Finance Exam 2

Sugar Cookies will pay an annual dividend of $1.23 a share next year. The firm expects to increase this dividend by 8 percent per year the following four years and then decrease the dividend growth to 2 percent annually thereafter. Which one of the following is the correct computation of the dividend for Year 7?

($1.23) ×(1.08)^4×(1.02)^2

There are three open positions on the board of directors of XYZ Enterprises. The company has 264,000 shares of stock outstanding. Each share is entitled to one vote. How many shares of stock must you own to guarantee your personal election to the board of directors if the firm uses cumulative voting?

66,001 shares

payback period decision criteria

< cutoff time

Average accounting return decision criteria

> cutoff amount

Which one of the following is most closely related to the net present value profile A: internal rate of return B: average accounting return C: profitability index D: payback E: discount payback

A: Internal rate of return

Which one of the following indicates that an independent project is definitely acceptable A: profitability index >1.0 B: negative net present value C: modified internal rate return that is lower than the requirement D: zero internal rate of return E: positive average accounting return

A: Profitability Index > 1.0

Which one of the following bonds is most apt to have the smallest liquidity premium? A: Treasury bill B: Corporate bond issued by a new firm C: Municipal bond issued by the State of New York D: Municipal bond issued by a rural city in Alaska E: Corporate bond issued by General Motors (GM)

A: treasury bill

Which of the following must equal zero if a firm pays constant annual dividend A: Dividend yield B: Capital gains yield C: Total return D: Par value per share E: Book value per share

B: Capital gains yield

the internal rate of return is the: A:discount rate that causes a project's aftertax income to equal zero. B: discount rate that results in a zero net present value for the project. C: discount rate that results in a net present value equal to the project's initial cost. D: rate of return required by the project's investors. E: project's current market rate of return

B: Discount rate that results in a zero net present value for the project

Which one of the following statements is correct? A: The internal rate of return is the most reliable method of analysis for any type of investment decision. B: The payback method is biased toward short-term projects. C: The modified internal rate of return is most useful when projects are mutually exclusive. D: The average accounting return is the most difficult method of analysis to compute. E: The net present value method is applicable only if a project has conventional cash flows.

B: the payback method is biased towards short-term projects

Which one of the following will occur when the internal rate of return equals the required return A: The average accounting return will equal 1.0. B: The profitability index will equal 1.0. C: The profitability index will equal 0. D: The net present value will equal the initial cash outflow. E: The profitability index will equal the average accounting return

B: the profitability index will equal 1.0

All else held constant, the present value of a bond increases when the A: coupon rate decreases. B: yield to maturity decreases. C: current yield increases. D: time to maturity of a premium bond decreases. E: time to maturity of a zero coupon bond increases

B: yield to maturity decreases

the net present value of an investment represents the difference between the investment's: A: cash inflows and outflows. B: cost and its net profit. C: cost and its market value. D: cash flows and its profits. E: assets and liabilities

C: cost and it's market value

Inside quotes are defined as the A: bid and asked prices presented by NYSE DMMs. B: last bid and asked price offered prior to the market close. C: lowest asked and highest bid offers. D: daily opening bid and asked quotes. E: last traded bid and asked prices.

C: lowest asked and highest bid offers

The possibility that more than one discount rate can cause the net present value of an investment to equal zero is referees to as: A: duplication B: the net present value profit C: multiple rate of return D: the AAR problem E: the dual dilemma

C: multiple rates of return

Which of the following can be defined as a benefit-cost ratio A: net present value B: internal rate of return C: profitability index D: accounting rate of return E: modified internal rate of return

C: profitability index

which one of the following statements is correct? Assuming cash flows are conventional A: If the IRR exceeds the required return, the profitability index will be less than 1.0. B: The profitability index will be greater than 1.0 when the net present value is negative. C: When the internal rate of return is greater than the required return, the net present value is positive. D: Projects with conventional cash flows have multiple internal rates of return. E: If two projects are mutually exclusive, you should select the project with the shortest payback period.

C: the internal rate of return is greater than the required return, the NPV is positive

features of bonds

Coupon, coupon rate, face value, par value, maturity

the payback method of analysis ignores which one of the following A: Initial cost of an investment B: Arbitrary cutoff point C: Cash flow direction D: Time value of money E: Timing of each cash inflow

D: time value of money

The lowest rating a bond can receive from standard and poor's (S&P) and still be classified as an investment-quality bond is: A: BB B: B C: B D: Ba E: BBB

E: BBB

The price at which a dealer will purchase a bond is referred to as the _____ price. A: asked B: face C: call D: put E: bid

E: Bid

Which of the following types of bonds should an investor purchase if he or she is primarily concerned about ensuring that bond ownership will increase their purchasing power A: OTC B: death C: CAT D: PETS E: TIPS

E: TIPS

If a project with conventional cash flows has a profitability index of 1, the project will A) never pay back. B) have a negative net present value. C) have a negative internal rate of return. D) produce more cash inflows than outflows in today's dollars. E) have an internal rate of return that equals the required return.

E: have an internal rate of return that equals the required return

Which one of the following individuals is most apt to purchase a municipal bond. A: Minimum-wage employee B: Retired individual with minimal current income C: Recent college graduate D: Tax-exempt organization E: Highly compensated business owner

E: highly compensated business owners

Which one of the following is specifically designed to compute the rate of return on a project that has multiple negative cash flows that are interrupted by one or more positive cash flows A: average accounting return B: profitability index C: internal rate of return D: indeed rate of return E: modified internal rate of return

E: modified internal rate of return

IRR decision criteria

IRR> discount rate

bond ratings

Moody's and Standard and Poor's rating services. used to determine the credit-worthiness of corporate issuers

Profitability index decision criteria

PI> 1

Benefits and drawbacks of payback period

Pros: - easy to understand - adjusts for uncertainties of later cash flows - biases towards liquidity cons: - ignores the time value of money - requires an arbitrary cutoff point - ignores cash flows beyond the cutoff date - biases against long-term projects, such as research and development, and new projects

call provision

a provision in a bond contract that gives the issuer the right to redeem the bonds under specified terms prior to the normal maturity date

initial cost

actual total expenditure for the investment

Bond

borrowing money from the public on a long-term basis. Mostly issued for the government or large businesses - the lender pays back interest every month but doesn't pay back the principal until the end of the loan - bond prices and interest rates will always move in opposite directions

Common stock valuations

dividend paying stock and non-dividend paying stock

Municipal bonds are: A: generally purchased by tax-exempt investors. B: risk-free. C: issued by federal, state, and local governmental bodies. D: zero coupon bonds. E: generally callable

generally callable.

NPV decision criteria

if NPV is positive

mutually exclusive projects

projects that compete with one another, so that the acceptance of one eliminates from further consideration all other projects that serve a similar function. If deciding whether or not to choose between mutually exclusive projects, pick the best/ highest option since you can only pick one.

Independent Projects

projects with cash flows that are not affected by the acceptance or non-acceptance of other projects. If deciding weather or not to choose between independent projects, pick any and all that meet the criteria

benefits and drawbacks to IRR

pros: - closely related to NPV, often leading to the same decisions - easy to understand and communicate cons: -may result in multiple answers with nonconventional cashflows - may lead to incorrect decisions in comparison of mutually exclusive investments

dividend

stock payment, not always cash

cost erosion

the cash flows to a new project that come at the expense of a firm's existing projects

incremental cash flow

the difference between a firm's future cash flows with a project and those without the project

determine the relationship between interest rate and coupon rate & maturity of the bonds

the higher the interest rate/coupon rate, the less time it will take for a bond to mature

bid price

the price a dealer is willing to pay for a security

ask price

the price at which a dealer will sell a security

Capital Budgeting

the process of planning and managing a firm's long-term investments. Deciding what long-term investment to make by using NPV, AAR, IRR, PBP, and PI

Determinate of bond yields (also components of term structure)

the relationship between long-term and short-term interest rates. Tells us what the nominal interest rates are on default-free, pure discount bonds of all maturities

inflation and interest rate (define Fisher equation)

the relationship between nominal returns, real returns, and inflation 1+R=(1+r)x(1+h) R= nominal rate r= real rate h= inflation rate

Define interest rate risk

the risk that arises for bond owners from fluctuating interest rates - the more time of a bond, the more the interest rate will affect the price - there is more uncertainty in longer amounts of time - can also look at the slope if there is a graph

examples of different types of bonds

treasury bond: government issued Private bond: nongovernment issued