FIN 3716 Exam 2

Free Cash Flow

(revenues - expenses - depreciation) × (1 - tax rate) + depreciation

NPV Decision Rule

- Accept positive-NPV projects; accepting them is equivalent to receiving their NPV in cash today, - Reject negative-NPV projects; accepting them would reduce the value of the firm, whereas rejecting them has no cost (NPV = 0)

Zero-Coupon Bonds

- Only two cash flows -- The bond's market price at the time of purchase -- The bond's face value at maturity - Treasury bills are zero-coupon U.S. government bonds with maturity of up to one year

$969.21 (FV = $1,000, PV = -959.71 , n = 20, i = 2.15%, solve for PMT. PMT = $19.00 , so coupon rate per 6 month period = 1.90 %. Accrued interest for three months = $19.00 /2= $9.50 , so dirty price = $959.71 + $9.50 = $969.21 .)

A 20-year bond with a $1,000 face value was issued with a yield to maturity of 4.3% and pays coupons semi-annually. After ten years, the yield to maturity is still 4.3% and the clean price of the bond is $959.71 . After three more months go by, what would you expect the dirty price to be? A) $978.71 B) $969.21 C) $997.71 D) Cannot be determined from information given.

the terms of the bond

A bond certificate includes ________. A) the terms of the bond B) the individual to whom payments will be made C) the yield to maturity of the bond D) the price of the bond

$400 (8% × 10,000 = 800 ÷ 2 = 400. The expected difference in this bondʹs price will be $400 since the bond pays semiannual coupon of $400.)

A bond has a $10,000 face value, ten years to maturity, and 8% semiannual coupon payments. What would be the expected difference in this bondʹs price immediately before and immediately after the next coupon payment? A) $800 B) $400 C) $1200 D) $200

$667 (NPV @ 5% interest= 13,333; 14,000-13,333= 667)

A car dealership offers a car for $14,000 , with up to one year to pay for the car. If the interest rate is 5%, what is the net present value (NPV) of this offer to buyers who elect not to pay for the car for one year? A) $667 B) $1333 C) $13,333 D) $14,000

$10.756 million ((-$0.12 - $1.6 / 5) * 60% + $1.6 / 5 + 10.7 = $10.756 million)

A company buys tracking software for its warehouse which, along with the computer system and ancillaries to run it, will cost $1.6 million. This purchase will be deducted over five years. It is expected that the software will reduce inventory by $10.7 million at the end of the first year after it is installed, though there will be an annual cost of $120,000 per year to run the system. If the companyʹs marginal tax rate is 40%, how will the purchase of this item change the companyʹs free cash flows in the first year? A) $10.756 million B) $10.380 million C) $9.680 million D) $11.832 million

Project II

A company has four projects it wishes to undertake. Which of these investments should be the lowest priority, given a discount rate of 5%? A) Project I B) Project II C) Project III D) Project IV

$883.91 (N= 16 semis (8 years × 2), I/Y= 4.05% (8.1% × 2), PV= ?, PMT= $30.50 (6.1% × 1,000 = $61/2= $30.50), FV = +1,000)

A company issues a ten-year $1,000 face value bond at par with a coupon rate of 6.1% paid semiannually. The YTM at the beginning of the third year of the bond (8 years left to maturity) is 8.1%. What is the new price of the bond? A) $883.91 B) $1060.69 C) $1237.47 D) $1,000.00

-8.13% (N = 16(8×2), I/Y = 4.05 % (8.1/2), PMT = 33.50 (67/2), FV = 1,000. PV = -918.73. Percentage change is 918.73-1000/1000 = -8.13%)

A company issues a ten-year $1,000 face value bond at par with a coupon rate of 6.7% paid semiannually. The YTM at the beginning of the third year of the bond (8 years left to maturity) is 8.1%. What was the percentage change in the price of the bond over the past two years? A) -6.50% B) -9.75% C) -8.13% D) -11.38 %

If the motor scooter is sold for $2,480, then the net present value (NPV) for the product will be zero.

A company planning to market a new model of motor scooter analyzes the effect of changes in the selling price of the motor scooter, the number of units that will be sold, the cost of making the motor scooter, the effect on Net Working Capital, and the cost of capital for the project. They predict that the break-even point for sales price for the motor scooter is $2,480. What does this mean? A) If the motor scooter is sold for $2,480, then the project will make a profit. B) If the motor scooter is sold for $2,480, then the net present value (NPV) for the product will be zero. C) The predicted selling price of the motor scooter is $2,480. D) The maximum that the motor scooter can sell for and still make the project have a positive net present value (NPV) is $2,480.

6%

A company releases a five-year bond with a face value of $1000 and coupons paid semiannually. If market interest rates imply a YTM of 6%, what should be the coupon rate offered if the bond is to trade at par? A) 3% B) 5% C) 6% D) 7%

10%

A company releases a five-year bond with a face value of $1000 and coupons paid semiannually. If market interest rates imply a YTM of 8%, which of the following coupon rates will cause the bond to be issued at a premium? A) 7% B) 6% C) 8% D) 10%

as a sunk cost

A company spends $20 million researching whether it is possible to create a durable plastic from the process waste from feedstock preparation. How should the $20 million best be considered? A) as a sunk cost B) as an opportunity cost C) as a fixed overhead expense D) as a capital cost

Prep for the Grad School Entry Test, Prep for the Law School Entry Test, and Prep for the Medical School Entry Test

A company that creates education products is planning to create a suite of books to help customers prepare for high-stakes tests for entry into college and grad school. They have 33 in-house writers to create these books. Due to the expertise needed in creating this content it will not be possible to hire temporary writers within the planned time-frame. Which projects should be undertaken? A) Prep for the College Entry Test and Prep for the Law School Entry Test B) Prep for the College Entry Test and Prep for the Grad School Entry Test C) Prep for the Dental School Entry Test, Prep for the Grad School Entry Test, and Prep for the Medical School Entry Test D) Prep for the Grad School Entry Test, Prep for the Law School Entry Test, and Prep for the Medical School Entry Test

175,034 (Annual difference = $160,000 - $115,000 = $45,000 ; PV over 5 years at 9% = $175,034)

A consultancy calculates that it can supply crude oil assaying services to a small oil producer for $115,000 per year for five years. There are some upfront costs the consultancy will require the oil producer to absorb. What is the maximum that these upfront costs could be, if the equivalent annual annuity to the oil company is to be under $160,000 , given that the cost of capital is 9%? A) $45,000 B) $175,034 C) $201,289 D) $160,000

cost of goods

A consumer good company is developing a new brand of organic toothpaste. Above is the sensitivity analysis for this product. The assumptions regarding which parameter should be scrutinized most carefully in the estimation process? A) units sold B) sales price C) cost of goods D) cost of capital

a 10-year bond with a face value of $2,000 and a coupon rate of 5.8% with monthly payments ($9.67 × 12 / (2,009.67 - 9.67) = 5.802%)

A corporate bond makes payments of $9.67 every month for ten years with a final payment of $2009.67. Which of the following best describes this bond? A) a 10-year bond with a face value of $2,000 and a coupon rate of 4.8% with monthly payments B) a 10-year bond with a face value of $2,000 and a coupon rate of 5.8% with monthly payments C) a 10-year bond with a face value of $2,009.67 and a coupon rate of 4.8% with monthly payments D) a 10-year bond with a face value of $2,009.67 and a coupon rate of 5.8% with monthly payments

an investment grade bond

A corporate bond which receives a BBB rating from Standard & Poorʹs is considered ________. A) a junk bond B) an investment grade bond C) a defaulted bond D) a high-yield bond

-$574

A delivery service is buying 600 tires for its fleet of vehicles. One supplier offers to supply the tires for $80 per tire, payable in one year. Another supplier will supply the tires for $20,000 down today, then $45 per tire, payable in one year. What is the difference in PV between the first and the second offer, assuming interest rates are 8.1%? A) -$860 B) -$229 C) -$574 D) $860

$10,048

A firm has an opportunity to invest $95,000 today that will yield $109,250 in one year. If interest rates are 4%, what is the net present value (NPV) of this investment? A) $10,048 B) $11,053 C) $16,077 D) $14,250

$416,250 (Annual depreciation = $300,000 / 4 = $75,000. Free Cash Flow ($1,300,000 - $700,000 - $75,000 ) × (1 - 0.35) + $75,000 = $416,250)

A firm is considering a new project that will generate cash revenue of $1,300,000 and cash expenses of $700,000 per year for five years. The equipment necessary for the project will cost $300,000 and will be depreciated straight line over four years. What is the expected free cash flow in the second year of the project if the firmʹs marginal tax rate is 35%? A) $374,625 B) $341,250 C) $416,250 D) $499,500

$135,000 ($125,000 + $100,000 - $90,000 = $135,000)

A firm is considering changing their credit terms. It is estimated that this change would result in sales increasing by $1,600,000 . This in turn would cause inventory to increase by $125,000 , accounts receivable to increase by $100,000 , and accounts payable to increase by $90,000 . What is the firmʹs expected change in net working capital? A) $1,735,000 B) $315,000 C) $225,000 D) $135,000

net present value (NPV)

A firm is considering several mutually exclusive investment opportunities. The best way to choose between them is which of the following? A) profitability index B) payback period C) net present value (NPV) D) internal rate of return (IRR)

Hoist B, since it has a greater equivalent annual annuity.

A garage is comparing the cost of buying two different car hoists. Hoist A will cost $20,000, will require servicing of $1000 every two years, and last ten years. Hoist B will cost $15,000, require servicing of $800 per year, and last eight years. If the cost of capital is 7%, which is the better option, given that the firm has an ongoing requirement for a hoist? A) Hoist A, since it has a greater present value (PV). B) Hoist B, since it has a greater present value (PV). C) Hoist A, since it has a greater equivalent annual annuity. D) Hoist B, since it has a greater equivalent annual annuity.

Option B, since it has a greater equivalent annual annuity. (Using a financial calculator, NPV(A) = -$2,298.54 equivalent annual annuity (A) = -$575.68 NPV(B) = -$1257.71 equivalent annual annuity (B) = -$488.03)

A janitorial services firm is considering two brands of industrial vacuum cleaners to equip their staff. Option A will cost $1,500, require servicing of $200 per year, and it will last five years. Option B will cost $1,000, require servicing of $100 per year, and it will last three years. If the cost of capital is 8%, which is the better option, given that the firm has an ongoing requirement for vacuum cleaners? A) Option A, since it has a lower equivalent annual annuity. B) Option B, since it has a lower equivalent annual annuity. C) Option A, since it has a greater equivalent annual annuity. D) Option B, since it has a greater equivalent annual annuity.

Yes, because it agrees with the Net Present Value rule. (N = 16 years, I/Y = 4%, PMT = 600,000, FV =0. Compute PV = 6,991,377)

A lottery winner can take $6 million now or be paid $600,000 at the end of each of the next 16 years. The winner calculates the internal rate of return (IRR) of taking the money at the end of each year and, estimating that the discount rate across this period will be 4%, decides to take the money at the end of each year. Was her decision correct? A) Yes, because it agrees with the Net Present Value rule. B) Yes, because it agrees with the payback rule. C) Yes, because it agrees with both the Net Present Value rule and the payback rule. D) Yes, because it disagrees with the Net Present Value rule.

$33,684 (Units sold = $1,280,000 / $38 = $33,684 units)

A maker of computer games expects to sell 475,000 games at a price of $48 per game. These units cost $10 to produce. Selling, general, and administrative expenses are $1.0 million and depreciation is $280,000 . What is the EBIT break-even point for the number of games sold in this case? A) $26,667 B) $26,316 C) $100,000 D) $33,684

It cannot be determined whether the decision was correct, since other factors contributing to the projectʹs net present value (NPV), such as the upfront investment, have not been included in the analysis.

A maker of kitchenware is planning on selling a new chef-quality kitchen knife. The manufacturer expects to sell 1.6 million knives at a price of $120 each. These knives cost $80 each to produce. Selling, general, and administrative expenses are $500,000. The machinery required to produce the knives cost $1.4 million, depreciated by straight-line depreciation over five years. The maker determines that the EBIT break-even point for units sold and sale price is less than these estimates and that the EBIT break-even point for costs per unit, SG&A, and depreciation are greater than these estimates, so decides to go ahead with manufacturing the knife. Was this the correct decision? A) No, since the cost per unit should be greater than the EBIT break-even point for cost of goods if the project is to have a positive EBIT. B) Yes, since if the estimates for each parameter are correct , the EBIT will be positive. C) Yes, since a positive EBIT ensures that the project will have a positive net present value (NPV). D) It cannot be determined whether the decision was correct, since other factors contributing to the projectʹs net present value (NPV), such as the upfront investment, have not been included in the analysis.

option to expand

A manufacturer of peripheral devices for PCs decides to try and capture some of the PC gaming market by creating gaming versions of its traditional peripheral devices. It decides to start with a gaming version of its standard keyboard, increasing the number of macro keys, adding a small LCD screen to display game data, and giving the user the ability to backlight keys in different colors. If this device is a success, the manufacturer plans to release gaming versions of its trackballs and other peripherals. What option is the manufacturer gaining by the release of the new keyboard? A) option to delay B) option to expand C) option to abandon D) option to switch

$950,349 (Using a financial calculator, enter CF0 = -830,000 , CF1 = 0, F1 = 1, CF2 = -830,000 , F2 = 1, CF3 = 1,200,000 , F3 = 3; calculate NPV for I = 10 = $950,349.)

A manufacturer of video games develops a new game over two years. This costs $830,000 per year with one payment made immediately and the other at the end of two years. When the game is released, it is expected to make $1.20 million per year for three years after that. What is the net present value (NPV) of this decision if the cost of capital is 10%? A) $950,349 B) $1,045,384 C) $1,520,559 D) $1,805,663

Net Present Value

A project has an initial cost of $27,400 and a market value of $32,600. What is the difference between these two values called?

No, since net present value (NPV) is negative.

A security firm is offered $80,000 in one year for providing CCTV coverage of a property. The cost of providing this coverage to the security firm is $74,000, payable now, and the interest rate is 8.5%. Should the firm take the contract? A) Yes, since net present value (NPV) is positive. B) It does not matter whether the contract is taken or not, since NPV = 0. C) Yes, since net present value (NPV) is negative. D) No, since net present value (NPV) is negative.

Fabrics, Luggage, Hardware, Watches, and Shoe Repair

A small department store in a mall has the opportunity to rent an additional 20,000 square feet of space for five years. It can divide up this space between the above new departments. Each department will require a different amount of space, and each department is expected to make a yearly profit as shown, for each of the next five years. The discount rate is 10%. Based on this information, what departments should be added? A) Pet, Fabrics, Hardware, and Shoe Repair B) Fabrics, Luggage, Hardware, Watches, and Shoe Repair C) Pets, Fabrics, Books, and Luggage D) Pet, Fabrics, Luggage, Hardware, and Shoe Repair

$337,500 (Incremental Revenue = 25% × 75 × $18,000 = $337,500)

A small manufacturer that makes clothespins and other household products buys new injection molding equipment for a cost of $500,000. This will allow the manufacturer to make more clothespins in the same amount of time with an estimated increase in sales of 25%. If the manufacturer currently makes 75 tons of clothespins per year, which sell at $18,000 per ton, what will be the increase in revenue next year from the new equipment? A) $125,000 B) $303,750 C) $337,500 D) $837,500

17.39% (Capital gain rate = (P1 - P0) / P0 = ($27.00 - $23.00 ) / $23.00 = 17.39 %)

A stock is bought for $23.00 and sold for $27.00 one year later, immediately after it has paid a dividend of $1.50. What is the capital gain rate for this transaction? A) 3.48% B) 8.70% C) 13.91% D) 17.39%

$8.86 (P0 = $0.70 / 0.079 = $8.86)

A stock is expected to pay $0.70 per share every year indefinitely. If the current price of the stock is $18.90 , and the equity cost of capital for the company that released the shares is 7.9%, what price would an investor be expected to pay per share five years into the future? A) $8.86 B) $14.18 C) $14.62 D) $15.06

$14.88 (P₀ = $1.25 / 0.084 = $14.88)

A stock is expected to pay $1.25 per share every year indefinitely and the equity cost of capital for the company is 8.4%. What price would an investor be expected to pay per share ten years in the future? A) $14.88 B) $22.32 C) $29.76 D) $37.20

semiannually

A university issues a bond with a face value of $5000 and a coupon rate of 4.41% that matures on July 15, 2018. The holder of such a bond receives coupon payments of $110.25 . How frequently are coupon payments made in this case? A) monthly B) quarterly C) semiannually D) annually

100

A ʺround lotʺ consists of how many shares? A) 1 B) 10 C) 100 D) 1,000

$24.96 (P0 = (0.5 × $641 million) / (0.11 - 0.07) = $8012.5 million; Price per share = $8012.5 million / 321 million = $24.96)

Aaron Inc. has 321 million shares outstanding. It expects earnings at the end of the year to be $641 million. The firmʹs equity cost of capital is 11%. Aaron pays out 50% of its earnings in total: 30% paid out as dividends and 20% used to repurchase shares. If Aaronʹs earnings are expected to grow at a constant 7% per year, what is Aaronʹs share price? A) $12.48 B) $24.96 C) $37.44 D) $49.92

IRR, NPV, Payback period

According to Graham and Harveyʹs 2001 survey (Figure 8.2 in the text), the most popular decision rules for capital budgeting used by CFOs are ________. A) NPV, IRR, MIRR B) MIRR, IRR, Payback period C) IRR, NPV, Payback period D) Profitability index, NPV, IRR

scenario analysis

An exploration of the effect of changing multiple project parameters on net present value (NPV) is called ________. A) scenario analysis B) internal rate of return (IRR) analysis C) accounting break-even analysis D) sensitivity analysis

Initial investment: $60,000; Cash flow in year 1: $6,000; Growth Rate: 2.50%; Cost of Capital: 7.2%

An investor has the opportunity to invest in four new retail stores. The amount that can be invested in each store, along with the expected cash flow at the end of the first year, the growth rate of the concern, and the cost of capital is shown for each case. It is assumed each investment will operate in perpetuity after the initial investment. Which investment should the investor choose? A) Initial investment: $100,000; Cash flow in year 1: $12,000; Growth Rate: 1.25%; Cost of Capital: 9.1% B) Initial investment: $90,000; Cash flow in year 1: $10,000; Growth Rate: 1.50%; Cost of Capital: 9.3% C) Initial investment: $80,000; Cash flow in year 1: $8,000; Growth Rate: 1.75%; Cost of Capital: 8.0% D) Initial investment: $60,000; Cash flow in year 1: $6,000; Growth Rate: 2.50%; Cost of Capital: 7.2%

$2.91 million

An investor is considering a project that will generate $900,000 per year for four years. In addition to upfront costs, at the completion of the project at the end of the fifth year there will be shut-down costs of $400,000 . If the cost of capital is 4.4%, based on the MIRR, at what upfront costs does this project cease to be worthwhile? A) $2.62 million B) $2.91 million C) $3.21 million D) $3.50 million

$3.3 million ($(15 + 1.5) / 5 = $3.3 million)

An oil company is buying a semi-submersible oil rig for $15 million. Additionally, it will cost $1.5 million to move the oil rig to the oil-field and to prepare it for operations. If it is depreciated over five years using straight-line depreciation, what are the yearly depreciation expenses in this case? A) $2.7 million B) $3.0 million C) $3.3 million D) $3.8 million

invest in project Beta, since NPVBeta > NPVAlpha > 0 (Compute Cash Flows and Compare two projects)

Assume that projects Alpha and Beta are mutually exclusive. The correct investment decision and the best rationale for that decision is to ________. A) invest in project Beta, since NPVBeta > 0 B) invest in project Alpha, since NPVBeta < NPVAlpha C) invest in project Beta, since IRRB > IRRA D) invest in project Beta, since NPVBeta > NPVAlpha > 0

CBFH

Assuming that your capital is constrained, so that you only have $600,000 available to invest in projects, which project should you invest in and in what order? A) CBFH B) CBGF C) BCFG D) CBFG

profitability Index

Assuming that your capital is constrained, which investment tool should you use to determine the correct investment decisions? A) profitability Index B) incremental IRR C) net present value (NPV) D) internal rate of return (IRR)

$9.23 (P₀ = $1.20 / (0.16 - 0.03) = $9.23)

Avril Synchronistics will pay a dividend of $1.20 per share this year. It is expected that this dividend will grow by 3% each year in the future. What will be the current value of a single share of Avrilʹs stock if the firmʹs equity cost of capital is 16%? A) $6.46 B) $6.92 C) $9.23 D) $10.15

Investment B

Based on the above information, and with an interest rate of 7%, which is the best investment? A) Investment A B) Investment B C) Investment C D) Investment D

$668,667 (($4 million + $12,000) / 6 = $668,667)

Cameron Industries is purchasing a new chemical vapor depositor in order to make silicon chips. It will cost $4 million to buy the machine and $12,000 to have it delivered and installed. Building a clean room in the plant for the machine will cost an additional $3 million. The machine is expected to have a working life of six years. If straight-line depreciation is used, what are the yearly depreciation expenses in this case? A) $666,667 B) $668,667 C) $1,166,667 D) $1,168,667

$668,667 (($4 million + $12,000)/6= $668,667)

Cameron Industries is purchasing a new chemical vapor depositor in order to make silicon chips. It will cost $4 million to buy the machine and $12,000 to have it delivered and installed. Building a clean room in the plant for the machine will cost an additional $3 million. The machine is expected to have a working life of six years. If straight-line depreciation is used, what are the yearly depreciation expenses in this case? A) $666,667 B) $668,667 C) $1,166,667 D) $1,168,667

the redesign of the plant only

Cameron Industries is purchasing a new chemical vapor depositor in order to make silicon chips. It will cost $6 million to buy the machine and $10,000 to have it delivered and installed. Building a clean room in the plant for the machine will cost an additional $3 million. The machine is expected to have a working life of six years. Which of these activities will be reported as an operating expense? A) the delivery and install cost only B) the cost of the depositor only C) the redesign of the plant only D) the delivery and install cost and the cost of the depositor

$2.492 million (Depreciation=4/6=$0.66666667 million; earnings before tax = $6 - $1.5 - $0.66666667 = $3.83333333 million; earnings after tax = $3.83333333 × 0.65 = $2.492 million)

CathFoods will release a new range of candies which contain anti-oxidants. New equipment to manufacture the candy will cost $4 million, which will be depreciated by straight-line depreciation over six years. In addition, there will be $5 million spent on promoting the new candy line. It is expected that the range of candies will bring in revenues of $6 million per year for five years with production and support costs of $1.5 million per year. If CathFoodʹs marginal tax rate is 35%, what are the incremental earnings in the second year of this project? A) $2.492 million B) $2.100 million C) $3.833 million D) $1.342 million

5.77% (N = 15 years, PV = -431, PMT = 0, FV = 1,000. Compute I/Y = 5.77%)

Consider a zero-coupon bond with a $1000 face value and 15 years left until maturity. If the bond is currently trading for $431 , then the yield to maturity on this bond is closest to ________. A) 2.89% B) 56.90 % C) 43.10% D) 5.77%

$18.06

Consider the following 2 projects: The net present value (NPV) for project beta is closest to ________. A) $21.67 B) $14.45 C) $18.06 D) $12.64

94.61 (N = 1 year, I/Y = 5.7% per year, PMT = 0, FV = 100. PV = 94.61)

Consider the following yields to maturity on various one-year, zero-coupon securities: The price (expressed as a percentage of the face value) of a one-year, zero-coupon corporate bond with a AAA rating is closest to ________. A) 113.53 B) 132.45 C) 75.69 D) 94.61

$28.87 (Using a financial calculator, PV = -$22.60, PMT = $1.20, n = 6 (3 years × 2 = 6), I = 9% (18%/ 2); calculate FV = $28.87 .)

Coolibah Holdings is expected to pay dividends of $1.20 every six months for the next three years. If the current price of Coolibah stock is $22.60 , and Coolibahʹs equity cost of capital is 18%, what price would you expect Coolibahʹs stock to sell for at the end of three years? A) $28.87 B) $31.76 C) $33.20 D) $34.64

Coupon Rate

Coupon Rate × Face Value/Number of Coupon Payments per Year

$3.56 (P₀ using the capital gain rate formula = ($1.70 + $62) / (1 + 0.09) = $58.44; Capital gain = P₁- P₀ = $62 - $58.44 = $3.56)

Credenza Industries is expected to pay a dividend of $1.70 at the end of the coming year. It is expected to sell for $62 at the end of the year. If its equity cost of capital is 9%, what is the expected capital gain from the sale of this stock at the end of the coming year? A) $3.56 B) $56.88 C) $5.12 D) $58.44

Depreciation

Depreciation expenses do not correspond to actual cash outflows

Coupon Rate

Determines the amount of each coupon payment of a bond. It is expressed as an APR, set by the issuer and stated on the bond certificate

12% (r = (D₁ ÷ P₀) + g. ($1.90 / $23.50 ) + 0.04 = 12%)

Gremlin Industries will pay a dividend of $1.90 per share this year. It is expected that this dividend will grow by 4% per year each year in the future. The current price of Gremlinʹs stock is $23.50 per share. What is Gremlinʹs equity cost of capital? A) 11% B) 12% C) 14% D) 16%

Such bonds are purchased at a discount, below their face value.

How are investors in zero-coupon bonds compensated for making such an investment? A) Such bonds are purchased at their face value and sold at a premium on a later date. B) Such bonds make regular interest payments. C) Such bonds are purchased at a discount, below their face value. D) Such bonds have a lower face value as compared to other bonds of similar term.

Project B

If WiseGuy Inc is choosing one of the above mutually exclusive projects (Project A or Project B), given a discount rate of 7%, which should the company choose? A) Project A B) Project B C) Neither project--both have negative NPV. D) Both projects--both have positive NPV.

Project B

If WiseGuy Inc. uses IRR rule to choose projects, which of the projects (Project A or Project B) will rank highest? A) Project A B) Project B C) Project A and Project B have the same ranking. D) Cannot calculate a payback period without a discount rate.

$19.32 (Two steps. Step 1: Solve for rE: rE = Div1 / P0 + g = $3.00/$25.50 + 0.04 = 0.15765 or 15.77% Step 2: Solve for new stock price: P0 = Div1 / (rE - g) = $1.50/(0.15765 - 0.08) = $19.32)

JRN Enterprises just announced that it plans to cut its dividend from $3.00 to $1.50 per share and use the extra funds to expand its operations. Prior to this announcement, JRNʹs dividends were expected to grow indefinitely at 4% per year and JRNʹs stock was trading at $25.50 per share. With the new expansion, JRNʹs dividends are expected to grow at 8% per year indefinitely. Assuming that JRNʹs risk is unchanged by the expansion, the value of a share of JRN after the announcement is closest to ________. A) $19.32 B) $12.75 C) $38.63 D) $25.50

Yes, since he invested a valuable asset, his time, in a project based on its previous costs.

Joe pre-orders a non-refundable movie ticket. He then reads a number of reviews of the movie in question that make him realize that he will not enjoy it. He goes to see it anyway, rationalizing that otherwise his money will have been wasted. Is Joe succumbing to the Sunk Cost Fallacy, and why? A) Yes, since he invested a valuable asset, his time, in a project based on its previous costs. B) No, because the cost of the movie was not recoverable and would have been lost whatever action he took. C) No, because going to see the movie means that the product of his initial investment was realized as originally planned. D) No, because he incurred no further costs by going to see the movie.

$21.18 (D₁=2.00(0.9)= 1.8, g= 0.1 × 0.25 = 0.025, P₀ = 1.8/(0.11-0.025)= $21.18)

Jumbo Transport, an air-cargo company, expects to have earnings per share of $2.00 in the coming year. It decides to retain 10% of these earnings in order to lease new aircraft. The return on this investment will be 25%. If its equity cost of capital is 11%, what is the expected share price of Jumbo Transport? A) $12.71 B) $14.83 C) $16.94 D) $21.18

14.33% ($0.28 + $3.15 - $3.00 = $0.43 ; cost of capital (r) = $0.43 /$3.00 = 14.33 %)

Jumbuck Exploration has a current stock price of $3.00 and is expected to sell for $3.15 in one yearʹs time, immediately after it pays a dividend of $0.28 . Which of the following is closest to Jumbuck Explorationʹs equity cost of capital? A) 7.17% B) 8.60% C) 14.33% D) 17.91 %

1.48% (rE1 = $2.15 / $27 = 7.96296296 %; rE2 = $1.75 / $27 = 6.48148148 %; growth rate = 7.96296296 % - 6.48148148 % = 1.48%)

Kirkevue Industries pays out all its earnings as dividends and has a share price of $27 . In order to expand, Kirkevue announces it will cut its dividend payments from $2.15 to $1.75 per share and reinvest the retained funds. What is the growth rate that should be achieved on the reinvested funds to keep the equity cost of capital unchanged? A) 1.48% B) 0.14% C) 0.17% D) 0.15%

5.5% (rE = Div1 / P0 + g 0.1=0.045 +g, so g=5.5%)

Luther Industries has a dividend yield of 4.5% and a cost of equity capital of 10%. Luther Industriesʹ dividends are expected to grow at a constant rate indefinitely. The growth rate of Lutherʹs dividends is closest to ________. A) 5.5% B) 14.5% C) 11.0% D) 5.0%

5 years (The number of years the tax loss carryforwards will last can be calculated as the tax loss carry forward dividend by the annual pre-tax income or: years with no tax = $72 million/$15 million = 4.80 years, so Luther wonʹt have to pay taxes for the next four years, but will have to start paying some taxes five years from now.)

Luther Industries has outstanding tax loss carryforwards of $72 million from losses over the past four years. If Luther earns $15 million per year in pre-tax income from now on, in how many years will Luther first pay taxes? A) 7 years B) 2 years C) 4 years D) 5 years

27,848 (FV = $1,000, PMT = $56.00, N = 10, I = 7.06%, Compute PV; Total number of bonds = $25,000,000 / $897.74 = 27,848)

Luther Industries needs to raise $25 million to fund a new office complex. The company plans on issuing ten-year bonds with a face value of $1,000 and a coupon rate of 5.6% (annual payments). The following table summarizes the YTM for similar ten-year corporate bonds of various credit ratings: Assuming that Luther's bonds receive a AA rating, the number of bonds that Luther must issue to raise the needed $25 million is closest to ________. A) 27,848 B) 33,417 C) 38,987 D) 22,278

$941 (N = 10 years, I/Y = 6.83% per year, PV = x, PMT = 60 (6.0% ×1,000), FV = 1,000. PV = 941)

Luther Industries needs to raise $25 million to fund a new office complex. The company plans on issuing ten-year bonds with a face value of $1,000 and a coupon rate of 6.0% (annual payments). The following table summarizes the YTM for similar ten-year corporate bonds of various credit ratings: Assuming that Lutherʹs bonds receive a AA rating, the price of the bonds will be closest to ________. A) $1129 B) $941 C) $1318 D) $753

BBB (N= 10 years, PV= -972.42, PMT= $70 (7.0% × 1,000), FV = 1,000)

Luther Industries needs to raise $25 million to fund a new office complex. The company plans on issuing ten-year bonds with a face value of $1,000 and a coupon rate of 7.0% (annual payments). The following table summarizes the YTM for similar ten-year corporate bonds of various credit ratings: Suppose that when these bonds were issued, Luther received a price of $972.42 for each bond. What is the likely rating that Lutherʹs bonds received? A) AA B) BBB C) B D) A

A (N = 10 years, I/Y = 7.0 % per year, PMT = 7.0% ×1,000 = $70, FV = 1,000. PV = 1,000)

Luther Industries needs to raise $25 million to fund a new office complex. The company plans on issuing ten-year bonds with a face value of $1,000 and a coupon rate of 7.0% (annual payments). The following table summarizes the YTM for similar ten-year corporate bonds of various credit ratings: What rating must Luther receive on these bonds if they want the bonds to be issued at par? A) A B) B C) BBB D) AA

Rule I only (Using a financial calculator, enter CF0 = 100,000, CF1 = 26,000, F1 = 5; calculate NPV for I = 8 = $203,810, which is greater than $200,000.)

Mary is in contract negotiations with a publishing house for her new novel. She has two options. She may be paid $100,000 up front, and receive royalties that are expected to total $26,000 at the end of each of the next five years. Alternatively, she can receive $200,000 up front and no royalties. Which of the following investment rules would indicate that she should take the former deal, given a discount rate of 8%? Rule I: The Net Present Value rule Rule II: The Payback Rule with a payback period of two years Rule III: The internal rate of return (IRR) Rule A) Rule I only B) Rule III only C) Rule II and III D) Rule I and II

present value (PV)

Most corporations measure the value of a project in terms of which of the following? A) discount value B) discount factor C) future value (FV) D) present value (PV)

$16.00 ((1 + 0.12 ) × $15.00 = $16.80 ; $16.80 - $0.80 = $16.00)

Owen Inc. has a current stock price of $15.00 and is expected to pay a $0.80 dividend in one year. If Owenʹs equity cost of capital is 12%, what price would its stock be expected to sell for immediately after it pays the dividend? A) $11.20 B) $12.80 C) $16.80 D) $16.00

NPV

PV (Benefits) - PV (Costs)

at least 1.4% (New marketing expenses = (1 + 0.4) × 0.15 = 0.21; increase in marketing expenses = 0.21 - 0.15 = 0.06; thus, revenues have to increase at least by 0.06 / 4.4 = 1.4%.)

Panjandrum Industries, a manufacturer of industrial piping, is evaluating whether it should expand into the sale of plastic fittings for home garden sprinkler systems. It has made the above estimates of free cash flows resulting from such a decision (all quantities in millions of dollars). It is thought that if marketing expenses are increased by 40%, then revenues will rise. By how much will revenues have to rise for the net present value (NPV) of the project to increase? A) at least 0.8% B) at least 1.4% C) at least 1.5% D) at least 2.0%

Capital Gain

P₁-P₀

$21.96 (Using a financial calculator, PV = -31.27, PMT = 5.70, n = 4, I = 12; Calculate FV = $21.96)

Rylan Industries is expected to pay a dividend of $5.70 year for the next four years. If the current price of Rylan stock is $31.27 , and Rylanʹs equity cost of capital is 12 %, what price would you expect Rylanʹs stock to sell for at the end of the four years? A) $21.96 B) $39.53 C) $17.57 D) $61.49

$25.78

Sinclair Pharmaceuticals, a small drug company, develops a vaccine that will protect against Helicobacter pylori, a bacteria that is the cause of a number of diseases of the stomach. It is expected that Sinclair Pharmaceuticals will experience extremely high growth over the next three years and will reinvest all of its earnings in expanding the company over this time. Earnings were $1.10 per share before the development of the vaccine and are expected to grow by 40% per year for the next three years. After this time, it is expected that growth will drop to 5% and stay there for the expected future. Four years from now Sinclair will pay dividends that are 75% of its earnings. If its equity cost of capital is 12%, what is the value of a share of Sinclair Pharmaceuticals today? A) $20.62 B) $25.78 C) $33.96 D) $33.51

$34.29 ($2.40/0.12-0.05 = 34.29)

Spacefood Products will pay a dividend of $2.40 per share this year. It is expected that this dividend will grow by 5% per year each year in the future. What will be the current value of a single share of Spacefoodʹs stock if the firmʹs equity cost of capital is 12%? A) $24.00 B) $22.29 C) $30.86 D) $34.29

$60.00 (P₀ = (0.6 × $6.0 million) / (0.1 - 0.05) = $72 million; P₀ = $72 million / 1.2 million = $60.00)

Sultan Services has 1.2 million shares outstanding. It expects earnings at the end of the year of $6.0 million. Sultan pays out 60% of its earnings in total: 40% paid out as dividends and 20% used to repurchase shares. If Sultanʹs earnings are expected to grow by 5% per year, these payout rates do not change, and Sultanʹs equity cost of capital is 10%, what is Sultanʹs share price? A) $12.00 B) $24.00 C) $36.00 D) $60.00

Tanner should be indifferent between the two investments, since both are equivalent to the same amount of cash today. (The NPVs are equal, so that each is the same as $31.40 today.)

Tanner is choosing between two investment options. He can invest $500 now and get (guaranteed) $550 in one year, or invest $500 now and get (guaranteed) $531.40 back later today. The risk-free rate is 3.5%. Which investment should Tanner prefer? A) $531.40 later today, since $1 today is worth more than $1 in one year. B) $550 in one year, since it is $50 more than he invested rather than $31.40 more than he invested. C) Neither - both investments have a negative NPV. D) Tanner should be indifferent between the two investments, since both are equivalent to the same amount of cash today.

$2,956,522 (FCF = ($21 - $8 - $2) × (1 - 0.35) + $2 = $9.15 million. Enter Cash flows at 15% and you get $2,956,522)

Temporary Housing Services Incorporated (THSI) is considering a project that involves setting up a temporary housing facility in an area recently damaged by a hurricane. THSI will lease space in this facility to various agencies and groups providing relief services to the area. THSI estimates that this project will initially cost $5 million to set up and will generate $21 million in revenues during its first and only year in operation (paid in one year). Operating expenses are expected to total $8 million during this year and depreciation expense will be another $2 million. THSI will require no working capital for this investment. THSIʹs marginal tax rate is 35% Assume that THSIʹs cost of capital for this project is 15%. The net present value (NPV) of this temporary housing project is closest to ________. A) $2,956,522 B) -$9.15 C) $5,913,044 D) -$2,956,522

$7.85 million (FCF = (revenues - expenses - depreciation) × (1 - tax rate) + depreciation. FCF = ($22 - $11 - $2) × (1 - 0.35) + $2 = $7.85 million)

Temporary Housing Services Incorporated (THSI) is considering a project that involves setting up a temporary housing facility in an area recently damaged by a hurricane. THSI will lease space in this facility to various agencies and groups providing relief services to the area. THSI estimates that this project will initially cost $6 million to set up and will generate $22 million in revenues during its first and only year in operation (paid in one year). Operating expenses are expected to total $11 million during this year and depreciation expense will be another $2 million. THSI will require no working capital for this investment. THSIʹs marginal tax rate is 35%. Ignoring the original investment of $5 million, what is THSIʹs free cash flow for the first and only year of operation? A) $6.00 million B) $3.85 million C) $9.81 million D) $7.85 million

15% ($29.50 + $0.59 - $26.10 = $3.99 ; $3.99 / $26.10 = 15.29%; rounded to 15%)

The Busby Corporation had a share price at the start of the year of $26.10 , paid a dividend of $0.59 at the end of the year, and had a share price of $29.50 at the end of the year. Which of the following is closest to the rate of return of investments in companies with equal risk to The Busby Corporation for this period? A) 14% B) 13% C) 12% D) 15%

(Units Sold × Sale Price) - (Units Sold × Cost per unit) - SG&A - Depreciation = 0

The EBIT break-even point can be calculated using which of the following formulas? A) (Units Sold × Sale Price) - (Units Sold × Cost per unit) - SG&A - Depreciation = 0 B) (Units Sold × Sale Price) + (Units Sold × Cost per unit) - SG&A - Depreciation = 0 C) (Units Sold × Sale Price) - (Units Sold × Cost per unit) + SG&A + Depreciation = 0 D) (Units Sold × Sale Price) + (Units Sold × Cost per unit) + SG&A - Depreciation = 0

$816 (N = 20 semis, I/Y = 5.55%, PMT = 40, FV = 1,000. Compute PV = $816)

The Sisyphean Company has a bond outstanding with a face value of $1000 that reaches maturity in 10 years. The bond certificate indicates that the stated coupon rate for this bond is 8.0% and that the coupon payments are to be made semiannually. Assuming the appropriate YTM on the Sisyphean bond is 11.1%, then the price that this bond trades for will be closest to ________. A) $652 B) $816 C) $979 D) $1142

a premium

The Sisyphean Company has a bond outstanding with a face value of $1000 that reaches maturity in 5 years. The bond certificate indicates that the stated coupon rate for this bond is 10.0% and that the coupon payments are to be made semiannually. Assuming the appropriate YTM on the Sisyphean bond is 7.5%, then this bond will trade at ________. A) par B) a discount C) a premium D) none of the above

a discount (As the coupon rate of 8.1% is less than the YTM of 10.6% on the bonds, so they will trade at a discount.)

The Sisyphean Company has a bond outstanding with a face value of $1000 that reaches maturity in 5 years. The bond certificate indicates that the stated coupon rate for this bond is 8.1% and that the coupon payments are to be made semiannually. Assuming the appropriate YTM on the Sisyphean bond is 10.6%, then this bond will trade at ________. A) a premium B) a discount C) par D) none of the above

6.56%

The Sisyphean Company has a bond outstanding with a face value of $1000 that reaches maturity in five years. The bond certificate indicates that the stated coupon rate for this bond is 8.5% and that the coupon payments are to be made semiannually. Assuming that this bond trades for $1081.73 , then the YTM for this bond is closest to ________. A) 5.2% B) 7.87% C) 6.56% D) 9.18%

$222.5 (Coupon payment = (coupon rate × face value)/number of coupons per year = (0.089 × 5000) / 2 = $222.5)

The Sisyphean Company has a bond outstanding with a face value of $5000 that matures in 10 years. The bond certificate indicates that the stated coupon rate for this bond is 8.9% and that the coupon payments are to be made semiannually. How much will each semiannual coupon payment be? A) $445.0 B) $222.5 C) $667.5 D) $890.0

$1,260,000 (.35 ×3.6 M = 1,260,000)

The Sisyphean Company is considering a new project that will have an annual depreciation expense of $3.6 million. If Sisypheanʹs marginal corporate tax rate is 35% and its average corporate tax rate is 30%, then what is the value of the depreciation tax shield on the companyʹs new project? A) $1,080,000 B) $1,260,000 C) $1,890,000 D) $1,134,000

$206,265

The Sisyphean Company is planning on investing in a new project. This will involve the purchase of some new machinery costing $420,000 . The Sisyphean Company expects cash inflows from this project as detailed below: The appropriate discount rate for this project is 16%. The net present value (NPV) for this project is closest to ________. A) $206,265 B) $144,385 C) $515,661 D) $216,578

-0.98% (P₀ = Div₁ / (rE - g) = $25.50 = $2.80 / (0.1 - g),so g = -0.0098 or -0.98%)

The Sisyphean Companyʹs common stock is currently trading for $25.50 per share. The stock is expected to pay a $2.80 dividend at the end of the year and the Sisyphean Companyʹs equity cost of capital is 10%. If the dividend payout rate is expected to remain constant, then the expected growth rate in the Sisyphean Companyʹs earnings is closest to ________. A) -1.96% B) -1.47% C) -0.98% D) -0.49%

$3500

The Sisyphean Corporation is considering investing in a new cane manufacturing machine that has an estimated life of three years. The cost of the machine is $30,000 and the machine will be depreciated straight line over its three-year life to a residual value of $0. The cane manufacturing machine will result in sales of 2000 canes in year 1. Sales are estimated to grow by 10% per year each year through year 3. The price per cane that Sisyphean will charge its customers is $18 each and is to remain constant. The canes have a cost per unit to manufacture of $9 each. Installation of the machine and the resulting increase in manufacturing capacity will require an increase in various net working capital accounts. It is estimated that the Sisyphean Corporation needs to hold 2% of its annual sales in cash, 4% of its annual sales in accounts receivable, 9% of its annual sales in inventory, and 5% of its annual sales in accounts payable. The firm is in the 35% tax bracket and has a cost of capital of 10%. The depreciation tax shield for the Sisyphean Corporationʹs project in the first year is closest to ________. A) $10,500 B) $3500 C) $3150 D) $2800

an investment grade bond

The above information is for a corporate bond issued by the Markel Corporation. What sort of bond is this? A) a high-risk bond B) an investment grade bond C) a speculative bond D) a high-yield bond

March 2008

The above screen shot above from Google Finance shows the price history of Progenics, a pharmaceutical company. In the time period shown, Progenics released information that an intravenously-administered formulation of their leading product had failed in a Phase III clinical trial. In which of the months shown in the price history is this most likely to have occurred? A) February 2008 B) March 2008 C) April 2008 D) May 2008

$688.00 (1600 × 0.43= 688)

The above screen shot from Google Finance shows basic stock information for PepsiCo. If you owned 1600 shares of PepsiCo for the period shown, how much would you have earned in dividend payments? A) $480.00 B) $658.44 C) $584.80 D) $688.00

$35.29

The above screen shot from Google Finance shows the basic stock information for Kraft Foods Inc. after the close of the stock market on May 30, 2008. What is the highest that the stock has traded at in the last 12 months? A) $32.44 B) $32.48 C) $32.99 D) $35.29

$0.24 ($26.30-26.06=$0.24)

The above screen shot from Google Finance shows the basic stock information for Logitech International SA (USA) after the close of business on August 22, 2008. What is the difference between the opening and closing price of the stock on this date? A) $0.49 B) $0.27 C) $0.24 D) $0.03

LOGI

The above screen shot from Google Finance shows the basic stock information for Logitech International SA (USA). What is Logitech International SA (USA)ʹs ticker symbol? A) LIS B) LOGITECH C) LOG D) LOGI

$82.55 (N = 3 years, I/Y = 6.6% per year, PMT = 0, FV = 100. PV = 82.55)

The above table shows the yields to maturity on a number of three-year, zero-coupon securities. What is the price per $100 of the face value of a three-year, zero-coupon corporate bond with a BBB rating? A) $99.06 B) $115.57 C) $82.55 D) $66.04

2.0% (B Rating - Treasury. 7.2% - 5.2% = 2.0%)

The above table shows the yields to maturity on a number of two -year, zero-coupon securities. What is the credit spread on a two -year, zero-coupon corporate bond with a B rating? A) 2.4% B) 2.0% C) 2.8% D) 1.6%

compiling a list of potential projects

The capital budgeting process begins by ________. A) analyzing alternate projects B) evaluating the net present value (NPV) of each project's cash flows C) compiling a list of potential projects D) forecasting the future consequences for the firm of each potential project

What is the correct tax rate that should be used for capital budgeting decisions?

The correct tax rate that should be used is the firm's marginal tax rate, which is the tax rate paid on the last dollar earned by the firm.

$87.99 (N= 4 years, I/Y= 3.25%, PMT= 0, FV= $100. Calculate PV and you get 87.99)

The current zero-coupon yield curve for risk-free bonds is shown above. What is the price of a zero-coupon, four-year, risk-free bond of $100? A) $85.64 B) $87.99 C) $92.15 D) $96.67

scenario analysis considers the effect on net present value (NPV) of changing multiple project parameters

The difference between scenario analysis and sensitivity analysis is ________. A) scenario analysis is based upon the internal rate of return (IRR) and sensitivity analysis is based upon net present value (NPV) B) only sensitivity analysis allows us to change estimated inputs of net present value (NPV) analysis C) scenario analysis considers the effect on net present value (NPV) of changing multiple project parameters D) only scenario analysis breaks the net present value (NPV) calculation into its component assumptions

Yield to Maturity of a Zero-Coupon Bond

The discount rate that sets the present value of the promised bond payments equal to the current market price of the bond

Maturity Date

The final repayment date of a bond

If the good costs $110 to make, the net present value (NPV) of the project will be zero.

The graph above shows the break-even analysis for the cost of making a certain good. Based on this chart, which of the following is true? A) The net present value (NPV) of the project increases with increased cost of goods sold. B) The project should not be undertaken if the predicted cost of goods sold is less than $110. C) The net present value (NPV) of the project will be positive if the cost of goods sold is greater than $110. D) If the good costs $110 to make, the net present value (NPV) of the project will be zero.

Payback Period

The length of time a firm must wait to recoup the money it has invested in a project

Why does the option to abandon a project have value?

The option to abandon a project can add value because it allows a firm to drop a project if the project turns out to be unsuccessful. This allows the firm to cut its losses.

The vertical axis crossing point cannot be calculated since the cash inflows are in perpetuity. (Since the $220,000 cash flows are perpetual, the sum of the cash flows (discount rate = 0%) is infinite.)

The owner of a hair salon spends $1,000,000 to renovate its premises, estimating that this will increase her cash flow by $220,000 per year. She constructs the above graph, which shows the net present value (NPV) as a function of the discount rate. At what dollar value should the NPV profile cross the vertical axis? A) $780,000 B) $1,000,000 C) Cannot be determined because inadequate information is given. D) The vertical axis crossing point cannot be calculated since the cash inflows are in perpetuity.

No, because the NPV is negative at that rate. (The point at which the graph line cuts the Discount Rate axis is in the negative NPV region.)

The owner of a hair salon spends $1,000,000 to renovate its premises, estimating that this will increase her cash flow by $220,000 per year. She constructs the above graph, which shows the net present value (NPV) as a function of the discount rate. If her discount rate is 6%, should she accept the project? A) Yes, because the NPV is positive at that rate. B) No, because the NPV is negative at that rate. C) No, because the NPV is positive at that rate. D) Cannot be determined from the information given.

the amount that an investment would yield if the benefit were realized today

The present value (PV) of an investment is ________. A) the amount that an investment would yield if the benefit were realized today B) the difference between the cost of the investment and the benefit of the investment in dollars today C) the amount you need to invest at the current interest rate to re-create the cash flow from the investment D) the amount by which the cash flow of an investment exceeds or falls short of the cash flow generated by the same amount of money invested at market rate

Dividend-Discount Model

The price of the stock is equal to the present value of all of the expected future dividends it will pay, along with the cash flow from the sale in year N

0.16 (Make cash flow table and enter cash flows into calculator. NPV @ 13%. 16.14/100. PI = NPV / Investment (or resources consumed))

The profitability index for project A is closest to ________. A) 0.16 B) 32.28 C) 0.24 D) 16.14

0.15 (Enter Cash Flows for Project B into the calculator. NPV @ 16% = 10.94541915 ÷ 73 = 0.15)

The profitability index for project B is closest to ________. A) 22.49 B) 14.99 C) 0.15 D) 0.09

How do you calculate the total return of a stock?

The total return of a stock is equial to the dividend yield plus the capital gain rate. The expected total return of a stock should equal its equity cost of capital: P₀=(Div₁+P₁)/(1+rE) rE = (Div₁+P₁)/P₀-1 = Div₁/P₀ (Dividend yield) + (P₁-P₀)/P₀ (Capital Gain Rate)

determine the effect of the decision to accept or reject a project on the firmʹs cash flows

The ultimate goal of the capital budgeting process is to ________. A) determine how the consequences of making a particular decision affects the firmʹs revenues and costs B) list the projects and investments that a company plans to undertake in the future C) forecast the consequences of a list of future projects for the firm D) determine the effect of the decision to accept or reject a project on the firmʹs cash flows

True

True or False: A bond is said to mature on the date when the issuer repays its notional value.

True

True or False: A bond will trade at a discount if its coupon rate is less than its yield to maturity.

False

True or False: A capital budget lists the potential projects a company may undertake in future years.

True

True or False: A firm can either pay its earnings to its investors, or it can keep them and reinvest them.

False

True or False: A floor broker is a person at the NASDAQ with a trading license who represents orders on the floor.

False

True or False: An announcement by the government that they will decrease corporate marginal tax rates in the future would increase the attractiveness of MACRS depreciation.

False

True or False: Before it matures, the price of any bond is always less than its face value.

False

True or False: Bond traders generally quote bond yields rather that bond prices, since yield to maturity depends on the face value of the bond.

False

True or False: Capital budgeting decisions use the Net Present Value rule so that those decisions maximize net present value (NPV).

True

True or False: Forecasting dividends requires forecasting the firmʹs earnings, dividend payout rate, and future share count.

True

True or False: Interest and other financing-related expenses are excluded when determining a projectʹs unlevered net income.

False

True or False: Internal rate of return (IRR) can reliably be used to choose between mutually exclusive projects.

True

True or False: Net Present value is the difference between PV of the benefits and the PV of the costs of a project or investment.

True

True or False: Net present value (NPV) is the difference between the present value (PV) of the benefits and the present value (PV) of the costs of a project or investment

True

True or False: Net present value (NPV) is usefully supplemented by internal rate of return (IRR), since IRR gives a good indication of the sensitivity of any decision made to changes in the discount rate

False

True or False: Preference for cash today versus cash in the future in part determines net present value (NPV).

False

True or False: Prior to its maturity date, the price of a zero-coupon bond is its face value.

True

True or False: Real options should only be exercised when they increase the NPV of a project.

False

True or False: Stocks that do not pay a dividend must have a value of $0.

True

True or False: The Net Present Value rule implies that we should compare a project's net present value (NPV) to zero.

True

True or False: The Valuation Principle states that the value of a stock is equal to the present value (PV) of both the dividends and future sale price of that stock which the investor will receive.

False

True or False: The coupon value of a bond is the face value of the bond.

False

True or False: The credit spread of a bond shrinks if it is perceived that the probability of the issuer defaulting increases.

False

True or False: The internal rate of return (IRR) rule will agree with the Net Present Value rule even when positive cash flows precede negative cash flows.

True

True or False: The only cash payment an investor in a zero-coupon bond receives is the face value of the bond on its maturity date.

True

True or False: The ownership in a corporation is divided into shares of stock, which carry rights to a share in the profits of the firm through future dividend payments.

True

True or False: The payback rule is based on the idea that an opportunity that pays back its initial investment quickly is a worthwhile opportunity.

False

True or False: Treasury bonds have original maturities from one to ten years, while Treasury notes have original maturities of more than ten years.

True

True or False: When an alternative decision rule disagrees with the net present value (NPV), the NPV should be followed

True

True or False: When comparing mutually exclusive projects which have different scales, you must know the dollar impact of each investment rather than percentage returns.

True

True or False: When different investment rules give conflicting answers, then decisions should be based on the Net Present Value rule, as it is the most reliable and accurate decision rule

True

True or False: When different investment rules give conflicting answers, then decisions should be based on the Net Present Value rule, as it is the most reliable and accurate decision rule.

False

True or False: When evaluating the effectiveness of an improved manufacturing process we should evaluate the total sales and costs generated by this process.

False

True or False: When using equivalent annual annuities to compare the costs of projects with different lives, you should not consider any changes in the expected replacement cost of equipment.

$75.12 (P0 = (0.4 × $800 million) / (0.09 - 0.07) = $16,000 million; Price per share = $16,000 million / 213 million = $75.12)

Valence Electronics has 213 million shares outstanding. It expects earnings at the end of the year of $800 million. Valence pays out 40% of its earnings in total15% paid out as dividends and 25% used to repurchase shares. If Valenceʹs earnings are expected to grow by 7% per year, these payout rates do not change, and Valenceʹs equity cost of capital is 9%, what is Valenceʹs share price? A) $11.27 B) $22.54 C) $60.10 D) $75.12

$38.09 (Using a financial calculator, CF0 = 0, CF1 = 1.75,CF2 = (41 + 2.35 ) = 43.35 ; calculate NPV at I = 9%, equals $38.09)

Valorous Corporation will pay a dividend of $1.75 per share at this yearʹs end and a dividend of $2.35 per share at the end of next year. It is expected that the price of Valorousʹ stock will be $41 per share after two years. If Valorous has an equity cost of capital of 9%, what is the maximum price that a prudent investor would be willing to pay for a share of Valorous stock today? A) $32.38 B) $36.19 C) $38.09 D) $39.99

$14.3 million (1.5 million × ($53 - $36 ) = $25.5 million; depreciation = 15 / 9 = $1.7 million; earnings before tax = $23.8 million; earnings after tax = $23.8 million × 0.6 = $14.3 million)

Vernon-Nelson Chemicals is planning to release a new brand of insecticide, Bee-Safe, that will kill many insect pests but not harm useful pollinators. Buying new equipment to manufacture the product will cost $15 million, and there will be an additional $2 million cost to reconfigure existing plant. The equipment is expected to have a lifetime of nine years and will be depreciated by the straight-line method over its lifetime. The firm expects that they should be able to sell 1,500,000 gallons per year at a price of $53 per gallon. It will take $36 per gallon to manufacture and support the product. If Vernon-Nelsonʹs marginal tax rate is 40%, what are the incremental earnings after tax in year 3 of this project? A) $25.5 million B) $14.3 million C) $23.8 million D) $9.5 million

12% (Using a financial calculator, CF0 = -300,000 , CF1 = 146,897.422 , F1 = 3; calculate IRR = 22%; thus, rise in discount rate = 22 - 10 = 12%.)

Visby Rides, a livery car company, is considering buying some new luxury cars. After extensive research, they come up with the above estimates of free cash flow from this project. By how much could the discount rate rise before the net present value (NPV) of this project is zero, given that it is currently 10%? A) 12% B) 17% C) 27% D) 22%

56% (Using a financial calculator, CF0 = -325,000 , CF1 = 221,000 , F1 = 3; calculate NPV at 8% = $244,538.43 ; using TVM keys, PV = 244,538.43 , N = 3, I = 8, compute PMT = $94,889.1063 ; pre-taxEBIT=$94,889.1063 /0.65=$145,983.24; change in revenue incorporating cost of goods sold = $145,983.24 / 0.55 = $265,424.074 ; percentage change = 265,424.074 / $475,000 = 56%)

Visby Rides, a livery car company, is considering buying some new luxury cars. After extensive research, they come up with the above estimates of free cash flow from this project. Visby learns that a competitor is thinking of offering similar services, thus reducing Visbyʹs sales. By how much could sales fall before the net present value (NPV) was zero, given that the cost of capital is 8%, and that cost of goods sold is 45% of revenues? A) 28% B) 34% C) 45% D) 56%

$42.86 (P₀=D₁/r-g. P₀= 3.00/0.13-0.06= $42.86)

Von Bora Corporation (VBC) is expected to pay a $3.00 dividend at the end of this year. If you expect VBCʹs dividend to grow by 6% per year forever and VBCʹs equity cost of capital to be 13%, then the value of a share of VBS stock is closest to ________. A) $42.86 B) $15.79 C) $25.72 D) $17.14

a share of the profits paid to each shareholder on the basis of the number of shares they hold

What are dividend payments? A) payments made to a company by investors for a share of the ownership of that company B) incremental increases in the value of the stock held by an investor due to rises in share price C) the difference between the original cost price of a share and the price an investor receives when that share is sold D) a share of the profits paid to each shareholder on the basis of the number of shares they hold

$450

What is the coupon payment of a 15-year $10,000 bond with a 9% coupon rate with semiannual payments? A) $150.00 B) $450 C) $900.00 D) $1800.00

$11.25 ($1000 × 0.045 / 4 = $11.25)

What is the coupon payment of a 25-year $1000 bond with a 4.5% coupon rate with quarterly payments? A) $3.75 B) $11.25 C) $22.50 D) $45.00

the bondʹs actual cash price

What is the dirty price of a bond? A) the bondʹs price based only on the bondʹs yield B) the bondʹs actual cash price C) the bondʹs price based only on coupon payments D) the bondʹs price less an adjustment for changes in interest rates

$800.68 (Using FV = $1000 , periods to maturity = 20 , PMT = $58.00 , and discount rate = 7.8% per period, calculate PV = $800.68)

What must be the price of a $1000 bond with a 5.8% coupon rate, annual coupons, and 20 years to maturity if YTM is 7.8% APR? A) $960.82 B) $1120.95 C) $800.68 D) $640.54

so that the projects can be compared on their cost or value created per year

When comparing two projects with different lives, why do you compute an annuity with an equivalent present value (PV) to the net present value (NPV)? A) so that you can see which project has the greatest net present value (NPV) B) so that the projects can be compared on their cost or value created per year C) to reduce the danger that changes in the estimate of the discount rate will lead to choosing the project with a shorter timeframe D) to ensure that cash flows from the project with a longer life that occur after the project with the shorter life has ended are considered

the amount by which a firm's earnings are expected to change as a result of an investment decision

Which of the following best defines incremental earnings? A) cash flows arising from a particular investment decision B) the amount by which a firm's earnings are expected to change as a result of an investment decision C) the earnings arising from all projects that a company plans to undertake in a fixed time span D) the net present value (NPV) of earnings that a firm is expected to receive as the result of an investment decision

generally lacks the characteristics of a desirable investment

Which of the following best describes a bond rated by Standard & Poorʹs and Moody as B? A) judged to be high quality by all standards B) considered to be medium grade obligations C) neither highly protected nor poorly secured D) generally lacks the characteristics of a desirable investment

Take any investment opportunity where the net present value (NPV) is not negative; turn down any opportunity when it is negative.

Which of the following best describes the Net Present Value rule? A) Take any investment opportunity where the net present value (NPV) is not negative; turn down any opportunity when it is negative. B) Take any investment opportunity where the net present value (NPV) exceeds the opportunity cost of capital; turn down any opportunity where the cost of capital exceeds the net present value (NPV) C) When choosing among any list of investment opportunities where resources are limited, always choose those projects with the highest net present value (NPV). D) If the difference between the present cost of an investment and the present value (PV) of its benefits after a fixed number of years is positive the investment should be taken, otherwise it should be rejected.

These earnings are not actual cash flows.

Which of the following best describes why the predicted incremental earnings arising from a given decision are not sufficient in and of themselves to determine whether that decision is worthwhile? A) They do not tell how the decision affects the firm's reported profits from an accounting perspective. B) They are not easily predicted from historical financial statements of a firm and its competitors. C) These earnings are not actual cash flows. D) They do not show how the firm's earnings are expected to change as the result of a particular decision.

When an investor buys a bond from an issuer, the investor is giving money to the issuer, with the assurance that it will be repaid at a date in the future.

Which of the following best illustrates why a bond is a type of loan? A) The issuers of bonds make regular payments to bondholders. B) When a company issues a bond, the buyer of that bond becomes an owner of the issuing company. C) Funds raised are used to finance long-term projects. D) When an investor buys a bond from an issuer, the investor is giving money to the issuer, with the assurance that it will be repaid at a date in the future.

a five-year bond with a $2,000 face value whose yield to maturity is 7.0% and coupon rate is 7.2% APR paid semiannually

Which of the following bonds is trading at a premium? A) a five-year bond with a $2,000 face value whose yield to maturity is 7.0% and coupon rate is 7.2% APR paid semiannually B) a ten-year bond with a $4,000 face value whose yield to maturity is 6.0% and coupon rate is 5.9% APR paid semiannually C) a 15-year bond with a $10,000 face value whose yield to maturity is 8.0% and coupon rate is 7.8% APR paid semiannually D) a two-year bond with a $50,000 face value whose yield to maturity is 5.2% and coupon rate is 5.2% APR paid monthly

a bond with a $1,000 face value trading at $1,000

Which of the following bonds is trading at par? A) a bond with a $2,000 face value trading at $1,987 B) a bond with a $1,000 face value trading at $999 C) a bond with a $1,000 face value trading at $1,000 D) a bond with a $2,000 face value trading at $2,012

a ten-year bond with a $2,000 face value whose yield to maturity is 5.8% and coupon rate is 5.8% APR paid semiannually

Which of the following bonds will be least sensitive to a change in interest rates? A) a ten-year bond with a $2,000 face value whose yield to maturity is 5.8% and coupon rate is 5.8% APR paid semiannually B) a 15-year bond with a $5,000 face value whose yield to maturity is 7.4% and coupon rate is 6.2% APR paid annually C) a 20-year bond with a $3,000 face value whose yield to maturity is 6.0% and coupon rate is 5.4% APR paid semiannually D) a 30-year bond with a $1,000 face value whose yield to maturity is 5.5% and coupon rate is 6.4% APR paid annually

opportunity cost

Which of the following costs would you consider when making a capital budgeting decision? A) sunk cost B) opportunity cost C) interest expense D) fixed overhead cost

payback period

Which of the following decision rules is best defined as the amount of time it takes to pay back the initial investment? A) internal rate of return (IRR) B) profitability index C) net present value (NPV) D) payback period

payback period

Which of the following decision rules might best be used as a supplement to net present value (NPV) by a firm that favors liquidity? A) profitability index B) MIRR C) equivalent annual annuity D) payback period

A new product typically has its highest sales immediately after release as customers are attracted by the novelty of the product.

Which of the following factors that a manager should bear in mind when estimating a project's revenues and costs is NOT correct? A) Sales of a product will typically accelerate, stabilize, and then decline as the product becomes outdated or faces increased competition. B) A new product typically has its highest sales immediately after release as customers are attracted by the novelty of the product. C) The prices of technology products tend to fall over time as newer, superior technologies emerge and production costs decline. D) Prices and costs tend to rise with the general level of inflation in the economy.

PN = (rE - g) × DivN+1 (PN = Div N +1/ rE-g)

Which of the following formulas is INCORRECT? A) Divt = EPSt × Dividend Payout Rate B) PN = (rE - g) × DivN+1 C) earnings growth rate = retention rate × return on new investment D) rE = (Divt / P0) + g

Cash + Inventory + Receivables - Payables

Which of the following formulas will correctly calculate Net Working Capital? A) Cash + Inventory + Receivables + Payables B) Cash + Inventory + Receivables - Payables C) Cash + Inventory - Receivables + Payables D) Cash - Inventory + Receivables + Payables

It is difficult to calculate.

Which of the following is NOT a limitation of the payback rule? A) It does not consider the time value of money. B) Lacks a decision criterion that is economically based. C) It is difficult to calculate. D) It does not consider cash flows occurring after the payback period

It can issue more shares.

Which of the following is NOT a method by which a company can increase its dividend payments? A. It can increase its earnings. B. It can issue more shares. C. It can increase its dividend payout rate. D. It can decrease the number of shares outstanding.

by increasing its retention rate

Which of the following is NOT a way that a firm can increase its dividend? A) by increasing its retention rate B) by decreasing its shares outstanding C) by increasing its earnings (net income) D) by increasing its dividend payout rate

It cannot handle negative growth rates.

Which of the following is a limitation of the dividend-discount model? A) It cannot handle negative growth rates. B) It requires accurate dividend forecasts, which is not possible. C) It requires that the growth rate always be higher than the required rate of return, which is not realistic. D) It does not consider past earnings and performance.

A toothpaste manufacturer adds a new line of toothpaste (that contains baking soda) to its product line.

Which of the following is an example of cannibalization? A) A toothpaste manufacturer adds a new line of toothpaste (that contains baking soda) to its product line. B) A grocery store begins selling T-shirts featuring the local universityʹs mascot. C) A basketball manufacturer adds basketball hoops to its product line. D) A convenience store begins selling pre-paid cell phones.

Attention must be taken when using it to make sure that all of the constrained resource is utilized.

Which of the following is true regarding the profitability index? A) It does not use the net present value (NPV) to assess benefits. B) It is very simple to compute. C) Attention must be taken when using it to make sure that all of the constrained resource is utilized. D) It is unreliable when used for choosing between different projects.

the fluctuations in the cost of capital over the period in question

Which of the following is usually NOT a factor that must be considered when estimating the revenues and costs arising from a new product? A) the fluctuations in the cost of capital over the period in question B) the sales of a new product will typically accelerate, plateau, and ultimately decline over time C) the prices of technology products generally fall over time D) competition tends to reduce profit margins over time in most industries

II only

Which of the following models directly values all of the firmʹs equity, rather than a single share? I. Dividend-discount model II. Total payout model III. Discounted cash flow model A) I only B) II only C) III only D) II and III

All of the above can lead to IRR giving a different decision than NPV.

Which of the following situations can lead to IRR giving a different decision than NPV? A) delayed investment B) multiple IRRs C) differences in project scale D) All of the above can lead to IRR giving a different decision than NPV.

During periods of high growth, it is not unusual for firms to pay out 100% of their earnings to shareholders in the form of dividends. (During periods of high growth, it is not unusual for these firms to retain 100% of their earnings to exploit profitable investment opportunities.)

Which of the following statements is FALSE about dividend payout and growth? A) A common approximation is to assume that in the long run, dividends will grow at a constant rate. B) The dividend each year is the firmʹs earnings per share (EPS) multiplied by its dividend payout rate. C) There is a tremendous amount of uncertainty associated with any forecast of a firmʹs future dividends. D) During periods of high growth, it is not unusual for firms to pay out 100% of their earnings to shareholders in the form of dividends.

We cannot use the dividend-discount model to value the stock of a firm with rapid or changing growth. (A multistage dividend-discount model can be used to value the stock of a firm with rapid or changing growth.)

Which of the following statements is FALSE of the dividend-discount model? A) We cannot use the dividend-discount model to value the stock of a firm with rapid or changing growth. B) As firms mature, their growth slows to rates more typical of established companies. C) The dividend-discount model values the stock based on a forecast of the future dividends paid to shareholders. D) The simplest forecast for the firmʹs future dividends states that they will grow at a constant rate, i.e., forever.

If a firm wants to increase its share price, it must diversify.

Which of the following statements is FALSE regarding profitable and unprofitable growth? A) If a firm wants to increase its share price, it must diversify. B) If a firm retains more earnings, it will pay out less of those earnings, reducing its dividends. C) A firm can increase its growth rate by retaining more of its earnings. D) Cutting a firmʹs dividend to increase investment will raise the stock price if the new investment has a positive net present value (NPV).

Total return equals earnings multiplied by the dividend payout rate.

Which of the following statements is FALSE? A) As firms mature, their earnings exceed their investment needs and they begin to pay dividends. B) Total return equals earnings multiplied by the dividend payout rate. C) Cutting the firmʹs dividend to increase investment will raise the stock price if, and only if, the new investments have a positive net present value (NPV). D) We cannot use the constant dividend growth model to value the stock of a firm with rapid or changing growth.

According to the constant dividend growth model, the value of the firm depends on the current dividend level, divided by the equity cost of capital plus the grow rate. (According to the constant dividend growth model, the value of the firm depends on the current dividend level, divided by the equity cost of capital adjusted by the growth rate.)

Which of the following statements is FALSE? A) Estimating dividends, especially for the distant future, is difficult. B) A firm can only pay out its earnings to investors or reinvest their earnings. C) Successful young firms often have high initial earnings growth rates. D) According to the constant dividend growth model, the value of the firm depends on the current dividend level, divided by the equity cost of capital plus the grow rate.

When evaluating a capital budgeting decision, we generally include interest expense.

Which of the following statements is FALSE? A) Many projects use a resource that the company already owns. B) When evaluating a capital budgeting decision, we generally include interest expense. C) Only include as incremental expenses in your capital budgeting analysis the additional overhead expenses that arise because of the decision to take on the project. D) As a practical matter, to derive the forecasted cash flows of a project, financial managers often begin by forecasting earnings.

When we are certain regarding the input to a capital budgeting decision, it is often useful to determine the break-even level of that input.

Which of the following statements is FALSE? A) Sensitivity analysis allows us to explore the effects of errors in our estimated inputs in our net present value (NPV) analysis for the project. B) To compute the net present value (NPV) for a project, you need to estimate the incremental cash flows and choose a discount rate. C) Estimates of the cash flows and cost of capital are often subject to significant uncertainty. D) When we are certain regarding the input to a capital budgeting decision, it is often useful to determine the break-even level of that input.

An internal rate of return (IRR) will always exist for an investment opportunity.

Which of the following statements is FALSE? A) The payback investment rule is based on the notion that an opportunity that pays back its initial investments quickly is a good idea. B) An internal rate of return (IRR) will always exist for an investment opportunity. C) A net present value (NPV) will always exist for an investment opportunity. D) In general, there can be as many internal rates of return (IRRs) as the number of times the projectʹs cash flows change sign over time.

The payback rule is reliable because it considers the time value of money and depends on the cost of capital.

Which of the following statements is FALSE? A) The payback rule is useful in cases where the cost of making an incorrect decision might not be large enough to justify the time required for calculating the net present value (NPV). B) The payback rule is reliable because it considers the time value of money and depends on the cost of capital. C) For most investment opportunities, expenses occur initially and cash is received later. D) Fifty percent of firms surveyed reported using the payback rule for making decisions.

Investments in plant, property, and equipment are directly listed as expense when calculating earnings.

Which of the following statements is FALSE? A) We begin the capital budgeting process by determining the incremental earnings of a project. B) The marginal corporate tax rate is the tax rate the firm will pay on an incremental dollar of pretax income. C) Investments in plant, property, and equipment are directly listed as expense when calculating earnings. D) The opportunity cost of using a resource is the value it could have provided in its best alternative use.

Prior to its maturity date, the price of a zero-coupon bond is always greater than its face value.

Which of the following statements regarding bonds and their terms is FALSE? A) The amount of each coupon payment is determined by the coupon rate of the bond. B) Prior to its maturity date, the price of a zero-coupon bond is always greater than its face value. C) The zero-coupon bond has no periodic interest payments. D) Treasury bills are U.S. government bonds with a maturity of up to one year.

The only cash payments the investor will receive from a zero-coupon bond are the interest payments that are paid up until the maturity date.

Which of the following statements regarding bonds and their terms is FALSE? A) The bond certificate typically specifies that the coupons will be paid periodically until the maturity date of the bond. B) The bond certificate indicates the amounts and dates of all payments to be made. C) The only cash payments the investor will receive from a zero-coupon bond are the interest payments that are paid up until the maturity date. D) The face value of a bond is repaid at maturity.

The yield to maturity of a bond is the discount rate that sets the future value (FV) of the promised bond payments equal to the current market price of the bond.

Which of the following statements regarding bonds and their terms is FALSE? A) The internal rate of return (IRR) of an investment in a zero-coupon bond is the rate of return that investors will earn on their money if they buy a default-free bond at its current price and hold it to maturity. B) The yield to maturity of a bond is the discount rate that sets the future value (FV) of the promised bond payments equal to the current market price of the bond. C) Financial professionals also use the term spot interest rates to refer to the default-free zero-coupon yields. D) When we calculate a bondʹs yield to maturity by solving the formula, Price of an n-period bond = Coupon/ (1+YTM)1 + Coupon/(1+YTM)2+...+Coupon+Face/(1+YTM)n, the yield we compute will be a rate per coupon interval

When prices are quoted in the bond market, they are conventionally quoted in increments of $1,000.

Which of the following statements regarding bonds and their terms is FALSE? A) Zero-coupon bonds are also called pure discount bonds. B) The internal rate of return (IRR) of an investment opportunity is the discount rate at which the net present value (NPV) of the investment opportunity is equal to zero. C) The yield to maturity for a zero-coupon bond is the return you will earn as an investor from holding the bond to maturity and receiving the promised face value payment. D) When prices are quoted in the bond market, they are conventionally quoted in increments of $1,000.

By convention, the coupon rate is expressed as an effective annual rate.

Which of the following statements regarding bonds and their terms is FALSE? A) Bonds are securities sold by governments and corporations to raise money from investors today in exchange for a promised future payment. B) By convention, the coupon rate is expressed as an effective annual rate. C) Bonds typically make two types of payments to their holders. D) The time remaining until the repayment date is known as the term of the bond.

Real options enhance the forecast of a projectʹs expected future cash flows by incorporating, at the start of the project, the effect of decisions that will be made at a later date.

Which of the following statements regarding real options is NOT correct? A) Real options should only be exercised when they increase the NPV of a project. B) Real options enhance the forecast of a projectʹs expected future cash flows by incorporating, at the start of the project, the effect of decisions that will be made at a later date. C) Real options give owners the right, but not the obligation, to exercise these opportunities at a later date. D) Real options build greater flexibility into a project and thus increase its net present value (NPV).

I and II

Which of the following will be a source of cash flows for a shareholder of a certain stock? I. Sale of the shares at a future date II. The firm in which the shares are held paying out cash to shareholders in the form of dividends III. The firm in which the shares are held increasing the total number of shares outstanding through a stock split A) I only B) II only C) I and II D) II and III

a decrease in the sales price

Which of the following will cause the EBIT Break-Even for sales to increase? A) a decrease in the sales price B) a decrease in depreciation expense C) a decrease in selling, general, and administrative expenses D) a decrease in the number of units sold

U.S. Treasury securities are widely regarded to be risk-free.

Why are the interest rates of U.S. Treasury securities less than the interest rates of equivalent corporate bonds? A) The U.S. government has a high credit spread. B) There is significant risk that the U.S. government will default. C) U.S. Treasury securities are widely regarded to be risk-free. D) U.S. Treasury securities yield inflation adjusted interest rates.

Since such a bond provides a risk-free return over that period, the Law of One Price guarantees that the risk-free interest rate equals the yield to maturity.

Why is the yield to maturity of a zero-coupon, risk-free bond that matures at the end of a given period the risk-free interest rate for that period? A) Since such a bond provides a risk-free return over that period, the Law of One Price guarantees that the risk-free interest rate equals the yield to maturity. B) Since a bondʹs price will converge on its face value as the bond approaches the maturity date, the Law of One Price dictates that the risk-free interest rate will reflect this convergence. C) Since interest rates will rise and fall in response to the movement in bond prices. D) Since there is, by definition, no risk in investing in such bonds, the return from such bonds is the best that can be expected from any investment over the period.

$3,290 ($47,000 / 5 years = $9400 depreciation per year. Then 0.35 × $9400 = $3290 depreciation tax shield per year.)

You are considering adding a microbrewery onto one of your firmʹs existing restaurants. This will entail an investment of $47,000 in new equipment. This equipment will be depreciated straight-line over five years. If your firmʹs marginal corporate tax rate is 35%, then what is the value of the microbreweryʹs depreciation tax shield in the first year of operation? A) $3290 B) $16,450 C) $6110 D) $30,550

$41.36

You expect that Bean Enterprises will have earnings per share of $2 for the coming year. Bean plans to retain all of its earnings for the next three years. For the subsequent two years, the firm plans on retaining 50% of its earnings. It will then retain only 25% of its earnings from that point forward. Retained earnings will be invested in projects with an expected return of 20% per year. If Beanʹs equity cost of capital is 10%, then the price of a share of Beanʹs stock is closest to ________. A) $24.82 B) $16.54 C) $41.36 D) $66.18

$23.33 (P₀=D₁/r-g. $2.10/0.09= $23.33)

ada Industries pays a dividend of $2.10 per share and is expected to pay this amount indefinitely. If Matildaʹs equity cost of capital is 9%, which of the following would be closest to Matildaʹs stock price? A) $14.00 B) $18.66 C) $23.33 D) $29.16

Depreciation Tax Shield

depreciation × tax rate

Capital Gain

difference between the expected sale price and purchase price divided by current stock price.

Bond

security sold by governments and corporations to raise money from investors today in exchange for a promised future payment.

Bond Certificate

states the terms of a bond as well as the amounts and dates of all payments to be made

Face Value, Par Value, Principal Amount

the notional amount of a bond used to compute its interest payments. The face value of the bond os generally due at the bond's maturity.

Dividend Yield

the percentage return the investor expects to earn from the dividend paid by the stock.

Coupons

the promised interest payments of a bond, paid periodically until the maturity date of the bond

Term

the time remaining until the final repayment date of a bond

True

true or false: Firms should use the most accelerated depreciation scheme allowable

True

true or false: The most difficult part of the capital budgeting process is accurately estimating cash flows and cost of capital

False

true or false: To evaluate a capital budgeting decision, it is sufficient to determine its consequences for the firmʹs earnings.

limit order

you placed an order to purchase stock where you specified the maximum price you were willing to pay. this type of order is known as a ___ a. maximum order b. limit order c. floor order d. market order