Corporate Finance Test 3

If firm U is unlevered and firm L is levered, then which of the following is true: I) VU = EU. II) VL = EL + DL. III) VL = EU + DL. A. I only B. I and II only C. I, II, and III D. III only

B. I and II

Underwriters are typically compensated for their services in helping a firm issue new securities in the form of a: A. commission. B. set fee. C. spread. D. finder's fee.

C. spread

For every dollar of operating income paid out as interest, the bondholder realizes: A. (1 - Tp) B. (1 - TpE) (1 - TC) C. (1 - TC) D. 1/(1 - TC)

A. (1 - Tp)

Large technology firms like Intel, Johnson and Johnson, and Sun Microsystems that provide equity capital to new innovative companies are called: A. angel investors. B. corporate venturers. C. white knights. D. mezzanine financiers.

B. corporate ventures

Which type of voting allows minority shareholders to allocate their votes in a manner to increase the chance of electing a director? A. majority voting B. cumulative voting C. representative voting D. executive voting

B. cumulative voting

Which of the following are NOT usually regarded as investment funds? A. mutual funds B. insurance companies C. pension funds D. hedge funds

B. insurance companies

The maximum number of shares a firm can issue is known as: A. number of shares issued but not outstanding. B. number of shares issued and outstanding. C. number of authorized shares. D. number of treasury shares.

C. number of authorized shares

When a company sells an entire issue of securities to a small group of institutional investors like like insurance companies, pension funds, etc., it is called a(an): A. rights offering. B. general art offering. C. private placement. D. unseasoned issue.

C. private placement

An EPS-operating income graph, for different debt ratios, shows the: I) greater risk associated with debt financing, which is evidenced by a greater slope; II) the break-even point where EPS of two different debt ratios are equal; III) the minimum earnings needed to pay the debt financing for a given level of debt A. I only B. II only C. III only D. I, II, and III only

D. I, II, and III only

In the United Sates, who holds the smallest portion of corporate equities? A. households B. pension funds C. mutual funds D. insurance companies

D. insurance companies

If a firm borrows $50 million for one year at an interest rate of 10%, what is the present value of the interest tax shield? Assume a 30% marginal corporate tax rate. A. $1.36 million B. $1.50 million C. $1.00 million D. $4.55 million

A. $1.36 million PV of interest tax shield = ((0.3)(50)(0.1))/1.1 = $1.364.

The New Word Corporation has 1,000,000 shares outstanding at $30/share. If the firm wishes to raise $13.5 million at a subscription price (North American rights offering) of $27/share, calculate the value of a right. A. $1/right B. $2/right C. $3/right D. $4/right

A. $1/right Number of new shares = 13,500,000/27 = 500,000 shares; Stock price after issue = ($30M + 13.5M)/1.5M = $29; Number of rights required to buy a new share = 1,000,000/500,000 = 2 rights; Value of a right = (29 - 27)/(2) = $1/right.

Suppose that your firm's current unlevered value is $800,000, and its marginal corporate tax rate is 35%. Also, you model the firm's PV of financial distress as a function of its debt ratio (D/V) according to the relation: PV of financial distress = 800,000 × (D/V)2. What is the firm's levered value if it issues $200,000 of perpetual debt to buy back stock? A. $820,000. B. $869,555. C. $920,000. D. $350,000.

A. $820,000 Value of firm = value of unlevered firm + PV(tax shield) - PV(cost of financial distress); Value of firm (in 000s) = 800 + (0.35 × 200) - 800 × [(200/800)^2] = 820K.

A firm in Australia earns a pretax profit of $A10 per share. Suppose that it pays a corporate tax of $3 per share (30% tax rate) in taxes. The firm pays the remaining $A7 in dividends to a shareholder in the 40% marginal tax bracket. What is the amount of additional tax paid by the shareholder under an imputation tax system? A. $A1.00 B. $0.00 C. $A4.00 D. $A5.80

A. $A1.00

If an investor buys a portion (X) of an unlevered firm's equity, then his/her payoff is: A. (X) × (profits) B. (X) × (interest) C. (X) × (profits - interest) D. (1/X) × (profits)

A. (X) × (profits)

If an investor buys a portion (X) of both the debt and equity of a levered firm, then his/her payoff is: A. (X) × (profits) B. (X) × (interest) C. (X) × (profits - interest)

A. (X) × (profits)

Exploitation of minority shareholders by majority shareholders is called: A. a reverse stock split. B. tunneling. C. financial engineering. D. proxy fighting.

B. tunneling

The market value of equity equals: A. (Market price) × (# of shares outstanding) B. (Market price) × (# of treasury shares) C. (Market price) × (# of authorized shares) D. (Par value) × (# of shares outstanding)

A. (market price) x (# of shares outstanding)

A small business received a five-year $1,000,000 loan at a subsidized rate of 3% per year. The firm will pay 3% annual interest payment each year and the principal at the end of five years. If market interest rates on similar loans are 6% per year, what is the NPV of the loan? (Ignore taxes. A. +$126,371 B. +$348,369 C. -$501,595 D. -$137,391

A. +$126,371 NPV = +1,000,000 - [((30,000/1.06) + ... + (30,000/(1.06^5)) + (1,000,000/(1.06^5))] = 126,371.

A firm's equity beta is 1.2 and its debt is risk free. Given a 0.7 debt to equity ratio, what is the firm's asset beta? (Assume no taxes.) A. 0.7 B. 1.0 C. 1.2 D. 0.0

A. 0.7 1.2 = BA + 0.7 × (BA - 0); 1.2 = 1.7BA; BA = (1.2/1.7) = 0.706.

The asset beta of a levered firm is 1.1. The beta of debt is 0.3. If the debt equity ratio is 0.5, what is the equity beta? (Assume no taxes.) A. 1.5 B. 1.1 C. 0.3 D. 0.15

A. 1.5 bE = 1.1 + 0.5(1.1 - 0.3) = 1.5.

What is the relative tax advantage of debt? Assume that personal and corporate taxes are given by: TC = (corporate tax rate) = 35%; TpE = personal tax rate on equity income = 30%; and Tp = personal tax rate on interest income = 20%. A. 1.76 B. 1.16 C. 1.35 D. 0.86

A. 1.76 Relative advantage = (1 - 0.2)/[(1 - 0.3)(1 - 0.35)] = 1.76.

The M&M Company is financed by $10 million in debt (market value) and $40 million in equity (market value). The cost of debt is 10% and the cost of equity is 20%. Calculate the weighted average cost of capital assuming no taxes. A. 18% B. 20% C. 10% D. 12%

A. 18% WACC = (1/5)(10) + (4/5)(20) = 2 + 16 = 18%.

Health and Wealth Company is financed entirely by common stock that is priced to offer a 15% expected return. If the company repurchases 25% of the common stock and substitutes an equal value of debt yielding 6%, what is the expected return on the common stock after refinancing? (Ignore taxes.) A. 18.0% B. 21.0% C. 15.0% D. 10.5%

A. 18.0% rE = rA + (D/E)(rA - rD) = 15 + (0.25/0.75)(15 - 6) = 18%.

Learn and Earn Company is financed entirely by common stock that is priced to offer a 20% expected return. If the company repurchases 50% of the stock and substitutes an equal value of debt yielding 8%, what is the expected return on its common stock after refinancing? A. 32% B. 28% C. 20% D. 14%

A. 32% RE = 0.2 + (0.5/0.5)(0.20 - 0.08) = 0.32 = 32%.

A firm has $100 million in current liabilities, $200 million in total long-term liabilities, $300 million in stockholders' equity, and total assets of $600 million. Calculate the firm's ratio of long-term debt to long-term debt plus equity. A. 40% B. 20% C. 50% D. 17%

A. 40% Ratio = (200)/500 = 0.4, or 40%.

If you own 1,000 shares of common stock of a firm and there are five directors being elected, what is the maximum number of votes you can cast for a particular director under cumulative voting? A. 5,000 B. 1,000 C. 200 D. 5

A. 5,000 Total number of votes = 5 × 1,000 = 5,000

A corporation has 1,000,000 shares outstanding, and 10 directors are up for election. If the stock features cumulative voting, approximately how many shares do you have to muster in order to guarantee yourself a place on the board of directors? (Ignore possible ties.) A. 500,000 B. 200,000 C. 100,000 D. 1,000,000

A. 500,000Number of votes outstanding = 1,000,000 × 10 = 10,000,000. Number of votes required for guaranteed placement = 10,000,000/2 = 5,000,000. Number of shares required to generate guaranteed votes = 5,000,000/10 = 500,000.

Suppose that a government wishes to auction 5 million bonds (quantity), and three potential buyers submit the following bids: Buyer A: Price $1,015 Quantity 2M Buyer B: Price $1,000 Quantity 3M Buyer C: Pricy $990 Quantity 1M In a discriminatory auction: A. Buyer A pays $1,015 and Buyer B pays $1,000. B. Buyer A pays $1,000 and Buyer B pays $1,000. C. Buyer A pays $990 and Buyer B pays $990. D. Buyer A pays $1,000 and Buyer C Pays $990.

A. Buyer A pays $1,015 and Buyer B pays $1,000

Firm A and Firm B are identical except that A is incorporated while B is an unlimited liability partnership. Both have assets worth $500,000 ($500K) funded with a debt ratio of 40%. Suppose that the assets suddenly become worthless, what is the maximum possible loss to the equityholders of each company? A. Firm A: $300K; Firm B: $500K B. Firm A: $200K; Firm B: $300K C. Firm A: $500K; Firm B: $200K D. Firm A: $500K; Firm B: $500K

A. Firm A: $300K; Firm B: $500K Firm A's equityholders can declare bankruptcy resulting in a maximum loss of their original $300K of equity. Firm B's equityholders cannot escape their debt position. Their equity position has deteriorated from $300K to -$200K, a loss of $500K.

Although the use of debt provides tax benefits to the firm, debt also puts pressure on the firm to: I) Meet interest and principal payments, which if not met can put the company into financial distress; II) make dividend payments, which if not met can put the company into financial distress; III) meet both interest and dividend payments, which when met increase the firm cash flow; IV) meet increased tax payments, thereby increasing firm value A. I only B. II only C. II and III only D. III and IV only

A. I only

Different classes of stocks are usually issued in order to: I) maintain ownership control, by holding the class of stock with greater voting rights; II) pay less dividends to different classes of stock; III) extract perquisites without the other class of stockholders knowing A. I only B. II only C. III only D. I and II only

A. I only

Generally, firms engage in stock repurchases during: I) boom times as firms accumulate excess cash; II) recessions due to low stock prices; III) times when competitor's stock prices are dropping A. I only B. II only C. III only D. II and III only

A. I only

Given corporate taxes, why does adding debt to the capital structure increase firm value? I) Extra cash flow goes to the firm's investors rather than the tax authorities. II) Earnings before interest and taxes are fully taxed at the corporate rate. III) Personal tax rates are the same as marginal corporate tax rates. A. I only B. II only C. III only D. II and III only

A. I only

A Dutch auction is the same as a(an): A. discriminatory price auction. B. uniform price auction. C. English auction. D. share repurchase.

B. uniform price auction

The market for venture capital refers to the: I) private financial marketplace for providing equity investment for small, start-up firms; II) bond market; III) market for providing equity to well-established firms A. I only B. II only C. II and III only D. III only

A. I only

The statement that stock prices follow a random walk implies that: I) successive price changes are independent of each other; II) successive price changes are positively related; III) successive price changes are negatively related; IV) the autocorrelation coefficient is either +1.0 or -1.0 A. I only B. II and III only C. IV only D. III only

A. I only

The statement that stock prices follow a random walk implies that: I) the correlation coefficient between successive price changes (autocorrelation) is not significantly different from zero; II) successive price changes are positively related; III) successive price changes are negatively related; IV) the autocorrelation coefficient is positive A. I only B. II only C. II and III only D. IV only

A. I only

Which of the following is a statement of semistrong form efficiency? I) Stock prices will adjust immediately to public information. II) Stock prices reflect all information. III) Stock prices will adjust to newly published information after a long time delay. A. I only B. II only C. II and III only D. III only

A. I only

Which of the following is a statement of weak-form efficiency? I) If markets are efficient in the weak form, then it is impossible to make consistently superior profits by using trading rules based on past returns. II) If markets are efficient in the weak form, then prices will adjust immediately to public information. III) If markets are efficient in the weak form, then prices reflect all information. A. I only B. II only C. II and III only D. III only

A. I only

The underwriter's spread is the highest for: A. IPOs. B. seasoned equity offerings. C. convertible bonds. D. straight bonds.

A. IPOs

The stock exchange that specializes in trading the shares of young and rapidly growing companies is: A. Nasdaq. B. NYSE. C. London Stock Exchange. D. Tokyo Stock Exchange.

A. Nasdaq

46. The SEC provision under which qualified institutional investors can trade privately placed securities among themselves is called: A. Rule 144A. B. Rule 415. C. the Sarbanes-Oxley Act. D. none of the options.

A. Rule 144A

What does "risk shifting" imply? A. When faced with bankruptcy, managers tend to invest in high-risk, high-return projects. B. When faced with bankruptcy, managers do not invest more equity capital. C. When faced with bankruptcy, managers may make accounting changes to conceal the true extent of the problem. D. When faced with bankruptcy, managers invest in low risk projects to conserve capital.

A. When faced with bankruptcy, managers tend to invest in high-risk, high-return projects

The rightist position is that the market will reward firms for having: A. a high dividend yield. B. a low dividend yield C. good management, regardless of dividend yield. D. a zero payout policy.

A. a high dividend yield

For most stocks, a scatter plot chart of stock returns versus stock returns on the prior trading day will appear as: A. a shotgun pattern centered close to the origin. B. a random pattern mostly concentrated in the top-right and lower-left quadrants. C. a random pattern mostly concentrated in the lower-left and upper-right quadrants. D. none of the options.

A. a shotgun pattern centered close to the origin

For an all-equity firm, A. as earnings before interest and taxes (EBIT) increases, the earnings per share (EPS) increases by the same percentage B. as EBIT increases, the EPS increases by a larger percentage C. as EBIT increases, the EPS decreases at the same rate D. as EBIT increases, the EPS decreases by a larger percentage

A. as EBIT increases, the EPS increases by the same percentage

Generally, investors interpret the announcement of a decrease in dividends as: A. bad news and the stock price drops. B. good news and the stock price increases. C. a nonevent and does not affect the stock prices. D. very good news and the stock price jumps up.

A. bad news and the stock price drops

Strong-form efficiency implies that mutual fund managers should: A. buy the index that maximizes diversification and minimizes the cost of managing portfolios. B. actively seek underperforming stocks and buy them. C. generally earn superior returns each year. D. attempt to earn superior returns by using technical analysis.

A. buy the index that maximizes diversification and minimizes the cost of managing portfolios

What would best explain the reluctance of General Motors to eliminate its dividend in 2008, only a few months before its financial collapse and eventual government takeover? A. clientele effect B. leftist theory C. unwillingness to initiate a share repurchase program D. expectations of tax law changes

A. clientele effect

If you own 1,000 shares of stock and you can cast 5,000 votes for a particular director, then the stock features: A. cumulative voting. B. straight voting. C. majority voting. D. proxy voting.

A. cumulative voting

Which of these dates, when arranged in chronological order, occurs last? A. dividend payment date B. ex-dividend date C. record date D. dividend declaration date

A. dividend payment date

Inclusion of restrictions in a bond contract leads to: A. higher agency costs. B. higher bankruptcy costs. C. higher interest costs. D. lower agency costs.

A. higher agency costs

The pecking order theory of capital structure predicts that: A. if two firms are equally profitable, the more rapidly growing firm will borrow more, other things equal. B. firms prefer equity to debt financing. C. firms prefer financing by debt versus internally generated cash. D. high-risk firms will end up borrowing more.

A. if two firms are equally profitable, the more rapidly growing firm will borrow more, other things equal

Recently, which of the following sources of funds has played the greatest role in the financing of U.S. nonfinancial firms? A. internal funds B. net equity issues C. net borrowing D. all of the sources were approximately the same

A. internal funds

According to behavioral finance, investors prefer dividends because: A. investors prefer the discipline that comes from spending only the dividends. B. dividends generate lower taxes. C. the stock market is efficient. D. dividends provide a tax deduction.

A. investors prefer the discipline that comes from spending only the dividends

Why does MM Proposition I not hold in the presence of corporate taxes? A. Levered firms pay lower taxes when compared with identical unlevered firms. B. Bondholders require higher rates of return compared with stockholders. C. Earnings per share are no longer relevant with taxes. D. Dividends are no longer relevant with taxes.

A. levered firms pay lower taxes when compared to identical unlevered firms

What is the likely impact on a typical individual investor if a firm undertakes a stock repurchase in lieu of a cash dividend? A. Lower income taxes, if capital gains tax rates are less than dividend tax rates B. Higher income taxes, if capital gains tax rates are less than dividend tax rates C. Lower share price D. A tax-free transaction

A. lower income taxes, if capital gains tax rates are less than dividend tax rates

Minimizing the weighted average cost of capital (WACC) is the same as maximizing the: A. market value of the firm. B. book value of the firm. C. profits of the firm. D. liquidating value of the firm.

A. market value of the firm

According to the trade-off theory of capital structure: A. optimal capital structure occurs when the present value of tax savings on account of additional borrowing just offsets the increase in the present value of costs of distress. B. optimal capital structure occurs when the stockholders' right to default is balanced by the bondholders' right to get interest and principal payments. C. optimal capital structure occurs when the benefits of limited liability is just offset by the value of the firm's lawyers' claims. D. none of the options.

A. optimal capital structure occurs when the present value of tax savings on account of additional borrowing just offsets the increase in the present value of costs of distress

Under the trade-off theory, how will a government loan guarantee impact financing? A. Prefer to issue debt B. Prefer to issue stock C. Prefer internal money D. No impact

A. prefer to issue debt

Investors who purchased shares from the Facebook IPO did so in which market? A. primary market B. secondary market C. over-the-counter market D. NYSE

A. primary market

When new securities are sold by a firm, it is termed a: A. primary market transaction. B. secondary market transaction. C. OTC market transaction. D. Open market operations.

A. primary market transaction

Preference in position among creditors when it comes to repayment is called: A. seniority. B. securitization. C. time preference. D. absolute return.

A. seniority

As a provider of funds to a corporation, owning which of the following corporate securities will generally give you the strongest rights to cash flow? A. short-term bank loan B. long-term bond C. preferred stock D. common stock

A. short term bank loan

One important implication of the efficient markets hypothesis is that most investors: A. should avoid active trading. B. can benefit by purchasing high-beta stocks. C. should trade actively to help ensure the highest overall gain in their portfolios. D. should hold IPO stock issues for the long-term.

A. should avoid active trading

Modigliani and Miller's Proposition I states that: A. the market value of any firm is independent of its capital structure B. the market value of a firm's debt is independent of its capital structure C. the market value of a firm's common stock is independent of its capital structure D. none of the options

A. the market value of any firm is independent of its capital structure

Equity investment in start-up private companies is called: A. venture capital. B. mezzanine financing. C. initial public offering (IPO). D. seasoned equity offering (SEO).

A. venture capital

Which of the following instruments gives the owner the right to purchase securities directly from the firm at a fixed price during a specified period of time? A. warrant B. Treasury stock C. subordinated debt D. short-term bank loan

A. warrant

According to financial executives' views on dividend policy, which of the following statements is most frequently cited? A. We try to avoid reducing the dividend. B. We try to maintain a smooth dividend stream. C. We look at the current dividend level. D. We are reluctant to make a change that may have to be reversed.

A. we try to avoid reducing the dividend

The possibility that the winner (highest bidder) in an auction process may have bid a price that is very high (far above the value) is called: A. winner's curse. B. seniority. C. English auction. D. uniform-price auction.

A. winner's curse

Company X has 100 shares outstanding. It earns $1,000 per year and expects to pay all of it as dividends. If the firm expects to maintain this dividend forever, calculate the stock price today. (The required rate of return is 10%.) A. $110 B. $100 C. $90 D. $10

B. $100 Dividends = 1000/100 = $10; P = 10/0.1 = $100.

Assume the marginal corporate tax rate is 30%. The firm has no debt in its capital structure. It is valued at $100 million. What would be the value of the firm if it issued $50 million in perpetual debt and repurchased the same amount of equity? A. $65 million B. $115 million C. $100 million D. $150 million

B. $115 million VU = 100; (TC)(B) = 0.3(50) = 15; VL = VU + TCB = 100 + 15 = $115.

Learn and Earn Company is financed entirely by common stock that is priced to offer a 20% expected rate of return. The stock price is $60 and the earnings per share are $12. If the company repurchases 50% of the stock and substitutes an equal value of debt yielding 8%, what is the expected earnings per share value after refinancing? A. $12.00 B. $19.20 C. $24.00 D. $15.60

B. $19.20

A firm in Australia earns a pretax profit of $A10 per share. Suppose that it pays a corporate tax of $3 per share (30% tax rate) in taxes. The firm pays the remaining $A7 in dividends to a shareholder in the 30% marginal tax bracket. What is the amount of additional tax paid by the shareholder under an imputation tax system? A. $A 2.10 B. $A 0.00 C. $A3.00 D. $A 5.10

B. $A 0.00

For every dollar of operating income paid out as equity income, the bondholder realizes: A. (1 - Tp) B. (1 - TpE) (1 - TC) C. (1 - TC) D. 1/(1 - TC)

B. (1 - TpE) (1 - TC)

A large firm received a loan guarantee from the government. Due to the guarantee, the firm can borrow $50 million for five years at 8% interest rate per year instead of 10% per year. Calculate the value of the guarantee to the firm. (Ignore taxes.) A. +$53.79 million B. +$3.79 million C. -$3.79 million D. $3.99 million

B. +$3.79 million

Analysis of past monthly movements in Wal-Mart's stock price has produced the following estimates: α = -0.45% and β = 0.5. If the market index subsequently rises by 5% while Wal-Mart's stock price rises by 3%, what is the abnormal change in Wal-Mart's stock price? A. -0.45% B. +0.95% C. +0.05% D. +2.50%

B. +0.95% Expected change: -0.45 + 0. 5(+5) = 2.05; Abnormal return = 3 - 2.05 = +0.95%

If you own 1,000 shares of common stock of a firm and there are five directors being elected, what is the maximum number of votes you can cast for a particular director under majority voting? A. 5,000 B. 1,000 C. 200 D. 5

B. 1,000

A firm has a debt-to-equity ratio of 0.50. Its cost of debt is 10%. Its overall cost of capital is 14%. What is its cost of equity if there are no taxes? A. 13% B. 16% C. 15% D. 18%

B. 16% 14 = [1/3](10) + (2/3)(X); solve for X; 42 = 10 + 2X; X = 16%.

New Image Corporation has 1,000,000 shares outstanding. It wishes to issue 500,000 new shares using rights issue. How many (North American) rights are needed to buy one new share? A. 1 right/share B. 2 rights/share C. 3 rights/share D. 4 rights/share Number of rights required = 1,000,000/500,000 = 2.

B. 2 rights/share Number of rights required = 1,000,000/500,000 = 2.

The beta of an all-equity firm is 1.2. Suppose the firm changes its capital structure to 50% debt and 50% equity using 8% debt financing. What is the equity beta of the levered firm? The beta of debt is 0.2. (Assume no taxes.) A. 1.2 B. 2.2 C. 2.4 D. 1.7

B. 2.2 βE = 1.2 + (0.5/0.5)(1.2 - 0.2) = 2.2.

Venture capital investment was highest in the year: A. 1999. B. 2000. C. 2003. D. 2005.

B. 2000

Suppose a government wishes to auction 5 million bonds, and three would-be buyers submit the following bids: Buyer A: Price $1,015 Quantity 2M Buyer B: Price $1,000 Quantity 3M Buyer C: Pricy $990 Quantity 1M In a uniform-price auction: A. Buyer A pays $1,015 and Buyer B pays $1,000. B. Buyer A pays $1,000 and Buyer B pays $1,000. C. Buyer A pays $990 and Buyer B pays $990. D. Buyer A pays $1,000 and Buyer C Pays $990.

B. Buyer A pays $1,000 and Buyer B pays $1,000.

The average initial returns from investing in IPOs is the highest in: A. Denmark. B. China. C. Italy. D. Mexico.

B. China

Consider the procedure whereby the firm states a series of prices at which it is prepared to repurchase stock. Shareholders then submit offers indicting how many shares they wish to sell and at which price. The firm then calculates the lowest price at which it is able to buy the desired number of shares. This procedure is known as a(n): A. open market repurchase. B. Dutch auction. C. green mail. D. tender offer.

B. Dutch auction

Which of the following investments allows investors to own assets indirectly via shares that are part of a pool of other investors? I) REIT; II) trust; III) option A. I only B. I and II only C. I, II, and III D. III only

B. I and II only

Arrange the following in chronological order for a typical start-up firm: I) VC financing; II) mezzanine financing; III) stage 1, 2, 3, 4, etc., financing; IV) IPO A. I, II, III, and IV B. I, III, II, and IV C. IV, I, II, and III D. III, I, II, and IV

B. I, III, II, and IV

A grant of authority allowing someone else to vote shares of stock that you own is called: I) repurchase agreement; II) proxy voting; III) share repurchase A. I only B. II only C. III only D. I and III only

B. II only

Financing decisions differ from investment decisions for which of the following reasons? I) you cannot use NPV to evaluate financing decisions; II) markets for financial assets are more active than for real assets; III) it is easier to find financing decisions with positive NPV than to find investment decisions with positive NPV A. I only B. II only C. III only D. I and III only

B. II only

In order to calculate the tax shield of interest payments for a corporation, always use the: I) average corporate tax rate; II) marginal corporate tax rate; III) marginal rate on personal income tax A. I only B. II only C. III only D. I and III only

B. II only

Predictable cycles in stock price movements: I) tend to persist for a long time; II) tend to self-destruct as soon as investors recognize them; III) never appear, since stock returns change randomly A. I only B. II only C. III only D. I, II, and III

B. II only

The capital structure of the firm can be defined as: I) the firm's mix of different debt securities; II) the firm's mix of different securities used to finance assets; III) the market imperfection that the firm's managers can exploit A. I only B. II only C. III only D. I, II, and III

B. II only

The main advantage of debt financing for a firm is: I) no SEC registration is required for bond issues; II) interest expenses are tax deductible; III) unlevered firms have higher value than levered firms A. I only B. II only C. III only D. I and III only

B. II only

When shareholders pursue strategies such as taking excessive risks or paying excessive dividends, these will result in: I) no action by debtholders since these are equityholder concerns; II) positive agency costs, as bondholders act on various restrictions and covenants, which will diminish firm value; III) investments of the same risk class that the firm is in A. I only B. II only C. III only D. I and III only

B. II only

The premium paid by investors to gain voting control, among the countries mentioned, is the highest in: A. U.S. B. Mexico. C. Italy. D. none of the options.

B. Mexico

The main reason for the recent migration of a large number of firms from public-to-private ownership is: A. blue-sky laws. B. Sarbanes-Oxley Act. C. international accounting standards (IAS). D. advent of shelf registration.

B. Sarbanes-Oxley Act

In an EPS-operating income graphical relationship, the slope of the debt line is steeper than the equity line. The debt line has a negative intercept because: A. the break-even point is higher with debt. B. a fixed interest charge must be paid even at low earnings. C. the amount of interest per share has only a positive effect on the intercept. D. the higher the interest rate, the greater the slope.

B. a fixed interest charge must be paid even at low earnings

Suppose a group of outsiders solicits shareholders' authority to vote shares to replace existing management. This is called: A. a tender offer. B. a proxy contest. C. a vote of confidence. D. greenmail.

B. a proxy contest

If capital markets are efficient, then the sale or purchase of any security at the prevailing market price is generally: A. a positive-NPV transaction. B. a zero-NPV transaction. C. a negative-NPV transaction. D. no general trend exists for such transactions.

B. a zero-NPV transaction

If a shareholder or an investor wants to acquire a new share of stock under a rights issue, he/she must: A. buy call options on the stock. B. acquire the appropriate number of rights per share and subscription price per share and submit them to the subscription agent. C. acquire the correct number of rights per share and submit them to the subscription agent. D. register his order with the NYSE.

B. acquire the appropriate number of rights per share and subscription price per share and submit them to the subscription agent

For a levered firm, A. as earnings before interest and taxes (EBIT) increases, the earnings per share (EPS) increases by the same percentage B. as EBIT increases, the EPS increases by a larger percentage C. as EBIT increases, the EPS decreases at the same rate D. as EBIT increases, the EPS decreases by a larger percentage

B. as EBIT increases, the EPS increases by a larger percentage

Miller and Modigliani's indifference proposition regarding dividend policy: A. assumes that tax rates increase at the same rate as inflation. B. assumes that investors can sell their stock at a fair price. C. states that investors are indifferent between stock dividends and cash dividends. D. states that investors are indifferent between stock repurchases and cash dividends.

B. assumed that investors can sell their stock at a fair price

For a levered firm where bA = beta of assets and bD = beta of debt, the equity beta (bE) equals: A. bE = bA B. bE = bA + (D/E) × [bA - bD] C. bE = bA + (D/(D + E)) × [bA - bD] D. none of the options

B. bE = bA + (D/E) × [bA - bD]

Which of the following is true? A. bD > bA > bE B. bE > bA > bD C. bA > bE > bD D. bA > bD > bE

B. bE > bA > bD

The managing underwriter is also called the: A. syndicate. B. book runner. C. specialist. D. lead angel.

B. book runner

Which voting system is most friendly towards minority shareholders? A. majority voting B. cumulative voting C. straight voting D. dual-class share voting

B. cumulative voting

The winner's curse is reduced in a(an): A. discriminatory auction. B. uniform-price auction. C. English auction. D. winner-take-all auction.

B. uniform-price auction

Even if both dividends and capital gains are taxed at the same ordinary income tax rate, the effect of each type of tax is different because: A. capital gains are actually taxed, while dividends are taxed on paper only. B. dividends are taxed when distributed, while capital gains are deferred until the stock is sold. C. both dividends and capital gains are taxed every year. D. both A and C.

B. dividends are taxed when distributed, while capital gains are deferred until the stock is sold

Venture capitalists provide start-up companies: A. all the money they will need up front. B. enough money at each stage so that they can reach the next stage or major checkpoint. C. assistance in managing the initial public offering (IPO). D. funding intended to buy-out the company's founders.

B. enough money at each stage so that they can reach the next stage or major checkpoint

The effect of financial leverage on the performance of the firm depends on the: A. expected rate of return on equity. B. firm's level of operating income. C. current market value of the debt. D. rate of dividend growth.

B. firm's level of operating income

Generally, investors interpret the announcement of an increase in dividends as: A. bad news and the stock price drops. B. good news and the stock price increases. C. a nonevent and does not affect the stock price. D. very bad news and the stock price plunges.

B. good news and the stock price increases

Generally, investors view the announcement of an open-market repurchase program as: A. bad news and the stock price drops. B. good news and the stock price increases. C. a nonevent and does not affect the stock price. D. very bad news and the stock price plunges.

B. good news and the stock price increases

According to an EPS-operating income graph, debt financing is the preferred outcome in the case when expected operating income is: A. less than the break-even income. B. greater than the break-even income. C. equal to the break-even income. D. not able to be determined.

B. greater than the break-even income

Compared to a firm with unlimited liability, the limited liability feature of common equity results in a: A. lower present value of the interest tax shield. B. higher value to equityholders. C. leveraged buyout mechanism. D. higher value to debtholders.

B. higher value of equityholders

Most financial economists attribute the drop in the price of equity subsequent to the announcement of a new issue to: A. an increase in the supply of shares. B. information effect. C. both a and b. D. neither a nor b.

B. information effect

Suppose that a company can direct $1 to either debt interest or capital gains for equity investors. If there were no personal taxes on capital gains, which of the following investors would not care how the money was channeled? (The marginal corporate tax rate is 35%.) A. investors paying personal tax of 17.5% B. investors paying personal tax of 35% C. investors paying personal tax of 53% D. tax-exempt personal investors

B. investors paying personal tax of 35%

Shares held by investors are known as: A. issued but not outstanding B. issued and outstanding C. authorized shares D. treasury stock

B. issued and outstanding

The par value of the outstanding shares is known as: A. retained earnings. B. legal capital. C. book value of equity. D. additional paid-in capital.

B. legal capital

If a firm is financed with both debt and equity, the firm's equity is known as: A. unlevered equity. B. levered equity. C. preferred equity. D. none of the options.

B. levered equity

In order to calculate the tax shields provided by debt, the tax rate used is the: A. average corporate tax rate. B. marginal corporate tax rate. C. average of shareholders' equity tax rates. D. average of bondholders' personal tax rates.

B. marginal corporate tax rate

The semistrong form of efficiency focuses on the economic ineffectiveness of the following type of information: A. insider information. B. publicly available information. C. privileged information. D. only information provided by the SEC.

B. publicly available information

Generally, which of the following is true? A. rE < rD < rA B. rD < rA < rE C. rE < rA < rD D. rD < rE < rA

B. rD < rA < rE

An abnormal stock return is calculated as the: A. return on the stock minus the expected stock return. B. return on the stock minus the return on the market. C. return on the stock for the current period minus the return on the stock for the previous period. D. return on the stock minus the return on a comparable firm.

B. return on the stock minus the return on the market

The trade-off theory of capital structure predicts that: A. unprofitable firms should borrow more than profitable ones. B. safe firms should borrow more than risky ones. C. rapidly growing firms should borrow more than mature firms. D. increasing leverage increases firm value, especially at high debt ratios.

B. safe firms should borrow more than risky ones

The indirect costs of bankruptcy are borne principally by: A. bondholders. B. stockholders. C. managers. D. the federal government.

B. stockholders

The law of conservation of value implies that: A. the return on a firm's common stock is unchanged when debt is added to its capital structure. B. the value of any asset is preserved regardless of the nature of the claims against it. C. the return on a firm's debt is unchanged when common stock is added to its capital structure. D. the value of an asset increases as debt is reduced.

B. the value of any asset is preserved regardless of the nature of the claims against it

If a firm permanently borrows $50 million at an interest rate of 10%, what is the present value of the interest tax shield? Assume a 30% marginal corporate tax rate. A. $50.0 million B. $25.0 million C. $15.0 million D. $1.5 million

C. $15.0 million PV of interest tax shield = (0.30)(50) = $15.0 million.

If a firm permanently borrows $100 million at an interest rate of 8%, what is the present value of the interest tax shield? (Assume that the marginal corporate tax rate is 30%.) A. $8.00 million B. $5.60 million C. $30.00 million D. $26.67 million

C. $30.00 million PV of interest tax shield = (0.3)(100) = $30 million

Wealth and Health Company is financed entirely by common stock that is priced to offer a 15% expected return. The common stock price is $40/share. The earnings per share (EPS) is expected to be $6. If the company repurchases 25% of the common stock and substitutes an equal value of debt yielding 6%, what is the expected value of earnings per share after refinancing? (Ignore taxes.) A. $6.00 B. $7.52 C. $7.20 D. $6.90

C. $7.20 Firm borrows $10 per share. Interest per share = ($10)(0.06) = $0.60. New EPS = (6 - 0.60)/0.75 = $7.20/share. Note that the new expected return on equity is 18%.

Internally generated cash is calculated as: Internally generated cash is calculated as: I) retained earnings; II) interest payments; III) depreciation A. (I - II) B. (I + II) C. (I + III) D. (I - III)

C. (I + IIII)

If an investor buys a portion (X) of the equity of a levered firm, then his/her payoff is: A. (X) × (profits) B. (X) × (interest) C. (X) × (profits - interest) D. (1/X) × (profits - interest)

C. (X) × (profits - interest)

A random walk process for a single stock consists of the toss of a fair coin at the end of each day. If the outcome is heads, the stock price increases by 1.25%. If the outcome is tails, the stock price decreases by 0.75%. What is the drift of such a process? A. +1.25% B. -0.75% C. +0.25% D. +2.0%

C. +0.25% Drift = (0.5)(1.25%) + (0.5)(-0.75%) = +0.25%.

Analysis of past monthly movements in IBM's stock price produces the following estimates: α = 2.5% and β = 1.6. If the market index subsequently rises by 12% in one month and IBM's stock price increases by 20%, what is the abnormal change in IBM's stock price? A. +1.7% B. +8.0% C. -1.7% D. +2.5%

C. -1.7% Expected change = 2.5 + 1.6(12) = 21.7; Abnormal change = 20 - 21.7 = -1.7%

Assume the following data for U&P Company: Debt (D) = $100 million; Equity (E) = $300 million; rD = 6%; rE = 12%; and TC = 30%. Calculate the after-tax weighted average cost of capital (WACC): A. 10.50% B. 15.00% C. 10.05% D. 9.45%

C. 10.05% After-tax WACC = (1/4)(1 - 0.3)(6) + (3/4)(12) = 10.05%.

If the corporate tax rate is 35%, what is the maximum effective tax rate on dividends received by another corporation? A. 35% B. 30% C. 10.5% D. 65%

C. 10.5% 70% of dividends received by another corporation is tax-exempt. Tax rate = (0.3) × (0.35) = 0.105 = 10.5%.

A firm has a debt-to-equity ratio of 1. Its levered cost of equity is 16%, and its cost of debt is 8%. If there were no taxes, what would be its cost of equity if the debt-to-equity ratio were zero? A. 8% B. 10% C. 12% D. 14%

C. 12% 16 = rA + 1(rA - 8); 16 = 2rA - 8; 24 = 2rA; rA = 12%.

A firm has zero debt in its capital structure. Its overall cost of capital is 10%. The firm is considering a new capital structure with 60% debt. The interest rate on the debt would be 8%. Assuming there are no taxes, its cost of equity capital with the new capital structure would be: A. 8% B. 16% C. 13% D. 10%

C. 13% rE = 10 + (60/40)(10 - 8) = 10 + 3 = 13

A firm has a debt-to-equity ratio of 1.0. If it had no debt, its cost of equity would be 12%. Its cost of debt is 9%. What is its cost of equity if there are no taxes? A. 21% B. 18% C. 15% D. 16%

C. 15% rE = 12 + 1.0(12 - 9) = 15%.

According to the National Venture Capital Association, "venture capital funds earn an average annual rate of return (after expenses) of about": A. 32%. B. 24%. C. 19%. D. 12%.

C. 19%

In the United States the premium that an investor needed to pay to gain voting control is: A. 29%. B. 36%. C. 2%. D. 32%.

C. 2%

A firm has $100 million in current liabilities, $200 million in total long-term liabilities, $300 million in stockholders' equity, and total assets of $600 million. Calculate the debt ratio for the firm. A. 40% B. 20% C. 50% D. 33%

C. 50% Debt ratio = (100 + 200)/600 = 0.5, or 50%.

The M&M Company is financed by $4 million (market value) in debt and $6 million (market value) in equity. The cost of debt is 5% and the cost of equity is 10%. Calculate the weighted average cost of capital. (Assume no taxes.) A. 10% B. 15% C. 8% D. 7%

C. 8% Weighted average cost of capital (WACC) = (4/10)(5) + (6/10)(10) = 2 + 6 = 8%.

If the abnormal return for a stock during the first week is +5% and +3% during the second week, what is the abnormal return for the two-week period? A. 5% B. 3% C. 8.15% D. 8.00%

C. 8.15% Abnormal return = (1.05)(1.03) - 1 = 8.15%.

Company X has 100 shares outstanding. It earns $1,000 per year and announces that it will use all $1,000 to repurchase its shares in the open market instead of paying dividends. Calculate the number of shares outstanding at the end of year 1, after the first share repurchase, if the required rate of return is 10%. A. 110.0 B. 100.0 C. 90.91 D. 89.0

C. 90.91 Share price at beginning of year = [$1000/0.1]/100 = $100 per share. Share price at end of year, before repurchase, equals $100 × 1.10 = $110. Number of shares purchased = $1,000/$110 = 9.09. 100 - 9.09 = 90.91 shares remain.

When financial distress is a possibility, the value of a levered firm consists of: I) value of the firm if all-equity-financed; II) present value of tax shield; III) present value of costs of financial distress; IV) present value of omitted dividend payments A. I only B. I + II C. I + II - III D. I + II - III - IV

C. I + II - III

Firms can pay out cash to their shareholders in the following ways: I) dividends; II) share repurchases; III) interest payments A. I only B. II only C. I and II only D. III only

C. I and II only

If a corporation cannot use its interest payments as a tax shield for a particular year because it has suffered a loss, it is still possible to use the tax shield because: I) the carry-back provision allows corporations to carry back the loss and receive a tax refund up to the amount of taxes paid in the previous two years; II) the carry-forward provision allows corporations to carry forward the loss and use it to shield income in subsequent years A. I only B. II only C. I and II D. the firm will lose the tax shield

C. I and II only

In the case of Google, which has issued Class A and Class B shares: I) both classes of shares have the same cash-flow rights; II) both classes of shares have the same control rights; III) both classes of shares have different cash-flow rights; IV) both classes of shares have different control rights A. I and II only B. II and III only C. I and IV only D. III and IV only

C. I and IV only

A general cash offer involves the following processes: I) register the issue with the SEC; II) sell the securities through an underwriter or a syndicate of underwriters; III) have underwriter build up a book of likely demand for the securities; IV) price of the issue is fixed; V) sell the securities to the public A. I, II, and III only B. I, II, and IV only C. I, II, III, IV, and V D. II, III, IV, and V only

C. I, II, III, IV, and V

According to Rajan and Zingales, debt ratios of individual companies depend on: I) size: large firms have higher debt ratios; II) tangible assets: firms with high ratios of fixed assets to total assets have higher debt ratios; III) profitability: more profitable firms have lower debt ratios; IV) market to book: firms with higher ratios of market-to-book value have lower debt ratios; V) market structure: firms with monopoly power have higher debt ratios A. I and II only B. I, II, and III only C. I, II, III, and IV only D. I, II, III, IV, and V

C. I, II, III, and IV only

Financing decisions differ from investment decisions because: I) financing decisions are easier to reverse; II) markets for financial assets are generally more competitive than real asset markets; III) generally, financing decisions have NPVs very close to zero A. I only B. I and II only C. I, II, and III D. II and III only

C. I, II, and III

In order to test the strong form of market efficiency, researchers have examined the: I) recommendations of professional security analysts; II) performance of mutual funds; III) performance of pension funds A. I only B. I and II only C. I, II, and III D. II and III only

C. I, II, and III

Stockholders usually have the following rights: I) to elect board members, authorize issue of new shares, and vote on matters of great importance like mergers; II) to share proportionally in regular and liquidating dividends; III) to share proportionally in any new stock sold A. I only B. I and II only C. I, II, and III D. I and III only

C. I, II, and III

The following functions, provided by financial intermediaries, enable the smooth functioning of the economy: I) processing of payments; II) borrowing and lending; III) pooling risks A. I only B. I and II only C. I, II, and III D. III only

C. I, II, and III

The pecking order theory of capital structure implies that: I) high-risk firms will end up borrowing more; II) firms prefer internal finance; III) firms prefer debt to equity when external financing is required A. I only B. II only C. II and III only D. III only

C. II and III only

Which of the following statements regarding financial distress is (are) true? I) Firms in financial distress always end up in bankruptcy. II) Firms can postpone bankruptcy for many years. III) Ultimately, the firm may recover from financial distress and avoid bankruptcy altogether. A. I only B. II only C. II and III only D. III only

C. II and III only

Which of the following statements about partnership and limited liability is (are) true? I) All the partners in a partnership can have limited liability. II) General partners in a partnership cannot have limited liability. III) General partners in a partnership can be corporations. IV) Only limited partners in a partnership can have limited liability. A. I and II only B. I, II, and III only C. II, III, and IV only D. I and III only

C. II, III, and IV only

Dividend policy changes are decided by: I) the managers of a firm; II) the government; III) the board of directors A. I only B. II only C. III only D. I and II only

C. III only

Generally, venture capital funds are organized as: I) proprietorships; II) corporations; III) limited private partnerships A. I only B. II only C. III only D. I and II only

C. III only

Strong-form market efficiency states that the market incorporates all information into stock prices. Strong-form efficiency implies that: I) an investor can only earn risk-free rates of return; II) an investor can always rely on technical analysis; III) an insider or corporate officer cannot outperform the market by trading on the inside information A. I only B. II only C. III only D. I, II, and III

C. III only

The following are characteristics of preferred stock except: I) pays fixed dividends; II) can demand payments of cumulative dividends; III) has voting rights A. I only B. I and II only C. III only D. II only

C. III only

Wealthy individuals who provide equity investment for new firms are called: I) white knights; II) red herrings; III) angel investors A. I only B. I and II only C. III only D. II only

C. III only

What are some of the possible consequences of financial distress? I) Bondholders, who face the prospect of getting only part of their money back, will likely want the company to take additional risks. II) Equity investors would like the company to cut its dividend payments to conserve cash. III) Equity investors would like the firm to shift toward riskier lines of business. A. I only B. II only C. III only D. I and II only

C. III only

Which of the following dividends is never in the form of cash? I) regular dividend; II) special dividend; III) stock dividend; IV) liquidating dividend A. I only B. II only C. III only D. I, II, and IV only

C. III only

Which of the following observations would provide evidence against the strong form of efficient market theory? I) Mutual fund managers do not on average make superior returns. II) In any year approximately 50% of all pension funds outperform the market. III) Managers who trade in their own firm's stocks make superior returns. A. I only B. II only C. III only D. I and II only

C. III only

The dividend-irrelevance proposition of Miller and Modigliani depends on the following relationship between investment policy and dividend policy: A. Changes in investment policy will alter dividend policy. B. Changes in dividend policy will alter investment policy. C. Investment policy is independent of dividend policy. D. Dividends are tax-deductible and investments are depreciable.

C. Investment policy is independent of dividend policy

Firms looking to raise funds will file registration statements with the: A. Federal Reserve Board (FED). B. Office of the Comptroller of the Currency (OCC). C. Securities and Exchange Commission (SEC). D. Public Company Accounting Oversight Board (PCAOB).

C. Securities and Exchange Commission

Learn and Earn Company is financed entirely by common stock that is priced to offer a 20% expected rate of return. The stock price is $60 and the earnings per share are $12. The company wishes to repurchase 50% of the stock and substitutes an equal value of debt yielding 8%. Suppose that before refinancing, an investor owned 100 shares of Learn and Earn common stock. What should he do if he wishes to ensure that risk and expected return on his investment are unaffected by this refinancing? A. Borrow $3,000 and buy 50 more shares. B. Continue to hold 100 shares. C. Sell 50 shares and purchase $3,000 of 8% debt (bonds). D. Sell 8% of his stock and invest in bonds.

C. Sell 50 shares and purchase $3,000 of 8% debt (bonds) The refinancing results in a D/E ratio of 1.0. The new expected return on the stock increases from 20% to 32%. With 50 shares (worth $3,000) and $3,000 of 8% debt, the expected return remains at 0.5 × 32% + 0.5 × 8% = 20%.

Which of the following statements is generally true of venture capital (VC) firms? A. VCs are always silent partners in the start-up company that they finance. B. VCs always have a majority of directors in the start-up company. C. VCs generally provide management advice and contacts in addition to capital. D. VCs are combinations of publicly-traded companies.

C. VCs generally provide management advice and contacts in addition to capital

In a uniform-price auction: A. all winning bidders pay the price that they bid. B. all winning bidders pay a price that is the highest bid. C. all winning bidders pay a price that is the lowest winning bid. D. all winning bidders receive their full allocation.

C. all winning bidders pay a price that is the lowest winning bid

The very first public equity sold by a company is referred to as: A. a rights issue. B. American depositing receipts (ADRs). C. an initial public offering (IPO). D. a seasoned equity offering (SEO).

C. an initial public offering (IPO)

The maximum number of shares that can be issued by a firm is called: A. Treasury stock. B. outstanding shares. C. authorized shares. D. none of the options.

C. authorized shares

Which of the following are NOT financial intermediaries? A. insurance companies B. mutual funds C. banking regulators D. venture capital funds

C. banking regulators

What term might be used to describe an underwriter who influences an analyst in the same firm to modify a report so as to create a favorable impression of a securities issue? A. SOX compliance B. spinning C. conflict of interest D. Chinese wall

C. conflict of interest

A corporate bond that can be exchanged for a fixed number of shares of stock is called a: A. callable bond. B. debenture. C. convertible bond. D. warrant.

C. convertible bond

In order to find the present value of the tax shields provided by debt, the discount rate used is the: A. cost of capital. B. cost of equity. C. cost of debt. D. T-bill rate.

C. cost of debt

Which of the following lists events in chronological order from earliest to latest? A. Record date, declaration date, ex-dividend date B. Declaration date, record date, ex-dividend date C. Declaration date, ex-dividend date, record date D. Record date, ex-dividend date, declaration date

C. declaration date, ex-dividend date, record date

Weak-form efficiency implies that past stock returns: A. form patterns that tend to repeat. B. are major inputs to investors for forming trading strategies. C. do not matter. D. are difficult to explain.

C. do not moatter

If the debt beta is zero, then the relationship between the equity beta and the asset beta is given by: A. equity beta = 1 + [(beta of assets)/(debt-equity ratio)] B. equity beta = (1 - debt-equity ratio)(beta of assets) C. equity beta = (1 + debt-equity ratio)(beta of assets) D. equity beta = 1 + (debt-equity ratio/ beta of assets)

C. equity beta = (1 + debt-equity ratio)(beta of assets)

Informational efficiency in financial markets results in stock prices being: A. higher. B. lower. C. fairer. D. easier to predict.

C. fairer

If investors do not like dividends because of the additional taxes that they have to pay, how would you expect stock prices to behave on the ex-dividend date? A. Fall by more than the amount of the dividend B. Fall exactly by the amount of the dividend C. Fall by less than the amount of the dividend D. Cannot be predicted

C. fall by less than the amount of the dividend (Relative demand for the stock will increase on the ex-dividend date since the stock no longer trades with the dividend attached. So the stock price will fall due to the dividend, but will increase to some extent due to its ex-dividend status. On net, it will fall less than the amount of the dividend)

If the weak form of market efficiency holds, then: I) technical analysis is useless; II) stock prices reflect all information contained in past prices; III) stock price returns follow a random walk A. I only B. I and II only C. I, II, and III D. I and III only

C. i, II, and III

If an individual wants to borrow with limited liability, he/she should: A. invest in the equity of an unlevered firm. B. borrow on his/her own account. C. invest in the equity of a levered firm. D. invest in a risk-free asset like T-bills.

C. invest in the equity of a levered firm

Shelf registration is more often used for the: A. issue of common stock. B. issue of convertible securities. C. issue of corporate bonds. D. issue of warrants.

C. issue of corporate bonds

In order to test the semistrong form of the efficient-market hypothesis, researchers have mostly relied on the: A. estimation of the serial correlation coefficients (autocorrelations) for securities and markets. B. measurement of the performance of technical trading strategies over the years. C. measurement of how rapidly security prices adjust to different news items. D. all of the options.

C. measurement of how rapidly security prices adjust to different news items

In order to test the weak form of the efficient-market hypothesis, researchers have used the following methods EXCEPT: A. estimation of the serial correlation (autocorrelation) for securities and markets. B. measurement of the profitability of trading rules used by technical analysts. C. measurement of how rapidly security prices adjust to different news items. D. all of the options are methods used for testing weak-form market efficiency.

C. measurement of how rapidly security prices adjust to different news items

If a bond is junior or subordinated, it: A. has a higher priority status than specified creditors. B. has been issued because the company is in default. C. must give preference to senior creditors in the event of default. D. is secondary to equity.

C. must give preference to senior creditors in the event of default

The rare event in which a firm's existing directors and management compete with outsiders for the effective control of the corporation is called a: A. majority vote. B. supermajority amendment. C. proxy contest. D. merger.

C. proxy contest

Generally, which of the following is true? A. rD > rA > rE B. rE > rD > rA C. rE > rA > rD D. rA > rE > rD

C. rE > rA > rD

Assuming that bonds are sold at a fair price, the benefits from the interest tax shield go to the: A. managers of the firm. B. bondholders of the firm. C. stockholders of the firm. D. lawyers of the firm.

C. stockholders of the firm

Consider the aggregate balance sheet for manufacturing corporations in the U.S. Which of the following sources of financing plays the smallest role? A. current liabilities B. long-term debt C. stockholders' equity D. Each of the sources plays an equal role.

C. stockholders' equity

The conviction of Raj Rajratnam for insider trading supplies evidence against which form of the efficient markets hypothesis? A. Weak-form efficiency B. Semistrong form efficiency C. Strong-form efficiency D. It is evidence against all forms

C. strong-form efficiency

Suppose that a lawyer works for a firm that advises corporate firms planning to sue other corporations for antitrust damages. He finds that he can "beat the market" by short selling the stock of firms that will be sued. This hypothetical finding would violate the: A. weak-form hypothesis of market efficiency. B. semistrong form hypothesis of market efficiency. C. strong-form hypothesis of market efficiency. D. none of the hypotheses of market efficiency.

C. strong-form hypothesis of market efficiency

The change in a firm's retained earnings is: A. the amount of cash that the firm has saved up. B. the difference between the market price of the stock and the book value. C. the difference between the net income earned and the dividends paid during a year. D. the amount of directly contributed equity capital in excess of par value.

C. the difference between the net income earned and the dividends paid during a year

Which of the following statements best describes shelf registration? A. The issuance of securities to qualified institutional investors. B. The enforcement of blue-sky laws. C. The provision that allows large companies to file a single registration statement covering financing plans up to three years into the future. D. Registration of the sale of securities in the primary market.

C. the provision that allows large companies to file a single registration statement covering financing plans up to three years into the future

In Miller's model, when the quantity (1 - TC)(1 - TpE) = (1 - Tp), then: A. the firm should hold no debt. B. the value of the levered firm is greater than the value of the unlevered firm. C. the tax shield on debt is exactly offset by higher personal taxes paid on interest income. D. the firm should be financed by 100% equity.

C. the tax shield on debt is exactly offset by higher personal taxes paid on interest income

Stock price cycles or patterns tend to self-destruct as soon as investors recognize them through: A. stock market regulation by the Securities and Exchange Commission (SEC). B. price fixing by the specialists on the New York Stock Exchange. C. trading by investors. D. the actions of corporate treasurers.

C. trading by investors

Shares of stock that have been repurchased by the corporation are called: A. authorized shares. B. repurchase agreements. C. Treasury stock. D. retained equity.

C. treasury stock

Generally, initial public offerings (IPOs) are: A. overpriced. B. correctly priced. C. underpriced. D. there is no general trend.

C. underpriced

Image Storage Corporation has 1,000,000 shares outstanding. It wishes to issue 500,000 new shares using a (North American) rights issue. If the current stock price is $50 and the subscription price is $47/share, what is the value of a right? A. $0.40/right B. $5.00/right C. $2.50/right D. $1.00/right

D. $1.00/right Stock price after issue = ($50M + 0.5 × 47)/1.5M = $49. Shareholders were offered one right per share of stock. Value of two rights = (49 - 47) = $2. Value of 1 right = $1.00

If a firm borrows $50 million for one year at an interest rate of 9%, what is the present value of the interest tax shield? Assume a 30% marginal corporate tax rate. A. $50.00 million B. $17.50 million C. $1.45 million D. $1.24 million

D. $1.24 million PV of interest tax shield = [(0.3)(50)(0.09)]/1.09 = $1.239 million.

Bombay Company's book and market value balance sheets are: (NWC = net working capital; LTA = long term assets; D = debt; E = equity; V = firm value): (refer to #13 in ch 18 practice questions) According to MM's Proposition I corrected for taxes, what will be the change in company value if Bombay issues $200 of equity and uses it to make a permanent reduction in the company's debt? Assume a 35% marginal corporate tax rate. A. +$140 B. +$70 C. $0 D. -$70

D. -$70 PV of tax shield = -200 (0.35) = -$70.

The equity beta of a levered firm is 1.2. The beta of debt is 0.2. The firm's market value debt to equity ratio is 0.5. What is the asset beta if the tax rate is zero? A. 1.20 B. 0.73 C. 0.20 D. 0.87

D. 0.87 1.2 = βA + (0.5)( βA - 0.2); 1.5βA = 1.3; βA = 1.3/1.5 = 0.87

A firm is unlevered and has a cost of equity capital of 9%. What is the cost of equity if the firm becomes levered at a debt-equity ratio of 2? The expected cost of debt is 7%. (Assume no taxes.) A. 15.0% B. 16.0% C. 14.5% D. 13.0%

D. 13.0% rE = 9 + 2(9 - 7) = 13%.

A firm's return on assets is 12% and the cost of the firm's debt is 7%. Given a 0.7 debt to equity ratio, what is the levered cost of equity? A. 7.0% B. 12.0% C. 13.6% D. 15.5%

D. 15.5% Re = 0.12 + (.12 - .07) × 0.7 = .155

Suppose that there are no taxes, transactions costs, or other market imperfections. Which of the following actions is most likely to make shareholders better off? A. Increase dividends. B. Reduce share repurchases. C. Announce that dividends will not change for at least three years. D. Eliminate negative-NPV projects.

D. Eliminate negative-NPV projects

MM Proposition I with corporate taxes states that: I) capital structure can affect firm value by an amount that is equal to the present value of the interest tax shield; II) by raising the debt-to-equity ratio, the firm can lower its taxes and thereby increase its total value; III) firm value is maximized by using an all-equity capital structure A. I only B. II only C. III only D. I and II

D. I and II

If the efficient market hypothesis holds, investors should expect: I) to receive a fair price for their security II) to earn a normal rate of return on their investments III) to be able to pick stocks that will outperform the market A. I only B. II only C. III only D. I and II only

D. I and II only

An investor can undo the effect of leverage on his/her own account by: I) investing in the equity of a levered firm; II) borrowing on his/her own account; III) investing in risk-free debt like T-bills A. I only B. II only C. III only D. I and III above

D. I and III above

An investor can create the effect of leverage on his/her account by: I) buying equity of an unlevered firm; II) investing in risk-free debt like T-bills; III) borrowing on his/her own account A. I only B. II only C. III only D. I and III only

D. I and III only

The costs of financial distress depend on the: I) probability of financial distress; II) corporate and personal tax rates; III) magnitude of costs encountered if financial distress occurs A. I only B. I and II only C. I, II, and III D. I and III only

D. I and III only

When a firm has no debt, then such a firm is known as: I) an unlevered firm; II) a levered firm; III) an all-equity firm A. I only B. II only C. III only D. I and III only

D. I and III only

Underwriters will handle an issue of new securities on a: I) best efforts basis; II) firm commitment basis; III) all or none basis A. I only B. II only C. III only D. I or II or III

D. I or II or III

The following are debts in disguise except: I) accounts payable II) leases III) underfunded pensions A. I only B. II only C. III only D. I, II, and III

D. I, II, III

The various lessons of market efficiency are: I) markets have no memory; II) trust market prices; III) read the entrails; IV) there are no financial illusions; V) the do-it yourself alternative; VI) seen one stock, seen them all A. I and II only B. I, II, III, and IV only C. I, II, III, IV, and V only D. I, II, III, IV, V, and VI

D. I, II, III, IV, V, VI

A business plan generally contains: I) a description of the proposed products; II) a description of the potential market; III) a description of the underlying technology; IV) a description of resources needed A. I only B. I and II only C. II and III only D. I, II, III, and IV

D. I, II, III, and IV

Financial slack includes: I) cash; II) marketable securities; III) readily salable real assets; IV) ready access to debt markets or bank loans A. I only B. IV only C. III only D. I, II, III, and IV

D. I, II, III, and IV

Firms can repurchase shares in the following ways: I) open market repurchase; II) tender offer; III) Dutch auction; IV) direct negotiation with a major shareholder A. I only B. II only C. III only D. I, II, III, and IV

D. I, II, III, and IV

Internal funds constitute the majority of corporate financing in the following countries: I) U.S. II) U.K. III) Germany IV) Japan A. I only B. I and II only C. I, II, and III only D. I, II, III, and IV

D. I, II, III, and IV

The semistrong form of the efficient markets hypothesis has been tested by measuring how rapidly security prices react to various news items like: I) earnings announcements; II) dividend announcements; III) news of takeovers; IV) macroeconomic information A. I and II only B. I, II, and III only C. IV only D. I, II, III, and IV

D. I, II, III, and IV

12. The different forms of market efficiency are: I) weak form; II) semistrong form; III) strong form A. I only B. I and II only C. I and III only D. I, II, and III

D. I, II, and III

A policy of maximizing the value of the firm is the same as a policy of minimizing the weighted average cost of capital providing that: I) the firm's investment policy is settled; II) there are no taxes; III) an issue of new debt does not affect the market value of existing debt A. I only B. II only C. III only D. I, II, and III

D. I, II, and III

According to the graph of WACC for Union Pacific, which of the following is (are) true? I) The cost of equity is an increasing function of the debt-equity ratio. II) The cost of debt is an increasing function of the debt-equity ratio. III) The weighted average cost of capital (WACC) is a decreasing function of the debt-equity ratio. A. I only B. I and II only C. III only D. I, II, and III

D. I, II, and III

According to the middle-of-the-roaders, a firm's value is not affected by its dividend policy because: I) of the clientele effect; II) of the tax loopholes available to wealthy stockholders; III) well-managed companies prefer to signal their worth by paying high dividends A. I only B. II only C. III only D. I, II, and III

D. I, II, and III

Capital structure is irrelevant if: I) capital markets are efficient; II) each investor can borrow/lend on the same terms as the firm; III) there are no tax benefits to debt A. I only B. II only C. III only D. I, II, and III

D. I, II, and III

Generally, managers of corporations prefer internally generated cash to finance their capital expenditures because: I) they can avoid the discipline of financial markets; II) the costs of issuing new securities are high; III) the announcement of a new equity issue is usually bad news for investors A. I only B. II only C. II and III only D. I, II, and III

D. I, II, and III

Generally, underwriters provide the following services to the issuing firm: I) provide advice; II) buy some or all of the new issue; III) resell the issue to the public A. I only B. I and II only C. I and III only D. I, II, and III

D. I, II, and III

MM Proposition II states that: I) the expected return on equity is positively related to leverage; II) the required return on equity is a linear function of the firm's debt to equity ratio; III) the risk to equity increases with leverage A. I only B. II only C. III only D. I, II, and III

D. I, II, and III

The cost of capital for a firm, rWACC, in a tax-free environment is: I) equal to the market value weighted average of the return on equity and the return on debt; II) equal to rA, the rate of return for that business risk class; III) equal to the overall rate of return required on the levered firm A. I only B. II only C. III only D. I, II, and III

D. I, II, and III

The following are advantages of shelf registration except: I) securities can be issued in dribs and drabs without incurring excessive transaction costs; II) securities can be issued on short notice; III) security issues can be timed to take advantage of market conditions A. I only B. II only C. III only D. I, II, and III

D. I, II, and III

The following are indicators that the firm has a cash surplus: I) Free cash flow is reliably positive. II) The firm has a low debt ratio compared to similar firms. III) The firm has sufficient debt capacity to cover unexpected opportunities or setbacks. A. I only B. II only C. III only D. I, II, and III

D. I, II, and III

The law of conservation of value implies that: I) the mix of common stock and preferred stock does not affect the value of the firm; II) the mix of long-term and short-term debt does not affect the value of the firm; III) the mix of secured and unsecured debt does not affect the value of the firm A. I only B. II only C. III only D. I, II, and III

D. I, II, and III

The law of conservation of value implies that: I) the mix of senior and subordinated debt does not affect the value of the firm; II) the mix of convertible and nonconvertible debt does not affect the value of the firm; III) the mix of common stock and preferred stock does not affect the value of the firm A. I only B. II only C. III only D. I, II, and III

D. I, II, and III

Value additivity works for: I) combining assets; II) splitting up of assets; III) the mix of debt securities issued by the firm A. I only B. II only C. I and II only D. I, II, and III

D. I, II, and III

When completing a large debt issue, financial managers of large firms will usually consider the following questions EXCEPT: I) Should the firm borrow short term or long term? II) Should the firm issue fixed- or floating-rate debt? III) Should the firm borrow in foreign currency? A. I only B. II only C. III only D. I, II, and III

D. I, II, and III

When faced with financial distress, managers of firms acting on behalf of their shareholders' interests will tend to: I) favor high-risk, high-return projects even if they have negative NPV; II) refuse to invest in low-risk, low-return projects with positive NPVs; III) delay the onset of bankruptcy as long as they can A. I only B. II only C. III only D. I, II, and III

D. I, II, and III

Which of the following are true? I) Firms have long-run target dividend payout ratios. II) Dividend changes follow shifts in long-term, sustainable earnings. III) Managers are reluctant to make dividend changes that might have to be reversed. A. I only B. II only C. III only D. I, II, and III

D. I, II, and III

One of the indirect costs to bankruptcy is the incentive toward underinvestment. Following this strategy may result in: I) the firm always choosing projects with positive NPVs; II) stockholders turning down low-risk, low-return but positive NPV projects; III) the firm declaring and paying high cash dividends A. I only B. II only C. III only D. II and III only

D. II and III only

The MM theory with taxes implies that firms should issue maximum debt. In practice, this is not true because: I) debt is more risky than equity; II) bankruptcy and its attendant costs are a disadvantage to debt; III) the payment of personal taxes may offset the tax benefit of debt A. I only B. II only C. III only D. II and III only

D. II and III only

Generally, a firm is able to find positive-NPV opportunities among its: I) financing decisions; II) capital investment decisions; III) short-term borrowing decisions A. I only B. I and III only C. III only D. II only

D. II only

The following are the main characteristics of financial intermediaries except: I) they raise money from investors; II) they invest in financial assets; III) they mainly invest in real assets A. I only B. I and II only C. II only D. III only

D. III only

The following are anomalies countering the efficient market hypothesis EXCEPT: I) the small-firm effect; II) the earnings announcement puzzle; III) the new-issue puzzle; IV) trading rules based on patterns A. I only B. I and II only C. I, II, and III only D. IV only

D. IV only

Which of the following statements is(are) true if the strong-form efficient market hypothesis holds? I) Analysts can easily forecast stock price changes. II) Financial markets are irrational. III) Stock returns follow a particular pattern. IV) Stock prices reflect all available information. A. I only B. II only C. I and III only D. IV only

D. IV only

What signal is sent to the market when a firm decides to issue new stock to raise capital? A. Bond markets are overpriced. B. Bond markets are underpriced. C. Stock price is too low. D. Stock price is too high.

D. Stock price is too high

The total market value (V) of the securities of a firm that has both debt (D) and equity (E) is: A. V = D - E B. V = E - D C. V = D × E D. V = D + E

D. V = D + E

The after-tax weighted average cost of capital (WACC) is given by (corporate tax rate = TC): A. WACC = (rD)(D/V) + (rE)(E/V) B. WACC = (rD)(D/V) +[(rE )(E/V)/(1 - TC)] C. WACC = [(rD)(D/V) + (rE)(E/V)]/(1 - TC) D. WACC = (rD)(1 - TC)(D/V) + (rE)(E/V)

D. WACC = (rD)(1 - TC)(D/V) + (rE)(E/V)

Which of the following is NOT a sensible reason for a firm to rely on internal funds? A. Equity issues are generally expensive. B. A new bond issue may drive the firm's debt ratio too high. C. Financial markets interpret the issuance of equity unfavorably. D. All of the these are sensible reasons to rely on internal funds.

D. all of these are sensible reasons to rely on internal funds

State laws that regulate sales of securities within the state are called: A. red herrings. B. registration laws. C. Rule 415 regulations. D. blue-sky laws.

D. blue-sky laws

SEC registration is not required when a company makes a: A. private placement of securities. B. public offering of securities issue having a value less than $5 million and a maturity less than nine months. C. public offering of securities having a value greater than $5 million. D. both A and B.

D. both A and B

Suppose a firm sets aside assets to protect particular investors. These assets are called: A. repurchased shares. B. senior debt. C. subordinated debt. D. collateral.

D. collateral

As a provider of funds to a corporation, owning which of the following corporate securities will give you the most control rights? A. short-term bank loan B. long-term bond C. preferred stock D. common stock

D. common stock

Which of the following investors has the strongest tax reason to prefer dividends over capital gains? A. pension funds B. financial institutions C. individuals D. corporations

D. corporations

According to evidence from surveys of CFOs, the top-most motive for firms to go public is to: A. broaden the base of ownership. B. enhance the reputation of the firm. C. establish a market price/value for our firm. D. create public shares for use in future acquisitions.

D. create public shares for use in future acquisitions

Which of the following is NOT a potential result from financial distress? A. Suppliers refuse to extend terms to the firm. B. Key employees leave the firm, fearing the firm won't last. C. The firm has difficulty issuing additional bonds. D. Due to interest tax shields, the firm's effective tax rate is very low.

D. due to interest tax shields, the firm's effective tax rate is very low

Consider the payout policies of U.S. firms from 2001-2010. Which category had the highest percentage of firms? A. Firms that paid dividends and repurchased shares B. Firms that paid dividends but did not repurchase shares C. Firms that paid no dividends but did repurchase shares D. Firms that paid no dividends and did not repurchase shares

D. firms that paid no dividends and did not repurchase shares

According to survey data, which is the least-often cited dividend policy consideration? A. Firms want to avoid dividend reductions. B. Firms desire a smooth dividend policy. C. Firms avoid dividend policy reversals. D. Firms would prefer to raise new funds rather than reduce dividends.

D. firms would prefer to raise new funds rather than reduce dividends

Under what conditions would a policy of maximizing the value of the firm not be the same as a policy of maximizing shareholders' wealth? A. If the issue of debt increases the financial risk of the firm's equity B. If the firm issues debt for the first time C. If the beta of equity is positive D. If an issue of debt affects the market value of existing debt

D. if an issue of debt affects the market value of existing debt

Generally, nonfinancial U.S. corporations have financed their capital expenditures through: A. issuance of new equity. B. issuance of debt. C. increases in working capital. D. internally generated cash.

D. internally generated cash

The study of behavioral finance has best helped explain which of the following investor behaviors? A. Investors are often unable to short-sell unfavorable stocks. B. Investors often create undiversified portfolios. C. Investors tend to sell their losing stocks and retain stocks that have capital gains. D. Investors are generally too slow to update their beliefs in the face of new evidence.

D. investors are generally slow to update their beliefs in the face of new evidence

Suppose that a company can direct $1 to either debt interest or to capital gains for equity investors. The capital gains tax rate is 15%. Which investor would not care how the money is channeled? (The marginal corporate tax rate is 35%.) A. investors paying zero personal tax B. investors paying a personal tax rate of 53% C. investors paying a personal tax rate of 17.5% D. investors paying a personal tax rate of 45%

D. investors paying a personal tax rate of 45% For an indifferent investor, it must be the case that (1 - TC)(1 - TpE) = (1 - Tp). Or, (1 - 0.35) (1 - 0.15) = (1 - Tp). Tp = 44.75%.

During which year have U.S. nonfinancial firms raised positive net equity? A. 2007 B. 2008 C. 2009 D. net equity has been negative from 2007 to 2009

D. net equity has been negative from 2006 to 2009

A key assumption of the Miller and Modigliani (MM) dividend irrelevance argument is that: A. future stock prices are certain. B. firms have an adequate supply of Treasury shares. C. there exists a risk-free asset. D. new shares are sold at a fair price.

D. new shares are sold at a fair price

If markets are efficient, which of the following investors should achieve superior returns over time? A. Investors who choose stocks by throwing darts at a list of stocks in the financial pages of a newspaper B. Analysts who spend considerable time evaluating the best stocks to buy C. Mutual fund managers who manage other people's money for a living D. None of the options

D. none of the options

A rights issue is also called a(an): A. private placement. B. shelf registration. C. initial public offering (IPO). D. privileged subscription.

D. privileged subscription

When comparing levered vs. unlevered capital structures, leverage works to increase EPS for high levels of operating income because interest payments on the debt: A. vary with EBIT levels. B. stay fixed, leaving less income to be distributed over fewer shares. C. stay fixed, leaving less income to be distributed over more shares. D. stay fixed, leaving more income to be distributed over fewer shares.

D. stay fixed, leaving more income to be distributed over fewer shares

Generally, which of the following issues have the lowest total direct costs of issuing as a percentage of gross proceeds? A. initial public offerings (IPOs) B. seasoned equity offerings (SEOs) C. convertible bonds D. straight bonds

D. straight bonds

A modification to the company charter that requires 75% shareholder approval for a merger is called a: A. majority voting amendment. B. cumulative voting amendment. C. proxy voting amendment. D. supermajority amendment.

D. supermajority amendment

Which of the following is a possible exception to the efficient-market theory? A. Underwriters charge investors more for IPO shares than they pay the issuing firms. B. IPO spreads are lower on larger issues. C. The issuance of equity is interpreted as an unfavorable signal by investors. D. The long-run returns of IPOs tend to underperform the market.

D. the long-run returns of IPOs tend to underperform the market

Typically, the book value of shareholders' equity equals: A. total assets minus current liabilities. B. total assets minus net worth. C. the sum of preferred stock, debt, and the par value of equity. D. the sum of the par value of common stock, additional paid-in capital, and accumulated retained earnings.

D. the sum of the par value of common stock, additional paid-in capital, and accumulated retained earnings

One possible reason that shareholders often insist on higher dividends is: A. they agree with Miller and Modigliani. B. the capital gains tax disadvantage. C. the stock market is efficient. D. they do not trust managers to spend retained earnings wisely.

D. they do not trust managers to spend retained earnings wisely

What costs in an IPO generally exceed all other costs? A. commissions B. issues fees C. spreads D. underpricing

D. underpricing