we scrwed FINAL

28) Georga's Restaurants has 7,000 bonds outstanding with a face value of $1,000 each, a market price of $982, and a coupon rate of 6.95 percent. The interest is paid semiannually. What is the amount of the annual interest tax shield if the tax rate is 23 percent? A) $111,895 B) $113,323 C) $107,750 D) $110,420 E) $113,006

A) $111,895

22) The common stock of Water Town Mills pays a constant annual dividend of $2.25 a share. What is one share of this stock worth at a discount rate of 16.2 percent? A) $13.89 B) $14.01 C) $14.56 D) $13.79 E) $13.28

A) $13.89

20) Holly's is currently an all-equity firm that has 7,200 shares of stock outstanding at a market price of $41 a share. The firm has decided to leverage its operations by issuing $60,000 of debt at an interest rate of 7.6 percent. This new debt will be used to repurchase shares of the outstanding stock. The restructuring is expected to increase the earnings per share. What is the minimum level of earnings before interest and taxes that the firm is expecting? Ignore taxes. A) $22,435 B) $19,516 C) $26,400 D) $17,141 E) $25,020

A) $22,435

21) Hi-Tek is a young start-up company that is currently retaining all of its earnings. The company plans to pay a $2 per share dividend in Year 7 and increase that dividend by 2.2 percent per year thereafter. What is the current share price if the required return is 16 percent? A) $5.95 B) $6.62 C) $8.59 D) $14.29 E) $11.78

A) $5.95

21) The systematic risk of the market is measured by a: A) beta of 1. B) beta of 0. C) standard deviation of 1. D) standard deviation of 0. E) variance of 1.

A) beta of 1.

12) An agent who arranges a transaction between a buyer and a seller of equity securities is called a: A) broker. B) floor trader. C) capitalist. D) principal. E) dealer.

A) broker.

21) Paradise Travels is an all-equity firm that has 9,000 shares of stock outstanding at a market price of $27 a share. Management has decided to issue $25,000 worth of debt and use the funds to repurchase shares of the outstanding stock. The interest rate on the debt will be 7.3 percent. What are the earnings per share at the break- even level of earnings before interest and taxes? Ignore taxes. A) $2.28 B) $1.97 C) $1.67 D) $2.12 E) $1.92

B) $1.97

16) Three Corners Markets paid an annual dividend of $1.42 a share last month. Today, the company announced that future dividends will be increasing by 1.3 percent annually. If you require a return of 14.6 percent, how much are you willing to pay to purchase one share of this stock today? A) $11.23 B) $10.82 C) $10.68 D) $9.68 E) $11.57

B) $10.82

20) The UpTowner just paid an annual dividend of $4.12. The company has a policy of increasing the dividend by 2.5 percent annually. You would like to purchase shares of stock in this firm but realize that you will not have the funds to do so for another four years. If you require a rate of return of 16.7 percent, how much will you be willing to pay per share when you can afford to make this investment? A) $32.03 B) $32.83 C) $33.12 D) $33.65 E) $32.47

B) $32.83

38) The risk-free rate of return is 2.7 percent, the inflation rate is 3.1 percent, and the market risk premium is 6.9 percent. What is the expected rate of return on a stock with a beta of 1.08? A) 10.92 percent B) 10.15 percent C) 12.22 percent D) 11.47 percent E) 11.79 percent

B) 10.15 percent

23) Ignoring taxes, Pewter & Glass has a weighted average cost of capital of 10.82 percent. The company can borrow at 7.4 percent. What is the cost of equity if the debt-equity ratio is .68? A) 12.87% B) 13.15% C) 11.09% D) 15.85% E) 12.49%

B) 13.15%

4) Suzie owns five different bonds and twelve different stocks. Which one of the following terms most applies to her investments? A) Index B) Portfolio C) Collection D) Grouping E) Risk-free

B) Portfolio

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

B) Portfolio weight

31) Which one of the following should earn the highest risk premium based on CAPM? A) Diversified portfolio with returns similar to the overall market B) Stock with a beta of 1.38 C) Stock with a beta of .74 D) U.S. Treasury bill E) Portfolio with a beta of 1.01

B) Stock with a beta of 1.38

12) Which one of the following risks is irrelevant to a well-diversified investor? A) Systematic risk B) Unsystematic risk C) Market risk D) Non-diversifiable risk E) Systematic portion of a surprise

B) Unsystematic risk

11) When the present value of the cash inflows exceeds the initial cost of a project, then the project should be: A) accepted because the payback period is less than the required time period. B) accepted because the profitability index is greater than 1. C) accepted because the profitability index is negative. D) rejected because the internal rate of return is negative. E) rejected because the net present value is positive.

B) accepted because the profitability index is greater than 1.

10) If a company uses its WACC as the discount rate for all of the projects it undertakes then the company will tend to: A) accept all positive net present value projects. B) increase the average risk level of the company over time. C) reject all high-risk projects. D) reject all negative net present value projects. E) favor low-risk projects over high-risk projects.

B) increase the average risk level of the company over time.

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

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

12) When a manager develops a cost of capital for a specific project based on the cost of capital for another firm that has a similar line of business as the project, the manager is utilizing the _____ approach. A) subjective risk B) pure play C) divisional cost of capital D) capital adjustment E) security market line

B) pure play

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

B) risk-free rate.

15) The Garden Shoppe has adopted a policy of increasing its annual dividend at a constant rate of 1.35 percent annually. The company just paid its annual dividend of $1.84. What will the dividend be nine years from now? A) $2.10 B) $2.05 C) $2.08 D) $2.02 E) $2.15

C) $2.08

31) Mountain Groves has an unlevered cost of capital of 13.2 percent, a cost of debt of 8.3 percent, and a tax rate of 21 percent. What is the target debt-equity ratio if the targeted cost of equity is 14.5 percent? A) .54 B) .29 C) .34 D) .48 E) .33

C) .34

20) Assume a project has cash flows of -$54,300, $18,200, $37,300, and $14,300 for Years 0 to 3, respectively. What is the profitability index given a required return of 12.6 percent? A) .946 B) .98 C) 1.02 D) 1.06 E) 1.00

C) 1.02

33) You own a portfolio that has $2,800 invested in Stock A and $3,250 invested in Stock B. The expected returns on these stocks are 14.7 percent and 9.3 percent, respectively. What is the expected return on the portfolio? A) 12.06 percent B) 12.36 percent C) 11.80 percent D) 11.13 percent E) 11.41 percent

C) 11.80 percent

17) Street Corporation's common stock has a beta of 1.33. The risk-free rate is 3.4 percent and the expected return on the market is 10.97 percent. What is the cost of equity? A) 12.49 percent B) 12.84 percent C) 13.47percent D) 14.07 percent E) 13.33 percent

C) 13.47percent

32) What is the expected return and standard deviation for the following stock? (see chart within the study guide so it makes more sense) State of Economy boom normal recession Profitability of State of Econ. boom = .06 normal = .74 recession = .20 Rate of Return if state occurs boom = -.06 normal = .07 recession = .18 A) 8.53 percent; 5.69 percent B) 8.53 percent; 5.74 percent C) 8.42 percent; 5.69 percent D) 8.80 percent; 5.74 percent E) 8.42 percent; 5.74 percent

C) 8.42 percent; 5.69 percent

13) A floor broker on the NYSE does which one of the following? A) Supervises the commission brokers of a specific financial firm B) Trades for his or her own personal inventory C) Executes orders on behalf of customers D) Maintains an inventory and assumes the role of a market maker E) Is charged with maintaining a liquid, orderly market

C) Executes orders on behalf of customers

29) Which one of the following will be constant for all securities if the market is efficient and securities are priced fairly? A) Variance B) Standard deviation C) Reward-to-risk ratio D) Beta E) Risk premium

C) Reward-to-risk ratio

14) Which one of the following is a risk that applies to most securities? A) Unsystematic B) Diversifiable C) Systematic D) Asset-specific E) Industry

C) Systematic

6) Which one of the following statements is correct in relation to M&M Proposition II, without taxes? A) The cost of equity remains constant as the debt-equity ratio increases. B) The cost of equity is inversely related to the debt-equity ratio. C) The required return on assets is equal to the weighted average cost of capital. D) Financial risk determines the return on assets. E) Financial risk is unaffected by the debt-equity ratio.

C) The required return on assets is equal to the weighted average cost of capital.

5) Answer this question based on the dividend growth model. If you expect the market rate of return to increase across the board on all equity securities, then you should also expect: A) an increase in all stock values. B) all stock values to remain constant. C) a decrease in all stock values. D) dividend-paying stocks to maintain a constant price while non-dividend paying stocks decrease in value. E) dividend-paying stocks to increase in price while non-dividend paying stocks remain constant in value.

C) a decrease in all stock values.

6) A project's average net income divided by its average book value is referred to as the project's average: A) net present value. B) internal rate of return. C) accounting return. D) profitability index. E) payback period.

C) accounting return.

11) The subjective approach to project analysis: A) is used only when a firm has an all-equity capital structure. B) uses the WACC of Firm X as the basis for the discount rate for a project under consideration by Firm Y. C) assigns discount rates to projects based on the discretion of the senior managers of a firm. D) allows managers to randomly adjust the discount rate assigned to a project once the project's standard deviation has been determined. E) applies a lower discount rate to projects that are financed totally with equity as compared to those that are partially financed with debt.

C) assigns discount rates to projects based on the discretion of the senior managers of a firm.

5) Textile Mills borrows money at a rate of 8.7 percent. This interest rate is referred to as the: A) compound rate. B) current yield. C) cost of debt. D) capital gains yield. E) cost of capital.

C) cost of debt.

14) The explicit costs, such as legal and administrative expenses, associated with corporate default are classified as ___ costs. A) flotation B) issue C) direct bankruptcy D) indirect bankruptcy E) unlevered

C) direct bankruptcy

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

C) eliminate asset-specific risk.

3) Assume Russo's has a debt-equity ratio of .4 and uses the capital asset pricing model (CAPM) to determine its cost of equity. As a result, the company's cost of equity: A) is affected by the firm's rate of growth projections. B) implies that the firm pays out all of its earnings to its shareholders. C) is dependent upon a reliable estimate of the market risk premium. D) would be unaffected if the dividend discount model were applied instead. E) will be unaffected by changes in overall market risks.

C) is dependent upon a reliable estimate of the market risk premium.

24) A preferred stock sells for $63.60 a share and provides a return of 8.40 percent. What is the amount of the dividend per share? A) $5.45 B) $5.25 C)$5.34 D) $5.43 E) $5.28

C)$5.34

27) The June Bug has a $565,000 bond issue outstanding. These bonds have a coupon rate of 6.65 percent, pay interest semiannually, and sell at 98.7 percent of face value. The tax rate is 21 percent. What is the amount of the annual interest tax shield? A) $7,573 B) $6,907 C) $8,333 D) $7,890 E) $8,250

D) $7,890

35) What is the beta of the following portfolio? (see chart on study guide) Amount Invested Stock A = $14,200 Stock B = $23,900 Stock C = $8,400 Security Beta A = 1.39 B = .98 C = 1.52 A) 1.12 B) 1.01 C) 1.05 D) 1.20 E) 1.23

D) 1.20

22) Grill Works has 6 percent preferred stock outstanding that is currently selling for $49 a share. The market rate of return is 14 percent and the tax rate is 21 percent. What is the cost of preferred stock if its stated value is $100 per share? A) 12.77 percent B) 12.29 percent C) 12.67 percent D) 12.24 percent E) 12.54 percent

D) 12.24 percent

22) Total risk is measured by and systematic risk is measured by A) beta; alpha B) beta; standard deviation C) alpha ; beta D) standard deviation; beta E) standard deviation; variance

D) standard deviation; beta

2) The value of a firm is maximized when the: A) cost of equity is maximized. B) tax rate equals the cost of capital. C) levered cost of capital is maximized. D) weighted average cost of capital is minimized. E) debt-equity ratio is minimized.

D) weighted average cost of capital is minimized.

29) D. L. Tuckers has $57,000 of debt outstanding that is selling at par and has a coupon rate of 7.15 percent. The tax rate is 21 percent. What is the present value of the tax shield? A) $11,647 B) $12,791 C) $13,106 D) $12,200 E) $11,970

E) $11,970

24) Winter's Toyland has a debt-equity ratio of .57. The pretax cost of debt is 8.2 percent and the required return on assets is 14.7 percent. What is the company's cost of equity if you ignore taxes? A) 14.70 percent B) 19.74 percent C) 15.29 percent D) 17.46 percent E) 18.41 percent

E) 18.41 percent

40) The expected return on JK stock is 16.28 percent while the expected return on the market is 11.97 percent. The stock's beta is 1.63. What is the risk-free rate of return? A) 2.22 percent B) 4.31 percent C) 2.42 percent D) 4.50 percent E) 5.13 percent

E) 5.13 percent

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

E) A decrease in the portfolio standard deviation

11) An agent who maintains an inventory from which he or she buys and sells securities is called a: A) broker. B) trader. C) capitalist. D) principal. E) dealer.

E) dealer.

3) The optimal capital structure has been achieved when the: A) debt-equity ratio is equal to 1. B) weight of equity is equal to the weight of debt. C) cost of equity is maximized given a pretax cost of debt. D) debt-equity ratio is such that the cost of debt exceeds the cost of equity. E) debt-equity ratio results in the lowest possible weighted average cost of capital.

E) debt-equity ratio results in the lowest possible weighted average cost of capital.

15) The Green Fiddle is considering a project with sales of $86,800 a year for the next four years. The profit margin is 6 percent, the project cost is $97,500, and depreciation is straight-line to a zero book value over the life of the project. The required accounting return is 10.8 percent. This project should be _____ because the AAR is ____ percent. A) rejected; 11.03 B) accepted; 10.68 C) rejected; 11.16 D) accepted; 11.03 E) rejected; 10.68

E) rejected; 10.68

4) The dividend growth model: A) assumes dividends increase at a decreasing rate. B) only values stocks at Time 0. C) cannot be used to value constant dividend stocks. D) can be used to value both dividend-paying and non-dividend-paying stocks. E) requires the growth rate to be less than the required return.

E) requires the growth rate to be less than the required return.

18) Dee's made two announcements concerning its common stock today. First, the company announced that the next annual dividend will be $1.58 a share. Secondly, all dividends after that will decrease by 1.15 percent annually. What is the value of this stock at a discount rate of 15.5 percent? A) $9.49 B) $10.10 C) $9.82 D) $10.51 E) $11.01

A) $9.49

25) Roy's Welding has a cost of equity of 14.1 percent and a pretax cost of debt of 7.7 percent. The required return on the assets is 13.2 percent. What is the debt-equity ratio based on M&M II with no taxes? A) .164 B) .217 C).408 D) .108 E) .583

A) .164

36) Your portfolio is comprised of 36 percent of Stock X, 18 percent of Stock Y, and 46 percent of Stock Z. Stock X has a beta of 1.19, Stock Y has a beta of .87, and Stock Z has a beta of 1.26. What is the beta of your portfolio? A) 1.16 B) 1.09 C) 1.13 D) 1.18 E) 1.11

A) 1.16

27) The current dividend yield on CJ's common stock is 1.89 percent. The company just paid an annual dividend of $1.56 and announced plans to pay $1.70 next year. The dividend growth rate is expected to remain constant at the current level. What is the required rate of return on this stock? A) 10.86 percent B) 15.82 percent C) 9.08 percent D) 13.39 percent E) 12.75 percent

A) 10.86 percent

27) Which one of the following is the formula that explains the relationship between the expected return on a security and the level of that security's systematic risk? A) Capital asset pricing model B) Time value of money equation C) Unsystematic risk equation D) Market performance equation E) Expected risk formula

A) Capital asset pricing model

19) Which of the following statements concerning risk are correct? I. Non-diversifiable risk is measured by beta. II. The risk premium increases as diversifiable risk increases. III. Systematic risk is another name for non-diversifiable risk. IV. Diversifiable risks are market risks you cannot avoid. A) I and III only B) II and IV only C) I and II only D) III and IV only E) I, II, and III only

A) I and III only

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

A) Reducing the number of stocks held in a portfolio

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

A) the risk-free rate.

30) Douglass & Frank has a debt-equity ratio of .61. The pretax cost of debt is 7.8 percent while the unlevered cost of capital is 12.6 percent. What is the cost of equity if the tax rate is 21 percent? A) 13.75 percent B) 14.91 percent C) 14.25 percent D) 14.33 percent E) 14.14 percent

B) 14.91 percent

25) The common stock of Dayton Repair sells for $47.92 a share. The stock is expected to pay $2.28 per share next year when the annual dividend is distributed. The company increases its dividends by 1.65 percent annually. What is the market rate of return on this stock? A) 4.84 percent B) 6.41 percent C) 9.92 percent D) 6.14 percent E) 7.28 percent

B) 6.41 percent

37) The market has an expected rate of return of 12.6 percent. The long-term government bond is expected to yield 4.8 percent and the U.S. Treasury bill is expected to yield 2.7 percent. The inflation rate is 3.2 percent. What is the market risk premium? A) 9.4percent B) 9.9 percent C) 7.8 percent D) 8.5 percent E) 9.3 percent

B) 9.9 percent

1) What is the model called that determines the market value of a stock based on its next annual dividend, the dividend growth rate, and the applicable discount rate? A) Maximal-growth model B) Constant-growth model C) Capital pricing model D) Realized-earnings model E) Realized-growth model

B) Constant-growth model

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

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

24) At a minimum, which of the following would you need to know to estimate the amount of additional reward you will receive for purchasing a risky asset instead of a risk-free asset? I. Asset's standard deviation II. Asset's beta III. Risk-free rate of return IV. Market risk premium A) I and III only B) II and IV only C) III and IV only D) I, III, and IV only E) I, II, III, and IV

B) II and IV only

1) A firm should select the capital structure that: A) produces the highest cost of capital. B) maximizes the value of the firm. C) minimizes taxes. D) is fully unlevered. E) equates the value of debt with the value of equity.

B) maximizes the value of the firm.

23) Which one of the following is most directly affected by the level of systematic risk in a security? A) Variance of the returns B) Standard deviation of the returns C) Expected rate of return D) Risk-free rate E) Market risk premium

C) Expected rate of return

14) A securities market primarily composed of dealers who buy and sell for their own inventories is referred to which type of market? A) Auction B) Private C) Over-the-counter D) Regional E) Insider

C) Over-the-counter

34) You have $21,600 to invest in a stock portfolio. Your choices are Stock X with an expected return of 14.3 percent and Stock Y with an expected return of 8.1 percent. Your goal is to create a portfolio with an expected return of 12.5 percent. All money must be invested. How much will you invest in Stock X? A) $15,800 B) $18,273 C) $14,600 D) $15,329 E) $19,208

D) $15,329

19) Yummy Bakery just paid an annual dividend of $3.40 a share and is expected to increase that amount by 2.2 percent per year. If you are planning to buy 1,000 shares of this stock next year, how much should you expect to pay per share if the market rate of return for this type of security is 14.8 percent at the time of your purchase? A) $29.89 B) $27.58 C) $29.83 D) $28.18 E) $27.20

D) $28.18

23) J&J Foods wants to issue 5.4 percent preferred stock with a stated liquidating value of $100 a share. The company has determined that stocks with similar characteristics provide a return of 8.2 percent. What should the offer price be? A) $67.26 B) $61.38 C) $64.20 D) $65.85 E) $64.60

D) $65.85

2) Which one of following is the rate at which a stock's price is expected to appreciate? A) Current yield B) Total return C) Dividend yield D) Capital gains yield E) Coupon rate

D) Capital gains yield

8) Which one of the following rights is never directly granted to all shareholders of a publicly held corporation? A) Electing the board of directors B) Receiving a distribution of company profits C) Voting either for or against a proposed merger or acquisition D) Determining the amount of the dividend to be paid per share E) Having first chance to purchase any new equity shares that may be offered

D) Determining the amount of the dividend to be paid per share

3) A decrease in which of the following will increase the current value of a stock according to the dividend growth model? A) Dividend amount B) Number of future dividends, provided the total number of dividends is less than infinite C) Dividend growth rate D) Discount rate E) Both the discount rate and the dividend growth rate

D) Discount rate

25) Which one of the following is a positively sloped linear function that is created when expected returns are graphed against security betas? A) Reward-to-risk matrix B) Portfolio weight graph C) Normal distribution D) Security market line E) Market real returns

D) Security market line

7) Which one of the following represents the capital gains yield as used in the dividend growth model? A) D1 B) DI PO C) Po D) g E) g/Po

D) g

6) Supernormal growth is a growth rate that: A) is both positive and follows a year or more of negative growth. B) exceeds a firm's previous year's rate of growth. C) is generally constant for an infinite period of time. D) is unsustainable over the long term. E) applies to a single, abnormal year.

D) is unsustainable over the long term.

39) The common stock of Jensen Shipping has an expected return of 15.4 percent. The return on the market is 11.2 percent, the inflation rate is 3.1 percent, and the risk-free rate of return is 3.6 percent. What is the beta of this stock? A) 1.46 B) 1.23 C) 1.33 D) 1.41 E) 1.55

E) 1.55

17) Home Products common stock sells for $36.84 a share and has a market rate of return of 15.8 percent. The company just paid an annual dividend of $1.61 per share. What is the dividend growth rate? A) 11.43 percent B) 11.06 percent C) 10.87 percent D) 11.18 percent E) 10.95 percent

E) 10.95 percent

26) Southern Markets recently paid an annual dividend of $2.62 on its common stock. This dividend increases at an average rate of 3.8 percent per year. The stock is currently selling for $28.12 a share. What is the market rate of return? A) 13.88 percent B) 14.07 percent C) 14.21 percent D) 14.37 percent E) 13.47 percent

E) 13.47 percent

10) 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? A) Dual class B) Cumulative C) Non-cumulative D) Preferred E) Common

E) Common

9) Which one of the following statements related to corporate dividends is correct? A) Dividends are nontaxable income to shareholders. B) Dividends reduce the taxable income of the corporation. C) The chief executive officer of a corporation is responsible for declaring dividends. D) The chief financial officer of a corporation determines the amount of dividend to be paid. E) Corporate shareholders may receive a tax break on a portion of their dividend income.

E) Corporate shareholders may receive a tax break on a portion of their dividend income.

26) Which one of the following is represented by the slope of the security market line? A) Reward-to-risk ratio B) Market standard deviation C) Beta coefficient D) Risk-free interest rate E) Market risk premium

E) Market risk premium

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

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

6) Which one of these will increase a company's aftertax cost of debt? A) A decrease in the company's debt-equity ratio B) A decrease in the company's tax rate C) An increase in the credit rating of the company's bonds D) An increase in the company's beta E) A decrease in the market rate of interest

B) A decrease in the company's tax rate

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

C) Expected return

7) Which one of the following statements related to the internal rate of return (IRR) is correct? A) The IRR yields the same accept and reject decisions as the net present value method given mutually exclusive projects. B) A project with an IRR equal to the required return would reduce the value of a firm if accepted. C) The IRR is equal to the required return when the net present value is equal to zero. D) Financing type projects should be accepted if the IRR exceeds the required return. E) The average accounting return is a better method of analysis than the IRR from a financial point of view.

C) The IRR is equal to the required return when the net present value is equal to zero.

5) Why is payback often used as the sole method of analyzing a proposed small project? A) Payback considers the time value of money. B) All relevant cash flows are included in the payback analysis. C) The benefits of payback analysis usually outweigh the costs of the analysis. D) Payback is the most desirable of the various financial methods of analysis. E) Payback is focused on the long-term impact of a project.

C) The benefits of payback analysis usually outweigh the costs of the analysis.

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

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

12) A project has a required return of 12.6 percent, an initial cash outflow of $42,100, and cash inflows of $16,500 in Year 1, $11,700 in Year 2, and $10,400 in Year 4. What is the net present value? A) -$11,748.69 B)-$10,933.52 C) $11,208.62 D) -$10,457.09 E) $12,006.13

A) -$11,748.69

15) Highway Express has paid annual dividends of $1.32, $1.33, $1.38, $1.40, and $1.42 over the past five years, respectively. What is the average dividend growth rate? A) 1.85 percent B) 2.16 percent C) 1.98 percent D) 2.47 percent E) 2.39 percent

A) 1.85 percent

18) Stock in Country Road Industries has a beta of 1.62. The market risk premium is 8.2 percent while T-bills are currently yielding 2.9 percent. Country Road's last paid annual dividend was $1.87 per share and dividends are expected to grow at an annual rate of 3.8 percent indefinitely. The stock sells for $25 a share. What is the estimated cost of equity using the average return of the CAPM and the dividend discount model? A) 13.87 percent B) 14.06 percent C) 14.23 percent D) 13.38 percent E) 14.50 percent

A) 13.87 percent

11) Westover Mills reduced its taxes last year by $210 by increasing its interest expense by $1,000. Which one of the following terms is used to describe this tax savings? A) Interest tax shield B) Interest credit C) Homemade leverage shield D) Current tax yield E) Tax-loss interest

A) Interest tax shield

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

A) can be effectively eliminated by portfolio diversification.

5) You have computed the break-even point between a levered and an unlevered capital structure. Ignore taxes. At the break-even level, the: A) company is earning just enough to pay for the cost of the debt. B) company's earnings before interest and taxes are equal to zero. C) earnings per share for the levered option are exactly double those of the unlevered option. D) advantages of leverage exceed the disadvantages of leverage. E) company has a debt-equity ratio of .50.

A) company is earning just enough to pay for the cost of the debt.

3) Net present value: A) is the best method of analyzing mutually exclusive projects. B) is less useful than the internal rate of return when comparing different-sized projects. C) is the easiest method of evaluation for nonfinancial managers. D) cannot be applied when comparing mutually exclusive projects. E) is very similar in its methodology to the average accounting return.

A) is the best method of analyzing mutually exclusive projects.

16) The proposition that a company borrows up to the point where the marginal benefit of the interest tax shield derived from increased debt is just equal to the marginal expense of the resulting increase in financial distress costs is called: A) the static theory of capital structure. B) M&M Proposition I, with taxes. C) M&M Proposition II, with taxes. D) the pecking-order theory. E) the open markets theorem.

A) the static theory of capital structure.

12) M&M Proposition I with tax implies that the: A) weighted average cost of capital decreases as the debt-equity ratio increases. B) value of a company is inversely related to the amount of leverage used by that company. C) value of an unlevered company equals the value of a levered company plus the value of the interest tax shield. D) cost of capital is the same regardless of the mix of debt and equity used. E) cost of equity increases as the debt-equity ratio decreases.

A) weighted average cost of capital decreases as the debt-equity ratio increases.

20) Tidewater Fishing has a current beta of 1.16. The market risk premium is 6.8 percent and the risk-free rate of return is 2.9 percent. By how much will the cost of equity increase if the company expands its operations such that the company beta rises to 1.18? A) .28 percent B) .14 percent C) .26 percent D) .12 percent E) .43 percent

B) .14 percent

27) Delta Lighting has 24,500 shares of common stock outstanding at a market price of $19 a share. This stock was originally issued at $21 per share. The firm also has a bond issue outstanding with a total face value of $250,000 which is selling for 94 percent of par. The cost of equity is 12.6 percent while the aftertax cost of debt is 5.8 percent. The firm has a beta of 1.33 and a tax rate of 23 percent. What is the weighted average cost of capital? A) 10.07 percent B) 10.32 percent C) 12.36 percent D) 11.29 percent E) 11.47 percent

B) 10.32 percent

14) It will cost $9,600 to acquire an ice cream cart that is expected to produce cash inflows of $3,600 a year for three years. After the three years, the cart is expected to be worthless. What is the payback period? A) 1.82 years B) 2.67 years C) 2.82 years D) 1.67 years E) 1.79 years

B) 2.67 years

24) Jiminy's Cricket Farm issued a 20-year, 7 percent, semiannual bond four years ago. The bond currently sells for 108 percent of its face value. What is the aftertax cost of debt if the company's combined tax rate is 23 percent? A) 4.96 percent B) 4.78 percent C) 4.15 percent D) 4.12 percent E) 3.86 percent

B) 4.78 percent

28) AZ Products has 140,000 shares of common stock outstanding at a market price of $27 a share. Next year's annual dividend is expected to be $1.43 a share and the dividend growth rate is 2 percent. The company also has 2,500 bonds outstanding with a face value of $1,000 per bond. The bonds have a pretax yield of 7.35 percent and sell at 98.2 percent of face value. The company's tax rate is 21 percent. What is the weighted average cost of capital? A) 8.41 percent B) 6.71 percent C) 7.52 percent D) 6.58 percent E) 6.59 percent

B) 6.71 percent

16) A project has cash flows of $148,400, $42,500, $87,300, and $43,200 for Years 0 to 3, respectively. The required rate of return is 11 percent. Based on the internal rate of return of ____ percent for this project, you should ____ the project A) 7.91; accept B) 8.03; reject C) 6.67; reject D) 7.91; reject E) 8.03; accept

B) 8.03; reject

4) A group of individuals got together and purchased all of the outstanding shares of common stock of DL Smith Inc. What is the return that these individuals require on this investment called? A) Dividend yield B) Cost of equity C) Capital gains yield D) Cost of capital E) Income return

B) Cost of equity

17) Which one of the following is a marketed claim against the cash flows of a company? A) Tax payment to the IRS B) Dividend payment to shareholders C) Payment of employees' wages D) Payment for warranty work on a product produced by the company E) Payment of legal claim against the company

B) Dividend payment to shareholders

10) Which one of the following states that the value of a company is unrelated to the company's capital structure? A) Homemade leverage B) M&M Proposition I, no tax C) M&M Proposition II, no tax D) Pecking-order theory E) Static theory of capital structure

B) M&M Proposition I, no tax

13) Two mutually exclusive projects have an initial cost of $47,500 each. Project A produces cash inflows of $25,300, $37,100, and $22,000 for Years 1 through 3, respectively. Project B produces cash inflows of $43,600, $19,800 and $10,400 for Years 1 through 3, respectively. The required rate of return is 14.7 percent for Project A and 14.9 percent for Project B. Which project(s) should be accepted and why? A) Project A, because it has the higher required rate of return. B) Project A, because it has the larger NPV. C) Project B, because it has the largest cash inflow in Year 1. D) Project B, because it has the higher required rate of return. E) Project B, because it has the larger NPV

B) Project A, because it has the larger NPV.

18) You are considering two independent projects. Project A has an initial cost of $125,000 and cash inflows of $46,000, $79,000, and $51,000 for Years 1 to 3, respectively. Project B costs $135,000 with expected cash inflows for Years 1 to 3 of $50,000, $30,000, and $100,000, respectively. The required return for both projects is 16 percent. Based on IRR, you should: A) accept both projects. B) accept Project A and reject Project B. C) accept Project B and reject Project A. D) reject both projects. E) accept either one of the projects, but not both.

B) accept Project A and reject Project B.

18) The optimal capital structure of a company: A) minimizes the company's tax payments. B) maximizes the value of that company's marketed claims. C) minimizes both the marketed and nonmarketed claims against that company. D) eliminates all nonmarketed claims against that company. E) equates the company's marketed and nonmarketed claims.

B) maximizes the value of that company's marketed claims.

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

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

4) The length of time a firm must wait to recoup the money it has invested in a project is called the: A) internal return period. B) payback period. C) profitability period. D) discounted cash period. E) valuation period.

B) payback period.

16) Southern Bakeries just paid its annual dividend of $.48 a share. The stock has a market price of $17.23 and a beta of .93. The return on the U.S. Treasury bill is 3.1 percent and the market risk premium is 7.6 percent. What is the cost of equity? A) 9.98 percent B) 10.04 percent C) 10.17 percent D) 10.30 percent E) 10.45 percent

C) 10.17 percent

10) 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? A) Accept both projects because both NPVs are positive B) Accept Project A because it has the shortest payback period C) Accept Project B and reject Project A based on the NPVs D) Accept Project A and reject Project B based on their AARS E) Accept Project A because it has the lower required return

C) Accept Project B and reject Project A based on the NPVs

17) A proposed project has an initial cost of $38,000 and cash inflows of $12,300, $24,200, and $16,100 for Years 1 through 3, respectively. The required rate of return is 16.8 percent. Based on IRR, should this project be accepted? Why or why not? A) No; The IRR exceeds the required return. B) No; The IRR is less than the required return. C) Yes; The IRR exceeds the required return. D) Yes; The IRR equals the required return. E) No; The IRR equals the required return.

C) Yes; The IRR exceeds the required return.

15) The costs incurred by a business in an effort to avoid bankruptcy are classified as ___ costs. A) flotation B) direct bankruptcy C) indirect bankruptcy D) financial solvency E) capital structure

C) indirect bankruptcy

8) A company's weighted average cost of capital: A) is equivalent to the aftertax cost of the outstanding liabilities. B) should be used as the required return when analyzing any new project. C) is the return investors require on the total assets of the firm. D) remains constant when the debt-equity ratio changes. E) is unaffected by changes in corporate tax rates.

C) is the return investors require on the total assets of the firm.

8) 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: A) independent. B) interdependent. C) mutually exclusive. D) economically scaled. E) operationally distinct.

C) mutually exclusive.

13) The interest tax shield is a key reason why: A) the required rate of return on assets rises when debt is added to the capital structure. B) the value of an unlevered company is equal to the value of a levered company. C) the net cost of debt is generally less than the cost of equity. D) the cost of debt is equal to the cost of equity for a levered company. E) companies prefer equity financing over debt financing.

C) the net cost of debt is generally less than the cost of equity.

26) L.A. Clothing has expected earnings before interest and taxes (EBIT) of $63,300, an unlevered cost of capital of 14.7 percent, and a combined tax rate of 23 percent. The company also has $11,000 of debt that carries a coupon rate of 7 percent. The debt is selling at par value. What is the value of this company? A) $342,579 B) $273,333 C) $284,108 D) $334,101 E) $305,476

D) $334,101

25) The Downtowner has 168,000 shares of common stock outstanding valued at $53 a share along with 13,000 bonds selling for $1,008 each. What weight should be given to the debt when the company computes its weighted average cost of capital? A) 46.67 percent B) 65.05 percent C) 51.79 percent D) 59.54percent E) 48.27 percent

D) 59.54 percent

23) Jiminy's Cricket Farm issued a 20-year, 7 percent, semiannual bond four years ago. The bond currently sells for 108 percent of its face value. What is the pretax cost of debt? A) 5.860 percent B) 7.286 percent C) 5.554 percent D) 6.204 percent E) 7.258 percent

D) 6.204 percent

13) Chelsea Fashions is expected to pay an annual dividend of $1.26 a share next year. The market price of the stock is $24.09 and the growth rate is 2.6 percent. What is the cost of equity? A) 9.77 percent B) 7.91 percent C) 9.24 percent D) 7.83 percent E) 7.54 percent

D) 7.83 percent

21) Holdup Bank has an issue of preferred stock with a stated dividend of $7 that just sold for $87 per share. What is the bank's cost of preferred? A) 7.00 percent B) 7.64 percent C) 8.39 percent D) 8.05 percent E) 7.54 percent

D) 8.05 percent

14) Sweet Treats common stock is currently priced at $36.72 a share. The company just paid $2.18 per share as its annual dividend. The dividends have been increasing by 2.2 percent annually and are expected to continue doing the same. What is the cost of equity? A) 9.41 percent B) 9.51 percent C) 8.47 percent D) 8.27 percent E) 8.82 percent

D) 8.27 percent

8) Which one of the following is the equity risk that is most related to the daily operations of a firm? A) Market risk B) Systematic risk C) Extrinsic risk. D) Business risk E) Financial risk

D) Business risk

2) Which one of the following will decrease the net present value of a project? A) Increasing the value of each of the project's discounted cash inflows B) Moving each cash inflow forward one time period, such as from Year 3 to Year 2 C) Decreasing the required discount rate D) Increasing the project's initial cost at time zero E) Increasing the amount of the final cash inflow

D) Increasing the project's initial cost at time zero

9) The final decision on which one of two mutually exclusive projects to accept ultimately depends upon which one of the following? A) Initial cost of each project B) Timing of the cash inflows C) Total cash inflows of each project D) Net present value E) Length of each project's life

D) Net present value

15) A news flash just appeared that caused about a dozen stocks to suddenly increase in value by 12 percent. What type of risk does this news flash best represent? A) Portfolio B) Non-diversifiable C) Market D) Unsystematic E) Expected

D) Unsystematic

1) A company's current cost of capital is based on: A) only the return required by the company's current shareholders. B) the current market rate of return on equity shares. C) the weighted costs of all future funding sources. D) both the returns currently required by its debtholders and stockholders. E) the company's original debt-equity ratio.

D) both the returns currently required by its debtholders and stockholders.

9) Financial risk is: A) the risk inherent in a company's operations. B) a type of unsystematic risk. C) inversely related to the cost of equity. D) dependent upon a company's capital structure. E) irrelevant to the value of a company.

D) dependent upon a company's capital structure.

4) Assume you are reviewing a graph that plots earnings per share (EPS) against earnings before interest and taxes (EBIT). The steeper the slope of the plotted line the: A) lower the impact of financial leverage. B) lower the debt-equity ratio. C) higher the tax rate. D) greater the sensitivity of EPS to changes in EBIT. E) lower the probability of a negative EPS.

D) greater the sensitivity of EPS to changes in EBIT.

7) The business risk of a company: A) depends on the company's level of unsystematic risk. B) is inversely related to the required return on the company's assets. C) is dependent upon the relative weights of the debt and equity used to finance the company. D) has a positive relationship with the company's cost of equity. E) has no relationship with the required return on a company's assets according to M&M theory.

D) has a positive relationship with the company's cost of equity.

7) The cost of preferred stock is computed the same as the: A) pretax cost of debt. B) rate of return on an annuity. C) aftertax cost of debt. D) rate of return on a perpetuity. E) cost of an irregular growth common stock.

D) rate of return on a perpetuity.

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

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

29) Travis & Sons has a capital structure that is based on 45 percent debt, 5 percent preferred stock, and 50 percent common stock. The pretax cost of debt is 8.3 percent, the cost of preferred is 9.2 percent, and the cost of common stock is 15.4 percent. The tax rate is 21 percent. A project is being considered that is equally as risky as the overall company. This project has initial costs of $287,000 and annual cash inflows of $91,000, $248,000, and $145,000 over the next three years, respectively. What is the projected net present value of this project? A) $116,667 B) $121,802 C) $99,011 D) $104,308 E) $101,488

E) $101,488

22) Lamont Corp. is debt-free and has a weighted average cost of capital of 12.7 percent. The current market value of the equity is $2.3 million and there are no taxes. According to M&M Proposition I, what will be the value of the company if it changes to a debt-equity ratio of .85? A) $18,110,236 B) $1,955,000 C) $15,393,701 D) $2,705,882 E) $2,300,000

E) $2,300,000

19) Katlin Markets is debating between a levered and an unlevered capital structure. The all-equity capital structure would consist of 60,000 shares of stock. The debt and equity option would consist of 45,000 shares of stock plus $250,000 of debt with an interest rate of 7.25 percent. What is the break-even level of earnings before interest and taxes between these two options? Ignore taxes. A) $50,500 B) $68,200 C) $81,400 D) $66,667 E) $72,500

E) $72,500

26) Florida Groves has a $380,000 bond issue outstanding that is selling at 97.4 percent of face value. The firm also has 2,600 shares of preferred stock valued at $61 a share and 37,500 shares of common stock valued at $19 a share. What weight should be assigned to the common stock when computing the weighted average cost of capital? A) 55.75 percent B) 62.20 percent C) 58.75 percent D) 61.03 percent E) 57.40 percent

E) 57.40 percent

19) National Home Rentals has a beta of 1.06, a stock price of $17, and recently paid an annual dividend of $.92 a share. The dividend growth rate is 2.2 percent. The market has a rate of return of 11.2 percent and a risk premium of 7.3 percent. What is the estimated cost of equity using the average return of the CAPM and the dividend discount model? A) 10.05 percent B) 8.67 percent C) 9.13 percent D) 10.30 percent E) 9.68 percent

E) 9.68 percent

2) All else constant, which one of the following will increase a company's cost of equity if the company computes that cost using the security market line approach? Assume the firm currently pays an annual dividend of $1 a share and has a beta of 1.2. A) A reduction in the dividend amount B) An increase in the dividend amount C) A reduction in the market rate of return D) A reduction in the firm's beta E) A reduction in the risk-free rate

E) A reduction in the risk-free rate

6) The expected return on a portfolio considers which of the following factors? I. Percentage of the portfolio invested in each individual security II. Projected states of the economy III. The performance of each security given various economic states IV. Probability of occurrence for each state of the economy A) I and III only B) II and IV only C) I, III, and IV only D) II, III, and IV only E) I, II, III, and IV

E) I, II, III, and IV

21) You estimate that a project will cost $33,700 and will provide cash inflows of $14,800 in Year 1 and $24,600 in Year 3. Based on the profitability index rule, should the project be accepted if the discount rate is 14.2 percent? Why or why not? A) Yes; The PI is .87. B) Yes; The PI is .93. C) Yes; The PI is 1.06. D) No; The PI is 1.06. E) No; The PI is .87.

E) No; The PI is .87.

1) A project has a net present value of zero. Which one of the following best describes this project? A) The project has a zero percent rate of return. B) The project requires no initial cash investment. C) The project has no cash flows. D) The summation of all of the project's cash flows is zero. E) The project's cash inflows equal its cash outflows in current dollar terms.

E) The project's cash inflows equal its cash outflows in current dollar terms.

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

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

19) An investment costs $152,000 and has projected cash inflows of $71,800, $86,900, and -$11,200 for Years 1 to 3, respectively. If the required rate of return is 15.5 percent, should you accept the investment based solely on the internal rate of return rule? Why or why not? A) Yes; The IRR exceeds the required return. B) Yes; The IRR is less than the required return. C) No; The IRR is less than the required return. D) No; The IRR exceeds the required return E) You should not apply the IRR rule in this case.

E) You should not apply the IRR rule in this case.

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

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

9) The average of a company's cost of equity, cost of preferred, and aftertax cost of debt that is weighted based on the company's capital structure is called the: A) reward-to-risk ratio. B) weighted capital gains rate. C) structured cost of capital. D) subjective cost of capital. E) weighted average cost of capital.

E) weighted average cost of capital.