Corporate Finance

Which of the following statements is NOT CORRECT?

"Going public" establishes a firm's true intrinsic value and ensures that a liquid market will always exist for the firm's shares.

Last year Dania Corporation's sales were $525 million. If sales grow at 9.8% per year, how large (in millions) will they be 8 years later?

$1,109.12

You deposit $825 today in a savings account that pays 6% interest, compounded annually. How much will your account be worth at the end of 25 years?

$3,540.79

Helmuth Inc's latest net income was $1,500,000, and it had 225,000 shares outstanding. The company wants to pay out 45% of its income. What dividend per share should it declare? Do not round your intermediate calculations.

$3.00

Suppose a State of California bond will pay $1,000 eight years from now. If the going interest rate on these 8-year bonds is 5.4%, how much is the bond worth today?

$656.56

Kay Corporation's 5-year bonds yield 5.90% and 5-year T-bonds yield 4.40%. The real risk-free rate is r* = 2.5%, the inflation premium for 5-year bonds is IP = 1.50%, the default risk premium for Kay's bonds is DRP = 1.30% versus zero for T-bonds, and the maturity risk premium for all bonds is found with the formula MRP = (t - 1) 0.1%, where t = number of years to maturity. What is the liquidity premium (LP) on Kay's bonds?

0.20%

Zero Corp's total common equity at the end of last year was $350,000 and its net income was $70,000. What was its ROE?

20.00%

Song Corp's stock price at the end of last year was $28.75 and its earnings per share for the year were $1.30. What was its P/E ratio?

22.12

Ajax Corp's sales last year were $400,000, its operating costs were $362,500, and its interest charges were $12,500. What was the firm's times-interest-earned (TIE) ratio?

3.00

Suppose the rate of return on a 10-year T-bond is 6.90%, the expected average rate of inflation over the next 10 years is 2.0%, the MRP on a 10-year T-bond is 0.9%, no MRP is required on a TIPS, and no liquidity premium is required on any Treasury security. Given this information, what should the yield be on a 10-year TIPS? Disregard cross-product terms, i.e., if averaging is required, use the arithmetic average.

4.00%

Suppose the real risk-free rate is 4.20%, the average expected future inflation rate is 2.50%, and a maturity risk premium of 0.10% per year to maturity applies, i.e., MRP = 0.10%(t), where t is the number of years to maturity, hence the pure expectations theory is NOT valid. What rate of return would you expect on a 4-year Treasury security? Disregard cross-product terms, i.e., if averaging is required, use the arithmetic average.

7.10%

Royce Corp's sales last year were $250,000, and its net income was $23,000. What was its profit margin?

9.20%

You recently sold 200 shares of Disney stock, and the transfer was made through a broker. This is an example of

A secondary market transaction

Which of the following statements regarding a 30-year monthly payment amortized mortgage with a nominal interest rate of 10% is CORRECT?

A smaller proportion of the last monthly payment will be interest, and a larger proportion will be principal, than for the first monthly payment.

Under normal conditions, which of the following would be most likely to increase the coupon rate required for a bond to be issued at par?

Adding a call provision

Which of the following actions would be most likely to reduce potential conflicts of interest between stockholders and managers?

Change the corporation's formal documents to make it easier for outside investors to acquire a controlling interest in the firm through a hostile takeover.

Which of the following statements is CORRECT?

Convertible bonds generally have lower coupon rates than non-convertible bonds of similar default risk because they offer the possibility of capital gains.

Which of the following would be most likely to lead to a higher level of interest rates in the economy?

Corporations step up their expansion plans and thus increase their demand for capital.

Assume that interest rates on 20-year Treasury and corporate bonds are as follows: T-bond = 7.72% AAA = 8.72% A = 9.64% BBB = 10.18% The differences in these rates were probably caused primarily by:

Default and liquidity risk differences.

A call provision gives bondholders the right to demand, or "call for," repayment of a bond. Typically, companies call bonds if interest rates rise and do not call them if interest rates decline.

False

A decline in a firm's inventory turnover ratio suggests that it is improving both its inventory management and its liquidity position, i.e., that it is becoming more liquid.

False

A zero coupon bond is a bond that pays no interest and is offered (and initially sells) at par. These bonds provide compensation to investors in the form of capital appreciation.

False

If a firm sold some inventory for cash and left the funds in its bank account, its current ratio would probably not change much, but its quick ratio would decline.

False

If we are given a periodic interest rate, say a monthly rate, we can find the nominal annual rate by dividing the periodic rate by the number of periods per year.

False

In order to maximize its shareholders' value, a firm's management must attempt to maximize the stock price at a specific target date

False

Managers always attempt to maximize the long run value of the firms' stocks or the stocks' intrinsic value. This is exactly what stockholders desire. Thus, conflicts between shareholders and managers are not possible.

False

Midway through the life of an amortized loan, the percentage of the payment that represents interest must be equal to the percentage that represents repayment of principal. This is true regardless of the original life of the loan or the interest rate on the loan.

False

One disadvantage of forming a corporation rather than a partnership is that this makes it more difficult for the firm's investor to transfer their ownership interest

False

One of the four most fundamental factors that affect the cost of money as discussed in the text is the expected rate of inflation. If inflation is expected to be relatively high, then interest rates will tend to be relatively low, other things held constant.

False

Primary markets are large and important, while secondary markets are smaller and less important.

False

Since yield curves are based on a real risk-free rate plus the expected rate of inflation, at any given time there can be only one yield curve, and it applies to both corporate and Treasury securities.

False

Suppose the federal deficit increased sharply from one year to the next, and the Federal Reserve kept the money supply constant. Other things held constant, we would expect to see interest rates decline.

False

The greater the number of compounding periods within a year, then (1) the greater the future value of a lump sum investment at Time 0 and (2) the greater the present value of a given lump sum to be received at some future date.

False

The present value of a future sum increases as either the discount rate or the number of periods per year increases, other things held constant.

False

The term IPO stands for "individual purchase order," as when an individual (as opposed to an institution) places an order to buy a stock.

False

Which of the following is a primary market transaction?

IBM issues 2,000,000 shares of new stock and sells them to the public through an investment banker.

A 10-year bond pays an annual coupon, its YTM is 8%, and it currently trades at a premium. Which of the following statements is CORRECT?

If the yield to maturity remains at 8%, then the bond's price will decline over the next year.

A treasury bond has an 8% annual coupon and a 7.5% yield to maturity. Which of the following statements is CORRECT?

If the yield to maturity remains constant, the price of the bond will decline over time.

Which of the following events would make it more likely that a company would call its outstanding callable bonds?

Market interest rates decline sharply.

Which of the following is an example of a capital market instrument?

Preferred stock.

Which of the following Statements is CORRECT?

Reinvestment risk is lower, other things held constant, on long-term than on short-term bonds.

Money markets are markets for

Short-term debt securities such as Treasury bills and commercial paper

Which of the following statements is CORRECT?

The New York Stock Exchange is an auction market, and it has a physical location.

Which of the following statements is CORRECT?

The board of directors is the highest ranking body in a corporation, and the chairman of the board is the highest ranking individual. The CEO generally works under the board and its chairman, and the board generally has the authority to remove the CEO under certain conditions. The CEO, however, cannot remove the board, but he or she can endeavor to have the board voted out and a new board voted in should a conflict arise. It is possible for a person to simultaneously serve as CEO and chairman of the board, though many corporate control experts believe it is bad to vest both offices in the same person.

A 15-year bond with a face value of $1,000 currently sells for $850. Which of the following statements is CORRECT?

The bond's yield to maturity is greater than its coupon rate.

Which of the following statements is CORRECT?

The cash flows for an annuity due must all occur at the beginning of the periods.

A $50,000 loan is to be amortized over 7 years, with annual end-of-year payments. Which of these statements is CORRECT?

The proportion of each payment that represents interest as opposed to repayment of principal would be lower if the interest rate were lower.

Which of the following actions would be most likely to reduce potential conflicts of interest between the shareholders and bondholders?

The use of covenants in bond agreements that limit the firm's use of additional debt and constrain managers' action

If the Treasury yield curve is downward sloping, how should the yield to maturity on a 10-year Treasury coupon bond compare to that on a 1-year T-bill?

The yield on a 10-year bond would be less than that on a 1-year bill.

A financial intermediary is a corporation that takes funds from investors and then provides those funds to those who need capital. A bank that takes in demand deposits and then uses that money to make long term mortgage loans is one example of a financial intermediary.

True

Debt management ratios show the extent to which a firm's managers are attempting to magnify returns on owners' capital through the use of financial leverage.

True

Hedge funds are somewhat similar to mutual funds. The primary differences are that hedge funds are less highly regulated, have more flexibility regarding what they can buy, and restrict their investors to wealthy, sophisticated individuals and institutions.

True

If a bank compounds savings accounts quarterly, the effective annual rate will exceed the nominal rate.

True

Junk bonds are high-risk, high-yield debt instruments. They are often used to finance leveraged buyouts and mergers, and to provide financing to companies of questionable financial strength.

True

Other things held constant, the more debt a firm uses, the lower the firm's profit margin will be.

True

The "yield curve" shows the relationship between bonds' maturities and their yields.

True

The market value of any real or financial asset, including stocks, bonds, or art work purchased in hope of selling it at a profit, may be estimated by determining future cash flows and then discounting them back to the present.

True

The times-interest-earned ratio measures the extent to which operating income can decline before the firm is unable to meet its annual interest costs.

True

When a loan is amortized, a relatively low percentage of the payment goes to reduce the outstanding principal in the early years, and the principal repayment's percentage increases in the loan's later years.

True

The primary operating goal of a publicly-owned firm trying to best serve its stockholders should be to

Use a well-structured managerial compensation package to reduce conflicts that may exist between stockholders and managers.

Which of the following mechanisms would be most likely help motivate managers to act in the best interest of shareholders?

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