FIN 221 all questions from practice quizzes

chapter 7

chapter 7

chapter 8

chapter 8

chapter 9

chapter 9

55. Given the following probability distribution, what are the expected return and the standard deviation of returns for Security J? State. Pi. kJ 1. 0.2. 10% 2. 0.6. 15 3 0.2 20 a. 12%; 5.18% b. 15%; 10.00% c. 15%; 6.50% d. 15%; 3.16% e. 20%; 5.00%

d. 15%; 3.16%

1. Cheers Inc. operates as a partnership. Now the partners have decided to convert the business into a corporation. Which of the following statements is CORRECT? a.Cheers' investors will be exposed to less liability, but they will find it more difficult to transfer their ownership. b.Cheers will now be subject to fewer regulations. c.Assuming Cheers is profitable, none of its income will be subject to federal income taxes. d.Cheers will find it more difficult to raise additional capital.e.Cheers' shareholders (the ex-partners) will now be exposed to less liability.

d. Cheers will find it more difficult to raise additional capital.e.Cheers' shareholders (the ex-partners) will now be exposed to less liability.

68. A stock is expected to pay a $0.45 dividend at the end of the year (D1 = 0.45). The dividend is expected to grow at a constant rate of 4% a year, and the stock's required rate of return is 11%. What is the expected price of the stock 10 years from today? a.$12.65 b.$ 6.02 c.$ 9.15 d.$ 9.52 e.$18.25

d.$ 9.52

50. A 20-year, $1,000 face value bond has a 9% annual coupon. The bond currently sells for $925. If the bond's yield to maturity remains at its current rate, what will be the price of the bond 5 years from now? a.$ 966.79 b.$ 831.35 c.$1,090.00 d.$ 933.09 e.$ 925.00

d.$ 933.09

98. Mulroney Corp. is considering two mutually exclusive projects. Both require an initial investment of $10,000 at t = 0. Project X has an expected life of 2 years with after-tax cash inflows of $6,000 and $8,000 at the end of Years 1 and 2, respectively. Project Y has an expected life of 4 years with after-tax cash inflows of $4,000 at the end of each of the next 4 years. Each project has a WACC of 8%. Use the replacement chain approach to determine the NPV of the most profitable project. a.$4,734 b.$5,897 c.$5,120 d.$4,484 e.$5,456

d.$4,484

51. You have just been offered a $1,000 par value bond for $847.88. The bond has an annual coupon rate of 8% and annual interest rates on equally risky new issues are 10%. You want to know how many more interest payments you will receive, but the party selling the bond cannot remember. Can you determine how many interest payments remain? a.10 b.20 c.12 d.15 e.14

d.15

42. The real risk-free rate is 3%, inflation is expected to be 2% this year, and the maturity risk premium is zero. Ignoring any cross-product terms, what is the equilibrium rate of return on a 1-year Treasury bond? a.4.90% b.5.20% c.5.30% d.5.00% e.5.10%

d.5.00%

40. Assume that the real risk-free rate, r*, equals 3%, and it is expected to be constant over time. Expected inflation is expected to be 3% in Year 1, 4% in Year 2, and 5% in Year 3. Assume that the maturity risk premium (MRP) = 0. What is the interest rate on Treasury securities that mature in three years? a.6.5% b.7.5% c.8.0% d.7.0% e.6.0%

d.7.0%

41. A 5-year Treasury bond has a 5% yield. A 10-year Treasury bond has a 6% yield. A 10-year corporate bond has an 8% yield. The market expects that inflation will average 2.5% over the next 10 years (IP10 = 2.5%). Assume that there is no maturity risk premium (MRP = 0), and that the annual real risk-free rate of interest, r*, will remain constant over the next 10 years. A 5-year corporate bond has the same default risk premium and liquidity premium as the 10-year corporate bond described above. What is the yield on this 5-year corporate bond? a.8.0% b.6.0% c.6.5% d.7.0% e.7.5%

d.7.0%

8. Which of the following statements is CORRECT? a.Unlimited liability and limited life are two key advantages of the corporate form over other forms of business organization. b.Although the stockholders of the corporation are insulated by limited legal liability, the legal status of the corporation does not protect the firm's managers in the same way, i.e., bondholders can sue its managers if the firm defaults on its debt. c.Limited liability is an advantage of the corporate form of organization to its owners (stockholders), but corporations have more trouble raising money in financial markets because of the complexity of this form of organization. d.A corporation is a legal entity created by a state, and it has a life and existence that is separate from the lives and existence of its owners and managers. e.A hostile takeover is the main method of transferring ownership interest in a corporation.

d.A corporation is a legal entity created by a state, and it has a life and existence that is separate from the lives and existence of its owners and managers.

7. Which of the following actions would be most likely to reduce potential conflicts of interest between stockholders and managers? a.Eliminate a requirement that members of the board of directors must hold a high percentage of their personal wealth in the firm's stock. b.Pay managers large cash salaries but give them no stock options. 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 received can be sold. d.Change the corporate charter so as to make it easier for outside investors to acquire a controlling interest in the firm. e.Beef up the restrictive covenants in the firm's debt agreements.

d.Change the corporate charter so as to make it easier for outside investors to acquire a controlling interest in the firm.

24. Which of the following items is NOT included in current assets? a.Short-term, highly liquid, marketable securities. b.Accounts payable. c.Inventory. d.Cash. e.Accounts receivable.

b.Accounts payable.

78. Stephenson & Sons has a capital structure that consists of 20% equity and 80% debt. The company expects to report $3 million in net income this year, and 60% of the net income will be paid out as dividends. How large can the firm's capital budget be this year without it having to issue any new common stock? a.$ 6.00 million b.$13.00 million c.$ 1.50 million d.$ 1.20 million e.$ 0.24 million

a.$ 6.00 million

52. A 12-year bond, $1,000 face value bond pays an 8% annual coupon and a yield to maturity of 7%. What is the price of the bond today? a.$1,079.43 b.$1,000.00 c.$1,099.21 d.$1,070.24 e.$ 924.64

a.$1,079.43

29. Companies generate income from their "regular" operations and from things like interest on securities they hold, which is called non-operating income. Mitel Metals recently reported $9,000 of sales, $6,000 of operating costs other than depreciation, and $1,500 of depreciation. The company had no amortization charges and no non-operating income. It had issued $4,000 of bonds that carry a 7% interest rate, and its federal-plus-state income tax rate was 40%. What was the firm's operating income, or EBIT? a.$1,500 b.$1,400 c.$1,300 d.$1,200 e.$1,100

a.$1,500

28. Marcus Nurseries Inc.'s 2005 balance sheet showed total common equity of $2,050,000, which included $1,750,000 of retained earnings. The company had 100,000 shares of stock outstanding which sold at a price of $57.25 per share. If the firm had net income of $250,000 in 2006 and paid out $100,000 as dividends, what would its book value per share be at the end of 2006, assuming that it neither issued nor retired any common stock? a.$22.00 b.$20.00 c.$21.00 d.$23.00 e.$19.00

a.$22.00

79. The following information applies to the Coetzer Company: - Coetzer has a target capital structure of 40% debt and 60% common equity. - Coetzer has 15-year, 12% annual coupon bonds that have a face value of $1,000 and sell for $1,150. - The risk-free rate is 5%. The market risk premium (RPM) is also 5%. - Coetzer's common stock has a beta of 1.4. - Coetzer's tax rate is 40%. What is the company's after-tax cost of common equity? a.12.0% b.8.4% c.9.6% d.6.0% e.10.0%

a.12.0%

69. A share of preferred stock pays a quarterly dividend of $2.50. If the price of this preferred stock is currently $50, what is the nominal annual rate of return? a.20% b.12% c.23% d.28% e.18%

a.20%

19. The First National Bank offers a 5% nominal interest rate, compounded monthly on its savings accounts, while the Second National Bank offers the same effective annual return, but interest is compounded quarterly. What nominal rate does the Second National Bank offer on its savings accounts? a.5.02% b.5.12% c.1.28% d.5.22% e.5.00%

a.5.02%

49. Brown Enterprises' bonds currently sell for $1,025. They have a 9-year maturity, an annual coupon of $80, and a par value of $1,000. What is their yield to maturity? a.7.61% b.7.21% c.7.45% d.7.03% e.6.87%

a.7.61%

12. You are interested in investing your money in a bank account. Which of the following banks provides you with the highest effective rate of interest? a.Bank 4; 8.0% with daily (365-day) compounding. b.Bank 3; 8.0% with quarterly compounding. c.Bank 2; 8.0% with annual compounding. d.Bank 5; 8.2% with annual compounding. e.Bank 1; 8.0% with monthly compounding.

a.Bank 4; 8.0% with daily (365-day) compounding.

2. Which of the following statements is CORRECT? a.One advantage of forming a corporation is that equity investors are usually exposed to less liability than in a partnership. b.It is generally less expensive to form a proprietorship than a corporation because, with a proprietorship, extensive legal documents are required. c.Corporations face fewer regulations than sole proprietorships. d.One disadvantage of operating a business as a sole proprietor is that the firm is subject to double taxation, at both the firm level and the owner level. e.If a partnership goes bankrupt, each partner is exposed to liabilities only up the amount of his or her investment in the business.

a.One advantage of forming a corporation is that equity investors are usually exposed to less liability than in a partnership.

46. Which of the following statements is CORRECT? a.Relative to a coupon-bearing bond with the same maturity, a zero coupon bond has more interest rate risk but less reinvestment rate risk. b.Long-term bonds have less interest rate price risk and also less reinvestment rate risk than short-term bonds. c.If interest rates increase, all bond prices will increase, but the increase will be greater for bonds that have less interest rate risk. d.Long-term bonds have less interest rate price risk but more reinvestment rate risk than short-term bonds. e.One advantage of a zero coupon Treasury bond is that no one who owns the bond has to pay any taxes on it until it matures or is sold.

a.Relative to a coupon-bearing bond with the same maturity, a zero coupon bond has more interest rate risk but less reinvestment rate risk.

91. Which of the following statements is CORRECT? a.The NPV method assumes that cash flows will be reinvested at the WACC, while the IRR method assumes reinvestment at the IRR. b.The NPV method does not consider all relevant cash flows, particularly, cash flows beyond the payback period. c.The IRR method does not consider all relevant cash flows, particularly, cash flows beyond the payback period. d.The NPV method assumes that cash flows will be reinvested at the risk-free rate, while the IRR method assumes reinvestment at the IRR. e.The NPV method assumes that cash flows will be reinvested at the WACC, while the IRR method assumes reinvestment at the risk-free rate.

a.The NPV method assumes that cash flows will be reinvested at the WACC, while the IRR method assumes reinvestment at the IRR.

6. Which of the following actions would be likely to reduce conflicts of interest between stockholders and managers? a.The board of directors becomes more vigilant in its oversight of the company's management. b.The company's outside auditing firm is offered a lucrative consulting contract with the company. c.The company changes the way executive stock options are handled, with all options now being vested after only 2 years rather than having 20% of the options awarded be vested every 2 years over a 10-year period. d.Managerial compensation is changed so that managers receive larger cash salaries but fewer long-term options to buy shares of stock. e.Congress passes a law that severely restricts hostile takeovers.

a.The board of directors becomes more vigilant in its oversight of the company's management.

74. A share of stock has a dividend of D0 = $5. The dividend is expected to grow at a 20% rate for the next 10 years, then at a 15% rate for 10 more years, and then at a long-run normal growth rate of 10% forever. If investors require a 10% return on this stock, what is its current price? a.The data given in the problem are internally inconsistent, that is, the situation described is impossible in that no equilibrium price can be produced. b.$100.00 c.$212.62 d.$ 82.35 e.$195.50

a.The data given in the problem are internally inconsistent, that is, the situation described is impossible in that no equilibrium price can be produced.

23. Which of the following statements is CORRECT? a.The income statement for a given year, say 2005, is designed to give us an idea of how much the firm earned during that year. b.If a firm follows generally accepted accounting principles (GAAP), then its reported net income will be identical to its reported net cash flow. c.The reported income of two otherwise identical firms cannot be manipulated by different accounting procedures provided the firms follow Generally Accepted Accounting Principles (GAAP). d.The reported income of two otherwise identical firms must be identical if the firms are publicly owned, provided they follow standardized procedures as specified by the Securities and Exchange Commission (SEC). e.The focal point of the income statement is the cash account, because it cannot be manipulated by "accounting tricks."

a.The income statement for a given year, say 2005, is designed to give us an idea of how much the firm earned during that year.

45. Which of the following statements is NOT CORRECT? a.Under Chapter 11 of the Bankruptcy Act, firms' assets are liquidated and the sale proceeds are used to pay off its debt according to the seniority of the debt. b.A company's bond rating is affected by its financial ratios and provisions in its indenture. c.All else equal, senior debt has less default risk than subordinated debt. d.The expected return on a corporate bond must be less than its promised return if the probability of default is greater than zero. e.All else equal, secured debt is less risky than unsecured debt.

a.Under Chapter 11 of the Bankruptcy Act, firms' assets are liquidated and the sale proceeds are used to pay off its debt according to the seniority of the debt.

64. A money manager is holding the following portfolio: Stock. Amount Invested. Beta. 1. 300,000. 0.6 2. 300,000. 1.0 3. 500,000. 1.4 4. 500,000. 1.8 The risk-free rate is 6% and the portfolio's required return is 12.5%. The manager would like to sell all of her holdings of Stock 1 and use the proceeds to purchase more shares of Stock 4. What would be the portfolio's required rate of return following this change? a.10.29% b.13.63% c.12.52% d.14.33% e.11.05%

b.13.63%

89. Project A has a WACC of 10% and the following cash flows: Year. Project A Cash Flow 0. -300 1. 100 2. 150 3. 200 4 50 What is Project A's MIRR? a.15.54% b.18.15% c.14.49% d.7.40% e.12.15%

b.18.15%

58. Miller Inc. is considering a capital budgeting project that has an expected return of 10% and a standard deviation of 30%. What is the project's coefficient of variation? a.2.2 b.3.0 c.3.4 d.1.8 e.2.6

b.3.0

95. Tapley Dental Associates is considering a project that has the following cash flow and WACC data. What is the project's NPV? Note that a project's projected NPV can be negative, in which case it will be rejected. WACC = 10 % Year CF 0. -1000 1. 300 2. 300 3. 300 4. 300 5 300 a. $123.15 b. $116.73 c. $137.24 d. $131.96 e. $128.47

c. $137.24

chapter 10

chapter 10

77. Burlees Inc.'s CFO has collected the following information to calculate its WACC: - The company's capital structure consists of 40% debt and 60% common stock. - The company has 25-year, 12% annual coupon bonds that have a face value of $1,000 and sell for $1,252. - The company uses the CAPM to calculate the cost of common stock. Currently, the risk-free rate is 5% and the market risk premium is 6%. The company's common stock has a beta of 1.6. - The company's tax rate is 40%. What is the company's after-tax cost of debt? a.8.33% b.5.62% c.7.20% d.4.80% e.3.74%

b.5.62%

21. You have $2,000 invested in a bank account that pays a 4% nominal interest rate with daily compounding. How much money will you have in the account in 132 days? (Assume there are 365 days in each year.) a. $2,023.44 b. $2,029.14 c. $2,028.93 d. $2,040.00 e. $2,023.99

b. $2,029.14

96. Pettway Inc. is considering Projects S and L, whose cash flows are shown below. These projects are mutually exclusive, equally risky, and not repeatable. If the decision is made by choosing the project with the higher IRR, how much value will be forgone? Note that under some conditions choosing projects on the basis of the IRR will cause $0.00 value to be lost. WACC = 12 % Year. CFS. CFL 0. -1025. -2153 1. 375. 750 2. 380. 759 3. 385. 768 4. 390. 777 a. $21.49 b. $27.52 c. $33.69 d. $15.57 e. $37.39

b. $27.52

48. Which of the following events would make it more likely that a company would choose to call its outstanding callable bonds? a. Market interest rates rise sharply. b. Market interest rates decline sharply. c. The company's bonds are downgraded. d. Inflation increases significantly. e. The company's financial situation deteriorates significantly.

b. Market interest rates decline sharply.

73. Motor Homes Inc. (MHI) is presently in a stage of abnormally high growth because of a surge in the demand for motor homes. The company expects earnings and dividends to grow at a rate of 20% for the next 4 years, after which time there will be no growth (g = 0) in earnings and dividends. The company's last dividend was $1.50. MHI's beta is 1.6, the market risk premium is 8.75%, and the risk-free rate is 4%. What should be the current common stock price? a.$19.10 b.$15.17 c.$17.28 d.$22.21 e.$24.66

b.$15.17

72. A share of common stock has just paid a dividend of $2.00. If the expected long-run growth rate for this stock is 7%, and if investors require a(n) 11% rate of return, what is the price of the stock? a.$50.50 b.$53.50 c.$49.00 d.$52.00 e.$47.50

b.$53.50

80. Assume that you are a consultant to Morton Inc., and you have been provided with the following data: D1 = $1.00; P0 = $25.00; and g = 6% (constant). What is the cost of equity from retained earnings based on the DCF approach? a.10.33% b.10.00% c.9.86% d.9.79% e.10.20%

b.10.00%

92. Moynihan Motors has a WACC of 10%. The firm is considering two normal, equally risky, but mutually exclusive projects. Project A has an IRR of 15%, while Project B has an IRR of 20%. Which of the following statements is CORRECT? a.Only one project has a positive NPV. b.If the crossover rate is 8%, Project B will have a higher NPV than Project A. c.Both projects have a negative NPV. d.If the crossover rate is 8%, Project A will have a higher NPV than Project B. e.Since the projects are mutually exclusive, the firm should always select Project B.

b.If the crossover rate is 8%, Project B will have a higher NPV than Project A.

38. If the pure expectations theory of the term structure is correct, which of the following statements is CORRECT? a.Interest rate price risk is higher on short-term bonds, but reinvestment rate risk is higher on long-term bonds. b.Interest rate price risk is higher on long-term bonds, but reinvestment rate risk is higher on short-term bonds. c.An upward sloping yield curve would imply that interest rates are expected to be lower in the future. d.The yield on a 5-year corporate bond should always exceed the yield on a 3-year Treasury bond. e.If a 1-year Treasury bill has a yield to maturity of 7% and a 2-year Treasury bill has a yield to maturity of 8%, this would imply the market believes that 1-year rates will be 7.5% one year from now.

b.Interest rate price risk is higher on long-term bonds, but reinvestment rate risk is higher on short-term bonds.

93. Which of the following statements is CORRECT? Assume that the project being considered has normal cash flows, with one outflow followed by a series of inflows. a.The regular payback ignores cash flows beyond the payback period, but the discounted payback method overcomes this problem. b.One drawback of the payback criterion for evaluating projects is that this method does not take account of cash flows beyond the payback period. c.One drawback of the discounted payback is that this method does not consider the time value of money, while the regular payback overcomes this drawback. d.The shorter a project's payback period, the less desirable the project is normally considered to be by this criterion. e.If a project's payback is positive, then the project should be accepted because it must have a positive NPV.

b.One drawback of the payback criterion for evaluating projects is that this method does not take account of cash flows beyond the payback period.

44. An investor is considering buying one of two 10-year, $1,000 face value bonds: Bond A has a 7% annual coupon, while Bond B has a 9% annual coupon. Both bonds have a yield to maturity of 8%, which is expected to remain constant for the next 10 years. Which of the following statements is CORRECT? a.Both bonds have the same price today, and the price of each bond is expected to remain constant until the bonds mature. b.One year from now, Bond A's price will be higher than it is today. c.Bond A's current yield is greater than 8%. d.Bond A has a higher price than Bond B today, but one year from now the bonds will have the same price as each other. e.Bond B has a higher price than Bond A today, but one year from now the bonds will have the same price as each other.

b.One year from now, Bond A's price will be higher than it is today.

94. Which of the following statements is CORRECT? a.The payback method is generally regarded by academics as being the best single method for evaluating capital budgeting projects. b.The net present value method (NPV) is generally regarded by academics as being the best single method for evaluating capital budgeting projects. c.The modified internal rate of return method (MIRR) is generally regarded by academics as being the best single method for evaluating capital budgeting projects. d.The discounted payback method is generally regarded by academics as being the best single method for evaluating capital budgeting projects. e.The internal rate of return method (IRR) is generally regarded by academics as being the best single method for evaluating capital budgeting projects.

b.The net present value method (NPV) is generally regarded by academics as being the best single method for evaluating capital budgeting projects.

61. 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%, a beta of 1.6, and a standard deviation 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 portfolio? a.Your portfolio has a standard deviation of 30% and its expected return is 15%. b.Your portfolio has a beta equal to 1.6 and its expected return is 15%. c.Your portfolio has a beta greater than 1.6 and an expected return greater than 15%. d.Your portfolio has a standard deviation less than 30% and its beta is greater than 1.6. e.Your portfolio has a standard deviation greater than 30% and a beta equal to 1.6.

b.Your portfolio has a beta equal to 1.6 and its expected return is 15%.

chapter 11

chapter 11

chapter 12

chapter 12

chapter 2 and 6

chapter 2 and 6

99. Delta Software is considering a new project whose data are shown below. The equipment that would be used has a 3-year tax life, after which it will be worthless, and it will be depreciated by the straight line method over 3 years. Revenues and other operating costs are expected to be constant over the project s 3-year life. What is the project's operating cash flow during Year 1? Equipment cost (depreciable basis) $75,000 Straight line depreciation rate 33.33% Sales $60,000 Operating costs excl. deprn $25,000 Tax rate 35% a. $28,500 b. $33,000 c. $31,500 d. $30,000 e. $27,000

c. $31,500

60. Stock X has a beta of 0.5 and Stock Y has a beta of 1.5. Which of the following statements is CORRECT? a.Stock Y's return during the coming year will be higher than Stock X's return. b.If the market risk premium declines, but the risk-free rate is unchanged, Stock X will have a larger decline in its required return than will Stock Y. c. If expected inflation increases (but the market risk premium is unchanged), the required returns on the two stocks will increase by the same amount. d.Stock Y's return has a higher standard deviation than Stock X. e.If you invest $50,000 in Stock X and $50,000 in Stock Y, your 2-stock portfolio will have a beta significantly lower than 1.0, provided the returns on the two stocks are not perfectly correlated.

c. If expected inflation increases (but the market risk premium is unchanged), the required returns on the two stocks will increase by the same amount.

31. McGwire Aerospace expects to have net cash flow of $12 million. The company forecasts that its operating costs excluding depreciation and amortization will equal 75% of the company's sales. Depreciation and amortization expenses (the firm's only non-cash items) are expected to be $5 million and the company has no interest expense. If the company's tax rate is 40%, what is the company's expected sales? a.$ 26.67 million b.$ 46.67 million c.$ 66.67 million d.$133.33 million e.$ 68.00 million

c.$ 66.67 million

18. A real estate investment has the following expected cash flows: Year. Cash Flows 1. 10000 2. 25000 3. 50000 4. 35000 If the discount rate is 8%, what is the investment's present value? a.$120,000b.$103,799c.$ 96,110d.$ 77,592e.$ 95,353.

c.$ 96,110

53. A 12-year, $1,000 face value bond has a 9% annual coupon, and a yield to maturity of 8%. What is the price of the bond? a.$ 928 b.$1,957 c.$1,075 d.$1,469 e.$1,000

c.$1,075

20. What's the present value of $2,000 discounted back 3 years if the appropriate interest rate is 8%, compounded semiannually? a.$1,110.34 b.$1,976.84 c.$1,580.63 d.$1,413.68 e.$1,349.15

c.$1,580.63

84. Moussawi Enterprises, which finances only with equity from retained earnings, is considering two large capital budgeting projects, and its CFO hired you to assist in deciding whether one, both, or neither of the projects should be accepted. You have the following information: (1) rRF = 5.5%; RPM = 6%; and b = 0.8. (2) The company adds 3% to the corporate WACC when it evaluates relatively risky projects, and it deducts 1% from the WACC when evaluating relatively safe projects. (3) Project S is relatively safe, it costs $10,000, and its expected rate of return is 8%, while Project R is relatively risky, it costs $15,000, and its expected rate of return is 12%. If these are the only two projects under consideration, how large should the capital budget be? a.$25,000 b.$20,000 c.$15,000 d.$10,000 e.$ 5,000

c.$15,000

47. KJM Corporation's balance sheet as of January 1, 2006 is as follows: Long-term debt (bonds, at par) $10,000,000 Preferred stock. 2,000,000 Common stock ($10 par) 10,000,000 Retained earnings. 4,000,000 Total debt and equity $26,000,000 The bonds have a 4% semiannual coupon rate and a par value of $1,000. They mature on January 1, 2016. If the yield to maturity is 12%, what is the current market value of the firm's debt? a.$2,531,000 b.$7,706,000 c.$5,412,000 d.$5,480,000 e.$7,056,000

c.$5,412,000

57. Partridge Plastic's stock has an estimated beta of 1.4, and its required return is 13%. Cleaver Motors' stock has a beta of 0.8, and the risk-free rate is 6%. What is the required return on Cleaver Motors' stock? a.7.0% b.10.4% c.10.0% d.12.0% e.11.0%

c.10.0%

81. Assume that you are a consultant to Thornton Inc., and you have been provided with the following data: rRF = 5.5%; RPM = 6.0%; and b = 0.8. What is the cost of equity from retained earnings based on the CAPM approach? a.9.91% b.9.65% c.10.30% d.10.08% e.10.49%

c.10.30%

83. Which of the following is not a capital component when calculating the weighted average cost of capital (WACC)? a.Preferred stock. b.Long-term debt. c.Accounts payable. d.Common stock. e.Retained earnings.

c.Accounts payable.

37. Which of the following statements is CORRECT? a.Hedge funds have more in common with commercial banks than with any other type of financial institution. b.Hedge funds have more in common with investment banks than with any other type of financial institution. c.Hedge funds are not as highly regulated as most other types of financial institutions. The justification for this light regulation is that only "sophisticated" investors (i.e., those with high net worths and high incomes) are permitted to invest in these funds, and such investors supposedly can do the necessary "due diligence" on their own rather than have it done by the SEC or some other regulator. d.Hedge funds are legal in Europe and Asia, but they are not permitted to operate in the United States. e.Hedge funds are legal in the United States, but they are not permitted to operate in Europe or Asia.

c.Hedge funds are not as highly regulated as most other types of financial institutions. The justification for this light regulation is that only "sophisticated" investors (i.e., those with high net worths and high incomes) are permitted to invest in these funds, and such investors supposedly can do the necessary "due diligence" on their own rather than have it done by the SEC or some other regulator.

39. Which of the following statements is CORRECT? a.If the expectations theory holds, the yield curve will never be downward sloping. b.If the maturity risk premium (MRP) is greater than zero, the yield curve must be upward sloping. c.If inflation is expected to increase in the future and the maturity risk premium (MRP) is greater than zero, the yield curve will be upward sloping. d.If the maturity risk premium (MRP) equals zero, the yield curve must be flat. e.Because long-term bonds are riskier than short-term bonds, yields on long-term Treasury bonds will always be higher than yields on short-term T-bonds.

c.If inflation is expected to increase in the future and the maturity risk premium (MRP) is greater than zero, the yield curve will be upward sloping.

chapter 3

chapter 3

chapter 5

chapter 5

33. Most studies of stock market efficiency suggest that the stock market is highly efficient in the weak-form and reasonably efficient in the semistrong-form. Assuming these findings are correct, which of the following statements is CORRECT? a.You have been tracking a stock's price over the past 6 months, and you note that this particular stock has tended to rise sharply immediately after it has fallen for three days. You can use this information to devise a trading strategy that will help you beat the market. b.You notice that a company's stock price always seems to swing back and forth--whenever it falls by 10% or more, it seems to recover and to eventually exceed its former high. Since its price has fallen during the past 2 months, now is a great time to buy it before it takes off again. c.Information you read in The Wall Street Journal cannot be used to select stocks that are likely to produce above-average rates of return. d.Even if you possess insider information, you cannot use this information to earn above-average returns because such information will already be reflected in stock prices. e.If you apply financial analysis properly, you can use information provided in companies' annual reports to earn above-average returns.

c.Information you read in The Wall Street Journal cannot be used to select stocks that are likely to produce above-average rates of return.

5. Which of the following statements is CORRECT? a.Most business in the U.S. is conducted by corporations, and corporations' popularity results primarily from their favorable tax treatment. b.Firms in highly competitive industries are more likely to consciously exercise "social responsibility" than are firms in oligopolistic industries. c.One example of an agency relationship is the one between stockholders and managers. d.Corporations and partnerships have an advantage over proprietorships because a sole proprietor is exposed to unlimited liability, but the liability of all investors in the other types of businesses is more limited. e.A good goal for a firm's management is maximization of expected EPS.

c.One example of an agency relationship is the one between stockholders and managers.

3. Which of the following statements is CORRECT? a.It is easier to transfer one's ownership interest in a partnership than in a corporation. b.One of the advantages of a corporation from a social standpoint is that every stockholder has equal voting rights, i.e., "one person, one vote." c.One of the disadvantages of a sole proprietorship is that the proprietor is exposed to unlimited liability. d.One of the advantages of the corporate form of organization is that it avoids double taxation. e.Corporations of all types are subject to the corporate income tax.

c.One of the disadvantages of a sole proprietorship is that the proprietor is exposed to unlimited liability.

82. Which of the following statements is CORRECT? Assume that the firm is a publicly-owned corporation. a.If a firm has a beta that is less than 1.0, say 0.9, this would suggest that the expected returns on its assets are negatively correlated with the returns on most other firms' assets. b.If a firm evaluates all projects using the same cost of capital, then its risk will probably decline over time. c.Project A has a standard deviation of expected returns of 20%, while Project B's standard deviation is only 10%. A's returns are negatively correlated with the firm's other assets and with returns on most stocks in the economy, while B's returns are positively correlated. Therefore, Project A is less risky to a firm and should be evaluated with a lower cost of capital. d.Projects with more than average risk typically have higher than average expected returns. Therefore, to maximize a firm's intrinsic value, its managers should favor high beta projects over low beta projects. e.If a firm's managers want to maximize the value of the stock, they should, in theory, concentrate on project risk as measured by the standard deviation of the project's expected future cash flows.

c.Project A has a standard deviation of expected returns of 20%, while Project B's standard deviation is only 10%. A's returns are negatively correlated with the firm's other assets and with returns on most stocks in the economy, while B's returns are positively correlated. Therefore, Project A is less risky to a firm and should be evaluated with a lower cost of capital.

67. Stock A has a beta of 1.1 and Stock B has a beta of 0.9. The market risk premium is 6%, and the risk-free rate is 6.3%. Both stocks have a constant dividend growth rate of 7% a year. If the market is in equilibrium, which of the following statements is CORRECT? a.Stock B's dividend yield equals its expected dividend growth rate. b.Stock B must have the higher required return. c.Stock A must have a higher dividend yield than Stock B. d.Stock A must have a higher stock price than Stock B. e.Stock B could have the higher expected return.

c.Stock A must have a higher dividend yield than Stock B.

4. Which of the following statements is CORRECT? a.Managers generally welcome hostile takeovers since the company seeking to do the taking over generally offers a price for the stock that is higher than the price before the takeover action started. b.The entrenched managers of established, stable companies sometimes attempt to get their state legislatures to remove rules that make it more difficult for raiders to succeed with hostile takeovers. c.The entrenched 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. d.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.The entrenched 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.

13. A $10,000 loan is to be amortized over 5 years, with annual end-of-year payments. Given these facts, which of these statements is CORRECT? a.The annual payments would be larger if the interest rate were lower. b.The last payment would have a higher proportion of interest than the first payment. c.The proportion of each payment that represents interest as opposed to repayment of principal would be higher if the interest rate were higher. d.If the loan were amortized over 10 years rather than 5 years, and if the interest rate were the same in either case, the first payment would include more dollars of interest under the 5-year amortization plan. e.The proportion of interest versus principal repayment would be the same for each of the 5 payments.

c.The proportion of each payment that represents interest as opposed to repayment of principal would be higher if the interest rate were higher.

10. Which of the following statements is CORRECT? a.Conflicts would not exist if the lead agency, the Security and Exchange Commission, were abolished. b.Compensating managers with stock options will do nothing to help eliminate potential conflicts between stockholders and managers. c.Restrictions can be included in credit agreements, but these restrictions will do nothing to protect bondholders from conflicts of interest between them and the firm's managers and stockholders. d.Compensating managers with stock options can help reduce conflicts of interest between stockholders and managers, but if the options are all exercisable on a specific date in the near future, this can motivate managers to deceive stockholders. e.The threat of takeovers reduces conflict of interest problems, but only between bondholders and stockholders.

d.Compensating managers with stock options can help reduce conflicts of interest between stockholders and managers, but if the options are all exercisable on a specific date in the near future, this can motivate managers to deceive stockholders.

9. Which of the following statements is CORRECT? a.Large corporations are taxed more favorably than sole proprietorships. b.Corporate stockholders are exposed to unlimited liability. c.Most businesses (by number and total dollar sales) are organized as proprietorships or partnerships because it is easier to set up and operate as one of these forms rather than as a corporation. However, if the business gets very large, it becomes advantageous to convert to a corporation, primarily because corporations have important tax advantages over proprietorships and partnerships. d.Due to legal considerations related to ownership transfers and limited liability, most business (measured by dollar sales) is conducted by corporations in spite of large corporations' less favorable tax treatment. e.Due to limited liability, unlimited lives, and ease of ownership transfer, the vast majority of U.S. businesses (in terms of number of businesses) are organized as corporations.

d.Due to legal considerations related to ownership transfers and limited liability, most business (measured by dollar sales) is conducted by corporations in spite of large corporations' less favorable tax treatment.

34. If the stock market is semistrong-form efficient, which of the following statements would be CORRECT? a.The required returns on all stocks are the same, and the required returns on stocks are higher than the required returns on bonds. b.A trading strategy in which you buy stocks that have recently fallen in price is likely to provide you with a return that exceeds the return on the overall stock market. c.If you have insider information about a particular stock, you cannot expect to earn an above average return on this information because it is already incorporated into the current stock price. d.Even if a market is semistrong-form efficient, an investor could still earn a better return than the market return if he or she had inside information. e.The required returns on stocks equal the required returns on bonds.

d.Even if a market is semistrong-form efficient, an investor could still earn a better return than the market return if he or she had inside information.

86. Which of the following statements is CORRECT? a.All else equal, an increase in a company's stock price will increase its marginal cost of new common equity, re. b.All else equal, an increase in a company's stock price will increase its marginal cost of retained earnings, rs. c.Since the money is readily available, the after-tax cost of retained earnings is usually much lower than the after-tax cost of debt. d.If a company's tax rate increases but the YTM of its noncallable bonds remains the same, the after-tax cost of its debt will fall. e.When calculating the cost of preferred stock, a company needs to adjust for taxes, because preferred stock dividends are tax deductible.

d.If a company's tax rate increases but the YTM of its noncallable bonds remains the same, the after-tax cost of its debt will fall.

88. Braun Industries is considering an investment project that has the following cash flows: Year. Cash Flow 0. -1000 1. 400 2. 300 3. 500 4 400 The company's WACC is 10%. What is the project's payback, IRR, and NPV? a.Payback = 2.4, IRR = 21.22%, NPV = $260. b.Payback = 2.4, IRR = 10.00%, NPV = $600. c.Payback = 2.6, IRR = 21.22%, NPV = $300. d.Payback = 2.6, IRR = 21.22%, NPV = $260. e.Payback = 2.6, IRR = 24.12%, NPV = $300.

d.Payback = 2.6, IRR = 21.22%, NPV = $260.

36. Money markets are markets for a.Long-term bonds. b.Foreign currencies. c.Corporate stocks. d.Short-term debt securities such a Treasury bills. e.Consumer automobile loans.

d.Short-term debt securities such a Treasury bills.

27. Assume that Solo Company commenced operations on January 1, 2006, and it was granted permission to use the same depreciation calculations for shareholder reporting and income tax purposes. The company planned to depreciate its fixed assets over 15 years, but in December 2006 management realized that the assets would last for only 10 years. Solo's accountants plan to report the 2006 financial statements based on this new information. How would the new depreciation assumption affect the company's financial statements? a.Solo's reported 2006 earnings per share would increase. b.Solo's net liabilities would increase. c.Solo's reported net fixed assets would increase. d.Solo's cash position in 2006 and 2007 would increase. e.Solo's EBIT would increase.

d.Solo's cash position in 2006 and 2007 would increase.

85. When applying the CAPM, which of the following factors can be determined with the most precision? a.The market risk premium (RPM). b.The expected rate of return on the market, rM. c.The beta coefficient, bi, of a relatively safe company. d.The beta coefficient of either "the market" or a stock that is known with certainty to be of average risk. e.The risk-free rate, rRF.

d.The beta coefficient of either "the market" or a stock that is known with certainty to be of average risk.

25. Last year Aldrin Company's operations provided a negative net cash flow, yet the cash shown on its balance sheet increased. Which of the following statements could explain the increase in cash, assuming the company's financial statements were prepared under generally accepted accounting principles? a.The company had high depreciation expenses. b.The company dramatically increased its capital expenditures. c.The company repurchased some of its common stock. d.The company sold some of its fixed assets. e.The company retired a large amount of its long-term debt.

d.The company sold some of its fixed assets.

66. Which of the following statements is CORRECT? a.An IPO occurs whenever a company buys back its stock on the open market. b.If a company has two classes of common stock, Class A and Class B, the stocks may pay different dividends, but the two classes must have the same voting rights. c.The stock valuation model, P0 = D1/(rs - g), cannot be used for firms that have negative growth rates. d.The preemptive right is a provision in the corporate charter that gives common stockholders the right to purchase (on a pro rata basis) new issues of common stock. e.The stock valuation model, P0 = D1/(rs - g), can be used only for firms whose growth rates exceed their required return.

d.The preemptive right is a provision in the corporate charter that gives common stockholders the right to purchase (on a pro rata basis) new issues of common stock.

If a stock's expected return exceeds its required return, this suggests that a.The company is probably not trying to maximize price per share. b.The stock is experiencing supernormal growth. c.Dividends are not being declared. d.The stock is probably a good buy. e.The stock should be sold.

d.The stock is probably a good buy.

70. The Jones Company plans to issue preferred stock with a perpetual annual dividend of $5 per share and a par value of $30. If the required return on this stock is currently 20%, what should be the stock's market value? a.$ 50 b.$ 10 c.$150 d.$100 e.$ 25

e.$ 25

15. What is the future value of a 5-year ordinary annuity with annual payments of $200, evaluated at 15%? a.$ 842.91 b.$ 670.44 c.$1,169.56 d.$1,522.64 e.$1,348.48

e.$1,348.48

17. Your father has $500,000 and wants to retire. He expects to live for another 20 years, and to be able to earn 8% on his invested funds. How much could he withdraw at the end of each of the next 20 years and end up with zero in the account? a.$47,843.15 b.$54,764.40 c.$53,431.83 d.$55,119.76 e.$50,926.10

e.$50,926.10

30. Edge Brothers reported net income of $385,000, its interest expense was $200,000, and its tax rate is 40%. If Edge could double its operating income (EBIT), what would have been the company's net income, all else equal? a.$1,275,000 b.$1,100,000 c.$ 920,000 d.$ 770,000 e.$890,000

e.$890,000

35. An investor in Treasury securities expects inflation to be 3% in Year 1, 4% in Year 2, and 5% each year thereafter. Assume that the real risk-free rate is 3%, and that this rate will remain constant over time. Two-year Treasury securities yield 6.8%, while 4-year Treasury securities yield 7.6%. What is the difference in the maturity risk premiums (MRPs) on the two securities, that is, what is MRP4 - MRP2? Disregard cross-product terms, i.e., if averaging is required, use the arithmetic average. a.0.80% b.0.15% c.0.10% d.0.90% e.0.05%

e.0.05%

56. Apex Roofing's stock has a beta of 1.50, its required return is 14.00%, and the risk-free rate is 5.00%. What is the required rate of return on the stock market? (Hint: First find the market risk premium.) a.11.50% b.10.50% c.12.00% d.12.50% e.11.00%

e.11.00%

71. If D0 = $2.00, g (which is constant) = 6%, and P0 = $40, what is the stock's expected total return for the coming year? a.10.8% b.11.8% c.9.8% d.10.3% e.11.3%

e.11.3%

16. Your girlfriend just won the Power Ball lottery. She has the choice of $10,000,000 today or a 30-year annuity of $500,000, with the first payment coming today. What rate of return is built into the annuity? a.3.91% b.3.59% c.2.71% d.4.10% e.3.08%

e.3.08%

90. A project has the following cash flows: Year. CF 0. -3000 1. 1000 2. 1000 3. 1000 4. 1000 If its WACC is 10%, what is the project's discounted payback period? a.3.30 years b.3.52 years c.4.75 years d.3.00 years e.3.75 years

e.3.75 years

26 The Campbell Corporation just purchased an expensive piece of equipment. Assume that the firm planned to depreciate the equipment over 5 years on a straight-line basis, but Congress then passed a provision that requires the company to depreciate the equipment on a straight-line basis over 7 years. Other things held constant, which of the following will occur as a result of this Congressional action? Assume that the company uses the same depreciation for tax and stockholder reporting purposes. a.Campbell's reported net income after taxes for the year will be lower. b.Campbell's cash position will improve (increase). c.Campbell's tax liability for the year will be lower. d.Campbell's taxable income will be lower. e.Campbell's net fixed assets as shown on the balance sheet will be higher at the end of the year.

e.Campbell's net fixed assets as shown on the balance sheet will be higher at the end of the year.

59. A highly risk-averse investor is considering adding one additional stock to a 4-stock portfolio. Two stocks are under consideration. Both have an expected return,, of 15%. However, the distribution of possible returns associated with Stock A has a standard deviation of 12%, while Stock B's standard deviation is 8%. Both stocks are equally highly correlated with the market, with r equal to 0.75 for both stocks. Which stock should this risk-averse investor add to his/her portfolio? a.Either A or B. b.Add A, since its beta is lower. c.Stock A. d.Neither A nor B. e.Stock B.

e.Stock B.

14. Which of the following statements regarding a 30-year (360-month) $100,000 fixed-rate mortgage is CORRECT? (Ignore all taxes and transactions costs.) a.Because it is a fixed rate mortgage, the amount paid in interest per payment is constant. b.The remaining balance after three years will be $100,000 less the total amount of interest paid during the first 36 months. c.The monthly payment on the mortgage will steadily decline over time. d.The outstanding balance gets paid off at a faster rate early in a loan's life, rather than later. e.The proportion of the monthly payment that goes towards repayment of principal will be higher 10 years from now than it will be this year.

e.The proportion of the monthly payment that goes towards repayment of principal will be higher 10 years from now than it will be this year.

63. Stock A has a beta of 0.8 and Stock B has a beta of 1.2. 50% of Portfolio P is invested in Stock A and 50% is invested in Stock B. If the market risk premium (rM - rRF) were to increase but the risk-free rate (rRF) remained constant, which of the following would occur? a.The required return on Portfolio P will remain unchanged. b.The required return will increase for Stock B but will decrease for Stock A. c.The required return will increase for Stock A but will decrease for Stock B. d.The required return will decrease by the same amount for both Stock A and Stock B. e.The required return will increase for both stocks but the increase will be greater for Stock B than for Stock A.

e.The required return will increase for both stocks but the increase will be greater for Stock B than for Stock A.

62. Which of the following statements is CORRECT? a.If a company's beta is halved, then its required return will also be halved. b.If a company's beta doubles, then its required return will also double. c.If the risk-free rate rises, then the market risk premium will also rise. d.Beta is measured by the slope of the security market. e.The slope of the security market line is equal to the market risk premium, (rM - rRF).

e.The slope of the security market line is equal to the market risk premium, (rM - rRF).

100. Which of the following statements is CORRECT? a.Under current laws and regulations, corporations must use straight line depreciation for all assets whose lives are 3 years or longer. b.Under MACRS depreciation, firms write off assets slower than they would under straight line depreciation, and as a result projects' forecasted NPVs are normally lower than they would be if straight line depreciation were permitted for tax purposes. c.Since depreciation is not a cash expense, it plays no role in capital budgeting. d.Under MACRS depreciation, firms can write off assets faster than they could under straight line depreciation, and as a result projects' forecasted NPVs are normally lower than they would be if straight line depreciation were permitted for tax purposes. e.Under MACRS depreciation, firms can write off assets faster than they could under straight line depreciation, and as a result projects' forecasted NPVs are normally higher than they would be if straight line depreciation had to be used for tax purposes.

e.Under MACRS depreciation, firms can write off assets faster than they could under straight line depreciation, and as a result projects' forecasted NPVs are normally higher than they would be if straight line depreciation had to be used for tax purposes.