BUAD 3040 Finance Conceptual Problems Final
If its yield to maturity declined by 1%, which of the following bonds would have the largest percentage increase in value?
A 10-year zero coupon bond.
Which of the following bonds has the greatest price risk?
A 10-year, $1,000 face value, zero coupon bond.
A bond trader observes the following information: • The Treasury yield curve is downward sloping. • Empirical data indicate that a positive maturity risk premium applies to both Treasury and corporate bonds. • Empirical data also indicate that there is no liquidity premium for Treasury securities but that a positive liquidity premium is built into corporate bond yields.
A 5-year corporate bond must have a higher yield than a 10-year Treasury bond.
Which of the following statements is CORRECT?
A good example of a sunk cost is money that a banking corporation spent last year to investigate the site for a new office, then expensed that cost for tax purposes, and now is deciding whether to go forward with the project.
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 is CORRECT?
A sunk cost is a cost that was incurred and expensed in the past and cannot be recovered if the firm decides not to go forward with the project.
Stocks A and B have the following data. Assuming the stock market is efficient and the stocks are in equilibrium, which of the following statements is CORRECT? A B Price $25 $40 Expected growth 7% 9% Expected return 10% 12%
A's expected dividend is $0.75 and B's expected dividend is $1.20.
Which of the following is NOT a capital component when calculating the weighted average cost of capital (WACC) for use in capital budgeting?
Accounts payable.
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.
The relative risk of a proposed project is best accounted for by which of the following procedures?
Adjusting the discount rate upward if the project is judged to have above-average risk.
Which of the following statements is CORRECT?
All else equal, if a bond's yield to maturity increases, its price will fall.
Which of the following statements is CORRECT?
An example of an externality is a situation where a bank opens a new office, and that new office causes deposits in the bank's other offices to decline.
Which of the following statements is CORRECT?
An example of an externality is a situation where a bank opens a new office, and that new office causes deposits in the bank's other offices to increase.
Which of the following statements is CORRECT?
An increase in expected inflation, combined with a constant real risk-free rate and a constant market risk premium, would lead to identical increases in the required returns on a riskless asset and on an average stock, other things held constant.
Three $1,000 face value, 10-year, noncallable, bonds have the same amount of risk, hence their YTMs are equal. Bond 8 has an 8% annual coupon, Bond 10 has a 10% annual coupon, and Bond 12 has a 12% annual coupon. Bond 10 sells at par. Assuming that interest rates remain constant for the next 10 years, which of the following statements is CORRECT?
Bond 8 sells at a discount (its price is less than par), and its price is expected to increase over the next year.
Which of the following items is NOT normally considered to be a current asset?
Bonds.
Walter Industries' current ratio is 0.5. Considered alone, which of the following actions would increase the company's current ratio?
Borrow using short-term notes payable and use the cash to increase inventories.
Which of the following could explain why a business might choose to operate as a corporation rather than as a proprietorship or a partnership?
Corporations generally find it easier to raise large amounts of capital
Which of the following items cannot be found on a firm's balance sheet under current liabilities?
Cost of goods sold.
On its 12/31/15 balance sheet, Barnes Inc showed $510 million of retained earnings, and exactly that same amount was shown the following year. Assuming that no earnings restatements were issued, which of the following statements is CORRECT?
Dividends could have been paid in 2015, but they would have had to equal the earnings for the year.
Which of the following statements is CORRECT?
If Firms X and Y have the same net income, number of shares outstanding, and price per share, then their P/E ratios must also be the same
Which of the following statements is CORRECT?
If a coupon bond is selling at par, its current yield equals its yield to maturity, and its expected capital gains yield is zero.
Which of the following statements is CORRECT?
If a coupon bond is selling at par, its current yield equals its yield to maturity.
Which of the following statements is CORRECT?
If a firm is more profitable than average, we would normally expect to see its stock price exceed its book value per share.
Which of the following statements is CORRECT? Assume that all projects being considered have normal cash flows and are equally risky.
If a project's IRR is equal to its WACC, then under all reasonable conditions the project's NPV must be zero.
Assume that the risk-free rate is 5%. Which of the following statements is CORRECT?
If a stock has a negative beta, its required return under the CAPM would be less than 5%.
Stock HB has a beta of 1.5 and Stock LB has a beta of 0.5. The market is in equilibrium, with required returns equaling expected returns. Which of the following statements is CORRECT?
If both expected inflation and the market risk premium (rM - rRF) increase, the required return on Stock HB will increase by more than that on Stock LB.
Companies HD and LD have the same total assets, sales, operating costs, and tax rates, and they pay the same interest rate on their debt. Both firms finance using only debt and common equity and total assets equal total invested capital. However, company HD has a higher total debt to total capital ratio. Which of the following statements is CORRECT?
If the interest rate the companies pay on their debt is less than their basic earning power (BEP), then Company HD will have the higher ROE.
Bankston Corporation forecasts that if all of its existing financial policies are followed, its proposed capital budget would be so large that it would have to issue new common stock. Since new stock has a higher cost than retained earnings, Bankston would like to avoid issuing new stock. Which of the following actions would REDUCE its need to issue new common stock?
Increase the percentage of debt in the target capital structure.
A firm wants to strengthen its financial position. Which of the following actions would increase its current ratio?
Issue new stock, then use some of the proceeds to purchase additional inventory and hold the remainder as cash.
The primary operating goal of a publicly-owned firm interested in serving its stockholders should be to
Maximize the stock price per share over the long run, which is the stock's intrinsic value.
Which of the following statements is CORRECT?
One of the disadvantages of a proprietorship is that the proprietor is exposed to unlimited liability.
Consider the following information for three stocks, A, B, and C. The stocks' returns are positively but not perfectly positively correlated with one another, i.e., the correlations are all between 0 and 1. Stock Expected Return Standard Deviation Beta A 10% 20% 1.0 B 10% 10% 1.0 C 12% 12% 1.4 Portfolio AB has half of its funds invested in Stock A and half in Stock B. Portfolio ABC has one third of its funds invested in each of the three stocks. The risk-free rate is 5%, and the market is in equilibrium, so required returns equal expected returns. Which of the following statements is CORRECT?
Portfolio ABC's expected return is 10.66667%.
Stock A has a beta of 0.8, Stock B has a beta of 1.0, and Stock C has a beta of 1.2. Portfolio P has 1/3 of its value invested in each stock. Each stock has a standard deviation of 25%, and their returns are independent of one another, i.e., the correlation coefficients between each pair of stocks is zero. Assuming the market is in equilibrium, which of the following statements is CORRECT?
Portfolio P's expected return is equal to the expected return on Stock B.
Which of the following is an example of a capital market instrument?
Preferred stock.
Suppose Tapley Inc. uses a WACC of 8% for below-average risk projects, 10% for average-risk projects, and 12% for above-average risk projects. Which of the following independent projects should Tapley accept, assuming that the company uses the NPV method when choosing projects?
Project B, which has below-average risk and an IRR = 8.5%.
Which of the following statements is CORRECT?
Proprietorships and partnerships generally have a tax advantage over corporations.
Money markets are markets for
Short-term debt securities such as Treasury bills and commercial paper.
Which of the following statements is CORRECT?
Sinking fund provisions sometimes turn out to adversely affect bondholders, and this is most likely to occur if interest rates decline after the bond was issued.
Stocks A and B have the following data. Assuming the stock market is efficient and the stocks are in equilibrium, which of the following statements is CORRECT? A B Price $25 $25 Expected growth (constant) 10% 5% Required return 15% 15%
Stock A's expected dividend at t = 1 is only half that of Stock B.
Which of the following is NOT a relevant cash flow and thus should NOT be reflected in the analysis of a capital budgeting project?
Sunk costs that have been expensed for tax purposes.
Which of the following statements is CORRECT?
The NYSE operates as an auction market, whereas NASDAQ is an example of a dealer market.
Which of the following statements is CORRECT?
The advantage of the basic earning power ratio (BEP) over the return on total assets for judging a company's operating efficiency is that the BEP does not reflect the effects of debt and taxes.
A 10-year corporate bond has an annual coupon of 9%. The bond is currently selling at par ($1,000). Which of the following statements is CORRECT?
The bond's expected capital gains yield is zero.
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.
Analysts who follow Howe Industries recently noted that, relative to the previous year, the company's net cash provided from operations increased, yet cash as reported on the balance sheet decreased. Which of the following factors could explain this situation?
The company made large investments in fixed assets.
Casey Communications recently issued new common stock and used the proceeds to pay off some of its short-term notes payable. This action had no effect on the company's total assets or operating income. Which of the following effects would occur as a result of this action?
The company's current ratio increased.
Amram Inc. can issue a 20-year bond with a 6% annual coupon at par. This bond is not convertible, not callable, and has no sinking fund. Alternatively, Amram could issue a 20-year bond that is convertible into common equity, may be called, and has a sinking fund. Which of the following most accurately describes the coupon rate that Amram would have to pay on the second bond, the convertible, callable bond with the sinking fund, to have it sell initially at par?
The coupon rate could be less than, equal to, or greater than 6%, depending on the specific terms set, but in the real world the convertible feature would probably cause the coupon rate to be less than 6%.
Which of the following would indicate an improvement in a company's financial position, holding other things constant?
The current and quick ratios both increase.
Which of the following is most likely to occur as you add randomly selected stocks to your portfolio, which currently consists of 3 average stocks?
The diversifiable risk of your portfolio will likely decline, but the expected market risk should not change.
Below is the common equity section (in millions) of Timeless Technology's last two year-end balance sheets: 2015 2014 Common stock 2,000 1,000 Retained earnings 2,000 2,340 Total common equity $4,000 $3,340 The firm has never paid a dividend to its common stockholders. Which of the following statements is CORRECT?
The firm issued common stock in 2015.
Which of the following actions would be likely to encourage a firm's managers to make decisions that are in the best interests of shareholders?
The percentage of the firm's stock that is held by institutional investors such as mutual funds, pension funds, and hedge funds rather than by small individual investors rises from 10% to 80%.
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?
The required rate of return would increase because the bond would then be more risky to a bondholder.
Taggart Technologies is considering issuing new common stock and using the proceeds to reduce its outstanding debt. The stock issue would have no effect on total assets, the interest rate Taggart pays, EBIT, or the tax rate. Which of the following is likely to occur if the company goes ahead with the stock issue?
The tax bill will increase.
Safeco's current assets total to $20 million versus $10 million of current liabilities, while Risco's current assets are $10 million versus $20 million of current liabilities. Both firms would like to "window dress" their end-of-year financial statements, and to do so they tentatively plan to borrow $10 million on a short-term basis and to then hold the borrowed funds in their cash accounts. Which of the statements below best describes the results of these transactions?
The transactions would lower Safeco's financial strength as measured by its current ratio but raise Risco's current ratio.
Other things held constant, if the expected inflation rate decreases and investors also become more risk averse, the Security Market Line would be affected as follows:
The y-axis intercept would decline, and the slope would increase.
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.
The real risk-free rate is expected to remain constant at 3% in the future, a 2% rate of inflation is expected for the next 2 years, after which inflation is expected to increase to 4%, and there is a positive maturity risk premium that increases with years to maturity. Given these conditions, which of the following statements is CORRECT?
The yield on a 5-year Treasury bond must exceed that on a 2-year Treasury bond.
Stocks A and B have the following data. Assuming the stock market is efficient and the stocks are in equilibrium, which of the following statements is CORRECT? A B Required return 10% 12% Market price $25 $40 Expected growth 7% 9%
These two stocks must have the same dividend yield.
Assume the following: The real risk-free rate, r*, is expected to remain constant at 3%. Inflation is expected to be 3% next year and then to be constant at 2% a year thereafter. The maturity risk premium is zero. Given this information, which of the following statements is CORRECT?
This problem assumed a zero maturity risk premium, but that is probably not valid in the real world.
Your portfolio consists of $50,000 invested in Stock X and $50,000 invested in Stock Y. Both stocks have an expected return of 15%, betas of 1.6, and standard deviations of 30%. The returns of the two stocks are independent, so the correlation coefficient between them, rXY, is zero. Which of the following statements best describes the characteristics of your 2-stock portfolio?
Your portfolio has a beta equal to 1.6, and its expected return is 15%.
For a typical firm, which of the following sequences is CORRECT? All rates are after taxes, and assume that the firm operates at its target capital structure.
re > rs > WACC > rd.
