Unit 20: Analytical Methods
A corporation's balance sheet shows total assets of $930,000 of which $400,000 are current assets. It also shows $525,000 of total liabilities of which $215,000 are current liabilities. The company's working capital is A) $185,000. B) $715,000. C) $310,000. D) $405,000.
A) $185,000. Working capital is current assets minus current liabilities. In this question, that is $400,000 minus $215,000, or $185,000. As is often the case, there are numbers shown that have no relevance to the question.
ALFA Enterprises pays a quarterly dividend of $0.15 and has earnings per share of $2.40. Assuming that payout rate is continued, what is the dividend payout ratio? A) 25% B) 30% C) 14.4% D) 6.25%
A) 25% Earnings per share are typically calculated for a year. If the quarterly dividend rate of $0.15 is continued, that will be an annual payout of $0.60 ($0.15 × 4). So the annual dividend of $0.60 is divided by $2.40 to calculate what percentage of earnings is paid as a dividend; or rather, the dividend payout ratio (0.60 ÷ 2.40 = 25%).
ABD Corporation's income statement reports net sales of $100 million; cost of goods sold, $60 million; administrative costs, $20 million; and interest on debt, $5 million. Based on this information, ABD's gross margin is A) 40% B) 15% C) 35% D) 20%
A) 40% Gross margin, sometimes referred to as gross profit on the exam, is computed by subtracting the cost of goods sold (COGS) from the net sales (or revenues) and dividing the remainder by the net sales. In this case, the computation is $100 million minus $60 million, which equals $40 million, and then dividing that by the $100 million resulting in a gross margin (or margin of profit) of 40%. Administrative costs and interest are not included in COGS.
To make a quantitative evaluation using the present value computation, which of the following is not needed? A) Account value at the beginning of the period B) Account value at the end of the period C) Anticipated rate of return of the portfolio D) Time period involved
A) Account value at the beginning of the period Present value is calculated to determine the amount required now to have a specified value at some time in the future. It is what we are looking for so we don't have it now.
To make a quantitative evaluation using the future value computation, which of the following is NOT needed? A) Account value at the end of the period. B) Time period involved. C) Account value at the start of the period. D) Rate of return anticipated.
A) Account value at the end of the period. Future value is calculated to determine the value of a specific amount of money at some point in the future. The anticipated interest rate, the present amount to be invested, and a time period for the life of the investment are required to calculate the future value.
When analyzing a security's standard deviation, which of the following statements accurately describes observations according to a normal frequency distribution curve? A) Approximately two-thirds, or 68%, of observations will be within one standard deviation on either side of the mean. B) Approximately 95.5% of all observations will be within three standard deviations of the mean. C) Approximately 97.5% of all observations will be within three standard deviations of the mean. D) Approximately 97.5% of all observations will be within two standard deviations on either side of the mean.
A) Approximately two-thirds, or 68%, of observations will be within one standard deviation on either side of the mean. Approximately two-thirds, or 68.26%, of observations will be within one standard deviation on either side of the mean. Approximately 95% will be within two standard deviations and approximately 99% will be within three.
A company has two outstanding bond issues, both with a coupon rate of 8%. Bond A will mature in 2 years, while Bond B will mature in 15 years. If market interest rates were to increase to 10%, which of the following statements is correct? A) Bond B will be selling at a greater discount than Bond A. B) Both bonds will be selling at a premium. C) The company will attempt to postpone the maturity of Bond A. D) Bond B will be selling at a greater premium than Bond A.
A) Bond B will be selling at a greater discount than Bond A. An increase in interest rates in the marketplace will cause the price of a debt security to fall. The nearer the maturity, the shorter the duration, hence the less impact. Therefore, Bond B with a much longer maturity (and longer duration) will see its market price fall far more than Bond A.
Rank the following bonds in order of shortest to longest duration. ABC 8s of 2035. DEF 9s of 2034. GHI 5s of 2036. JKL zeros of 2033. A) II, I, III, IV. B) IV, III, I, II. C) IV, II, I, III. D) III, I, II, IV.
A) II, I, III, IV. There is an inverse relationship between a bond's coupon rate and its duration. A higher coupon will pay the investor back through cash flow at a faster rate. Therefore, a zero-coupon bond with no cash flow has a duration equal to its maturity.
All of the following statements regarding an investment's internal rate of return (IRR) are true except A) IRR is most often used with growth stocks B) IRR is the one rate of return that results in an investment having a net present value (NPV) of 0 C) investments are acceptable when their internal rates of return exceed the investor's required rate of return D) IRR expresses the rate of interest that matches the initial investment with the present value of future cash flows
A) IRR is most often used with growth stocks It is possible, although very difficult, to calculate IRR for investments with uneven cash flows such as growth stocks where dividends are generally not reliable. IRR is the rate of interest that equates the initial investment with the present value of future cash flows; it is the rate of return that results in an investment having a net present value of 0.
Which of the following is a stock valuation ratio? A) Price-earnings B) Dividend payout ratio C) Operating profits to net sales D) Revenues to assets
A) Price-earnings The price-earnings (PE) ratio is a valuation ratio used to calculate the value of a stock. For example, if a stock has a PE of 20, it means that the security is priced at 20 times earnings.
Your client owns a 91-day T-bill, a 2-year T-note, a 20-year T-bond, and a 20-year STRIP. The market price of which of these is likely to have the smallest movement when there are changes to the discount rate? A) T-bill B) T-bond C) T-note D) STRIP
A) T-bill As a short-term instrument (short duration), the price fluctuations of a T-bill are very small when there is a change to interest rates. Longer term instruments have much larger price movements.
An investor is considering the purchase of some bonds to diversify his portfolio. If he should decide to purchase Treasury STRIPS instead of Treasury Bonds, his major risk would be A) interest rate risk B) credit risk C) reinvestment risk D) purchasing power risk
A) interest rate risk Treasury STRIPS are zero-coupon bonds and, as such, have a longer duration than those paying semiannual interest. The longer the duration, the greater the interest rate risk. Because both are guaranteed by the U.S. government, there is no credit risk. Both have the same purchasing power risk, and there is no reinvestment risk with a zero-coupon bond.
If a stock has a beta of less than 1.0, the stock's price will A) not increase as much as the market when the market is up B) decrease more than the market when the market is down C) decrease regardless of whether the market is up or down D) increase more than the market when the market is up
A) not increase as much as the market when the market is up Beta compares a stock's price history to the movement of a total market index for the same period. A beta of less than 1 means that the stock's price does not swing as widely, up or down, as the average for the entire market.
An analyst is reviewing a company's financial statements. One of the calculations involves taking all of the current assets except the inventory and dividing that by the total current assets. This analyst is looking at the company's A) quick asset ratio. B) current ratio. C) debt-to-assets ratio. D) working capital.
A) quick asset ratio. The quick asset ratio (also known as the quick ratio or the acid test ratio) is calculated in one of two ways. One way is the analyst takes all of the current assets, subtracts the inventory, and then divides that by the current liabilities. The other, and the one used in this question, is to take all of the current assets excluding the inventory, and divide that by the current liabilities.
When an IA tells a client who is investigating the common stock of two different issuers that there is no linear relationship between the two stock's returns, it means A) the correlation coefficient is zero B) one is listed on an exchange, the other traded OTC C) one is likely to pay dividends, the other not D) one of the stock's standard deviation is significantly higher than the other
A) the correlation coefficient is zero A correlation coefficient of zero means that knowing the actual return of one security tells you nothing about the return of the other. They may move in the same or opposite directions.
A client who wishes to have $50,000 available to help fund a 3-year-old child's college education in 15 years estimates that if the portfolio can earn 7%, a deposit of $18,122.30 will be required today. This deposit is referred to as A) the present value B) the internal rate of return C) the net present value D) the future value
A) the present value This is a present value computation where the future value, time period, and earnings rate are known.
All of the following factors have an inverse relationship to a bond's duration except A) time to maturity. B) coupon rate. C) current yield. D) yield to maturity.
A) time to maturity. The relationship between the time to maturity (length) and duration is a linear one. That is, the longer the time until the bond matures, the higher (longer) the duration - it is a direct relationship. Yields, on the other hand, have an inverse relationship with duration. That is, the higher the yield, the lower (shorter) the duration. An example would be comparing a bond with an 8% coupon rate to one with a 6% coupon rate. All other things beging equal, the bond with the 8% coupon rate will have a shorter duration than the one with a 6% coupon; the relationship is inverse rather than linear.
A client wishes to endow an annual scholarship of $40,000 at her alma mater. If the investment can provide a perpetual return of 4.2% per annum, the lump sum deposit required to provide this income is A) $1,052,631.50. B) $952,380.95. C) $417,536.53. D) $168,000.00.
B) $952,380.95. This is an income in perpetuity computation. Divide the annual requirement ($40,000) by the annual return (4.2%) to get the correct answer. You should be able to "eyeball" this one. If the return were 4%, you would need $1 million to generate $40,000 per year. With a rate of 4.2%, you would need slightly less. There is only one answer that is slightly less than $1 million (and that would be true on the actual exam).
Assume you own KAPCO Stock Fund that returned 14% over the past five years, during which the stock market returned 12%. This fund has a beta of 1.1 and the risk-free rate of return is 4%. What is the fund's alpha? A) +2.0 B) +1.2 C) +9.1 D) +6.0
B) +1.2 14 − [4 + (12 − 4) 1.1] = 14 − [4 + 8.8] = 14 − 12.8 = 1.2. This positive result indicates that the fund manager outperformed the market by 1.2% on a risk adjusted basis.
XYZ Corporation has a beta of 1, and ABC has a beta of 1.4. XYZ has returned 12% and ABC 18.8%. Based on this information ABC had alpha of A) 18.8% B) 2% C) 6.8% D) 4.8%
B) 2% Alpha is the extent to which a security's performance exceeds (or falls short of) what would be expected based on its beta. A stock with a beta of 1.4 would be expected to perform 40% better in an up market than one with a beta of 1.0. Because XYZ with a beta of 1.0 gained 12%, ABC should return 140% of that or 16.8% (12% × 1.4). With an actual return of 18.8%, ABC beat the expected by 2% and that is its alpha. More accurately, this question should also include the risk-free rate, but if, as in this case, it doesn't, the computation is easier. If the RF rate was shown, then that would have to be subtracted from "both sides." If the RF was 2%, then the computation would be (12% − 2%) × 1.4 = 14%. Then, we subtract the 2% RF rate from the 18.8 to get 16.8%. The difference between 16.8% and 14% would be alpha of 2.8%.
During the past year, the market price of Kapco common stock has increased from $47 to $50 per share. Over that period, Kapco's earnings per share have increased from $2.00 to $2.50 per share, and their dividend payout ratio has decreased from 50% to 40%. Based on this information, Kapco's P/E ratio has decreased Kapco's P/E ratio has increased an investor holding Kapco over this period would have noticed a decrease in income received an investor holding Kapco over this period would have noticed no change in income received A) II and III B) I and IV C) I and III D) II and IV
B) I and IV At the beginning of the period, the P/E ratio was 23.5 to 1 ($47 divided by $2.). At the end of the period, the P/E ratio was 20 to 1 ($50 divided by $2.50). Initially, Kapco was paying out 50% of its $2.00 per share earnings, or $1.00 in dividends. At the end, Kapco was paying out 40% of its $2.50 per share earnings, also $1.00 in dividends.
Which of the following is not a valuation method for a fixed-income security? A) Dividend discount model B) Price-to-earnings ratio C) Conversion parity D) Discounted cash flow
B) Price-to-earnings ratio The P/E ratio is only used with common stock. The parity price is a way to value a convertible bond or convertible preferred stock. DCF is one of the most popular ways to value bonds. The DDM can be used with preferred stock, which, because of its fixed dividend, is considered in the general category of fixed-income security.
Beta is most frequently measured against which of the following? A) Nasdaq Composite Index B) S&P 500 C) S&P 100 D) Dow Jones Industrial Average
B) S&P 500 The index most commonly used to analyze the beta of an individual security or portfolio is the S&P 500. Companies (portfolios) with a beta of 1.0 would be expected to move in tandem with the market, while companies with a beta greater than 1.0 would be more volatile than the market as a whole. Companies with a beta less than 1.0 should show a rate of change less than that of the market as a whole.
Which of the following attributes of common stock best describes why internal rate of return (IRR) is not generally used to determine the return on common stock? A) No net present value B) Uneven cash flows, no maturity date and price C) Uneven cash flows D) Uneven cash flows and no maturity
B) Uneven cash flows, no maturity date and price Internal rate of return (IRR) best measures investments with a known price and maturity. The internal rate of return is the discount rate that makes the future value of an investment equal to its present value. The yield to maturity on a bond is actually its internal rate of return.
Of the following bonds, which has the greatest price volatility? A) Corporate bond fund B) Zero-coupon bond with 15 years to maturity C) Zero-coupon bond with 5 years to maturity D) AA corporate bond with 7 years to maturity
B) Zero-coupon bond with 15 years to maturity The longer the duration of a bond, the greater the volatility will be of its market price when interest rates change. Because zero-coupon bonds do not make interest payments but are priced at a deep discount to par value, they are more volatile than coupon-bearing bonds.
If yields should change by 75 basis points, which of the following bonds would have the greatest price change? A) DEF 4s 2035 B) GHI 4s 2030 C) ABC 4s 2040 D) JKL 4s 2025
C) ABC 4s 2040 When all coupons are the same, the bond with the longest maturity will have the longest duration and, therefore, will be subject to the greatest price fluctuations. Conversely, those with the shortest time until maturity (the 4s of 2026) will have the shortest duration and will be subject to the least amount of price fluctuation.
Which of the following methods of calculating investment returns are discounted cash flow (DCF) techniques? Net present value (NPV) Holding period return (HPR) Internal rate of return (IRR) A) I, II, and III B) II and III C) I and III D) I and II
C) I and III A discounted cash flow (DCF) technique is one that takes into account the time value of money. Holding period return (HPR) is the total of the income cash flows and capital growth earned by an investment during the period for which it is held. It does not take into account the time value of money. Both net present value (NPV) and internal rate of return (IRR) take the time value of money into account.
Which of the following statements with regards to net present value and internal rate of return is correct? A) If the net present value is less than zero, then the internal rate of return is greater than the required rate of return. B) If the net present value equals zero, then the internal rate of return is greater than the required rate of return. C) If the net present value is greater than zero, then the internal rate of return is greater than the required rate of return. D) If the net present value equals zero, then the internal rate of return is less than the required rate of return.
C) If the net present value is greater than zero, then the internal rate of return is greater than the required rate of return. Any time the net present value is greater than zero (a positive NPV), the internal rate of return is greater than the required rate of return and the investment should be made. If the net present value is zero, then the internal rate of return equals the required rate of return.
Fundamental analysts give significant credence to financial ratios. Which of the following tends to give an indication of the profitability of the enterprise? A) Debt-to-equity ratio B) Price-to-earnings ratio C) Sales-to-earnings ratio D) Current ratio
C) Sales-to-earnings ratio Of the four choices given, the sales-to-earnings ratio is the only one not discussed in the License Exam Manual. Why not? Because we know there will always be a question or two on the real exam that was not covered in our material. It is important that students use good test-taking skills to correctly answer those questions. It would seem logical that a question about profitability would relate to earnings. That would reduce the choices to two from four. The price-to-earnings (P/E) ratio reveals the relationship between the market price of the company's stock and its earnings, but it doesn't tell us anything about the degree of profitability of the enterprise. If we know that the P/E ratio compares the price to the earnings, then it makes sense that the sales-to-earnings ratio compares the net sales of the business with its earnings. Companies with a higher percentage of earnings from each dollar of sales are more profitable. For example, Company A and Company B both reported $100 million in net sales for the year. The net income (earnings) of Company A was $20 million and Company B was $8 million. We can see that each dollar of sales generated $0.20 of profit for Company A and only $0.08 of profit for Company B. Or, we could say that it takes $5 of Company A sales to generate $1 of profit ($100 ÷ 20) while it takes $12.50 of Company B sales ($100 ÷ 8) to earn that same $1 of profit.
Duration is A) the deviation of a bond's returns from its average returns B) equivalent to the yield to maturity C) a measure of a bond's price sensitivity with respect to a change in interest rates D) identical to a bond's maturity
C) a measure of a bond's price sensitivity with respect to a change in interest rates Duration measures a bond's sensitivity to a change in interest rates. The longer the duration, the greater the change in a bond's price with respect to interest rate changes.
If a corporation has a dividend payout ratio of 70%, the undistributed earnings will A) increase earnings per share B) decrease book value C) increase retained earnings D) increase capital surplus
C) increase retained earnings Retained earnings represent income that has not been paid out to shareholders.
In general, one would prefer to purchase a bond when its current market price is A) less than its future value B) more than its present value C) less than its present value D) the same as its present value
C) less than its present value When a bond can be purchased for less than its present value, it has a positive net present value (NPV). For example, if the present value of a bond is $600 and it can be purchased for $565, it has an NPV of $35 and should be an attractive investment. Every bond selling at a discount has a market price that is less than its future value (par), so that doesn't tell us anything about its NPV.
A bond's duration is A) an indication of a bond's yield that ignores its price volatility B) expressed as a percentage C) longer for a 10-year bond with a 5% coupon than it is for a 10-year bond with a 10% coupon D) identical to its maturity for an interest-bearing bond
C) longer for a 10-year bond with a 5% coupon than it is for a 10-year bond with a 10% coupon Duration measures a bond's price volatility by weighting the length of time it takes for a bond's cash flow to pay for itself. If 2 bonds with differing coupon rates have identical maturities, the one with the lower coupon has the longer duration. The cash flow from an interest-bearing bond makes its duration shorter than its maturity. Bonds with longer duration carry greater price volatility. Duration is expressed in years (time) rather than in percentage.
Securities analysts would agree that it makes sense to purchase a fixed-income security when its net present value (NPV) is A) negative B) variable C) positive D) zero
C) positive A positive NPV means the security is available for a price below its present value—it is a good buy. With a negative NPV, the price is too high. With a zero NPV, it is accurately priced.
The time value of money is part of the computation for A) the real rate of return B) the after-tax return C) the internal rate of return D) the risk-adjusted return
C) the internal rate of return One of the unique features of IRR is that it is a compounded rate using the time value of money.
A financial ratio used by some analysts to help determine if a company's stock is over or undervalued is A) the current ratio. B) the quick asset ratio. C) the price-to-book-value ratio. D) the dividend payout ratio.
C) the price-to-book-value ratio. The price-to-book-value ratio compares the company's market price with its book value per share. The higher the ratio, the greater premium the public is willing to pay over the theoretical liquidated value of the enterprise. Usually, a ratio of less than 1 indicates an undervalued company.
If a security has an anticipated return of 8.7% and a standard deviation of 14.6%, you would expect the returns to have a 95% probability (assuming a normal distribution) of falling between A) 8.7 and 23.3% B) −5.9 and +23.3% C) −20.5 and +37.9% D) 0 and 37.9%
C) −20.5 and +37.9% A security with a normal distribution has a 95% probability of falling within 2 standard deviations of its anticipated return. In this case, that would be −20.5% and +37.9%, which is computed by calculating return movements of 29.2% (14.6 × 2) in either direction.
Assume Frank has a portfolio with an actual return of 10.50% for the past year. The portfolio beta equals 1.25, the return on the market equals 9.75%, and the risk-free rate of return equals 3%. Based on this information, what is the alpha for Frank's portfolio and did it outperform or underperform the market? A) +3.3750%, outperform B) −1.6875%, underperform C) +9.1875%, outperform D) -.9375%, underperform
D) -.9375%, underperform The alpha for Frank's portfolio equals −.9375% indicating that his portfolio underperformed the market based on the level of assumed investment risk. Let's do the computation. As with most math, there are two ways to arrive at the correct answer. The method shown in the LEM follows the formula: (Actual return - RF rate) - (beta x [market return - RF rate]). Plugging in the numbers we get, (10.5% minus 3%) - (1.25 x [9.75% - 3%]). That breaks down to 7.5% - (1.25 x 6.75%) or 7.5% - 8.4375% = negative .9375% Alternatively some might prefer this formula for alpha: alpha = actual return - [risk-free rate + beta x(market return - RF)]. If we plug in the numbers, we get .105 - [.03 +1.25 x(.0975 - .03)] = −.009375, or−.9375%.
Bond X has an internal rate of return (IRR) of 7%. Bond Y has an IRR of 9%. Both bonds pay interest semiannually. If the required rate of return is A) 9%, both bonds will have a positive NPV. B) 7%, the net present value (NPV) of Bond X will exceed the NPV of Bond Y. C) 9%, the net present value (NPV) of Bond X will exceed the NPV of Bond Y. D) 7%, the net present value (NPV) of Bond Y will exceed the NPV of Bond X.
D) 7%, the net present value (NPV) of Bond Y will exceed the NPV of Bond X. We know that when a bond's IRR equals the required rate of return (the discount rate), the NPV of that bond is zero. That is the case with Bond X when the required rate of return is 7%. When the bond's IRR is above the required rate of return, it has a positive NPV. That is the case with Bond Y whose IRR is higher than the 7% required return. With a required return of 9%, Bond X has a negative NPV and Bond Y's NPV is zero. That is the technical explanation. The simple explanation is to compare the IRR with the required rate of return. Anytime the IRR is above the required rate, you've got a good deal (and that is what a positive NPV tells us).
An investment adviser reviewing the past performance of a portfolio observes that annual returns have been +6%, +11%, -5%, +8%, +14%, +1%, and +7%. From this information, the adviser would determine that the median value was A) 6.0% B) 7.4% C) 19.0% D) 7.0%
D) 7.0% The median of a set of numbers is the one in the middle. That is, the number with an equal number of values above and below. It is easiest to compute if the numbers are presented in ascending values. In this question, we have -5, +1, +6, +7, +8, +11, and +14. This way, it is plain to see that 7 has 3 values below and 3 values above.
Which of the following statements regarding the properties of duration is not true? A) Duration measures a bond's price volatility by weighting the length of time it takes for a bond to pay for itself. B) Duration measures the effect of an interest rate change on the price of a bond or bond portfolio. C) Duration is a weighted-average term to maturity of a bond's cash flows. D) Duration measures the holding period return on a bond.
D) Duration measures the holding period return on a bond. Duration does not measure the holding period return on a bond; it measures the effect of an interest rate change on the price of a bond or bond portfolio. Duration measures a bond's price volatility by weighting the length of time it takes for a bond to pay for itself. Duration is also a weighted-average term to maturity of a bond's cash flows.
The future value of an invested dollar is dependent on the exchange rate of the dollar at the beginning and end of the period the interest rate at maturity the rate of return it earns the time period over which it is invested A) I only B) II and III C) II only D) III and IV
D) III and IV The future value of a dollar reflects the interest rate it earns over time. The rate of foreign exchange is not related to or used in the calculation of the future value of a dollar. The foreign exchange rate is not relevant.
Which of the following are likely to have a low beta? A) Software stocks B) Aerospace stocks C) Technology stocks D) Public utility stocks
D) Public utility stocks Public utility stocks tend to have low betas as do other defensive stocks. Technology, aerospace, and software stocks tend to have high betas.
When constructing a portfolio, one of the goals is to increase diversification. Which of the following pairs offers the most diversification? A) Municipal GO bonds and long-term U.S. Treasury bonds B) Corporate debentures/convertible bonds C) Large-cap stock/blue-chip stock D) U.S. equity securities and foreign equity securities
D) U.S. equity securities and foreign equity securities Diversification is generally accomplished by adding securities that don't have a high degree of correlation. Large-cap and blue-chip are essentially the same thing. Most convertible bonds are debentures. Only in the case of domestic and international stocks will we find a low correlation.
Your client has the following bonds in her portfolio: XYZ 3s of 44. TUV 6s of 45. QRS 9s of 43. NOP 12s of 42. If interest rates were to suddenly rise, which of her bonds would suffer the greatest decline in market price? A) NOP 12s of 42 B) TUV 6s of 45 C) QRS 9s of 43 D) XYZ 3s of 44
D) XYZ 3s of 44 The technical method for answering this question is to compare the duration of each of the bonds. The one with the longest duration will be impacted the most by a change in interest rates. Invariably, when the length of time to maturity is relatively close (as is the case here), the bond with the lowest coupon rate will have the longest duration. It should be easy to spot that the bond with the shortest duration is the NOP 12s of 42 - they have both the highest coupon and the nearest maturity and would be the correct answer if the question had asked for the bond suffering the smallest decline in market price.
One of the critical components of making suitable recommendations is the ability to evaluate risk. Risk measurement tools would include all of the following except A) standard deviation B) beta C) Sharpe ratio D) future value
D) future value Future value measures the time value of money and has no relationship to risk.
A client owns an investment-grade bond with a coupon of 7%. If similarly rated bonds are being issued today with coupons of 5%, and the market is efficient, it would be expected that the client's bond A) has a positive net present value B) has a negative net present value C) will be selling at a discount from par D) has a zero net present value
D) has a zero net present value With a discount rate of 5% (the discount rate in a present value computation is the current market interest rate), a debt instrument with a 7% coupon rate will be selling at a premium (interest rates down, prices up). If the market is efficiently pricing that bond, its market price should be equal to its present value, resulting in an NPV of zero.
When a company's debt-to-equity ratio is higher than typical for that industry, it might be said that the company is A) about to increase their dividends B) suitable for a conservative investor C) highly profitable D) highly leveraged
D) highly leveraged The definition of a leverage is the use of borrowed money in the issuer's capital structure. This is seen through the debt-to-equity ratio. When that ratio is higher than industry standards, it is said that the company is highly leveraged.
The present value of a dollar A) is the amount of goods and services the dollar will buy in the future at today's rate price level B) cannot be calculated without knowing the level of inflation C) is equal to its future value if the level of interest rates stays the same D) indicates how much needs to be invested today at a given interest rate to equal a specific cash value in the future
D) indicates how much needs to be invested today at a given interest rate to equal a specific cash value in the future The present value of a dollar will indicate how much needs to be invested today at a given interest rate to equal a cash amount required in the future.
A company's current ratio is 0.5:1. This could be an indication A) the company's working capital is sufficient to meet daily needs. B) the company is highly leveraged. C) the company's current assets are twice its current liabilities. D) the company may have trouble paying its bills.
D) the company may have trouble paying its bills. The formula for current ratio is the current assets divided by the current liabilities. A 0.5:1 ratio means that the company has current liabilities that are twice its current assets. This would also mean a negative working capital (current assets minus current liabilities) and would probably mean that the company is going to have a difficult time paying its bills. A highly leveraged company is one whose long-term debt, such as bonds, represents more than 50% of the company's total capital. Nothing in this question relates to long-term debt or capitalization.
The financial ratio that shows the relationship between the price of a company's stock and the company's net worth (stockholders' equity) is A) the price-earnings (PE) ratio. B) the dividend discount ratio C) the price-sales ratio D) the price-to-book-value ratio
D) the price-to-book-value ratio The price-to-book-value ratio is calculated by dividing the price per share by the stockholders' equity per share. This ratio shows the relationship between a company's stock price and the company's book value.
An investor's required rate of return is 6%. If the internal rate of return of the investment offered is 6%, then the NPV is A) positive B) negative C) 6% D) zero
D) zero When an investment's IRR equals the required rated of return, the NPV is zero. If the IRR is higher than the required rate of return, the NPV is positive; if the IRR is lower than the rate of return, the NPV is negative.
