400,000 per year. Labor costs are not part of capital budgeting and should be excluded. D) The company will produce the detergent in a building that it renovated 2 years ago for $300,000. The $300,000 should be excluded from the analysis.

: D Diff: 2 Keywords: Opportunity Costs, Sunk Costs, Incremental Expenses

: Reflective thinking skills 34) A firm's optimal capital structure occurs where? A) EPS are maximized, and WACC is minimized. B) Stock price is maximized, and EPS are maximized. C) Stock price is maximized, and WACC is maximized. D) WACC is minimized, and stock price is maximized.

: D Diff: 2 Keywords: Optimal Capital Structure

: Analytic skills 60) How much would you be willing to pay (rounded to the nearest dollar) for a 20-year ordinary annuity if the payments are $4,500 per year and you want to earn a rate of return equal to 5.5% per year? A) $84,500 B) $63,445 C) $56,734 D) $53,777

: D Diff: 2 Keywords: Ordinary Annuity, Present Value

: Analytic skills 11) LTM, Inc. has an issue of preferred stock whose par value is $1,000. The preferred stock pays a 4.5% dividend. If investors require a 5.5% rate of return for these shares, what price should the preferred stock sell for? A) $611.11 B) $508.33 C) $409.09 D) $818.18

: D Diff: 2 Keywords: Preferred Stock Valuation

: Analytic skills 8) What is the value of a preferred stock that pays a $5.55 dividend to an investor with a required rate of return of 10%? A) $22.22 B) $27.83 C) $45 D) $55.50

: D Diff: 2 Keywords: Preferred Stock Valuation

: Analytic skills 4) Beaver Corp preferred stock has a market price of $14.50. If it has a yearly dividend of $3.50, what is your expected rate of return if you purchase the stock at its market price? A) 41.43% B) 19.45% C) 22.36% D) 24.14%

: D Diff: 2 Keywords: Preferred Stock, Expected Rate of Return

: Reflective thinking skills 6) The correct relationship for a premium bond is A) current yield > yield to maturity > coupon rate. B) current yield > coupon rate > yield to maturity. C) coupon rate > yield to maturity > current yield. D) coupon rate > current yield > yield to maturity.

: D Diff: 2 Keywords: Premium Bond, Current Yield, Yield to Maturity, Coupon Rate

: Analytic skills 26) What is the present value of $11,463 to be received 7 years from today? Assume a discount rate of 3.5% compounded annually and round to the nearest $1. A) $5,790 B) $6,508 C) $7,210 D) $9,010

: D Diff: 2 Keywords: Present Value

: Analytic skills 39) What is the present value of an annuity of $4,000 received at the beginning of each year for the next eight years? The first payment will be received today, and the discount rate is 9% (round to nearest $1). A) $36,288 B) $35,712 C) $25,699 D) $24,132

: D Diff: 2 Keywords: Present Value, Annuity Due

: Analytic skills 32) A zero coupon bond pays no annual coupon interest payments. When it matures at the end of 7.5 years it pays out $1,000. If investors wish to earn 2.35% per year on this bond investment, what is the current price of the bond? (Round to the nearest dollar.) A) $533 B) $561 C) $875 D) $840

: D Diff: 2 Keywords: Present Value, Zero Coupon Bond

: Analytic skills 18) Which of the following statements concerning the required rate of return on stocks is true? A) the higher an investor's required rate of return, the higher the value of the stock B) If risk is reduced, the required return will decrease because more investors are risk-averse. C) The required return on preferred stock is generally higher than the required return on common stock. D) the higher the risk, the higher the required return, other things being equal

: D Diff: 2 Keywords: Required Return, Risk, Stock Valuation

: Analytic skills 35) Which of the following is the slope of the security market line? A) beta B) one C) It varies, and is steeper for riskier securities. D) the market risk premium

: D Diff: 2 Keywords: Security Market Line, Market Risk Premium

: Reflective thinking skills 37) You are considering an investment in Citizens Bank Corp. The firm has a beta of 1.6. Currently, U.S. Treasury bills are yielding 2.75% and the expected return for the S & P 500 is 14%. What rate of return should you expect for your investment in Citizens Bank? A) 11.15% B) 15.39% C) 16.75% D) 20.75%

: D Diff: 2 Keywords: Security Market Line, Required Return

: Reflective thinking skills 33) Of the following, which differs in meaning from the other three? A) systematic risk B) market risk C) undiversifiable risk D) asset-unique risk

: D Diff: 2 Keywords: Systematic Risk, Market Risk, Undiversifiable Risk

: Reflective thinking skills 79) An asset with an original cost of $100,000 and a current book value of $20,000 is sold for $50,000 as part of a capital budgeting project. The company has a tax rate of 30%. This transaction will have what impact on the project's initial outlay? A) reduce it by $20,000 B) reduce it by $50,000 C) reduce it by $6,000 D) reduce it by $15,000

: D Diff: 2 Keywords: Tax Effect, Initial Outlay

: Analytic skills 41) Your company is considering the replacement of an old delivery van with a new one that is more efficient. The old van cost $40,000 when it was purchased 5 years ago. The old van is being depreciated using the simplified straight-line method over a useful life of 8 years. The old van could be sold today for $7,000. The new van has an invoice price of $80,000, and it will cost $6,000 to modify the van to carry the company's products. Cost savings from use of the new van are expected to be $28,000 per year for 5 years, at which time the van will be sold for its estimated salvage value of $18,000. The new van will be depreciated using the simplified straight-line method over its 5-year useful life. The company's tax rate is 35%. Working capital is expected to increase by $5,000 at the inception of the project, but this amount will be recaptured at the end of year five. What is the terminal cash flow? A) $23,000 B) $18,000 C) $17,250 D) $16,700

: D Diff: 2 Keywords: Terminal Cash Flow, Salvage Value, Tax Effect, Recapture of Net Working Capital

: Reflective thinking skills 19) Suppose a corporation can change its depreciation method so that its tax payments will decrease by $5,000 this year but increase by $5,000 next year. A) The change will have no impact on the value of the company because its cash flow over time will be the same. B) The change will decrease the value of the company because investors don't like changes in accounting methods. C) The change will decrease the value of the company because lower tax payments this year result from lower reported income. D) The change will increase the value of the company because the value of the cash savings this year exceeds the cost of the cash payments next year.

: D Diff: 2 Keywords: Time Value of Money, Depreciation

: Analytic skills 58) J.B. Enterprises purchased a new molding machine for $85,000. The company paid $8,000 for shipping and another $7,000 to get the machine integrated with the company's existing assets. J.B. must maintain a supply of special lubricating oil just in case the machine breaks down. The company purchased a supply of oil for $4,000. The machine is to be depreciated on a straight-line basis over its expected useful life of 8 years. Which of the following statements concerning the change in working capital is most accurate? A) The $4,000 paid for oil is added to the initial outlay, offset by the tax savings $1600. B) The $4,000 may be expensed each year over the life of the project as part of the incremental free cash flows. C) The $4,000 is added to the initial outlay and recaptured during the terminal year, hence having no impact on the projects NPV or IRR. D) Even if the $4,000 is fully recovered at the end of the project, the project's NPV and IRR will be lower if the change in working capital is included in the analysis.

: D Diff: 2 Keywords: Working Capital, Initial Outlay, Terminal Cash Flow

: Analytic skills 31) Visionary TV Corporation bonds are currently priced at $1,088. They have a par value of $1,000 and 12 years to maturity. They pay an annual coupon rate of 6%. What is the yield to maturity on this bond? A) 6.7% B) 6.1% C) 5.4% D) 5.0%

: D Diff: 2 Keywords: Yield to Maturity

: Reflective thinking skills 28) What is the yield to maturity of a corporate bond with 13 years to maturity, a coupon rate of 8% per year, a $1,000 par value, and a current market price of $1,250? Assume semiannual coupon payments. A) 4.2% B) 4.7% C) 6.0% D) 5.3%

: D Diff: 2 Keywords: Yield to Maturity

: Analytic skills 22) William Corp. Bonds have a current yield of 7% and mature in 10 years. Smith Corp. Bonds have a current yield of 5% and mature in 10 years. Given this information, which of the following statements is MOST correct? A) William Corp. Bonds will have a higher yield to maturity than Smith Corp. Bonds. B) Smith Corp. Bonds will sell for a lower price than William Corp. Bonds. C) Smith Corp. Bonds are riskier than William Corp. Bonds. D) If both bonds have the same yield to maturity, then the price of Smith Corp. Bonds must be less than the price of William Corp. Bonds.

: D Diff: 2 Keywords: Yield to Maturity, Intrinsic Value

: Analytic skills 39) Two investors are considering the purchase of Corporation LMQ bonds. The bonds are selling at their par value of $1,000 with a coupon rate of 9%. Investor A decides to buy the bonds and Investor B does not buy the bonds. A) Investor A must have a required return higher than the bond's yield to maturity. B) The yield to maturity for Investor A must be higher than the yield to maturity for Investor B. C) Investor B must have required return lower than the bond's yield to maturity. D) Investor A must have a required return less than or equal to 9%.

: D Diff: 2 Keywords: Yield to Maturity, Required Return

: Analytic skills 49) You are going to pay $100 into an account at the beginning of each of the next 40 years. At the beginning of the 41st year you buy a 30 year annuity whose first payment comes at the end of the 41st year (the accounts earn 12%). How much will you receive at the end of the 41st year (i.e. the first annuity payment). Round to nearest $100. A) $93,000 B) $7,800 C) $11,400 D) $10,700

: D Diff: 3 Keywords: Annuity Due, Ordinary Annuity, Future Value, Present Value, Annual Payment

: Reflective thinking skills 27) An investor currently holds the following portfolio: Amount Invested 8,000 shares of Stock A $16,000 Beta = 1.3 15,000 shares of Stock B $48,000 Beta = 1.8 25,000 shares of Stock C $96,000 Beta = 2.2 The investor is worried that the beta of his portfolio is too high, so he wants to sell some stock C and add stock D, which has a beta of 1.0, to his portfolio. If the investor wants his portfolio to have a beta of 1.72, how much stock C must he replace with stock D? A) $18,000 B) $24,000 C) $31,000 D) $36,000

: D Diff: 3 Keywords: Beta, Portfolio

: Reflective thinking skills 18) Green Company stock has a beta of 2 and a required return of 23%, while Gold Company stock has a beta of 1.0 and a required return of 14%. The standard deviation of returns for Green Company is 10% more than the standard deviation for Gold Company. The expected return on the market portfolio according to the CAPM is A) 9%. B) 10%. C) 12%. D) 14%.

: D Diff: 3 Keywords: CAPM, Security Market Line, Beta, Required Return

: Analytic skills 34) The return on the market portfolio is currently 12%. Mobile Phone Corporation stockholders require a rate of return of 30% and the stock has a beta of 3.2. According to CAPM, determine the risk-free rate. A) 9.80% B) 6.50% C) 4.64% D) 3.82%

: D Diff: 3 Keywords: CAPM, Security Market Line, Risk-free Rate of Return

: Analytic skills 17) You are considering the purchase of a common stock that paid a dividend of $2.00 yesterday. You expect this stock to have a growth rate of 15 percent for the next 3 years, resulting in dividends of D1=$2.30, D2=$2.645, and D3=$3.04. The long-run normal growth rate after year 3 is expected to be 10 percent (that is, a constant growth rate after year 3 of 10% per year forever). If you require a 14 percent rate of return, how much should you be willing to pay for this stock? A) $89.75 B) $83.65 C) $56.46 D) $62.57

: D Diff: 3 Keywords: Constant Growth, Stock Valuation

: Reflective thinking skills 30) Creighton Industries is considering the purchase of a new strapping machine, which will cost $150,000, plus an additional $10,500 to ship and install. The new machine will have a 5-year useful life and will be depreciated to zero using the straight-line method. The machine is expected to generate new sales of $45,000 per year and is expected to save $16,000 in labor and electrical expenses over the next 5-years. The machine is expected to have a salvage value of $20,000. Creighton's income tax rate is 35%. Creighton uses a 12.5% discount rate for capital budgeting purposes. What is the machine's NPV? A) $29,888 B) $25,062 C) $22,153 D) $27,894

: D Diff: 3 Keywords: Incremental After-Tax Cash Flows, Initial Outlay, Net Present Value, Risk-Adjusted Discount Rate

: Analytic skills 60) Project LMK requires an initial outlay of $500,000 and has a profitability index of 1.4. The project is expected to generate equal annual cash flows over the next ten years. The required return for this project is 16%. What is project LMK's internal rate of return? A) 19.88% B) 22.69% C) 24.78% D) 26.12%

: D Diff: 3 Keywords: Internal Rate of Return, Profitability Index, Ordinary Annuity

: Analytic skills 52) You are thinking of buying a craft emporium. It is expected to generate cash flows of $30,000 per year in years 1 through 5, and $40,000 per year in years 6 through 10. If the appropriate discount rate is 8%, what amount are you willing to pay for the emporium? A) $135,288 B) $167,943 C) $215,048 D) $228,476

: D Diff: 3 Keywords: Present Value, Annuity Due, Deferred Annuity

: Reflective thinking skills 33) The rate on T-bills is currently 2%. Environment Help Company stock has a beta of 1.5 and a required rate of return of 17%. According to CAPM, determine the return on the market portfolio. A) 27.5% B) 19.0% C) 14.0% D) 12.0%

: D Diff: 3 Keywords: T-bill, Beta, Security Market Line, CAPM

: Analytic skills 72) Sutter Corporation's common stock is selling for $16.80 a share. Last year Sutter paid a dividend of $.80. Investors are expecting Sutter's dividends to grow at an annual rate of 5% per year. What is the cost of internal equity?

: D1 = $.80 × 1.05 = $.84 Cost of internal equity = $.84/$16.80 + .05 = 10% Diff: 2 Keywords: Cost of Retained Earnings

: Analytic skills 75) Glenna Gayle common stock sells for $55, and dividends paid last year were $1.35. Flotation costs on issuing stock will be 8% of the market price. The dividends are predicted to have a 10% growth rate. What is the cost of internal equity, and new equity, respectively for Glenna Gayle?

: D1 = $1.35 × 1.1 = $1.49 Cost of internal equity = $1.49/$55 + .1 = 12.71% Cost of new equity = $1.49/($55 × .92) + .1 = 12.94% Diff: 2 Keywords: Cost of Retained Earnings, Cost of New Common Stock, Flotation Costs

: Reflective thinking skills 49) Diana Ltd. paid a $2.50 per share dividend yesterday. The dividend is expected to grow at 10 percent per year for the foreseeable future. Diana Ltd. has a beta of 1.6, a standard deviation of returns of 30 percent, and a required return of 18%. What is the value of a share of Diana Ltd. common stock?

: D1 = $2.50 * (1.10) = $2.75; P0 = D1/(rcs — g) = $2.75/(.18 - .10) = $34.38 Diff: 1 Keywords: Constant Growth Dividend Valuation Model

: Analytic skills 76) Toombes, Inc. is issuing new common stock at a market price of $55. Dividends last year were $3.30 per share and are expected to grow at a rate of 6%. Flotation costs will be 5% of the market price. What is Toombes' cost of retained earnings, and new equity, respectively?

: D1 = $3.30 × 1.06 = $3.50 Cost of retained earnings = $3.50/$55 + .06 = 12.36% Cost of new equity = $3.50/($55 × .95) + .06 = 12.70% Diff: 2 Keywords: Cost of Retained Earnings, Cost of New Common Stock, Flotation Costs

: Analytic skills 89) J.B. Corporation is considering the purchase of equipment that has an invoice price of $450,000. The equipment was recommended by a consulting firm that did an analysis for J.B. Corporation. J.B. paid the consulting firm $12,000 for its report. The cost of shipping and installation is $50,000. The equipment will be depreciated on a straight-line basis over its useful life of 10 years, assuming no salvage value. The equipment will replace existing assets that have a current book value of $100,000 and which could be sold for $150,000. Additional net working capital of $15,000 will be required to maintain the equipment and to support higher sales. J.B.'s marginal tax rate is 40%. Calculate the initial outlay required to fund this project.

: Depreciable cost of the new equipment = $450,000 + $50,000 = $500,000 Proceeds from the Sale of Old Assets = $150,000 Gain on Sale of Old Assets = $150,000 - $100,000 = $50,000 Tax Effect of Sale of Old Assets = $50,000 * 40% = $20,000 Additional Net Working Capital = $15,00 Initial Outlay = $500,000 - $150,000 + $20,000 + $15,000 = $385,000 Diff: 2 Keywords: Initial Outlay, Tax Effect of Sale of Old Assets, Additional Net Working Capital, Sunk Costs

: Analytic skills 8) You purchased one share of Sophia Enterprises common stock for $30 today. If the stock pays a dividend of $6.50 in one year, and sells for $32.50 at that time, what will the dividend yield, growth rate, and total rate of return be for the year?

: Dividend yield = Div/price = $6.50/$30 = 21.67% Growth rate = change in price = ($32.50 - $30)/$30 = 8.33% Total rate of return = Div. yield + growth rate = 30% Diff: 2 Keywords: Dividend Yield, Growth Rate, Total Rate of Return

: Reflective thinking skills 13) Bay Land, Inc. has the following distribution of returns: State Return Probability Boom 0.3 0.25 Normal 0.4 0.15 Bust 0.3 0.30 Assuming that these returns are normally distributed, what is the probability that Bay Land, Inc. will return less than 7.25%? Show all work, and clearly explain and state your answer.

: Exp. Return = (.3 × .25) + (.4 × .15) + (.3 × .05) = .15 std. Dev. = [(.25 - .15)2(0.3) + (.15 - .15)2(0.4) + (.05 - .15)2(0.3)]1/2 = .0775 = 7.75% Because 2/3 of the returns fall within one standard deviation of the mean (for a normal probability distribution), 1/3 do not. One-half of that one third (or 1/6) falls in the tail below one standard deviation below the mean (below 15% - 7.75% = 7.25%), thus the answer is 1/6, or 16.7%. Note, some students may have learned 68% fall within one standard deviation of the mean. Diff: 3 Keywords: Expected Return, Standard Deviation, Normal Distribution

: Reflective thinking skills 15) Accounting profits, adjusted for taxes and differences in accounting methods, provide the best measure of relevant cash flows for capital budgeting purposes.

: FALSE Diff: 1 Keywords: Accounting Profits, Cash Flow

: Analytic skills 1) Accounting profits is the most relevant variable the financial manager uses to measure returns.

: FALSE Diff: 1 Keywords: Accounting Profits, Cash Flows, Returns

: Analytic skills 4) Actual returns are always less than expected returns because actual returns are determined at the end of the period and must be discounted back to present value.

: FALSE Diff: 1 Keywords: Actual Returns, Expected Returns

: Reflective thinking skills 3) If the before-tax cost of debt is 7% and the firm has a 40% marginal tax rate, the after-tax cost of debt is 2.8%.

: FALSE Diff: 1 Keywords: After-tax Cost of Debt

: Reflective thinking skills 5) Asset allocation is not recommended by financial planners because mixing different types of assets, such as stocks with bonds, makes it more difficult to track performance and adjust portfolios to changing market conditions.

: FALSE Diff: 1 Keywords: Asset Allocation

: Reflective thinking skills 16) Portfolio performance is determined mainly by stock selection and market timing, with less emphasis on asset allocation.

: FALSE Diff: 1 Keywords: Asset Allocation, Portfolio Performance

: Analytic skills 6) The average cost of capital is the appropriate rate to use when evaluating new investments, even though the new investments may be in a higher risk class.

: FALSE Diff: 1 Keywords: Average Cost of Capital, Risk

: Reflective thinking skills 24) The portfolio beta is simply the sum of the betas of the individual stocks in the portfolio.

: FALSE Diff: 1 Keywords: Beta, Portfolio Beta

: Reflective thinking skills 13) The Wall Street Journal bond quotes indicate that the net close for a bond with a $1,000 par value is 100¾. The closing price for that bond was $100.75.

: FALSE Diff: 1 Keywords: Bond Quotations

: Reflective thinking skills 21) Federal regulations make it impossible for rating agencies to drop a company's credit rating more than two notches at a time in order to prevent panic in bond markets.

: FALSE Diff: 1 Keywords: Bond Rating

: Reflective thinking skills 4) A company with a AAA bond rating will command a higher interest rate on its bonds than a company with a lesser BBB bond rating.

: FALSE Diff: 1 Keywords: Bond Rating

: Reflective thinking skills 18) A bond rating of "BB" indicates that the company's financial position is above average and hence the default risk on the bonds is very low.

: FALSE Diff: 1 Keywords: Bond Rating, Default Risk

: Analytic skills 9) If a bond's rating declines, the interest rate demanded by investors, called the required return, also decreases.

: FALSE Diff: 1 Keywords: Bond Rating, Required Return

: Reflective thinking skills 4) The value of a bond is equal to the present value of the bond's interest payments plus the present value of the bond's maturity value, all discounted at the bond's coupon rate.

: FALSE Diff: 1 Keywords: Bond Valuation, Present Value, Coupon Rate

: Reflective thinking skills 8) If the demand for a new bond issue increases, it is likely that the coupon rate will be adjusted upward by the issuing company.

: FALSE Diff: 1 Keywords: Bond Value, Coupon Rates, Supply/Demand

: Reflective thinking skills 6) As market rates of interest rise, investors move their funds into bonds, thus increasing their price and lowering their yield.

: FALSE Diff: 1 Keywords: Bond Value, Interest Rates

: Analytic skills 5) Break-even analysis ignores fixed costs because fixed costs do not change.

: FALSE Diff: 1 Keywords: Break-even Analysis, Fixed Costs

: Reflective thinking skills 11) If fixed costs are $150,000, price per unit is $10, and variable cost per unit is $4, the break-even point is 15,000 units.

: FALSE Diff: 1 Keywords: Break-even Point

: Reflective thinking skills 5) Variation in a company's income stream results from its choice of business line, its choice of an operating cost structure, and its choice of a capital structure.

: FALSE Diff: 1 Keywords: Business Risk

: Reflective thinking skills 6) Business risk refers to the relative dispersion (variability) of a company's net income.

: FALSE Diff: 1 Keywords: Business Risk

: Reflective thinking skills 1) A key tool for evaluating business risk is break-even analysis.

: FALSE Diff: 1 Keywords: Business Risk, Operating Risk, Break-Even Analysis

: Reflective thinking skills 5) According to the CAPM, for each unit of Beta an asset's required rate of return increases by the market's return.

: FALSE Diff: 1 Keywords: CAPM, Beta, Required Return, Market Return

: Reflective thinking skills 4) The S&P 500 index must be used as the measure of market return in the CAPM or the results are not theoretically accurate.

: FALSE Diff: 1 Keywords: CAPM, S&P 500

: Reflective thinking skills 9) A call provision allows the issuing firm the opportunity to avoid rising interest rates by calling investors and asking for more cash.

: FALSE Diff: 1 Keywords: Call Provision

: Reflective thinking skills 21) A short-term T-bill's rate of return should be used in the CAPM formula to determine the cost of equity capital regardless of the length of the project under consideration.

: FALSE Diff: 1 Keywords: Capital Asset Pricing Model, Risk-free Rate of Return

: Reflective thinking skills 14) Toyota's capital budgeting analysis for the Prius, a gas-electric hybrid, was faulty because the car line has not made a profit to date.

: FALSE Diff: 1 Keywords: Capital Budgeting

: Analytic skills 1) Accounting profits are used to make capital budgeting decisions because generally accepted accounting principles ensure that profits are the best measure of a company's economic activity.

: FALSE Diff: 1 Keywords: Capital Budgeting Decisions, Accounting Profits vs Cash Flow

: Reflective thinking skills 34) Marketing is crucial to capital budgeting success because the goal of a good capital budgeting project is to maximize the company's sales.

: FALSE Diff: 1 Keywords: Capital Budgeting, Shareholder Wealth Maximization

: Reflective thinking skills 4) Capital rationing generally leads to higher stock prices as management is doing the best job it can in selecting only the best capital budgeting projects.

: FALSE Diff: 1 Keywords: Capital Rationing, Firm Value

: Reflective thinking skills 13) A company's capital structure mix is based on the proportion of fixed versus variable costs in its optimal production process.

: FALSE Diff: 1 Keywords: Capital Structure

: Reflective thinking skills 19) The characteristic line for any well-diversified portfolio is horizontal.

: FALSE Diff: 1 Keywords: Characteristic Line, Well-diversified Portfolio

: Reflective thinking skills 11) If a firm does not have enough money to pay any common stock dividends, it is technically in default to the common shareholders.

: FALSE Diff: 1 Keywords: Common Stock Dividends, Default

: Reflective thinking skills 6) Common stock cannot be worth less than its book value.

: FALSE Diff: 1 Keywords: Common Stock, Book Value

: Reflective thinking skills 11) Common stock valuation can be based on the present value of future dividends or alternatively on the present value of the firm's future quarterly net income.

: FALSE Diff: 1 Keywords: Common Stock, Valuation, Dividends, Net Income

: Reflective thinking skills 6) A compound annuity involves depositing or investing a single sum of money and allowing it to compound for a certain number of years.

: FALSE Diff: 1 Keywords: Compound Annuity

: Reflective thinking skills 9) The common stock of a constant-growth firm is valued in the same manner as its preferred stock.

: FALSE Diff: 1 Keywords: Constant Growth Common Stock Valuation Model, Preferred Stock

: Reflective thinking skills 7) Convertibility is a common feature of common stock; it allows the common stockholders to convert their common shares into preferred shares or into bonds.

: FALSE Diff: 1 Keywords: Convertibility

: Analytic skills 1) A company's cost of capital is equal to a weighted average of its investors' required returns.

: FALSE Diff: 1 Keywords: Cost of Capital, Investors' Required Returns

: Reflective thinking skills 23) The investor's required rate of return will equal the firm's cost of capital if corporate transactions costs are taken into account.

: FALSE Diff: 1 Keywords: Cost of Capital, Required Rate of Return

: Reflective thinking skills 5) If a firm's tax rate increases then its weighted average cost of capital increases also.

: FALSE Diff: 1 Keywords: Cost of Capital, Tax Rate

: Reflective thinking skills 12) The after-tax cost of equity equals one minus the marginal tax rate times the required rate of return on common stock.

: FALSE Diff: 1 Keywords: Cost of Common Equity

: Analytic skills 24) The cost of debt measures the cost of a bank loan, while the cost of preferred stock is used as a proxy for the cost of a new bond issue.

: FALSE Diff: 1 Keywords: Cost of Debt, Cost of Preferred Stock, Bonds

: Reflective thinking skills 26) An increase in a corporation's marginal tax rate will cause the corporation's after tax cost of debt to increase, other things remaining the same.

: FALSE Diff: 1 Keywords: Cost of Debt, Taxes

: Analytic skills 15) Financing with new common stock is generally more costly than financing with retained earnings due to increasing tax rates.

: FALSE Diff: 1 Keywords: Cost of New Common Stock, Cost of Retained Earnings

: Reflective thinking skills 13) If preferred stock pays a $5 annual dividend and sells for $50 the cost of preferred stock financing is 10% since dividends are not tax deductible and preferred stock is sold without flotation costs.

: FALSE Diff: 1 Keywords: Cost of Preferred Stock, Flotation Costs

: Analytic skills 10) The current yield for a bond is constant over time because the coupon rate is fixed.

: FALSE Diff: 1 Keywords: Coupon Rate, Current Yield

: Reflective thinking skills 9) Bond A has a current yield of 6% and Bond B has a current yield of 8%. If the market price of both bonds is the same, then the yield to maturity on Bond B must be higher than the yield to maturity on Bond A.

: FALSE Diff: 1 Keywords: Current Yield, Yield to Maturity

: Reflective thinking skills 12) Debentures are expected to have a lower yield than secured bonds because the debentures are more risky and therefore less desirable.

: FALSE Diff: 1 Keywords: Debenture, Secured Bond

: Reflective thinking skills 10) Increasing depreciation expense results in a decrease of the incremental after-tax free cash flow.

: FALSE Diff: 1 Keywords: Depreciation, Incremental Free Cash Flow

: Reflective thinking skills 16) Depreciation is a non-cash deduction so it may be ignored in the calculation of a project's incremental after-tax cash flows.

: FALSE Diff: 1 Keywords: Depreciation, Non-cash Expense, Incremental After-tax Cash Flows

: Analytic skills 41) Many financial managers believe the payback period is of limited usefulness because it ignores the time value of money; hence, it is referred to as the discounted payback period.

: FALSE Diff: 1 Keywords: Discounted Payback Period, Payback Period, Time Value of Money

: Reflective thinking skills 7) Adding stocks to a bond portfolio will increase the riskiness of the portfolio because stocks have higher standard deviations of returns than bonds.

: FALSE Diff: 1 Keywords: Diversification, Portfolio Risk

: Reflective thinking skills 12) The change in the value of a corporation's common stock as the result of growth is the same regardless of whether the growth is the result of internal growth or the infusion of new capital.

: FALSE Diff: 1 Keywords: Dividend Valuation Model, Internal Growth

: Analytic skills 2) The YLD% shown in Wall Street Journal stock quotes stands for the stock's dividend yield and is calculated by dividing the amount of the dividend by the stock's opening price on the first day of the year.

: FALSE Diff: 1 Keywords: Dividend Yield, Stock Quotes

: Reflective thinking skills 13) The upper limit on common stock dividends, which is set by the SEC, is generally equal to the sum of dividends paid on the company's preferred stock.

: FALSE Diff: 1 Keywords: Dividends, Common Stock

: Analytic skills 1) Calculating the cost of capital for divisions within a company is not recommended because the data is too fragmented and all divisions are part of the same company in any case.

: FALSE Diff: 1 Keywords: Divisional Costs of Capital

: Analytic skills 2) The EBIT-EPS indifference point is the level of production at which the company's EBIT equals its EPS.

: FALSE Diff: 1 Keywords: EBIT-EPS Indifference Point

: Reflective thinking skills 12) In Excel, the variable pvs stands for a bond's par value.

: FALSE Diff: 1 Keywords: Excel, Par Value

: Reflective thinking skills 13) When using the pvs (present value) function in Excel to calculate bond values, the bond's coupon rate is entered as the Rate variable.

: FALSE Diff: 1 Keywords: Excel, Required Return

: Reflective thinking skills 2) A company that sells common stock and uses the money to pay off a loan is increasing its use of financial leverage.

: FALSE Diff: 1 Keywords: Financial Leverage, Common Stock, Debt

: Reflective thinking skills 3) A company that sells preferred stock and uses the money to pay off a loan is decreasing its amount of financial leverage.

: FALSE Diff: 1 Keywords: Financial Leverage, Preferred Stock, Debt

: Reflective thinking skills 14) Proceeds from the issuance of new debt and principal payments upon maturity of debt used to finance a project should be included in the calculation of the project's after-tax cash flows.

: FALSE Diff: 1 Keywords: Financing Cash Flow, Incremental After-tax Cash Flows

: Reflective thinking skills 8) Interest payments on a loan obtained specifically to fund a new project should be considered an incremental cash flow for the new project when determining the accept/reject decision.

: FALSE Diff: 1 Keywords: Financing Cash Flow, Incremental Cash Flow

: Analytic skills 8) A decrease in the level of production results in decreased fixed cost per unit.

: FALSE Diff: 1 Keywords: Fixed Costs Per Unit

: Reflective thinking skills 16) Because fixed costs do not vary with a firm's revenues, firm's with high levels of fixed cost enjoy lower levels of operating risk because their costs are more certain, making budgeting easier.

: FALSE Diff: 1 Keywords: Fixed Costs, Operating Leverage

: Analytic skills 1) Flotation costs cause a corporation's cost of capital to be lower than its investors' required returns.

: FALSE Diff: 1 Keywords: Flotation Costs, Cost of Capital, Required Returns

: Analytic skills 23) In general, a project's free cash flows will fall into one of three categories: (1) incremental costs, (2) sunk costs, and (3) opportunity costs.

: FALSE Diff: 1 Keywords: Free Cash Flow

: Reflective thinking skills 15) The future value of a 10-year ordinary annuity is twice as much as the future value of an otherwise identical 5-year annuity.

: FALSE Diff: 1 Keywords: Future Value, Annuity, Time Periods

: Reflective thinking skills 16) Hershey's expects to sell $2 million of its new candy bar, although $200,000 of this amount would have been spent on its existing candy bar. The $2 million is the appropriate cash inflow for the new candy bar project, while the $200,000 will be counted against the return on the old candy bar.

: FALSE Diff: 1 Keywords: Incremental Cash Flows, Cannibalism

: Reflective thinking skills 9) To be included in a capital budgeting analysis, all incremental free cash flows must be expensed on the company's books, otherwise generally accepted accounting principles will be violated.

: FALSE Diff: 1 Keywords: Incremental Free Cash Flows

: Reflective thinking skills 25) The initial outlay includes the cost of purchasing the asset and getting is operational, but this excludes any training costs for employees which should be included as part of differential cash flows over the life of the project.

: FALSE Diff: 1 Keywords: Initial Outlay

: Reflective thinking skills 11) In the case of insolvency, the claims of debt are honored prior to those of common stock and after those of preferred stock.

: FALSE Diff: 1 Keywords: Insolvency, Risk

: Reflective thinking skills 6) A weakness in the capital budgeting process is the funds for an investment proposal obtained by issuing bonds, and the respective interest payments, are not considered in the capital budgeting process.

: FALSE Diff: 1 Keywords: Interest Payments, Capital Budgeting Process

: Reflective thinking skills 14) The Beta of a T-bill is zero.

: TRUE Diff: 1 Keywords: Beta, T-bill

: Reflective thinking skills 1) ABC Corp 5% preferred stock with a par value of $100 and a market price of $125 will pay an annual dividend this year of $12 per share.

: FALSE Diff: 1 Keywords: Preferred Stock, Dividends, Par Value

: Reflective thinking skills 9) The present value of an annuity increases as the discount rate increases.

: FALSE Diff: 1 Keywords: Present Value, Annuity, Discount Rate

: Analytic skills 6) The profitability index is the ratio of the company's net income (or profits) to the initial outlay or cost of a capital budgeting project.

: FALSE Diff: 1 Keywords: Profitability Index

: Reflective thinking skills 8) A mortgage bond is secured by a lien on real property.

: TRUE Diff: 1 Keywords: Mortgage Bond

: Analytic skills 18) Which of the following statements is MOST correct? A) If a bond's yield to maturity exceeds its coupon rate, the bond's current yield (interest yield) must also exceed its coupon rate. B) If a bond's yield to maturity exceeds its coupon rate, the bond's price must be less than its maturity value. C) If two bonds have the same maturity, the same yield to maturity, and the same level of risk, the bonds should sell for the same price regardless of the bond's coupon rate. D)

s B and C are correct. Answer: B Diff: 2 Keywords: Yield to Maturity, Coupon Rate, Bond Pricing

: Reflective thinking skills 15) The Beta of a T-bill is one.

: FALSE Diff: 1 Keywords: Beta, T-bill

: Reflective thinking skills 2) Private equity funds tend to focus their investments in situations where promised returns are very high and the need for funds is brief.

: TRUE Diff: 1 Keywords: Private Equity Funds

: Reflective thinking skills 1) Given taxes and bankruptcy costs exist, as financial increases, the weighted average cost of capital first decreases and then increases.

: TRUE Diff: 1 Keywords: Weighted Average Cost of Capital, Taxes, Bankruptcy Costs, Moderate View

: Reflective thinking skills 7) Capital structure is the mix of the long-term sources of funds used by the firm.

: TRUE Diff: 2 Keywords: Capital Structure

: Analytic skills 34) You borrow $25,000 to be repaid in 12 monthly installments of $2,292.00. The annual interest rate is closest to A) 1.5 percent. B) 12 percent. C) 18 percent. D) 24 percent.

: C Diff: 1 Keywords: Loan Amortization, Interest Rate

: Reflective thinking skills 11) An example of an annuity is the interest received from bonds.

: TRUE Diff: 1 Keywords: Annuity

: Analytic skills 18) Two sisters each open IRAs in 2011 and plan to invest $3,000 per year for the next 30 years. Mary makes her first deposit on January 1, 2011, and will make all future deposits on the first day of the year. Jane makes her first deposit on December 31, 2011, and will continue to make her annual deposits on the last day of each year. At the end of 30 years, the difference in the value of the IRAs (rounded to the nearest dollar), assuming an interest rate of 7% per year, will be A) $19,837. B) $12,456. C) $6,300. D) $210.

: A Diff: 2 Keywords: Time Value of Money, Future Value, Annuity, Annuity Due

: Analytic skills 42) Charlie wants to retire in 15 years, and he wants to have an annuity of $50,000 a year for 20 years after retirement. Charlie wants to receive the first annuity payment the day he retires. Using an interest rate of 8%, how much must Charlie invest today in order to have his retirement annuity (round to nearest $10). A) $167,130 B) $200,450 C) $256,890 D) $315,240

: A Diff: 3 Keywords: Present Value, Annuity Due, Deferred Annuity

: Analytic skills 33) Which of the following conclusions would be true if you earn a higher rate of return on your investments? A) The greater the present value would be for any lump sum you would receive in the future. B) The lower the present value would be for any lump sum you would receive in the future. C) Your rate of return would not have any effect on the present value of any sum to be received in the future. D) The greater the present value would be for any annuity you would receive in the future.

: B Diff: 1 Keywords: Time Value of Money, Present Value, Discount Rate

: Analytic skills 58) You are ready to retire. A glance at your 401(k) statement indicates that you have $750,000. If the funds remain in an account earning 9.0%, how much could you withdraw at the beginning of each year for the next 25 years? A) $55,620 B) $70,050 C) $35,830 D) $2,500

: B Diff: 2 Keywords: Annuity Due, Annual Payment

: Analytic skills 31) It is your 6th birthday today. You have a trust fund with $50,000 that is earning 8% per year. You expect to withdraw $30,000 per year for 7 years starting on your 22nd birthday for graduate school. How much money will be left in the trust fund after your last withdrawal (rounded to the nearest $10)? A) $125,660 B) $35,780 C) $4,140 D) You will not have enough money to pay for graduate school.

: C Diff: 2 Keywords: Annuity, Future Value, Single Sum

: Analytic skills 41) A deferred annuity will pay you $500 at the end of each year for 10 years, however the first payment will not be made until three years from today (payments will be made at the end of years 3 through 12). What amount will you have to deposit today to fund this deferred annuity? Use an 8% discount rate and round your answer to the nearest $100. A) $2,200 B) $2,400 C) $2,900 D) $3,400

: C Diff: 2 Keywords: Deferred Annuity, Present Value

: Analytic skills 22) You deposit $5,000 per year at the end of each of the next 25 years into an account that pays 8% compounded annually. How much could you withdraw at the end of each of the 20 years following your last deposit if all withdrawals are the same dollar amount? (The twenty-fifth and last deposit is made at the beginning of the 20-year period. The first withdrawal is made at the end of the first year in the 20-year period.) A) $18,276 B) $27,832 C) $37,230 D) $43,289

: C Diff: 3 Keywords: Annuity, Future Value, Present Value, Payment

: Reflective thinking skills 17) If the interest rate is positive, a six-year ordinary annuity of $500 per year must have a present value over $3,000.

: FALSE Diff: 1 Keywords: Ordinary Annuity, Present Value

: Reflective thinking skills 21) Beta represents the average movement of a company's stock returns in response to a movement in the market's returns.

: TRUE Diff: 1 Keywords: Beta

: Analytic skills 112) Kingston Corp. is considering a new machine that requires an initial investment of $480,000 installed, and has a useful life of 8 years. The expected annual after-tax cash flows for the machine are $89,000 for each of the 8 years and nothing thereafter. a. Calculate the net present value of the machine if the required rate of return is 11 percent. b. Calculate the IRR of this project. c. Should Kingston accept the project (assume that it is independent and not subject to any capital rationing constraint)? Explain your answer.

: a. NPV = ($21,995) From Excel Spreadsheet NPV function with rate = .11, cash flows as given, and then subtracting the initial investment of $480,000. b. IRR = 9.7% From Excel Spreadsheet IRR function, with cash flows as given above. c. No, the projects NPV is negative and the IRR is less than the required rate of return. Acceptance of this project would reduce shareholder value. Diff: 2 Keywords: NPV, IRR

: Analytic skills 69) You wish to accumulate $10,000 by depositing $481.46 per month into a savings account that earns 4.75% compounded monthly. How many monthly deposits must you make?

: 20 Diff: 2 Keywords: Annuity, Future Value, Number of Periods, Monthly Compounding

: Analytic skills 66) NewLinePhone Corp. is very risky, with a beta equal to 2.8 and a standard deviation of returns of 32%. The risk free rate of return is 3% and the market risk premium is 8%. NewLinePhone's marginal tax rate is 35%. Use the capital asset pricing model to estimate NewLinePhone's cost of retained earnings.

: 3% + (8%)(2.8) = 25.4% Diff: 2 Keywords: Cost of Retained Earnings, Capital Asset Pricing Model

: Analytic skills 35) You borrow $30,000 and agree to pay it off with one lump sum payment of $40,000 in 6 years. What annual rate of interest will you be charged?

: 4.91% Diff: 2 Keywords: Time Value of Money, Annual Rate of Interest

: Reflective thinking skills 29) Break-even analysis is used to study the effect on EBIT of changes in all of the following EXCEPT A) corporate taxes. B) prices. C) cost structure. D) volume.

: A Diff: 2 Keywords: Break-even Analysis

: Analytic skills 34) Which of the following would be considered a fixed cost in a manufacturing setting? A) depreciation B) direct labor C) sales commissions D) direct materials

: A Diff: 1 Keywords: Fixed Manufacturing Costs, Depreciation

: Analytic skills 70) A company is going to issue a $1,000 par value bond that pays a 7% annual coupon. The company expects investors to pay $942 for the 20-year bond. The expected flotation cost per bond is $42, and the firm is in the 34% tax bracket. Compute the following: a. The yield to maturity on the firm's bonds b. The firm's after-tax cost of existing debt c. The firm's after-tax cost of new debt

: a. YTM = 7.57% b. After-tax cost of existing debt = 7.57% × (1 - .34) = 5% c. After-tax cost of new debt = 8.02% × (1 - .34) = 5.29% Diff: 2 Keywords: After-tax Cost of Debt, Yield to Maturity, Flotation Costs

: Analytic skills 67) An investment promises to pay you the following amounts at the end of each of the next 10 years: (1) $1,000, (2) $2,000, (3) $3,000, (4) $4,000, (5) - (10) $5,000 per year. If you want to earn a return of 8% per year, how much will you be willing to pay for the investment today?

: $24,951.99 Diff: 2 Keywords: Deferred Annuity, Present Value, Uneven Cash Flows

: Analytic skills 65) Alarm Systems Corporation's preferred stock pays a dividend of $3.60 and sells for $28.00. Alarm Systems Corporation has a marginal tax rate of 35%. What is the cost of preferred financing?

: $3.60/$28 = .12857 =12.857%% Diff: 1 Keywords: Cost of Preferred Stock

: Analytic skills 27) Pentrax Corp issued 25 year bonds in 2002 with a coupon rate of 6% and a face value of $1,000. The bonds sold for face value when issued. Since 2002, interest rates have increased, so the going rate on similar bonds is now 9%. Which of the following statements is most accurate? A) An investor who purchased an Pentrax bond in 2002 and plans to keep the bond until it matures expects to earn 6% per year over the life of the bond. B) Pentrax Corp must now pay bondholders interest payments of $90 per year due to the increase in interest rates. C) An investor who purchased an Pentrax bond in 2002 and plans to keep the bond until it matures expects an increase in return from 6% per year to 9% per year. D) The price of an Pentrax Corp bond should be higher than $1,000 due to the increase in rates.

: A Diff: 1 Keywords: Yield to Maturity

: Reflective thinking skills 33) A bond's yield to maturity depends upon all of the following EXCEPT A) the individual investor's required return. B) the maturity of the bond. C) the coupon rate. D) the bond's risk as reflected by the bond rating.

: A Diff: 1 Keywords: Yield to Maturity

: Reflective thinking skills 24) A $1,000 par value 14-year bond with a 10 percent coupon rate recently sold for $965. The yield to maturity is A) 10.49%. B) 10.00%. C) 8.87%. D) 6.50%.

: A Diff: 1 Keywords: Yield to Maturity

: Analytic skills 32) The yield to maturity on long-term bonds A) is equal to the current yield if the bond is selling for face value. B) is equal to the coupon rate on the bond. C) is equal to the net present value of the bond's future cash flows. D) is set by the indenture agreement and will not change over the life of the bond.

: A Diff: 1 Keywords: Yield to Maturity, Current Yield

: Analytic skills 13) Which of the following is true of a zero coupon bond? A) The bond makes no coupon payments. B) The bond sells at a premium prior to maturity. C) The bond has a zero par value. D) The bond has no value until the year it matures because there are no positive cash flows until then.

: A Diff: 1 Keywords: Zero Coupon Bond

: Reflective thinking skills 13) Assume that Bunch Inc. has an issue of 18-year $1,000 par value bonds that pay 7% interest, annually. Further assume that today's required rate of return on these bonds is 5%. How much would these bonds sell for today? Round off to the nearest $1. A) $1,233.79 B) $1,201.32 C) $1,134.88 D) $1,032.56

: A Diff: 2 Keywords: Intrinsic Value, Required Return

: Reflective thinking skills 4) Both investor A and investor B are considering the purchase of Corporation FJR bonds. The bonds are selling at a price of $1,100 each. Investor A decides to buy the bonds and Investor B does not buy the bonds. A) Investor A must have a required return lower than the required return for Investor B. B) The yield to maturity for Investor A must be higher than the yield to maturity for Investor B. C) The yield to maturity for Investor A must be less than the yield to maturity for Investor B. D) The yield to maturity for this bond must be higher than the coupon rate.

: A Diff: 2 Keywords: Required Return, Bond Valuation

: Analytic skills 38) Facade Securities has an issue of $1,000 par value bonds with 18 years remaining to maturity. The bonds pay 7.7% interest on a semiannual basis. The current market price of the bonds is $1,175. What is the yield-to-maturity of the bonds? A) 6.09% B) 6.87% C) 7.24% D) 8.38%

: A Diff: 2 Keywords: Yield to Maturity, Semiannual Interest

: Reflective thinking skills 26) The pure play method A) calculates beta using only project returns. B) uses the beta of a firm that is similar to the project being analyzed to determine the required rate of return for the project. C) selects a firm similar to the project being analyzed and uses its returns as the market return in estimating a project beta. D) selects one of the firm's existing projects that is similar to the project being analyzed and uses that project's required rate of return.

: B Diff: 1 Keywords: Pure Play Method, Beta

: Analytic skills 5) A corporate bond has a face value of $1,000 and a coupon rate of 9%. The bond matures in 14 years and has a current market price of $946. If the corporation sells more bonds it will incur flotation costs of $26 per bond. If the corporate tax rate is 35%, what is the after-tax cost of debt capital? A) 5.57% B) 6.56% C) 8.18% D) 7.31%

: B Diff: 2 Keywords: After-tax Cost of Debt, Flotation Costs, Bond Valuation

: Reflective thinking skills 53) The cost of retained earnings is less than the cost of new common stock because A) marginal tax brackets increase. B) flotation costs are incurred when new stock is issued. C) dividends are not tax deductible. D) accounting rules allow a deduction when using retained earnings.

: B Diff: 2 Keywords: Flotation Costs, Cost of Retained Earnings, Cost of New Common Stock

: Analytic skills 14) Today is your 21st birthday and your bank account balance is $25,000. Your account is earning 6.5% interest compounded quarterly. How much will be in the account on your 50th birthday? A) $159,795 B) $162,183 C) $163,832 D) $164,631

: B Diff: 2 Keywords: Future Value, Monthly Compounding

: Analytic skills 3) What is the value of a bond that matures in 5 years, has an annual coupon payment of $110, and a par value of $2,000? Assume a required rate of return of 8.69%. A) $938.50 B) $1,876.99 C) $1,891.36 D) $1,749.83

: B Diff: 2 Keywords: Intrinsic Value, Bond Valuation

: Analytic skills 9) Andre owns a corporate bond with a coupon rate of 8% that matures in 10 years. Ruth owns a corporate bond with a coupon rate of 12% that matures in 25 years. If interest rates go down, then A) the value of Andre's bond will decrease and the value of Ruth's bond will increase. B) the value of both bonds will increase. C) the value of Ruth's bond will decrease more than the value of Andre's bond due to the longer time to maturity. D) the value of both bonds will remain the same because they were both purchased in an earlier time period before the interest rate changed.

: B Diff: 2 Keywords: Intrinsic Value, Time to Maturity

: Reflective thinking skills 82) What is the payback period for a project with an initial investment of $180,000 that provides an annual cash inflow of $40,000 for the first three years and $25,000 per year for years four and five, and $50,000 per year for years six through eight? A) 5.80 years B) 5.20 years C) 5.40 years D) 5.59 years

: B Diff: 2 Keywords: Payback Period

: Analytic skills 5) South Stage, Inc. preferred stock pays an annual dividend of $2.75 per share. If the stock is currently selling for $27.50 per share, what is the expected rate of return on this stock? A) 2.75% B) 10.0% C) 17.5% D) 27.5%

: B Diff: 2 Keywords: Preferred Stock, Expected Rate of Return

: Analytic skills 7) What is the value on 1/1/13 of the following cash flows: Date Cash Received Amount of Cash 1/1/14 $14,000 1/1/15 $20,000 1/1/16 $30,000 1/1/17 $43,000 1/1/18 $57,000 Use a 7% discount rate, and round your answer to the nearest $10. A) $153,270 B) $128,490 C) $112,350 D) $107,330

: B Diff: 2 Keywords: Uneven Cash Flows, Present Value

: Reflective thinking skills 17) Baxter Inc. has a target capital structure of 30% debt, 15% preferred stock, and 55% common equity. The company's after-tax cost of debt is 7%, its cost of preferred stock is 11%, its cost of retained earnings is 15%, and its cost of new common stock is 16%. The company stock has a beta of 1.5 and the company's marginal tax rate is 35%. What is the company's weighted average cost of capital if retained earnings are used to fund the common equity portion? A) 11.20% B) 12.00% C) 13.80% D) 14.45%

: B Diff: 2 Keywords: Weighted Average Cost of Capital

: Reflective thinking skills 21) PBJ Corporation issued bonds on January 1, 2006. The bonds had a coupon rate of 5.5%, with interest paid semiannually. The face value of the bonds is $1,000 and the bonds mature on January 1, 2021. What is the yield to maturity for an PBJ Corporation bond on January 1, 2012 if the market price of the bond on that date is $950? A) 5.50% B) 6.23% C) 8.43% D) 10.50%

: B Diff: 3 Keywords: Yield to Maturity, Semiannual Interest

: Reflective thinking skills 40) If we are able to fully diversify, what is the appropriate measure of risk to use? A) expected return B) standard deviation C) beta D) risk-free rate of return

: C Diff: 1 Keywords: Diversification, Beta

: Reflective thinking skills 8) The Modigliani and Miller hypothesis does NOT work in the "real world" because A) interest expense is tax deductible, providing an advantage to debt financing. B) higher levels of debt increase the likelihood of bankruptcy, and bankruptcy has real costs for any corporation. C) both A and B. D) dividend payments are fixed and tax deductible for the corporation.

: C Diff: 1 Keywords: Modigliani and Miller Hypothesis, Taxes, Bankruptcy Costs

: Reflective thinking skills 33) The simulation approach provides us with A) a single value for the risk-adjusted net present value. B) an approximation of the systematic risk level. C) a probability distribution of the project's net present value or internal rate of return. D) a graphic exposition of the year-by-year sequence of possible outcomes.

: C Diff: 1 Keywords: Simulation, Probability Distribution

: Reflective thinking skills 23) If you were to use the standard deviation as a measure of investment risk, which of the following has historically been the highest risk investment? A) common stock of large firms B) U.S. Treasury bills C) common stock of small firms D) long-term government bonds

: C Diff: 1 Keywords: Standard Deviation, Risk, Small Cap Common Stocks

: Analytic skills 23) Sunk costs are A) recoverable. B) incremental. C) not relevant in capital budgeting. D) not deductible for tax purposes.

: C Diff: 1 Keywords: Sunk Costs

: Reflective thinking skills 43) Butler Automotive developed a new diagnostic testing procedure that is expected to increase sales by $10,000 per month. As more drivers bring in their vehicles, Butler expects to also do more oil changes and brake repairs. As a result, inventory levels of oil and brake parts must be increased by $5,000. Revenues from oil changes and brake jobs are expected to increase by $4,000 per month. An example of a synergistic effect from the new diagnostic testing procedure is the A) increase in inventory levels of oil and brake parts. B) increase in revenue of $10,000 per month for the diagnostic testing. C) increase in revenues from oil changes and brake jobs of $4,000 per month. D) increase in all activities totaling $19,000 per month.

: C Diff: 1 Keywords: Synergistic Effects

: Analytic skills 62) Haroldson Inc. common stock is selling for $22 per share. The last dividend was $1.20, and dividends are expected to grow at a 6% annual rate. Flotation costs on new stock sales are 5% of the selling price. What is the cost of Haroldson's retained earnings? A) 5.73% B) 11.45% C) 11.78% D) 12.09%

: C Diff: 2 Keywords: Cost of Retained Earnings

: Reflective thinking skills 49) Phillips Enterprises Inc. is expected to pay a dividend of $2.60 next year. Dividends are expected to grow at a constant rate of 8% per year, and the stock price is currently $20.00. New stock can be sold at this price subject to flotation costs of 15%. The company's marginal tax rate is 35%. Compute the cost of internal equity (retained earnings) and the cost of external equity (new common stock), respectively. A) 0, 21.00% B) 8.00%, 23.29% C) 21.00%, 23.29% D) 23.00%, 25.48%

: C Diff: 2 Keywords: Cost of Retained Earnings, Cost of New Common Stock

: Reflective thinking skills 32) A Johnson corporation bond is currently selling for $850. The bond matures in 20 years, has a face value of $1,000, and a yield to maturity of 10.55%. The bond's coupon rate is A) 10%. B) 11%. C) 12%. D) 13%.

: C Diff: 2 Keywords: Coupon Rate, Bond Valuation

: Analytic skills 15) Today is your 21st birthday and your bank account balance is $25,000. Your account is earning 6.5% interest compounded monthly. How much will be in the account on your 50th birthday? A) $159,795 B) $162,183 C) $163,823 D) $164,631

: C Diff: 2 Keywords: Future Value, Monthly Compounding

: Analytic skills 12) Finance theory suggests that the current market value of a bond is based upon which of the following? A) the future value of interest paid on a bond B) the sum total of principal and interest paid on a bond C) the sum of the present value of the bond's interest payments and the present value of the principal D) the present value of a bond's par value plus the future value of the bond's present value

: C Diff: 2 Keywords: Market Value, Present Value

: Analytic skills 52) Project W requires a net investment of $1,000,000 and has a payback period of 5.6 years. You analyze Project W and decide that Year 1 free cash flow is $100,000 too low, and Year 3 free cash flow is $100,000 too high. After making the necessary adjustments A) the payback period for Project W will be longer than 5.6 years. B) the payback period for Project W will be shorter than 5.6 years. C) the IRR of Project W will increase. D) the NPV of Project W will decrease.

: C Diff: 2 Keywords: Payback Period, Net Present Value, Internal Rate of Return

: Reflective thinking skills 6) Stimpson Inc. preferred stock pays a $.50 annual dividend. What is the value of the stock if your required rate of return is 10%? A) $.05 B) $.50 C) $5.00 D) $50.00

: C Diff: 2 Keywords: Preferred Stock

: Analytic skills 36) Southland Tours has net income of $2 million this year. The book value of Southland Tours common equity is $8 million dollars. The company's dividend payout ratio is 60% and is expected to remain this way. What is Southland Tours' internal growth rate? A) 6% B) 9% C) 10% D) 15%

: C Diff: 2 Keywords: Sustainable Growth Rate

: Analytic skills 30) What is the yield to maturity of a bond that pays an 5% coupon rate with annual coupon payments, has a par value of $1,000, matures in 15 years, and is currently selling for $769? A) 2.4% B) 5.7% C) 7.6% D) 9.5%

: C Diff: 2 Keywords: Yield to Maturity

: Reflective thinking skills 3) Charlie Corporation has two bonds outstanding. Both bonds mature in 10 years, have a face value of $1,000, and have a yield to maturity of 8%. One bond is a zero coupon bond and the other bond has a coupon rate of 8%. Which of the following statements is true? A) Both bonds must sell for the same price if markets are in equilibrium. B) The zero coupon bond must have a higher price because of its greater capital gain potential. C) The zero coupon bond must sell for a lower price than the bond with an 8% coupon rate. D) All rational investors will prefer the 8% bond because it pays more interest.

: C Diff: 2 Keywords: Zero Coupon Bond, Coupon Rate, Bond Valuation

: Analytic skills 12) You believe in the power of compounding and decide to save $1 per day by avoiding the purchase of a soda. You deposit the $1 at the end of each day in a bank account that pays 8% interest compounded daily. You are going to take a trip in 20 years with the money you have accumulated. How much money will you have in 20 years, assuming 365 days per year? A) $7,500 B) $12,438 C) $18,032 D) $22,456

: C Diff: 3 Keywords: Annuity, Future Value, Compounding Periods

: Analytic skills 21) You are currently earning 12% compounded semiannually. Your investment company is switching all accounts to daily compounding. What rate will give you the same effective annual rate of return as you are receiving now? A) 10.83% B) 10.97% C) 11.66% D) 11.89%

: C Diff: 3 Keywords: Compounding Periods, Effective Annual Rate

: Reflective thinking skills 23) Which of the following is NOT true regarding common stock? A) Dividends, unlike interest payments, are not tax deductible. B) Common stock, unlike bond principal, does not mature. C) Common stockholders are owners of the firm, whereas bondholders are creditors. D) Dividend payments, like interest payments, are fixed.

: D Diff: 1 Keywords: Common Stock, Dividends

: Reflective thinking skills 20) A wildcat oil driller has enough capital to invest in only one project, that is, to drill one well in an East Texas oil field. A major oil company is drilling 100 wells in the same field. The probability of successfully striking oil is 10% for any well drilled in this field. Which of the following statements is MOST correct concerning the risk involved in these capital budgeting projects? A) The risk for the wildcat driller is the same as the risk for the major oil company since they are both drilling in the same oil field. B) The appropriate risk for the wildcat driller is systematic risk. C) The appropriate risk for the major oil company is contribution-to-firm risk, if all shareholders of the firm are well diversified. D) The best measure of risk for the wildcat oil driller is project standing alone risk.

: D Diff: 1 Keywords: Project Standing Alone Risk, Contribution-to-firm Risk, Systematic Risk

: Reflective thinking skills 17) Of the following different types of securities, which is typically considered most risky? A) long-term corporate bonds B) long-term government bonds C) common stocks of large companies D) common stocks of small companies

: D Diff: 1 Keywords: Risk, Stocks, Bonds

: Analytic skills 29) Marble Corp. has a beta of 2.5 and a standard deviation of returns of 20%. The return on the market portfolio is 15% and the risk free rate is 4%. What is the risk premium on the market? A) 5% B) 6% C) 9.00% D) 11%

: D Diff: 1 Keywords: Security Market Line, Market Risk Premium

: Analytic skills 32) The beta of ABC Co. stock is the slope of A) the security market line. B) the characteristic line for a plot of returns on the S&P 500 versus returns on short-term Treasury bills. C) the arbitrage pricing line. D) the characteristic line for a plot of ABC Co. returns against the returns of the market portfolio for the same period.

: D Diff: 2 Keywords: Beta, Characteristic Line

: Analytic skills 33) A local restaurant owner is considering expanding into another rural area. The expansion project will be financed through a line of credit with City Bank. The administrative costs of obtaining the line of credit are $500, and the interest payments are expected to be $1,000 per month. The new restaurant will occupy an existing building that can be rented for $2,500 per month. The incremental cash flows for the new restaurant include A) $500 administrative costs, $1,000 per month interest payments, $2,500 per month rent. B) $500 administrative costs, $2,500 per month rent. C) $1,000 per month interest payments, $2,500 per month rent. D) $2,500 per month rent.

: D Diff: 2 Keywords: Financing Cash Flow, Incremental Cash Flow

: Analytic skills 14) If market interest rates decline A) short-term bonds will decline in value more than long-term bonds. B) short-term bonds will rise in value more than long-term bonds. C) long-term bonds will decline in value more than short-term bonds. D) long-term bonds will rise in value more than short-term bonds.

: D Diff: 2 Keywords: Interest Rates, Intrinsic Value, Short-term Bonds, Long-term Bonds

: Analytic skills 69) Lithium, Inc. is considering two mutually exclusive projects, A and B. Project A costs $95,000 and is expected to generate $65,000 in year one and $75,000 in year two. Project B costs $120,000 and is expected to generate $64,000 in year one, $67,000 in year two, $56,000 in year three, and $45,000 in year four. Lithium, Inc.'s required rate of return for these projects is 10%. The modified internal rate of return for Project B is A) 17.84%. B) 18.52%. C) 19.75%. D) 22.80%.

: D Diff: 2 Keywords: Modified Internal Rate of Return

: Analytic skills 61) A capital budgeting project has a net present value of $30,000 and a modified internal rate of return of 15%. The project's required rate of return is 13%. The internal rate of return is A) greater than $30,000. B) less than 13%. C) between 13% and 15%. D) greater than 15%

: D Diff: 2 Keywords: Modified Internal Rate of Return, Net Present Value, Internal Rate of Return, Required Return

: Reflective thinking skills 3) You won the lottery and can receive either (1) $60,000 today, or (2) $10,000 one year from today plus $25,000 two years from today plus $35,000 three years from today. You plan to use the money to pay for your child's college education in 15 years. You should A) take the $60,000 today because of the time value of money regardless of current interest rates. B) take option two because you get $70,000 rather than $60,000 regardless of current interest rates. C) take the $60,000 today only if the current interest rate is at least 16.67% D) take the $60,000 today if you can earn 6.81% per year or more on your investments

: D Diff: 2 Keywords: Present Value, Uneven Cash Flows

: Analytic skills 11) A financial analyst tells you that investing in stocks will allow you to double your money in 7 years. What annual rate of return is the analyst assuming you can earn? A) 8.76% B) 9.87% C) 10.01% D) 10.41%

: D Diff: 2 Keywords: Rate of Return, Compound Interest

: Analytic skills 11) The risk-free rate of interest is 4% and the market risk premium is 9%. Howard Corporation has a beta of 2.0, and last year generated a return of 16% with a standard deviation of returns of 27%. The required return on Howard Corporation stock is A) 36%. B) 34%. C) 26%. D) 22%.

: D Diff: 2 Keywords: Required Return, Beta, Security Market Line

: Analytic skills 23) The DEF Company is planning a $64 million expansion. The expansion is to be financed by selling $25.6 million in new debt and $38.4 million in new common stock. The before-tax required rate of return on debt is 9 percent and the required rate of return on equity is 14 percent. If the company is in the 35 percent tax bracket, what is the firm's cost of capital? A) 8.92% B) 9.89% C) 11.50% D) 10.74%

: D Diff: 2 Keywords: Weighted Average Cost of Capital

: Analytic skills 19) Free cash flow calculations can be broken down into three parts: cash flows from operations, cash flows associated with working-capital requirements, and financing cash flows relating to interest and dividend payments.

: FALSE Diff: 1 Keywords: Free Cash Flow

: Analytic skills 5) Another name for an asset's expected rate of return is holding-period return.

: FALSE Diff: 1 Keywords: Holding Period Return, Expected Return

: Reflective thinking skills 1) The most critical aspect in determining the acceptability of a capital budgeting project is the impact the project will have on the company's net income over the projects entire useful life.

: FALSE Diff: 1 Keywords: Income vs. Cash Flow

: Reflective thinking skills 3) If project A generates $10 million of free cash flow over its five year useful life and project B generates $8 million of free cash flow over its useful life, then Project A will have a shorter payback period than Project B, assuming both projects require the same initial investment.

: FALSE Diff: 1 Keywords: Payback Period

: Reflective thinking skills 40) The payback period ignores the time value of money and therefore should not be used as a screening device for the selection of capital budgeting projects.

: FALSE Diff: 1 Keywords: Payback Period, Time Value of Money

: Reflective thinking skills 9) If a project is acceptable using the NPV criterion, then it will also be acceptable using the discounted payback period since both methods use discounted cash flows to make the accept/reject decision.

: FALSE Diff: 2 Keywords: NPV, Discounted Payback Period

: Reflective thinking skills 35) Because the NPV and PI methods both yield the same accept/reject decision, a company attempting to rank capital budgeting projects for funding consideration can use either method and get the same results.

: FALSE Diff: 2 Keywords: NPV, PI

: Analytic skills 18) Because financial markets can be extremely volatile, with bond and stock prices changing significantly from day to day, a firm's management has much greater control over the firm's operating leverage than over its financial leverage.

: FALSE Diff: 2 Keywords: Operating Leverage, Financial Leverage

: Analytic skills 83) Agri-Industries purchased some agricultural land at the edge of a large metropolitan area for $250,000 five years ago. In order to have the land classified as agricultural for property tax purposes, the company has been leasing the property to neighboring farmers. The before-tax return from leasing the property is $12,000 per year. This company's corporate tax rate is 35 percent. If the company sells the land for $400,000 today, what is the internal rate of return on this investment?

: Initial investment at time 0 = $250,000 Incremental after-tax cash flows time 1-5: (1-.35)($12,000)= $7,800 Terminal after-tax cash flow time 5: $400,000 - ($400,000 - $250,000)(.35) = $347,500 IRR = 9.56% Diff: 2 Keywords: Incremental After-Tax Cash Flows, Initial Outlay, Internal Rate of Return

: Reflective thinking skills 5) A certificate of deposit that pays 9.8% compounded monthly is better than a similar certificate of deposit that pays 10% compounded only once per year.

: TRUE Diff: 1 Keywords: APY, Effective Annual Rate

: Reflective thinking skills 4) For a given stated interest rate, an investor would receive a greater future value with daily compounding as opposed to monthly compounding.

: TRUE Diff: 1 Keywords: Future Value, Compounding Periods

: Reflective thinking skills 10) A firm can increase the growth rate of common stockholders' investment in the firm by retaining more earnings or increasing return on equity.

: TRUE Diff: 1 Keywords: Growth Rate, Common Stock, Retained Earnings, Return on Equity

: Reflective thinking skills 11) The modified internal rate of return represents the project's internal rate of return assuming that intermediate cash flows from the project can be reinvested at the project's required return.

: TRUE Diff: 1 Keywords: Modified Internal Rate of Return, Required Return

: Reflective thinking skills 14) The profitability index provides an advantage over the net present value method by reporting the present value of benefits per dollar invested.

: TRUE Diff: 1 Keywords: Profitability Index, Net Present Value

: Analytic skills 9) Tannerly Worldwide's common stock is currently selling for $48 a share. If the expected dividend at the end of the year is $2.40 and last year's dividend was $2.00, what is the rate of return implicit in the current stock price?

: rc = 2.40/48 + (2.40 - 2.00)/2.00 = .05 + .20 = 25% Diff: 2 Keywords: Expected Rate of Return, Dividend Yield, Growth Rate

: Analytic skills 69) The common stock for El Viss Company currently sells for $20 per share. The firm just paid a dividend of $1.50, and the dividend three years ago was $1.30. Dividends per share are anticipated to grow at the same rate in the future as they have over the past three years. Flotation costs for new shares will be 6% of the selling price. Calculate the following: a. the cost of retained earnings b. the cost of external equity capital

: a. g = 4.89% D1 = $1.50 × 1.049 = $1.57 Cost of retained earnings = $1.57/$20 + .049 = 12.75% b. Cost of external equity = $1.57/($20 × .94) + .049 = 13.25% Diff: 2 Keywords: Cost of Retained Earnings, Cost of New Common Stock

: Analytic skills 12) An investment will pay $500 in three years, $700 in five years and $1000 in nine years. If your opportunity rate is 6%, what is the present value of this investment?

: $1,534.79 Diff: 1 Keywords: Present Value, Uneven Cash Flows

: Reflective thinking skills 18) gat, Inc. has issued a $1,000 par 4% annual coupon bond that is to mature in 18 years. If your required rate of return is 6.5%, what price would you be willing to pay for the bond?

: $739.19 from Excel PV function with Rate = .065, Nper = 18, Pmt = 40, Fv = 1000, and Type = 0 Diff: 1 Keywords: Intrinsic Value, Required Return

: Analytic skills 36) You have $25,000 in an investment account today. How much will be in the account in 30 years if the account earns (a) 8% per year, (b) 8% compounded semiannually, (c) 8% compounded quarterly, (d) 8% compounded monthly, and (e) 8% compounded daily? Comment on the effect of more frequent compounding.

: (a) $251,566.42, (b) 262,990.69, (c) $269,129.08, (d) $273,393.24, (e) $275,506.95 The more frequent the compounding the higher the future value. However, there are diminishing returns Diff: 2 Keywords: Effective Annual Rate, Future Value

: Analytic skills 39) The expected return for the market portfolio is 13%, the expected return on U.S. Treasury Bills is 2%, and the expected return on AAA-rated short-term corporate bonds is 7%. Calculate the required return for a stock with a beta equal to 1.5.

: 2% + (13% - 2%)(1.5) = 18.5% Diff: 2 Keywords: Security Market Line, Beta, Required Return

: Analytic skills 68) You borrow $25,000 to buy a car, and agree to make 48 monthly payments of $607.39 to repay the loan. What annual rate of interest, which is being compounded monthly, are you being charged?

: 7.75% Diff: 2 Keywords: Annual Rate of Interest, Annuity, Loan Amortization

: Analytic skills 5) A bond maturing in 10 years pays $80 each year (including year 10) and $1,000 upon maturity. Assuming 10 percent to be the appropriate discount rate, the present value of the bond is A) $877.11. B) $1,000.00. C) $416.39. D) $1,785.67.

: A Diff: 1 Keywords: Present Value, Annuity, Single Sum, Bond

: Reflective thinking skills 24) Which of the following statements about project standing alone risk is true? A) It ignores the fact that much of the risk of a project will be diversified away as the project is combined with the firm's other projects. B) It ignores the cash flows that are associated with a project that occur beyond the payback period. C) It takes into consideration the effects of diversification of the firm's shareholders. D) It provides the best measure of project risk for a large, widely-held company.

: A Diff: 1 Keywords: Project Standing Alone Risk, Diversification

: Analytic skills 42) The recapture of net working capital at the end of a project will A) increase terminal year free cash flow. B) decrease terminal year free cash flow by the change in net working capital times the corporate tax rate. C) increase terminal year free cash flow by the change in net working capital times the corporate tax rate. D) have no effect on the terminal year free cash flow because the net working capital change has already been included in a prior year.

: A Diff: 1 Keywords: Recapture of Net Working Capital, Terminal Year Free Cash Flow

: Reflective thinking skills 9) A typical measure for the risk-free rate of return is the A) U.S. Treasury Bill rate. B) prime lending rate. C) money market rate. D) short-term AAA-rated bond rate.

: A Diff: 1 Keywords: Risk-Free Rate of Return, U.S. T-bill

: Reflective thinking skills 53) Assume that you have $165,000 invested in a stock whose beta is 1.25, $85,000 invested in a stock whose beta is 2.35, and $235,000 invested in a stock whose beta is 1.11. What is the beta of your portfolio? A) 1.37 B) 2.01 C) 1.85 D) 1.57

: A Diff: 2 Keywords: Beta, Portfolio

: Reflective thinking skills 24) Anchor Incorporated has a beta of 1.0. If the expected return on the market is 15%, what is the expected return on Anchor Incorporated's stock? A) 15% B) 14% C) 18% D) cannot be determined without the risk free rate

: A Diff: 2 Keywords: Beta, Security Market Line

: Analytic skills 25) Decker Corp. common stock has a required return of 17.5% and a beta of 1.75. If the expected risk free return is 3%, what is the expected return for the market based on the CAPM? A) 11.29% B) 14.29% C) 13.35% D) 15.27%

: A Diff: 2 Keywords: Beta, Security Market Line, Expected Return for the Market Portfolio

: Analytic skills 29) If Cindy deposits $12,000 into a bank account that pays 6% interest compounded semiannually, what will the account balance be in seven years? A) 18,151 B) 14,356 C) 16,987 D) 15,555

: A Diff: 2 Keywords: Future Value, semiannual Compounding

: Analytic skills 42) Crandle's common stock is currently selling for $79.00. It just paid a dividend of $4.60 and dividends are expected to grow at a rate of 5% indefinitely. What is the required rate of return on Crandle's stock? A) 11.11% B) 11.76% C) 12.2% D) 14.21%

: A Diff: 2 Keywords: Required Return, Constant Growth Dividend Valuation Model

: Analytic skills 47) You must add one of two investments to an already well- diversified portfolio. Security A Security B Expected Return = 14% Expected Return = 12% Standard Deviation of Standard Deviation of Returns = 15.0% Returns = 11% Beta = 1.5 Beta = 1.5 If you are a risk-averse investor, which one is the better choice? A) Security A B) Security B C) Either security would be acceptable. D) cannot be determined with information given

: A Diff: 2 Keywords: Well-diversified Portfolio, Risk-Return Trade Off, Beta

: Reflective thinking skills 7) A bond will sell at a premium (above par value) if A) the market value of the bond is greater than the discount rate of the bond. B) investor's current required rate of return is below the coupon rate of the bond. C) current market interest rates are moving in the same direction as bond values. D) the economy is in a recession.

: B Diff: 1 Keywords: Premium Bond, Required Return, Coupon Rate

: Analytic skills 11) QRM, Inc.'s marginal tax rate is 35%. It can issue 10-year bonds with an annual coupon rate of 7% and a par value of $1,000. After $12 per bond flotation costs, new bonds will net the company $966 in proceeds. Determine the appropriate after-tax cost of new debt for the firm to use in a capital budgeting analysis. A) 2.62% B) 4.87% C) 7.50% D) 7.8%

: B Diff: 2 Keywords: After-tax Cost of Debt, Flotation Costs

: Reflective thinking skills 18) Kohler Manufacturing typically achieves one of three production levels in any given year: 8 million pounds of steel, 10 million pounds of steel, or 16 million pounds of steel. In tracking some of its costs, Kohler's controller discovered one cost that was $10 per pound at a production level of 8 million pounds, $8 per pound at a production level of 10 million pounds, and $5 per pound at a production level of 16 million pounds. This is an example of a A) variable cost. B) fixed cost. C) semivariable cost. D) semifixed cost.

: B Diff: 2 Keywords: Fixed Costs Per Unit

: Analytic skills 68) Lithium, Inc. is considering two mutually exclusive projects, A and B. Project A costs $95,000 and is expected to generate $65,000 in year one and $75,000 in year two. Project B costs $120,000 and is expected to generate $64,000 in year one, $67,000 in year two, $56,000 in year three, and $45,000 in year four. Lithium, Inc.'s required rate of return for these projects is 10%.The modified internal rate of return for Project A is A) 19.19%. B) 24.18%. C) 26.89%. D) 29.63%.

: B Diff: 2 Keywords: Modified Internal Rate of Return

: Analytic skills 58) DYI Construction Co. is considering a new inventory system that will cost $750,000. The system is expected to generate positive cash flows over the next four years in the amounts of $350,000 in year one, $325,000 in year two, $150,000 in year three, and $180,000 in year four. DYI's required rate of return is 8%. What is the modified internal rate of return of this project? A) 10.87% B) 11.57% C) 13.68% D) 15.13%

: B Diff: 2 Keywords: Modified Internal Rate of Return

: Analytic skills 92) Consider a project with the following information: After-tax After-tax Accounting Cash Flow Year Profits from Operations 1 $799 $750 2 150 1,000 3 200 1,200 Initial outlay = $1,500 Compute the profitability index if the company's discount rate is 10%. A) 15.8 B) 1.61 C) 1.81 D) 0.62

: B Diff: 2 Keywords: Profitability Index

: Analytic skills 29) You are thinking of adding one of two investments to an already well- diversified portfolio. Security A Security B Expected Return = 14% Expected Return = 16% Standard Deviation of Standard Deviation of Returns = 16% Returns = -20% Beta = 1.2 Beta = 1.2 If you are a risk-averse investor, which one is the better choice? A) Security A B) Security B C) Either security would be acceptable because they have the same beta. D) Security B, but only if Security B's required return is greater than 12%

: B Diff: 2 Keywords: Risk-Aversion, Well-diversified Portfolio, Beta, Risk-Return Trade Off

: Reflective thinking skills 28) Who bears the greatest risk of loss of value if a firm should fail? A) bondholders B) preferred stockholders C) common stockholders D) All of the above bear equal risk of loss.

: C Diff: 1 Keywords: Claims on Assets, Bankruptcy, Risk

: Analytic skills 18) Your son is born today and you want to make him a millionaire by the time he is 50 years old. You deposit $10,700 in an investment account and want to know what annual interest rate must you earn in order to have the account value equal to $1,000,000 on your son's 50th birthday. A) 17.8% B) 12.4% C) 9.5% D) 6.2%

: C Diff: 1 Keywords: Compound Interest, Time Value of Money

: Reflective thinking skills 28) The present value of the expected future cash flows of an asset represents the asset's A) liquidation value. B) book value. C) intrinsic value. D) par value.

: C Diff: 1 Keywords: Intrinsic Value

: Analytic skills 57) When terminating a project for capital budgeting purposes, the working capital outlay required at the initiation of the project will A) not affect the cash flow. B) decrease the cash flow because it is a historical cost. C) increase the cash flow because it is recaptured. D) decrease the cash flow because it is an outlay.

: C Diff: 1 Keywords: Recapture, Net Working Capital

: Reflective thinking skills 15) The minimum rate of return necessary to attract an investor to purchase or hold a security is referred to as the A) stock's beta. B) investor's risk premium. C) investor's required rate of return. D) risk-free rate.

: C Diff: 1 Keywords: Required Rate of Return

: Reflective thinking skills 16) The relevant variable a financial manager uses to measure returns is A) net income determined using generally accepted accounting principles. B) earnings per share minus dividends per share. C) cash flows. D) dividends.

: C Diff: 1 Keywords: Returns

: Reflective thinking skills 27) Which of the following is NOT an important consideration in measuring risk for a capital budgeting project for a well-diversified firm? A) systematic risk B) contribution to firm risk C) total project risk D) None of the above—all may be important in measuring project risk

: C Diff: 1 Keywords: Risk, Total Project Risk, Systematic Risk, Contribution-to-firm Risk

: Analytic skills 39) Johnson Production Company paid a dividend yesterday of $3.50 per share. The dividend is expected to grow at a constant rate of 10% per year. The price of KayCee's common stock today is $40 per share. If KayCee decides to issue new common stock, flotation costs will equal $4.00 per share. KayCee's marginal tax rate is 35%. Based on the above information, the cost of retained earnings is A) 26.41%. B) 20.09%. C) 19.63%. D) 17.55%.

: C Diff: 2 Keywords: Cost of Retained Earnings

: Analytic skills 37) Messenger, Inc. bonds have a 4% coupon rate with semiannual coupon payments and a $1,000 par value. The bonds have 11 years until maturity, and sell for $925. What is the current yield for Messinger's bonds? A) 2.16% B) 3.45% C) 4.32% D) 5.52%

: C Diff: 2 Keywords: Current Yield

: Analytic skills 8) A bond will sell at a discount (below par value) if A) the market value of the bond is less than the present value of the discount rate of the bond. B) current market interest rates are moving in the same direction as bond values. C) investor's current required rate of return is above the coupon rate of the bond. D) the economy is booming.

: C Diff: 2 Keywords: Discount Bond, Required Return, Coupon Rate

: Analytic skills 80) Initial Outlay Cash Flow in Period 1 2 3 4 $4,000,000 $1,546,170 $1,546,170 $1,546,170 $1,546,170 The Internal Rate of Return (to nearest whole percent) is A) 10%. B) 18%. C) 20%. D) 24%.

: C Diff: 2 Keywords: Internal Rate of Return

: Analytic skills 14) Interstate Appliance Inc. is considering the following 3 mutually exclusive projects. Projected cash flows for these ventures are as follows: Plan A Plan B Plan C Initial Initial Initial Outlay=$3,600,000 Outlay=$6,000,000 Outlay=$3,500,000 Cash Flow: Cash Flow: Cash Flow: Yr 1=$ -0- Yr 1=$4,000,000 Yr 1=$2,000,000 Yr 2= -0- Yr 2= 3,000,000 Yr 2= -0- Yr 3= -0- Yr 3= 2,000,000 Yr 3=2,000,000 Yr 4= -0- Yr 4= -0- Yr 4=2,000,000 Yr 5=$7,000,000 Yr 5= -0- Yr 5=2,000,000 If Interstate Appliance has a 12% cost of capital, what decision should be made regarding the projects above? A) accept plan A B) accept plan B C) accept plan C D) accept Plans A, B and C

: C Diff: 2 Keywords: Net Present Value, Mutually Exclusive Projects

: Reflective thinking skills 74) All of the following are sufficient indications to accept a project EXCEPT (assume that there is no capital rationing constraint, and no consideration is given to payback as a decision tool) A) the net present value of an independent project is positive. B) the profitability index of an independent project exceeds one. C) the IRR of a mutually exclusive project exceeds the required rate of return. D) the NPV of a mutually exclusive project is positive and exceeds that of all other projects.

: C Diff: 2 Keywords: Net Present Value, Profitability Index, Internal Rate of Return, Mutually Exclusive Projects, Independent Projects

: Reflective thinking skills 2) Proper diversification generally results in the elimination of risk.

: FALSE Diff: 1 Keywords: Diversification, Risk

: Analytic skills 81) We compute the profitability index of a capital budgeting proposal by A) multiplying the internal rate of return by the cost of capital. B) dividing the present value of the annual after tax cash flows by the cost of capital. C) dividing the present value of the annual after tax cash flows by the cash investment in the project. D) multiplying the cash inflow by the internal rate of return.

: C Diff: 2 Keywords: Profitability Index

: Analytic skills 18) GHJ Inc. is investing in a major capital budgeting project that will require the expenditure of $16 million. The money will be raised by issuing $2 million of bonds, $4 million of preferred stock, and $10 million of new common stock. The company estimates is after-tax cost of debt to be 7%, its cost of preferred stock to be 9%, the cost of retained earnings to be 14%, and the cost of new common stock to be 17%. What is the weighted average cost of capital for this project? A) 12.20% B) 13.12% C) 13.75% D) 14.23%

: C Diff: 2 Keywords: Weighted Average Cost of Capital

: Analytic skills 21) Beauty Inc. plans to maintain its optimal capital structure of 40 percent debt, 10 percent preferred stock, and 50 percent common equity indefinitely. The required return on each component source of capital is as follows: debt--8 percent; preferred stock--12 percent; common equity--16 percent. Assuming a 40 percent marginal tax rate, what after-tax rate of return must the firm earn on its investments if the value of the firm is to remain unchanged? A) 12.40 percent B) 12.00 percent C) 11.12 percent D) 10.64 percent

: C Diff: 2 Keywords: Weighted Average Cost of Capital

: Analytic skills 31) PrimaCare has a capital structure that consists of $7 million of debt, $2 million of preferred stock, and $11 million of common equity, based upon current market values. The firm's yield to maturity on its bonds is 7.4%, and investors require an 8% return on the firm's preferred and a 14% return on PrimaCare's common stock. If the tax rate is 35%, what is Parker's WACC? A) 7.21% B) 8.12% C) 10.18% D) 12.25%

: C Diff: 2 Keywords: Weighted Average Cost of Capital, Capital Structure

: Reflective thinking skills 34) A corporate bond has a coupon rate of 9%, a face value of $1,000, a market price of $850, and the bond matures in 15 years. Therefore, the bond's yield to maturity is A) 9%. B) 24%. C) 11.1%. D) 13.45%.

: C Diff: 2 Keywords: Yield to Maturity

: Reflective thinking skills 19) A project would be acceptable if A) the payback is greater than the discounted equivalent annual annuity. B) the equivalent annual annuity is greater than or equal to the firm's discount rate. C) the profitability index is greater than the net present value. D) the net present value is positive.

: D Diff: 1 Keywords: Net Present Value, Equivalent Annual Annuity

: Reflective thinking skills 55) DYI Construction Co. is considering a new inventory system that will cost $750,000. The system is expected to generate positive cash flows over the next four years in the amounts of $350,000 in year one, $325,000 in year two, $150,000 in year three, and $180,000 in year four. DYI's required rate of return is 8%. What is the payback period of this project? A) 4.00 years B) 3.09 years C) 2.91 years D) 2.50 years

: D Diff: 1 Keywords: Payback Period

: Reflective thinking skills 26) What provision entitles the common shareholder to maintain a proportionate share of ownership in a firm? A) the cumulative feature B) the convertible feature C) the proportionality clause D) the preemptive right

: D Diff: 1 Keywords: Preemptive Right, Common Stock

: Reflective thinking skills 44) Beginning with an investment in one company's securities, as we add securities of other companies to our portfolio, which type of risk declines? A) systematic risk B) market risk C) non-diversifiable risk D) unsystematic risk

: D Diff: 1 Keywords: Unsystematic Risk, Diversification

: Analytic skills 26) Wildings, Inc. common stock has a beta of 1.2. If the expected risk free return is 4% and the expected market risk premium is 9%, what is the expected return on Wildings' stock? A) 10.0% B) 12.0% C) 13.8% D) 14.8%

: D Diff: 2 Keywords: Beta, Security Market Line, Market Risk Premium, Expected Return

: Analytic skills 4) As interest rates, and consequently investors' required rates of return, change over time the ________ of outstanding bonds will change as a result. A) maturity date B) coupon interest payment C) par value D) price

: D Diff: 2 Keywords: Bond Valuation, Interest Rates

: Analytic skills 13) Today is your 20th birthday and your bank account balance is $25,000. Your account is earning 6.5% interest compounded semiannually. How much will be in the account on your 50th birthday? A) $159,795 B) $162,183 C) $163,823 D) $170,351

: D Diff: 2 Keywords: Future Value, semiannual Compounding

: Analytic skills 50) AFB, Inc. requires an investment in equipment of $600,000 to replace existing equipment. The existing equipment will produce after-tax salvage value of $70,000. Net working capital requirements are increased by $50,000. What is the total cash outflow at time zero? A) $720,000 B) $650,000 C) $530,000 D) $580,000

: D Diff: 2 Keywords: Initial Outlay, Net Working Capital

: Reflective thinking skills 68) A new machine can be purchased for $1,200,000. It will cost $35,000 to ship and $15,000 to modify the machine. A $12,000 recently completed feasibility study indicated that the firm can employ an existing factory owned by the firm, which would have otherwise been sold for $180,000. The firm will borrow $750,000 to finance the acquisition. Total interest expense for 5-years is expected to approximate $350,000. What is the investment cost of the machine for capital budgeting purposes? A) $2,180,000 B) $1,780,000 C) $1,442,000 D) $1,430,000

: D Diff: 2 Keywords: Initial Outlay, Sunk Costs

: Analytic skills 2) What is the value of a bond that matures in 17 years, makes an annual coupon payment of $50, and has a par value of $1,000? Assume a required rate of return of 5.90%. A) $823.48 B) $856.98 C) $895.23 D) $905.02

: D Diff: 2 Keywords: Intrinsic Value, Bond Valuation

: Analytic skills 90) For the net present value (NPV) criteria, a project is acceptable if NPV is ________, while for the profitability index a project is acceptable if PI is ________. A) greater than zero; greater than the required return B) greater than or equal to zero; greater than zero C) greater than one; greater than or equal to one D) greater than or equal to zero; greater than or equal to one

: D Diff: 2 Keywords: Net Present Value, Profitability Index

: Analytic skills 18) Which of the following statements about the net present value is true? A) It produces a percentage result that is easy to describe. B) It has an inadequate reinvestment assumption. C) It is likely that there will be more than one NPV for a project. D) It may be used to select among projects of different sizes.

: D Diff: 2 Keywords: Net Present Value, Unequal Size Projects

: Analytic skills 7) Stock W has an expected return of 12% with a standard deviation of 8%. If returns are normally distributed, then approximately two-thirds of the time the return on stock W will be A) between 12% and 20%. B) between 8% and 12%. C) between -4% and 28%. D) between 4% and 20%.

: D Diff: 2 Keywords: Normal Distribution, Expected Return, Standard Deviation

: Analytic skills 37) You are analyzing the purchase of new equipment. Since you are not an expert on this type of equipment, you hire a consulting firm to make recommendations. The consultant charged you $1,500 and recommended the purchase of the latest model from ACME Corp. of America. The equipment costs $80,000, and it will cost another $10,000 to modify it for special use by your firm. The equipment will be depreciated on a straight-line basis over six years with no salvage value. You expect the equipment will be sold after three years for $28,000. Use of the equipment will require an increase in your company's net working capital of $4,000, but this $4,000 will be recovered at the end of year three. The use of the equipment will have no effect on revenues, but it is expected to save the firm $50,000 per year in before-tax operating costs. Your company's marginal tax rate is 35%. What is the terminal cash flow for this project? A) ($17,000) B) $24,500 C) $33,950 D) $37,950

: D Diff: 2 Keywords: Terminal Cash Flow, Recapture of Net Working Capital, Tax Effect

: Analytic skills 14) Using the weighted average cost of capital as the required rate of return for every project will A) cause a firm to reject projects that should have been accepted. B) cause a firm to accept projects that were too risky. C) result in maximization of shareholder wealth. D) A and B above

: D Diff: 2 Keywords: Weighted Average Cost of Capital, Accept/Reject Decision

: Reflective thinking skills 22) Because risk is measured by variability of returns, how long we hold our investments does not matter very much when it comes to reducing risk.

: FALSE Diff: 1 Keywords: Diversification, Risk Reduction

: Reflective thinking skills 14) Leveraged b (los) are used by existing corporate bondholders to increase the rate of return earned on their bonds.

: FALSE Diff: 1 Keywords: Leveraged Buyouts

: Reflective thinking skills 19) Liquidation value is of primary importance to investors because it represents the true amount of cash that an investor is likely to receive.

: FALSE Diff: 1 Keywords: Liquidation Value

: Reflective thinking skills 50) Calculating the modified internal rate of return on an Excel spreadsheet involves the use of the IRR function multiple times, once using the financing rate, and once using the reinvestment rate.

: FALSE Diff: 1 Keywords: MIRR, Excel, Reinvestment Rate

: Reflective thinking skills 6) The most relevant measure of risk for capital budgeting is project standing alone risk.

: FALSE Diff: 1 Keywords: Project Standing Alone Risk

: Reflective thinking skills 26) In a replacement decision, the initial outlay is equal to the cost of the new asset less the reduction in depreciation from elimination of the old asset.

: FALSE Diff: 1 Keywords: Replacement Project, Initial Outlay

: Reflective thinking skills 4) As the required rate of return of an investment decreases, the market price of the investment decreases.

: FALSE Diff: 1 Keywords: Required Rate of Return

: Reflective thinking skills 7) Investment A and Investment B both have the same expected return, but Investment A is more risky than Investment B. In the technical jargon of modern portfolio theory, Investment A is said to "dominate" Investment B.

: FALSE Diff: 2 Keywords: Risk-Return Trade Off

: Analytic skills 8) Negative historical returns are not possible during periods of high volatility (high standard deviations of returns) due to the risk-return tradeoff.

: FALSE Diff: 2 Keywords: Risk-Return Tradeoff, Historical Returns, Standard Deviation

: Reflective thinking skills 18) TRL, Inc. has spent $2,000,000 in nonrefundable engineering fees in contemplation of building a convention center and the additional costs to complete the project are $18,000,000. The present value of all benefits the center will produce in its lifetime are $19,000,000, so TRL should not build the convention center.

: FALSE Diff: 2 Keywords: Sunk Costs

: Analytic skills 11) Use the following data: Market risk premium = 10% Risk free rate = 2% Beta of XYZ stock = 1.6 Beta of PDQ stock = 2.4 Investment in XYZ stock = $15,000 Investment in PDQ stock = $60,000 You have no assets other than your investments in XYZ and PDQ stock. What is the expected return of your portfolio? Show all work.

: Portfolio Beta method: Bp = (15/75 × 1.6) + (60/75 × 2.4) = 2.24 Rp = .02 + (2.24 × .10) = .244 = 24.4% Weighting individual stock return method: RXYZ = .02 + (1.6 × .10) = .18 RPDQ = .02 + (2.4 × .10) = .26 WXYZ = $15,000/($15,000 + $60,000) = .2 WPDQ = $50,000/($15,000 + $50,000) = .8 RP = (.2 × .18) + (.8X .26) = .244 = 24.4% Both approaches are equivalent. Diff: 2 Keywords: Beta, Portfolio, Security Market Line

: Reflective thinking skills 5) Additional investment in working capital, even if it may be recovered at the end of a project, must be included in capital budgeting analysis because of the time value of money.

: TRUE Diff: 1 Keywords: Additional Working Capital, Recovery of Additional Working Capital, Time Value of Money

: Reflective thinking skills 11) If the cash flows of an accepted investment project are negatively correlated with the average cash flow of the firm's existing assets, then the company's total exposure to risk can decrease.

: TRUE Diff: 1 Keywords: Contribution-To-Firm Risk, Negative Correlation

: Reflective thinking skills 6) Bonds issued in a country different from the one in which the currency of the bond is denominated are called Eurobonds.

: TRUE Diff: 1 Keywords: Eurobonds

: Reflective thinking skills 4) Financial risk applies to both the additional variability in earnings available to common shareholders and the additional chance of insolvency caused by the use of financial leverage.

: TRUE Diff: 1 Keywords: Financial Risk, Variability, Insolvency, Financial Leverage

: Analytic skills 12) Fixed costs per unit vary inversely with production output.

: TRUE Diff: 1 Keywords: Fixed Costs Per Unit

: Reflective thinking skills 4) As production levels increase, fixed costs stay the same in total, but decrease on a per unit basis.

: TRUE Diff: 1 Keywords: Fixed Costs Per Unit

: Reflective thinking skills 13) Over the relevant range of output, fixed costs remain unchanged.

: TRUE Diff: 1 Keywords: Fixed Costs, Relevant Range

: Analytic skills 12) If a project is acceptable using the IRR criterion, it will also be acceptable using the MIRR criterion.

: TRUE Diff: 1 Keywords: IRR, MIRR

: Reflective thinking skills 5) A call provision entitles a company to repurchase its preferred stock from holders at stated prices over a given time period.

: TRUE Diff: 1 Keywords: Preferred Stock, Call Provision

: Reflective thinking skills 15) Two approaches that allow for the retirement of preferred stock are call provisions and sinking fund provisions.

: TRUE Diff: 1 Keywords: Preferred Stock, Call Provision, Sinking Fund Provision

: Reflective thinking skills 3) Preferred stock is less risky than common stock, but more risky than debt.

: TRUE Diff: 1 Keywords: Preferred Stock, Debt, Common Stock, Required Return

: Reflective thinking skills 4) A grocery store decides to offer beer for sale and this decision results in more potato chip sales. This is an example of a synergistic effect.

: TRUE Diff: 1 Keywords: Synergistic Effects

: Reflective thinking skills 2) If an old asset is sold for less than its book value the resulting loss will save the company taxes, hence lowering the cost of the project.

: TRUE Diff: 1 Keywords: Tax Effect, Sale of Old Machine, Book Value

: Analytic skills 4) One example of a terminal cash flow is the recapture of the net working capital associated with the project.

: TRUE Diff: 1 Keywords: Terminal Cash Flow, Recapture, Net Working Capital

: Analytic skills 9) Cash flows associated with a project's termination generally include the salvage value of the project net of any taxes associated with the sale.

: TRUE Diff: 1 Keywords: Terminal Year Cash Flows, Salvage Value, Tax Effect

: Reflective thinking skills 12) A firm's weighted average cost of capital is a function of (1) the individual costs of capital, (2) the capital structure mix, and (3) the level of financing necessary to make the investment.

: TRUE Diff: 1 Keywords: Weighted Average Cost of Capital

: Reflective thinking skills 2) A corporation may lower its cost of capital by shifting a portion of its total financing from a higher cost source of capital, such as common equity, to a lower cost source of capital, such as debt.

: TRUE Diff: 1 Keywords: Weighted Average Cost of Capital

: Reflective thinking skills 10) Break-even analysis assumes that a multiproduct firm maintains a constant production and sales mix.

: TRUE Diff: 2 Keywords: Break-even Analysis, Multiproduct Firm

: Reflective thinking skills 6) Bonds generally have a maturity date while preferred stocks do not.

: TRUE Diff: 1 Keywords: Bonds, Maturity Date, Preferred Stock

: Reflective thinking skills 3) Break-even analysis is a short-term concept because, in the long run, all costs are variable.

: TRUE Diff: 1 Keywords: Break-even Analysis

: Analytic skills 10) The break-even model assumes that selling price per unit and variable cost per unit of output are constant over the relevant range of output.

: TRUE Diff: 1 Keywords: Break-even Model, Selling Price Per Unit, Variable Cost Per Unit

: Reflective thinking skills 2) The break-even quantity of output is that quantity of output, in units, that results in an EBIT equal to zero.

: TRUE Diff: 1 Keywords: Break-even Quantity, EBIT

: Analytic skills 9) If sales double, the break-even model assumes that total variable costs will double.

: TRUE Diff: 1 Keywords: Break-even, Variable Costs

: Analytic skills 1) Business risk refers to the relative dispersion of a firm's earnings before interest and taxes.

: TRUE Diff: 1 Keywords: Business Risk

: Reflective thinking skills 3) The three major components responsible for variation in a company's income stream are business risk, operating risk, and financial risk.

: TRUE Diff: 1 Keywords: Business Risk, Operating Risk, Financial Risk

: Reflective thinking skills 22) The capital asset pricing model uses three variables to evaluate required returns on common equity: the risk free rate, the beta coefficient, and the market risk premium.

: TRUE Diff: 1 Keywords: CAPM

: Reflective thinking skills 6) According to the CAPM, for each unit of Beta an asset's required rate of return increases by the market's risk premium.

: TRUE Diff: 1 Keywords: CAPM, Beta, Required Return, Market Risk Premium

: Reflective thinking skills 3) The CAPM designates the risk-return tradeoff existing in the market, where risk is defined in terms of beta.

: TRUE Diff: 1 Keywords: CAPM, Risk-Return Trade Off, Beta

: Reflective thinking skills 3) According to the CAPM, systematic risk is the only relevant risk for capital budgeting purposes.

: TRUE Diff: 1 Keywords: CAPM, Systematic Risk

: Reflective thinking skills 2) The T-bill return is used in the CAPM model as the risk free rate.

: TRUE Diff: 1 Keywords: CAPM, T-bill, Risk-free Rate

: Reflective thinking skills 7) The Capital Asset Pricing Model may be used to estimate the cost of retained earnings.

: TRUE Diff: 1 Keywords: Capital Asset Pricing Model, Cost of Retained Earnings

: Reflective thinking skills 2) Capital budgeting decisions are based on free cash flow because free cash flow better reflects when money is received and available for reinvestment than account profits.

: TRUE Diff: 1 Keywords: Capital Budgeting Decisions, Free Cash Flow, Accounting Profits

: Reflective thinking skills 1) Free cash flows represent the benefits generated from accepting a capital-budgeting proposal.

: TRUE Diff: 1 Keywords: Capital Budgeting, Free Cash Flow

: Reflective thinking skills 18) The capital budgeting decision-making process involves measuring the incremental cash flows of an investment proposal and evaluating the attractiveness of these cash flows relative to the project's cost.

: TRUE Diff: 1 Keywords: Capital Budgeting, Incremental Cash Flows

: Analytic skills 20) For companies in competitive markets, the evolution and introduction of new products may serve more to preserve market share than to expand it.

: TRUE Diff: 1 Keywords: Capital Budgeting, Synergistic Effects

: Reflective thinking skills 29) If a firm imposes a capital constraint on investment projects, the appropriate decision criterion is to select the set of projects that has the highest positive net present value subject to the capital constraint.

: TRUE Diff: 1 Keywords: Capital Constraint, Net Present Value

: Reflective thinking skills 16) The firm's best financial structure is determined by finding the capital structure that minimizes the firm's cost of capital.

: TRUE Diff: 1 Keywords: Capital Structure, Cost of Capital

: Reflective thinking skills 15) Two key components of a prudent capital structure are the debt maturity composition and the debt to equity composition.

: TRUE Diff: 1 Keywords: Capital Structure, Debt Maturity Composition, Debt-Equity Composition

: Reflective thinking skills 14) Financial structure is equal to non-interest bearing liabilities, such as accounts payable and accruals, plus capital structure, which includes short- and long-term debt, preferred stock, and common equity.

: TRUE Diff: 1 Keywords: Capital Structure, Financial Structure

: Reflective thinking skills 2) Capital structure is equal to financial structure minus current liabilities.

: TRUE Diff: 1 Keywords: Capital Structure, Financial Structure

: Reflective thinking skills 7) Corporations utilize external financing either because they do not have sufficient earnings to reinvest or they want to rebalance their capital structures.

: TRUE Diff: 1 Keywords: Capital Structure, Internal Financing, External Financing

: Reflective thinking skills 8) Preferred stock is riskier than long-term debt because its claim on assets and income come after those of bonds.

: TRUE Diff: 1 Keywords: Claims on Income, Preferred Stock, Long-term Debt

: Reflective thinking skills 2) Because common stock represents a residual interest in the corporation, the value of common stock is equal to the total firm value less the firm's outstanding debt.

: TRUE Diff: 1 Keywords: Common Stock Valuation, Enterprise Value, Residual Interest

: Reflective thinking skills 1) The most relevant form of growth for valuing a firm's common stock is internal growth.

: TRUE Diff: 1 Keywords: Common Stock Valuation, Internal Growth

: Reflective thinking skills 11) Bondholders and preferred stockholders can be viewed as creditors, whereas the common stockholders are the true owners of the firm.

: TRUE Diff: 1 Keywords: Common Stock, Preferred Stock, Bonds

: Reflective thinking skills 7) In general, common stock and preferred stock are both valued by calculating the present value of all expected future cash flows, using the required return as the discount rate.

: TRUE Diff: 1 Keywords: Common Stock, Preferred Stock, Valuation, Present Value, Required Return

: Reflective thinking skills 9) Company unique risk can be virtually eliminated with a portfolio consisting of approximately 20 securities.

: TRUE Diff: 1 Keywords: Company Unique Risk, Diversification

: Analytic skills 3) If we invest money for 10 years at 8 percent interest, compounded semiannually, we are really investing money for 20 six-month periods, and receiving 4 percent interest each period.

: TRUE Diff: 1 Keywords: Compounding Periods, Time Value of Money

: Reflective thinking skills 4) Given the constant growth dividend valuation model, the expected percentage growth in value of a stock is equal to the capital gains yield for that stock.

: TRUE Diff: 1 Keywords: Constant Growth Dividend Valuation Model, Capital Gains Yield

: Reflective thinking skills 4) A project's contribution-to-firm risk does allow for diversification within the firm.

: TRUE Diff: 1 Keywords: Contribution-To-Firm Risk, Diversification

: Analytic skills 1) A small, family-owned corporation would be more likely to use the contribution-to-firm risk criteria rather than the systematic risk to evaluate capital budgeting projects.

: TRUE Diff: 1 Keywords: Contribution-To-Firm Risk, Systematic Risk

: Reflective thinking skills 24) The control hypothesis suggests that shareholders prefer an increase in the firm's debt in order to reduce the agency costs associated with excessive free cash flow.

: TRUE Diff: 1 Keywords: Control Hypothesis, Agency Costs

: Reflective thinking skills 7) Convertible bonds are debt securities that can be converted into a firm's stock at a prespecified price.

: TRUE Diff: 1 Keywords: Convertible Bonds

: Reflective thinking skills 4) If a firm were to earn exactly its cost of capital, we would expect the price of its common stock to remain unchanged.

: TRUE Diff: 1 Keywords: Cost of Capital, Firm Value

: Reflective thinking skills 2) The cost of a particular source of capital (debt, preferred stock, common stock) is equal to the investor's required rate of return after adjusting for the effects of both flotation costs and corporate taxes.

: TRUE Diff: 1 Keywords: Cost of Capital, Flotation Costs, Corporate Taxes

: Reflective thinking skills 3) The firm's cost of capital may also be referred to as the firm's opportunity cost of capital.

: TRUE Diff: 1 Keywords: Cost of Capital, Opportunity Cost of Capital

: Reflective thinking skills 10) A firm's cost of capital is the required rate of return on the firm's average project.

: TRUE Diff: 1 Keywords: Cost of Capital, Required Return

: Reflective thinking skills 11) The firm financed completely with equity capital has a cost of capital equal to the required return on common stock.

: TRUE Diff: 1 Keywords: Cost of Capital, Required Return on Common Stock

: Reflective thinking skills 2) The cost of capital is the rate that must be earned on an investment project if the project is to increase the value of the common shareholders' investment.

: TRUE Diff: 1 Keywords: Cost of Capital, Shareholder Value

: Reflective thinking skills 5) A corporation's cost of common equity may be estimated using either a dividend valuation model or the capital asset pricing model.

: TRUE Diff: 1 Keywords: Cost of Common Equity, Dividend Growth Model, Capital Asset Pricing Model

: Reflective thinking skills 6) Corporations have two costs of common equity, one for retained earnings and one if the company issues new common stock.

: TRUE Diff: 1 Keywords: Cost of Common Equity, Retained Earnings

: Reflective thinking skills 5) The cost of debt increases relative to the investor's required return due to flotation costs, but decreases relative to the investor's required return due to the tax deductibility of interest.

: TRUE Diff: 1 Keywords: Cost of Debt, Flotation Costs, Taxes, Interest

: Reflective thinking skills 4) The cost of preferred stock is equal to the preferred stock dividend divided by the net proceeds per preferred share.

: TRUE Diff: 1 Keywords: Cost of Preferred Stock, Net Proceeds, Flotation Costs

: Analytic skills 20) The cost of internal common equity is already on an after-tax basis since dividends paid to common stockholders are not tax deductible.

: TRUE Diff: 1 Keywords: Cost of Retained Earnings

: Analytic skills 14) Other things equal, management should retain profits only if the company's investments within the firm are at least as attractive as the stockholders' other investment opportunities.

: TRUE Diff: 1 Keywords: Cost of Retained Earnings, Shareholder Value

: Reflective thinking skills 13) Under cumulative voting a 10% shareholder will likely be able to elect 10% of the board of directors.

: TRUE Diff: 1 Keywords: Cumulative Voting, Board of Directors

: Reflective thinking skills 4) Cumulative voting is advantageous to minority shareholders because it may allow them to elect a member of the board of directors.

: TRUE Diff: 1 Keywords: Cumulative Voting, Minority Shareholders

: Reflective thinking skills 19) A corporation's debt capacity is the maximum proportion of debt that the corporation can include in its capital structure and still maintain its lowest composite cost of capital.

: TRUE Diff: 1 Keywords: Debt Capacity, Optimal Range of Financial Leverage

: Analytic skills 15) The presence of debt and/or preferred stock in a firm's financial structure means the firm is using financial leverage.

: TRUE Diff: 1 Keywords: Debt, Preferred Stock, Financial Leverage

: Reflective thinking skills 17) Depreciation expense produces a cash inflow equal to the depreciation expense multiplied by the firm's marginal tax rate.

: TRUE Diff: 1 Keywords: Depreciation Expense, Cash Inflow

: Reflective thinking skills 1) In an efficient market, two investors may agree on the amount and timing of a bond's expected cash flows and also on the bond's risk level, as measured by its debt rating, and still determine two different values for the bond.

: TRUE Diff: 1 Keywords: Determinants of Value, Bonds

: Reflective thinking skills 2) A bond selling at a discount will have a built-in capital gain if the bond is held to maturity.

: TRUE Diff: 1 Keywords: Discount Bond, Capital Gain

: Reflective thinking skills 14) The value of a bond investment, which provides fixed interest payments, will increase when discounted at a 8% rate rather than at a 11% rate.

: TRUE Diff: 1 Keywords: Discount Rate, Present Value, Annuity

: Reflective thinking skills 44) A major disadvantage of the discounted payback period is the arbitrariness of the process used to select the maximum desired payback period.

: TRUE Diff: 1 Keywords: Discounted Payback Period, Arbitrary Decision Rule

: Reflective thinking skills 42) The discounted payback period takes the time value of money into account in that it uses discounted free cash flows rather than actual undiscounted free cash flows in calculating the payback period.

: TRUE Diff: 1 Keywords: Discounted Payback Period, Time Value of Money

: Analytic skills 1) The benefits of diversification occur as long as the investments in a portfolio are not perfectly positively correlated.

: TRUE Diff: 1 Keywords: Diversification, Correlation

: Reflective thinking skills 23) The market rewards the patient investor, for between 1926 and 2008, there has never been a time when an investor lost money if she held an all-stock portfolio for ten years.

: TRUE Diff: 1 Keywords: Diversification, Investment Horizon

: Reflective thinking skills 13) Unique security risk can be eliminated from an investor's portfolio through diversification.

: TRUE Diff: 1 Keywords: Diversification, Portfolio

: Reflective thinking skills 8) An all-stock portfolio is more risky than a portfolio consisting of all bonds.

: TRUE Diff: 1 Keywords: Diversification, Portfolio Risk

: Reflective thinking skills 2) Historically, price appreciation, or capital gains yield, has accounted for a greater portion of returns on common stocks than dividend payments.

: TRUE Diff: 1 Keywords: Dividends, Returns on Common Stock, Price Appreciation

: Reflective thinking skills 2) An example of a Eurobond is a bond issued in Asia by a U.S. Corporation with interest and principal payments made in U.S. dollars.

: TRUE Diff: 1 Keywords: Eurobonds

: Reflective thinking skills 12) Inputs using an Excel spreadsheet are almost identical to those on a financial calculator, except the interest rate is entered either as a decimal (.05) or a whole number followed by a % sign (5%) rather than simply a whole number (5) as you would enter using a financial calculator.

: TRUE Diff: 1 Keywords: Excel, Financial Calculator

: Reflective thinking skills 3) The expected rate of return from an investment is equal to the expected cash flows divided by the initial investment.

: TRUE Diff: 1 Keywords: Expected Rate of Return, Expected Cash Flows

: Reflective thinking skills 7) When using a financial calculator, cash outflows generally have to be entered as negative numbers, because a financial calculator sees money "leaving your hands."

: TRUE Diff: 1 Keywords: Financial Calculator

: Reflective thinking skills 6) Fixed costs are called indirect costs while variable costs are called direct costs.

: TRUE Diff: 1 Keywords: Fixed Costs, Variable Costs, Direct Costs, Indirect Costs

: Reflective thinking skills 13) A project's annual free cash flow is the change in operating cash flow less any change in net working capital and less any change in capital spending.

: TRUE Diff: 1 Keywords: Free Cash Flow

: Reflective thinking skills 29) A project's annual free cash flow is the change in operating cash flow less any change in net working capital and less any change in capital spending.

: TRUE Diff: 1 Keywords: Free Cash Flow

: Analytic skills 1) In general, a project's free cash flows will fall in one of the following three categories: initial outlay, differential cash flows over the project's life, and the terminal cash flow.

: TRUE Diff: 1 Keywords: Free Cash Flow, Initial Outlay, Differential Cash Flows, Terminal Cash Flow

: Reflective thinking skills 12) Bill saves $3,000 per year in his IRA starting at age 25 and continuing to age 65, when he retires. The amount Bill has in his IRA at age 65 can be characterized as the future value of an annuity.

: TRUE Diff: 1 Keywords: Future Value of an Annuity

: Reflective thinking skills 16) The future value of an annuity due is greater than the future value of an otherwise identical ordinary annuity.

: TRUE Diff: 1 Keywords: Future Value, Annuity Due, Ordinary Annuity

: Reflective thinking skills 7) Tim invested $1,000 in a mutual fund paying 8% per year. John invested $500 in the same fund. If both Tim and John keep their money invested for the same period of time, Tim will end up with twice as much money as John.

: TRUE Diff: 1 Keywords: Future Value, Lump Sum

: Reflective thinking skills 6) The realized rate of return, or holding period return, is equal to the holding period dollar gain divided by the price at the beginning of the period.

: TRUE Diff: 1 Keywords: Holding Period Return, Holding Period Dollar Gain

: Analytic skills 2) IRR should not be used to choose between mutually exclusive projects.

: TRUE Diff: 1 Keywords: IRR, Mutually Exclusive Projects

: Reflective thinking skills 36) A project's IRR is analogous to the concept of the yield to maturity for bonds.

: TRUE Diff: 1 Keywords: IRR, Yield to Maturity

: Reflective thinking skills 10) In measuring cash flows we are interested only in the incremental or incremental after-tax cash flows that are attributed to the investment proposal being evaluated.

: TRUE Diff: 1 Keywords: Incremental After-Tax Cash Flows

: Reflective thinking skills 3) The guiding rule in deciding if a free cash flow is incremental is to look at the company with, versus without, the new project.

: TRUE Diff: 1 Keywords: Incremental Free Cash Flows

: Reflective thinking skills 6) An infinite-life replacement chain allows projects of different lengths to be compared.

: TRUE Diff: 1 Keywords: Infinite-life Replacement Chain

: Reflective thinking skills 24) The initial outlay includes the cost of purchasing the asset and getting it operational, including the purchase price, shipping and installation, and any training costs for employees who will be operating the equipment, and any increases in working capital requirements.

: TRUE Diff: 1 Keywords: Initial Outlay

: Reflective thinking skills 5) The initial outlay of a project may be reduced by the after-tax salvage value of replaced equipment.

: TRUE Diff: 1 Keywords: Initial Outlay, Salvage Value

: Reflective thinking skills 8) Interest expenses are not included as incremental free cash flows because the cost of funds is recognized as cash flows are discounted back to present value.

: TRUE Diff: 1 Keywords: Interest Expense, Risk-Adjusted Discount Rate

: Reflective thinking skills 15) Interest payments on debt are not included in a project's incremental cash flows, but are instead accounted for in the project's discount rate.

: TRUE Diff: 1 Keywords: Interest Payments, Financing Cash flows, Incremental Cash Flows, Discount Rate

: Analytic skills 1) Long-term bonds have greater interest rate risk than shorter-term bonds.

: TRUE Diff: 1 Keywords: Interest Rate Risk

: Reflective thinking skills 18) Artificially low interest rates helped create the housing bubble because low interest rates (r value) create higher values (higher PVs).

: TRUE Diff: 1 Keywords: Interest Rates, Present Value, Time Value of Money

: Reflective thinking skills 5) To determine the periodic interest payments that a bond makes, multiply the bond's stated coupon rate by its par value and divide by the number of coupon payments per year.

: TRUE Diff: 1 Keywords: Interest, Coupon Rate, Par Value

: Analytic skills 26) The internal rate of return is the discount rate that equates the present value of the project's future free cash flows with the project's initial outlay.

: TRUE Diff: 1 Keywords: Internal Rate of Return

: Reflective thinking skills 47) The internal rate of return is the discount rate that equates the present value of the project's free cash flows with the project's initial cash outlay.

: TRUE Diff: 1 Keywords: Internal Rate of Return

: Analytic skills 23) The internal rate of return will equal the discount rate when the net present value equals zero.

: TRUE Diff: 1 Keywords: Internal Rate of Return, Discount Rate, Net Present Value

: Reflective thinking skills 3) The sum of the present values of an investment's expected future cash flows is known as the investment's intrinsic value.

: TRUE Diff: 1 Keywords: Intrinsic Value

: Reflective thinking skills 4) In an efficient market, the market value and intrinsic value of a security should be equal.

: TRUE Diff: 1 Keywords: Intrinsic Value

: Reflective thinking skills 14) Junk bonds typically have an interest rate of between 3 and 5 percent more than AAA-rated long-term debt.

: TRUE Diff: 1 Keywords: Junk Bonds

: Reflective thinking skills 5) The expected yield on junk bonds is higher than the yield on AAA-rated bonds because of the higher default risk associated with junk bonds.

: TRUE Diff: 1 Keywords: Junk Bonds, Default Risk, Bond Yields

: Reflective thinking skills 4) Junk bonds are also called high-yield bonds.

: TRUE Diff: 1 Keywords: Junk Bonds, High-Yield Bonds

: Reflective thinking skills 2) The par value of a corporate bond indicates the payment that the issuer promises to make to the bondholder at maturity.

: TRUE Diff: 1 Keywords: Keywords: Par Value

: Reflective thinking skills 18) Limited liability for a corporation's common shareholders is a protective provision that aids the corporation in raising funds.

: TRUE Diff: 1 Keywords: Limited Liability

: Reflective thinking skills 15) Under majority voting a majority (>50%) shareholder will be able to elect the entire board of directors.

: TRUE Diff: 1 Keywords: Majority Voting, Board of Directors

: Reflective thinking skills 8) A reasonable estimate of the market risk premium based on historical data and expert opinion is between 5% and 7%.

: TRUE Diff: 1 Keywords: Market Risk Premium, Capital Asset Pricing Model

: Reflective thinking skills 11) The market value weights are preferred when calculating a firm's weighted average cost of capital.

: TRUE Diff: 1 Keywords: Market Value Weights, Weighted Average Cost of Capital

: Reflective thinking skills 19) When several sign reversals in the cash flow stream occur, a project can have more than one IRR.

: TRUE Diff: 1 Keywords: Multiple Internal Rates of Return, Sign Reversals

: Reflective thinking skills 21) NPV is the most theoretically correct capital budgeting decision tool examined in the text.

: TRUE Diff: 1 Keywords: NPV

: Reflective thinking skills 32) The main disadvantage of the NPV method is the need for detailed, long-term forecasts of free cash flows generated by prospective projects.

: TRUE Diff: 1 Keywords: NPV, Free Cash Flow

: Reflective thinking skills 37) NPV assumes reinvestment of intermediate free cash flows at the cost of capital, while IRR assumes reinvestment of intermediate free cash flows at the IRR.

: TRUE Diff: 1 Keywords: NPV, IRR, Reinvestment Rate

: Analytic skills 28) If a project is acceptable using the NPV criteria, it will also be acceptable when using the profitability index and IRR criteria.

: TRUE Diff: 1 Keywords: NPV, PI, IRR

: Reflective thinking skills 48) A project that is very sensitive to the selection of a discount rate will have a steep net present value profile.

: TRUE Diff: 1 Keywords: Net Present Value Profile

: Reflective thinking skills 38) A project's net present value profile shows how sensitive the project is to the choice of a discount rate.

: TRUE Diff: 1 Keywords: Net Present Value Profile, Discount Rate

: Reflective thinking skills 11) Operating leverage is the responsiveness of a firm's EBIT to changes in sales revenues.

: TRUE Diff: 1 Keywords: Operating Leverage

: Reflective thinking skills 7) Operating leverage contributes ultimately to the variability of a firm's earnings per share.

: TRUE Diff: 1 Keywords: Operating Leverage, Variability of EPS

: Reflective thinking skills 20) An opportunity cost is a relevant incremental cost for capital budgeting decisions.

: TRUE Diff: 1 Keywords: Opportunity Costs, Incremental Costs

: Analytic skills 1) Three of the most common options that can add value to a capital budgeting project are the option to delay the project, the option to expand the project, and the option to abandon the project.

: TRUE Diff: 1 Keywords: Options in Capital Budgeting

: Reflective thinking skills 7) Overhead costs are sometimes incremental cash flows and other times are considered sunk costs.

: TRUE Diff: 1 Keywords: Overhead Costs, Incremental Cash Flows

: Analytic skills 1) If a bond sells for its par value, the coupon interest rate and yield to maturity are equal.

: TRUE Diff: 1 Keywords: Par Value, Coupon Rate, Yield to Maturity

: Analytic skills 4) A project with a payback period of four years is acceptable as long as the company's target payback period is greater than or equal to four years.

: TRUE Diff: 1 Keywords: Payback Period

: Reflective thinking skills 12) One drawback of the payback method is that some cash flows may be ignored.

: TRUE Diff: 1 Keywords: Payback Period

: Reflective thinking skills 2) Advantages of the payback period include that it is easy to calculate, easy to understand, and that it is based on cash flows rather than on accounting profits.

: TRUE Diff: 1 Keywords: Payback Period

: Reflective thinking skills 31) One positive feature of the payback period is it emphasizes the earliest forecasted free cash flows, which are less uncertain than later cash flows and provide for the liquidity needs of the firm.

: TRUE Diff: 1 Keywords: Payback Period

: Analytic skills 1) The payback period may be more appropriate to use for companies experiencing capital rationing.

: TRUE Diff: 1 Keywords: Payback Period, Capital Rationing

: Analytic skills 17) One of the disadvantages of the payback method is that it ignores time value of money.

: TRUE Diff: 1 Keywords: Payback Period, Time Value of Money

: Analytic skills 1) A share of preferred stock that pays the same annual dividend forever is an example of a perpetuity.

: TRUE Diff: 1 Keywords: Perpetuity, Preferred Stock

: Reflective thinking skills 7) The amount of the preferred stock dividend is generally fixed either as a dollar amount or as a percentage of the par value.

: TRUE Diff: 1 Keywords: Preferred Stock Dividend

: Reflective thinking skills 1) Preferred stock is referred to as a hybrid security because it has many characteristics of both common stock and bonds.

: TRUE Diff: 1 Keywords: Preferred Stock, Hybrid Security

: Reflective thinking skills 2) Because most preferred stocks are perpetuities, their value can be determined by dividing the annual dividend by an investor's required return.

: TRUE Diff: 1 Keywords: Preferred Stock, Perpetuity, Intrinsic Value

: Reflective thinking skills 10) Although under normal operating conditions preferred shareholders do not have voting rights, protective provision generally allow for voting rights in the event of nonpayment of preferred dividends.

: TRUE Diff: 1 Keywords: Preferred Stock, Protective Provisions

: Reflective thinking skills 17) The same underlying formula is used for computing both the future value and present value.

: TRUE Diff: 1 Keywords: Present Value, Future Value

: Analytic skills 16) The present value of a single future sum of money is inversely related to both the number of years until payment is received and the discount rate.

: TRUE Diff: 1 Keywords: Present Value, Single Sum, Discount Rate

: Reflective thinking skills 27) If a project's profitability index is less than one then the project should be rejected.

: TRUE Diff: 1 Keywords: Profitability Index

: Reflective thinking skills 33) The profitability index is the ratio of the present value of the future free cash flows to the initial investment.

: TRUE Diff: 1 Keywords: Profitability Index

: Reflective thinking skills 2) The profitability index can be helpful when a financial manager encounters a situation where capital rationing is required.

: TRUE Diff: 1 Keywords: Profitability Index, Capital Rationing

: Analytic skills 10) Both the profitability index (PI) and net present value (NPV) are based on the present value of all future free cash flows, but the PI is a relative measure while the NPV is an absolute measure of a project's desirability.

: TRUE Diff: 1 Keywords: Profitability Index, Net Present Value

: Reflective thinking skills 7) A project's contribution to firm risk is relevant for undiversified investors or when bankruptcy costs exist.

: TRUE Diff: 1 Keywords: Project's Contribution to Firm Risk

: Reflective thinking skills 15) A common protective provision in a bond indenture is the limitation of dividends on the issuing firm's common stock.

: TRUE Diff: 1 Keywords: Protective Covenants, Bond Indenture

: Reflective thinking skills 15) A method for estimating a project's beta that attempts to identify publicly traded firms engage solely in the same business as the project is called the pure play method.

: TRUE Diff: 1 Keywords: Pure Play Method, Beta

: Reflective thinking skills 16) A company's market capitalization is generally greater than its book value, in part due to its reputation for being able to deliver growth, attract top talent, and avoid ethical mistakes.

: TRUE Diff: 1 Keywords: Reputation, Book Value, Market Capitalization

: Reflective thinking skills 13) The required rate of return reflects the costs of funds needed to finance a project.

: TRUE Diff: 1 Keywords: Required Return

: Reflective thinking skills 3) An investor's required rate of return for a common stock can be estimated by summing the stock's dividend yield and annual growth rate, assuming the growth rate is constant over time.

: TRUE Diff: 1 Keywords: Required Return, Dividend Yield, Growth Rate, Constant Growth Dividend Valuation Model

: Analytic skills 1) The expected rate of return implied by a given market price equals the required rate of return for investors at the margin.

: TRUE Diff: 1 Keywords: Required Return, Expected Return

: Reflective thinking skills 19) A security with a reasonably stable price will have a lower required rate of return than a security with an unstable price.

: TRUE Diff: 1 Keywords: Required Return, Variability of Returns

: Analytic skills 18) Investors require higher rates of return to compensate for purchasing power losses resulting from inflation.

: TRUE Diff: 1 Keywords: Required Returns, Inflation

: Reflective thinking skills 9) The retention ratio is equal to 1 minus the dividend payout ratio.

: TRUE Diff: 1 Keywords: Retention Ratio, Dividend Payout Ratio

: Analytic skills 12) Financial theory assumes that individuals are risk averse.

: TRUE Diff: 1 Keywords: Risk Aversion

: Reflective thinking skills 9) The use of risk-adjusted discount rates is based on the concept that investors require a higher rate of return for more risky projects.

: TRUE Diff: 1 Keywords: Risk-Adjusted Discount Rate, Risk/Return Tradeoff

: Reflective thinking skills 16) Sensitivity analysis involves changing one variable at a time.

: TRUE Diff: 1 Keywords: Sensitivity Analysis

: Reflective thinking skills 25) For a project with multiple sign reversals in its cash flows, the net present value can be the same for two entirely different discount rates.

: TRUE Diff: 1 Keywords: Sign Reversals, Net Present Value, Discount Rates

: Reflective thinking skills 5) If you only earned interest on your initial investment, and not on previously earned interest, it would be called simple interest.

: TRUE Diff: 1 Keywords: Simple Interest

: Reflective thinking skills 17) A typical decision rule used in simulation is to accept the project if the probability is sufficiently high that the net present value is positive.

: TRUE Diff: 1 Keywords: Simulation

: Reflective thinking skills 14) A sinking-fund provision allows for the retirement of a portion of preferred stock each year.

: TRUE Diff: 1 Keywords: Sinking Fund, Preferred Stock

: Reflective thinking skills 1) Subordinated debentures are more risky than unsubordinated debentures because the claims of subordinated debenture holders are less likely to be honored in the event of liquidation.

: TRUE Diff: 1 Keywords: Subordinated Debentures, Unsubordinated Debentures, Liquidation

: Analytic skills 18) As a rule, any cash flows that are not affected by the accept/reject criterion should not be included in capital-budgeting analysis.

: TRUE Diff: 1 Keywords: Sunk Costs

: Reflective thinking skills 6) Sunk costs are cash outflows that will occur regardless of the current accept/reject decision, and therefore should be excluded from the analysis.

: TRUE Diff: 1 Keywords: Sunk Costs

: Reflective thinking skills 10) To evaluate or compare investment proposals, we must adjust the value of all cash flows to a common date.

: TRUE Diff: 1 Keywords: Time Value of Money

: Reflective thinking skills 2) A rational investor would prefer to receive $1,200 today rather than $100 per month for 12 months.

: TRUE Diff: 1 Keywords: Time Value of Money

: Analytic skills 3) If the future value of an annuity is known, then the present value of the annuity can be found using the present value of a lump sum formula, even if the amount of each annuity payment is unknown.

: TRUE Diff: 1 Keywords: Time Value of Money, Annuity

: Analytic skills 2) The future value of an annuity will increase if the interest rate goes up, but the present value of the same annuity will decrease as the interest rate goes up.

: TRUE Diff: 1 Keywords: Time Value of Money, Annuity

: Analytic skills 1) If the future value of annuity A is greater than the future value of annuity B, then the present value of annuity A must also be greater than the present value of annuity B.

: TRUE Diff: 1 Keywords: Time Value of Money, Annuity Due, Ordinary Annuity

: Reflective thinking skills 13) Tim has $100 in a bank account paying 2% interest per year. At the end of 5 years, Tim's bank account balance will be $110 if interest is not compounded, but will be greater than $110 if interest is compounded.

: TRUE Diff: 1 Keywords: Time Value of Money, Compound Interest

1) The time value of money is the opportunity cost of passing up the earning potential of a dollar today.

: TRUE Diff: 1 Keywords: Time Value of Money, Opportunity Cost

: Reflective thinking skills 3) A timeline identifies the timing and amount of a stream of cash flows, along with the interest rate it earns.

: TRUE Diff: 1 Keywords: Timelines

: Reflective thinking skills 8) The mixture of financing sources used by a firm will vary from year to year, so many firms use target capital structure proportions when calculating the firm's weighted average cost of capital.

: TRUE Diff: 1 Keywords: Weighted Cost of Capital

: Reflective thinking skills 9) Using the weighted cost of capital as a cutoff rate assumes that the riskiness of the project being evaluated is similar to the riskiness of the company's existing assets.

: TRUE Diff: 1 Keywords: Weighted Cost of Capital

: Reflective thinking skills 10) Using the weighted cost of capital as a cutoff rate assumes that future investments will be financed so as to maintain the firm's target degree of financial leverage.

: TRUE Diff: 1 Keywords: Weighted Cost of Capital, Target Capital Structure

: Analytic skills 5) The yield to maturity is the discount rate that equates the present value of the interest and principal payments with the current market price of the bond.

: TRUE Diff: 1 Keywords: Yield to Maturity

: Reflective thinking skills 14) Jones Blanket Company sells blankets for $25 each. The variable cost of each blanket is $10. If fixed cost is $4,500,000 then the break-even point is 300,000 units.

: TRUE Diff: 2 Keywords: Break-even Point

: Reflective thinking skills 9) The moderate view of capital structure theory allows for the tax-deductibility of interest expense.

: TRUE Diff: 2 Keywords: Capital Structure Theory, Tax-deductible Interest

: Reflective thinking skills 3) The cost of debt capital is obtained by substituting the net proceeds per bond for the bond price in the bond valuation equation and solving for the required return.

: TRUE Diff: 2 Keywords: Cost of Debt

: Analytic skills 28) An increase in a corporation's marginal tax rate will decrease the corporation's cost of debt, but have no impact on its cost of preferred stock or cost of common equity.

: TRUE Diff: 2 Keywords: Cost of Debt, Cost of Preferred Stock, Cost of Common Equity, Marginal Tax Rate

: Reflective thinking skills 10) Other things the same, the use of debt financing reduces the firm's total tax bill resulting in a higher total market value.

: TRUE Diff: 2 Keywords: Debt Financing, Interest Tax Shield

: Reflective thinking skills 16) Borrowing funds using short-term debt, such as commercial paper, and using the proceeds to invest in long-term investments, creates a re-financing risk that can force firm's to sell assets at distressed prices if financing becomes unavailable.

: TRUE Diff: 2 Keywords: Debt Maturity Composition, Capital Structure

: Analytic skills 15) Depreciation is considered a fixed cost.

: TRUE Diff: 2 Keywords: Depreciation, Fixed Cost

: Reflective thinking skills 43) Any project deemed acceptable using the discounted payback period will also be acceptable if using the traditional payback period.

: TRUE Diff: 2 Keywords: Discounted Payback Period, Payback Period

: Reflective thinking skills 3) An EBIT-EPS analysis allows the decision maker to visualize the impact of different financing plans on EPS over a range of EBIT levels.

: TRUE Diff: 2 Keywords: EBIT-EPS Analysis

: Reflective thinking skills 4) Because there are no fixed financing costs, a common stock plan line in an EBIT-EPS analysis chart will have a less-steep slope than will a bond-plan line.

: TRUE Diff: 2 Keywords: EBIT-EPS Analysis

: Reflective thinking skills 5) One danger of EBIT-EPS analysis is that it ignores the implicit cost of debt financing.

: TRUE Diff: 2 Keywords: EBIT-EPS Analysis

: Analytic skills 14) If a company sells bonds and uses the proceeds to buy back common stock, the company's financial leverage with increase.

: TRUE Diff: 2 Keywords: Financial Leverage

: Reflective thinking skills 12) The more fixed-charge securities (such as bonds and preferred stock) the firm employs in its financial structure, the greater its financial leverage.

: TRUE Diff: 2 Keywords: Financial Leverage

: Analytic skills 13) An increase in financial leverage will increase the absolute value of EPS, everything else equal.

: TRUE Diff: 2 Keywords: Financial Leverage, EPS

: Reflective thinking skills 23) The implicit cost of debt takes into consideration the change in the cost of common equity brought on by using additional debt.

: TRUE Diff: 2 Keywords: Implicit Cost of Debt

: Reflective thinking skills 8) The independence hypothesis suggests that the total market value of the firm's outstanding securities is unaffected by its capital structure.

: TRUE Diff: 2 Keywords: Independence Hypothesis, Capital Structure

: Reflective thinking skills 11) The tax shield on interest is calculated by multiplying the interest rate paid on debt by the principal amount of the debt and the firm's marginal tax rate.

: TRUE Diff: 2 Keywords: Interest Tax Shield

: Reflective thinking skills 30) For any individual project, if the project is acceptable based on its internal rate of return, then the project will also be acceptable based on its modified internal rate of return.

: TRUE Diff: 2 Keywords: Internal Rate of Return, Modified Internal Rate of Return

: Reflective thinking skills 9) If a project's internal rate of return is greater than the project's required return, then the project's profitability index will be greater than one.

: TRUE Diff: 2 Keywords: Internal Rate of Return, Profitability Index

: Reflective thinking skills 20) If a bond has a market value that is higher than its par value, then the required return on the bond must be less than the bond's coupon rate.

: TRUE Diff: 2 Keywords: Market Value, Par Value, Required Return, Coupon Rate

: Reflective thinking skills 11) If a project's IRR is equal to its required return, then the project's NPV is equal to zero and its PI is equal to one.

: TRUE Diff: 2 Keywords: NPV, PI, IRR

: Reflective thinking skills 8) Operating leverage is measured as the responsiveness of the firm's earnings before interest and taxes relative to fluctuations in sales.

: TRUE Diff: 2 Keywords: Operating Leverage

: Reflective thinking skills 9) Financial leverage is typically more under the control of management than is operating leverage because the nature of the product often dictates the type of production process needed.

: TRUE Diff: 2 Keywords: Operating Leverage, Financial Leverage

: Reflective thinking skills 22) If we ignore bankruptcy and agency costs then the optimal capital structure for a firm under the moderate view would be 100% debt.

: TRUE Diff: 2 Keywords: Optimal Capital Structure, Capital Structure Theory, Bankruptcy Costs, Agency Costs

: Reflective thinking skills 3) In terms of risk, preferred stock is safer than common stock because it has a prior claim on assets and income.

: TRUE Diff: 2 Keywords: Preferred Stock, Common Stock, Risk

: Analytic skills 6) A common stock with an expected dividend growth rate of zero would be valued in the same way as preferred stock, that is, the expected dividend divided by the required return.

: TRUE Diff: 2 Keywords: Preferred Stock, Constant Growth Dividend Valuation Model

: Reflective thinking skills 13) The risk-adjusted discount rate for a replacement decision will be less than the rate used by the same firm when considering a new product line.

: TRUE Diff: 2 Keywords: Risk-Adjusted Discount Rate, Replacement Decision

: Reflective thinking skills 7) Stocks that plot above the security market line are underpriced because their expected returns exceed their risk-adjusted required returns.

: TRUE Diff: 2 Keywords: Security Market Line

: Reflective thinking skills 6) Small company stocks have historically had higher average annual returns than large company stocks, and also a higher risk premium.

: TRUE Diff: 2 Keywords: Small Company Stocks, Risk Premium

: Reflective thinking skills 18) A saucer-shaped or U-shaped weighted average cost of capital curve results from the tax deductibility of interest, which results in the downward slope, followed by the recognition of potential financial distress costs, that cause the upward slope as the amount of debt ratio increases.

: TRUE Diff: 2 Keywords: U-Shaped WACC Curve, Interest Deductibility, Financial Distress Costs

: Reflective thinking skills 21) Capital budgeting projects that expand sales are more likely to involve increases in working capital than are projects that involve the replacement of existing assets.

: TRUE Diff: 2 Keywords: Working-Capital Requirements

: Analytic skills 51) The price of DDS Corporation stock is expected to be $45 in 5 years. Dividends are anticipated to increase at an annual rate of 10 percent from the most recent dividend of $1.00. If your required rate of return is 15 percent, how much are you willing to pay for DDS stock?

: The expected cash flows are the future dividends plus the future selling price, Year D PV @ 15% 1 1.10 .96 2 1.21 .91 3 1.33 .88 4 1.46 .84 5 1.61 .80 $4.39 =PV of dividends only P = $4.39 + ($68/(1.155 = 22.37) = $26.76 Diff: 2 Keywords: Common Stock Valuation

: Analytic skills 12) Discuss whether the standard deviation of a portfolio is, or is not, a weighted average of the standard deviations of the assets in the portfolio. Fully explain your answer.

: The standard deviation of a portfolio is not a weighted average of the standard deviations of the assets in the portfolio. If the portfolio is well-diversified then it should have a standard deviation that is lower than most or all of the assets placed in that portfolio. Betas can be averaged, but standard deviations cannot, due to the diversifiable risk that is contained in the standard deviation but not reflected by beta. Diff: 2 Keywords: Standard Deviation, Portfolio, Diversification

: Analytic skills 40) A zero coupon bond is selling for $476. The bond has a face value of $1,000 and matures in 8 years. Your friend asks you if he should buy the bond. He tells you his required return is 9 percent. Would you recommend he buy the bond or not? Explain your answer.

: The yield to maturity on the zero coupon bond is ($1,000/$476)1/8 — 1 = 9.7%. Therefore, your friend should buy the bond. Diff: 2 Keywords: Yield to Maturity, Zero Coupon Bond

: Analytic skills 40) Security A has an expected rate of return of 29.8 percent and a beta of 3.1. Security B has a beta of 1.70. If the Treasury bill rate is 5 percent, what is the expected rate of return for Security B?

: Use A to determine the market risk premium. .298 = .05 + 3.1(market return - .05) .248 = (3.1 × market return) - .155 .403/3.1 = .13 = market return Return on B = .05 + 1.7(.13 - .05) = .186 = 18.6% Diff: 3 Keywords: Security Market Line, Beta, Expected Return, Treasury Bill

: Analytic skills 50) You are considering the purchase of Zee Company stock. You anticipate that the company will pay dividends of $3.50 per share next year and $4.00 per share the following year. You believe that you can sell the stock for $20.00 per share two years from now. If your required rate of return is 10 percent, what is the maximum price that you would pay for a share of Zee Company stock?

: VC = $3.50 (PVIF10%,1) + $24.00 (PVIF10%,2) = $23.02 Diff: 2 Keywords: Common Stock Valuation

: Analytic skills 16) Due to a number of lawsuits related to toxic wastes, a major chemical company has recently experienced a market revaluation. The firm has bonds outstanding that were issued 8 years ago at their par value of $1,000. These bonds have 12 years to maturity and a coupon rate of 6 percent, with interest paid semiannually. The required return on these bonds has increased to 14 percent. What is the current value of one of these bonds?

: Value of Bond = 30 (PVIFA7%,24) + 1000 (PVIF7%,24) = $541.23 Diff: 1 Keywords: Bond Valuation, Semiannual Interest

: Analytic skills 15) If Neal O'Danny preferred stock pays an annual dividend of $2.80, and investors require a 9% return, what is the value of O'Danny's preferred stock today?

: Vp = Div/R = $2.80/.09 = $31.11 Diff: 1 Keywords: Preferred Stock Valuation

: Analytic skills 42) If you are willing to pay $1,077 for a 15-year $1,000 par value bond that pays 9 percent interest semiannually, what is your expected rate of return?

: Yield to Maturity = 8.1% Diff: 2 Keywords: Yield to Maturity, Expected Rate of Return

: Reflective thinking skills 41) Jackson Corp $1,000 par value bonds currently sell for $752.18. The coupon rate is 7 percent, paid semiannually. If the bonds have 6 years before maturity, what is the yield to maturity on the bonds?

: Yield to maturity = 14.07%, using Excel YIELD function, with Settlement Date = "January 1, 2010", Maturity Date = "January 1, 2016", Rate = .07, Pr = 75.218, Redemption = 100, Frequency = 2, and Basis = 0 Diff: 2 Keywords: Yield to Maturity

: Reflective thinking skills 17) Beta is a measurement of the relationship between a security's returns and the general market's returns.

: TRUE Diff: 1 Keywords: Beta

: Reflective thinking skills 12) A security with a beta of one has a required rate of return equal to the overall market rate of return.

: TRUE Diff: 1 Keywords: Beta

: Reflective thinking skills 3) A stock with a beta of 1 has systematic or market risk equal to the "typical" stock in the marketplace.

: TRUE Diff: 1 Keywords: Beta, Systematic Risk

: Reflective thinking skills 6) A stock with a beta of 1.4 has 40% more variability in returns than the average stock.

: TRUE Diff: 1 Keywords: Beta, Variability

: Reflective thinking skills 17) In theory, shareholders select the board of directors, but in reality, management effectively selects the directors.

: TRUE Diff: 1 Keywords: Board of Directors, Agency Problems

: Reflective thinking skills 7) Bond prices are inversely related to market interest rates.

: TRUE Diff: 1 Keywords: Bond Prices, Interest Rates

: Reflective thinking skills 2) A bond with a par value of $1,000 is listed in the Wall Street Journal at a price of 100.50. This bond is selling for $1,005.

: TRUE Diff: 1 Keywords: Bond Quotation, Par Value

: Reflective thinking skills 16) A firm's bond rating would be favorably affected if they have a low use of financial leverage (debt).

: TRUE Diff: 1 Keywords: Bond Rating, Financial Leverage

: Reflective thinking skills 17) The value of a bond is inversely related to changes in the investor's present required rate of return.

: TRUE Diff: 1 Keywords: Bond Valuation, Required Return

: Analytic skills 82) Premium Pie Company needs to purchase a new baking oven to replace an older oven that requires too much energy to run. The industrial size oven will cost $1,200,000. The oven will be depreciated on a straight-line basis over its six-year useful life. The old oven cost the company $800,000 just four years ago. The old oven is being depreciated on a straight-line basis over its expected ten-year useful life. (That is, the old oven is expected to last six more years if it is not replaced now.) Due to changes in fuel costs, the old oven may only be sold today for $100,000. The new oven will allow the company to expand, increasing sales by $300,000 per year. Expenses will also decrease by $50,000 per year due to the more energy efficient design of the new oven. Premium Pie Company is in the 40% marginal tax bracket and has a required rate of return of 10%. a. Calculate the net present value and internal rate of return of replacing the existing machine b. Explain the impact on NPV of the following: i. Required rate of return increases ii. Operating costs of new machine are increased iii. Existing machine sold for less

: a. Calculate Initial Outlay Purchase Price $1,200,000 Sale of old (100,000) Tax savings from sale ($100,000 - 480,000) × .40 ($152,000) Initial Outlay 948,000 Incremental Cash Flow Book Profit Cash Flow Increased Sales $300,000 $300,000 Reduced costs 50,000 50,000 Increased depreciation* (120,000) Net savings (before tax) $230,000 Less taxes (40%) (92,000) (92,000) Net cash flow $258,000 *Depreciation on old machine: $800,000/10 = $80,000 Depreciation on new machine: $1,200,000/6 = $200,000 Increase Depreciation = $200,000 - $80,000 = $120,000 NPV = -$76,343 IRR = 7.8% b. i. NPV decreases ii. NPV decreases iii. NPV decreases Diff: 3 Keywords: Incremental After-Tax Cash Flows, Net Present Value, Initial Outlay

: Analytic skills 67) Dickerson Corporation's common stock is currently selling for $38. Last year's dividend was $4.00 per share. Investors expect dividends to grow at an annual rate of 7 percent indefinitely. Flotation costs of 4% will be incurred when new stock is sold. a. What is the cost of internal common equity? b. What is the cost of new common equity?

: a. D1 = $4.00 × 1.07 = $4.28 Cost of internal common equity = $4.28/$38 + .07 = 18.26% b. Cost of new common equity = $4.28/($38 × .96) + .07 = 18.73% Diff: 2 Keywords: Cost of Retained Earnings, Cost of New Common Stock, Flotation Costs

: Analytic skills 15) The MAX Corporation is planning a $4,000,000 expansion this year. The expansion can be financed by issuing either common stock or bonds. The new common stock can be sold for $60 per share. The bonds can be issued with a 12 percent coupon rate. The firm's existing shares of preferred stock pay dividends of $2.00 per share. The company's corporate income tax rate is 46 percent. The company's balance sheet prior to expansion is as follows: MAX Corporation Current Assets $2,000,000 Fixed Assets 8,000,000 Total Assets $10,000,000 Current Liabilities $1,500,000 Bonds: (8%, $1,000 par value) 1,000,000 (10%, $1,000 par value) 4,000,000 Preferred Stock: ($100 par value) $500,000 Common Stock: ($2 par value) 700,000 Retained Earnings 2,300,000 Total Liabilities and Equity $10,000,000 a. Calculate the indifference level of EBIT between the two plans. b. If EBIT is expected to be $3 million, which plan will result in higher EPS?

: a. EPS: Stock Plan EPS: Bond Plan (350,000)[EBIT(.54)-$269,200] = (416,667)[EBIT(.54)-$528,400] (189,000)EBIT-$94,220,000,000 = (225,000)EBIT-$220,000,000,000 (36,000)EBIT = $125,780,000,000 EBIT = $3,493,889 b. EPS: Stock Plan = = 3.24 EPS: Bond Plan = = $3.12 Stock plan has higher EPS. Diff: 3 Keywords: EBIT-EPS Analysis, Indifference Point, EPS

: Reflective thinking skills 24) You are considering a security with the following possible rates of return: Probability Return (%) 0.15 9.5 0.25 13.6 0.50 14.9 0.10 25.3 a. Calculate the expected rate of return. b. Calculate the standard deviation of the returns.

: a. Expected Return = (0.15)(9.5)+(0.25)(13.6)+(0.50)(14.9)+(0.1)(25.3) = 14.81% b. Std. Dev. = [(9.5 - 14.81)2(0.15) + (13.6 - 14.81)2(0.25) + (14.9 - 14.81)2(0.5) + (25.3 - 14.81)2(0.1)]1/2 = 3.95% Diff: 2 Keywords: Expected Rate of Return, Standard Deviation of Returns

: Reflective thinking skills 35) KLE Holdings is considering a capital budgeting project with a life of 7 years that requires an initial outlay of $277,400. The probability distribution for annual incremental cash flows is as follows: Probability Incremental Free Cash Flow 4% -$15,000 16% 18,000 55% 65,000 25% 99,000 a. The risk-adjusted required rate of return for this project is 12%. Calculate the risk-adjusted net present value of the project and the project's IRR. b. Should the project be accepted?

: a. Expected annual cash flow = (.04 × -$15,000) + (.16 × $18,000) + (.55 × $65,000) + (.25 × $99,000) = $62,780 Risk adjusted NPV = $9,112.64, IRR =13.03% b. Accept because NPV is positive and IRR exceeds the risk adjusted required return. Diff: 2 Keywords: Risk-Adjusted Net Present Value, IRR

: Analytic skills 84) Calculate the internal rate of return on the following projects: a. Initial outlay of $60,500 with an after-tax cash flow of $11,897 per year for eight years. b. Initial outlay of $647,000 with an after-tax cash flow of $118,000 per year for ten years. c. Initial outlay of $25,400 with an after-tax cash flow $11,788 per year for three years.

: a. IRR = 11.33% b. IRR = 12.74% c. IRR = 18571% Diff: 2 Keywords: Initial Outlay, Incremental Cash Flows, Internal Rate of Return

: Analytic skills 88) LEE Corporation intends to purchase equipment for $1,500,000. The equipment has a 5-year useful life and will be depreciated on a straight-line basis. Addition of the equipment requires additional working capital of $20,000. The $20,000 is expected to be recaptured at the end of the project. LEE's marginal tax rate is 40%. Use of the equipment is expected to change the company's reported EBIT by $600,000 in year one, $700,000 in year two, $550,000 in year three, $200,000 in year four, and $100,000 in year five. Due to changing market conditions, the equipment did have a salvage value of $100,000 at the end of year five. a. Calculate the initial outlay and the incremental free cash flows over the life of the project. b. If the risk-adjusted discount rate for this project is 20%, calculate the project's net present value and internal rate of return and comment on the acceptability of the project.

: a. Initial Outlay = $1,500,000 + $20,000 = $1,520,000 Incremental Free Cash Flows: Year 1 Year 2 Year 3 Year 4 Year 5 EBIT $600,000 $700,000 $550,000 $200,000 $100,000 Less Taxes (40%) 240,000 280,000 220,000 80,000 40,000 Plus Depreciation 300,000 300,000 300,000 300,000 300,000 Operating Cash Flow $660,000 $720,000 $630,000 $420,000 $360,000 Free Cash Flow $660,000 $720,000 $630,000 $420,000 $360,000 Salvage Value $100,000 Minus Tax on Gain -40,000 Plus Recovery of Working Capital 20,000 Terminal Cash Flow $80,000 Total Final Year Cash Flow $440,000 b. NPV = $273,956 and the project is acceptable since the NPV is positive. IRR = 28.73% and the project is acceptable since the IRR exceeds the required return. Diff: 2 Keywords: Incremental Free Cash Flows, Net Present Value, Internal Rate of Return

: Analytic skills 11) You are given the following probability distribution for XYZ common stock's returns during the next year, which are assumed to be normally distributed. Show all work below, and complete the following: Return Probability 12% 20% 16% 60% 20% 20% a. Calculate the standard deviation of the returns, and round to the nearest one-half percent. b. Draw a graphical representation of XYZ's normal distribution below (ye old bell-shaped curve). LABEL THE AXES OF THE GRAPH OR THE FOLLOWING RESULTS WILL BE MEANINGLESS. Using your result in part A for the standard deviation (rounded to the nearest one-half percent) explain and indicate on the graph, the probability that XYZ will return more than 13.5%, assuming a normal distribution.

: GRAPH: a. Exp. Return = (.12 × .2) + (.16 × .6) + (.2 × .2) = .16 Std. Dev. = [(.12 - .16)2(0.2) + (.16 - .16)2(0.6) + (.20 - .16)2(0.2)]1/2 = .0253 = 2.53% rounded to 2.5% b. The graph should have probability as the vertical axis and return (outcome, value of the variable, etc.) as the horizontal axis. It should be bell-shaped and centered at the 16% mean. 13.5% is one standard deviation below the mean. The text indicates that 2/3 of outcomes fall within one standard deviation of the mean for a normal probability distribution, so 2/3 of outcomes fall within 13.5% and 18.5%. Since one-half of the remaining 1/3 would be in the upper tail more than one standard deviation above the mean, 1/6 would fall above 16% + 2.5% = 18.5%. Thus, 2/3 + 1/6 = 5/6, or roughly 83% lie above 13.5%. Note, some students may have learned 68% fall within one standard deviation of the mean. Diff: 3 Keywords: Expected Return, Standard Deviation, Normal Deviation

: Analytic skills 73) Leigh Delight Candy, Inc. is choosing between two bonds in which to invest their cash. One is being offered from Hershey's and will mature in 10 years and pay $30 each quarter. The other alternative is a Mars' bond that will mature in 20 years and pay $30 each quarter. What would be the present value of each bond if the discount rate is 10% compounded quarterly, and each bond pays $1,000 at maturity?

: Hershey's: $1,125.51 Mars': $1,172.26 Diff: 2 Keywords: Annuity, Quarterly Compounding, Present Value, Bond

: Analytic skills 113) D&B Contracting plans to purchase a new backhoe. The one under consideration costs $233,000, and has a useful life of 8 years. After-tax cash flows are expected to be $31,384 in each of the 8 years and nothing thereafter. Calculate the internal rate of return for the grader.

: IRR = 1.69% from Excel Spreadsheet function IRR with cash flows of -233000 followed by eight cash flows of 3384) Diff: 2 Keywords: IRR

: Analytic skills 9) Define interest rate risk. How does a bond's level of interest rate risk depend on its maturity?

: Interest rate risk is the risk of changing (especially falling) bond prices from changing (especially rising) interest rates. If interest rates rise the bond's cash flows are discounted at a higher rate, thus the present value of its cash flows fall, thus its price falls. The longer the maturity, the greater the interest rate risk, because the distant cash flows are discounted a greater number of periods, and thus lose more value (or gain more value if interest rates fall). Diff: 2 Keywords: Interest Rate Risk

: Analytic skills 86) Dave Company, Inc. is considering purchasing a new grinding machine with a useful life of five years. The initial outlay for the machine is $165,000. The expected cash inflows are as follows: Year After-tax Expected Cash Flow 1 15,000 2 35,000 3 70,000 4 90,000 5 70,000 Given that the firm has a 10% required rate of return, what is the NPV?

: NPV = $35,089.72 Diff: 2 Keywords: Net Present Value, Initial Outlay, Incremental After-tax Cash Flows

: Analytic skills 42) Redesign Corp is considering a new strategy that would increase its expected return from 12% to 13.9%, but would also increase its beta from 1.2 to 1.8. If the risk free rate is 5% and the return on the market is expected to be 10%, should Redesign change its strategy?

: No. Currently the company's required return is 11% and the company is earning 12%. After the changes, the company's required return would increase to 14%, but its expected return would increase to only 13.9%. Thus, the increased return is not sufficient to justify the increase risk. Diff: 2 Keywords: Risk-Return Tradeoff, CAPM, Security Market Line, Beta

: Analytic skills 11) The common stock of Cranberry Inc. is selling for $26.75 on the open market. Next year's dividend is expected to be $3.68, and the growth rate of this company is estimated to be 5.5%. If Richard Dean, an average investor, is considering purchasing this stock at the market price, what is his expected rate of return?

: R = (D/V) + g R = ($3.68/$26.75) + .055 R = 19.26% Diff: 2 Keywords: Expected Rate of Return, Dividend Yield, Growth Rate

: Analytic skills 48) The Knight Corporation projects that next year its fixed costs will total $240,000. Its only product sells for $34 per unit, of which $18 is a variable cost. The management of Knight is considering the purchase of a new machine that will lower the variable cost per unit to $14. The new machine, however, will add to fixed costs through an increase in depreciation expense. How large can the addition to fixed costs be in order to keep the firm's break-even point in units produced and sold unchanged?

: Step 1 Compute the percent level of break-even output: QB = F/(P-V) = $240,000/($34-$18) = 15,000 units Step 2 Compute the new level of fixed cost at the break-even output: F + (14) (15,000) = 34 (15,000) F + 210,000 = 510,000 F = 300,000 Step 3 Compute the addition to fixed costs $300,000 - $240,000 = $60,000 addition Diff: 3 Keywords: Break-even Analysis

: Reflective thinking skills 2) The after-tax cost of debt is equal to one minus the marginal tax rate times the yield to maturity on the firm's outstanding debt.

: TRUE Diff: 1 Keywords: After-tax Cost of Debt, Yield to Maturity

: Reflective thinking skills 8) The present value of a deferred annuity (e.g., an annuity that starts 10 years from today) can be calculated in two steps: (1) calculate the future value of the annuity, and (2) calculate the present value of the amount determined in step (1).

: TRUE Diff: 1 Keywords: Annuity

: Reflective thinking skills 10) When solving a problem involving an annuity due, you must select the "beg" or beginning mode on your financial calculator.

: TRUE Diff: 1 Keywords: Annuity Due, Financial Calculator

: Reflective thinking skills 11) When solving time value of money problems using Excel, the type = 0 variable means payments are made at the end of each period, and the type = 1 variable means payments are made at the beginning of each period.

: TRUE Diff: 1 Keywords: Annuity, Excel

: Reflective thinking skills 4) Diversifying among different kinds of assets is called asset allocation.

: TRUE Diff: 1 Keywords: Asset Allocation, Diversification