Financial Management Chapter 7-9
Dee's made two announcements concerning its common stock today. First, the company announced that the next annual dividend will be $1.94 a share. Secondly, all dividends after that will decrease by 1.25 percent annually. What is the value of this stock at a discount rate of 14.5 percent? $12.32 $12.10 $14.82 $14.51 $14.21
$12.32 P0 = $1.94 / [.145 − (−.0125)] = $12.32
The common stock of Water Town Mills pays an annual dividend of $1.84 a share. The company has promised to maintain a constant dividend even though economic times are tough. How much are you willing to pay for one share of this stock if you want to earn a 13.6 percent annual return? $13.53 $14.01 $14.56 $13.79 $13.28
$13.53 P0 = $1.84 / .136 = $13.53
A project has an initial cash outflow of $39,800 and produces cash inflows of $18,304, $19,516, and $14,280 for years 1 through 3, respectively. What is the NPV at a discount rate of 11 percent? $7,675.95 -$1,208.19 $2,971.13 $2,029.09 $1,311.16
$2,971.13 NPV = -$39,800 + $18,304 / 1.11 + $19,516 / 1.112 + $14,280 / 1.113 NPV = $2,971.13
A bond that is payable to whomever has physical possession of the bond is said to be in: New-issue condition. Registered form. Bearer form. Debenture status. Collateral status.
Bearer Form
Mutually exclusive projects are best defined as competing projects that: Would need to commence on the same day. Have the same initial start-up costs. Both require the total use of the same limited resource. Both have negative cash outflows at time zero. Have the same life span.
Both require the total use of the same limited resource
An agent who arranges a transaction between a buyer and a seller of equity securities is called a: Broker. Floor trader. Capitalist. Principal. Dealer.
Broker
Future Motors is expected to pay a $3.30 a share annual dividend next year. Dividends are expected to increase by 2.75 percent annually. What is one share of this stock worth to you today if your required rate of return is 15 percent? $25.06 $26.30 $24.56 $26.94 $27.59
$26.94 P0 = $3.30 / (.15 - .0275) = $26.94
How much are you willing to pay for one share of LBM stock if the company just paid a $1.23 annual dividend, the dividends increase by 3.1 percent annually, and you require a return of 16 percent? $9.29 $9.33 $9.83 $10.21 $9.59
$9.83 P0 = [$1.23 ×(1 + .031)] / (.16 - .031) = $9.83
Isaac has analyzed two mutually exclusive projects that have 3-year lives. Project A has an NPV of $81,406, a payback period of 2.48 years, and an AAR of 9.31 percent. Project B has an NPV of $82,909, a payback period of 2.57 years, and an AAR of 9.22 percent. The required return for Project A is 11.5 percent while it is 12 percent for Project B. Both projects have a required AAR of 9.25 percent. Isaac must make a recommendation and justify it in 15 words or less. What should his recommendation be? Accept both projects because both NPVs are positive. Accept Project A because it has the shortest payback period. Accept Project B and reject Project A based on the NPVs. Accept Project A and reject Project B based on their AARs. Accept Project A because it has the lower required return.
Accept Project B and reject Project A based on the NPVs.
Which one of the following increases the net present value of a project? An increase in the required rate of return. An increase in the initial capital requirement. A deferment of some cash inflows until a later year. An increase in the aftertax salvage value of the fixed assets. A reduction in the final cash inflow.
An increase in the aftertax salvage value of the fixed assets
Bonds issued by the U.S. government: Are considered to be free of interest rate risk. Generally have higher coupons than comparable bonds issued by a corporation. Are considered to be free of default risk. Pay interest that is exempt from federal income taxes. Are called "munis."
Are considered to be free of default risk
Protective covenants: Apply to short-term debt issues but not to long-term debt issues. Only apply to privately issued bonds. Are a feature found only in government-issued bond indentures. Only apply to bonds that have a deferred call provision. Are primarily designed to protect bondholders.
Are primarily designed to protect bondholders
A $1,000 face value bond can be redeemed early at the issuer's discretion for $1,030, plus any accrued interest. The additional $30 is called the: Dirty price. Redemption value. Call premium. Original-issue discount. Redemption discount.
Call Premium
A bond that can be paid off early at the issuer's discretion is referred to as being which type of bond? Par value. Callable. Senior. Subordinated. Unsecured.
Callable
Which one of following is the rate at which a stock's price is expected to appreciate? Current yield. Total return Dividend yield. Capital gains yield. Coupon rate.
Capital gains yield
Rossiter Restaurants is analyzing a project that requires $180,000 of fixed assets. When the project ends, those assets are expected to have an aftertax salvage value of $45,000. How is the $45,000 salvage value handled when computing the net present value of the project? Reduction in the cash outflow at time zero. Cash inflow in the final year of the project. Cash inflow for the year following the final year of the project. Cash inflow prorated over the life of the project. Not included in the net present value.
Cash inflow in the final year of the project
Which one of the following types of stock is defined by the fact that it receives no preferential treatment in respect to either dividends or bankruptcy proceedings? Dual class. Cumulative. Non-cumulative. Preferred. Common.
Common
The interest rate risk premium is the: Additional compensation paid to investors to offset rising prices. Compensation investors demand for accepting interest rate risk. Difference between the yield to maturity and the current yield. Difference between the market interest rate and the coupon rate. Difference between the coupon rate and the current yield.
Compensation investors demand for accepting interest rate risk
Which one of the following applies to a premium bond? Yield to maturity > current yield > coupon rate. Coupon rate = current yield = yield-to-maturity. Coupon rate > yield-to-maturity > current yield. Coupon rate < yield to maturity < current yield. Coupon rate > current yield > yield to maturity.
Coupon rate > current yield > yield to maturity.
The price sensitivity of a bond increases in response to a change in the market rate of interest as the: Coupon rate increases. Time to maturity decreases. Coupon rate decreases and the time to maturity increases. Time to maturity and coupon rate both decrease. Coupon rate and time to maturity both increase.
Coupon rate decreases and time to maturity increases
The IRR that causes the net present value of the differences between two project's cash flows to equal zero is called the: Required return. Zero-sum rate. Present value rate. Break-even rate. Crossover rate.
Crossover Rate
An agent who maintains an inventory from which he or she buys and sells securities is called a: Broker. Trader. Capitalist. Principal. Dealer.
Dealer
Jason's Paints just issued 20-year, 7.25 percent, unsecured bonds at par. These bonds fit the definition of which one of the following terms? Note. Discounted. Zero-coupon. Callable. Debenture.
Debenture
A decrease in which of the following will increase the current value of a stock according to the dividend growth model? Dividend amount. Number of future dividends, provided the number is less than infinite. Dividend growth rate. Discount rate. Both the discount rate and the dividend growth rate.
Discount Rate
The internal rate of return is defined as the: Maximum rate of return a firm expects to earn on a project. Rate of return a project will generate if the project in financed solely with internal funds. Discount rate that equates the net cash inflows of a project to zero. Discount rate which causes the net present value of a project to equal zero. Discount rate that causes the profitability index for a project to equal zero.
Discount rate which causes the new present value of a project to equal zero
Which one of the following methods of project analysis is defined as computing the value of a project based on the present value of the project's anticipated cash flows? Constant dividend growth model. Discounted cash flow valuation. Average accounting return. Expected earnings model. Internal rate of return.
Discounted cash flow valuation
What is the model called that determines the present value of a stock based on its next annual dividend, the dividend growth rate, and the applicable discount rate? Zero growth. Dividend growth. Capital pricing. Earnings capitalization. Discounted dividend.
Dividend Growth
Which one of the following is computed by dividing next year's annual dividend by the current stock price? Yield to maturity. Total yield. Dividend yield. Capital gains yield. Growth rate.
Dividend Yield
What are the distributions of either cash or stock to shareholders by a corporation called? Coupon payments. Retained earnings. Dividends. Capital payments. Diluted profits.
Dividends
Which one of the following applies to the dividend growth model? An individual stock has the same value to every investor. Even if the dividend amount and growth rate remain constant, the value of a stock can vary. Zero-growth stocks have no market value. Stocks that pay the same annual dividend will have equal market values. The dividend growth rate is inversely related to a stock's market price.
Even if the dividend amount and growth rate remain constant, the value of a stock can vary
A bond's coupon rate is equal to the annual interest divided by which one of the following? Call price. Current price. Face value. Clean price. Dirty price.
Face Value
Bert owns a bond that will pay him $75 each year in interest plus a $1,000 principal payment at maturity. What is the $1,000 called? Coupon. Face value. Discount. Yield. Dirty price.
Face Value
Treasury bonds are: Issued by any governmental agency in the U.S. Issued only on the first day of each fiscal year by the U.S. Department of Treasury. Bonds that offer the best tax benefits of any bonds currently available. Generally issued as semi-annual coupon bonds. Totally risk-free.
Generally issued as semi-annual coupon bonds
Which one of the following will decrease the net present value of a project? Increasing the value of each of the project's discounted cash inflows. Moving each of the cash inflows forward to a sooner time period. Decreasing the required discount rate. Increasing the project's initial cost at time zero. Increasing the amount of the final cash inflow.
Increasing the project's initial cost at time zero
Real rates are defined as nominal rates that have been adjusted for which of the following? Inflation. Default risk. Accrued interest. Interest rate risk. Both inflation and interest rate risk.
Inflation
A "fallen angel" is a bond that has moved from: Being publicly traded to being privately traded. Being a long-term obligation to being a short-term obligation. Being a premium bond to being a discount bond. Senior status to junior status for liquidation purposes. Investment grade to speculative grade.
Investment grade to speculative grade
Net present value: Is the best method of analyzing mutually exclusive projects. Is less useful than the internal rate of return when comparing different sized projects. Is the easiest method of evaluation for nonfinancial managers to use. Cannot be applied when comparing mutually exclusive projects. Is very similar in its methodology to the average accounting return.
Is the best method of analyzing mutually exclusive projects
Supernormal growth is a growth rate that: Is both positive and follows a year or more of negative growth. Exceeds a firm's previous year's rate of growth. Is generally constant for an infinite period of time. Is unsustainable over the long term. Applies to a single, abnormal year.
Is unsustainable over the long term
Which of the following are advantages of the payback method of project analysis? Considers time value of money, liquidity bias. Liquidity bias, arbitrary cutoff point. Liquidity bias, ease of use. Ignores time value of money, ease of use. Ease of use, arbitrary cutoff point.
Liquidity bias, ease of use
Which one of these is most apt to be included in a bond's indenture one year after the bond has been issued? Current yield. Written record of all the current bond holders. List of collateral used as bond security. Current market price. Price at which a bondholder can resell the bond to another bondholder.
List of collateral used as bond security
Which bond would you generally expect to have the highest yield? Risk-free Treasury bond Non-taxable, highly-liquid bond Long-term, high-quality, tax-free bond Short-term, inflation-adjusted bond Long-term, taxable junk bond
Long-term, taxable junk bond
You expect interest rates to decline in the near future even though the bond market is not indicating any sign of this change. Which one of the following bonds should you purchase now to maximize your gains if the rate decline does occur? Short-term; low coupon. Short-term; high coupon. Long-term; zero coupon. Long-term; low coupon. Long-term; high coupon.
Long-term, zero coupon
The current yield is defined as the annual interest on a bond divided by which one of the following? Coupon rate. Face value. Market price. Call price. Par value.
Market Price
The secondary market is best defined by which one of the following? Market in which subordinated shares are issued and resold. Market conducted solely by brokers. Market dominated by dealers. Market where outstanding shares of stock are resold. Market where warrants are offered and sold.
Market where outstanding shares of stocks are resold
A Treasury yield curve plots Treasury interest rates relative to which one of the following? Market rates. Comparable corporate bond rates. The risk-free rate. Inflation. Maturity.
Maturity
If a firm accepts Project A it will not be feasible to also accept Project B because both projects would require the simultaneous and exclusive use of the same piece of machinery. These projects are considered to be: Independent. Interdependent. Mutually exclusive. Economically scaled. Operationally distinct.
Mutually Exclusive
A project has an initial cost of $27,400 and a market value of $32,600. What is the difference between these two values called? Net present value. Internal return. Payback value. Profitability index. Discounted payback.
Net Present Value
Southern Chicken is considering two projects. Project A consists of creating an outdoor eating area on the unused portion of the restaurant's property. Project B would use that outdoor space for creating a drive-thru service window. When trying to decide which project to accept, the firm should rely most heavily on which one of the following analytical methods? Profitability index. Internal rate of return. Payback. Net present value. Accounting rate of return.
Net Present Value
Which one of the following methods determines the amount of the change a proposed project will have on the value of a firm? Net present value. Discounted payback. Internal rate of return. Profitability index. Payback.
Net Present Value
Last year, Lexington Homes issued $1 million in unsecured, noncallable debt. This debt pays an annual interest payment of $55 and matures six years from now. The face value is $1,000 and the market price is $1,020. Which one of these terms correctly describes a feature of this debt? Semiannual coupon. Discount bond. Note. Trust deed. Collateralized.
Note
The length of time a firm must wait to recoup the money it has invested in a project is called the: Internal return period. Payback period. Profitability period. Discounted cash period. Valuation period.
Payback Period
National Trucking has paid an annual dividend of $1 per share on its common stock for the past 15 years and is expected to continue paying a dollar a share long into the future. Given this, one share of the firm's stock is: Basically worthless as it offers no growth potential. Equal in value to the present value of $1 paid one year from today. Priced the same as a $1 perpetuity. Valued at an assumed growth rate of 1 percent. Worth $1 a share in the current market.
Priced the same as a $1 perpetuity
Emst & Frank stock is listed on NASDAQ. The firm is planning to issue some new equity shares for sale to the general public. This sale will definitely occur in which one of the following markets? Private. Auction. Tertiary. Secondary. Primary.
Primary
The constant dividend growth model: rev: Assumes dividends increase at a decreasing rate. Only values stocks at Time 0. Cannot be used to value constant dividend stocks. Can be used to value both dividend-paying and non-dividend-paying stocks. Requires the growth rate to be less than the required return.
Requires the growth rate to be less than the required return
Which one of the following statements is correct? Stocks can only be assigned one dividend growth rate. Preferred stocks generally have constant growth rates. Dividend growth rates must be either zero or positive. All stocks can be valued using the dividend discount models. Stocks can have negative growth rates.
Stocks can have negative growth rates
The internal rate of return is: The discount rate that makes the net present value of a project equal to the initial cash outlay. Equivalent to the discount rate that makes the net present value equal to one. Tedious to compute without the use of either a financial calculator or a computer. Highly dependent upon the current interest rates offered in the marketplace. A better methodology than net present value when dealing with unconventional cash flows.
Tedious to compute without the use of either finical calculate or a compute
Which one of the following statements related to the internal rate of return (IRR) is correct? The IRR yields the same accept and reject decisions as the net present value method given mutually exclusive projects. A project with an IRR equal to the required return would reduce the value of a firm if accepted. The IRR is equal to the required return when the net present value is equal to zero. Financing type projects should be accepted if the IRR exceeds the required return. The average accounting return is a better method of analysis than the IRR from a financial point of view.
The IRR is equal to the required return when the net present value is equal to zero
Swenson's is considering two mutually exclusive projects, Projects A and B, and has determined that the crossover rate for these projects is 11.7 percent. Given this you know that: Neither project will be accepted if the discount rate is less than 11.7 percent. Both projects have a negative NPV at discounts rates greater than 11.7 percent. Both projects provide an internal rate of return of 11.7 percent. Both projects have a zero NPV at a discount rate of 11.7 percent. The project that is preferred at a discount rate of 11 percent will be the opposite project of that preferred at a discount rate of 12 percent.
The project that is preferred at a discount rate of 11 percent will be the opposite project of that preferred at a discount rate of 12 percent.
A project has a net present value of zero. Which one of the following best describes this project? The project has a zero percent rate of return. The project requires no initial cash investment. The project has no cash flows. The summation of all of the project's cash flows is zero. The project's cash inflows equal its cash outflows in current dollar terms.
The project's cash inflows equal its cash outflows in current dollar terms
You cannot attend the shareholder's meeting for Alpha United so you authorize another shareholder to vote on your behalf. What is the granting of this authority called? Alternative voting. Cumulative voting. Straight voting. Indenture voting. Voting by proxy.
Voting by proxy
