Financial Management
17) Which capital intensity ratio indicates the smallest need for fixed assets per dollar of sales?
.07
10) The Well Derrick has 6.3 percent preferred stock outstanding that sells for $57 a share. This stock was originally issued at $45 per share and has a stated value of $100 per share. What is the cost of preferred stock if the relevant combined tax rate is 23 percent?
11.05 percent RP = .063($100)/$57 RP = .1105, or 11.05%
11) A project has a net present value of zero. Which one of the following best describes this project?
The project's cash inflows equal its cash outflows in current dollar terms.
1) Which one of the following statements correctly defines a time value of money relationship?
Time and present value are inversely related, all else held constant.
2) Which one of the following is the primary determinant of a firm's cost of capital?
Use of the funds raised
15) Which one of the following is the best example of two mutually exclusive projects?
Waiting until a machine finishes molding Product A before being able to mold Product
20) An investment costs $152,000 and has projected cash inflows of $71,800, $86,900, and −$11,200 for Years 1 to 3, respectively. If the required rate of return is 15.5 percent, should you accept the investment based solely on the internal rate of return rule? Why or why not?
You should not apply the IRR rule in this case.
13) The expected return on a stock computed using economic probabilities is:
a mathematical expectation based on a weighted average and not an actual anticipated outcome.
19) A project has average net income of $6,250 a year over its 6-year life. The initial cost of the project is $98,400 which will be depreciated using straight-line depreciation to a book value of zero over the life of the project. The firm set a minimum average accounting return of 12.5 percent. The firm should ________ the project because the AAR is ________ percent.
accept; 12.70 AAR = $6,250/[$98,400 + 0)/2] AAR = .1270, or 12.70% The firm should accept the project because the AAR exceeds the requirement.
13) A project's average net income divided by its average book value is referred to as the project's average:
accounting return.
17) NYSE designated market makers:
act as dealers.
11) Atlas Industries combines the investment proposals from each operational unit into one single project for planning purposes. This process is referred to as:
aggregation.
14) You are comparing two mutually exclusive projects. The crossover point is 12.3 percent. You have determined that you should accept project
always accept Project A if the required return exceeds the crossover rate
11) U. S. Treasury bonds:
are quoted as a percentage of par
3) A company's current cost of capital is based on:
both the returns currently required by its debt holders and stockholders.
14) Christina invested $3,000 five years ago and earns 2 percent annual interest. By leaving her interest earnings in her account, she increases the amount of interest she earns each year. The way she is handling her interest income is referred to as:
compounding
7) The average compound return earned per year over a multiyear period is called the ________ average return.
geometric
9) Callable bonds generally:
have a sinking fund provision
14) You purchase a bond with an invoice price of $1,119. The bond has a coupon rate of 6.25 percent, a face value of $1,000, and there are four months to the next semiannual coupon date. What is the clean price of this bond?
$1,108.58 Explanation: Accrued interest = (.0625)($1,000)(1/2)(2/6) Accrued interest = $10.42 Clean price = $1,119 − 10.42 Clean price = $1,108.58
4) Nelson Mfg. owns a manufacturing facility that is currently sitting idle and is debt-free. The facility is located on a piece of land that originally cost $159,000. The facility itself cost $1,390,000 to build. As of now, the book value of the land and the facility are $159,000 and $458,000, respectively. The firm received a bid of $1,700,000 for the land and facility last week. The firm's management rejected this bid even though they were told that it is a reasonable offer in today's market. If the firm was to consider using this land and facility in a new project, what cost, if any, should it include in the project analysis?
$1,700,000
8) The common stock of Metal Molds has a negative growth rate of 1.63 percent and a required return of 18.21 percent. The current stock price is $9.82. What was the amount of the last dividend paid?
$1.98 RE = .1821 = {D0[1 + (−.0163)]}/$9.82 + (−.0163) D0 = $1.98
7) You just signed a consulting contract that will pay you $38,000, $42,000, and $45,000 annually at the end of the next three years, respectively. What is the present value of this contract given a discount rate of 10.5?
$102,138.76 PV = $38,000/1.105 + $42,000/1.1052 + $45,000/1.1053 PV = $102,138.76
6) Hot and Cold has annual sales of $847,000, annual depreciation of $47,000, and net working capital of $43,000. The tax rate is 21 percent and the profit margin is 7.3 percent. The firm has no interest expense. What is the amount of the operating cash flow?
$108,831 Explanation: OCF = $847,000(.073) + $47,000 OCF = $108,831
8) Phil can afford $240 a month for five years for a car loan. If the interest rate is 8.5 percent, how much can he afford to borrow to purchase a car?
$11,697.88 PVA = $240({1 − [1/(1 + .085/12)(5)(12)]}/(.085/12)) PVA = $11,697.88
9) Theresa adds $1,500 to her savings account on the first day of each year. Marcus adds $1,500 to his savings account on the last day of each year. They both earn 6.5 percent annual interest. What is the difference in their savings account balances at the end of 35 years?
$12,093.38 FVADue = $1,500[(1.06535 − 1)/.065](1.065) FVADue = $198,145.42 FVA = $1,500[(1.06535 − 1)/.065] FVA = $186,052.04 Difference = $198,145.42 − 186,052.04 Difference = $12,093.38
19) Next year, Jensen's will pay an annual dividend of $3.32 per share. The company has been reducing its dividends by 7 percent annually. What is this stock worth today if the required return is 15.5 percent?
$14.76 Explanation: P0 = $3.32/(.155 + .07) P0 = $14.76
18) Flo's Flowers pays an annual dividend that increases by 1.8 percent per year, commands a market rate of return of 13.8 percent, and sells for $19.08 a share. What is the expected amount of the next dividend?
$2.29 Explanation: $19.08 = D1/(.138 − .018) D1 = $2.29
18) Alex invested $2,550 in an account that pays 5 percent simple interest. How much money will he have at the end of four years?
$3,060.00 FV = $2,550 + ($2,550)(.05)(4) FV = $3,060
20) You just received a $5,000 gift from your grandmother which you have decided to save and then gift to your grandchildren 50 years from now. How much additional money will you gift if you earn 7.5 percent interest rather than 7 percent interest over the next 50 years?
$38,663.60 FV = $5,000(1.07550) FV = $185,948.73 FV = $5,000(1.0750) FV = $147,285.13 Difference = $185,948.73 − 147,285.13 Difference = $38,663.60
20) HCC, Inc., expects its dividends to grow at 25 percent per year for the next seven years before levelling off to a constant 3 percent growth rate. The required return is 11 percent. What is the current stock price if the annual dividend per share that was just paid was $1.05?
$43.21 Explanation: P7 = [$1.05(1.25)7(1.03)]/(.11 − .03) P7 = $64.46 P0 = [$1.05 (1.25)/(.11 − .25)][1 − (1.25/1.11)7] + $64.46/1.117 P0 = $43.21
20) Muder's Market has sales of $28,400, net income of $2,250, and a retention ratio of 60 percent. Assume the profit margin and the payout ratio are constant and sales increase by 6 percent. What is the pro forma retained earnings if the current retained earnings balance is $4,100?
$5,531 Pro forma retained earnings = $4,100 + ($2,250) (.60) (1.06) Pro forma retained earnings = $5,531
2) Atlas Manufacturing purchased a new computer system in 2018 at a cost of $622,400. This system falls in the 5-year MACRS class that has depreciation allowance percentages of 20, 32, 19.2, 11.52, 11.52, and 5.76. What is the maximum amount of depreciation the firm can claim on this system in the first year if it selects the bonus depreciation method?
$622,400
10) Racing Motors wants to save $825,000 to buy some new equipment three years from now. The plan is to set aside an equal amount of money on the first day of each quarter starting today. How much does the company need to save each quarter to achieve its goal if it can earn 4.45 percent on its savings?
$63,932.91 FVADue = $825,000 = C{[(1 + .0445/4)(3)(4) − 1]/(.0445/4)}(1 + .0445/4) C = $63,932.91
19) You own a classic car currently valued at $64,000. If the value increases by 2.5 percent annually, how much will the car be worth 15 years from now?
$92,691.08 FV = $64,000(1.02515) FV = $92,691.08
10) Oil Creek Auto has sales of $3,340, net income of $274, net fixed assets of $2,600, and current assets of $920. The firm has $430 in inventory. What is the common-size statement value of inventory?
12.22 percent Common-size inventory = $430/($2,600 + 920)
19) The returns on the common stock of New Image Products are quite cyclical. In a boom economy, the stock is expected to return 23 percent in comparison to 14 percent in a normal economy and a negative 18 percent in a recessionary period. The probability of a recession is 18 percent while the probability of a boom is 22 percent. What is the standard deviation of the returns on this stock?
13.71 percent E(r) = .22(.23) + .60(.14) + .18(−.18) E(r)= .1022 σ = [.22(.23 − .1022)2 + .60(.14 − .1022)2 + .18(−.18 − .1022)2].5 σ = .1371, or 13.71%
15) When planning for the long run, the planning horizon is usually a period of:
2 to 5 years
9) You own 850 shares of Western Feed Mills stock valued at $53.15 per share. What is the dividend yield if your total annual dividend income is $1,256?
2.78 percent Dividend yield = ($1,256/850)/$53.15
10) Suppose you bought a $1,000 face value bond with a coupon rate of 5.6 percent one year ago. The purchase price was $987.50. You sold the bond today for $994.20. If the inflation rate last year was 2.6 percent, what was your exact real rate of return on this investment?
3.65 percent Nominal return = ($994.20 − 987.50 + 56)/$987.50
9) Jiminy's Cricket Farm issued a 20-year, 7 percent, semiannual bond four years ago. The bond currently sells for 108 percent of its face value. What is the aftertax cost of debt if the company's combined tax rate is 23 percent?
4.78 percent 1.08($1,000) = [.07($1,000)/2][(1 − {1/[1 + (r/2)]16(2)})/(r/2)] + $1,000/[1 + (r/2)]16(2) r = 6.204 percent
18) An investment project provides cash flows of $1,562 per year for 10 years. If the initial cost is $8,720, what is the payback period?
5.58 years Payback = $8,720/$1,562 Payback = 5.58 years
5) Which one of these will increase a company's aftertax cost of debt?
A decrease in the company's tax rate
3) Which one of the following statements is correct concerning bid prices?
A firm can submit a bid that is higher than the computed bid price and still break even.
4) All else constant, which one of the following will increase a company's cost of equity if the company computes that cost using the security market line approach? Assume the firm currently pays an annual dividend of $1 a share and has a beta of 1.2.
A reduction in the risk-free rate
3) Which one of the following is a source of cash?
Acquisition of debt
11) Andy deposited $3,000 this morning into an account that pays 5 percent interest, compounded annually. Barb also deposited $3,000 this morning at 5 percent interest, compounded annually. Andy will withdraw his interest earnings and spend it as soon as possible. Barb will reinvest her interest earnings into her account. Given this, which one of the following statements is true?
Barb will earn more interest in Year 2 than Andy
5) Assume you invest in a portfolio of long-term corporate bonds. Based on the period 1926-2016, what average annual rate of return should you expect to earn?
Between 6 and 7 percent
16) Which ratio identifies the amount of total assets a firm needs in order to generate $1 in sales?
Capital intensity ratio
16) Which one of the following types of stock is defined by the fact that it receives no preferential treatment in respect to either dividends or bankruptcy proceedings?
Common
2) Which one of the following is a use of cash?
Decrease in accounts payable
4) Which one of the following is a source of cash?
Decrease in inventory
12) Which one of the following methods of project analysis is defined as computing the value of a project based on the present value of the project's anticipated cash flows?
Discounted cash flow valuation
5) On the statement of cash flows, which one of the following is considered a financing activity?
Dividends paid
16) Which one of the following statements is correct concerning unsystematic risk?
Eliminating unsystematic risk is the responsibility of the individual investor.
11) You own a stock that you think will produce a return of 11 percent in a good economy and 3 percent in a poor economy. Given the probabilities of each state of the economy occurring, you anticipate that your stock will earn 6.5 percent next year. Which one of the following terms applies to this 6.5 percent?
Expected return
13) You are investing $100 today in a savings account. Which one of the following terms refers to the total value of this investment one year from now?
Future value
14) Which one of the following statements is correct concerning a portfolio of 20 securities with multiple states of the economy when both the securities and the economic states have unequal weights?
Given both the unequal weights of the securities and the economic states, an investor might be able to create a portfolio that has an expected standard deviation of zero
1) Which one of the following is a source of cash for a tax-exempt firm?
Increase in common stock
6) Which one of the following is a correct ranking of securities based on the volatility of their annual returns over the period of 1926-2016? Rank from highest to lowest.
Long-term government bonds, long-term corporate bonds, intermediate-term government bonds
17) Which one of the following is represented by the slope of the security market line?
Market risk premium
12) Nan and Neal are twins. Nan invests $5,000 at 7 percent at age 25. Neal invests $5,000 at 7 percent at age 30. Both investments compound interest annually. Both twins retire at age 60 and neither adds nor withdraws funds prior to retirement. Which statement is correct?
Nan will have more money than Neal at any age
2) Which one of the following correctly describes the dividend yield?
Next year's annual dividend divided by today's stock price
8) Mortgage lenders probably have the most interest in the ________ ratios.
long-term debt and times interest earned
4) You are comparing two investment options that each pay 6 percent interest, compounded annually. Both options will provide you with $12,000 of income. Option A pays $2,000 the first year followed by two annual payments of $5,000 each. Option B pays three annual payments of $4,000 each. Which one of the following statements is correct given these two investment options? Assume a positive discount rate. (No calculations needed.)
Option B has a higher present value at Time 0.
5) Which one of these statements related to growing annuities and perpetuities is correct?
The present value of a growing perpetuity will decrease if the discount rate is increased.
17) Two mutually exclusive projects have an initial cost of $47,500 each. Project A produces cash inflows of $25,300, $37,100, and $22,000 for Years 1 through 3, respectively. Project B produces cash inflows of $43,600, $19,800 and $10,400 for Years 1 through 3, respectively. The required rate of return is 14.7 percent for Project A and 14.9 percent for Project B. Which project(s) should be accepted and why?
Project A, because it has the larger NPV NPVA = −$47,500 + $25,300/1.147+ $37,100/1.1472+ $22,000/1.1473 NPVA = $17,336.57 NPVB = −$47,500 + $43,600/1.149 + $19,800/1.1492+ $10,400/1.1493 NPVB = $12,299.79
3) Project A has cash flows of $4,000, $3,000, $0, and $3,000 for Years 1 to 4, respectively. Project B has cash flows of $2,000, $3,000, $2,000, and $3,000 for Years 1 to 4, respectively. Which one of the following statements is correct assuming the discount rate is positive? (No calculations needed)
Project B is worth less today than Project A
2) Project X has cash flows of $8,500, $8,000, $7,500, and $7,000 for Years 1 to 4, respectively. Project Y has cash flows of $7,000, $7,500, $8,000, and $8,500 for Years 1 to 4, respectively. Which one of the following statements is true concerning these two projects given a positive discount rate? (No calculations needed)
Project X has both a higher present and a higher future value than Project Y
15) Which one of the following is least apt to reduce the unsystematic risk of a portfolio?
Reducing the number of stocks held in a portfolio
1) Which one of the following best illustrates erosion as it relates to a hot dog stand located on the beach?
Selling fewer hot dogs because hamburgers were added to the menu
4) Which one of the following categories of securities had the highest average annual return for the period 1926-2016?
Small-company stocks
6) Which one of the following statements related to WACC is correct for a company that uses debt in its capital structure?
The WACC would most likely decrease if the firm replaced its preferred stock with debt
5) You own some equipment that you purchased four years ago at a cost of $287,000. The equipment is five-year property for MACRS. The MACRS rates are .2, .32, .192, .1152, .1152, .0576, for Years 1 to 6, respectively. You are considering selling the equipment today for $105,000. Which one of the following statements is correct if your tax rate is 24 percent and you claim no bonus depreciation?
The aftertax salvage value is $91,702.46 Explanation: Accumulated depreciation4 = $287,000(.20 + .32 + .192 + .1152) Accumulated depreciation4 = $237,406.40 Book value4 = $287,000 − 237,406.40 Book value4 = $49,593.60 Taxable gain on sale = $105,000 − 49,593.60 Taxable gain on sale = $55,406.40 Tax due = $55,406.40(.24) Tax due = $13,297.54 Aftertax salvage value = $105,000 − 13,297.54 Aftertax salvage value = $91,702.46
1) Stacy purchased a stock last year and sold it today for $4 a share more than her purchase price. She received a total of $1.15 per share in dividends. Which one of the following statements is correct in relation to this investment?
The capital gains yield is positive.
8) A $1,000 par value corporate bond that pays $60 annually in interest was issued last year. Which one of these would apply to this bond today if the current price of the bond is $996.20?
The current yield exceeds the coupon rate
16) Which one of the following statements would generally be considered as accurate given independent projects with conventional cash flows?
The payback decision rule could override the net present value decision rule should cash availability be limited.
19) The financial planning process is least apt to:
consider the development of future technologies.
13) Financial planning:
considers multiple options and scenarios.
3) Bayside Marina just announced it is decreasing its annual dividend from $1.48 per share to $1.45 per share effective immediately. If the dividend yield remains at its pre-announcement level, then you know the stock price:
decreased proportionately with the dividend decrease.
1) The cost of capital for a new project:
depends upon how the funds raised for that project are going to be spent.
16) The process of determining the present value of future cash flows in order to know their value today is referred to as:
discounted cash flow valuation
8) Evidence seems to support the view that studying public information to identify mispriced stocks is:
ineffective
15) Art invested $100 two years ago at 8 percent interest. The first year, he earned $8 interest on his $100 investment. He reinvested the $8. The second year, he earned $8.64 interest on his $108 investment. The extra $.64 he earned in interest the second year is referred to as:
interest on interest
7) The cash coverage ratio directly measures the ability of a company to meet its obligation to pay:
interest to a lender
6) A loan that calls for periodic interest payments and a lump sum principal payment is referred to as a(n) ________ loan.
interest-only
17) Your goal is to have $1 million in your retirement savings on the day you retire. To fund this goal, you will make one lump sum deposit today. If you plan to retire ________ rather than ________ and earn a ________ rate of interest, then you can deposit a smaller lump sum today.
later; sooner; high
18) The internal growth rate of a firm is best described as the ________ growth rate achievable ________.
maximum; excluding external financing of any kind
10) Municipal bonds:
pay interest that is federally tax free.
7) When a manager develops a cost of capital for a specific project based on the cost of capital for another firm that has a similar line of business as the project, the manager is utilizing the ________ approach.
pure play
9) The most acceptable method of evaluating the financial statements is to compare the company's current financial:
ratios to the company's historical ratios.
15) The dividend growth model:
requires the growth rate to be less than the required return.
18) The ________ of a security divided by the beta of that security is equal to the slope of the security market line if the security is priced fairly.
risk premium
12) The yields on a corporate bond differ from those on a comparable Treasury security primarily because of:
taxes and default risk.
6) On a common-size balance sheet all accounts for the current year are expressed as a percentage of:
total assets for the current year
12) The expected return on a stock given various states of the economy is equal to the:
weighted average of the returns for each economic state.
7) A five-year project has an initial fixed asset investment of $613,600, an initial net working capital investment of $22,200, and an annual operating cash flow of -$76,540. The fixed asset is fully depreciated over the life of the project and has no salvage value. The net working capital will be recovered when the project ends. The required return is 11.7 percent. What is the project's equivalent annual cost, or EAC?
−$248,092.76 Explanation: NPV = −$613,600 − 22,200 − $76,540{[1 − (1/1.1175)]/.117} + $22,200/1.1175 NPV = −$901,005.55 EAC = −$901,005.55/{[1 − (1/1.1175)]/.117} EAC = −$248,092.76