Finance Ch 15 16 18 26
85. Unlike options, a futures contract binds the buyer to buy the commodity at a fixed price.
& TRUE
86. The profit from a futures contract is the difference between the initial futures price and the spot price at expiration.
& TRUE
89. Both the seller and the buyer in a futures contract are required to put up margins.
& TRUE
50. Assume the issuer incurs $1 million in other expenses to sell 3 million shares at $40 each to an underwriter and the underwriter sells the shares at $43 each. By the end of the first day's trading, the issuing company's stock price had risen to $70. What is the cost of underpricing?
** 81 million - 91 million - 101 million - 111 million underwriting spread: 3 million x $3 = $9 million The underpricing cost is 3 million x ($70 - $43) = 81 million. Direct expenses and underpricing cost sum to 91 million. %age of direct expense = = = 7.75% %age of market value absorbed by direct expenses and underpricing cost = = = 43.33%
In regards to new issues of common stock, economists have found that the announcement of a new issue:
** Results in the stock price falling - Causes the stock price to rise - Has no effect on the stock price - Increases the market value of the stock temporarily
6. When underwriters issue securities on a best efforts basis, they:
** Sell as much of the stock as possible, but with no guarantee - Submit a bid for purchase, which the issuer compares to other bids - Buy the entire issue from the firm - Guarantee that the issuer will receive the spread
46. The "winner's curse" is a reminder that:
** Successful bidders may often overpay for an object - Underwriters charge excessive fees - Stocks are much riskier than bonds - Underpricing an issue is a cost to existing owners
66. All of the following are advantages of shelf registration except:
** The issuing firm can avoid competition from underwriters - Securities can be issued with short notice - Securities can be issued in small amounts without excessive costs - It allows the firm to take advantage of market conditions
11. The most likely reason that underpricing of new issues occurs more frequently than overpricing is the:
** Underwriters' desire to reduce the risk of a firm commitment - Demand for a new issue is typically too high - Underwriters earn low rates of return - Issuing firms demand that equity be underpriced
24. If a corporation's management, with its superior knowledge of proposed investments, considers a security issue to be underpriced, it may react by:
** Withdrawing the issue - Lowering the price of the existing shares to equal the new shares - Increasing the number of shares to be sold - Adopting POP registration, which automatically raises the issue price
30. Private placement of debt securities occurs more frequently in:
** smaller-sized firms - larger-sized firms - Firms that are using venture capitalists - Combination with convertible bonds
64. If an investor can earn 20% on underpriced IPOs, but will lose 10% on overpriced IPOs in which he was awarded $2,000 worth of the overpriced issue, how much of the underpriced issue must he be awarded in order to gain $500?
- $1,500 - $2,500 ** $3,500 - $10,000 500 = (0.20 x Value of shares) - (0.10 x 2,000) Value of shares = $3,500
7. If an underwriter charges the public $40 per share for a new issue after having promised the issuer $38 per share, the spread per share is:
- $1.00 ** $2.00 - $38.00 - $40.00
19. What was the market price of a share of stock before a rights issue if one share of new stock could be purchased at $100 for every four shares that were previously owned? The stock price after the successful rights issue was $200.
- $150 ** $225 - $241 - $250 4x + 100 = $200 x 5 4x/4 = 900/4 x = $225
71. Plasti-tech In- has decided to go public and has sold 2 million of its shares to its underwriter for $20 per share. The underwriter then sold them to the public for $22 each. Plasti-tech also encountered $0.5 million in administrative fees. Soon after the issue, the stock price rose to $25. Find Plasti-tech In-'s total cost of this issue.
- $4.5 million - $9.5 million ** $10.5 million - $14.5 million
55. A rights issue offers the firm's shareholders one new share of stock at $40 for every three shares of stock they currently own. What should be the stock price after the rights issue if the stock sells for $80 per share before the issue?
- $56.67 - $60.00 ** $70.00 - $71.33 Post right - issue price = = $280/4 = $70
27. A firm has just issued $250 million of equity, which caused its stock price to drop by 3%. Calculate the loss in value of the firm's equity given that its market value of equity was $1 billion before the new issue.
- $7.5 million ** $30.0 million - $33.3 million - $37.5 million Loss in value = .03 x $1 billion = $30 billion
18. What would you expect to be the market price of stock after a sold-out rights issue if each existing shareholder purchases one new share at $60 for each three that they currently hold and the current share price is $100?
- $75.00 - $80.00 - $85.00 ** $90.00 3(100) + 60 = 360/4 = $90
12. How much will a firm receive in net funding from a firm commitment underwriting of 250,000 shares priced to the public at $40 if a 10% underwriting spread has been added to the price paid by the underwriter? Additionally, the firm pays $600,000 in legal fees.
- $8,400,000 - $8,460,000 ** $8,490,000 - $8,545,455 Cost to public = $40 Net to issuer = $40/1.10 = $36.36 Therefore, the spread was $3.64 per share.
40. An underwriter issues a firm commitment to sell 1 million shares at $20 each, including a $2 sprea- How much does the issuing firm receive if only 500,000 shares are sold?
- $9 million - $10 million ** $18 million - $20 million proceeds to firm + (price to public - underwriting spread) x number of shares committed = ($20 - $2) x 1 million = $18 million
52. Assume the issuer incurs $1 million in other expenses to sell 3 million shares at $40 each to an underwriter and the underwriter sells the shares at $43 each. By the end of the first day's trading, the issuing company's stock price had risen to $70. In %age terms, how much market value is absorbed by the total cost (direct expenses plus underpricing cost)?
- 13.33% - 23.33% - 33.33% ** 43.33% underwriting spread: 3 million x $3 = $9 million The underpricing cost is 3 million x ($70 - $43) = 81 million. Direct expenses and underpricing cost sum to 91 million. %age of direct expense = = = 7.75% %age of market value absorbed by direct expenses and underpricing cost = = = 43.33%
32. Which of the following is least likely to explain why entrepreneurs contribute their personal funds to start-up projects? Their contribution:
- Acts as a signal to venture capitalists ** Repays debt held by the venture capitalist - Retains a portion of the firm's equity - Provides incentive to expend efforts
5. the most important function of an underwriter is to:
- Assess the firm's capital needs - Approve the prospectus before distribution to the public - Provide private placement of the firm's debt ** Buy the issue of securities from the firm and resell to the public
35. One of the primary reasons for disbursing venture-capital funds in installments is to:
- Avoid tax liability ** Identify and cut losses early - Increase the importance of the venture capitalist - Take advantage of the time value of money
47. The direct expense of a stock issue includes the:
- Cost of underpricing the stock ** Underwriting spread and other expenses - Underwriting spread, other expenses, and cost of underpricing - Underwriting spread
38. When underwriters offer a firm commitment on a stock issue, they:
- Employ their best efforts in selling the stock ** Guarantee the proceeds to the issuing firm - Agree to purchase the venture capitalists' shares - Assure purchasers that the stock will appreciate
69. In a firm commitment, the underwriter:
- Encounters virtually no risk because the spread is fixed - Is allowed to sell the shares at any price they choose - Is protected against being stuck with unsold shares ** Is allowed to sell the shares at a price slightly higher than the price they paid to the company
26. Issue costs for equity are higher than those for debt for all of the following reasons except:
- Equity issues have higher administrative costs - Underwriting stock is riskier than underwriting bonds - Equity issues involve significantly more time to sell ** Equity issues have lower economies of scale
9. A major purpose of the prospectus is to:
- Inform investors of the security's rate of return ** Advise investors of the security's potential risk - Distribute stock warrants to prospective investors - List the security's dividend payment dates
37. Stock underwriters are:
- Investors seeking low prices - Regulatory agencies that evaluate equity offerings - The firm's founders who guarantee a stock's performance ** Investment banking firms that coordinate equity offerings
31. In return for providing funds, venture capitalists receive:
- Long-term bonds of the firm - Short-term bonds of the firm ** An equity position in the firm - Ownership of the entire firm
13. The primary reason for an underwriters' syndication is to:
- Monitor the actions of the different underwriters ** Reduce the risk of selling a large issue - Increase the size of the spread - Avoid the scrutiny of the Securities and Exchange Commission
56. The POP system allows firms to:
- Purchase securities for up to two years without registration ** Incur only short time delays in selling securities - Wait for two years before paying for securities - Offer rights issues to non-existing shareholders
8. When underwriters are unsure of the demand for a new offering, they:
- Reduce their spread - Undertake the issue on a firm commitment basis ** Undertake the issue on a best efforts basis - Provide shelf registration for the issue
22. Which one of the following would not be included among the benefits of shelf registration?
- Reduction of lead time for security issuance ** No additional registration necessary for five years - Issuer can take advantage of favourable conditions - Issuer can search for best underwriting terms
20. When a public company offers shares to the general public, it does so under a(n):
- Rights issue - Initial public offering - Shelf registration ** General cash offer
62. Which of the following methods may be particularly cost effective to smaller issuers of securities?
- Seasoned offerings ** Private placement - General cash offer - Best efforts underwriting
61. Private placement of securities involves:
- Selling only to the firm's current investors - Non-disclosure of the issuing firm's name until after the sale - The exchange of convertible bonds for equity ** Non-public sale of securities to a limited number of investors
72. Underwriters are used for all of the following except:
- Selling securities to the public - Making initial public offerings ** Assisting a company in raising cash - Providing equity capital for young businesses
29. Which of the following statements is incorrect concerning private placements?
- Terms of the financing can be custom-tailored - The securities are not made available to the public - The securities are often less marketable ** Only a small amount of corporate debt is financed in this manner
21. Shelf registration in the U.S. was enacted to allow:
- The Department of Justice to prosecute those guilty of insider trading - The prospectus to be distributed after the sale of securities begins - Underwriters to join together in syndication ** Single registration of limited future financing plans
23. The allowance of POP registration in Canada is likely to have increased:
- The cost of issuing new securities - The profits of venture capitalists ** Competition among underwriters - The underpricing of securities
80. Speculators are a necessary component of well-functioning futures markets.
& TRUE
82. Hedging reduces risk, but it is seldom cost free.
& TRUE
84. By using options a firm can protect against increase in raw material prices, while continuing to benefit from price decreases.
& TRUE
94. The swap is the arrangement by two counterparties to exchange one stream of cash flow for another.
& TRUE
95. Forward contracts are equivalent to tailor-made futures contracts.
& TRUE
96. Engaging itself in a swap contract, a firm might agree to make a series of regular payments in one currency in return for receiving a series of payments in another currency.
& TRUE
18. What is the amount of the annual interest tax shield for a firm with $3 million in debt that pays 12% interest if the firm is in the 35% tax bracket?
** $126,000 - $234,000 - $360,000 - $1,050,000 Interest tax shield = interest expense x tax rate = $360,000 x .35 = $126,000
63. A farmer hedged his risk by buying put options on wheat with an exercise price of $2.70 at a price of $0.14 per bushel. If the price of wheat at the expiration of the contract is $2.70, what is the net revenue from each bushel of wheat?
** $2.56 - $2.63 - $2.70 - $2.84 Revenue from one bushel of wheat = $2.70
59. Which of the following security issues might have the lowest direct costs?
** Bonds - Convertibles - Seasoned equity offerings - IPOs
2. How might a firm such as General Mills use options to control raw material prices for breakfast cereals?
** Buy call options on commodities - Sell call options on commodities - Buy put options on commodities - Sell put options on commodities
60. A firm can hedge the risk of upward movement in raw material prices by taking one of the following positions.
** Buying a call option - Selling a put option - Buying a put option - Selling a futures contract
40. According to MM, if individuals cannot obtain the same borrowing terms as firms, then:
** Capital structure may be relevant - Capital structure may be irrelevant - Individuals should not invest in levered firms - Firms should increase their payments to individuals
8. A farmer who sells a futures contract is betting that prices will _____ at the expiration of the contract.
** Decrease - Increase - Remain constant - Guarantee high profits
17. When securities are issued under a rights issue:
** Existing shareholders have the opportunity to expand their holdings - Shares are offered to the public at a discount - The existing shares will increase in price - Current shareholders have the right to resell their stock to the issuer
48. MM's proposition II states that the:
** Expected return on equity increases as financial leverage increases - Expected return on assets decreases as expected return on debt decreases - Firm's capital structure is irrelevant to value determination - Greater the proportion of equity, the higher the expected return on debt
8. An increase in a firm's financial leverage will:
** Increase the variability in earnings per share - Reduce the operating risk of the firm - Increase the value of the firm in a non-MM world - Increase the WACC
73. When a corporation issues permanent debt, the value of all its securities:
** Increases by the present value of the tax shield - Decreases by the present value of the tax shield - Increases by the annual interest tax shield - Decreases by the annual interest tax shield
54. The present value of a perpetual tax shield increases as the firm's tax rate _____ and the amount of principal _____.
** Increases; increases - Increases; decreases - Decreases; decreases - Decreases; increases
51. Which of the following futures contract holders is speculating?
- A wheat farmer who sells wheat futures ** A cattle rancher who buys live cattle futures - A candy maker who buys sugar futures - An oil producer who sells crude oil futures
66. Which of the following statements is correct?
- An option seller makes more profits than an option buyer - A futures seller makes more profits than a futures buyer ** A futures buyer's profit will be equal to the futures seller's loss - Both futures buyer and seller make profit
26. Which of the following is not correct concerning forward contracts? Forward contracts:
- Are not standardized ** Do not set the price until the end of the contract - Are not traded on organized exchanges - Are not marked to market daily
23. The primary purpose of financial futures is to:
- Benefit from increases in interest rates ** Protect against swings in interest rates or prices of financial assets - Translate one currency into another - Guarantee the repayment of loan principal
41. A share repurchase is said to be equivalent to the payment of a cash dividend because each strategy:
- Causes share price to decline - Causes share price to increase - Creates the same tax liability for the investor ** Leaves the firm with the same amount of assets
60. The date on which actual dividend cheques are mailed to shareholders is the:
- Declaration date ** Payment date - Ex-dividend date - With-dividend date
3. The record date for a dividend is scheduled between the:
- Declaration date and the with-dividend date - With-dividend date and ex-dividend date ** Ex-dividend date and the payment date - Declaration date and ex-dividend date
62. Which of the following is the order in which key dividend dates occur:
- Declaration, with-dividend, record, ex-dividend, payment ** Declaration, with-dividend, ex-dividend, record, payment - Record, declaration, with-dividend, payment, ex-dividend - With-dividend, ex-dividend, record, declaration, payment
46. Managers have been characterized as reluctant to increase dividends if:
- Dividends were increased in the preceding year - Earnings have permanently increased ** The dividend increase cannot be sustained - The dividend payout ratio exceeds 20%
76. The Beta Corporation had 1,000 shares outstanding and a market value of $90,000 prior to the declaration of a $5 per share dividen- To finance a new project they will issue equity and the end result will be that the market value of the firm:
- Drops by $1,000 ** Drops to $85,000 - Increases by $1,000 - Increases to $95,000 Share price prior to declaration: = $90,000/1,000) = $90 Share price after declaration: = $90 - $5 = $85 Market value of firm = $85 x (1,000) = $85,000
38. What happens to an all-equity firm's EPS when $1 million of 20% debt is issued and proceeds used to repurchase two-thirds of the stock if operating income equals $1.5 million and EPS were $2 when the firm was all equity financed? Ignore taxes.
- EPS increase to $2.60 - EPS increase to $3.00 - EPS increase to $4.80 ** EPS increase to $5.20
63. A corporation that has an automatic reinvestment plan:
- Forces shareholders to automatically reinvest dividends in the company - Never physically pays out declared dividends - Helps investors plan their investment portfolio ** Gives shareholders the option to automatically reinvest dividends in the company
54. What is the primary reason for a reduction in share value after a successful rights issue? The new shares:
- Have higher underwriting expense ** Are offered at attractive prices - Reduce the firm's return on equity - Do not include voting rights
36. Manufacturers who are concerned about volatile commodity prices often use option contracts to alter their risks. What is the worst-case scenario for a seller of put options on corn with a strike price of $2.25 per bushel?
- If corn prices drop below $2.25 the option premium will be lost - If corn prices rise above $2.25 the option premium will be lost ** Losses can be unlimited if prices drop sufficiently - Losses can be unlimited if prices rise sufficiently
43. Securities exchanges will not permit securities to be sold:
- If they have been overpriced ** prior to approval of the registration statements - Unless the issuer guarantees their value - Until a shelf registration exists
40. As time draws closer to contract expiration, futures contract prices can be expected to:
- Increase as the demand for delivery intensifies - Decrease as speculators resolve the uncertainty of prices - Move similarly to broad-based market indices, such as the S&P 500 ** Converge upon the spot price
4. What would you expect to happen to the price of a share of stock on the day it goes ex-dividend? The price should:
- Increase by the amount of the dividend ** Decrease by the amount of the dividend - Decrease by one-half the amount of the dividend - Remain constant
77. The possibility of bankruptcy will do all of the following except:
- Increase financial distress costs - Reduce the current market value of the firm ** Reduce the interest rate on debt - Reduce the possible payoff to stockholders
32. Because most hedging acts to reduce risk, managers should expect that hedging will:
- Increase profits ** Decrease profits - Increase the firm's stock price - Stabilize the firm's dividend payout
65. Leverage will __________ shareholders' expected return and _________ their risk.
- Increase; decrease - Decrease; increase ** Increase; increase - Increase; do nothing to
54. Which of the following is not a logical justification for dividend preference (versus capital gains) in the real world?
- Institutional restrictions involving dividends ** Higher share prices from higher payouts - A steady source of cash without transaction costs - Differing income tax rates
55. A forward market contract to buy Japanese yen three months in the future at a price of 105/$will:
- Insulate the buyer from changes in interest rates ** Protect the buyer from changes in exchange rates - Lock in a profit based on current exchange rates - Require delivery of the yen at the Chicago Board of Trade
48. Financial futures are available to protect against all of the following except:
- Interest-rate risk - Level of equity prices ** Currency swap risk - Exchange-rate risk
74. An assumption of the MM dividend irrelevance proposition is:
- Investors are willing to pay higher prices for shares with higher payouts - Capital gains are offset by receiving no dividend - Extra cash dividends are offset by a capital gain ** Extra cash dividends are offset by a capital loss
21. A dividend clientele effect assumes that:
- Investors prefer higher rather than lower dividends - Shareholders are indifferent regarding dividends ** Investors have specific dividend preferences - Investors are making "homemade" dividends
81. Which of the following statements is correct about investors in Ajax Industries, which has just announced a three-for-one stock split?
- Investors will triple their wealth after the split - Investors' wealth will fall by two-thirds after the split - %age of ownership increases for the investors ** Earnings per share will fall by two-thirds after the split
66. The WACC is used to value:
- Projects with any risk ** Projects with the same risk as the firm's current business - Projects with the same risk as the firm's debt - Projects with the same risk as the firm's equity
42. Provincial securities regulations exist in order to:
- Protect stock underwriters from fraudulent firms - Restrict the amount of profit from IPOs - Control the amount of stock owned by one investor ** Protect investors from deceptive firms
15. When taxes are ignored, which of the following can be used to calculate the weighted-average cost of capital?
- Ratio of expected operating income to book value of all securities - The expected return on equity times the debt-equity ratio ** Ratio of expected operating income to market value of all securities - The required return on equity plus the required return on debt
22. The effect of marking a futures contract to market is similar to:
- Requiring daily payments from the contract buyer - Requiring daily payments from the contract seller ** Closing the current position and opening a new position daily - Imposing a daily fee on both buyers and sellers
15. Major international commercial banks are:
- Responsible for most underwriting in the U.S - Not allowed to engage in any form of underwriting - Not able to compete with U.S. investment banks ** Engaged in underwriting a significant portion of securities
73. The derivatives market is characterized by:
- Stability ** Innovation - Riskiness - Private deals
25. If the announcement of a new equity offering causes current equity values to drop, then signaling theory would predict that:
- Supply of equity will outstrip demand ** Management knows the issue to be overpriced - The firm has no attractive investment opportunities - Underwriters charge too high a spread
63. To be successful, a start-up business will require:
- Taking a big risk, even if the payoff is only mediocre ** Funds from a venture capitalist - Large amounts of debt financing - An initial public offering
84. A company may choose to repurchase stock rather than pay out dividends when:
- The company wants to distribute excess cash to its investors - The company wants to give its investors a bumper dividend ** The company does not want to make a commitment to distribute more cash - The company does not want to embark on unprofitable ventures
32. Although the value of an additional interest tax shield may be positive, firms may restrict borrowing if:
- The returns on the project are too high ** Their asset base is largely intangible - Their asset beta is zero - The borrowing increases their WACC
58. Some investors believe that the decision by management to issue equity as opposed to issuing debt is a signal that:
- The stock is currently undervalued ** The stock is currently overvalued - The firm will avoid dilution of stock value - A shelf registration of securities will occur
92. A dividend does not accompany stocks that are purchased on the ex-dividend date.
TRUE
92. Privately placed securities may be difficult to remarket.
TRUE
93. A rights issue is one in which a public company offers shares only to existing shareholders in order to raise additional cash.
TRUE
93. Anyone holding a stock before its ex-dividend date is entitled to the dividend.
TRUE
68. Firms go public to:
** Raise additional capital - Diversify public debt holders' risk - Avoid second stage financing - Increase their leverage
34. Second-stage financing occurs:
** prior to the initial public offering - When company founders sell a portion of their shares - After the best efforts of the underwriters - When the IPO does not raise sufficient cash
90. What is the proportion of debt financing for a firm that expects a 35% return on equity, a 20% return on assets, and a 15% return on debt? Ignore taxes.
- 15% - 25% ** 75% - 80%
c15 Key 1. Money that is offered to finance a new business is known as:
- A general cash offer ** Venture capital - Private placement - A rights issue
45. The seller of a pork bellies futures contract at $.41 per pound noted that the closing price of pork bellies was $0.44 today. What will happen to this contract, which requires delivery of 40,000 of pork bellies at expiration?
- A loss of $400 is posted to the account - A gain of $400 is posted to the account ** A loss of $1,200 is posted to the account - A gain of $1,200 is posted to the account A seller of a futures contract loses when the closing price rises. Therefore, 3 rise x 40,000 pounds = $1,200 loss to be marked to market.
23. Which of the following signals is most likely to elicit a decrease in share price?
- A repurchase of 5% of the firm's stock - An increase in the regular quarterly dividend ** A decrease in the regular quarterly dividend - Borrowing funds in order to pay a cash dividend
56. Corporations may have a legitimate preference for dividends over capital gains because:
- Capital gains have a 50% tax rate - Dividends received by corporations are not taxable - 30% of dividends received by corporations are exempt from taxation ** 70% of dividends received by corporations are exempt from taxation
75. Regarding the profitability of options, it is impossible for a producer who sells put options to lose more than the price of the option premium.
& FALSE
78. Futures contracts are standardized to expire at one time each year.
& FALSE
53. Which of the following is not an example of market imperfections that make dividend policy relevant?
- Institutional restrictions on stock holdings ** Differences in dividend-payout ratios - Transaction costs such as brokerage fees - Differences among investors in marginal tax rates
14. Studies show that recent returns on venture capital investments have been:
- Negative, on average - Zero, on average ** Nearly 20%, on average - At least 50%, on average
107. A two-for-one stock split is like a 200% stock dividend.
FALSE
77. The costs of underpricing an equity issue are borne mostly by the underwriter.
FALSE
100. MM's dividend irrelevance proposition assumes that dividends do not affect investment or borrowing policies.
TRUE
100. Studies suggest that the indirect costs of bankruptcy are typically of a significant magnitude.
TRUE
101. According to the MM dividend-irrelevance proposition, since investors do not need dividends to convert their shares to cash, they will not pay higher prices for firms with higher dividend payouts.
TRUE
101. Management's perceived signals to investors form an important component of pecking-order theory.
TRUE
102. Debt financing affects neither the operating risk nor the business risk of the firm.
TRUE
81. Economies of scale are apparent in the issuance of securities.
TRUE
94. Investors forego the right to the dividend if they purchase after the cum-dividend date.
TRUE
87. A farmer can reduce the quantity risk by buying a futures contract.
& FALSE
99. Corporate dividends are less volatile than corporate earnings.
TRUE
2. An investor exercises her right to buy one additional share at $20 for every five shares hel- How much should each share be worth after the rights issue if they previously sold for $50 each?
- $35.00 - $41.67 ** $45.00 - $46.00
33. What is the market value placed on a firm in which an entrepreneur invests $1 million and a venture capitalist invests $3 million in first-stage financing for a 50% interest in the firm?
- $4 million ** $6 million - $7 million - $8 million
48. What%age of direct expense is required to market stock if the issuer incurs $1 million in other expenses to sell 3 million shares at $34 each to an underwriter and the underwriter sells the shares at $40 each?
- 6.98% ** 7.19% - 7.75% - 8.33% underwriting spread 3 million x $3 = $9 million %age of direct expense = = = 7.19%
49. What %age of direct expense is required to market stock if the issuer incurs $1 million in other expenses to sell 3 million shares at $40 each to an underwriter and the underwriter sells the shares at $43 each?
- 6.98% - 7.19% ** 7.75% - 8.33% underwriting spread: 3 million x $3 = $9 million %age of direct expense = = = 7.75%
65. When issuing new stock, a firm received $50 million while the underwriting spread was $4 million and total direct expenses were $6 million. The %age of the proceeds absorbed by direct expenses was:
- 7.14% - 8.00% ** 10.71% - 12.00% 6/(6 + 50) = 10.71%
28. Companies making smaller security issues may prefer to issue them through:
- A private placement because lower rates of return can be offered ** A private placement because it is cheaper than a public issue - A public issue because it is cheaper than a private placement - A public issue because more exposure will be achieved
67. Second-stage financing:
- Involves a substantial increase in leverage - Immediately precedes first-stage financing for every new business ** Involves issuing more stock - Occurs when the company is in danger of bankruptcy
53. Stock that is sold through a rights issue:
- Is offered for cash to the general investing public - Will not affect the market price of the shares ** is limited for sale to existing shareholders - Must be sold on a firm commitment basis
16. The consent of a corporation's shareholders must be received prior to any:
- Issue of new securities - Selection of an underwriter ** Increase in authorized capital - Private placement of securities
79. Financial futures contracts are available only through the Chicago Board of Trade.
& FALSE
81. Forward contracts are marked to market.
& FALSE
83. All options are standardized, exchange-traded financial instruments.
& FALSE
88. Exchange traded futures contracts allow the seller to choose the place of delivery for the commodity.
& FALSE
91. All financial futures contracts are written on a deliverable asset.
& FALSE
92. Counterparties to an interest rate swap exchange both interest payments and principal amounts.
& FALSE
74. The most common use of hedging in finance is to reduce, rather than increase, risk.
& TRUE
76. Put options can be thought of as insurance policies for commodity producers.
& TRUE
77. An oil producer would sell, rather than buy, crude oil futures for protection from falling prices.
& TRUE
90. A farmer can avoid delivery on a futures contract by buying an offsetting futures contract.
& TRUE
93. A speculator takes a position in the futures market without holding an offsetting position in the commodity market.
& TRUE
97. Regarding the profitability of options, it is impossible for a producer who sells put options to lose more than the exercise price agreed in the option contract.
& TRUE
74. If the value of a levered firm is $4,000,000, then the value of the same firm yet all-equity financed is:
** $3,000,000 - $4,500,000 - $5,500,000 - $6,000,000 *No calculations are necessary because the value of a levered firm will always be greater than the value of the same firm with all-equity financing.
86. A firm has an expected return on equity of 14% and an after-tax cost of debt of 6%. What debt-equity ratio should be used in order to keep the WACC at 10%?
** 1.00 - 0.75 - 0.50 - 0.25 Feedback: Let x = debt/asset ratio. Then .10 = .06x + (1-x).14 .10=.06x + .14 - .14x .10-.14 = .06x - .14x -.04 = .08x X = -.04/-.08 X = .5 X = debt = 50%, equity = 50%, and debt-equity ratio = 1.
91. Calculate the WACC for a firm with a debt-equity ratio of .6. The debt pays 12% interest and the equity is expected to return 14%. Assume a 40% tax rate and risk-free debt.
** 11.45% - 12.50% - 13.55% - 14.60% If D/E = .6, then debt %age is .6/1.6 = .375 and equity is .625
23. With a tax rate of 35%, calculate the WACC for a firm that pays 10% on its debt, requires an 18% rate of return on its equity, and finances 45% of assets with debt.
** 12.83% - 14.00% - 14.40% - 18.20% WACC = = .65(.10)(.45) + .18(.55) = .0293 + .099 = 12.83%
67. Calculate the firm's expected return on its assets if its expected return on debt is 10%, their expected return on equity is 20%, and its WACC is 14%:
** 14% - 15% - 16% - Cannot be calculated WACC = expected return on assets = 14%
12. What is the expected return on equity for a firm with a 14% expected return on assets that pays 9% on its debt, which totals 30% of assets?
** 16.14% - 17.00% - 19.00% - 25.67% Expected return on equity = Expected return on assets + = 14% + = 14% + [.4286 x 5%] = 16.14%
37. What is the return on equity for a firm with 15% return on assets, 10% return on debt, and a .75 debt/equity ratio?
** 18.75% - 20.00% - 23.75% - 26.25% requity = rassets + = .15 + .75(.15 - .10) = .15 + .0375 = .1875
42. A decrease in the possible range of %age stock returns can be achieved by:
** A decrease in the firm's financial leverage - An increase in the firm's asset risk - An increase in the firm's business risk - A decrease in the firm's debt beta
54. Which of the following characteristics is similar in both futures and forward contracts?
** Future asset transactions are conducted at an agreed price - Contracts are sold through organized exchanges - Contract terms are standardized - Price changes are settled daily
31. Based upon the "trade-off theory" of capital structure, what differences might you expect in the capital structure of a food producer and a defence contractor?
** Higher debt-equity ratio for food producer - Higher debt-equity ratio for defence contractor - Neither firm should use debt in their structure - Differences in capital structure will make no valuation differences in these firms
78. Costs of distress are greater when a large amount of __________ affect(s) the prosperity of the firm.
** Intangible assets - Tangible assets - Net working capital - Retained earnings
81. The pecking-order theory of capital structure suggests the following order of financing:
** Internal financing, debt issue, equity issue - Internal financing, equity issue, debt issue - Debt issue, equity issue, internal financing - Equity issue, internal financing, debt issue
10. Ignoring taxes, a firm's weighted-average cost of capital is equal to:
** Its expected return on assets - Its expected return on equity - The sum of expected return on equity and expected return on debt - Its expected return on assets times the debt-equity ratio
6. Selling a futures contract may be appropriate for one who wishes to:
** Lock in a future sales price - Lock in a future purchase price - Speculate that future spot prices are going down - Have a ready market in which to sell product
35. Restructuring a firm involves changing the:
** Mix of liabilities and equity - Dividend payout ratio - Managerial personnel - Interest rate on debt
15. What must happen to prices over the course of a contract for the seller of a futures contract to maximize benefits of the hedge?
** Prices must decrease - Prices must increase - Prices must remain constant - The seller will profit on the hedge regardless of the direction of price movements
42. How does a soybean farmer lock in a price of $5.40 per bushel when the cash price at harvest is only $4.90?
** Profit in futures market to offset loss in cash market by selling futures contract at $5.40/bushel - Break even in both markets by buying a futures contract at $5.40/bushel - Profit in cash market to offset loss in futures market by buying futures contract at $5.40/bushel - Break even in both markets by selling a futures contract at $5.40/bushel
88. A firm has a debt/equity ratio of ½. The debt pays a 6% rate of interest. The expected rate of return on equity is 12%. What would happen to the expected rate of return if the firm reduced its debt/equity ratio to 1/3?
** Rate of return would increase to 11.33% - Rate of return would increase to 12.50% - Rate of return would decrease to 10.60% - Rate of return would decrease to 8.33%
37. Producers who hedge through the purchase of put options must remember that they may be:
** Reducing their profits compared to not hedging - Obligated to sell their product at a lower than market price - Increasing their overall risk - Facing unlimited price risk
14. A hedger buys a futures contract that obligates the owner to take delivery of 5,000 bushels of wheat at a price of $3.30 per bushel. At expiration the spot price of wheat is $3.80 per bushel. The hedger has:
** Saved 50 per bushel through hedging - Gained peace of mind at a price of 50 per bushel - The opportunity to avoid taking delivery, since price declined - Locked in an effective price of $3.05 per bushel
3. The spot price of silver closes at $7 per ounce at the expiration of an option contract. Which one of the following option positions will have value?
** The buyer of a call with $5 strike price - The seller of a call with $5 strike price - The buyer of a put with $5 strike price - The seller of a put with $5 strike price
21. What has happened to cause a $250 loss to be marked to the margin account of a futures contract buyer?
** The commodity decreased in value on that day - The commodity increased in value on that day - The commodity decreased in value by $250 over the contract's life - The commodity increased in value by $250 over the contract's life
19. A soybean oil contract calls for delivery of 60,000 pounds. What happens to the seller of a soybean futures contract at 16 cents per pound if the futures price closes the next day at 18 cents per pound?
** The contract is marked to market with a $1,200 loss - The contract is marked to market with a $1,200 gain - Futures contracts are voided if price increases before expiration - Nothing happens until the expiration of the contract 60,000 pounds x 2 = $1,200 loss marked to market
47. The seller of a copper futures contract noticed that her account was marked with a $500 gain yesterday. If the standardized contract requires delivery of 25,000 pounds of copper, what happened that day to the price of copper?
** The price closed down $0.02 per pound - The price closed up $0.02 per pound - The price closed down $0.20 per pound - The price closed up $0.20 per pound
25. If the market for corn futures has more prospective sellers than buyers, then one would expect:
** The price of corn futures to decrease - The price of corn futures to increase - Some traders to change from seller to buyer - The market to cease operations until demand is rebalanced
85. What is the amount of the annual interest tax shield for a firm with $5 million in debt that pays 10% interest if the firm is in the 40% tax bracket?
- $100,000 ** $200,000 - $300,000 - $400,000 Interest tax shield = interest expense x tax rate = $5,000,000 x .1 x .40 = $200,000
62. General Mills bought September call options for wheat with an exercise price of $2.80 at a price of $0.10 per bushel. If the price of wheat at the expiration is $2.90, what is the cost of one bushel of wheat for General Mills?
- $2.70 - $2.80 ** $2.90 - $3.00 Cost of one bushel of wheat = $2.90
19. What is the present value of the tax shields for a firm that anticipates a perpetual debt level of $10 million at an interest rate of 7% and a tax rate of 35%?
- $245,000 - $700,000 ** $3,500,000 - $10,000,000 PV tax shield = = $3,500,000
27. How much should an investor pay now for a stock expected to sell for $30 one year from now if: the stock offers a $2 dividend, dividends are taxed at 40%, capital gains are taxed at 20%, and a 15% after-tax return is expected on the investment?
- $25.04 ** $26.53 - $27.09 - $27.50 .15 = .15 = .15P0 = 1.20 + 24 - .8P0 P0 = $26.53
86. Cormex In- paid a dividend of $0.75 per share. It forecasted a $1.90 per share in earnings and had a stock price of $27. Determine the stock price if Cormex declared a 10% stock dividen-
- $27.55 - $26.55 - $25.55 ** $24.55 A 10% stock dividend increases shares outstanding by 10%. The stock dividend therefore will reduce the stock price to $27/1.10 = $24.55.
7. ABC Corp. stock is selling for $30 per share when a 10% stock dividend is declare- If you own 100 shares of ABC Corp. then you will receive:
- $3 - $3 times 100 shares = $300 - $300 plus 10 shares of ABC Corp ** 10 shares of ABC Corp
55. How much debt is outstanding in a firm that has calculated the present value of a perpetual tax shield to be $300,000 if the tax rate is 35% and the debt carries a 10% rate of return?
- $300,000 ** $857,143 - $3,000,000 - $3,750,000 PV tax shield = $300,000 = 30,000 = 28.5714D $857,143 = D
87. Jackson Corporation paid a dividend of $1.50 per share. It forecasted a $2.50 per share in earnings and had a stock price of $45. Determine the stock price if Cormex declared a 15% stock dividen-
- $33.88 - $36.21 ** $39.13 - $42.28 A 15% stock dividend increases shares outstanding by 15%. The stock dividend therefore will reduce the stock price to $45/1.15 = $39.13.
55. A stock is currently priced at $65 per share and will pay a $4 dividend in one year. What must the stock sell for in one year to meet investors' expectations of a 15% after-tax yield if dividends are taxed at 28%? Ignore capital gains taxes due to investor timing.
- $70.75 ** $71.87 - $73.63 - $76.00 After-tax return = 15% = 15% = $9.75 = Price 1 - $62.12 $71.87 = Price 1
25. A firm has an expected return on equity of 16% and an after-tax cost of debt of 8%. What debt-equity ratio should be used in order to keep the WACC at 12%?
- .50 - .75 ** 1.00 - 1.50 Let x = debt/asset ratio. Then .12 = .08x + (1-x).16 = .08x + .16 - .16x .08x/.08 = .04/.08 x = .50 \debt = 50%, equity = 50%, and debt-equity ratio = 1.
87. A firm has an expected return on equity of 15% and an after-tax cost of debt of 10%. What debt-equity ratio should be used in order to keep the WACC at 11%?
- 1.00 - 2.00 - 3.00 ** 4.00 Feedback: Let x = debt/asset ratio. Then .11 = .10x + (1-x).15 .11=.10x + .15 - .15x .11-.15 = .10x - .15x -.04 = -.05x X = -.04/-.05 X = .8 X = debt = 80%, equity = 20%, and debt-equity ratio = 4.
85. A company has a retention ratio of 40%, net income of $17 million, and 10 million shares outstanding. What would be the dividend per share for this company?
- 1.10 ** 1.02 - .95 - .82 Payout ratio is (1 - retention ratio). Therefore, total dividends paid would be equal to (1-.40) $17,000,000 = $10,200,000. Dividends per share would be equal to $10,200,000/10,000,000 = $1.02.
31. ABC Corp. entered into a currency swap with its bank, providing that ABC borrows $5 million at 10 percent and swaps for a 12 percent yen loan. The spot exchange rate is 105/$. If interest only is to be repaid on an annual basis, how much does ABC pay annually to the bank?
- 1.26 million - 5.71 million - 52.50 million ** 63.00 million $5 million x 105 = 525,000,000. $525,000,000 x 12% interest = 63,000,000 annually
56. What is the expected rate of return to equityholders if the firm has a 35% tax rate, a 10% rate of interest paid on debt, a 15% WACC and a 60% debt-asset ratio?
- 12.50% - 21.25% - 22.50% ** 27.75% WACC = .15 = .65(.10)(.60) + requity(.40) .111 = .4 requity 27.75% = requity
69. A firm with a debt equity ratio of 1/2, return on assets of 15%, and return on debt of 10% will have return on equity of:
- 15.00% ** 16.67% - 20.00% - 21.17% requity = 0.15 + 1/3(0.15 - 0.10) = 16.67%
13. What is the expected return on equity for a firm with a 14% expected return on assets that pays 9% on its debt, which totals 70% of assets?
- 16.14% - 17.00% - 19.00% ** 25.67% Expected return on equity = Expected return on assets + = 14% + = 14% + [2.3333 x 5%] = 25.67%
39. An investor owns 300 shares of stock currently selling for $70 per share. What should the investor expect to have after the stock declares a three-for-two split?
- 200 shares selling for $93.10 each - 200 shares selling for $105.00 each ** 450 shares selling for $46.67 each - 450 shares selling for $93.10 each Current wealth = 300 x $70 = $21,000 Expected wealth = 450 x $46.67 = $21,000
89. What is the proportion of equity financing for a firm that expects a 15% return on equity, a 10% return on assets, and an 8% return on debt? Ignore taxes.
- 25% ** 29% - 75% - 71%
37. After the payment of a 25% stock dividend, an investor has 500 shares of stock and $400. What did the investor have prior to the stock dividend?
- 300 shares of stock ** 375 shares of stock and $400 - 400 shares of stock - 625 shares of stock and $400
24. What is the after-tax cost of debt for a firm in the 35% tax bracket that pays 15% on its debt?
- 5.25% ** 9.75% - 12.17% - 20.25% After-tax cost of debt = (1-Tc)rdebt = .65 x .15 = 9.75%
11. What is the proportion of debt financing for a firm that expects a 24% return on equity, a 16% return on assets, and a 12% return on debt? Ignore taxes.
- 54.0% - 60.0% ** 66.7% - 75.0% .24 = .16 + .24 = .16 + 2.0 = \The firm is financed with 66.67% debt.
62. Stockholders' expected return on a stock priced at $25 per share with zero-growth dividends of $4.00 is:
- 6.25%. - 13.64%. ** 16.00%. - 21.00%. Expected return = ($4/$25) = 16%
45. What is the maximum rate that can be paid on debt and maintain a 14% WACC with a 19% expected return on equity in a firm with a 60% debt-to-asset ratio? Ignore taxes.
- 6.50% - 9.90% ** 10.67% - 11.14% WACC = rdebt + requity 14% = rdebt(.60) + 19%(.40) 14% = .6rdebt + 7.6% 10.67% = rdebt
57. What capital gain must a non-dividend-paying stock attain in order for a corporate investor in the 35% tax bracket to be indifferent to a stock paying an 8% dividend but having no capital gain?
- 8.00% - 9.29% ** 11.02% - 12.31% After-tax return on dividend-paying stock: = 8% - (8% x .3 x .35) = 8% - .0084 = 7.16% After-tax return on non-dividend-paying stock: = capital gain (1 - .35) 7.16% = .65 x capital gain 11.02% = capital gain
51. Assume the issuer incurs $1 million in other expenses to sell 3 million shares at $40 each to an underwriter and the underwriter sells the shares at $43 each. By the end of the first day's trading, the issuing company's stock price had risen to $70. What is the total cost (direct expenses plus underpricing cost)?
- 81 million ** 91 million - 101 million - 111 million underwriting spread: 3 million x $3 = $9 million The underpricing cost is 3 million x ($70 - $43) = 81 million. Direct expenses and underpricing cost sum to 91 million. %age of direct expense = = = 7.75% %age of market value absorbed by direct expenses and underpricing cost = = = 43.33%
33. Which of the following statements is correct for stock purchased on the last day to trade "cum dividend"?
- A dividend will be declared on the next trading day - A dividend will be paid on the next trading day ** The stock price should decline on the next trading day - The stock price should have declined on the previous trading day
44. A gasoline distributor buys a gasoline futures contract that requires acceptance of 42,000 gallons of gasoline at $0.94 per gallon. How is the account marked to market if gasoline futures close the next day at $0.97?
- A loss of $1,260 is posted to the account ** A gain of $1,260 is posted to the account - A loss of $12,600 is posted to the account - A gain of $12,600 is posted to the account A buyer of a futures contract gains when the closing price rises. Therefore, 3 rise x 42,000 gallons = $1,260 gain to be marked to market.
5. A dividend is declared on January 1, has a with-dividend date of January 19, and a record date of January 26. Which of the following shareholders will not receive the dividend?
- A shareholder who purchases on December 31 - A shareholder who purchases on January 10 - A shareholder who purchases on January 19 ** A shareholder who purchases on January 24
76. The optimal capital structure is met when:
- Additional borrowing results in lower financial distress costs - Additional borrowing is offset by the interest tax shield ** The tax savings from additional leverage is just offset by the costs of distress - The present value of the tax shield is greater than the value of an all-equity financed firm
16. An implicit cost of adding debt to the capital structure is that it:
- Adds interest expense to the operating statement ** Increases the required return on equity - Reduces the expected return on assets - Decreases the firm's beta
51. MM's assertion that dividend policy will not affect the value of the firm requires that dividend policy does not:
- Alter the retained earnings of the firm ** Affect investment and borrowing policies - Allow the payout ratio to change - Alter the number of outstanding shares
75. When corporate taxes are considered, how does leverage affect the WACC?
- An increase in leverage will be offset by a decrease in equity financing, thus leaving WACC unchanged - Changes in leverage will affect the WACC only if the interest rate on debt changes - Increased leverage will increase the WACC ** Increased leverage will decrease the WACC
79. High dividends may be used as __________ of a firm's __________.
- An indicator; high capital gains - An indicator; tax liability - A signal; return on equity ** A signal; good prospects
c18 Key 1. When a firm declares a special cash dividend of $1 per share, shareholders realize that the:
- Annual dividend will be $4 per share - Dividends are considered regular ** Dividend is not likely to be repeated - Stock must be owned prior to the declaration date to receive the dividend
45. A firm is said to be "smoothing" dividends if dividends:
- Are paid through an automatic dividend reinvestment plan ** Change more gradually than changes in earnings - Increase by the same dollar amount each year - Are paid only in even dollar amounts
34. A firm's capital structure is represented by its mix of:
- Assets ** Liabilities and equity - Assets and liabilities - Assets, liabilities and equity
42. Assuming no market imperfections, which of the following will not be affected by a repurchase of shares?
- Assets of the firm - Equity of the firm - Shares outstanding ** Price per share
17. When debt is risky under MM II:
- Bond holders shift more of the risk to equity holders ** Equity holders shift more of the risk to bond holders - The value of the interest tax shield is at its highest - There is more overall risk in the firm
53. Any financial benefit derived from the interest tax shield accrues to the:
- Bondholders ** Shareholders - Bondholders and shareholders, equally - Shareholders and the federal government
38. What effect does a stock dividend have on the book and market values of the firm?
- Book value increases; market value increases - Book value increases; market value decreases - Book value decreases; market value increases ** Book and market values remain constant
56. Nestlé wishes to obtain a loan denominated in Swiss francs but considers the U.S. market to offer better terms. How can Nestlé accomplish this?
- Borrow francs in Switzerland, exchange for dollars and arrange a currency swap - Borrow francs in Switzerland, exchange for dollars and arrange an interest-rate swap - Borrow dollars in U.S., exchange for francs and arrange an interest-rate swap ** Borrow dollars in U.S., exchange for francs and arrange a currency swap
72. When the firm has a high retention ratio, thus paying low dividends, the dividend is a by-product of what kind of decision?
- Borrowing - Debt policy - Financing ** Capital budgeting
64. Debt usage will have an effect on:
- Business risk ** Financial risk - Operating risk - Asset risk
4. What form of hedging would you suggest for a producer that wishes to be protected from future price decreases but wants to benefit from any future price increases?
- Buy a call option on the asset - Sell a call option on the asset ** Buy a put option on the asset - Sell a put option on the asset
39. In general, when deciding whether a market participant needs to buy or sell futures contracts in order to hedge, the rule could be:
- Buy futures if you have the underlying asset and sell futures if you need the underlying asset ** Sell futures if you have the underlying asset and buy futures if you need the underlying asset - Buy futures if you want to speculate, sell futures if you want to hedge - Buy futures if you are willing to have unlimited risk, sell futures if you want capped risk
61. A farmer can hedge the risk of downward movement in the price of the produce by taking one of the following positions.
- Buying a call option - Selling a put option ** Buying a put option - Buying a futures contract
11. A producer that is worried about the future price that will be available when the product is to be sold can hedge this price risk by:
- Buying a futures contract ** Selling a futures contract - Buying a put option - Selling a call option
64. A copper producer is worried about the copper prices going down. The risk of downward movement in prices can be hedged by taking one of the following positions.
- Buying call options on copper ** Selling copper futures - Buying copper futures - Selling copper call options
65. A miller can hedge the price risk on wheat by taking one of the following positions.
- Buying put options on wheat - Selling call options on wheat ** Buying wheat futures - Selling wheat futures
61. By changing the mix of securities a firm uses for financing, the financial manager:
- Can increase the book value of the firm ** Is changing the firm's capital structure - Can increase the market value of the firm - Is changing the firm's dividend policy
11. A corporation's dividend payout ratio is the %age of _____ paid out as dividends.
- Cash ** Earnings - Earnings before interest and taxes - Retained earnings
83. When large firms file for bankruptcy, they usually do so under an arrangement called:
- Chapter 9 ** Chapter 11 - Chapter 13 - Chapter 14
35. Hershey's Chocolate is concerned about cocoa prices prior to building inventory for Halloween sales. Analysts project that price per ton could vary from $1,250 to $1,500. A September call option can be purchased with a $1,300 strike price for a premium of $145. What is Hershey's worst-case scenario if it purchases these options?
- Cocoa prices will rise to $1,500 and Hershey is only protected to a price of $1,300 - Cocoa prices will decline to $1,250 and Hershey must pay an extra $50 per ton - Cocoa prices will not rise above Hershey's break-even price of $1,445, which equals the sum of the strike price plus the option premium ** Cocoa Prices will remain below $1,300 and Hershey will lose $145 per option contract
72. Which of the following is a source of profit for a swap dealer?
- Commission charged on the sale of bonds ** Bid-ask spread - Margin account - Option premium
30. Compare the after-tax returns for a corporation that invests in preferred stock with a 12% dividend versus a common stock with no dividend but a 16% capital gain. The corporation's tax rate is 35%. The:
- Common stock returns 2.60% more than preferred ** Preferred stock returns 0.34% more than common - Common stock returns 2.32% more than preferred - Returns are equal on an after-tax basis After-tax returns: Preferred Stock: 12% - (12% x 35% x 30%) = 10.74% Common Stock: 16% - (16% x 35%) = 10.40% The preferred stock's after-tax return is 34 basis points higher, although it returned 400 basis points less on a before-tax basis.
72. Those who benefit from the interest tax shield are:
- Debt holders ** Equity holders - Both debt holders and equity holders - Only the firm's customers benefit from the interest tax shield
70. As the debt to equity ratio decreases when debt is not risk free:
- Debt holders demand a higher expected return ** Debt holders demand a lower expected return - The expected return on equity increases - The expected return on assets increases
59. Which of the following lists presents the order of financing from most preferred to least preferred according to the pecking order theory?
- Debt issue, stock issue, internally generated funds ** Internally generated funds, debt issue, stock issue - Stock issue, internally generated funds, debt issue - Internally generated funds, stock issue, debt issue
7. A hedger who buys a futures contract is betting that prices will _____ at the expiration of the contract.
- Decrease ** Increase - Remain constant - Guarantee high profits
10. The customary delivery procedure at the expiration of a commodity futures contract is:
- Delivering the commodity to the futures buyer - Delivering the commodity to the futures exchange ** Offsetting the initial futures position and settling in cash - Adding the profit or loss to your margin account and continuing to trade
68. According to MM II, if the expected return on assets decreases, what happens to the expected return on equity?
- Depends on the firm's capital structure ** Decreases - Remains constant - Increases
60. A private placement avoids which of the following costs?
- Depression in the stock price - Administration costs ** Registration with the SEC - Fixed costs
52. The interest tax shield is equal to the:
- Difference between interest expense and income taxes - Amount of interest paid in a given year ** Product of the interest expense and the tax rate - Product of the debt principal and the interest rate on debt
43. Which of the following processes would not be expected to have an effect on share price?
- Dividend declaration and payment ** Stock repurchase - Stock dividend - Stock split
c16 Key 1. Which of the following is an example of restructuring the firm?
- Dividends are increased from $1 to $2 per share - A new investment increases the firm's business risk ** New equity is issued and the proceeds repay debt - A new board of directors is elected to the firm
3. A firm issues 100,000 equity shares with a total market value of $5,000,000. The firm's market value of debt is also of equal amount, i.e., $5,000,000. The firm is expected to generate $1.5 million in operating income and pay $250,000 in interest. Ignoring taxes, this will generate $12.50 earnings per share. What will happen to EPS if the firm's borrowing and interest expense increases by 50% and the number of shares in circulation is cut by 50% (assuming that the share price remains unchanged with this change in capital structure)?
- EPS decrease to $10.00 - EPS decrease to $11.67 - EPS increase to $15.00 ** EPS increase to $22.50
4. A firm issues 100,000 equity shares with a total market value of $5,000,000. The firm's market value of debt is also of equal amount, i.e., $5,000,000. The firm is expected to generate $1.5 million in operating income and pay $250,000 in interest. Ignoring taxes, this will generate $12.50 earnings per share. What will happen to EPS if the firm's borrowing and interest expense increases by 75% and the number of shares in circulation is cut by 75% (assuming that the share price remains unchanged with this change in capital structure)?
- EPS decrease to $10.00 - EPS decrease to $11.67 - EPS increase to $15.00 ** EPS increase to $42.50
2. A firm is expected to generate $1.5 million in operating income and pay $250,000 in interest. Ignoring taxes, this will generate $12.50 earnings per share. What will happen to EPS if operating income increases to $2.0 million?
- EPS will increase to $15.63 - EPS will increase to $16.67 ** EPS will increase to $17.50 - EPS will increase to $20.00
82. When a firm announces a two-for-one stock split (in the absence of other new information), investors should expect that:
- Earnings per share will fall by half but stock price will remain the same - Stock price will fall by half but earnings per share will remain the same - Both earnings per share and stock price will remain the same ** Both earnings per share and stock price will fall by half
5. Which of the following is not correct concerning futures contracts?
- Entails an obligation rather than an option - Contract price is set at the beginning of the contract - Contracts are exchange-traded ** Gains or losses are recorded at contract expiration
82. The pecking-order theory suggests that less profitable firms borrow more because:
- Equity issues are more expensive - Leverage is preferred over raising funds internally - Debt issues are good omens ** They have insufficient internal funds
61. An investor who owns stock on the company's __________ date will receive the dividends declare-
- Ex-dividend - Record ** With-dividend - Payment
27. The present value of the costs of financial distress increases with increases in the debt ratio because the:
- Expected return on assets increases - Present value of the interest tax shield is greater - Equity tax shield is depleted ** Probability of default and/or bankruptcy is greater
47. If a firm's expected return on equity equals its expected return on assets, then the:
- Expected return on debt exceeds the expected return on assets - Likelihood of financial distress is high - Firm has too much debt ** Firm has no debt in its capital structure
36. A decrease of debt in the capital structure tends to reduce a firm's EPS when the firm:
- Faces high interest rates ** Faces strong growth in business conditions - Pays taxes - Does not reinvest its earnings
7. The stability of a firm's operating income is the focus of:
- Financial leverage - Weighted-average cost of capital - Capital structure ** Business risk
24. An increase in share price following an increase in dividends is logical if the:
- Firm borrows to obtain cash for the dividend ** Increased dividend signals higher future earnings - Financial markets are efficient - Clientele effect is not important
26. If the present value of the tax shield equals the present value of the costs of financial distress, then the:
- Firm is using the optimal level of debt - Firm is paying too high an interest rate ** Firm's market value equals the value of the unlevered firm - Firm should increase its use of debt
22. In a world with corporate taxes but no possibility of financial distress, the value of the firm is maximized when the:
- Firm uses no debt in its capital structure ** Firm uses no equity in its capital structure - Firm uses a debt-equity ratio of 1.0 - Corporate tax rate approaches 100%
63. Which of the following statements is FALSE regarding MM's proposition I:
- Firm value is unaffected by its capital structure - It is also called the debt irrelevance proposition ** Shareholders should care about the firm's debt policy - After restructuring, the firm's value should be the same as it was prior to restructuring
44. According to MM, an increase in expected earnings per share can leave the share price unchanged if the:
- Firm's operating risk decreases - Number of shares is decreased ** Required return on equity increases - Firm has no financial leverage
30. The "trade-off theory" of capital structure suggests that:
- Firms add leverage whenever interest rates are low ** Firms with higher risk should use less debt - Firms should use 50% debt and 50% equity - Firms should use debt to overcome high par values of stock
12. Which of the following is not found in John Lintner's "stylized facts" of corporate dividend policies?
- Firms have long-run target dividend payout ratios ** Managers focus more on dividend absolute levels than on its changes - Dividend changes follow shifts in long-run, sustainable levels of earnings rather than short-run changes in earnings - Managers are reluctant to make dividend changes that might have to be reversed
19. MM's proposition of dividend irrelevance depends upon:
- Firms maintaining a constant dividend payout - Dividends being taxed the same as capital gains - The existence of a dividend clientele ** The efficiency of capital markets
30. In an interest rate swap, borrowers typically exchange fixed-rate payments in one currency for:
- Fixed-rate payments in another currency - Variable-rate payments in another currency - Fixed-rate payments in the same currency ** Variable-rate payments in the same currency
58. Which of the following statements regarding "taxation of dividends and capital gains under current tax law" is incorrect (assuming that the marginal tax rate for a large corporation is 35%)?
- For-profit corporations have a tax reason to prefer dividends. - Corporations pay corporate income tax on only 30% of any dividends receive- ** The effective tax rate on dividends received by large corporations is 35% of the marginal corporate tax rate. - Corporations have to pay a 35% tax on the full amount of any realized capital gain.
69. Which of the following is the major difference between forward and futures contracts?
- Futures contracts are more expensive than forward contracts - Forward contracts are available only for foreign currencies - Futures contracts are always delivered ** Forward contracts are not marked to market
68. At the expiration of a futures contract, the futures price will be:
- Greater than spot price ** Equal to the spot price - Less than the spot price - More than the forward price
47. A firm's dividend policy involves a trade-off between:
- Growth versus no growth in investment - High share price versus low share price ** Internal versus external financing of investment - A large asset base and a small asset base
17. The purpose of a margin account for a futures contract is to:
- Guarantee a minimum margin of profit for the contract holder - Allow futures traders to have more than one contract at once ** Provide a cushion for the exchange against defaults on the contract - Hold interest payments until expiration
43. Which of the following is least responsible for the success of futures exchanges such as the Winnipeg Commodity Exchange?
- Guaranteed settlement - Standardized contracts ** Reduction of hedging costs through marking to market - Variety of settlement dates
20. A futures contract seller is obligated to deliver 5,000 bushels of soybeans for $5.00 per bushel at expiration. If soybean futures close at $5.10 the next day, the seller:
- Has a profit of $500 thus far on the contract ** Has a loss of $500 thus far on the contract - Has no profit or loss, but is still obligated to deliver 5,000 bushels at $5.00 - Will receive a cheque for $500 from the buyer of the contract
50. With risky debt and MM II, the expected return on assets _____ as the debt-equity ratio _____.
- Increases; increases - Decreases; increases - Increases; decreases ** Is constant; increases
80. Of the following, who has tax benefits for preferring dividends?
- Individual investors ** Corporations - Financial institutions - Banks
6. Under the assumptions necessary for MM I, if investors can borrow or lend at the same terms as the firm, they will:
- Invest in debt only and ignore equity investments ** Not be willing to pay more for a restructured firm - Require a higher rate of return on equity - Accept a lower rate of return on equity
9. What happens to the price of a futures contract as expiration draws closer?
- It exceeds the spot price of the asset - It is exceeded by the spot price of the asset ** It approaches the spot price of the asset - There is no relationship between futures price and spot price as the contract approaches expiration
c26 Key 1. Which of the following is not generally considered a benefit of hedging?
- It reduces one or more aspects of business risk - It allows prices to be locked in advance ** The costs of hedging are paid by the speculators - It can stabilize profits
14. According to MM II, as a firm's debt-to-equity ratio decreases:
- Its financial risk increases - Its operating risk increases - The required rate of return on equity increases ** The required rate of return on equity decreases
77. In regards to dividend policy, unless a firm's investment policy and borrowing remain constant:
- Its overall cash flows will remain the same ** Its overall cash flows will change - Shareholders' risk will increase - Shareholders' risk will decrease
57. Currency swaps are used to:
- Lock in an exchange rate for future delivery of a foreign currency ** Effectively transform loans originated in one currency to a different currency - Transform fixed-rate loans into variable-rate loans - Exchange foreign currencies in amounts not possible in the foreign exchange market
50. A cotton producer has purchased cotton futures that involve 50,000 pounds of cotton at a price of $0.60 per poun- By contract expiration the producer finds that cotton prices have declined by $0.07 per poun- As a result of the futures contracts, the producer will:
- Lose $3,500 per contract in the futures market which offsets gains in the cash market - Gain $3,500 per contract in the futures market which offsets losses in the cash market ** Lose $3,500 per contract in the futures market and suffer an opportunity cost in the cash market - Gain $3,500 per contract in the futures market and gain $0.10 per pound in the cash market
25. Investors may prefer lower dividends over higher dividends because:
- Low dividends are more predictable ** Capital gains may be taxed less heavily than dividends - Of the "bird in the hand" logic - Low dividends indicate heavy investment for the future
51. With the inclusion of taxes, MM I is incorrect and the capital structure of the firm can be important due to:
- Lower tax rates on dividends than on debt - Higher tax rates on retained earnings than on debt ** Lower tax liability due to interest deductibility - Higher operating income from less dividends
14. A policy of dividend "smoothing" refers to:
- Maintaining a constant dividend payout ratio - Keeping the regular dividend at the same level indefinitely ** Maintaining a steady progression of dividend increases over time - Alternating cash dividends with stock dividends
22. Why are dividend changes rather than their absolute level perceived to be more important to managers and shareholders?
- Managers only change dividends under threatening conditions ** Dividend changes are thought to signal future expectations - MM states that the absolute level of dividends is irrelevant - Changes determine whether borrowing must occur
43. The reason that financial leverage increases shareholder risk is that there is:
- More debt which increases the operating risk ** Less equity to absorb the operating risk - Less business risk to be spread around - More financial risk due to reduced business risk
75. With respect to the proposition that dividend policy does not matter, in order to raise an additional $5,600 in cash by issuing stock, the stock sold must be worth:
- More than $5,600 - $2,800 ** $5,600 - Need to know the number of shares issued to calculate
41. Why are most futures contracts not settled through delivery of the product?
- Most contracts are settled through the margin account - Most contracts expire with neither party having an obligation to the other party - Most participants cancel their futures contracts through purchase of an option contract ** It is easier and cheaper to settle in cash or by offset
60. Debt may be the preferred form of external financing for many firms because:
- Most firms already have too much equity - Tax rates on equity are lower - Debt will not adversely affect the firm's financial ratios ** Equity issuance is considered by investors to be a negative sign
33. According to pecking-order theory, managers will often choose to finance with:
- New equity rather than debt, due to bankruptcy costs ** Debt rather than new equity, to avoid reduced share price - Debt rather than retained earnings, to lower the WACC - New equity rather than debt, to strengthen EPS
4. A secondary offering IPO occurs when:
- New shares are sold to provide the company with additional funds - The second public issue of equity becomes available ** The company's founders or venture capitalists market a portion of their shares - Not all of the shares in a primary IPO were sold
69. With a stock repurchase:
- No cash flow is extended from the company ** The company obtains some of its stock, and the value of the firm drops - Shareholders' ownership in the company will decrease - The equity of the firm will increase
45. One strategy that appears to be used by certain underwriters to reduce the risk of marketing a stock is to:
- Offer a firm commitment on the issue ** Set the initial stock price below its true value - Sell the securities in foreign countries - Offer price rebates on the stock purchases
50. MM's proposition concerning dividends contends that shareholders will:
- Offer higher prices for higher dividend payouts ** Not offer higher prices for higher dividend payouts - Offer higher prices for lower dividend payouts - Only purchase stocks that have high dividend payouts
40. When a corporation engages in a 10% stock repurchase, it:
- Offers shareholders 110 shares for every 100 they currently own ** Purchases for cash 10% of the outstanding shares - Sells treasury stock at a 10% discount to investors - Purchases 10% of previously issued stock dividends
49. Which of the following is not correct concerning the financial futures markets?
- One of the prominent exchanges for financial futures is the Chicago Board of Trade - The contracts were first traded in 1972 - A major use is protection from interest-rate risk ** Trading in commodity futures significantly exceeds trading in financial futures
39. A firm is currently expected to develop $2 EPS when operating income equals $4 million and interest expense equals $2 million. How low can operating income drop before EPS is reduced by half, to $1? Ignore taxes.
- Operating income drops to $3.5 million ** Operating income drops to $3.0 million - Operating income drops to $2.5 million - Operating income drops to $2.0 million
53. Those who invest in derivative instruments with the purpose of increasing rather than decreasing risk are known as:
- Option traders - Futures traders - Hedgers ** Speculators
35. Automatic dividend reinvestment plans allow firms to:
- Pay dividends on a more frequent schedule ** Reduce their cash outflow to shareholders - Transform regular dividends into stock dividends - Avoid the ex-dividend date reduction in stock price
38. One distinguishing difference between the buyer of a futures contract and the buyer of an option contract is that the futures buyer:
- Pays a much higher premium than option buyers ** Has an obligation to purchase, not a choice - Can lose no more than the initial premium - Has increased rather than reduced risk
57. When corporate taxes and the cost of financial distress are taken into consideration, the market value of a firm equals the value if all-equity financed _____ the PV of the tax shield _____ the costs of financial distress.
- Plus; plus - Minus; plus ** Plus; minus - Minus; minus
52. The activities of speculators are necessary in the futures markets in order to:
- Prevent hedgers from trading options - Provide a continual stream of profit to hedgers ** Maintain futures prices at appropriate levels - Understand the direction of future price changes
8. XYZ Corp. has 1,000 shares outstanding and retained earnings of $25,000. Theoretically, what would you expect to happen to the price of their stock, currently selling for $30 per share, if a 25% stock dividend is declared?
- Price should increase to $44.00 per share - Price should increase to $37.50 per share ** Price should decrease to $24.00 per share - Nothing; price should remain at $30.00
34. If managers are rational, they will only hedge when they perceive that:
- Prices are headed in an adverse direction - Derivative instruments are priced lower than actual value ** Risk reduction is preferable to higher potential profits - They can increase their profitability by doing so
46. The typical sequence of cash flows in a futures contract is:
- Purchase price plus a margin account up front, differences are settled at expiration ** Margin account up front, differences are posted daily and settled in cash if margin drops too low - Margin account up front, all differences settled at expiration - All funds are paid at expiration of the contract
20. According to MM, "homemade" dividends are created by:
- Purchasing only stocks that continually increase their regular dividends ** Selling a portion of your non-dividend paying holdings - Purchasing Treasury bills rather than common stocks - Withdrawing cash from savings on dividend payment dates
16. Which of the following would not be regulated in a standardized futures contract?
- Quantity of asset to be traded - Quality of asset to be traded ** The spot price - Date of settlement
59. Interest rate swaps allow both counterparties to:
- Reduce interest expenses - Avoid repayment of the notional principal ** Rearrange the balance sheet - Pay a floating rate of interest on their debt
64. The primary purpose of laws prohibiting a firm from paying dividends that include its legal capital is to:
- Reduce investors' tax liability - Ensure that the balance sheet balances ** Prevent managers from paying out all the firm's assets - Prevent managers from paying large dividends
5. What is meant by investors being able "to undo" the effects of corporate restructuring? Investors:
- Repay their portion of the firm's debt - Only purchase securities in unlevered firms - Will pay more for unlevered shares ** Borrow in their name and replicate the effects of restructuring
41. MM Proposition I states that a firm's value is unaffected by its:
- Required rate of return on equity - Operating income, in the absence of taxes - Interest rate paid on debt ** Mixture of debt and equity
44. Which of the following is correct for a firm with $400,000 in net earnings, 20,000 shares, and a 30% payout ratio?
- Retained earnings will increase by $120,000 - Each share will receive a $1.20 dividend - $120,000 will be spent on new investment ** The dividend per share will equal $6.00
73. Dividend policy is a trade-off between ___________ and ___________.
- Retained earnings; borrowing - Capital budgeting; capital structure ** Retained earnings; issuing stock - Declaring stock splits; stock dividends
9. Financial risk refers to the:
- Risk of owning equity securities ** Risk faced by equity holders when debt is used - General business risk of the firm - Possibility that interest rates will increase
13. A hedger buys a futures contract that obligates the owner to take delivery of 5,000 bushels of wheat at a price of $3.30 per bushel. At expiration the spot price of wheat is $2.80 per bushel. The hedger has:
- Saved 50 per bushel through hedging ** Gained peace of mind at a price of 50 per bushel - The opportunity to avoid taking delivery, since price declined - Locked in an effective price of $3.05 per bushel
48. How can a 10% dividend be "homemade" by an investor that owns 100 non-dividend-paying shares priced at $20 each?
- Sell 10 shares and retain 90 shares priced at $18 ** Sell 10 shares and retain 90 shares priced at $20 - Sell 10 shares and retain 90 shares priced at $22 - Dividends can be homemade only by the company
49. How can a 10% dividend be "homemade" by an investor that owns 100 non-dividend-paying shares priced at $20 each?
- Sell 10 shares and retain 90 shares priced at $18 ** Sell 10 shares and retain 90 shares priced at $20 - Sell 10 shares and retain 90 shares priced at $22 - Dividends can be homemade only by the company
17. A firm with 2,000 outstanding shares selling for $10 each does not have the cash to pay its dividen- In an ideal MM world, how many new shares must be sold and at what price to pay a $2 dividend per share to old shareholders?
- Sell 2,000 shares at a price of $2 each - Sell 667 shares at a price of $6 each ** Sell 500 shares at a price of $8 each - Sell 400 shares at a price of $10 each Thus, there are now 2,500 shares outstanding at a market value of $8 each.
31. Which of the following would you expect to have more impact on a dividend-based-stock-valuation model?
- Special dividend ** Regular dividend - Extra dividend - Stock dividend
80. According to the trade-off theory, the capital structure is a trade-off between:
- Tangible and intangible asset risk - High and low target debt ratios ** Tax savings and financial distress costs - Tax shields and equity financing
79. Which of the following statements is TRUE regarding the trade-off theory:
- Target debt ratios are similar among firms in the same industry - Riskier firms tend to rely mostly on debt financing - Riskier firms should have high target debt ratios ** Less risky firms ought to have a greater amount of debt financing
71. One advantage of debt financing over equity financing is:
- Tax deductible dividends ** Tax deductible interest - Tax deductible principal repayment - Tax free interest income
29. Capital gains may be preferred by investors over dividends even if their tax rates are equal because:
- Taxes on dividends are withheld from paycheques - Taxes on capital gains are paid annually ** Taxes on capital gains can be timed - After-tax dividends are less certain than capital gains
6. Boards of directors may be legally restricted in their declaration of dividends if:
- The cash must be borrowed for the dividend payment - Dividends have increased substantially over a short period of time ** The dividend would create a situation of insolvency - The stock is selling at a low relative price
26. Those economists feeling that low dividend payouts will increase share price focus on:
- The difficulty in predicting earnings - Superior reinvestment opportunities ** Tax differentials between dividends and capital gains - The cost of borrowing to maintain high payouts
32. Why may a large increase in earnings not translate into a large increase in dividends?
- The earnings will be taxed - Some investors may prefer capital gains ** Managers wish to assess the earning's persistence - The earnings may already be a part of retained earnings
49. As a firm's debt/equity ratio approaches zero, the firm's expected return on equity approaches:
- The expected return on debt ** The expected return on assets - Its maximum - Zero
12. A farmer stores his fall harvest of corn and sells corn futures for March delivery at $2.50 per bushel. In March the spot price of corn is $2.20 per bushel. Which of the following is correct?
- The farmer is obligated to deliver corn to the futures buyer at $2.20 ** The farmer has locked in an effective price of $2.50 per bushel - The farmer would have been better off without the futures contact - The farmer will receive $4.70 per bushel, which more than doubles the profit obtained without futures
83. A two-for-one stock split will result in:
- The firm acquiring new assets - A decrease in the stock price, but an increase in shareholder wealth - An increase in the stock price, and an increase in shareholder wealth ** A decrease in the stock price, and no change to shareholder wealth
28. When financial disaster is looming, management may borrow to invest in projects having a negative expected NPV because:
- The firm's beta is now negative - Taxes are no longer a concern - The interest tax shield will cover the loan costs ** The lender bears all the risk
52. The manager of XYZ Corp. feels that a dividend increase will increase stock price because many investors value stock with a dividend-discount model. Why might MM disagree with this assertion?
- The increased dividend makes the firm much riskier ** Future dividend growth may slow due to less retained earnings - Investors prefer capital gains over dividends - Dividend increases will increase the book value but not the market value of the firm
10. An investor owns 5,000 shares, which is 1% of a corporation's outstanding stock before a stock repurchase. The investor did not sell any of his stock during the 25,000 share repurchase. Which of the following statements is correct?
- The investor still owns 1% of the corporation - The stock's price is likely to drop by 5% ** The investor owns more than 1% of the corporation - The investor now has 5,250 shares
16. Under the idealized conditions of MM, which statement is correct when a firm issues new stock in order to pay a cash dividend on existing shares?
- The new shares are worth less than the old shares - The old shares drop in value to equal the new price - The value of the firm is reduced by the amount of the dividend ** The value of the firm is unaffected
70. When a firm declares a stock repurchase:
- The number of outstanding shares falls along with the price ** The number of outstanding shares falls and the price remains unchanged - An investor will receive cash in exchange for a smaller %age of ownership - Demand drives the stock price up
34. With respect to the dividend-payment process, the price of a share of stock can logically be expected to drop on:
- The payment date - The date of record ** The ex-dividend date - The declaration date
84. When large firms file for bankruptcy:
- The proceedings involve costly delays and legal tangles, and the business continues to deteriorate ** Their purpose is usually to nurse the firm back to health and enable it to face the world again - Their benefit is that their creditors will be forced by law to give up their claims on the firm - Their creditors often try to seize the assets as soon as possible
18. The process of marking a futures contract to market means that:
- The profitability of the contract is locked in from the onset of the contract - The amount of commodity to be delivered changes as prices change - Contracts are closed out as soon as they become unprofitable ** Profits or losses are posted to the contract daily
36. If the total assets of a firm are unaffected by a stock dividend, then:
- The stock should retain the same price per share - Stock dividends should be preferred by corporations over cash dividends ** An investor's wealth should not be changed - Only bondholders benefit from stock dividends
58. Which of the following is a safe assumption for a firm in which the PV of the tax shield is approximately equal to the costs of financial distress?
- The tax shield has been calculated incorrectly ** The firm is too heavily levered financially - The firm has reached its optimal debt level - The firm appears to have low risk of financial distress
70. Which of the following statements is correct for an interest rate swap?
- There is an exchange on principal between counterparties ** There is no exchange of principal between counterparties - There is an exchange of currencies between counterparties - There is no exchange of cash between counterparties
58. Why might an individual or organization be willing to swap fixed-rate loans for floating-rate loans?
- They may perceive that interest rates are ready to increase ** Their cash flows may vary directly with interest rates - Floating rates are lower than fixed rates - They may be able to postpone the payment of principal
29. Firms facing financial distress may pass up positive NPV projects rather than commit new equity because:
- They prefer to finance with debt ** The benefits may be shared with the bondholders - No cash is available for dividends - There is no interest tax shield associated with equity
33. Managers are willing to pay a price to hedge because:
- They receive increased profits in return - The returns on derivative instruments are not taxed ** They value the reduction in uncertainty - It permits the managers to receive higher cash bonuses
28. Which of the following is a major reason for firms to engage in currency swaps?
- They will only be required to repay the interest ** They can obtain more favourable borrowing terms in a different currency - The debt will not show on their balance sheets - Borrowing in a foreign currency offers lucrative tax breaks
29. When two borrowers engage in a currency swap, they agree to:
- Trade one currency for another, thus avoiding the foreign exchange market ** Make payments on each other's borrowings in a different currency - Pay to each other any depreciation or appreciation of the currency - Exchange fixed-rate interest payments for variable-rate interest payments
67. Most actively traded forward contracts are written on:
- U.S. Treasury bills - Standard & Poor's index - Wheat contracts ** Foreign currencies
71. Which of the following futures contract is written on a non-deliverable asset?
- U.S. Treasury bills - Wheat ** Standard & Poor's index - British pounds
20. When taxes are considered, the value of a levered firm equals the value of the:
- Unlevered firm - Unlevered firm plus the value of the debt ** Unlevered firm plus the present value of the tax shield - Unlevered firm plus the value of the debt plus the value of the tax shield
21. What is the change in value for a firm with $1 million in equity, $1 million in permanent debt at a 10% interest rate, and a 35% tax rate if MM I is modified to recognize corporate taxes?
- Value increases by $35,000 - Value increases by $100,000 ** Value increases by $350,000 - Value increases by $700,000 PV of interest tax shield = Tc x D = .35 x $1,000,000 = $350,000 Value of levered firm = value of all-equity financed + present value of tax shield = $1,000,000 + $350,000 = $1,350,000 which is an increase of $350,000
46. Which of the following would not be expected to change with changes in the firm's capital structure?
- Weighted-average cost of capital - Expected return on equity ** Expected return on assets - Expected earnings per share
24. The basic difference between speculators and hedgers in futures contracts is that speculators:
- Will profit regardless of the direction of price change ** Are not protecting their commodity holdings through an offsetting transaction - Are concerned only with long-term price movements - Take a position in more than one commodity at a time
27. You enter into a forward contract to take delivery of one million Deutsche marks three months from now. What happens to the price you will pay at expiration if marks depreciate during the contract?
- Your price will increase - Your price will decrease ** Your price was fixed at the onset of the contract - Your price was fixed, and you will receive correspondingly more marks due to the depreciation
70. Those subject to the winner's curse are:
- underwriters ** uninformed investors - firms issuing IPOs - venture capitalists
86. IPOs are generally overpriced in order to raise large amounts of cash.
FALSE
88. Underwriters are commercial banking firms that act as financial midwives to a new issue.
FALSE
91. Underwriters typically try to overprice the initial public offering.
FALSE
92. A firm's capital structure refers to the maturity of debt it employs.
FALSE
94. According to the efficient market hypothesis, large issues of new stock may depress the stock price temporarily.
FALSE
94. Under MM II assumptions, the expected return on equity is equal to the expected return on assets for a levered firm.
FALSE
95. A stock split will affect the stock's price while a stock dividend will not.
FALSE
95. Proposition II of MM states that the expected return on assets increases as the debt-equity ratio increases.
FALSE
96. A 50% stock dividend provides the same return to an investor as a 50% cash dividend.
FALSE
97. Even after relaxing the MM assumption of no taxes, it can be observed that restructuring does not affect the value of the firm.
FALSE
97. The effect of a stock repurchase is not equivalent to that of a cash dividend.
FALSE
98. Dividends are likely to shift up and down as earnings fluctuate so that managers can maintain a stable payout ratio.
FALSE
102. Dividend policy may be defined as the trade-off between retaining earnings on the one hand and paying out cash and issuing shares on the other.
TRUE
103. Debt financing affects neither the operating risk nor the business risk of the firm.
TRUE
103. Under current tax law, the longer an investor waits to sell an inflated stock, the lower is the present value of the tax liability.
TRUE
104. Canadian corporations are likely to prefer dividends over capital gains on their own investments.
TRUE
104. Financial leverage describes debt financing's amplification of the effects of changes in operating income on the returns to stockholders.
TRUE
105. Financial risk is the risk to shareholders that result from debt financing.
TRUE
105. If a firm declares a stock dividend of 10%, it would send each shareholder one additional share for each ten that are currently owned.
TRUE
106. In a two-for-one stock split, each investor would receive one additional share for each share already held.
TRUE
106. MM's Proposition II states that the expected return on equity increases as the firm's debt-equity ratio increases.
TRUE
108. A two-for-one stock split results in a doubling of the number of outstanding shares, but they do not affect the company's assets, profits, or total value.
TRUE
109. A 100% stock dividend results in a doubling of the number of outstanding shares, but they do not affect the company's assets, profits, or total value.
TRUE
75. Venture capital is traded for an equity interest rather than a debt interest in the new firm.
TRUE
76. When securities are issued under a firm commitment, the underwriter bears the risk of low sales.
TRUE
82. Issue costs for debt are considerably lower than issue costs for equity securities.
TRUE
83. The evidence indicates that stock prices decrease by approximately 3%, on average, when new equity issues are announced.
TRUE
87. The winner's curse theory assumes that the informed investor receives the majority of the underpriced IPOs.
TRUE
89. Underwriters usually play a triple role—first providing the company with procedural and financial advice, then buying the stock, and finally reselling it to the public.
TRUE
90. Sometimes new issues are dramatically underpriced.
TRUE
96. The benefit of an interest tax shield is captured by the equity holders.
TRUE
98. The "trade-off theory" of capital structure suggests that firms have an optimal level of debt.
TRUE
99. At some debt-equity ratio, the costs of financial distress are expected to overcome the value of the tax shield for a firm.
TRUE
28. Which statement is
TRUE concerning the one-year after-tax return on the following stocks, assuming a 40% tax rate on dividends and a 20% tax rate on capital gains: Stock A is purchased for $50, offers a 5% dividend yield, and is sold for $56; Stock B is purchased for $60, offers no dividend yield, but is sold after one year for $70. &- Stock A's after-tax return is higher by 1.27% ** Stock B's after-tax return is higher by 0.73% - Stock A's after-tax return is higher by 0.27% - Stock B's after-tax return is higher by 0.58% After-tax ReturnA = = = 12.6% After-tax ReturnB = = = 13.33% 13.33% - 12.6% = 0.73% difference
71. Research has shown all of the following to be
TRUE of the way corporations determine dividends except: ** Firms have short-run target payout ratios - Firms have long-run target payout ratios - The focus is more on dividend changes rather than absolute dividends - Managers try to avoid dividend changes that may need to be reversed
68. Which of the following statements regarding stock dividends and stock splits is
TRUE: &- A two-for-one stock split is equivalent to a 50% stock dividend - A three-for-one stock split is equivalent to a 66% stock dividend - A three-for-two stock split is equivalent to a 100% stock dividend ** A 50% stock dividend is equivalent to a three-for-two stock split
67. In a three for two stock split for a company that previously had 1 million shares outstanding selling at $100 per share and a total market value of $100 million, which of the following is
TRUE: &- The number of outstanding shares will drop to 666,666, and the stock price will increase to $150 ** The number of outstanding shares will increase to 1.5 million, and the stock price will drop to $66.67 - The number of outstanding shares will increase to 1.5 million, and the stock price will rise to $133.33 - The market value of the firm will increase 1 million shares x (.15) = 1.5 million Since total market value does not change: ($100 mil/1.5 mil shares) = $66.67 = Stock price
9. The stock in your portfolio was selling for $40 per share yesterday, but has today declared a three for two split. Which of the following statements seems to be
TRUE? &- There will be two-thirds as many shares outstanding, and they will sell for $60.00 each - There will be four times as many shares outstanding, and they will sell for $160.00 each ** There will be 50% more shares outstanding, and they will sell for $26.67 each - There will be one-and-one-half times as many shares outstanding, and they will sell for $60.00 each
95. A general cash offer is necessary when issuing a private placement.
FALSE
98. Typical firms that engage in private placements usually have a low degree of risk.
FALSE
73. Currently, M& S In- has 2 million shares outstanding selling at $70 a share. A rights issue will be made that allows 1 share to be purchased for every 5 shares currently held by stockholders for $40 each. Which of the following is true?
- The number of shares outstanding will fall to 1.6 million - The firm will raise $13.33 million ** The stock price will fall to $65 - The total value of the firm will equal $124 million Number of shares issued (2 million/5) = 400,000 Number of shares outstanding 2 million + 0.4 million = 2.4 million Firm will raise $40 x 400,000 = $16 million Total value of firm will increase from $140 million to $156 million Stock price will fall to ($156 million/2.4 million) = $65
36. The difference between an IPO and a secondary offering is that:
- The secondary offering does not incur direct costs - Venture capitalists fund the secondary offering ** Additional, non-outstanding shares are issued in an IPO - Shares may be repurposed by the underwriter in a secondary offering
39. Which of the following is correct for stock issued under a firm commitment where the underwriter is to receive an 8% spread?
- The underwriter's profits are guaranteed to be 8% - The underwriter must sell at least 92% of the shares - The underwriter receives 8% of all shares ** The underwriter may suffer a loss on the issue
41. Which of the following is correct if an underwriter is selling stock to the public at $40 per share, the underwriter receives a $3 per share spread, 2 million shares are sold, and the issuing firm receives $111 million from the underwriter?
- The underwriter's spread was greater than $3 - The issue appreciated in price immediately ** The issue included 3 million shares - The stock was issued on a best efforts basis
57. Which of the following statements is generally true concerning the costs of security issue?
- Underpricing is rarely a significant cost - Equity is cheaper to issue than debt ** Debt is cheaper to issue than equity - There are no economies of scale in security issuance
3. A firm's first offering of stock to the general public is known as:
- first-stage financing ** An IPO - A general cash offer - A seasoned offering
10. Studies have shown that, on average, new security issues are:
- subject to flotation costs of approximately 32% - Overpriced by the amount of the spread ** Underpriced - Overpriced to reward venture capitalists
44. Prospective investors are advised of a stock's potential risks by the:
- underwriter - Underpricing laws ** Prospectus - Initial public offering
78. Underwriters are guaranteed to profit by at least the amount of the spread.
FALSE
79. Rights offerings are gaining in popularity in Canada although they are declining on a foreign basis.
FALSE
80. Bought deals are more common in the U.S. than in Canada.
FALSE
84. Firms are attracted to the private placement of debt because of the lower average interest rates.
FALSE
85. A prospectus certificate indicates equity ownership in a firm.
FALSE
93. In an MM world, restructuring the firm will not change its overall value.
TRUE
96. Private placement contracts may be custom tailored for each individual investor.
TRUE
97. One advantage to private placements is the low cost associated with its issue.
TRUE