1.       Market risk is the chance that a totally unexpected event will have a significant effect on the value of the firm or a specific investment. Answer: FALSE

 

2.       Purchasing-power risk is the chance that changes in interest rates will adversely affect the value of an investment; most investments decline in value when the interest rates rise and increase in value when interest rates fall. Answer: FALSE

 

3.       If a person's required return does not change when risk increases, that person is said to be

A) risk-seeking.

B) risk-indifferent.

C) risk-averse.

D) risk-aware.

 

4.       If a person's required return decreases for an increase in risk, that person is said to be

A) risk-seeking.

B) risk-indifferent.

C) risk-averse.

D) risk-aware.

 

5.       ________ is the chance of loss or the variability of returns associated with a given asset.

A) Return

B) Value

C) Risk

D) Probability

 

6.       The ________ of an asset is the change in value plus any cash distributions expressed as a percentage of the initial price or amount invested

A) return

B) value

C) risk

D) probability

 

7.       Risk aversion is the behavior exhibited by managers who require a (n) ________.

A)increase in return, for a given decrease in risk

B) increase in return, for a given increase in risk

C) decrease in return, for a given increase in risk

D) decrease in return, for a given decrease in risk

 

8.       Perry purchased 100 shares of Ferro, Inc. common stock for $25 per share one year ago. During the year, Ferro, Inc. paid cash dividends of $2 per share. The stock is currently selling for $30 per share. If Perry sells all of his shares of Ferro, Inc. today, what rate of return would he realize?

Answer: Realized return = = 28%


9.       Tim purchased a bounce house one year ago for $6,500. During the year it generated $4,000 in cash flow. If Time sells the bounce house today, he could receive $6,100 for it. What would be his rate of return under these conditions?

 

Answer: Realized return = = 55%

 

10.    On average, during the past 75 years, the return on small-company stocks has exceeded the return on large-company stocks. Answer: TRUE

 

11.    On average, during the past 75 years, the return on long-term government bonds has exceeded the return on long-term corporate bonds. Answer: FALSE

 

12.    On average, during the past 75 years, the return on long-term corporate bonds has exceeded the return on long-term government bonds. Answer: TRUE

 

13.    Which asset would the risk-averse financial manager prefer? (See below.)

 

 

A) Asset A.

B) Asset B.

C) Asset C.

D) Asset D.

 

14.    The expected value and the standard deviation of returns for asset A is (See below.)

 

Asset A

 

A) 12 percent and 4 percent.

B) 12.7 percent and 2.3 percent.

C) 12.7 percent and 4 percent.

D) 12 percent and 2.3 percent.

 

15.    Nico bought 100 shares of Cisco Systems stock for $24.00 per share on January 1, 2002. He received a dividend of $2.00 per share at the end of 2002 and $3.00 per share at the end of 2003. At the end of 2004, Nico collected a dividend of $4.00 per share and sold his stock for $18.00 per share. What was Nico's realized holding period return? What was Nico's compound annual rate of return?

A) -12.5%; -4.4%

B) +12.5%; +4.4%

C) -16.7%; -4.4%

D) +16.7%; +4.4%

 

 

16.    Given the following information about the two assets A and B, determine which asset is preferred.

 

 

Answer: Asset A is preferred because it has a lower range for the same expected return.

 

17.    Assuming the following returns and corresponding probabilities for asset A, compute its standard deviation and coefficient of variation.

 

Answer:

 

SD = 3.87%

CV = SD/K = 3.87/15 = 0.26

 

18.    Akai has a portfolio of three assets. Find the expected rate of return for the portfolio assuming he invests 50 percent of its money in asset A with 10 percent rate of return, 30 percent in asset B with a rate of return of 20 percent, and the rest in asset C with 30 percent rate of return.

 

 





19.    The creation of a portfolio by combining two assets having perfectly positively correlated returns cannot reduce the portfolio's overall risk below the risk of the least risky asset. On the other hand, a portfolio combining two assets with less than perfectly positive correlation can reduce total risk to a level below that of either of the components. Answer: TRUE

 

20.    The risk of a portfolio containing international stocks generally contains less nondiversifiable risk than one that contains only American stocks. Answer: TRUE

 

21.    The risk of a portfolio containing international stocks generally does not contain less nondiversifiable risk than one that contains only American stocks. Answer: FALSE

 

22.    Diversified investors should be concerned solely with nondiversifiable risk because it can create a portfolio of assets that will eliminate all, or virtually all, diversifiable risk. Answer: TRUE

 

23.    Nondiversifiable risk reflects the contribution of an asset to the risk, or standard deviation, of the portfolio. Answer: TRUE

 

24.    Systematic risk is that portion of an asset's risk that is attributable to firm-specific, random causes.

Answer: FALSE

 

25.    Unsystematic risk can be eliminated through diversification. Answer: TRUE

 

26.    Unsystematic risk is the relevant portion of an asset's risk attributable to market factors that affect all firms. Answer: FALSE

 

27.    The required return on an asset is an increasing function of its nondiversifiable risk. Answer: TRUE

 

28.    The empirical measurement of beta can be approached by using least-squares regression analysis to find the regression coefficient (bj) in the equation for the slope of the "characteristic line." Answer: TRUE

 

29.    Nico owns 100 shares of stock X which has a price of $12 per share and 200 shares of stock Y which has a price of $3 per share. What is the proportion of Nico's portfolio invested in stock X?

A) 77%

B) 67%

C) 50%

D) 33%

 

30.    Nico wants to invest all of his money in just two assets: the risk free asset and the market portfolio. What is Nico's portfolio beta if he invests a quarter of his money in the market portfolio and the rest in the risk free asset?

A) 0.00

B) 0.25

C) 0.75

D) 1.00

 

31.    What is the expected market return if the expected return on asset X is 20 percent, its beta is 1.5, and the risk free rate is 5 percent?

A) 5.0%

B) 7.5%

C) 15.0%

D) 22.5%

 

32.    The term structure of interest rates is the graphical presentation of the relationship between the annual rate of interest earned on a security purchased on a given day and held to maturity and the remaining time to maturity. Answer: FALSE

 

33.    An inverted yield curve is a downward-sloping yield curve that indicates generally cheaper long-term borrowing costs than short-term borrowing costs. Answer: TRUE

 

34.    A yield curve that reflects relatively similar borrowing costs for both short- and long-term loans is called a normal yield curve. Answer: FALSE

 

35.    Upward-sloping yield curves result from higher future inflation expectations, lender preferences for shorter maturity loans, and greater supply of short-term as opposed to long-term loans relative to their respective demand. Answer: TRUE

 

36.    The risk free rate of interest is equal to the sum of the real rate of interest plus an inflation risk premium. Answer: TRUE

 

37.    An inverted yield curve is upward-sloping and indicates generally cheaper long-term borrowing costs than short-term borrowing costs. Answer: FALSE

 

38.    A yield curve that reflects relatively similar borrowing costs for both short-term and long-term loans is called

A) normal yield curve.

B) inverted yield curve.

C) flat yield curve.

D) none of the above.

 

39.    The theory suggesting that for any given issuer, long-term interest rates tends to be higher than short-term rates is called

A) expectation hypothesis.

B) liquidity preference theory.

C) market segmentation theory.

D) none of the above.

 

40.    The yield curve in an economic period where higher future inflation is expected would most likely be

A) upward-sloping.

B) flat.

C) downward-sloping.

D) linear.

 

41.    The yield curve in an economic period where lower future inflation is expected would most likely be

A) upward-sloping.

B) flat.

C) downward-sloping.

D) linear.

 

42.    In a bond indenture, the term security interest refers to the fact that most firms that issue bonds are required to establish sinking fund provisions to protect bondholders. Answer: FALSE

 

43.    In a bond indenture, the term security interest refers to collateral pledged against the bond. Answer: TRUE

 

44.    The length of the maturity on a bond offering affects its cost. In general, the longer the maturity, the higher the cost. Answer: TRUE

 

45.    The length of the maturity on a bond offering affects its cost. In general, the longer the maturity, the lower the cost. Answer: FALSE

 

46.    All of the following are examples of long-term debt EXCEPT

A) bonds.

B) lines of credit.

C) term loans.

D) debentures.

 

47.    The legal contract setting forth the terms and provisions of a corporate bond is a(n)

A) indenture.

B) debenture.

C) loan document.

D) promissory note.

 

48.    ________ is a stipulation in a long-term debt agreement that subsequent or less important creditors agree to wait until all claims of the ________ are satisfied before having their claims satisfied.

A) Subordination; common stockholders

B) Subordination; senior debt

C) The combination restriction; senior debt

D) The senior debt; common stockholders

 

49.    Violation of any standard or restrictive provision by the borrower gives the lender the right to do all of the following EXCEPT

A) alter the terms of the initial agreement, for example accelerate the maturity date.

B) demand immediate repayment.

C) increase the interest rate.

D) seize the loan collateral.

 

50.    To compensate for the uncertainty of future interest rates and the fact that the longer the term of a loan the higher the probability that the borrower will default, the lender typically

A) charges a higher interest rate on long-term loans.

B) reserves the right to change the terms of the loan at any time.

C) includes excessively restrictive debt provisions.

D) reserves the right to demand immediate payment at any time.

 

51.    The size of the loan and its issuance costs (as a percentage of the amount borrowed) are

A) not related.

B) inversely related.

C) independent.

D) correlated.

 

52.    A call feature is a feature included in all corporate bonds and allows the issuer to repurchase bonds at the market price prior to maturity. Answer: FALSE

 

53.    There is an inverse relationship between the quality or rating of a bond and the rate of return it must provide bondholders. Answer: TRUE

 

54.    In a bond indenture, subordination is the stipulation that subsequent creditors agree to wait until all claims of the senior debt are satisfied. Answer: TRUE

 

55.    Bondholders will convert their convertible bonds into shares of stock only when the conversion price is greater than the market price of the stock. Answer: FALSE

 

56.    To sell a callable bond, the issuer must pay a higher interest rate than on an otherwise equivalent noncallable bond. Answer: TRUE

 

57.    The conversion feature of a bond is a feature that is included in all corporate bond issues that gives the issuer the opportunity to repurchase bonds at a stated price prior to maturity. Answer: FALSE

 

58.    A call feature in a bond allows the issuer the opportunity to repurchase bonds at a stated price prior to maturity. This option has a greater chance of being exercised (to the detriment of the bondholder) if market interest rates have risen since the bond was issued. Answer: FALSE

 

59.    In general, IBM bonds will experience greater trading activity (in terms of the number of bonds traded on a given day) compared to IBM stock. Answer: FALSE

 

60.    In general, IBM bonds will experience less trading activity (in terms of the number of bonds traded on a given day) compared to IBM stock. Answer: TRUE

 

61.    Any bond rated according to Moody's Caa through Aaa would be considered investment grade debt. Answer: FALSE

 

62.    Any bond rated according to Moody's Ba or lower would be considered speculative or "junk." Answer: TRUE

 

63.    A feature that gives the issuer the opportunity to repurchase bonds at a stated price prior to maturity is called

A) stock purchase warrants.

B) call feature.

C) conversion feature.

D) none of the above.

 

64.    An instrument that give their holders the right to purchase a certain number of shares of the firm's common stock at a specified price over a certain period of time is called

A) stock purchase warrants.

B) call feature.

C) conversion feature.

D) none of the above.

 

65.    The riskiness of publicly traded bond issues is rated by independent agencies. According to Moody's rating system, an Aaa bond and a Caa bond are ________ and ________, respectively.

A) speculative; investment grade

B) prime quality; medium grade

C) prime quality; speculative

D) medium grade; lowest grade

 

66.    A putable bond gives the bondholder

A) the right to sell the bond back to the corporation at the original purchase price.

B) the right to sell the bond back to the corporation at a stated premium.

C) the right to sell the bond back to the corporation at the current market value.

D) the right to sell the bond back to the corporation at par.

 

67.    A record collector has agreed to sell her entire collection to a historical museum in three years at a price of $100,000. The current risk-free rate is 7 percent. At what price should she value her collection today?

Answer: $100,000(0.816) = $81,600

 

68.    A corporate financial analyst must calculate the value of an asset which produces year-end annual cash flows of $0 the first year, $2,000 the second year, $3,000 the third year, and $2,500 the fourth year. Assuming a discount rate of 15 percent, what is the value of this asset?

Answer: Using PVIF(15,n):

= $0(0.870) + $2,000(0.756) + $3,000(0.658) + $2,500(0.572)

= $0 + $1,512 + $1,974 + $1,430 = $4,916

 

69.    What is the value of an asset which pays $200 a year for the next 5 years and can be sold for $1,500 at the end of five years from now? Assume that the opportunity cost is 10 percent.

Answer: P = 200(PVIFA) + 1,500(PVIF)

= 200(3.791) + 1,500(0.621) = $1,689.70

 

70.    When the required return is constant but different from the coupon rate, the price of a bond as it approaches its maturity date will

A) remain constant.

B) increase.

C) decrease.

D) approach par.

 

71.    If the required return is greater than the coupon rate, a bond will sell at

A) par.

B) a discount.

C) a premium.

D) book value.

 

72.    The ABC company has two bonds outstanding that are the same except for the maturity date. Bond D matures in 4 years, while Bond E matures in 7 years. If the required return changes by 15 percent

A) Bond D will have a greater change in price.

B) Bond E will have a greater change in price.

C) the price of the bonds will be constant.

D) the price change for the bonds will be equal.

 

73.    A firm has an issue of $1,000 par value bonds with a 12 percent stated interest rate outstanding. The issue pays interest annually and has 10 years remaining to its maturity date. If bonds of similar risk are currently earning 8 percent, the firm's bond will sell for ________ today.

A) $1,000

B) $805.20

C) $851.50

D) $1,268.20

 

74.    On January 1, 2002, Zheng Corporation will issue new bonds to finance its expansion plans. In its efforts to price the issue, Zheng Corporation has identified a company of similar risk with an outstanding bond issue that has an 8 percent coupon rate that is due January 1, 2017. This firm's bonds currently are selling for $1,091.96. If interest is paid semiannually for both bonds, what must the coupon rate of the new bonds be in order for the issue to sell at par?

A) 5.75%

B) 6.00%

C) 6.50%

D) 7.00%

 

75.    To expand its business, the Kingston Outlet factory would like to issue a bond with par value of $1,000, coupon rate of 10 percent, and maturity of 10 years from now. What is the value of the bond if the required rate of return is 1) 8 percent, 2) 10 percent, and 3) 12 percent?

Answer: Coupon payment = 1,000 0.10 = $100

1) B = 100(PVIFA8%,10) + 1,000(PVIF8%,10)

= 100(6.710) + 1,000(0.463) = $1,134.00

2) B = $1,000 since coupon rate and required rate of return are equal.

3) B = 100(PVIFA12%,10) + 1,000(PVIF12%,10)

= 100(5.650) + 1,000(0.322) = $887

 

76.    To finance a new line of product, the Tangshan Toys has issued $1,000,000 bond with a par value of $1,000, coupon rate of 8 percent, and maturity of 30 years. Compute the price of the bond if the opportunity cost is 11 percent.

Answer: Coupon payment = 1,000 0.08 = $80

B = 80(PVIFA11%,30) + 1,000(PVIF11%,30)

= 80(8.694) + 1,000(0.044) = $739.52

 

77.    The yield to maturity on a bond with a price equal to its par value will

A) be less than the coupon rate.

B) be more than the coupon rate.

C) always be equal to the coupon rate.

D) be more or less than the coupon rate depending on the required return.

 

78.    What is the approximate yield to maturity for a $1,000 par value bond selling for $1,120 that matures in 6 years and pays 12 percent interest annually?

A) 8.5 percent

B) 9.4 percent

C) 12.0 percent

D) 13.2 percent

 

79.    Tangshan Industries has issued a bond which has a $1,000 par value and a 15 percent annual coupon interest rate. The bond will mature in ten years and currently sells for $1,250. Using this information, the yield to maturity on the Tangshan Industries bond is ________.

A) 10.79 percent

B) 11.39 percent

C) 12.19 percent

D) 13.29 percent

 

80.    What is the yield to maturity, to the nearest percent, for the following bond: current price is $908, coupon rate is 11 percent, $1,000 par value, interest paid annually, eight years to maturity?

A) 11 percent

B) 12 percent

C) 13 percent

D) 14 percent

 

81.    Danno is trying to decide which of two bonds to buy. Bond H is a 10 percent coupon, 10-year maturity, $1,000 par, January 1, 2000 issue paying annual interest. Bond F is a 10 percent coupon, 10-year maturity, $1,000 par, January 1, 2000 issue paying semiannual interest. The market required return for each bond is 10 percent. When using present value to determine the prices of the bonds, Danno will find that

A) there is no difference in price.

B) the price of F is greater than H.

C) the price of H is greater than F.

D) he needs more information before determining the prices.

 

82.    Equity capital can be raised through

A) the money market.

B) the NYSE bond market.

C) retained earnings and the stock market.

D) a private placement with an insurance company as the creditor.

 

83.    Holders of equity capital

A) own the firm.

B) receive interest payments.

C) receive guaranteed income.

D) have loaned money to the firm.

 

84.    As a form of financing, equity capital

A) has a maturity date.

B) is only liquidated in bankruptcy.

C) is temporary.

D) has priority over bonds.

 

85.    If bankruptcy were to occur, stockholders would have prior claim on assets over

A) preferred stockholders.

B) secured creditors.

C) unsecured creditors.

D) no one.

 

86.    Which of the following terms typically applies to common stock but not to preferred stock?

A) Par value.

B) Dividend yield.

C) Legally considered as equity in the firm.

D) Voting rights.

 

87.    Preferred stock has characteristics of debt since it provides a fixed periodic cash payment. Answer: TRUE

 

88.    The amount of the claim of preferred stockholders in liquidation is normally equal to the market value of the preferred stock. Answer: FALSE

 

89.    Cumulative preferred stocks are preferred stocks for which all passed (unpaid) dividends in arrears must be paid along with the current dividend prior to the payment of dividends to common stockholders. Answer: TRUE

 

90.    Because preferred stock is a form of ownership and has no maturity date, its claims on income and assets are secondary to those of the firm's creditors. Answer: TRUE

 

91.    One advantage of preferred stock is its ability to increase leverage, which in turn will magnify the effects of increased earnings on common stockholders' returns. Answer: TRUE

 

92.    Supervoting shares of common stock provide shareholders with ten times the voting power of ordinary shares of common stock. Answer: FALSE

 

93.    Under the Jobs and Growth Tax Relief Reconciliation Act of 2003, dividends are subject to a maximum tax rate of 20 percent. Answer: FALSE

 

94.    Under the Jobs and Growth Tax Relief Reconciliation Act of 2003, dividends are subject to a maximum tax rate of 15 percent. Answer: TRUE

 

95.    ________ are promised a fixed periodic dividend that must be paid prior to paying any common stock dividends.

A) Preferred stockholders

B) Common stockholders

C) Bondholders

D) Creditors

 

96.    Dividends in arrears that must be paid to the preferred stockholders before payment of dividends to common stockholders are

A) cumulative.

B) noncumulative.

C) participating.

D) convertible.

 

97.    A firm has issued cumulative preferred stock with a $100 par value and a 12 percent annual dividend. For the past two years, the board of directors has decided not to pay a dividend. The preferred stockholders must be paid ________ prior to paying the common stockholders.

A) $ 0/share

B) $12/share

C) $24/share

D) $36/share

 

98.    A firm has an outstanding issue of 1,000 shares of preferred stock with a $100 par value and an 8 percent annual dividend. The firm also has 5,000 shares of common stock outstanding. If the stock is cumulative and the board of directors has passed the preferred dividend for the prior two years, how much must the preferred stockholders be paid prior to paying dividends to common stockholders?

A) $ 8,000

B) $16,000

C) $24,000

D) $25,000

 

99.    An ADR is

A) a claim issued by a U.S. bank representing ownership of shares of a foreign company's stock held on deposit by the U.S. bank and is issued in dollars to U.S. investors.

B) a claim issued by a foreign bank representing ownership of shares of a foreign company's stock held on deposit by the foreign bank and is issued in dollars to U.S. investors.

C) a claim issued by a U.S. bank representing ownership of shares of a U.S. company's stock held on deposit by the U.S. bank and is issued in dollars to U.S. investors.

D) none of the above.

 

100.                        Preferred stockholders

A) do not have preference over common stockholders in the case of liquidation.

B) do have preference over bondholders in the case of liquidation.

C) do not have preference over bondholders in the case of liquidation.

D) Two of the above are true statements.

 

101.                        The free cash flow valuation model can be used to determines the value of an entire company as the present value of its expected free cash flows discounted at the firm's weighted average cost of capital. Answer: TRUE

 

102.                        A common stockholder has no guarantee of receiving any cash inflows, but receives what is left after all other claims on the firm's income and assets have been satisfied. Answer: TRUE

 

103.                        Preferred stock that provides for dividend payments based on certain formulas allowing preferred stockholders to participate with common stockholders in the receipt of dividends beyond a specified amount is called cumulative preferred stock. Answer: FALSE

 

104.                        Preemptive rights allow existing shareholders to maintain voting control and protect against the dilution of their ownership. Answer: TRUE

 

105.                        American Depositary Receipts (ADRs) are claims issued by U.S. banks representing ownership of shares of a foreign company's stock held on deposit by the U.S. bank in the foreign market and issued in dollars to U.S. investors. Answer: TRUE

 

106.                        Treasury stock generally does not have voting rights, does not earn dividends, and does not have a claim on assets in liquidation. Answer: TRUE

 

107.                        The ________ are sometimes referred to as the residual owners of the corporation.

A) preferred stockholders

B) unsecured creditors

C) common stockholders

D) secured creditors

 

108.                        Treasury stock results from the

A) firm selling stock for greater than its par value.

B) cumulative feature on preferred stock.

C) repurchase of outstanding stock.

D) authorization of additional shares of stock by the board of directors.

 

109.                        The purpose of nonvoting common stock is to

A) limit the voting power of the management.

B) allow the minority interest to elect one director.

C) raise capital without giving up any voting rights.

D) give preference on distribution of earnings to those shareholders who own the stock.

 

110.                        A proxy statement gives the shareholder the right

A) of one vote for each share owned.

B) to give up their vote to another party.

C) to maintain their proportionate ownership in the corporation when new common stock is issued.

D) to sell their share of stock at a premium.

 

111.                        A firm issued 5,000 shares of $1 par-value common stock, receiving proceeds of $20 per share. The accounting entry for the paid-in capital in excess of par account is

A) $5,000.

B) $ 95,000.

C) $100,000.

D) $0.

 

112.                        A firm issued 10,000 shares of $2 par-value common stock, receiving proceeds of $40 per share. The accounting entry for the paid-in capital in excess of par account is

A) $200,000.

B) $380,000.

C) $400,000.

D) $800,000.

 

113.                        A firm has the balance sheet accounts, common stock, and paid-in capital in excess of par, with values of $10,000 and $250,000, respectively. The firm has 10,000 common shares outstanding. If the firm had a par value of $1, the stock originally sold for

A) $24/share.

B) $25/share.

C) $26/share.

D) $30/share.

 

114.                        A firm has the balance sheet accounts, common stock, and paid-in capital in excess of par, with values of $40,000 and $500,000, respectively. The firm has 40,000 common shares outstanding. If the firm had a par value of $1, the stock originally sold for

A) $11.50/share.

B) $12.50/share.

C) $13.50/share.

D) $15.50/share.

 

Table 7.1

 

115.                        According to Table 7.1, Ford's common stock must have closed at ________ per share on the previous trading day.

A) $29.64

B) $30.76

C) $30.99

D) $31.55

 

116.                        According to Table 7.1, the expected dividend per share for Ford is

A) $0.25.

B)$1.00.

C) $2.00.

D) $3.30.

 

117.                        Referring to Table 7.1, if we assume that Ford's dividends will grow at a rate of 10 percent forever, the required return on Ford's stock would be

A) 7.4%.

B) 8.9%.

C) 11.0%.

D) 13.6%

 

118.                        Based on Table 7.1, Ford's earnings per share are

A) $0.80.

B) $1.21.

C) $1.68.

D) $1.91.

 

119.                        Based on the information given in Table 7.1, the number of shares of Ford that were traded on the previous day was

A) 2,092.

B) 20,925.

C) 209,250.

D) 2,092,500.

 

120.                        In an efficient market, the expected return and the required return are equal. Answer: TRUE

 

121.                        To a buyer, an asset's value represents the minimum price that he or she would pay to acquire it. Answer: FALSE

 

122.                        If the expected return is less than the required return, investors will sell the asset, because it is not expected to earn a return commensurate with its risk. Answer: TRUE

 

123.                        If the expected return were above the required return, investors would buy the asset, driving its price up and its expected return down. Answer: TRUE

 

124.                        Efficient market hypothesis is the theory describing the behavior of an assumed "perfect" market in which securities are typically in equilibrium, security prices fully reflect all public information available and react swiftly to new information, and, because stocks are fairly priced, investors need not waste time looking for mispriced securities. Answer: TRUE

 

125.                        In an efficient market, stock prices adjust quickly to new public information. Answer: TRUE

 

126.                        In an inefficient market, stock prices adjust quickly to new public information. Answer: FALSE

 

127.                        In an inefficient market, securities are typically in equilibrium, which means that they are fairly priced and that their expected returns equal their required returns. Answer: FALSE

 

128.                        A firm has an expected dividend next year of $1.20 per share, a zero growth rate of dividends, and a required return of 10 percent. The value of a share of the firm's common stock is ________.

A) $120

B) $10

C) $12

D) $100

 

129.                        A firm has an issue of preferred stock outstanding that has a par value of $100 and a 4% dividend. If the current market price of the preferred stock is $50, the yield on the preferred stock is ________.

A) 4.00%

B) 6.00%

C) 8.00%

D) none of the above

 

130.                        The ________ is utilized to value preferred stock.

A) constant growth model

B) variable growth model

C) zero-growth model

D) Gordon model

 

131.                        In the Gordon model, the value of the common stock is the

A) net value of all assets which are liquidated for their exact accounting value.

B) actual amount each common stockholder would expect to receive if the firm's assets are sold, creditors and preferred stockholders are repaid, and any remaining money is divided among the common stockholders.

C) present value of a non-growing dividend stream.

D) present value of a constant, growing dividend stream.

 

132.                        Emmy Lou, Inc. has an expected dividend next year of $5.60 per share, a growth rate of dividends of 10 percent, and a required return of 20 percent. The value of a share of Emmy Lou, Inc.'s common stock is ________.

A) $28.00

B) $56.00

C) $22.40

D) $18.67

 

133.                        A firm has experienced a constant annual rate of dividend growth of 9 percent on its common stock and expects the dividend per share in the coming year to be $2.70. The firm can earn 12 percent on similar risk involvements. The value of the firm's common stock is ________.

A) $22.50/share

B) $9/share

C) $90/share

D) $30/share

 

134.                        A common stock currently has a beta of 1.3, the risk-free rate is an annual rate of 6 percent, and the market return is an annual rate of 12 percent. The stock is expected to generate a constant dividend of $5.20 per share. A toxic spill results in a lawsuit and potential fines, and the beta of the stock jumps to 1.6. The new equilibrium price of the stock

A) will be $37.68.

B) will be $43.33.

C) will be $33.33.

D) cannot be determined from the information given.

 

135.                        Nico Corporation's common stock currently sells for $180 per share. Nico just paid a dividend of $10.18 and dividends are expected to grow at a constant rate of 6 percent forever. If the required rate of return is 12 percent, what will Nico Corporation's stock sell for one year from now?

A) $190.80

B) $187.04

C) $195.40

D) $179.84

 

136.                        Tangshan China Company's stock is currently selling for $80.00 per share. The expected dividend one year from now is $4.00 and the required return is 13 percent. What is Tangshan's dividend growth rate assuming that dividends are expected to grow at a constant rate forever?

A) 8%

B) 9%

C) 10%

D) 11%

 

137.                        Tangshan China's stock is currently selling for $160.00 per share and the firm's dividends are expected to grow at 5 percent indefinitely. Assuming Tangshan China's most recent dividend was $5.50, what is the required rate of return on Tangshan's stock?

A) 7.3%

B) 8.6%

C) 9.5%

D) 10.6%

 

138.                        ________ is the actual amount each common stockholder would expect to receive if the firm's assets are sold, creditors and preferred stockholders are repaid, and any remaining money is divided among the common stockholders.

A) Liquidation value

B) Book value

C) The P/E multiple

D) The present value of the dividends

 

139.                        ________ is a guide to the firm's value if it is assumed that investors value the earnings of a given firm in the same way they do the average firm in the industry.

A) Liquidation value

B) Book value

C) The P/E multiple

D) The present value of the dividends

 

140.                        Which of the following valuation methods is superior to the others in the list since it considers expected earnings?

A) liquidation value

B) book value

C) P/E multiple

D) present value of the interest

 

141.                        The use of the ________ is especially helpful in valuing firms that are not publicly traded.

A) liquidation value

B) book value

C) P/E multiple

D) present value of the dividends

 

142.                        The current price of DEF Corporation stock is $26.50 per share. Earnings next year should be $2 per share and it should pay a $1 dividend. The P/E multiple is 15 times on average. What price would you expect for DEF's stock in the future?

A) $13.50

B) $15.00

C) $26.50

D) $30.00

 

143.                        Nico Corporation expects to generate free-cash flows of $200,000 per year for the next five years. Beyond that time, free cash flows are expected to grow at a constant rate of 5 percent per year forever. If the firm's average cost of capital is 15 percent, the market value of the firm's debt is $500,000, and Nico has a half million shares of stock outstanding, what is the value of Nico's stock?

A) $2..43

B) $3.43

C) $1.43

D) $0.00

 

144.                        Karina's Caribbean Foods had total assets as recorded on its balance sheet are $1,500,000. What is the value of the Karina's common stock if it has $950,000 in liabilities, and 7,500 shares of common stock outstanding? Answer: P = (1,500,000 - 950,000)/7,500 = $73.33

 

145.                        Scooter World has estimated the market value of its assets to be $1,250,000. What is the value of Scooter Wrold's common stock if it has $900,000 in liabilities, $50,000 in preferred stock, and 7,500 shares of common stock outstanding? Answer: P = (1,250,000 - 900,000 - 50,000)/7,500 = $40

 

146.                        Tangshan Antiques has a beta of 1.40, the annual risk-free rate of interest is currently percent, and the required return on the market portfolio is 16 percent. The firm estimates that its future dividends will continue to increase

 

at an annual compound rate consistent with that experienced over the 2000-2003 period.

 

(a) Estimate the value of Tangshan Antiques stock.

(b) A lawsuit has been filed against the company by a competitor, and the potential loss has increased risk, which is reflected in the company's beta, increasing it to 1.6. What is the estimated price of the stock following the filing of the lawsuit.

Answer:

 

(a) ks = 0.10 + 1.4(0.16 - 0.10) = 0.184

growth rate of dividends = $3.40/$2.70 = 1.259 FVIF3, k = 8%

Po = $3.40(1.08)/(0.184 - 0.08) = $35.31

(b) ks = 0.10 + 1.6(0.16 - 0.10) = 0.196

Po = $3.40(1.08)/(0.196 - 0.08) = $31.66

 

147.                        The capital budgeting process consists of five distinct but interrelated steps: proposal generation, review and analysis, decision making, implementation, and follow-up. Answer: TRUE

 

148.                        The capital budgeting process consists of four distinct but interrelated steps: proposal generation, review and analysis, decision making, and termination. Answer: FALSE

 

149.                        Independent projects are projects that compete with one another for the firm's resources, so that the acceptance of one eliminates the others from further consideration. Answer: FALSE

 

150.                        A non-conventional cash flow pattern associated with capital investment projects consists of an initial outflow followed by a series of inflows. Answer: FALSE

 

151.                        If a firm has unlimited funds to invest in capital assets, all independent projects that meet its minimum investment criteria should be implemented. Answer: TRUE

 

152.                        The following three projects would seem to compete with one another form the firm's resources and therefore would be examples of mutually exclusive projects.

(1) installing air conditioning in the plant

(2) acquiring a small supplier

(3) purchasing a new computer system

Answer: FALSE

 

153.                        If a firm has unlimited funds to invest, all the mutually exclusive projects that meet its minimum investment criteria can be implemented. Answer: FALSE

 

154.                        Mutually exclusive projects are projects whose cash flows are unrelated to one another; the acceptance of one does not eliminate the others from further consideration. Answer: FALSE

 

155.                        A conventional cash flow pattern is one in which an initial outflow is followed only by a series of inflows. Answer: TRUE

 

156.                        A nonconventional cash flow pattern is one in which an initial outflow is followed only by a series of inflows. Answer: FALSE

 

157.                        A nonconventional cash flow pattern is one in which an initial outflow is followed by a series of both inflows and outflows. Answer: TRUE

 

158.                        Relevant cash flows are the incremental cash outflows and inflows associated with a proposed capital expenditure. Answer: TRUE

 

159.                        The three major cash flow components include the initial investment, operating cash inflows, and terminal cash flows. Answer: TRUE

 

160.                        International capital budgeting differs from domestic capital budgeting because (1) cash inflows and outflows occur in a foreign currency, and (2) foreign investments potentially face significant political risk. Answer: TRUE

 

161.                        In case of international capital budgeting, a U.S. company can minimize its political risk by creating a joint venture with a competent and well-connected local partner. Answer: TRUE

 

162.                        Sunk costs are cash outlays that have already been made and therefore have no effect on the cash flows relevant to the current decision. As a result, sunk costs should not be included as relevant in computing a project's incremental cash flows. Answer: TRUE

 

163.                        Opportunity costs should be included as cash cash flows when determining a project's incremental cash flows. Answer: TRUE

 

164.                        A corporation is considering expanding operations to meet growing demand. With the capital expansion, the current accounts are expected to change. Management expects cash to increase by $20,000, accounts receivable by $40,000, and inventories by $60,000. At the same time accounts payable will increase by $50,000, accruals by $10,000, and long-term debt by $100,000. The change in net working capital is

A) an increase of $120,000.

B) a decrease of $40,000.

C) a decrease of $120,000.

D) an increase of $60,000.

 

165.                        A corporation is considering expanding operations to meet growing demand. With the capital expansion the current accounts are expected to change. Management expects cash to increase by $10,000, accounts receivable by $20,000, and inventories by $30,000. At the same time accounts payable will increase by $40,000, accruals by $30,000, and long-term debt by $80,000. The change in net working capital is

A) an increase of $10,000.

B) a decrease of $10,000.

C) a decrease of $90,000.

D) an increase of $80,000.

 

166.                        A corporation is selling an existing asset for $21,000. The asset, when purchased, cost $10,000, was being depreciated under MACRS using a five-year recovery period, and has been depreciated for four full years. If the assumed tax rate is 40 percent on ordinary income and capital gains, the tax effect of this transaction is

A) $0 tax liability.

B) $7,560 tax liability.

C) $4,400 tax liability.

D) $7,720 tax liability.

 

167.                        A corporation is selling an existing asset for $1,700. The asset, when purchased, cost $10,000, was being depreciated under MACRS using a five-year recovery period, and has been depreciated for four full years. If the assumed tax rate is 40 percent on ordinary income and capital gains, the tax effect of this transaction is

A) $0 tax liability.

B) $840 tax liability.

C) $3,160 tax liability.

D) $3,160 tax benefit.

 

168.                        A corporation is selling an existing asset for $1,000. The asset, when purchased, cost $10,000, was being depreciated under MACRS using a five-year recovery period, and has been depreciated for four full years. If the assumed tax rate is 40 percent on ordinary income and capital gains, the tax effect of this transaction is


A) $0 tax liability.

B) $1,100 tax liability.

C) $3,600 tax liability.

D) $280 tax benefit.

 

169.                        A mixer was purchased two years ago for $120,000 and can be sold for $125,000 today. The mixer has been depreciated using the MACRS 5-year recovery period and the firm pays 40 percent taxes on both ordinary income and capital gain.

(a) Compute recaptured depreciation and capital gain (loss), if any.

(b) Find the firm's tax liability.

 

Answer:

(a) Book Value = 120,000 (1 - 0.20 - 0.32) = $57,600

Recaptured depreciation = 120,000 - 57,600 = $62,400

Capital gain = 125,000 - 120,000 = 5,000

$67,400

(b) Tax liability = 67,400 0.40 = $26,960

 

170.                        An asset was purchased three years ago for $100,000 and can be sold for $40,000 today. The asset has been depreciated using the MACRS 5-year recovery period and the firm pays 40 percent taxes on both ordinary income and capital gain.

(a) Compute recaptured depreciation and capital gain (loss), if any.

(b) Find the firm's tax liability.

 

Answer: (a) Book Value = 100,000 (1 - 0.20 - 0.32 - 0.19) = $29,000

Recaptured depreciation = 40,000 - 29,000 = $11,000

Capital gain = 0

$11,000

(b) Tax liability = 11,000 0.40 = $4,400

 

 

171.                        Computer Disk Duplicators, Inc. has been considering several capital investment proposals for the year beginning in 2004. For each investment proposal, the relevant cash flows and other relevant financial data are summarized in the table below. In the case of a replacement decision, the total installed cost of the equipment will be partially offset by the sale of existing equipment. The firm is subject to a 40 percent tax rate on ordinary income and on long-term capital gains. The firm's cost of capital is 15 percent.

______________________________________________________________________

*Not applicable

 

172.                        For Proposal 1, the cash flow pattern for the expansion project is ________. (See Table 8.4.)

A) a mixed stream and conventional.

B) a mixed stream and non-conventional.

C) an annuity and conventional.

D) an annuity and non-conventional.

 

173.                        For Proposal 1, the initial outlay equals ________. (See Table 8.4.)

A) $1,380,000

B) $1,440,000

C) $1,500,000

D) $1,620,000

 

174.                        For Proposal 1, the depreciation expense for year 1 is ________. (See Table 8.4.)

A) $110,400

B) $115,200

C) $150,000

D) $300,000

 

175.                        For Proposal 1, the annual incremental after-tax cash flow from operations for year 1 is ________. (See Table 8.4.)

A) $60,000

B) $255,000

C) $300,000

D) $210,000

 

176.                        For Proposal 2, the cash flow pattern for the replacement project is ________. (See Table 8.4.)

A) a mixed stream and conventional.

B) a mixed stream and non-conventional.

C) an annuity and conventional.

D) an annuity and non-conventional.

 

177.                        For Proposal 2, the book value of the existing asset is ________. (See Table 8.4.)

A) $13,600

B) $34,400

C) $66,400

D) $80,000

 

178.                        For Proposal 2, the tax effect on the sale of the existing asset results in ________. (See Table 8.4.)

A) $12,000 tax liability.

B) $14,560 tax liability.

C) $25,280 tax liability.

D) $16,600 tax liability.

 

179.                        For Proposal 2, the initial outlay equals ________. (See Table 8.4.)

A) $120,720 cash outflow.

B) $164,560 cash outflow.

C) $150,000 cash outflow.

D) $167,520 cash outflow.

 

180.                        For Proposal 2, the incremental depreciation expense for year 2 is ________. (See Table 8.4.)

A) $16,800

B) $26,400

C) $38,400

D) $60,000

 

181.                        For Proposal 2, the annual incremental after-tax cash flow from operations for year 2 is ________. (See Table 8.4.)

A) $18,000

B) $24,000

C) $66,000

D) $84,000

 

182.                        For Proposal 3, the cash flow pattern for the replacement project is ________. (See Table 8.4.)

A) a mixed stream and conventional.

B) a mixed stream and non-conventional.

C) an annuity and conventional.

D) an annuity and non-conventional.

 

183.                        For Proposal 3, the book value of the existing asset is ________. (See Table 8.4.)

A) $21,000

B) $43,000

C) $52,000

D) $80,000

 

184.                        For Proposal 3, the tax effect on the sale of the existing asset results in ________. (See Table 8.4.)

A) $8,000 tax liability.

B) $16,000 tax liability.

C) $20,000 tax liability.

D) $23,200 tax liability.

 

185.                        Which of the following capital budgeting techniques ignores the time value of money?

A) Payback.

B) Net present value.

C) Internal rate of return.

D) Two of the above

 

186.                        Diagrams that permit the mapping of the various investment decision alternatives and payoffs as well as their

probabilities of occurrence are called

A) simulations.

B) sensitivity analysis.

C) decision trees.

D) multiple regression analysis.

 

187.                        ________ measure(s) the risk of a capital budgeting project by estimating the NPVs associated with the optimistic, most likely, and pessimistic cash flow estimates.

A) Simulations

B) Risk-adjusted discount rates

C) Sensitivity analysis

D) Multiple regression analysis

 

188.                        The advantage of using simulation in the capital budgeting process is

A) ease of calculation.

B) the availability of a continuum of risk-return trade-offs which may be used as the basis for decision-making.

C) dependability of predetermined probability distributions.

D) that it generates a continuum of risk-return trade-offs rather than a single-point estimate.

 

189.                        Many firms use the payback method as a guideline in capital investment decisions. Reasons they do so include all of the following EXCEPT

A) it gives an implicit consideration to the timing of cash flows.

B) it recognizes cash flows which occur after the payback period.

C) it is a measure of risk exposure.

D) it is easy to calculate.

 

190.                        Payback is considered an unsophisticated capital budgeting because it

A) gives explicit consideration to the timing of cash flows and therefore the time value of money.

B) gives explicit consideration to risk exposure due to the use of the cost of capital as a discount rate.

C) gives explicit consideration to the timing of cash flows and therefore the time value of money.

D) none of the above.

 

191.                        Some firms use the payback period as a decision criterion or as a supplement to sophisticated decision techniques, because

A) it explicitly considers the time value of money.

B) it can be viewed as a measure of risk exposure because of its focus on liquidity.

C) the determination of the required payback period for a project is an objectively determined criteria.

D) none of the above.

 

192.                        A firm is evaluating a proposal which has an initial investment of $35,000 and has cash flows of $10,000 in year 1, $20,000 in year 2, and $10,000 in year 3. The payback period of the project is

A) 1 year.

B) 2 years.

C) between 1 and 2 years.

D) between 2 and 3 years.

 

193.                        If the NPV is greater than the initial investment, a project should be accepted. Answer: FALSE

 

194.                        If the NPV is greater than $0.00, a project should be accepted. Answer: TRUE

 

195.                        The NPV of an project with an initial investment of $1,000 that provides after-tax operating cash flows of $300 per year for four years where the firm's cost of capital is 15 percent is $856.49. Answer: FALSE

 

196.                        The NPV of an project with an initial investment of $1,000 that provides after-tax operating cash flows of $300 per year for four years where the firm's cost of capital is 15 percent is $143.51. Answer: FALSE

 

197.                        The NPV of an project with an initial investment of $1,000 that provides after-tax operating cash flows of $300 per year for four years where the firm's cost of capital is 15 percent is -$143.51. Answer: TRUE

 

198.                        The risk-adjusted discount rate (RADR) is the risk-adjustment factor that represents the percent of estimated cash inflows that investors would be satisfied to receive for certain rather than the cash inflows that are possible for each year. Answer: FALSE

 

199.                        The risk-adjusted discount rate (RADR) is the rate of return that must be earned on a given project to compensate the firm's owners adequately, thereby resulting in the maintenance or improvement of share price. Answer: TRUE

 

200.                        A market risk-return function is a graphical presentation of the discount rates associated with each level of project risk. Answer: TRUE

 

201.                        Risk-adjusted discount rates (RADRs) are the risk-adjustment factors that represent the percent of estimated cash inflows that investors would be satisfied to receive for certain rather than the cash inflows that are possible for each year. Answer: FALSE

 

202.                        What is the NPV for the following project if its cost of capital is 15 percent and its initial after tax cost is $5,000,000 and it is expected to provide after-tax operating cash inflows of $1,800,000 in year 1, $1,900,000 in year 2, $1,700,000 in year 3 and $1,300,000 in year 4?

A) $1,700,000.

B) $371,764.

C) ($137,053).

D) None of the above.

 

203.                        What is the NPV for the following project if its cost of capital is 0 percent and its initial after tax cost is $5,000,000 and it is expected to provide after-tax operating cash inflows of $1,800,000 in year 1, $1,900,000 in year 2, $1,700,000 in year 3 and $1,300,000 in year 4?

A) $1,700,000.

B) $371,764.

C) $137,053.

D) None of the above.

 

204.                        What is the NPV for the following project if its cost of capital is 12 percent and its initial after tax cost is $5,000,000 and it is expected to provide after-tax operating cash flows of $1,800,000 in year 1, $1,900,000 in year 2, $1,700,000 in year 3 and ($1,300,000) in year 4?

A) $(1,494,336).

B) $1,494,336.

C) $158,011.

D) Two of the above.

 

205.                        The amount by which the required discount rate exceeds the risk-free rate is called

A) the opportunity cost.

B) the risk premium.

C) the risk equivalent.

D) the excess risk.

 

206.                        A sophisticated capital budgeting technique that can be computed by solving for the discount rate that equates the present value of a projects inflows with the present value of its outflows is called internal rate of return Answer: TRUE

 

207.                        If its IRR is greater than $0.00, a project should be accepted. Answer: FALSE

 

208.                        If its IRR is greater than 0 percent, a project should be accepted.Answer: FALSE

 

209.                        If its IRR is greater than the cost of capital, a project should be accepted. Answer: TRUE

 

210.                        A firm's investment opportunities schedule (IOS) is a graphical presentation of the firm's collection of project IRRs in descending order against the total dollar investment. Answer: TRUE

 

211.                        Real options are opportunities that are embedded in capital budgeting projects that enable managers to alter their cash flows and risks in a way that affects project acceptability. Answer: TRUE

 

212.                        Consider the following projects, X and Y, where the firm can only choose one. Project X costs $600 and has cash flows of $400 in each of the next 2 years. Project Y also costs $600, and generates cash flows of $500 and $275 for the next 2 years, respectively. Which investment should the firm choose if the cost of capital is 10 percent?

A) Project X.

B) Project Y.

C) Neither.

D) Not enough information to tell.

 

213.                        Consider the following projects, X and Y where the firm can only choose one. Project X costs $600 and has cash flows of $400 in each of the next 2 years. Project B also costs $600, and generates cash flows of $500 and $275 for the next 2 years, respectively. Which investment should the firm choose if the cost of capital is 25 percent?

A) Project X.

B) Project Y.

C) Neither.

D) Not enough information to tell.

 

214.                        Tangshan Mining Company is considering investing in a new mining project. The firm's cost of capital is 12 percent and the project is expected to have an initial after tax cost of $5,000,000. Furthermore, the project is expected to provide after-tax operating cash flows of $2,500,000 in year 1, $2,300,000 in year 2, $2,200,000 in year 3 and ($1,300,000) in year 4?

(a) Calculate the project's NPV.

(b) Calculate the project's IRR.

(c) Should the firm make the investment?

 

Answer:

 

 

No the firm should not accept the project.

 

 

Table 9.10

 

A firm must choose from six capital budgeting proposals outlined below. The firm is subject to capital rationing and has a capital budget of $1,000,000; the firm's cost of capital is 15 percent.

 

 

215.                        Using the internal rate of return approach to ranking projects, which projects should the firm accept? (See Table 9.10)

A) 1, 2, 3, 4, and 5

B) 1, 2, 3, and 5

C) 2, 3, 4, and 6

D) 1, 3, 4, and 6

 

216.                        Using the net present value approach to ranking projects, which projects should the firm accept? (See Table 9.10)

A) 1, 2, 3, 4, and 5

B) 1, 2, 3, 5, and 6

C) 2, 3, 4, and 5

D) 1, 3, 5, and 6

 

217.                        When the net present value is negative, the internal rate of return is ________ the cost of capital.

A) greater than

B) greater than or equal to

C) less than

D) equal to

 

218.                        A firm is evaluating two independent projects utilizing the internal rate of return technique. Project X has an initial investment of $80,000 and cash inflows at the end of each of the next five years of $25,000. Project Z has a initial investment of $120,000 and cash inflows at the end of each of the next four years of $40,000. The firm should

A) accept both if the cost of capital is at most 15 percent.

B) accept only Z if the cost of capital is at most 15 percent.

C) accept only X if the cost of capital is at most 15 percent.

D) none of the above