Finance test 2

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Which of the following decision rules is best defined as the amount of time it takes to pay back the initial investment? A) internal rate of return (IRR) B) profitability index C) net present value (NPV) D) payback period

Which of the following decision rules might best be used as a supplement to net present value (NPV) by a firm that favors liquidity? A) profitability index B) MIRR C) equivalent annual annuity D) payback period

Which of the following is NOT a valid method of modifying cash flows to produce a MIRR? A) Discount all of the negative cash flows to time 0 and leave the positive cash flows alone. B) Leave the initial cash flow alone and compound all of the remaining cash flows to the final period of the project. C) Discount all of the negative cash flows to the present and compound all of the positive cash flows to the end of the project. D) Turn multiple negative cash flows into a single negative cash flow by summing all negative cash flows over the projectʹs lifetime.

Which of the following is a disadvantage of the Net Present Value rule? A) can be misleading if inflows come before outflows B) not necessarily consistent with maximizing shareholder wealth C) ignores cash flows after the cutoff point D) relies on accurate estimate of the discount rate

Which of the following is true about the face value of a bond? A) It is the notional amount we use to compute coupon payments. B) It is the amount that is repaid at maturity. C) It is usually denominated in standard increments, such as $1,000. D) All of the above are true.

Which of the following situations can lead to IRR giving a different decision than NPV? A) delayed investment B) multiple IRRs C) differences in project scale D) All of the above can lead to IRR giving a different decision than NPV.

Which of the following statements regarding bonds and their terms is FALSE? A) Zero-coupon bonds are also called pure discount bonds. B) The internal rate of return (IRR) of an investment opportunity is the discount rate at which the net present value (NPV) of the investment opportunity is equal to zero. C) The yield to maturity for a zero-coupon bond is the return you will earn as an investor from holding the bond to maturity and receiving the promised face value payment. D) When prices are quoted in the bond market, they are conventionally quoted in increments of $1,000.

29) A firm is considering changing their credit terms. It is estimated that this change would result in sales increasing by $1,600,000 . This in turn would cause inventory to increase by $125,000 , accounts receivable to increase by $100,000 , and accounts payable to increase by $90,000 . What is the firmʹs expected change in net working capital? A) $1,735,000 B) $315,000 C) $225,000 D) $135,000

D) $125,000 + $100,000 - $90,000 = $135,000

The Busby Corporation had a share price at the start of the year of $26.10 , paid a dividend of $0.59 at the end of the year, and had a share price of $29.50 at the end of the year. Which of the following is closest to the rate of return of investments in companies with equal risk to The Busby Corporation for this period? A) 14% B) 13% C) 12% D) 15%

D) $29.50 + $0.59 - $26.10 = $3.99 ;$3.99 / $26.10 = 15.29%; rounded to 15%

A stationery company plans to launch a new type of indelible ink pen. Advertising for the new product will be heavy and will cost the company $8 million, although the company expects general revenues of $280 million next year from sources other than sales of the new pen. If the company has a corporate tax-rate of 35% on its pretax income, what effect will the advertising for the new pen have on its taxes? A) It will increase taxes by $8 million. B) It will increase taxes by $2.8 million. C) It will have no effect on taxes. D) It will reduce taxes by $2.8 million.

D) $8 × 0.35 = $2.8 million

Owen Inc. has a current stock price of $15.00 and is expected to pay a $0.80 dividend in one year. If Owenʹs equity cost of capital is 12%, what price would its stock be expected to sell for immediately after it pays the dividend? A) $11.20 B) $12.80 C) $16.80 D) $16.00

D) (1 + 0.12 ) × $15.00 = $16.80 ; $16.80 - $0.80 = $16.00

Which of the following statements is FALSE? A) Estimating dividends, especially for the distant future, is difficult. B) A firm can only pay out its earnings to investors or reinvest their earnings. C) Successful young firms often have high initial earnings growth rates. D) According to the constant dividend growth model, the value of the firm depends on the current dividend level, divided by the equity cost of capital plus the grow rate.

D) According to the constant dividend growth model, the value of the firm depends on the current dividend level, divided by the equity cost of capital adjusted by the growth rate.

A firm issues two -year bonds with a coupon rate of 6.7%, paid semiannually. The credit spread for this firmʹs two -year debt is 0.8%. New two -year Treasury notes are being issued at par with a coupon rate of 3.1%. What should the price of the firmʹs outstanding two -year bonds be per $100 of face value? A) $126.40 B) $147.47 C) $84.27 D) $105.34

D) Calculate the PV of the bond with FV = $100, YTM = 1.95 %, PMT = 3.35 , and N = 4 which = $105.34 .

A five-year bond with a $1,000 face value has a yield to maturity is 5.0% and itʹs coupon rate is 6.0% paid annually. The dirty price of this bond exactly 6 months after its second coupon payment is closest to ________. A) $1087.23 B) $1147.23 C) $1027.23 D) $1057.23

D) Calculate the clean price right after second coupon payment using FV = $1,000. YTM = 5.0%, PMT = 60, and N = 3; clean price = $1027.23 ; accrued interest six months after last coupon is $30 ; dirty price = $1027.23 + $30 = $1057.23 .

A stock is bought for $23.00 and sold for $27.00 one year later, immediately after it has paid a dividend of $1.50. What is the capital gain rate for this transaction? A) 3.48% B) 8.70% C) 13.91% D) 17.39 %

D) Capital gain rate = (P1 - P0) / P0 = ($27.00 - $23.00 ) / $23.00 = 17.39 %

Jumbo Transport, an air-cargo company, expects to have earnings per share of $2.00 in the coming year. It decides to retain 10% of these earnings in order to lease new aircraft. The return on this investment will be 25%. If its equity cost of capital is 11%, what is the expected share price of Jumbo Transport? A) $12.71 B) $14.83 C) $16.94 D) $21.18

D) D1 = $2.00 × (1 - 0.1) = $1.8;g = 0.1 × 0.25 = 0.025 ;P0 = $1.8 / (0.11 - 0.025 ) = $21.18

Which of the following statements is FALSE about dividend payout and growth? A) A common approximation is to assume that in the long run, dividends will grow at a constant rate. B) The dividend each year is the firmʹs earnings per share (EPS) multiplied by its dividend payout rate. C) There is a tremendous amount of uncertainty associated with any forecast of a firmʹs future dividends. D) During periods of high growth, it is not unusual for firms to pay out 100% of their earnings to shareholders in the form of dividends.

D) During periods of high growth, it is not unusual for these firms to retain 100% of their earnings to exploit profitable investment opportunities.

Which of the following statements is FALSE? A) In general, the difference between the cost of capital and the internal rate of return (IRR) is the maximum amount of estimation error in the cost of capital estimate that can exist without altering the original decision. B) The internal rate of return (IRR) can provide information on how sensitive your analysis is to errors in the estimate of your cost of capital. C) If you are unsure of your cost of capital estimate, it is important to determine how sensitive your analysis is to errors in this estimate. D) If the cost of capital estimate is more than the internal rate of return (IRR), the net present value (NPV) will be positive.

D) If the cost of capital estimate is more than the internal rate of return (IRR), the NPV will be negative.

You are considering adding a microbrewery onto one of your firmʹs existing restaurants. This will entail an increase in inventory of $8700 , an increase in accounts payables of $2300 , and an increase in property, plant, and equipment of $48,000 . All other accounts will remain unchanged. The change in net working capital resulting from the addition of the microbrewery is ________. A) $54,400 B) $11,000 C) $7680 D) $6400

D) NWC = CA - CL = $8700 - $2300 = $6400

Spacefood Products will pay a dividend of $2.40 per share this year. It is expected that this dividend will grow by 5% per year each year in the future. What will be the current value of a single share of Spacefoodʹs stock if the firmʹs equity cost of capital is 12%? A) $24.00 B) $22.29 C) $30.86 D) $34.29

D) P0 = $2.40 / (0.12 - 0.05) = $34.29

A stock is expected to pay $2.60 per share every year indefinitely and the equity cost of capital for the company is 11%. What price would an investor be expected to pay per share next year? A) $5.91 B) $11.82 C) $17.73 D) $23.64

D) P0 = $2.60 / 0.11 = $23.64

Valence Electronics has 213 million shares outstanding. It expects earnings at the end of the year of $800 million. Valence pays out 40% of its earnings in total15% paid out as dividends and 25% used to repurchase shares. If Valenceʹs earnings are expected to grow by 7% per year, these payout rates do not change, and Valenceʹs equity cost of capital is 9%, what is Valenceʹs share price? A) $11.27 B) $22.54 C) $60.10 D) $75.12

D) P0 = (0.4 × $800 million) / (0.09 - 0.07) = $16,000 million; Price per share = $16,000 million / 213 million = $75.12

Sultan Services has 1.2 million shares outstanding. It expects earnings at the end of the year of $6.0 million. Sultan pays out 60% of its earnings in total: 40% paid out as dividends and 20% used to repurchase shares. If Sultanʹs earnings are expected to grow by 5% per year, these payout rates do not change, and Sultanʹs equity cost of capital is 10%, what is Sultanʹs share price? A) $12.00 B) $24.00 C) $36.00 D) $60.00

D) P0 = (0.6 × $6.0 million) / (0.1 - 0.05) = $72 million; P0 = $72 million / 1.2 million = $60.00

NoGrowth Industries presently pays an annual dividend of $1.20 per share and it is expected that these dividend payments will continue indefinitely. If NoGrowthʹs equity cost of capital is 10%, then the value of a share of NoGrowthʹs stock is closest to ________. A) $9.60 B) $14.40 C) $13.20 D) $12.00

D) P0 = Div1 / (rE - g) = $1.20 / (0.1 - 0) = $12.00

A florist is buying a number of motorcycles to expand its delivery service. These will cost $78,000 but are expected to increase profits by $3000 per month over the next four years. What is the payback period in this case? A) 10.40 months B) 15.60 months C) 19.50 months D) 26.00 months

D) Payback period = 78,000 / 3000 = 26.00 months

A risk-free, zero-coupon bond with a face value of $10,000 has 15 years to maturity. If the YTM is 6.1%, which of the following would be closest to the price this bond will trade at? A) $4937 B) $5760 C) $6582 D) $4114

D) Price = (Face value) / (1 + YTM)N. Price = ($10,000 ) / (1 + 6.1%)15 = $4114

The owner of a hair salon spends $1,000,000 to renovate its premises, estimating that this will increase her cash flow by $220,000 per year. She constructs the above graph, which shows the net present value (NPV) as a function of the discount rate. At what dollar value should the NPV profile cross the vertical axis? A) $780,000 B) $1,000,000 C) Cannot be determined because inadequate information is given. D) The vertical axis crossing point cannot be calculated since the cash inflows are in perpetuity.

D) Since the $220,000 cash flows are perpetual, the sum of the cash flows (discount rate = 0%) is infinite.

Tanner is choosing between two investment options. He can invest $500 now and get (guaranteed) $550 in one year, or invest $500 now and get (guaranteed) $531.40 back later today. The risk-free rate is 3.5%. Which investment should Tanner prefer? A) $531.40 later today, since $1 today is worth more than $1 in one year. B) $550 in one year, since it is $50 more than he invested rather than $31.40 more than he invested. C) Neither - both investments have a negative NPV. D) Tanner should be indifferent between the two investments, since both are equivalent to the same amount of cash today.

D) The NPVs are equal, so that each is the same as $31.40 today.

A bond has five years to maturity, a $1000 face value, and a 5.5% coupon rate with annual coupons. What is its yield to maturity if it is currently trading at $846.11 ? A) 11.41 % B) 13.31 % C) 7.61% D) 9.51%

D) Using FV = $1000 , periods to maturity = 5, PMT = 55.00 , and PV = $846.11 , calculate discount rate = 9.5089 % per period.

A $5000 bond with a coupon rate of 5.7% paid semiannually has ten years to maturity and a yield to maturity of 6.4%. If interest rates fall and the yield to maturity decreases by 0.8%, what will happen to the price of the bond? A) The price of the bond will fall by $293.50 . B) The price of the bond will fall by $352.20 . C) The price of the bond will rise by $410.90 . D) The price of the bond will rise by $293.50

D) Using FV = $5000 periods to maturity = 20, PMT = $142.50 , and discount rate = 6.4/2%, calculate PV = $4744.3939 ;Using FV = $5000 , periods to maturity = 20, PMT = $142.50 , and discount rate = 5.6/2% , calculate PV = $5037.8909 ; difference = $5037.8909 - $4744.3939 = $293.4969 .

A company buys a color printer that will cost $16,000 to buy, and last 5 years. It is assumed that it will require servicing costing $500 each year. What is the equivalent annual annuity of this deal, given a cost of capital of 8%? A) -$3155 B) -$3606 C) -$4057 D) -$4507

D) Using a financial calculator,NPV = -$17,996 equivalent annual annuity = -$4507

A security company offers to provide CCTV coverage for a parking garage for ten years for an initial payment of $50,000 and additional payments of $30,000 per year. What is the equivalent annual annuity of this deal, given a cost of capital of 5%? A) -$21,885 B) -$25,533 C) -$29,180 D) -$36,475

D) Using a financial calculator,NPV = -$281,652 equivalent annual annuity = -$36,475

A janitorial services firm is considering two brands of industrial vacuum cleaners to equip their staff. Option A will cost $1,500, require servicing of $200 per year, and it will last five years. Option B will cost $1,000, require servicing of $100 per year, and it will last three years. If the cost of capital is 8%, which is the better option, given that the firm has an ongoing requirement for vacuum cleaners? A) Option A, since it has a lower equivalent annual annuity. B) Option B, since it has a lower equivalent annual annuity. C) Option A, since it has a greater equivalent annual annuity. D) Option B, since it has a greater equivalent annual annuity.

D) Using a financial calculator,NPV(A) = -$2,298.54 equivalent annual annuity (A) = -$575.68 NPV(B) = -$1257.71 equivalent annual annuity (B) = -$488.03

A garage is comparing the cost of buying two different car hoists. Hoist A will cost $20,000, will require servicing of $1000 every two years, and last ten years. Hoist B will cost $15,000, require servicing of $800 per year, and last eight years. If the cost of capital is 7%, which is the better option, given that the firm has an ongoing requirement for a hoist? A) Hoist A, since it has a greater present value (PV). B) Hoist B, since it has a greater present value (PV). C) Hoist A, since it has a greater equivalent annual annuity. D) Hoist B, since it has a greater equivalent annual annuity.

D) Using a financial calculator,NPV(A) = -$23,393 equivalent annual annuity (A) = -$3,331 NPV(B) = -$19,777 equivalent annual annuity (B) = -$3,312

Jenkins Security has learned that a rival has offered to supply a parking garage with security for ten years for $45,000 up front and a further $15,000 per year. If Jenkins Security offers to provide security for eight years for an upfront cost of $60,000 and a separate yearly payment, by what maximum amount can this yearly payment be over $20,000, so that Jenkinsʹ offer matches the equivalent annual annuity of their rivalʹs offer? (Assume a cost of capital of 5%.) A) -$89 B) -$94 C) -$100 D) -$111

D) Using a financial calculator,spreading $45,000 over 10 years = $5827.70587 ; thus, EAA = $9172.29413 ; spreading $60,000 over 8 years = $9283.30882 ; thus, the difference = -$111 .

The owners of a chain of fast-food restaurants spend $25 million installing donut makers in all their restaurants. This is expected to increase cash flows by $11 million per year for the next five years. If the discount rate is 5.3%, were the owners correct in making the decision to install donut makers? A) No, as it has a net present value (NPV) of -$4.45 million. B) No, as it has a net present value (NPV) of -$2.22 million. C) Yes, as it has a net present value (NPV) of $13.34 million. D) Yes, as it has a net present value (NPV) of $22.23 million.

D) Using financial calculator, enter CF0 = -25,000,000 , CF1 = 11,000,000 , F1 = 5; calculate NPV for I = 5.3% = $22,231,874.40 .

Which of the following formulas is INCORRECT? A) g = Retention Rate × Return on New Investment B) Divt = EPSt × Dividend Payout Rate C) P0=Div1/(rE-g) D) rE = (Div1 / P0) - g

D) rE = (Div1 / P0) + g

What role do dividends play in stock investing?

Dividends are periodic payments given out by the firm to shareholders. It is not necessary for a firm to declare dividends, but mature firms tend to pay out dividends.

Martin is offered an investment where for $6000 today, he will receive $6180 in one year. He decides to borrow $6000 from the bank to make this investment. What is the maximum interest rate the bank needs to offer on the loan if Martin is at least to break even on this investment? A) 1% B) 2% C) 3% D) 4%

Explanation: C) ($6180 - $6000 )/ 6000 = 3%

1) When evaluating the effectiveness of an improved manufacturing process we should evaluate the total sales and costs generated by this process.

FALSE

A floor broker is a person at the NASDAQ with a trading license who represents orders on the floor.

FALSE

Before it matures, the price of any bond is always less than its face value.

FALSE

Bond traders generally quote bond yields rather than bond prices, since yield to maturity depends on the face value of the bond.

FALSE

Capital budgeting decisions use the Net Present Value rule so that those decisions maximize net present value (NPV).

FALSE

Internal rate of return (IRR) can reliably be used to choose between mutually exclusive projects.

FALSE

Prior to its maturity date, the price of a zero-coupon bond is its face value.

FALSE

The credit spread of a bond shrinks if it is perceived that the probability of the issuer defaulting increases.

FALSE

Treasury bonds have original maturities from one to ten years, while Treasury notes have original maturities of more than ten years.

FALSE

When different projects put different demands on a limited resource, then net present value (NPV) is always the best way to choose the best project.

FALSE

When using equivalent annual annuities to compare the costs of projects with different lives, you should not consider any changes in the expected replacement cost of equipment.

FALSE

The coupon value of a bond is the face value of the bond.

False

Assuming everything else remains unchanged, how does a firmʹs decision to increase its dividend-payout ratio affect its growth rate?

Increasing dividend-payout ratio will decrease the retention rate, thereby decreasing the growth rate.

What issues should one be careful of when calculating the bond price from its yield to maturity using the time value of money (TVM) keys of a financial calculator?

It is quite simple to transfer the bond cash flow timeline to a financial calculator. Care has to be taken when using the TVM keys in understanding that the last cash flow, i.e., the return of principal by the issuer, is automatically augmented by the last coupon payment and no special steps are needed for that.

How can the financial calculator be used to calculate the price of a coupon bond from its yield to maturity?

Most popular financial calculators can help compute the price of a coupon bond in several ways. Two such ways may be using ʹtime value of money (TVM) keys and cash flow (CF) keys.

A bond will trade at a discount if its coupon rate is less than its yield to maturity.

TRUE

Bonds with a high risk of default generally offer high yields.

TRUE

Interest and other financing-related expenses are excluded when determining a projectʹs unlevered net income.

TRUE

Net present value (NPV) is usefully supplemented by internal rate of return (IRR), since IRR gives a good indication of the sensitivity of any decision made to changes in the discount rate.

TRUE

The cash flow effect from a change in Net Working Capital is always equal in size and opposite in sign to the changes in Net Working Capital.

TRUE

The only cash payment an investor in a zero-coupon bond receives is the face value of the bond on its maturity date.

TRUE

The ownership in a corporation is divided into shares of stock, which carry rights to a share in the profits of the firm through future dividend payments.

TRUE

When an alternative decision rule disagrees with the net present value (NPV), the NPV should be followed.

TRUE

When comparing mutually exclusive projects which have different scales, you must know the dollar impact of each investment rather than percentage returns.

TRUE

When different investment rules give conflicting answers, then decisions should be based on the Net Present Value rule, as it is the most reliable and accurate decision rule.

TRUE

What is the decision criteria using internal rate of return (IRR) rule?

The decision criteria using internal rate of return (IRR) rule for project type cash flows is to accept projects if the internal rate of return (IRR) is greater than the cost of capital.

What is the decision criterion using the Net Present Value rule?

The decision criteria using the Net Present Value rule is to reject projects if their net present value (NPV) is less than zero.

What is the decision criterion while using the payback rule?

The payback rule does not have any decision criteria. Consequently, decision making using payback rule is rather subjective.

What issues should one be careful of when calculating the bond price from its yield to maturity using the cash flow (CF) keys of a financial calculator?

There are two issues that one has to be careful about when using the CF keys in computing the price of coupon bonds from its yield to maturity. Since the coupon payments are generally identical over the life of the bond, it might be prudent to use the frequency key while entering this cash flow. That is the first pitfall to be aware of as the frequency to be entered into the calculator has to be reduced by one to account for the last coupon payment that gets added to the return of principal. Similarly, the last cash flow has to be the sum of principal and the last coupon payment.

What care, if any, should be taken regarding the timing of the cash flows while drawing the timeline and associated cash flows of a coupon bond?

There are two issues that one has to be careful of in marking the timing of cash flows associated with a coupon bond. The first is to be cognizant of the periodicity of the coupon payment, as most coupons are not paid annually. The second is to make sure that the return of principal at the end of the life also has a last coupon payment associated with it.

A bond is said to mature on the date when the issuer repays its notional value.

True

A firm can either pay its earnings to its investors, or it can keep them and reinvest them.

True

The Valuation Principle states that the value of a stock is equal to the present value (PV) of both the dividends and future sale price of that stock which the investor will receive.

True

Under what situation should the clean price, dirty price, and the price calculated by the basic annuity and present value (PV) equations for a bond be equal?

Typically, while drawing the timeline for bond cash flows, the price calculated is the price on the date of coupon payment. Even on this date there would be a pre-coupon payment price and a post-coupon payment price. The clean price, dirty price and the price calculated by the annuity and present value (PV) equations converge to a single price right after the coupon has detached from the bond and paid to the holder.

Under what situation can a zero-coupon bond be selling at par to its face value?

Unlike a coupon bond, a zero-coupon bond does not have a periodic cash flow with one lump-sum payment of the face value at its maturity. Consequently, a zero-coupon bond will be always selling at a price less than its face value and can never sell at par with its face value. If it does then the time value of money concepts will be violated, which never happens.

Under what situation can a zero-coupon bond be selling at a premium?

Unlike a coupon bond, a zero-coupon bond does not have a periodic cash flow with one lump-sum payment of the face value at its maturity. Consequently, a zero-coupon bond will be always selling at a price less than its face value. If it does then the time value of money concepts will be violated, which never happens.

How do you apply the Net Present Value rule when multiple projects are available and you have the added constraint of accepting only one project?

When making an investment decision under the availability of multiple projects, take the alternative with the highest net present value (NPV).

page 210 #5

pg. 211 7&8

Check number 8 page 207

see page 208, #9

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yes

11 & 12 pg.218

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21 & 22 pg. 226

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Food For Less (FFL), a grocery store, is considering offering one-hour photo developing in their store. The firm expects that sales from the new one-hour machine will be $175,000 per year. FFL currently offers overnight film processing with annual sales of $90,000 . While many of the one-hour photo sales will be to new customers, FFL estimates that 40% of their current overnight photo customers will switch and use the one-hour service. The level of incremental sales associated with introducing the new one hour photo service is closest to ________. A) $139,000 B) $175,000 C) $36,000 D) $70,000

175,000 - 0.40 × $90,000 = $139,000

A bond certificate includes ________. A) the terms of the bond B) the individual to whom payments will be made C) the yield to maturity of the bond D) the price of the bond

A company issues a ten-year $1,000 face value bond at par with a coupon rate of 6.1% paid semiannually. The YTM at the beginning of the third year of the bond (8 years left to maturity) is 8.1%. What is the new price of the bond? A) $883.91 B) $1060.69 C) $1237.47 D) $1,000.00

A company spends $20 million researching whether it is possible to create a durable plastic from the process waste from feedstock preparation. The $20 million should best be considered ________. A) as a sunk cost B) as an opportunity cost C) as a fixed overhead expense D) as a capital cost

Joe pre-orders a non-refundable movie ticket. He then reads a number of reviews of the movie in question that make him realize that he will not enjoy it. He goes to see it anyway, rationalizing that otherwise his money will have been wasted. Is Joe succumbing to the Sunk Cost Fallacy, and why? A) Yes, since he invested a valuable asset, his time, in a project based on its previous costs. B) No, because the cost of the movie was not recoverable and would have been lost whatever action he took. C) No, because going to see the movie means that the product of his initial investment was realized as originally planned. D) Yes, because he incurred no further costs by going to see the movie.

The Sisyphean Company has a bond outstanding with a face value of $1000 that reaches maturity in 10 years. The bond certificate indicates that the stated coupon rate for this bond is 8.2% and that the coupon payments are to be made semiannually.Assuming the appropriate YTM on the Sisyphean bond is 7.3%, then the price that this bond trades for will be closest to ________. A) $1063 B) $850 C) $1276 D) $1488

The term cannibalization refers to ________. A) decrease in the sales of current project caused by the launching of new project B) decrease in the sunk cost caused by launching of new project C) decrease in overhead expenses incurred due to launch of new project D) cost of using a resource for the best value it could provide in its best alternative

Which of the following best describes the Net Present Value rule? A) Take any investment opportunity where the net present value (NPV) is not negative; turn down any opportunity when it is negative. B) Take any investment opportunity where the net present value (NPV) exceeds the opportunity cost of capital; turn down any opportunity where the cost of capital exceeds the net present value (NPV) C) When choosing among any list of investment opportunities where resources are limited, always choose those projects with the highest net present value (NPV). D) If the difference between the present cost of an investment and the present value (PV) of its benefits after a fixed number of years is positive the investment should be taken, otherwise it should be rejected.

Which of the following bonds is trading at a premium? A) a five-year bond with a $2,000 face value whose yield to maturity is 7.0% and coupon rate is 7.2% APR paid semiannually B) a ten-year bond with a $4,000 face value whose yield to maturity is 6.0% and coupon rate is 5.9% APR paid semiannually C) a 15-year bond with a $10,000 face value whose yield to maturity is 8.0% and coupon rate is 7.8% APR paid semiannually D) a two-year bond with a $50,000 face value whose yield to maturity is 5.2% and coupon rate is 5.2% APR paid monthly

Which of the following bonds will be least sensitive to a change in interest rates? A) a ten-year bond with a $2,000 face value whose yield to maturity is 5.8% and coupon rate is 5.8% APR paid semiannually B) a 15-year bond with a $5,000 face value whose yield to maturity is 7.4% and coupon rate is 6.2% APR paid annually C) a 20-year bond with a $3,000 face value whose yield to maturity is 6.0% and coupon rate is 5.4% APR paid semiannually D) a 30-year bond with a $1,000 face value whose yield to maturity is 5.5% and coupon rate is 6.4% APR paid annually

Which of the following is NOT a way that a firm can increase its dividend? A) by increasing its retention rate B) by decreasing its shares outstanding C) by increasing its earnings (net income) D) by increasing its dividend payout rate

Which of the following is a limitation of the dividend-discount model? A) It cannot handle negative growth rates. B) It requires accurate dividend forecasts, which is not possible. C) It requires that the growth rate always be higher than the required rate of return, which is not realistic. D) It does not consider past earnings and performance.

Which of the following is an example of cannibalization? A) A toothpaste manufacturer adds a new line of toothpaste (that contains baking soda) to its product line. B) A grocery store begins selling T-shirts featuring the local universityʹs mascot. C) A basketball manufacturer adds basketball hoops to its product line. D) A convenience store begins selling pre-paid cell phones.

Which of the following is usually NOT a factor that must be considered when estimating the revenues and costs arising from a new product? A) the fluctuations in the cost of capital over the period in question B) the sales of a new product will typically accelerate, plateau, and ultimately decline over time C) the prices of technology products generally fall over time D) competition tends to reduce profit margins over time in most industries

Which of the following statements is FALSE regarding profitable and unprofitable growth? A) If a firm wants to increase its share price, it must diversify. B) If a firm retains more earnings, it will pay out less of those earnings, reducing its dividends. C) A firm can increase its growth rate by retaining more of its earnings. D) Cutting a firmʹs dividend to increase investment will raise the stock price if the new investment has a positive net present value (NPV).

Which of the following will NOT increase a companyʹs dividend payments? A) It can issue more shares. B) It can increase its earnings. C) It can decrease the number of shares outstanding. D) It can increase its dividend payout rate.

Why is the yield to maturity of a zero-coupon, risk-free bond that matures at the end of a given period the risk-free interest rate for that period? A) Since such a bond provides a risk-free return over that period, the Law of One Price guarantees that the risk-free interest rate equals the yield to maturity. B) Since a bondʹs price will converge on its face value as the bond approaches the maturity date, the Law of One Price dictates that the risk-free interest rate will reflect this convergence. C) Since interest rates will rise and fall in response to the movement in bond prices. D) Since there is, by definition, no risk in investing in such bonds, the return from such bonds is the best that can be expected from any investment over the period.

You are trying to decide between three mutually exclusive investment opportunities. The most appropriate tool for identifying the correct decision is ________. A) net present value (NPV) B) profitability index C) internal rate of return (IRR) D) incremental internal rate of return (IRR)

he present value (PV) of an investment is ________. A) the amount that an investment would yield if the benefit were realized today B) the difference between the cost of the investment and the benefit of the investment in dollars today C) the amount you need to invest at the current interest rate to re-create the cash flow from the investment D) the amount by which the cash flow of an investment exceeds or falls short of the cash flow generated by the same amount of money invested at market rate

How are the cash flows of a coupon bond different from an amortizing loan?

A coupon bond pays interest over the life of the bond and returns the principal at the end of the term. Thus the cash flows are smaller over the life of the bond with a lump -sum payment at the end. In contrast, an amortizing loan has identical cash flows over its life with a part of the cash flow going toward interest and the balance as return of principal.

What can you comment about the shape of the net present value (NPV) profile of a multiple IRR project?

A multiple IRR project will have a net present value (NPV) profile that cuts the discount rate axis as many times as there are IRRs because the point of intersections of the discount rate axis by the net present value (NPV) profile curve are the IRRs of the project.

What care, if any, should be taken regarding the sign of the cash flows while drawing the timeline and associated cash flows of a coupon bond?

A typical coupon bond will have the first cash flow in the opposite direction as compared to all the rest of the cash flows over its life. The first cash corresponds to the issuer borrowing the money, while all the rest of the cash flows are payments by the issuer to the bondholder either in the form of interest or principal.

How are the cash flows of a zero-coupon bond different from those of a coupon bond?

A zero-coupon bond has only two cash flows over its life. The first one is associated with the issues borrowing the money and the second when the issuer returns the principal. A coupon bond, on the other hand, has several cash flows over its life. The first cash flow of both these types of bonds, zero-coupon and coupon are similar as they denote the issuer borrowing the money. However, for a coupon bond the subsequent cash flows over its life correspond to the interest payment promised by the issuer with a final payment equal to the return of principal.

A firm has an opportunity to invest $95,000 today that will yield $109,250 in one year. If interest rates are 4%, what is the net present value (NPV) of this investment? A) $10,048 B) $11,053 C) $16,077 D) $14,250

A) $109,250 / (1 + 0.04) = $105,048.077 ; $105,048.077 - $95,000 = $10,048

A brewer is launching a new product: brewed ginger ale with a low alcohol content. The brewer plans to spend $4 million promoting this product this year, which is expected to expand the sales of this product to $11 million this year and $8 million next year. They do expect there will be loss of sales of $1 million this year and next year in their other products as customers switch to drinking the new ginger ale. The gross profit margin for the new ginger ale is 40%, the gross profit margin of all of the brewerʹs other products is 30%, and the brewerʹs marginal corporate tax rate is 35%. What are incremental earnings arising from the promotional campaign this year? A) $1.625 million B) $1.26 million C) $2.11 million D) $4.40 million

A) $11 - $4 - $1 = $6; $6 × 0.6 = $3.6; $3.6 × 0.65 = $2.34 million ($11 - $4) × 40% - ($1 × 30%) = $2.5; $2.5 × 0.65 = $1.625 million

A car dealership offers a car for $14,000 , with up to one year to pay for the car. If the interest rate is 5%, what is the net present value (NPV) of this offer to buyers who elect not to pay for the car for one year? A) $667 B) $1333 C) $13,333 D) $14,000

A) $14,000 / (1 + 0.05) = $13,333.3333 ; $14,000 - $13,333 = $667

Ford Motor Company is considering launching a new line of hybrid diesel-electric SUVs. The heavy advertising expenses associated with the new SUV launch would generate operating losses of $35 million next year. Without the new SUV, Ford expects to earn pre-tax income of $80 million from operations next year. Ford pays a 35% tax rate on its pre-tax income. The amount that Ford Motor Company owes in taxes next year without the launch of the new SUV is closest to ________. A) $28.0 million B) 12.3 million C) $40.3 million D) $15.8 million

A) $80 × 0.35 = $28.0 million

Ford Motor Company is considering launching a new line of hybrid diesel-electric SUVs. The heavy advertising expenses associated with the new SUV launch would generate operating losses of $30 million next year. Without the new SUV, Ford expects to earn pre-tax income of $80 million from operations next year. Ford pays a 30% tax rate on its pre-tax income. The amount that Ford Motor Company owes in taxes next year with the launch of the new SUV is closest to ________. A) $15.0 million B) $9.0 million C) $33.0 million D) $24.0 million

A) ($80 - $30 ) × 0.30 = $15.0 million

Cameron Industries is purchasing a new chemical vapor depositor in order to make silicon chips. It will cost $6,000,000 to buy the machine and $20,000 to have it delivered and installed. Building a clean room in the plant for the machine will cost an additional $3 million. The machine is expected to raise gross profits by $4,000,000 per year, starting at the end of the first year, with associated costs of $1 million for each of those years. The machine is expected to have a working life of five years and will be depreciated over those five years. The marginal tax rate is 40%. What are the incremental free cash flows associated with the new machine in year 0? A) -$6,020,000 B) -$6,000,000 C) -$5,418,000 D) $1,204,000

A) -$6,000,000 - $20,000 = -$6,020,000

Which of the following statements is FALSE of the dividend-discount model? A) We cannot use the dividend-discount model to value the stock of a firm with rapid or changing growth. B) As firms mature, their growth slows to rates more typical of established companies. C) The dividend-discount model values the stock based on a forecast of the future dividends paid to shareholders. D) The simplest forecast for the firmʹs future dividends states that they will grow at a constant rate, i.e., forever.

A) A multistage dividend-discount model can be used to value the stock of a firm with rapid or changing growth.

A firm issues 5-year bonds with a coupon rate of 4.7%, paid semiannually. The credit spread for this firmʹs 5-year debt is 1.2%. New 5-year Treasury notes are being issued at par with a coupon rate of 5.1%. What should the price of the firmʹs outstanding 5-year bonds be if their face value is $1,000? A) $932.28 B) $12.00 C) $1305.19 D) $745.82

A) Calculate the PV of the bond with FV = $1,000, YTM = 3.150 %, PMT = 23.50 , and N = 10, which = $932.28 .

CathFoods will release a new range of candies which contain antioxidants. New equipment to manufacture the candy will cost $2 million, which will be depreciated by straight-line depreciation over four years. In addition, there will be $5 million spent on promoting the new candy line. It is expected that the range of candies will bring in revenues of $4 million per year for four years with production and support costs of $1.5 million per year. If CathFoodʹs marginal tax rate is 35%, what are the incremental free cash flows in the second year of this project? A) $1.800 million B) $1.400 million C) $2.000 million D) $0.700 million

A) Depreciation = $2 / 4 = $0.5; earnings = $4 - 1.5 - $0.5 = $2; earnings after tax = $2 × 0.65 = $1.3000 ;add back depreciation = $1.3000 + $0.5 = $1.800 million.

You are considering adding a microbrewery onto one of your firmʹs existing restaurants. This will entail an investment of $47,000 in new equipment. This equipment will be depreciated straight-line over five years. If your firmʹs marginal corporate tax rate is 35%, then what is the value of the microbreweryʹs depreciation tax shield in the first year of operation? A) $3290 B) $16,450 C) $6110 D) $30,550

A) First figure out the straight-line depreciation. $47,000 / 5 years = $9400 depreciation per year. Then 0.35 × $9400 = $3290 depreciation tax shield per year.

A company has stock which costs $41.50 per share and pays a dividend of $2.50 per share this year. The companyʹs cost of equity is 7%. What is the expected annual growth rate of the companyʹs dividends? A) 0.98% B) 1.96% C) 2.94% D) 3.92%

A) Growth rate = 0.07 - ($2.50 / $41.50 ) = 0.98 %

Your firm is considering building a new office complex. Your firm already owns land suitable for the new complex. The current book value of the land is $130,000 ; however, a commercial real estate agent has informed you that an outside buyer is interested in purchasing this land would be willing to pay $700,000 for it. When calculating the net present value (NPV) of your new office complex, ignoring taxes, the appropriate incremental cash flow for the use of this land is ________. A) $700,000 B) $0 C) $130,000 D) $830,000

A) It is appropriate to use the market value. If taxes are included, the value would be the after-tax value of the land.

An auto-parts company is deciding whether to sponsor a racing team for a cost of $1 million. The sponsorship would last for three years and is expected to increase cash flows by $570,000 per year. If the discount rate is 6.9%, what will be the change in the value of the company if it chooses to go ahead with the sponsorship? A) $498,597 B) $747,896 C) $797,756 D) $847,615

A) NPV = -1,000,000 + 570,000 / (1 + 0.069 ) + 570,000 / (1 + 0.069 )2 + 570,000 / (1 + 0.069 )3 = $498,597

A stock is expected to pay $0.70 per share every year indefinitely. If the current price of the stock is $18.90 , and the equity cost of capital for the company that released the shares is 7.9%, what price would an investor be expected to pay per share five years into the future? A) $8.86 B) $14.18 C) $14.62 D) $15.06

A) P0 = $0.70 / 0.079 = $8.86

A stock is expected to pay $1.25 per share every year indefinitely and the equity cost of capital for the company is 8.4%. What price would an investor be expected to pay per share ten years in the future? A) $14.88 B) $22.32 C) $29.76 D) $37.20

A) P0 = $1.25 / 0.084 = $14.88

Von Bora Corporation (VBC) is expected to pay a $3.00 dividend at the end of this year. If you expect VBCʹs dividend to grow by 6% per year forever and VBCʹs equity cost of capital to be 13%, then the value of a share of VBS stock is closest to ________. A) $42.86 B) $15.79 C) $25.72 D) $17.14

A) P0 = Div1 / (rE - g) = $3.00 / (0.13 - 0.06) = $42.86

Credenza Industries is expected to pay a dividend of $1.70 at the end of the coming year. It is expected to sell for $62 at the end of the year. If its equity cost of capital is 9%, what is the expected capital gain from the sale of this stock at the end of the coming year? A) $3.56 B) $56.88 C) $5.12 D) $58.44

A) P0 using the capital gain rate formula = ($1.70 + $62) / (1 + 0.09) = $58.44; Capital gain = P1 - P0 = $62 - $58.44 = $3.56

Which of the following risk-free, zero-coupon bonds could be bought for the lowest price? A) one with a face value of $1,000, a YTM of 4.8%, and 5 years to maturity B) one with a face value of $1,000, a YTM of 3.2%, and 8 years to maturity C) one with a face value of $1,000, a YTM of 6.8%, and 10 years to maturity D) one with a face value of $1,000, a YTM of 5.9%, and 20 years to maturity

A) Price = $1,000 / (1 + 4.8%)5 = $791 B) Price = $1,000 / (1 + 3.2%)8 = $777 C) Price = $1,000 / (1 + 6.8%)10 = $518 D) Price = $1,000 / (1 + 5.9%)20 = $318 (lowest price)

JRN Enterprises just announced that it plans to cut its dividend from $3.00 to $1.50 per share and use the extra funds to expand its operations. Prior to this announcement, JRNʹs dividends were expected to grow indefinitely at 4% per year and JRNʹs stock was trading at $25.50 per share. With the new expansion, JRNʹs dividends are expected to grow at 8% per year indefinitely. Assuming that JRNʹs risk is unchanged by the expansion, the value of a share of JRN after the announcement is closest to ________. A) $19.32 B) $12.75 C) $38.63 D) $25.50

A) Two steps.Step 1: Solve for rE: rE = Div1 / P0 + g = $3.00/$25.50 + 0.04 = 0.15765 or 15.77% Step 2: Solve for new stock price: P0 = Div1 / (rE - g) = $1.50/(0.15765 - 0.08) = $19.32

What must be the price of a $10,000 bond with a 6.1% coupon rate, semiannual coupons, and five years to maturity if it has a yield to maturity of 10% APR? A) $8494.26 B) $10,193.11 C) $11,891.97 D) $6795.41

A) Using FV = $10,000 , periods to maturity = 10 , PMT = 305.00 , and periodic discount rate = 5.0% per period, calculate PV = $8494.26 .

What is the coupon rate of an eight-year, $10,000 bond with semiannual coupons and a price of $9006.6568 , if it has a yield to maturity of 6.5%? A) 4.888 % B) 5.87% C) 6.84% D) 3.91%

A) Using FV = $10,000 , periods to maturity = 16, and discount rate = 3.25%, calculate PMT = $244.4000 ; annual couponpayment = $244.4000 × 2 = $488.8000 ; coupon rate = 4.888 %.

Coolibah Holdings is expected to pay dividends of $1.20 every six months for the next three years. If the current price of Coolibah stock is $22.60 , and Coolibahʹs equity cost of capital is 18%, what price would you expect Coolibahʹs stock to sell for at the end of three years? A) $28.87 B) $31.76 C) $33.20 D) $34.64

A) Using a financial calculator, PV = -$22.60, PMT = $1.20, n = 6, I = 18% / 2; calculate FV = $28.87 .

Rylan Industries is expected to pay a dividend of $5.70 year for the next four years. If the current price of Rylan stock is $31.27 , and Rylanʹs equity cost of capital is 12 %, what price would you expect Rylanʹs stock to sell for at the end of the four years? A) $21.96 B) $39.53 C) $17.57 D) $61.49

A) Using a financial calculator, PV = -31.27, PMT = 5.70, n = 4, I = 12; Calculate FV = $21.96

A manufacturer of video games develops a new game over two years. This costs $830,000 per year with one payment made immediately and the other at the end of two years. When the game is released, it is expected to make $1.20 million per year for three years after that. What is the net present value (NPV) of this decision if the cost of capital is 10%? A) $950,349 B) $1,045,384 C) $1,520,559 D) $1,805,663

A) Using a financial calculator, enter CF0 = -830,000 , CF1 = 0, F1 = 1, CF2 = -830,000 , F2 = 1, CF3 = 1,200,000 , F3 = 3; calculate NPV for I = 10 = $950,349 .

Mary is in contract negotiations with a publishing house for her new novel. She has two options. She may be paid $100,000 up front, and receive royalties that are expected to total $26,000 at the end of each of the next five years. Alternatively, she can receive $200,000 up front and no royalties. Which of the following investment rules would indicate that she should take the former deal, given a discount rate of 8%? Rule I: The Net Present Value ruleRule II: The Payback Rule with a payback period of two years Rule III: The internal rate of return (IRR) Rule A) Rule I only B) Rule III only C) Rule II and III D) Rule I and II

A) Using a financial calculator, enter CF0 = 100,000, CF1 = 26,000, F1 = 5; calculate NPV for I = 8 = $203,810, which is greater than $200,000.

A lottery winner can take $6 million now or be paid $600,000 at the end of each of the next 16 years. The winner calculates the internal rate of return (IRR) of taking the money at the end of each year and, estimating that the discount rate across this period will be 4%, decides to take the money at the end of each year. Was her decision correct? A) Yes, because it agrees with the Net Present Value rule. B) Yes, because it agrees with the payback rule. C) Yes, because it agrees with both the Net Present Value rule and the payback rule. D) Yes, because it disagrees with the Net Present Value rule

A) Using a financial calculator, enter PMT = 600,000, N = 16, I = 4%; calculate PV = $6,991,377 , which is greater than $6,000,000.

An orcharder spends $110,000 to plant pomegranate bushes. It will take four years for the bushes to provide a usable crop. He estimates that every year for 20 years after that he will receive a crop worth $10,500 per year. If the discount rate is 9%, what is the net present value (NPV) of this investment? A) -$42,098 B) -$21,049 C) $8420 D) $12,629

A) Using financial calculator, enter CF0 = -110,000 , CF1 = 0, F1 = 4, CF2 = 10,500 , F2 = 20; calculate NPV for I = 9% = -$42,098 .

A risk-free, zero-coupon bond with a $5000 face value has 15 years to maturity. The bond currently trades at $3750 . What is the yield to maturity of this bond? A) 1.936 % B) 0.968 % C) 62.500 % D) 75.000 %

A) YTM = (Face Value / Price) 1/n - 1; YTM = ($5000 / $3750 )1/15 - 1 = 1.936 %

Luther Industries has a dividend yield of 4.5% and a cost of equity capital of 10%. Luther Industriesʹ dividends are expected to grow at a constant rate indefinitely. The growth rate of Lutherʹs dividends is closest to ________. A) 5.5% B) 14.5% C) 11.0% D) 5.0%

A) rE = Div1 / P0 + g 0.1=0.045 +g,sog=5.5%

Kirkevue Industries pays out all its earnings as dividends and has a share price of $27 . In order to expand, Kirkevue announces it will cut its dividend payments from $2.15 to $1.75 per share and reinvest the retained funds. What is the growth rate that should be achieved on the reinvested funds to keep the equity cost of capital unchanged? A) 1.48% B) 0.14% C) 0.17% D) 0.15%

A) rE1 = $2.15 / $27 = 7.96296296 %; rE2 = $1.75 / $27 = 6.48148148 %; growth rate = 7.96296296 % - 6.48148148 % = 1.48%

CathFoods will release a new range of candies which contain anti-oxidants. New equipment to manufacture the candy will cost $4 million, which will be depreciated by straight-line depreciation over six years. In addition, there will be $5 million spent on promoting the new candy line. It is expected that the range of candies will bring in revenues of $6 million per year for five years with production and support costs of $1.5 million per year. If CathFoodʹs marginal tax rate is 35%, what are the incremental earnings in the second year of this project? A) $2.492 million B) $2.100 million C) $3.833 million D) $1.342 million

A)Depreciation=4/6=$0.66666667 million;earningsbefore tax = $6 - $1.5 - $0.66666667 = $3.83333333 million; earnings after tax = $3.83333333 × 0.65 = $2.492 million

If a business owner is using the extra space at home for his business, does it imply a zero opportunity cost for the space?

Answer: As long as there is an alternative use of the place, it has an opportunity cost. Opportunity cost of idle assets is often mistaken as zero, but that is inaccurate.

Consider a zero-coupon bond with $100 face value and 15 years to maturity. If the YTM is 7.4%, this bond will trade at a price closest to ________. A) $41.13 B) $34.27 C) $47.98 D) $54.83

Answer: B

You expect that Bean Enterprises will have earnings per share of $2 for the coming year. Bean plans to retain all of its earnings for the next three years. For the subsequent two years, the firm plans on retaining 50% of its earnings. It will then retain only 25% of its earnings from that point forward. Retained earnings will be invested in projects with an expected return of 20% per year. If Beanʹs equity cost of capital is 10%, then the price of a share of Beanʹs stock is closest to ________. A) $24.82 B) $16.54 C) $41.36 D) $66.18

Answer: C

1) Preference for cash today versus cash in the future in part determines net present value (NPV).

Answer: FALSE

A capital budget lists the potential projects a company may undertake in future years.

Answer: FALSE

An announcement by the government that they will decrease corporate marginal tax rates in the future would increase the attractiveness of MACRS depreciation.

Answer: FALSE

Stocks that do not pay a dividend must have a value of $0.

Answer: FALSE

The internal rate of return (IRR) rule will agree with the Net Present Value rule even when positive cash flows precede negative cash flows.

Answer: FALSE

To evaluate a capital budgeting decision, it is sufficient to determine its consequences for the firmʹs earnings.

Answer: FALSE

Assuming that this bond trades for $1,035.44, then the YTM for this bond is equal to ________.

Answer: FV = $1,000 PMT = 40 (80 / 2) N = 30 (15 × 2)PV = -$1,035.44Compute I = 3.8 × 2 = 7.6 or 7.6%

What is the relationship between the growth rate and the cost of equity implied in the dividend-discount model?

Answer: For the dividend-discount model equation to be viable, the growth rate should be smaller than the cost of equity because the model becomes meaningless if the growth rate is equal to or greater than the cost of equity.

What is a safe method to use when confronted with mutually exclusive projects?

Answer: Generally the net present value (NPV) method will give the correct decision in case of mutually exclusive projects.

What is a major assumption about growth rate in the dividend-discount model?

Answer: It is assumed that the growth rate used in the dividend-discount model be constant in the future.

How can the dividend-discount model handle changing growth rates?

Answer: Most firms have high growth rate during the early part of their existence, which gradually tapers to the steady-state growth rate. We cannot apply the formula during the period while the growth rate is changing. We can only apply it once the growth rate has stabilized to a constant rate

Is there a unique way for calculating the MIRR to resolve the multiple IRR situation?

Answer: No there are several ways of computing the MIRR and each of them are subject to their respective assumptions.

Should personal preferences for cash today versus cash tomorrow play a role in the net present value (NPV) decision-making process?

Answer: No; personal preferences for cash flow should not affect the decision-making process. A manager should decide based on always maximizing the net present value (NPV).

What are some potential problems in using internal rate of return (IRR) for mutually exclusive projects?

Answer: One has to be careful when evaluating mutually exclusive projects especially using internal rate of return (IRR) as they may lead to incorrect decision making.

What are project externalities?

Answer: Project externalities are indirect effects of the project that may increase or decrease the profits of other business activities of the firm.

What are sunk costs?

Answer: Sunk costs are payments already made or that will be made that are independent of the project under discussion. These are costs for which the firm is already liable.

Firms should use the most accelerated depreciation scheme allowable.

Answer: TRUE

Forecasting dividends requires forecasting the firmʹs earnings, dividend payout rate, and future share count.

Answer: TRUE

Net present value (NPV) is the difference between the present value (PV) of the benefits and the present value (PV) of the costs of a project or investment.

Answer: TRUE

The Net Present Value rule implies that we should compare a projectʹs net present value (NPV) to zero.

Answer: TRUE

The payback rule is based on the idea that an opportunity that pays back its initial investment quickly is a worthwhile opportunity.

Answer: TRUE

The profitability index can break down completely when dealing with multiple resource restraints.

Answer: TRUE

You can evaluate alternative projects with different lives by calculating and comparing their equivalent annual annuity.

Answer: TRUE

What is the Net Present Value rule?

Answer: The Net Present Value rule states to accept a project if its net present value (NPV) is greater than zero.

What is the correct tax rate that should be used for capital budgeting decisions?

Answer: The correct tax rate that should be used is the firmʹs marginal tax rate, which is the tax rate paid on the last dollar earned by the firm.

Under what situation can the net present value (NPV) profile be upward sloping?

Answer: The net present value (NPV) profile can be upward sloping if the benefits of the cash flows occur before the costs. In that case the net present value (NPV) profile will be a rising function of discount rates.

What is the general shape of the net present value (NPV) profile?

Answer: The net present value (NPV) profile for most projects is a downward sloping graph cutting the x-axis at the project internal rate of return (IRR).

How can you calculate the y-intercept of a net present value (NPV) profile without using TVM concepts?

Answer: The y-intercept of a net present value (NPV) profile is the algebraic sum of the project cash flows, since the discount rate is zero at that point

How are the taxes paid under MACRS different from that paid under straight -line depreciation?

Answer: We are not paying less in taxes when using MACRS, but it is the timing of the tax payment that is different.

How do we handle interest expense when making a capital budgeting decision?

Answer: We do not generally include interest expense when making capital budgeting decisions.

If available, should MACRS be preferred to straight-line depreciation?

Answer: Yes, MACRS should be preferred to straight-line depreciation due to the time value of money. While both methods pay the same amount in taxes, MACRS gives more money in the pocket in the initial days.

Can the dividend-discount model handle negative growth rates?

Answer: Yes, the dividend-discount model can handle negative growth rates. The model works as long as growth rate is smaller than the cost of equity and negative growth rate is smaller than the cost of equity.

A 20-year bond with a $1,000 face value was issued with a yield to maturity of 4.3% and pays coupons semi-annually. After ten years, the yield to maturity is still 4.3% and the clean price of the bond is $959.71 . After three more months go by, what would you expect the dirty price to be? A) $978.71 B) $969.21 C) $997.71 D) Cannot be determined from information given.

A lawn maintenance company compares two ride-on mowersthe Excelsior, which has an expected working-life of six years, and the Grassassinator, which has a working life of four years. After examining the equivalent annual annuities of each mower, the company decides to purchase the Excelsior. Which of the following, if true, would be most likely to make them change that decision? A) Fuel prices are expected to rise and raise the annual running costs of all mowers. B) The mower is only expected to be needed for three years. C) The prices of equivalent mowers are expected to grow in the future as lawnmower manufacturers consolidate. D) The number of customers requiring lawn-mowing services is expected to sharply increase in the near future.

Peter has a business opportunity that requires him to invest $10,000 today, and receive $12,000 in one year. He can either use $10,000 that he already has for this investment or borrow the money from his bank at an interest rate of 10%. However, the $10,000 he has right now is needed for urgent repairs to his home, repairs that will cost at least $15,000 if he delays them for a year. What is the best alternative for Peter out of the following choices? A) No, since the net present value (NPV) of the investment, should he take it, is less than the net present value (NPV) of the home repairs if he delays them for one year. B) Yes, since he can borrow the $10,000 from a bank, repair his home, invest $10,000 in the business opportunity, which, since it has a NPV > 0 will mean he will still come out ahead after repaying the loan. C) Yes, since the net present value (NPV) of the investment is greater than zero he can invest the $10,000 in the business opportunity, and then next year use this money plus the benefit from this money to make the necessary home repairs. D) Yes, since the net present value (NPV) of the investment, should he take it, is greater than the net present value (NPV) of the home repairs if he delays them for one year.

The Sisyphean Company has a bond outstanding with a face value of $1000 that reaches maturity in 10 years. The bond certificate indicates that the stated coupon rate for this bond is 8.0% and that the coupon payments are to be made semiannually.Assuming the appropriate YTM on the Sisyphean bond is 11.1%, then the price that this bond trades for will be closest to ________. A) $652 B) $816 C) $979 D) $1142

What is the dirty price of a bond? A) the bondʹs price based only on the bondʹs yield B) the bondʹs actual cash price C) the bondʹs price based only on coupon payments D) the bondʹs price less an adjustment for changes in interest rates

When comparing two projects with different lives, why do you compute an annuity with an equivalent present value (PV) to the net present value (NPV)? A) so that you can see which project has the greatest net present value (NPV) B) so that the projects can be compared on their cost or value created per year C) to reduce the danger that changes in the estimate of the discount rate will lead to choosing the project with a shorter timeframe D) to ensure that cash flows from the project with a longer life that occur after the project with the shorter life has ended are considered

Which of the following best defines incremental earnings? A) cash flows arising from a particular investment decision B) the amount by which a firmʹs earnings are expected to change as a result of an investment decision C) the earnings arising from all projects that a company plans to undertake in a fixed time span D) the net present value (NPV) of earnings that a firm is expected to receive as the result of an investment decision

Which of the following costs would you consider when making a capital budgeting decision? A) sunk cost B) opportunity cost C) interest expense D) fixed overhead cost

Which of the following formulas will correctly calculate Net Working Capital? A) Cash + Inventory + Receivables + Payables B) Cash + Inventory + Receivables - Payables C) Cash + Inventory - Receivables + Payables D) Cash - Inventory + Receivables + Payables

Which of the following is NOT a factor that a manager should bear in mind when estimating a projectʹs revenues and costs? A) Sales of a product will typically accelerate, stabilize, and then decline as the product becomes outdated or faces increased competition. B) A new product typically has its highest sales immediately after release as customers are attracted by the novelty of the product. C) The prices of technology products tend to fall over time as newer, superior technologies emerge and production costs decline. D) Prices and costs tend to rise with the general level of inflation in the economy.

Which of the following is NOT a limitation of the payback period rule? A) It does not account for the time value of money. B) It is difficult to calculate. C) It ignores cash flows after payback. D) It does not account for changes in the discount rate.

Which of the following models directly values all of the firmʹs equity, rather than a single share? I. Dividend-discount model II. Total payout model III. Discountedcashflowmodel A) I only B) II only C) III only D) II and III

Which of the following statements is FALSE? A) As firms mature, their earnings exceed their investment needs and they begin to pay dividends. B) Total return equals earnings multiplied by the dividend payout rate. C) Cutting the firmʹs dividend to increase investment will raise the stock price if, and only if, the new investments have a positive net present value (NPV). D) We cannot use the constant dividend growth model to value the stock of a firm with rapid or changing growth.

Which of the following statements is FALSE? A) Many projects use a resource that the company already owns. B) When evaluating a capital budgeting decision, we generally include interest expense. C) Only include as incremental expenses in your capital budgeting analysis the additional overhead expenses that arise because of the decision to take on the project. D) As a practical matter, to derive the forecasted cash flows of a project, financial managers often begin by forecasting earnings.

Which of the following statements is FALSE? A) The payback investment rule is based on the notion that an opportunity that pays back its initial investments quickly is a good idea. B) An internal rate of return (IRR) will always exist for an investment opportunity. C) A net present value (NPV) will always exist for an investment opportunity. D) In general, there can be as many internal rates of return (IRRs) as the number of times the projectʹs cash flows change sign over time.

Which of the following statements is FALSE? A) The payback rule is useful in cases where the cost of making an incorrect decision might not be large enough to justify the time required for calculating the net present value (NPV). B) The payback rule is reliable because it considers the time value of money and depends on the cost of capital. C) For most investment opportunities, expenses occur initially and cash is received later. D) Fifty percent of firms surveyed reported using the payback rule for making decisions.

Which of the following statements regarding bonds and their terms is FALSE? A) Bonds are securities sold by governments and corporations to raise money from investors today in exchange for a promised future payment. B) By convention, the coupon rate is expressed as an effective annual rate. C) Bonds typically make two types of payments to their holders. D) The time remaining until the repayment date is known as the term of the bond.

Which of the following statements regarding bonds and their terms is FALSE? A) One advantage of quoting the yield to maturity rather than the price is that the yield is independent of the face value of the bond. B) Unlike the case of bonds that pay coupons, for zero-coupon bonds, there is no formula to solve for the yield to maturity. C) Because we can convert any bond price into a yield, and vice versa, bond prices and yields are often used interchangeably. D) The internal rate of return (IRR) of a bond is given a special name, the yield to maturity (YTM).

Which of the following statements regarding bonds and their terms is FALSE? A) The amount of each coupon payment is determined by the coupon rate of the bond. B) Prior to its maturity date, the price of a zero-coupon bond is always greater than its face value. C) The zero-coupon bond has no periodic interest payments. D) Treasury bills are U.S. government bonds with a maturity of up to one year.

You placed an order to purchase stock where you specified the maximum price you were willing to pay. This type of order is known as a ________. A) maximum order B) limit order C) floor order D) market order

Cameron Industries is purchasing a new chemical vapor depositor in order to make silicon chips. It will cost $4 million to buy the machine and $12,000 to have it delivered and installed. Building a clean room in the plant for the machine will cost an additional $3 million. The machine is expected to have a working life of six years. If straight-line depreciation is used, what are the yearly depreciation expenses in this case? A) $666,667 B) $668,667 C) $1,166,667 D) $1,168,667

B( 4 mil +12000) / 6 = 668,667

An oil company is buying a semi-submersible oil rig for $15 million. Additionally, it will cost $1.5 million to move the oil rig to the oil-field and to prepare it for operations. If it is depreciated over five years using straight-line depreciation, what are the yearly depreciation expenses in this case? A) $2.7 million B) $3.0 million C) $3.3 million D) $3.8 million

B) $(15 + 1.5) / 5 = $3.3 million

What is the coupon payment of a 15-year $10,000 bond with a 9% coupon rate with semiannual payments? A) $150.00 B) $450 C) $900.00 D) $1800.00

B) $10,000 × 0.09/2 = $450

What is the coupon payment of a 25-year $1000 bond with a 4.5% coupon rate with quarterly payments? A) $3.75 B) $11.25 C) $22.50 D) $45.00

B) $1000 × 0.045 / 4 = $11.25

A firm is considering investing in a new machine that will cost $400,000 and will be depreciated straight-line over five years. If the firmʹs marginal tax rate is 39%, what is the annual depreciation tax shield of purchasing the machine? A) $80,000 B) $31,200 C) $28,080 D) $156,000

B) $400,000 / 5 = $80,000 ; $80,000 × 0.39 = $31,200

A corporate bond makes payments of $9.67 every month for ten years with a final payment of $2009.67. Which of the following best describes this bond? A) a 10-year bond with a face value of $2,000 and a coupon rate of 4.8% with monthly payments B) a 10-year bond with a face value of $2,000 and a coupon rate of 5.8% with monthly payments C) a 10-year bond with a face value of $2,009.67 and a coupon rate of 4.8% with monthly payments D) a 10-year bond with a face value of $2,009.67 and a coupon rate of 5.8% with monthly payments

B) $9.67 × 12 / (2,009.67 - 9.67) = 5.802%

Vernon-Nelson Chemicals is planning to release a new brand of insecticide, Bee-Safe, that will kill many insect pests but not harm useful pollinators. Buying new equipment to manufacture the product will cost $15 million, and there will be an additional $2 million cost to reconfigure existing plant. The equipment is expected to have a lifetime of nine years and will be depreciated by the straight-line method over its lifetime. The firm expects that they should be able to sell 1,500,000 gallons per year at a price of $53 per gallon. It will take $36 per gallon to manufacture and support the product. If Vernon-Nelsonʹs marginal tax rate is 40%, what are the incremental earnings after tax in year 3 of this project? A) $25.5 million B) $14.3 million C) $23.8 million D) $9.5 million

B) 1.5 million × ($53 - $36 ) = $25.5 million; depreciation = 15 / 9 = $1.7 million; earnings before tax = $23.8 million;earnings after tax = $23.8 million × 0.6 = $14.3 million

A consultancy calculates that it can supply crude oil assaying services to a small oil producer for $115,000 per year for five years. There are some upfront costs the consultancy will require the oil producer to absorb. What is the maximum that these upfront costs could be, if the equivalent annual annuity to the oil company is to be under $160,000 , given that the cost of capital is 9%? A) $45,000 B) $175,034 C) $201,289 D) $160,000

B) Annual difference = $160,000 - $115,000 = $45,000 ; PV over 5 years at 9% = $175,034

The Sisyphean Company has a bond outstanding with a face value of $1000 that reaches maturity in 5 years. The bond certificate indicates that the stated coupon rate for this bond is 8.1% and that the coupon payments are to be made semiannually.Assuming the appropriate YTM on the Sisyphean bond is 10.6%, then this bond will trade at ________. A) a premium B) a discount C) parD) none of the above

B) As the coupon rate of 8.1% is less than the YTM of 10.6% on the bonds, so they will trade at a discount.

An investor is considering a project that will generate $900,000 per year for four years. In addition to upfront costs, at the completion of the project at the end of the fifth year there will be shut-down costs of $400,000 . If the cost of capital is 4.4%, based on the MIRR, at what upfront costs does this project cease to be worthwhile? A) $2.62 million B) $2.91 million C) $3.21 million D) $3.50 million

B) Bring all negative cash flows to time 0; thus, PV shut-down cost = -400,000 / (1 + 0.044 )5 = -$322,520.63 ;FV positive cash flows at time 5 = $4,013,810.7 ; PV of positive cash flows at time 0 = $3,139,085; NPV at 4.4% = 2.91 million

Gremlin Industries will pay a dividend of $1.90 per share this year. It is expected that this dividend will grow by 4% per year each year in the future. The current price of Gremlinʹs stock is $23.50 per share. What is Gremlinʹs equity cost of capital? A) 11% B) 12% C) 14% D) 16%

B) Cost of capital = ($1.90 / $23.50 ) + 0.04 = 12%

The Sisyphean Company has a bond outstanding with a face value of $5000 that matures in 10 years. The bond certificate indicates that the stated coupon rate for this bond is 8.9% and that the coupon payments are to be made semiannually. How much will each semiannual coupon payment be? A) $445.0 B) $222.5 C) $667.5 D) $890.0

B) Coupon payment = (coupon rate × face value)/number of coupons per year = (0.089 × 5000) / 2 = $222.5

Sinclair Pharmaceuticals, a small drug company, develops a vaccine that will protect against Helicobacter pylori, a bacteria that is the cause of a number of diseases of the stomach. It is expected that Sinclair Pharmaceuticals will experience extremely high growth over the next three years and will reinvest all of its earnings in expanding the company over this time. Earnings were $1.10 per share before the development of the vaccine and are expected to grow by 40% per year for the next three years. After this time, it is expected that growth will drop to 5% and stay there for the expected future. Four years from now Sinclair will pay dividends that are 75% of its earnings. If its equity cost of capital is 12%, what is the value of a share of Sinclair Pharmaceuticals today? A) $20.62 B) $25.78 C) $33.96 D) $33.51

B) E3 = $3.0184 ; D3 = $2.2638E4 = $3.16932 ; D4 = $2.37699 ; P3 = $2.37699 /(0.12 - 0.05 ) = $33.96 ; P0 = ($33.96 + $2.2638 ) / (1 + 0.12)3 = $25.78

Bubba Ho-Tep Company reported net income of $290 million for the most recent fiscal year. The firm had depreciation expenses of $100 million and capital expenditures of $150 million. Although it had no interest expense, the firm did have an increase in net working capital of $30 million. What is Bubba Ho-Tepʹs free cash flow? A) $10 million B) $210 million C) $270 million D) $570 million

B) FCF = NI + Dep - Capital Ex - inc.in NWC = $290 million + $100 million - $150 million - $30 million = $210 million

The Sisyphean Company is considering a new project that will have an annual depreciation expense of $3.6 million. If Sisypheanʹs marginal corporate tax rate is 35% and its average corporate tax rate is 30%, then what is the value of the depreciation tax shield on the companyʹs new project? A) $1,080,000 B) $1,260,000 C) $1,890,000 D) $1,134,000

B) Here we need to use the marginal tax rate. So, depreciation tax shield = $3.6 million × 0.35 = $1.26 million

If WiseGuy Inc. uses IRR rule to choose projects, which of the projects (Project A or Project B) will rank highest? A) Project A B) Project B C) Project A and Project B have the same ranking. D) Cannot calculate a payback period without a discount rate.

B) IRRA=10.7%, IRRB=26.4%

A company has identified the following investments as looking promising. Each requires an initial investment of $1.2 million. Which is the best investment? A) a perpetuity that generates a cash flow at the end of year 1 of $100,000, has a growth rate of 1.25%, and a cost of capital of 11.0% B) a perpetuity that generates a cash flow at the end of year 1 of $800,000, has a growth rate of 2.25%, and a cost of capital of 11.8% C) an investment that generates a cash flow of $400,000 at the end of each of the next five years, when the cost of capital is 6.1% D) an investment that generates a cash flow of $200,000 at the end of each of the next ten years, when the cost of capital is 6.1%

B) NPV (B) = -1.2 + 0.8 / (0.118 - 0.0225) = $7.177 million NPV (A) = -1.2 + 0.1 / (0.11 - 0.0125) = -$0.174 million NPV (C) = using a financial calculator = 0.480 million NPV (D) = using a financial calculator = $0.265 million

Aaron Inc. has 321 million shares outstanding. It expects earnings at the end of the year to be $641 million. The firmʹs equity cost of capital is 11%. Aaron pays out 50% of its earnings in total: 30% paid out as dividends and 20% used to repurchase shares. If Aaronʹs earnings are expected to grow at a constant 7% per year, what is Aaronʹs share price? A) $12.48 B) $24.96 C) $37.44 D) $49.92

B) P0 = (0.5 × $641 million) / (0.11 - 0.07) = $8012.5 million; Price per share = $8012.5 million / 321 million = $24.96

Which of the following formulas is INCORRECT? A) Divt = EPSt × Dividend Payout Rate B) PN = (rE - g) × DivN+1 C) earnings growth rate = retention rate × return on new investment D) rE = (Divt / P0) + g

B) PN = DivN + 1/rE - g

A bond has a $10,000 face value, ten years to maturity, and 8% semiannual coupon payments. What would be the expected difference in this bondʹs price immediately before and immediately after the next coupon payment? A) $800 B) $400 C) $1200 D) $200

B) The expected difference in this bondʹs price will be $400 since the bond pays semiannual coupon of $400 .

The owner of a hair salon spends $1,000,000 to renovate its premises, estimating that this will increase her cash flow by $220,000 per year. She constructs the above graph, which shows the net present value (NPV) as a function of the discount rate. If her discount rate is 6%, should she accept the project? A) Yes, because the NPV is positive at that rate. B) No, because the NPV is negative at that rate. C) No, because the NPV is positive at that rate. D) Cannot be determined from the information given.

B) The point at which the graph line cuts the Discount Rate axis is in the negative NPV region.

Which of the following statements regarding bonds and their terms is FALSE?

B) The yield to maturity of a bond is the discount rate that sets the future value (FV) of the promised bond payments equal to the current market price of the bond.

Which of the following would you NOT consider when making a capital budgeting decision? A) the additional taxes a firm would have to pay in the next year B) the cost of a marketing study completed last year C) the opportunity to lease out a warehouse instead of using it to house a new production line D) the change in direct labor expense due to the purchase of a new machine

B) This is a sunk cost.

A $1000 bond with a coupon rate of 6.2% paid semiannually has eight years to maturity and a yield to maturity of 8.3%. If interest rates rise and the yield to maturity increases to 8.6%, what will happen to the price of the bond? A) The price of the bond will fall by $18.93 . B) The price of the bond will fall by $15.78 . C) The price of the bond will rise by $15.78 . D) The price of the bond will not change.

B) Using FV = $1000 , periods to maturity = 16 , PMT = 31.00 , and discount rate = 4.15 %, calculate PV = $878.9937 ;Using FV = $1000 , periods to maturity = 16 , PMT = 31.00 , and discount rate = 4.30 %, calculate PV = $863.2168 ; difference = $878.9937 - $863.2168 = $15.7769 .

What is the yield to maturity of a(n) eight-year, $5000 bond with a 4.4% coupon rate and semiannual coupons if this bond is currently trading for a price of $4723.70 ? A) 6.31% B) 5.26% C) 7.36% D) 2.63%

B) Using FV = $5000 , periods to maturity = 16 , PMT = 110.00 , and PV = $4724 , calculate discount rate = 2.6275 % per period; 2.6275 × 2 = 5.255 %.

The owner of a number of gas stations is considering installing coffee machines in his gas stations. It will cost $270,000 to install the coffee machines, and they are expected to boost cash flows by $120,536 per year for their five-year working life. What must the cost of capital be if this investment has a profitability index of 1? A) 1.89% B) 3.78% C) 7.55% D) 9.44%

B) Using a financial calculator, PMT = 120,536 , N = 5, PV = 540,000 , compute I = 3.78%.

You expect KT industries (KTI) will have earnings per share of $5 this year and expect that they will pay out $1.25 of these earnings to shareholders in the form of a dividend. KTIʹs return on new investments is 13% and their equity cost of capital is 15%. The expected growth rate for KTIʹs dividends is closest to ________. A) 11.3% B) 9.8% C) 5.9% D) 3.9%

B) g = Retention rate × Return on new investment =($5-$1.25)/$5×0.13=0.0975 or9.8%

3) Which of the following bonds is trading at par? A) a bond with a $2,000 face value trading at $1,987 B) a bond with a $1,000 face value trading at $999 C) a bond with a $1,000 face value trading at $1,000 D) a bond with a $2,000 face value trading at $2,012

A company releases a five-year bond with a face value of $1000 and coupons paid semiannually. If market interest rates imply a YTM of 6%, what should be the coupon rate offered if the bond is to trade at par? A) 3% B) 5% C) 6% D) 7%

A firm is considering several mutually exclusive investment opportunities. The best way to choose between them is which of the following? A) profitability index B) payback period C) net present value (NPV) D) internal rate of return (IRR)

A round lot consists of how many shares? A) 1 B) 10 C) 100 D) 1,000

A ten-year, zero-coupon bond with a yield to maturity of 4% has a face value of $1000 . An investor purchases the bond when it is initially traded, and then sells it four years later. What is the rate of return of this investment, assuming the yield to maturity does not change? A) 3.20% B) 2.40% C) 4.00% D) 2.00%

A university issues a bond with a face value of $5000 and a coupon rate of 4.41% that matures on July 15, 2018. The holder of such a bond receives coupon payments of $110.25 . How frequently are coupon payments made in this case? A) monthly B) quarterly C) semiannually D) annually

According to Graham and Harveyʹs 2001 survey (Figure 8.2 in the text), the most popular decision rules for capital budgeting used by CFOs are ________. A) NPV, IRR, MIRR B) MIRR, IRR, Payback period C) IRR, NPV, Payback period D) Profitability index, NPV, IRR

An investor purchases a 30-year, zero-coupon bond with a face value of $5000 and a yield to maturity of 8.4%. He sells this bond ten years later. What is the rate of return on his investment, assuming yield to maturity does not change? A) 6.72% B) 5.04% C) 8.40% D) 4.20%

Cameron Industries is purchasing a new chemical vapor depositor in order to make silicon chips. It will cost $6 million to buy the machine and $10,000 to have it delivered and installed. Building a clean room in the plant for the machine will cost an additional $3 million. The machine is expected to have a working life of six years. Which of these activities will be reported as an operating expense? A) the delivery and install cost only B) the cost of the depositor only C) the redesign of the plant only D) the delivery and install cost and the cost of the depositor

How are investors in zero-coupon bonds compensated for making such an investment? A) Such bonds are purchased at their face value and sold at a premium on a later date. B) Such bonds make regular interest payments. C) Such bonds are purchased at a discount, below their face value. D) Such bonds have a lower face value as compared to other bonds of similar term.

The Sisyphean Company has a bond outstanding with a face value of $1000 that reaches maturity in five years. The bond certificate indicates that the stated coupon rate for this bond is 8.5% and that the coupon payments are to be made semiannually. Assuming that this bond trades for $1081.73 , then the YTM for this bond is closest to ________. A) 5.2% B) 7.87% C) 6.56% D) 9.18%

The capital budgeting process begins by ________. A) analyzing alternate projects B) evaluating the net present value (NPV) of each projectʹs cash flows C) compiling a list of potential projects D) forecasting the future consequences for the firm of each potential project

Which of the following best describes why the predicted incremental earnings arising from a given decision are not sufficient in and of themselves to determine whether that decision is worthwhile? A) They do not tell how the decision affects the firmʹs reported profits from an accounting perspective. B) They are not easily predicted from historical financial statements of a firm and its competitors. C) These earnings are not actual cash flows. D) They do not show how the firmʹs earnings are expected to change as the result of a particular decision.

Which of the following bonds will be most sensitive to a change in interest rates if all bonds have the same initial yield to maturity? A) a ten-year bond with a $1,000 face value whose coupon rate is 5.8% APR paid semiannually B) a ten-year bond with a $1,000 face value whose coupon rate is 7.4% APR paid semiannually C) a 20-year bond with a $1,000 face value whose coupon rate is 5.8% APR paid semiannually D) a 20-year bond with a $1,000 face value whose coupon rate is 7.4% APR paid semiannually

Which of the following is NOT a limitation of the payback rule? A) It does not consider the time value of money. B) Lacks a decision criterion that is economically based. C) It is difficult to calculate. D) It does not consider cash flows occurring after the payback period.

Which of the following is true regarding the profitability index? A) It does not use the net present value (NPV) to assess benefits. B) It is very simple to compute. C) Attention must be taken when using it to make sure that all of the constrained resource is utilized. D) It is unreliable when used for choosing between different projects.

Which of the following statements is FALSE? A) We begin the capital budgeting process by determining the incremental earnings of a project. B) The marginal corporate tax rate is the tax rate the firm will pay on an incremental dollar of pre-tax income. C) Investments in plant, property, and equipment are directly listed as expense when calculating earnings. D) The opportunity cost of using a resource is the value it could have provided in its best alternative use.

Which of the following statements is true of bond prices? A) A fall in bond prices causes interest rates to fall. B) A fall in interest rates causes a fall in bond prices. C) A rise in interest rates causes bond prices to fall. D) Bond prices and interest rates are not connected.

Which of the following statements regarding bonds and their terms is FALSE? A) The bond certificate typically specifies that the coupons will be paid periodically until the maturity date of the bond. B) The bond certificate indicates the amounts and dates of all payments to be made. C) The only cash payments the investor will receive from a zero-coupon bond are the interest payments that are paid up until the maturity date. D) The face value of a bond is repaid at maturity.

Which of the following will be a source of cash flows for a shareholder of a certain stock? Sale of the shares at a future date The firm in which the shares are held paying out cash to shareholders in the form of dividends III. The firm in which the shares are held increasing the total number of shares outstanding through a stock split A) I only B) II only C) I and II D) II and III

Why are the interest rates of U.S. Treasury securities less than the interest rates of equivalent corporate bonds? A) The U.S. government has a high credit spread. B) There is significant risk that the U.S. government will default. C) U.S. Treasury securities are widely regarded to be risk-free. D) U.S. Treasury securities yield inflation adjusted interest rates.

An investor holds a Ford bond with a face value of $5000 , a coupon rate of 8.5%, and semiannual payments that matures on January 15, 2029. How much will the investor receive on January 15, 2029? A) $2606.25 B) $5000.00 C) $5212.50 D) $5425.00

C - see explanation

A small manufacturer that makes clothespins and other household products buys new injection molding equipment for a cost of $500,000. This will allow the manufacturer to make more clothespins in the same amount of time with an estimated increase in sales of 25%. If the manufacturer currently makes 75 tons of clothespins per year, which sell at $18,000 per ton, what will be the increase in revenue next year from the new equipment? A) $125,000 B) $303,750 C) $337,500 D) $837,500

C .25 * 75 * 18000 = 337,500

Jumbuck Exploration has a current stock price of $3.00 and is expected to sell for $3.15 in one yearʹs time, immediately after it pays a dividend of $0.28 . Which of the following is closest to Jumbuck Explorationʹs equity cost of capital? A) 7.17% B) 8.60% C) 14.33% D) 17.91 %

C) $0.28 + $3.15 - $3.00 = $0.43 ; cost of capital = $0.43 /$3.00 = 14.33 %

A farmer sows a certain crop. It costs $240,000 to buy the seed, prepare the ground, and sow the crop. In one yearʹs time it will cost $93,200 to harvest the crop. If the crop will be worth $350,000 , and the interest rate is 7%, what is the net present value (NPV) of this investment? A) $240,000 B) $87,103 C) $0 D) $567,103

C) (350,000 - $93,200 )/ (1+.07) - 240,000 = $0

A delivery service is buying 600 tires for its fleet of vehicles. One supplier offers to supply the tires for $80 per tire, payable in one year. Another supplier will supply the tires for $20,000 down today, then $45 per tire, payable in one year. What is the difference in PV between the first and the second offer, assuming interest rates are 8.1%? A) -$860 B) -$229 C) -$574 D) $860

C) -$80 × 600 = $48,000 ;PV1 = 48,000 / (1 + 0.081 ) = $44,403.3302 ;-$45 × 600 = $27,000 ;PV2 = -20,000 + $27,000 / (1 + 0.081 ) = $44,976.8733 ; PV1-PV2=$44,403.3302 -$44,976.8733 =-$574

A firm is considering a new project that will generate cash revenue of $1,300,000 and cash expenses of $700,000 per year for five years. The equipment necessary for the project will cost $300,000 and will be depreciated straight line over four years. What is the expected free cash flow in the second year of the project if the firmʹs marginal tax rate is 35%? A) $374,625 B) $341,250 C) $416,250 D) $499,500

C) Annual depreciation = $300,000 / 4 = $75,000 .Free Cash Flow ($1,300,000 - $700,000 - $75,000 ) × (1 - 0.35) + $75,000 = $416,25

The Sisyphean Company has a bond outstanding with a face value of $1000 that reaches maturity in 5 years. The bond certificate indicates that the stated coupon rate for this bond is 10.0% and that the coupon payments are to be made semiannually.Assuming the appropriate YTM on the Sisyphean bond is 7.5%, then this bond will trade at ________. A) par B) a discount C) a premium D) none of the above

C) As the coupon rate of 10.0% is more than the YTM of 7.5% on the bonds, so the bonds will trade at a premium.

A mining company plans to mine a beach for rutile. To do so will cost $14 million up front and then produce cash flows of $7 million per year for five years. At the end of the sixth year the company will incur shut-down and clean-up costs of $6 million. If the cost of capital is 13.0%, then what is the MIRR for this project? A) -60.97 % B) -78.39 % C) -87.10% D) -95.81 %

C) Bring all negative cash flows to time 0;thus, PV shut-down cost = -6 / (1 + 0.13)6 = 2.88191116 ; FVpositivecashflowsattime6=51.2589405; MIRRoftheproject=-87.10%.

Sunnyfax Publishing pays out all its earnings and has a share price of $37 . In order to expand, Sunnyfax Publishing decides to cut its dividend from $3.00 to $2.00 per share and reinvest the retained funds. Once the funds are reinvested, they are expected to grow at a rate of 13%. If the reinvestment does not affect Sunnyfaxʹs equity cost of capital, what is the expected share price as a consequence of this decision? A) $36.67 B) $41.90 C) $52.38 D) $62.86

C) Cost of capital = $3/$37 = 0.08108108 ; g = 0.33 × 0.13 = 0.0429; P0=$2/(0.08108108 -0.0429)=$52.38

Cameron Industries is purchasing a new chemical vapor depositor in order to make silicon chips. It will cost $5,000,000 to buy the machine and $10,000 to have it delivered and installed. Building a clean room in the plant for the machine will cost an additional $3 million. The machine is expected to raise gross profits by $4,500,000 per year, starting at the end of the first year, with associated costs of $1 million for each of those years. The machine is expected to have a working life of six years and will be depreciated over those six years. The marginal tax rate is 40%. What are the incremental free cash flows associated with the new machine in year 2? A) $835,000 B) $2,665,000 C) $2,434,000 D) $831,667

C) Depreciation = ($5,000,000 + $10,000 ) / 6 = $835,000 ;$4,500,000 - 1,000,000 - $835,000 = $2,665,000 ;$2,665,000 × (0.6) = $1,599,000 ; add back depreciation to get $2,434,000 .

Avril Synchronistics will pay a dividend of $1.20 per share this year. It is expected that this dividend will grow by 3% each year in the future. What will be the current value of a single share of Avrilʹs stock if the firmʹs equity cost of capital is 16%? A) $6.46 B) $6.92 C) $9.23

C) P0 = $1.20 / (0.16 - 0.03) = $9.23

Chittenden Enterprises has 643 million shares outstanding. It expects earnings at the end of the year to be $960 million. The firmʹs equity cost of capital is 9%. Chittenden pays out 30% of its earnings in total: 20% paid out as dividends and 10% used to repurchase shares. If Chittendenʹs earnings are expected to grow at a constant 3% per year, what is Chittendenʹs share price? A) $3.74 B) $2.24 C) $7.47 D) $14.94

C) P0 = (0.3 × $960 million) / (0.09 - 0.03) = $4800 million; Price per share = $4800 million / 643 million = $7.47

The Sisyphean Companyʹs common stock is currently trading for $25.50 per share. The stock is expected to pay a $2.80 dividend at the end of the year and the Sisyphean Companyʹs equity cost of capital is 10%. If the dividend payout rate is expected to remain constant, then the expected growth rate in the Sisyphean Companyʹs earnings is closest to ________. A) -1.96% B) -1.47% C) -0.98% D) -0.49%

C) P0 = Div1 / (rE - g) = $25.50 = $2.80 / (0.1 - g),so g = -0.0098 or -0.98%

Matilda Industries pays a dividend of $2.10 per share and is expected to pay this amount indefinitely. If Matildaʹs equity cost of capital is 9%, which of the following would be closest to Matildaʹs stock price? A) $14.00 B) $18.66 C) $23.33 D) $29.16

C) PV0 = $2.10 / 0.09 = $23.33

A risk-free, zero-coupon bond has 15 years to maturity. Which of the following is closest to the price per $1000 of face value that the bond will trade at if the YTM is 6.1%? A) $663.78 B) $774.42 C) $553.15 D) $885.05

C) Price = (Face value) / (1 + YTM)N. Price = ($1000 ) / (1 + 6.1%)10 = $553.15

A company issues a ten-year $1,000 face value bond at par with a coupon rate of 6.7% paid semiannually. The YTM at the beginning of the third year of the bond (8 years left to maturity) is 8.1%. What was the percentage change in the price of the bond over the past two years? A) -6.50% B) -9.75% C) -8.13% D) -11.38 %

C) The new price would be $918.73 . ($918.73 - $1000)/1000 = -8.13%

What is the yield to maturity of a ten-year, $10,000 bond with a 5.4% coupon rate and semiannual coupons if this bond is currently trading for a price of $9207.93 ? A) 7.79% B) 9.08% C) 6.49% D) 3.24%

C) Using FV = $10,000 , periods to maturity = 20 , PMT = 270.00 , and PV = $9207.93 , calculate discount rate = 3.2445 % per period; 3.2445 × 2 = 6.489 %.

What must be the price of a $1000 bond with a 5.8% coupon rate, annual coupons, and 20 years to maturity if YTM is 7.8% APR? A) $960.82 B) 1120.95 C) $800.68 D) $640.54

C) Using FV = $1000 , periods to maturity = 20 , PMT = $58.00 , and discount rate = 7.8% per period, calculate PV = $800.68

Valorous Corporation will pay a dividend of $1.75 per share at this yearʹs end and a dividend of $2.35 per share at the end of next year. It is expected that the price of Valorousʹ stock will be $41 per share after two years. If Valorous has an equity cost of capital of 9%, what is the maximum price that a prudent investor would be willing to pay for a share of Valorous stock today? A) $32.38 B) $36.19 C) $38.09 D) $39.99

C) Using a financial calculator, CF0 = 0,CF1 = 1.75,CF2 = (41 + 2.35) = 43.35; calculate NPV at I = 9%, equals $38.09 .

A local government awards a landscaping company a contract worth $1.5 million per year for five years for maintaining public parks. The landscaping company will need to buy some new machinery before they can take on the contract. If the cost of capital is 6%, what is the most that this equipment could cost if the contract is to be worthwhile for the landscaping company? A) $5.69 million B) $6.00 million C) $6.32 million D) $6.63 million

C) Using a financial calculator, enter PMT = 1.5, N = 5, I = 6%; calculate PV = $6.32 million.

You expect KT industries (KTI) will have earnings per share of $5 this year and expect that they will pay out $2.50 of these earnings to shareholders in the form of a dividend. KTIʹs return on new investments is 14% and their equity cost of capital is 11%. The value of a share of KTIʹs stock today is closest to ________. A) $75.00 B) $37.50 C) $62.50 D) $25.00

C) g = Retention rate × Return on new investment = ($5 - $2.50)/$5 × 0.14 = 0.07 or 7% P0 = Div1 / (rE - g) = $2.50 / (0.11 - 0.07) = $62.50

What is the yield to maturity of a one-year, risk-free, zero-coupon bond with a $10,000 face value and a price of $9400 when released? A) 3.191 % B) 6.000 % C) 6.383% D) 0.009 %

Calculate the discount rate that equates $10,000 to $9400 in one year. 1 + YTMn = (Face value / price)1/n. YTMn = 6.383%

12) Which of the following bonds will be most sensitive to a change in interest rates? A) a ten-year bond with a $2,000 face value whose yield to maturity is 5.8% and coupon rate is 5.8% APR paid semiannually B) a 15-year bond with a $5,000 face value whose yield to maturity is 7.4% and coupon rate is 6.2% APR paid annually C) a 20-year bond with a $3,000 face value whose yield to maturity is 6.0% and coupon rate is 5.4% APR paid semiannually D) a 30-year bond with a $1,000 face value whose yield to maturity is 5.5% and coupon rate is 6.4% APR paid annually

A bond is currently trading below par. Which of the following must be true about that bond? A) The bondʹs yield to maturity is less than its coupon rate. B) The bond is a zero-coupon bond. C) The bondʹs yield to maturity is greater than its coupon rate. D) B or C above

A company releases a five-year bond with a face value of $1000 and coupons paid semiannually. If market interest rates imply a YTM of 8%, which of the following coupon rates will cause the bond to be issued at a premium? A) 7% B) 6% C) 8% D) 10%

A convenience store owner is contemplating putting a large neon sign over his store. It would cost $50,000, but is expected to bring an additional $24,000 of profit to the store every year for five years. Would this project be worthwhile if evaluated using a payback period of two years or less and if the cost of capital is 10%? A) Yes, since it will pay back its initial investment in two years. B) Yes, since the value of the cash flows into the store, in present dollars, are greater than the initial investment. C) Yes, since the cash flows after two years are greater than the initial investment. D) No, since the value of the cash flows over the first two years are less than the initial investment.

A security firm is offered $80,000 in one year for providing CCTV coverage of a property. The cost of providing this coverage to the security firm is $74,000, payable now, and the interest rate is 8.5%. Should the firm take the contract? A) Yes, since net present value (NPV) is positive. B) It does not matter whether the contract is taken or not, since NPV = 0. C) Yes, since net present value (NPV) is negative. D) No, since net present value (NPV) is negative.

An insurance office owns a large building downtown. The sixth floor of this building currently houses its entire Human Resources Department. After carrying out a survey to see whether the sixth floor could be rented and for what price, the company must decide whether to split the Human Resources Department between currently unoccupied spaces on several floors and rent out the entire sixth floor or to leave things as they currently are. Which of the following should NOT be considered when deciding whether to rent out the sixth floor? A) the amount obtained by renting the sixth floor B) the cost of refurbishing the new space to be occupied by the Human Resources Department C) cost involved with a loss of efficiency resulting from the Human Resources Department being split between several spaces D) the cost of the research into the feasibility of renting the sixth floor

Consider a zero-coupon bond with a $1000 face value and 10 years left until maturity. If the YTM of this bond is 10.2%, then the price of this bond is closest to ________. A) $1000 B) $454.32 C) $530.04 D) $379

Consider a zero-coupon bond with a $1000 face value and 15 years left until maturity. If the bond is currently trading for $431 , then the yield to maturity on this bond is closest to ________. A) 2.89% B) 56.90 % C) 43.10% D) 5.77%

If the yield to maturity of all of the following bonds is 6%, which will trade at the greatest premium per $100 face value? A) a bond with a $10,000 face value, four years to maturity and 6.2% semiannual coupon payments B) a bond with a $500 face value, seven years to maturity and 5.2% annual coupon payments C) a bond with a $5,000 face value, seven years to maturity and 5.5% annual coupon payments D) a bond with a $1,000 face value, five years to maturity and 6.3% annual coupon payments

Luther Industries has outstanding tax loss carryforwards of $72 million from losses over the past four years. If Luther earns $15 million per year in pre-tax income from now on, in how many years will Luther first pay taxes? A) 7 years B) 2 years C) 4 years D) 5 years

Most corporations measure the value of a project in terms of which of the following? A) discount value B) discount factor C) future value (FV) D) present value (PV)

The Sisyphean Company has a bond outstanding with a face value of $5000 that reaches maturity in 8 years. The bond certificate indicates that the stated coupon rate for this bond is 8.2% and that the coupon payments are to be made semiannually. Assuming that this bond trades for $4541.53 , then the YTM for this bond is closest to ________. A) 7.9% B) 11.9% C) 13.8% D) 9.9%

The ultimate goal of the capital budgeting process is to ________. A) determine how the consequences of making a particular decision affects the firmʹs revenues and costs B) list the projects and investments that a company plans to undertake in the future C) forecast the consequences of a list of future projects for the firm D) determine the effect of the decision to accept or reject a project on the firmʹs cash flows

What are dividend payments? A) payments made to a company by investors for a share of the ownership of that company B) incremental increases in the value of the stock held by an investor due to rises in share price C) the difference between the original cost price of a share and the price an investor receives when that share is sold D) a share of the profits paid to each shareholder on the basis of the number of shares they hold

Which of the following adjustments should NOT be made when computing free cash flow from incremental earnings? A) adding depreciation B) adding all non-cash expenses C) subtracting increases in Net Working Capital D) subtracting depreciation expenses from taxable earnings

Which of the following best describes a bond rated by Standard & Poorʹs and Moody as B? A) judged to be high quality by all standards B) considered to be medium grade obligations C) neither highly protected nor poorly secured D) generally lacks the characteristics of a desirable investment

Which of the following best illustrates why a bond is a type of loan? A) The issuers of bonds make regular payments to bondholders. B) When a company issues a bond, the buyer of that bond becomes an owner of the issuing company. C) Funds raised are used to finance long-term projects. D) When an investor buys a bond from an issuer, the investor is giving money to the issuer, with the assurance that it will be repaid at a date in the future.

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