exam 3

Southern Markets recently paid a $2.80 annual dividend on its common stock. This dividend increases at an average rate of 3.8 percent per year. The stock is currently selling for $26.91 a share. What is the market rate of return?

14.6

You are purchasing a 20-year, zero-coupon bond. The yield to maturity is 8.68 percent and the face value is $1,000. What is the current market price? Assume semiannual compounding.

182.8

Flo's Flowers pays an annual dividend that is expected to increase by 2.1 percent per year. The stock commands a market rate of return of 13.8 percent and sells for $19.06 a share. What is the expected amount of the next dividend?

2.23

Global Tek is a new firm in a rapidly growing industry. The company is planning on increasing its annual dividend by 15 percent a year for the next four years and then decreasing the growth rate to 3.5 percent per year. The company just paid its annual dividend in the amount of $.20 per share. What is the current value of one share of this stock if the required rate of return is 15.5 percent?

2.49

what is the PI for a project with an initial cash outflow of $30 and subsequent cash inflows of $80 in year 1 and $20 in year 2 if the discount rate is 12 percent?

2.91

Sweatshirts Ltd. is downsizing. The company paid a $3.80 annual dividend last year and has announced plans to lower the dividend by 30 percent each year. Once the dividend amount becomes zero, the company will go out of business. You have a required rate of return of 18 percent on this particular stock given the company's situation. What are your shares in this firm worth today on a per share basis?

5.54

what is the NPV of a project with an initial investment of $95, a cash flow in one year of $107, and a discount rate of 6 percent?

5.94

The 7 percent bonds issued by Modern Kitchens pay interest semiannually, mature in eight years, and have a $1,000 face value. Currently, the bonds sell for $1,032. What is the yield to maturity?

6.48

Do-Well bonds have a face value of $1,000 and are currently quoted at 867.25. The bonds have a 7 percent coupon rate. What is the current yield on these bonds?

8.07 (face value x coupon rate)/ current price

GW's $1,000 par bonds are due in 25 years

872.16

what is the IRR for a project with an initial investment of $250 and subsequent cash inflows of $100 per year for 3 years?

9.7

Oil Wells offers 6.5 percent coupon bonds with semiannual payments and a yield to maturity of 6.94 percent. The bonds mature in seven years. What is the market price per bond if the face value is $1,000?

975.93

the spreadsheet function for calculating net present value is ______

=NPV()

which of the following projects is acceptable if the average accounting return is required to be at lease 20%?

Restaurant: average income = $450,000; average book value = $2.180,000 and book store: average income = $140,000; average book value = $600,000

in a simple two-state, world, the value of a call option is equal to:

S0 - E/(1+R(subT))

the PI rule for an independent project is to _____ the project if the PI is greater than 1

accept

why are warrants referred to as equity kickers?

because they are issued in combination with bonds

project Alpha's NPV profile crosses the vertical axis at $230,000. Project Beta's NPV profile crosses the vertical axis at $150,000. If project Alpha and Beta have conventional cash flows, are mutually exclusive, and the NPV profile crosses at 15% (where the NPVs are positive), which of the projects has a higher internal rate of return?

beta

convertible bonds are:

bonds that can be converted to stock

what is a call option

call options give the owner the right to buy shares at a fixed price

A bond that can be paid off early at the issuer's discretion is referred to as being which type of bond?

callable

the formula for determining the number of call options to buy in order to replicate the stocks payoffs in the simple two-state model is:

delta S / delta C

All else constant, a bond will sell at _____ when the coupon rate is _____ the yield to maturity.

discount; less than

___ option contracts can be exercised only on the expiration date while _____ option contracts can be exercised anytime up to and including the expiration date

european; american

sultan enterbrises currently has 1,000 shares of common stock and 200 convertible bonds outstanding. each zero coupon bond has a par value of $1,000. at maturity, each bond can be converted into 5 newly issued shares in Sultan Enterprises. It will be advantageous for the convertible bondholders to convert their bonds to equity if the value of the firm:

exceeds $400,000

which of the following are the main features of an option contract?

expiration date; strike price

true or false: investing more money in a project is a guarantee of greater profits

false

true or false: most warrants cannot be detached from the bond

false

the present value of all cash flows (after the initial investment) is divided by the _____ to calculate the profitability index

initial investment

the most important alternative to NPV is the _____ method

internal rate of return

the point at which the NPV profile crosses the horizontal axis is the

internal rate of return

how does a firm benefit from an option to delay

it prevents losses from hasty business decisions; it delays decision making until more information is available; it allows the firm to invest in a project in stages

when cash flows are conventional, NPV is _____ if the discount rate is above the IRR

negative

one of the flaws of the payback period method is that cash flows after the cutoff date are _____

not considered in the analysis

why can't the value of call option be negative?

options are rights that will not be exercised by the buyer if it will result in a loss; options are a limited liability instrument where the loss is limited to what the buyer initially paid for it

what are the two main determinants of the straight bond value

the general level of interest rates; default risk

which of the following are true about detachable warrants?

the loan agreement will specify whether the warrant is detachable or not; detachable warrants can be sold separately from the bond to which they are attached

what determines the conversion value of convertible bonds?

the market price per share of common stock

a conversion ration is:

the number of shares received for each convertible bonds

what are the two threshold prices that a gold miner needs to worry about?

the price at which to open a closed mine; the price at which to close an open mine

which of the following factors affect the call option value?

the risk free rate of return; the volatility of the underlying asset's price

in a two-state world, where there are only two possible payoffs on a share of stock at the end of a year, the stock payoffs can be exactly duplicated using a combination of a call option on the stock and:

the risk-free asset

what are the two minimum values for convertible bonds?

the straight bond value; the conversion value

how are convertible preferred stock and convertible bonds similar?

they both are issued by the firm; they both allow conversion to common stock

true or false: some projects, such as mines, have cash outflows followed by cash inflows, which are then followed by cash outflows, giving the project multiple rates of return

true

true or false: the crossover rate is the rate at which the NPV of two projects are equal

true

when a _____ is exercised, a firm must issue new stock, but when a call option is exercised the number of outstanding shares remains the same

warrant

which one of the following securities generally has a longer time to maturity at the time of issue?

warrants

how is a warrant different from a call option

warrants tend to have longer lives than call options; warrants are issued by the firm while call options are issued by other investors

when will a call option on a stock be classified as an "underwater" call option?

when the market price of stock is far below the exercise price

you have warrants on Catona Corporation (CC) with an exercise price of $39. when will it be profitable to exercise the warrants?

when the stock price of CC is greater than $39

The bond market requires a return of 9.8 percent on the five-year bonds issued by JW Industries. The 9.8 percent is referred to as which one of the following?

yield to maturity

capital corp is considering a project whose internal rate of return is 14%. if capital's required return is 14%, the project's NPV is:

zero

what is the NPV of a one year project that requires an initial investment of $10,000 and is expected to generate $16,000 next year if the discount rate is 12%?

$4,285.71

saxon company is considering a project that will generate net income of $50,000 in year 1, $75,000 in year 2, and $90,000 in year 3. the cost of the project is $700,000, and this cost will be depreciated to zero in the three years of the investment. what is their average accounting return?

20.48

Future Motors is expected to pay a $3.30 a share annual dividend next year. Dividends are expected to increase by 2.75 percent annually. What is one share of this stock worth to you today if your required rate of return is 15 percent?

26.94

Which one of the following bonds is the least sensitive to interest rate risk?

3 year 6% coupon

Farmco just paid a dividend of $.20 per share. The dividends are expected to grow at 20 percent annually for the next 7 years and then level off to an annual growth rate of 3 percent indefinitely. What is the price of this stock today given a required return of 15 percent?

3.98

Home Products common stock sells for $18.31 a share and has a market rate of return of 12.8 percent. The company just paid an annual dividend of $1.42 per share. What is the dividend growth rate?

4.68

Currently, a firm has an EPS of $2.54 and a benchmark PE of 16.4. Earnings are expected to grow 3.8 percent annually. What is the estimated current stock price?

41.66

The semiannual, 8-year bonds of Alto Music are selling at par and have an effective annual yield of 8.6285 percent. What is the amount of each interest payment if the face value of the bonds is $1,000?

42.25

consider a stock that currently sells for $78 a share. in one year, the stock will sell for either $80 or $86. a call option on this particular stock expires in one year and has a strike price of $84. assume a risk free rate of 6(2/3)%. in order to replicate the stocks payoffs, you must buy three call options and invest $_____ in the riskless asset.

75

the internal rate of return is a function of _____

a project's cash flows

according to the average accounting return rule, a project is acceptable if its average accounting return exceeds:

a target average accounting return

the basic NPV investment rule is:

accept a project if the NPV is greater than zero; if the NPV is equal to zero, acceptance or rejection of the project is a matter of indifference; reject a project if its NPV is less than zero

payback period tells the time it takes to break even in an ____ sense. discounted payback period tells the time it takes to break even in an ____ or financial sense

accounting; economic

how does the timing and the size of cash flows affect the payback method? assume the project does pay back within the project's lifetime

an increase in the size of the first cash inflow will decrease the payback period, all else held constant

define an option contract

an option contract gives the owner the right to buy or sell some asset at a fixed price on or before a given date

which of these exist if identical securities are listed at two different prices on two different exchanges?

arbitrage; inefficient markets; riskless profits

what are the similarities between call options and warrant

both can be traded in the secondary market; common stock is the underlying asset for both warrants and options; both give the owner the right to buy

the conversion price depends upon the:

conversion ration; face value of the bond

what are the two main determinants of a straight bond value?

default risk; the general level of interest rates

the payback period rule ____ a project if it has a payback period that is less than or equal to a particular cutoff date

suggests accepting

the point at which the NPV profile crosses the vertical axis is the

sum of the cash flows of the project

what are the choices available to an investor who bought options on GE stock?

the buyer can choose not to exercise the option; the buyer can exercise the option; the buyer can trade the option in the options exchange

what are some of the other options that may exist in the modern corporation?

the call provision on a bond; put bonds

what is the larges organized options exchange in the USA

the chicago board options exchange

which of the following are specified in a warrant?

the exercise price for the shares; the number of shares that can be bought; the expiration date

the CEO of JNL corporation has been recently awarded 10,000 stock options. what are some factors that may influence the value of these options

the exercise price of the stock options; the volatility of JNL stock; number of months to expiration

which of the following factors affect the price of a call option?

the exercise price, the expiration date, the underlying stock price

A "fallen angel" is a bond that has moved from:

Investment grade to speculative grade.

capital _____ is the decision-making process for accepting and rejecting projects

budgeting

NPV _____ cash flows properly

discounts

true or false: the MIRR function eliminates multiple IRRs and should replace NPV

false

true or false: the discounted payback rule has an objective benchmark to use in decision making

false

the profitability index is calculated by dividing the PV of the _____ cash flows by the initial investment

future

Which one of the following represents the capital gains yield as used in the dividend growth model?

g

convertible bondholders should convert to common stock at the maturity date if the conversion value is:

greater than the straight bond value

`an executive has been awarded 5,000 stock options in his company KJL, if their stock price becomes more volatile, the value of the options will tend to :

increase

a(n) _____ project does not rely on the acceptance or rejection of another project

independent

Real rates are defined as nominal rates that have been adjusted for which of the following?

inflation

which of the following are advantages of AAR?

is easy to compute; needed information is always available

how does the exercise of a call option affect the firms cash flows

it does not affect the firms cash flows

IRR continues to be very popular in practice, partly because

it gives a rate of return rather than a dollar value

jill sold call options on BAC stock to james. the options have an exercise price of $20 and expire on january 15 20XX. what are jills obligations

jills opbligations end after january 15, 20XX; jill must sell the shares at $20 if james chooses not to exercise

Jill sold call options on BAC stock to Jim. the options have an exercise price of $20 and expire on January 15, 20XX. what rights belong to Jim

jim has no rights after January 15, 20XX; jim has the right to choose not to exercise his call option; jim has the right to buy BAC stock at $20 on or before january 15 20XX

the discounted payback period has which of these weaknesses?

loss of simplicity as compared to the payback method; arbitrary cutoff date; exclusion of some cash flows

The current yield is defined as the annual interest on a bond divided by which one of the following?

market price

A Treasury yield curve plots Treasury interest rates relative to which one of the following?

maturity

when cash flows are conventional, NPV is ___

negative for discount rates above the IRR; equal to zero when the discount rates equal the IRR; positive for discount rates below the IRR

according to Graham and Harvey's 1999 survey of 392 CFOs, which of the following two capital budgeting methods are most used by firms in the U.S. and Canada?

net present value; internal rate of return

the IRR can lead to bad decisions when _____ or _____

projects are mutually exclusive cash flows are not conventional

The items included in an indenture that limit certain actions of the issuer in order to protect a bondholder's interests are referred to as the:

protective covenants

an option on a real asset rather than a financial asset is known as a:

real option

internal rate of return (IRR) must be compared to the _____ in order to determine the acceptability of a project

required return

NPV accounts for the size of the project and thus mitigates the effects of _____

scale

why is there a positive relationship between interest rates and the value of a call option

since the exercise price is paid later by the call buyer, the delayed payment is more valuable when interests rates are high

which of the following scenarios would IRR always recommend the wrong decision?

starting cash flow: 1000 ending cash flow: -2000

which of these will help align the interests of management with the interests of shareholders

stock options awarded to management

a call option has value when the _____

stock price exceeds the exercise price

when the value of the firm is very low, the _____ primarily determines the value of its convertible bonds

straight bond value

what are the advantages of the payback period method for management?

the payback period method is easy to use; it allows lower level managers to make small decisions efficiently; the payback period method is idea for short projects

Jackson, INC. issues warrants that have an exercise price of $40 and time to maturity of 9 months. what are the rights of a warrant holder with regard to exercising the warrants?

the warrant holder can receive a stock certificate in exchange for $40; the warrant holder can buy shares at $40 regardless of the market price; the warrant holder can exercise the warrants at any time within 9 months

steps involved in the discounted payback period

1. discount the cash flows using the discount rate 2. add the discounted cash flows 3. accept if the discounted payback period is less than some pre-specified number of years

The common stock of Water Town Mills pays an annual dividend of $1.84 a share. The company has promised to maintain a constant dividend even though economic times are tough. How much are you willing to pay for one share of this stock if you want to earn a 13.6 percent annual return?

13.53

Arcs and Triangles paid an annual dividend of $1.47 a share last month. The company is planning on paying $1.55, $1.63, and $1.65 a share over the next three years, respectively. After that, the dividend will be constant at $1.70 per share per year. What is the market price of this stock if the market rate of return is 11 percent?

15.23

Distant Groves announced today that it will begin paying annual dividends next year. Dividends for the first three years will be $.15, $.20, and $.25 a share, respectively. After that, dividends are projected to increase by 4 percent per year. What is one share of this stock worth today at a required return of 8.5 percent?

5.03

New Homes has a bond issue with a coupon rate of 5.5 percent that matures in 8.5 years. The bonds have a par value of $1,000 and a market price of $972. Interest is paid semiannually. What is the yield to maturity?

5.92

what are some reasons for rewarding employees with options (ESOs)?

ESOs have no immediate upfront costs; ESOs align the interests of employees with that of the shareholders

Exxon Mobil is planning to acquire land in Alberta, Canada. Exxon Mobil is currently being offered a very attractive price for the land. However, oil prices are currently at historic lows. what should the company do with this investment proposal?

Exxon mobil should buy the land now and if oil prices show no possibility of rising, it can sell the land in the future; exxon mobil should buy the land now but delay the decision to drill

if a project has multiple internal rates of return, which of the following methods should be used?

MIRR; NPV

which of the following are features of a American call option?

a call contract is executed with another investor through a options exchange

what is the name of the security that gives the owner the right to buy shares of ABC for $45 each on or before January 10, 20XX

a call option contract

recall the graph that depicts the value of a call option on the expiration date, what does the graph indicate about the nature of the relationship between the price of the underlying stock and the value of corresponding call option

a call option is worthless over a given range of stock prices; after the stock price equals the exercise price, the call option will increase in value by $1 for every $1 increase in the market price of the stock

repricing of employee stock options is controversial because:

a lower stock price is, in essence, a reward for failing; if employees know that options will be repriced then incentive effect is lost

during reorganization, ULA issued bonds with detachable warrants. the warrants have an exercise price of $10 and a maturity date of 2 years. the bonds have a par value of $1,000. what will the payoff on the warrants be if the stock price at expiration is $8?

$0

a call option with an exercise price of $37 costs $10. if the underlying stock is currently trading for $48, what is the arbitrage profit?

$1

JKM Enterprises issued convertible bonds that provided for the conversion of each bond into 20 shares of JKM common stock. The bonds have a par value of $1,000 and are currently trading at $1,100. If the current price of JKM stock is $56, what is the conversion value of a JKM convertible bond?

$1,120

during reorganization, GS issued bonds with detachable warrants. the warrants have an exercise price of $20 and mature in 1 year. the bonds have a par value of $1,000. what will the payoff per warrant be if the stock price at the expiration date is $28 and the price of the bond is $900?

$8 gain

Dexter Mills issued 20-year bonds a year ago at a coupon rate of 10.2 percent. The bonds make semiannual payments and have a par value of $1,000. If the YTM on these bonds is 9.2 percent, what is the current bond price?

1089.02

Next year, Jensen's will pay an annual dividend of $2.75 per share. The company has been reducing the dividends by 10 percent annually. How much are you willing to pay today to purchase stock in this company if your required rate of return is 11.5 percent?

12.79

Three Corners Markets paid an annual dividend of $1.37 a share last month. Today, the company announced that future dividends will be increasing by 2.8 percent annually. If you require a return of 11.6 percent, how much are you willing to pay to purchase one share of this stock today?

16

AC Electric just paid a $2.10 per share annual dividend. The firm pledges to increase its dividend by 2.4 percent for the next 5 years and then maintain a constant 2 percent rate of dividend growth. If the required return is 15 percent, what is the current value of one share of this stock?

16.74

You expect interest rates to decline in the near future even though the bond market is not indicating any sign of this change. Which one of the following bonds should you purchase now to maximize your gains if the rate decline does occur?

long term; zero coupon

both options and warrants are profitable to exercise when the exercise price is _____ than the market price of the underlying asset

lower

the current extraction price of gold is $700 per ounce. why is a gold mine owner likely to wait until the gold price rises sufficiently above $700 per ounce before beginning extraction?

opening the mine will require additional costs that must be covered by the price of gold; gold prices are volatile so a marginal increase above $700 could be followed by a drop below $700 resulting in losses

this capital budgeting method allows lower management to make smaller, everyday financial decisions effectively

payback method

the amount of time needed for the cash flows from an investment to pay for its initial cost is the

payback period

in capital budgeting, the net _____ determines the value of a project to the company

present value

true or false: two challenges with the IRR approach when comparing two mutually exclusive projects that are scale and cash flow timing

true

which of the following are mutually exclusive investments?

two different choices for the assembly lines that will make the same product; a restaurant or a gas station on the same piece of land

A six-year, $1,000 face value bond issued by Taylor Tools pays interest semiannually on February 1 and August 1. Assume today is October 1. What will be the difference, if any, between this bond's clean and dirty prices today?

two months interest

the three attributes of NPV are that it:

uses all the cash flows of a project; discounts the cash flows properly; uses cash flows