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You purchased a stock today. What should you expect if the stock goes ex-dividend tomorrow?
The stock price should decline tomorrow.
On a large and healthy firm, the use of yield to maturity as the cost of debt when calculating WACC is appropriate because
bankruptcy is sufficiently low.
Which of these institutions are not major investors in U.S. equities?
banks
The slope of the fitted fit on a graph of observations of a stock return and the market return is called
beta
A stock's total risk depends on the stock's ________ and ________.
beta; market risk
The yield curve depicts the current relationship between:
bond yields and maturity.
Governments and corporations borrow money by selling _______ to investors.
bonds
A corporation will choose to go bankrupt only if the value of its assets is less than the amount of its ____________.
debt
The capital structure decision is the choice between
debt and equity financing
Bonds are defined as
debt securities
The fixed-income market is used to sell ______.
debt securities
The company cost of capital is calculated as a weighted average of the firm's _______ and _______.
debt; equity
If the general sentiment of investors is pessimistic, stock prices are more apt to:
decline.
The internal rate of return (IRR) is also called the:
discounted cash flow (DCF) rate of return
Discounting a future value FV at interest rate r over time t is termed a ______________ calculation.
discounted cash-flow
Risks are averaged out through
diversification
Corporations exchange dollars and other currencies in the
foreign exchange market
One reason suggesting that banks may be better than individuals at matching lenders to borrowers is that banks:
have information to evaluate creditworthiness.
When a firm issues 50,000 shares with a par value of $5 and a market price of $22 per share, additional paid in capital will:
increase by $850,000.
Changing the capital structure by adding debt will:
increase debtholder risk.
The cost of capital used by firms should be based on ______values of the firm's securities. (Use one word to fill in the blank.)
market
The yield to maturity assumes the bond is held to _____.
maturity
The financial objective of the corporation's financial managers is to
maximize the market value of the firm
The primary goal of corporate management should be to:
maximize the shareholders' wealth.
If net equity issues have been negative,
more shares have been repurchased than newly issued.
Successful firms are generally worth __________ their liquidation value.
more than
The time value of money concept states that a dollar today is worth _______ a dollar tomorrow.
more than
Increasing the amount debt makes debt ______ risky and equity _____ risky.
more, more
If two projects (investments) A and B are said to be mutually exclusive then we know that the firm ______________.
must choose to invest in either A or B, but not both.
Which type of investment pools its investors' savings and invests in a portfolio of securities?
mutual fund
Match the financial calculator keys on the left below with their correct functions listed on the right.
n - number of periods i - interest rate expressed as a percentage PV - Present Value FV - Future Value PMT - constant recurring payment
If changing discount rates from the company cost of capital to the project cost of capital changes NPV from negative to positive, then the project should use the:
project cost of capital and be accepted.
Corporate raiders will be looked upon most favorably if they:
take actions that increase current shareholder wealth.
Since interest payments on debt are paid out of before-tax income, debt reduces the ________ of the firm.
tax liability
The appropriate cost of capital to be used to discount risk-free projects is ________.
the Treasury bill rate of return
When a corporation fails, the maximum that can be lost by an individual shareholder is:
the amount of their initial investment.
Which of the following individuals or groups is responsible for appointing the top management of a corporation?
the board of directors
Which of the following are problems that managers may encounter when deciding between mutually exclusive projects?
the choice between short and long-lived equipment when equipment should be replaced the timing of investments
Which of the following statements are possible explanations for a high receivables turnover number?
the firm has a restrictive credit policy the firm has an efficient credit department that is quick to follow up on late payers unpaid bills are a small proportion of sales
When evaluating a single project for acceptance, the NPV and IRR decision rules will give the same result when _________.
the graph of NPV versus discount rate declines smoothly as discount rate increases
When considering mutually exclusive projects, the project that adds most to shareholder wealth is the one with:
the highest NPV
The Annual Percentage Rate (APR) on a loan or investment is properly defined as:
the interest rate per period multiplied by the number of compounding periods per year
Which of the following is a proper definition for the effective annual interest rate?
the interest rate that is annualized using compound interest
The payback period for a project can best be defined as:
the length of time before you recover your initial investment
True or false: the market value and book value of debt are often very similar, so many financial managers use book value in WACC calculations.
true
A disadvantage of a partnership is
unlimited liability
A firm that examines a competitor's market-to-book and P/E ratios is in the beginning stages of __________________.
valuation by comparables
A major limitation of using standard deviation of historical stock returns to predict future investment risk is ________.
variability of returns does not remain constant from year to year
Firms that make investment decisions based on the payback rule may be biased toward rejecting projects:
with long lives.
Public corporations can draw savings from investors
worldwide
The discount rate that makes the present value of the bond's payments equal to its price is known as the Multiple choice question. yield to maturity
yield to maturity
The discount rate that makes the present value of a bond's payments equal to its price is termed the:
yield to maturity.
What is the standard deviation of the market portfolio if the standard deviation of a well-diversified portfolio with a beta of 1.25 equals 20%?
16.00%
An investor purchases a share of stock today for $27.50 and holds it for a year. During the year the stock pays $4.50 in dividends. The investor sells the stock at the end of the year for $29.25. What is her dividend yield? (Record your answer as a percent rounded to one decimal place.)
16.4% Reason: Dividend yield = $4.50/$27.50 = 16.4%
According to CAPM estimates, what is the cost of equity for a firm with a beta of 1.5 when the risk-free interest rate is 6% and the expected return on the market portfolio is 15%?
19.5%
A project has an initial investment of $5 million and cash flows for 6 years of $1.5 million per year. What is the project's internal rate of return (IRR)? Hint: use your financial calculator or financial spreadsheet to answer this question. Or, use trial and error to see which discount rate below offers an NPV closest to zero.
19.9% Reason: An IRR of 19.9% gives an NPV of $673.16, which is the closest figure to zero.
The worst stock market crash in history in which stock prices fell by almost 90% happened in the year
1929
A mortgage company is advertising a 30 year fixed rate mortgage with monthly payments and an APR of 3.0 percent. What is the effective annual interest rate of this loan?
3.04% Reason: First, find the monthly interest rate: .03/12= .0025%. Next, convert this to an annually compounded interest rate: 1 + effective annual rate = (1 + monthly rate)12 = (1 + .0025)12= 1.0304. The effective annual interest rate is 3.04%.
A project has an initial investment of $125,000 and cash flows of $50,000 per year for 3 years. What is the project's internal rate of return (IRR)? Hint: use your financial calculator or financial spreadsheet to answer this question. Or, use trial and error to see which discount rate below offers an NPV closest to zero.
9.7%
For a firm with EBIT of $10 million, paying $6 million per year in interest expense, a drop in the corporate tax rate from 35% to 21% will have what impact on their interest tax shield?
$0.84 million lower
How much is $100 at the end of each year forever at 10% interest worth today?
$1,000 Reason: $100/.10 = $1,000
A dollar invested today at 8.0 percent simple annual interest will be worth _________ three years from now.
$1.24 Reason: With simple interest, the bank calculates interest only on the principal investment: $1.00 + $.08 + $.08 + $.08 = $1.24. Do not confuse this with compound interest, which computes interest earned on interest.
A dollar invested today at 8.0 percent interest compounded annually will be worth _______ three years from now.
$1.2597 Reason: FV=$1.00(1+0.08)^3
A project requires a $12 million initial investment and has expected after-tax cash flows of $2 million in perpetuity. The weighted-average cost of capital is 15%. What is the project's net present value (NPV)?
$1.33 million Reason: -$12 million + ($2 million/.15)=$1.33 million
An asset turnover ratio of 1.75 can be interpreted as:
$1.75 in sales are generated by every $1 of assets.
What is the value of the expected dividend per share for a stock that has a required return of 16%, a price of $45, and a constant-growth rate of 12%?
$1.80 Explanation $45 = DIV1/(0.16 − 0.12); Div1 = $1.80
What is the present value of $100 to be deposited today into an account paying 8%, compounded semiannually for 2 years?
$100.00
The total value of a firm's stock is $23.75 per share. The value of the firm's assets in place is $12 per share. What is the firm's present value of growth opportunities (PVGO)?
$11.75 Reason: Value of assets in place + PVGO = total value of stock; therefore $12 + PVGO = $23.75. PVGO = $23.75 - 12= $11.75
In 2013 the CPI was about 2.5 times its level in 1981. If the cost of one semester of college was $5000 in 1981, what should the nominal cost of a semester of college be in 2013 assuming the real price is constant?
$12,500 Reason: 2.5 x $5000= $12,500
What price will be paid for a U.S. Treasury bond with an ask price of 135.4062 if the face value is $100,000?
$135,406.20 Price = 1.354062 × $100,000 = $135,406.20
What is the future value of $100 invested for 4 years at 10% interest?
$146.41 Reason: FV = $100 x (1+r)t = $100 x (1+.1)4=$146.41
A car's price is currently $20,000 and is expected to rise by 4% a year. If the interest rate is 6%, how much do you need to put aside today to buy the car one year from now?
$19,623 Explanation Future price of car = ($20,000 × 1.04) = $20,800 PV = $ 20,800 / (1.06) = $19,623
How much would an investor lose the first year if she purchased a 30-year zero-coupon bond with a $1,000 par value and a 10% yield to maturity, only to see market interest rates increase to 12% one year later?
$19.93 Explanation Price = $1,000 / 1.1030 = $57.31 New price = $1,000 / 1.1229 = $37.38 Loss = $57.31 − 37.38 = $19.93
If the interest rate is 6%, which of these investments would you prefer?
A perpetuity of $30 a year starting in one year's time. Explanation PV($500 in year 3) = 500 / 1.063 = $419.81 PV ($40 a year for 20 years) = 40(1 / 0.06 − 1 / (0.06 × 1.0620)) = $458.80 PV ($30 in perpetuity) = 30 / 0.06 = $50
Which shareholder is more likely to receive regular dividend income?
A preferred stockholder
Which one of the following forms of compensation is most apt to align the interests of managers and shareholders?
A salary that is paid partly in the form of the company's shares
Companies who have rating of _____ can raise long-term debt at the lowest interest rate
AAA
Other things equal, which of the following will decrease the WACC of a firm that has both debt and equity in its capital structure?
An increase in the tax rate
How much does the $1,000 to be received upon a bond's maturity in 4 years add to the bond's price if the appropriate discount rate is 6%?
$792.09 Explanation $1,000 / 1.064 = $792.09
The average beta for all stocks (the beta of the market portfolio) is ____.
+1.0
If an investor purchases a security today for $9.00 and sells it tomorrow for $7.50, his capital gain will be _________.
--1.50 Reason: $7.50 - $9.00 = -$1.50
ABC Corporation has total liabilities of 45,500 and total assets of $63,900. Its total debt ratio is:
.712 Reason: $45,500/$63,900=.712
Rank the following in order of risk, from least risky to most risky.
1. Treasury Bills 2. Long-Term Treasury bonds 3. Common Stocks
ABC Corporation had sales of $4,000,000 and receivables of $350,000. ABC's receivables turnover ratio is _____.
11.43 Reason: Receivables turnover = sales/ receivables = $4,000,000/$350,000= 11.43
A stock has a beta of 1.5, the market risk premium is 6% and the risk-free rate is 2%. What is the lowest return the company should accept on a new investment?
12.50%
What is the yield to maturity on Dotte Inc.'s bonds if its after-tax cost of debt is 10% and its tax rate is 21%?
B) 12.66%Yield = 10%/(1-21%) = 12.66%
Which of the following financial assets is least likely to have an active secondary market?
Bank loans made to smaller firms
The expected return on a stock in a diversified portfolio is the risk-free rate plus a premium for risk. That risk premium is related to the stock's beta by which of the following equations?
Beta x market risk premium
Good corporate governance includes which of the following?
Boards of directors Activist shareholders Laws and regulations protecting investors
If ROE and the plowback ratio are held constant, then which of the following figures will increase at the sustainable growth rate?
Book equity Earnings Dividends
A type of pension plan that requires a percentage of the employee's paycheck to be contributed to the pension fund.
Defined-contribution
The financial crisis had its roots in which of the following policies?
Easy-money policies
Which one of these best defines the objective of a well-functioning financial market?
Establishing accurate security prices
True or false: Financial analysts are not responsible for monitoring and controlling risk.
False
True or false: IRR is essentially the same as the opportunity cost of capital.
False
True or false: If a corporation uses cumulative voting and you are a minority shareholder who wants a seat on the board, you will prefer staggering.
False
True or false: Most managers believe that short-term returns are better predictors than long-run historical returns.
False
Which market is used for debt securities?
Fixed-income market
Select all that apply Which of the following statements regarding the company cost of capital are true?
It is the minimum rate of return that the firm must earn on its average risk investments. It is used to value new assets that have the same risk as the existing ones. It is an opportunity cost.
Which of the following best describes the prime rate?
It is the rate charged by banks to large customers with very good credit
Which one of the following must be correct for a bond currently selling at a premium?
Its current yield is lower than its coupon rate.
An investor purchased a fixed-coupon bond at a time when the bond's yield to maturity was 6.9%. The investor sold the bond prior to maturity and realized a total return of 7.1%. Which of these most likely occurred while the investor owned the bond?
Market interest rates declined.
When is a corporation legally obligated to pay dividends to preferred stockholders?
Never
Which of the following are well known organized exchanges in the U.S.?
New York Stock Exchange NASDAQ
In MM's analysis, which one of these is not fixed?
Payout decisions ??
Which of the following expressions correctly calculates an investor's percentage capital gain?
Percentage capital gain = capital gain/initial share price
Which of the following expressions correctly calculates an investor's percentage return on a share of stock?
Percentage return = (capital gain + dividend)/initial share price
Sole proprietors are subject to which type of liability?
Personal
Which of the following ratios measures the proportion of sales that finds its way into profits?
Profit margin
Which of the following investment criteria takes the time value of money into consideration?
Profitability index, internal rate of return, and net present value
Projects A and B are mutually exclusive lending projects. Project A has an IRR of 20% while Project B has an IRR of 30%. You would be more likely to choose B unless:
Project A is twice the size of Project B.
What are the conditions imposed on a debt issuer that are designed to protect bondholders ?
Protective covenants
Which debt is paid first in the event of bankruptcy?
Senior Debt
Which one of the following gives a corporation its permanence?
Separation of ownership and control
Who elects the board of directors?
Shareholders
Who is entitled to any profits that are left after lenders have been paid?
Shareholders
Which one of these statements is correct?
Smart investment decisions create more value than smart financing decisions.
Why should stock market investors ignore specific risks when calculating required rates of return?
Specific can be diversified away.
The U.S. Treasury issues ___________, which adjust nominal cash flows based on the consumer price index.
TIPS Reason: Treasury Inflation-Protected Securities (TIPS) are inflation-indexed bonds that adjust nominal cash flows based on changes in the consumer price index.
Which one of the following is most likely for a CCC-rated bond, compared to a BBB-rated bond?
The CCC bond will offer a higher promised yield to maturity
An investor owns 5,000 shares, which is 1% of a corporation's outstanding stock before a stock repurchase. The investor did not sell any of his stock during the 25,000 share repurchase. Which one of the following statements is correct?
The investor owns more than 1% of the corporation.
Which of the following is least likely to be discussed in the articles of incorporation?
The price range of the shares of stock
All of the following are true of retained earnings except: They are the difference between paid-in capital and the total dividends paid. They represent the amount of new capital shareholders have indirectly contributed. They are equal to the cumulative earnings less dividends. They are the amount of earnings plowed back into the firm.
They are the difference between paid-in capital and the total dividends paid.
How many IRRs are possible for the following set of cash flows? CF0 = −$1,000, C1 = $500, C2 = −$300, C3 = $1,000, C4 = $200.
Three
Which of the following ratios shows the extent to which interest obligations are covered by earnings?
Times interest earned ratio
Why do investors require a market risk premium to invest in common stock? (select all that apply)
To compensate them for the extra risk of investing in common stock over risk-free Treasury bills. Because stock returns fluctuate widely over time and may be negative, while Treasury bill returns are relatively stable and risk free.
Which of the following is the primary motive for creating dual or multiple classes of stock?
To maintain control of the firm
Which of the firm's financial managers is most likely to be involved with obtaining financing for the firm?
Treasurer
Companies can pay out cash to their shareholders in two ways. They can pay a dividend or they can buy back some of their outstanding shares.
True
Investors often interpret a stock split announcement as a signal of management's confidence in the future.
True
True or false: An efficient market absorbs new information immediately, thereby making it very difficult to detect undervalued stocks and to beat the market consistently.
True
True or false: Treating customers and employees fairly can help maximize the value of the firm.
True
True or false: When choosing among mutually exclusive projects, choose the one that offers the highest NPV.
True
True or false: a market "bubble" is characterized by stock prices that are at levels in excess of what would be justified by expected dividends and earnings. In short, the market is seriously overpriced for some class of stocks.
True
True or false: individual projects which seem risky to a firm do not contribute much risk to the portfolio of a diversified investor.
True
True or false: the dividend yield is an indicator of how much dividend income you will receive for every $100 you invest in the stock.
True
True or false: the nominal interest rate can be defined as an interest rate quoted today by a financial institution on a loan or investment, such as an APR or a periodic rate.
True
Which one of these is the safest investment?
U.S. Treasury bills
Select all of the terms below that are related to the riskiness of an asset investment.
Volatility of returns Variability of returns Standard deviation of returns
What are some of the limitations of using an historical market risk premium to forecast future market returns? (select all that apply)
We cannot be sure that investors demand the same risk premium today as in the past. Some financial managers and economists believe that the historical risk premium is too large, It is very difficult to measure the market risk premium exactly.
If markets are efficient, when new information about a stock becomes available, the price will:
accurately and rapidly adjust to include this new information.
Stock is almost always sold to investors at a price that exceeds the par value. This additional amount over par is recorded on the company's books as ____________ or _____________.
additional paid in capital capital surplus
The difference between the issue price and par value of a stock is the _______________.
additional paid-in capital
MM's assertion that dividend policy will not affect the value of the firm requires that dividend policy does not:
affect investment and borrowing policies.
Like common stock dividends, preferred stock dividends are paid out of ________ income.
after-tax
Return on capital is equal to
after-tax operating income divided by total capitalization
Losses in value from agency problems or from costs of mitigating such problems are known as
agency costs
When managers seek their own interests rather than the interests of the shareholders, the company incurs
agency costs.
When managers seek their own interests rather than the interests of the shareholders, the company is said to have:
agency problems
Managers of a corporation are the _____ of the shareholders.
agents or representatives
In the case of a limited liability partnership, ________ has/have limited liability.
all of the partners
In theory, the "market portfolio" should contain:
all risky assets
The WACC is the return the company needs to earn after tax in order to satisfy
all security holders
The weighted average cost of capital is the expected rate of return investors would demand on a portfolio of:
all the firm's outstanding securities
When the annual rate of return on U.S. Treasury bills is historically high, investors expect the return on the stock market:
also to be high.
A stock with a beta greater than 1.0 would be termed:
an aggressive stock, expected to increase more than the market increases
The Dow Jones Industrial Average is:
an index of 30 major stocks.
The announcement of a share repurchase may have a less positive effect on the firm's share price than a dividend increase announcement because ___________.
announcement of a share repurchase is not a commitment to future repurchases
The current yield on a bond is equal to
annual coupon payment divided by bond price
If interest is paid m times per year, then the per-period interest rate equals the:
annual percentage rate (APR) divided by m.
The effective annual interest rate is also known as the ______________.
annually compounded rate
A fixed stream of cash flows that ends after a specified number of years is called a(n):
annuity
A series of level payments that begins immediately for a specified period of time is called a(n):
annuity due
The present value of an annuity of $1 per period is called the ______________.
annuity factor
Risks that are peculiar to a single firm:
are called specific risks
Occasionally projects may have positive initial cash flows. Such projects:
are like borrowing money.
The purchaser of a bond pays the ______ price, whereas the investor who already owns the bond and sells it receives the ________ price.
asked, bid
Corporate debt depends on the value and the risk of the firm's
assets
An analyst who relies on past cycles of stock pricing to make investment decisions is:
assuming that the market is not even weak-form efficient.
The field of behavioral finance shows that _________ caused investors to pile more and more money into tech companies, causing the dot-com bubble.
attitudes toward risk
The WACC is the appropriate discount rate for use with ______ projects but should be adjusted ______ for lower risk ones.
average; downward
When a corporation fails to repay interest and/or principal payments on its debt, it may go into _______ and have to hand-over its assets to the creditors.
bankruptcy
Because interest payments on debt are paid out of _______ income and dividends are paid out of ________ income, debt has a tax advantage over equity.
before-tax; after-tax
The Profitability Index is also known as the ________.
benefit-cost ratio
Plot a firm's stock returns versus the market portfolio returns using data for a fixed period of time. The slope of the straight line fitted to those points is called:
beta
Projects whose earnings tend to be highly dependent upon the state of the economy have higher _______ than other projects.
beta
The CAPM predicts that the difference in return between stock A and stock B should be due only to the difference in the _______ of the two stocks.
beta
The following process will result in the calculation of a firm's ___________: 1)Observe the rates of return for the firm's stock and the overall market. 2) Plot the observations on a graph. 3) Fit a line showing the average return to the stock at different market returns.
beta
The sensitivity of a stock's return to the return on the market portfolio is called the stock's _____
beta
Financial managers are responsible for organizing and supervising the
capital budgeting process
Long-term financing decisions commonly occur in the:
capital markets.
The limit set on the amount of funds available for investment is referred to as:
capital rationing
When new shares of stock are sold at a price greater than par value, the excess over par is recorded as:
capital surplus.
Liquid assets are those that can be quickly converted to _______.
cash
The ________ sets the agenda and guides the board's deliberations, thereby having extra influence over the board.
chair of the board
Secured debt is tied to specific assets, called ______.
collateral
When determining if a ratio is good or bad, managers look at industry norms in order to
compare their measures with the measures of companies in the same line of business.
Permanence means that a corporation, in principle, can
continue without disruption if ownership changes hands exist forever survive even if managers quit
The individual responsible for the corporation's internal budgets is the
controller
A bond that may be converted entirely to shares of stock at the discretion of the bondholder is called a ______ bond.
convertible
Preferred stock that includes the option of exchanging it for the company's common stock is called _________ preferred stock.
convertible
Which type of bond generally offers the highest yield?
corporate
As debt is added to the capital structure, the:
cost of debt can be expected to rise.
The inventory turnover ratio compares:
cost of goods sold to inventory.
The interest payments to the bondholder are called the
coupon
A bond's _______ is fixed, but the present value is affected by changes in the ________.
coupon payment, interest rate
Which methods of payment allow individuals and businesses to send and receive payments quickly and safely?
credit cards electronic transfers checking accounts
If the market portfolio return decreases by 2%, then each firm's stock return will ________ by about _______ percent.
decrease; 2xbeta
If the cash coverage ratio exceeds the times interest earned ratio, then the firm has:
depreciable assets.
Internally generated cash is calculated as a combination of:
depreciation retained earnings
Markets for options and other derivatives is known as the
derivative market
An asset turnover ratio of 2.10 states that
each dollar of assets produced $2.10 in sales
Dividend changes are typically viewed by investors as signals of future changes in:
earnings
If a firm's ROE is held constant, then ________ will grow in direct proportion to equity.
earnings per share
The use of debt in the firm's capital structure will increase ROE if the firm:
earns a higher return than the rate paid on debt.
An asset's liquidity measures its:
ease and cost of being converted to cash.
Return on capital and return on assets are used instead of _____ to compare managers whose assets differ in size.
economic value added
Asset turnover, inventory turnover, and receivables turnover are all ratios used to measure a firm's __________.
efficiency
Which of the following industries have less-than-average exposure to macro and market risk?
electric utilities grocery stores
Ethical decision making by management has a payoff for shareholders in terms of:
enhanced firm reputation value.
The rate of return rule states that the rate of return is the discount rate at which NPV:
equals 0
Stock markets are also called _____ markets, since stockholders are said to own the common equity of the firm.
equity
The cash flow per period with the same present value as the cost of buying and operating a machine is called the:
equivalent annual annuity
A ________ is a bond that is sold internationally regardless of its currency of denomination.
eurobond
Dollars held on deposit in banks outside of the U.S. are called _______
eurodollars
Pounds held on deposit in banks outside of the U.K. are called _______.
europounds
The date after which a purchaser of stock is not eligible to receive the declared dividend is the _______.
ex-dividend date
A firm is considering expanding its current operations and has estimated the internal rate of return on that expansion to be 12.2%. The firm's WACC is 11.8%. Given this, you know that the:
expansion should be undertaken as it has a positive net present value.
A firm's present value of growth opportunities (PVGO) can be defined as the net present value of the firm's:
expected future investments
A bond's par value can also be called its:
face value
True or false: A firm will increase its value by increasing its dividends.
false
The duty that CEOs and financial managers are required to act fairly and responsibly in the stockholders' interests is known as a
fiduciary duty
A bank loan is a
financial asset
The main investments for a financial intermediary are in
financial assets
When businesses need to finance growth they can seek assistance from which of the following sources?
financial institutions financial markets
A quick ratio of .50 states that
for every dollar in current liabilities the company has $0.50 cents in quick assets
A current ratio of 2 states that
for every dollar in current liabilities the company has $2 in current assets
A firm with good corporate _______ will have few agency problems.
governance
For projects of higher than average risk, firms may use a discount rate that is _________ than the company cost of capital.
greater than
If interest rates fall, the rate of return on a bond will be _____ the yield to maturity.
greater than
A private investment fund that pursues high-risk investment strategies is known as a
hedge fund
Investment banks like Morgan Stanley or Goldman Sachs:
help companies sell their securities to investors.
It makes more sense for young firms to have a (high/low) earnings reinvestment rate.
high
Value stocks here are defined as those with ____(high/low) ratios of book value to market value; growth stocks are those with _____(high/low) ratios of book to market value.
high low
Other things being equal, the more frequent the compounding period, the:
higher the effective annual interest rate.
The wider the dispersion of returns on a stock, the:
higher the standard deviation
When the firm's budget is limited, then the firm should select the project with the __________.
highest PI ratio
The standard deviation of the returns of an individual security measures ___________.
how risky that security would be if held in isolation
Investing borrowed funds in a stock portfolio will generally:
increase the beta of the portfolio
The overall goal of capital budgeting projects should be to
increase the wealth of the firm's shareholders.
The overall goal of capital budgeting projects should be to:
increase the wealth of the firm's shareholders.
Corporations that issue financial securities such as stock or debt obligations to the public do so primarily to:
increase their access to funds.
If the market portfolio return increases by 1%, then each firm's stock return will ________ by about ________ percent.
increase; beta
In 2013 the CPI was about 2.5 times its level in 1981. If the price of a pack of cigarettes was $1.00 in 1981 and $5.00 in 2013, then the real price has ______ since 1981. The inflation-adjusted price today should be _______ if there had been no real growth in the price of a pack.
increased; $2.50
The corporation's financial managers have the important task of
increasing market value
Other things equal, a firm's sustainable growth rate could increase as a result of:
increasing the plowback ratio.
The New York Stock Exchange and NASDAQ require that the board of directors of their member firms have a majority of __________ directors.
independent outside
When firms decide to go public by issuing shares on an organized exchange, the first issue is called an
initial public offering
When a firm sells its shares to the public for the first time, this is called a(n) _________.
initial public offering (IPO)
The financial environment has two main segments: financial markets and financial _____.
institutions
Insurance companies raise money primarily through the sale of
insurance policies
When money is invested at compound interest, the growth rate is equal to the __________.
interest rate
The expected return on the stock market can be expressed as the sum of the _________ and a __________.
interest rate on Treasury bills; normal risk premium
The __________ on government bonds provide a benchmark for all interest rates.
interest rates
The present value of the cash payoffs anticipated by the investor in a stock is called the share's _____________.
intrinsic value
The average days in inventory ratio is equal to
inventory divided by daily cost of goods sold
Net common equity is the total amount contributed by shareholders in direct and indirect ways when the firm:
issues new stock plows back earnings
Bonds rated Ba or below by Moody's or BB and below by Standard & Poors are known as
junk bonds
A long-term rental agreement is called a:
lease
The long-term debt-equity ratio is a measure of:
leverage
A business organization that classifies partners as general or limited is called a
limited partnership
The market value of equity can be calculated by multiplying the _______ times _______.
market price per share; the number of shares outstanding
For a well-diversified investor, the only type of risk that matters is _______.
market risk
Free cash flow may be _________ for rapidly growing businesses that are reinvesting all of their earnings into new investments.
negative
A block holder is commonly defined as an investor who:
owns 5 percent or more of a firm's outstanding shares.
If The Wall Street Journal lists a stock's dividend as $1, then it is most likely the case that the stock:
paid $.25 per share per quarter for the past year.
The price at which a share of stock is recorded in the company's books when issued is referred to as the _________.
par value
Net common equity is the sum of ______ , _______ and _______ less _______.
par value; additional paid in capital; retained earnings; repurchased stock
In a partnership, how business decisions are to be made and how profits will be dispersed is set up in the
partnership agreement
"Double taxation" refers to:
paying taxes on profits at the corporate level and dividends at the personal level.
A stream of cash flows means that ________.
payments are made over time
The fraction of earnings paid out as dividends is a firm's:
payout ratio
A fund set up by an employer to provide for employees' retirement is known as a
pension fund
For well-diversified investors, the only relevant measure of investment risk is their __________.
portfolio beta
In general, ______ shareholders do not have the right to vote.
preferred
What must happen to asset turnover to leave ROE unchanged from its original 16% level if the operating profit margin is reduced from 8% to 6% and the leverage ratio increases from 1.2 to 1.6? Asset turnover must:
remain constant. Explanation Original: ROE = leverage ratio × asset turnover × operating profit margin 0.16 = 1.2 × asset turnover × 0.08 Asset turnover = 1.67 New: 0.16 = 1.6 × asset turnover × 0.06 Asset turnover = 1.67
Economic value added is also referred to as
residual income.
An indirect form of shareholder investment in the company that occurs when the company keeps some portion of its profits for reinvestment is called __________.
retained earnings
Earnings not paid out as dividends are called:
retained earnings
When interest rates fall, bond prices
rise
The security market line describes the expected returns and risks from dividing a portfolio between _________ and _________.
risk-free securities; the market portfolio
The receivables turnover ratio is equal to
sales divided by receivables
The asset turnover ratio is equal to
sales divided by total assets
When investors sell shares of a firm's stock to each other on an exchange or through an electronic network, this is called a __________ transaction.
secondary market
A business organization in which a single person owns the assets and is responsible for the debt is known as a
sole proprietorship
Investment projects offering rates of return lower than the company's cost of capital
subtract value from the firm
MM's proposition of dividend irrelevance depends upon:
the efficiency of capital markets.
The opportunity cost of capital can best be described as:
the expected rate of return given up by investing in a project rather than in the capital market
For a company that pays no corporate taxes, its WACC will be equal to:
the expected return on its assets.
The appropriate cost of capital to be used to discount average risk projects is _________.
the expected return on the market portfolio
The total risk of a diversified portfolio of assets can be measured by _________
the standard deviation of the portfolio returns
The total risk of a diversified portfolio of assets can be measured by _________.
the standard deviation of the portfolio returns
To state that financing at current market terms is a zero-NPV transaction indicates that:
there are no bargains when financing at current terms
U.S. Treasury bills are nearly a risk-free investment because:
they are issued by the U.S. government they have short-term maturities
A graph of the yield curve shows the bond yield to maturity on the _____ axis and the time to maturity on the _____ axis.
vertical, horizontal
Disgruntled shareholders who sell all of their shares of stock in one company to purchase shares of stock in other companies are said to be taking the
wall street walk
The right to buy shares from a company at a stipulated price before a set date is called a ___________.
warrant
The right to buy shares from a company at a stipulated price before a set date is called a:
warrant
The CAPM assumes that the stock market is composed of _______ investors.
well-diversified
A total debt ratio of 0.35:
would exist if a firm had liabilities of $700 and assets of $2,000. Explanation Total debt ratio = total debt / assets = $700 / $2,000 = 0.35
A plot drawn to show the relationship between bond yields and maturity is known as the
yield curve
A measure of return that takes account of both coupon payments and change in a bond's value over its life is a standard measure known as
yield to maturity
If the after-tax cost of debt is 10%, what is the pretax cost for a firm in the 21% tax bracket?
C) 12.66%After-tax cost of debt = 0.10 / (1-0.21) = 0.1266, or 12.66%
The firm's cost of equity is usually calculated using the _______ equation.
CAPM
Which of the three limitations of the Payback Rule can be overcome with a modification to it?
Gives equal weight to all cash flows arriving before the cutoff period
Rank the following stocks from lowest risk to highest risk. Instructions
1. United Electric Power Co (beta = 0.2) 2. Zippy Electric Car Corp (beta = 0.9) 3. Gigantic Pharmaceuticals (beta = 1.2) 4. Colossal Bank Holding Co (beta = 2.0)
SkiFree Incorporated has $20 million of debt and $80 million of equity outstanding. The market cost of debt is 6% and the cost of equity is 12%. The firm has a 35% corporate tax rate. What is SkiFree's WACC?
10.38% Reason: (.2)(.65)6 + (.8)12 = 10.38%
If a bank account pays a monthly interest rate on deposits of 0.5 percent, what is the APR the bank will quote for this account?
6 percent Reason: 12 x 0.5 = 6 percent
ABC Corporation has long-term debt of $100,000 and equity of $160,000. ABC's long-term debt-equity ratio is _____.
62.5% Reason: Long-term debt-equity ratio = long-term debt/equity = $100,000/$160,000 = .625 or 62.5%
If a firm has twice as much equity as debt in its capital structure, then the firm is financed with:
66.7% equity.
Which of the following situations accurately describes a growth stock, assuming that each firm has a required return of 12%?
A firm with investment opportunities yielding 15%.
What is variance?
A measure of the squared deviations of a security's return from its expected return
Which of the following is NOT a claim on the assets of a company?
A patent
If the rate of return on an investment project is greater than the stockholder could earn on their own, should the financial manager accept or reject the investment?
Accept
Which of the following is the most common provider of payment services?
Banks
What is the decision rule in the case of sign changes that produce multiple IRRs for a project?
Calculate the modified internal rate of return.
Which market is used to sell both equity and long-term debt securities?
Capital market
Which of the following actions does not help reduce risk?
Converting your money market account to a mutual fund account
Which of the following are the principal themes of the study of corporate finance?
Corporate finance is about adding value. Good governance matters. Smart investment decisions create more value than smart financing decisions. The opportunity cost of capital sets the standard for investments.
Which of the following stock indexes tracks the performance of a portfolio consisting of 1 share each of 30 "blue chip" stocks?
Dow Jones Industrial Average
When comparing investments in assets with different lives, which project is best?
EAA = -$3,000; NPV = -$10,000
Which one of the following may be the best measure of company performance since it accounts for the opportunity cost of capital?
EVA
Which of the following is least likely to represent an agency problem?
Executive incentive compensation plans
What is the CAPM formula?
Expected return = RF + beta × (RM- RF)
True or false: Shareholders have direct ownership of the corporation's real assets.
False
The commodities market is used to trade which of the following items?
Fuel oil Platinum Corn
Which of the following relies, in part, on well-designed management compensation packages?
Good corporate governance
When Tri-C Corp. compares its ratios to industry averages, it has a higher current ratio, an average quick ratio, and a lower inventory turnover. What might you assume about Tri-C?
Its average inventory is relatively high.
What happens to a firm that reinvests its earnings at a rate equal to the firm's required return?
Its stock price will remain constant.
Which one of these is generally a key difference between U.S. and foreign commercial banks?
Making equity investments in corporations
The correct equation for the Profitability Index (PI) is given by:
PI = NPV/initial investment
Which securities are paid out on an after tax basis?
Preferred Stock Common Stock
Which of the following is the least effective measure of operating performance?
ROE
Why is it not reasonable to use the past average stock market return to forecast the expected future stock market return? (select all that apply)
The market return can be expressed as the sum of the Treasury bill return plus a market risk premium. The Treasury bill return varies over time. Investors are not likely to demand the same return each year on their stock investment.
True or false: The time value of money functions that are provided by your financial calculator are also available as functions in an Excel spreadsheet.
True
True or false: the discount factor refers to the present value of a $1 future payment.
True Reason: This is true. The discount factor measures the present value of $1 received in year t.
For corporate financial managers an important lesson of market efficiency is:
Trust market prices unless you have a clear advantage that ensures the odds are in your favor.
The fitted line's _______ measures a stock's market risk.
beta slope
Which one of the following can best be characterized as an agency problem?
differing incentives between managers and owners.
The ___________ method of project selection asks, "How long must the project last in order to offer a positive net present value?"
discounted-payback
The chief financial officer oversees the work of all
financial staff
The value in t years of an investment made today at interest rate r is called the ___________ of your investment.
future value
In a limited partnership, the partners that manage the business and have unlimited liability are known as
general partners
Projects with high fixed costs will tend to have earnings that vary _______ with any change in revenues
more
Which type of interest rate is generally quoted for loans and by banks and other financial institutions?
nominal
Companies that grow rapidly for several years before settling down to a stable growth rate should use the ___________ for stock valuation.
non-constant growth model
Collateralized debt obligations backed by __________ became nearly worthless during the financial crisis of 2008, resulting in huge losses for investors.
sub-prime mortgages
For bonds priced at face value, the rate of return is
the coupon rate
The real interest rate can be defined as:
the real change in value of an investment (or real cost of a loan) after adjustment for inflation
The discount rate that makes the present value of the bond's payments equal to its price is known as the
yield to maturity
Appointing a non-executive chair for the board of directors reduces the influence of the ______ on the board of directors.
CEO
When it comes to financial ratios and assessing company performance, management usually look at which of the following?
Comparing ratios with companies in the same line of business How the company's financial ratios have changed over time
Which of the following groups is least likely to be considered a stakeholder of the firm?
Competitors
Which one of the following situations is most likely to occur today for a stock that went down in price yesterday?
The stock has no predictable price-change pattern.
You believe that Alpha stock which has a beta of 1.32 will return 16.0% this coming year. The market is expected to return 11.4% and T-bills return 3.8%. According to CAPM, which one of these statements is correct given this information?
The stock is currently underpriced.
Which one of these costs accounts for the difference between accounting income and economic value added?
Cost of capital
Which one of the following is fixed for the life of a given bond?
Coupon rate
What causes bonds to sell for a premium?
Coupon rates that exceed market rates
Which two groups usually compete to obtain votes from shareholders during a proxy fight?
Current management and an outside group of shareholders
Which of the following ratios shows the dollar value of current assets for every dollar in current liabilities?
Current ratio
Which of the following would not be associated with a zero-coupon bond?
Current yield
Which of the following statements is true regarding the risks undertaken by investors in U.S. Treasury bonds?
Their principal is guaranteed, but their market price may fall with rising interest rates.
Which one of the following statements is incorrect? Market values should be used in calculating WACC. The equity component of WACC reflects the return expected by the company's shareholders. Preferred equity is a separate component of WACC. There is a tax shield on the equity dividends paid.
There is a tax shield on the equity dividends paid.
What is the legal consequence if the firm is unable to pay dividends to preferred stockholders?
There is no legal consequence as dividends are not a liability.
Which one of the following risks would be classified as a specific risk for an auto manufacturer?
Delays in launching a new model
True or false: Investors are likely to demand the same return each year on an investment in common stocks.
False Reason: The total rate depends on a multitude of factors and is unlikely to be the same each year.
True or false: the payback rule states that a project should be accepted if its payback period is greater than a specified cutoff period. True false question. True
False Reason: payback period LESS than a specified cutoff period
What is the most likely explanation for a +20.0% return on a stock with a beta of 1.0 in a month when the market returned +10.0%?
Favorable firm-specific news was reported.
_______managers are responsible for the corporation's financing and investing decisions.
Financial
Which of the following statements best distinguishes the difference between real and financial assets?
Financial assets represent claims to income that is generated by real assets.
Which of the following statements regarding mutual funds and financial institutions are true?
Financial institutions lend directly to individuals and mutual funds do not. Both invest in securities.
Which of the following refers to using borrowed funds, or debt, so as to attempt to increase the returns to equity?
Financial leverage
What is primarily responsible for the potential distortion among the ROA of different firms when net income is used in the numerator of ROA?
Financial leverage varies among firms.
Which one of these statements is correct?
Financial managers have a fiduciary duty to stockholders.
Which one of the following is least likely to contribute to the positive-NPV investments found in product markets?
Financing strategies
Why is it that a firm's capital investments can be positive NPV investments? Choose all that apply.
Firms may enjoy a monopoly advantage in their geographical area. Firms can exploit patents or exclusive technology to create competitive advantage. Firms can build customer recognition and loyalty for their products to generate repeat sales.
Which of the following are restrictions that state law may place on the payment of dividends?
Firms may not pay dividends if doing so would make them insolvent. Firms may not pay dividends if doing so would cut into legal capital.
Which of the following are not plain vanilla bonds?
Floating-rate Bonds Zero-coupon Bonds Convertible Bonds
Under what conditions may a preferred stockholder be given the right to vote?
If preferred dividends have not been paid
Investment banks differ from commercial banks in which of the following ways?
Investment banks underwrite stock offerings Investment banks do not generally take deposits Investment banks advise on takeovers
Good governance requires laws and regulations that protect whom from self-dealing by insiders?
Investors
Which of the following represent questions the financial manger would ask to evaluate financing decisions? (Do not confuse the financing decision with the investment decision)
Is the financing strategy prudent? Does the firm have sufficient liquidity?
If cash-forecasts are prepared properly then which of the following are true?
It cannot be fudged for forecasting errors. The discount rate should reflect only the market risk of the project.
Which of the following statements are true regarding the intrinsic value of a stock?
It is the price that should be observed in a well-functioning stock market It is the present value of the cash payoffs anticipated by the investor who buys the stock.
Under which conditions are shareholders most likely to be concerned about agency conflicts?
Large free cash flows generated by a mature firm
The job of financial analysts may include which of the following?
Managing risk Monitoring risk Analyzing new investments
Which of the following organizations is least likely to use a professional corporation (PC) structure?
Manufacturers
Which of the following appears to be the most appropriate goal for corporate management?
Maximizing market value of the company's shares
Which market is used to trade short-term securities?
Money market
Which one of the following statements more accurately describes the controller than the treasurer?
Monitors capital expenditures to make sure that they are not misappropriated
A safe dollar is worth _____ than a risky one.
More
With respect to the proposition that dividend policy does not matter, in order to raise an additional $5,600 in cash by issuing stock, the stock sold must be worth
More than $5,600 assuming issue costs, $5600 assuming no issue costs
The type of market efficiency that asserts that investors cannot make superior returns by searching for patterns in past returns is _______.
Weak form efficiency
The _________ measures the return to investors if they buy a bond at the asked price and hold it to maturity.
asked yield to maturity
Joseph signs a contract with a company that will pay him $25,000. Following the principles of the time value of money, Joseph would be best off if he received payment:
at the beginning of the project Reason: The time value of money states that a dollar today is worth more than a dollar tomorrow. Therefore, if he received the $25,000 at the beginning of the project, he would have 3 months to invest his money and have it grow.
A corporation is a legal entity that has the rights to do which of the following?
borrow money sue or be sued enter into contracts
The capital market is used to sell
both equity and long-term debt securities
For large public corporations, the savings flow through
both financial markets and intermediaries
A positive NPV investment _________ while a negative NPV investment __________.
builds shareholder value; destroys shareholder value
In a professional corporation (PC), the ______ has/have limited liability but the ________ can still be sued.
business, professionals
The relationship between the NPV profile and the discount rate is
declining
A tax-paying firm is currently financed with 50% debt and 50% equity. The after-tax cost of debt is 6% and the cost of equity is 12%. If the firm issues some 8% preferred stock at par, then the firm's WACC will:
decrease.
At a rate of interest of 10% (r), the present value (PV) or $100 will ___________ as the time period (t) ________________.
decrease; increases Reason: Present value will decrease as the time period increases. This follows the time value of money concept that a dollar today is worth more than a dollar tomorrow.
When a company repurchases some of its outstanding stock from stockholders and returns it to the company treasury, the book value of stockholders' equity is _________.
decreased
When a company repurchases $10 million of its outstanding stock from stockholders, the book value of stockholders' equity _________.
decreases by $10 million
The additional yield on a bond that investors require for bearing default risk is known as
default premium
The risk that a bond issuer may not pay on its bonds in known as
default risk
Securities whose payoffs depend on the prices of other securities and commodities are known as _____.
derivatives
Most firms would prefer both high profit margin and high turnover; however, this strategy typically leads to lower sales per dollar of assets. The Du Pont formula can help companies
determine if they should pursue a high profit margin/low turnover strategy determine if they should pursue a high turnover/low profit margin strategy Identify the constraints firms face
Investment risk can best be described as the:
dispersion of possible returns.
Different classes of stock usually imply
disproportional voting rights
The principal of _____ demonstrates that a single stock that appears very risky may not contribute much to the overall risk of a well-diversified portfolio.
diversification
The standard deviation of returns is a useful measure of risk for individual assets in isolation, but is a misleading risk measure for assets in a portfolio due to the ________ effect caused by ________.
diversification; imperfect correlation of portfolio asset returns
If banks are worried about a borrower's ability to pay back debt, they may decide to place ____________ on the firm.
dividend restrictions
The current yield on a bond is similar to the __________ on a stock in that both ignore prospective capital gains and losses.
dividend yield
In the constant growth dividend discount model, the expected return is equal to:
dividend yield + growth rate
Many trades are now transacted through _______ rather than through the two primary exchanges.
electronic communications networks (ECN)
The average of the betas for all stocks is:
exactly 1.0; these stocks represent the market.
The increase in the rate that bondholders demand as the amount of debt borrowed increases is called the _______ cost of debt.
explicit
The payment made when a bond matures is called the bond's:
face value
When the coupon rate of a bond is equal to the current interest rate, the bond will sell for
face value
When interest rates rise, bond prices
fall
The share price declines when a stock repurchase occurs.
false
True or false: A sensible way for a manager to account for overoptimistic cash-flow forecasts is to adjust the discount rate.
false
True or false: Dividend cuts convey bad news especially when the information is already out.
false
If a firm's cash coverage ratio is greater than its times interest earned ratio, then the:
firm's assets are not fully depreciated.
Points that fall above or below the straight line fitted to the plot of firm return versus market portfolio return indicate the effect of ________.
firm-specific risk
A traditional (non-growing) annuity consists of a(n) ________ stream of cash flows for a fixed period of time.
fixed
A profit margin of 7% states that
for every dollar in sales the company generates $0.07 cents in profit
Sole proprietorships resolve the issue of agency problems primarily by:
forcing owners to bear the full cost of their actions.
Lenders transport money ______ (forward/backward) in time; borrowers transport money _____(forward/backward) in time.
foward, backward
The plowback ratio is defined as the:
fraction of earnings retained by the firm
Debt that is repayable more than one year from the date of issue is called _______ debt, or _______ debt.
funded; long-term
The dividend discount model implies that investors who agree about the firm's _______ and _______ will also agree about its _______.
future dividends; risk; current share price
When the financial markets and institutions ceased to operate properly prior to 2007, the result was
global recession
If the interest rate is greater than zero, the present value of an annuity due is always ______ an ordinary annuity.
greater than Reason: Cash flows for annuities due always come one period earlier than the corresponding cash flows for ordinary annuities. Therefore, each is discounted for one less period and the present value for the annuity due increases by a factor of (1+r) over that of the ordinary annuity.
A firm that is experiencing rapid _____ may see its free cash flow be zero or negative since it is reinvesting all of its earnings into new investments.
growth
Based on the random walk theory, if a stock's price decreased last week, then this week the price:
has an equal chance of going either up or down.
Funded debt refers to those liabilities that:
have a maturity of more than one year remaining.
If the coupon rate on an outstanding bond is lower than the relevant current interest rate, then the yield to maturity will be:
higher than the coupon rate.
Plowed back earnings will add to firm value when they are expected to earn:
higher than the rate of return that investors require
The IRR rule specifies that a firm should select any project whose IRR is __________ the firm's ___________.
higher than; opportunity cost of capital
Select which of the following relationships is correct:
if the opportunity cost of capital is less than a project's rate of return, then the NPV of the project is positive
The ______ cost of debt is the increase in the required return on common equity as the amount of debt borrowed increases.
implicit
Corporate debt instruments are most commonly traded:
in the over-the-counter market.
Nominal U.S. Treasury bond yields:
include an inflation premium.
A times interest earned ratio of 5 states that
income before interest and taxes covers the interest obligation 5 times.
If dividends and repurchases return cash to investors that would otherwise be misused by managers, then such dividends and repurchases may _______ firm value.
increase
If the firm chooses a payout policy that results in less taxes paid by investors on their returns, then its stock price should ______.
increase
A firm's financial deficit is the gap between __________ and __________.
internally generated cash; cash the company needs
Bonds rated Baa or above by Moody's or BBB or above by Standard & Poors are known as
investment grade bonds
Stock repurchases are an attractive alternative to dividends because:
investors interpret dividends as repeated cash distributions
Psychologists have observed that:
investors tend to place too much faith in their ability to spot mispriced stocks.
Which of these statements is correct? Free cash flow
is available to be paid out to investors as interest or dividends, or to repay debt or buy back stock.
When a firm repurchases some of its shares, their price per share _______ by the amount of the repurchase.
is not affected
An example of a firm's financing decision would be:
issuing 10-year versus 20-year bonds.
Which of the following statements are correct about the book value of a firm's equity?
it can be calculated from the balance sheet as assets minus liabilities it is generally less than the market value of the firm's equity
For projects of lower than average risk, firms may use a discount rate that is _________ than the company cost of capital.
less than
If interest rates rise, the rate of return on a bond will be _____ the yield to maturity.
less than
The net proceeds that could be realized by selling the firm's assets and paying off its creditors is known as the firm's _________.
liquidation value
When loaning money, creditors are interested in the borrower's financial leverage as well as their
liquidity
The long-term debt-equity ratio is equal to
long-term debt divided by equity
The long-term debt ratio is equal to
long-term debt divided by long-term debt plus equity
Capital structure decisions refer to the firm's sources of
long-term financing
When a bond has a sinking fund, investors may be prepared to lend at a ________ rate of interest for that bond.
lower
If two machines produce the same product but have different lives, you should choose the machine with the:
lowest equivalent annual cost.
The most important measure of risk in a well-diversified portfolio is
macroeconomic risk
A policy of dividend "smoothing" refers to:
maintaining a steady progression of dividend increases over time.
The system of electing a board of directors where each director is voted on separately is known as:
majority voting.
Soft capital rationing is imposed upon a firm by ________, while hard capital rationing is imposed by ________.
management; the capital market.
Projects whose earnings tend to be highly dependent upon the state of the economy have higher ________ risk.
market
The _______ value of equity should always be used when calculating a firm's capital structure weight of equity.
market
The impact of macroeconomic news is tracked by the rate of return on a _____________ of all securities.
market portfolio
The difference between the market portfolio return and the risk free rate is called the ______.
market risk premium
The total risk of a security investment consists of _______ plus _______.
market risk; firm specific risk market risk; diversifiable risk
Which of the following values accounts for both present earnings and future earning power?
market value
inancial managers increase value by accepting all investment projects that earn _____ the opportunity cost of capital.
more than
The most common type of asset-backed bond is backed by:
mortgages
The board of directors of a public corporation usually consists of the following members. (Select all that apply.)
outside directors who are not firm employees members of the firm's top management The CEO
Behavioral finance has shown that most investors are _________ in their ability to pick stocks that will offer superior returns.
overconfident
With respect to the notion that stock prices follow a random walk, many researchers have concluded that:
past stock price changes provide little useful information about future stock price changes.
The price of a bond can be quoted as a _____ of face value.
percentage
The interest rate on the financial calculator is expressed as a
percentage.
The legal "life" of a corporation is
permanent, regardless of current ownership.
A stock that pays out a perpetual stream of constant dividends can be valued as a(n) _________.
perpetuity
C/r is the formula for the present value of a(n) ____.
perpetuity
The fraction of earnings reinvested in the firm is called the:
plowback ratio
All of the following are types of innovative bonds except: preferred stock. mortality bonds. collateralized debt obligations (CDOs). asset-backed bonds.
preferred stock.
The present value of an annuity due is equal to the:
present value of an ordinary annuity x (1+r)
The semi-strong form of the efficient market hypothesis states that:
prices reflect all publicly available information.
Companies sell new share issues in the
primary market
The sale of new securities by corporations takes place in the _________.
primary market
A _________ refers to a corporation selling shares in the firm to investors.
primary offering
Loans with floating rate interest payments are usually tied to benchmark rates such as the ______.
prime rate
A bond that is sold directly to a small number of qualified institutional investors and may only be resold to other qualified institutional investors is called a _________.
private placement
The sale of securities to a limited number of investors without a public offering is called a(n):
private placement
Economic value added is defined as the
profit after deducting all costs, including the cost of capital.
The _____ _____allows the firm to focus on getting the biggest NPV bang for each investment buck.
profitability Index
Unethical managers run the risk of damaging the company's
profitability reputation ability to attract customers
In simple cases of capital rationing, the _________ can tell a firm which projects to accept.
profitability index (PI)
A project's IRR measures the _________ whereas the opportunity cost of capital is equal to the ____________.
profitability of a project; return offered by equivalent-risk investments in the capital market
The minimum acceptable expected rate of return for a project is called the ________________.
project cost of capital
The major benefit of diversification is the:
reduction in the portfolio's total risk.
The value of retained earnings on the corporate balance sheet represents the amount of earnings:
reinvested in the firm since its inception.
If a corporation issues 1,000 shares of $1 par value stock for $10 per share, then retained earnings will:
remain unchanged.
In a leasing arrangement, if the lessee fails to make lease payments, the lessor may _______ the leased equipment.
repossess
To determine a firm's sustainable growth rate, which three figures must remain constant?
return on equity plowback ratio long-term debt ratio
The money market is used to trade
short-term securities
In principle the market portfolio should contain all assets in the world economy. In practice, financial analysts use _______ as a proxy for the market portfolio.
stock market indexes like the S&P500
To provide executives with an incentive to maximize the company's stock value, corporations should provide some compensation in the form of _____.
stock options
Investors' collective assessment of how well a company is doing is summarized in the firm's company values and:
stock prices
Top management is motivated to increase the company's market value when their compensation is linked to
stock prices
In addition to paying a dividend, a firm can return cash to its equity investors through a:
stock repurchase
The owners of most major corporations are called _________ or _________.
stockholders; shareholders
Real-world investments often involve many payments received or paid over time. Managers refer to this as a ___________________.
stream of cash flows
By 2007, more than half of the new issues of CDOs involved exposure to ________.
subprime mortgages
A firm's internally generated funds are calculated by:
subtracting dividends from net income plus depreciation
Some decisions, such as approval of mergers, require much more than 50% of the shareholder votes to approve. This is called a ______.
supermajority vote
The firm's growth rate if it plows back a constant fraction of earnings, maintains a constant return on equity, and keeps its debt ratio constant is the firm's __________________.
sustainable growth rate
The type of risk that cannot be diversified away is called ______ or _______.
systematic risk market risk
When a firm repurchases stock by offering to buy back a stated number of shares at a fixed price, this is a(n) ________.
tender offer
The principal stock markets in the United States are _____________ and ____________.
NYSE; NASDAQ
What happens if preferred stock dividends are unpaid?
No dividends will be paid on common stock until the preferred dividend has been paid.
An average days in inventory ratio of 30 states that
the company has inventory to maintain operations for 30 days
One way that investors contribute capital to the firm is by:
the company plowing back part of its earnings.
The best known price index used by economists who measure inflation is ________.
the consumer price index (CPI)
Which of the following depends on the alternative investment opportunities available to shareholders in financial markets?
Opportunity cost of capital
If a stock has a required return of "r", its next dividend is expected to be "DIV1", and its dividends are expected to grow at a constant rate "g" thereafter, then its current share price "P0" can be determined by __________.
P0=DIV1/(r-g)
Which of the following is the correct equation for the present value of an annuity with regular payment C for t periods at interest rate r?
PV = C[1/r - 1/r(1+r)^t]
If the interest rate (r) increases, what will happen to present value (PV) over time?
PV will decline Reason: If the interest rate increases, the present value will decrease over time.
The price of a bond is equal to the
PV(coupon) plus PV(face value)
Which one of the following equity concepts would you expect to be least important to a financial analyst?
Par value per share
If a corporation has more shares issued than outstanding, then:
the corporation has treasury stock.
Additional paid-in capital refers to:
the difference between the issue price and the par value.
The Internal Rate of Return (IRR) can best be defined as:
the discount rate at which the NPV equals zero
Which statement is correct?
the dividend discount model is no longer applicable when there are stock repurchases. ??
The book value of a firm's equity is equal to:
the firm's assets minus the firm's liabilities
The market risk premium is the additional return that investors require to invest in ________ rather than _________.
the market portfolio; treasury bills
The market value of a firm is equal to:
the market value of debt + the market value of equity
If no price change occurs in a stock on the day that it announces its next dividend, it can be assumed that:
the market was expecting this information.
The extra annual return from investing in long versus short-term Treasury securities is known as:
the maturity premium
A share repurchase may signal to investors that the firm's shares are _________.
underpriced
Debt that is repayable less than one year from the date of issue is called _______ debt, or _______ debt.
unfunded; short-term
To calculate the present value of a business, the firm's free cash flows should be discounted at the firm's:
weighted-average cost of capital.
Short selling involves selling a security:
you do not own.
What is the term used in finance to represent simple, standard, and common?
Plain vanilla
Which type of bond is certain to provide a capital loss if held to maturity?
Premium bond
Which mutually exclusive project would you select, if both are priced at $1,000 and your required return is 15%: Project A with three annual cash flows of $1,000; or Project B, with 3 years of zero cash flow followed by 3 years of $1,500 annually?
Project ANPVA = -$1,000 + $1,000[(1/0.15) - 1/0.15(1.15)3] = $1,283.23NPVB = -$1,000 + {$1,500[(1/0.15) - 1/0.15(1.15)3]}/1.153 = $1,251.89
Which of the following are steps bondholders can take to minimize default risk?
Protective covenants Security Seniority
Which of the following methods can be used by investors and businesses to reduce and reallocate risk?
Purchase an exchange traded fund (ETF) Purchase insurance Purchase shares in a mutual fund
Which of the following are methods for transporting income across time?
Purchase of life insurance Saving for retirement Taking out a loan
Which of the following ratios shows the amount of quick assets for every dollar of current liabilities?
Quick ratio
If a company earns a constant return on equity and plows back a constant proportion of earnings, then its growth rate, g, is:
ROE x plowback ratio
Some investors have preference for high dividend payout stocks. Which of the following are reasons why investors may prefer high dividend stocks?
Some financial institutions are legally restricted from holding stocks lacking established dividend records. Some investors use dividends for a steady source of cash income to live on.
Which of the following stock indexes includes the stocks of 500 major companies in proportion to the number of their shares that have been issued to investors
Standard & Poor's Composite Index
Which of the following statements are true about variance?
Standard deviation is the square root of variance. Variance is a measure of the squared deviations of a security's return from its expected return.
Which of the following sell bonds?
State and local governments U.S. Treasury Corporations
In general, which stocks should be combined into a portfolio if the goal is the greatest reduction possible in overall portfolio risk?
Stocks with returns that are not correlated
Under which of the following forms of market efficiency would stock prices always reflect fair value?
Strong-form efficiency
Which country has the lowest market risk premium?
Switzerland
The weights used in WACC are based on
The Market Value of Debt and the Market Value of Equity
Which one of the following should be assumed about a project that requires a $100,000 investment at time zero, then returns $20,000 annually for 5 years?
The NPV is negative.
Which one of the following statements is correct when Treasury bills yield 3.5% and the market risk premium is 9.5%?
The S&P 500 would be expected to return 13.00%.
Who was responsible for the financial crisis of 2007-2009?
The U.S. Federal Reserve, the U.S. government, rating agencies, and bankers
Which of the following statements is/are true of the relationship between shareholders and the board of directors?
The board of directors acts as a link between shareholders and management. The board of directors' role is to protect the interests of shareholders. Shareholders elect the board of directors.
A long-term debt ratio of 40% states that
$0.40 cents of every dollar of long-term capital is in the form of debt.
Rosita purchased a bond for $989 that had a 7% coupon and semiannual interest payments. She sold the bond after 6 months and earned a total return of 4.8% on this investment. At what price, did she sell the bond?
$1,001.47 0.048 = (Selling price + [(0.07 × $1,000) / 2] − $989) / $989 Selling price = $1,001.47
Approximately how much must be saved for retirement in order to withdraw $100,000 per year for the next 25 years if the balance earns 8% annually, and the first payment occurs one year from now?
$1,067,477.62 Explanation PV = $100,000 {(1 / 0.08) − [1 / 0.08(1.08)25]} PV = $1,067,477.62
A dollar invested today at 7.5 percent interest compounded annually will be worth _______ one year from now.
$1.075 Reason: FV=$1.00(1+0.075)1
If an investor purchases a security for $12.30, then sells it at a later date for $14.10, her capital gain would be ____________.
$1.80 Reason: $14.10 - $12.30 = $1.80
If a firm issues 100 million shares of stock with part value $.10 what is the total par value?
$10 million
What is the residual income for a firm that is entirely equity-financed with $1 million in capital, $300,000 in net income, and a 20% cost of capital?
$100,000 Explanation Residual income = net income − (cost of capital × total capitalization) Residual income = $300,000 − (0.20 × $1,000,000) Residual income = $100,000
If the annual coupon rate on a fixed interest loan is 12% and the amount borrowed is $1000, how much is the annual interest payment?
$120
A $100,000 bond quoted at 120% will sell for
$120,000 Reason: $100,000 x 1.20 = $120,000
You have just retired with savings of $1.5 million. If you expect to live for 30 years and to earn 8% a year on your savings, how much can you afford to spend each year? Assume that you spend the money at the start of each year.
$123,371.44 Explanation $1,500,000 = PmtOA {(1 / 0.08) − [1 / 0.08(1.08)30]} PMTOA = $133,241.15 PMTAD = PMTOA / (1 + r) PMTAD = $133,241.15 / 1.08 PMTAD = $123,371.44
A currently used machine costs $10,000 annually to run. What is the maximum that should be paid to replace the machine with one that will last 3 years and cost only $4,000 annually to run? The opportunity cost of capital is 12%.
$14,410.99 NPV = [-$10,000 - (-$4,000)][(1/0.12) - 1/0.12(1.12)3] = $14,410.99
ABC Corporation has current assets of $50,000, total assets of $150,000, current liabilities of $35,000, total liabilities of $90,000, and shareholders' equity of $25,000. What is ABC Corporation's net working capital worth?
$15,000 Reason: Net working capital = current assets - current liabilities = $50,000 - $35,000 = $15,000
Miller's Hardware plans on saving $42,000, $54,000, and $58,000 at the end of each year for the next three years, respectively. How much will the firm have saved at the end of the three years if it can earn 4.5% on its savings?
$160,295.05 Explanation FV = ($42,000 × 1.0452) + ($54,000 × 1.045) + $58,000 FV = $160,295.05
A project requires a $1 million initial investment and has an expected after-tax cash flow of $2.4 million per year in perpetuity. The weighted-average cost of capital (WACC) is 13%. What is the net present value (NPV) of the project?
$17.46 million Reason: NPV = -$1 million + ($2.4 million/.13) = $17.46 million
Smithfield Hams is forecasted to pay a dividend of $1.50 for the following year and expects dividends to grow at a rate of 3 percent into the future. If investors require an 11 percent rate of return from Smithfield, what should its current share price be?
$18.75 Reason: $1.50/(.11 - .03) = $18.75
How much will a firm need in cash flow before tax and interest to satisfy debtholders and equity holders if the tax rate is 21%, there is $10 million in common stock requiring a 12% return, and $6 million in bonds requiring an 8% return?
$2,000,000
$200 at the end of each year forever at 10% per year is worth how much today?
$2,000.00 Reason: $200/0.10 = $2,000
Machines A and B are mutually exclusive and have the following investment and operating costs. Machine A has a life of 3 years while Machine B has a 2 year life. Year: 0 1 2 3 A $5,000 $800 $900 $1,000 B $6,000 $850 $900 -- Assume the discount rate is 9 percent. The equivalent annual annuity of machine A is ______. The equivalent annual annuity of machine B is ______.
$2,869.53; $4,284.74 Reason: For Machine A, the PV of costs at 9% is $7,263.64. To find the equivalent annual annuity, set the PV of costs for 3 years to $7,263.64. You will see that an equivalent annual annuity of $2,869.53 works out: $2,869.53/(1.09)1 + $2,869.53/(1.09)2 + $2,869.53/(1.09)3 = $7,263.63 For Machine B, the PV of costs at 9% is $7,537.33. To find the equivalent annual annuity, set the PV of costs for 2 years to $7,537.33. You will see that an equivalent annual annuity of $4,284.74 works out: $4,284.74/(1.09)1 + $4,284.74/(1.09)2 = $7,537.33.
A project has an initial investment of $1.4 million and a present value of cash flows totaling $4 million. What is the project's net present value (NPV)?
$2.6 million Reason: NPV=initial investment + PV of cash flows= -$1.4 million + 4 million = $2.6 million
What is the present value of an ordinary annuity that pays $100 per year for three years if the interest rate is 10% per year?
$248.69 Reason: 100[(1/.10)-(1/(.10(1.10)^3))] = 248.69
A machine that costs $20,000 today has annual operating costs of $1,500, $1,600, $1,700 and $1,800 in each of the next four years. The discount rate is 10 percent. The PV of costs is ________ and the equivalent annual annuity is _______.
$25,192.61; $7,947.53
What is the present value of your trust fund if you have projected that it will provide you with $50,000 7 years from today and it earns 10% compounded annually?
$25,657.91 Explanation PV = FV / (1 + r)t PV = $50,000 / 1.107 PV = $25,657.91
A bond promises to pay $1,000 20 years from today. No interest will be paid on the bonds during the 20 years If the interest rate is 7%, what is the bond's present value?
$258.42 Explanation PV = FV / (1 + r)t = $1,000 / 1.0720 = $258.42
If a corporation receives $50,000 in preferred stock dividends, how much tax does it pay on these dividends? The corporate tax rate is 21%.
$3,150 70% of dividend received are exempt from taxes and on balance 30%, tax is applicable 50000*30%*21%
How much must be invested today in order to generate a 5-year annuity of $1,000 per year, with the first payment 1 year from today, at an interest rate of 12%?
$3,604.78 Explanation PV = $1,000{(1 / 0.12) − [1 / 0.12(1.125)]} PV = $3,604.78
Assume the total expense for your current year in college equals $20,000. How much would your parents have needed to invest 21 years ago in an account paying 8% compounded annually to cover this amount?
$3,973.11 Explanation PV = $20,000 / (1.08)21 PV = $3,973.11
A firm has declared a stock dividend of 25 percent.You currently own 100 shares priced at $50 per share. What will be the price per share after the stock dividend?
$40 $50/1.25=$40
Helena Handbaskets expects to pay a dividend of $0.50 at year end and expects that dividend to grow at a rate of 6 percent per year thereafter. If investors require a 15 percent return on Helena's stock, what should the current share price be?
$5.56 Reason: $0.50/(0.15-0.06)=$5.56
What is the NPV of a project with an initial investment of $95, a cash flow in one year of $107, and a discount rate of 6%? (Be sure to record the initial investment as a negative number.)
$5.94
XYZ Corporation's shares are selling for $50 a share and the number of shares currently outstanding is 1,000. XYZ's market capitalization is:
$50,000 Reason: Market capitalization = share price x number of outstanding shares = $50 x 1,000 = $50,000
A firm has $2 million in earnings. It has a plowback ratio of 75%. How much will the firm pay out in dividends to shareholders?
$500,000 Reason: If the firm's plowback ratio is 75%, then its payout ratio is 25%. It will pay out $2 million x.25 = $500,000
You will receive $100 in 1 year, $200 in 2 years and $300 in 3 years. If you can earn a 7.5% rate of interest, what is the present value of this stream of cash flows? (Please note that you receive nothing immediately - there is no initial payment).
$507.58 Reason: $100/(1.075)^1 + $200/(1.075)^2 + $300/(1.075)^3 = $507.58
A firm has a debt-to-value ratio of 40%, a cost of equity of 14%, and an after-tax cost of debt of 5.5%. It plans to launch a new product that will produce cash flows of $398,000 next year and $211,000 in year 2. If this project is about as risky as the firm's existing assets, what is the present value of the project?
$532,349
How much more would you be willing to pay today for an investment offering $10,000 in 4 years rather than in 5 years? Your discount rate is 8%.
$544.47 Explanation Difference = FV / (1 + r)t − 1 − FV / (1 + r) Difference = $10,000 / 1.084 − $10,000 / 1.085 Difference = $544.47
You put $100 in the bank now, $200 in the bank a year from now, and $300 in the bank in two years. How much money will you have available 3 years from now if you earn a 7.5% rate of interest? (Calculate the future value of this stream of cash flows. Refer to Example 5.6.)
$677.85 Reason: $100 x (1.075)^3 + $200 x (1.075)^2 + $300 x (1.075) = $677.85
How much should you pay for a $1,000 bond with 10% coupon, annual payments, and 5 years to maturity if the interest rate is 12%?
$927.90 Price = (0.10 × $1,000) {(1 / 0.12) − [1 / 0.12(1.12)5]} + $1,000/1.125 Price = $927.90
A company issues a $1,000 bond with a coupon rate of 6% that matures in 5 years. The current interest rate is 7%. How much will the bond issue sell for?
$959 Reason: Present value of the interest payments = $1,000 x .06 = 60 x [1-(1/(1.07)^5]/.07 = $246.0118462 Present value of the face amount of the bond = $1,000/(1.07)^5 = $712.9861795 Add the present value of the interest to the present value of the face of the bond = $958.998
DEF Corporation has $40,000 in cash, $22,000 in marketable securities, $8,000 in receivables, and $160,000 in current liabilities. What is DEF Corporation's quick ratio?
.44 Reason: Quick ratio = ($40,000 + $22,000 + $8,000) / $160,000 = .44
If a project has ____NPV, then the expected cash flows, discounted at the WACC, are just sufficient to provide returns debtholders and shareholders require.
0
Two assets whose returns move totally independent of one another have a correlation of _________.
0
U.S. Treasury securities are considered to be a risk-free investment that is fixed and not affected by movements in the market. Such a security would naturally have a beta of ______,
0
What is the return to an investor who purchases a stock for $30, receives a $1.50 dividend at the end of the year, and then sells the share for $28.50?
0%
XYZ Corporation has a return on capital of 16% and a cost of capital of 6%. How much did XYZ earn in excess of investors' requirements?
10% 16-6=10
A firm is financed 55% by common stock, 10% by preferred stock and 35% by debt. The required return is 15% on the common, 10% on the preferred, and 8% on the debt. If the tax rate is 21% what is the WACC?
10.72%
An investment in Dunwich Borers Inc stock may return -50% with a 5% probability, 5% with a 35% probability, 15% with a 35% probability and 25% with a 25% probability. What is the expected return on an investment in Dunwich Borers Inc stock?
10.75% Reason: (0.05)(-50)+ (0.35)(5)+ (0.35)(15)+ (0.25)(25) = 10.75%
Vandalay Industries has $30 million of debt, $10 million of preferred stock and $60 million of common stock outstanding. The market cost of debt is 8%, the cost of preferred is 9% and the cost of common equity is 14%. The firm has a 35% corporate tax rate. What is Vandalay's WACC?
10.86% Reason: WACC = [$30/$100 x (1-.35)x8%] + ($10/$100 x 9%) +($60/$100 x 14%) = (0.3)(0.65).08+ (0.1).09 + (0.6).14 = 10.86%
A stock is expected to pay dividends of $1.20 per share in Year 1 and $1.35 per share in Year 2. After that, the dividend is expected to increase by 2.5% annually. What is the current value of the stock at a discount rate of 14.5%?
10.87
Spock Enterprises has a market value of $100 million in debt outstanding. They also have a market value of equity of $400 million. Shareholders require a 12% return on their shares and creditors require a 7% before-tax return on their investment. The weighted average return required by investors in Spock Enterprises is ______ percent.
11.0 Reason: (0.2x0.07) + (0.8x0.12) =11.0
A firm's after-tax operating income was $1,000,000 in 2017. It started the year with total capital of $8,000,000 and raised an additional $1 million of capital during the year. The additional capital raised during 2017 only started to affect the operating income in 2018. Which value best represents the return on capital for 2017?
12.5% Explanation ROC = $1,000,000/$8,000,000 = .125, or 12.5%
Martin Co. has issued preferred stock with an annual dividend of $6.00. The current market price per share of this preferred stock is $47.00. What is the expected return on the Martin preferred stock?
12.8% Reason: $6.00/$47.00=12.8%
A project will generate a $1 million net cash flow annually in perpetuity. If the project costs $7 million, what is the break-even WACC?
14.29%
Last year's asset turnover ratio was 2.0. Sales have increased by 25% and total assets have increased by 10% since that time. What is the current asset turnover ratio?
2.27 Explanation Asset turnover = sales / total assets = 2 2 × 1.25 / 1.1 = 2.27
Your neighborhood bank is offering investors a money market account that pays 3.5 percent interest on deposits. If the current annual rate of inflation is 1.2 percent, how much is the exact real rate for this account?
2.27 percent Reason: [1.035/1.012] - 1 = 2.27 percent
ABC Corporation had sales of $125,000. Total assets at the beginning the year were 53,000 and at the end of the year were $55,000. ABC's asset turnover for the entire year was _____. (Use the average total assets to solve)
2.31 Reason: Sales/average total assets = $125,000/(($53,000+$55,000)/2)
History came close to repeating the stock market crash of 1929 in the year
2008
Once you have added about ______ or more diversified stocks to your portfolio, you have removed about as much specific risk as you possibly can.
30
Only _______ percent of the dividends received by a corporation for their ownership in the preferred or common stock of another corporation is subject to corporate taxes.
30
What is the debt ratio of a firm that has outstanding $15 million in bonds and equity with a market value of $35 million?
30%
A firm has declared a 3 for 1 stock split.You currently own 100 shares. How many shares will you own after the split?
300
The board of directors is dissatisfied with last year's ROE of 15%. If the operating profit margin and asset turnover ratio remain unchanged at 8% and 1.25, respectively, by how much must the leverage ratio (i.e., assets/equity) increase to achieve 20% ROE?
33.33% Explanation Last year: ROE = leverage ratio × asset turnover × operating profit margin 0.15 = leverage ratio × 1.25 × 0.08 Leverage ratio = 1.5
What is the ROE for a firm with a times interest earned ratio of 2, a tax liability of $1 million, and interest expense of $1.5 million if equity equals $1.5 million?
33.33% Explanation Times interest earned = EBIT / Interest 2 = EBIT / $1,500,000 EBIT = $3,000,000 Net income = EBIT − interest − taxes Net income = $3,000,000 − 1,500,000 − 1,000,000 Net income = $500,000 ROE = net income / equity ROE = $500,000 / $1,500,000 ROE = 0.3333, or 33.33%
What is the rate of return for an investor who pays $1,054.47 for a 3-year bond with an annual coupon payment of 6.5% and sells the bond 1 year later for $1,037.19?
4.53% Rate of return = [$1,037.19 + (0.065 × $1,000) − $1,054.47] / $1,054.47 = 0.0453, or 4.53%
A shareholder owning 100 shares of stock is voting for the board of directors who are elected by cumulative voting. How many votes will the shareholder cast for Director "A" if four directors are to be elected and the maximum number of votes are cast for "A"?
400 Maximum votes with cumulative voting = 4 × 100 = 400
In cumulative voting, if nine directors are up for election and you own 50 shares of stock, how many votes can you cast?
450
What is the current yield of a bond with a 6% coupon, 4 years until maturity, and a price quote of 84?
7.14% Current yield = $60 / (0.84 × $1,000) = 0.0714, or 7.14%
Dani's just paid an annual dividend of $6 per share. What is the dividend expected to be in five years if the growth rate is 4.2%?
7.37
If a borrower promises to pay you $1,900 nine years from now in return for a loan of $1,000 today, what effective annual interest rate is being offered if interest is compounded annually?
7.39% Explanation FV = PV × (1 + r)t $1,900 = $1,000 × (1 + r)9 r = 1.91 / 9 − 1 r = 0.0739, or 7.39%
ABC Corporation had net income of $75,000 and sales of $1,000,000. ABC's profit margin is _____.
7.5% Reason: Profit margin = net income / sales = $75,000 / $1,000,000 = .075 or 7.5%
Would you prefer a savings account that paid 7% interest compounded quarterly, 6.8% compounded monthly, 7.2% compounded weekly, or an account that paid 7.5% with annual compounding?
7.5% compounded annually Explanation EAR = [1 + (0.07 / 4)]4 − 1 = 0.0719, or 7.19% EAR = [1 + (0.068 / 12)]12 − 1 = 0.0702, or 7.02% EAR = [1 + (0.072 / 52)]52 − 1 = 0.0746, or 7.46% EAR = APR = 7.5%
The annual market risk premium averaged over the past century is approximately ______.
7.6%
You pay $1,200 for a bond and receive an annual coupon payment of $100. The current yield on the bond is _____.
8.33% Reason: Current yield= annual coupon payment/bond price = $100/$1,200 = .0833 or 8.33%
If a project costs $72,000 and returns $18,500 per year for 5 years, what is its IRR?
8.98%
A car dealer offers payments of $522.59 per month for 48 months on a $25,000 car after making a $4,000 down payment. What is the loan's APR?
9% Explanation $25,000 − 4,000 = $522.59 {(1 / r) − [1 / r(1 + r)48]} Using a financial calculator or Excel, r = 0.0075 APR = 0.0075 × 12 APR = 0.09, or 9%
When Treasury bills yield 3% and the expected return on the market is 12%, then the risk premium on an asset is equal to:
9% times the asset's beta.
A company with a return on equity of 15% and a plowback ratio of 60% would expect a constant-growth rate of:
9%. Explanation g = 0.15 × 0.60 = 0.09, or 9%
What nominal return would an investor need to receive if he desires a real return of 4% and the rate of inflation is 5%?
9.20% Nominal return = (1.04 ×1.05) − 1 = 0.0920, or 9.20%
A furniture store is offering free credit on purchases over $1,000. You observe that a big-screen television can be purchased for nothing down and $4,000 due in one year. The store next door offers an identical television for $3,650 but does not offer credit terms. Which statement below best describes the cost of the "free" credit?
9.59% Explanation FV = PV(1 + r)t $4,000 = $3,650(1 + r) r = 0.0959, or 9.59%
Which one of the following is a real asset?
A patent
This morning, you purchased a TIPS. Which one of these should you expect to occur if you hold this bond during an inflationary period?
The maturity value will increase in nominal terms.
Which statement is correct?
The momentum factor refers to the tendency for stock price changes to persist for a while and then revert.
Project A has an initial investment of $10,000 and an NPV of $15,000. Project B has an initial investment of $100,000 and an NPV of $101,000. Based on the PI (Profitability Index), project _______ would be selected. Based on the NPV, project _______ would be accepted. Selecting project ______ will actually maximize shareholder value.
A; B; B
If your current portfolio contains assets that are highly correlated, what should you do to reduce risk?
Add some assets that have negative correlation with the portfolio.
Which one of the following statements about portfolio diversification and negatively correlated assets is true?
Adding a negatively correlated asset will initially reduce volatility of portfolio returns.
Which of the following is true in well-functioning stock markets?
All securities of the same risk are priced to offer the same rate of return.
Inflation can be defined as:
An overall general rise in prices
Which of the following are considered disadvantages of using EVA and Accounting rates of return over market-value based measures?
Assets could be grossly undervalued Current market values of assets are not considered
Which of the following is the relevant risk to investors of a single stock held in a diversified portfolio?
The sensitivity of its returns to fluctuations in the overall stock market
Which statement is correct?
Bubbles can result when prices rise rapidly and investors join the game on the assumption that prices will continue to rise.
Which of the following markets are used by firms for financing?
Stock market Fixed-income market
Which of the following provides powerful incentives to maximize stock price per share?
Stock options
Which of the following statements is false?
Stock repurchases have become less common over the past 30 years.
Owners of a corporation are called
Stockholders Shareholders
Approximately how much must be saved for retirement in order to withdraw $100,000 per year for the next 25 years if the balance earns 8% annually, and the first payment occurs one year from now?
$1,067,477.62 Explanation PV = $100,000 {(1 / 0.08) − [1 / 0.08(1.08)25]} PV = $1,067,477.62
Today you deposit $1000 in an account paying 6% interest. At the end of years 1, 2 and 3 you will deposit $100 in that account. What is the present value of that stream of cash flows?
$1,267.30 Reason: $1000 + $100/(1.06)^1 + $100/(1.06)^2 + $100/(1.06)^3 = $1,267.30
You are borrowing $245,000 to purchase a home. The loan agreement requires a monthly payment based upon a 4.5% quoted APR over 20 years. What is your monthly mortgage payment? (Round to two decimal places)
$1,549.99 Explanation $245,000 = PMT([1/(.00375)] - 1/{(.00375)[(1.00375)]20 × 12}) PMT = $1,549.99
Find the future value of an annuity of $100 per year for 10 years at 10 percent per year.
$1,593.75 Reason: First, find the PV by using the 10 year annuity factor: PV = $100 x 10 year annuity factor = $100 x [1/.1 - 1/.1x(1.1)^10]= $614.46 To find the future value, multiply $614.46 x (1.1)^10= $1,593.75.
Today you deposit $1000 in an account paying 6% interest. At the end of years 1, 2 and 3 you will deposit $100 in that account. How much will you have at the end of year 4?
$1,599.94 Reason: $1000(1.06)4 + $100(1.06)3 + $100(1.06)2 + $100(1.06)1 = $1,599.94
A firm plans to invest $10,000,000 in a new factory that will generate annual cash flows to the firm of $3,000,000 for 5 years, then will be scrapped. If the appropriate opportunity cost of capital for this investment is 8.0 percent, what is its NPV?
$1,978,130 Reason: $1,978,130 = -10,000,000 + 3M/(1.08) + 3M/(1.08)2 + 3M/(1.08)3 + 3M/(1.08)4 + 3M/(1.08)5
A dollar invested today at 7.5 percent simple annual interest will be worth _______ one year from now.
$1.075 Reason: FV = $1.00 + $0.075
What is the most likely value of the PVGO for a stock with a current price of $50, expected earnings of $6 per share, and a required return of 20%?
$20 Explanation With a 100% payout ratio, the stock would be valued at $30 ($6/0.20 = $30). Thus, the $20 of additional price must represent the PVGO.
A firm has declared a 3 for 1 stock split.You currently own 100 shares priced at $60 each. What will the price per share be after the split?
$20 Reason: $60/3=$20
A polisher costs $10,000 and will cost $20,000 a year to operate and maintain. If the discount rate is 10% and the polisher will last for 5 years, what is the equivalent annual cost of the tool?
$22,637.98
The bank offers a credit card with an initial promotional rate of 0.0%. After six months, the rate adjusts to 21%. If no payments are required on an initial balance of $10,000, and the bank calculates payments based on a five year repayment schedule, what will the monthly payment be after six months?
$270.53 Explanation $10,000 = PMT([1/(1.75)] - 1/{(1.75)[(2.75)]5 × 12}) PMT = $270.53
Someone offers to buy your car for four, equal annual payments, beginning 2 years from today. If you think that the present value of your car is $9,000 and the interest rate is 10%, what is the minimum annual payment that you would accept?
$3,123.16 Explanation PV = C{(1 / 0.1) − [1 / (0.1 × 1.14)]} / 1.1 = $9,000 C = $3,123.16
Using the dividend discount model for a no-growth stock, what is the value of a stock that pays a $3 dividend and has a discount rate of 10%?
$30 Reason: Value of a no-growth stock = DIV1/r = $3/.1=$30
By how much must a firm reduce its assets in order to improve ROA from 10% to 12% if the firm's operating profit margin is 5% on sales of $4 million? Assume that the reduction in assets has no effect on sales or profit margin
$333,333 Explanation ROA = (sales / assets) × operating profit margin 0.10 = ($4,000,000 / assets) × 0.05 Assets = $2,000,000 0.12 = ($4,000,000 / assets) × 0.05 Assets = $1,666,667 Reduction in assets = $2,000,000 − 1,666,667 Reduction in assets = $333,333
What should be the price of a stock that offers a $4.32 annual dividend with no prospects of growth, and has a required return of 12.5%?
$34.56 Explanation P = $4.32/0.125 = $34.56
An all-equity firm reports a net profit margin of 10% on sales of $3 million. If the tax rate is 21%, what is the pretax profit
$379,746 Explanation Net profit margin = Net profit margin = (Pretax income - Taxes)/Sales .10 = (1 - .21) x Pretax income/$3,000,000 → Pretax income = $379,746
A perpetuity of $5,000 per year beginning today offers a 15% return. What is its present value?
$38,333.33 Explanation PV = $5,000 + $5,000 / r PV = $5,000 + $5,000 / 0.15 PV = $5,000 + $5,000 / 0.15 PV = $38,333.33
The salesperson offers, "Buy this new car for $25,000 cash or, with an appropriate down payment, pay $500 per month for 48 months at 8% interest." Assuming that the salesperson does not offer a free lunch, calculate the "appropriate" down payment.
$4,519.04 Explanation PV = $500 × {[1 / (0.08 / 12)] − [1/(0.08 / 12)(1 + (0.08 / 12)48)]} PV = $20,480.96 Down payment = $25,000 − 20,480.96 = $4,519.04
A company issues a $5,000 bond that matures in 5 years with a coupon rate of 6% and a current interest rate of 6%. The bond will sell for
$5,000 Reason: When the bond coupon rate and the interest rate are the same, the bond will sell for face value. No calculations are necessary.
Your car loan requires payments of $200 per month for the first year and payments of $400 per month during the second year. The APR is 12% and payments begin in one month. What is the present value of this 2-year loan?
$6,246.34 Explanation PV = {$200 {(1 / 0.01) − [1 / 0.01(1.01)12]}} + ({$400 {(1 / 0.01) − [1 / 0.01(1.01)12]} / 1.0112)} PV = $6,246.34
Your car loan requires payments of $200 per month for the first year and payments of $400 per month during the second year. The APR is 12% and payments begin in one month. What is the present value of this 2-year loan?
$6,246.34 Explanation PV = {$200 {(1 / 0.01) − [1 / 0.01(1.01)12]}} + ({$400 {(1 / 0.01) − [1 / 0.01(1.01)12]} / 1.0112)} PV = $6,246.34
A firm has $1 million in earnings. It has a payout ratio of 40%. How much will the firm plow back into the firm?
$600,000 Reason: This is the firm's payout to shareholders. If the payout ratio is 40%, the plowback ratio will be 60%, which means the firm will plow back $1 million x.6= $600,000
The present value of an annuity stream of $100 per year is $614 when valued at a 10% rate. By approximately how much would the value change if these were annuities due?
$61.40 Explanation PVAnnuity due = PV ordinary annuity × (1 + r) Difference = $614(1.1) − $614 = $61.40
What is the book value per share for a firm with 2 million shares outstanding at a price of $50, a market-to-book ratio of 0.75, and a dividend-payout ratio of 50%?
$66.67 Explanation Market-to-book ratio = stock price / book value per share 0.75 = $50 / book value per share Book value per share = $66.67
What will be the monthly payment on a $75,000 30-year home mortgage at 1% interest per month?
$771.46 Explanation Payment = $75,000 / [(1 / 0.01) − 1 / 0.01(1.01)360] Payment = $771.46
A firm plans to invest $300,000 in a new high-efficiency furnace that will reduce it's energy bill by $100,000 in years 1 and 2, $75,000 in years 3,4,5 and $50,000 in year 6. If the appropriate discount rate is 7.5%, the NPV of this project is ________.
$80,729 Reason: 50000/(1.075)6 + 75000/(1.075)5 + 75000/(1.075)4 + 75000/(1.075)3 + 100000/(1.075)2 + 100000/(1.075) - 300000
What is the present value of an annuity consisting of 100 end of year payments of $50,000 when the interest rate is 6 percent? Use your financial calculator.
$830,877.31 Reason: n=100,i=6,PMT=50000,fv FV=0, compute FV=830877.31
The present value of $100 paid annually at year end for 20 years at 10% per year is:
$851.36 Reason: 100[(1/.10)-(1/(.10(1.10)^20))] = 851.36
What is the market price of a share of stock for a firm with 100,000 shares outstanding, a book value of equity of $3,000,000, and a market-to-book ratio of 3?
$90 Explanation Market price per share = ($3,000,000 / 100,000) × 3 = $90
Lester's just signed a contract that will provide the firm with annual cash inflows of $28,000, $35,000, and $42,000 over the next three years with the first payment of $28,000 occurring one year from today. What is this contract worth today at a discount rate of 7.25%?
$90,580.55 Explanation PV = $28,000 / 1.0725 + $35,000 / 1.07252 + $42,000 / 1.07253 PV = $90,580.55
You are considering the purchase of a home that would require a mortgage of $150,000. How much more in total interest will you pay if you select a 30-year mortgage at 5.65% rather than a 15-year mortgage at 4.9%? (Round the monthly payment amount to 2 decimal places.)
$99,595.80 Explanation $150,000 = PMT([1 / (0.0565 / 12)] − 1 / {(0.0565 / 12)[1 + (0.0565 / 12)]30 × 12}) PMT = $865.85 $150,000 = PMT([1 / (0.049 / 12)] − 1 / {(0.049 / 12)[1 + (0.049 / 12)]15 × 12}) PMT = $1,178.39 Total difference = ($865.85 ×12 × 30) − ($1,178.39 × 12 × 15) = $99,595.80
Compound growth means that value increases after t periods by:
(1 + growth rate)t
A firm's after-tax cost of debt is equal to:
(1 - tax rate) x pretax cost
Two assets whose returns move up and down similarly but not in perfect tandem could have a correlation of about _______.
+0.5
Two assets whose returns move up and down in perfect tandem have a correlation of ________.
+1
Select all that apply Why is it that buying or selling financial securities in an efficient market is a zero NPV investment? Choose all that apply.
- The price of a financial security in an efficient market is the present value of the expected future cash flows.- Financial securities are priced at their true value and investors cannot make excess profit from the transaction.
Two assets whose returns move in exact opposite directions have a correlation of ________.
-1
Rank the following investments in terms of historical returns, starting from the lowest to the highest.
1. Treasury Bills 2. Treasury Bonds 3. Common Stock
To achieve diversification benefits similar to the market portfolio, an investor can invest in mutual funds with a portfolio beta of close to ______.
1.0
If you invest 50 percent of your funds in a stock with beta=1.5, 30 percent in a stock with beta=0.9 and 20 percent in a stock with beta=0.3, your portfolio beta will be _______.
1.08 Explanation: (1.5)(0.50)+ (0.9)(0.30)+ (0.3)(0.20)=1.08
If a bank quotes a loan with an APR of 15 percent, compounded monthly, what is the periodic rate on this loan?
1.25 percent Reason: 15/12 = 1.25 percent
ABC Corporation has current assets of $50,000, total assets of $150,000, current liabilities of $35,000, total liabilities of $90,000, and shareholders' equity of $25,000. What is ABC Corporation's current ratio?
1.43 Reason: Current ratio = current assets/current liabilities = $50,000/$35,000 = 1.43
Order the following three components of the firm's capital structure from riskiest to least risky. Instructions
1.common stock 2.preferred stock 3.debt
Which of the following is the correct formula for the discount factor?
1/(1+r)^t
Shareholders will not welcome higher _____-term profits if ______-term profits are damaged.
short, long
Marley Corporation's bonds have four years left to maturity. Interest is paid annually, and the bonds have a $1,000 par value and a coupon rate of 5%. If the price of the bond is $841.51, the yield to maturity is _____. (Use trial and error to calculate yield).
10% Reason: First, calculate the coupon payment: $1,000 x .05 = $50. Next, discount the payments at each yield to determine the appropriate yield that gives a bond price of $841.51. You will see that by doing trial and error on the 4 given yields in the multiple choice question (5%, 8%, 10%, and 12%), the correct yield is 10%: $841.51 = $50/(1+.1) + $50/(1+.1)22+ $50/(1+.1)33+ $1,050/(1.1)4
Calculate the risk premium on stock C given the following information: risk-free rate = 5%, market return = 13%, stock C's beta = 1.3.
10.4%
What is the annually compounded rate of interest on an account with an APR of 10% and monthly compounding?
10.47% Explanation EAR = [1 + (0.10 / 12)] 12 − 1 = 0.1047, or 10.47%
Spock Enterprises has a market value of $100 million in debt outstanding. They also have a market value of equity of $400 million. Shareholders require a 12% return on their shares and creditors require a 7% before-tax return on their investment. Spock's tax rate is 35%. The WACC of Spock Enterprises is ______ percent.
10.5 Reason: (12)(0.80) + (7)(0.20)(0.65)= 10.5
If you construct an investment portfolio by investing 75% of your funds in the market portfolio (r = 14%) and 25% of your funds in Treasury bills (r = 3%), what is the expected return of your portfolio according to the CAPM?
11.25% Reason: 3 + (14 - 3)(0.75)=11.25
Vandalay Industries has $30 million of debt and $70 million of equity outstanding. The market cost of debt is 8% and the cost of equity is 14%. The firm has a 35% corporate tax rate. What is Vandalay's WACC?
11.36% Reason: (0.3)(0.65)8.0 + (0.7)14.0 =11.36%
firm has just paid its annual dividend of $5.64 a share. Thereafter the dividend is expected to increase at a rate of 2% a year. If the firm's stock currently sells for $60 a share, what is the cost of equity?
11.59%
If the nominal rate of return on a stock is expected to be 14.2% and inflation is expected to be 2.2%, then the real rate of return on the stock is expected to be ______.
11.7% Reason: (1.142/1.022) - 1 = 11.7
What is the required return for a stock that has a constant-growth rate of 3.3%, a price of $25, an expected dividend of $2.10, and a P/E ratio of 14.4?
11.70% Explanation $25 = $2.10/(r − 0.033); r = 11.70%
A project has a beta of 0.97, the risk-free rate is 4.1%, and the market risk premium is 8.1%. What is the project's expected rate of return?
11.96%
Little LampLighter Inc has a book value of $10 million in debt; it's bonds are trading at $900 and there are 11,000 outstanding. It also has a market value of equity of $25 million. Shareholders require a 14% return on their shares and creditors require a 8% before-tax return on their investment. The weighted average return required by investors in Spock Enterprises is ______ percent.
12.3 Reason: (0.28x0.08) + (0.72x0.14) =12.3
What is the WACC for a firm with 50% debt and 50% equity that pays 12% on its debt, 20% on its equity, and has a 21% tax rate?
14.7%
Suppose the risk-free rate is 5%, the market rate of return is 10%, and beta is 2. Find the expected rate of return using the CAPM.
15%
Potter National Bank has a beta of 1.8. The risk-free rate is currently quoted at 1.5% and the expected market risk premium is 7.5%. What is Potter's cost of equity?
15.0% Reason: Cost of equity = risk-free rate + beta (expected market risk premium) = 1.5 + 1.8(7.5) = 15%
An investor purchases a share of stock today for $27.50 and holds it for a year. During the year the stock pays $4.50 in dividends. The investor sells the stock at the end of the year for $29.25. What is her percentage return? (Record your answer as a percent rounded to one decimal place.)
22.7% Reason: ($29.25 - $27.50 + $4.50)/$27.50 = 22.7%
The top tax rate on both dividends and capital gains is ______.
23.8%
What should be the current price of a stock if the expected dividend is $5, the stock has a required return of 20%, and a constant dividend growth rate of 6%?
35.71
What should be the stock value one year from today for a stock that currently sells for $35, has a required return of 15%, an expected dividend of $2.80, and a constant dividend growth rate of 7%?
37.45
What should be the current price of a share of stock if a $5 dividend was just paid, the stock has a required return of 20%, and a constant dividend growth rate of 6%?
37.86
ABC Corporation has long-term debt of $100,000 and equity of $160,000. ABC's long-term debt ratio is _____.
38.5% Reason: Long-term debt ratio = long-term debt/(long-term debt + equity) = $100,000 / ($100,000 + $160,000) = .385 0r 38.5%
Households account for approximately how much of corporate equity holdings?
40%
An individual invested $1,000 in a bond with a coupon payment of $12. The price of the bond increased to $1,400. What is the rate of return on this bond?
41.2% Reason: Rate of return=(coupon income + price change)/investment= ($12+$400)/$1,000=.412 or 41.2%
ABC Corporation had $370,000 in inventory at the start of the year and daily cost of goods sold of $8,220. ABC's average days in inventory is _____.
45.01 Reason: 37000/8220=45.01
If the toss of a coin comes down heads, you win a dollar. If it comes down tails, you lose fifty cents. How much would you expect to gain after 20 tosses?
5.00
If the Jones Corporation has a pretax cost of debt of 8% and a corporate tax rate of 35%, what is Jones' after-tax cost of debt?
5.2% Reason: After-tax cost of debt = (1-tax rate) x pretax cost (1-.35) x .08 = 5.2%
An investment in XYZ Corporation stock may return -20% with a 20% probability, 3% with a 25% probability, 12% with a 30% probability and 22% with a 25% probability. What is the expected return on an investment in XYZ corporation stock?
5.85% Reason: (0.20)(-20)+ (0.25)(3)+ (0.30)(12)+ (0.25)(22) = 5.85%
Assume a firm's debt is selling at face value. What is the firm's cost of debt if the debt has a coupon rate of 7.5% and the tax rate is 21%?
5.93%
Spock Enterprises has a market value of $100 million in debt outstanding. They also have a market value of equity of $400 million. Spock's total market value is ______ million.
500
You currently own 200 shares of stock valued at $6 per share. If the firm declares a 1-for-4 reverse stock dividend you will own ________ shares valued at ________ per share.
50; $24
An investor purchases a share of stock today for $27.50 and holds it for a year. The investor sells the stock at the end of the year for $29.25. What is her percentage capital gain?
6.4% Reason: The capital gain is $29.25 - $27.50 = $1.75. Therefore the percentage capital gain = $1.75/$27.50 = 6.4%
The rate quoted by Big Bank on a car loan is 8 percent. The annual rate of inflation is currently 1.5 percent. What is the approximate real interest rate paid by the consumer on this loan?
6.5 percent
Mortor's Corporation sold 6 year bonds for $1,072.62, with a face value of $1,000 and a coupon rate of 8%. The annual yield to maturity is
6.5% Reason: First, calculate the coupon payment: $1,000 x .08 = $80. Next, discount the payments at each yield to determine the appropriate yield that gives a bond price of $1,072.62. You will see that by doing trial and error on the 4 given yields in the multiple choice question (6%, 6.5%, 7%, and 7.5%), the correct yield is 6.5%: $1,072.62 = $80/(1+.065) + $80/(1+.065)22+ $80/(1+.065)33+ $80/(1.+.065)44+ $80/(1 + .065)55+ $1,080/(1+.065)6
What is the coupon rate for a bond with 6 years until maturity, a price of $984.32, and a yield to maturity of 7%? Interest is paid semi-annually.
6.68% $984.32 = PMT {(1 / 0.035) − [1 / 0.035(1.035)12]} + $1,000 / 1.03512 PMT = $33.38 Coupon rate = ($33.38 × 2) / $1,000 = 0.06675, or 6.68%
If a bond offers an investor 11% in nominal return during a year in which the rate of inflation is 4%, then the investor's real return is:
6.73% 1 + real return = 1.11 / 1.04 − 1 = 0.0673, or 6.73%
If the nominal rate of interest is 10% and the rate of inflation is 3%, the real interest rate is ____.
6.8% Reason: 1 + real interest rate = (1 +.1)/(1 +.03) = 1.068 - 1 = .068 or 6.8%
If the expected return on Treasury bills for 2015 is 0.25 percent and the market risk premium for the U.S. is 7.50 percent, what is the expected return on the U.S. stock market for 2015?
7.75% Reason: 7.50% +0.25%=7.75%
ABC Corporation had $3,000,000 in cost of goods sold and $370,000 in inventory. ABC's inventory turnover is _____.
8.11 Reason: Inventory turnover = cost of goods sold/inventory = $3,000,000/$370,000= 8.11
A firm has a payout ratio of.3, plowback ratio of.7 and a return on equity of .13. What is the firm's growth rate?
9.1% Reason: Growth rate = plowback ratio x ROE =.7 x.13=.091 or 9.1%
A bank offers a savings account with an APR of 9 percent with monthly compounding. What is the effective annual interest rate of this investment?
9.38 percent Reason: EAR=(1 + 0.09/12)^12 - 1 = 9.38 percent
A bond has a coupon rate of 8%, pays interest semiannually, sells for $960, and matures in 3 years. What is its yield to maturity?
9.57%
Which item indicates a flaw in the efficient market hypothesis?
A bubble in asset prices
Which of the following is a perpetuity?
A constant stream of cash flows forever
Which one of the following is a financial asset?
A corporate bond
Which one of the following will increase a firm's times interest earned ratio?
A decrease in cost of goods sold
Which one of the following signals is most likely to elicit a decrease in share price?
A decrease in the regular quarterly dividend
Which one of the following changes will provide an increase in a firm's ROE?
A decrease in the tax rate
Which of the following statements are correct regarding the method of valuation by comparables? (Choose 2).
A firm's market value can be estimated by multiplying its book value by the market/book ratio for a similar firm A firm's market value can be estimated by multiplying its earnings per share by the P/E ratio for a similar firm
Which of the following statements is correct?
A stock repurchase does not increase stock price but it does avoid the fall in price that would occur on the ex-dividend date.
Which of the following is the correct definition of the Equivalent Annual Annuity (EAA)?
A stream of cash flows or payments that have the same present value as a project or investment's cash flows.
Which of the following statements is/are correct?
Accumulation of cash by a mature firm can lead to problems like overinvestment and excessive perks. Shareholders' taxes can be affected by the firm's decision to payout cash or retain it. In a maturing company that is not paying out cash to shareholders, the stock price will begin to stagnate.
Which of the following are important lessons that the finance world learned from the financial crisis?
Agency problems can cause management to make decisions that do not align with shareholder interest Firms financed mostly by debt can quickly become insolvent An absence of liquidity compromises the informational function of financial markets
What price would you pay today for a stock if you require a rate of return of 13%, the dividend growth rate is 3.6%, and the firm recently paid an annual dividend of $2.50?
Answer: $27.55 Explanation: Formula to determine the would be price= Price = ( dividend × (1+growth rate)) divided by (rate of return - growth rate) Price = ($2.50 × (1 +.036)/(0.13 - 0.036) = (2.50 ×1.036)/(0.13 - 0.036) = 2.59/0.094 price = $27.55
The board of directors is responsible for which of the following?
Appoints the CFO Appoints the CEO Approves important financial decisions
Which of the following ratios shows how much sales are generated by each dollar of total assets?
Asset turnover ratio
Which of the following ratios shows the number of days in which a company has sufficient inventories to maintain operations?
Average days in inventory
Which of the following regulations were enacted following the financial crisis?
Banks' dividend payments can be stopped if the equity ratio is too low Banks are required to finance using more equity than in the past
Which of the following statements are true regarding the beta of a common stock?
Beta is the relevant measure of risk that diversified investors care about Beta measures the sensitivity of a stock's returns to fluctuations in the market portfolio.
Which of the following are three limitations of the Payback Rule for accepting projects?
Biases the firm against long-term projects in favor of short-term ones Gives equal weight to all cash flows arriving before the cutoff period Does not consider cash flows after the payback period
Initially, convertible preferred stock received ____dividends but has the option to exchange this preferred stock for the company's ____ ____
Blank 1: fixed Blank 2: common Blank 3: stock, shares, or equity
Which of the following are considered advantages of using EVA and Accounting rates of return over market-value based measures?
Can be calculated for a particular division Show current performance Not affected by economic factors that move stock market prices
Given the various investment options listed, what investment criteria concept might make an investor select Project B over other projects? Project NPV Profitability Index A $ 1.3 mil 0.23 B $ 2.2 mil 0.54 C $ 3.5 mil 0.49 D $ 4.6 mil 0.38
Capital rationing
Making the choice to invest today or to postpone that investment to a future date is a choice between mutually exclusive projects. When making this choice, what is the correct criterion to use?
Choose the investment date that produces the highest NPV today.
Which of the following is a major source of loans for corporations?
Commercial banks
Which of the following is not generally allowed to make equity investments in corporations in the United States?
Commercial banks
Which market is used to trade cotton, natural gas, and silver?
Commodities market
Which of the following markets are not sources of financing but markets that are used to adjust the firm's exposure to risk?
Commodities market Derivative market
Who enjoys the right to elect the board of directors in a corporation?
Common stockholders
Volatility is likely to be highest in which of the following investments?
Common stocks
The exact effect of inflation on the nominal rate of return is:
Real Rate of Return = (1+ Nominal Rate of return)/(1+ Inflation rate)
Which one of the following is correct concerning real interest rates?
Real interest rates, if positive, increase purchasing power over time.
Which of the following can result when enough shareholders take the "Wall Street Walk"?
Damage to top managements' reputation Takeover The company's stock price falls
A firm who raises money by promising to pay back the cash plus interest is participating in what type of financing?
Debt
Assume a firm with 5,000 shares outstanding earns $10 per share and has a 30% plowback ratio. In this case retained earnings will:
Decrease by $15000 Change in Retained Earnings = 5000 x $10 x 0.30 = $15,000
Which one of these is included in the yield of a bond with a low credit rating but not included in a U.S. Treasury bond yield? Assume both bonds are selling at a premium.
Default premium
Which capital budgeting decision method finds the present value of each cash flow before calculating a payback period?
Discounted payback period
Which of the following expressions correctly calculates an investor's dividend yield on a share of stock?
Dividend yield = dividend/initial share price
A firm has current assets of $1.2 million, fixed assets of $3.6 million, and debt of $2.2 million. There are 250,000 shares of stock outstanding. What will be the book value of equity if the firm repurchases 10% of its outstanding shares for $10.40 a share?
Equity = $1.2m + 3.6m - 2.2m - (0.10 × 250,000 × $10.40) = $2,340,000
Last year's return on equity was 30%. This year the ROE has decreased to 20% even though the firm's earnings equaled last year's earnings. The firm has no preferred stock. What caused the decrease?
Equity increased by 50%. Explanation NI = 0.3(Old equity) NI = 0.2(Old equity + New equity) 0.3(Old equity) = 0.2(Old equity + New equity) New equity = 0.5 Old equity
True or false: it is acceptable to use book values of debt and equity to calculate the weights of debt and equity for the company cost of capital calculation.
False
True or false: the difference in returns between short-term and long-term Treasury securities is called the "bond time premium"
False It is called the "Maturity Premium"
The financial crisis of 2007-2009 contributed to the largest sovereign default in history by which one of these countries?
Greece
A stock's price is increasing in which of following variables?
Growth Rate Dividend
Hedge funds differ from mutual funds in which of the following ways?
Hedge funds are restricted to knowledgeable investors Hedge funds require a higher initial investment Hedge funds follow complex, high-risk strategies
Which of the following is inconsistent with a firm that sells for very near book value?
High future earning power
Which of the following is least likely to contribute to going concern value?
High liquidation value
Given the future value, which of the following will contribute to a lower present value?
Higher discount rate
When projects are mutually exclusive, you should choose the project with the:
Highest NPV.
Which of the following holds the largest amount of corporate equities in the US?
Households
Which of the following represent questions the financial manger would ask to evaluate investment decisions? (Do not confuse the investment decision with the financing decision)
How should profitability be measured? How profitable are investments relative to the cost of capital?
Which of the following statements is(are) true of the payout practices of U.S. firms between 2003 and 2014?
Most firms did not payout cash at all. More firms paid dividends than repurchased shares
Which one of the following statements is incorrect concerning stock indexes?
Most indexes include all of the publicly-traded common stocks.
Assuming no market imperfections, which one of the following would not be expected to have an effect on share price?
Stock Repurchase
Which of the following choices would be guaranteed to increase a firm's ROE if the ROA is currently 10% and the leverage ratio equals 1?
Increase the debt burden from its current level
Corporations generally need shareholder approval to do which one of the following?
Increase the number of authorized shares
Which of the following is more important to corporations for the long-term financing of the business?
Insurance companies
Which of the following are considered to be a financial institution?
Insurance companies Banks
Which of the following forms of information provided by financial markets is often essential to financial managers?
Interest rates Commodity prices Values of the company
Recently, which of the following sources of funds has played the greatest role in the financing of U.S. nonfinancial firms?
Internal funds
Which of the following ratios measure the firm's efficiency with which it uses its assets?
Inventory turnover Asset turnover
An investor prefers to invest in companies that have high operating leverage. How can this be accomplished if the investor also requires a portfolio beta of 1.0?
Invest a portion of the portfolio in U.S. Treasury securities
Which parts of the return on equity equation depend on the firm's financing mix (its debt-equity mix)?
Leverage ratio Debt burden
Which statement is likely true for a company with a cash ratio close to 1.95?
Lines of credit can be easily repaid
The typical marketing location of Eurobonds is
London branches of international banks
Which of the following ratios shows the percent of long-term capital that is financed by debt?
Long-term debt ratio
Which two types of voting methods are used to elect directors to a corporation's board?
Majority voting Cumulative voting
Which of the following risks are not typically associated with Treasury Bonds?
Market Risk Default Risk
Which of the following values treats the firm as a going concern?
Market value
Which one of the following statements is typically correct for a going-concern firm?
Market value of equity exceeds book value of equity.
Which of the following is probably the most important financial market for a public corporation?
Stock market
Which type of fund can investors buy and sell as they please and initial investments are often $3,000 or less?
Mutual fund
The single variable of interest for the investment timing problem is
NPV
Which of the following is the capital investment decision criterion that will always lead management to make the value-maximizing choice?
NPV
Which mutually exclusive project should a manager select?
NPV = $1,800, Total Cash Flow = $9,000
When there is no real capital rationing the preferred valuation metric is
NPV, because it will favor large projects over small ones.
Which of the following figures shows the company's potential net reservoir of cash?
Net working capital
A firm has $600,000 in current assets and $150,000 in current liabilities. Which of the following is correct if it uses cash to pay off $50,000 in accounts payable?
Net working capital will not change.Correct
Which of the following statements are true regarding the present value of a stream of cash payments?
Nominal cash payments should be discounted using a nominal interest rate. Real cash payments should be discounted using a real interest rate.
______ dollars refer to the actual number of dollars of the day, whereas ______ dollars refer to the amount of purchasing power.
Nominal, real Current, constant
According to the Du Pont System, return on assets is dependent upon which of the following two factors?
Operating profit margin Asset turnover
Which of the following statements is true regarding the risks undertaken by investors in U.S. Treasury bills?
Other than some uncertainty about inflation, they are nearly risk-free.
Even when the yield curve of a long-term bond is upward-sloping some investors prefer short-term bonds. Which of the following reasons would explain why this statement is true?
Prices of long-term bonds fluctuate more than prices of short-term bonds Short-term investors can profit if interest rates rise
Which of the following is a disadvantage to incorporating a business?
Profits taxed at the corporate level and the shareholder level
A company has the opportunity to invest in one of two mutually exclusive projects. Project A has an initial cost of $1.2 million and cash flows with a present value of $4.5 million. Project B has an initial cost of $2 million and cash flows with a present value of $5 million. Which project should the firm choose to invest in?
Project A because it has a higher net present value Reason: Project A does have a lower initial cost, but this is not why you should choose it over Project B. Instead, look at the overall net present value. For Project A, it is $4.5 million - $1.2 million = $3.3 million. For Project B, NPV is only $5 million - $2 million = $3 million.
A project with higher than average risk offers an expected return of 14%. Which statement is correct if the company's opportunity cost of capital is 12% and the project's opportunity cost of capital is 15%?
Project NPV is negative; it should be rejected.
If Nuka-Cola purchases 100,000 shares at $35 per share of Poseidon Energy which pays a dividend of $2 per share, what is the tax liability for Nuka-Cola with respect to its ownership of Poseidon Energy during the first year (assuming it sells none of the shares)?
Reason:$2 X 100,000 X .50 = $100,000
Which of the following ratios shows the number of times outstanding credit accounts are collected during the year?
Receivables turnover
If the rate of return on an investment project is less than the stockholder could earn on their own, should the financial manager accept or reject the investment?
Reject
Which of the following statements is true?
Repurchases have grown in popularity since 1980.
Which one of these parties is most likely to prefer a stock with a high-dividend payout policy?
Retired individuals
Which one of these transports income forward in time?
Retirement savings
Which part of the return on equity equation depends on the firm's production and marketing skills, not the firm's financing mix?
Return on assets
Which of the following are helpful for measuring the firm's profits per dollar of assets?
Return on equity Return on assets Return on capital
Which of the following statements are true regarding the risks undertaken by investors in common stock?
Returns on stock are dependent upon possible dividends and capital gains/losses. The investor can lose all or part of the principal invested. Risk is almost always higher than for Treasury bills and bonds.
Which of the following statements about the CAPM is FALSE?
Risk is measured by the CAPM.
Why is debt financing said to include a tax shield for the company?
Taxable income is reduced by the amount of the interest
Which of the following statements is correct for a 10% coupon bond that has a current yield of 7%?
The bond's market value is higher than its face value.
Which of the following is NOT a requirement of the Sarbanes-Oxley Act of 2002?
The compensation committee must be appointed by an outside director
What is one necessary condition to use WACC to value an entire business?
The debt ratio will stay the same over time.
Which of the following is the correct definition of the market risk premium?
The difference between the rate of return on common stocks and the interest rate on Treasury bills
Which statement correctly describes the company's dividend decision?
The dividend payment must be approved by the board of directors.
When will ROE equal ROC?
Whenever the firm has no debt
Which one of the following would you expect to represent the broadest-based index of U.S. stocks?
Wilshire 5000
A proposed project has a positive NPV if it is financed entirely by equity. If the project can sensibly be financed partly by debt and the firm pays tax, will the project remain acceptable?
Yes, using debt will increase the NPV.
A "convertible bond" provides the option to convert:
a bond into shares of common stock.
The coupon rate of a bond equals:
a defined percentage of its face value.
A bond that is priced below its face value is said to sell for
a discount
Which type of firm is most likely to pay a dividend?
a mature, profitable company
Which types of firms are less likely to pay a dividend? a mature, struggling company a growth company a mature, profitable company
a mature, struggling company a growth company
A bond that is priced above its face value is said to sell for
a premium
Under which of the following situations should the IRR decision rule be avoided?
a project with multiple rates of return selection of mutually exclusive projects project NPV does not decline smoothly as discount rate increases
In a market where stocks are fairly valued, stock prices follow:
a random walk
A dividend increase may be used as ________ of a firm's ________.
a signal; good prospects
The expected rate of return on risky securities is normally _____ the interest rate on corporate borrowing.
above
The net present value rule states that managers increase shareholder wealth by:
accepting all projects with a positive NPV.
Eurobonds are long-term, corporate liabilities that:
are marketed in many countries.
The purpose of the business and how it is to be managed, financed, and governed is set out in the
articles of incorporation
When a company bundles the cash flows from a group of loans and sells them, the resulting bond is called a(n) _________.
asset-backed bond
An ordinary annuity is a series of level payments that begin ____.
at the end of one payment period
The maximum number of shares that a firm can issue without the approval of the existing shareholders is called the _____________.
authorized share capital
The WACC is the appropriate discount rate for use with ______ projects but should be adjusted ______ for higher risk ones
average; upward;
Knowing that the issuing firm may buy back a callable bond, its market price will never rise above its _________.
call price
The price that the issuing firm will pay investors for a callable bond that is being bought back is known as the ________.
call price
Investment banks _____ make equity investments in corporations.
can
Real interest rates:
can be negative, zero, or positive.
A corporate director:
can be voted out of power by the shareholders.
If the price of a stock falls on 4 consecutive days of trading, then stock prices:
can still be following a random walk.
To determine the equity value of an entire business, discount the firm's _____ using the ______ as the discount rate, then subtract the value of the firm's _____.
cash flows; WACC; debt
If the corporate tax rate is not zero, increasing the proportion of debt in the capital structure causes the WACC to _______.
change
A project can have as many different internal rates of return as it has:
changes in the sign of the cash flows.
A corporation whose shares are not publicly traded, but instead owned by a small number of investors, is called a privately owned or ____________ company.
closely held
An investor who purchases ______ receives ownership shares in a publicly held corporation.
common stock
Another name for the WACC is the ___________.
company cost of capital
Firms may use a ____________ to discount the cash flows of their average risk projects.
company cost of capital
The opportunity cost of capital for investment in the firm as a whole is called the:
company cost of capital
To shareholders, an increase in the dividend payment sends a signal of managers' ________.
confidence in the future prospects of the firm
The individual responsible for the corporation's tax affairs is the
controller
In a large corporation, preparation of the firm's financial statements would most likely be conducted by the:
controller.
The laws, regulations, institutions, and corporate practices that protect investors is known as
corporate governance
The minimum acceptable rate of return on capital investment is known as the
cost of capital
The inventory turnover ratio is equal to
cost of goods sold divided by inventory at the start of the year
The fixed interest rate charged on most long term loans is called the _______ rate.
coupon
The _______ is the annual interest payment on a bond, expressed as a percentage of face value.
coupon rate
Limitation or subordination of new debt is a form of a protective _____ on existing debt.
covenant
Foreign exchange markets are used to trade _______.
currency
The current ratio is equal to
current assets divided by current liabilities
Net working capital of $4,000 states that the company's
current assets exceed current liabilities by $4,000
Net working capital is equal to
current assets minus current liabilities
Industries that generally perform very well when the entire economy performs well and perform very badly when the economy performs badly are called:
cyclical industries.
If DIV0 is the dividend just paid by a stock that you own, DIV1 is the next expected dividend, P0 is the price you paid for the stock and P1 is the price you expect to receive when you sell it, then the dividend yield can be calculated as __________.
dividend yield = DIV1/P0
The expected return on a stock can be calculated as the sum of the _______ and the ________.
dividend yield; capital gain
Preferred stock is valued like a perpetuity. The price of a preferred stock is therefore equal to:
dividend/r (sub)preferred
In order to accommodate share repurchases by a dividend paying firm, the Dividend Discount Model must use ________ for its cash flows.
dividends per share
The current yield of a bond can be calculated by:
dividing the annual coupon payments by the price.
The present value of a perpetuity can be determined by:
dividing the payment by the interest rate.
The random walk of stock prices dictates that a stock's price on any given day:
do not depend on previous stock price movement
Professional corporations are often created by _________ and __________.
doctors accountants
Plowed back earnings may result in ______ and _______ growth, but it will not increase ______ if that money is expected to earn only the return that investors require.
earnings, dividend, stock price
A(n) ________ market is one in which prices reflect all available information.
efficient
Agency problems can least be controlled by:
electing senior managers to the board of directors.
An organization that raises money from investors and provides financing to others is known as a _____.
financial intermediary
A market where securities are issued and traded is known as a
financial market
The chief financial officer is involved in
financial policy financial planning
Financial intermediaries are an important source of ________ for corporations.
financing
When returns are higher or lower than beta predicts it could be caused by _____-specific risk.
firm
Last month a stock with a beta of 1.0 lost 20% while the S&P 500 had a 10% gain. Given this, it is most likely that the:
firm released some negative information about itself.
If you were willing to bet that the overall stock market was heading up on a sustained basis, it would be more profitable to invest in:
high beta stocks
Projects with high fixed costs will tend to have _______ betas than other projects.
higher
Since a risky dollar is worth less than a safe one, returns for risky projects must be ________ than those of a risk-free investment.
higher
The banking crisis of 2007-2009 shows that investors prefer ________ in bonds; therefore, heavily traded bonds offer ________ yields.
higher liquidity, lower
A convertible bond will sell at a _________ a comparable bond that is not convertible.
higher price than
A highly leveraged company will have a long-term debt-equity ratio that is _________ a less leveraged company.
higher than
When the interest rate is lower than the coupon rate on a bond, the price of the bond will be:
higher than face value Reason: Take, for example, a 5 year, $1,000 bond offering a 10% coupon. If the interest rate is less than the coupon rate - for example, if the interest rate is 5%, the PV of the bond would be: $100/(1.05)^1 + $100/(1.05)^2 + $100/(1.05)^3 + $100/(1.05)^4 + $1,100/(1.05)^5 = $1,216.47 - a higher price than the $1,000 face value.
If an investor purchases a bond when its current yield is higher than the coupon rate, then the bond's price will be expected to:
increase over time, reaching par value at maturity.
The announcement of a dividend increase prompts a(n) _______ in stock price and a dividend decrease prompts a(n) ________ in stock price.
increase; decrease
Assume your uncle recorded his salary history during a 40-year career and found that it had increased 10-fold. If inflation averaged 4% annually during the period, then over his career his purchasing power:
increased by nearly 2% annually. Explanation FV = PV(1 + r)t 10 = 1(1 + i)40 r = 5.93% Real rate = (1.0593 / 1.04) − 1 = 0.0186, or 1.86%
In good times, financial leverage _____ returns to shareholders.
increases
Long-term bond prices are more sensitive than short-term bond prices to
increases in interest rates
Assume you are making $989 monthly payments on your amortized mortgage. The amount of each payment that is applied to the principal balance:
increases with each succeeding payment.
If a supermajority of votes are needed for a firm to be taken over, this protects
incumbent management
Which type of bond links coupon payments to inflation?
indexed bonds
High levels of liquidity may indicate:
inefficient use of assets.
A perpetuity is a constant stream of cash flows for a(n) ______ period of time.
infinite
Because the _____ rate is uncertain, so is the _______ rate of interest offered on bonds.
inflation, real
Which two investment criterion methods are most used by firms?
internal rate of return net present value
Which of the following is true regarding the market value of the firm?
it is affected by the earnings a firm can generate by current tangible and intangible assets it includes investors' expectations of future earnings power it treats the firm as a going concern
If choices you make today do not affect future investment opportunities, then
it is enough simply to compare the NPV of the projects.
If a firm's debt ratio is greater than 0.5, then:
its debt-equity ratio exceeds 1.0.
When a project's cash flows are discounted at the WACC and the NPV is exactly zero, then those cash flows are _________ to give debtholders and shareholders the returns they require.
just enough
You can continue to use your less efficient machine at a cost of $8,000 annually. Alternatively, you can purchase a more efficient machine for $12,000 plus $5,000 annual maintenance. If the new machine lasts 5 years and the cost of capital is 15%, you should:
keep the old machine and save $580 in equivalent annual costs. NPV = -$12,000 - $5,000[(1/0.15) - 1/0.15(1.15)5] = -$28,760.78Using a financial calculator:N = 5; I = 15%; PV = -$28,760.78; FV = 0; CPT PMT = $8,579.79Change in annual cost = $8,579.79 - 8,000 = $579.79
The profitability index selects projects based on the:
largest return per dollar invested.
If you are promised $100 in one year, $200 in two years, and $300 in 3 years, then those promises combined equal ______ $600 today.
less than Reason: This relates to the time value of money concept - $1 is worth more today than it is in the future. Therefore, any funds that you receive in the future will be worth less than they are if you received them today.
Assume market interest rates have risen substantially in the 5 years since an investor purchased Treasury bonds that were offering a 3% return over their 15-year life. If the investor sells now, he or she is likely to realize a total return that is:
less than 3%.
When the interest rate is higher than a bond's coupon rate, the bond will be priced at:
less than face value Reason: Take, for example, a 5 year, $1,000 bond offering a 10% coupon. If the interest rate is higher than the coupon rate - for example, if the interest rate is 12%, the PV of the bond would be: $100/(1.12)^1 + $100/(1.12)^2 + $100/(1.12)^3 + $100/(1.12)^4 + $1,100/(1.12)^5 = $927.90 - a lower price than the $1,000 face value.
The ability to turn an investment back into cash when needed is called:
liquidity
Diversification works best when portfolio stock returns are ______ correlated.
negatively
If a dividend cut conveys information to shareholders that they already expected or knew, then the effect of the announcement of the dividend cut on the firm's share price may be ______.
negligible
After-tax operating income for a leveraged firm is defined as:
net income + after-tax interest.
The profit margin is equal to
net income divided by sales
Economic value added is equal to
net income minus the cost of capital.
When a project's internal rate of return equals its opportunity cost of capital, then the:
net present value will be zero
If investors are expecting a dividend cut, then the announcement of the decreased dividend payment will:
not affect the stock price as long as the announcement was in line with expectations.
When calculating a project's payback period, cash flows are:
not discounted at all.
A bond can also be called a:
note debenture
In majority voting, if nine directors are up for election, each director is voted on separately and each stockholder can cast ____ vote(s) per candidate for each share they own.
one
A staggered election occurs when:
only a fraction of the board are elected at a time
If a firm uses its book value of debt instead of its market value of debt to calculate its WACC, then its WACC will likely be:
only slightly off
When a firm repurchases stock by purchasing it in the secondary market like any other shareholder, this is called a(n) _________.
open-market repurchase
The expected rate of return that investors can achieve in financial markets at the same level of risk is known as the
opportunity cost of capital
The rate of return rule states that a firm should invest in any project offering a rate of return that is higher than the:
opportunity cost of capital
Common stock that has been issued and is in the hands of shareholders is called ________.
outstanding shares
The present value formula for a(n) ______ is PV = C/r, where C is the constant and regularly timed cash flow to infinity, and r is the interest rate.
perpetuity
To use your financial calculator to solve annuity problems, you use the _____ key for entry of the constant payment C.
pmt
The average of the betas of the individual securities in a portfolio, weighted by the investment in each security, is called the:
portfolio beta
The total risk of a diversified portfolio of stocks is determined by the _________, since all ________ has been diversified away.
portfolio beta; firm specific risk portfolio beta; diversifiable risk
The total risk of a well-diversified portfolio of stocks can be calculated as the product of the ________ times the _________.
portfolio beta; standard deviation of the market portfolio
When the overall market is up by 10%, investors with portfolios of defensive stocks will probably have:
positive portfolio returns less than 10%.
In Excel, cash inflows are recognized as ______ values and cash outflows are recognized as ______ values. Interest rates should be entered as ______.
positive, negative, decimals
The appropriate opportunity cost of capital is the return that investors give up on alternative investments that:
possess the same level of risk.
A stock's par value is the:
price at which each share is recorded.
XYZ Industries is considering the following list of projects. For each, the project cost of capital and expected return are given. Which of these projects should the firm accept?
project cost of capital=9%; expected return=9.1% project cost of capital=12%; expected return=14.5% project cost of capital=7%; expected return=8%
The ________ is usually accepted as a firm's cost of debt capital for WACC calculations.
promised yield to maturity on the firm's existing bonds
Conditions imposed on borrowers to protect lenders from unreasonable risk are known as
protective covenants
Over the long run value stocks have:
provided a higher return than growth stocks.
The New York Stock Exchange is used to trade shares for _____ corporations.
public
Diversification of a stock portfolio can be achieved by __________.
purchasing stocks whose returns are less than perfectly correlated purchasing stocks of companies across a wide variety of industries
The quick ratio is equal to
quick assets divided by current liabilities
The expected rate of return for a stock whose next dividend is "DIV1", that has a required rate of return "r" and expects to grow its future dividends at a rate of "g" is ________.
r = (DIV1/P0) + g
The financing decision involves
raising money that the firm requires for its investments and operations
If the corporate tax rate is zero, then increasing the proportion of debt in a firm's capital structure causes the WACC to _______.
ramain unchanged
The total income per period per dollar invested is known as the
rate of return
Which type of price refers to the of purchasing power of money?
real
The main investments for a manufacturing company are in
real assets
Real cash flow must be discounted by the
real interest rate.
The equation used to determine the approximate real interest rate is:
real interest rate= nominal interest rate - inflation rate
Misuse of cash by managers of firms that have plentiful cash but few good investment opportunities can ________ firm value.
reduce
If investors pay a higher tax rate on dividends than on capital gains, then investors should prefer firms that _____ over firms that ______.
repurchase shares; pay dividends
Ethical decision making in business:
requires adherence to implied rules as well as written rules.
The opportunity cost of capital is determined by the ______ of a project.
risk
When a firm puts up collateral assets to back up a loan, the debt is said to be:
secured
The statement that there are no free lunches on Wall Street suggests that:
security prices reflect all available information.
When comparing investments in assets with different lives you should:
select the project with the lowest equivalent annual annuity of costs
When market interest rates exceed a bond's coupon rate, the bond will:
sell for less than par value.
The primary market is used by companies to
sell new issues of stock
If investors believe that a stock is not providing a return that sufficiently compensates them for the risk of the stock, they will _________.
sell the stock, driving its market price down and its expected return up
The firm must make up its financial deficit by ________ or _______.
selling new equity; borrowing
The type of market efficiency that asserts that investors cannot earn superior returns through a study of information available to other investors is:
semi-strong form efficiency
Investors looking to minimize risk will hold which type of debt?
senior
A firm's authorized share capital is the maximum number of shares the firm can issue without ______ approval.
shareholder
Most major corporations are owned by multiple investors, called __________.
shareholders
The individuals who sit on the board of directors are elected by
shareholders
An implicit cost of increasing the proportion of debt in a firm's capital structure is that:
shareholders will demand a higher rate of return.
A company's board of directors is primarily an agent of the company's:
shareholders.
Soft capital rationing:
should be costless to the shareholders of the firm.
In order to be prepared to repay a bond's principal at maturity, a firm may annually put aside a sum of cash into a _______ fund.
sinking
Match the type of capital rationing with its definition below.
soft - self-imposed by firm management as a fiscal discipline mechanism hard - imposed externally by investors who will no longer provide funds to the firm
Capital rationing that is imposed by top management of a firm is called ______capital rationing. On the other hand, _______capital rationing occurs when a firm cannot raise the money it needs from outside sources.
soft, hard
Which of the following types of businesses is least likely to encounter agency problems due to the fact that the owner's personal wealth is tied to the value of the business?
sole proprietorship
Unlimited liability is faced by the owners of:
sole proprietorships and general partnerships
A fund with a beta of 1.0 will eliminate nearly all ________ risk.
specific
The type of risk that can be eliminated by diversification of a security portfolio is _______.
specific risk
A scatter in the plot of a stock's returns versus the returns on the market reflects the:
specific risk of the stock.
The difference between the bid price and the asked price of a bond is the _______.
spread
To estimate the future risk of a stock investment, analysts will calculate the _________ and assume it is a reasonable estimate of future risk.
standard deviation of historical returns for that stock
The measure of total risk for a security is its ________.
standard deviation of returns
Which form of government is most likely to set limitations on dividends?
state law
Investors can purchase a firm's shares in the _____ market.
stock
The discount rate used to value capital investments is often referred to as ____.
the opportunity cost of capital
In a partnership form of organization, income tax liability, if any, is incurred by:
the partners individually
In a partnership form of organization, income tax liability, if any, is incurred by:
the partners individually.
The future value of an annuity that lasts n years is equal to
the present value allowed to grow n years.
The dividend discount model asserts that the value of a share of stock today is determined by _____________.
the present value of all forecasted future dividends paid by the stock
The company cost of capital may be an inappropriate discount rate for a capital budgeting proposal if:
the project has a different degree of risk from the company.
The payout ratio is defined as:
the proportion of earnings to be paid out as dividends
If an investor's portfolio is allocated 75% to the market portfolio and 25% to Treasury bills, then the investor should expect to receive:
the risk-free rate plus 75% of the expected market risk premium.
Ignoring taxes and market imperfections, the total wealth of shareholders is _______ if the firm distributes cash by dividends rather than by repurchases.
the same
The terminal value is defined as __________.
the stock price at the start of the year in which constant dividend growth begins
One of the commonly cited problems with having profit maximization as a corporate objective is that it fails to consider:
the timing of benefits
One continuing problem with managerial incentive compensation plans is that:
their effectiveness is difficult to evaluate.
The idea that investors on average have earned a higher return from common stocks than from Treasury bills supports the view that:
there is a relationship between risk and return.
One way to increase the NPV of a project is to decrease the:
time until the receipt of cash inflows.
The main goal of a proxy fight is:
to replace the current management team
The total debt ratio is equal to
total liabilities divided by total assets
Market capitalization is defined as the
total market value of the firm's equity.
The secondary market is where investors:
trade shares among other investors
Shares of public companies and mutual funds are said to be liquid because they are
traded continuously
The individual responsible for maintaining relationships with banks and other investors is the
treasurer
The individual responsible for raising new capital for the corporation is the
treasurer
Common stock that has been issued but is currently held by the company is called _________.
treasury stock
A beta of 0 indicates that a security is _________ by what happens in the market.
unaffected
If a firm pays for a dividend by issuing additional shares of stock, it's total firm value will be _____
unchanged or constant
If the ratio of total liabilities to total assets is 0.5, long-term liabilities are $3,000, and equity is $5,000, then:
you know that current liabilities must be $ 2,000. Explanation Total liabilities / total assets = (long-term liabilities + current liabilities) / (long-term liabilities + current liabilities + equity) 0.5 = ($3,000 + current liabilities) / ($3,000 + current liabilities + $5,000) Current liabilities = $2,000
If inflation is 6%, what real rate of return is earned by an investor in a bond that was purchased for $1,000, has an annual coupon of 8%, and was sold at the end of the year for $960?
−1.89%
Which of the following projects would you feel safest in accepting? Assume the opportunity cost of capital to be 12% for each project.
"D" has a zero NPV when discounted at 14%.
What is the NPV for the following project cash flows at a discount rate of 15%? C0 = −$1,000, C1 = $700, C2 = $700.
$138.00NPV = -$1,000 + $700[(1/0.15) - 1/0.15(1.15)2] = $138.00
A firm has just declared a 1 for 5 reverse stock split. You own 100 shares priced at $5 each. What will be the price per share after the reverse split?
$25 Reason: $5 x 5 = $25 for each of your 20 shares
What is the standard deviation of returns for an investment that is equally likely to return 100% as it is to provide a 100% loss?
100%
Stock A has an expected return of 15%; stock B has an expected return of 8%. What is the expected return on a portfolio is comprised of 60% of Stock A and 40% of Stock B?
12.2%
A firm has declared a stock dividend of 25 percent. You currently own 100 shares. How many shares will you own after you receive the stock dividend?
125
Calculate the variance of returns for Alpha stock with the following historical rates of return: 2015 20% 2016 25% 2017 30%
16.67
What is the variance of returns of a portfolio that produced returns of 20%, 25%, and 30%, respectively?
16.7
A firm has just declared a 1 for 5 reverse stock split. You own 100 shares. How many shares will you have after the reverse split?
20 100/5 = 20
If Nuka-Cola Inc declared a stock dividend of 20%, John-Caleb would receive _____new shares if he currently owned 20,000 shares.
4000
From 2011 to 2017, what percentage of firms neither paid a dividend nor repurchased shares?
42%
The decision rule for net present value is to:
Accept all projects with positive net present values
Which method of share repurchase requires investors to submit bids and the companies takes the lowest ones, in sequence?
Auction repurchase
Why may a large increase in earnings not translate into a large increase in dividends?
Managers wish to assess the earning's persistence.
Which of the following are ways that firms pay out cash to shareholders?
Repurchase shares Pay cash dividends
MM's dividend irrelevance proposition assumes an efficient market with no taxes or issue costs.
True
True or false: if lenders are concerned about the creditworthiness of the borrowing firm, they may restrict dividends to protect their interests
True
The benefits of portfolio diversification are highest when the individual securities within the portfolio have returns that:
are largely uncorrelated with the rest of the portfolio.
One of the advantages of capital gains over dividends is that taxes on dividends must be paid immediately, while taxes on capital gains ________.
may be deferred until the stock is sold
A distribution of additional shares to a firm's stockholders is called a:
stock dividend
A maturity premium is offered on long-term Treasury bonds due to:
the risk of changing interest rates.
If a firm pays for a dividend by issuing additional shares of stock, its total firm value will be ______ and its price per share will _______.
unchanged; decrease
