FRL 3000 Midterm Study Set
real rate
(nominal-inflation rate)/(1+inflation)
You own one share of a cumulative preferred stock that pays quarterly dividends. The firm has recently suffered some financial setbacks and has failed to pay the last two dividends. However, new funding has been arranged and the firm intends to restore all dividends, both common and preferred, this quarter. As a preferred shareholder, you should expect to receive the equivalent of ____ quarter(s) of dividends when the next dividend is paid.
3 quarters (two owed plus one new one)
AOK preferred stock pays an annual dividend of $6.50. What is the current price of this stock at a discount rate of 8.9 percent?
6.50/.089=73.03
J&J Foods wants to issue 5.4 percent preferred stock with a stated liquidating value of $100 a share. The company has determined that stocks with similar characteristics provide a return of 8.2 percent. What should the offer price be?
65.85 offer price = annual divident x100 /return on similar stock P = [.054 ($100)]/.082P = $65.85
A project has an initial cost of $31,300 and a three-year life. The company uses straight-line depreciation to a book value of zero over the life of the project. The projected net income from the project is $1,750, $2,100, and $1,700 a year for the next three years, respectively. What is the average accounting return?
AAR = [($1,750 + 2,100 + 1,700)/3]/[($31,300 + 0)/2] AAR = .1182, or 11.82%
Isaac has analyzed two mutually exclusive projects that have 3-year lives. Project A has an NPV of $81,406, a payback period of 2.48 years, and an AAR of 9.31 percent. Project B has an NPV of $82,909, a payback period of 2.57 years, and an AAR of 9.22 percent. The required return for Project A is 11.5 percent while it is 12 percent for Project B. Both projects have a required AAR of 9.25 percent. Isaac must make a recommendation and justify it in 15 words or less. What should his recommendation be?
Accept Project B and reject Project A based on the NPVs
Aftertax salvage value
Aftertax salvage value = Sale price - tax( sale price - book value)
U. S. Treasury bonds:
Are quoted as a percentage of par.
You just purchased $218,000 of equipment that is classified as five-year MACRS property. The MACRS rates are .2, .32, .192, .1152, .1152, and .0576 for Years 1 to 6, respectively. What will be the book value of this equipment at the end of three years assuming no bonus depreciation is taken?
Book value3 = $218,000(1 − .2 − .32 − .192) Book value3 = $62,784
Allison just received the semiannual payment of $35 on a bond she owns. Which term refers to this payment?
Coupon
Which one of these statements related to preferred stock is correct?
Cumulative preferred shares are more valuable than comparable noncumulative shares
current price of stock equation
D/r
Estimated current stock price equation
EPS x PE ration
West Corp. issued 22-year bonds 2 years ago at a coupon rate of 10.1 percent. The bonds make semiannual payments. If these bonds currently sell for 99 percent of par value, what is the YTM?
Here we are finding the YTM of a semiannual coupon bond. The bond price equation is: P = 990 = $50(PVIFAR%,40) + $1,000(PVIFR%,40) Since we cannot solve the equation directly for R, using a spreadsheet, a financial calculator, or trial and error, we find: R = 5.1092% Since the coupon payments are semiannual, this is the semiannual interest rate. The YTM is the APR of the bond, so: YTM = 2 × 5.1092% YTM = 10.22%
Which one of the following bonds is the least sensitive to interest rate risk?
Higher the time to maturity higher is the sensitivity lower the coupon rate higher is the sensitivity hence 3 year 6 percent coupon
The Sly Fox pays a constant dividend of $1.46 a share. The company announced today that it will continue to pay the dividend for another 2 years and then in Year 3 it will pay a final liquidating dividend of $15.25 a share. What is one share of this stock worth today at a required return of 18.5 percent?
P0 = $1.46/1.185 + $1.46/1.185^2 + $15.25/1.185^3 P0 = $11.44
Currently, a firm has an EPS of $2.08 and a benchmark PE of 12.7. Earnings are expected to grow by 3.8 percent annually. What is the estimated current stock price?
P0 = $2.08(12.7) P0 = $26.42
Galloway, Inc., just paid a dividend of $3 per share and has announced that it will increase its dividend by $1 per share for each of the next 4 years, and then never pay another dividend. What is the current per share value at a required return of 12.7 percent?
P0 = $4/1.127 + $5/1.127^2 + $6/1.127^3 + $7/1.127^4 P0 = $16.02
Kay's Sewing Loft is going to reduce its annual dividend by 10 percent a year for the next two years. After that, it will maintain a constant dividend of $2 a share. Last year, the company paid an annual dividend of $3 per share. What is the market value of this stock if the required return is 13.7 percent?
P2 = $2/.137P2 = $14.60 P0 = [$3(1 − .10)]/1.137 + {[$3(1 − .10)2] + 14.60}/1.1372P0 = $15.55
Hi-Tek is a young start-up company that is currently retaining all of its earnings. The company plans to pay a $2 per share dividend in Year 7 and increase that dividend by 2.2 percent per year thereafter. What is the current share price if the required return is 16 percent?
P6 = $2/(.16 − .022)P6 = $14.49 P0 = $14.49/1.16^6 P0 = $5.95
Assume a project has cash flows of −$54,300, $18,200, $37,300, and $14,300 for Years 0 to 3, respectively. What is the profitability index given a required return of 12.6 percent?
PVInflows = $18,200/1.126 + $37,300/1.126^2 + $14,300/1.126^3 PVInflows = $55,599.30 PI = $55,599.30/$54,300 PI = 1.02
Which one of the following best illustrates erosion as it relates to a hot dog stand located on the beach?
Selling fewer hot dogs because hamburgers were added to the menu
Which one of the following statements is correct? Multiple Choice Stocks can only be assigned one dividend growth rate. Preferred stocks generally have variable growth rates. Dividend growth rates must be either zero or positive. All stocks can be valued using the dividend discount models. Stocks can have negative growth rates.
Stocks can have negative growth rates
Which one of the following statements related to the internal rate of return (IRR) is correct?
The IRR is equal to the required return when the net present value is equal to zero.
Round Dot Inns is preparing a bond offering with a coupon rate of 6 percent, paid semiannually, and a face value of $1,000. The bonds will mature in 10 years and will be sold at par. Given this, which one of the following statements is correct?
The bonds will sell at a premium if the market rate is 5.5 percent
Suppose you buy a 7 percent coupon, 20-year bond today when it's first issued. If interest rates suddenly rise to 15 percent, what happens to the value of your bond?
The price of the bond will fall
A project has a net present value of zero. Which one of the following best describes this project?
The project's cash inflows equal its cash outflows in current dollar terms.
Is the yield to maturity on a bond the same thing as the required return? Is YTM the same thing as the coupon rate? Suppose today a 10 percent coupon bond sells at par. Two years from now, the required return on the same bond is 8 percent. What is the coupon rate on the bond?
The yield to maturity is the required rate of return on a bond expressed as a nominal annual interest rate. For noncallable bonds, the yield to maturity and required rate of return are interchangeable terms. Unlike YTM and required return, the coupon rate is not a return used as the interest rate in bond cash flow valuation, but is a fixed percentage of par over the life of the bond used to set the coupon payment amount. For the example given, the coupon rate on the bond is still 10 percent, and the YTM is 8 percent.
Weismann Co. issued 15-year bonds a year ago at a coupon rate of 4.9 percent. The bonds make semiannual payments and have a par value of $1,000. If the YTM on these bonds is 4.5 percent, what is the current bond price?
To find the price of this bond, we need to realize that the maturity of the bond is 14 years. The bond was issued 1 year ago, with 15 years to maturity, so there are 14 years left on the bond. Also, the coupons are semiannual, so we need to use the semiannual interest rate and the number of semiannual periods. The price of the bond is N=28, I/Y(4.5%/2), PV(1041.22), PMT(.049x1000)/2), FV (1000)
When comparing a 10-year bond versus a 1-year bond, the 10-year bond has a much greater interest rate risk? T/F
True
When the present value of the cash inflows exceeds the initial cost of a project, then the project should be:
accepted because the profitability index is greater than 1.
Which one of these equations applies to a bond that currently has a market price that exceeds par value?
Yield to maturity < Coupon rate
You are considering two mutually exclusive projects. Project A has cash flows of −$125,000, $51,400, $52,900, and $63,300 for Years 0 to 3, respectively. Project B has cash flows of −$85,000, $23,100, $28,200, and $69,800 for Years 0 to 3, respectively. Project A has a required return of 9 percent while Project B's required return is 11 percent. Should you accept or reject these mutually exclusive projects based on IRR analysis?
You should not use IRR; use a different method of analysis. Because these are mutually exclusive projects of differing sizes you should not apply the IRR rule.
A project's average net income divided by its average book value is referred to as the project's average:
accounting return
offer price
annual divident x shareprice/ return on similar stock
Average accounting return (AAR) equation
average net income/ average investment
Book Value Equation
book value = cost - accumulated depreciation
Which one of the following types of stock is defined by the fact that it receives no preferential treatment in respect to either dividends or bankruptcy proceedings?
common stock
Recently, you discovered a convertible, callable bond with a semiannual coupon of 5 percent. If you purchase this bond you will have the right to:
convert the bond into equity shares
The price sensitivity of a bond increases in response to a change in the market rate of interest as the:
coupon rate decreases and the time to maturity increases
stock value equation
d1/(1+r)^t+d2/(1+r)^t+d3/(1+r)^t
An agent who maintains an inventory from which he or she buys and sells securities is called a:
dealer
Which one of the following premiums is compensation for the possibility that a bond issuer may not pay a bond's interest or principal payments as expected?
default risk
depreciation tax shield equation
depreciation x tax rate
Which one of the following rights is never directly granted to all shareholders of a publicly held corporation?
determining the amount of the dividend to be paid per share
The internal rate of return is defined as the:
discount rate which causes the net present value of a project to equal zero.
A forward PE is based on:
estimated future earnings
A discount bond's coupon rate is equal to the annual interest divided by the:
face value
A person on the floor of the NYSE who executes buy and sell orders on behalf of customers is called a(n):
floor broker
Treasury bonds are:
generally issued as semi-annual coupon bonds
Kelley's Baskets makes handmade baskets and is currently considering making handmade wreaths as well. Which one of the following is the best example of an incremental operating cash flow related to the wreath project?
hiring additional employees to handle the increased workload should the firm accept the wreath project
The difference between a company's future cash flows if it accepts a project and the company's future cash flows if it does not accept the project is referred to as the project's:
incremental cash flows
The Fisher effect primarily emphasizes the effects of _____ on an investor's rate of return.
inflation
Annual depreciation expense formula
initial cost/years of depreciation
A "fallen angel" is a bond that has moved from:
investment grade to speculative grade
Net Present Value (NPV)
is the best method of analyzing mutually exclusive projects
Which one of the following risk premiums compensates for the inability to easily resell a bond prior to maturity?
liquidity
Which of the following are advantages of the payback method of project analysis?
liquidity bias, ease of use
Interest Rate Risk is the risk that arises for bond owners from fluctuating interest rates. All other things being equal, the _______ the time to maturity, the _________ the interest rate risk.
longer,greater
Interest Rate Risk is the risk that arises for bond owners from fluctuating interest rates. All other things being equal, the _______ the coupon rate, the _________ the interest rate risk.
lower, greater
DLQ Inc. bonds mature in 12 years and have a coupon rate of 6 percent. If the market rate of interest increases, then the:
market price of the bond will decrease
target share price formula
market price x (100 x estimated growth rate)
PE formula
market price/EPS
A bond's principal is repaid on the ____ date.
maturity
A project's cash flow is equal to the project's operating cash flow:
minus both the project's change in net working capital and capital spending.
Which one of the following should not be included in the analysis of a new product?
money already spent for research and development of the new product
Boston Free Press has a dividend policy whereby the firm pays a constant annual dividend of $2.40 per share of common stock. The firm has 1,000 shares of stock outstanding. The company:
must still declare each dividend before it becomes an actual company liability
If a firm accepts Project A it will not be feasible to also accept Project B because both projects would require the simultaneous and exclusive use of the same piece of machinery. These projects are considered to be:
mutually exclusive
OCF
net income + depreciation
approximate real rate equation
nominal-inflation
The option that is forgone so that an asset can be utilized by a specific project is referred to as which one of the following?
opportunity cost
The stream of customer orders coming in to the NYSE trading floor is called the:
order flow
Municipal bonds:
pay interest that is federally tax-free
The length of time a firm must wait to recoup the money it has invested in a project is called the:
payback period
National Trucking has paid an annual dividend of $1 per share on its common stock for the past 15 years and is expected to continue paying a dollar a share long into the future. Given this, one share of the firm's stock is:
priced the same as a $1 perpetuity
The present value of an investment's future cash flows divided by the initial cost of the investment is called the:
profitability index
GL Plastics spent $1,200 last week repairing a machine. This week the company is trying to decide if the machine could be better utilized if they assigned it a proposed project. When analyzing the proposed project, the $1,200 should be treated as which type of cost?
sunk cost
Which one of the following costs was incurred in the past and cannot be recouped?
sunk costs
average net income equation
total net income/total time period
You cannot attend the shareholder's meeting for Alpha United so you authorize another shareholder to vote on your behalf. What is the granting of this authority called?
voting by proxy