Business Finance Midterm Prep

Which of the following statements is NOT CORRECT? a. The stock of publicly owned companies must generally be registered with and reported to a regulatory agency such as the SEC. b. When a corporation's shares are owned by a few individuals, we say that the firm is "closely, or privately, held." c. When stock in a closely held corporation is offered to the public for the first time, the transaction is called "going public, or an IPO," and the market for such stock is called the new issue or IPO market. d. "Going public" establishes a firm's true intrinsic value and ensures that a liquid market will always exist for the firm's shares. e. It is possible for a firm to go public and yet not raise any additional new capital for the firm itself.

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

Your uncle is about to retire, and he wants to buy an annuity that will provide him with $80,000 of income a year for 20 years, with the first payment coming immediately. The going rate on such annuities is 5.25%. How much would it cost him to buy the annuity today? a. $1,027,427.14 b. $1,058,249.96 c. $1,202,089.76 d. $1,243,186.84 e. $955,507.24

$1,027,427.14

New Business is just being formed by 10 investors, each of whom will own 10% of the business. The firm is expected to earn $500,000 before taxes each year. The corporate tax rate is 34% and the personal tax rate for the firm's investors is 35%. The firm does not need to retain any earnings, so all of its after-tax income will be paid out as dividends to its investors. The investors will have to pay personal taxes on whatever they receive. How much additional spendable income will each investor have if the business is organized as a partnership rather than as a corporation? a. $9,282 b. $10,056 c. $11,713 d. $12,266 e. $11,050

$11,050

Shrives Publishing recently reported $13,000 of sales, $5,500 of operating costs other than depreciation, and $1,250 of depreciation. The company had $3,500 of bonds that carry a 6.25% interest rate, and its federal-plus-state income tax rate was 35%. During the year, the firm had expenditures on fixed assets and net operating working capital that totaled $1,550. These expenditures were necessary for it to sustain operations and generate future sales and cash flows. What was its free cash flow? (Round your intermediate and final answers to whole dollar amount.) a. $3,086 b. $3,763 c. $4,704 d. $2,898 e. $3,161

$3,763

Sue now has $320. How much would she have after 8 years if she leaves it invested at 8.5% with annual compounding? a. $510.11 b. $590.01 c. $731.37 d. $602.30 e. $614.59

$614.59

A disadvantage of the corporate form of organization is that corporate stockholders are more exposed to personal liabilities in the event of bankruptcy than are investors in a typical partnership. Select one: True False

'False'.

One advantage of the corporate form of organization is that it avoids double taxation. Select one: True False

'False'.

The primary reason the annual report is important in finance is that it is used by investors when they form expectations about the firm's future earnings and dividends and the riskiness of those cash flows. Select one: True False

'True'.

Time lines can be constructed for annuities where the payments occur at either the beginning or the end of the periods. Select one: True False

'True'.

When a corporation's shares are owned by a few individuals who are associated with the firm's management, we say that the stock is closely held. Select one: True False

'True'.

Stock X has a beta of 0.6, while Stock Y has a beta of 1.4. Which of the following statements is CORRECT? a. If the market risk premium declines but expected inflation is unchanged, the required return on both stocks will decrease, but the decrease will be greater for Stock Y. b. Stock Y must have a higher expected return and a higher standard deviation than Stock X. c. If expected inflation increases but the market risk premium is unchanged, then the required return on both stocks will fall by the same amount. d. If expected inflation declines but the market risk premium is unchanged, then the required return on both stocks will decrease but the decrease will be greater for Stock Y. e. A portfolio consisting of $50,000 invested in Stock X and $50,000 invested in Stock Y will have a required return that exceeds that of the overall market.

If the market risk premium declines but expected inflation is unchanged, the required return on both stocks will decrease, but the decrease will be greater for Stock Y.

47. Returns for the Dayton Company over the last 3 years are shown below. What's the standard deviation of the firm's returns? (Hint: This is a sample, not a complete population, so the sample standard deviation formula should be used.) Do not round your intermediate calculations. Year Return 2013 21.00% 2012 -12.50% 2011 35.00% a. 23.43% b. 27.09% c. 18.79% d. 24.41% e. 30.02%

24.41%

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? a. 3.48 b. 2.61 c. 2.46 d. 3.66 e. 3.00

3.00

A new firm is developing its business plan. It will require $735,000 of assets (which equals total invested capital), and it projects $450,000 of sales and $355,000 of operating costs for the first year. Management is reasonably sure of these numbers because of contracts with its customers and suppliers. It can borrow at a rate of 7.5%, but the bank requires it to have a TIE of at least 4.0, and if the TIE falls below this level the bank will call in the loan and the firm will go bankrupt. The firm will use only debt and common equity for financing. What is the maximum debt to capital ratio (measured as debt/total invested capital) the firm can use? (Hint: Find the maximum dollars of interest, then the debt that produces that interest, and then the related debt to capital ratio.) Do not round your intermediate calculations. a. 53.85% b. 38.78% c. 43.08% d. 46.53% e. 34.90%

43.08%

Sadik Inc.'s bonds currently sell for $1,300 and have a par value of $1,000. They pay a $105 annual coupon and have a 15-year maturity, but they can be called in 5 years at $1,100. What is their yield to call (YTC)? a. 5.10% b. 5.31% c. 4.30% d. 4.94% e. 6.00%

5.31%

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. a. 7.10% b. 7.53% c. 5.40% d. 6.96% e. 7.67%

7.10%

Malko Enterprises' bonds currently sell for $1,020. They have a 6-year maturity, an annual coupon of $75, and a par value of $1,000. What is their current yield? a. 8.46% b. 6.40% c. 6.62% d. 6.91% e. 7.35%

7.35%

Which of the following statements best describes what you should expect if you randomly select stocks and add them to your portfolio? a. Adding more such stocks will have no effect on the portfolio's risk. b. Adding more such stocks will increase the portfolio's expected rate of return. c. Adding more such stocks will reduce the portfolio's market risk but not its unsystematic risk. d. Adding more such stocks will reduce the portfolio's beta coefficient and thus its systematic risk. e. Adding more such stocks will reduce the portfolio's unsystematic, or diversifiable, risk.

Adding more such stocks will reduce the portfolio's unsystematic, or diversifiable, risk.

Which of the following statements is CORRECT? a. Both NASDAQ dealers and "specialists" on the NYSE hold inventories of stocks. b. If General Electric were to issue new stock this year, this would be considered a secondary market transaction since the company already has stock outstanding. c. The most important difference between spot markets versus futures markets is the maturity of the instruments that are traded. Spot market transactions involve securities that have maturities of less than one year whereas futures markets transactions involve securities with maturities greater than one year. d. Capital market transactions involve only preferred stock or common stock. e. Money market transactions do not involve securities denominated in currencies other than the U.S. dollar.

Both NASDAQ dealers and "specialists" on the NYSE hold inventories of stocks.

If you plotted the returns on a given stock against those of the market, and if you found that the slope of the regression line was negative, the CAPM would indicate that the required rate of return on the stock should be greater than the risk-free rate for a well-diversified investor, assuming that the observed relationship is expected to continue into the future. Select one: True False

False

The NYSE is defined as a "primary" market because it is one of the largest and most important stock markets in the world. Select one: True False

False

The Chairman of the Board must also be the CEO. Select one: True False

False'

The more conservative a firm's management is, the higher the firm's total debt to total capital ratio [measured as (Short-term debt + Long-term debt)/(Debt + Preferred stock + Common equity)] is likely to be. Select one: True False

False'.

Which of the following statements is CORRECT? a. Other things held constant, if investors suddenly become convinced that there will be deflation in the economy, then the required returns on all stocks should increase. b. If a company's beta doubles, then its required rate of return will also double. c. If the risk-free rate rises by 0.5% but the market risk premium declines by that same amount, then the required rate of return on an average stock will remain unchanged, but required returns on stocks with betas less than 1.0 will rise. d. If a company's beta were cut in half, then its required rate of return would also be halved. e. If the risk-free rate rises by 0.5% but the market risk premium declines by that same amount, then the required rates of return on stocks with betas less than 1.0 will decline while returns on stocks with betas above 1.0 will increase.

If the risk-free rate rises by 0.5% but the market risk premium declines by that same amount, then the required rate of return on an average stock will remain unchanged, but required returns on stocks with betas less than 1.0 will rise.

Which of the following investments would have the highest future value at the end of 10 years? Assume that the effective annual rate for all investments is the same and is greater than zero. a. Investment A pays $250 at the beginning of every year for the next 10 years (a total of 10 payments). b. Investment D pays $2,500 at the end of 10 years (just one payment). c. Investment E pays $250 at the end of every year for the next 10 years (a total of 10 payments). d. Investment B pays $125 at the end of every 6-month period for the next 10 years (a total of 20 payments). e. Investment C pays $125 at the beginning of every 6-month period for the next 10 years (a total of 20 payments).

Investment A pays $250 at the beginning of every year for the next 10 years (a total of 10 payments).

Which of the following statements is CORRECT? a. EVA gives us an idea about how much value a firm's management has added over the firm's life. b. EVA stands for "economic value added" and is defined as follows: EVA = NOPAT - (Total invested capital)(AT cost of capital %) c. MVA gives us an idea about how much value a firm's management has added during the last year. d. The primary difference between EVA and accounting net income is that when net income is calculated, a deduction is made to account for the cost of common equity, whereas EVA represents net income before deducting the cost of the equity capital the firm uses. e. MVA stands for "market value added" and is defined as follows: MVA = (Shares outstanding)(Stock price) + Book value of common equity.

MVA stands for "market value added" and is defined as follows: MVA = (Shares outstanding)(Stock price) + Book value of common equity.

Which of the following statements is CORRECT? a. Managers generally welcome hostile takeovers since the "raider" generally offers a price for the stock that is higher than the price before the takeover action started. b. Most business in U.S. is conducted by corporations, and corporations' popularity results primarily from their favorable tax treatment. c. Using restrictive covenants in debt agreements is an effective way to reduce conflicts between stockholders and managers. d. The managers of established, stable companies sometimes attempt to get their state legislatures to ​impose rules that make it more difficult for raiders to succeed with hostile takeovers. e. One disadvantage of organizing a business as a corporation rather than a partnership is that the equity investors in a corporation are exposed to unlimited liability.

NOT - e. One disadvantage of organizing a business as a corporation rather than a partnership is that the equity investors in a corporation are exposed to unlimited liability.

Which of the following statements is CORRECT? (Assume that the risk-free rate is a constant.) a. The effect of a change in the market risk premium depends on the slope of the yield curve. b. If the market risk premium increases by 1%, then the required return will increase by 1% for a stock that has a beta of 1.0. c. If the market risk premium increases by 1%, then the required return on all stocks will rise by 1%. d. If the market risk premium increases by 1%, then the required return will increase for stocks that have a beta greater than 1.0, but it will decrease for stocks that have a beta less than 1.0. e. The effect of a change in the market risk premium depends on the level of the risk-free rate.

NOT - e. The effect of a change in the market risk premium depends on the level of the risk-free rate.

Which of the following statements is CORRECT? a. ​Only institutions, and not individuals, can engage in derivative market transactions. b. ​If you purchase 100 shares of Disney stock from your brother-in-law, this is an example of a primary market transaction. c. ​The NYSE is an example of an over-the-counter market. d. ​As they are generally defined, money market transactions involve debt securities with maturities of less than one year. e. ​If Disney issues additional shares of common stock through an investment banker, this would be a secondary market transaction.

NOT - e. ​If Disney issues additional shares of common stock through an investment banker, this would be a secondary market transaction.

Which of the following statements is CORRECT? a. One drawback of forming a corporation is that it generally subjects the firm to additional regulations. b. One disadvantage of forming a corporation is that it is more difficult for the firm's investors to transfer their ownership interests. c. One advantage of forming a corporation is that it subjects the firm's investors to fewer taxes. d. One drawback of forming a corporation is that it makes it more difficult for the firm to raise capital. e. One drawback of forming a corporation is that it subjects the firm's investors to increased personal liabilities.

One drawback of forming a corporation is that it generally subjects the firm to additional regulations.

Stocks A, B, and C all have an expected return of 10% and a standard deviation of 25%. Stocks A and B have returns that are independent of one another, i.e., their correlation coefficient, r, equals zero. Stocks A and C have returns that are negatively correlated with one another, i.e., r is less than 0. Portfolio AB is a portfolio with half of its money invested in Stock A and half in Stock B. Portfolio AC is a portfolio with half of its money invested in Stock A and half invested in Stock C. Which of the following statements is CORRECT? a. Portfolio AC has an expected return that is less than 10%. b. Portfolio AB has a standard deviation that is equal to 25%. c. Portfolio AC has a standard deviation that is less than 25%. d. Portfolio AC has an expected return that is greater than 25%. e. Portfolio AB has a standard deviation that is greater than 25%.

Portfolio AC has a standard deviation that is less than 25%.

Money markets are markets for a. Consumer automobile loans. b. Foreign currencies. c. Long-term bonds. d. Short-term debt securities such as Treasury bills and commercial paper. e. Common stocks.

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

Most corporations earn returns for their stockholders by acquiring and operating tangible and intangible assets. The relevant risk of each asset should be measured in terms of its effect on the risk of the firm's stockholders. Select one: True False

True'.

Suppose 1-year Treasury bonds yield 4.00% while 2-year T-bonds yield 5.10%. Assuming the pure expectations theory is correct, and thus the maturity risk premium for T-bonds is zero, what is the yield on a 1-year T-bond expected to be one year from now? Round the intermediate calculations to 4 decimal places and final answer to 2 decimal places. a. 7.39 b. 6.21 c. 7.27 d. 6.09 e. 5.47

b. 6.21 r1-year 4.00% r2-year 5.10% r1-year1 year from now X in the equation (1.04)(1+X) = (1.051)2 = 1.1046 X = (1.051)2 / (1.040) - 1.0 = r1-year in 1 yr 6.21%

Money markets are markets for a. Long-term bonds. b. Consumer automobile loans. c. Foreign currencies. d. Common stocks. e. Short-term debt securities such as Treasury bills and commercial paper.

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

04 If a corporation elects to be taxed as an S corporation, then both it and its stockholders can avoid all Federal taxes. This provision was put into the Federal Tax Code in order to encourage the formation of small businesses. Select one: True False

false

05 In order to maximize its shareholders' value, a firm's management must attempt to maximize the expected EPS. Select one: True False

false

07 The NYSE is defined as a "spot" market purely and simply because it has a physical location. The NASDAQ, on the other hand, is not a spot market because it has no one central location. Select one: True False

false

15 The balance sheet measures the flow of funds into and out of various accounts over time, while the income statement measures the firm's financial position at a point in time. Select one: True False

false

18 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. Select one: True False

false

21 Other things held constant, a decline in sales accompanied by an increase in financial leverage must result in a lower profit margin. Select one: True False

false

22 Time lines cannot be constructed in situations where some of the cash flows occur annually but others occur quarterly. Select one: True False

false

29 If the Treasury yield curve were downward sloping, the yield to maturity on a 10-year Treasury coupon bond would be higher than that on a 1-year T-bill. Select one: True False

false

31 Because short-term interest rates are much more volatile than long-term rates, you would, in the real world, generally be subject to much more price risk if you purchased a 30-day bond than if you bought a 30-year bond. Select one: True False

false

39 Portfolio A has only one stock, while Portfolio B consists of all stocks that trade in the market, each held in proportion to its market value. Because of its diversification, Portfolio B will by definition be riskless. Select one: True False

false

Firms A and B have the same current ratio, 0.75, the same amount of sales, and the same amount of current liabilities. However, Firm A has a higher inventory turnover ratio than B. Therefore, we can conclude that A's quick ratio must be smaller than B's. Select one: True False

false

Other things held constant, a decline in sales accompanied by an increase in financial leverage must result in a lower profit margin. Select one: True False

false

Private markets are those like the NYSE, where transactions are handled by members of the organization, while public markets are those like the NASDAQ, where anyone can make transactions. Select one: True False

false

06 If someone deliberately understates costs and thereby increases profits, this can cause the stock price to rise above its intrinsic value. The stock price will probably fall in the future. Also, those who participated in the fraud can be prosecuted, and the firm itself can be penalized. Select one: True False

true

11 A publicly owned corporation is a company whose shares are held by the investing public, which may include other corporations as well as institutional investors. Select one: True False

true

13 The income statement shows the difference between a firm's income and its costs—i.e., its profits—during a specified period of time. However, not all reported income comes in the form of cash, and reported costs likewise may not be consistent with cash outlays. Therefore, there may be a substantial difference between a firm's reported profits and its actual cash flow for the same period. Select one: True False

true

16 The time dimension is important in financial statement analysis. The balance sheet shows the firm's financial position at a given point in time, the income statement shows results over a period of time, and the statement of cash flows reflects specific changes in accounts over that period of time. Select one: True False

true

17 The current and quick ratios help us measure a firm's liquidity. The current ratio measures the relationship of the firm's current assets to its current liabilities, while the quick ratio measures the firm's ability to pay off short-term obligations without relying on the sale of inventories. Select one: True False

true

19 The inventory turnover ratio and days sales outstanding (DSO) are two ratios that are used to assess how effectively a firm is managing its current assets. Select one: True False

true

20 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. Select one: True False

true

28 Because the maturity risk premium is normally positive, the yield curve is normally upward sloping. Select one: True False

true

30 If a firm raises capital by selling new bonds, it could be called the "issuing firm," and the coupon rate is generally set equal to the required rate on bonds of equal risk. Select one: True False

true

As a general rule, a company's debentures have higher required interest rates than its mortgage bonds because mortgage bonds are backed by specific assets while debentures are unsecured. Select one: True False

true

Financial institutions are more diversified today than they were in the past, when federal laws kept investment banks, commercial banks, insurance companies, and similar organizations quite separate. Today the larger financial services corporations offer a variety of services, ranging from checking accounts, to insurance, to underwriting securities, to stock brokerage. Select one: True False

true

If investors expect a zero rate of inflation, then the nominal rate of return on a very short-term U.S. Treasury bond should be equal to the real risk-free rate, r*. Select one: True False

true

If we are given a periodic interest rate, say a monthly rate, we can find the nominal annual rate by multiplying the periodic rate by the number of periods per year. Select one: True False

true

The income statement shows the difference between a firm's income and its costs—i.e., its profits—during a specified period of time. However, not all reported income comes in the form of cash, and reported costs likewise may not be consistent with cash outlays. Therefore, there may be a substantial difference between a firm's reported profits and its actual cash flow for the same period. Select one: True False

true

Typically, the statement of stockholders' equity starts with total stockholders' equity at the beginning of the year, adds net income, subtracts dividends paid, and ends with total stockholders' equity at the end of the year. Over time, a profitable company will have earnings in excess of the dividends it pays out, resulting in a substantial amount of retained earnings shown on the balance sheet. Select one: True False

true

You have funds that you want to invest in bonds, and you just noticed in the financial pages of the local newspaper that you can buy a $1,000 par value bond for $800. The coupon rate is 10% (with annual payments), and there are 10 years before the bond will mature and pay off its $1,000 par value. You should buy the bond if your required return on bonds with this risk is 12%. Select one: True False

true

32 A bond has a $1,000 par value, makes annual interest payments of $100, has 5 years to maturity, cannot be called, and is not expected to default. The bond should sell at a premium if market interest rates are below 10% and at a discount if interest rates are greater than 10%. Select one: True False

ture

Which of the following actions would be most likely to reduce potential conflicts of interest between stockholders and managers? a. Pay managers large cash salaries and give them no stock options. b. Eliminate a requirement that members of the board of directors must hold a high percentage of their personal wealth in the firm's stock. c. For a firm that compensates managers with stock options, reduce the time before options are vested, i.e., the time before options can be exercised and the shares that are received can be sold. d. Beef up the restrictive covenants in the firm's debt agreements. e. 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.

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? a. Individuals are allowed to exclude 70% of their dividend income from their taxes. b. Corporations are allowed to exclude 70% of their interest income from corporate taxes. c. Corporations are allowed to exclude 70% of their dividend income from corporate taxes. d. Individuals pay taxes on only 30% of the income realized from municipal bonds. e. Individuals are allowed to exclude 70% of their interest income from their taxes.

Corporations are allowed to exclude 70% of their dividend income from corporate taxes.

Which of the following statements is CORRECT? a. IPO prices are generally established by the market, and buyers of the new stock must pay the price that prevails at the close of trading on the day the stock is offered to the public. b. In a "Dutch auction," investors who want to buy shares in an IPO submit bids indicating how many shares they want to buy and the price they are willing to pay. The company determines how many shares it wants to sell. The highest price that enables the company to sell the desired number of shares is the price that all buyers must pay. c. It is possible that the price set in an IPO is so high that investors will refuse to buy the number of shares that the company wants to sell. In this situation, the IPO is said to be oversubscribed. d. It is possible that the price set in an IPO is so low that investors will want to buy more shares than the company wants to sell. In that case, the company will have to issue more shares than it wants to sell. e. The term "IPO" stands for Introductory Price Offered, and it is the price at which shares of a new company are offered to the public.

NOT - d. It is possible that the price set in an IPO is so low that investors will want to buy more shares than the company wants to sell. In that case, the company will have to issue more shares than it wants to sell.

Which of the following statements is CORRECT? a. Time lines can only be constructed for annuities where the payments occur at the end of the periods, i.e., for ordinary annuities. b. Time lines can be constructed where some of the payments constitute an annuity but others are unequal and thus are not part of the annuity. c. Time lines cannot be constructed to deal with situations where some of the cash flows occur annually but others occur quarterly. d. A time line is not meaningful unless all cash flows occur annually. e. Time lines are not useful for visualizing complex problems prior to doing actual calculations.

NOT - a. Time lines can only be constructed for annuities where the payments occur at the end of the periods, i.e., for ordinary annuities.

Which of the following bonds would have the greatest percentage increase in value if all interest rates in the economy fall by 1%? a. 1-year, 10% coupon bond. b. 20-year, 5% coupon bond. c. 20-year, 10% coupon bond. d. 20-year, zero coupon bond. e. 10-year, zero coupon bond.

NOT - b. 20-year, 5% coupon bond.

Which of the following statements is CORRECT? a. Because of their simplified organization, it is easier for proprietors and partnerships to raise large amounts of outside capital than it is for corporations. b. Bond covenants are an effective way to resolve conflicts between shareholders and managers. c. Managers who face the threat of hostile takeovers are less likely to pursue policies that maximize shareholder value compared to managers who do not face the threat of hostile takeovers. d. One advantage to forming a corporation is that the owners of the firm have limited liability. e. Corporations face few regulations and more favorable tax treatment than do proprietorships and partnerships.

NOT - b. Bond covenants are an effective way to resolve conflicts between shareholders and managers.

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

NOT - b. Elect a board of directors that allows managers greater freedom of action.

For a portfolio of 40 randomly selected stocks, which of the following is most likely to be true? a. The beta of the portfolio is less than the weighted average of the betas of the individual stocks. b. The riskiness of the portfolio is the same as the riskiness of each stock if it was held in isolation. c. The beta of the portfolio is equal to the weighted average of the betas of the individual stocks. d. The beta of the portfolio is larger than the weighted average of the betas of the individual stocks. e. The riskiness of the portfolio is greater than the riskiness of each of the stocks if each was held in isolation.

NOT - b. The riskiness of the portfolio is the same as the riskiness of each stock if it was held in isolation.

If a bank loan officer were considering a company's loan request, which of the following statements would be CORRECT, other things held constant? a. The lower the total debt to total capital ratio, the lower the interest rate the bank should charge. b. The higher the days sales outstanding ratio, the lower the interest rate the bank should charge. c. The lower the company's TIE ratio, the lower the interest rate the bank should charge. d. The lower the current ratio, the lower the interest rate the bank should charge. e. The lower the company's inventory turnover ratio, the lower the interest rate the bank should charge.

NOT - c. The lower the company's TIE ratio, the lower the interest rate the bank should charge.

Which of the following statements is CORRECT? a. An example of a primary market transaction would be your uncle transferring 100 shares of Walmart stock to you as a birthday gift. b. If your uncle in New York sold 100 shares of Microsoft through his broker to an investor in Los Angeles, this would be a primary market transaction. c. The NYSE does not exist as a physical location. Rather it represents a loose collection of dealers who trade stock electronically. d. While the two frequently perform similar functions, investment banks generally specialize in lending money, whereas commercial banks generally help companies raise large blocks of capital from investors. e. Capital market instruments include both long-term debt and common stocks.

NOT - d. While the two frequently perform similar functions, investment banks generally specialize in lending money, whereas commercial banks generally help companies raise large blocks of capital from investors.

Which of the following is an example of a capital market instrument? a. Commercial paper. b. U.S. Treasury bills. c. Banker's acceptances. d. Preferred stock. e. Money market mutual funds.

NOT - e. Money market mutual funds.

Which of the following statements is CORRECT? a. One advantage of operating a business as a corporation is that stockholders can deduct their pro rata share of the taxes the firm pays, thereby eliminating the double taxation investors would face in a partnership. b. One drawback of forming a corporation is that you lose the limited liability that you would otherwise receive as a proprietor. c. Potential conflicts between stockholders and bondholders are increased if a firm's bonds are convertible into its common stock. d. Because bankruptcy requires that corporate bondholders be paid in full before stockholders receive anything, bondholders generally prefer to see corporate managers invest in high risk/high return projects rather than low risk/low return projects. e. Since bondholders receive fixed payments, they do not share in the gains if risky projects turn out to be highly successful. However, they do share in the losses if risky projects fail and drive the firm into bankruptcy. Therefore, bondholders generally prefer to see corporate managers invest in low risk/low return projects rather than high risk/high return projects.

Since bondholders receive fixed payments, they do not share in the gains if risky projects turn out to be highly successful. However, they do share in the losses if risky projects fail and drive the firm into bankruptcy. Therefore, bondholders generally prefer to see corporate managers invest in low risk/low return projects rather than high risk/high return projects.

Over the past 89 years, we have observed that investments with the highest average annual returns also tend to have the highest standard deviations of annual returns. This observation supports the notion that there is a positive correlation between risk and return. Which of the following answers correctly ranks investments from highest to lowest risk (and return), where the security with the highest risk is shown first, the one with the lowest risk last? a. Large-company stocks, small-company stocks, long-term corporate bonds, long-term government bonds, U.S. Treasury bills. b. Small-company stocks, long-term corporate bonds, large-company stocks, long-term government bonds, U.S. Treasury bills. c. U.S. Treasury bills, long-term government bonds, long-term corporate bonds, small-company stocks, large-company stocks. d. Large-company stocks, small-company stocks, long-term corporate bonds, U.S. Treasury bills, long-term government bonds. e. Small-company stocks, large-company stocks, long-term corporate bonds, long-term government bonds, U.S. Treasury bills.

Small-company stocks, large-company stocks, long-term corporate bonds, long-term government bonds, U.S. Treasury bills.

13. Below are the 2017 and 2018 year-end balance sheets for Tran Enterprises: Assets: 2018 2017 Cash $ 200,000 $ 170,000 AR 864,000 700,000 Inven. 2,000,000 1,400,000 Total Cur.Ass. $3,064,000 $2,270,000 Net FA 6,000,000 5,600,000 Total Ass $9,064,000 $7,870,000 Liabilities and equity: AP $1,400,000 $1,090,000 Notes pay. - bank 1,600,000 1,800,000 Total Cur. Liab. $3,000,000 $2,890,000 Long-term debt 2,400,000 2,400,000 Common stock 3,000,000 2,000,000 Retained earnings 664,000 580,000 Total com. eq $3,664,000 $2,580,000 Total liab.&Equity $9,064,000 $7,870,000 The firm has never paid a dividend on its common stock, and it issued $2,400,000 of 10-year, non-callable, long-term debt in 2017. As of the end of 2018, none of the principal on this debt had been repaid. Assume that the company's sales in 2017 and 2018 were the same. Which of the following statements must be CORRECT? a. The firm had negative net income in 2018. b. The firm repurchased some common stock in 2018. c. The firm increased its short-term bank debt in 2018. d. The firm issued new common stock in 2018. e. The firm issued long-term debt in 2018.

The firm issued new common stock in 2018.

Which of the following statements is CORRECT? a. Suppose a firm's total assets turnover ratio falls from 1.0 to 0.9, but at the same time its profit margin rises from 9% to 10%and its debt increases from 40% of total assets to 60%. The firm finances using only debt and common equity, and total assets equal total invested capital. Under these conditions, the ROE will decrease. b. Other things held constant, an increase in the total debt to total capital ratio will result in an increase in the profit margin. c. Suppose a firm's total assets turnover ratio falls from 1.0 to 0.9, but at the same time its profit margin rises from 9% to 10% and its debt increases from 40% of total assets to 60%. The firm finances using only debt and common equity, and total assets equal total invested capital. Without additional information, we cannot tell what will happen to the ROE. d. Suppose a firm's total assets turnover ratio falls from 1.0 to 0.9, but at the same time its profit margin rises from 9% to 10% and its debt increases from 40% of total assets to 60%. The firm finances using only debt and common equity, and total assets equal total invested capital. Under these conditions, the ROE will increase. e. The DuPont equation provides information about how operations affect the ROE, but the equation does not include the effects of debt on the ROE.

Suppose a firm's total assets turnover ratio falls from 1.0 to 0.9, but at the same time its profit margin rises from 9% to 10% and its debt increases from 40% of total assets to 60%. The firm finances using only debt and common equity, and total assets equal total invested capital. Under these conditions, the ROE will increase.

Which of the following statements is CORRECT? a. The CFO generally reports to the firm's chief accounting officer, who is normally the controller. b. 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. c. By law in most states, the chairman of the board must also be the CEO. d. The CFO is responsible for raising capital and for making sure that capital expenditures are desirable, but he or she is not responsible for the validity of the financial statements, as the controller and the auditors have that responsibility. e. In most corporations, the CFO ranks above the CEO.

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.

Austin Financial recently announced that its net income increased sharply from the previous year, yet its net cash provided from operations declined. Which of the following could explain this performance? a. The company's cost of goods sold increased. b. The company's expenditures on fixed assets declined. c. The company's depreciation expense declined. d. The company's dividend payment to common stockholders declined. e. The company's interest expense increased.

The company's depreciation expense declined.

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 riskiness of the investment's cash flows decreases. b. The discount rate decreases. c. The discount rate increases. 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 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.

The discount rate increases.

Which of the following statements is CORRECT? a. Using restrictive covenants in debt agreements is an effective way to reduce conflicts between stockholders and managers. b. One disadvantage of organizing a business as a corporation rather than a partnership is that the equity investors in a corporation are exposed to unlimited liability. c. Managers generally welcome hostile takeovers since the "raider" generally offers a price for the stock that is higher than the price before the takeover action started. d. Most business in U.S. is conducted by corporations, and corporations' popularity results primarily from their favorable tax treatment. e. The managers of established, stable companies sometimes attempt to get their state legislatures to ​impose rules that make it more difficult for raiders to succeed with hostile takeovers.

The managers of established, stable companies sometimes attempt to get their state legislatures to ​impose rules that make it more difficult for raiders to succeed with hostile takeovers.

Which of the following statements is CORRECT? a. Liquidity premiums are higher for Treasury than for corporate bonds. b. Most evidence suggests that the maturity risk premium is zero. c. The real risk-free rate is higher for corporate than for Treasury bonds. d. The yield on a 3-year Treasury bond cannot exceed the yield on a 10-year Treasury bond. e. The pure expectations theory states that the maturity risk premium for long-term Treasury bonds is zero and that differences in interest rates across different Treasury maturities are driven by expectations about future interest rates.

The pure expectations theory states that the maturity risk premium for long-term Treasury bonds is zero and that differences in interest rates across different Treasury maturities are driven by expectations about future interest rates.

Which of the following statements is CORRECT? a. The total (rate of) return on a bond during a given year is the sum of the coupon interest payments received during the year and the change in the value of the bond from the beginning to the end of the year, divided by the bond's price at the beginning of the year. b. The price of a 20-year, 10% bond is less sensitive to changes in interest rates than the price of a 5-year, 10% bond. c. A $1,000 bond with $100 annual interest payments that has 5 years to maturity and is not expected to default would sell at a discount if interest rates were below 9% and at a premium if interest rates were greater than 11%. d. A 10-year, 10% coupon bond has less reinvestment risk than a 10-year, 5% coupon bond (assuming all else equal). e. 10-year, zero coupon bonds have more reinvestment risk than 10-year, 10% coupon bonds.

The total (rate of) return on a bond during a given year is the sum of the coupon interest payments received during the year and the change in the value of the bond from the beginning to the end of the year, divided by the bond's price at the beginning of the year.

Suppose 1-year T-bills currently yield 7.00% and the future inflation rate is expected to be constant at 6.00% per year. What is the real risk-free rate of return, r*? Disregard any cross-product terms, i.e., if averaging is required, use the arithmetic average. a. 1.00% b. 0.97% c. 0.85% d. 0.82% e. 1.15%

a. 1.00% 1-year T-bill rate 7.00% Inflation 6.00% Difference = real risk-free rate, r* 1.00%

Which of the following would generally indicate an improvement in a company's financial position, holding other things constant? a. The quick ratio increases. b. The DSO increases. c. The total assets turnover decreases. d. The TIE declines. e. The current ratio declines.

a. The quick ratio increases.

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 equal amounts invested in each of the three stocks. Each of the stocks has a standard deviation of 25%. The returns on the three stocks are independent of one another (i.e., the correlation coefficients all equal zero). Assume that there is an increase in the market risk premium, but the risk-free rate remains unchanged. Which of the following statements is CORRECT? a. The required return on Stock A will increase by less than the increase in the market risk premium, while the required return on Stock C will increase by more than the increase in the market risk premium. b. The required return on the average stock will remain unchanged, but the returns of riskier stocks (such as Stock C) will increase while the returns of safer stocks (such as Stock A) will decrease. c. The required returns on all three stocks will increase by the amount of the increase in the market risk premium. d. The required return of all stocks will remain unchanged since there was no change in their betas. e. The required return on the average stock will remain unchanged, but the returns on riskier stocks (such as Stock C) will decrease while the returns on safer stocks (such as Stock A) will increase.

a. The required return on Stock A will increase by less than the increase in the market risk premium, while the required return on Stock C will increase by more than the increase in the market risk premium.

Short Corp just issued bonds that will mature in 10 years, and Long Corp issued bonds that will mature in 20 years. Both bonds promise to pay a semiannual coupon, they are not callable or corvertible, and they are equally liquid. Further assume that the Treasury yield curve is based only on the pure expectations theory. Under these conditions, which of the following statements is CORRECT? a. If Long's and Short's bonds have the same default risk, their yields must under all conditions be equal. b. If the Treasury yield curve is upward sloping and Short has less default risk than Long, then Short's bonds must under all conditions have a lower yield than Long's bonds. c. If the Treasury yield curve is downward sloping, Long's bonds must under all conditions have the lower yield. d. If the yield curve for Treasury securities is flat, Short's bond must under all conditions have the same yield as Long's bonds. e. If the yield curve for Treasury securities is upward sloping, Long's bonds must under all conditions have a higher yield than Short's bonds.

b. If the Treasury yield curve is upward sloping and Short has less default risk than Long, then Short's bonds must under all conditions have a lower yield than Long's bonds.

Kern Corporation's 5-year bonds yield 7.50% and 5-year T-bonds yield 4.30%. The real risk-free rate is r* = 2.5%, the default risk premium for Kern's bonds is DRP = 1.90% versus zero for T-bonds, the liquidity premium on Kern's bonds is LP = 1.3%, 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 inflation premium (IP) on all 5-year bonds? a. 1.06% b. 1.64% c. 1.19% d. 1.40% e. 1.32%

d. 1.40% Maturity 5 rKern Yield 7.50% rT-bond Yield 4.30% r* Included in both bonds 2.50% LP Included in Kern's only 1.30% DRP Included in Kern's only 1.90% MRP Included in both bonds (t - 1) × 0.1% 0.40% rT-bond = r* + IP + MRP + DRP + LP rKern = r* + IP + MRP + DRP + LP IP = rKern - r* - LP - MRP - DRP = 1.40% Or, IP = rT-bond - r* - MRP = 1.40%

Precision Aviation had a profit margin of 6.25%, a total assets turnover of 1.5, and an equity multiplier of 1.8. What was the firm's ROE? a. 13.84% b. 17.72% c. 20.93% d. 16.88% e. 14.34%

d. 16.88% Profit margin 6.25% TATO 1.5 Equity multiplier 1.8 ROE = PM × TATO × Eq. Multiplier = 16.88%

You agree to make 24 deposits of $500 at the beginning of each month into a bank account. At the end of the 24th month, you will have $13,000 in your account. If the bank compounds interest monthly, what nominal annual interest rate will you be earning? a. 6.63% b. 8.91% c. 8.00% d. 7.62% e. 5.79%

d. 7.62% BEGIN Mode N 24 PV $0 PMT $500 FV $13,000 I/MO 0.63% I/YR 7.62%

Which of the following statements is CORRECT? a. If Firms X and Y have the same earnings per share and market-to-book ratio, then they must have the same price/earnings ratio. b. If Firm X's P/E ratio exceeds that of Firm Y, then Y is likely to be less risky and/or be expected to grow at a faster rate. c. If Firms X and Y have the same net income, number of shares outstanding, and price per share, then their market-to-book ratios must also be the same. d. 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. e. If Firms X and Y have the same P/E ratios, then their market-to-book ratios must also be equal.

d. 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. No reason for a to be true. b must be true, as EPS and P will be equal. No reason for c to be true. Wrong, because high risk and low growth lead to low P/Es. No reason for e to be true.​

Radoski Corporation's bonds make an annual coupon interest payment of 7.35% every year. The bonds have a par value of $1,000, a current price of $920, and mature in 12 years. What is the yield to maturity on these bonds? a. 9.53% b. 6.83% c. 7.25% d. 8.10% e. 8.44%

e. 8.44% Coupon rate 7.35% N 12 PV = Price $920 PMT $73.50 FV = Par $1,000 I/YR 8.44% =YTM

Which of the following statements is CORRECT? a. The next-to-last line on the income statement shows the firm's earnings, while the last line shows the dividends the company paid. Therefore, the dividends are frequently called "the bottom line." b. Most rapidly growing companies have positive free cash flows because cash flows from existing operations will exceed fixed assets and working capital needed to support the growth. c. An increase in accounts receivable is added to net income in the operating activities section because if accounts receivable increase, then when they are collected cash will come into the firm. d. In finance, we are generally more interested in cash flows than in accounting profits. Free cash flow (FCF) is calculated as after-tax operating income plus depreciation less the sum of capital expenditures and the change in net operating working capital. Free cash flow is the amount of cash that could be withdrawn without harming the firm's ability to operate and to produce future cash flows. e. The first major section of a typical statement of cash flows is "Operating Activities," and the first entry in this section is "Net Income." Then, also in the first section, we show some items that add to or subtract from cash, and the last entry is called "Net Cash Provided by Operating Activities." This number can be either positive or negative, but if it is negative, the firm is almost certain to soon go bankrupt.

d. In finance, we are generally more interested in cash flows than in accounting profits. Free cash flow (FCF) is calculated as after-tax operating income plus depreciation less the sum of capital expenditures and the change in net operating working capital. Free cash flow is the amount of cash that could be withdrawn without harming the firm's ability to operate and to produce future cash flows.

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? a. The yield on a 10-year bond would have to be higher than that on a 1-year bill because of the maturity risk premium. b. The yields on the two securities would be equal. c. It is impossible to tell without knowing the relative risks of the two securities. d. The yield on a 10-year bond would be less than that on a 1-year bill. e. It is impossible to tell without knowing the coupon rates of the bonds.

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

Which of the following statements is CORRECT? a. The market value of a bond will always approach its par value as its maturity date approaches. This holds true even if the firm has filed for bankruptcy. b. Rising inflation makes the actual yield to maturity on a bond greater than a quoted yield to maturity that is based on market prices. c. The expected capital gains yield on a bond will always be zero or positive because no investor would purchase a bond with an expected capital loss. d. The yield to maturity on a coupon bond that sells at its par value consists entirely of a current interest yield; it has a zero expected capital gains yield. e. The yield to maturity for a coupon bond that sells at a premium consists entirely of a positive capital gains yield; it has a zero current interest yield.

d. The yield to maturity on a coupon bond that sells at its par value consists entirely of a current interest yield; it has a zero expected capital gains yield.

Maureen Smith is a single individual. She claims one exemption of $4,050 for herself and claims a standard deduction of $6,350. Her salary for the year was $71,850. Assume the following tax table is applicable. Single Individuals​ ​ If Your Taxable Income Is You Pay This Amount on the Base of the Bracket Plus This Percentage on the Excess over the Base Average Tax Rate at Top of Bracket Up to $9,325 $0.00 10.0% 10.0% $9,325-$37,950 932.50 15.0 13.8 $37,950-$91,900 5,226.25 25.0 20.4 $91,900-$191,650 18,713.75 28.0 24.3 $191,650-$416,700 46,643.75 33.0 29.0 $416,700-$418,400 120,910.25 35.0 29.0 Over $418,400 121,505.25 39.6 39.6 What is her average tax rate? a. 19.33% b. 17.70% c. 19.87% d. 14.63% e. 18.07%

e. 18.07% taxable income = Salary - Exemption - Standard DeductionTaxable income = $71,850 - $4,050 - $6,350Taxable income = $61,450 ​ The marginal tax rate is the tax rate applicable to the last unit of a person's income. Since taxable income is $61,450, the marginal tax rate is shown in Column 3 for the income bracket that includes the taxable income amount - which is 25%. ​ Taxable income is $61,450, so the federal tax liability is calculated as follows: Federal tax liability = $5,226.25 + [(61,450 - 37,950) × 0.25]Federal tax liability = $5,226.25 + $5,875.00 = $11,101.25 ​ $11,101.25 was the tax paid and $61,450 is the taxable income, so the average tax rate is calculated as follows: Average tax rate = Tax paid/Taxable income Average tax rate = $11,101.25/$61,450 Average tax rate = 18.07%

Suppose the real risk-free rate is 3.50% and the future rate of inflation is expected to be constant at 4.80%. What rate of return would you expect on a 1-year Treasury security, assuming the pure expectations theory is valid? Disregard cross-product terms, i.e., if averaging is required, use the arithmetic average. a. 9.79% b. 8.38% c. 8.80% d. 9.38% e. 8.30%

e. 8.30 Real risk-free rate, r* 3.50% Inflation 4.80% Yield on 1-year T-bond 8.30%