Financial Management Final Exam

Which of the following statements is most correct? a. Corporations are taxed more favorably than sole proprietorships. b. Corporations have unlimited liability. c. Because of their size, large corporations face fewer regulations than smaller corporations and sole proprietorships. d. Reducing the threat of corporate takeover increases the likelihood that managers will act in shareholders' interest. e. Bond covenants are designed to reduce potential conflicts between stockholders and bondholders.

. Bond covenants are designed to reduce potential conflicts between stockholders and bondholders.

The payment made each period on an amortized loan is constant, and it consists of some interest and some principal. The closer we are to the end of the loan's life, the smaller the percentage of the payment that will be a repayment of principal. a. True b. False

B. False

Which of the following could explain why a business might choose to operate as a corporation rather than as a sole proprietorship or a partnership? a. Corporations generally face fewer regulations. b. Less of a corporation's income is generally subject to federal taxes. c. Corporate shareholders are exposed to unlimited liability, but this factor is offset by the tax advantages of incorporation. d. Corporate investors are exposed to unlimited liability. e. Corporations generally find it easier to raise large amounts of capital.

Corporations generally find it easier to raise large amounts of capital.

Which of the following statements is most correct? a. A hostile takeover is the main method of transferring ownership interest in a corporation. b. The corporation is a legal entity created by the state and is a direct extension of the legal status of its owners and managers, that is, the owners and managers are the corporation. c. Unlimited liability and limited life are two key advantages of the corporate form over other forms of business organization. d. In part due to limited liability and ease of ownership transfer, corporations have less trouble raising money in financial markets than other organizational forms. e. Although stockholders of the corporation are insulated by limited legal liability, the legal status of the corporation does not protect the firm's managers in the same way.

D. In part due to limited liability and ease of ownership transfer, corporations have less trouble raising money in financial markets than other organizational forms.

Which of the following mechanisms would be most likely to help motivate managers to act in the best interests of shareholders? a. Decrease the use of restrictive covenants in bond agreements. b. Take actions that reduce the possibility of a hostile takeover. c. Elect a board of directors that allows managers greater freedom of action. d. Increase the proportion of executive compensation that comes from stock options and reduce the proportion that is paid as cash salaries. e. Eliminate a requirement that members of the board of directors have a substantial investment in the firm's stock.

D. Increase the proportion of executive compensation that comes from stock options and reduce the proportion that is paid as cash salaries.

Suppose Randy Jones plans to invest $1,000. He can earn an effective annual rate of 5% on Security A, while Security B has an effective annual rate of 12%. After 11 years, the compounded value of Security B should be somewhat less than twice the compounded value of Security A. (Ignore risk, and assume that compounding occurs annually.) a. True b. False

False

The primary goal of a publicly-owned firm interested in serving its stockholders should be to a. Maximize expected total corporate profit. b. Maximize expected EPS. c. Minimize the chances of losses. d. Maximize the stock price per share. e. Maximize expected net income.

Maximize stock price per share

Tucker Corporation is planning to issue new 20-year bonds. The current plan is to make the bonds non-callable, but this may be changed. If the bonds are made callable after 5 years at a 5% call premium, how would this affect their required rate of return? a. Because of the call premium, the required rate of return would increase. b. There is no reason to expect a change in the required rate of return. c. The required rate of return would decline because the bond would then be less risky to a bondholder. d. The required rate of return would increase because the bond would then be less risky to a bondholder. e. It is impossible to say without more information.

A. Because of the call premium, the required rate of return would increase.

You plan to analyze the value of a potential investment by calculating the sum of the present values of its expected cash flows. Which of the following would lower the calculated value of the investment? a. The cash flows are in the form of a deferred annuity, and they total to $100,000. You learn that the annuity lasts for only 5 rather than 10 years, hence that each payment is for $20,000 rather than for $10,000. b. The discount rate increases. c. The riskiness of the investment's cash flows decreases. d. The total amount of cash flows remains the same, but more of the cash flows are received in the earlier years and less are received in the later years. e. The discount rate decreases.

B. The discount rate increases.

Which of the following statements is CORRECT? a. A zero coupon bond's current yield is equal to its yield to maturity. b. If a bond's yield to maturity exceeds its coupon rate, the bond will sell at par. c. All else equal, if a bond's yield to maturity increases, its price will increase. d. If a bond's yield to maturity exceeds its coupon rate, the bond will sell at a discount below par. e. All else equal, if a bond's yield to maturity increases, its current yield will fall.

D. If a bond's yield to maturity exceeds its coupon rate, the bond will sell at a discount below par.

Which of the following statements is most correct? a. The proper goal of the financial manager should be to maximize the firm's expected cash flow, because this will add the most wealth to each of the individual shareholders (owners) of the firm. b. One way to state the decision framework most useful for carrying out the firm's objective is as follows: "The financial manager should seek that combination of assets, liabilities, and capital that will generate the largest expected projected after-tax income over the relevant time horizon." c. The riskiness inherent in a firm's earnings per share (EPS) depends on the characteristics of the projects the firm selects, which means it depends upon the firm's assets, but EPS does not depend on the manner in which those assets are financed. d. Since large, publicly-owned firms are controlled by their management teams, and typically, ownership is widely dispersed, managers have great freedom in managing the firm. Managers may operate in stockholders' best interests, but they may also operate in their own personal best interests. As long as managers stay within the law, there simply aren't any effective controls over managerial decisions in such situations. e. Agency problems exist between stockholders and managers, and between stockholders and creditors.

E

Bob has a $50,000 stock portfolio with a beta of 1.2, an expected return of 10.8 percent, and a standard deviation of 25 percent. Becky has a $50,000 portfolio with a beta of 0.8, an expected return of 9.2 percent, and a standard deviation of 25 percent. The correlation coefficient, r, between Bob's and Becky's portfolios is 0. Bob and Becky are engaged to be married. Which of the following best describes their combined $100,000 portfolio? a. The combined portfolio's expected return is a simple average of the expected returns of the two individual portfolios (10%). b. The combined portfolio's beta is a simple average of the betas of the two individual portfolios (1.0). c. The combined portfolio's standard deviation is less than a simple average of the two portfolios' standard deviations (25%), even though there is no correlation between the returns of the two portfolios. d. Statements a and b are correct. e. All of the statements above are correct.

E. All of them are correct.

The primary operating goal of a publicly-owned firm trying to best serve its stockholders should be to a. Maximize managers' own interests, which are by definition consistent with maximizing shareholders' wealth. b. Maximize shareholder wealth, which is equivalent to maximizing the firm's stock price per share. c. Minimize the firm's risks because most stockholders dislike risk. In turn, this will maximize the firm's stock price. d. Use a well-structured managerial compensation package to maximize conflicts that may exist between stockholders and managers. e. Since it is impossible to measure a stock's intrinsic value, the text states that it is better for managers to attempt to maximize the current stock price than its intrinsic value.

Maximize shareholder wealth, which is equivalent to maximizing the firm's stock price per share.

Which of the following statements is CORRECT? a. One disadvantage of forming a corporation is that equity investors are usually exposed to more liability than they would be in a partnership. b. Corporations face fewer regulations than sole proprietorships. c. One disadvantage of operating a business as a corporation is that the firm is subject to double taxation, because taxes are levied at both the firm level and the individual shareholder level. d. It is generally less expensive to form a corporation than a proprietorship because, with a proprietorship, extensive legal documents are required. e. If a partnership goes bankrupt, each partner is exposed to liabilities only up to the amount of his or her investment in the business.

One disadvantage of operating a business as a corporation is that the firm is subject to double taxation, because taxes are levied at both the firm level and the individual shareholder level.

An investor is considering buying one of two bonds issued by Carson City Airlines. Bond A has a 7 percent annual coupon, whereas Bond B has a 9 percent annual coupon. Both bonds have 10 years to maturity, face values of $1,000, and yields to maturity of 8 percent. Assume that the yield to maturity for both of the bonds will remain constant over the next 10 years. Which of the following statements is most correct? Bond A has a higher price than Bond B today, but one year from now the bonds will have the same price as each other. Bond B has a higher price than Bond A today, but one year from now the bonds will have the same price as each other. Both bonds have the same price today, and the price of each bond is expected to remain constant until the bonds mature. One year from now, Bond A's price will be higher than it is today. Bond A's current yield (not to be confused with its yield to maturity) is greater than 8 percent.

One year from now, Bond A's price will be higher than it is today.

Suppose someone offered you the choice of two equally risky annuities, each paying $10,000 per year for five years. One is an ordinary (or deferred) annuity, the other is an annuity due. Which of the following statements is most correct? a. The present value of the ordinary annuity must exceed the present value of the annuity due, but the future value of an ordinary annuity may be less than the future value of the annuity due. b. The present value of the annuity due exceeds the present value of the ordinary annuity, while the future value of the annuity due is less than the future value of the ordinary annuity. c. The present value of the annuity due exceeds the present value of the ordinary annuity, and the future value of the annuity due also exceeds the future value of the ordinary annuity. d. If interest rates increase, the difference between the present value of the ordinary annuity and the present value of the annuity due remains the same. e. Statements a and d are correct.

The present value of the annuity due exceeds the present value of the ordinary annuity, and the future value of the annuity due also exceeds the future value of the ordinary annuity. (Both present value and future value exceed.

Managers do not always attempt to maximize the long-run value of their firms' stocks, or the stocks' intrinsic values. Thus, conflicts between stockholders and managers can exist. Additionally, there can be conflicts between stockholders and bondholders. a. True b. False

True

Until this year, Cheers Inc. was organized as a partnership. This year, the partners have decided to organize the business as a corporation. As a result of this change in organizational form, which of the following statements is most correct? a. Cheers' shareholders (the ex-partners) will now have limited liability. b. Cheers will now be subject to fewer regulations. c. Cheers will now pay less in taxes. d. Cheers' investors will now find it more difficult to transfer ownership. e. Cheers will now find it more difficult to raise additional capital.

a. Cheers' shareholders (the ex-partners) will now have limited liability.

Which of the following is correct? a. Even if the pure expectations theory is correct, there might at times be an inverted Treasury yield curve. b. If the yield curve is inverted, short-term bonds have lower yields than long-term bonds. c. The higher the maturity risk premium, the higher the probability that the yield curve will be inverted. d. Inverted yield curves can exist for Treasury bonds, but because of default premiums, the corporate yield curve cannot become inverted. e. The most likely explanation for an inverted yield curve is that investors expect inflation to increase in the future.

a. Even if the pure expectations theory is correct, there might at times be an inverted Treasury yield curve.

Which of the following works to reduce agency conflicts between stockholders and bondholders? a. Including restrictive covenants in the company's bond contract. b. Providing managers with a large number of stock options. c. The passage of laws that make it easier for companies to resist hostile takeovers. d. Statements b and c are correct. e. All of the statements above are correct.

a. Including restrictive covenants in the company's bond contract.

Which of the following statements is most correct? a. One advantage of forming a corporation is that you have limited liability. b. Corporations face fewer regulations than sole proprietorships. c. One disadvantage of being a sole proprietor is that you have to pay corporate taxes, even though you don't realize the benefits of being a corporation. d. Statements b and c are correct. e. None of the statements above is correct.

a. One advantage of forming a corporation is that you have limited liability.

Which of the following statements is most correct? a. The stock valuation model, P0 = D1/(ks - g), can be used for firms which have negative growth rates. b. If a stock has a required rate of return ks = 12 percent, and its dividend grows at a constant rate of 5 percent, this implies that the stock's dividend yield is 5 percent. c. The price of a stock is the present value of all expected future dividends, discounted at the dividend growth rate. d. Statements a and c are correct. e. All of the statements above are correct.

a. The stock valuation model, P0 = D1/(ks - g), can be used for firms which have negative growth rates.

One reason the preemptive right is important to shareholders is because it a. prevents managers from issuing and purchasing a large number of additional shares b. will result in higher dividends per share. c. is included in every corporate charter. d. protects the current shareholders against an increase in their ownership interests. e. protects bondholders, and thus enables the firm to issue debt with a relatively low interest rate.

a. prevents managers from issuing and purchasing a large number of additional shares

Which of the following statements regarding a 15-year (180-month) $125,000, fixed-rate mortgage is CORRECT? (Ignore taxes and transactions costs.) a. The remaining balance after three years will be $125,000 less one third of the interest paid during the first three years. b. Because it is a fixed-rate mortgage, the monthly loan payments (which include both interest and principal payments) are constant. c. Interest payments on the mortgage will increase steadily over time, but the total amount of each payment will remain constant. d. The proportion of the monthly payment that goes towards repayment of principal will be lower 10 years from now than it will be the first year. e. The outstanding balance declines at a slower rate in the later years of the loan's life.

b. Because it is a fixed-rate mortgage, the monthly loan payments (which include both interest and principal payments) are constant.

Which of the following statements is CORRECT? (Assume that the risk-free rate is a constant.) a. If the market risk premium increases by 1%, then the required return on all stocks will rise by 1%. b. If the market risk premium increases by 1%, then the required return will increase for stocks that have a positive beta, but it will decrease for stocks that have a negative beta. c. If the market risk premium increases by 1%, then the required return will increase by 1% for a stock that has a beta of 0.50. d. The effect of a change in the market risk premium on the required rate of return depends on the level of the risk-free rate. e. The effect of a change in the market risk premium on the required rate of return depends on the slope of the yield curve.

b. If the market risk premium increases by 1%, then the required return will increase for stocks that have a positive beta, but it will decrease for stocks that have a negative beta.

Stock A and Stock B both have an expected return of 10 percent and a standard deviation of 25 percent. Stock A has a beta of 0.8 and Stock B has a beta of 1.2. The correlation coefficient, r, between the two stocks is 0.6. Portfolio P is a portfolio with 50 percent invested in Stock A and 50 percent invested in Stock B. Which of the following statements is most correct? a. Portfolio P has a coefficient of variation equal to 2.5. b. Portfolio P has more market risk than Stock A but less market risk than Stock B. c. Portfolio P has a standard deviation of 25 percent and a beta of 1.0. d. All of the statements above are correct. e. None of the statements above is correct.

b. Portfolio P has more market risk than Stock A but less market risk than Stock B.

Stock A and Stock B both have an expected return of 10% and a standard deviation of returns of 25%. Stock A has a beta of 0.8 and Stock B has a beta of 1.2. The correlation coefficient, r, between the two stocks is 0.6. Portfolio P is a portfolio with 50% invested in Stock A and 50% invested in Stock B. Which of the following statements is CORRECT? a. Portfolio P has a coefficient of variation equal to 2.5. b. Portfolio P has more market risk than Stock A but less market risk than Stock B. c. Portfolio P has a standard deviation of 25% and a beta of 1.0. d. Based on the information we are given, and assuming those are the views of the marginal investor, it is apparent that the two stocks are in equilibrium. e. Stock A should have a higher expected return than Stock B as viewed by the marginal investor.

b. Portfolio P has more market risk than Stock A but less market risk than Stock B.

Which of the following statements is most correct? a. Sinking fund provisions do not require companies to retire their debt; they only establish "targets" for the company to reduce its debt over time. b. Sinking fund provisions sometimes work to the detriment of bondholders--particularly if interest rates have declined over time. c. If interest rates have increased since the time a company issues bonds with a sinking fund provision, the company is more likely to retire the bonds by buying them back in the open market, as opposed to calling them in at the sinking fund call price. d. Statements a and b are correct. e. Statements b and c are correct.

b. Sinking fund provisions sometimes work to the detriment of bondholders--particularly if interest rates have declined over time. c. If interest rates have increased since the time a company issues bonds with a sinking fund provision, the company is more likely to retire the bonds by buying them back in the open market, as opposed to calling them in at the sinking fund call price.

A 10-year Treasury bond has an 8% coupon, and an 8-year Treasury bond has a 10% coupon. Neither is callable, and both have the same yield to maturity. If the yield to maturity of both bonds decreases by the same amount, which of the following statements would be CORRECT? a. The prices of both bonds will decrease by the same amount. b. Both bonds would decline in price, but the 10-year bond would have the greater percentage decline in price. c. Both bonds would increase in price, but the 10-year bond would have the greater percentage increase in price. d. One bond's price would increase, while the other bond's price would decrease. e. The prices of the two bonds would remain constant.

c. Both bonds would increase in price, but the 10-year bond would have the greater percentage increase in price.

Which of the following statements is correct? a. If companies have fewer good investment opportunities, interest rates are likely to increase. b. If individuals increase their savings rate, interest rates are likely to increase. c. If expected inflation increases, interest rates are likely to increase. d. Interest rates on all debt securities tend to rise during recessions because recessions increase the possibility of bankruptcy, hence the riskiness of all debt securities. e. Interest rates on long-term bonds are more volatile than rates on short-term debt securities like T-bills.

c. If expected inflation increases, interest rates are likely to increase.

Which of the following statements is correct? a. Downward sloping yield curves are inconsistent with the expectations theory. b. The shape of the yield curve depends only on expectations about future inflation. c. If the pure expectations theory is correct, a downward sloping yield curve indicates that interest rates are expected to decline in the future. d. If the yield curve is upward sloping, the inflation rate must be expected to increase. e. Yield curves must be either upward or downward sloping—they cannot first rise and then decline.

c. If the pure expectations theory is correct, a downward sloping yield curve indicates that interest rates are expected to decline in the future.

Which of the following statements is most correct? a. One of the advantages of the corporate form of organization is that there is no double taxation. b. The partnership form of organization has easy transferability of ownership. c. One of the disadvantages of the sole proprietorship form of organization is that there is unlimited liability. d. Statements b and c are correct. e. None of the statements above is correct.

c. One of the disadvantages of the sole proprietorship form of organization is that there is unlimited liability.

Which of the following statements is most correct? a. Relative to short-term bonds, long-term bonds have less interest rate risk but more reinvestment rate risk. b. Relative to short-term bonds, long-term bonds have more interest rate risk and more reinvestment risk. c. Relative to coupon-bearing bonds, zero coupon bonds have more interest rate risk but less reinvestment rate risk. d. If interest rates increase, all bond prices will increase, but the increase will be greatest for bonds that have less interest rate risk. e. One advantage of zero coupon bonds is that you don't have to pay any taxes until you sell the bond or it matures.

c. Relative to coupon-bearing bonds, zero coupon bonds have more interest rate risk but less reinvestment rate risk.

Your bank account pays a 6% nominal rate of interest. The interest is compounded quarterly. Which of the following statements is CORRECT? a. The periodic rate of interest is 1.5% and the effective rate of interest is 3%. b. The periodic rate of interest is 6% and the effective rate of interest is greater than 6%. c. The periodic rate of interest is 1.5% and the effective rate of interest is greater than 6%. d. The periodic rate of interest is 3% and the effective rate of interest is 6%. e. The periodic rate of interest is 6% and the effective rate of interest is also 6%. 

c. The periodic rate of interest is 1.5% and the effective rate of interest is greater than 6%.

Under normal conditions, which of the following would be most likely to decrease the coupon rate required for a bond to be issued at par? a. Removing some restrictive covenants that limit management's actions. b. Adding a call provision. c. The rating agencies change the bond's rating from Baa to Aaa. d. Making the bond a debenture rather than a first mortgage bond. e. Removing a sinking fund.

c. The rating agencies change the bond's rating from Baa to Aaa.

Which of the following statements is CORRECT, assuming stocks are in equilibrium? a. The dividend yield on a constant growth stock must equal its expected total return plus its expected capital gains yield. b. Assume that the required return on a given stock is 13%. If the stock's dividend is growing at a constant rate of 5%, its expected dividend yield is 5% as well. c. A stock's dividend yield can never exceed its expected growth rate. d. A required condition for one to use the constant growth model is that the stock's required rate of return exceeds the expected growth rate. e. Other things held constant, the higher a company's beta coefficient, the lower its required rate of return.

d. A required condition for one to use the constant growth model is that the stock's required rate of return exceeds the expected growth rate.

Which of the following actions are likely to reduce the agency problem between stockholders and managers? a. Congress passes a law that severely restricts hostile takeovers. b. A manager receives a lower salary but receives additional shares of the company's stock. c. The board of directors has become more vigilant in its oversight of the company's management. d. Statements b and c are correct. e. All of the statements above are correct.

d. Statements b and c are correct. A manager receives a lower salary but receives additional shares of the company's stock. c. The board of directors has become more vigilant in its oversight of the company's management.

Which of the following statements is CORRECT? a. One disadvantage of operating as a corporation rather than as a partnership is that corporate shareholders are exposed to more personal liability than are partners. b. Relative to sole proprietorships, corporations generally face fewer regulations, and they also find it easier to raise capital. c. There is no good reason to expect a firm's stockholders and bondholders to react differently to the types of assets in which it invests. d. Stockholders should generally be happier than bondholders to have managers invest in risky projects with high potential returns as opposed to safe projects with lower expected returns. e. Bondholders should generally be happier than stockholders to have managers invest in risky projects with high potential returns as opposed to safe projects with lower expected returns.

d. Stockholders should generally be happier than bondholders to have managers invest in risky projects with high potential returns as opposed to safe projects with lower expected returns.

Stock A has a beta of 1.5 and Stock B has a beta of 0.5. Which of the following statements must be true about these securities? (Assume the market is in equilibrium.) a. When held in isolation, Stock A has greater risk than Stock B. b. Stock B would be a more desirable addition to a portfolio than Stock A. c. Stock A would be a more desirable addition to a portfolio than Stock B. d. The expected return on Stock A will be greater than that on Stock B. e. The expected return on Stock B will be greater than that on Stock A.

d. The expected return on Stock A will be greater than that on Stock B.

Stocks A and B have the following data: Stock A has a required return of 10%, its stock has a market price of $25, and Stock A has an expected growth rate of 9%. Stock B has a required return of 12%, its stock has a market price of $40, and Stock B has an expected growth rate of 9%. Assuming the stock market is efficient and the stocks are in equilibrium, which of the following statements is CORRECT? a. These two stocks should have the same price. b. These two stocks must have the same dividend yield. c. These two stocks should have the same expected return. d. These two stocks must have the same expected capital gains yield. e. These two stocks must have the same expected year-end dividend.

d. These two stocks must have the same expected capital gains yield.

Which of the following statements would most people in business agree with? a. A corporation's short-run profits will almost always increase if the firm takes actions that the government has determined are in the best interests of the nation. b. Firms and government agencies almost always agree with one another regarding the restrictions that should be placed on hiring and firing employees. c. "Whistle blowers," because of the courage it takes to blow the whistle, are generally promoted more rapidly than other employees. d. It is not useful for large corporations to develop a formal set of rules defining ethical and unethical behavior. e. Although people's moral characters are probably developed before they are admitted to a business school, it is still useful for business schools to cover ethics, if only to give students an idea about the adverse consequences of unethical behavior to themselves, their firms, and the nation.

e. Although people's moral characters are probably developed before they are admitted to a business school, it is still useful for business schools to cover ethics, if only to give students an idea about the adverse consequences of unethical behavior to themselves, their firms, and the nation.

Which of the following statements is most correct? a. Corporations are taxed more favorably than sole proprietorships. b. Corporations have unlimited liability. c. Because of their size, large corporations face fewer regulations than smaller corporations and sole proprietorships. d. Reducing the threat of corporate takeover increases the likelihood that managers will act in shareholders' interest. e. Bond covenants are designed to reduce potential conflicts between stockholders and bondholders. 

e. Bond covenants are designed to reduce potential conflicts between stockholders and bondholders.

Assume that the risk-free rate is 5%. Which of the following statements is correct? a. If a stock's beta doubled, its required return would also double. b. If a stock's beta doubled, its required return would more than double. c. If a stock's beta were 1.0, its required return would be 5%. d. If a stock's beta were less than 1.0, its required return would be less than 5%. e. If a stock has a negative beta, its required return would be less than 5%.

e. If a stock has a negative beta, its required return would be less than 5%.

Which of the following is likely to encourage a firm's managers to make decisions that are in the best interest of shareholders? a. Executive compensation comes primarily in the form of stock options. b. The state legislature recently passed a law that makes it more difficult to successfully complete a hostile takeover. c. Institutional investors such as mutual funds and pension funds hold large amounts of the firm's stock. d. Statements a and b are correct. e. Statements a and c are correct.

e. Statements a and c are correct. Executive compensation comes primarily in the form of stock options. Institutional investors such as mutual funds and pension funds hold large amounts of the firm's stock.