FIN 310 CHAPTER 10, Fin 310 Chapter 9, Fin 310 Chapter 8, FIN 310 Chapter 6, Fin 310 Chapter 7

The ________ the coefficient of variation, the ________ the risk

lower; lower

Stock rights provide the stockholder with ________.

the right to purchase additional shares in direct proportion to their number of owned

A putable bond gives the bondholder ________.

the right to redeem the bond back to the corporation at par

The cost to a firm of each type of capital is dependent upon ________.

the risk-free rate of each type of capital plus the business risk and the financial risk of the firm

Nominal rate of interest is equal to ________.

the risk-free rate plus a risk premium

Combining negatively correlated assets having the same expected return results in a portfolio with ________ level of expected return and ________ level of risk.

the same; a lower

In the capital asset pricing model, the general risk preferences of investors in the marketplace are reflected by ________.

the slope of the security market line

Equity capital can be raised through ________.

the stock market

Debt is generally the least expensive source of capital. This is primarily due to ________.

the tax deductibility of interest payments

What is the IRR for the following project if its initial after-tax cost is $5,000,000 and it is expected to provide after-tax operating cash inflows of $1,800,000 in year 1, $1,900,000 in year 2, $1,700,000 in year 3, and $1,300,000 in year 4?

13.57%

Smith Corporation's common stock is expected to pay a dividend of $3.00 forever and currently sells for $21.42. What is the required rate of return?

14%

Which of the following is a disadvantage of issuing preferred stock from the common stockholders' perspective?

There is a seniority of preferred stockholder's claim over common stockholders.

Which of the following is true of a common stock

There is no fixed dividend payment obligation for the company.

________ is the value of a firm's ownership in the event that all assets are sold for their exact accounting value and the proceeds remaining after paying all liabilities (including preferred stock) are divided among common stockholders

book value

Generally, the order of cost, from the least expensive to the most expensive, for long-term capital of a corporation is ________.

long-term debt, preferred stock, retained earnings, new common stock

Common stockholders expect to earn a return by receiving ________.

dividends

Which of the following is true of efficient-market hypothesis?

Since stocks are fully and fairly priced, it follows that investors should not waste their time trying to find and capitalize on miss-priced (undervalued or overvalued) securities.

A proxy battle is the attempt by ________.

a nonmanagement group to unseat the existing management and gain control of the firm

A corporate financial analyst must calculate the value of an asset which produces year-end annual cash flows of $0 the first year, $2,000 the second year, $3,000 the third year, and $2,500 the fourth year. Assuming a discount rate of 15 percent, what is the value of this asset?

$0/(1.15)1 + $2,000/(1.15)2 + $3,000/(1.15)3 + $2,500/(1.15)4 = $4,914

What is the current price of a $1,000 par value bond maturing in 12 years with a coupon rate of 14 percent, paid semiannually, that has a YTM of 13 percent?

$1,060

Hewitt Packing Company has an issue of $1,000 par value bonds with a 14 percent annual coupon interest rate. The issue has ten years remaining to the maturity date. Bonds of similar risk are currently selling to yield a 12 percent rate of return. The current value of each Hewitt bond is ________.

$1,113.00

A firm has an issue of $1,000 par value bonds with a 12 percent stated interest rate outstanding. The issue pays interest annually and has 10 years remaining to its maturity date. If bonds of similar risk are currently earning 8 percent, the firm's bond will sell for ________ today.

$1,268.40

What is the NPV for a project if its cost of capital is 0 percent and its initial after-tax cost is $5,000,000 and it is expected to provide after-tax operating cash inflows of $1,800,000 in year 1, $1,900,000 in year 2, $1,700,000 in year 3, and $1,300,000 in year 4?

$1,700,000

A record collector has agreed to sell her entire collection to a historical museum in three years at a price of $100,000. The current risk-free rate is 7 percent. At what price should she value her collection today?

$100,000(1.07)-3 = $81,630

A firm has to pay a dividend of $1.20 per share till perpetuity, a zero growth rate of dividends, and a required return of 10 percent. The value of the firm's preferred stock is ________.

$12

A firm has the balance sheet accounts, Common Stock and Paid-in Capital in Excess of Par, with values of $40,000 and $500,000, respectively. The firm has 40,000 common shares outstanding. If the firm had a par value of $1, the stock originally sold for ________.

$13.50/share

At year end, Tangshan China Company balance sheet showed total assets of $60 million, total liabilities (including preferred stock) of $45 million, and 1,000,000 shares of common stock outstanding. Based on this information, Tangshan's book value per share of common stock is ________.

$15

Jia Hua Enterprises wants to issue sixty 20-year, $1,000 par value, zero-coupon bonds. If each bond is priced to yield 7 percent, how much will Jia Hua receive (ignoring issuance costs) when the bonds are first sold?

$15,505

Harry Corporation's common stock currently sells for $180 per share. Harry just paid a dividend of $10.18 and dividends are expected to grow at a constant rate of 6 percent forever. If the required rate of return is 12 percent, what will Harry Corporation's stock sell for one year from now?

$190.64

High-risk, high-yield junk bonds have declined in popularity over time due to ________.

a number of major defaults on these bonds

What is the yield to maturity, to the nearest percent, for the following bond: current price is $908, coupon rate is 11 percent, $1,000 par value, interest paid annually, eight years to maturity?

13%

Ted Corporation expects to generate free-cash flows of $200,000 per year for the next five years. Beyond that time, free cash flows are expected to grow at a constant rate of 5 percent per year forever. If the firm's average cost of capital is 15 percent, the market value of the firm's debt is $500,000, and Ted has a half million shares of stock outstanding, what is the value of Ted stock?

$2.43

At year end, Tangshan China Company balance sheet showed total assets of $60 million, total liabilities (including preferred stock) of $45 million, and 1,000,000 shares of common stock outstanding. Next year, Tangshan is projecting that it will have net income of $1.5 million. If the average P/E multiple in Tangshan's industry is 15, what should be the price of Tangshan's stock?

$22.50

Daniel Custom Cycles' common stock currently pays no dividends. The company plans to begin paying dividends beginning 3 years from today. The first dividend will be $3.00 and dividends will grow at 5 percent per year thereafter. Given a required return of 15 percent, what would you pay for the stock today?

$22.68

A firm has an outstanding issue of 1,000 shares of preferred stock with a $100 par value and an 8 percent annual dividend. The firm also has 5,000 shares of common stock outstanding. If the stock is cumulative and the board of directors has passed the preferred dividend for the prior two years, how much must the preferred stockholders be paid prior to paying dividends to common stockholders at the end of third year?

$24,000

A firm has an issue of preferred stock outstanding that has a stated annual dividend of $4. The required return on the preferred stock has been estimated to be 16 percent. The value of the preferred stock is ________.

$25

A firm has the balance sheet accounts, Common Stock and Paid-in Capital in Excess of Par, with values of $10,000 and $250,000, respectively. The firm has 10,000 common shares outstanding. If the firm had a par value of $1, the stock originally sold for ________.

$26/share

Julian is considering purchasing the stock of Pepsi Cola because he really loves the taste of Pepsi. What should Julian be willing to pay for Pepsi today if it is expected to pay a $2 dividend in one year and he expects dividends to grow at 5 percent indefinitely? Julian requires a 12 percent return to make this investment.

$28.57

The current price of DEF Corporation stock is $26.50 per share. Earnings next year should be $2 per share and it should pay a $1 dividend. The P/E multiple is 15 times on average. What price would you expect for DEF's stock in the future?

$30.00

A firm has issued cumulative preferred stock with a $100 par value and a 12 percent annual dividend. For the past two years, the board of directors has decided not to pay a dividend. At the end of the current year, the preferred stockholders must be paid ________ prior to paying the common stockholders

$36/share

A firm issued 10,000 shares of $2 par-value common stock, receiving proceeds of $40 per share. The amount recorded for the paid-in capital in excess of par account is ________.

$380,000

What is the dividend on an 8 percent preferred stock that currently sells for $45 and has a face value of $50 per share?

$4.00

A firm issued 10,000 shares of no par-value common stock, receiving proceeds of $40 per share. The amount recorded is ________.

$400,000 in the Common Stock account

Emmy Lou, Inc. has an expected dividend next year of $5.60 per share, a growth rate of dividends of 10 percent, and a required return of 20 percent. The value of a share of Emmy Lou, Inc.'s common stock is ________.

$56.00

Jia's Fashions recently paid a $2 annual dividend. The company is projecting that its dividends will grow by 20 percent next year, 12 percent annually for the two years after that, and then at 6 percent annually thereafter. Based on this information, how much should Jia's Fashions common stock sell for today if her required return is 10.5%?

$59.16

Patrick Company expects to generate free-cash of $120,000 per year forever. If the firm's required return is 12 percent, the market value of debt is $300,000, the market value of preferred stock is $70,000, and the company has 100,000 shares of stock outstanding. What is the value of Patrick's stock?

$6.30

Calculate the value of a $1,000 bond which has 10 years until maturity and pays quarterly interest at an annual coupon rate of 12 percent. The required return on similar-risk bonds is 20 percent

$656.82

At year end, Tangshan China Company balance sheet showed total assets of $60 million, total liabilities (including preferred stock) of $45 million, and 1,000,000 shares of common stock outstanding. If Tangshan could sell its assets for $52.5 million, Tangshan's liquidation value per share of common stock is ________.

$7.50

An 8 percent preferred stock with a market price of $110 per share and a $100 par value pays a cash dividend of ________.

$8.00

You are planning to purchase the stock of Ted's Sheds Inc. and you expect it to pay a dividend of $3 in 1 year, $4.25 in 2 years, and $6.00 in 3 years. You expect to sell the stock for $100 in 3 years. If your required return for purchasing the stock is 12 percent, how much would you pay for the stock today?

$81.52

A firm has an issue of $1,000 par value bonds with a 9 percent stated interest rate outstanding. The issue pays interest annually and has 20 years remaining to its maturity date. If bonds of similar risk are currently earning 11 percent, the firm's bond will sell for ________

$840.73

A firm has experienced a constant annual rate of dividend growth of 9 percent on its common stock and expects the dividend per share in the coming year to be $2.70. The firm can earn 12 percent on similar risk involvements. The value of the firm's common stock is ________.

$90/share

What is the current price of a $1,000 par value bond maturing in 9 years with a coupon rate of 8 percent, paid annually, that has a YTM of 9 percent?

$940

A firm issued 5,000 shares of $1 par-value common stock, receiving proceeds of $20 per share. The amount recorded for the paid-in capital in excess of par account is ________.

$95,000

Tangshan Coal Inc. just issued a 10 percent, 25-year bond with a $1,000 par value that pays interest semiannually. (a) How much can the investor expect in annual interest (in dollars)? (b) How much can the investor expect in interest every six months (in dollars)? (c) How much can the investor expect in par value at the end of the 25th year?

(a) $100 (b) $50 (c) $1,000

Smith, Inc. stock currently sells for $75 per share. The firm has total assets of $1,000,000 and total liabilities, including preferred stock, of $350,000. If the firm has 10,000 shares of common stock outstanding, (a) what is the book value of each share of common stock? (b) is the stock overvalued or undervalued in the marketplace? (c) what is the reason(s) for your answer in (b)?

(a) Book value per share = ($1,000,000-$350,000)/(10,000) = $65 per share (b) Overvalued (c) Market value of the assets is greater than the book value.

Ria's Doll Company has an outstanding preferred issue of stock with a par value of $100 and an annual dividend of 10 percent (of par). Similar risk preferred stocks are yielding an 11.5 percent annual rate of return. (a) What is the current value of the outstanding preferred stock? (b) What will happen to price as the risk-free rate increases? Explain.

(a) Current value of the outstanding preferred stock = $100 × 0.10 / 0.115 = $86.96 (b) As the risk-free rate increases, the required rate of return will increase and the price will drop

Tangshan China's stock is currently selling for $160.00 per share and the firm's dividends are expected to grow at 5 percent indefinitely. In addition, Tangshan China's most recent dividend was $5.50. The expected risk free rate of return is 3 percent, the expected market return is 8 percent, and Tangshan has a beta of 1.20. (a) What is the expected return based on the dividend valuation model? (b) What is the required return based on the CAPM? (c) Would Tangshan China be a good investment at this time? Explain

(a) rs = [$5.50(1.05)]/$160.00 + 0.05 = 8.6% (b) rs = 0.03 + 1.2(0.08 - 0.03) = 9% (c) The expected return is 8.6 percent but the required return is 9 percent. Based on this information, Tangshan is overvalued and would not be a good investment at this time

Nico bought 100 shares of Cisco Systems stock for $30.00 per share on January 1, 2013. He received a dividend of $2.00 per share at the end of 2013 and $3.00 per share at the end of 2014. At the end of 2015, Nico collected a dividend of $4.00 per share and sold his stock for $33.00 per share. What was Nico's realized holding period return?

+40%

A firm is evaluating an investment proposal which has an initial investment of $5,000 and cash flows presently valued at $4,000. The net present value of the investment is ________.

-$1,000

What is the NPV for a project if its cost of capital is 12 percent and its initial after-tax cost is $5,000,000 and it is expected to provide after-tax operating cash flows of $1,800,000 in year 1, $1,900,000 in year 2, $1,700,000 in year 3, and ($1,300,000) in year 4?

-$1,494,336

What is the NPV for a project whose cost of capital is 15 percent and initial after-tax cost is $5,000,000 and is expected to provide after-tax operating cash inflows of $1,800,000 in year 1, $1,900,000 in year 2, $1,700,000 in year 3, and $1,300,000 in year 4?

-$137,053

Nico wants to invest all of his money in just two assets: the risk-free asset and the market portfolio. What is Nico's portfolio beta if he invests a quarter of his money in the market portfolio and the rest in the risk free asset?

0.25

What is Nico's portfolio beta if he invests an equal amount in Asset X with a beta of 0.60, Asset Y with a beta of 1.60, and the risk-free asset?

0.73

Nico Nelson, a management trainee at a large New York-based bank, is trying to estimate the real rate of return expected by investors. He notes that the 3-month T-bill currently yields 3 percent and has decided to use the consumer price index as a proxy for expected inflation. What is the estimated real rate of interest if the CPI is currently 2 percent?

1%

Asset P has a beta of 0.9. The risk-free rate of return is 8 percent, while the return on the market portfolio of assets is 14 percent. The asset's required rate of return is ________.

13.4%

What is the profitability index of a project that has an initial cash outflow of $600, an inflow of $250 for the next 3 years and a cost of capital of 10 percent?

1.036

Nicole holds three stocks in her portfolio: A, B, and C. The portfolio beta is 1.40. Stock A comprises 15 percent of the dollar value of her holdings and has a beta of 1.0. If Nicole sells all of her investment in A and invests the proceeds in the risk-free asset, her new portfolio beta will be ________.

1.25

An investment banker has recommended a $100,000 portfolio containing assets B, D, and F. $20,000 will be invested in asset B, with a beta of 1.5; $50,000 will be invested in asset D, with a beta of 2.0; and $30,000 will be invested in asset F, with a beta of 0.5. The beta of the portfolio is ________.

1.45

A firm has issued 10 percent preferred stock, which sold for $100 per share par value. The cost of issuing and selling the stock was $2 per share. The firm's marginal tax rate is 40 percent. The cost of the preferred stock is ________.

10.2 percent

A firm has determined it can issue preferred stock at $115 per share par value. The stock will pay a $12 annual dividend. The cost of issuing and selling the stock is $3 per share. The cost of the preferred stock is ________.

10.7 percent

The approximate before-tax cost of debt for a 15-year, 10 percent, $1,000 par value bond selling at $950 is ________.

10.7 percent

Given the returns of two stocks J and K in the table below over the next 4 years. Find the expected return and standard deviation of holding a portfolio of 40% of stock J and 60% in stock K over the next 4 years: Stock J Stock K 2010 10% 9% 2011 12% 8% 2012 13% 10% 2013 15% 11%

10.7% and 1.34%

Tangshan Industries has issued a bond which has a $1,000 par value and a 15 percent annual coupon interest rate. The bond will mature in ten years and currently sells for $1,250. Using this information, the yield to maturity on the Tangshan Industries bond is ________.

10.79%

Source of capital Target Market Prop After-tax Long-term debt 40% 6% Preferred stock 10% 11% common stock equity 50% 15% The weighted average cost of capital is ________.

11 percent

An investment advisor has recommended a $50,000 portfolio containing assets R, J, and K; $25,000 will be invested in asset R, with an expected annual return of 12 percent; $10,000 will be invested in asset J, with an expected annual return of 18 percent; and $15,000 will be invested in asset K, with an expected annual return of 8 percent. The expected annual return of this portfolio is

12.00%

A firm has common stock with a market price of $55 per share and an expected dividend of $2.81 per share at the end of the coming year. The dividends paid on the outstanding stock over the past five years are as follows:The cost of the firm's common stock equity is ________.

12.1 percent

A firm has issued preferred stock at its $125 per share par value. The stock will pay a $15 annual dividend. The cost of issuing and selling the stock was $4 per share. The cost of the preferred stock is ________.

12.4 percent

Nico bought 500 shares of a stock for $24.00 per share on January 1, 2013. He received a dividend of $2.50 per share at the end of 2013 and $4.00 per share at the end of 2014. At the end of 2015, Nico collected a dividend of $3.00 per share and sold his stock for $20.00 per share. What is Nico's realized total rate of return?

12.5%

A firm has common stock with a market price of $100 per share and an expected dividend of $5.61 per share at the end of the coming year. A new issue of stock is expected to be sold for $98, with $2 per share representing the underpricing necessary in the competitive capital market. Flotation costs are expected to total $1 per share. The dividends paid on the outstanding stock over the past five years are as follows: The cost of this new issue of common stock is ________.

12.8 percent

A firm has common stock with a market price of $25 per share and an expected dividend of $2 per share at the end of the coming year. The growth rate in dividends has been 5 percent. The cost of the firm's common stock equity is ________.

13 percent

The inflation risk premium on a bond is 2 percent, the U.S. T-bill rate is 5 percent, the maturity risk premium on the bond is 3 percent, the default risk premium on the bond is 2 percent, and the liquidity risk premium on the bond is 1 percent. Calculate its nominal rate of return.

13%

Nico Corp issued bonds bearing a coupon rate of 12 percent, pay coupons semiannually, have 3 years remaining to maturity, and are currently priced at $940 per bond. What is the yield to maturity?

14.54%

What is the expected market return if the expected return on Asset X is 20 percent, its beta is 1.5, and the risk free rate is 5 percent?

15.00%

A firm has a beta of 1.2. The market return equals 14 percent and the risk-free rate of return equals 6 percent. The estimated cost of common stock equity is ________.

15.6 percent

Last year, Mike bought 100 shares of Dallas Corporation common stock for $53 per share. During the year he received dividends of $1.45 per share. The stock is currently selling for $60 per share. What rate of return did Mike earn over the year?

15.9%

What would be the cost of new common stock equity for Tangshan Mining if the firm just paid a dividend of $4.25, the stock price is $55.00, dividends are expected to grow at 8.5 percent indefinitely, and flotation costs are $6.25 per share?

17.22%

What would be the cost of retained earnings equity for Tangshan Mining if the expected return on U.S. Treasury Bills is 5.00%, the market risk premium is 10.00 percent, and the firm's beta is 1.3?

18.0%

What is the approximate yield to maturity for a $1,000 par value bond selling for $1,120 that matures in 6 years and pays 12 percent interest annually?

9.3%

Source of capital Target Market Prop After-tax Long-term debt 45% 5% Preferred stock 10% 14% common stock equity 45% 22% Other things remaining constant, if the firm were to shift toward a capital structure with ________ the weighted average cost of capital will be higher.

20% long-term debt, 60% common stock, and 20% preferred stock

What is the expected return for Asset X if it has a beta of 1.5, the expected market return is 15 percent, and the expected risk-free rate is 5 percent?

20.0%

A firm is evaluating a proposal which has an initial investment of $50,000 and has cash flows of $15,000 per year for five years. The payback period of the project is ________.

3.3 years

What is the payback period for Tangshan Mining company's new project if its initial after-tax cost is $5,000,000 and it is expected to provide after-tax operating cash inflows of $1,800,000 in year 1, $1,900,000 in year 2, $700,000 in year 3, and $1,800,000 in year 4?

3.33 years

If a corporation has an average tax rate of 40 percent, the approximate annual, after-tax cost of debt for a 10-year, 8 percent, $1,000 par value bond selling at $1,150 is ________.

3.6 percent

The approximate after-tax cost of debt for a 20-year, 7 percent, $1,000 par value bond selling at $960 (assume a marginal tax rate of 40 percent) is ________.

4.43 percent

What is the expected risk-free rate of return if Asset X, with a beta of 1.5, has an expected return of 20 percent, and the expected market return is 15 percent?

5.0%

Tangshan Mining is considering issuing preferred stock. The preferred stock would have a par value of $75 and a 5.50 percent dividend. What is the cost of preferred stock for Tangshan if flotation costs would amount to 5.5 percent of par value?

5.82%

What is the IRR for the following project if its initial after-tax cost is $5,000,000 and it is expected to provide after-tax operating cash flows of ($1,800,000) in year 1, $2,900,000 in year 2, $2,700,000 in year 3, and $2,300,000 in year 4?

5.83%

The approximate before-tax cost of debt for a 10-year, 8 percent, $1,000 par value bond selling at $1,150 is ________.

5.97 percent

Given that the cost of common stock is 18 percent, dividends are $1.50 per share and the price of the stock is $12.50 per share, what is the annual growth rate of dividends?

6 percent

Asset Y has a beta of 1.2. The risk-free rate of return is 6 percent, while the return on the market portfolio of assets is 12 percent. The asset's market risk premium is ________.

6.0%

Zheng Corporation plans to issue new bonds to finance its expansion plans. In its efforts to price the issue, Zheng Corporation has identified a company of similar risk with an outstanding bond issue that has an 8 percent coupon rate having a maturity of ten years. This firm's bonds are currently selling for $1,091.96. If interest is paid annually for both bonds, what must the coupon rate of the new bonds be in order for the issue to sell at par?

6.71%

Nico owns 100 shares of Stock X which has a price of $12 per share and 200 shares of Stock Y which has a price of $3 per share. What is the proportion of Nico's portfolio invested in stock X?

67%

The before-tax cost of debt for a firm, which has a marginal tax rate of 40 percent, is 12 percent. The after-tax cost of debt is ________.

7.2 percent

Nico Trading Corporation is considering issuing long-term debt. The debt would have a 30-year maturity and a 10 percent coupon rate. In order to sell the issue, the bonds must be underpriced at a discount of 5 percent of face value. In addition, the firm would have to pay flotation costs of 5 percent of face value. The firm's tax rate is 35 percent. Given this information, the after-tax cost of debt for Nico Trading would be ________.

7.26%

If a corporation has an average tax rate of 40 percent, the approximate, annual, after-tax cost of debt for a 15-year, 12 percent, $1,000 par value bond, selling at $950 is ________.

7.7 percent

Tangshan China Company's stock is currently selling for $80.00 per share. The expected dividend one year from now is $4.00 and the required return is 13 percent. What is Tangshan's dividend growth rate assuming that dividends are expected to grow at a constant rate forever?

8%

A firm has an issue of preferred stock outstanding that has a par value of $100 and a 4% dividend. If the current market price of the preferred stock is $50, the yield on the preferred stock is ________.

8.00%

Tangshan China's stock is currently selling for $160.00 per share and the firm's dividends are expected to grow at 5 percent indefinitely. Assuming Tangshan China's most recent dividend was $5.50, what is the required rate of return on Tangshan's stock?

8.4%

Tangshan Mining is considering issuing long-term debt. The debt would have a 30 year maturity and a 12 percent coupon rate and make semiannual coupon payments. In order to sell the issue, the bonds must be underpriced at a discount of 2.5 percent of face value. In addition, the firm would have to pay flotation costs of 2.5 percent of face value. The firm's tax rate is 33 percent. Given this information, the after-tax cost of debt for Tangshan Mining would be ________.

8.48%

To finance a new line of product, the Tangshan Toys has issued a bond with a par value of $1,000, coupon rate of 8 percent, and maturity of 30 years. Compute the price of the bond if the opportunity cost is 11 percent.

ANSWER: Coupon payment = 1,000 × 0.08 = $80 Using financial calculator: PMT = 80, I = 11, N = 30, FV = 1000, CPT PV = $739.19

Zhen Yi Computers has an outstanding issue of bond with a par value of $1,000, paying 12 percent coupon rate semi-annually. The bond was issued 25 years ago and has 5 years to maturity. What is the value of the bond assuming 14 percent rate of interest?

ANSWER: Coupon payment = 1,000 × 0.12 = $120 Semi-annual coupon payment = 120 CPT PV = $929.76/2 = $60 Using financial calculator: PMT = 60, I = 7, N = 10, FV = 1000, CPT PV = $926.76

The Oxford Heating Company has been very successful in the past four years. Over these years, it paid common stock dividend of $4 in the first year, $4.20 in the second year, $4.41 in the third year, and its most recent dividend was $4.63. The company wishes to continue this dividend growth indefinitely. What is the value of the company's stock if the required rate of return is 12 percent?

Answer: Constant growth rate, g = ($4.63 / $4.00) 1 / 3 - 1 = 0.04996, g = 5% P = D5 / (r - g) = 4.63 (1 + 0.05) / (0.12 - 0.05) = $69.45

Yantai Food, Inc. has issued a bond with par value of $1,000, a coupon rate of 9 percent that is paid semi-annually, and that matures in 10 years. What is the value of the bond if the required rate of return is 12 percent?

Answer: Coupon payment = 1,000 × 0.09 = $90 Semi-annual coupon payment = 90/2 = $45 Using financial calculator: PMT = 45, I = 6, N = 20, FV = 1000, CPT PV = $827.95

To expand its business, the Kingston Outlet factory would like to issue a bond with par value of $1,000, coupon rate of 10 percent, and maturity of 10 years from now. What is the value of the bond if the required rate of return is 1) 8 percent, 2) 10 percent, and 3) 12 percent?

Answer: Coupon payment = 1,000 × 0.10 = $100 1) Using Financial calculator: PMT = 100, N = 10, I = 8, FV = 1000, CPT PV = $1,134.20 2) $1,000 since coupon rate and required rate of return are equal. 3) Using Financial calculator: PMT = 100, N = 10, I = 12, FV = 1000, CPT PV = $887

The Bradshaw Company's most recent dividend was $6.75. The historical dividend payment by the company shows a constant growth rate of 5 percent per year. What is the maximum you would be willing to pay for a share of its common stock if your required rate of return is 8 percent?

Answer: D1 = $6.75 × (1 + 0.05) = $7.0875 P = D1 / (r - g) = $7.0875 / (0.08 - 0.05) = $236.25

Ted has 10 shares of Grand Company. Based on the company's dividend policy, Ted will receive a total of $450 a year in perpetuity. What is the value of each share if the rate of interest is 8 percent?

Answer: Dividend per share = $450 / 10 = $45 P = D / r = 45 / 0.08 = $562.50

A beta coefficient of -1 represents an asset that ________.

has the same response as the market portfolio but in opposite direction

In the capital asset pricing model, an increase in inflationary expectations will be reflected by ________.

a parallel shift upward in the security market

Which of the following is true of outstanding shares?

Authorized shares become outstanding shares when they are issued or sold to investors.

Which of the following is a difference between common stock and bonds?

Bondholders have a senior claim on assets and income relative to stockholders.

China Imports currently has 2,000 shares of common stock outstanding. The firm has assets of $200,000 and total liabilities including preferred stock of $75,000. Calculate the book value per share of China Imports common stock

Book value per share = (200,000-$75,000)/(2000) = $62.50 per share

________ is the process of evaluating and selecting long-term investments that are consistent with a firm's goal of maximizing owners' wealth.

Capital budgeting

Which of the following is true of risk aversion?

Changes in risk aversion, and therefore shifts in the SML, result from changing preferences of investors

________ are secured by stock and/or bonds that are owned by the issuer.

Collateral trust bonds

Which of the following is typically a feature of common stock?

Common stocks may or may not pay dividends

________ is a statistical measure of the relationship between any two series of numbers.

Correlation

________ risk represents the portion of an asset's risk that can be eliminated by combining assets with less than perfect positive correlation. A) Diversifiable

Diversifiable

________ is used to finance "rolling stock"—airplanes,trucks,boats,railroad cars.

Equipment trust certificates

Based on analysis of the company and expected industry and economic conditions, China Imports is expected to earn $4.60 per share of common stock next year. The average price/earnings ratio for firms in the same industry is 8. Calculate the estimated value of a share of China Imports common stock

Estimated value of share price = $4.60 × 8 = $36.80 per share

Which of the following explains the general shape of the yield curve of a bond?

Expectations theory

________ have a short maturities, typically one to five years, and which can be renewed for a similar period at the option of their holders

Extendible notes

The cost of common stock equity may be estimated by using the ________.

Gordon model

Which of the following statements is true of payback period?

If the payback period is less than the maximum acceptable payback period, accept the project.

________ bonds are characterized by interest payments that are required only when earnings are available.

Income

________ projects do not compete with each other; the acceptance of one ________ the others from consideration.

Independent; does not eliminate

Which of the following is true of the accept-reject approach?

It can be used for making capital budgeting decisions when there is capital rationing.

Which of the following is a reason for firms not using the payback method as a guideline in capital investment decisions?

It cannot be specified in light of the wealth maximization goal.

Which of the following is true of NPV profile?

It charts the net present value of a project as a function of the cost of capital

Which of the following is a disadvantage of payback period approach?

It does not explicitly consider the time value of money.

Which of the following is true of equity?

It does not mature, so repayment is not required

Which of the following is true of common stock ?

It gives the holder voting rights which permit selection of the firm's directors.

Which of the following is true of the issuance of nonvoting common stock?

It helps the corporation to raise capital through the sale of common stock, without giving up its voting control

Which of the following is true of par value of a common stock?

It is an arbitrary value established for legal purposes in a firm's corporate charter.

Which of the following is true of a capital expenditure?

It is commonly used to expand the level of operations.

Which of the following is an advantage of NPV?

It takes into account the time value of investors' money.

________ is the actual amount each common stockholder would expect to receive if a firm's assets are sold for their market value, creditors and preferred stockholders are repaid, and any remaining money is divided among the common stockholders

Liquidation value

Smith has current assets of $800,000, which can be liquidated at 90 percent of book value. Total liabilities, including preferred stock, equal $270,000. The firm has 15,000 shares of common stock outstanding. What is the liquidation value per share of common stock?

Liquidation value per share = ($800,000*90%-$270,000)/15,000 = $30 per share

________ mainly explains the tendency for the yield curve to be upward sloping.

Liquidity preference theory

Which of the following affects the slope of yield curve?

Liquidity preferences

________ projects have the same function; the acceptance of one ________ the others from consideration.

Mutually exclusive; eliminates

Should Tangshan Mining company accept a new project if its maximum payback is 3.25 years and its initial after-tax cost is $5,000,000 and it is expected to provide after-tax operating cash inflows of $1,800,000 in year 1, $1,900,000 in year 2, $700,000 in year 3, and $1,800,000 in year 4?

No, since the payback period of the project is more than the maximum acceptable payback period.

Gong Li has recently inherited $10,000 and is considering purchasing 10 bonds of the Lucky Corporation. The bond has a par value of $1,000 with 10 percent coupon rate and will mature in 10 years. Does Gong Li have enough money to buy 10 bonds if the required rate of return is 9 percent?

No. Since the required rate of return (9%) is less than the bond's coupon rate (10%), the bond's price is greater than its par value ($1,000). Thus, the total price of 10 bonds is greater than $10,000.

Aunt Tilly's Fur Company has been experiencing several years of financial difficulty and, thus, has considered maintaining its dividend payment at $2.50 indefinitely. What is the value of its common stock if the required rate of return is 8.5 percent

P = D / r = $2.50 / 0.085 = $29.41

The board of directors of Ride World, Inc. has declared $5.00 common stock dividend and accepted a plan to freeze the dividend at $5 per year indefinitely. What is the value of the Ride World's common stock if the required rate of interest is 15 percent?

P = D / r = $5 / 0.15 = $33.33

Jia's Kitchen Stuff has recently sold 1,000 shares of preferred stock. What is the value of the stock assuming 10 percent required rate of return and a preferred dividend of $6.75

P = D / r = $6.75 / 0.10 = $67.50

Tina's Medical Equipment Company paid $2.25 common stock dividend last year. The company's policy is to allow its dividend to grow at 5 percent per year indefinitely. What is the value of the stock if the required rate of return is 8 percent?

P = D1 / (r - g) = $2.25 × (1 + 0.05) / (0.08 - 0.05) = $78.75

In response to the stock market's reaction to its dividend policy, the Nico's Toy Company has decided to increase its dividend payment at a rate of 4 percent per year. The firm's most recent dividend is $3.25 and the required rate of interest is 9 percent. What is the maximum you would be willing to pay for a share of the stock?

P = D1 / (r - g) = 3.25 × (1 + 0.04) / (0.09 - 0.04) = $67.60

The use of the ________ is especially helpful in valuing firms that are not publicly traded.

P/E multiple

Which of the following valuation methods is superior to others in the list since it considers expected earnings?

P/E multiple

A(n)________ is hired by a firm to find prospective buyers for its new stock or bond issue

investment banker

Which of the following is true of preferred stocks?

Preferred stock with a conversion feature allows holders to change each share into a stated number of shares of common stock.

________ are promised a fixed periodic dividend that must be paid prior to paying any common stock dividends

Preferred stockholders

Evaluate the following projects using the payback method assuming a rule of 3 years for payback YEAR Project A Project B 0 -10,000 -10,000 1 4,000 4,000 2 4,000 3,000 3 4,000 2,000 4 0 1,000,000

Project A can be accepted because the payback period is 2.5 years but Project B cannot be accepted because its payback period is longer than 3 years.

Consider the following projects, X and Y, where the firm can only choose one. Project X costs $600 and has cash flows of $400 in each of the next 2 years. Project Y also costs $600, and generates cash flows of $500 and $275 for the next 2 years, respectively. Which investment should the firm choose if the cost of capital is 10 percent?

Project X, since it has a higher NPV than Project Y

________ is the extent of an asset's risk. It is found by subtracting the pessimistic outcome from the optimistic outcome.

Range

Nico bought 100 shares of a company's stock for $22.00 per share on January 1, 2013. He received a dividend of $2.00 per share at the end of 2013 and $3.00 per share at the end of 2014. At the end of 2015, Nico collected a dividend of $4.00 per share and sold his stock for $18.00 per share. What was Nico's realized holding period return? What was Nico's compound annual rate of return? Explain the difference?

Realized return = ($22-$18+$9)/$22 = 59.09% Compound Return: $22 = $2/(1+r)^2 + $3/(1+r)^2 + ($4 + 18)/ (1+r)^3 Solve for r either with a calculator or through trial and error. The calculator is approximately 7.8%. The reason the realized holding period return is so much larger than the compound rate of return is that the realized return does not account for the time value of money.

Asset A was purchased six months ago for $25,000 and has generated $1,500 cash flow during that period. What is the asset's rate of return if it can be sold for $26,750 today?

Realized return = ($26,750-$25,000+$1,500)/$25,000 = 13% Annual rate of return = 13% × 2 = 26%

Perry purchased 100 shares of Ferro, Inc. common stock for $25 per share one year ago. During the year, Ferro, Inc. paid cash dividends of $2 per share. The stock is currently selling for $30 per share. If Perry sells all of his shares of Ferro, Inc. today, what rate of return would he realize?

Realized return = ($30-$25+$2)/25 = 28%

Tim purchased a bounce house one year ago for $6,500. During the year it generated $4,000 in cash flow. If Time sells the bounce house today, he could receive $6,100 for it. What would be his rate of return under these conditions?

Realized return = ($6,100-$6,500+$4,000)/$6,500 = 55.38%

Which of the following is true of risk-return trade off?

Risk can be measured on the basis of variability of return

Which of the following is true of risk?

Risk is a measure of the uncertainty surrounding the return that an investment will earn.

As risk aversion increases ________.

investors' required rate of return will increase

Ride World has estimated the market value of its assets to be $1,250,000. What is the value of Ride World's common stock if it has $900,000 in liabilities, $50,000 in preferred stock, and 7,500 shares of common stock outstanding?

Stock price = ($1,250,000 - $900,000 - $50,000) / 7,500 = $40

Karina's Caribbean Foods had total assets as recorded on its balance sheet are $1,500,000. What is the value of the Karina's common stock if it has $950,000 in liabilities, and 7,500 shares of common stock outstanding?

Stock price = ($1,500,000 - $950,000) / 7,500 = $73.33

Due to growing demand for computer software, the Shine Company has had a very successful year and expects its earnings per share to grow by 25 percent to reach $5.50 for this year. Estimate the price of the company's common stock assuming the industry's price/earning ratio is 12.

Stock price = (P/E × E) = 12 × $5.50 = $66

________ are claims that are not satisfied until those of the creditors holding certain (senior) debts have been fully satisfied

Subordinated debentures

________ means that subsequent creditors agree to wait until all claims of the are senior debt satisfied before having their claims satisfied.

Subordination

________ is a guide to a firm's value if it is assumed that investors value the earnings of a given firm in the same way they do the average firm in the industry.

The P/E multiple

Edward Accounting Services has an outstanding issue of 1,000 shares preferred stock with a $100 par value, an 9 percent annual dividend, and 5,000 shares of common stock outstanding. If the stock is cumulative and the board of directors has passed the preferred dividend for the last two years, how much must preferred stockholders be paid prior to paying dividends to common stockholders?

The amount to be paid to preferred stockholders prior to paying dividends to common stockholders = Cumulative preferred dividends + Current year preferred dividend = $9,000 × 2 + $9,000 = $27,000

Which of the following is true of common stocks?

The common stock of a corporation can be either privately or publicly owned.

Which of the following is true of risk premium?

The lower-rated corporate issues have a higher risk premium than that of the higher rated corporate issues.

Which of the following is a reason that makes NPV a better approach to capital budgeting on a purely theoretical basis?

The reinvestment rate assumed by this method is reasonable.

Uncle Tim's Inventions has an expected dividend next year of $3.60 and a required return of 12 percent. Assuming the dividends will be paid indefinitely, calculate the value of a share of common stock assuming a zero growth rate of dividends.

The value of a share of common stock = ($3.60/0.12)= $30

Angel recently purchased a block of 100 shares of Hayley's Optical common stock for $6,000. The stock is expected to provide an annual cash flow of dividends of $400 indefinitely. Assuming a discount rate of 8 percent, how does the price Angel paid compare to the value of the stock?

The value of the stock is = ($400/0.08) = $5,000

Which of the following is typically a feature of preferred stocks?

They are settled prior to common stocks during liquidation.

Which of the following is true of long-term funds?

They are the sources that supply the financing necessary to support a firm's capital budgeting activities.

Which of the following is an attribute of investment bankers?

They bear the risk of selling a security issue.

Which of the following is true of securities analysts?

They use a variety of models and techniques to value stocks

Rational buyers and sellers use their assessment of an asset's risk and return to determine its value. Relative to this concept, which of the following is true?

To a buyer the asset's value represents the maximum price that he or she would pay to acquire it.

Which of the following is a marketable security?

Treasury bill

The total rate of return on an investment over a given period of time is calculated

dividing the asset's cash distributions during the period, plus change in value, by its beginning-of period investment value.

What is the value of an asset which pays $200 a year for the next 5 years and can be sold for $1,500 at the end of five years from now? Assume that the opportunity cost is 10 percent

Using Financial calculator: FV = 1500, PMT = 200, N = 5, I = 10, CPT PV = -1689.54 The value of the asset = $1,689.54.

Hewitt Packing Company has an issue of $1,000 par value bonds with a 14 percent coupon interest rate outstanding. The issue pays interest semiannually and has 10 years remaining to its maturity date. Bonds of similar risk are currently selling to yield a 12 percent rate of return. What is the value of these Hewitt Packing Company bonds?

Using financial calculator: PMT = $70, N = 20, FV = 1000, I = 6, CPT PV = $1,114.70

Which of the following is a reason for a firm to underprice new issues?

When the market is in equilibrium, additional demand for shares can be achieved only at a lower price.

Which of the following is an example of a nonconventional pattern of cash flows?

Year 0 1 2 3 4 cash flow 200 100 -100 200 -300

Milton Glasses recently paid a dividend of $1.70 per share, is currently expected to grow at a constant rate of 5%, and has a required return of 11%. Milton Glasses has been approached to buy a new company. Milton estimates if it buys the company, its constant growth rate would increase to 6.5%, but the firm would also be riskier, therefore increasing the required return of the company to 12%. Should Milton go ahead with the purchase of the new company?

Yes, because the value of the Milton Co. will increase by $3.17 per share

Should Tangshan Mining company accept a new project if its maximum payback is 3.5 years and its initial after-tax cost is $5,000,000 and it is expected to provide after-tax operating cash inflows of $1,800,000 in year 1, $1,900,000 in year 2, $700,000 in year 3, and $1,800,000 in year 4?

Yes, since the payback period of the project is less than the maximum acceptable payback period.

If the required return is greater than the coupon rate, a bond will sell at ________.

a discount

Using the capital asset pricing model, the cost of common stock equity is the return required by investors as compensation for ________.

a firm's nondiversifiable risk

On ________, the stated interest rate is adjusted periodically within stated limits in response to changes in specified money or capital market rates.

a floating rate bond

Generally, an increase in risk will result in ________.

a higher required return or interest rate

Which of the following is a strength of payback period?

a measure of risk exposure

If you expect the market to increase which of the following portfolios should you purchase?

a portfolio with a beta of 1.9

If the required return is less than the coupon rate, a bond will sell at ________.

a premium

A bond rated Aaa according to Moody's, is considered ________.

a prime quality bond

An annuity is ________.

a series of equal annual cash flows

One of the circumstances in which the Gordon growth valuation model for estimating the value of a share of stock should be used is ________.

a steady growth rate in dividends

The decision to refund a callable bond ________.

is a capital budgeting decision

The purpose of the restrictive debt covenant that limits the distribution of profits to shareholders is to ________.

avoid default of payments to bondholders

PROJECT Internal Rate Of Return 1 12% 2 15% 3 13% The firm should ________.

accept Project 2, and reject Projects 1 and 3

A firm is evaluating two independent projects utilizing the internal rate of return technique. Project X has an initial investment of $80,000 and cash inflows at the end of each of the next five years of $25,000. Project Z has an initial investment of $120,000 and cash inflows at the end of each of the next four years of $40,000. The firm should ________.

accept Project Y because its IRR is higher than Project Z

PROJECT NPV 1 $100 2 $10 3 -$100 The firm should ________.

accept Projects 1 and 2, and reject Project 3

The specific cost of each source of long-term financing is based on ________ and ________ costs.

after-tax; current

Yield to maturity on a bond with price equal to its par value will ________.

always be equal to the coupon rate

Risk aversion is the behavior exhibited by managers who require

an increase in return, for a given increase in risk

An increase in the beta of a corporation, all else being the same, indicates ________.

an increase in risk, a higher required rate of return, and hence a lower share price

A debenture is ________.

an unsecured bond that only creditworthy firms can issue

When the required return is constant but different from the coupon rate, the price of a bond as it approaches its maturity date will ________.

approach par

A bond will sell ________ when the stated rate of interest exceeds the required rate of return, ________ when the stated rate of interest is less than the required return, and ________ when the stated rate of interest is equal to the required return

at a premium; at a discount; equal to the par value

According to the efficient market hypothesis, prices of actively traded stocks ________.

do not differ from their true values in an efficient market

ABC company has two bonds outstanding that are the same except for the maturity date. Bond D matures in 4 years, while Bond E matures in 7 years. If the required return changes by 5 percent, then ________.

bond E will have a greater change in price

A type of long-term financing used by both corporations and government entities is ________.

bonds

The simplest type of probability distribution is a ________.

bar chart

A firm is evaluating a proposal which has an initial investment of $35,000 and has cash flows of $10,000 in year 1, $20,000 in year 2, and $10,000 in year 3. The payback period of the project is ________.

between 2 and 3 years

Preferred stockholders ________.

do not have preference over bondholders in the case of liquidation

If the expected return is above the required return on an asset, rational investors will ________.

buy the asset, which will drive the price up and cause expected return to reach the level of the required return

A beta coefficient of +1 represents an asset that ________.

has the same response as the market portfolio

The ________ feature permits the issuer to repurchase bonds at a stated price prior to maturity

call

Unsystematic risk

can be eliminated through diversification

The ________ describes the relationship between nondiversifiable risk and the required rate of return.

capital asset pricing model

A $60,000 outlay for a new machine with a usable life of 15 years is called ________.

capital expenditure

A firm with limited dollars available for capital expenditures is subject to ________.

capital rationing

The return expected from an asset is fully defined by its ________.

cash flow and timing

The key inputs to the valuation process include ________.

cash flow, cash flow timing, and risk

An increase in nondiversifiable risk would ________.

cause an increase in the beta and would increase the required return

To compensate for the uncertainty of future interest rates and the fact that the longer the term of a loan the higher the probability that the borrower will default, the lender typically ________.

charges a higher interest rate on long-term loans

A ________ is a measure of relative dispersion used in comparing the risk of assets with differing expected returns

coefficient of variation

An efficient portfolio is defined as ________.

collection of assets with the aim of maximizing the return

Regarding the tax treatment of payments to securities holders, it is true that ________.

common stock dividends and preferred stock dividends are not tax-deductible, while interest is tax-deductible

The ________ feature allows bondholders to change each bond into stated number of shares of stock

conversation

A debt instrument indicating that a corporation has borrowed a certain amount of money and promises to repay it in the future under clearly defined terms is called a(n) ________.

corporate bond

The ________ is a weighted average of the cost of funds which reflects the interrelationship of financing decisions

cost of capital

The ________ is the rate of return required by the market suppliers of capital in order to attract their funds to the firm.

cost of capital

The ________ is the rate of return that a firm must earn on its investments in order to maintain the market value of its stock.

cost of capital

The ________ in the capital market is the basis for determining a bond's coupon interest rate

cost of money

Dividends in arrears that must be paid to the preferred stockholders before payment of dividends to common stockholders are ________.

cumulative

Convertible bonds are normally ________.

debentures

Combining two assets having perfectly negatively correlated returns will result in the creation of a portfolio with an overall risk that ________.

decreases to a level below that of either asset

Interest rate risk and the time to maturity have a relationship that is best characterized as ________.

direct

In the basic valuation model, risk is generally incorporated into the ________.

discount rate

Bonds which sell at less than face value are priced at a ________, while bonds which sell at greater than face value sell at a ________.

discount; premium

Strikes, lawsuits, regulatory actions, or the loss of a key account are all examples of ________.

diversifiable risk

Combining two negatively correlated assets to reduce risk is known as

diversification

A(n) ________ yield curve reflects lower expected future rates of interest

downward-sloping

Assume the following returns and yields: U.S. T-bill = 8%, 5-year U.S. T-note = 7%, IBM common stock = 15%, IBM AAA Corporate Bond = 12% and 10-year U.S. T-bond = 6%. Based on this information, the shape of the yield curve is ________.

downward-sloping

The yield curve in an economic period where lower future inflation is expected would be ________.

downward-sloping

Fixed assets that provide the basis for a firm's earning and value are often called ________.

earning assets

A(n) ________ portfolio maximizes return for a given level of risk, or minimizes risk for a given level of return.

efficient

The purpose of the debt covenant that requires maintaining a minimum level of net working capital is to ________.

ensure a cash shortage does not cause an inability to meet current obligations

If a corporate bond is issued with a coupon rate that varies directly with the required return, the price of the bond will ________.

equal the face value

The cost of retained earnings is ________.

equal to the cost of common stock equity

The constant-growth valuation model is based on the premise that the value of a share of common stock is ________.

equal to the present value of all expected future dividends

The basic motive for capital expenditure is to ________.

expand operations

One of the primary motives for adding fixed assets to a firm is ________.

expansion

A yield curve that reflects relatively similar borrowing costs for both short-term and long-term loans is called as ________.

flat yielded curve

A(n) ________ gives purchasers inflation protection

floating rate bond

Stated interest rate under ________ is adjusted periodically within stated limits in response to changes in specified money market or capital market rates.

floating rate bonds

The cost of new common stock financing is higher than the cost of retained earnings due to ________.

flotation costs and underpricing

The final step in the capital budgeting process is ________.

follow-up

A violation of preferred stock restrictive covenants usually permits preferred shareholders to ________.

force the retirement of the preferred stock at or above its par value

A foreign bond is issued by a(n) ________.

foreign corporation or government and is denominated in the investor's home currency and sold in the investor's home market

A significant portion of the return on a zero coupon bond is in the form of ________.

gain in value

Because equityholders are the last to receive any distribution of assets as a result of bankruptcy proceedings, they expect ________.

greater returns from their investment in the firm's stock

Lower (less positive and more negative) the correlation between asset returns

greater the potential diversification of risk

The cost of preferred stock is ________.

higher than the cost of long-term debt and lower than the cost of common stock.

Less certain a cash flow, the ________ the risk, and ________ the present value of the cash flow.

higher; lower

Which of the following steps in the capital budgeting process follows the decision making step?

implementation

Payment of interest required only when earnings are made available from which to make a payment is characteristic of a(n) ________.

income bond

________ bonds are characterized by interest payments that are required only when earnings , and commonly issued in the reorganization of a failed or failing firm

income bonds

Bond indentures include restrictive covenants.These provisions protect the bondholders against ________.

increase in borrower's risk

A corporation has concluded that its financial risk premium is too high. In order to decrease this, the firm can ________.

increase the proportion of common stock equity to decrease financial risk

As the need for capital increases beyond the optimum capital structure, the cost of debt financing will ________ the firm's weighted average cost of capital.

increase, raising

A(n) ________ in the beta coefficient normally causes ________ in the required return and therefore ________ in the price of the stock, everything else remaining the same.

increase; an increase; a decrease

An increase in the Treasury Bill rate ________.

increases the required rate of return of a common stock

The legal contract setting forth the terms and provisions of a corporate bond is a(n) ________.

indenture

The value of a bond is the present value of the ________.

interest payments and maturity value

The ________ is the compound annual rate of return that a firm will earn if it invests in the project and receives the given cash inflows.

internal rate of return

The ________ is the discount rate that equates the present value of the cash inflows with the initial investment.

internal rate of return

The price of a bond with a fixed coupon rate and the required return have a relationship that is best described as ________.

inverse

The size of a loan and its issuance costs (as a percentage of the amount borrowed) are ________.

inversely related

A downward-sloping yield curve that indicates generally cheaper long-term borrowing costs than short-term borrowing costs is called ________.

inverted yield curve

The beta associated with a risk-free asset ________.

is equal to 0

The cost of a long-term debt generally ________ that of a short-term debt.

is greater than

The beta of a portfolio ________.

is the weighted average of the betas of the individual assets in the portfolio

A beta coefficient of 0 represents an asset that ________.

is unrelated to the market portfolio

Some firms use the payback period as a decision criterion or as a supplement to sophisticated decision techniques, because ________.

it can be viewed as a measure of risk exposure due to its focus on liquidity

Payback is considered an unsophisticated capital budgeting because it ________.

it does not explicitly consider the time value of money.

________ are debt rated Ba or lower by Moody's or BB or lower by Standard & Poor's and are commonly used by rapidly growing firms to obtain growth capital, most often to finance mergers and takeovers.

junk bonds

________ are popular vehicle used to finance mergers and takeovers.

junk bonds

When the net present value is negative, the internal rate of return is ________ the cost of capital

less than

Since retained earnings are viewed as a fully subscribed issue of additional common stock, the cost of retained earnings is ________.

less than the cost of new common stock equity

Combining two assets having perfectly positively correlated returns will result in the creation of a portfolio with an overall risk that ________.

lies between the asset with the higher risk and the asset with the lower risk

The purpose of the debt covenant that prohibits borrowers from entering into certain types of leases is to ________.

limit the amount of fixed-payment obligations

The purpose of the restrictive debt covenant that prohibits the sale of accounts receivable is to ________.

limit the realization of current assets to cash

The theory suggesting that for any given issuer, long-term interest rates tends to be higher than short-term rates is called ________.

liquidity preference theory

A tax adjustment must be made in determining the cost of ________.

long-term debt

Generally the least expensive source of long-term capital is ________.

long-term debt

Bonds are ________.

long-term debt instruments used to raise large sums of money

The four basic sources of long-term funds for a firm are ________.

long-term debt, common stock, preferred stock, and retained earnings

When discussing weighing schemes for calculating the weighted average cost of capital, ________.

market value weights are preferred over book value weights and target weights are preferred over historical weights

Which of the following affects the cost of a bond?

maturity of a bond

An efficient portfolio is one that ________.

maximizes return for a given level of risk

Comparing net present value and internal rate of return ________.

may give different accept-reject decisions

The goal of an efficient portfolio is to ________.

minimize risk for a given level of return

A(n) ________ is secured by real estate

mortgage bond

Projects that compete with one another, so that the acceptance of one eliminates the others from further consideration are called ________.

mutually exclusive projects

Consider the following projects, X and Y where the firm can only choose one. Project X costs $600 and has cash flows of $400 in each of the next 2 years. Project Y also costs $600, and generates cash flows of $500 and $275 for the next 2 years, respectively. Which investment should the firm choose if the cost of capital is 25 percent?

neither, since both the projects have negative NPV

Which capital budgeting method is most useful for evaluating a project that has an initial after-tax cost of $5,000,000 and is expected to provide after-tax operating cash flows of $1,800,000 in year 1, ($2,900,000) in year 2, $2,700,000 in year 3, and $2,300,000 in year 4?

net present value

In comparing the internal rate of return and net present value methods of evaluation, ________.

net present value is theoretically superior, but financial managers prefer to use internal rate of return

The ________ from the sale of a security are the funds actually received from the sale after ________.

net proceeds; reducing the flotation costs

Which of the following is an advantage for a firm to issue common stock over long-term debt?

no maturity date on which the par value of the issue must be repaid

________ rate of interest is the actual rate charged by the supplier and paid by the demander of funds.

nominal

Nico invested an amount a year ago and calculated his return on investment. He found that his purchasing power had increased by 15 percent as a result of his investment. If inflation during the year was 4 percent, then Nico's ________.

nominal return on investment is more than 15 percent

Which pattern of cash flow stream is the most difficult to use when evaluating projects?

nonconventional flow

Risk that affects all firms is called

nondiversifiable risk

Systematic risk is also referred to as ________.

nondiversifiable risk

War, inflation, and the condition of the foreign markets are all examples of ________.

nondiversifiable risk

In the capital asset pricing model, the beta coefficient is a measure of ________.

nondiversifiable risk and market risk

The weights used in weighted average cost of capital must be ________.

nonnegative

An upward-sloping yield curve that indicates cheaper short-term borrowing costs than long-term borrowing costs is called as ________.

normal yield curve

If a firm has class A and class B common stock outstanding, it means that ________.

one of the classes is probably nonvoting stock

A nonconventional cash flow pattern associated with capital investment projects consists of an initial ________.

outflow followed by a series of both cash inflows and outflows

A conventional cash flow pattern associated with capital investment projects consists of an initial ________.

outflow followed by a series of inflows

Shares of stock currently owned by a firm's shareholders are called ________.

outstanding shares

The cost of capital reflects the cost of funds ________.

over a long-run time period

Tangshan China's stock is currently selling for $160.00 per share and the firm's dividends are expected to grow at 5 percent indefinitely. In addition, Tangshan China's most recent dividend was $5.50. If the expected risk free rate of return is 3 percent, the expected market return is 8 percent, and Tangshan has a beta of 1.2, Tangshan's stock would be ________.

overvalued because the market price is higher than the resulting share value

Holders of equity capital ________.

own the firm

A $1,000, 8% bond sells for 980. $1,000 is called the ________.

par value

Corporate bonds have a ________.

par value of $1,000

An example of a standard debt provision is to ________.

pay taxes and other liabilities when due

The ________ measures the amount of time it takes a firm to recover its initial investment.

payback period

Which of the following is an unsophisticated capital budgeting technique?

payback period

Which of the following capital budgeting techniques ignores the time value of money?

payback period approach

If the coupon rate of a bond is equal to its required rate of return, then ________.

the current value is equal to par value

Preferred stock is valued as if it were a ________.

perpetuity

Perfectly ________ correlated series move exactly together and have a correlation coefficient of ________, while perfectly ________ correlated series move exactly in opposite directions and have a correlation coefficient of ________.

positively; +1; negatively; -1

In the Gordon model, the value of a common stock is the ________.

present value of a constant growing dividend stream

The value of a bond is the present value of its interest payments plus ________.

present value of its par value

The purpose of the restrictive debt covenant that imposes fixed assets restrictions is to ________.

prevent the firm from liquidation and ensure its ability to repay the debt

The riskiness of publicly traded bond issues is rated by independent agencies. According to Moody's rating system, an Aaa bond and a Caa bond are ________ and ________ respectively

prime quality; speculative

A(n) ________ distribution shows all possible outcomes and associated probabilities for a given event

probability

The ________ of a given outcome is its chance of occurring

probability

When evaluating projects using NPV approach, ________.

projects having higher early-year cash flows tend to be preferred at higher discount rates

The first step in the capital budgeting process is ________.

proposal generation

The purpose of the restrictive debt covenant that requires that subsequent borrowing be subordinated to the original loan is to ________.

protect the original lender in the priority of claims during liquidation

The attempt by a nonmanagement group to gain control of the management of a firm by soliciting a sufficient number of proxy votes is called a ________.

proxy battle

Bonds that can be redeemed at par at the option of their holders either at specific date after the date of issue and every 1 to 5 years thereafter or when and if the firm takes specified actions such as being acquired, acquiring another company, or issuing a large amount of additional debt are called ________.

putable bonds

Preferred stock is characterized by ________.

quasi-debt nature

Dr. Dan is considering investment in a project with beta coefficient of 1.75. What would you recommend him to do if this investment has an 11.5 percent rate of return, risk-free rate is 5.5 percent, and the rate of return on the market portfolio of assets is 8.5 percent?

r = RF + b(rm - RF) = 0.055 + 1.75(0.085 - 0.055) = 0.108 = 10.75%

Adam wants to determine the required return on a stock portfolio with a beta coefficient of 0.5. Assuming the risk-free rate of 6 percent and the market return of 12 percent, compute the required rate of return.

r = RF + b(rm - RF) = 0.06 + 0.5(0.12 - 0.06) = 0.09 = 9%

Assuming a risk-free rate of 8 percent and a market return of 12 percent, would a wise investor acquire a security with a beta of 1.5 and a rate of return of 14 percent given the facts above?

r = RF + b(rm - RF) = 0.08 + 1.5(0.12 - 0.08) = 0.14 = 14%

Akai has a portfolio of three assets. Find the expected rate of return for the portfolio assuming he invests 50 percent of its money in asset A with 10 percent rate of return, 30 percent in asset B with a rate of return of 20 percent, and the rest in asset C with 30 percent rate of return.

r*W A= 10%*0.50 = 5.00 B= 20%*0.30 = 6.00 C= 30%*0.20 = 6.00 = 17.00 Expected rate of return = 17 percent

The purpose of nonvoting common stock is to ________.

raise capital without giving up any voting control

________ rate of interest creates equilibrium between the supply of savings and the demand for investment funds.

real

The ________ is utilized to value preferred stock

zero-growth model

The purpose of adding an asset with a negative or low positive beta is to ________.

reduce risk

When the required return is constant and equal to the coupon rate, the price of a bond as it approaches its maturity date will ________.

remain at par

Treasury stock refers to the ________.

repurchase of outstanding stock

Common stockholders are sometimes referred to as ________.

residual owners

Which of the following is a source of long-term funds?

retained earnings

Which of the following is usually a right of a preferred stockholder?

right to receive dividend payments before any dividends are paid to common stockholders

In a ________, new shares are sold to the existing shareholders.

rights offering

________ are financial instruments that allow stockholders to purchase additional shares at a price below the market price, in direct proportion to their number of owned shares

rights offering

If a manager requires greater return when risk increases, then he is said to be

risk-averse

The ________ rate is typically the nominal rate of interest on a three-month U.S. Treasury bill.

risk-free

The CAPM can be divided into ________.

risk-free rate and risk premium

If a manager prefers a higher return investment regardless of its risk, then he is following a ________ strategy.

risk-neutral

If a manager prefers investments with greater risk even if they have lower expected returns, then he is following a ________ strategy.

risk-seeking

A common approach of estimating the variability of returns involving the forecast of pessimistic, most likely, and optimistic returns associated with an asset is called

scenario analysis

If bankruptcy were to occur, ________ would have the first claim on assets

secured creditors

ADRs are ________.

securities, backed by American depositary shares (ADSs), that permit U.S. investors to hold shares of non-U.S. companies and trade them in U.S. markets

If expected return is less than required return on an asset, rational investors will ________.

sell the asset, which will drive the price down and cause the expected return to reach the level of the required return

A ________ is a restrictive provision in a bond indenture, providing for the systematic retirement of the bonds prior to their maturity

sinking-fund requirement

A ________ measures the dispersion around the expected value.

standard deviation

________ allow bondholders to purchase a certain number of shares of the firm's common stock at a specified price over a certain period of time.

stock purchase warrants

The value of any asset is the ________.

sum of the present values of all future cash flows it is expected to provide over the relevant time period

Relevant portion of an asset's risk attributable to market factors that affect all firms is called ________.

systematic risk

The ________ is the firm's desired optimal mix of debt and equity financing.

target capital structure

The preferred capital structure weights to be used in the weighted average cost of capital are ________.

target weights

From a corporation's point of view, a disadvantage of issuing preferred stock is ________.

that the dividends are not tax-deductible

In comparing the constant-growth model and the capital asset pricing model (CAPM) to calculate the cost of common stock equity, ________.

the CAPM directly considers risk as reflected in the beta, while the constant-growth model uses the market price as a reflection of the expected risk-return preference of investors

The current yield on a bond is measured by ________.

the annual interest payment divided by the current price

In calculating the cost of common stock equity, the model which describes the relationship between the required return and the nondiversifiable risk of the firm is ________.

the capital asset pricing model

The minimum return that must be earned on a project in order to leave the firm's value unchanged is ________.

the cost of capital

When determining the after-tax cost of a bond, the face value of the issue must be adjusted to the net proceeds amounts by considering ________.

the flotation costs

Although a firm's existing mix of financing sources may reflect its target capital structure, it is ultimately ________.

the marginal cost of capital that is relevant for evaluating the firm's future investment opportunities

The term structure of interest rates is the relationship between ________.

the maturity and rate of return for bonds with similar level of risk

The higher an asset's beta, ________.

the more responsive it is to changing market returns

A firm can accept a project with a net present value of zero because ________.

the project would maintain the wealth of the firm's owners

Unlike the net present value criteria, the internal rate of return approach assumes a reinvestment rate equal to ________.

the project's internal rate of return

The cost of common stock equity is ________.

the rate at which investors discount the expected dividends of the firm to determine its share value

The underlying cause of conflicts in ranking for projects by internal rate of return and net present value methods is ________.

the reinvestment rate assumption regarding intermediate cash flows

Stock purchase warrants are instruments that give their holders ________.

the right to purchase a certain number of shares of the issuer's common stock at a specified price over a certain period of time

In calculating the cost of common stock equity, ________.

the use of the constant-growth valuation model is often preferred, because the data required are more readily available

A proxy statement is a statement transferring ________.

the votes of a stockholder to another party

In order to recognize the interrelationship between financing and investments, a firm should use ________ when evaluating an investment.

the weighted average cost of all financing sources

Danno is trying to decide which of two bonds to buy. Bond H is a 10 percent coupon, 10-year maturity, $1,000 par, January 1, 2000 issue paying annual interest. Bond F is a 10 percent coupon, 10-year maturity, $1,000 par, January 1, 2000 issue paying semiannual interest. The market required return for each bond is 10 percent. When using present value to determine the prices of the bonds, Danno will find that ________.

there is no difference in price

A proxy statement gives shareholders the right ________.

to give up their vote to another party

Which of the following is a restrictive covenant?

to impose fixed asset restrictions

The preemptive right gives shareholders the right ________.

to maintain their proportionate ownership in the corporation when new common stock is issued

As randomly selected securities are combined to create a portfolio, the ________ risk of the portfolio decreases until 10 to 20 securities are included. The portion of the risk eliminated is ________ risk, while that remaining is ________ risk.

total; diversifiable; nondiversifiable

An example of an external factor that affects a corporation's risk or beta, is ________.

toxic spills used during takeovers

A(n) ________ is a paid individual, corporation, or a commercial bank trust department that acts as a third party to a bond indenture

trustee

One major expense associated with issuing new shares of common stock is ________.

underpricing

Tangshan China's stock is currently selling for $160.00 per share and the firm's dividends are expected to grow at 5 percent indefinitely. In addition, Tangshan China's most recent dividend was $5.50. If the expected risk free rate of return is 3 percent, the expected market premium is 4 percent, and Tangshan has a beta of 1.2, Tangshan's stock would be ________.

undervalued because the market price is less than the resulting share value

A group formed by an investment banker to share the financial risk associated with underwriting new securities is called a(n) ________.

underwriting syndicate

The portion of an asset's risk that is attributable to firm-specific, random causes is called ________.

unsystematic risk

A(n) ________ yield curve reflects higher expected future rates of interest.

upward-sloping

The yield curve in an economic period where higher future inflation is expected would be ________.

upward-sloping

The process that links risk and return in order to determine the worth of an asset is termed ________.

valuation

Which of the following typically applies to common stock but not to preferred stock?

voting rights

A(n) ________ is a graphic depiction between the maturity and rate of return for bonds with similar risks

yield curve

For an investor who plans to purchase a bond maturing in one year, the primary consideration should be ________.

yield to maturity

The ________ is the compound annual rate of interest earned on a debt security purchased on a given date and held to maturity.

yield to maturity

Deeply discounted bond that pays no coupon interest is a ________.

zero coupon bond

When issuing a(n) ________ the issuer can annually deduct the current year's interest accrual without having to actually pay the interest until the bond matures.

zero coupon bond

A(n) ________ is issued with no or very low coupon and sells significantly below its par value.

zero or low coupon bond