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32. A firm's capital structure is the mix of financial securities used to finance its activities and can include all of the following except A) stock. B) bonds. C) equity options. D) preferred stock.

34. Which ONE of the following statements is true? A) Cash conversion cycle = DSO + DSI + DPO B) Cash conversion cycle = DSO + DSI - DPO C) Cash conversion cycle = DSO - DPO D) None of the above.

35. Which one of the following statements is NOT true? A) Cash conversion cycle = DSO + DSI - DPO B) Operating cycle = DSO + DSI C) a and b D) None of the above

D Feedback: Stock price at end of first day = $61.00 First-day underpricing = ($61.00 - $50.00) = $11.00 per share. Total underpricing = ($11.00 per share x 500,000 shares of stock) = $5,500,000 Underwriter's gross spread ($50.00 x .12) =$6.00 per share. Underwriting cost = ($6.00 per share x 500,000 shares) = $3 million Total cost to the firm of selling the IPO = $3,000,000 + $600,000 + $5,500,000 = $9,100,000

77. A firm is making an initial public offering. The investment bankers agree to a firm underwriting commitment of 500,000 shares priced to the public at $50 a share. The underwriter's spread is 12%. In addition, the underwriter charges $600,000 in legal fees. On the first day of trading, the firm's stock closed at $61. What were the total costs of the issue? a. $3,000,000 b. $3,600,000 c. $8,500,000 d. $9,100,000

D Feedback: The payoff from the put option is $0 if the stock price rises and $7 if the stock price falls. From the binomial pricing model we can create a replicating portfolio with the following two equations: $0 = ($31 × x) + (1.00 × y) $7 = ($18 × x) + (1.00 × y) x = -0.54 shares of stock y = $16.69 of risk-free bonds The value of the option is the value of the replicating portfolio: (-0.54 × $22) + ($16.69) = $4.85

81. Binomial pricing: Assume that the stock of ABC, Inc., is currently trading for $22 and will either rise to $31 or fall to $18 in one year. The risk-free rate for one year is 0 percent. What is the value of a put option with a strike price of $25? A) $0 B) $1.85 C) $3.00 D) $4.85

B Feedback:

Dynamo Corp. produces annual cash flows of $150 and is expected to exist forever. The company is currently financed with 75 percent equity and 25 percent debt. Your analysis tells you that the appropriate discount rates are 10 percent for the cash flows, and 7 percent for the debt. You currently own 10 percent of the stock. 52. M&M Proposition 1: How much is Dynamo worth today? A) $1,765 B) $1,500 C) $2,143 D) None of the above.

A Feedback: Cash flows to shareholders = Cash flows - Interest payments = $150 - ($1,500) × (0.25) × (0.07) = $123.75 Therefore, your 10% share = $123.75 × 0.1 = $12.375

Dynamo Corp. produces annual cash flows of $150 and is expected to exist forever. The company is currently financed with 75 percent equity and 25 percent debt. Your analysis tells you that the appropriate discount rates are 10 percent for the cash flows, and 7 percent for the debt. You currently own 10 percent of the stock. 53. M&M Proposition 1: How much are your cash flows today? A) $12.38 B) $15 C) $4.50 D) $150

D Feedback: Debt today = 0.25 × $1,500 = $375 Debt after restructuring = 0.40 × $1,500 = $600 Total debt issuance = $600 - $375 = $225

Dynamo Corp. produces annual cash flows of $150 and is expected to exist forever. The company is currently financed with 75 percent equity and 25 percent debt. Your analysis tells you that the appropriate discount rates are 10 percent for the cash flows, and 7 percent for the debt. You currently own 10 percent of the stock. 54. M&M Proposition 1: If Dynamo wishes to change its capital structure from 75 percent to 60 percent equity and use the debt proceeds to pay a special dividend to shareholders, how much debt should they issue? A) $321 B) $375 C) $600 D) $225

B Feedback: Debt today = 0.25 × $1500 = $375 Interest payment on debt before restructuring = $375 × 0.07 = $26.25 Total debt after restructuring =0 .4 × $1,500 = $600 Interest payment on debt after restructuring = 0.07 × $600 = $42

Dynamo Corp. produces annual cash flows of $150 and is expected to exist forever. The company is currently financed with 75 percent equity and 25 percent debt. Your analysis tells you that the appropriate discount rates are 10 percent for the cash flows, and 7 percent for the debt. You currently own 10 percent of the stock. 55. M&M Proposition 1: How much does Dynamo currently pay in interest, and how much will it have to pay after the restructuring in the prior problem, assuming that the cost of debt is constant? A) $42 and $26.25 B) $26.25 and $42 C) $160 and $37.50 D) $37.50 and $60

D Feedback: Portion of special dividend received = 0.10 × $225 = $22.50 Cash flows to you after restructuring = 0.10 × ($150 - $42) = $10.80 Note: $42 = Interest payment on debt after restructuring

Dynamo Corp. produces annual cash flows of $150 and is expected to exist forever. The company is currently financed with 75 percent equity and 25 percent debt. Your analysis tells you that the appropriate discount rates are 10 percent for the cash flows, and 7 percent for the debt. You currently own 10 percent of the stock. 56. M&M Proposition 1: How much of the special dividend do you receive, and how much do you receive in regular dividends per annum after the restructuring? A) $15 and $60 B) $60 and $15 C) $10.80 and $22.50 D) $22.50 and $10.80

C Feedback: M&M Proposition 1 says to take your portion of the special dividend ($22.50) and buy that much of the new debt issuance.

Dynamo Corp. produces annual cash flows of $150 and is expected to exist forever. The company is currently financed with 75 percent equity and 25 percent debt. Your analysis tells you that the appropriate discount rates are 10 percent for the cash flows, and 7 percent for the debt. You currently own 10 percent of the stock. 57. M&M Proposition 1: According to M&M Proposition 1, what transaction do you need to take in order to undo the restructuring? A) Sell $22.50 of stock. B) Sell $10.80 worth of stock. C) Buy $22.50 worth of debt. D) Buy $10.80 worth of debt.

A Feedback: Since you have purchased $22.50 worth of debt, then you will receive $22.50 × 0.07 = $1.58 in interest payments. Since you will receive $10.80 in dividends after the restructuring, your total cash flows are $1.58 + $10.80 = $12.38, the same as before the restructuring!

Dynamo Corp. produces annual cash flows of $150 and is expected to exist forever. The company is currently financed with 75 percent equity and 25 percent debt. Your analysis tells you that the appropriate discount rates are 10 percent for the cash flows, and 7 percent for the debt. You currently own 10 percent of the stock. 58. M&M Proposition 1: What are the interest payments that you receive after you undo the restructuring, and what are your total cash flows? A) $1.58 and $12.38 B) $23.55 and $75 C) $1.125 and $12.38 D) None of the above.

D Feedback: Annual sales = 700 units Cost of placing an order = $1,100 Inventory carrying cost = $120 Economic order quantity = 113 cars

Economic order quantity: Jensen Autos, one of the largest car dealers in Eau Claire, sells about 700 vehicles a year. The cost of placing an order with their supplier is $1,100, and the inventory carrying costs are $120 for each car. Most of their sales are in late fall of each year. 76. What is the number of cars per order? A) 80 cars B) 101cars C) 58 cars D) 113 cars

C Feedback: Number of orders = 700 / 113 6

Economic order quantity: Jensen Autos, one of the largest car dealers in Eau Claire, sells about 700 vehicles a year. The cost of placing an order with their supplier is $1,100, and the inventory carrying costs are $120 for each car. Most of their sales are in late fall of each year. 77. How many orders will the dealer need to place this year? A) 4 orders B) 5 orders C) 6 orders D) 7 orders

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Easy 31. Which type of dividend is most likely to be used to distribute the revenue from a one-time sale of a large asset? A) Regular cash dividend B) Extra dividend C) Special dividend D) Liquidating dividend

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Basic 78. Which of the following is the equation for net working capital? A) Total assets - total liabilities B) Current assets - current liabilities C) Current assets/current liabilities D) Total assets/total liabilities

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Easy 31. The initial seed money comes from A) public investors. B) investment banks. C) the entrepreneur or other founders. D) commercial banks.

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Easy 32. Bootstrapping is the process by which A) many entrepreneurs raise "seed" money and obtain other resources necessary to start their businesses. B) the entrepreneur often fleshes out his or her ideas and makes them operational. C) most businesses are started by an entrepreneur. D) none of the above.

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Easy 32. Which type of dividend is used to distribute any remaining value when the company's assets are being sold as the company is terminated? A) Regular cash dividend B) Extra dividend C) Special dividend D) Liquidating dividend

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Easy 33. Consider a company that had unexpectedly higher earnings last quarter and intends to pay out some additional value to shareholders. Which type of dividend is the company likely to use? A) Regular cash dividend B) Extra dividend C) Special dividend D) Liquidating dividend

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Easy 33. The optimal capital structure of a firm A) minimizes the cost of financing a firm's projects. B) minimizes interest payments to creditors. C) maximizes firm value. D) both a and c.

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Easy 33. Which one of the following statements is NOT true? A) The process by which many entrepreneurs raise "seed" money and obtain other resources necessary to start their businesses is often called bootstrapping. B) Most businesses are started by an entrepreneur who has a vision for a new business or product and a passionate belief in the concept's viability. C) The initial "seed" money usually comes from the entrepreneur or other founders. D) The seed money is spent on developing an initial public offering.

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Easy 34. M&M Proposition 1 assumes all of the following except that A) there are no taxes. B) there are no costs to acquiring information. C) there are no transactions costs. D) the real investment policy of the firm is affected by its capital structure decisions.

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Easy 34. Which step in the dividend payment process for a public company usually results in a change in the company's stock price? Assume the dividend has changed from the last dividend paid. A) Public announcement B) Ex-dividend date C) Payable date D) Both a and b

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Easy 35. A firm's enterprise value is given by A) the value of equity plus the value of debt. B) the value of equity minus the value of debt. C) the value of equity minus the value of debt plus the value of future projects. D) none of the above.

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Easy 35. The finance balance sheet is A) the same as the accounting balance sheet, but it is based on market values. B) the same as the accounting balance sheet, but it does not have to balance. C) based on cash rather than accrual accounting. D) net income.

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Easy 36. A financial restructuring A) will not change the value of a firm's real assets under M&M Proposition 1. B) includes financial transactions that change the capital structure of the firm. C) means that a firm has issued equity to retire debt. D) both a and b.

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Easy 36. Which one of these examples does NOT meet the strict definition for a dividend? A) Steel Gen Corp regularly distributes $0.05 to each shareholder for every share they own. B) Chalone Vineyards once offered their investors discounts on wine in proportion to the number of shares they owned. C) Churchill Downs, Inc., which operates several horse racing tracks, including the location for the Kentucky Derby, distributes two free general admission tickets to every investor who holds more then 100 shares in the company (as of 2008). D) Both b and c do not meet the definition for a dividend.

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Easy 37. The beta for a firm can be estimated by A) adding up the betas of the individual projects of the firm. B) taking the weighted average of the beta for the individual projects of the firm. C) taking the simple average of the beta for the individual projects of the firm. D) None of the above.

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Easy 37. The weighted average cost of capital (WACC) includes A) the required return on equity and required return on underlying firm assets. B) the cost of any debt and the cost of equity. C) the cost of any debt and required return on underlying firm assets. D) none of the above.

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Easy 38. M&M Proposition 2 states that the cost of a firm's common stock is related to A) the debt-to-equity ratio. B) the required rate of return on the firm's underlying assets. C) the return of the market index. D) a and b.

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Easy 38. The firm can be viewed as A) a portfolio of individual projects, each with their own risks, cost of capital, and returns. B) a collection of equity shares comprising it. C) a collection of debt instruments financing it. D) none of the above.

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Easy 39. According to M&M Proposition 2, the cost of a firm's equity A) increases with the debt-to-equity ratio. B) decreases with the debt-to-equity ratio. C) increases and then falls with the debt-to-equity ratio. D) decreases and then increases with the debt-to-equity ratio.

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Easy 41. Which of the following is a reason financial policy might matter? A) Firms must pay corporate income taxes. B) Capital structure choices can affect investment decisions, such as R&D and PP&E. C) Issuing equity is expensive. D) All of the above.

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: medium 36. Suppose you own a call option on a stock with a strike price of $20 that expires today. The price of the underlying stock is $15. If you exercise the option and immediately sell the stock, A) you will earn $5. B) you will lose $5. C) you will lose $15. D) you will earn $15.

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Medium 28. Which one of the following statements is NOT true? A) Gross working capital is the funds invested in a company's current liabilities. B) Net working capital (NWC) refers to the difference between current assets and current liabilities. C) Working capital efficiency refers to the length of time between when a working capital asset is acquired and when it is converted into cash. D) Working capital management involves making decisions regarding the use and sources of current assets.

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Medium 29. Which one of the following statements is NOT true? A) The higher the cash balance, the better the ability of the firm to meet its short-term financial obligations. B) The lower the cash balance, the better the ability of the firm to meet its short-term financial obligations. C) The level of the cash balance has no bearing on the firm's ability to meet its short-term financial obligations. D) None of the above.

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Medium 33. Firms have no way to directly estimate the discount rate that reflects the risk of A) a publicly traded security. B) its debt securities. C) the incremental cash flows from a particular project. D) none of the above.

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Medium 34. A firm's overall cost of capital is A) equal to its cost debt. B) a weighted average of the costs of capital for the collection of individual projects that the firm is working on. C) best measured by the cost of capital of the riskiest projects that the firm is working on. D) none of the above.

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Medium 35. The shares of ABC, Inc., fell sharply today after the company announced that it is increasing its regular cash dividend distributions. Which one of the following explanations may explain investors' negative reaction? A) Changes in regular cash dividends are made frequently so that the company's management can adjust for changes in short-term earnings. The decrease in the stock price is probably related to some other negative event. B) Investors previously believed the company had many lucrative growth opportunities. By announcing higher regular cash dividends, the company is sending a signal that it doesn't have enough positive-NPV projects to use all the money. C) Investors expected that the company would announce a stock repurchase rather then a cash dividend increase. Since a change in dividend policy is commonly viewed as a weaker signal than a stock repurchase, the share price fell on the news of the dividend increase. D) None of the above explanations can possibly explain investor's reaction.

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Medium 36. The value of the cash flows that the assets of the firm are expected to generate must equal A) the value of the cash flows claimed by the equity investors. B) the value of the cash flows claimed by the debt investors. C) the value of the cash flows claimed by both the equity and debt investors. D) the revenue produced by the firm.

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Medium 40. Financial risk A) refers to the effect that a firm's financing decisions has on the riskiness to cash flows that investors will receive. B) increases a firm's business risk. C) decreases a firm's business risk. D) is related to how debt affects the business decisions of a firm.

C Feedback: The dividend payment will be ($40 million / 160 million shares) = $0.25 per share. With 100 shares you will receive 100 × $0.25 = $25.

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Medium 56. Types of dividends: ABC Co. will be distributing $40 million to shareholders through a special dividend. The company has 160 million shares outstanding. If you own 100 shares of ABC Co., how much will you receive? Ignore taxes. A) $400 B) $100 C) $25 D) None of the above

B Feedback: The price would be expected to drop by the amount investors receive after taxes: $0.45 × 85% = $0.38

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Medium 57. The ex-dividend date: ABC Co. has announced it will pay its regular cash dividend of $0.45 per share. If dividends are taxed at 15 percent, about how much do you expect the price of ABC to drop on the ex-dividend day? A) $0.07 B) $0.38 C) $0.45 D) $0.52

B Feedback: With no taxes you expect that the company's stock will drop by $1.50 to $10.00. Your holdings will be worth 10,000 × $10 = $100,000

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Medium 58. The ex-dividend date: You own 10,000 shares of ABC Co., which is currently trading for $11.50 per share. The company has announced that it will soon pay a special dividend of $1.50 per share. Tomorrow is the ex-dividend day. Ignoring taxes, what do you expect your block of shares will be worth tomorrow? A) $15,000 B) $100,000 C) $115,000 D) $200,000

C Feedback: WACC = xDebt kDebt + xEquity kEquity = (0.40 ×.08) + (0.60 × 0.12) = 0.104

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Medium 59. M&M Proposition 2: Rubber Chicken Inc. currently has a capital structure that is 40% debt and 60% equity. If the firm's cost of equity is 12%, the cost of debt is 8%, and the risk-free rate is 3%, what is the appropriate WACC? A) 8.4% B) 9.6% C) 10.4% D) 9.2%

D Feedback: The price would be expected to drop by the amount investors receive after taxes: $0.40 × 85% = $0.34 The new stock price would be $25.70 - $0.34 = $25.36

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Medium 59. The ex-dividend date: ABC Co. stock is currently trading at $25.70 per share. The company pays a regular cash dividend of $0.40 every quarter. Tomorrow is ex-dividend day for the upcoming regular dividend. The tax rate on dividends is 15 percent. Assuming there is no new information released about the company, how much do you expect the company's stock to trade for tomorrow? A) $0.40 B) $25.24 C) $25.30 D) $25.36

C Feedback: Using the debt-to-equity ratio, you can solve for the percentage of the capital structure that is debt and the percentage that is equity. If D/E = 0.5, then let's assume that D = 1 and E = 2. Therefore, D + E = 3. This gives a debt percentage of 33.33% and an equity percentage of 66.66%. Then, WACC = xDebt kDebt + xEquity kEquity = (1/3) × 0.07 + (2/3) × 0.13 = 0.11.

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Medium 60. M&M Proposition 2: Gangland Water Guns, Inc., has a debt-to-equity ratio of 0.5. If the firm's cost of debt is 7% and its cost of equity is 13%, what is the appropriate WACC? A) 9% B) 10% C) 11% D) None of the above.

A Feedback: The price would be expected to drop by the amount investors receive after taxes: $0.80 × 85% = $0.68 The new stock price would be $38.15 - $0.68 = $37.47

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Medium 60. The ex-dividend date: ABC Co. stock is currently trading at $38.15 per share. The company pays a regular cash dividend of $0.80 every quarter. Tomorrow is ex-dividend day for the upcoming regular dividend. The tax rate on dividends is 15 percent. Assuming there is no new information released about the company, how much do you expect the company's stock to trade for tomorrow? A) $37.47 B) $37.35 C) $37.32 D) $37.23

D Feedback: WACC = xDebt kDebt + xEquity kEquity = xDebt × 0.08 + xEquity × 0.12 = 11% Also, D + E = 1 by definition. Therefore, substituting gives you: xDebt × 0.8 + (1 - xDebt) × 0.12 = 0.11. Solving for xDebt gives you 1/4, which means that xEquity must be 3/4. Therefore, the D/E is 1/3.

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Medium 61. M&M Proposition 2: Swirlpool, Inc., has a WACC of 11%, a cost of debt of 8%, and a cost of equity of 12%. What must the debt-to-equity ratio be? A) 1/2 B) 1/4 C) 1/6 D) None of the above.

C Feedback: The price would be expected to drop by the amount investors receive after taxes: ($0.40 + 0.10)× 85% = $0.42 The new stock price would be $37.00 - $0.42 = $36.58

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Medium 61. The ex-dividend date: ABC. Co is currently trading at $37.00 per share. The company is paying a regular cash dividend of $0.40 per share and an extra dividend of $0.10 per share. Tomorrow is the ex-dividend day. The tax rate on dividends is 15 percent. Assuming there is no new information released about the company, how much do you expect the company's stock to trade for tomorrow? A) $36.43 B) $36.50 C) $36.58 D) $37.00

A Feedback: WACC with taxes = xDebt kDebt pretax (1 - t) + xEquity kEquity = 0.30 ×.06×(1 - 0.35) + 0.70 × 0.10 = 0.0817

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Medium 62. M&M Proposition 2: Melba's Toast has a capital structure with 30% debt and 70% equity. Its pretax cost of debt is 6%, and its cost of equity is 10%. The firm's marginal corporate income tax rate is 35%. What is the appropriate WACC? A) 8.17% B) 6.35% C) 8.80% D) 7.44%

A Feedback: The price would be expected to drop by the amount investors receive after taxes: ($0.30 + $0.05)× 85% = $0.30 The new stock price would be $22.00 - $0.30 = $21.70

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Medium 62. The ex-dividend date: ABC. Co is currently trading at $22.00 per share. The company is paying a regular cash dividend of $0.30 per share, and an extra dividend of $0.05 per share. Tomorrow is the ex-dividend day. The tax rate on dividends is 15 percent. Assuming there is no new information released about the company, how much do you expect the company's stock to trade for tomorrow? A) $21.70 B) $21.65 C) $21.60 D) $21.55

D Feedback: WACC = xDebt kDebt + xEquity kEquity = (300/1200) × 0.07 + (900/1200) × 0.11 = 0.10

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Medium 63. M&M Proposition 2: A firm has $300mm in outstanding debt and $900mm in outstanding equity. Its cost of equity is 11%, and its cost of debt is 7%. What is the appropriate WACC? A) 6% B) 8% C) 9% D) 10%

B Feedback: Shareholders will receive the residual claim after other claimholders have been paid: 20 million - 18 million = 2 million That 2 million will be distributed pro-rata. As a holder of 2,000 shares, you will receive: 2 million × (2,000 shares / 30 million shares) = $133.33

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Medium 63. Types of dividends: Distressed Capital, Inc., is being liquidated. The company's assets can be sold for $20 million. It will cost $18 million for the company to meet all its previous obligations and to payoff debt holders. The company has 30 million shares outstanding. If you own 2,000 shares, how much do you expect to receive in liquidating dividends? Ignore taxes. A) $0.00 B) $133.33 C) $266.66 D) $1,200.00

B Feedback: WACC = 0.085 = (1 - xEquity)kDebt (1 - t) + xEquity kEquity = (1 - xEquity) × 0.05 × (1 - 0.35) + xEquity × 0.12 Solving for xEquity gives you 0.60

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Medium 64. M&M Proposition 2: A firm has a WACC of 8.5%, a pretax cost of debt of 5%, a cost of equity of 12%, and a marginal corporate income tax rate of 35%. What percent of the firm is financed with equity? A) 50% B) 60% C) 70% D) None of the above

C Feedback: The 300 million shares will be distributed pro-rata. You will receive: $300 million × (20,000 shares / 20 million shares) = $300,000

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Medium 64. Types of dividends: You own 20,000 shares of stock in Casi-knows, Inc., which has just sold one of its large resort hotels for $300 million. Management intends to return the entire revenue from the sale to shareholders by issuing a special dividend. If Casi-knows has 20 million shares outstanding, how large a dividend payment do you expect to receive? A) $20,000 B) $200,000 C) $300,000 D) $1,000,000

B Feedback: kcs = kAssets + (D/E)(kAssets - kDebt) = 0.12 + (1/5)(0.12 - 0.0625) = 0.1315

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Medium 65. M&M Proposition 2: Bellamee, Inc., has a required rate of return on its assets of 12% and a cost of debt of 6.25%. Their current debt-to-equity ratio is 1/5. What is the required rate of return on their equity? A) 12.15% B) 13.15% C) 14.15% D) None of the above

D Feedback: The company earned $0.35 × 4 quarters = $1.40 per share this year. To achieve the 40 percent target, the firm must distribute $1.40 x 40% = $0.56 per share to shareholders. The company has already distributed $0.10 × 3 quarters = $0.30 per share. The company could meet the target by distributing another $0.26 per share through a regular dividend of 0.10 and an extra dividend of 0.16 per share.

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Medium 65. Types of dividends: ABC Co. has a policy of returning a minimum of 40 percent of earnings to shareholders every year through dividend issues and open-market stock repurchases. In each quarter this year, the company earned $0.35 per share. In each of the first three quarters the company paid a regular cash dividend of $0.10 per share. What combination of dividends could the company's board approve to meet their target payout percentage? A) A regular cash dividend of $0.10 per share. B) A regular cash dividend of $0.10 per share and an extra dividend of 0.56 per share. C) A regular cash dividend of $0.10 per share and an extra dividend of $0.46 per share. D) A regular cash dividend of $0.10 per share and an extra dividend of $0.16 per share.

A Feedback: kcs = kAssets + (D/E)(kAssets - kDebt) = 0.12 + (2/5)(0.12 - .07) = 0.14

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Medium 66. M&M Proposition 2: Using the information for Bellamee from Question 64, what is its required return on equity if its debt-to-equity ratio changes to 2/5 and this increases the required rate of return on their debt to 7%? A) 14% B) 14.25% C) 14.50% D) 15%

A Feedback: The company earned $0.20 × 4 quarters = $0.80 per share this year. To achieve the 25 percent target, the firm must distribute $0.80 × 25% = $0.20 per share to shareholders. The company has already distributed $0.05 × 3 quarters = $0.15 per share. The company could meet the target by distributing another $0.05 per share through a regular dividend.

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Medium 66. Types of dividends: ABC Co. has a policy of returning a minimum of 25 percent of earnings to shareholders every year through dividend issues and open-market stock repurchases. In each quarter this year, the company earned $0.20 per share. In each of the first three quarters, the company paid a regular cash dividend of $0.05 per share. What combination of dividends could the company's board approve to meet their target payout percentage? A) A regular cash dividend of $0.05 B) A regular cash dividend of $0.05 per share and an extra dividend of 0.05 per share C) A regular cash dividend of $0.05 per share and an extra dividend of $0.10 per share D) A regular cash dividend of $0.05 per share and an extra dividend of $0.20 per share

D Feedback: kcs = kAssets + (D/E)(kAssets - kDebt) 12% = kAssets + (1/6)( kAssets - 7.5%) Then, kAssets= 11.4%. Note that if D/E changes, kAssets does not change. The new cost of equity is then given by kcs = 11.4% + (1/3)(11.4% - 7.5%) = 12.7%

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Medium 70. M&M Proposition 2: Suppose a firm has a cost of equity of 12%, a D/E or 1/6, and the YTM on its bonds is 7.5%. The risk-free rate is currently 3%. What is the current required rate of return on its assets and equity if the D/E is changed to 1/3? A) 11.35% and 13.25% B) 11.35% and 8.25% C) 13.25% and 11.35% D) None of the above.

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: hard 71. Option payoffs: What is the payoff for a put option with a strike price of $20 if the price of the underlying stock at expiration is $18? A) $0 B) $2 C) $18 D) $20

B Feedback: Steve holds ($120) / ($20) per share = 6 shares of stock. His gain is (6 shares) x ($23 per share) - $120 = $18 Carol holds ($120) / ($6 per call option) = 20 call options. The final price of the stock is above the $15 strike price, so her options are in the money. Her gain is ($23 - $15) x (20 call options) - $120 = $40 Paul holds ($120) / ($1 per put option) = 120 put options. The final price of the stock is above the $15 strike price, so his options are out of the money. He received no payoff. His loss is -$120. Carol made the most money.

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: hard 75. Option payoffs: Kelvin's Thermostats, Inc., stock is currently trading at $20 per share. There are two types of options written on the stock. Call options with a strike price of $15, which expire next month, are currently trading at $6.00. Put options with a strike price of $15 which expire next month are currently trading at $1.00. Steve invests $120 in common stock. Carol invests $120 in the call options. Paul invests $120 in the put options. At the end of one month, the price of Kelvin's Thermostats, Inc., is $23. Who made the most money off of their investment? A) Steve B) Carol C) Paul D) Steve and Carol Tied

C Feedback: Steve holds ($120) / ($20) per share = 6 shares of stock. The stock went down, so Steve lost money. His loss is (6 shares) × ($18 per share) - $120 = -$12. Carol holds ($120) / ($8 per call option) = 15 call options. The final price of the stock is below the $20 strike price, so her options are out of the money. There is no payoff from her call options. Her loss is -$120. Paul holds ($120) / ($2 per put option) = 60 put options. The final price of the stock is below the $20 strike price, so his options are in the money. His gain is ($20 - $18) × (60) - $120 = 0. Paul broke even, the others lost money.

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: hard 76. Option payoffs: Haumer Hardware Co. stock is currently trading at $20. There are two types of options written on the stock. Call options with a strike price of $20, which expire next year, are currently trading at $8. Put options with a strike price of $20, which expire next year, are currently trading for $2. Steve invests $120 in common stock. Carol invests $120 in the call options. Paul invests $120 in the put options. At the end of one year the price of Haumer Hardware Co. stock is $18. Who made the most money off of their investment? A) Steve B) Carol C) Paul D) Steve and Carol tied

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: medium 32. An investor (the buyer) purchases a call option from a seller. On the expiration date of a call option, A) the buyer has the obligation to buy the underlying asset and the seller has the obligation to sell it. B) the buyer has the right to buy the underlying asset and the seller has the obligation to sell it. C) the buyer has the obligation to buy the underlying asset and the seller has the right to sell it. D) None of the above.

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: medium 33. An investor (the buyer) purchases a put option from a seller. On the expiration date of a call option, A) the buyer has the obligation to sell the underlying asset and the seller has the right to buy it. B) the buyer has the obligation to sell the underlying asset and the seller has the obligation to buy it. C) the buyer has the right to sell the underlying asset and the seller has the obligation to buy it. D) None of the above

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: medium 34. Which one of the following statements is NOT true? A) The value of a call option can never be negative. B) The value of a call option can never be more than the value of the underlying asset. C) The value of a call option can never be worth less than the current value of the asset minus present value of the strike price. D) The value of a call option can never be worth more than the strike price.

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: medium 35. Which one of the following statements is NOT true? A) The value of a put option can never be negative. B) The value of a put option can never be worth more than the underlying asset. C) The value of a put option can never be less than the present value of the strike price minus the current value of the underlying asset. D) All the above statements are true.

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: medium 37. Suppose you own a put option on a stock with a strike price of $35 that expires today. The price of the underlying stock is $25. If you purchase the stock and exercise the put option, A) you will earn $10. B) you will lose $10. C) you will earn $25. D) you will lose $25.

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: medium 38. Consider an option that gives the owner the right to buy a stock for $20 only on the third Friday of May, next year. The option being described is A) an American call option. B) a European put option. C) an American put option. D) a European call option.

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: medium 39. Consider an American and a European call option on a dividend-paying stock, with otherwise identical features (same strike price, etc.). Which one of the following statements is true? A) The American call option will never be worth less than the European call option. B) The European call option will never be worth less than the American call option. C) Both options should always have the same value. D) None of the above statements is true.

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: medium 40. A straddle is a combination of a put option and a call option on the same asset with the same strike price. Which one of the following statements about a straddle is NOT true? A) The owner of a straddle will receive a payoff if the price of the underlying asset is higher than the strike price at expiration. B) The owner of a straddle will receive a payoff if the price of the underlying asset is lower than the strike price at expiration. C) The owner of a straddle will never exercise the put and the call option at the same time. D) The owner of a straddle will receive a higher payoff if the price of the underlying asset at expiration is near the strike price.

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: medium 41. Which of the following changes, when considered individually, will increase the value of a call option? A) The value of the underlying asset becomes more volatile. B) The price of the underlying asset goes down. C) Getting closer to the expiration date (the passage of time). D) A higher strike price.

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: medium 42. Which of the following changes, when considered individually, will increase the value of a put option? A) An increase in the risk-free interest rate B) Lower volatility of the price of the underlying asset C) A higher strike price D) None of the above

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: medium 66. Option payoffs: What is the payoff for a call option with a strike price of $45 if the underlying stock price at expiration is $75? A) $30 B) $45 C) $75 D) None of the above

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: medium 67. Option payoffs: What is the payoff for a call option with a strike price of $30 if the underlying stock price at expiration is $25? A) $5 B) $25 C) $30 D) None of the above

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: medium 68. Option payoffs: What is the payoff for a put option with a strike price of $65 if the underlying stock price at expiration is $33? A) $0 B) $33 C) $32 D) $65

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: medium 69. Option payoffs: You own a put option on ABC. Co. stock with a strike price of $40. The current stock price is $40. You will benefit if A) the stock price goes up. B) the stock price goes down. C) the stock price stays the same. D) It doesn't matter; you are indifferent to changes in the stock price.

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: medium 70. Option payoffs: You have sold a call option on ABC Co. stock with a strike price of $40. You do not intend to make any other transactions before the options expiration date. The current stock price is $20. Which of the following statements best describes your hopes for the stock? A) You want the stock price to fall. B) You want the stock price to rise. C) You are indifferent, as long as the stock price stays under $40. D) It doesn't matter; you are indifferent to changes in the stock price.

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Easy 30. The cash conversion cycle A) shows how long the firm keeps its inventory before selling it. B) begins when the firm invests cash to purchase the raw materials that would be used to produce the goods that the firm manufactures. C) begins when the firm uses its cash to purchase raw materials and ends when the firm collects cash payments on its credit sales. D) estimates how long it takes on average for the firm to collect its outstanding accounts receivable balance.

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Easy 32. The operating cycle A) begins when the firm receives the raw materials it purchased that would be used to produce the goods that the firm manufactures. B) begins when the firm uses its cash to purchase raw materials and ends when the firm collects cash payments on its credit sales. C) To measure operating cycle we need another measure called the days' payables outstanding. D) ends not with the finished goods being sold to customers and the cash collected on the sales; but when you take into account the time taken by the firm to pay for its purchases.

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Easy 34. Which ONE of the following statements is true? A) The venture capital industry as we know it today emerged in the late 1960s with the formation of the first venture capital limited partnerships. B) Modern venture capital firms tend to specialize in a specific line of business, such as hospitality, food manufacturing, or medical devices. C) A significant number of venture capital firms focus on high-technology investments. D) All of the above are true statements.

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Easy 35. Which one of the following statements is NOT true? A) Approximately $23 billion was invested in venture capital funds in 2010. B) The venture capital industry as we know it today emerged in the late 1990s. C) Modern venture capital firms tend to specialize in a specific line of business, such as hospitality, food manufacturing, or medical devices. D) A significant number of venture capital firms focus on high-technology investments.

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Easy 36. Tactics that venture capitalists use to reduce the risk of their investment include A) funding the ventures in stages, requiring entrepreneurs to make no personal investments, syndicating investments, and maintaining in-depth knowledge about the industry in which they specialize. B) funding the ventures completely in the beginning, requiring entrepreneurs to make personal investments, syndicating investments, and maintaining in-depth knowledge about the industry in which they specialize. C) funding the ventures in stages, requiring entrepreneurs to make personal investments, syndicating investments, and maintaining in-depth knowledge about the industry in which they specialize. D) None of the above.

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Easy 37. Which of the following is NOT a possible result of a stock repurchase? A) Removing a large number of shares from circulation can change the ability of certain shareholders to control the firm. B) If the number of remaining shares is relatively small, the remaining shares will be less liquid. C) The company will decrease its leverage ratio (debt-to-equity ratio). D) By repurchasing stock when it is undervalued, managers can effectively transfer value from selling stockholders to stockholders who don't take part in the repurchase.

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Easy 37. Which one of the following statements is NOT true? A) Venture capitalists often require an entrepreneur to make a substantial personal investment in the business. B) Syndication occurs when the originating venture capitalist buys off other venture capitalists involved in the venture. C) Another factor that reduces risk is the venture capitalist's in-depth knowledge of the industry and technology. D) The key idea behind staged funding is that each funding stage gives the venture capitalist an opportunity to reassess the management team and the firm's financial performance.

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Easy 38. Provisions that are part of venture capital agreements include A) timing of exit, number of board positions after exit, and what price is acceptable. B) timing of exit, the method of exit, and what price is acceptable. C) the method of exit, number of board positions after exit, and what price is acceptable. D) None of the above.

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Easy 39. The three principal ways in which venture capital firms exit venture-backed companies are A) selling to a strategic buyer, buying out the founder, and offering stock to the public. B) selling to a strategic buyer, selling to a financial buyer, and buying out the founder. C) selling to a strategic buyer, selling to a financial buyer, and offering stock to the public. D) None of the above.

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Easy 39. Which type of stock repurchase allows management to set the repurchase price at the lowest level necessary to repurchase the desired number of shares? A) Open-market repurchase B) Fixed-price tender offer repurchase C) Dutch auction tender offer repurchase D) All of the above will generate the same purchase price.

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Easy 40. Which ONE of the following statements is true? A) A typical venture capital fund may generate annual returns of 15 to 25 percent on the money that it invests, compared with an average annual return for the S&P 500 of almost 12 percent. B) A typical venture capital fund may generate annual returns of 12 percent on the money that it invests, compared with an average annual return for the S&P 500 of about 20 percent. C) A typical venture capital fund may generate annual returns of 12 percent on the money that it invests, compared with an average annual return for the S&P 500 of about 25 percent. D) None of the above

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Easy 43. In order to calculate the present value of debt tax savings, the _______ is used as the discount rate. A) WACC B) risk-free rate C) required rate of return on debt D) none of the above

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Easy 44. Academic studies have estimated that the tax benefit of debt realized by firms is approximately A) 10% of firm value. B) a 10% reduction in WACC. C) a 10% reduction in the cost of debt D) 10% of debt value.

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Easy 45. The use of debt financing A) may cause a manager to take on riskier projects in order to make interest payments. B) is more expensive than issuing equity due to the use of covenants. C) allows managers to make discretionary interest payments. D) limits the ability of managers to waste stockholder money.

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Hard 104. What is the value of the conversion feature if the company can issue either for a par value of $1000: 20 year, semiannual plain vanilla bonds at 6.5% or 20 year, semiannual 4.8% convertible bonds (convertible to 15 shares of common stock) a. $811.23 b. $540.82 c. $217.02 d. $188.77

A Feedback: After-tax earnings = (Earnings - Interest payments)×(1 - t) = ($500 - $160) × (1 -.3) = $238

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Hard 71. The benefits of debt: Packman Corporation has a reported EBIT of $500, which is expected to remain constant in perpetuity. If the firm borrows $2,000, its YTM will be 6.5% and its coupon rate will be 8%. If the company's marginal tax rate is 30% and its average tax rate is 20%, what are its after-tax earnings? A) $238 B) $272 C) $259 D) None of the above.

B Feedback: Tax shield = D × kDebt × t = $1,000,000 × 0.09 × 0.25 = $22,500

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Hard 72. The benefits of debt: A firm plans to issue $1 million worth of debt at a YTM of 9%. The debt is trading at par. The firm's marginal corporate tax rate is 25%, while its average tax rate is 15%. By how much will this debt issuance reduce the firm's annual tax liability? A) $13,500 B) $22,500 C) $32,500 D) None of the above.

C Feedback: VTax-savings debt = D × t = $1,000,000 × 0.35 = $350,000

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Hard 73. The benefits of debt. A firm plans to issue $1 million worth of debt at a YTM of 9%. The debt is trading at par. The firm's marginal corporate tax rate is 35%. What is the present value of the tax savings in perpetuity? A) $11,025 B) $20,475 C) $350,000 D) $227,500

A Feedback: If they take on the project, the firm will receive its $10mm back, along with the $16mm. This gives them assets worth $96mm, which is still less than the value of outstanding debt. Therefore, the shareholders would be out the $10mm of equity that they had to sell in order to take on the project.

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Hard 80. Agency costs: Suppose that JMK, Inc., has debt with a face value of $100mm and assets worth $70mm. Firm management has just identified a project that will require an initial outlay of $10mm and will return a NPV of $16mm, risk-free. The firm currently has no cash. What would be the net return to shareholders if they took on this project? A) $-10mm B) $0mm C) $26mm D) $70mm

Ans: B

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium 102. When a company issues convertible bonds with a $1,000 par value that can be converted to 10 shares of common stock, each bond includes A) A put with an exercise price of $100 per share B) A call with an exercise price of $100 per share C) A put with an exercise price of $10 per share D) A call with an exercise price of $10 per share E)

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium 103. What are the options to purchase common stock that are bundled with the common shares that are being sold in an IPO are called? A) puts B) convertibles C) warrants D) preferred stock

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium 31. Which one of the following statements is NOT true? A) The cash conversion cycle begins when the firm invests cash to purchase the raw materials that would be used to produce the goods that the firm manufactures. B) The cash conversion cycle begins when the firm uses its cash to purchase raw materials and ends when the firm collects cash payments on its credit sales. C) To measure the cash conversion cycle, we need another measure called the days' payables outstanding. D) The cash conversion cycle ends not with the finished goods being sold to customers and the cash collected on the sales; but when you take into account the time taken by the firm to pay for its purchases.

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium 33. Which ONE of the following statements is true when managing working capital accounts? A) Maintain minimal raw material inventories without causing manufacturing delays. B) Use as little labor as possible to manufacture the product while producing a quality product. C) Delay paying accounts payable as long as possible without suffering any penalties. D) All of the above are true.

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium 38. Which type of stock repurchase often takes place at a price below the current market price of the stock? A) Open-market repurchase B) Fixed-price tender offer repurchase C) Dutch auction tender offer repurchase D) Targeted stock repurchase

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium 39. In order for a firm to estimate its cost of debt capital by observing the price of its debt instruments, A) the firm must depend on markets being reasonably efficient. B) the debt must be privately held. C) the beta of the debt must be greater than the beta of the firm's equity. D) None of the above.

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium 40. If markets are not reasonably efficient, then A) the estimates of expected returns are not needed. B) the need for a discount rate to analyze project cash flows is not needed. C) estimates of expected returns that were based on security prices will not be reliable. D) none of the above.

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium 41. When estimating the cost of debt capital for the firm, we are primarily interested in A) the cost of short-term debt. B) the cost of long-term debt. C) the coupon rate of the debt. D) none of the above.

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium 42. Long-term debt typically describes A) debt with a maturity greater than one year. B) only coupon debt. C) publicly traded debt. D) none of the above.

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium 42. The interest tax shield A) does not affect the WACC. B) makes it less costly to distribute cash to the security holder through interest payments than through dividends. C) is given by D × (1 - t). D) b and c.

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium 43. Which of the following need to be excluded from the calculation of the firm's amount of permanent debt? A) Long-term debt B) Revolving lines of credit C) Mortgage debt D) None of the above

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium 44. When analyzing a firm's cost of debt, we are typically interested in A) the cost of the debt on the date that the analysis is being completed. B) the coupon rate on the firm's bonds. C) the risk-free rate plus half a percent. D) none of the above.

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium 45. If a firm has bonds outstanding and the firm would like to calculate the current cost of debt for the bonds, then the firm would A) use the coupon rate of the bonds to estimate the cost. B) use the current yield to maturity of the bonds to estimate the cost. C) use the current coupon yield of the bonds to estimate the cost. D) none of the above.

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium 46. A bond has a coupon rate of 6 percent and the bond makes semiannual coupon payments. The dollar amount of coupon interest received every six months is A) $60. B) $30. C) $30 plus or minus the prorate portion of the discount or premium that the bond was purchased for. D) none of the above.

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium 46. Which of these statements about direct bankruptcy costs is not true? A) Direct bankruptcy costs include the hiring of additional accountants, lawyers, and consultants. B) Direct bankruptcy costs are less than indirect costs. C) Suppliers requiring cash on delivery is part of a firm's direct bankruptcy costs. D) Negotiating with lenders may help a firm reduce direct bankruptcy costs.

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium 47. Bond issuance costs include A) investment banking fees. B) legal fees. C) accountant fees. D) all of the above.

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium 47. Which of these is not an example of indirect bankruptcy costs? A) A firm's customers become concerned about whether or not warranties will be honored. B) Employees begin to leave the firm. C) New accountants are brought in to help with the bankruptcy process. D) A bankruptcy judge orders new projects to be halted.

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium 48. Income taxes have the effect of A) increasing the cost of debt. B) decreasing the cost of debt. C) decreasing the cost of capital for the firm. D) both b and c are correct.

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium 48. The use of debt financing A) reduces agency costs between the stockholders and management by increasing the amount of risk the managers take. B) increases agency costs between the stockholders and management by limiting the amount of risk the managers take. C) increases agency costs since managers prefer to keep more retained earnings rather than pay a dividend. D) b and c.

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium 49. GHI Co. has just announced that the board has reached a targeted stock repurchase agreement with a large stockholder. The company will repurchase all of the large investor's stock for 90 percent of the current market value. When the stock repurchase was announced, the shares of GHI Co. fell by 7 percent. Which one of these explanations could reasonably explain the drop in share price? A) The willingness of the large investor to accept the targeted stock repurchase signals that the large investor believes the company will not do well in the future. B) A targeted stock repurchase essentially transfers value from the average investor to the targeted investor. C) Investors believe that the company's management is entrenching itself by buying off any large block shareholders. D) Both a and c are possible explanations.

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium 49. The asset substitution problem occurs when A) managers substitute riskier assets for less risky ones to the detriment of bondholders. B) managers substitute less risky assets for riskier ones to the detriment of bondholders. C) managers substitute riskier assets for less risky ones to the detriment of equity holders. D) managers substitute less risky assets for riskier ones to the detriment of equity holders.

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium 50. The underinvestment problem occurs in a financially distressed firm when A) the value of investing in a positive-NPV project is likely to go to debt holders instead of equity holders. B) the value of investing in a positive-NPV project is likely to go to equity holders instead of debt holders. C) management invests in negative-NPV projects to reduce their own risk. D) issuing equity becomes difficult due to increased risk.

C Feedback: DSI = 10 days DSO = 32 days

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium 53. Operating cycle: Trend Foods distributes its products to more than 100 restaurants and delis. The company's collection period is 32 days, and it keeps its inventory for 10 days. What is Trend's operating cycle? A) 22 days B) 32 days C) 42 days D) None of the above.

C Feedback: Operating cycle = 81 days DSO = 47 days Cost of goods sold = $19,630 Operating cycle = DSO + DSI DSI = OC - DSO = 81 - 47 = 34 days

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium 54. Operating cycle: Stamp, Inc., has an operating cycle of 81 days and takes 47 days to collect on its receivables. What is its level of inventory if the firm's cost of goods sold is $312,455? Round to the nearest dollar. A) $9,190 B) $14,685 C) $29,105 D) $69,339

A Feedback: Operating cycle = 123 days DSI = 73 days Operating cycle = DSO + DSI DSO = OC - DSI = 123 - 73 = 50 days Credit sales = $433,450

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium 55. Operating cycle: Le Baron Company, a men's designer firm, has an operating cycle of 123 days. The firm's days' sales in inventory is 73 days. How much does the firm have in receivables if it has credit sales of $433,450? Round to the nearest dollar. A) $59,377 B) $71,252 C) $47,501 D) $64,233

A Feedback: Operating cycle = 74 days Cost of goods sold = 212,902 Inventory = $44,233 Operating cycle = DSO + DSI DSO = OC - DSI = 74 - 31.5 = 42.5 days

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium 56. Operating cycle: All Stars, Inc., has inventory of $44,233 and cost of goods sold of $512,902. The company has an operating cycle of 74 days. What is the firm's days' sales outstanding (DSO)? A) 43 days B) 32 days C) 49 days D) 26 days

C Feedback: Feedback for Question 57: DPO = 31 DSI = 54 DSO = 34 Cash conversion cycle = DSO + DSI - DPO =34 + 54 - 31 = 57

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium 59. Cash conversion cycle: Wolfgang Electricals estimates that it takes the company 31 days on average to pay off its suppliers. It also knows that it has days' sales in inventory of 54 days and days sales' outstanding of 34 days. What is its cash conversion cycle? A) 119 days B) 34 days C) 57 days D) 46 days

A Feedback: DPO = 27 days DSI = 43 days DSO = 45 days Renald's cash conversion cycle =

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium 60. Cash conversion cycle: Renald Corp. estimates that it takes the company 27 days on average to pay off its suppliers. It also knows that it has days' sales in inventory of 43 days and days sales' outstanding of 45 days. What is its cash conversion cycle? A) 61 days B) 115 days C) 57 days D) 46 days

D Feedback: Accounts receivables = $97,900 Accounts payables = $115,100 Net sales = $324,000 Inventory = $126,300 Cost of goods sold = $282,000

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium 61. Cash conversion cycle: Your boss asks you to compute the company's cash conversion cycle. Looking at the financial statements, you see that the average inventory for the year was $126,300, accounts receivable were $97,900, and accounts payable were at $115,100. You also see that the company had sales of $324,000 and that cost of goods sold was $282,000. What is your firm's cash conversion cycle? Round to the nearest day. A) 119 days B) 34 days C) 57 days D) 125 days

C Feedback: Using the formula for pricing bonds, we have

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium 61. The cost of debt: Bellamee, Inc., has semiannual bonds outstanding with five years to maturity and are priced at $920.87. If the bonds have a coupon rate of 7 percent, then what is the YTM for the bonds? A) 4.5% B) 7.0% C) 9.0% D) 9.2%

A Feedback: Net sales = $423,000 Credit sales = (0.3 x $423,000) = $126,900 Cash conversion cycle = 47.9 days Operating cycle = 86.3 days Cost of goods sold = $324,000 The firm has accounts payables of $34,087.

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium 62. Cash conversion cycle: West Handicrafts, Inc., has net sales of $423,000 with 30 percent of it being credit sales. Its cost of goods sold is $324,000. The firm's cash conversion cycle is 47.9 days. The firm's operating cycle is 86.3 days. What is the firm's accounts payable? Round to the nearest dollar A) $34,087 B) $126,900 C) $71,203 D) $56,322

C Feedback: Using the formula for pricing bonds, we have

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium 62. The cost of debt: Dynamo Corporation has semiannual bonds outstanding with 12 years to maturity and are currently priced at $1,080.29. If the bonds have a coupon rate of 8 percent, then what is the equivalent annual return (EAR) to the investor for purchasing the bonds at the described price? A) 3.5% B) 7.00% C) 7.12% D) 8.00%

B Feedback: Using the formula for pricing bonds, we have

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium 63. The cost of debt: Beckham Corporation has semiannual bonds outstanding with 13 years to maturity and are currently priced at $746.16. If the bonds have a coupon rate of 8.5 percent, then what is the after-tax cost of debt for Beckham if its marginal tax rate is 35%? Assume that your calculation is made as on Wall Street. A) 6.250% B) 8.125% C) 12.500% D) 12.890%

A Feedback: Using the formula for pricing bonds, we have

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium 64. The cost of debt: PackMan Corporation has semiannual bonds outstanding with nine years to maturity and are currently priced at $754.08. If the bonds have a coupon rate of 7.25 percent, then what is the after-tax cost of debt for Beckham if its marginal tax rate is 30 percent? Complete the calculation as is done on Wall Street. A) 7.050% B) 8.225% C) 11.750% D) 12.095%

A Feedback: Before the repurchase, the firm was worth $40 per share × 3 million shares = $120 million. The firm repurchased 10 million shares at the market price of $40 = 250,000 shares. After the repurchase, the firm has $120 million - $10 million = $110 million. The number of remaining shares is 2,750,000. So each share is worth: $110,000,000 / 2,750,000 = $40

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium 72. How stock is repurchased: ABC Co has 3 million shares outstanding. The shares are currently selling for $40. If the firm repurchases $10 million at market prices, approximately how much will the stock be worth after the repurchase? Ignore taxes. A) $40 B) $38 C) $42 D) $50

C Feedback: 20M @ 7% and 50M - 12M - 20M = 18M @ 8.5% Weighted average pretax cost of debt = 7(20/38) + 8.5(18/38) = 7.71% After-tax cost of debt = 7.71% (1-.33) = 5.17%

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium 84. After-tax cost of debt financing A recent leveraged buyout was financed with $50M. This amount comprised of partner's equity capital of $12M, $20M unsecured debt borrowed at 7% from one bank and the remainder from another bank at 8.5%. What is the overall after-tax cost of the debt financing if you expect the firm's tax rate to be 33%? A) 2.55% B) 3.34% C) 5.17% D) 7.71%

C Feedback: Without arbitrage, the value of the option must fall between $10.96 and $30. Out of the given choices, only $15 is a possible price for the option.

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: hard 72. Option valuation: Consider a call option with a strike price of $20, which expires in one year. The risk-free rate of interest is 5 percent. The underlying stock price is $30. Without arbitrage, which of the following is a possible price for the call option? A) $0 B) $8 C) $15 D) None of the above

C Feedback: Without arbitrage, the value of the option must fall between $20.91 and $30. Out of the given choices, only $21 is a possible price for the option.

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: hard 73. Option valuation: Consider a call option with a strike price of $10, which expires in one year. The risk-free rate of interest is 10 percent. The current underlying stock price is $30. Without arbitrage, which of the following is a possible price for the call option? A) $0 B) $20.50 C) $21.00 D) None of the above

C Feedback: Without arbitrage, the value of the put option must fall between $17.04 and $37.04. Out of the given choices, only $25 is a possible price for the option.

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: hard 74. Option valuation: Consider a put option with a strike price of $40, which expires in one year. The risk-free rate of interest is 8 percent. The current underlying stock price is $20. Without arbitrage, which of the following is a possible price for the put option? A) $0.50 B) $16.50 C) $25.00 D) None of the above

A Feedback: The payoff from the call option is $5 if the stock price rises and $0 if the stock price falls. From the binomial pricing model we can create a replicating portfolio with the following two equations: $5 = ($20 × x) + (1.10 × y) $0 = ($14 × x) + (1.10 × y) x = 0.83 shares of stock y = -$10.51 of risk-free bonds The value of the option is the value of the replicating portfolio: (0.83 × $18) + (-10.51) = $4.39

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: hard 77. Binomial pricing: Assume that the stock of Malcolm's Mufflers, Inc,. is currently trading for $18 and will either rise to $20 or fall to $14 in one year. The risk-free rate for one year is 10 percent. What is the value of a call option with a strike price of $15? A) $4.39 B) $3.33 C) $2.04 D) $0.83

D Feedback: The payoff from the call option is $10 if the stock price rises and $0 if the stock price falls. From the binomial pricing model we can create a replicating portfolio with the following two equations: $10 = ($55 × x) + (1.08 × y) $0 = ($17 × x) + (1.08 × y) x = 0.263 shares of stock y = -$4.14 of risk-free bonds The value of the option is the value of the replicating portfolio: (0.263 × $43) + (-4.14) = $7.17

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: hard 78. Binomial pricing: Assume that the stock of Malcolm's Mufflers, Inc., is currently trading for $43 and will either rise to $55 or fall to $17 in one year. The risk-free rate for one year is 8 percent. What is the value of a call option with a strike price of $45? A) $4.40 B) $5.84 C) $6.84 D) $7.17

Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Easy 38. A restrictive current asset investment strategy calls for A) current assets kept to a minimum. B) the firm barely investing in cash and inventory. C) tight terms of sale intended to curb credit sales and accounts receivable. D) All of the above

D Feedback: The payoff from the call option is $17 if the stock price rises and $12 if the stock price falls. From the binomial pricing model we can create a replicating portfolio with the following two equations: $17 = ($47 × x) + (1.05 × y) $12 = ($42 × x) + (1.05 × y) x = 1 share of stock y = -28.57 of risk free bonds The value of the option is the value of the replicating portfolio: (1 × $45) + (-28.57) = $16.43

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: hard 79. Binomial pricing: ABC, Inc., stock is currently trading for $45 and will either rise to $47 or fall to $42 in one year. The risk-free rate for one year is 5 percent. You own a call option with a strike price of $30, which expires in one year. What is the value of your call option? A) 0 B) 2.27 C) 12.05 D) 16.43

A Feedback: The payoff from the call option is $0 if the stock price rises and $0 if the stock price falls. This option will never payoff, so it has a value of $0.

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: hard 80. Binomial pricing: Assume that the stock of ABC, Inc., is currently trading for $17 and will either rise to $23 or fall to $12 in one year. The risk-free rate for one year is 10 percent. What is the value of a call option with a strike price of $25? A) $0 B) $6.23 C) $5.72 D) None of the above

B Feedback: The payoff from the put option is $0 if the stock price rises and $11 if the stock price falls. From the binomial pricing model we can create a replicating portfolio with the following two equations: $0 = ($50 × x) + (1.04 × y) $11 = ($29 × x) + (1.04 × y) x = -0.52 shares of stock y = $25.08 of risk-free bonds The value of the option is the value of the replicating portfolio: (-0.52 × $44) + ($25.08) = $2.20

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: hard 82. Binomial pricing: Assume that the stock of ABC, Inc., is currently trading for $44 and will either rise to $50 or fall to $29 one year. The risk-free rate for one year is 4 percent. What is the value of a put option with a strike price of $40? A) $0 B) $2.20 C) $3.14 D) $5.54

C Feedback: The payoff from the put option is $0 if the stock price rises and $9 if the stock price falls. From the binomial pricing model we can create a replicating portfolio with the following two equations: $0 = ($23.50 × x) + (1.03 × y) $9 = ($9 × x) + (1.03 × y) x = -0.62 shares of stock y = $14.16 of risk-free bonds The value of the option is the value of the replicating portfolio: (-0.62 × $16) + ($14.16) = $4.23

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: hard 83. Binomial pricing: Assume that the stock of ABC, Inc., is currently trading for $16 and will either rise to $23.50 or fall to $9 in one year. The risk-free rate for one year is 3 percent. What is the value of a put option with a strike price of $18 that expires in three months? A) $0 B) $2.75 C) $4.23 D) $5.73

D Feedback: The payoff from the put option is $0 if the stock price rises and $25 if the stock price falls. From the binomial pricing model we can create a replicating portfolio with the following two equations: $0 = ($32 × x) + (1.02 × y) $25 = ($5 × x) + (1.02 × y) x = -0.93 shares of stock y = $29.05 of risk-free bonds The value of the option is the value of the replicating portfolio: (-0.93 × $29) + ($29.05) = $2.08

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: hard 84. Binomial pricing: Assume that the stock of ABC, Inc., is currently trading for $29 and will either rise to $32 or fall to $5 in one year. The risk-free rate for one year is 2 percent. What is the value of a put option with a strike price of $30? A) $0 B) $0.41 C) $1.78 D) $2.08

B Feedback: The payoff from the put option is $0 if the stock price rises and $3 if the stock price falls. From the binomial pricing model we can create a replicating portfolio with the following two equations: $0 = ($30 × x) + (1.00 × y) $3 = ($12 × x) + (1.00 × y) x = -0.167 shares of stock y = $5 of risk-free bonds The value of the option is the value of the replicating portfolio: (-0.167 × $18) + ($5) = $2

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: hard 85. Binomial pricing: Assume that the stock of ABC, Inc., is currently trading for $18 and will either rise to $30 or fall to $12 in one year. The risk-free rate for one year is 0 percent. What is the value of a put option with a strike price of $15? A) $0 B) $2 C) $5 D) $6

C Feedback: The payoff from the put option is $0 if the stock price rises and $5 if the stock price falls. From the binomial pricing model we can create a replicating portfolio with the following two equations: $0 = ($10 × x) + (1.01 × y) $5 = ($0 × x) + (1.01 × y) x = -0.5 shares of stock y = $4.95 of risk-free bonds The value of the option is the value of the replicating portfolio: (-0.5 × $2.6) + ($4.95) = $3.65

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: hard 86. Binomial pricing: Assume that the stock of ABC, Inc., is currently trading for $2.60 and will either rise to $10 or fall to $0 in one year. The risk-free rate for one year is 1 percent. What is the value of a put option with a strike price of $5? A) $0 B) $2.35 C) $3.65 D) $3.70

C Feedback: First, we can calculate the value of the put option with the binomial model. The payoff from the put option is $0 if the stock price rises and $8 if the stock price falls. From the binomial pricing model we can create a replicating portfolio with the following two equations: $0 = ($30 × x) + (1.00 × y) $8 = ($12 × x) + (1.00 × y) x = -0.44 shares of stock y = $13.33 of risk-free bonds The value of the option is the value of the replicating portfolio: (-0.44 × $18) + ($13.33) = $5.33 The payoff from exercising the put option now is the option strike price minus the current stock price: $20 - $18 = $2

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: hard 87. Binomial pricing: You own a share of common stock in ABC, Inc., which is currently trading for $18 and will either rise to $30 or fall to $12 in one year. The risk-free rate for one year is 0 percent. You also own an American put option on the stock with a strike price of $20, which expires in one year. What is the value of the put option, and what would be the net payoff from exercising the option now? A) Option Value: $3.33 - Net Payoff $2 B) Option Value: $3.33 - Net Payoff $6 C) Option Value: $5.33 - Net Payoff $2 D) Option Value: $5.33 - Net Payoff $6

C Feedback: The payoff from the put option is $45 if the stock price rises and $48 if the stock price falls. When the put option pays off in either state, the value of the option is the PV of the strike price minus the current stock price. ($50 / 1.00) - $4 = $46

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: hard 88. Binomial pricing: You are fortunate enough to own a put option with a strike price of $50 on the stock of ABC, Inc. The current stock price is $4. When the option expires, you expect the stock price to be either $2 or $5. The risk-free rate of interest is zero. What is the value of your option? A) 0 B) 45 C) 46 D) 48

A Feedback: The payoff from the put option is $0 if the stock price rises and $0 if the stock price falls. Either way the put option has no payoff. The value of this put option is $0.

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: hard 89. Binomial pricing: Assume that the stock of ABC, Inc., is currently trading for $16 and will either rise to $18 or fall to $12 in one year. The risk-free rate for one year is 1 percent. What is the value of a put option with a strike price of $10? A) $0 B) $2.00 C) $2.33 D) $5.00

D Feedback: To calculate the value of this portfolio, we can use the binomial pricing model to calculate that value of the call and the put. Then we can add the values together. The payoff from the call option is $5 if the stock price rises and $0 if the stock price falls. From the binomial pricing model we can create a replicating portfolio with the following two equations: $5 = ($30 × x) + (1.00 × y) $0 = ($18 × x) + (1.00 × y) x = 0.417 shares of stock y = -$7.5 of risk-free bonds The value of the option is the value of the replicating portfolio: (0.417 × $21) + (-7.5) = $1.25 The payoff from the put option is $0 if the stock price rises and $7 if the stock price falls. From the binomial pricing model we can create a replicating portfolio with the following two equations: $0 = ($30 × x) + (1.00 × y) $7 = ($18 × x) + (1.00 × y) x = -0.583 shares of stock y = $17.5 of risk-free bonds The value of the option is the value of the replicating portfolio: (-0.583 × $21) + ($17.5) = $5.25 The total value of the straddle is $1.25 + $5.25 = $6.50

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: hard 90. Binomial pricing: Assume that the stock of ABC, Inc., is currently trading for $21 and will either rise to $30 or fall to $18 in one year. The risk-free rate for one year is 0 percent. You own a portfolio that consists of one call option and one put option. Both options have a strike price of $25, and both expire in one year. What is the value of your portfolio? A) $0 B) $25.00 C) $6.00 D) $6.50

D Feedback: To calculate the value of this portfolio, we can use the binomial pricing model to calculate that value of the call and the put. Then we can add the values together. The payoff from the call option is $5 if the stock price rises and $0 if the stock price falls. From the binomial pricing model we can create a replicating portfolio with the following two equations: $35 = ($50 × x) + (1.08 × y) $0 = ($2 × x) + (1.08 × y) x = 0.729 shares of stock y = -$1.35 of risk-free bonds The value of the option is the value of the replicating portfolio: (0.729 × $16) + (-1.35) = $10.32 The payoff from the put option is $0 if the stock price rises and $13 if the stock price falls. From the binomial pricing model we can create a replicating portfolio with the following two equations: $0 = ($50 × x) + (1.08 × y) $13 = ($2 × x) + (1.08 × y) x = -0.271 shares of stock y = $12.54 of risk-free bonds The value of the option is the value of the replicating portfolio: (-0.271 × $16) + ($12.54) = $8.20 The total value of the straddle is $10.32 + $8.20 = $18.52

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: hard 91. Binomial pricing: Assume that the stock of ABC, Inc., is currently trading for $16 and will either rise to $50 or fall to $2 in one year. The risk-free rate for one year is 8 percent. You own a portfolio that consists of one call option and one put option. Both options have a strike price of $15, and both expire in one year. What is the value of your portfolio? A) $0 B) $15 C) $21.40 D) $18.52

B Feedback: First we can price the LowVol call option. The payoff from the LowVol call option is $3 if the stock price rises and $0 if the stock price falls. From the binomial pricing model we can create a replicating portfolio with the following two equations: $3 = ($18 × x) + (1.00 × y) $0 = ($14 × x) + (1.00 × y) x = 0.75 shares of stock y = -$10.50 of risk free bonds The value of the option is the value of the replicating portfolio: (0.75 × $16) + (10.50) = $1.50 Next we can price the HighVol call option. The payoff from the HighVol call option is $7 if the stock price rises and $0 if the stock price falls. From the binomial pricing model we can create a replicating portfolio with the following two equations: $7 = ($22 × x) + (1.00 × y) $0 = ($0 × x) + (1.00 × y) x = 0.32 shares of stock y = $0 of risk-free bonds The value of the option is the value of the replicating portfolio: (0.32 × $16) + ($0) = $5.09 The HighVol call option is worth more.

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: hard 92. Binomial pricing: Consider two call options written on different stocks. Both call options have a strike price of $15 and expire one year from today. The first option is written on LowVol Co., whose current stock price is $16. One year from now, shares of LowVol Co. will either rise to $18 or fall to $14. The second option is written on HighVol, Inc., whose current stock price is also $16. One year from now shares of HighVol Inc. will either rise to $22, or fall to $0. The risk-free interest rate is 0 percent. Which call option is worth more? A) The call option on LowVol is worth more. B) The call option on HighVol is worth more. C) They are both worth the same amount. D) There is not enough information to make a comparison.

C Feedback: The payoff from the call option is $4 if the stock price rises and $0 if the stock price falls. From the binomial pricing model we can create a replicating portfolio with the following two equations: $4 = ($24 × x) + (1.00 × y) $0 = ($18 × x) + (1.00 × y) x = 0.67 shares of stock y = -$12 of risk-free bonds The value of the option is the value of the replicating portfolio: (0.67 × $20) + (-12) = $1.33 The payoff from the put option is $0 if the stock price rises and $2 if the stock price falls. From the binomial pricing model we can create a replicating portfolio with the following two equations: $0 = ($24 × x) + (1.00 × y) $2 = ($18 × x) + (1.00 × y) x = -0.333 shares of stock y = $8 of risk-free bonds The value of the option is the value of the replicating portfolio: (-0.333 x $20) + ($8) = $1.33 The call and the put options are worth the same. Note that this is a special case where interest rates are zero. With a positive interest rate, the call will be worth more than the put.

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: hard 93. Binomial pricing: Consider a call option and a put option both written on ABC, Inc. stock. Both options have a strike price of $20 and expire in one year. The stock of ABC, Inc., is currently selling for $20. In one month the stock will be at either $24 or $18. The risk-free rate is 0 percent. Which is worth more, the put option or the call option? A) The put option is worth more. B) The call option is worth more. C) They are worth the same. D) There is not enough information.

Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Easy 39. The restrictive strategy is a high-risk, high-return alternative to the flexible strategy because of A) financial shortage costs. B) production shortage costs. C) human resources shortages costs. D) None of the above.

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: hard 94. Combining options: Suppose you are creating a portfolio that consists of zero-interest bonds, stock from a single company, and call and put options on the stock. Holding which of the following combination of securities will give the payoff shown in the following diagram? A) Buy one call option and one put option on the stock with a strike price of $60. B) Buy one call option with a strike price of $60 and sell short one call option with a strike price of $80. Buy one put option at a strike price at $60 and sell short one put option with a strike price of $40. C) Buy one share of the underlying stock. In addition, buy two call options, one with a $40 strike price, and one with a $80 strike price. D) Buy one share of the underlying stock, and a put option with a strike price of $60. Sell short call two call options—one with a strike price of $40 and one with a strike price of $80.

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: hard 95. Combining options: Suppose you are creating a portfolio that consists of zero-interest bonds, stock from a single company, and call and put options on the stock. Holding which of the following combination of securities will give the payoff shown in the following diagram? A) Buy $20 in risk-free bonds, and sell short one call option with a strike price of $60. B) Buy $20 in risk-free bonds, and buy one put option with a strike price of $60. C) Buy one share of stock, and buy one call option with a strike price of $60. D) Buy one share of stock, and sell one put option with a strike price of $60.

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: hard 96. Combining options: Suppose you are creating a portfolio that consists of zero-interest bonds, stock from a single company, and call and put options on the stock. Holding which of the following combination of securities will give the payoff shown in the following diagram? A) Buy one put option of the stock with a strike price of $60. Sell short a call option with a strike price of $120. B) Buy $60 in zero-interest bonds. Sell short one call option with a strike price of $60. Sell short one put option with a strike price of $60. C) Buy one share of stock. Sell one call option with a strike price of $120. D) Buy one share of the stock. Sell short two call options with a strike price of $60. Buy one call option with a strike price of $120.

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: hard 97. Combining options: Suppose you are creating a portfolio that consists of zero-interest bonds, stock from a single company, and call and put options on the stock. Holding which of the following combination of securities will give the payoff shown in the following diagram? A) Buy one call option with a strike price of $40 and one put option with a strike price of $80. B) Buy one call option with a strike price of $80 and one put option with a strike price of $40. C) Sell one call option with a strike price of $40 and one put option with a strike price of $80. D) Sell one call option with a strike price of $80 and one put option with a strike price of $40.

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: medium 43. What happens to the value of call and put options if the volatility of the price of underlying asset decreases? A) Put options will be worth more, call options will be worth less. B) Put options will be worth less, call options will be worth more. C) Both call and put options will be worth more. D) Both call and put options will be worth less.

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: medium 44. If the price of the underlying asset increases, what happens to the value of call and put options? A) Put options will be worth more, call options will be worth less. B) Put options will be worth less, call options will be worth more. C) Both call and put options will be worth more. D) Both call and put options will be worth less.

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: medium 45. With everything else constant, as the expiration date gets closer, what happens to the value of call and put options? A) Call option will be worth more, put options will be worth less. B) Call option will be worth less, put options will be worth more. C) Both call and put options will be worth more. D) Both call and put options will be worth less.

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: medium 46. With everything else held constant, what happens to the value of call and put options if the risk-free interest rate increases? A) Call options will be worth more, put options will be worth less. B) Call options will be worth less, put options will be worth more. C) Both call and put options will be worth less. D) Both call and put options will be worth more.

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: medium 47. The management at Socrates Motors considered the option to abandon when building their new manufacturing plant. The design of the plant allows it to be easily converted to manufacture other types of large machinery. If their new line of cars is poorly received, their plant should be easy to sell to another manufacturing company. In this example, the price at which they expect to sell the plant if things go poorly resembles A) the premium of a put option on the plant. B) the premium of a call option on the plant. C) the strike price of a put option on the plant. D) the strike price of a call option the plant.

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: medium 48. Socrates Motors is very likely to enter financial distress. Without a dramatic change of events over the next couple of years, the company will be unable to pay its lenders, who will then gain control of the company's assets. A group of stockholders has pressured the company's management to begin manufacturing and selling one of the company's concept cars in the hope that it will be a big hit. Concept cars are prototypes that are developed to test new ideas and to show off at auto shows. Although elements of concept cars are often incorporated into product lines, rushing a concept car into production is very risky. The best estimates about the concept car make it appear to be a negative-NPV project. This is a good example of A) the dividend payout problem. B) the underinvestment problem. C) the asset substitution problem. D) the agency cost of equity.

Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Easy 36. The flexible current asset investment strategy A) has a high percent of current assets to sales. B) calls for management to invest large amounts in cash, marketable securities, and inventory. C) leads to high levels of accounts receivable. D) All of the above.

Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Easy 41. Advantages of going public include all EXCEPT A) Larger amount of capital can be raised this way than the amount that can be raised through private sources. B) Publicly traded firms find it harder to attract top management talent. C) Going public can enable an entrepreneur to fund a growing business without giving up control. D) Additional equity capital can usually be raised through follow-on seasoned public offerings at a low cost.

Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Easy 41. Operating shortage costs that result from lost production and sales are caused by A) not holding enough raw materials in inventory. B) running out of finished goods. C) restrictive sale policies. D) All of the above.

Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Easy 42. Which ONE of the following statements is true? A) After the IPO, there is a less active secondary market for the firm's shares. B) Only smaller amounts of capital can be raised through an IPO than the amount that can be raised through private sources. C) Publicly traded firms find it easier to attract top management talent. D) Going public can enable an entrepreneur to fund a growing business but not without giving up control.

B Feedback:

Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Hard 65. The cost of equity: Jacque Ewing Drilling, Inc., has a beta of 1.3 and is trying to calculate its cost of equity capital. If the risk-free rate of return is 8 percent and the expected return on the market is 12 percent, then what is the firm's after-tax cost of equity capital if the firm's marginal tax rate is 40 percent? A) 7.92% B) 13.20% C) 15.57% D) 23.60%

D Feedback:

Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Hard 66. The cost of equity: TeleNyckel, Inc., has a beta of 1.4 and is trying to calculate its cost of equity capital. If the risk-free rate of return is 9 percent and the market risk premium is 5 percent, then what is the firm's after-tax cost of equity capital if the firm's marginal tax rate is 30 percent? A) 11.20% B) 10.60% C) 15.14% D) 16.00%

D Feedback:

Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Hard 69. The cost of equity: UltraFlex Diving Boards, Inc., is just paid a dividend of $1.50. If the firm's growth in dividends is expected to remain at a flat 4 percent forever, then what is the cost of equity capital for Ultra Flex Diving Boards if the price of its common shares is currently $26.00? A) 5.77% B) 6.00% C) 9.77% D) 10.00%

B Feedback:

Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Hard 70. The cost of equity: Rubber Chicken, Inc., was paid a dividend of $1.87 last year. If the firm's growth in dividends is expected to be 10 percent next year and then zero thereafter, then what is the cost of equity capital for Rubber Chicken if the price of its common shares is currently $25.71? A) 7.27% B) 8.00% C) 18.00% D) The problem is not solvable with the information that is given.

C Feedback:

Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Hard 71. The cost of equity: The Dedus Shoes, Inc., has common shares with a price of $28.76 per share. The firm paid a dividend of $1.00 yesterday, and dividends are expected to grow at 10 percent for two years and then at 5 percent thereafter. What is the implied cost of common equity capital for Dedus? A) 7.00% B) 8.00% C) 9.00% D) 10.00%

C Feedback:

Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Hard 74. The cost of preferred equity: Billy's Goat Coats has a preferred share issue outstanding with a current price of $38.89. The firm last paid a dividend on the issue of $3.50 per share. What is the firm's cost of preferred equity? A) 7% B) 8% C) 9% D) 10%

C Feedback:

Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Hard 76. The cost of equity: Melba's Toast has a preferred share issue outstanding with a current price of $19.50. The firm is expected to pay a dividend of $2.34 per share a year from today. What is the firm's cost of preferred equity? A) 11.50% B) 11.75% C) 12.00% D) 12.25%

C Feedback: According to the pecking order theory, the firm will first use its available cash, which is $10mm. Next, the firm will turn to debt. Since the amount of debt it can raise plus the amount of cash on hand is less than the project cost, their entire line of credit will be used. Therefore, $75mm/$150mm = 50%.

Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Hard 81. The pecking order theory: A firm wishes to undertake a project that costs $150mm. It currently has $10mm in cash on hand and believes that it can raise $75mm in debt and $100mm in equity if needed. According to the pecking order theory of the capital structure, what percent of the project will be financed by debt? A) 0% B) 26.67% C) 50% D) None of the above

Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium 37. Which one of the following is NOT true about the flexible current asset investment strategy? A) The strategy promotes a liberal trade credit policy for customers. B) The flexible strategy calls for management to invest large amounts in cash, marketable securities, and inventory. C) The flexible strategy is perceived be a high-risk and high-return course of action for management to follow. D) The strategy's downside is the high inventory carrying cost.

Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium 40. Which ONE of the following statements is true? A) Financial shortage costs arise mainly from illiquidity—shortage of cash or a lack of marketable securities to sell for cash. B) Operating shortage costs result from lost production and sales. C) Operating shortage costs can be substantial, especially if the product markets are competitive. D) All of the above.

Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium 40. Which of the following explanations is NOT a possible benefit of dividends? A) Some investors prefer dividend-paying stocks and will be willing to pay a higher price for stocks with regular dividends. B) Paying out large regular dividends can force management to regularly raise more capital. The extra scrutiny involved in raising capital can increase the incentives of management to run the company efficiently. C) Dividends can be used to manage the capital structure of the company. D) Paying dividends reduces the probability that the firm will enter financial distress.

Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium 41. Which of the following statements about the relative advantages of stock repurchases over dividends is NOT true? A) Stock repurchases send a stronger signal than dividends to the market about management's belief that the firm's prospects are good. B) Open-market stock purchases allow management more flexibility because investors are less likely to react if the management cuts back or ends a stock repurchase as compared to cutting back on dividend payments. C) Stock repurchases allow stockholders to choose whether or not to participate in the stock repurchase. This allows stockholders to have more control over their tax burden. D) Historically, taxes on dividend payment have been higher than those on stock repurchases.

Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium 42. In early 2003, the U.S. government cut the tax rate on dividends to a flat 15 percent instead of treating dividend payments as other income. All else being equal, how would we expect the number of companies paying dividends to change. A) We would expect the number of dividend-paying companies to increase. B) We would expect the number of dividend-paying companies to decrease. C) We would expect the number of dividend-paying companies to stay relatively constant. D) None of the above.

Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium 43. Disadvantages of going public include all EXCEPT A) Managers' tendency to focus on long-term profits. B) The high cost of the IPO itself. C) The costs of complying with ongoing SEC disclosure requirements. D) The transparency that results from this compliance can be costly for some firms.

Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium 43. Suppose you are advising a retiree who holds 2,000 shares of LargeDiv Corp. The company is largely held by tax-paying institutional investors and has announced that it will shortly be issuing a large dividend. Because the shares are held in the retiree's Roth IRA, she will not incur taxes on either capital gains or dividends. The retiree has decided to sell the shares sometime this year, and use the money for living expenses. You expect the only upcoming change in the stock price will result from the dividend. Ignoring any discounting for time, what advice should you give? A) Sell the stock now—the stock price is likely to decrease more than just the dividend amount. B) Sell the stock ex-dividend—the stock price is likely to decline, but by less than the dividend amount. C) It doesn't matter when the stock is sold. D) Sell the stock now—it is always better to sell the stock immediately regardless of the tax consequences.

Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium 43. Which one of the following statements about working capital trade-off is NOT true? A) Financial managers need to balance shortage costs against carrying costs to find an optimal strategy. B) If carrying costs are smaller than shortage costs, then the firm will maximize value by adopting a more restrictive strategy. C) If shortage costs dominate carrying costs, the firm will need to move toward a more flexible policy. D) Management will try to find the level of current assets that minimizes the sum of the carrying costs and shortage costs.

Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium 49. The appropriate risk-free rate to use when calculating the cost of equity for a firm is A) a long-term Treasury rate. B) a short-term Treasury rate. C) a 50/50 mix of short-term and long-term Treasury rates. D) none of the above.

Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium 50. The average risk-premium for the market from 1926 to 2009 was A) 8.00%. B) 7.50%. C) 6.01%. D) 6.51% + the Treasury rate.

Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium 51. The recommended model to estimate the cost of common equity for a firm is A) a one-stage constant growth model. B) a multistage growth model. C) the CAPM. D) none of the above.

Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium 51. Which of the following supports the trade-off theory of capital structure? A) Firms use cash on hand first, since issuing equity and debt is expensive. B) A firm's capital structure is the result of past equity and debt issuance decisions. C) Firms have a target capital structure. D) a and b.

B Feedback: The company earned $0.25 × 4 quarters = $1.00 per share this year. To achieve the 25 percent target, the firm must distribute $1.00 × 25% = $0.25 per share to shareholders. The company has already distributed $0.05 × 3 quarters = $0.15 per share. If the company issues another regular dividend of $0.05 per share, it will still have $0.05 per share to remaining to be returned to shareholders. The stock repurchase required to return that value would be (0.05 per share × 2 million shares) = $100,000 of stock repurchase.

Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium 67. How stock repurchases differ from dividends: ABC Co. has a policy of returning a minimum of 25 percent of earnings to shareholders every year through dividend issues and open-market stock repurchases. In each quarter this year, the company earned $0.25 per share. In each of the first three quarters, the company paid a regular cash dividend of $0.05 per share. The company has 2 million shares of common stock outstanding. What combination of dividends and stock repurchases could the company's board approve to meet their target payout percentage? A) A regular cash dividend of $0.05 B) A regular cash dividend of $0.05 per share and an open-market stock repurchase of $100,000 in stock C) A regular cash dividend of $0.05 per share and an open-market stock repurchase of $400,000 in stock D) A regular cash dividend of $0.05 per share and an open-market stock repurchase of 500,000 in stock

C Feedback:

Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium 67. The cost of equity: RadicalVenOil, Inc., has a cost of equity capital equal to 22.8 percent. If the risk-free rate of return is 10 percent and the expected return on the market is 18 percent, then what is the firm's beta if the firm's marginal tax rate is 35 percent? A) 1.0 B) 1.28 C) 1.60 D) 4.10

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Easy 44. The aging schedule A) shows the breakdown of the firm's accounts receivable by their date of sale. B) identifies and then tracks delinquent accounts and to see that they are paid. C) are an important financial tool for analyzing the quality of a company's receivables. D) All of the above.

D Feedback: The company earned $0.20 × 4 quarters = $0.80 per share this year. To achieve the 40 percent target, the firm must distribute $0.80 × 40% = $0.32 per share to shareholders. The company has already distributed $0.05 × 3 quarters = $0.15 per share. To meet the 40 percent target the company must distribute another ($0.31 - $0.15) = $0.17 per share. The company could meet the target in two ways: 1. It could distribute another $0.17 per share through a regular dividend of $0.05 and an extra dividend of $0.12 per share. 2. The company could pay another $0.17 per share through a regular dividend of $0.05 and a stock repurchase of ($0.12 per share × 8 million shares) = $960,000 in stock.

Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium 68. How stock repurchases differ from dividends: ABC Co. has a policy of returning a minimum of 40 percent of earnings to shareholders every year through dividend issues and open-market stock repurchases. In each quarter this year, the company earned $0.20 per share. In each of the first three quarters, the company paid a regular cash dividend of $0.05 per share. The company has 8 million shares of common stock outstanding. What combination of dividends and stock repurchases could the company's board approve to meet their target payout percentage? A) A regular cash dividend of $0.05 B) A regular cash dividend of $0.05 per share and an open-market stock repurchase of $960,000 in stock C) A regular cash dividend of $0.05 per share and a special dividend of $0.12 D) Both b and c will meet the target payout percentage

C Feedback:

Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium 68. The cost of equity: Gangland Water Guns, Inc., is expected to pay a dividend of $2.10 one year from today. If the firm's growth in dividends is expected to remain at a flat 3 percent forever, then what is the cost of equity capital for Gangland if the price of its common shares is currently $17.50? A) 12.00% B) 14.65% C) 15.00% D) 15.36%

D Feedback: We can use the common stock pricing equation to solve for the cost of common equity capital:

Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium 72. The cost of equity: Tranquility, Inc., has common shares with a price of $18.37 per share. The firm paid a dividend of $1.50 yesterday, and dividends are expected to grow at 9 percent for three years and then at 2 percent thereafter. What is the implied cost of common equity capital for Tranquility? A) 9% B) 10% C) 11% D) 12%

B Feedback:

Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium 73. The cost of equity: Oasis, Inc., has common shares with a price of $21.12 per share. The firm is expected to pay a dividend of $1.75 one year from today, and dividends are expected to grow at 10 percent for two years after that and then at 5 percent thereafter. What is the implied cost of common equity capital for Oasis? A) 13% B) 14% C) 15% D) 16%

B Feedback:

Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium 75. The cost of equity: Wally's War Duds has a preferred share issue outstanding with a current price of $26.57. The firm is expected to pay a dividend of $1.86 per share a year from today. What is the firm's cost of preferred equity? A) 6.50% B) 7.00% C) 7.50% D) 8.00%

Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: medium 49. Consider a CEO who holds neither stock nor stock options in the company she runs. Her payoff function regarding the firm's performance is most likely to resemble A) stockholders. B) lenders. C) owners of a call option on the firm. D) holders of a risk-free bond with coupon payments equal to her salary.

Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: medium 51. Which of the following reasons is NOT a valid explanation of why managers sometimes choose to take on negative-NPV Projects: A) The NPV analysis does not include a valuable real option to expand the project if things go well. B) If the firm has debt, managers may create value for shareholders by taking on some risky negative-NPV projects. C) Managers' payoff functions represent the payoffs of lenders. By taking negative-NPV projects, the managers can create value for lenders. D) All of the above descriptions are valid explanations for why managers sometimes take on negative NPV projects.

Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: medium 52. As the manager of a sporting goods company, you are presented with a new golf project. An inventor has recently patented the design for a new golf club that makes playing golf much easier. Your company has made contact with the inventor, who is willing to sell the exclusive rights to the technology, but if you don't act fast he will sell the rights to a rival company. You are not certain whether the new golf club will become popular, but your analysts have completed a basic NPV analysis. Given the available information, the project has a positive NPV. However, you know there are several real options associated with the project, including the option to abandon the project and the option to make follow-on investments. Which one of the following statements regarding the project is correct? A) Based on the NPV analysis, you should accept the project. The value of the project may be worth more than the NPV analysis but not less. B) Based on the NPV analysis, you should accept the project. The NPV analysis contains all the information about the value of the project. C) Based on the NPV analysis, you should reject the project. Without additional information about the value of the real options, there is no way to make a decision. D) Based on the NPV analysis, you should reject the project. The NPV analysis contains all the information about the value of the project.

Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: medium 53. A start-up company is making a decision on whether to develop a new internet social networking site. The site will cost $1 million to develop, but it is unclear whether the new technology critical to the site will work correctly. If development is successful, it will cost an additional $20 million next year to advertise the site to Internet users. If the site becomes popular with Internet users, it is expected to generate a present value of $100 million in advertising revenue. There is a 10 percent chance that the site will be successfully developed and subsequently become popular with Internet users. The company's cost of capital is 15 percent. Should the company pursue the project? A) No, the project has a negative NPV. B) Yes, the project has a positive NPV. C) It doesn't matter. The project has zero NPV. D) There is not enough information to make a decision.

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Easy 44. Basic services investment bankers provide when bringing securities to market include A) Origination B) Underwriting C) distribution. D) All of the above.

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Easy 45. Which one of the following statements is NOT true? A) Investment bankers provide three basic services when bringing securities to market—origination, underwriting, and distribution. B) During the origination phase, the investment banker helps the firm determine whether it is ready for an IPO. C) Origination is the risk-bearing part of investment banking. D) Origination includes giving the firm financial advice and getting the issue ready to sell.

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Easy 47. With a best-efforts underwriting A) the investment banking firm makes no guarantee to sell the securities at a particular price. B) the investment banker does not bear the price risk associated with underwriting the issue. C) compensation is based on the number of shares sold. D) All of the above.

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Easy 49. The three basic costs associated with issuing stock in an IPO are A) price premium, out-of-pocket expenses, and underpricing. B) underwriting spread, out-of-pocket expenses, and underpricing. C) underwriting spread, price premium, and underpricing. D) None of the above.

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Easy 52. Which one of the following statements is NOT true? A) Accounts payable (trade credit), bank loans, and commercial paper are common sources of short-term financing. B) An informal line of credit is a verbal agreement between the firm and the bank, allowing the firm to borrow up to an agreed-upon upper limit. C) An informal line of credit is also known as "revolving credit." D) A formal line of credit is also known as "revolving credit."

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Hard 52. In order to use the WACC to evaluate a future project's flows, which of the following must hold? A) The project will be financed with the same proportion of debt and equity as the firm. B) The systematic risk of the project is the same as the overall systematic risk of the firm. C) The project must be viable. D) a and b above.

D Feedback: E(Ri) = Rrf + i [E(Rm) - Rrf] = 0.04 + 2.0 [0.06] = 0.04 + 0.12 = 0.16

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Hard 53. Overall cost of capital: If the market risk premium is currently 6 percent and the risk-free rate of return is 4 percent, then what is the expected return on a common share with a beta equal to 2? A) 8.0% B) 10.0% C) 12.0% D) 16.0%

B Feedback: E(Ri) = Rrf + i [E(Rm) - Rrf] ==> 0.213 = 0.07 + i [0.18 - 0.07] ==> i= 1.30

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Hard 54. Overall cost of capital: What is the beta of a firm whose equity has an expected return of 21.3 percent when the risk-free rate of return is 7.0 percent and the expected return on the market is 18.0 percent? A) 0.79 B) 1.30 C) 1.57 D) none of the above

D Feedback: MV of assets = MV of liabilities + MV of equity = (1.01 x $30,000,000) + (3,000,000 x 15) = $75,300,000

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Hard 55. Overall cost of capital: Stryder, Inc., has 3 million shares outstanding at a current price of $15 per share. The book value of the shares is $10 per share. The firm also has $30 million in par value of bonds outstanding. The bonds are selling at a price equal to 101 percent of par. What is the market value of the firm? A) $30.0 million B) $45.0 million C) $75.0 million D) $75.3 million

B Feedback:

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Hard 56. How firms estimate their cost of capital: The Diverse Co. has invested 40 percent of the firm's assets in a project with a beta of 0.4 and the remaining assets in a project with a beta of 1.8. What is the beta of the firm? A) 0.96 B) 1.24 C) 1.28 D) None of the above

C Feedback: kFirm = xDebt kDebt + xEquity kEquity = (0.35 x 0.08) + (0.65 x 0.2) = 0.158

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Hard 57. How firms estimate their cost of capital: You are analyzing the cost of capital for a firm that is financed with 65 percent equity and 35 percent debt. The cost of debt capital is 8 percent, while the cost of equity capital is 20 percent for the firm. What is the overall cost of capital for the firm? A) 12.2% B) 14.0% C) 15.8% D) 20.0%

C Feedback: xDebt = 200/500 = 0.4, xEquity = 300/500 = 0.6 kFirm = xDebt kDebt + xEquity kEquity = (0.4 x 0.09) + (0.6 x 0.19) = 0.15

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Hard 58. How firms estimate their cost of capital: You are analyzing the cost of capital for a firm that is financed with $300 million of equity and $200 million of debt. The cost of debt capital for the firm is 9 percent, while the cost of equity capital is 19 percent. What is the overall cost of capital for the firm? A) 13.0% B) 14.0% C) 15.0% D) 16.0%

C Feedback:

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Hard 77. Using the WACC in practice: Swirlpool, Inc., has found that its cost of common equity capital is 18 percent, and its cost of debt capital is 8 percent. If the firm is financed with 60 percent common shares and 40 percent debt, then what is the after-tax weighted average cost of capital for Swirlpool if it is subject to a 40 percent marginal tax rate? A) 10.37% B) 12.00% C) 12.72% D) 14.00%

C Feedback:

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Hard 78. Using the WACC in practice: Maloney's, Inc., has found that its cost of common equity capital is 17 percent and its cost of debt capital is 6 percent. If the firm is financed with $3,000,000 of common shares (market value) and $2,000,000 of debt, then what is the after-tax weighted average cost of capital for Maloney's if it is subject to a 40 percent marginal tax rate? A) 8.96% B) 11.16% C) 11.64% D) 12.60%

B Feedback: Noting that the proportion of debt and equity is:

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Hard 79. Using the WACC in practice: Ronnie's Comics has found that its cost of common equity capital is 15 percent and its cost of debt capital is 12 percent. If the firm is financed with $250,000,000 of common shares (market value) and $750,000,000 of debt, then what is the after-tax weighted average cost of capital for Ronnie's if it is subject to a 35 percent marginal tax rate? A) 6.05% B) 9.6% C) 8.75% D) 13.65%

D Feedback:

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Hard 81. Using the WACC in practice: Marley's Pipe Shops has found that its common equity capital shares have a beta equal to 1.5 while the risk-free return is 8 percent and the expected return on the market is 14 percent. Its cost of debt financing is 12 percent. If the firm is financed with $120,000,000 of common shares (market value) and $80,000,000 of debt, then what is the after-tax weighted average cost of capital for Marley's if it is subject to a 35 percent marginal tax rate? A) 10.20% B) 11.76% C) 11.88% D) 13.32%

D Feedback:

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Hard 82. Using the WACC in practice: Droz's Hiking Gear, Inc., has found that its common equity capital shares have a beta equal to 1.5 while the risk-free return is 8 percent and the expected return on the market is 14 percent. It has 7-year semiannual maturity bonds outstanding with a price of $767.03 that have a coupon rate of 7 percent.. If the firm is financed with $120,000,000 of common shares (market value) and $80,000,000 of debt, then what is the after-tax weighted average cost of capital for Droz's if it is subject to a 35 percent marginal tax rate? Calculate the cost of debt as it would be done on Wall Street. A) 10.20% B) 11.76% C) 11.88% D) 13.32%

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium 44. Suppose you own shares of ThreeFor, Inc., which has just announced a 3-for-1 stock split. Immediately after the announcement, the price of the company's shares rose by 5 percent. You don't expect any new information about the company until after the stock split. Ignoring any discounting for time, if you intend to sell your shares soon, you should A) sell the stock now—the single share you have now is likely to be worth more than the three shares you'll have after the split. B) sell the stock after the split—typically, the marker reacts positively to stock splits. The three shares you'll have after the split will be worth more than the single share you have now. C) sell the stock now—the stock is likely to be more liquid before the split when there are fewer shares. D) It doesn't matter when the stock is sold. If there is no new information about the stock, then the value of three shares after the split should be the same as the value of the single share you hold now.

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium 45. Generally, management undertakes a reverse stock split to A) send a signal to investors that the company is expected to perform poorly. B) meet the minimum requirements to be listed on one of the major stock exchanges. C) increase the liquidity of shares by decreasing the number of share available. D) reduce the administrative costs associated with investor relations.

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium 46. All of the following about a firm-commitment underwriting is true EXCEPT: A) The investment banker guarantees the issuer a fixed amount of money from the stock sale. B) The investment banker actually buys the stock from the firm. C) The issuer bears the risk that the resale price might be lower than the price the underwriter pays. D) The underwriter bears the risk that the resale price might be lower than the price the underwriter pays.

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium 48. Which one of the following statements is NOT true? A) In a best-efforts offering, the underwriters will suffer a financial loss if the offer price is set too high. B) In a best-efforts agreement, the issuing firm will lose if the offer price is set too high. C) If the underpricing is significant, the investment banking firm will suffer a loss of reputation for failing to price the new issue correctly and raising less money for its client than it could have. D) Underpricing is defined as offering new securities for sale at a price below their true value.

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium 50. Data from the marketplace show that the shares sold in an IPO are typically A) priced between 2 and 5 percent below the price at which they close at the end of first day of trading. B) priced between 10 and 15 percent above the price at which they close at the end of first day of trading. C) priced between 10 and 15 percent below the price at which they close at the end of first day of trading. D) priced between 2 and 5 percent above the price at which they close at the end of first day of trading.

A Feedback: The company had 1 million shares outstanding and is issuing a 4-for-1 stock split. 4 × 1 million = 4 million.

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium 51. Stock splits: Split-Gram, Inc., has announced a 4-to-1 stock split. If the company currently has 1 million shares outstanding, how many outstanding shares will it have after the split? A) 4 million B) 3 million C) 2 million D) 1 million

A Feedback: You own 3,000 shares of a company that is undergoing a 4-for-1 split. You will have: 4 × 3,000 = 12,000 shares After the split, each share will be worth one-fourth of the original share price, so your total holding will be worth: ($48 / 4 ) × 12,000 = $144,000

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium 52. Stock splits: You own 3,000 shares of Split Holdings Co. The shares are currently selling for $48. The company has just announced a 4-for-1 stock split. How many shares will you own after the split, and approximately what will your holdings in Split Holdings Co be worth? A) 12,000 shares worth about $144,000 B) 12,000 shares worth about $576,000 C) 15,000 shares worth about $144,000 D) 15,000 shares worth about $720,000

B Feedback: To avoid sending a bad signal to investors, the company needs to pay out the same dividend relative to the number of outstanding shares. After a 2-for-1 split, the equivalent regular cash dividend would be $0.10 / 2 = $0.05.

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium 53. Stock dividends and stock splits: Split-Div, Inc., has issued quarterly dividends of $0.10 per share each quarter over the last few years. This quarter Split-Div initiated a 2-for-1 stock split. What is the minimum quarterly dividend the board of Split-Div should approve to avoid sending a bad signal to investors? A) $0.02 per share B) $0.05 per share C) $0.10 per share D) $0.20 per share

B Feedback: You own 1,200 shares. After a 3-for-1 reverse stock split, you would own: 1,200 / 3 = 400 shares

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium 54. Stock splits: You own 1,200 shares of ABC, Co. The company has recently announced a 1-for-3 reverse stock split. How many shares will you own after the reverse split? A) 300 shares B) 400 shares C) 3,600 shares D) 4,800 shares

C Feedback: After the stock dividend, there will be 110 percent more shares representing the same amount of assets: $54 / 110% = $49.09 per share

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium 55. Stock dividends: ABC Co. stock is currently trading for $54. Assume there is no new information about the company. If the company issues a 10 percent stock dividend, what will the approximate price of the stock be after the stock dividend is issued? A) $47.80 per share B) $48.60 per share C) $49.09 per share D) $54.00 per share

B Feedback: xDebt = 25/100 = 0.25, xEquity = 75/100 = 0.75 kFirm = xDebt kDebt + xEquity kEquity ==> .1975 = (0.25 x 0.07) + (0.75 x kEquity) ==> kEquity = 0.2400

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium 59. How firms estimate their cost of capital: The WACC for a firm is 19.75 percent. You know that the firm is financed with $75 million of equity and $25 million of debt. The cost of debt capital is 7 percent. What is the cost of equity for the firm? A) 19.75% B) 24.00% C) 32.50% D) 58.00%

D Feedback: xDebt = Y, xEquity = (1 - Y) kFirm = xDebt kDebt + xEquity kEquity ==> 0.13= (Y x 0.1) + ((1 - Y) x 0.20) ==> Y = 0.7

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium 60. How firms estimate their cost of capital: The WACC for a firm is 13.00 percent. You know that the firm's cost of debt capital is 10 percent and the cost of equity capital is 20%. \ What proportion of the firm is financed with debt? A) 30% B) 33% C) 50% D) 70%

A Feedback: Amount to be borrowed = $50,000 Stated annual interest rate = 8.5% Compensating balance = 8% Amount deposited as compensating balance = $50,000 x 0.08 = $4,000 Effective borrowing amount = $50,000 - $4,000 = $46,000 Interest expense = $50,000 x 0.085 = $4,250

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium 63. Effective interest rate: Serengeti Travels has borrowed $50,000 at a stated APR of 8.5 percent. The loan calls for a compensating balance of 8 percent. What is the effective interest rate for this company? A) 9.24% B) 8.50% C) 8.00% D) 16.50%

B Feedback: Amount to be borrowed = $63,000 Stated annual interest rate = 10% Compensating balance = 10% Amount deposited as compensating balance = $63,000 x 0.10 = $6,300 Effective borrowing amount = $63,000 - $6,300 = $56,700 Interest expense = $63,000 x 0.10 = $6,300

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium 64. Effective interest rate: Sun Prairie Traders borrowed $63,000 at an APR of 10 percent. The loan called for a compensating balance of 10 percent. What is the effective interest rate on the loan? A) 10.00% B) 11.11% C) 8.00% D) 12.50%

C Feedback: Stock price at end of first day = $19.30 × (1.18) = $22.78 First-day underpricing = ($22.78 - $19.30) = $3.48 per share. Total underpricing = ($3.48 per share x 2,000,000 shares of stock) = $6,960,000

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium 64. IPO pricing: Pau, Inc., issues a $38.6 million IPO priced at $12.50 per share, and the offering price to the public is $19.30 per share. The firm's legal fees, SEC registration fees, and other administrative costs are $270,000. The firm's stock price increases 18 percent on the first day. What is the underpricing cost of issuing the securities to the firm? A) $13.6 million B) $20.6 million C) $6.96 million D) $7.57 million

C Feedback: Amount to be borrowed = $225,000 Stated annual interest rate = ? Compensating balance = 10% Effective interest rate = 8.25% Compensating balance = (0.10 x $225,000) = $22,500 Effective borrowed amount = $225,000 - $22,500 = $202,500 Stated interest rate = $16,706.25 / $225,000 =7.425%

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium 65. Effective interest rate: Good Homes Furnishings is borrowing $225,000. The loan requires a 10 percent compensating balance, and the effective interest rate on the loan is 8.25 percent. What is the stated APR on this loan? Round to one decimal place. A) 10.00% B) 11.11% C) 7.4% D) 8.25%

A Feedback: Underwriter's gross spread ($19.30 - $12.50) =$6.80 per share. Number of shares outstanding = ($38.6 million/$19.30 per share) = 2 million. Underwriting cost = ($6.80 per share x 2.0 million shares) = $13.6 million

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium 65. IPO pricing: Pau, Inc., issues a $38.6 million IPO priced at $12.50 per share, and the offering price to the public is $19.30 per share. The firm's legal fees, SEC registration fees, and other administrative costs are $270,000. The firm's stock price increases 18 percent on the first day. What is the underwriting cost? A) $13.6 million B) $20.6 million C) $6.96 million D) None of the above.

B Feedback: Amount to be borrowed = $375,000 Stated annual interest rate = ? Compensating balance = 8% Effective interest rate = 10.326% Compensating balance = (0.08 x $375,000) = $30,000 Effective borrowed amount = $375,000 - $30,000 = $345,000 Stated interest rate = $35,625 / $375,000 =9.5%

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium 66. Effective interest rate: Maggie's Bistro is borrowing $375,000. The loan requires an 8 percent compensating balance, and the effective interest rate on the loan is 10.326 percent. What is the stated APR on this loan? Round to one decimal place. A) 10.0% B) 9.5% C) 7.4% D) 8.5%

B Feedback: Stock price at end of first day = $19.30(1.18) = $22.78 First-day underpricing = ($22.78 - $19.30) = $3.48 per share. Total underpricing = ($3.48 per share x 2,000,000 shares of stock) = $6,960,000 Underwriter's gross spread ($19.30 - $12.50) =$6.80 per share. Number of shares outstanding = ($38.6 million/$19.30 per share) = 2 million. Underwriting cost = ($6.80 per share x 2.0 million shares) = $13.6 million Total cost to the firm of selling the IPO = $13,960,000 + $270,000 + $6,960,000 = $20,830,000

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium 66. IPO pricing: Pau, Inc., issues a $38.6 million IPO priced at $12.50 per share, and the offering price to the public is $19.30 per share. The firm's legal fees, SEC registration fees, and other administrative costs are $270,000. The firm's stock price increases 18 percent on the first day. What is the total cost of issuing the securities to the firm? A) $13.6 million B) $20.83 million C) $20.6 million D) None of the above

D Feedback: Change in price on first day = $24.70 - $19.00 = $5.70 Number of shares outstanding = 4.0 million Loss due to underpricing = $5.70 × 4,000,000 = $22.8 million

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium 67. IPO underpricing: When Geo Corp. went public in September 2008, the offer price was $19.00 per share and the closing price at the end of the first day was $24.70. The firm issued 4 million shares. What was the loss to the company due to underpricing? A) $13.6 million B) $20.83 million C) $20.6 million D) $22.8 million

A Feedback: Gross proceeds from offer = $25.00 x 4,000,000 = $100,000,000 Underwriting spread = $100,000,000 x 0.18 = $18,000,000 Proceeds to issuer = ($23 x $4,000,000) - $18,000,000 = $74 million

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium 68. IPO: Bethesda Biosys issues an IPO sold on a best-efforts basis. The company's investment bank demands a spread of 18 percent of the offer price, which is set at $25 per share. Four million shares are issued. However, the bank was overly optimistic and eventually is able to sell the stock for only $23 per share. What are the proceeds for the issuer? A) $74 million B) $92 million C) $100 million D) None of the above

B Feedback: You will only be taxed on the capital gain. So you will receive: 3,000 shares x ($40 + ($70 - $40) × 0.80) = $192,000

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium 69. How stock repurchases differ from dividends: You purchased 3,000 shares of Space Apparition Co. four years ago at $40 per share You have just received a mailing from the company announcing a fixed-price tender offer stock repurchase at $70 per share. Capital gains are taxed at 20 percent. If you participate in the repurchase, how much will you receive? A) $31,500 B) $192,000 C) $178,000 D) $210,000

A Feedback: Number of shares issued = 5 million Net Proceeds to issuer = $110 million Underwriting spread = 20% Gross proceeds from offer = $110,000,000 / 0.80 = $137.5 million Selling price per share = $137.5 million / 5 million = $27.50

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium 69. IPO: Fortune Hotels issues an IPO sold on a best-efforts basis. The company's investment bank demands a spread of 20 percent. Five million shares are issued. However, the bank was overly optimistic and could not sell at the offer price of $31. If the net proceeds to the issuer were $110 million, what was the per share price at which the shares were sold? A) $27.50 B) $22 C) $31 D) None of the above

C Feedback: You will only be taxed on the capital gain. So you will receive: 3,000 shares x ($30 + ($36-$30) × 0.85) = $105,300

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium 70. How stock repurchases differ from dividends: You purchased 3,000 shares of Purple Stuff Beverage Co. four years ago at $30 per share. You have just received a mailing from the company announcing a fixed-price tender offer stock repurchase at $36 per share. Capital gains are taxed at 15 percent. If you participate in the repurchase, how much will you receive? A) $18,000 B) $91,800 C) $105,300 D) $108,800

B Feedback: Number of shares issued = 5 million Net proceeds to issuer = $110 million Underwriting spread = 20% Gross proceeds from offer = $110,000,000 / 0.80 = $137.5 million Proceeds to underwriter = $137.5 million × 0.20 = $27.5 million

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium 70. IPO: Fortune Hotels issues an IPO sold on a best-efforts basis. The company's investment bank demands a spread of 20 percent. Five million shares are issued. However, the bank was overly optimistic and could not sell at the offer price of $31. If the net proceeds to the issuer is $110 million, how much did the investment bank receive? A) $22.0 million B) $27.5 million C) $31.0 million D) None of the above

C Feedback: You will only be taxed on the capital gain. So you will receive: 2,500 shares x ($40 + ($54 - $40) × 0.85 ) = $129,750

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium 71. How stock repurchases differ from dividends: You purchased 2,500 shares of DotCom.com several years ago for $40 per share. The company is offering a fixed-price tender offer repurchase for $54 per share. What is the amount of after-tax proceeds you would receive from taking part in the repurchase if capital gains are taxed at 15 percent? A) $120,000 B) $121,250 C) $129,750 D) $135,000

C Feedback: Number of shares issued = 3 million Gross proceeds from issue = ($26.25 × 3,000,000) = $78,750,000 Underwriting spread = $78,750,000 x 0.16 = $12,600,000 Proceeds to issuer = $78,750,000 - $12,600,000 = $66.15 million

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium 71. IPO: Dienz Pharma issues an IPO sold on a best-efforts basis. The company's investment bank demands a spread of 16 percent of the selling price. The offer price is set at $32 per share. Three million shares are issued. However, the bank was able to see the shares at $26.25 per share. What are the proceeds for the issuer? A) $96.00 million B) $78.75 million C) $66.15 million D) None of the above

C Feedback: Credit terms = 2/10 EOM, net 30 Effective annual rate =(1 + 2/98)365/20 - 1 = (1.0204)18.2500 - 1 = 1.4459 - 1 = 0.4459, or 44.59%

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium 72. Cost of trade credit: Senter Corp. sells its goods with terms of 2/10 EOM, net 30. What is the implicit cost of the trade credit? A) 18.50% B) 30.00% C) 44.59% D) 21.89%

D Feedback: Credit terms = 3/15 EOM, net 60 Effective annual rate = (1 + 3/97)365/45 - 1 = (1.0309)8.1111 - 1 = 1.2800- 1 = 0.28, or 28%

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium 73. Cost of trade credit: Kearns, Inc., sells its goods with terms of 3/15 EOM, net 60. What is the implicit cost of the trade credit? A) 15% B) 45% C) 34% D) 28%

A Feedback: If you take part in the repurchase, you will have to pay taxes on your capital gains. So you will receive: 500 shares × ($20 + ($30 - $20) × 0.85 ) = $14,250

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium 73. How stock repurchases differ from dividends: You purchased 500 shares in Div Choice, Inc., several years ago for $20. The company previously announced it will be distributing cash to shareholders in a novel way. First, the company will a have a tender offer stock repurchase at $30 per share. After the repurchase, it will issue a special dividend of $5.00 per share to the remaining stockholders. Suppose that you want to convert your holdings in Div Choice, Inc., into cash. Assume the tax on dividends is 30 percent and the tax on capital gains is 15 percent. The shares are currently trading for $30. Assume no new information comes out about the company. How much cash will you receive from taking part in the repurchase? A) You will receive $14,250 by taking part in the repurchase. B) You will receive $15,000 by taking part in the repurchase. C) You will receive $15,750 by taking part in the repurchase. D) You will receive $16,000 by taking part in the repurchase.

Format: Multiple Choice Learning Objective: LO 6 Level of Difficulty: Easy 56. Advantages of private placements include: A) Cost of funds may be lower. B) Private lenders are more willing to negotiate changes to a bond contract. C) The speed of private placement deals and flexibility in issue size. D) All of the above.

C Feedback: This question is a bit tricky. If you wait until after the dividend payment, you will pay a 30 percent tax on the dividend, so you will receive $5 × 70% = $3.50 per share in dividends. However, we would expect the price of the stock to only fall by the after-tax amount of the dividend. So the stock will be worth about $30 - $3.50 = $26.50. Thus, from selling the stock you will receive. (20 + (26.50 - 20) × 0.85) = $25.525 per share. In total, you will receive ($25.525+ $3.50) × 500 shares = $14,512.50.

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium 74. How stock repurchases differ from dividends: Using the same information from the preceding question, approximately how much will you receive by waiting until after the ex-dividend day and then selling the shares in the market? A) You will receive about $13,500 by selling after the ex-dividend day. B) You will receive about $14,775 by selling after the ex-dividend day. C) You will receive about $14,512 by selling after the ex-dividend day. D) You will receive about $15,000 by selling after the ex-dividend day.

Ans:A Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium 76. The most likely reason that underpricing of new issues occurs more frequently than overpricing is the: A) Underwriters' desire to reduce the risk of a firm commitment. B) Demand for a new issue is typically too high. C) Underwriters earn low rates of return D) Issuing firms demand that equity be underpriced. E)

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium 83. Which type of project do financial managers typically use the highest cost of capital when evaluating? A) Extension projects B) New product projects C) Efficiency projects D) Market expansion projects

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium 85. If a company's weighted average cost of capital is less than the required return on equity, then the firm: A) Is financed with more than 50% debt. B) Is perceived to be safe C) Has debt in its capital structure D) Must have preferred stock in its capital structure

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: medium 50. Which of the following compensation methods is NOT likely to reduce agency costs between stockholders and managers? A) Stock compensation—giving the CEO stock in the company as part of her salary. B) A golden parachute—a guaranteed large lump-sum payment in the event that the CEO is fired. C) A higher salary than that of other CEOs in similar companies. D) Performance bonuses—a higher bonus if the company's cash flows are higher then expected.

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: medium 62. The claim stockholders hold on cash flows in a company with outstanding debt is often described as A) a call option on the firm's assets. B) a put option on the firm's assets. C) an interest-free bond with the same value as the firm's assets. D) none of the above

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: medium 63. Which of the following statements is NOT an example of the agency cost of debt? A) ABC Co. shareholders pressure management to invest in very risky projects in hopes that one of the investments might pay off. The company is highly leveraged, so shareholders have little to lose. B) ABC Co. has a large amount of debt but very few investment opportunities. The board of directors decides to pay out a large special dividend, and the company subsequently enters bankruptcy. Lenders collect about 60 percent of the face value of the debt. C) ABC Co. is very close to financial distress. The company has a positive-NPV investment opportunity, but even with the project the company is likely to enter bankruptcy. Investors refuse to invest the additional funds necessary to pursue the project, even though it has a positive NPV. D) Investors are unsure of the value for ABC Co. ABC Co. decides to issue equity to pay down debt. The market assumes that ABC Co.'s managers are issuing equity because they think that the company's stock is overvalued. As a result, the company's stock price falls when the equity issue is announced.

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: medium 64. The claim lenders' hold on cash flows in a company with outstanding risky debt is often thought of as A) holding a call option on the firm's assets. B) holding a put option on the firm's assets. C) selling a put option on the firm's assets and holding a risk-free bond. D) selling a call option on the firm's asset and holding a risk-free bond.

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: medium 65. Adding stock options and bonuses for performance to the compensation of a manager is intended to closer align the interest of the manager with A) stockholders. B) lenders. C) employees. D) none of the above.

Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Easy 45. Which ONE of the following statements is true? A) The economic order quantity (EOQ) mathematically determines the minimum total inventory cost. B) The EOQ takes into account reorder costs and inventory carrying costs. C) The optimal order size is determined by the EOQ model. D) All of the above

Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Easy 46. Which one of the following statements describes the finding from academic studies on corporate dividend policy? A) Managers tend to increase regular cash dividends in response to unexpectedly high earnings. B) Managers tend to maintain a level dividend payment at an amount that they are relatively certain they can maintain in the future. C) Managers tend to focus on dividends rather than stock repurchases because institutional investors tend to prefer regular dividends. D) Dividend policy doesn't matter because investors can re-create dividends by selling a fraction of their shares.

Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Easy 47. Which one of the following statements about just-in-time inventory management policy is NOT true? A) It calls for the exact day-by-day, or even hour-by-hour raw material needs to be delivered by the suppliers. B) If the supplier fails to make the needed deliveries, then production shuts down. C) A big disadvantage in this system is that there are high raw inventory costs. D) It eliminates obsolescence or loss to theft.

Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Easy 48. Which one of these actions could by itself have an impact on the control of the firm? A) A tender offer stock repurchase B) A special dividend payment C) A stock split D) A regular cash dividend payment

Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Easy 51. Which one of the following statements is NOT true? A) In a competitive sale, the firm specifies the type and amount of securities it wants to sell. B) In a negotiated sale, the issuer selects the underwriter at the beginning of the origination process. C) In a general cash offer, management must decide whether to sell the securities on a competitive or a negotiated basis. D) For equity securities, competitive sales generally provide the lowest-cost method of sale.

A Feedback: Economic order quantity = 124 clocks

Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Medium 80. Ticktock Clocks sells 10,000 alarm clocks each year. If the total cost of placing an order is $65 and it costs $85 per year to carry the alarm clock in inventory, use the EOQ formula to calculate the optimal order size. A) 124 clocks B) 161 clocks C) 15,294 clocks D) 26,154 clocks

Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Medium 42. Which ONE of the following statements about working capital tradeoff is true? A) Financial managers need to balance shortage costs against carrying costs to find an optimal strategy. B) If carrying costs are larger than shortage costs, then the firm will maximize value by adopting a more restrictive strategy. C) If shortage costs dominate carrying costs, the firm will need to move toward a more flexible policy. D) All of the above

Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Medium 46. Which one of the following statements is NOT true? A) The economic order quantity (EOQ) mathematically determines the minimum total inventory cost. B) The EOQ ignores reorder costs and inventory carrying costs. C) The optimal order size is determined by the EOQ model. D) All of the above.

Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Medium 47. Which of the following considerations should NOT be related to management's concerns when setting a dividend or stock repurchase policy? A) Over the long term, how much does the company's level of earnings exceed its investment requirements? How certain is this level? B) Is the stock currently undervalued? Can the management add value to the company by initiating a stock repurchase? C) Does the firm have enough financial reserves to maintain the dividend policy in periods when earnings are down or investment requirements are up? D) Can the firm quickly raise equity capital if necessary?

Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Medium 50. Good Signal Co. is currently trading for $10 with 1 million shares outstanding. Which of the following actions would be the most credible signal that management believes that the long-term prospects for a company has improved? A) Pay a $0.20 extra dividend in addition to the company's $0.20 regular quarterly dividend. B) Increase the company's regular quarterly dividend from $0.20 to $0.40. C) Initiate an open-market stock repurchase of 2 percent of the company's stock. D) Initiate a Dutch auction tender offer stock repurchase for 2 percent of the company's stock.

Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Medium 52. Which one of the following statements is NOT true? A) Shelf registration gives firms less flexibility in bringing securities to market. B) During a two-year window, the firm can take the securities "off the shelf" and sell them as needed. C) Shelf registration allows firms to periodically sell small amounts of securities. D) A shelf registration statement can cover multiple securities, and there is no penalty if authorized securities are not issued.

Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Medium 53. Benefits from shelf registration include all EXCEPT: A) Greater flexibility in bringing securities to market. B) Shelf registration allows firms to periodically sell small amounts of securities and raise capital as needed. C) A shelf registration statement can cover multiple securities, but there is a penalty if authorized securities are not issued. D) Costs associated with selling the securities are reduced because only a single registration statement is required.

A Feedback: Underwriter's spread = 6 % Price per share the firm gets = 23.50*(1 - 0.06) = $22.09 Therefore, to raise $30 million, the company needs to issue: $30,000,000 / $22.09 = 1,358,081 new shares

Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Medium 72. General cash offering: Star Corporation, an auto fuel cell maker, is planning a new plant and needs to raise $30 million to finance it. The company plans to raise the money through a general cash offering priced at $23.50 a share. Star's underwriters charge a 6 percent spread. How many shares does the company have to sell to achieve its goal? A) 1,358,081 shares B) 1,276,596 shares C) 1,200,000 shares D) None of the above

C Feedback: Each share you sell will yield ($50 + ($75 - $50) × 0.85) = $71.25. To raise $3,420, you must sell $3,420 / $71.25 = 48 shares.

Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Medium 75. Dividend policy and firm value: You purchased 2,000 shares of NoDiv Technologies several years ago at $50 per share. The company does not pay a regular cash dividend. You want to "manufacture" your own dividend by selling a little bit of stock each quarter. The company's stock is currently trading at $75. If capital gains are taxed at 15 percent, how many shares would you have to sell to receive $3,420 in cash? A) 27 shares B) 46 shares C) 48 shares D) 51 shares

C Feedback: Each share you sell will yield ($20 + ($60 - $20) × 0.85) = $54. To raise $2,000 you must sell $2,000 / $54 = 37 shares.

Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Medium 76. Dividend policy and firm value: You purchased 8,000 shares of NoDiv Technologies several years ago at $20 per share. The company does not pay a regular cash dividend. You want to "manufacture" your own dividend by selling a little bit of stock each quarter. The company's stock is currently trading at $60. If capital gains are taxed at 15 percent, how many shares would you have to sell to receive $2,000 in cash? A) 30 shares B) 33 shares C) 37 shares D) 39 shares

Format: Multiple Choice Learning Objective: LO 6 Level of Difficulty: Medium 48. Which one of the following statements about collection time is NOT true? A) Collection time, or float, is the time between when a customer makes a payment and when the cash becomes available to the firm. B) Collection time can be broken down into three components. C) Delivery time or mailing time is not part of the float. D) Processing delay is part of the collection time.

B Feedback: After taxes you will receive ($2.00 x 0.85) × 4,000 shares = $6,800. With the DRIP program, you will not have any transaction costs to reinvest. So you can buy: ($6,800 / $48.20) = 141 shares

Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Medium 77. Dividend policy and firm value: You purchased 4,000 shares of High-Div Co. several years ago at $50 per share. The company has decided to pay a special dividend of $2.00 per share. Dividend payments are taxed at 15 percent. You intend to reinvest in the company through the dividend reinvestment program. If the company's stock is trading at $48.20 following the dividend payment, how many additional shares can you buy through the dividend reinvestment program? A) 166 shares B) 141 shares C) 134 shares D) 125 shares

D Feedback: After taxes you will receive ($1.00 x 0.85) × 7,000 shares = $5,950. You will also have to pay the $46 transaction fee, leaving you with $5,904 to invest. So you can buy: ($5,904 / $12.43) = 475 shares

Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Medium 78. Dividend policy and firm value: You own 7,000 shares of No-Drip Co. The company has decided to pay a special dividend of $1.00 per share. Dividend payments are taxed at 15 percent. You intend to reinvest your dividend back into the company, but the company does not have a dividend reinvestment program. To reinvest through your broker, you will have to pay a $46 commission. If the company's stock is trading at $12.43 following the dividend payment, how many additional shares will you be able to purchase? A) 563 shares B) 481 shares C) 478 shares D) 475 shares

D Feedback: To continue the current dividend pattern, the company will need to pay $0.20 per quarter x 4 quarter) x 2 million shares = $1,600,000. The company will also need ($800,000 debt payments + 200,000 CapEx) = $1,000,000. The company must maintain $500,000 cash and cash equivalents. The result is that to meet the dividend payments and other requirements operations must provide $1,600,000 + $1,000,000 = $2,600,000.

Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Medium 79. Stock price reactions to dividend announcements: The Dimples Golf Ball Co. has paid a regular dividend of $0.20 quarterly for the last three years. The company has 2 million shares outstanding. Over the next year the company will have to spend $800,000 to service its debt and spend $200,000 in capital expenditures. The company has $500,000 of cash and cash equivalents. Over the next year how much cash must be provided from operations to continue to make the same quarterly dividend payment, and still have $500,000 in cash at the end of the year? A) 1,000,000 B) 1,600,000 C) 2,000,000 D) 2,600,000

Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Medium 79. Why is the total cost of bringing a general cash offer to the market lower than issuing an IPO? a. They do not include a large underpricing b. Underwriting spreads are smaller c. There is less risk involved with a general cash offer than an IPO d. all of the above

Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Medium 80. Stock price reactions to dividend announcements: The Wyoming Boot Co. has paid a regular dividend of $0.25 quarterly for the last several years. The company has 1 million shares outstanding. Over the next year the company will have to spend $600,000 to service its debt and spend $500,000 in capital expenditures. The company has $600,000 of cash and cash equivalents. Over the next year how much cash must be provided from operations to continue to make the same quarterly dividend payment and still have $250,000 in cash at the end of the year? A) 1,000,000 B) 1,100,000 C) 1,750,000 D) 2,100,000

Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: hard 100. Real options: Consider a lease agreement recently offered by a car dealership. The agreement gives the customer the right to use a new SUV for three years in exchange for payments of $550 per month. At the end of the lease, the customer can choose to purchase the SUV for $15,000. What sort or option does this resemble? A) A put option on the SUV with a strike price of $15,000 B) A call option on the SUV with a strike price of $15,000 C) A put option on the SUV with a strike price of $19,800 D) A call option on the SUV with a strike price of $19,800

Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: hard 101. Risk management: CoolHaus, Inc., is a manufacturer of residential air conditioning equipment. Air conditioning equipment requires a lot of copper. In six months the company will purchase its copper supply for the next two years. Management is very concerned about the volatility of copper prices. Assume the risk-free rate of interest is 0 percent. Which of the following transactions will ensure the company does not have to pay more then $8,100 per ton of copper six months from now? A) The company purchases a put option for the necessary amount of copper with a strike price of $8,000 per ton, a premium of $100 per ton, and an expiration date six months from now. B) The company purchases a call option for the necessary amount of copper with a strike price of $8,000 per ton, a premium of $100 per ton, and an expiration date six months from now. C) The company sells a put option for the necessary amount of copper with a strike price of $8,000 per ton, a premium of $100 per ton and an expiration date six months from now. D) The company sells a call option for the necessary amount of copper with a strike price of $8,000 per ton, a premium of $100 per ton, and an expiration date six months from now.

Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: hard 98. Risk management: OilDog Co. is a privately owned oil drilling and hot dog producing company with a significant amount of debt. Most of the company's cash flows come from the very safe hot dog unit of the business. With only the assets in place, the company is very likely to avoid financial distress for the foreseeable future. Avoiding financial distress is very important to the owners, who founded the company. The company is considering a new oil field project, determined to have a positive NPV. Because of the nature of oil prices, the project is very risky. At any oil price above $110 the project would add value to the company. However, if oil prices were to fall below $90 the losses could push the entire business into financial distress. The risk-free interest rate is 0 percent. Which one of the following strategies would allow the firm to pursue the positive-NPV project while hedging the oil price risk? A) The firm purchases call options with a strike price of $120 for each barrel of oil it expects to produce. Each call option costs $5. B) The firm sells call options with a strike price of $120 on each barrel of oil it expects to produce. Each option costs $5. C) The firm purchases put options with a strike price of $120 on each barrel of oil it expects to produce. Each option costs $5. D) The firm sells put options with a strike price of $120 on each barrel of oil it expects to produce. Each option costs $5.

Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: hard 99. Risk management: Consider a wheat farmer who expects to produce 50,000 bushels of wheat at the end of this season. To hedge the risk associated with wheat prices, the farmer purchases put options to cover his entire crop. The put options have a strike price of $7.50 per and a premium of $0.30 per bushel. He also sells an equal amount of call options with a strike price of $7.50 per bushel and a premium of $0.43 a bushel. Which of the following statements is NOT correct? A) From this transaction the farmer can pocket $6,500 immediately. B) If wheat prices go up substantially, the farmer will earn more money. C) The put options guarantee that the farmer will receive at least $7.50 per bushel at the end of the season. D) The farmer has guaranteed that he will sell his wheat for $7.50 a bushel.

Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: medium 54. The employment contracts for professional athletes often contain options for either the player or the team. Consider one recent contract in Major League Baseball. The player's salary was guaranteed for the first couple years. However, after several years, the team had the option to cancel the contract if the player became injured. If we think of each player as a project for the team, this option feature of the contract is best described as A) the option to defer investment. B) the option to make follow-on investments. C) the option to change operations. D) the option to abandon projects.

Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: medium 55. RealEstates LLP is considering the construction of a new development of condominiums in downtown Austin, Texas. The site for the new development is currently occupied by an office building owned by the city. The project's profitability will depend largely on the population increase in Austin over the next several years. Rather than buy the site, RealEstates has entered into an agreement with the city to pay $200,000 for the right to purchase the site for $10 million two years from now. The real option embedded in this contract is best described as A) the option to defer investment. B) the option to make follow-on investments. C) the option to change operations. D) the option to abandon projects.

Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: medium 56. Consider a new firm that is working on the first generation of long-awaited consumer jet packs. The project will take a tremendous amount of R&D expenditure. Even if the development is successful, manufacturing the first generation of jet packs is likely to be so expensive that only a select few consumers will be able to afford them. The projected sales of the first generation of jet packs almost certainly won't cover the development and manufacturing costs—the project has a negative NPV. Which of these reasons would validate the firm's decision to pursue the jet pack project? A) If development is unsuccessful, it can abandon the project before spending money on manufacturing. B) If the project is successful, it may lead to a very profitable second project—a cheaper jet pack that will be a positive-NPV project. C) Because it is a high-tech firm, the cash flows generated by a project are not important to valuing the company. D) None of these reasons support the decision to pursue the project.

Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: medium 57. A local city government has awarded a contract to sequentially build five new elementary schools over the next 10 years. The price for each school has been spelled out in the contract, but at the beginning of each year the city can cancel the order for the remaining schools. The city government is concerned that if the population of the town does not grow as expected it may not need all of the schools. What sort of financial option does the option to cancel the order resemble? A) Owning a call option on the value of the new schools B) Owning a put option on the value of the new schools C) Selling a call option on the value of the new schools D) Selling a put option on the value of the new schools

Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: medium 58. Purchasing a house is a somewhat complicated process. Typically, if the buyer's offer is accepted by the seller, the transaction will not be completed or "closed" for several weeks. During this time the buyer may gather more information about the house or research other houses in the area. Some home purchase contracts include an option fee. The buyer may pay the seller a few hundred dollars for the right to walk away from the contract prior to closing for any reason. This option fee is best described as A) the option to defer investment. B) the option to make follow-on investments. C) the option to change operations. D) a put option on the house.

Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: medium 59. The management at Socrates Motors considered the option to abandon when building their new manufacturing plant. The design of the plant allows it to easily be converted to manufacture other types of large machinery. If their new line of cars is poorly received, their plant should be easy to sell to another manufacturing company. In this example, the extra cost of building the plant in such a way that it can easily be converted for other uses resembles A) the premium of a put option on the plant. B) the premium of a call option on the plant. C) the strike price of a put option on the plant. D) the strike price of a call option on the plant.

Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: medium 60. Franklin Foods has made the decision to invest in a new line of organic microwave dinners. The new line of dinners is a negative-NPV project; paying its suppliers to convert to organic practices will be expensive. However, the company will be in a good position to expand into more profitable lines of food if consumer demand for organic foods grows more then expected. The negative value of the organic dinner project most closely resembles: A) the premium of a put option on future organic projects. B) the premium of a call option on future organic projects. C) the strike price of a put option on future organic projects. D) the strike price of a call option on future organic projects.

Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: medium 61. Gnu Homes, Inc., is a developer of planned residential communities. It has entered into an option contract with a land owner outside Austin, Texas. It will pay the land owner $100,000 for the option to buy the land in two years at a price of $20 million. During that time Gnu Homes will evaluate population and real estate trends in Austin. Their plan is to buy the land if real estate prices in Austin increase enough that developing the land would be worth more then the $20 million price. The $20 million purchase price resembles A) the premium price of a put option on the land. B) the premium price of a call option on the land. C) the strike price of a put option on the land. D) the strike price of a call option on the land.

Format: Multiple Choice Learning Objective: LO 6 Level of Difficulty: Medium 54. Which one of the following statements is NOT true? A) For many smaller firms and firms of lower credit standing that have limited access, or no access, to the public markets, the cheapest source of external funding is often the private markets. B) Bootstrapping and venture capital financing are not part of the private market. C) Bootstrapping and venture capital financing are part of the private market. D) Many private companies that are owned by entrepreneurs, families, or family foundations and are sizable companies of high credit quality prefer to sell their securities in the private markets.

Format: Multiple Choice Learning Objective: LO 6 Level of Difficulty: Medium 55. Which one of the following statements is NOT true? A) Private placement occurs when a firm sells unregistered securities directly to investors such as insurance companies, commercial banks, or wealthy individuals. B) All corporate debt is sold through the private placement market. C) About half of all corporate debt is sold through the private placement market. D) Investment banks and money center banks often assist firms with private placements.

Format: Multiple Choice Learning Objective: LO 6 Level of Difficulty: Medium 57. Which one of the following statements is NOT true? A) Private equity firms pool money from wealthy investors, pension funds, insurance companies, and other sources to make investments. B) Private equity firms invest in more mature companies. C) Private equity firms invest in new companies. D) Private equity investors focus on firms that have stable cash flows because they use a lot of debt to finance their acquisitions.

Format: Multiple Choice Learning Objective: LO 6 Level of Difficulty: Medium 59. Which one of the following statements is NOT true? A) PIPE transactions are registered with the SEC. B) PIPE transactions are not registered with the SEC. C) In a PIPE transaction, investors purchase securities (equity or debt) directly from a publicly traded company in a private placement. D) The securities are virtually always sold to the investors at a discount to the price at which they would sell in the public markets.

Format: Multiple Choice Learning Objective: LO 6 Level of Difficulty: Medium 60. Which ONE of the following statements is true? A) Under federal securities law, they can be resold to investors in the public markets immediately even if they are not registered. B) As part of the PIPE contract, the company often agrees to register the restricted securities with the SEC, usually within 90 days of the PIPE closing. C) As part of the PIPE contract, the company often agrees to register the restricted securities with the SEC after 90 days of the PIPE closing. D) PIPE transactions involving a healthy firm can also be executed without the use of an investment bank but result in a cost increase of 7 to 8 percent of the proceeds.

A Feedback: Average daily sales = $41,250 No. of business days = 270 Average check amount = $165 No. of checks processed per day = $41,250 / $165 = 250 Collection time saved = 2.3 days Per check processing fee = $0.39 The cost of a lockbox = 250 checks × $0.39 per check × 270 days = $26,325 Savings from mail float = 2.3 days × $41,250 = $94,875 Savings from lockbox = ($94,875 - $26,325) = $68,550 x .05 = $4,743.75

Format: Multiple Choice Learning Objective: LO 6 Level of Difficulty: Medium 70. Lockbox: Porter Corp. has just signed up for a lockbox. Management expects the lockbox to reduce the mail float by 2.3 days. The firm's remittances average $41,250 a day, with the average check being $165. The bank charges $0.39 per processed check. Assume that there are 270 business days in a year and their opportunity cost of funds is 5 percent. What will the firm's savings be from using the lockbox? A) $4,743.75 B) $975.50 C) $2,632.50 D) $94,875.00

B Feedback: Average daily sales = $18,100 Collection time saved = 2.2 days Savings from mail float = 2.2 days × $18,100 = $39,820 Savings if invested = $39,820 x 0.06 = $2,389.20

Format: Multiple Choice Learning Objective: LO 6 Level of Difficulty: Medium 71. Lockbox: Rocky Corp. has daily sales of $18,100. The financial manager determined that a lockbox would reduce the collection time by 2.2 days. Assuming the company can earn 6 percent interest per year, what are the savings from the lockbox? Round to the nearest dollar. A) $3,620.50 B) $2,389.20 C) $39,820 D) $1,100.45

Format: Multiple Choice Learning Objective: LO 7 Level of Difficulty: Basic 79. Which of the following is a short-term financing instrument? A) Accounts payable B) Bank loans with a maturity of less than 1 year C) Commercial paper D) All of the above

Format: Multiple Choice Learning Objective: LO 7 Level of Difficulty: Medium 49. Which ONE of the following statements about matching maturity strategy is true? A) All working capital is funded with short-term borrowing. B) As the level of sales varies seasonally, short-term borrowing fluctuates between some minimum and maximum level. C) All fixed assets are funded with long-term financing. D) All of the above.

Format: Multiple Choice Learning Objective: LO 7 Level of Difficulty: Medium 50. Which ONE of the following statements about short term funding strategy is true? A) All working capital and a portion of fixed assets are funded with short-term debt. B) This strategy lowers the cost under some interest rate scenarios. C) It forces the firm to continually refinance the funding of the long-term assets in a changing interest rate environment. D) All of the above.

Format: Multiple Choice Learning Objective: LO 7 Level of Difficulty: Medium 51. Which one of the following statements is NOT true? A) Firms using matching maturity strategy fund all working capital needs with long-term borrowing. B) Long-term financing strategy relies on long-term debt to finance both capital assets and working capital. C) All working capital and a portion of fixed assets are funded with short-term debt when firms use the aggressive funding strategy. D) Firms using a matching maturity strategy fund all working capital needs with short-term borrowing.

Format: Multiple Choice Learning Objective: LO 7 Level of Difficulty: Medium 58. Private equity firms improve the performance of firms in which they invest by: A) making sure that the firms have the best possible management teams. B) closely monitoring each firm's performance and providing advice and counsel to the firm's management team. C) facilitating mergers and acquisitions that help improve the competitive positions of the companies in which they invest. D) All of the above.

C Feedback: Line of credit limit = $1,000,000 Loan rate = 6.25% Annual fee on unused balance = 0.5% Amount borrowed = $600,000 Unused balance = $400,000 Annual fee = $400,000 x 0.005 = $2,000 Interest expense = $600,000 x 0.0625 = $37,500

Format: Multiple Choice Learning Objective: LO 7 Level of Difficulty: Medium 67. Formal line of credit: Gibbs, Inc., has just set up a formal line of credit of $1 million with First National Bank. The line of credit is good for up to five years. The bank will be charging them an interest rate of 6.25 percent on the loan, and in addition the firm will pay an annual fee of 50 basis points on the unused balance. The firm borrowed $600,000 on the first day the credit line became available. What is the firm's effective interest rate on this line of credit? A) 8.00% B) 7.25% C) 6.58% D) 8.25%

D Feedback: Line of credit limit = $5,000,000 Loan rate = 7.5% Annual fee on unused balance = 0.5% Amount borrowed = $2,300,000 Unused balance = $2,700,000 Annual fee = $2,700,000 x 0.005 = $13,500 Interest expense = $2,300,000 x 0.075 = $172,500

Format: Multiple Choice Learning Objective: LO 7 Level of Difficulty: Medium 68. Formal line of credit: Trend, Inc., has just set up a formal line of credit of $5 million with First National Bank. The line of credit is good for up to three years. The bank will be charging them an interest rate of 7.5 percent on the loan, and in addition the firm will pay an annual fee of 50 basis points on the unused balance. The firm borrowed $2,300,000 on the first day the credit line became available. What is the firm's effective interest rate on this line of credit? Round to one decimal place. A) 8.5% B) 7.25% C) 9.0% D) 8.1%

B Feedback: Line of credit limit = $3,000,000 Loan rate = 6.25% Annual fee on unused balance = 0.6% Amount borrowed = $1,500,000 Unused balance = $500,000 Annual fee = $500,000 x 0.006 = $3,000 Interest expense = $1,500,000 x 0.0625 = $93,750

Format: Multiple Choice Learning Objective: LO 7 Level of Difficulty: Medium 69. Formal line of credit: Storm Electronics has set up a formal line of credit of $2 million with First Kentucky Bank. The line of credit is good for up to three years. The bank will be charging them an interest rate of 6.25 percent on the loan, and in addition the firm will pay an annual fee of 60 basis points on the unused balance. The firm borrowed $1,500,000 on the first day the credit line became available. What is the firm's effective interest rate on this line of credit? Round to two decimal places. A) 7.50% B) 6.45% C) 6.25% D) 7.15%

C Feedback: Prime rate = PR = 7.5% Maturity risk premium = MAT = 0.75% Default risk premium = DRP = 1.5% Cost of loan = k = PR + DRP + MAT = 7.5% + 1.5% = 0.75% = 9.75%

Format: Multiple Choice Learning Objective: LO 7 Level of Difficulty: Medium 73. Bank lending: Jasper, Inc., is looking for a five-year term loan of $3 million. Its bank is willing to make the loan. The firm will have to pay a premium of 1.5 percent for default risk and another 0.75 percent for maturity risk. The current prime rate is 7.5 percent. What is the loan rate on this bank loan? A) 9% B) 8.25% C) 9.75% D) None of the above

B Feedback: Prime rate =PR = 5.75%; Maturity risk premium = MAT = k10-year - kT-bill = 4.24% - 3.54% = 0.70% Borrowing rate for firm A = k = Prime rate + MAT = 5.75% + 0.70% = 6.45% Borrowing rate for firm B = k = Prime rate + 2% + MAT = 5.75% + 2% + 0.70% = 8.45%

Format: Multiple Choice Learning Objective: LO 7 Level of Difficulty: Medium 74. Bank lending: Suppose two firms want to borrow money from a bank for a period of 10 years. Firm A has excellent credit and can borrow at the prime rate, whereas Firm B's credit standing is prime + 2. The current prime rate is 5.75 percent, the 30-year Treasury bond yield is 4.35 percent, the three-month Treasury bill yield is 3.54 percent, and the 10-year Treasury note yield is 4.24 percent. What are the appropriate loan rates for each customer? A) 6.45%, 7.75% B) 6.45%, 8.45% C) 5.75%, 8.45% D) None of the above

A Feedback: Accounts receivables sold = $150,000 Factor discount = 2.875% Average collection period = 75 days Dollar cost of factoring per month = $150,000 x 0.02875 = $4,312.50 Simple monthly interest cost of factoring = 2.875/97.125 = 0.0296 Simple interest cost of factoring = 0.0296 x 12 = 35.5%

Format: Multiple Choice Learning Objective: LO 7 Level of Difficulty: Medium 74. Factoring: Pride, Inc., sells $150,000 of its accounts receivable to factors at 2.875 percent discount. The firm's average collection period is 75 days. What is the simple annual interest cost of the factors loan? A) 35.5% B) 32.9% C) 27.8% D) 31.1%

A Feedback: Prime rate =PR = 6.5%; Default risk premium = DRP = 1.5% Maturity risk premium = MAT = k5-year - kT-bill = 4.25% - 3.25% = 0.725% Borrowing rate for firm A = k = PR +DRP+ MAT = 6.5% + + 1.5% + 0.725% = 8.725%

Format: Multiple Choice Learning Objective: LO 7 Level of Difficulty: Medium 75. Bank lending: Marigold Corp. wants to borrow money from Howard Bank for a period of five years. The firm's credit standing calls for a premium of 1.5 percent over the prime rate. The current prime rate is 6.5 percent, the 30-year Treasury bond yield is 5.375 percent, the three-month Treasury bill yield is 3.525 percent, and the 5-year Treasury note yield is 4.25 percent. What is the appropriate loan rate for this customer? A) 8.725% B) 7.225% C) 6.500% D) None of the above

C Feedback: Accounts receivables sold = $125,000 Factor discount = 3% Average collection period = 30 days Dollar cost of factoring per month = $125,000 x 0.03 = $3,750

Format: Multiple Choice Learning Objective: LO 7 Level of Difficulty: Medium 75. Factoring: A firm sells $125,000 of its accounts receivable to factors at 3 percent discount. The firm's average collection period is one month. What is the dollar cost of the factoring service? A) $3,000 B) $4,500 C) $3,750 D) $4,250

B Feedback: kl = 2.75 + 1.80 + 0.50 = 5.05%

Format: Multiple Choice Learning Objective: LO 7 Level of Difficulty: Medium 78. Castle Co. needs to borrow $10 million for process improvement upgrades. Management decides to sell 20-year bonds. They determine that the 3-month Treasury bill rate is 2.75 percent, the firm's credit rating is A, and the yield on 20-year Treasury bonds is 1.80 percent higher than that for 3-month Treasury bills. Bonds with an A rating are selling for 50 basis points above the 20-year Treasury bond rate. What is the borrowing cost to do this transaction? a. 4.55% b. 5.05% c. 7.75% d. 9.55%

Format: Multiple Choice Learning Objective: LO for Appendix Level of Difficulty: Hard 85. LMNO Manufacturing needs a new laser and is comparing buying or leasing. Under either alternative, the company will only need the laser for 5 years. Assume LMNOs marginal tax rate is 30 percent. Purchase Alternative: It would cost $50,000 to purchase the laser and the amount could be financed with a five year balloon loan at 9%. The laser will be depreciated on straight line and have no salvage value. Maintenance on the laser is expected to be $1,200 per year. Lease alternative: The company that manufactures the laser offers a 5 year leasing option with annual lease payments of $12,500.With this option the lessor will be responsible for maintenance of the laser and will take it back after 5 years. The lease will be classified as an operating lease. Which is the best option for LMNO Manufacturing? A) Purchase, the company will be $4,416 better off. B) Lease, the company will be $4,416 better off. C) Purchase, the company is $10,496 better off D) Lease, the company is $10,496 better off

Format: Multiple Choice Learning Objective: LO for Appendix Level of Difficulty: Medium 82. Which of the following should a company consider when deciding to buy or lease an asset? A) Taxes B) Information or transaction costs C) If the choice would affect the real investment policy of the firm D) All of the above

Format: Multiple Choice Learning Objective: LO for Appendix Level of Difficulty: Medium 83. Which of the following arises because the lessee can have the incentive to use the asset more than the lessor would prefer? A) Operating lease conflict B) Capital lease conflict C) Intensity of use conflict D) Maintenance conflict

Format: Multiple Choice Learning Objective: LO for Appendix Level of Difficulty: Medium 84. Which of the following will limit the asset abuse problem for the lessor? A) Track the total services obtained from the asset and charge the lessee based on usage B) Bundle the lease contract with a service contract C) Provide the lessee with the right to buy the asset when the lease expires D) All of the above

C Feedback: Value of risk-free debt owner - Value of bonds maturing = $20mm

Suppose that UBM Corp has $100mm invested in 8% risk-free bonds that mature in one-year. The firm also has $80mm in debt outstanding that will also mature in a year. UBM shareholders are considering selling the $100mm in debt and investing in a project that has a 60% chance of returning $200mm and a 40% chance of returning $2mm. 76. Agency costs: What will the equity value of UBM be in one-year without shareholders taking on the project? A) $100mm B) $80mm C) $20mm D) $8mm

D Feedback: VFirm = [ CF × (1-t)] /i = [ $1,000 × (1 - 0.35) ] / 0.12 = $5,417

Millennium Motors has current pretax annual cash flows of $1,000 and is in the 35% tax bracket. The appropriate discount rate for its cash flows is 12%. Suppose the firm issues a $1,500 bond and uses these proceeds to pay a one-time special dividend to shareholders. 74. The cost of equity: What is its value without debt in the capital structure? A) $350 B) $650 C) $2,917 D) $5,417

B Feedback: PV of tax shield = $1,500 × 0.35 = $525 VFirm = VNo leverage+ PV of the tax shield = $5,417 + $525 = $5,942

Millennium Motors has current pretax annual cash flows of $1,000 and is in the 35% tax bracket. The appropriate discount rate for its cash flows is 12%. Suppose the firm issues a $1,500 bond and uses these proceeds to pay a one-time special dividend to shareholders. 75. The cost of equity: What is Millennium's value after the debt issuance? A) $5,417 B) $5,942 C) $6,392 D) None of the above.

B Feedback: Accounts receivables = $12,800 Accounts payables = $12,670 Net sales = $124,589 Inventory = $12,890 Cost of goods sold = $99,630

Ridge Company Account $ Inventory $12,890 Accounts receivable 12,800 Accounts payable 12,670 Net sales $124,589 Cost of goods sold 99,630 57. Operating cycle: What is the operating cycle for Ridge Company? A) 47 days B) 85 days C) 36 days D) 51 days

B Feedback: Accounts receivables = $12,800 Accounts payables = $12,670 Net sales = $124,589 Inventory = $12,890 Cost of goods sold = $99,630

Ridge Company Account $ Inventory $12,890 Accounts receivable 12,800 Accounts payable 12,670 Net sales $124,589 Cost of goods sold 99,630 58. Cash conversion cycle: What is the cash conversion cycle for Ridge Company? A) 83.5 days B) 38.3 days C) 129.9 days D) 46.4 days

C Feedback: With the debt, fixed cost percentage is (SG&A + Interest payments)/(SG&A + Interest payments + CGS) = ($100 + ($700)(0.05)) / ($100 + ($700)(0.05) + $400) = 25.23%. Therefore, variable costs are $400 / ($100 + ($200)(0.05) + $400) or 74.77%.

Suppose that Banana Computers has $1,000 in revenue this year, along with COGS of $400 and SG&A of $100. The required rate of return on its equity is 14%, and the risk-free rate is 5%. Assume that the COGS only includes the marginal costs of selling a computer. Banana is considering adding $700 worth of debt with a coupon rate of 5% and a YTM of 7.9% to its capital structure. 67. M&M Proposition 2: What percent of the firm's costs are fixed, and what percent are variable with the added debt? A) 27.9% and 72.1% B) 72.1% and 27.9% C) 25.23 and 74.77% D) 74.77% and 25.23%

C Feedback: Without debt, net income is $1000 - $400 - $100 = $500 With debt, net income is $1000 - $400 - $100 - $35 = $165

Suppose that Banana Computers has $1,000 in revenue this year, along with COGS of $400 and SG&A of $100. The required rate of return on its equity is 14%, and the risk-free rate is 5%. Assume that the COGS only includes the marginal costs of selling a computer. Banana is considering adding $700 worth of debt with a coupon rate of 5% and a YTM of 7.9% to its capital structure. 68. M&M Proposition 2: What is the net income of Banana without and with the debt? A) $500 and $484.2 B) $484.2 and $500 C) $500 and $465 D) $490 and $500

B Feedback: Without debt, the new net income is $700 - $400 - $100 = $200 Therefore, the percent change is ($500 - $200) / $500 = 60% With debt, the new net income is $700 - $400 - $100 - $35 = $165 Therefore, the percent change is ($465 - $165) / $465 = 64.5%

Suppose that Banana Computers has $1,000 in revenue this year, along with COGS of $400 and SG&A of $100. The required rate of return on its equity is 14%, and the risk-free rate is 5%. Assume that the COGS only includes the marginal costs of selling a computer. Banana is considering adding $700 worth of debt with a coupon rate of 5% and a YTM of 7.9% to its capital structure. 69. M&M Proposition 2: Suppose revenues fall by $300. What is the percent change in net income with and without the debt? Assume that the total variable productions costs remain the same. A) 64.5% and 60% B) 60% and 64.5% C) 59.2% and 40.8% D) 40.8% and 59.2%

C Feedback: E[VBonds] = (0.60 × $80 mm) × + (0.40 × $2mm) = $48.8 mm

Suppose that UBM Corp has $100mm invested in 8% risk-free bonds that mature in one-year. The firm also has $80mm in debt outstanding that will also mature in a year. UBM shareholders are considering selling the $100mm in debt and investing in a project that has a 60% chance of returning $200mm and a 40% chance of returning $2mm. 77. Agency costs: What is the expected value of the bonds to the lenders if the stockholders sell the debt? A) $100mm B) $88.8mm C) $48.8 mm D) None of the above.

D Feedback: E[VEquity] = ((0.60 × $200mm) - $80mm) + (0.40 × $0mm) = $40mm

Suppose that UBM Corp has $100mm invested in 8% risk-free bonds that mature in one-year. The firm also has $80mm in debt outstanding that will also mature in a year. UBM shareholders are considering selling the $100mm in debt and investing in a project that has a 60% chance of returning $200mm and a 40% chance of returning $2mm. 78. Agency costs: What is the expected value of the equity if the stockholders sell the debt? A) $175mm B) $97.5mm C) $51mm D) None of the above.

D Feedback: E[VEquity] = (PSuccess × 200mm - $80mm) + ((1 - PSuccess) × $0) = $20mm (PSuccess × 200mm - $80mm) = $20mm Therefore, PSuccess must be 1/6.

Suppose that UBM Corp has $100mm invested in 8% risk-free bonds that mature in one-year. The firm also has $80mm in debt outstanding that will also mature in a year. UBM shareholders are considering selling the $100mm in debt and investing in a project that has a 60% chance of returning $200mm and a 40% chance of returning $2mm. 79. Agency costs: Given the payoffs of the project, what does the percent chance of success need to be in order for the expected value of equity with the project to be equal to the expected value of equity without the project? A) 1/3 B) 1/4 C) 1/5 D) 1/6

D Feedback:

The formula for WACC is: Format: Multiple Choice Learning Objective: LO 4 Level of D ifficulty: Hard 80. Using the WACC in practice: Poly's Parrot Shops has found that its cost of common equity capital is 17 percent. It has 7-year maturity semiannual bonds outstanding with a price of $767.03 that have a coupon rate of 7 percent. If the firm is financed with $120,000,000 of common shares (market value) and $80,000,000 of debt, then what is the after-tax weighted average cost of capital for Poly's if it is subject to a 35 percent marginal tax rate? A) 10.20% B) 11.76% C) 11.88% D) 13.32%

B Feedback: Underwriter's gross spread ($22 - $17) =$5 per share. Number of shares outstanding = ($66 million/$22 per share) = 3 million. Underwriting cost = ($5 per share x 3.0 million shares) = $15.0 million

Use the following to answer questions 61-63: IPO pricing: Stump, Inc., a technology firm in Prairie View, Texas, issues a $66 million IPO priced at $17 per share, and the offering price to the public is $22 per share. The firm's legal fees, SEC registration fees, and other administrative costs are $350,000. The firm's stock price increases 15 percent on the first day. 61. What is the underpricing spread? A) $51 million B) $15 million C) $66 million D) None of the above.

A Feedback: Stock price at end of first day = $22(1.15) = $25.30 First-day underpricing = ($25.30 - $22) = $3.30 per share. Total underpricing = ($3.30 per share x 3,000,000 shares of stock) = $9,900,000

Use the following to answer questions 61-63: IPO pricing: Stump, Inc., a technology firm in Prairie View, Texas, issues a $66 million IPO priced at $17 per share, and the offering price to the public is $22 per share. The firm's legal fees, SEC registration fees, and other administrative costs are $350,000. The firm's stock price increases 15 percent on the first day. 62. What is the underpricing on this issue? A) $9,900,000 B) $24,900,000 C) $15,000,000 D) None of the above.

C Feedback: Total cost to the firm of selling the IPO = $15,000,000 + $350,000 + $9,900,000 = $25,250,000

Use the following to answer questions 61-63: IPO pricing: Stump, Inc., a technology firm in Prairie View, Texas, issues a $66 million IPO priced at $17 per share, and the offering price to the public is $22 per share. The firm's legal fees, SEC registration fees, and other administrative costs are $350,000. The firm's stock price increases 15 percent on the first day. 63. What is the firm's total cost of issuing the securities? A) $24.9 million B) $15.35 million C) $25.25 million D) None of the above

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