FIN3403 - Gunter - Exam 3

1. Last year, T-bills returned 2 percent while your investment in large-company stocks earned an average of 5 percent. Which one of the following terms refers to the difference between these two rates of return? A. risk premium B. geometric return C. arithmetic D. standard deviation E. variance

A. risk premium

100. A stock has a beta of 1.2 and an expected return of 17 percent. A risk-free asset currently earns 5.1 percent. The beta of a portfolio comprised of these two assets is 0.85. What percentage of the portfolio is invested in the stock? A. 71 percent B. 77 percent C. 84 percent D. 89 percent E. 92 percent

A. 71 percent βp = 0.85 = 1.2x + (1 - x)(0); Bp = 71 percent

30. Which one of the following is least apt to reduce the unsystematic risk of a portfolio? A. reducing the number of stocks held in the portfolio B. adding bonds to a stock portfolio C. adding international securities into a portfolio of U.S. stocks D. adding U.S. Treasury bills to a risky portfolio E. adding technology stocks to a portfolio of industrial stocks

A. reducing the number of stocks held in the portfolio

3. An analysis of the change in a project's NPV when a single variable is changed is called _____ analysis. A. forecasting B. scenario C. sensitivity D. simulation E. break-even

C. sensitivity

3. Which one of the following costs was incurred in the past and cannot be recouped? A. incremental B. side C. sunk D. opportunity E. erosion

C. sunk

7. The _____ tells us that the expected return on a risky asset depends only on that asset's nondiversifiable risk. A. efficient markets hypothesis B. systematic risk principle C. open markets theorem D. law of one price E. principle of diversification

B. systematic risk principle

30. The current book value of a fixed asset that was purchased two years ago is used in the computation of which one of the following? A. depreciation tax shield B. tax due on the salvage value of that asset C. current year's operating cash flow D. change in net working capital E. MACRS depreciation for the current year

B. tax due on the salvage value of that asset

3. Standard deviation is a measure of which one of the following? A. average rate of return B. volatility C. probability D. risk premium E. real returns

B. volatility

58. The Pancake House has sales of $1,642,000, depreciation of $27,000, and net working capital of $218,000. The firm has a tax rate of 35 percent and a profit margin of 6 percent. The firm has no interest expense. What is the amount of the operating cash flow? A. $98,520 B. $125,520 C. $147,480 D. $268,480 E. $343,520

B. $125,520 OCF = ($1,642,000 × 0.06) + $27,000 = $125,520

57. You own 400 shares of Western Feed Mills stock valued at $51.20 per share. What is the dividend yield if your annual dividend income is $352? A. 1.68 percent B. 1.72 percent C. 1.83 percent D. 1.13 percent E. 1.21 percent

B. 1.72 percent Dividend yield = ($352/400)/$51.20 = 1.72 percent

65. Peterborough Trucking just purchased some fixed assets that are classified as 3-year property for MACRS. The assets cost $10,600. What is the amount of the depreciation expense in year 3? MACRS 3-year Property (year / rate) 1 / 33.33% 2 / 44.45% 3 / 14.81% 4 / 7.41% A. $537.52 B. $1,347.17 C. $1,569.86 D. $1,929.11 E. $2,177.56

C. $1,569.86 Depreciation3 = $10,600 × 0.1481 = $1,569.86

63. Jerilu Markets has a beta of 1.09. The risk-free rate of return is 2.75 percent and the market rate of return is 9.80 percent. What is the risk premium on this stock? A. 6.47 percent B. 7.03 percent C. 7.68 percent D. 8.99 percent E. 9.80 percent

C. 7.68 percent Risk premium = 1.09 (0.098 - 0.0275) = 7.68 percent

61. The common stock of Manchester & Moore is expected to earn 13 percent in a recession, 6 percent in a normal economy, and lose 4 percent in a booming economy. The probability of a boom is 5 percent while the probability of a recession is 45 percent. What is the expected rate of return on this stock? A. 8.52 percent B. 8.74 percent C. 8.65 percent D. 9.05 percent E. 9.28 percent

C. 8.65 percent E(r) = (0.45 × 0.13) + (0.50 × 0.06) + (0.05 × - 0.04) = 8.65 percent

91. Which one of the following stocks is correctly priced if the risk-free rate of return is 3.7 percent and the market risk premium is 8.8 percent? Stock / Beta / Expected Return A / 0.64 / 9.47% B / 0.97 / 12.03% C / 1.22 / 14.44% D / 1.37 / 15.80% E / 1.68 / 18.37% A. A B. B C. C D. D E. E

C. C E(r)A = 0.037 + (0.64 × 0.088) = 0.0933 E(r)B = 0.037 + (0.97 × 0.088) = 0.1224 E(r)C = 0.037 + (1.22 × 0.088) = 0.1444 Stock C is correctly priced. E(r)D = 0.037 + (1.37 × 0.088) = 0.1576 E(r)E = 0.037 + (1.68 × 0.088) = 0.1848

84. The market has an expected rate of return of 11.2 percent. The long-term government bond is expected to yield 5.8 percent and the U.S. Treasury bill is expected to yield 3.9 percent. The inflation rate is 3.6 percent. What is the market risk premium? A. 6.0 percent B. 7.3 percent C. 7.6 percent D. 8.5 percent E. 9.3 percent

B. 7.3 percent Market risk premium = 11.2 percent - 3.9 percent = 7.3 percent

9. Which one of the following is a positively sloped linear function that is created when expected returns are graphed against security betas? A. reward-to-risk matrix B. portfolio weight graph C. normal distribution D. security market line E. market real returns

D. security market line

29. Which type of analysis identifies the variable, or variables, that are most critical to the success of a particular project? A. leverage B. risk C. break-even D. sensitivity E. cash flow

D. sensitivity

4. An analysis which combines scenario analysis with sensitivity analysis is called _____ analysis. A. forecasting B. combined C. complex D. simulation E. break-even

D. simulation

46. Total risk is measured by _____ and systematic risk is measured by _____. A. beta; alpha B. beta; standard deviation C. alpha; beta D. standard deviation; beta E. standard deviation; variance

D. standard deviation; beta

47. Inside information has the least value when financial markets are: A. weak form efficient. B. semiweak form efficient. C. semistrong form efficient. D. strong form efficient. E. inefficient.

D. strong form efficient.

96. Dog Up! Franks is looking at a new sausage system with an installed cost of $397,800. This cost will be depreciated straight-line to zero over the project's 7-year life, at the end of which the sausage system can be scrapped for $61,200. The sausage system will save the firm $122,400 per year in pretax operating costs, and the system requires an initial investment in net working capital of $28,560. All of the net working capital will be recovered at the end of the project. The tax rate is 33 percent and the discount rate is 9 percent. What is the net present value of this project? A. -$41,311 B. -$7,820 C. $81,507 D. $98,441 E. $118,821

E. $118,821

82. Based on past 23 years, Westerfield Industrial Supply's common stock has yielded an arithmetic average rate of return of 10.5 percent. The geometric average return for the same period was 8.57 percent. What is the estimated return on this stock for the next 4 years according to Blume's formula? A. 8.70 percent B. 8.92 percent C. 9.13 percent D. 9.38 percent E. 10.24 percent

E. 10.24 percent

95. What are the two primary lessons learned from capital market history? Use historical information to justify that these lessons are correct.

First, there is a reward for bearing risk, and second, the greater the risk, the greater the potential reward. As evidence, students should provide a brief discussion of the historical rates of return and the related standard deviations of the various asset classes discussed in the text.

104. What is the formula for the tax-shield approach to OCF? Explain the two key points the formula illustrates.

OCF = (Sales - Costs) × (1 - T) + Depreciation × T The formula illustrates that cash income and expenses affect OCF on an aftertax basis. The formula also illustrates that even though depreciation is a non-cash expense it does affect OCF because of the tax savings realized from the depreciation expense.

50. The Fluffy Feather sells customized handbags. Currently, it sells 18,000 handbags annually at an average price of $89 each. It is considering adding a lower-priced line of handbags that sell for $59 each. The firm estimates it can sell 7,000 of the lower-priced handbags but will sell 3,000 less of the higher-priced handbags by doing so. What is the amount of the sales that should be used when evaluating the addition of the lower-priced handbags? A. $146,000 B. $275,000 C. $413,000 D. $623,000 E. $680,000

A. $146,000 Sales = (7,000 × $59) + (-3,000 × $89) = $146,000

107. Explain how the beta of a portfolio can equal the market beta if 50 percent of the portfolio is invested in a security that has twice the amount of systematic risk as an average risky security.

An average risky security has a beta of 1.0, which is the market beta. Risk-free securities, i.e., U.S. Treasury bills, have a beta of zero. A portfolio that is invested 50 percent in a security that has a beta of 2.0 (twice the systematic risk as an average risky security) and 50 percent in risk-free securities (U.S. Treasury bills) will have a beta of 1.0 (which is the market beta).

102. Consider a project to supply 60,800,000 postage stamps to the U.S. Postal Service for the next 5 years. You have an idle parcel of land available that cost $760,000 five years ago; if the land were sold today, it would net you $912,000, aftertax. The land can be sold for $1,500,000 after taxes in 5 years. You will need to install $2,356,000 in new manufacturing plant and equipment to actually produce the stamps; this plant and equipment will be depreciated straight-line to zero over the project's 5-year life. The equipment can be sold for $456,000 at the end of the project. You will also need $469,000 in initial net working capital for the project, and an additional investment of $38,000 in every year thereafter. All net working capital will be recovered when the project ends. Your production costs are 0.38 cents per stamp, and you have fixed costs of $608,000 per year. Your tax rate is 31 percent and your required return on this project is 11 percent. What bid price per stamp should you submit? A. $0.018 B. $0.020 C. $0.023 D. $0.026 E. $0.029

D. $0.026

53. Nelson Mfg. owns a manufacturing facility that is currently sitting idle. The facility is located on a piece of land that originally cost $159,000. The facility itself cost $1,390,000 to build. As of now, the book value of the land and the facility are $159,000 and $458,000, respectively. The firm owes no debt on either the land or the facility at the present time. The firm received a bid of $1,700,000 for the land and facility last week. The firm's management rejected this bid even though they were told that it is a reasonable offer in today's market. If the firm was to consider using this land and facility in a new project, what cost, if any, should it include in the project analysis? A. $0 B. $617,000 C. $1,460,000 D. $1,700,000 E. $1,619,000

D. $1,700,000

6. The principle of diversification tells us that: A. concentrating an investment in two or three large stocks will eliminate all of the unsystematic risk. B. concentrating an investment in three companies all within the same industry will greatly reduce the systematic risk. C. spreading an investment across five diverse companies will not lower the total risk. D. spreading an investment across many diverse assets will eliminate all of the systematic risk. E. spreading an investment across many diverse assets will eliminate some of the total risk.

E. spreading an investment across many diverse assets will eliminate some of the total risk.

22. Which of the following variables will be at their highest expected level under a worst case scenario? I. fixed cost II. sales price III. variable cost IV. sales quantity

I and III only

109. A portfolio beta is a weighted average of the betas of the individual securities which comprise the portfolio. However, the standard deviation is not a weighted average of the standard deviations of the individual securities which comprise the portfolio. Explain why this difference exists.

Standard deviation measures total risk. The unsystematic portion of the total risk can be eliminated by diversification. Therefore, the total risk of a diversified portfolio is less than the total risk of the component parts. Beta, on the other hand, measures systematic risk, which cannot be eliminated by diversification. Thus, the systematic risk of a portfolio is the summation of the systematic risk of the component parts.

Define and explain the three forms of market efficiency.

The current stock price reflects the following information for each form of efficiency: Weak form efficiency - all historical information Semistrong form efficiency - all public and historical information Strong form efficiency - all private, public, and historical information

106. Assume a firm sets its bid price for a project at the minimum level as computed using the discounted cash flow method. Given this, what do you know about the net present value and the internal rate of return on the project as bid?

The discounted cash flow approach to setting a bid price assumes the net present value of the project will be zero which means the internal rate of return must equal the required rate.

107. Can the initial cash flow at time zero for a project ever be a positive value? If yes, give an example. If no, explain why not.

The initial cash flow can be a positive value. For example, if a project reduced net working capital by an amount that exceeded the initial cost for fixed assets, the initial cash flow would be a positive amount.

106. Explain how the slope of the security market line is determined and why every stock that is correctly priced, according to CAPM, will lie on this line.

The market risk premium is the slope of the security market line. Slope is the rise over the run, which in this case is the difference between the market return and the risk-free rate divided by a beta of 1.0 minus a beta of zero. If a stock is correctly priced the reward-to-risk ratio will be constant and equal to the slope of the security market line. Thus, every stock that is correctly priced will lie on the security market line.

105. What is the primary purpose of computing the equivalent annual costs when comparing two machines? What is the assumption that is being made about each machine?

The primary purpose is to compute the annual cost of each machine on a comparable basis so that the least expensive machine can be identified given that the machines generally have differing lives and costs. The assumption is that whichever machine is acquired, it will be replaced at the end of its useful life.

96. How can an investor lose money on a stock while making money on a bond investment if there is a reward for bearing risk? Aren't stocks riskier than bonds?

There is a reward for bearing risk over the long-term. However, the nature of risk implies the returns on a high risk security will be more volatile than the returns on a low risk security. Thus, stocks can produce lower returns in the short run. It is the acceptance of this risk that justifies the potential long-term reward.

108. Explain the difference between systematic and unsystematic risk. Also explain why one of these types of risks is rewarded with a risk premium while the other type is not.

Unsystematic, or diversifiable, risk affects a limited number of securities and can be eliminated by investing in securities from various industries and geographic regions. Unsystematic risk is not rewarded since it can be eliminated by investors. Systematic risk is risk which affects most, or all, securities and cannot be diversified away. Since systematic risk must be accepted by investors it is rewarded with a risk premium and is measured by beta.

98. You want to invest in an index fund which directly correlates to the overall U.S. stock market. How can you determine if the market risk premium you are expecting to earn is reasonable for the long-term?

You could compare your expectation to the historical market risk premium for the United States, as well as other industrialized countries, realizing of course, that the future will not be exactly like the past. Nevertheless, this should indicate whether or not your expectation is at least reasonable.

87. Keyser Mining is considering a project that will require the purchase of $875,000 in new equipment. The equipment will be depreciated straight-line to a zero book value over the 7-year life of the project. The equipment can be scraped at the end of the project for 5 percent of its original cost. Annual sales from this project are estimated at $420,000. Net working capital equal to 20 percent of sales will be required to support the project. All of the net working capital will be recouped. The required return is 16 percent and the tax rate is 34 percent. What is the value of the depreciation tax shield in year 4 of the project? A. $42,500 B. $52,200 C. $68,600 D. $71,400 E. $76,500 Depreciation tax shield = $875,000/7 × 0.34 = $42,500

A. $42,500 Depreciation tax shield = $875,000/7 × 0.34 = $42,500

62. The Lumber Yard is considering adding a new product line that is expected to increase annual sales by $238,000 and cash expenses by $184,000. The initial investment will require $96,000 in fixed assets that will be depreciated using the straight-line method to a zero book value over the 6-year life of the project. The company has a marginal tax rate of 32 percent. What is the annual value of the depreciation tax shield? A. $5,120 B. $13,160 C. $25,840 D. $32,560 E. $41,840

A. $5,120 Depreciation tax shield = ($96,000/6) × 0.32 = $5,120

98. A 4-year project has an initial asset investment of $306,600, and initial net working capital investment of $29,200, and an annual operating cash flow of -$46,720. The fixed asset is fully depreciated over the life of the project and has no salvage value. The net working capital will be recovered when the project ends. The required return is 15 percent. What is the project's equivalent annual cost, or EAC? A. -$158,491 B. -$152,309 C. -$147,884 D. -$145,509 E. -$142,212

A. -$158,491

78. Champion Bakers uses specialized ovens to bake its bread. One oven costs $689,000 and lasts about 4 years before it needs to be replaced. The annual operating cost per oven is $41,000. What is the equivalent annual cost of an oven if the required rate of return is 13 percent? A. -$272,638 B. -$248,313 C. -$232,407 D. -$200,561 E. $196,210

A. -$272,638

77. Automated Manufacturers uses high-tech equipment to produce specialized aluminum products for its customers. Each one of these machines costs $1,480,000 to purchase plus an additional $52,000 a year to operate. The machines have a 6-year life after which they are worthless. What is the equivalent annual cost of one these machines if the required return is 16 percent? A. -$453,657 B. -$427,109 C. -$301,586 D. -$295,667 E. -$256,947

A. -$453,657

80. The Buck Store is considering a project that will require additional inventory of $216,000 and will increase accounts payable by $181,000. Accounts receivable are currently $525,000 and are expected to increase by 9 percent if this project is accepted. What is the project's initial cash flow for net working capital? A. -$82,250 B. -$12,250 C. $12,250 D. $36,250 E. $44,250

A. -$82,250 NWC requirement = -$216,000 + $181,000 - ($525,000 × 0.09) = - $82,250

67. What is the amount of the risk premium on a U.S. Treasury bill if the risk-free rate is 2.8 percent and the market rate of return is 8.35 percent? A. 0.00 percent B. 2.80 percent C. 5.55 percent D. 8.35 percent E. 11.15 percent

A. 0.00 percent

81. Your portfolio is comprised of 40 percent of stock X, 15 percent of stock Y, and 45 percent of stock Z. Stock X has a beta of 1.16, stock Y has a beta of 1.47, and stock Z has a beta of 0.42. What is the beta of your portfolio? A. 0.87 B. 1.09 C. 1.13 D. 1.18 E. 1.21

A. 0.87 BetaPortfolio = (0.40 × 1.16) + (0.15 × 1.47) + (0.45 × 0.42) = 0.87

77. What is the standard deviation of the returns on a portfolio that is invested 52 percent in stock Q and 48 percent in stock R? SoE / Prob. of SOE / RoR if SoE Occurs Q / R Boom / 10% / 14% / 16% Normal / 90% / 8% / 11% A. 1.66 percent B. 2.47 percent C. 2.63 percent D. 3.28 percent E. 3.41 percent

A. 1.66 percent E(r)Boom = (0.52 × 0.14) + (.0.48 × 0.16) = 0.1496 E(r)Normal = (0.52 × 0.08) + (0.48 × 0.11) = 0.0944 E(r)Portfolio = (0.10 × .0.1496) + (0.90 × 0.0944) = 0.09992 VarPortfolio = [0.10 × (0.1496 - 0.09992)2] + [0.90 × (0.0944 - 0.09992)2] = 0.000274 Std dev = √0.000274 = 1.66 percent

73. What is the expected return on a portfolio that is equally weighted between stocks K and L given the following information? SoE / Prob. of SOE / RoR if SoE Occurs K / L Boom / 25% / 16% / 13% Normal / 75% / 12% / 8% A. 11.13 percent B. 11.86 percent C. 12.25 percent D. 13.32 percent E. 14.40 percent

A. 11.13 percent E(r) = 0.25[(0.16 + 0.13)/2] + 0.75[(0.12 + 0.08)/2] = 11.13 percent

66. The returns on the common stock of New Image Products are quite cyclical. In a boom economy, the stock is expected to return 32 percent in comparison to 14 percent in a normal economy and a negative 28 percent in a recessionary period. The probability of a recession is 25 percent while the probability of a boom is 20 percent. What is the standard deviation of the returns on this stock? A. 21.41 percent B. 21.56 percent C. 25.83 percent D. 32.08 percent E. 39.77 percent

A. 21.41 percent E(r) = (0.20 × 0.32) + (0.55 × 0.14) + (0.25 × -0.28) = 0.071 Var = 0.20 (0.32 - 0.071)2 + 0.55 (0.14 - 0.071)2 + 0.25 (-0.28 - 0.071)2 = 0.045819 Std dev = √0.045819 = 21.41 percent

69. You own the following portfolio of stocks. What is the portfolio weight of stock C? A. 39.85 percent B. 42.86 percent C. 44.41 percent D. 48.09 percent E. 52.65 percent

A. 39.85 percent Portfolio weightC = (600 × $18)/[(500 × $14) + (200 × $23) + (600 × $18) + (100 × $47)] = $10,800/$27,100 = 39.85 percent

79. A stock had returns of 16 percent, 4 percent, 8 percent, 14 percent, -9 percent, and -5 percent over the past six years. What is the geometric average return for this time period? A. 4.26 percent B. 4.67 percent C. 5.13 percent D. 5.39 percent E. 5.60 percent

A. 4.26 percent Geometric average = (1.16 × 1.04 × 1.08 × 1.14 × 0.91 × 0.95)1/6 - 1 = 4.26 percent

59. One year ago, you purchased a stock at a price of $47.50 a share. Today, you sold the stock and realized a total loss of 22.11 percent. Your capital gain was -$12.70 a share. What was your dividend yield? A. 4.63 percent B. 4.88 percent C. 5.02 percent D. 12.67 percent E. 14.38 percent

A. 4.63 percent Dividend yield = -0.2211 - (-12.70/$47.50) = 4.63 percent

38. According to Jeremy Siegel, the real return on stocks over the long-term has averaged about: A. 6.7 percent B. 8.7 percent C. 10.4 percent D. 12.3 percent E. 14.8 percent

A. 6.7 percent

79. Precision Tool is analyzing two machines to determine which one it should purchase. The company requires a 15 percent rate of return and uses straight-line depreciation to a zero book value over the life of its equipment. Machine A has a cost of $892,000, annual operating costs of $28,200, and a 4-year life. Machine B costs $1,118,000, has annual operating costs of $19,500, and has a 5-year life. Whichever machine is purchased will be replaced at the end of its useful life. Precision Tool should purchase Machine _____ because it lowers the firm's annual cost by approximately _______ as compared to the other machine. A. A; $12,380 B. A; $17,404 C. B; $16,965 D. B; $17,404 E. B; $17,521

A. A; $12,380

32. Which one of the following statements is correct? A. The greater the volatility of returns, the greater the risk premium. B. The lower the volatility of returns, the greater the risk premium. C. The lower the average return, the greater the risk premium. D. The risk premium is unrelated to the average rate of return. E. The risk premium is not affected by the volatility of returns.

A. The greater the volatility of returns, the greater the risk premium.

44. The systematic risk of the market is measured by: A. a beta of 1.0. B. a beta of 0.0. C. a standard deviation of 1.0. D. a standard deviation of 0.0. E. a variance of 1.0.

A. a beta of 1.0.

6. The return earned in an average year over a multi-year period is called the _____ average return. A. arithmetic B. standard C. variant D. geometric E. real

A. arithmetic

8. Which one of the following measures the amount of systematic risk present in a particular risky asset relative to the systematic risk present in an average risky asset? A. beta B. reward-to-risk ratio C. risk ratio D. standard deviation E. price-earnings ratio

A. beta

21. Changes in the net working capital requirements: A. can affect the cash flows of a project every year of the project's life. B. only affect the initial cash flows of a project. C. only affect the cash flow at time zero and the final year of a project. D. are generally excluded from project analysis due to their irrelevance to the total project. E. reflect only the changes in the current asset accounts.

A. can affect the cash flows of a project every year of the project's life.

28. Unsystematic risk: A. can be effectively eliminated by portfolio diversification. B. is compensated for by the risk premium. C. is measured by beta. D. is measured by standard deviation. E. is related to the overall economy.

A. can be effectively eliminated by portfolio diversification.

11. Which one of the following is the formula that explains the relationship between the expected return on a security and the level of that security's systematic risk? A. capital asset pricing model B. time value of money equation C. unsystematic risk equation D. market performance equation E. expected risk formula

A. capital asset pricing model

36. The top-down approach to computing the operating cash flow: A. ignores noncash expenses. B. applies only if a project increases sales. C. applies only to cost cutting projects. D. is equal to sales - costs - taxes + depreciation. E. is used solely to compute a bid price.

A. ignores noncash expenses.

1. The difference between a firm's future cash flows if it accepts a project and the firm's future cash flows if it does not accept the project is referred to as the project's: A. incremental cash flows. B. internal cash flows. C. external cash flows. D. erosion effects. E. financing cash flows.

A. incremental cash flows.

27. Which one of the following is an example of systematic risk? A. investors panic causing security prices around the globe to fall precipitously B. a flood washes away a firm's warehouse C. a city imposes an additional one percent sales tax on all products D. a toymaker has to recall its top-selling toy E. corn prices increase due to increased demand for alternative fuels

A. investors panic causing security prices around the globe to fall precipitously

49. The market rate of return is 11 percent and the risk-free rate of return is 3 percent. Lexant stock has 3 percent less systematic risk than the market and has an actual return of 12 percent. This stock: A. is underpriced. B. is correctly priced. C. will plot below the security market line. D. will plot on the security market line. E. will plot to the right of the overall market on a security market line graph.

A. is underpriced.

92. Assume that the returns from an asset are normally distributed. The average annual return for the asset is 18.1 percent and the standard deviation of the returns is 32.5 percent. What is the approximate probability that your money will triple in value in a single year? A. less than 0.5 percent B. less than 1 percent but greater than 0.5 percent C. less then 2.5 percent but greater than 1 percent D. less than 5 percent but greater than 2.5 percent E. less than 10 percent but greater than 5 percent

A. less than 0.5 percent

10. Which one of the following correctly describes the dividend yield? A. next year's annual dividend divided by today's stock price B. this year's annual dividend divided by today's stock price C. this year's annual dividend divided by next year's expected stock price D. next year's annual dividend divided by this year's annual dividend E. the increase in next year's dividend over this year's dividend divided by this year's dividend

A. next year's annual dividend divided by today's stock price

100. Chapman Machine Shop is considering a 4-year project to improve its production efficiency. Buying a new machine press for $576,000 is estimated to result in $192,000 in annual pretax cost savings. The press falls in the MACRS 5-year class, and it will have a salvage value at the end of the project of $84,000. The press also requires an initial investment in spare parts inventory of $24,000, along with an additional $3,600 in inventory for each succeeding year of the project. The inventory will return to its original level when the project ends. The shop's tax rate is 35 percent and its discount rate is 11 percent. Should the firm buy and install the machine press? Why or why not? MACRS 5-year Property (year / rate) 1 / 20.00% 2 / 32.00% 3 / 19.20% 4 / 11.52% 5 / 11.52% 6 / 5.76% A. no; The net present value is -$7,489. B. no; The net present value is -$667. C. yes; The net present value is $211. D. yes; The net present value is $4,319. E. yes; The net present value is $8,364.

A. no; The net present value is -$7,489.

47. The intercept point of the security market line is the rate of return which corresponds to: A. the risk-free rate. B. the market rate. C. a return of zero. D. a return of 1.0 percent. E. the market risk premium.

A. the risk-free rate.

16. Standard deviation measures which type of risk? A. total B. nondiversifiable C. unsystematic D. systematic E. economic

A. total

28. Sensitivity analysis is based on: A. varying a single variable and measuring the resulting change in the NPV of a project. B. applying differing discount rates to a project's cash flows and measuring the effect on the NPV. C. expanding and contracting the number of years for a project to determine the optimal project length. D. the best, worst, and most expected situations. E. various states of the economy and the probability of each state occurring.

A. varying a single variable and measuring the resulting change in the NPV of a project.

50. If you excel in analyzing the future outlook of firms, you would prefer the financial markets be ____ form efficient so that you can have an advantage in the marketplace. A. weak B. semiweak C. semistrong D. strong E. perfect

A. weak

97. Shawn earned an average return of 14.6 percent on his investments over the past 20 years while the S&P 500, a measure of the overall market, only returned an average of 13.9 percent. Explain how this can occur if the stock market is efficient.

An investor can purchase securities that have a higher level of risk than the overall market. In an efficient market, these securities will earn a higher return over the long-term as compensation for the assumption of the increased risk. This is the first lesson of the capital markets: There is a reward for bearing risk.

103. In a single sentence, explain how you can determine which cash flows should be included in the analysis of a project.

Any changes in cash flows that will result from accepting a new project should be included in the analysis of that project.

13. Which one of the following is an example of a sunk cost? A. $1,500 of lost sales because an item was out of stock B. $1,200 paid to repair a machine last year C. $20,000 project that must be forfeited if another project is accepted D. $4,500 reduction in current shoe sales if a store commences selling sandals E. $1,800 increase in comic book sales if a store commences selling puzzles

B. $1,200 paid to repair a machine last year

94. Phone Home, Inc. is considering a new 5-year expansion project that requires an initial fixed asset investment of $2.484 million. The fixed asset will be depreciated straight-line to zero over its 5-year tax life, after which time it will be worthless. The project is estimated to generate $2,208,000 in annual sales, with costs of $883,200. The tax rate is 32 percent and the required return on the project is 11 percent. What is the net present value for this project? A. $1,432,155 B. $1,433,059 C. $1,434,098 D. $1,434,217 E. $1,435,008

B. $1,433,059

59. Northern Railway is considering a project which will produce annual sales of $975,000 and increase cash expenses by $848,000. If the project is implemented, taxes will increase from $141,000 to $154,000 and depreciation will increase from $194,000 to $272,000. The company is debt-free. What is the amount of the operating cash flow using the top-down approach? A. $25,000 B. $114,000 C. $157,000 D. $181,000 E. $209,000

B. $114,000 OCF = $975,000 - $848,000 - ($154,000 - $141,000) = $114,000

72. Kwik 'n Hot Dogs is considering the installation of a new computerized pressure cooker that will cut annual operating costs by $23,000. The system will cost $39,900 to purchase and install. This system is expected to have a 4-year life and will be depreciated to zero using straight-line depreciation. What is the amount of the earnings before interest and taxes for this project? A. $10,525 B. $13,025 C. $15,525 D. $16,900 E. $19,400

B. $13,025 Earnings before interest and taxes = $23,000 - ($39,900/4) = $13,025

28. Morris Motors just purchased some MACRS 5-year property at a cost of $216,000. Which one of the following will correctly give you the book value of this equipment at the end of year 2? MACRS 5-year Property (year / rate) 1 / 20.00% 2 / 32.00% 3 / 19.20% 4 / 11.52% 5 / 11.52% 6 / 5.76% A. $216,000/(1 + 0.20 + 0.32) B. $216,000 × (1 - 0.20 - 0.32) C. $216,000 × (0.20 + 0.32) D. [$216,000 × (1 - 0.20)] × (1 - 0.32) E. $216,000/[(1 + 0.20)(1 + 0.32)]

B. $216,000 × (1 - 0.20 - 0.32)

71. A project will produce an operating cash flow of $14,600 a year for 7 years. The initial fixed asset investment in the project will be $48,900. The net aftertax salvage value is estimated at $12,000 and will be received during the last year of the project's life. What is the net present value of the project if the required rate of return is 12 percent? A. $22,627.54 B. $23,159.04 C. $34,627.54 D. $39,070.26 E. $41,040.83

B. $23,159.04

91. Consider the following income statement: Sales $510,944 Costs $332,416 Depreciation $77,300 EBIT ???? Taxes (32%) ???? Net Income ???? What is the amount of the depreciation tax shield? A. $23,607 B. $24,736 C. $24,598 D. $26,211 E. $26,919

B. $24,736 Depreciation tax shield = $77,300 × .32 = $24,736

64. You just purchased some equipment that is classified as 5-year property for MACRS. The equipment cost $147,000. What will the book value of this equipment be at the end of 4 years should you decide to resell the equipment at that point in time? MACRS 5-year Property (year / rate) 1 / 20.00% 2 / 32.00% 3 / 19.20% 4 / 11.52% 5 / 11.52% 6 / 5.76% A. $8,467.20 B. $25,401.60 C. $42,336.00 D. $121,598.40 E. $138,532.80

B. $25,401.60 Book Value4 = $147,000 × (0.1152 + 0.0576) = $25,401.60

55. Six months ago, you purchased 100 shares of stock in Global Trading at a price of $38.70 a share. The stock pays a quarterly dividend of $0.15 a share. Today, you sold all of your shares for $40.10 per share. What is the total amount of your dividend income on this investment? A. $15 B. $30 C. $45 D. $50 E. $60

B. $30 Dividend income = ($0.15 × 2) × 100 = $30

88. Keyser Mining is considering a project that will require the purchase of $980,000 in new equipment. The equipment will be depreciated straight-line to a zero book value over the 7-year life of the project. The equipment can be scraped at the end of the project for 5 percent of its original cost. Annual sales from this project are estimated at $420,000. Net working capital equal to 20 percent of sales will be required to support the project. All of the net working capital will be recouped. The required return is 16 percent and the tax rate is 35 percent. What is the amount of the aftertax salvage value of the equipment? A. $17,150 B. $31,850 C. $118,800 D. $237,600 E. $343,000

B. $31,850 Aftertax salvage value = $980,000 × 0.05 × (1 - 0.35) = $31,850

95. Phone Home, Inc. is considering a new 4-year expansion project that requires an initial fixed asset investment of $3 million. The fixed asset will be depreciated straight-line to zero over its 4-year tax life, after which time it will have a market value of $225,000. The project requires an initial investment in net working capital of $330,000, all of which will be recovered at the end of the project. The project is estimated to generate $2,640,000 in annual sales, with costs of $1,056,000. The tax rate is 33 percent and the required return for the project is 15 percent. What is the net present value for this project? A. $714,056 B. $681,409 C. $741,335 D. $742,208 E. $744,595

B. $681,409

85. Hollister & Hollister is considering a new project. The project will require $535,000 for new fixed assets, $218,000 for additional inventory, and $39,000 for additional accounts receivable. Short-term debt is expected to increase by $165,000. The project has a 6-year life. The fixed assets will be depreciated straight-line to a zero book value over the life of the project. At the end of the project, the fixed assets can be sold for 20 percent of their original cost. The net working capital returns to its original level at the end of the project. The project is expected to generate annual sales of $875,000 and costs of $640,000. The tax rate is 31 percent and the required rate of return is 14 percent. What is the amount of the aftertax cash flow from the sale of the fixed assets at the end of this project? A. $35,496 B. $73,830 C. $104,400 D. $287,615 E. $344,520

B. $73,830 Aftertax salvage value = $535,000 × 0.20 × (1 - 0.31) = $73,830

47. Kelly's Corner Bakery purchased a lot in Oil City 6 years ago at a cost of $302,000. Today, that lot has a market value of $340,000. At the time of the purchase, the company spent $15,000 to level the lot and another $20,000 to install storm drains. The company now wants to build a new facility on that site. The building cost is estimated at $1.51 million. What amount should be used as the initial cash flow for this project? A. -$1,470,000 B. -$1,850,000 C. -$1,875,000 D. -$1,925,000 E. -$1,945,000

B. -$1,850,000 CF0 = -$340,000 - $1,510,000 = -$1,850,000

63. Four months ago, you purchased 1,500 shares of Lakeside Bank stock for $11.20 a share. You have received dividend payments equal to $0.25 a share. Today, you sold all of your shares for $8.60 a share. What is your total dollar return on this investment? A. -$3,900 B. -$3,525 C. -$3,150 D. -$2,950 E. -$2,875

B. -$3,525 Total dollar return = ($8.60 - $11.20 + $0.25) × 1,500 = -$3,525

54. One year ago, you purchased a stock at a price of $33.49. The stock pays quarterly dividends of $0.20 per share. Today, the stock is selling for $28.20 per share. What is your capital gain on this investment? A. -$5.49 B. -$5.29 C. -$4.76 D. -$4.16 E. -$5.09

B. -$5.29 Capital gain = $28.20 - $33.49 = -$5.29

83. Hollister & Hollister is considering a new project. The project will require $543,000 for new fixed assets, $218,000 for additional inventory, and $42,000 for additional accounts receivable. Short-term debt is expected to increase by $165,000. The project has a 6-year life. The fixed assets will be depreciated straight-line to a zero book value over the life of the project. At the end of the project, the fixed assets can be sold for 20 percent of their original cost. The net working capital returns to its original level at the end of the project. The project is expected to generate annual sales of $875,000 with costs of $640,000. The tax rate is 34 percent and the required rate of return is 13 percent. What is the project's cash flow at time zero? A. -$536,000 B. -$638,000 C. -$720,000 D. -$779,000 E. -$944,000

B. -$638,000 Initial cash flow = -$543,000 - $218,000 - $42,000 + $165,000 = -$638,000

80. A stock had the following prices and dividends. What is the geometric average return on this stock? Year / Price / Dividend 1 / $16.40 / - 2 / $16.10 / $0.50 3 / $15.48 / $0.50 4 / $9.15 / $0.75 A. -15.87 percent B. -13.71 percent C. -13.33 percent D. -12.91 percent E. -11.48 percent

B. -13.71 percent

66. One year ago, you purchased 150 shares of a stock at a price of $54.18 a share. Today, you sold those shares for $40.25 a share. During the past year, you received total dividends of $182 while inflation averaged 4.2 percent. What is your approximate real rate of return on this investment? A. -24.20 percent B. -27.67 percent C. -20.00 percent D. 20.00 percent E. 24.20 percent

B. -27.67 percent

75. What is the variance of the returns on a portfolio that is invested 60 percent in stock S and 40 percent in stock T? SoE / Prob. of SOE / RoR if SoE Occurs S / T Boom / 20% / 17% / 7% Normal / 80% / 13% / 10% A. .000017 B. .000023 C. .000118 D. .000136 E. .000161

B. .000023 E(r)Boom = (0.60 × 0.17) + (0.40 × 0.07) = 0.13 E(r)Normal = (0.60 × 0.13) + (0.40 × 0.10) = 0.118 E(r)Portfolio = (0.20 × 0.13) + (0.80 × 0.118) = 0.1204 VarPortfolio = 0.20 (0.13 - 0.1204)2] + 0.80 (0.118 - 0.1204)2 = .000023

64. If the economy is normal, Charleston Freight stock is expected to return 16.5 percent. If the economy falls into a recession, the stock's return is projected at a negative 11.6 percent. The probability of a normal economy is 80 percent while the probability of a recession is 20 percent. What is the variance of the returns on this stock? A. 0.010346 B. 0.012634 C. 0.013420 D. 0.013927 E. 0.014315

B. 0.012634

87. You've observed the following returns on Crash-n-Burn Computer's stock over the past five years: 2 percent, -12 percent, 16 percent, 22 percent, and 18 percent. What is the variance of these returns? A. 0.02070 B. 0.01972 C. 0.01725 D. 0.01684 E. 0.02633

B. 0.01972 Average = (0.02 - 0.12 + 0.16 + 0.22 + 0.18)/5 = 0.092 Variance = [1/(5 - 1)] [(0.02 - 0.092)2 + (-0.12 - 0.092)2 + (0.16 - 0.092)2 + (0.22 - 0.092)2 + (0.18 - 0.092)2] = 0.01972

71. A stock has an expected rate of return of 13 percent and a standard deviation of 21 percent. Which one of the following best describes the probability that this stock will lose at least half of its value in any one given year? A. 0.1 percent B. 0.5 percent C. 1.0 percent D. 2.5 percent E. 5.0 percent

B. 0.5 percent

99. A stock has an expected return of 11 percent, the risk-free rate is 5.2 percent, and the market risk premium is 5 percent. What is the stock's beta? A. 1.08 B. 1.16 C. 1.29 D. 1.32 E. 1.35

B. 1.16 E(Ri) = 0.11 = 0.052 + βi(0.04); βi = 1.16

89. You bought one of Great White Shark Repellant Co.'s 10 percent coupon bonds one year ago for $815. These bonds pay annual payments, have a face value of $1,000, and mature 14 years from now. Suppose you decide to sell your bonds today when the required return on the bonds is 14 percent. The inflation rate over the past year was 3.7 percent. What was your total real return on this investment? A. 2.97 percent B. 1.75 percent C. 1.18 percent D. 3.44 percent E. 2.58 percent

B. 1.75 percent Nominal return = ($759.92 - $815 + $100)/$815 = 0.0551 Real return = [(1 + 0.0551)/(1 + 0.037)] - 1 = 1.75 percent

40. How many diverse securities are required to eliminate the majority of the diversifiable risk from a portfolio? A. 5 B. 10 C. 25 D. 50 E. 75

B. 10

91. A stock had returns of 12 percent, 16 percent, 10 percent, 19 percent, 15 percent, and -6 percent over the last six years. What is the geometric average return on the stock for this period? A. 10.90 percent B. 10.68 percent C. 13.56 percent D. 14.76 percent E. 15.01 percent

B. 10.68 percent Geometric average = (1.12 × 1.16 × 1.10 × 1.19 × 1.15 × 0.94)1/6 - 1 = 10.68 percent

85. The risk-free rate of return is 3.9 percent and the market risk premium is 6.2 percent. What is the expected rate of return on a stock with a beta of 1.21? A. 10.92 percent B. 11.40 percent C. 12.22 percent D. 12.47 percent E. 12.79 percent

B. 11.40 percent E(r) = 0.039 + (1.21 × 0.062) = 11.40 percent

72. What is the expected return on this portfolio? Stock / Expected Return / # of Shares / Stock Price A / 12% / 300 / $28 B / 7% / 500 / $10 C / 15% / 600 / $19 A. 11.48 percent B. 12.37 percent C. 13.03 percent D. 13.42 percent E. 13.97 percent

B. 12.37 percent Portfolio value = (300 × $28) + (500 × $10) + (600 × $19) = $8,400 + $5,000 + $11,400 = $24,800; E(r) = ($8,400/$24,800) (0.12) + ($5,000/$24,800) (0.07) + ($11,400/$24,800) (0.15) = 12.37 percent

96. What is the expected return of an equally weighted portfolio comprised of the following three stocks? SoE / Prob. of SOE / RoR if SoE Occurs Stock A / B / C Boom / 0.64 / 0.19 / 0.13 / 0.31 Bust / 0.36 / 0.15 / 0.11 / 0.17 A. 16.33 percent B. 18.60 percent C. 19.67 percent D. 20.48 percent E. 21.33 percent

B. 18.60 percent E(Rp)Boom = (0.19 + 0.13 + 0.31)/3 = 0.21 E(Rp)Bust = (0.15 + 0.11 + 0.17)/3 = 0.1433 E(Rp) = 0.64(0.21) + 0.36(0.1433) = 18.60 percent

67. What is the standard deviation of the returns on a stock given the following information? SoE / Prob. of SOE / RoR if SoE Occurs Boom / 30% / 15% Normal / 65% / 12% Recession / 5% / 6% A. 1.57 percent B. 2.03 percent C. 2.89 percent D. 3.42 percent E. 4.01 percent

B. 2.03 percent E(r) = (0.30 × 0.15) + (0.65 × 0.12) + (0.05 × 0.06) = 0.126 Var = 0.30 (0.15 - 0.126)2 + 0.65 (0.12 - 0.126)2 + 0.05 (0.06 - 0.126)2 = 0.000414 Std dev = √0.000414 = 2.03 percent

78. What is the standard deviation of the returns on a $30,000 portfolio which consists of stocks S and T? Stock S is valued at $21,000. SoE / Prob. of SOE / RoR if SoE Occurs S / T Boom / 5% / 11% / 5% Normal / 85% / 8% / 6% Recession / 10% / -5% / 8% A. 2.07 percent B. 2.61 percent C. 3.36 percent D. 3.49 percent E. 3.63 percent

B. 2.61 percent E(r)Boom = [$21,000/$30,000] [0.11] + [($30,000 - $21,000)/$30,000] [0.05] = 0.092 E(r)Normal = [$21,000/$30,000] [0.08] + [($30,000 - $21,000)/$30,000] [0.06] = 0.074 E(r)Bust = [$21,000/$30,000] [-0.05] + [($30,000 - $21,000)/$30,000] [0.08] = -0.011 E(r)Portfolio = (0.05 × 0.092) + (0.85 × 0.074) + (0.10 × -0.011) = 0.0664 VarPortfolio = [0.05 × (0.074 - 0.0664)2] + [0.85 × (0.068 - 0.0664)2] + [0.10 × (0.028 - 0.0664)2] = .000680940 Std dev = √0.000680940 = 2.61 percent

62. You are comparing stock A to stock B. Given the following information, what is the difference in the expected returns of these two securities? SoE / Prob. of SOE / Stock A RoR if SoE Occurs/ Stock B RoRif SoE Occurs Normal / 45% / 12% / 17% Recession / 55% / -22% / -31% A. -0.85 percent B. 2.70 percent C. 3.05 percent D. 13.45 percent E. 13.55 percent

B. 2.70 percent

62. Today, you sold 200 shares of Indian River Produce stock. Your total return on these shares is 6.2 percent. You purchased the shares one year ago at a price of $31.10 a share. You have received a total of $100 in dividends over the course of the year. What is your capital gains yield on this investment? A. 3.68 percent B. 4.59 percent C. 5.67 percent D. 7.26 percent E. 7.41 percent

B. 4.59 percent

77. A stock has annual returns of 6 percent, 14 percent, -3 percent, and 2 percent for the past four years. The arithmetic average of these returns is _____ percent while the geometric average return for the period is _____ percent. A. 4.57; 4.75 B. 4.75; 4.57 C. 6.33; 6.19 D. 6.19; 6.33 E. 6.33; 6.33

B. 4.75; 4.57

30. The average annual return on small-company stocks was about _____ percent greater than the average annual return on large-company stocks over the period 1926-2010. A. 3 B. 5 C. 7 D. 9 E. 11

B. 5

88. You've observed the following returns on Crash-n-Burn Computer's stock over the past five years: 3 percent, -10 percent, 24 percent, 22 percent, and 12 percent. Suppose the average inflation rate over this time period was 3.6 percent and the average T-bill rate was 4.8 percent. Based on this information, what was the average nominal risk premium? A. 5.15 percent B. 5.40 percent C. 6.01 percent D. 6.37 percent E. 6.60 percent

B. 5.40 percent Average return = (0.03 - 0.10 + 0.24 + 0.22 + 0.12)/5 = 0.102 Average nominal risk premium = 0.102 - 0.048 = 5.40 percent

65. Last year, you purchased a stock at a price of $47.10 a share. Over the course of the year, you received $2.40 per share in dividends while inflation averaged 3.4 percent. Today, you sold your shares for $49.50 a share. What is your approximate real rate of return on this investment? A. 6.30 percent B. 6.79 percent C. 7.18 percent D. 9.69 percent E. 10.19 percent

B. 6.79 percent Nominal return = ($49.50 - $47.10 + $2.40)/$47.10 = 10.19 percent Approximate real return = 0.1019 - 0.034 = 6.79 percent

68. You have a portfolio consisting solely of stock A and stock B. The portfolio has an expected return of 9.8 percent. Stock A has an expected return of 11.4 percent while stock B is expected to return 6.4 percent. What is the portfolio weight of stock A? A. 59 percent B. 68 percent C. 74 percent D. 81 percent E. 87 percent

B. 68 percent 0.098 = [0.114 x] + [0.064 (1 - x)]; x = 68 percent

87. The common stock of United Industries has a beta of 1.34 and an expected return of 14.29 percent. The risk-free rate of return is 3.7 percent. What is the expected market risk premium? A. 7.02 percent B. 7.90 percent C. 10.63 percent D. 11.22 percent E. 11.60 percent

B. 7.90 percent E(r) = 0.1429 = 0.037 + 1.34 Mrp; Mrp = 7.90 percent

38. Which one of the following statements is correct concerning bid prices? A. The bid price is the maximum price that a firm should bid. B. A firm can submit a bid that is higher than the computed bid price and still break even. C. A bid price ignores taxes. D. A bid price should be computed based solely on the operating cash flows of the project. E. A bid price should be computed based on a zero percent required rate of return.

B. A firm can submit a bid that is higher than the computed bid price and still break even.

43. Which one of the following statements is correct concerning a portfolio beta? A. Portfolio betas range between -1.0 and +1.0. B. A portfolio beta is a weighted average of the betas of the individual securities contained in the portfolio. C. A portfolio beta cannot be computed from the betas of the individual securities comprising the portfolio because some risk is eliminated via diversification. D. A portfolio of U.S. Treasury bills will have a beta of +1.0. E. The beta of a market portfolio is equal to zero.

B. A portfolio beta is a weighted average of the betas of the individual securities contained in the portfolio.

26. Which one of the following statements is correct? A. Project analysis should only include the cash flows that affect the income statement. B. A project can create a positive operating cash flow without affecting sales. C. The depreciation tax shield creates a cash outflow for a project. D. Interest expense should always be included as a cash outflow when analyzing a project. E. The opportunity cost of a company-owned building that is going to be used in a new project should be included as a cash inflow to the project.

B. A project can create a positive operating cash flow without affecting sales.

101. Eads Industrial Systems Company (EISC) is trying to decide between two different conveyor belt systems. System A costs $427,000, has a 6-year life, and requires $115,000 in pretax annual operating costs. System B costs $502,000, has an 8-year life, and requires $79,000 in pretax annual operating costs. Both systems are to be depreciated straight-line to zero over their lives and will have a zero salvage value. Whichever system is chosen, it will not be replaced when it wears out. The tax rate is 33 percent and the discount rate is 24 percent. Which system should the firm choose and why? A. A; The net present value is $211,516. B. A; The net present value is -$588,792. C. A; The net present value is -$314,216. D. B; The net present value is $308,222. E. B: The net present value is -$612,240.

B. A; The net present value is -$588,792.

7. Which one of the following is the depreciation method which allows accelerated write-offs of property under various lifetime classifications? A. IRR B. ACRS C. AAR D. straight-line to zero E. straight-line with salvage

B. ACRS

12. Which one of the following statements related to capital gains is correct? A. The capital gains yield includes only realized capital gains. B. An increase in an unrealized capital gain will increase the capital gains yield. C. The capital gains yield must be either positive or equal to zero. D. The capital gains yield is expressed as a percentage of the sales price. E. The capital gains yield represents the total return earned by an investor.

B. An increase in an unrealized capital gain will increase the capital gains yield.

92. Which one of the following stocks is correctly priced if the risk-free rate of return is 3.2 percent and the market rate of return is 11.76 percent? Stock / Beta / Expected Return A / 0.87 / 11.03% B / 1.09 / 12.50% C / 1.18 / 13.21% D / 1.34 / 15.02% E / 1.62 / 17.07% A. A B. B C. C D. D E. E

B. B E(r)A = 0.0354 + [0.87 × (0.1176 - 0.0354)] = 0.1069 E(r)B = 0.0354 + [1.09 × (0.1176 - 0.0354)] = 0.1250 Stock B is correctly priced. E(r)C = 0.0354 + [1.18 × (0.1176 - 0.0354)] = 0.1324 E(r)D = 0.0354 + [1.34 × (0.1176 - 0.0354)] = 0.1456 E(r)E = 0.0354 + [1.62 × (0.1176 - 0.0354)] = 0.1686

31. Which one of the following statements is correct concerning unsystematic risk? A. An investor is rewarded for assuming unsystematic risk. B. Eliminating unsystematic risk is the responsibility of the individual investor. C. Unsystematic risk is rewarded when it exceeds the market level of unsystematic risk. D. Beta measures the level of unsystematic risk inherent in an individual security. E. Standard deviation is a measure of unsystematic risk.

B. Eliminating unsystematic risk is the responsibility of the individual investor.

17. Which one of the following statements is a correct reflection of the U.S. markets for the period 1926-2010? A. U.S. Treasury bill returns never exceeded a 9 percent return in any one year during the period. B. U.S. Treasury bills provided a positive rate of return each and every year during the period. C. Inflation equaled or exceeded the return on U.S. Treasury bills every year during the period. D. Long-term government bonds outperformed U.S. Treasury bills every year during the period. E. National deflation occurred at least once every decade during the period.

B. U.S. Treasury bills provided a positive rate of return each and every year during the period.

41. Systematic risk is measured by: A. the mean. B. beta. C. the geometric average. D. the standard deviation. E. the arithmetic average.

B. beta.

29. Assume that you invest in a portfolio of large-company stocks. Further assume that the portfolio will earn a rate of return similar to the average return on large-company stocks for the period 1926-2010. What rate of return should you expect to earn? A. less than 10 percent B. between 10 and 12.5 percent C. between 12.5 and 15 percent D. between 15 and 17.5 percent E. more than 17.5 percent

B. between 10 and 12.5 percent

25. Sensitivity analysis determines the: A. range of possible outcomes given that most variables are reliable only within a stated range. B. degree to which the net present value reacts to changes in a single variable. C. net present value range that can be realized from a proposed project. D. degree to which a project relies on its fixed costs. E. ideal ratio of variable costs to fixed costs for profit maximization.

B. degree to which the net present value reacts to changes in a single variable.

2. Scenario analysis is defined as the: A. determination of the initial cash outlay required to implement a project. B. determination of changes in NPV estimates when what-if questions are posed. C. isolation of the effect that a single variable has on the NPV of a project. D. separation of a project's sunk costs from its opportunity costs. E. analysis of the effects that a project's terminal cash flows has on the project's NPV.

B. determination of changes in NPV estimates when what-if questions are posed.

32. Ted is analyzing a project using simulation. His focus is limited to the short-term. To ease the simulation process, he is combining expenses into various categories. Which one of the following should he include in the fixed cost category? A. production department payroll taxes B. equipment insurance C. sales tax D. raw materials E. product shipping costs

B. equipment insurance

34. To convince investors to accept greater volatility, you must: A. decrease the risk premium. B. increase the risk premium. C. decrease the real return. D. decrease the risk-free rate. E. increase the risk-free rate.

B. increase the risk premium.

53. Individuals who continually monitor the financial markets seeking mispriced securities: A. earn excess profits over the long-term. B. make the markets increasingly more efficient. C. are never able to find a security that is temporarily mispriced. D. are overwhelmingly successful in earning abnormal profits. E. are always quite successful using only historical price information as their basis of evaluation.

B. make the markets increasingly more efficient.

56. According to CAPM, the amount of reward an investor receives for bearing the risk of an individual security depends upon the: A. amount of total risk assumed and the market risk premium. B. market risk premium and the amount of systematic risk inherent in the security. C. risk free rate, the market rate of return, and the standard deviation of the security. D. beta of the security and the market rate of return. E. standard deviation of the security and the risk-free rate of return.

B. market risk premium and the amount of systematic risk inherent in the security.

20. If a stock portfolio is well diversified, then the portfolio variance: A. will equal the variance of the most volatile stock in the portfolio. B. may be less than the variance of the least risky stock in the portfolio. C. must be equal to or greater than the variance of the least risky stock in the portfolio. D. will be a weighted average of the variances of the individual securities in the portfolio. E. will be an arithmetic average of the variances of the individual securities in the portfolio.

B. may be less than the variance of the least risky stock in the portfolio.

41. Estimates of the rate of return on a security based on a historical arithmetic average will probably tend to _____ the expected return for the long-term and estimates using the historical geometric average will probably tend to _____ the expected return for the short-term. A. overestimate; overestimate B. overestimate; underestimate C. underestimate; overestimate D. underestimate; underestimate E. accurately; accurately

B. overestimate; underestimate

2. Suzie owns five different bonds valued at $36,000 and twelve different stocks valued at $82,500 total. Which one of the following terms most applies to Suzie's investments? A. index B. portfolio C. collection D. grouping E. risk-free

B. portfolio

3. Steve has invested in twelve different stocks that have a combined value today of $121,300. Fifteen percent of that total is invested in Wise Man Foods. The 15 percent is a measure of which one of the following? A. portfolio return B. portfolio weight C. degree of risk D. price-earnings ratio E. index value

B. portfolio weight

26. The excess return is computed as the: A. return on a security minus the inflation rate. B. return on a risky security minus the risk-free rate. C. risk premium on a risky security minus the risk-free rate. D. the risk-free rate plus the inflation rate. E. risk-free rate minus the inflation rate.

B. return on a risky security minus the risk-free rate.

53. The excess return earned by an asset that has a beta of 1.34 over that earned by a risk-free asset is referred to as the: A. market risk premium. B. risk premium. C. systematic return. D. total return. E. real rate of return.

B. risk premium.

15. The expected risk premium on a stock is equal to the expected return on the stock minus the: A. expected market rate of return. B. risk-free rate. C. inflation rate. D. standard deviation. E. variance.

B. risk-free rate.

2. The fact that a proposed project is analyzed based on the project's incremental cash flows is the assumption behind which one of the following principles? A. underlying value principle B. stand-alone principle C. equivalent cost principle D. salvage principle E. fundamental principle

B. stand-alone principle

57. Which one of the following should earn the most risk premium based on CAPM? A. diversified portfolio with returns similar to the overall market B. stock with a beta of 1.38 C. stock with a beta of 0.74 D. U.S. Treasury bill E. portfolio with a beta of 1.01

B. stock with a beta of 1.38

35. The bottom-up approach to computing the operating cash flow applies only when: A. both the depreciation expense and the interest expense are equal to zero. B. the interest expense is equal to zero. C. the project is a cost-cutting project. D. no fixed assets are required for a project. E. both taxes and the interest expense are equal to zero.

B. the interest expense is equal to zero.

46. Efficient financial markets fluctuate continuously because: A. the markets are continually reacting to old information as that information is absorbed. B. the markets are continually reacting to new information. C. arbitrage trading is limited. D. current trading systems require human intervention. E. investments produce varying levels of net present values.

B. the markets are continually reacting to new information.

33. Which one of the following risks is irrelevant to a well-diversified investor? A. systematic risk B. unsystematic risk C. market risk D. nondiversifiable risk E. systematic portion of a surprise

B. unsystematic risk

27. A company that utilizes the MACRS system of depreciation: A. will have equal depreciation costs each year of an asset's life. B. will have a greater tax shield in year two of a project than it would have if the firm had opted for straight-line depreciation, given the same depreciation life. C. can depreciate the cost of land, if it so desires. D. will expense less than the entire cost of an asset. E. cannot expense any of the cost of a new asset during the first year of the asset's life.

B. will have a greater tax shield in year two of a project than it would have if the firm had opted for straight-line depreciation, given the same depreciation life.

81. Over the past fifteen years, the common stock of The Flower Shoppe, Inc. has produced an arithmetic average return of 12.2 percent and a geometric average return of 11.5 percent. What is the projected return on this stock for the next five years according to Blume's formula? A. 11.70 percent B. 11.89 percent C. 12.00 percent D. 12.03 percent E. 12.12 percent

C. 12.00 percent

76. You are working on a bid to build two apartment buildings a year for the next 5 years for a local college. This project requires the purchase of $750,000 of equipment that will be depreciated using straight-line depreciation to a zero book value over the project's life. The equipment can be sold at the end of the project for $325,000. You will also need $140,000 in net working capital over the life of the project. The fixed costs will be $628,000 a year and the variable costs will be $1,298,000 per building. Your required rate of return is 14.5 percent for this project and your tax rate is 35 percent. What is the minimal amount, rounded to the nearest $100, you should bid per building? A. $1,423,700 B. $1,489,500 C. $1,733,000 D. $2,780,600 E. $3,465,900

C. $1,733,000

89. Keyser Mining is considering a project that will require the purchase of $980,000 in new equipment. The equipment will be depreciated straight-line to a zero book value over the 7-year life of the project. The equipment can be scraped at the end of the project for 5 percent of its original cost. Annual sales from this project are estimated at $420,000. Net working capital equal to 25 percent of sales will be required to support the project. All of the net working capital will be recouped. The required return is 16 percent and the tax rate is 35 percent. What is the recovery amount attributable to net working capital at the end of the project? A. $21,000 B. $54,600 C. $105,000 D. $178,000 E. $196,000

C. $105,000 NWC recapture = $420,000 × 0.25 = $105,000

84. Hollister & Hollister is considering a new project. The project will require $522,000 for new fixed assets, $218,000 for additional inventory, and $39,000 for additional accounts receivable. Short-term debt is expected to increase by $165,000. The project has a 6-year life. The fixed assets will be depreciated straight-line to a zero book value over the life of the project. At the end of the project, the fixed assets can be sold for 20 percent of their original cost. The net working capital returns to its original level at the end of the project. The project is expected to generate annual sales of $875,000 and costs of $640,000. The tax rate is 34 percent and the required rate of return is 14 percent. What is the amount of the earnings before interest and taxes for the first year of this project? A. $97,680 B. $130,000 C. $148,000 D. $217,320 E. $235,000

C. $148,000 EBIT = $875,000 - $640,000 - ($522,000/6) = $148,000

61. A proposed expansion project is expected to increase sales of JL Ticker's Store by $41,000 and increase cash expenses by $21,000. The project will cost $28,000 and be depreciated using straight-line depreciation to a zero book value over the 4-year life of the project. The store has a marginal tax rate of 30 percent. What is the operating cash flow of the project using the tax shield approach? A. $5,600 B. $7,800 C. $16,100 D. $13,300 E. $14,600

C. $16,100 OCF = ($41,000 - $21,000) (1 - 0.30) + ($28,000/4) (0.30) = $16,100

99. Heer Enterprises needs someone to supply it with 225,000 cartons of machine screws per year to support its manufacturing needs over the next 7 years, and you've decided to bid on the contract. It will cost you $1,230,000 to install the equipment necessary to start production; you'll depreciate this cost straight-line to zero over the project's life. You estimate that in 7 years, this equipment can be salvaged for $75,000. Your fixed production costs will be $360,000 per year, and your variable production costs should be $13.20 per carton. You also need an initial investment in net working capital of $112,500, all of which will be recovered when the project ends. Your tax rate is 32 percent and you require a 13 percent return on your investment. What bid price per carton should you submit? A. $17.04 B. $16.56 C. $16.31 D. $15.03 E. $14.81

C. $16.31

93. Phone Home, Inc. is considering a new 6-year expansion project that requires an initial fixed asset investment of $5.876 million. The fixed asset will be depreciated straight-line to zero over its 6-year tax life, after which time it will be worthless. The project is estimated to generate $5,328,000 in annual sales, with costs of $2,131,200. The tax rate is 32 percent. What is the annual operating cash flow for this project? A. $1,894,318 B. $2,211,407 C. $2,487,211 D. $2,663,021 E. $2,848,315 OCF = (5,328,000 - $2,131,200)(1 - 0.32) + ($5,876,000/6)(0.32) = $2,487,211

C. $2,487,211 OCF = (5,328,000 - $2,131,200)(1 - 0.32) + ($5,876,000/6)(0.32) = $2,487,211

52. You own a house that you rent for $1,100 a month. The maintenance expenses on the house average $200 a month. The house cost $219,000 when you purchased it 4 years ago. A recent appraisal on the house valued it at $239,000. If you sell the house you will incur $14,000 in real estate fees. The annual property taxes are $4,000. You are deciding whether to sell the house or convert it for your own use as a professional office. What value should you place on this house when analyzing the option of using it as a professional office? A. $211,800 B. $221,000 C. $225,000 D. $235,000 E. $239,000

C. $225,000 Opportunity cost = $239,000 - $14,000 = $225,000

55. Jefferson & Sons is evaluating a project that will increase annual sales by $145,000 and annual cash costs by $94,000. The project will initially require $110,000 in fixed assets that will be depreciated straight-line to a zero book value over the 4-year life of the project. The applicable tax rate is 32 percent. What is the operating cash flow for this project? A. $11,220 B. $29,920 C. $43,480 D. $46,480 E. $46,620

C. $43,480 OCF = ($145,000 - $94,000)(1 - 0.32) + ($110,000/4)(0.32) = $43,480

60. You just sold 600 shares of Wesley, Inc. stock at a price of $32.04 a share. Last year, you paid $30.92 a share to buy this stock. Over the course of the year, you received dividends totaling $1.20 per share. What is your total capital gain on this investment? A. -$618 B. -$672 C. $672 D. $618 E. $720

C. $672 Capital gain = ($32.04 - $30.92) × 600 = $672

51. Mason Farms purchased a building for $689,000 eight years ago. Six years ago, repairs were made to the building which cost $136,000. The annual taxes on the property are $11,000. The building has a current market value of $840,000 and a current book value of $494,000. The building is totally paid for and solely owned by the firm. If the company decides to use this building for a new project, what value, if any, should be included in the initial cash flow of the project for this building? A. $494,000 B. $582,000 C. $840,000 D. $865,000 E. $953,000

C. $840,000

86. Hollister & Hollister is considering a new project. The project will require $522,000 for new fixed assets, $218,000 for additional inventory, and $39,000 for additional accounts receivable. Short-term debt is expected to increase by $165,000. The project has a 6-year life. The fixed assets will be depreciated straight-line to a zero book value over the life of the project. At the end of the project, the fixed assets can be sold for 20 percent of their original cost. The net working capital returns to its original level at the end of the project. The project is expected to generate annual sales of $875,000 and costs of $640,000. The tax rate is 34 percent and the required rate of return is 14 percent. What is the cash flow recovery from net working capital at the end of this project? A. $14,000 B. $75,000 C. $92,000 D. $344,000 E. $422,000

C. $92,000 Net working capital recovery = $218,000 + $39,000 - $165,000 = $92,000

49. Webster & Moore paid $148,000, in cash, for a piece of equipment 3 years ago. At the beginning of last year, the company spent $21,000 to update the equipment with the latest technology. The company no longer uses this equipment in its current operations and has received an offer of $96,000 from a firm that would like to purchase it. Webster & Moore is debating whether to sell the equipment or to expand its operations so that the equipment can be used. When evaluating the expansion option, what value, if any, should the firm assign to this equipment as an initial cost of the project? A. $0 B. $21,000 C. $96,000 D. $110,000 E. $160,000

C. $96,000

48. Sailcloth & More currently produces boat sails and is considering expanding its operations to include awnings for homes and travel trailers. The company owns land beside its current manufacturing facility that could be used for the expansion. The company bought this land 5 years ago at a cost of $319,000. At the time of purchase, the company paid $24,000 to level out the land so it would be suitable for future use. Today, the land is valued at $295,000. The company has some unused equipment that it currently owns valued at $38,000. This equipment could be used for producing awnings if $12,000 is spent for equipment modifications. Other equipment costing $490,000 will also be required. What is the amount of the initial cash flow for this expansion project? A. -$785,000 B. -$823,000 C. -$835,000 D. -$859,000 E. -$883,000

C. -$835,000 CF0 = -$295,000 - $38,000 - $12,000 - $490,000 = -$835,000

72. A stock has returns of 18 percent, 15 percent, -21 percent, and 6 percent for the past four years. Based on this information, what is the 95 percent probability range of returns for any one given year? A. -13.56 to 20.56 percent B. -24.60 to 31.80 percent C. -31.00 to 40.00 percent D. -47.68 to 54.68 percent E. -71.73 to 71.73 percent

C. -31.00 to 40.00 percent

76. What is the variance of the returns on a portfolio comprised of $5,400 of stock G and $6,600 of stock H? SoE / Prob. of SOE / RoR if SoE Occurs G / H Boom / 36% / 21% / 13% Normal / 64% / 13% / 5% A. .000709 B. .000848 C. .001475 D. .001554 E. .001568

C. .001475 E(r)Boom = [$5,400/($5,400 + $6,600)][0.21] + [($6,600/($5,400 + $6,600)][0 .13] = 0.166 E(r)Normal = [$5,400/($5,400 + $6,600)][0.13] + [$6,600/($5,400 + $6,600)][0.05] = 0.086 E(r)Portfolio = (0.36 × 0.166) + (0.64 × 0.086) = 0.1148 VarPortfolio = [0.36 × (0.166 - 0.1148)2] + [0.64 × (0.086 - 0.1148)2] = 0.001475

65. The rate of return on the common stock of Lancaster Woolens is expected to be 21 percent in a boom economy, 11 percent in a normal economy, and only 3 percent in a recessionary economy. The probabilities of these economic states are 10 percent for a boom, 70 percent for a normal economy, and 20 percent for a recession. What is the variance of the returns on this common stock? A. 0.002150 B. 0.002606 C. 0.002244 D. 0.002359 E. 0.002421

C. 0.002244

60. You recently purchased a stock that is expected to earn 30 percent in a booming economy, 9 percent in a normal economy, and lose 33 percent in a recessionary economy. There is a 5 percent probability of a boom and a 75 percent chance of a normal economy. What is your expected rate of return on this stock? A. -3.40 percent B. -2.25 percent C. 1.65 percent D. 2.60 percent E. 3.50 percent

C. 1.65 percent E(r) = (0.05 × 0.30) + (0.75 × 0.09) + (0.20 × -0.33) = 1.65 percent

93. You own a portfolio that has $2,000 invested in Stock A and $3,500 invested in Stock B. The expected returns on these stocks are 14 percent and 9 percent, respectively. What is the expected return on the portfolio? A. 10.06 percent B. 10.50 percent C. 10.82 percent D. 11.13 percent E. 11.41 percent

C. 10.82 percent E(Rp) = [$2,000/($2,000 + $3,500)] [0.14] + [$3,500/($2,000 + $3,500)] [0.09] = 10.82 percent

102. Suppose you observe the following situation: Security / Beta / Expected Return Pete Corp. / 0.8 / 0.12 Repete Corp. / 1.1 / 0.16 Assume these securities are correctly priced. Based on the CAPM, what is the return on the market? A. 13.99 percent B. 14.42 percent C. 14.67 percent D. 14.78 percent E. 15.01 percent

C. 14.67 percent Rf: (0.12 - Rf)/0.8 = (0.16 - Rf)/1.1; Rf = 1.33 percent RM: 0.12 = 0.0133 + 0.8(RM - 0.0133); RM = 14.67 percent

95. What is the expected return and standard deviation for the following stock? SoE / Prob. of SOE / RoR if SoE Occurs Boom / .10 / -0.19 Normal / .60 / 0.17 Recession / .30 / 0.35 A. 15.49 percent; 14.28 percent B. 15.49 percent; 14.67 percent C. 18.80 percent; 14.95 percent D. 18.80 percent; 15.74 percent E. 18.80 percent'; 16.01 percent

C. 18.80 percent; 14.95 percent E(R) = 0.10(-0.19) + 0.60(0.17) + 0.30(0.35) = 18.80 percent σ2 = 0.10(-0.19 - 0.188)2 + 0.60(0.17 - 0.188)2 + 0.30(0.35 - 0.188)2 = 0.022356 σ = √0.022356 = 14.95 percent

22. Which one of the following time periods is associated with high rates of inflation? A. 1929-1933 B. 1957-1961 C. 1978-1981 D. 1992-1996 E. 2001-2005

C. 1978-1981

61. Last year, you purchased 500 shares of Analog Devices, Inc. stock for $11.16 a share. You have received a total of $120 in dividends and $7,190 from selling the shares. What is your capital gains yield on this stock? A. 26.70 percent B. 26.73 percent C. 28.85 percent D. 29.13 percent E. 31.02 percent

C. 28.85 percent Capital gains yield = [($7,190/500) - $11.16]/$11.16 = 28.85 percent

85. Suppose you bought a 10 percent coupon bond one year ago for $950. The face value of the bond is $1,000. The bond sells for $985 today. If the inflation rate last year was 9 percent, what was your total real rate of return on this investment? A. -4.88 percent B. -5.32 percent C. 4.78 percent D. 9.78 percent E. 10.47 percent

C. 4.78 percent Nominal return = ($985 - $950 + $100)/$950 = 0.1421 Real return = [(1 + 0.1421)/(1 + 0.09)] - 1 = 4.78 percent

36. Which one of the following statements is correct based on the historical record for the period 1926-2010? A. The standard deviation of returns for small-company stocks was double that of large-company stocks. B. U.S. Treasury bills had a zero standard deviation of returns because they are considered to be risk-free. C. Long-term government bonds had a lower return but a higher standard deviation on average than did long-term corporate bonds. D. Inflation was less volatile than the returns on U.S. Treasury bills. E. Long-term government bonds underperformed intermediate-term government bonds.

C. Long-term government bonds had a lower return but a higher standard deviation on average than did long-term corporate bonds.

33. Which one of the following is a correct method for computing the operating cash flow of a project assuming that the interest expense is equal to zero? A. EBIT + D B. EBIT - T C. NI + D D. (Sales - Costs) × (1 - D) × (1- T) E. (Sales - Costs) × (1 - T)

C. NI + D

22. Which one of the following is a project cash inflow? Ignore any tax effects. A. decrease in accounts payable B. increase in inventory C. decrease in accounts receivable D. depreciation expense based on MACRS E. equipment acquisition

C. decrease in accounts receivable

32. Three years ago, Knox Glass purchased a machine for a 3-year project. The machine is being depreciated straight-line to zero over a 5-year period. Today, the project ended and the machine was sold. Which one of the following correctly defines the aftertax salvage value of that machine? (T represents the relevant tax rate) A. Sale price + (Sales price - Book value) × T B. Sale price + (Sales price - Book value) × (1 - T) C. Sale price + (Book value - Sale price) × T D. Sale price + (Book value - Sale price) × (1 - T) E. Sale price × (1 - T)

C. Sale price + (Book value - Sale price) × T

23. Which one of the following statements concerning U.S. Treasury bills is correct for the period 1926- 2010? A. The annual rate of return always exceeded the annual inflation rate. B. The average risk premium was 0.7 percent. C. The annual rate of return was always positive. D. The average excess return was 1.1 percent. E. The average real rate of return was zero.

C. The annual rate of return was always positive.

43. The bid price always assumes which one of the following? A. A project has a one-year life. B. The aftertax net income of the project is zero. C. The net present value of the project is zero. D. Any assets purchased will have a positive salvage value at the end of the project. E. Assets will be depreciated based on MACRS.

C. The net present value of the project is zero.

46. Dexter Smith & Co. is replacing a machine simply because it has worn out. The new machine will not affect either sales or operating costs and will not have any salvage value at the end of its 5-year life. The firm has a 34 percent tax rate, uses straight-line depreciation over an asset's life, and has a positive net income. Given this, which one of the following statements is correct? A. As a project, the new machine has a net present value equal to minus one times the machine's purchase price. B. The new machine will have a zero rate of return. C. The new machine will generate positive operating cash flows, at least in the first few years of its life. D. The new machine will create a cash outflow when the firm disposes of it at the end of its life. E. The new machine creates erosion effects.

C. The new machine will generate positive operating cash flows, at least in the first few years of its life.

32. Which one of the following statements related to risk is correct? A. The beta of a portfolio must increase when a stock with a high standard deviation is added to the portfolio. B. Every portfolio that contains 25 or more securities is free of unsystematic risk. C. The systematic risk of a portfolio can be effectively lowered by adding T-bills to the portfolio. D. Adding five additional stocks to a diversified portfolio will lower the portfolio's beta. E. Stocks that move in tandem with the overall market have zero betas.

C. The systematic risk of a portfolio can be effectively lowered by adding T-bills to the portfolio.

24. Which one of the following events would be included in the expected return on Sussex stock? A. The chief financial officer of Sussex unexpectedly resigned. B. The labor union representing Sussex' employees unexpectedly called a strike. C. This morning, Sussex confirmed that its CEO is retiring at the end of the year as was anticipated. D. The price of Sussex stock suddenly declined in value because researchers accidentally discovered that one of the firm's products can be toxic to household pets. E. The board of directors made an unprecedented decision to give sizeable bonuses to the firm's internal auditors for their efforts in uncovering wasteful spending.

C. This morning, Sussex confirmed that its CEO is retiring at the end of the year as was anticipated.

48. A stock with an actual return that lies above the security market line has: A. more systematic risk than the overall market. B. more risk than that warranted by CAPM. C. a higher return than expected for the level of risk assumed. D. less systematic risk than the overall market. E. a return equivalent to the level of risk assumed.

C. a higher return than expected for the level of risk assumed.

44. Which one of the following would make a project unacceptable? A. cash inflow for net working capital at time zero B. requiring fixed assets that would have no salvage value C. an equivalent annual cost that exceeds that of an alternative project D. lack of revenue generation E. a depreciation tax shield that exceeds the value of the interest expense

C. an equivalent annual cost that exceeds that of an alternative project

11. Bayside Marina just announced it is decreasing its annual dividend from $1.64 per share to $1.50 per share effective immediately. If the dividend yield remains at its pre-announcement level, then you know the stock price: A. was unaffected by the announcement. B. increased proportionately with the dividend decrease. C. decreased proportionately with the dividend decrease. D. decreased by $0.14 per share. E. increased by $0.14 per share.

C. decreased proportionately with the dividend decrease.

38. The primary purpose of portfolio diversification is to: A. increase returns and risks. B. eliminate all risks. C. eliminate asset-specific risk. D. eliminate systematic risk. E. lower both returns and risks.

C. eliminate asset-specific risk.

39. Dan is comparing three machines to determine which one to purchase. The machines sell for differing prices, have differing operating costs, differing machine lives, and will be replaced when worn out. Which one of the following computational methods should Dan use as the basis for his decision? A. internal rate of return B. operating cash flow C. equivalent annual cost D. depreciation tax shield E. bottom-up operating cash flow

C. equivalent annual cost

42. Which one of the following is most directly affected by the level of systematic risk in a security? A. variance of the returns B. standard deviation of the returns C. expected rate of return D. risk-free rate E. market risk premium

C. expected rate of return

1. You own a stock that you think will produce a return of 11 percent in a good economy and 3 percent in a poor economy. Given the probabilities of each state of the economy occurring, you anticipate that your stock will earn 6.5 percent next year. Which one of the following terms applies to this 6.5 percent? A. arithmetic return B. historical return C. expected return D. geometric return E. required return

C. expected return

58. The CFO of Edward's Food Distributors is continually receiving capital funding requests from its division managers. These requests are seeking funding for positive net present value projects. The CFO continues to deny all funding requests due to the financial situation of the company. Apparently, the company is: A. operating at the accounting break-even point. B. operating at the financial break-even point. C. facing hard rationing. D. operating with zero leverage. E. operating at maximum capacity.

C. facing hard rationing.

6. Which one of the following best describes pro forma financial statements? A. financial statements expressed in a foreign currency B. financial statements where the assets are expressed as a percentage of total assets and costs are expressed as a percentage of sales C. financial statements showing projected values for future time periods D. financial statements expressed in real dollars, given a stated base year E. financial statements where all accounts are expressed as a percentage of last year's values

C. financial statements showing projected values for future time periods

50. Which one of the following will be constant for all securities if the market is efficient and securities are priced fairly? A. variance B. standard deviation C. reward-to-risk ratio D. beta E. risk premium

C. reward-to-risk ratio

27. As the degree of sensitivity of a project to a single variable rises, the: A. less important the variable to the final outcome of the project. B. less volatile the project's net present value to that variable. C. greater the importance of accurately predicting the value of that variable. D. greater the sensitivity of the project to the other variable inputs. E. less volatile the project's outcome.

C. greater the importance of accurately predicting the value of that variable.

10. Kelley's Baskets makes handmade baskets for distribution to upscale retail outlets. The firm is currently considering making handmade wreaths as well. Which one of the following is the best example of an incremental operating cash flow related to the wreath project? A. storing supplies in the same space currently used for materials storage B. utilizing the basket manager to oversee wreath production C. hiring additional employees to handle the increased workload should the firm accept the wreath project D. researching the market to determine if wreath sales might be profitable before deciding to proceed E. planning on lower interest expense by assuming the proceeds of the wreath sales will be used to reduce the firm's currently outstanding debt

C. hiring additional employees to handle the increased workload should the firm accept the wreath project

19. Scenario analysis is best suited to accomplishing which one of the following when analyzing a project? A. determining how fixed costs affect NPV B. estimating the residual value of fixed assets C. identifying the potential range of reasonable outcomes D. determining the minimal level of sales required to break-even on an accounting basis E. determining the minimal level of sales required to break-even on a financial basis

C. identifying the potential range of reasonable outcomes

1. Forecasting risk is defined as the possibility that: A. some proposed projects will be rejected. B. some proposed projects will be temporarily delayed. C. incorrect decisions will be made due to erroneous cash flow projections. D. some projects will be mutually exclusive. E. tax rates could change over the life of a project.

C. incorrect decisions will be made due to erroneous cash flow projections.

48. According to theory, studying historical stock price movements to identify mispriced stocks: A. is effective as long as the market is only semistrong form efficient. B. is effective provided the market is only weak form efficient. C. is ineffective even when the market is only weak form efficient. D. becomes ineffective as soon as the market gains semistrong form efficiency. E. is ineffective only in strong form efficient markets.

C. is ineffective even when the market is only weak form efficient.

15. As long as the inflation rate is positive, the real rate of return on a security will be ____ the nominal rate of return. A. greater than B. equal to C. less than D. greater than or equal to E. unrelated to

C. less than

17. The expected rate of return on a stock portfolio is a weighted average where the weights are based on the: A. number of shares owned of each stock. B. market price per share of each stock. C. market value of the investment in each stock. D. original amount invested in each stock. E. cost per share of each stock held.

C. market value of the investment in each stock.

14. The real rate of return on a stock is approximately equal to the nominal rate of return: A. multiplied by (1 + inflation rate). B. plus the inflation rate. C. minus the inflation rate. D. divided by (1 + inflation rate). E. divided by (1 - inflation rate).

C. minus the inflation rate.

4. Which one of the following is defined by its mean and its standard deviation? A. arithmetic nominal return B. geometric real return C. normal distribution D. variance E. risk premium

C. normal distribution

15. Which one of the following best illustrates erosion as it relates to a hot dog stand located on the beach? A. providing both ketchup and mustard for its customer's use B. repairing the roof of the hot dog stand because of water damage C. selling fewer hot dogs because hamburgers were added to the menu D. offering French fries but not onion rings E. losing sales due to bad weather

C. selling fewer hot dogs because hamburgers were added to the menu

51. You are aware that your neighbor trades stocks based on confidential information he overhears at his workplace. This information is not available to the general public. This neighbor continually brags to you about the profits he earns on these trades. Given this, you would tend to argue that the financial markets are at best _____ form efficient. A. weak B. semiweak C. semistrong D. strong E. perfect

C. semistrong

18. Which one of the following categories of securities had the highest average return for the period 1926-2010? A. U.S. Treasury bills B. large company stocks C. small company stocks D. long-term corporate bonds E. long-term government bonds

C. small company stocks

24. Which one of the following is a correct ranking of securities based on their volatility over the period of 1926-2010? Rank from highest to lowest. A. large company stocks, U.S. Treasury bills, long-term government bonds B. small company stocks, long-term corporate bonds, large company stocks C. small company stocks, long-term corporate bonds, intermediate-term government bonds D. large company stocks, small company stocks, long-term government bonds E. intermediate-term government bonds, long-term corporate bonds, U.S. Treasury bills

C. small company stocks, long-term corporate bonds, intermediate-term government bonds

27. Which one of the following earned the highest risk premium over the period 1926-2010? A. long-term corporate bonds B. U.S. Treasury bills C. small-company stocks D. large-company stocks E. long-term government bonds

C. small-company stocks

16. Small-company stocks, as the term is used in the textbook, are best defined as the: A. 500 newest corporations in the U.S. B. firms whose stock trades OTC. C. smallest twenty percent of the firms listed on the NYSE. D. smallest twenty-five percent of the firms listed on NASDAQ. E. firms whose stock is listed on NASDAQ.

C. smallest twenty percent of the firms listed on the NYSE.

15. The procedure of allocating a fixed amount of funds for capital spending to each business unit is called: A. marginal spending. B. capital preservation. C. soft rationing. D. hard rationing. E. marginal rationing.

C. soft rationing.

4. Which one of the following is a risk that applies to most securities? A. unsystematic B. diversifiable C. systematic D. asset-specific E. total

C. systematic

5. Which one of the following best describes the concept of erosion? A. expenses that have already been incurred and cannot be recovered B. change in net working capital related to implementing a new project C. the cash flows of a new project that come at the expense of a firm's existing cash flows D. the alternative that is forfeited when a fixed asset is utilized by a project E. the differences in a firm's cash flows with and without a particular project

C. the cash flows of a new project that come at the expense of a firm's existing cash flows

44. Which one of the following is most indicative of a totally efficient stock market? A. extraordinary returns earned on a routine basis B. positive net present values on stock investments over the long-term C. zero net present values for all stock investments D. arbitrage opportunities which develop on a routine basis E. realizing negative returns on a routine basis

C. zero net present values for all stock investments

105. According to CAPM, the expected return on a risky asset depends on three components. Describe each component and explain its role in determining expected return.

CAPM suggests the expected return is a function of (1) the risk-free rate of return, which is the pure time value of money, (2) the market risk premium, which is the reward for bearing systematic risk, and (3) beta, which is the amount of systematic risk present in a particular asset. Better answers will point out that both the pure time value of money and the reward for bearing systematic risk are exogenously determined and can change on a daily basis, while the amount of systematic risk for a particular asset is determined by the firm's decision-makers.

73. Colors and More is considering replacing the equipment it uses to produce crayons. The equipment would cost $1.37 million, have a 12-year life, and lower manufacturing costs by an estimated $310,000 a year. The equipment will be depreciated using straight-line depreciation to a book value of zero. The required rate of return is 15 percent and the tax rate is 35 percent. What is the net income from this proposed project? A. $18,508.75 B. $40,211.24 C. $66,441.67 D. $127,291.67 E. $136,709.48

D. $127,291.67 Net income = [$310,000 - ($1,370,000/12)] × [1 - 0.35] = $127,291.67

68. Edward's Manufactured Homes purchased some machinery 2 years ago for $319,000. These assets are classified as 5-year property for MACRS. The company is replacing this machinery today with newer machines that utilize the latest in technology. The old machines are being sold for $140,000 to a foreign firm for use in its production facility in South America. What is the aftertax salvage value from this sale if the tax rate is 35 percent? MACRS 5-year Property (year / rate) 1 / 20.00% 2 / 32.00% 3 / 19.20% 4 / 11.52% 5 / 11.52% 6 / 5.76% A. $135,408 B. $140,000 C. $142,312 D. $144,592 E. $146,820

D. $144,592

54. Cool Comfort currently sells 300 Class A spas, 450 Class C spas, and 200 deluxe model spas each year. The firm is considering adding a mid-class spa and expects that if it does it can sell 375 of them. However, if the new spa is added, Class A sales are expected to decline to 225 units while the Class C sales are expected to decline to 200. The sales of the deluxe model will not be affected. Class A spas sell for an average of $12,000 each. Class C spas are priced at $6,000 and the deluxe model sells for $17,000 each. The new mid-range spa will sell for $8,000. What is the value of the erosion? A. $600,000 B. $1,200,000 C. $1,800,000 D. $2,400,000 E. $3,900,000

D. $2,400,000 Erosion = [(300 - 225) × $12,000] + [(450 - 200) × $6,000] = $2,400,000

66. Crafter's Supply purchased some fixed assets 2 years ago at a cost of $38,700. It no longer needs these assets so it is going to sell them today for $25,000. The assets are classified as 5-year property for MACRS. What is the net cash flow from this sale if the firm's tax rate is 30 percent? MACRS 5-year Property (year / rate) 1 / 20.00% 2 / 32.00% 3 / 19.20% 4 / 11.52% 5 / 11.52% 6 / 5.76% A. $13,122.20 B. $18,576.00 C. $20,843.68 D. $23,072.80 E. $25,211.09

D. $23,072.80 Book value2 = $38,700 × (1 - 0.20 - 0.32) = $18,576 Aftertax salvage = $25,000 + [($18,576 - $25,000) × 0.30] = $23,072.80

90. Winnebagel Corp. currently sells 28,200 motor homes per year at $42,300 each, and 11,280 luxury motor coaches per year at $79,900 each. The company wants to introduce a new portable camper to fill out its product line. It hopes to sell 19,740 of these campers per year at $11,280 each. An independent consultant has determined that if Winnebagel introduces the new campers, it should boost the sales of its existing motor homes by 4,700 units per year, and reduce the sales of its motor coaches by 1,222 units per year. What is the amount that should be used as the annual sales figure when evaluating this project? A. $297,613,400 B. $301,002,300 C. $314,141,800 D. $323,839,400 E. $327,289,500

D. $323,839,400 Sales = (19,740 × $11,280) + (4,700 × $42,300) + (-1,222 × $79,900) = $323,839,400

59. You have a $12,000 portfolio which is invested in stocks A and B, and a risk-free asset. $5,000 is invested in stock A. Stock A has a beta of 1.76 and stock B has a beta of 0.89. How much needs to be invested in stock B if you want a portfolio beta of 1.10? A. $3,750.00 B. $4,333.33 C. $4,706.20 D. $4,943.82 E. $5,419.27

D. $4,943.82 BetaPortfolio = 1.10 = ($5,000/$12,000)(1.76) + (x/$12,000)(0.89) + (($12,000 - $5,000 - x)/$12,000)(0); x = $4,943.82

58. You want your portfolio beta to be 0.90. Currently, your portfolio consists of $4,000 invested in stock A with a beta of 1.47 and $3,000 in stock B with a beta of 0.54. You have another $9,000 to invest and want to divide it between an asset with a beta of 1.74 and a risk-free asset. How much should you invest in the risk-free asset? A. $3,965.52 B. $4,425.29 C. $4,902.29 D. $5,034.48 E. $5,683.92

D. $5,034.48 BetaPortfolio = 0.90 = ($4,000/$16,000)(1.47) + ($3,000/$16,000)(0.54) + (x/$16,000)(1.74) + (($9,000 - x)/$16,000)(0); Investment in risk-free asset = $9,000 - $3,965.52 = $5,034.48

60. Bi-Lo Traders is considering a project that will produce sales of $28,000 and increase cash expenses by $17,500. If the project is implemented, taxes will increase by $3,000. The additional depreciation expense will be $1,600. An initial cash outlay of $1,400 is required for net working capital. What is the amount of the operating cash flow using the top-down approach? A. $4,500 B. $5,900 C. $6,100 D. $7,500 E. $8,900

D. $7,500 OCF = $28,000 - $17,500 - $3,000 = $7,500

57. The Beach House has sales of $784,000 and a profit margin of 8 percent. The annual depreciation expense is $14,000. What is the amount of the operating cash flow if the company has no long-term debt? A. $68,760 B. $72,240 C. $74,240 D. $76,720 E. $81,760

D. $76,720 OCF = ($784,000 × 0.08) + $14,000 = $76,720

94. You have $10,000 to invest in a stock portfolio. Your choices are Stock X with an expected return of 13 percent and Stock Y with an expected return of 8 percent. Your goal is to create a portfolio with an expected return of 12.4 percent. All money must be invested. How much will you invest in stock X? A. $800 B. $1,200 C. $4,600 D. $8,800 E. $9,200

D. $8,800 E(Rp) = 0.124 = .13x + .08(1 - x); x = 88 percent Investment in Stock X = 0.88($10,000) = $8,800

70. Jasper Metals is considering installing a new molding machine which is expected to produce operating cash flows of $73,000 a year for 7 years. At the beginning of the project, inventory will decrease by $16,000, accounts receivables will increase by $21,000, and accounts payable will increase by $15,000. All net working capital will be recovered at the end of the project. The initial cost of the molding machine is $249,000. The equipment will be depreciated straight-line to a zero book value over the life of the project. The equipment will be salvaged at the end of the project creating a $48,000 aftertax cash flow. At the end of the project, net working capital will return to its normal level. What is the net present value of this project given a required return of 14.5 percent? A. $77,211.20 B. $79,418.80 C. $82,336.01 D. $84,049.74 E. $87,925.54

D. $84,049.74

56. A year ago, you purchased 300 shares of Stellar Wood Products, Inc. stock at a price of $8.62 per share. The stock pays an annual dividend of $0.10 per share. Today, you sold all of your shares for $4.80 per share. What is your total dollar return on this investment? A. -$382 B. -$1,372 C. -$1,528 D. -$1,116 E. -$1,360

D. -$1,116 Total dollar return = ($4.80 - $8.62 + $0.10) × 300 = -$1,116

82. Home Furnishings Express is expanding its product offerings to reach a wider range of customers. The expansion project includes increasing the floor inventory by $430,000 and increasing its debt to suppliers by 70 percent of that amount. The company will also spend $450,000 for a building contractor to expand the size of its showroom. As part of the expansion plan, the company will be offering credit to its customers and thus expects accounts receivable to rise by $90,000. For the project analysis, what amount should be used as the initial cash flow for net working capital? A. -$39,000 B. -$70,000 C. -$156,000 D. -$219,000 E. -$391,000

D. -$219,000 NWC requirement = -$430,000 + (0.70 × $430,000) - $90,000 = -$219,000

80. What is the beta of the following portfolio? Stock / Amt Invested / Security Beta A / $6,700 / 1.41 B / $3,000 / 1.23 C / $8,500 / 0.79 A. .95 B. 1.01 C. 1.05 D. 1.09 E. 1.23

D. 1.09 ValuePortfolio = $6,700 + $3,000 + $8,500 = $18,200 BetaPortfolio = ($6,700/$18,200 × 1.41) + ($4,900/$18,200 × 1.23) + ($8,500/$18,200 × 0.79) = 1.09

93. Over a 30-year period an asset had an arithmetic return of 13 percent and a geometric return of 10.5 percent. Using Blume's formula, what is your best estimate of the future annual returns over the next 5 years? A. 11.18 percent B. 12.27 percent C. 11.84 percent D. 12.66 percent E. 12.46 percent

D. 12.66 percent

89. Thayer Farms stock has a beta of 1.12. The risk-free rate of return is 4.34 percent and the market risk premium is 7.92 percent. What is the expected rate of return on this stock? A. 8.35 percent B. 9.01 percent C. 10.23 percent D. 13.21 percent E. 13.73 percent

D. 13.21 percent E(r) = 0.0434 + (1.12 × 0.0792) = 13.21 percent

83. A stock has a geometric average return of 14.6 percent and an arithmetic average return of 15.5 percent based on the last 33 years. What is the estimated average rate of return for the next 6 years based on Blume's formula? A. 14.79 percent B. 14.96 percent C. 15.28 percent D. 15.36 percent E. 15.42 percent

D. 15.36 percent

37. What is the probability that small-company stocks will produce an annual return that is more than one standard deviation below the average? A. 1.0 percent B. 2.5 percent C. 5.0 percent D. 16 percent E. 32 percent

D. 16 percent

97. Your firm is contemplating the purchase of a new $1,628,000 computer-based order entry system. The system will be depreciated straight-line to zero over its 5-year life. It will be worth $156,300 at the end of that time. You will save $642,500 before taxes per year in order processing costs and you will be able to reduce working capital by $115,764 (this is a one-time reduction). The net working capital will return to its original level when the project ends. The tax rate is 35 percent. What is the internal rate of return for this project? A. 11.78 percent B. 13.49 percent C. 18.21 percent D. 22.15 percent E. 23.58 percent

D. 22.15 percent

68. A stock had returns of 11 percent, -18 percent, -21 percent, 20 percent, and 34 percent over the past five years. What is the standard deviation of these returns? A. 18.74 percent B. 20.21 percent C. 20.68 percent D. 24.01 percent E. 23.49 percent

D. 24.01 percent Average return = (0.11 - 0.18 - 0.21 + 0.20 + 0.34)/5 = .052; σ = √[1/(5 - 1)] [(0.11 - 0.052)2 + (-0.18 - 0.052)2 + (-0.21 -0.052)2 + (0.05 - 0.052)2 + (0.34 - 0.052)2] = 24.01 percent

90. You find a certain stock that had returns of 4 percent, -5 percent, -15 percent, and 16 percent for four of the last five years. The average return of the stock for the 5-year period was 13 percent. What is the standard deviation of the stock's returns for the five-year period? A. 21.39 percent B. 24.98 percent C. 27.16 percent D. 31.23 percent E. 34.02 percent

D. 31.23 percent Return for missing year: 0.04 - 0.05 - 0.15 + 0.16 + x = 0.13 × 5; x = 65 percent Std dev = √[1/(5 - 1)] [(0.04 - 0.13)2 + (-0.05 - 0.13)2 + (-0.15 - 0.13)2 + (0.16 - 0.13)2 + (0.65 - 0.13)2 = 31.23 percent

71. What is the expected return on a portfolio which is invested 25 percent in stock A, 55 percent in stock B, and the remainder in stock C? SoE / Prob. of SOE / RoR if SoE Occurs A / B / C Boom / 5% / 19% / 9% / 6% Normal / 45% / 11% / 8% / 13% Recession / 50% / -23% / 5% / 25% A. -1.06 percent B. 2.38 percent C. 2.99 percent D. 5.93 percent E. 6.10 percent

D. 5.93 percent E(r)Boom = (0.25 × 0.19) + (0.55 × 0.09) + (0.20 × 0.06) = 0.109 E(r)Normal = (0.25 × 0.11) + (0.55 × 0.08) + (0.20 × 0.13) = .0975 E(r)Bust = (0.25 × -0.23) + (0.55 × 0.05) + (0.20 × 0.25) = 0.02 E(r)Portfolio = (0.05 × 0.109) + (0.45 × 0.0975) + (0.50 × 0.02) = 5.93 percent

83. You would like to combine a risky stock with a beta of 1.68 with U.S. Treasury bills in such a way that the risk level of the portfolio is equivalent to the risk level of the overall market. What percentage of the portfolio should be invested in the risky stock? A. 32 percent B. 40 percent C. 54 percent D. 60 percent E. 68 percent

D. 60 percent BetaPortfolio = 1.0 = [(x) × 1.68] + [(1 - x) × 0]; x = 60 percent

79. What is the standard deviation of the returns on a portfolio that is invested in stocks A, B, and C? Twenty five percent of the portfolio is invested in stock A and 40 percent is invested in stock C. SoE / Prob. of SOE / RoR if SoE Occurs A / B / C Boom / 5% / 17% / 6% / 22% Normal / 55% / 8% / 10% / 15% Recession / 40% / -3% / 19% / -25% A. 6.31 percent B. 6.49 percent C. 7.40 percent D. 7.83 percent E. 8.72 percent

D. 7.83 percent E(r)Boom = (0.25 × 0.17) + (0.35 × 0.06) + (0.40 × 0.22) = 0.1515 E(r)Normal = (0.25 × 0.08) + (0.35 × 0.10) + (0.40 × 0.15) = 0.115 E(r)Bust = (0.25 × -0.03) + (0.35 × 0.19) + (0.40 × -0.25) = -0.041 E(r)Portfolio = (0.05 × 0.1515) + (0.55 × 0.115) + (0.40 × -0.041) = 0.054425 VarPortfolio = [0.05 × (0.1515 - 0.054425)2] + [0.55 × (0.115 - 0.054425)2] + [0.40 × (-0.041 - 0.054425)2] = 0.006132 Std dev = √.006132 = 7.83 percent

84. Suppose a stock had an initial price of $80 per share, paid a dividend of $1.35 per share during the year, and had an ending share price of $87. What was the capital gains yield? A. 1.55 percent B. 1.69 percent C. 8.05 percent D. 8.75 percent E. 10.44 percent

D. 8.75 percent Capital gains yield = ($87 - $80)/$80 = 8.75 percent

70. You own a portfolio with the following expected returns given the various states of the economy. What is the overall portfolio expected return? SoE / Prob. of SOE / RoR if SoE Occurs Boom / 27% / 17% Normal / 70% / 8% Recession / 3% / -11% A. 6.49 percent B. 8.64 percent C. 8.87 percent D. 9.86 percent E. 10.23 percent

D. 9.86 percent E(r) = (0.27 × 0.17) + (0.70 × 0.08) + (0.03 × -0.11) = 9.86 percent

45. Which one of the following statements is correct concerning market efficiency? A. Real asset markets are more efficient than financial markets. B. If a market is efficient, arbitrage opportunities should be common. C. In an efficient market, some market participants will have an advantage over others. D. A firm will generally receive a fair price when it issues new shares of stock. E. New information will gradually be reflected in a stock's price to avoid any sudden change in the price of the stock.

D. A firm will generally receive a fair price when it issues new shares of stock.

8. Which one of the following statements best defines the efficient market hypothesis? A. Efficient markets limit competition. B. Security prices in efficient markets remain steady as new information becomes available. C. Mispriced securities are common in efficient markets. D. All securities in an efficient market are zero net present value investments. E. Profits are removed as a market incentive when markets become efficient.

D. All securities in an efficient market are zero net present value investments.

39. The historical record for the period 1926-2010 supports which one of the following statements? A. A higher-risk security will provide a higher rate of return next year than will a lower-risk security. B. If you need a stated amount of money next year, your best investment option today for those funds would be long-term government bonds. C. Increased long-run potential returns are obtained by lowering risks. D. It is possible for small-company stocks to more than double in value in any one given year. E. Inflation was positive each year throughout the period of 1926-2010.

D. It is possible for small-company stocks to more than double in value in any one given year.

24. Which one of the following statements concerning scenario analysis is correct? A. The pessimistic case scenario determines the maximum loss, in current dollars, that a firm could possibly incur from a given project. B. Scenario analysis defines the entire range of results that could be realized from a proposed investment project. C. Scenario analysis determines which variable has the greatest impact on a project's final outcome. D. Scenario analysis helps managers analyze various outcomes that are possible given reasonable ranges for each of the assumptions. E. Management is guaranteed a positive outcome for a project when the worst case scenario produces a positive NPV.

D. Scenario analysis helps managers analyze various outcomes that are possible given reasonable ranges for each of the assumptions.

9. Stacy purchased a stock last year and sold it today for $3 a share more than her purchase price. She received a total of $0.75 in dividends. Which one of the following statements is correct in relation to this investment? A. The dividend yield is expressed as a percentage of the selling price. B. The capital gain would have been less had Stacy not received the dividends. C. The total dollar return per share is $3. D. The capital gains yield is positive. E. The dividend yield is greater than the capital gains yield.

D. The capital gains yield is positive.

31. Which one of the following was the least volatile over the period of 1926-2010? A. large-company stocks B. inflation C. long-term corporate bonds D. U.S. Treasury bills E. intermediate-term government bonds

D. U.S. Treasury bills

36. Which one of the following is the best example of a diversifiable risk? A. interest rates increase B. energy costs increase C. core inflation increases D. a firm's sales decrease E. taxes decrease

D. a firm's sales decrease

14. The expected return on a stock computed using economic probabilities is: A. guaranteed to equal the actual average return on the stock for the next five years. B. guaranteed to be the minimal rate of return on the stock over the next two years. C. guaranteed to equal the actual return for the immediate twelve month period. D. a mathematical expectation based on a weighted average and not an actual anticipated outcome. E. the actual return you should anticipate as long as the economic forecast remains constant.

D. a mathematical expectation based on a weighted average and not an actual anticipated outcome.

17. Forecasting risk emphasizes the point that the correctness of any decision to accept or reject a project is highly dependent upon the: A. method of analysis used to make the decision. B. initial cash outflow. C. ability to recoup any investment in net working capital. D. accuracy of the projected cash flows. E. length of the project.

D. accuracy of the projected cash flows.

8. The depreciation tax shield is best defined as the: A. amount of tax that is saved when an asset is purchased. B. tax that is avoided when an asset is sold as salvage. C. amount of tax that is due when an asset is sold. D. amount of tax that is saved because of the depreciation expense. E. amount by which the aftertax depreciation expense lowers net income.

D. amount of tax that is saved because of the depreciation expense.

25. What was the highest annual rate of inflation during the period 1926-2010? A. between 0 and 3 percent B. between 3 and 5 percent C. between 5 and 10 percent D. between 10 and 15 percent E. between 15 and 20 percent

D. between 10 and 15 percent

28. What was the average rate of inflation over the period of 1926-2010? A. less than 2.0 percent B. between 2.0 and 2.5 percent C. between 2.5 and 3.0 percent D. between 3.0 and 3.5 percent E. greater than 3.5 percent

D. between 3.0 and 3.5 percent

23. Net working capital: A. can be ignored in project analysis because any expenditure is normally recouped at the end of the project. B. requirements, such as an increase in accounts receivable, create a cash inflow at the beginning of a project. C. is rarely affected when a new product is introduced. D. can create either a cash inflow or a cash outflow at time zero of a project. E. is the only expenditure where at least a partial recovery can be made at the end of a project.

D. can create either a cash inflow or a cash outflow at time zero of a project.

51. The reward-to-risk ratio for stock A is less than the reward-to-risk ratio of stock B. Stock A has a beta of 0.82 and stock B has a beta of 1.29. This information implies that: A. stock A is riskier than stock B and both stocks are fairly priced. B. stock A is less risky than stock B and both stocks are fairly priced. C. either stock A is underpriced or stock B is overpriced or both. D. either stock A is overpriced or stock B is underpriced or both. E. both stock A and stock B are correctly priced since stock A is riskier than stock B.

D. either stock A is overpriced or stock B is underpriced or both.

45. Decreasing which one of the following will increase the acceptability of a project? A. sunk costs B. salvage value C. depreciation tax shield D. equivalent annual cost E. accounts payable requirement

D. equivalent annual cost

5. The average compound return earned per year over a multi-year period is called the _____ average return. A. arithmetic B. standard C. variant D. geometric E. real

D. geometric

73. Your friend is the owner of a stock which had returns of 25 percent, -36 percent, 1 percent, and 16 percent for the past four years. Your friend thinks the stock may be able to achieve a return of 50 percent or more in a single year. Based on these returns, what is the probability that your friend is correct? A. less than 0.5 percent B. greater than 0.5 percent but less than 1.0 percent C. greater than 1.0 percent but less than 2.5 percent D. greater than 2.5 percent but less than 16 percent E. greater than 16.0 percent

D. greater than 2.5 percent but less than 16 percent

74. A stock had returns of 15 percent, 8 percent, 12 percent, -15 percent, and -4 percent for the past five years. Based on these returns, what is the approximate probability that this stock will return at least 20 percent in any one given year? A. less than 0.5 percent B. greater than 0.5 percent but less than 1.0 percent C. greater than 1.0 percent but less than 2.5 percent D. greater than 2.5 percent but less than 16 percent E. greater than 16.0 percent

D. greater than 2.5 percent but less than 16 percent

75. A stock had returns of 14 percent, 13 percent, -10 percent, and 7 percent for the past four years. Which one of the following best describes the probability that this stock will lose no more than 10 percent in any one year? A. greater than 0.5 but less than 1.0 percent B. greater than 1.0 percent but less than 2.5 percent C. greater than 2.5 percent but less than 16 percent D. greater than 84 percent but less than 97.5 percent E. greater than 95 percent

D. greater than 84 percent but less than 97.5 percent

76. Over the past five years, a stock produced returns of 11 percent, 14 percent, 4 percent, -9 percent, and 5 percent. What is the probability that an investor in this stock will not lose more than 10 percent in any one given year? A. greater than 0.5 but less than 1.0 percent B. greater than 1.0 percent but less than 2.5 percent C. greater than 2.5 percent but less than 16 percent D. greater than 84 percent but less than 97.5 percent E. greater than 95 percent

D. greater than 84 percent but less than 97.5 percent

12. The stand-alone principle advocates that project analysis should be based solely on which one of the following costs? A. sunk B. total C. variable D. incremental E. fixed

D. incremental

34. The operating cash flow for a project should exclude which one of the following? A. taxes B. variable costs C. fixed costs D. interest expense E. depreciation tax shield

D. interest expense

70. A stock had annual returns of 3.6 percent, -8.7 percent, 5.6 percent, and 12.5 percent over the past four years. Which one of the following best describes the probability that this stock will produce a return of 22 percent or more in a single year? A. less than 0.1 percent B. less than 0.5 percent but greater than 0.1 percent C. less than 1.0 percent but greater the 0.5 percent D. less than 2.5 percent but greater than 0.5 percent E. less than 5 percent but greater than 2.5 percent

D. less than 2.5 percent but greater than 0.5 percent

4. The option that is foregone so that an asset can be utilized by a specific project is referred to as which one of the following? A. salvage value B. wasted value C. sunk cost D. opportunity cost E. erosion

D. opportunity cost

54. The _____ of a security divided by the beta of that security is equal to the slope of the security market line if the security is priced fairly. A. real return B. actual return C. nominal return D. risk premium E. expected return

D. risk premium

56. Uptown Promotions has three divisions. As part of the planning process, the CFO requested that each division submit its capital budgeting proposals for next year. These proposals represent positive net present value projects that fall within the long-range plans of the firm. The requests from the divisions are $4.2 million, $3.1 million, and $6.8 million, respectively. For the firm as a whole, the management of Uptown Promotions has limited spending to $10 million for new projects next year. This is an example of: A. scenario analysis. B. sensitivity analysis. C. determining operating leverage. D. soft rationing. E. hard rationing.

D. soft rationing.

52. The U.S. Securities and Exchange Commission periodically charges individuals with insider trading and claims those individuals have made unfair profits. Given this, you would be most apt to argue that the markets are less than _____ form efficient. A. weak B. semiweak C. semistrong D. strong E. perfect

D. strong

52. The market risk premium is computed by: A. adding the risk-free rate of return to the inflation rate. B. adding the risk-free rate of return to the market rate of return. C. subtracting the risk-free rate of return from the inflation rate. D. subtracting the risk-free rate of return from the market rate of return. E. multiplying the risk-free rate of return by a beta of 1.0.

D. subtracting the risk-free rate of return from the market rate of return.

20. Which one of the following will be used in the computation of the best-case analysis of a proposed project? A. minimal number of units that are expected to be produced and sold B. the lowest expected salvage value that can be obtained for a project's fixed assets C. the most anticipated sales price per unit D. the lowest variable cost per unit that can reasonably be expected E. the highest level of fixed costs that is actually anticipated

D. the lowest variable cost per unit that can reasonably be expected

5. A news flash just appeared that caused about a dozen stocks to suddenly drop in value by about 20 percent. What type of risk does this news flash represent? A. portfolio B. nondiversifiable C. market D. unsystematic E. total

D. unsystematic

13. The expected return on a stock given various states of the economy is equal to the: A. highest expected return given any economic state. B. arithmetic average of the returns for each economic state. C. summation of the individual expected rates of return. D. weighted average of the returns for each economic state. E. return for the economic state with the highest probability of occurrence.

D. weighted average of the returns for each economic state.

30. Simulation analysis is based on assigning a _____ and analyzing the results. A. narrow range of values to a single variable B. narrow range of values to multiple variables simultaneously C. wide range of values to a single variable D. wide range of values to multiple variables simultaneously E. single value to each of the variables

D. wide range of values to multiple variables simultaneously

23. When you assign the lowest anticipated sales price and the highest anticipated costs to a project, you are analyzing the project under the condition known as: A. best case sensitivity analysis. B. worst case sensitivity analysis. C. best case scenario analysis. D. worst case scenario analysis. E. base case scenario analysis.

D. worst case scenario analysis.

81. The Card Shoppe needs to maintain 20 percent of its sales in net working capital. Currently, the shoppe is considering a 6-year project that will increase sales from its current level of $379,000 to $421,000 the first year and to $465,000 a year for the following 5 years of the project. What amount should be included in the project analysis for net working capital in year 6 of the project? A. -$17,200 B. -$2,990 C. $0 D. $2,990 E. $17,200

E. $17,200 NWC recovery = ($465,000 - $379,000) × 0.2 = $17,200

56. Marie's Fashions is considering a project that will require $28,000 in net working capital and $87,000 in fixed assets. The project is expected to produce annual sales of $75,000 with associated cash costs of $57,000. The project has a 5-year life. The company uses straight-line depreciation to a zero book value over the life of the project. The tax rate is 30 percent. What is the operating cash flow for this project? A. -$1,520 B. -$580 C. $420 D. $15,680 E. $17,820

E. $17,820 OCF = ($75,000 - $57,000)(1 - 0.30) + ($87,000/5)(0.30) = $17,820

86. The common stock of Jensen Shipping has an expected return of 14.7 percent. The return on the market is 10.8 percent and the risk-free rate of return is 3.8 percent. What is the beta of this stock? A. .92 B. 1.23 C. 1.33 D. 1.41 E. 1.56

E. 1.56 E(r) = 0.147 = 0.038 + β (0.108 - 0.038); β = 1.56

75. You are working on a bid to build two city parks a year for the next three years. This project requires the purchase of $185,000 of equipment that will be depreciated using straight-line depreciation to a zero book value over the 3-year project life. The equipment can be sold at the end of the project for $34,000. You will also need $20,000 in net working capital for the duration of the project. The fixed costs will be $18,000 a year and the variable costs will be $168,000 per park. Your required rate of return is 15 percent and your tax rate is 34 percent. What is the minimal amount you should bid per park? (Round your answer to the nearest $100) A. $72,500 B. $128,600 C. $154,300 D. $189,100 E. $219,900

E. $219,900

58. West Wind Tours stock is currently selling for $48 a share. The stock has a dividend yield of 3.2 percent. How much dividend income will you receive per year if you purchase 200 shares of this stock? A. $24.96 B. $36.20 C. $424.80 D. $362.00 E. $307.20

E. $307.20 Dividend income = $48 × 0.032 × 200 = $307.20

92. Consider an asset that costs $176,000 and is depreciated straight-line to zero over its 11-year tax life. The asset is to be used in a 7-year project; at the end of the project, the asset can be sold for $22,000. The relevant tax rate is 30 percent. What is the aftertax cash flow from the sale of this asset? A. $31,800 B. $32,600 C. $33,300 D. $34,100 E. $34,600

E. $34,600 Book value at end of year 7 = $176,000 × 4/11 = $64,000 Aftertax salvage value = $22,000 + [($64,000 - $22,000) × .30] = $34,600

69. Bruno's Lunch Counter is expanding and expects operating cash flows of $29,000 a year for 4 years as a result. This expansion requires $39,000 in new fixed assets. These assets will be worthless at the end of the project. In addition, the project requires $3,000 of net working capital throughout the life of the project. What is the net present value of this expansion project at a required rate of return of 15 percent? A. $18,477.29 B. $21,033.33 C. $28,288.70 D. $29,416.08 E. $42,509.63

E. $42,509.63

63. Bernie's Beverages purchased some fixed assets classified as 5-year property for MACRS. The assets cost $94,000. What will the accumulated depreciation be at the end of year three? MACRS 5-year Property (year / rate) 1 / 20.00% 2 / 32.00% 3 / 19.20% 4 / 11.52% 5 / 11.52% 6 / 5.76% A. $13,520 B. $25,056 C. $38,241 D. $48,759 E. $66,928

E. $66,928 Depreciation = $94,000 × (0.20 + 0.32 + 0.192) = $66,928

29. Keyser Petroleum just purchased some equipment at a cost of $67,000. What is the proper methodology for computing the depreciation expense for year 2 if the equipment is classified as 5-year property for MACRS? MACRS 5-year Property (year / rate) 1 / 20.00% 2 / 32.00% 3 / 19.20% 4 / 11.52% 5 / 11.52% 6 / 5.76% A. $67,000 × (1 - 0.20) × 0.32 B. $67,000/(1 - 0.20 - 0.32) C. $67,000 × (1 + 0.32) D. $67,000 × (1 - 0.32) E. $67,000 × 0.32

E. $67,000 × 0.32

98. You own a portfolio equally invested in a risk-free asset and two stocks. One of the stocks has a beta of 1.9 and the total portfolio is equally as risky as the market. What is the beta of the second stock? A. 0.75 B. 0.80 C. 0.94 D. 1.00 E. 1.10

E. 1.10 βp = 1.0 = (1/3)(0) + (1/3)(βx) + (1/3)(1.9); βx = 1.10

74. What is the expected return on a portfolio comprised of $6,200 of stock M and $4,500 of stock N if the economy enjoys a boom period? SoE / Prob. of SOE / RoR if SoE Occurs M / N Boom / 14% / 20% / 5% Normal / 80% / 13% / 9% Recession / 6% / -31% / 18% A. 10.93 percent B. 11.16 percent C. 12.55 percent D. 12.78 percent E. 13.69 percent

E. 13.69 percent E(r)Boom = [$6,200/($6,200 + $4,500)][0.20] + [$4,500/($6,200 + $4,500)] [0.05] = 13.69 percent

97. Your portfolio is invested 30 percent each in Stocks A and C, and 40 percent in Stock B. What is the standard deviation of your portfolio given the following information? SoE / Prob. of SOE / RoR if SoE Occurs Stock A / B / C Boom / 0.25 / 0.25 / 0.25 / 0.45 Good / 0.25 / 0.10 / 0.13 / 0.11 Poor / 0.25 / 0.03 / 0.05 / 0.05 Bust / 0.25 / -0.04 / -0.09 / -0.09 A. 12.38 percent B. 12.64 percent C. 12.72 percent D. 12.89 percent E. 13.97 percent

E. 13.97 percent E(Rp)Boom = 0.3(0.25) + 0.4(0.25) + 0.3(0.45) = 0.31 E(Rp)Good = 0.3(0.10) + 0.4(0.13) + 0.3(0.11) = 0.115 E(Rp)Poor = 0.3(0.03) + 0.4(0.05) + 0.3(0.05) = 0.044 E(Rp)Bust = 0.3(-0.04) + 0.4(-0.09) + 0.3(-0.09) = -0.075 E(Rp) = 0.25(0.31) + 0.25(0.115) + 0.25(0.044) + 0.25(-0.075) = 0.0985 σp2 = 0.25(0.31 - 0.0985)2 + 0.25(0.115 - 0.0985)2 + 0.25(0.044 - 0.0985)2 + 0.25(-0.075 - 0.0985)2 = 0.019519250 σp = √0.019519250 = 13.97 percent

86. Calculate the standard deviation of the following rates of return: Year / Return 1 / 7% 2 / 25% 3 / 14% 4 / -15% 5 / 16% A. 10.79 percent B. 12.60 percent C. 13.48 percent D. 14.42 percent E. 15.08 percent

E. 15.08 percent Average return = (0.07 + 0.25 + 0.14 - 0.15 + 0.16)/5 = 0.094 Standard deviation = √[1/(5 - 1)] [(0.07 - 0.094)2 + (0.25 - 0.094)2 +(0.14 - 0.094)2 +(-0.15 - 0.094)2 + (0.16 - 0.094)2] = 15.08 percent

69. The common stock of Air United, Inc., had annual returns of 15.6 percent, 2.4 percent, -11.8 percent, and 32.9 percent over the last four years, respectively. What is the standard deviation of these returns? A. 13.29 percent B. 14.14 percent C. 16.50 percent D. 17.78 percent E. 19.05 percent

E. 19.05 percent Average return = (0.156 + 0.024 - 0.118 + 0.329)/4 = 0.09775 σ = √[1/(4 - 1)] [(0.156 - 0.09775)2 + (0.024 - 0.09775)2 + (-0.118 - 0.09775)2 + (0.329 - 0.09775)2] = 19.05 percent

88. The expected return on JK stock is 15.78 percent while the expected return on the market is 11.34 percent. The stock's beta is 1.51. What is the risk-free rate of return? A. 2.22 percent B. 2.31 percent C. 2.42 percent D. 2.50 percent E. 2.63 percent

E. 2.63 percent E(r) = 0.1578 = rf + 1.51 (0.1134 - rf); rf = 2.63 percent

82. Your portfolio has a beta of 1.12. The portfolio consists of 40 percent U.S. Treasury bills, 30 percent stock A, and 30 percent stock B. Stock A has a risk-level equivalent to that of the overall market. What is the beta of stock B? A. 1.47 B. 1.52 C. 1.69 D. 1.84 E. 2.73

E. 2.73 BetaPortfolio = 1.12 = (0.4 × 0) + (0.3 × 1) + (0.3 × βB); βB = 2.73 The beta of a risk-free asset is zero. The beta of the market is 1.0.

104. Suppose you observe the following situation: SoE / Prob. of SOE / RoR if SoE Occurs A / B Bust / 0.22 / -0.12 / -0.27 Normal / 0.48 / 0.10 / 0.05 Boom / 0.30 / 0.23 / 0.28 Assume the capital asset pricing model holds and stock A's beta is greater than stock B's beta by 0.21. What is the expected market risk premium? A. 8.8 percent B. 9.5 percent C. 12.6 percent D. 17.9 percent E. 20.0 percent

E. 20.0 percent E(RA) = 0.22(-0.12) + 0.48(0.10) + 0.30(0.23) = .0906 E(RB) = 0.22(-0.27) + 0.48(0.05) + 0.30(0.28) = .0486 SlopeSML = (.0906 - 0.0486)/0.21 = 20 percent

101. Consider the following information on three stocks: SoE / Prob. of SOE / RoR if SoE Occurs A / B / C Boom / .45 / 0.42 / 0.35 / 0.65 Normal / .50 / 0.31 / 0.18 / 0.04 Bust / .05 / 0.17 / -0.17 / -0.64 A portfolio is invested 35 percent each in Stock A and Stock B and 30 percent in Stock C. What is the expected risk premium on the portfolio if the expected T-bill rate is 3.3 percent? A. 11.47 percent B. 12.38 percent C. 16.67 percent D. 24.29 percent E. 25.82 percent

E. 25.82 percent E(Rp)Boom = 0.35(0.42) + 0.35(0.35) + 0.30(0.65) = 0.4645 E(Rp)Normal = 0.35(0.31) + 0.35(0.18) + 0.30(0.04) = 0.1835 E(Rp)Bust = 0.35(0.17) + 0.35(-0.17) + 0.30(-0.64) = -0.192 E(Rp) = 0.45(0.51) + 0.50(0.229) + 0.05(-0.122) = 0.2912 RPi = 0.2912 - 0.033 = 29.99 percent

103. Consider the following information on Stocks I and II: SoE / Prob. of SOE / RoR if SoE Occurs I / II Recession / 0.06 / 0.15 / -0.35 Normal / 0.69 / 0.35 / 0.35 Irrational exuberance / 0.25 / 0.43 / 0.45 The market risk premium is 8 percent, and the risk-free rate is 3.6 percent. The beta of stock I is _____ and the beta of stock II is _____. A. 2.08; 2.47 B. 2.08; 2.76 C. 3.21; 3.84 D. 4.47; 3.89 E. 4.03; 3.71

E. 4.03; 3.71 E(RI) = 0.06(0.15) + 0.69(0.35) + 0.25(0.43) = 0.358 BI: 0.358 = 0.036 + BI (0.08); BI = 4.03 E(RII) = 0.06(-0.35) + 0.69(0.35) + 0.25(0.45) = 0.333 BII: 0.333 = 0.036 + BII (0.08); BII = 3.71

78. A stock has annual returns of 5 percent, 21 percent, -12 percent, 7 percent, and -6 percent for the past five years. The arithmetic average of these returns is _____ percent while the geometric average return for the period is _____ percent. A. 3.89; 3.62 B. 3.89; 4.60 C. 3.62; 3.89 D. 4.60; 3.62 E. 4.60; 3.89

E. 4.60; 3.89

64. One year ago, you purchased 500 shares of Best Wings, Inc. stock at a price of $9.75 a share. The company pays an annual dividend of $0.10 per share. Today, you sold all of your shares for $15.60 a share. What is your total percentage return on this investment? A. 38.46 percent B. 39.10 percent C. 39.72 percent D. 62.50 percent E. 61.03 percent

E. 61.03 percent Total percentage return = ($15.60 - $9.75 + $0.10)/$9.75 = 61.03 percent

23. Which one of the following statements is correct concerning a portfolio of 20 securities with multiple states of the economy when both the securities and the economic states have unequal weights? A. Given the unequal weights of both the securities and the economic states, the standard deviation of the portfolio must equal that of the overall market. B. The weights of the individual securities have no effect on the expected return of a portfolio when multiple states of the economy are involved. C. Changing the probabilities of occurrence for the various economic states will not affect the expected standard deviation of the portfolio. D. The standard deviation of the portfolio will be greater than the highest standard deviation of any single security in the portfolio given that the individual securities are well diversified. E. Given both the unequal weights of the securities and the economic states, an investor might be able to create a portfolio that has an expected standard deviation of zero.

E. Given both the unequal weights of the securities and the economic states, an investor might be able to create a portfolio that has an expected standard deviation of zero.

25. Which one of the following statements is correct? A. The unexpected return is always negative. B. The expected return minus the unexpected return is equal to the total return. C. Over time, the average return is equal to the unexpected return. D. The expected return includes the surprise portion of news announcements. E. Over time, the average unexpected return will be zero.

E. Over time, the average unexpected return will be zero.

90. The common stock of Alpha Manufacturers has a beta of 1.14 and an actual expected return of 15.26 percent. The risk-free rate of return is 4.3 percent and the market rate of return is 12.01 percent. Which one of the following statements is true given this information? A. The actual expected stock return will graph above the Security Market Line. B. The stock is underpriced. C. To be correctly priced according to CAPM, the stock should have an expected return of 21.95 percent. D. The stock has less systematic risk than the overall market. E. The actual expected stock return indicates the stock is currently underpriced.

E. The actual expected stock return indicates the stock is currently underpriced. E(r) = 0.043 + 1.14 (0.1201 - 0.043) = 13.09 percent The stock is underpriced because its actual expected return is greater than the CAPM return.

67. You own some equipment that you purchased 4 years ago at a cost of $225,000. The equipment is 5-year property for MACRS. You are considering selling the equipment today for $87,000. Which one of the following statements is correct if your tax rate is 35 percent? MACRS 5-year Property (year / rate) 1 / 20.00% 2 / 32.00% 3 / 19.20% 4 / 11.52% 5 / 11.52% 6 / 5.76% A. The tax due on the sale is $26,425. B. The book value today is $186,120. C. The accumulated depreciation to date is $38,880. D. The taxable amount on the sale is $38,880. E. The aftertax salvage value is $70,158.

E. The aftertax salvage value is $70,158.

2. Which one of the following best defines the variance of an investment's annual returns over a number of years? A. The average squared difference between the arithmetic and the geometric average annual returns. B. The squared summation of the differences between the actual returns and the average geometric return. C. The average difference between the annual returns and the average return for the period. D. The difference between the arithmetic average and the geometric average return for the period. E. The average squared difference between the actual returns and the arithmetic average return.

E. The average squared difference between the actual returns and the arithmetic average return.

26. Assume you graph a project's net present value given various sales quantities. Which one of the following is correct regarding the resulting function? A. The steepness of the function relates to the project's degree of operating leverage. B. The steeper the function, the less sensitive the project is to changes in the sales quantity. C. The resulting function will be a hyperbole. D. The resulting function will include only positive values. E. The slope of the function measures the sensitivity of the net present value to a change in sales quantity.

E. The slope of the function measures the sensitivity of the net present value to a change in sales quantity.

19. Which one of the following categories of securities had the lowest average risk premium for the period 1926-2010? A. long-term government bonds B. small company stocks C. large company stocks D. long-term corporate bonds E. U.S. Treasury bills

E. U.S. Treasury bills

21. Which one of the following statements correctly applies to the period 1926-2010? A. Large-company stocks earned a higher average risk premium than did small-company stocks. B. Intermediate-term government bonds had a higher average return than long-term corporate bonds. C. Large-company stocks had an average annual return of 14.7 percent. D. Inflation averaged 2.6 percent for the period. E. U.S. Treasury bills had a positive average real rate of return.

E. U.S. Treasury bills had a positive average real rate of return.

26. Which one of the following statements related to unexpected returns is correct? A. All announcements by a firm affect that firm's unexpected returns. B. Unexpected returns over time have a negative effect on the total return of a firm. C. Unexpected returns are relatively predictable in the short-term. D. Unexpected returns generally cause the actual return to vary significantly from the expected return over the long-term. E. Unexpected returns can be either positive or negative in the short term but tend to be zero over the long-term.

E. Unexpected returns can be either positive or negative in the short term but tend to be zero over the long-term.

74. Gateway Communications is considering a project with an initial fixed asset cost of $2.46 million which will be depreciated straight-line to a zero book value over the 10-year life of the project. At the end of the project the equipment will be sold for an estimated $300,000. The project will not directly produce any sales but will reduce operating costs by $725,000 a year. The tax rate is 35 percent. The project will require $45,000 of inventory which will be recouped when the project ends. Should this project be implemented if the firm requires a 14 percent rate of return? Why or why not? A. No; The NPV is -$172,937.49. B. No; The NPV is -$87,820.48. C. Yes; The NPV is $251,860.34. D. Yes; The NPV is $387,516.67. E. Yes; The NPV is $466,940.57.

E. Yes; The NPV is $466,940.57.

39. Which one of the following indicates a portfolio is being effectively diversified? A. an increase in the portfolio beta B. a decrease in the portfolio beta C. an increase in the portfolio rate of return D. an increase in the portfolio standard deviation E. a decrease in the portfolio standard deviation

E. a decrease in the portfolio standard deviation

19. Which one of the following will increase a bid price? A. a decrease in the fixed costs B. a reduction in the net working capital requirement C. a reduction in the firm's tax rate D. an increase in the salvage value E. an increase in the required rate of return

E. an increase in the required rate of return

21. The standard deviation of a portfolio: A. is a weighted average of the standard deviations of the individual securities held in the portfolio. B. can never be less than the standard deviation of the most risky security in the portfolio. C. must be equal to or greater than the lowest standard deviation of any single security held in the portfolio. D. is an arithmetic average of the standard deviations of the individual securities which comprise the portfolio. E. can be less than the standard deviation of the least risky security in the portfolio.

E. can be less than the standard deviation of the least risky security in the portfolio.

22. The standard deviation of a portfolio: A. is a measure of that portfolio's systematic risk. B. is a weighed average of the standard deviations of the individual securities held in that portfolio. C. measures the amount of diversifiable risk inherent in the portfolio. D. serves as the basis for computing the appropriate risk premium for that portfolio. E. can be less than the weighted average of the standard deviations of the individual securities held in that portfolio.

E. can be less than the weighted average of the standard deviations of the individual securities held in that portfolio.

21. The base case values used in scenario analysis are the ones considered the most: A. optimistic. B. desired by management. C. pessimistic. D. conducive to creating a positive net present value. E. likely to occur.

E. likely to occur.

24. The operating cash flow of a cost cutting project: A. is equal to the depreciation tax shield. B. is equal to zero because there is no incremental sales. C. can only be analyzed by projecting the sales and costs for a firm's entire operations. D. includes any changes that occur in the current accounts. E. can be positive even though there are no sales.

E. can be positive even though there are no sales.

14. Bell Weather Goods has several proposed independent projects that have positive NPVs. However, the firm cannot initiate any of the projects due to a lack of financing. This situation is referred to as: A. financial rejection. B. project rejection. C. soft rationing. D. marginal rationing. E. capital rationing.

E. capital rationing.

29. Which one of the following is an example of unsystematic risk? A. income taxes are increased across the board B. a national sales tax is adopted C. inflation decreases at the national level D. an increased feeling of prosperity is felt around the globe E. consumer spending on entertainment decreased nationally

E. consumer spending on entertainment decreased nationally

12. Treynor Industries is investing in a new project. The minimum rate of return the firm requires on this project is referred to as the: A. average arithmetic return. B. expected return. C. market rate of return. D. internal rate of return. E. cost of capital.

E. cost of capital.

31. The net book value of equipment will: A. remain constant over the life of the equipment. B. vary in response to changes in the market value. C. decrease at a constant rate when MACRS depreciation is used. D. increase over the taxable life of an asset. E. decrease slower under straight-line depreciation than under MACRS.

E. decrease slower under straight-line depreciation than under MACRS.

37. Increasing which one of the following will increase the operating cash flow assuming that the bottom-up approach is used to compute the operating cash flow? A. erosion effects B. taxes C. fixed expenses D. salaries E. depreciation expense

E. depreciation expense

7. Assume that the market prices of the securities that trade in a particular market fairly reflect the available information related to those securities. Which one of the following terms best defines that market? A. riskless market B. evenly distributed market C. zero volatility market D. Blume's market E. efficient capital market

E. efficient capital market

9. The annual annuity stream of payments that has the same present value as a project's costs is referred to as which one of the following? A. yearly incremental costs B. sunk costs C. opportunity costs D. erosion cost E. equivalent annual cost

E. equivalent annual cost

16. PC Enterprises wants to commence a new project but is unable to obtain the financing under any circumstances. This firm is facing: A. financial deferral. B. financial allocation. C. capital allocation. D. marginal rationing. E. hard rationing.

E. hard rationing.

17. You are considering the purchase of a new machine. Your analysis includes the evaluation of two machines which have differing initial and ongoing costs and differing lives. Whichever machine is purchased will be replaced at the end of its useful life. You should select the machine which has the: A. longest life. B. highest annual operating cost. C. lowest annual operating cost. D. highest equivalent annual cost. E. lowest equivalent annual cost.

E. lowest equivalent annual cost.

10. Which one of the following is represented by the slope of the security market line? A. reward-to-risk ratio B. market standard deviation C. beta coefficient D. risk-free interest rate E. market risk premium

E. market risk premium

42. The primary purpose of Blume's formula is to: A. compute an accurate historical rate of return. B. determine a stock's true current value. C. consider compounding when estimating a rate of return. D. determine the actual real rate of return. E. project future rates of return.

E. project future rates of return.

18. Steve is fairly cautious when analyzing a new project and thus he projects the most optimistic, the most realistic, and the most pessimistic outcome that can reasonably be expected. Which type of analysis is Steve using? A. simulation testing B. sensitivity analysis C. break-even analysis D. rationing analysis E. scenario analysis

E. scenario analysis

31. Which one of the following types of analysis is the most complex to conduct? A. scenario B. break-even C. sensitivity D. degree of operating leverage E. simulation

E. simulation

20. Which one of the following categories of securities has had the most volatile returns over the period 1926-2010? A. long-term corporate bonds B. large-company stocks C. intermediate-term government bonds D. U.S. Treasury bills E. small-company stocks

E. small-company stocks

57. Brubaker & Goss has received requests for capital investment funds for next year from each of its five divisions. All requests represent positive net present value projects. All projects are independent. Senior management has decided to allocate the available funds based on the profitability index of each project since the company has insufficient funds to fulfill all of the requests. Management is following a practice known as: A. scenario analysis. B. sensitivity analysis. C. leveraging. D. hard rationing. E. soft rationing.

E. soft rationing.

14. G & L Plastic Molders spent $1,200 last week repairing a machine. This week the company is trying to decide if the machine could be better utilized if they assigned it a proposed project. When analyzing the proposed project, the $1,200 should be treated as which type of cost? A. opportunity B. fixed C. incremental D. erosion E. sunk

E. sunk

18. The bid price is: A. an aftertax price. B. the aftertax contribution margin. C. the highest price you should charge if you want the project. D. the only price you can bid if the project is to be profitable. E. the minimum price you should charge if you want to earn a target return on investment.

E. the minimum price you should charge if you want to earn a target return on investment.

40. The equivalent annual cost method is useful in determining: A. which one of two machines to purchase if the machines are mutually exclusive, have differing lives, and are a one-time purchase. B. the tax shield benefits of depreciation given the purchase of new assets for a project. C. the operating cash flows of a cost-cutting project. D. which one of two investments to accept when the investments have different required rates of return. E. which one of two machines should be purchased when the machines are mutually exclusive, have different machine lives, and will be replaced once they are worn out.

E. which one of two machines should be purchased when the machines are mutually exclusive, have different machine lives, and will be replaced once they are worn out.

108. How can two firms arrive at two different bid prices when bidding for the same job and given the same bid specifications?

Each bidding firm usually arrives at a different calculated bid price because they use different assumptions in the evaluation process, such as the estimated time to complete the project, the material costs, and the estimated labor costs. In addition, firms often times have differing required rates of return and tax rates.

103. What is forecasting risk and why is it important to the analysis of capital expenditure projects? What methods can be used to reduce this risk?

Forecasting risk is the possibility that errors in projected cash flows will lead to incorrect decisions. Projects are generally accepted when they have positive NPVs and rejected when they have negative NPVs. If the cash inflows of a project are overestimated, the NPV will be overstated potentially resulting in an incorrect acceptance of the project. On the other hand, if cash inflows are underestimated, a good project might be erroneously rejected. To offset some of this risk, managers should employ sensitivity and scenario analysis as well as break-even analysis to better understand the potential outcomes associated with the project.

41. When using the equivalent annual cost as a basis for deciding which equipment should be purchased, the equipment under consideration must fit which two of the following criteria? I. differing productive lives II. differing manufacturers III. required replacement at end of economic life IV. differing initial cost

I and III

13. Which of the following statements is correct in relation to a stock investment? I. The capital gains yield can be positive, negative, or zero. II. The dividend yield can be positive, negative, or zero. III. The total return can be positive, negative, or zero. IV. Neither the dividend yield nor the total return can be negative.

I and III only

37. Which of the following statements concerning risk are correct? I. Nondiversifiable risk is measured by beta. II. The risk premium increases as diversifiable risk increases. III. Systematic risk is another name for nondiversifiable risk. IV. Diversifiable risks are market risks you cannot avoid.

I and III only

20. All of the following are related to a proposed project. Which of these should be included in the cash flow at time zero? I. purchase of $1,400 of parts inventory needed to support the project II. loan of $125,000 used to finance the project III. depreciation tax shield of $1,100 IV. $6,500 of equipment needed to commence the project

I and IV only

34. Which of the following are examples of diversifiable risk? I. earthquake damages an entire town II. federal government imposes a $100 fee on all business entities III. employment taxes increase nationally IV. toymakers are required to improve their safety standards

I and IV only

35. Which of the following statements are correct concerning diversifiable risks? I. Diversifiable risks can be essentially eliminated by investing in thirty unrelated securities. II. There is no reward for accepting diversifiable risks. III. Diversifiable risks are generally associated with an individual firm or industry. IV. Beta measures diversifiable risk.

I, II and III only

18. The expected return on a portfolio considers which of the following factors? I. percentage of the portfolio invested in each individual security II. projected states of the economy III. the performance of each security given various economic states IV. probability of occurrence for each state of the economy

I, II, III, and IV

25. Pro forma statements for a proposed project should: I. be compiled on a stand-alone basis. II. include all the incremental cash flows related to the project. III. generally exclude interest expense. IV. include all project-related fixed asset acquisitions and disposals.

I, II, III, and IV

42. The equivalent annual cost considers which of the following? I. required rate of return II. operating costs III. need for replacement IV. economic life

I, II, III, and IV

19. The expected return on a portfolio: I. can never exceed the expected return of the best performing security in the portfolio. II. must be equal to or greater than the expected return of the worst performing security in the portfolio. III. is independent of the unsystematic risks of the individual securities held in the portfolio. IV. is independent of the allocation of the portfolio amongst individual securities.

I, II, and III only

49. Which of the following statements related to market efficiency tend to be supported by current evidence? I. Markets tend to respond quickly to new information. II. It is difficult for investors to earn abnormal returns. III. Short-run prices are difficult to predict accurately based on public information. IV. Markets are most likely weak form efficient.

I, II, and III only

11. Danielle's is a furniture store that is considering adding appliances to its offerings. Which of the following should be considered incremental cash flows of this project? I. utilizing the credit offered by a supplier to purchase the appliance inventory II. benefiting from increased furniture sales to appliance customers III. borrowing money from a bank to fund the appliance project IV. purchasing parts for inventory to handle any appliance repairs that might be necessary

I, II, and IV only

55. The capital asset pricing model (CAPM) assumes which of the following? I. a risk-free asset has no systematic risk. II. beta is a reliable estimate of total risk. III. the reward-to-risk ratio is constant. IV. the market rate of return can be approximated.

I, III, and IV only

35. If the variability of the returns on large-company stocks were to increase over the long-term, you would expect which of the following to occur as a result? I. decrease in the average rate of return II. increase in the risk premium III. increase in the 68 percent probability range of the frequency distribution of returns IV. decrease in the standard deviation

II and III only

45. At a minimum, which of the following would you need to know to estimate the amount of additional reward you will receive for purchasing a risky asset instead of a risk-free asset? I. asset's standard deviation II. asset's beta III. risk-free rate of return IV. market risk premium

II and IV only

16. Which of the following should be included in the analysis of a new product? I. money already spent for research and development of the new product II. reduction in sales for a current product once the new product is introduced III. increase in accounts receivable needed to finance sales of the new product IV. market value of a machine owned by the firm which will be used to produce the new product

II, III, and IV only

33. Which of the following correspond to a wide frequency distribution? I. relatively low risk II. relatively low rate of return III. relatively high standard deviation IV. relatively large risk premium

III and IV only

43. Which two of the following are the most likely reasons why a stock price might not react at all on the day that new information related to the stock issuer is released? I. insiders knew the information prior to the announcement II. investors need time to digest the information prior to reacting III. the information has no bearing on the value of the firm IV. the information was anticipated

III and IV only

40. Which of the following statements are true based on the historical record for 1926-2010? I. Risk and potential reward are inversely related. II. Risk-free securities produce a positive real rate of return each year. III. Returns are more predictable over the short-term than they are over the long-term. IV. Bonds are generally a safer investment than are stocks.

IV only

105. Assume that a country experiences a financial crisis that causes the nation's financial markets to freeze in a manner that prevents a private firm from raising capital from any source. Explain how project analysis conducted by that firm would work in this situation.

This situation is known as hard rationing. In this situation, the firm cannot obtain financing capital regardless of the rate of return offered. Thus, no externally-financed projects would be acceptable based on the normal methods of project analysis.