final 82-

168. If a corporation has an average tax rate of 40 percent, the approximate annual, after-tax cost of debt for a 10 year, 8 percent, $1,000 par value bond selling at $1,150 is

A. 3.6 percent. After tax cost of debt = {[I + (PV - Nd)/n]/(PV+Nd)/2}(1-t) ={[80 + (1000 - 1,150)/10]/[(1000 + 1,150)/2]} (1-.4) = 3.6 percent

172. A firm has common stock with a market price of $25 per share and an expected dividend of $2 per share at the end of the coming year. The cost of the firm's common stock equity is 13 percent. The growth rate in dividends is

A. 5 percent. P0 = D1/r-g, where g = r - D1/ P0 = .13 - 2/25 = 5 percent

147. If you were to create a portfolio designed to reduce risk by investing equal proportions in each of two different assets, which portfolio would you recommend? (See Figure 801.) Expected Return (%) __________________ Year A B C 1 6 8 6 2 7 7 7 3 8 6 8

A. Assets A and B

110. The ______ feature permits the issuer to repurchase bonds at a stated price prior to maturity.

A. call

The rate of interest actually paid or earned annually is called the ______ interest rate.

A. effective

142. The ______ portfolio maximizes return for a given level of risk, or minimizes risk for a given level of return.

A. efficient

176. As a source of financing, once retained earnings have been exhausted, the weighted average cost of capital will

A. increase

134. If a person's required return decreases for an increase in risk, that person is said to be

A. risk-seeking

153. The portion of an asset's risk that is attributable to firm-specific, random causes is called

A. unsystematic risk

Indicate which of the following is true about annuities.

An annuity due is an equal payment paid or received at the beginning of each period.

90. The future value of an ordinary annuity of $1,000 each year for 10 years, deposited at 3 percent, is

B. $11,464 FVOA = PMT x [FVOAIF3%, 10] = 1,000(11.464) = 11,464

Find the future value at the end of year 3 of the following stream of cash flows received at the end of each year, assuming the firm can earn 17 percent on its investments. Year Amount 1 $3,000 2 6,000 3 9,000

B. $20,127 F = 3,000 (1.17)2 + 6,000(1.17) + 9,000 = 20,127

87. The present value of a $20,000 perpetuity at a 7 percent discount rate is

B. $285,714 Present value of a perpetuity (PVP) = Annuity/ discount rate

92. A generous benefactor to the local ballet plans to make a one time endowment which would provide the ballet with $150,000 per year into perpetuity. The rate of interest is expected to be 5 percent for all future time periods. How large must the endowment be?

B. $3,000,000 PVP = 150,000/.05 = 3,000,000

A generous benefactor to the local ballet plans to make a one time endowment which would provide the ballet with $150,000 per year into perpetuity. The rate of interest is expected to be 5 percent for all future time periods. How large must the endowment be?

B. $3,000,000 PVP = 150,000/.05 = 3,000,000

89. The future value of a $2,000 annuity due deposited at 8 percent compounded annually for each of the next 10 years is

B. $31,292 FVAD = PMT x [FVOAIF8%, 10 x (1.10)]

124. An 8 percent preferred stock with a market price of $100 per share and $90 par value pays a cash dividend of _____.

B. $7.20 Preferred dividend = 90*.08 = 7.20

166. The approximate before tax cost of debt for a 15 year, 10 percent, $1,000 par value bond selling at $950 is

B. 10.6 percent.Before tax cost of debt = [I + (PV - Nd)/n]/(PV+Nd)/2, where I, denotes interest, PV, present value, Nd , net proceeds on debt and n, number of years remaining until maturity = [100 + (1,000 - 950)/15]/(1,000 + 950)/2 = 10.6 percent

141. The expected value and the standard deviation of returns for asset A are (See below.) Asset A _______________________________________________________ Possible outcomes Probability Returns (%) _______________________________________________________ Pessimistic .25 10 Most likely .45 12 Optimistic .30 16

B. 12.7 percent and 2.3 percent.

The rate of return (r) earned on an investment of $50,000 today that guarantees a perpetual income of $10,489 per year is approximately

B. 21% PVP = 50,000 = 10,489/r, solve for r and get 21%

157. Asset Y has a beta of 1.2. The risk free rate of return is 6 percent, while the return on the market portfolio of assets is 12 percent. The asset's market risk premium (RP) is

B. 6.0 percent. RP = Rm - Rf =12-6 = 6%

160. ______ is the risk to the firm of being unable to cover operating costs.

B. Business risk

111. ______ allow the holder to purchase a certain number of shares of the firm's common stock at a specified price over a certain period of time and are occasionally part of a debt agreement.

B. Stock purchase warrants

143. A collection of assets is called

B. a portfolio

154. A beta coefficient of 1 represents an asset that

B. has the same response as the market portfolio.

Figure 801 Expected Return (%) __________________ Year A B C 1 6 8 6 2 7 7 7 3 8 6 8 146. The correlation of returns between Asset A and Asset B can be characterized as (See Figure 801.)

B. perfectly negatively correlated.

122. The direct sale of a new security issue to one or more purchasers is known as

B. private placement

The ______ rate of interest creates equilibrium between the supply of savings and the demand for investment funds.

B. real

150. The purpose of adding an asset with a negative or low positive beta is to

B. reduce risk

132. If a person's required return does not change when risk increases, that person is said to be

B. risk indifferent or risk neutral

133. If a person's required return does not change when risk increases, that person is said to be

B. risk indifferent or risk neutral

148. In general, the lower (less positive and more negative) the correlation between asset returns,

B. the greater the potential diversification of risk

177. A firm expects to have available $500,000 of earnings in the coming year, which it will retain for reinvestment purposes. Given the following target capital structure, at what level of total new financing will retained earnings be exhausted? Long-term debt 40% Preferred stock 10 Common stock equity 50

C. $1,000,000 Breakeven point = Available fund/ target ratio = 500,000/.5 = $1,000,000

A firm has an outstanding issue of 1,000 shares of preferred stock with a $100 par value and an 8 percent annual dividend. The firm also has 5,000 shares of common stock outstanding. If the stock is cumulative and the board of directors has passed the preferred dividend for the prior two years, how much must the preferred stockholders be paid prior to paying dividends to common stockholders?

C. $24,000 Preferred dividend = Dividends in arrears + current dividend = {[(100*.08)*2] + [100*.08]}*1,000 =

120. A firm has an issue of preferred stock outstanding that has a stated annual dividend of $4. The required return on the preferred stock has been estimated to be 16 percent. The value of the preferred stock is _____.

C. $25

The future value of $200 received today and deposited at 8 percent compounded semi annually for three years is

C. $253 F = 200 (1.04)6 = 253; note that the annual interest is divided by 2 and there are 6 semiannual periods in 3 years.

119. A firm has the balance sheet accounts, common stock (CS), and paid in capital in excess of par (PICEPV), with values of $10,000 and $250,000, respectively. The firm has 10,000 common shares outstanding. If the firm had a par value of $1, the stock originally sold for

C. $26/share Original stock price = (CS + PICEPV)/number of shares outstanding = 260,000/10,000 = $26

Present value of a perpetuity (PVP) = Annuity/ discount rate = 20,000/.07 = $285,714 88. Dan plans to fund his individual retirement account (IRA) with the maximum contribution of $2,000 at the end of each year for the next 10 years. If Dan can earn 10 percent on his contributions, how much will he have at the end of the tenth year?

C. $31,874 FVOA = PMT x [FVOAIF10%, 10]

164. What is the dividend on an 8 percent preferred stock that currently sells for $45 and has a face value of $50 per share?

C. $4.00 Preferred dividend = 50 *.08 = 4

155. An investment banker has recommended a $100,000 portfolio containing assets B, D, and F. $20,000 will be invested in asset B, with a beta of 1.5; $50,000 will be invested in asset D, with a beta of 2.0; and $30,000 will be invested in asset F, with a beta of .5. The beta of the portfolio (Bp) is

C. 1.45 Bp = .2*1.5 + .5*2 + .3*.5 = 1.45, where .2, .3, and .5 represent the proportion of the total portfolio of $100,000 that is invested in assets B, D, and F, respectively

175. A firm has determined its cost of each source of capital and optimal capital structure, which is composed of the following sources and target market value proportions: Target market /After-tax cost Long-term debt: 40% 6% Preferred stock: 10 11 Common stock equity: 50 15 The weighted average cost of capital (WACC) is

C. 11 percent. WACC = .4(6%) + .1(11%) + .5(15%) = 11%

173. A firm has common stock with a market price of $55 per share and an expected dividend of $2.81 per share at the end of the coming year. The dividends paid on the outstanding stock over the past five years are as follows: Year Dividend 1 2.00 2 2.14 3 2.29 4 2.45 5 2.62 The cost of the firm's common stock equity (R) is

C. 12.1 percent. Note: To determine the growth rate take only the values in years 1 and 5. Year 1 is the base year and the change occurred over 4 years. You ignore intermediate values as long as dividends grow steadily over the years. First calculate g, where g = (2.62/2.00)1/4 -1 = 7 percent R = D1/P0 + g = 2.81/55 + .07 = 12.1 percent

165. A firm has issued preferred stock at its $125 per share par value. The stock will pay a $15 annual dividend. The cost of issuing and selling the stock was $4 per share. The cost of the preferred stock (R p/s) is

C. 12.4 percent. R p/s = Dividend/ Price of preferred stock less floatation cost = 15/ (125-4) = 12.4 percent

171. A firm has a beta of 1.2. The estimated cost of common stock equity is 15.6 percent and the risk free rate of return equals 6 percent. The market return equals

C. 14 percent. E(R) = Rf + B (Rm - Rf) 15.6 = 6 + 1.2 (Rm - 6); solve for Rm and get 14 percent

163. The before tax cost of debt for a firm which has a 40 percent marginal tax rate is 12 percent. The after-tax cost of debt is

C. 7.2 percent. After tax cost of debt = before tax cost of debt (1 - tax rate) = 12(1-.4) = 7.2 percent

167. If a corporation has an average tax rate of 40 percent, the approximate, annual, after-tax cost of debt for a 15 year, 12 percent, $1,000 par value bond, selling at $950 is

C. 7.6 percent. After tax cost of debt = {[I + (PV - Nd)/n]/ (PV+Nd)/2}(1-t) ={[120 + (1,000 - 950)/15]/[(1,000 + 950)/2]} (1-.4) = 7.6 percent

112. ______ is secured by real estate.

C. A mortgage bond

169. The cost of common stock equity may be estimated by using the

C. Gordon model.

135. ______ is the chance of loss or the variability of returns associated with a given asset.

C. Risk

117. If the required return is less than the coupon rate, a bond will sell at

C. a premium

125. The _____ are sometimes referred to as the residual owners of the corporation.

C. common stockholders

159. The ______ is the rate of return required by the market suppliers of capital in order to attract their funds to the firm.

C. cost of capital

170. The cost of retained earnings is

C. equal to the cost of common stock equity

121. The cost of preferred stock is

C. higher than the cost of long term debt and lower than the cost of common stock

114. The less certain a cash flow, the ______ the risk, and the ______ the value of the cash flow.

C. higher; lower

151. The beta of the market

C. is 1.

161. In order to recognize the interrelationship between financing and investments, the firm should use ______ when evaluating an investment.

C. the weighted average cost of all financing sources

118. A firm has an issue of $1000 par value bonds with a 12 percent stated interest rate outstanding. The issue pays interest annually and has 10 years remaining to its maturity date. If bonds of similar risk are currently earning 8 percent, the firm's bond will sell for ______ today.

D. $1,268 The value of the bond today = Preset value of coupon (interest) payments + present value of principal = B0 = 120[PVOAIF8%, 10] + 1000[PVIF8%, 10] =1,268

85. To pay for her college education, Gina is saving $2,000 at the beginning of each year for the next eight years in a bank account paying 12 percent interest. How much will Gina have in that account at the end of 8th year?

D. $27,552 FVAD = PMT x [FVOAIF12%, 8 x (1.12)] = 2,000(12.3) (1.12) = 27,552

93. To pay for her college education, Gina is saving $20,000 at the beginning of each year for the next eight years in a bank account paying 12 percent interest. How much will Gina have in that account at the end of 8th year?

D. $275,520 FVAD = PMT x [FVOAIF12%, 8 x (1.12)] = 20,000(12.3) (1.12) = 275,520

To pay for her college education, Gina is saving $20,000 at the beginning of each year for the next eight years in a bank account paying 12 percent interest. How much will Gina have in that account at the end of 8th year?

D. $275,520 FVAD = PMT x [FVOAIF12%, 8 x (1.12)] = 20,000(12.3) (1.12) = 275,520

131. The current price of ABC Corporation stock is $16.50 per share. Earnings next year is expected to be $2 per share and pay $0.60 in dividends. If the P/E multiple is 15 times, on average, ABC's stock price should be?

D. $30.00 P = EPS*P/E = 2*15 =30

136. Last year Mike bought 100 shares of Dallas Corporation common stock for $53 per share. During the year he received dividends of $1.45 per share. The stock is currently selling for $60 per share. What rate of return did Mike earn over the year?

D. 15.9 percent. R = [P1-P0+D]/P0 = (60 - 53 - 1.45)/53 = 15.9%

138. ______ probability distribution shows all possible outcomes and associated probabilities for a given event.

D. A continuous

140. Which asset would the risk averse financial manager prefer? (See below.) Asset A B C D Initial $15,000 $15,000 $15,000 $15,000 investment Annual rate of return Pessimistic 8% 5% 3% 11% Most likely 12% 12% 12% 12% Optimistic 14% 13% 15% 14%

D. Asset D Given the most likely outcome 12% in each case, choose stock D since it has the lowest range, and hence the lowest risk.

113. A debenture is

D. an unsecured bond that only creditworthy firms can issue.

144. The goal of an efficient portfolio is to

D. minimize risk for a given level of return.

145. Perfectly ______ correlated series move exactly together and have a correlation coefficient of ______, while perfectly ______ correlated series move exactly in opposite directions and have a correlation coefficient of ______.

D. positively; +1; negatively; 1

137. The ______ is the extent of an asset's risk. It is found by subtracting the pessimistic outcome from the optimistic outcome.

D. range

139. Since for a given increase in risk, most managers require an increase in return, they are

D. risk

152. The beta of the risk free asset is

D. zero

108. The major factor(s) affecting the cost, or interest rate, on a bond is (are) its

E. All of the above

Indicate which formula is correct to determine the future value of an annuity due.

FVADs = PMT x [FVIFAi,n x (1 + i)]

128. In the Gordon model, the value of the common stock is the

present value of a constant, growing dividend stream

129. According to the efficient market theory,

prices of actively traded stocks do not differ from their true values in an efficient market.

109. The major factors affecting the cost of long term debt include all of the following EXCEPT

restrictive covenants

107. All of the following are examples of restrictive debt covenants EXCEPT

supplying the creditor with audited financial statements.

126. Advantages of issuing common stock versus long term debt include all of the following EXCEPT

the effects of dilution on earnings and voting power.

The nominal rate of interest is composed of

the risk free rate plus a risk premium.

127. The _____ is utilized to value preferred stock.

zero-growth model

______ yield curve reflects lower expected future rates of interest

A downward sloping

Under MACRS, an asset which originally cost $100,000, incurred installation costs of $10,000, and has an estimated salvage value of $25,000, is being depreciated using a 5 year normal recovery period. The cost of the asset that has yet to be depreciated at the end of year 1 is

A. $88,000 = Original cost + installation cost - accumulated depreciation

158. Asset P has a beta of .9. The risk free rate of return is 8 percent, while the return on the market portfolio of assets is 14 percent. The asset's required rate of return is

A. 13.4 percent. E(R) = Rf + B (Rm - Rf) = 8 + .9 (14 - 8) = 13.4 percent

130. If the expected return is above the required return on an asset, rational investors will

buy the asset, which will drive the price up and cause expected return to reach the level of the required return.

123. Dividends in arrears which must be paid to the preferred stockholders before payment of dividends to common stockholders are

cumulative

91. If the present value of a perpetual income stream is increasing, the discount rate must be

decreasing

If the present value of a perpetual income stream is increasing, the discount rate must be

decreasing

A yield curve that reflects relatively similar borrowing costs for both short-term and long-term loans is called

flat yield curve

105. The cost of long-term debt generally ______ that of short term debt.

is greater than

156. The beta of a portfolio is

is the weighted average of the betas of the individual assets included in the portfolio.

The theory that explains only the tendency for the yield curve to be upward sloping is

liquidity preference theory

174. Generally, the order of cost, from the least expensive to the most expensive, for long-term capital of a corporation is

long-term debt, preferred stock, retained earnings, new common stock.

162. The ______ from the sale of a security are the funds actually received from the sale after ______, or the total costs of issuing and selling the security, which have been subtracted from the total proceeds.

net proceeds; the flotation costs

149. Systematic risk is also referred to as

non diversifiable risk

106. If a bond pays $1,000 plus interest at maturity, $1,000 is called the

par value

115. The ______ value of a bond is also called its face value. Bonds which sell at less than face value are priced at a ______, while bonds which sell at greater than face value sell at a ______.

par; discount; premium

Generally, an increase in risk will result in ______ required return or interest rate.

a higher

116. Corporate bonds typically have

a par value of $1000

The legal contract setting forth the terms and provisions of a corporate bond is

an indenture

178. The investment opportunity schedule (IOS) is

an internal rate of return ranking of capital projects from best to worst.