Exam#2 (5-9)
What is the real interest rate given a nominal rate of 8% and an inflation rate of 4.5%? A) 8.0% B) 4.9% C) 4.5% D) 3.3%
D) 3.3%
Which of the following formulas will correctly calculate Net Working Capital? A) Cash - Inventory + Receivables + Payables B) Cash + Inventory + Receivables + Payables C) Cash+Inventory-Receivables+Payables D) Cash + Inventory + Receivables - Payables
D) Cash + Inventory + Receivables - Payables
Matilda Industries pays a dividend of $2.25 per share and is expected to pay this amount indefinitely. If Matildaʹs equity cost of capital is 12%, which of the following would be expected to be closest to Matildaʹs stock price? A) $18.75 B) $12.25 C) $14.65 D) $21.98
A) $18.75
How much will the coupon payments be of a 30-year $10,000 bond with a 4.5% coupon rate and semiannual payments? A) $225 B) $30 C) $450 D) $350
A) $225
An oil company is buying a semi-submersible oil rig for $20 million. Additionally, it will cost $1.5 23) million to move the oil rig to the oil-field and to prepare it for operations. If it is depreciated over five years using straight-line depreciation, what are the yearly depreciation expenses in this case? A) $4.0 million B) $4.3 million C) $3.8 million D) $5.0 million
A) $4.0 million
Praetorian Industries will pay a dividend of $2.50 per share this year and has an an equity cost of capital of 8%. Praetorianʹs stock is currently trading at $84 per share. By comparing Praetorian with similar firms, an investor expects that its dividends will grow by up to 5% per year. What is the best next step that the investor should take regarding Praetorianʹs stock? A) Revise her estimate of Praetorianʹs dividend growth. B) Short Praetorianʹs stock. C) Revise Praetorianʹs equity cost of capital. D) Sell any Praetorian stock that she owns.
A) Revise her estimate of Praetorianʹs dividend growth.
Which of the following statements is true of bond prices? A. A rise in interest rates causes bond prices to fall. B. A fall in bond prices causes interest rates to fall. C. A fall in interest rates causes a fall in bond prices. D. Bond prices and interest rates are not connected.
A. A rise in interest rates causes bond prices to fall.
Which of the following statements is FALSE? A. According to the constant dividend growth model, the value of then from depends on the current dividend level, divided by the equity cost of capital plus the grow rate. B. Successful young films often have high initial earnings growth rates. C. Estimating dividends, especially for the distant future, is difficult. D. A firm can only pay out its earnings to investors or reinvest their earnings.
A. According to the constant dividend growth model, the value of then from depends on the current dividend level, divided by the equity cost of capital plus the grow rate.
Which of the following statements is FALSE? A. Fundamentally, interest rates are determined by the Federal Reserve. B. The Federal Reserve determines very short-term interest rates through its influence on the federal funds rate. C. The interest rates that banks offer on investments or charge on loans depend on the horizon of the investment or loan. D. The interest rates that are quoted by banks and other financial institutions are nominal interest rates.
A. Fundamentally, interest rates are determined by the Federal Reserve.
According to Graham and Harvey's 2001 survey (Figure 8.2 in the text), the most popular decision rules for capital budgeting used by CFOs are ____________________. A. IRR, NPV, Payback period B. Profitability index, NPV, IRR C. MIRR, IRR, Payback period D. NPV, IRR, MIRR
A. IRR, NPV, Payback period
In an effort to maintain price stability, it is expected that the European Central Bank will raise interest rates in the future. Which of the following is the most likely effect of such an action on short - term and long - term interest rates in Europe? A. Long-term interest rates will tend to be higher than short-term interest rates. B. Both long-and short-term interest rates would be expected to fall sharply. C. No relative change in short and long term interest rates could be predicted. D. Long-term interest rates will be about the same as short-term interest rates.
A. Long-term interest rates will tend to be higher than short-term interest rates.
Which of the following statement is FALSE about interest rates? A. The annual percentage rate indicates the amount of interest including the effect of compounding. B. The effective annual rate indicates the amount of interest that will be earned at the end of one year. C. As interest rates may be quoted for different time intervals, it is often necessary to adjust the interest rate to a time period that matches that of cast flows. D. The annual percentage rate indicates the amount of simple interest earned in one year.
A. The annual percentage rate indicates the amount of interest including the effect of compounding.
How does the credit spread change with the bond rating? Why? A. The credit spread increases as the bond rating falls because lower-rated bonds are riskier. B. The credit spread decreases as the bond rating rises because higher-rated bonds are riskier. C. The credit spread decreases as the bond rating falls because lower-rated bonds are riskier. D. The credit spread increases as the bond rating rises because higher-rated bonds are riskier.
A. The credit spread increases as the bond rating falls because lower-rated bonds are riskier.
Which of the following is NOT a way that a firm can increase its dividend? A. by increasing its retention rate B. by increasing its earnings (net income) C. by decreasing its shares outstanding D. by increasing its dividend payout rate
A. by increasing its retention rate
Which of the following formulas in INCORRECT? A. rE = (Div1 / P0) - g B. g = Retention Rate x Return on New Investment C. DIVt = EPSt x Dividend Payout Rate D. Po = Div1 / (rE - g)
A. rE = (Div1 / P0) - g
Which of the following is NOT a limitation of the payback rule? A) It does not consider the time value of money. B) It is difficult to calculate. C) Lacks a decision criterion that is economically based. D) It does not consider cash flows occurring after the payback period.
B) It is difficult to calculate.
Which of the following statement is FALSE regarding profitable and unprotect able growth? A. A firm can increase its growth rate by retaining more of its earning . B. If a firm wants to increase it share price, it must diversify. C. If a firm retains more earnings, it will pay out less of those earnings, reducing its dividends. D. Cutting a firm's dividend to increase investment will raise the stock price if the new investment has positive net present value (NPV).
B. If a firm wants to increase it share price, it must diversify.
What is the effective annual rate (EAR)? A. It refers to the cash flows from an investment over a one-year period divided by the number of times that interest is compounding during the year. B. It is the interest rate that would earn the same interest with annual compounding. C. It is the ratio of the number of the annual percentage rate to the number of compounding periods per year. D. It is the interest rate for an n - year time interval, where n may be more than one year or less than or equal to one year (a fraction).
B. It is the interest rate that would earn the same interest with annual compounding.
Which of the following situations would result in lowing of interest rates by the banking authority of a country? A. The level of investment is quite high. B. The economy is slowing down. C. The rate of saving is quite low. D. Inflation is rising rapidly.
B. The economy is slowing down.
Which of the following reasons for considering long-term loans inherently more risky than short-term loans is most accurate? A. Long-term loans typically have ongoing cost that accumulate over the life of the loan. B. The loan values are very sensitive to changes in market interest rates. C. There is a greater chance that inflation may fall in a longer time-frame. D. The penalties for closing out a long term loan early make them unattractive to many investors.
B. The loan values are very sensitive to changes in market interest rates.
Which of the following statements is FALSE? A. The payback rule is useful in cases where the cost of making an correct decision might not be large enough to justify the time required for calculating the net present value (NPV). B. The payback rule is reliable because it considers the time value of money and depends on the cost of capital. C. FOr most investment opportunities, expenses occur initially and cash is received later. D. Fifty percent of firms surveyed reporting using the payback rule for making decisions.
B. The payback rule is reliable because it considers the time value of money and depends on the cost of capital.
Historically, why were high inflation rates associated with high nominal interest rates? A. Growth in investment and savings is encouraged when consumers are judged to be overspending. B. The real interest rate needs to be high enough so that individuals can expect their savings to have greater purchasing power in the future than in the present. C. Individuals will spend more when they expect their investments to increase in value. D. High inflation leads to a decrease in purchasing power and thus increases the attractiveness of investment over consumption in the short term.
B. The real interest rate needs to be high enough so that individuals can expect their savings to have greater purchasing power in the future than in the present.
A decrease in the sales of a current project because of the launching of a new project is A. a sunk cost B. cannibalization C. an overhead expense D. irrelevant to the investment decision
B. cannibalization
You are trying to decide between three mutually exclusive investment opportunities. The most appropriate tool identifying the correct decision is __________________. A. profitability index B. net present value (NPV) C. incremental internal rate of return (IRR) D. internal rate of return (IRR)
B. net present value (NPV)
You are opening up a brand new retail strip mall. You presently have more potential retail outlets wanting to locate in your mall than you have space available. What is the most appropriate tool to use if you are trying to determine the optimal allocation of your retail space? A. payback period B. profitability index C. internal rate of return (IRR) D. net present value (NPV)
B. profitability index
On a particular date, FedEx has a stock price of $88.66 and an EPS of $6.34. Its competitor, UPS, 6) had an EPS of $0.40. What would be the expected price of UPS stock on this date, if estimated using the method of comparables? A) $8.39 B) $10.49 C) $5.59 D) $13.98
C) $5.59
A bond has three years to maturity, a $2000 face value, and a 6.3% coupon rate with annual coupons. What is its yield to maturity if it is currently trading at $1801? A) 6.30% B) 9.22% C) 10.32% D) 8.48%
C) 10.32%
Jumbuck Exploration has a current stock price of $2.00 and is expected to sell for $2.10 in one 1) yearʹs time, immediately after it pays a dividend of $0.26. Which of the following is closest to Jumbuck Explorationʹs equity cost of capital? A) 12% B) 22% C) 18% D) 9%
C) 18%
A bank offers a loan that will requires you to pay 6% interest compounded monthly. Which of the following is closest to the EAR charged by the bank? A) 6.00% B) 5.84% C) 6.17% D) 72.00%
C) 6.17%
A firm has an opportunity to invest $100,000 today that will yield $115,000 in one year. If interest rates are 6%, what is the net present value (NPV) of this investment? A) $14,151 B) $15,000 C) $9000 D) $8491
D) $8491
Which of the following bonds is trading at a premium? A) a two-year bond with a $50,000 face value whose yield to maturity is 5.2% and coupon rate is 5.2% APR paid monthly B) a ten-year bond with a $4000 face value whose yield to maturity is 6.0% and coupon rate is 5.9% APR paid semiannually C) a five-year bond with a $2000 face value whose yield to maturity is 7.0% and coupon rate is 7.2% APR paid semiannually D) a 15-year bond with a $10,000 face value whose yield to maturity is 8.0% and coupon rate is 7.8% APR paid semiannually
C) a five-year bond with a $2000 face value whose yield to maturity is 7.0% and coupon rate is 7.2% APR paid semiannually
What are dividend payments? A) payments made to a company by investors for a share of the ownership of that company B) incremental increases in the value of the stock held by an investor due to rises in share price C) a part share of the profits or earnings of a company paid to each shareholder on the basis of the number of shares they hold D) the difference between the original cost price of a share and the price an investor receives when that share is sold
C) a part share of the profits or earnings of a company paid to each shareholder on the basis of the number of shares they hold
Which of the following statements is FALSE? A. The payback investment rule is based on the notion that an opportunity that pays back its initial investments quickly is a good idea. B. A net present value (NPV) will always exist for an investment opportunity. C. An internal rate of return (IRR) will always exist for an investment opportunity. D. In general, there can be as many internal rates of returns (IRRs) as the number of times the project's cash flows change sign over time.
C. An internal rate of return (IRR) will always exist for an investment opportunity.
Which of the following will be a source of cash flows for a shareholder of a certain stock? I. Sale of the shares at a future date. II. The firm in which the shares are held paying out crash to shareholders in the form of dividends. III. The firm in which the shares are held increasing the total number of shares outstanding through a stock split. A. I only B. II only C. I and II D. II and III
C. I and II
Given that the inflation rate in 2006 was about 3.24%, while a short-term municipal bond offered a rate of 2.9%, which of the following statement is correct? A. The purchasing power of investors in these bonds grew over the course of the year. B. The nominal interest rate offered by these bonds gave the try increase in purchasing power that resulted from investing in these bonds. C. Investors in the these bonds were able to buy less at the end of the year than they could have purchased at the start of the year. D. The real interest rate for investors in these bonds was greater than the rate of inflation.
C. Investors in the these bonds were able to buy less at the end of the year than they could have purchased at the start of the year.
Which of the following will NOT increase a company's dividend payments? A. It can increase its earnings. B. It can increase its dividend payout rate. C. It can issue more shares. D. It can decrease the number of shares outstanding
C. It can issue more shares
When the costs of an investment come before that investment's benefits, what will be the effect of a rise in interest rates on the attractiveness of that investment to potential investors? A. It will make it more attractive, since it will increase the investment's net present value (NPV). B. It will make it more attractive, since it will decrease the investment's net present value (NPV). C. It will make it less attractive, since it will decrease the investment's net present value (NPV). D. It will make it less attractive, since it will increase the investment's net present value (NPV).
C. It will make it less attractive, since it will decrease the investment's net present value (NPV).
Which of the following formulas is INCORRECT? A. earnings growth rate = retention rate x return on new investment b. Div1 = EPSt x Dividend Payout Rate C. Pn = (rE - g) x DivN+1 D. rE = (DivT / Po) + g
C. Pn = (rE - g) x DivN+1
How are investors in zero - coupon bonds compensated for making such an investment? A. Such bonds make regular interest payments. B. Such Bonds are purchased at their face value and sold at a premium on a later date. C. Such bonds are purchased ad a discount, below their face value. D. Such bonds have a lower face value as compared to other bonds of similar term.
C. Such bonds are purchased at a discount, below their face value.
Which of the following statements is FALSE of the dividend - discount model? A. As firms mature, their growth slows to rates more typical of established companies. B. The dividend - discount model values the stock based on a forecast of the future dividends paid to shareholders. C. We cannot use the dividend - discount model to value the stock of a firm with rapid or changing growth. D. The simplest forecast for the firm's future dividends states that they they will grow at a constant rate, i.e., forever.
C. We cannot use the dividend - discount model to value the stock of a firm with rapid or changing growth.
Which of the following statements is FALSE? A. Only include as incremental expenses in your capital budgeting analysis the additional overhead expenses that arise because of the decision to take on the project. B. Many projects use a resource that the company already owns. C. When evaluating a capital budgeting decision, we generally include interest expense. D. As a practical matter, to derive the forecasted cash flows of a project, financial managers often begin by forecasting earnings.
C. When evaluating a capital budgeting decision, we generally include interest expense.
Bond is trading below PAR or at a discount when
Coupon rate < yield to maturity
Bond is trading at PAR when
Coupon rate = yield to maturity
Bond is trading at above PAR or at PREMIUM when
Coupon rate > yield to maturity
Valuation models use the relationship between share value, future cash flows, and the cost of capital to estimate these quantities for a given firm. Realistically, for a publicly traded firm, what can we reliably use such models to determine? I. the firmʹs future cash flows II. the firmʹs cost of capital III. the firmʹs stock price A) I only B) III only C) II only D) I and II
D) I and II
A lottery winner can take $6 million now or be paid $600,000 at the end of each of the next 16 19) years. The winner calculates the internal rate of return (IRR) of taking the money at the end of each year and, estimating that the discount rate across this period will be 6%, decides to take the money at the end of each year. Was her decision correct? A) Yes, because it agrees with the payback rule. B) Yes, because it agrees with both the Net Present Value rule and the payback rule. C) No, because it disagrees with the Net Present Value rule. D) Yes, because it agrees with the Net Present Value rule.
D) Yes, because it agrees with the Net Present Value rule.
An investor estimates the value of a firm which manufactures cookware by examining the cash flows of similar firms. Which of the following is assumed to be the same for these firms? A) annual growth rates B) P/E C) payout rates D) all of the above
D) all of the above
Which of the following situations can lead to IRR giving a different decision than NPV? A. delayed investment B. differences in project scale C. multiple IRRS D. All of the above can lead to IRR giving a different decision than NPV.
D. All of the above can lead to IRR giving a different decision than NPV.
Which of the following statements regarding bonds and their terms is FALSE? A. Bonds typically make two types of payments to their holders. B. Bonds are securities sold by governments and corporations to raise money from investors today in exchange for a promised futures payment. C. The time remaining until the repayment date is known as the term of the bond. D. By convention, the coupon rate is expressed as an effective annual rate.
D. By convention , the coupon rate is expressed as an effective annual rate.
Which of the following statements is FALSE? A. In general, the difference between the cost of capital and the internal rate of return (IRR) is the maximum amount of estimation error in the cost of capital estimate that can exist without altering the original decision. B. The internal rate of return (IRR) can provide information on how sensitive your analysis is to errors in the estimate of your cost of capital. C. If you are unsure of your cost of capital estimate, it is important to determine how sensitive your analysis is to errors in this estimate. D. If the cost of capital estimate is more than the internal rate of return (IRR), the net present value (NPV) will be positive.
D. If the cost of capital estimate is more than the internal rate of return (IRR), the net present value (NPV) will be positive.
Why are the interest rates of U. S. Treasury securities less than the interest rates equivalent corporate bonds? A. U.S. Treasury securities yield inflation adjusted interest rates. B. The U.S. government has high credit spread. C. There is significant risk that the U.S. government will default. D. U.S. Treasury securities are widely regarded to be risk - free.
D. U.S. Treasury securities are widely regarded to be risk - free.
Which of the following would you NOT consider when making a capital budgeting decision? A. the additional taxes a firm would have to pay in the next year B. the opportunity to lease out a warehouse instead of using it to house a new production line C. the change in direct labor expense due to the purchase of a new machine D. the cost of a marketing study completed last year
D. the cost of a marketing study completed last year
An announcement by the government that they will decrease corporate marginal tax rates in the future would increase the attractiveness of MACRS depreciation. TRUE/FALSE
FALSE
A firm can either pay it earnings to its investors, or it can keep them and invest them. TRUE/FALSE
TRUE
Bonds with high risk of default generally offer high yields. TRUE/FALSE
TRUE
Firms should use the most accelerated depreciation scheme allowable. TRUE/FALSE
TRUE
Interest and other financing - related expenses are excluded when determining a project's unleveled net income. TRUE/FALSE
TRUE
Market forces determine interest rates based ultimately on the willingness of individuals, banks, and firms to borrow, save, and lead. TRUE FALSE
TRUE
The Net Present Value rule implies that we should compare a project's net present value (NVP) to zero. TRUE/FALSE
TRUE
The payback is based on the idea than an opportunity that pays back it initial investment quickly is a worth while opportunity. TRUE/FALSE
TRUE
When different investment rules give conflicting answers, then decisions should be based on the Net Present Value rule, as it is the most reliable and accurate decision rule. TRUE/FALSE
TRUE
When you borrow money, the interest rate on the borrowed money is the price you pay to be able to convert your future loan payments into money today. TRUE FALSE
TRUE
