Module 7 Questions

Essex Corporation is evaluating a lease that takes effect on March 1, 2012. The company must make eight equal payments, with the first payment due on March 1, 2012. The concept most relevant to the evaluation of the lease is: a. The present value of an annuity due. b. The present value of an ordinary annuity. c. The future value of an annuity due. d. The future value of an ordinary annuity.

A

Which of the following categories of risk does an investment's beta measure? a. The investment's systematic risk. b. The investment's unsystematic risk. c. The investment's default risk. d. The investment's interest rate risk.

A

Which of the following characteristics, if any, should be taken into account in valuing a specific item? Location, Condition a. Yes, Yes b. Yes, No c. No, Yes d. No, No

A

Which of the following types of active markets, if any, would be considered as providing level 1 inputs under the U.S. GAAP hierarchy of inputs for fair value determination? NYSE, Over-the-Counter Market a. Yes, Yes b. Yes, No c. No, Yes d. No, No

A

Which one of the following approaches to valuing a business is most likely to be appropriate when the business has been losing money and is going to be sold in a distressed sale? a. Asset approach. b. Market approach. c. Income approach using capitalized earnings. d. Income approach using free cash flow.

A

Which one of the following beta values indicates the least volatility? a. Beta = 0.5 b. Beta = 0.8 c. Beta = 1.0 d. Beta = 1.5

A

Banner Electronics has subsidiaries in several international locations and is concerned about its exposure to foreign exchange risk. In countries where currency values are likely to fall, Banner should encourage all of the following except: a. Granting trade credit wherever possible. b. Investing excess cash in inventory or other real assets. c. Purchasing materials and supplies on a trade credit basis. d. Borrowing local currency funds if an appropriate interest rate can be obtained.

A Banner would not encourage granting of trade credit whenever possible if currency values expected to fall. By doing so, Banner would recognize AR that will be collected with currency that has less value than when receivable was recognized.

Assume the following rates exist in the U.S.: Prime interest rate = 6% Fed discount rate = 4% U.S. Treasury Bond rate = 2% Inflation rate = 1% Which one of the following is most likely the nominal risk-free rate of return in the U.S.? a. 1% b. 2% c. 4% d. 6%

B

Carter Co. paid $1,000,000 for land three years ago. Carter estimates it can sell the land for $1,200,000, net of selling costs. If the land is not sold, Carter plans to develop the land at a cost of $1,500,000. Carter estimates net cash flow from the development in the first year of operations would be $500,000. What is Carter's opportunity cost of the development? a. $1,500,000 b. $1,200,000 c. $1,000,000 d. $ 500,000

B

Which of the following "tools" are likely to be used in financial management? TVM, IR Concepts, Balance of Payment Accounts a. Yes, Yes, Yes b. Yes, Yes, No c. Yes, No, No d. No, Yes, No

B

A derivative security: a. has no risk of default. b. is traded only in the over-the-counter market. c. has a value based on another security or index. d. can be used only for hedging.

C

The optimal capitalization for an organization usually can be determined by the: a. Maximum degree of financial leverage (DFL). b. Maximum degree of total leverage (DTL). c. Lowest total weighted-average cost of capital (WACC). d. Intersection of the marginal cost of capital and the marginal efficiency of investment.

C

The variance of an individual investment captures: a. Only systematic risk. b. Only unsystematic risk. c. Both systematic risk and unsystematic risk. d. Neither systematic nor unsystematic risk.

C

Which of the following financial management-related areas are considered long-term issues? Trade AP, Inventories, Capital Budgeting a. Yes, Yes, Yes b. No, Yes, Yes c. No, No, Yes d. Yes, No, Yes

C

Which of the following risks can be hedged? Foreign Exchange Risk IR Risk Default Risk A. Yes Yes No B. Yes No Yes C. Yes Yes Yes D. No Yes Yes a. Row A b. Row B c. Row C d. Row D

C

A corporation obtains a loan of $200,000 at an annual rate of 12%. The corporation must keep a compensating balance of 20% of any amount borrowed on deposit at the bank, but it normally does not have a cash balance account with the bank. What is the effective cost of the loan? a. 12.0% b. 13.3% c. 15.0% d. 16.0%

C Interest = $200,000 * 0.12 = $24,000 Balance = $200,000 - (200,000 * 0.20) = $160,000 EIR = $24,000 / 160,000 = 0.15 = 15%

Assume the following values for an investment: Risk-free rate of return = 2% Expected rate of return = 9% Beta = 1.4 Which one of the following is the required rate of return for the investment? a. 9.0% b. 9.8% c. 11.8% d. 12.6%

C ROR = RFR + Beta (ERR - RFR) ROR = 0.02 + 1.4 (0.09 - 0.02) ROR = 0.118 = 11.8%

For the year ended December 31, 2004, Abel Co. incurred direct costs of $500,000 based on a particular course of action during the year. If a different course of action had been taken, direct costs would have been $400,000. In addition, Abel's 2004 fixed costs were $90,000. The incremental cost was: a. $10,000 b. $90,000 c. $100,000 d. $190,000

C - $500,000 - 400,000

ABC Co. had debt with a market value of $1 million and an after-tax cost of financing of 8%. ABC also had equity with a market value of $2 million and a cost of equity capital of 9%. ABC's weighted-average cost of capital would be: a. 8% b. 8.5% c. 8.7% d. 9%

C - (⅓ * 0.08) + (⅔ * 0.09)

What accounts for the difference between the stated rate and the effective annual rate of a loan? a. The rate of inflation. b. The risk of the borrower. c. The frequency of compounding. d. The risk-free interest rate.

C - frequency of compounding explains the difference between the stated rate and the effective rate

The target capital structure of Traggle Co. is 50% debt, 10% preferred equity, and 40% common equity. The interest rate on debt is 6%, the yield on the preferred is 7%, the cost of common equity is 11.5%, and the tax rate is 40%. Traggle does not anticipate issuing any new stock. What is Traggle's weighted-average cost of capital? a. 6.5% b. 6.77% c. 7.1% d. 8.30%

C - {50% debt × [6% × (1 − 0.4 tax rate)]] + (10% preferred stock × 7%) + (40% common stock × 11.5%)}

A graph that plots beta would show the relationship between: a. Asset risk and asset return. b. Asset risk and benchmark return. c. Benchmark risk and asset return. d. Asset return and benchmark return.

D

Which of the following levels of the U.S. GAAP hierarchy of inputs used for determining fair value can be based on inputs not directly observable for the item being valued? Level 1, Level 2, Level 3 a. Yes, Yes, Yes b. Yes, Yes, No c. Yes, No, Yes d. No, Yes, Yes

D

A business with a net book value of $150,000 has an appropriate fair value of $120,000. Charles Harvey, one of three owners, has decided to sell his 10% interest in the business. Which one of the following is most likely the amount at which Harvey can sell his interest? a. $40,000 b. $15,000 c. $12,000 d. < $12,000

D - $120,000 * 0.10 = $12,000 Because owns such small interest, likely wouldn't receive full $12,000

Assume the following abbreviated Income Statement: Revenues $100,000 COGS 60,000 Gross Profit $ 40,000 Operating Expenses 20,000 Finance Expense 5,000 NI $ 15,000 In a common-size income statement, which one of the following percentages would be shown for Finance Expense? a. 33.33% b. 12.50% c. 8.33% d. 5.00%

D - $5,000 / 100,000 (total revenues)

Conceptually, which one of the following U.S. GAAP approaches for determining value is most likely to provide the best evidence of fair value? a. Market approach. b. Income approach. c. Correlation approach. d. Cost approach.

A

Which one of the following gives the holder the right to buy an asset for a specified exercise price on or before a specified expiration date? a. Call option. b. Put option. c. Futures contract. d. Forward contract.

A

Assume the following abbreviated Balance Sheet: CA $100,000 CL $ 30,000 Investments 25,000 LT Liabilities 75,000 FA 75,000 CS 70,000 RE 25,000 Total Assets $200,000 Total L + SE $200,000 In a common-sized balance sheet, which one of the following percentages would be shown for current liabilities? a. 15.0% b. 17.6% c. 28.5% d. 30.0%

A - $30,000/200,000 (total assets)

Josey maintained a $10,000 balance in his savings account throughout Year 1, the first year of the account. The savings account paid 2% interest compounded annually. For Year 1, the inflation rate was 3%. For Year 1, what is Josey's real interest rate on the savings account? a. - 1%. b. 1% c. 3% d. 5%

A - RIR = Nominal IR - Inflation Rate RIR = 2% - 3%

Which one of the following is not a financial derivative? a. Futures contract. b. Swap contract. c. Common stock. d. Options.

C

Which one of the following options, A through D, is most likely to have the greatest value (all other things being equal)? Option, Time to Expiration, Risk-Free IR, Beta a. A, 3 Yrs., 3.0%, 2.00 b. B, 1 Yr., 4.0%, 1.00 c. C, 2 Yrs., 2.0%, 1.60 d. D, 8 Yrs., 4.5%, 4.00

D

A company uses its company-wide cost of capital to evaluate new capital investments. What is the implication of this policy when the company has multiple operating divisions, each having unique risk attributes and capital costs? a. High-risk divisions will over-invest in new projects and low-risk divisions will under-invest in new projects. b. High-risk divisions will under-invest in high-risk projects. c. Low-risk divisions will over-invest in low-risk projects. d. Low-risk divisions will over-invest in new projects and high-risk divisions will under-invest in new projects.

A

Assuming they are traded in an active market, which of the following types of investments, if any, could be valued using level 1 inputs of the U.S. GAAP hierarchy of inputs for determining fair value? Equity Securities, Debt Securities a. Yes, Yes b. Yes, No c. No, Yes d. No, No

A

Financial management involves decisions and activities that deal with: ST Matters, LT Matters a. Yes, Yes b. Yes, No c. No, Yes d. No, No

A

Quoted prices in which of the following types of markets could be level 2 inputs in determining fair value under the U.S. GAAP hierarchy of inputs for fair value determination? Active Markets, Inactive Markets a. Yes, Yes b. Yes, No c. No, Yes d. No, No

A

Regarding financial resources, financial management is concerned with the efficiency and effectiveness of which of the following? Acquiring Financial Resources, Using Financial Resources a. Yes, Yes b. Yes, No c. No, Yes d. No, No

A

Which of the following describes a normal yield curve? a. Upward sloping. b. Downward sloping. c. Flat. d. Humped.

A

Which of the following does investment's beta measure? a. The investment's systematic risk. b. The investment's unsystematic risk. c. The investment's default risk. d. The investment's interest rate risk.

A

Which of the following statements is correct regarding the weighted-average cost of capital (WACC)? a. One of a company's objectives is to minimize the WACC. b. A company with a high WACC is attractive to potential shareholders. c. An increase in the WACC increases the value of the company. d. WACC is always equal to the company's borrowing rate.

A

Which one of the following is not a limitation of the basic Black-Scholes option pricing model? a. It fails to consider the probability that the option will be exercised. b. It assumes the stock does not pay dividends. c. It assumes the risk-free rate of return used for discounting remains constant during the option period. d. It assumes the option can be exercised only at the expiration date.

A

An American importer of English clothing has contracted to pay an amount fixed in British pounds three months from now. If the importer worries that the U.S. dollar may depreciate sharply against the British pound in the interim, it would be well advised to: a. Buy pounds in the forward exchange market. b. Sell pounds in the forward exchange market. c. Buy dollars in the futures market. d. Sell dollars in the futures market.

A Selling pounds would increase firm's risk associated with decrease in value of dollar against pound.

Which of the following could be used to hedge a net receivable denominated in British pounds by a U.S. company? a. Purchase a currency put option in British pounds. b. Purchase a currency call option in British pounds. c. Purchase a forward contract to buy British pounds. d. Purchase a forward contract to buy U.S. dollars.

A Would enable U.S. company to lock in price at which it could sell (put) British pounds when received.

Which of the following changes would result in the highest present value? a. A $100 decrease in taxes each year for four years. b. A $100 decrease in the cash outflow each year for three years. c. A $100 increase in disposal value at the end of four years. d. A $100 increase in cash inflows each year for three years.

A C is for single amount (PV single amount < PV annuities) PV annuity greater when period is longer (A = 4 years, B = 3, D = 3)

Which of the following level(s) of input in the U.S. GAAP hierarchy of inputs for fair value determination is/are likely to be most appropriate for valuing basic agricultural commodities? a. Level 1, only. b. Level 2, only. c. Level 3, only. d. Level 1 and level 3.

A - Agricultural commodities of identical nature widely traded in active commodities markets.

DQZ Telecom is considering a project for the coming year that will cost $50,000,000. DQZ plans to use the following combination of debt and equity to finance the investment: - Issue $15,000,000 of 20-year bonds at a price of 101, with a coupon rate of 8%, and flotation costs of 1.5% of par. The after-flotation cost yield is 8.08%. - Use $35,000,000 of funds generated from earnings. - The equity market is expected to earn 12%. U.S. Treasury bonds are currently yielding 5%. The beta coefficient for DQZ is estimated to be .60. - DQZ is subject to an effective corporate income tax rate of 40%. The Capital Asset Pricing Model (CAPM) computes the expected return on a security by adding the risk-free rate of return to the incremental yield of the expected market return, which is adjusted by the company's beta. Compute DQZ's expected rate of return on equity. a. 9.2% b. 12.2% c. 7.2% d. 12%

A - CAPM = RFR + Beta (ERR - RFR) RFR = treasury bond rate = 0.05 Beta = 0.60 ERR = market expectation = 0.12 CAPM = 0.05 + 0.60 (0.12 - 0.05) CAPM = 0.092 = 9.2%

A company is arranging financing for the purchase of a new piece of equipment that has a five-year expected useful life. Which of the following alternative financing arrangements has the lowest effective annual percentage rate if each has a quoted nominal rate of 9.5%? a. A five-year term loan with interest compounded annually. b. A ten-year term loan with interest compounded semiannually. c. A five-year term loan with interest compounded quarterly. d. A ten-year term loan with interest compounded monthly.

A - EAPR = (1 + Annual IR / Periods in Year) ^ Periods in Year - 1 Want lowest number of periods

The following information is available on market interest rates: The risk-free rate of interest = 2% Inflation premium = 1% Default risk premium = 3% Liquidity premium = 2% Maturity risk premium = 1% What is the market rate of interest on a one-year U.S. Treasury bill? a. 3%. b. 5%. c. 6%. d. 7%.

A - Treasury bills considered risk free in environment where zero inflation isexpected. Market rate of interest on one-year U.S. Treasury bill would be the risk-free rate plus inflation premium (for expected rate of inflation during life of security), or 2% + 1% = 3%.

Charles Allen was granted options to buy 100 shares of Dean Company stock. The options expire in one year and have an exercise price of $60.00 per share. An analysis determines that the stock has an 80% probability of selling for $72.50 at the end of the one-year option period and a 20% probability of selling for $65.00 at the end of the year. Dean Company's cost of funds is 10%. Which one of the following is most likely the current value of the 100 stock options? a. $1,000 b. $1,100 c. $6,875 d. $7,100

A - [(.80 x $12.50) + (.20 x $ 5.00)]/1.10 $12.50 = $72.50 - $60.00 (exercise price) $5.00 = $65.00 - $60.00 (exercise price)

The ABC Company is trying to decide between keeping an existing machine and replacing it with a new machine. The old machine was purchased just two years ago for $50,000 and had an expected life of 10 years. It now costs $1,000 a month for maintenance and repairs, due to a mechanical problem. A new replacement machine is being considered, with a cost of $60,000. The new machine is more efficient and it will only cost $200 a month for maintenance and repairs. The new machine has an expected life of 10 years. In deciding to replace the old machine, which of the following factors, ignoring income taxes, should ABC not consider? a. Any estimated salvage value on the old machine. b. The original cost of the old machine. c. The estimated life of the new machine. d. The lower maintenance cost of the new machine.

B

The land and building that constitute a strip shopping mall were valued using the recent sales price of a comparable strip shopping mall located across the street. The method of valuation would be an example of the: a. Income approach. b. Market approach. c. Asset approach. d. Cost approach.

B

Which of the following U.S. GAAP levels of inputs for valuation purposes is/are based on observable inputs? Level 1, Level 2, Level 3 a. Yes, Yes, Yes b. Yes, Yes, No c. Yes, No, No d. No, No, Yes

B

Which of the following describes an option? a. A standardized contract to take delivery of a specified quantity of a financial instrument in the future. b. A contract that allows the holder to purchase a specified quantity of a financial instrument at a specified price. c. A negotiated contract to purchase a specified quantity of a financial instrument in the future. d. An agreement to swap a stream of cash flows.

B

Which one of the following describes the relationship shown by a yield curve? a. A yield curve shows the relationship between liquidity and bond interest rates. b. A yield curve shows the relationship between time to maturity and bond interest rates. c. A yield curve shows the relationship between risk and bond interest rates. d. A yield curve shows the relationship between bond interest rates and bond prices.

B

Which one of the following would be considered a long-term financial management activity or concern? a. Cash management. b. Dividend policy management. c. Inventories management. d. Accounts payable management.

B

Strobel Company has a large amount of variable rate financing due in one year. Management is concerned about the possibility of increases in short-term rates. Which one of the following would be an effective way of hedging this risk? a. Buy Treasury notes in the futures market. b. Sell Treasury notes in the futures market. c. Buy an option to purchase Treasury bonds. d. Sell an option to purchase Treasury bonds.

B Buying notes now for future delivery would put firm at greater risk if ST IR increase because if IR increase, value of futures purchase contract will decrease. If IR increase, value of T-notes contract will decline, which would enable firm to acquire notes at new lower value and sell at higher futures contract price, resulting in gain.

A company has recently purchased some stock of a competitor as part of a long-term plan to acquire the competitor. However, it is somewhat concerned that the market price of this stock could decrease over the short run. The company could hedge against the possible decline in the stock's market price by: a. Purchasing a call option on that stock. b. Purchasing a put option on that stock. c. Selling a put option on that stock. d. Obtaining a warrant option on that stock.

B Would hedge against possible decline in stock's market price. Would give company option to sell stock at specified price in future. If price of stock declines, value of put option will increase by like amount.

Which one of the following is LEAST likely to be the reason an entity would seek a valuation of the entity as a going concern? a. In connection with a planned sale of the entity. b. In connection with a property tax determination. c. In connection with developing a buy-sell agreement among the owners. d. In connection with developing a settlement with the estate of a recently deceased owner.

B Entity would not seek to determine value of entity as going concern in connection with property tax determination. Valuation for property tax purposes would be concerned only with value of separate taxable assets of entity, not with value of entity as going concern.

Assume that nominal interest rates just increased substantially but that the expected future dividends for a company over the long run were not affected. As a result of the increase in nominal interest rates, the company's stock price should: a. Increase. b. Decrease. c. Stay constant. d. Change, but in no obvious direction.

B - If nominal IR increases, investors will expect higher yield from all investments. Therefore, stock price will decline.

A company had a choice between project X and project Y. The net present value of project X is $1,000,000, and the net present value of project Y is $750,000. The company chose project X. What is the opportunity cost of that decision? a. $250,000 b. $750,000 c. $1,000,000 d. $1,750,000

B - OC = benefit lost from next best opportunity as result of selecting another opportunity. Revenue or other benefit which would have been derived from next best alternative not selected = OC associated with selected alternative.

A company has the following financial information: Source Proportion Cost of Capital Long-term debt 60% 7.1% Preferred stock 20% 10.5% Common stock 20% 14.2% To maximize shareholder wealth, the company should accept projects with returns greater than what percent? a. 7.1% b. 9.2% c. 10.6% d. 14.2%

B - [(7.1% × 60%) + (10.5% × 20%) + (14.2% × 20%)]

Assume that a firm has a 40% tax rate and the following capital structure: Amount Cost before tax Debt $10,000,000 6% PS 5,000,000 6% CS 25,000,000 10% Total $40,000,000 What is the firm's weighted-average cost of capital? a. 7% b. 7.9% c. 8.5% d. 10%

B - [6% × (1 − 0.4)] × $10,000,000 / 40,000,000] + [(6% × $5,000,000 / 40,000,000)] + [10% × $25,000,000 / $40,000,000]

A company wants to approximate the 12% annual interest rate based on a 365-day year it pays on its working capital loan. Which of the following terms should the company offer its customers? a. 2.00%, 15, net 45. b. 1.00%, 15, net 45. c. 0.75%, 10, net 30. d. 0.50%, 10, net 30.

B - [Discount Rate/Principal] × [1/(Length of discount period/365)] 45 - 15 = 30 days 365/30 = 12.1 12.1 × .01 = .121 = 12%

Axel Corp. is planning to buy a new machine with the expectation that this investment should earn a discounted rate of return of at least 15%. This machine, which costs $150,000, would yield an estimated net cash flow of $30,000 a year for 10 years, after income taxes. In order to determine the net present value of buying the new machine, Axel should first multiply the $30,000 by which of the following factors? a. 20.304 (Future amount of an ordinary annuity of $1). b. 5.109 (Present value of an ordinary annuity of $1). c. 4.046 (Future amount of $1). d. 0.247 (Present value of $1).

B - to determine NPV need PV number, not FV

The foreign currency exchange rate for the immediate delivery of the currencies being exchanged is the: a. Historic rate. b. Forward rate. c. Spot rate. d. Prime rate.

C

Which one of the following U.S. GAAP approaches to determining fair value converts future amounts to current amounts? a. Market approach. b. Sales comparison approach. c. Income approach. d. Cost approach.

C

Which one of the following is not a limitation of the capital asset pricing model? a. It assumes that there are no restrictions on borrowing at the risk-free rate of return. b. It assumes that no external costs are associated with the investment. c. It fails to consider the time value of money. d. It fails to consider risk derived from other than variances from the asset class benchmark.

C

Which one of the following is not a major approach for assigning a value to an entire going business? a. Market approach. b. Income approach. c. Cost approach. d. Asset approach.

C

An individual received an inheritance from a grandparent's estate. The money can be invested and the individual can either (a) receive a $20,000 lump-sum amount at the end of 10 years or (b) receive $1,400 at the end of each year for the next 10 years. The individual wants a rate of return of 12% and uses the following information: Present value of $1 = 0.322 Present value of annuity of $1 = 5.650. What is the preferred investment option and what is its net present value? a. Option b, $451. b. Option a, $6,440. c. Option b, $7,910. d. Option a, $113,000.

C Option A = $20,000 * 0.322 = $6,440 Option B = $1,400 * 5.650 = $7,910

Which of the following statements regarding forward contracts is true? a. The buyer of a forward contract gains when prices decrease, and the seller of a forward contract loses when prices increase. b. The buyer of a forward contract gains when prices increase, and the seller of a forward contract loses when prices decrease. c. The buyer of a forward contract gains when prices increase, and the seller of a forward contract loses when prices increase. d. The buyer of a forward contract gains when prices decrease, and the seller of a forward contract loses when prices decrease.

C Because buyer has lower purchased price (contract price) than price at which contracted asset can be sold after price increase. Seller will lose when price increases because seller agreed to sell at lower price than price of asset after price increase. Also, if buyer gains, seller must lose.

At the beginning of year 1, $10,000 is invested at 8% interest, compounded annually. What amount of interest is earned for year 2? a. $800.00 b. $806.40 c. $864.00 d. $933.12

C Year 1: $10,000 * 0.08 = $800 Year 2: ($10,000 + 800) * 0.08 = $864

Beta Company has arranged to borrow $10,000 for 180 days. Beta will repay the principal amount plus $600 in interest at the maturity of the note. Which one of the following is the annual percentage rate (APR) of interest that Beta is paying on the loan? a. 3.0% b. 6.0% c. 12.0% d. 16.6%

C - APR = EIR for Part of Year x Number Parts in year EIR = $600/10,000 = 6% APR = 6% x 2 (semi-annual) = 12%

Which of the following statements is true regarding opportunity cost? a. Opportunity cost is recorded in the accounts of an organization that has a full costing system. b. The potential benefit is not sacrificed when selecting an alternative. c. Idle space that has no alternative use has an opportunity cost of zero. d. Opportunity cost is representative of actual dollar outlay.

C - OC = discounted dollar value of benefits lost from alternative as result of choosing another opportunity Does not involve actual transaction or cash outlay.

Which one of the following sets of interest (or discount) rates will give the greater present value of $1.00 and greater future value of $1.00? Greater Present Value, Greater Future Value a. 10%, 10% b. 10%, 8% c. 8%, 10% d. 8%, 8%

C - PV: 10% rate "takes out" more of future amount as interest than does 8% rate

Management at MDK Corp. is deciding whether to replace a delivery van. A new delivery van costing $40,000 can be purchased to replace the existing delivery van, which cost the company $30,000 and has accumulated depreciation of $20,000. An employee of MDK has offered $12,000 for the old delivery van. Ignoring income taxes, which of the following correctly states relevant costs when making the decision whether to replace the delivery vehicle? a. Purchase price of new van, disposal price of old van, gain on sale of old van. b. Purchase price of new van, purchase price of old van, gain on sale of old van. c. Purchase price of new van, disposal price of old van. d. Purchase price of new van, purchase price of old van, accumulated depreciation of old van, gain on sale of old van, disposal price of old van.

C - gain would be difference between CV of van and disposal price (i.e., proceeds received on sale of old van) Therefore, gain part of disposal price (i.e., disposal price proceeds = CV + gain on sale).

Pole Co. is investing in a machine with a 3-year life. The machine is expected to reduce annual cash operating costs by $30,000 in each of the first 2 years and by $20,000 in year 3. Present values of an annuity of $1 at 14% are: Period 1 0.88 2 1.65 3 2.32 Using a 14% cost of capital, what is the present value of these future savings? a. $59,600 b. $60,800 c. $62,900 d. $69,500

C - values converted into 2 series of equal payments: $20,000 for years 1, 2 and 3, and $10,000 for years 1 and 2. $20,000 x 2.32 = $46,400 $10,000 x 1.65 = $16,500 Total = $62,900

A downward-sloping yield curve depicting the term structure of interest rates implies that: a. Interest rates have declined over recent years. b. Interest rates have increased over recent years. c. Prevailing short-term interest rates are lower than prevailing long-term interest rates. d. Prevailing short-term interest rates are higher than prevailing long-term interest rates.

D

The P/E ratio for a share of common stock is computed as: a. Par value/EPS. b. Par value x EPS. c. EPS x Market price. d. Market price/EPS.

D

The real risk-free rate: a. Includes a default premium. b. Assumes that inflation is expected. c. Includes a liquidity premium. d. Is the basic component of interest.

D

Which of the following factors would not be relevant when determining the risk premium on a specific security? a. Length of maturity b. Relative liquidity c. Relative seniority d. Earnings per share

D

Which of the following is assigned to goods that were either purchased or manufactured for resale? a. Relevant cost. b. Period cost. c. Opportunity cost. d. Product cost.

D

Which of the following is the most expensive form of additional capital? a. New debt. b. New preferred stock. c. Retained earnings. d. New common stock.

D

Which one of the following characteristics is not an advantage of the Black-Scholes option pricing model? a. Incorporates the probability that the price of the stock will pay off within the time to expiration. b. Incorporates the probability that the option will be exercised. c. Discounts the exercise price. d. Accommodates options when the price of the underlying stock changes significantly and rapidly.

D

Which one of the following is not a factor routinely considered in valuing a stock option? a. Time until expiration date. b. Risk-free rate of return. c. Exercise price of the option. d. Industry classification of the stock.

D

Which one of the following risks relates to the possibility that a derivative might not be effective at hedging a particular asset? a. Credit risk. b. Default risk. c. Market risk. d. Basis risk.

D

Alpha Corporation has the following capital structure and related cost of capital for each source: Component Amount Percent Cost of Capital Bonds Payable $300,000 30% 8% Preferred Stock 100,000 10% 10% Common Stock 600,000 60% 12% Totals $1,000,000 100% Which one of the following is Alpha's weighted average cost of capital? a. 3.53% b. 8.20% c. 10.00% d. 10.60%

D - (0.30 * 0.08) + (0.10 * 0.10) + (0.60 * 0.12)

A company with a combined federal and state tax rate of 30% has the following capital structure: Weight Instrument Cost of capital 40% Bonds 10% 50% Common stock 10% 10% Preferred stock 20% What is the weighted-average after-tax cost of capital for this company? a. 3.3% b. 7.7% c. 8.2% d. 9.8%

D - (0.40 * [0.10 * 0.70]) + (0.50 * 0.10) + (0.10 * 0.20)

An entity is examining potential investments and notes that 1-year maturity yields are higher than those for 10-year maturities. Which of the following explanations for this occurrence is best? a. The short-term investments have higher liquidity and therefore carry a higher rate of interest. b. The short-term investments carry a more immediate default risk premium resulting in higher rates of return. c. The long-term instruments provide a longer stream of investment income and therefore carry a lower rate of return. d. Investors are expecting reduced inflation in the future as reflected in the lower long-term returns.

D - ST investments do not necessarily carry more immediate default risk premium Whether ST investment carries more immediate risk of default depends on financial characteristics of issuing firm.