TEST BANK FOR Fundamentals of Financial Management 16th edition by Eugene F. Brigham and Joel F. Houston Chapter 1-21 with All Appendixes Chapter 01: An Overview of Financial Management Note that there is an overlap between the T/F and multiple-choice questions, as some of the T/F statements are used in multiple-choice questions. Multiple Choice: True/False 1. In most corporations, the CFO ranks under the CEO. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 1-1 What Is Finance? QUESTION TYPE: True / False HAS VARIABLES: False PREFACE NAME: T/F LEARNING OBJECTIVES: FOFM.BRIG.17.01.01 - What Is Finance? NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - Students will understand and be - Students will understand and be able to articulate the goals of the firm, the role of the finance function in the enterprise's organization, and as an analyst using public information. TOPICS: Role of finance KEYWORDS: Bloom's Knowledge DATE CREATED: 9/21/2017 3:15 PM DATE MODIFIED: 9/21/2017 3:15 PM 2. The Chairman of the Board must also be the CEO. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 1-1 What Is Finance? QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.01.01 - What Is Finance? NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking Copyright Cengage Learning. Powered by Cognero.
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TOPICS: KEYWORDS: DATE CREATED: DATE MODIFIED:
United States - OH - DISC.FOFM.BRIG.17.06 - Finance function United States - OH - Default City - Students will understand and be - Students will understand and be able to articulate the goals of the firm, the role of the finance function in the enterprise's organization, and as an analyst using public information. Role of finance Bloom's: Knowledge 9/21/2017 3:15 PM 9/21/2017 3:15 PM
3. The board of directors is the highest ranking body in a corporation, and the chairman of the board is the highest ranking individual. The CEO generally works under the board and its chairman, and the board generally has the authority to remove the CEO under certain conditions. The CEO, however, cannot remove the board, but he or she can endeavor to have the board voted out and a new board voted in should a conflict arise. It is possible for a person to simultaneously serve as CEO and chairman of the board, though many corporate control experts believe it is bad to vest both offices in the same person. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 1-1 What Is Finance? QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.01.01 - What Is Finance? NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - Students will understand and be - Students will understand and be able to articulate the goals of the firm, the role of the finance function in the enterprise's organization, and as an analyst using public information. TOPICS: Role of finance KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 3:15 PM DATE MODIFIED: 9/21/2017 3:15 PM 4. Partnerships and proprietorships generally have a tax advantage over corporations. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 1-3 Forms of Business Organization QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.01.03 - Forms of Business Organization NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - Students will understand and be - Students will Copyright Cengage Learning. Powered by Cognero.
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understand and be able to articulate the goals of the firm, the role of the finance function in the enterprise's organization, and as an analyst using public information. Forms of organization Bloom's: Knowledge 9/21/2017 3:15 PM 9/21/2017 3:15 PM
5. A disadvantage of the corporate form of organization is that corporate stockholders are more exposed to personal liabilities in the event of bankruptcy than are investors in a typical partnership. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 1-3 Forms of Business Organization QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.01.03 - Forms of Business Organization NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - Students will understand and be - Students will understand and be able to articulate the goals of the firm, the role of the finance function in the enterprise's organization, and as an analyst using public information. TOPICS: Forms of organization KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 3:15 PM DATE MODIFIED: 9/21/2017 3:15 PM 6. An advantage of the corporate form of organization is that corporations are generally less highly regulated than proprietorships and partnerships. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 1-3 Forms of Business Organization QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.01.03 - Forms of Business Organization NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - Students will understand and be - Students will understand and be able to articulate the goals of the firm, the role of the finance function in the enterprise's organization, and as an analyst using public information. TOPICS: Forms of organization KEYWORDS: Bloom's: Knowledge Copyright Cengage Learning. Powered by Cognero.
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DATE CREATED: DATE MODIFIED:
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7. Some partners in a partnership may have different rights, privileges, and responsibilities than other partners. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 1-3 Forms of Business Organization QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.01.03 - Forms of Business Organization NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - Students will understand and be - Students will understand and be able to articulate the goals of the firm, the role of the finance function in the enterprise's organization, and as an analyst using public information. TOPICS: Forms of organization KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 3:15 PM DATE MODIFIED: 9/21/2017 3:15 PM 8. One advantage of the corporate form of organization is that it avoids double taxation. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 1-3 Forms of Business Organization QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.01.03 - Forms of Business Organization NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - Students will understand and be - Students will understand and be able to articulate the goals of the firm, the role of the finance function in the enterprise's organization, and as an analyst using public information. TOPICS: Forms of organization KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 3:15 PM DATE MODIFIED: 9/21/2017 3:15 PM 9. It is generally harder to transfer one's ownership interest in a partnership than in a corporation. a. True b. False Copyright Cengage Learning. Powered by Cognero.
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ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 1-3 Forms of Business Organization QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.01.03 - Forms of Business Organization NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - Students will understand and be - Students will understand and be able to articulate the goals of the firm, the role of the finance function in the enterprise's organization, and as an analyst using public information. TOPICS: Forms of organization KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 3:15 PM DATE MODIFIED: 9/21/2017 3:15 PM 10. One danger of starting a proprietorship is that you may be exposed to personal liability if the business goes bankrupt. This problem would be avoided if you formed a corporation to operate the business. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 1-3 Forms of Business Organization QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.01.03 - Forms of Business Organization NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - Students will understand and be - Students will understand and be able to articulate the goals of the firm, the role of the finance function in the enterprise's organization, and as an analyst using public information. TOPICS: Forms of organization KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 3:15 PM DATE MODIFIED: 9/21/2017 3:15 PM 11. If a corporation elects to be taxed as an S corporation, then it can avoid the corporate tax. However, its stockholders will have to pay personal taxes on the firm's net income. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 1-3 Forms of Business Organization Copyright Cengage Learning. Powered by Cognero.
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QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.01.03 - Forms of Business Organization NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - Students will understand and be - Students will understand and be able to articulate the goals of the firm, the role of the finance function in the enterprise's organization, and as an analyst using public information. TOPICS: Forms of organization KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 3:15 PM DATE MODIFIED: 9/21/2017 3:15 PM 12. If a corporation elects to be taxed as an S corporation, then both it and its stockholders can avoid all Federal taxes. This provision was put into the Federal Tax Code in order to encourage the formation of small businesses. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 1-3 Forms of Business Organization QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.01.03 - Forms of Business Organization NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - Students will understand and be - Students will understand and be able to articulate the goals of the firm, the role of the finance function in the enterprise's organization, and as an analyst using public information. TOPICS: Forms of organization KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 3:15 PM DATE MODIFIED: 9/21/2017 3:15 PM 13. It is generally less expensive to form a corporation than a proprietorship because, with a proprietorship, extensive legal documents are required. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 1-3 Forms of Business Organization QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.01.03 - Forms of Business Organization NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking Copyright Cengage Learning. Powered by Cognero.
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STATE STANDARDS: LOCAL STANDARDS:
TOPICS: KEYWORDS: DATE CREATED: DATE MODIFIED:
United States - OH - DISC.FOFM.BRIG.17.06 - Finance function United States - OH - Default City - Students will understand and be - Students will understand and be able to articulate the goals of the firm, the role of the finance function in the enterprise's organization, and as an analyst using public information. Forms of organization Bloom's: Knowledge 9/21/2017 3:15 PM 9/21/2017 3:15 PM
14. The more capital a firm is likely to require, the greater the probability that it will be organized as a corporation. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 1-3 Forms of Business Organization QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.01.03 - Forms of Business Organization NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - Students will understand and be - Students will understand and be able to articulate the goals of the firm, the role of the finance function in the enterprise's organization, and as an analyst using public information. TOPICS: Forms of organization KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 3:15 PM DATE MODIFIED: 9/21/2017 3:15 PM 15. One disadvantage of forming a corporation rather than a partnership is that this makes it more difficult for the firm's investors to transfer their ownership interests. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 1-3 Forms of Business Organization QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.01.03 - Forms of Business Organization NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - Students will understand and be - Students will understand and be able to articulate the goals of the firm, the role of the finance function in the enterprise's organization, and as an analyst using public information. TOPICS: Forms of organization Copyright Cengage Learning. Powered by Cognero.
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Bloom's: Knowledge 9/21/2017 3:16 PM 9/21/2017 3:16 PM
16. Organizing as a corporation makes it easier for the firm to raise capital. This is because corporations' stockholders are not subject to personal liabilities if the firm goes bankrupt and also because it is easier to transfer shares of stock than partnership interests. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 1-3 Forms of Business Organization QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.01.03 - Forms of Business Organization NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - Students will understand and be - Students will understand and be able to articulate the goals of the firm, the role of the finance function in the enterprise's organization, and as an analyst using public information. TOPICS: Forms of organization KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 3:16 PM DATE MODIFIED: 9/21/2017 3:16 PM 17. In order to maximize its shareholders' value, a firm's management must attempt to maximize the stock price in the long run, or the stock's "intrinsic value." a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 1-4 The Main Financial Goal: Creating Value for Investors QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.01.04 - The Main Financial Goal: Creating Value for Investors NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - Students will understand and be - Students will understand and be able to articulate the goals of the firm, the role of the finance function in the enterprise's organization, and as an analyst using public information. TOPICS: Intrinsic values KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 3:16 PM DATE MODIFIED: 9/21/2017 3:16 PM Copyright Cengage Learning. Powered by Cognero.
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18. If management operates in a manner designed to maximize the firm's expected profits for the current year, this will also maximize the stockholders' wealth as of the current year. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 1-4 The Main Financial Goal: Creating Value for Investors QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.01.04 - The Main Financial Goal: Creating Value for Investors NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - Students will understand and be - Students will understand and be able to articulate the goals of the firm, the role of the finance function in the enterprise's organization, and as an analyst using public information. TOPICS: Intrinsic values KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 3:16 PM DATE MODIFIED: 9/21/2017 3:16 PM 19. In order to maximize its shareholders' value, a firm's management must attempt to maximize the expected EPS. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 1-7 Balancing Shareholder Interests and the Interests of Society QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.01.07 - Balancing Shareholder Interest and the Interests of Society NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - Students will understand and be - Students will understand and be able to articulate the goals of the firm, the role of the finance function in the enterprise's organization, and as an analyst using public information. TOPICS: Shareholder interests KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 3:16 PM DATE MODIFIED: 9/21/2017 3:16 PM 20. In order to maximize its shareholders' value, a firm's management must attempt to maximize the stock price on a specific target date. a. True b. False ANSWER: False Copyright Cengage Learning. Powered by Cognero.
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POINTS: 1 DIFFICULTY: EASY REFERENCES: 1-7 Balancing Shareholder Interests and the Interests of Society QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.01.07 - Balancing Shareholder Interest and the Interests of Society NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - Students will understand and be - Students will understand and be able to articulate the goals of the firm, the role of the finance function in the enterprise's organization, and as an analyst using public information. TOPICS: Shareholder interests KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 3:16 PM DATE MODIFIED: 9/21/2017 3:16 PM 21. As a result of financial scandals occurring during the past decade, there has been a strong push to improve business ethics. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 1-8 Business Ethics QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.01.08 - Business Ethics NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.02 - Ethics United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - Students will understand and be - Students will understand and be able to articulate the goals of the firm, the role of the finance function in the enterprise's organization, and as an analyst using public information. TOPICS: Business ethics KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 3:16 PM DATE MODIFIED: 9/21/2017 3:16 PM 22. There are many types of unethical business behavior. One example is where executives provide information that they know is incorrect to banks and to stockholders. It is illegal to provide such information to banks, but it is not illegal to provide it to stockholders because they are the owners of the firm, not outsiders. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 1-8 Business Ethics Copyright Cengage Learning. Powered by Cognero.
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QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.01.08 - Business Ethics NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.02 - Ethics United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - Students will understand and be - Students will understand and be able to articulate the goals of the firm, the role of the finance function in the enterprise's organization, and as an analyst using public information. TOPICS: Business ethics KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 3:16 PM DATE MODIFIED: 9/21/2017 3:16 PM 23. A stock's market price would equal its intrinsic value if all investors had all the information that is available about the stock. In this case the stock's market price would equal its intrinsic value. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 1-4 The Main Financial Goal: Creating Value for Investors QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.01.04 - The Main Financial Goal: Creating Value for Investors NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Intrinsic values KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 3:16 PM DATE MODIFIED: 9/21/2017 3:16 PM 24. If a stock's market price is above its intrinsic value, then the stock can be thought of as being undervalued, and it would be a good buy. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 1-4 The Main Financial Goal: Creating Value for Investors QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.01.04 - The Main Financial Goal: Creating Value for Investors NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds Copyright Cengage Learning. Powered by Cognero.
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LOCAL STANDARDS: TOPICS: KEYWORDS: DATE CREATED: DATE MODIFIED:
United States - OH - Default City - Tier 2: - Capital structure Intrinsic values Bloom's: Comprehension 9/21/2017 3:16 PM 9/21/2017 3:16 PM
25. If a stock's intrinsic value is greater than its market price, then the stock is overvalued and should be sold. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 1-4 The Main Financial Goal: Creating Value for Investors QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.01.04 - The Main Financial Goal: Creating Value for Investors NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Intrinsic values KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 3:16 PM DATE MODIFIED: 9/21/2017 3:16 PM 26. For a stock to be in equilibrium as the book defines it, its market price should exceed its intrinsic value. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 1-4 The Main Financial Goal: Creating Value for Investors QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.01.04 - The Main Financial Goal: Creating Value for Investors NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Intrinsic values KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 3:16 PM DATE MODIFIED: 9/21/2017 3:16 PM 27. The term "marginal investor" means an investor who is active in the market and would tend to buy a stock if its price fell and sell it if it rose, barring any new information coming out about the stock. It is the "marginal investor" who determines the actual stock price. a. True Copyright Cengage Learning. Powered by Cognero.
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b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 1-4 The Main Financial Goal: Creating Value for Investors QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.01.04 - The Main Financial Goal: Creating Value for Investors NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Intrinsic values KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 3:16 PM DATE MODIFIED: 9/21/2017 3:16 PM 28. Managers always attempt to maximize the long-run value of their firms' stocks, or the stocks' intrinsic values. This is exactly what stockholders desire. Thus, conflicts between stockholders and managers are not possible. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 1-5 Stockholder-Manager Conflicts QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.01.05 - Stockholder-Manager Conflicts NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.02 - Ethics United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - Students will understand and be - Students will understand and be able to articulate the goals of the firm, the role of the finance function in the enterprise's organization, and as an analyst using public information. TOPICS: Stockholder/manager conflicts KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 3:16 PM DATE MODIFIED: 9/21/2017 3:16 PM 29. A hostile takeover is said to occur when another corporation or group of investors gains voting control over a firm and replaces the old managers. If the old managers were managing the firm inefficiently, then hostile takeovers can improve the economy. However, hostile takeovers are controversial, and legislative actions have been taken to make them more difficult to undertake. a. True b. False ANSWER: True POINTS: 1 Copyright Cengage Learning. Powered by Cognero.
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DIFFICULTY: MODERATE REFERENCES: 1-5 Stockholder-Manager Conflicts QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.01.05 - Stockholder-Manager Conflicts NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - Students will understand and be - Students will understand and be able to articulate the goals of the firm, the role of the finance function in the enterprise's organization, and as an analyst using public information. TOPICS: Stockholder/manager conflicts KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 3:16 PM DATE MODIFIED: 9/21/2017 3:16 PM 30. If a lower level person in a firm does something illegal, like "cooking the books" to understate costs and thereby increase profits above the correct profits because he or she was told to do so by a superior, the lower level person cannot be prosecuted but the superior can be prosecuted. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 1-8 Business Ethics QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.01.08 - Business Ethics NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.02 - Ethics United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - Students will understand and be - Students will understand and be able to articulate the goals of the firm, the role of the finance function in the enterprise's organization, and as an analyst using public information. TOPICS: Business ethics KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 3:16 PM DATE MODIFIED: 9/21/2017 3:16 PM 31. If someone deliberately understates costs and thereby increases profits, this can cause the stock price to rise above its intrinsic value. The stock price will probably fall in the future. Also, those who participated in the fraud can be prosecuted, and the firm itself can be penalized. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 1-8 Business Ethics Copyright Cengage Learning. Powered by Cognero.
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QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.01.08 - Business Ethics NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.02 - Ethics United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Business ethics KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 3:16 PM DATE MODIFIED: 9/21/2017 3:16 PM 32. If a firm's board of directors wants to maximize value for its stockholders in general (as opposed to some specific stockholders), it should design an executive compensation system whose focus is on the firm's long-term value. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 1-4 The Main Financial Goal: Creating Value for Investors QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.01.04 - The Main Financial Goal: Creating Value for Investors NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - Students will understand and be - Students will understand and be able to articulate the goals of the firm, the role of the finance function in the enterprise's organization, and as an analyst using public information. TOPICS: Intrinsic values KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 3:16 PM DATE MODIFIED: 9/21/2017 3:16 PM Multiple Choice: Conceptual Please note that some of the answer choices, or answers that are very close, are used in different questions. This has caused us no difficulties, but please take this into account when you make up exams. 33. Which of the following statements is CORRECT? a. One of the disadvantages of incorporating your business is that you could become subject to the firm's liabilities in the event of bankruptcy. b. Proprietorships are subject to more regulations than corporations. c. In any partnership, every partner has the same rights, privileges, and liability exposure as every other partner. d. Corporations of all types are subject to the corporate income tax. e. Proprietorships and partnerships generally have a tax advantage over corporations. ANSWER: e Copyright Cengage Learning. Powered by Cognero.
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RATIONALE:
Some corporations (S corporations) are able to avoid the corporate income tax. Proprietorships and partnerships pay personal income tax, but they avoid the corporate income tax. POINTS: 1 DIFFICULTY: EASY REFERENCES: 1-3 Forms of Business Organization QUESTION TYPE: Multiple Choice HAS VARIABLES: False PREFACE NAME: Conceptual LEARNING OBJECTIVES: FOFM.BRIG.17.01.03 - Forms of Business Organization NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - Students will understand and be - Students will understand and be able to articulate the goals of the firm, the role of the finance function in the enterprise's organization, and as an analyst using public information. TOPICS: Forms of organization KEYWORDS: Bloom's: Knowledge OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 3:16 PM DATE MODIFIED: 9/21/2017 3:16 PM 34. Which of the following statements is CORRECT? a. One of the advantages of the corporate form of organization is that it avoids double taxation. b. It is easier to transfer one's ownership interest in a partnership than in a corporation. c. One of the disadvantages of a proprietorship is that the proprietor is exposed to unlimited liability. d. One of the advantages of a corporation from a social standpoint is that every stockholder has equal voting rights, i.e., "one person, one vote." e. Corporations of all types are subject to the corporate income tax. ANSWER: c POINTS: 1 DIFFICULTY: EASY REFERENCES: 1-3 Forms of Business Organization QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.01.03 - Forms of Business Organization NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - Students will understand and be - Students will understand and be able to articulate the goals of the firm, the role of the finance function in the enterprise's organization, and as an analyst using public information. TOPICS: Forms of organization KEYWORDS: Bloom's: Knowledge OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 3:16 PM DATE MODIFIED: 9/21/2017 3:16 PM Copyright Cengage Learning. Powered by Cognero.
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35. Which of the following statements is CORRECT? a. One advantage of forming a corporation is that equity investors are usually exposed to less liability than they would be in a partnership. b. Corporations face fewer regulations than proprietorships. c. One disadvantage of operating a business as a proprietor is that the firm is subject to double taxation, because taxes are levied at both the firm level and the owner level. d. It is generally less expensive to form a corporation than a proprietorship because, with a proprietorship, extensive legal documents are required. e. If a partnership goes bankrupt, each partner is exposed to liabilities only up to the amount of his or her investment in the business. ANSWER: a RATIONALE: Corporations have limited liability; however, they face more regulations than the other forms of organization. Proprietorships do not pay corporate taxes. POINTS: 1 DIFFICULTY: EASY REFERENCES: 1-3 Forms of Business Organization QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.01.03 - Forms of Business Organization NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - Students will understand and be - Students will understand and be able to articulate the goals of the firm, the role of the finance function in the enterprise's organization, and as an analyst using public information. TOPICS: Forms of organization KEYWORDS: Bloom's: Knowledge OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 3:16 PM DATE MODIFIED: 9/21/2017 3:16 PM 36. Relaxant Inc. operates as a partnership. Now the partners have decided to convert the business into a corporation. Which of the following statements is CORRECT? a. Relaxant's shareholders (the ex-partners) will now be exposed to less liability. b. The company will probably be subject to fewer regulations and required disclosures. c. Assuming the firm is profitable, none of its income will be subject to federal income taxes. d. The firm's investors will be exposed to less liability, but they will find it more difficult to transfer their ownership. e. The firm will find it more difficult to raise additional capital to support its growth. ANSWER: a POINTS: 1 DIFFICULTY: EASY REFERENCES: 1-3 Forms of Business Organization QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.01.03 - Forms of Business Organization NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.06 - Finance function Copyright Cengage Learning. Powered by Cognero.
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LOCAL STANDARDS:
TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
United States - OH - Default City - Students will understand and be - Students will understand and be able to articulate the goals of the firm, the role of the finance function in the enterprise's organization, and as an analyst using public information. Forms of organization Bloom's: Comprehension Multiple Choice: Conceptual 9/21/2017 3:16 PM 9/21/2017 3:16 PM
37. Which of the following statements is CORRECT? a. Corporations generally face fewer regulations than proprietorships. b. Corporate shareholders are exposed to unlimited liability. c. It is usually easier to transfer ownership in a corporation than in a partnership. d. Corporate shareholders are exposed to unlimited liability, but this factor is offset by the tax advantages of incorporation. e. There is a tax disadvantage to incorporation, and there is no way any corporation can escape this disadvantage, even if it is very small. ANSWER: c RATIONALE: If ownership in a proprietorship or partnership is transferred, the basic documents under which the firm operates must be rewritten, whereas for a corporation the seller simply sells shares to a buyer. POINTS: 1 DIFFICULTY: EASY REFERENCES: 1-3 Forms of Business Organization QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.01.03 - Forms of Business Organization NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - Students will understand and be - Students will understand and be able to articulate the goals of the firm, the role of the finance function in the enterprise's organization, and as an analyst using public information. TOPICS: Forms of organization KEYWORDS: Bloom's: Knowledge OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 3:16 PM DATE MODIFIED: 9/21/2017 3:16 PM 38. Which of the following could explain why a business might choose to operate as a corporation rather than as a proprietorship or a partnership? a. Corporations generally face fewer regulations. b. Less of a corporation's income is generally subject to federal taxes. c. Corporate shareholders are exposed to unlimited liability, but this factor is offset by the tax advantages of incorporation. d. Corporate investors are exposed to unlimited liability. e. Corporations generally find it easier to raise large amounts of capital. ANSWER: e Copyright Cengage Learning. Powered by Cognero.
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RATIONALE:
Outsiders thinking about investing in a business are generally not willing to be subjected to unlimited liability, and they also want to be able to sell their shares should they choose to do so. Corporations provide these advantages; hence, firms that need large amounts of capital that must be raised in capital markets generally choose to incorporate. POINTS: 1 DIFFICULTY: EASY REFERENCES: 1-3 Forms of Business Organization QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.01.03 - Forms of Business Organization NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - Students will understand and be - Students will understand and be able to articulate the goals of the firm, the role of the finance function in the enterprise's organization, and as an analyst using public information. TOPICS: Forms of organization KEYWORDS: Bloom's: Knowledge OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 3:16 PM DATE MODIFIED: 9/21/2017 3:16 PM 39. The primary operating goal of a publicly-owned firm interested in serving its stockholders should be to a. Maximize its expected total corporate income. b. Maximize its expected EPS. c. Minimize the chances of losses. d. Maximize the stock price per share over the long run, which is the stock's intrinsic value. e. Maximize the stock price on a specific target date. ANSWER: d RATIONALE: The primary operating goal should be to maximize the long-run stock price, or the intrinsic value. POINTS: 1 DIFFICULTY: EASY REFERENCES: 1-4 The Main Financial Goal: Creating Value for Investors QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.01.04 - The Main Financial Goal: Creating Value for Investors NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - Students will understand and be - Students will understand and be able to articulate the goals of the firm, the role of the finance function in the enterprise's organization, and as an analyst using public information. TOPICS: Intrinsic values KEYWORDS: Bloom's: Knowledge OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 3:16 PM DATE MODIFIED: 9/21/2017 3:16 PM Copyright Cengage Learning. Powered by Cognero.
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40. Which of the following statements is CORRECT? a. In most corporations, the CFO ranks above the CEO. b. By law in most states, the chairman of the board must also be the CEO. c. The board of directors is the highest ranking body in a corporation, and the chairman of the board is the highest ranking individual. The CEO generally works under the board and its chairman, and the board generally has the authority to remove the CEO under certain conditions. The CEO, however, cannot remove the board, but he or she can endeavor to have the board voted out and a new board voted in should a conflict arise. It is possible for a person to simultaneously serve as CEO and chairman of the board, though many corporate control experts believe it is bad to vest both offices in the same person. d. The CFO generally reports to the firm's chief accounting officer, who is normally the controller. e. The CFO is responsible for raising capital and for making sure that capital expenditures are desirable, but he or she is not responsible for the validity of the financial statements, as the controller and the auditors have that responsibility. ANSWER: c POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 1-1 What Is Finance? QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.01.01 - What Is Finance? NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - Students will understand and be - Students will understand and be able to articulate the goals of the firm, the role of the finance function in the enterprise's organization, and as an analyst using public information. TOPICS: Role of finance KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 3:16 PM DATE MODIFIED: 9/21/2017 3:16 PM 41. Which of the following statements is CORRECT? a. One drawback of forming a corporation is that it generally subjects the firm to additional regulations. b. One drawback of forming a corporation is that it subjects the firm's investors to increased personal liabilities. c. One drawback of forming a corporation is that it makes it more difficult for the firm to raise capital. d. One advantage of forming a corporation is that it subjects the firm's investors to fewer taxes. e. One disadvantage of forming a corporation is that it is more difficult for the firm's investors to transfer their ownership interests. ANSWER: a RATIONALE: Corporations have to do more reporting to state and federal agencies than other businesses. POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 1-3 Forms of Business Organization QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.01.03 - Forms of Business Organization NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking Copyright Cengage Learning. Powered by Cognero.
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STATE STANDARDS: LOCAL STANDARDS:
TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
United States - OH - DISC.FOFM.BRIG.17.06 - Finance function United States - OH - Default City - Students will understand and be - Students will understand and be able to articulate the goals of the firm, the role of the finance function in the enterprise's organization, and as an analyst using public information. Forms of organization Bloom's: Knowledge Multiple Choice: Conceptual 9/21/2017 3:16 PM 9/21/2017 3:16 PM
42. Which of the following statements is CORRECT? a. If a corporation elects to be taxed as an S corporation, then both it and its stockholders can avoid all Federal taxes. This provision was put into the Federal Tax Code in order to encourage the formation of small businesses. b. The more capital a firm is likely to require, the smaller the probability that it will be organized as a corporation. c. It is generally easier to transfer one's ownership interest in a partnership than in a corporation. d. One danger of starting a proprietorship is that you may be exposed to personal liability if the business goes bankrupt. This problem would be avoided if you formed a corporation to operate the business. e. Corporate shareholders are exposed to unlimited liability, but this factor is offset by the tax advantages of incorporation. ANSWER: d POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 1-3 Forms of Business Organization QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.01.03 - Forms of Business Organization NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - Students will understand and be - Students will understand and be able to articulate the goals of the firm, the role of the finance function in the enterprise's organization, and as an analyst using public information. TOPICS: Forms of organization KEYWORDS: Bloom's: Knowledge OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 3:16 PM DATE MODIFIED: 9/21/2017 3:16 PM 43. Which of the following statements is CORRECT? a. Due to limited liability, unlimited lives, and ease of ownership transfer, the vast majority of U.S. businesses (in terms of number of businesses) are organized as corporations. b. Most businesses (by number and total dollar sales) are organized as proprietorships or partnerships because it is easier to set up and operate one of these forms rather than as a corporation. However, if the business gets very large, it becomes advantageous to convert to a corporation, primarily because corporations have important tax advantages over proprietorships and partnerships. c. Due to legal considerations related to ownership transfers and limited liability, which affect the ability to attract capital, most business (measured by dollar sales) is conducted by corporations in spite of large Copyright Cengage Learning. Powered by Cognero.
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corporations' less favorable tax treatment. d. Large corporations are taxed more favorably than proprietorships. e. Corporate stockholders are exposed to unlimited liability. ANSWER: c POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 1-3 Forms of Business Organization QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.01.03 - Forms of Business Organization NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - Students will understand and be - Students will understand and be able to articulate the goals of the firm, the role of the finance function in the enterprise's organization, and as an analyst using public information. TOPICS: Forms of organization KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 3:16 PM DATE MODIFIED: 9/21/2017 3:16 PM 44. Which of the following statements is CORRECT? a. A hostile takeover is the main method of transferring ownership interest in a corporation. b. A corporation is a legal entity created by a state, and it has a life and existence that is separate from the lives and existence of its owners and managers. c. Unlimited liability and limited life are two key advantages of the corporate form over other forms of business organization. d. Limited liability is an advantage of the corporate form of organization to its owners (stockholders), but corporations have more trouble raising money in financial markets because of the complexity of this form of organization. e. Although the stockholders of the corporation are insulated by limited legal liability, the legal status of the corporation does not protect the firm's managers in the same way, i.e., bondholders can sue the firm’s managers if the firm defaults on its debt. ANSWER: b POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 1-3 Forms of Business Organization QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.01.03 - Forms of Business Organization NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - Students will understand and be - Students will understand and be able to articulate the goals of the firm, the role of the finance function in the enterprise's organization, and as an analyst using public information. TOPICS: Corporate form KEYWORDS: Bloom's: Knowledge Copyright Cengage Learning. Powered by Cognero.
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OTHER: DATE CREATED: DATE MODIFIED:
Multiple Choice: Conceptual 9/21/2017 3:16 PM 9/21/2017 3:16 PM
45. Which of the following statements is CORRECT? a. In a typical partnership, liability for other partners' misdeeds is limited to the amount of a particular partner's investment in the business. b. In a limited partnership, the limited partners have voting control, while the general partner has operating control over the business, and the limited partners are individually responsible, on a pro rata basis, for the firm's debts in the event of bankruptcy. c. A slow-growth company, with little need for new capital, would be more likely to organize as a corporation than would a faster growing company. d. Partnerships have more difficulty attracting large amounts of capital than corporations because of such factors as unlimited liability, the need to reorganize when a partner dies, and the illiquidity (difficulty buying and selling) of partnership interests. e. A major disadvantage of a partnership relative to a corporation is the fact that federal income taxes must be paid by the partners rather than by the firm itself. ANSWER: d POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 1-3 Forms of Business Organization QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.01.03 - Forms of Business Organization NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - Students will understand and be - Students will understand and be able to articulate the goals of the firm, the role of the finance function in the enterprise's organization, and as an analyst using public information. TOPICS: Partnership form KEYWORDS: Bloom's: Knowledge OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 3:16 PM DATE MODIFIED: 9/21/2017 3:16 PM 46. The primary operating goal of a publicly-owned firm trying to best serve its stockholders should be to a. Maximize managers' own interests, which are by definition consistent with maximizing shareholders' wealth. b. Maximize the firm's expected EPS, which must also maximize the firm's price per share. c. Minimize the firm's risks because most stockholders dislike risk. In turn, this will maximize the firm's stock price. d. Use a well-structured managerial compensation package to reduce conflicts that may exist between stockholders and managers. e. Since it is impossible to measure a stock's intrinsic value, the text states that it is better for managers to attempt to maximize the current stock price than its intrinsic value. ANSWER: d POINTS: 1 DIFFICULTY: MODERATE Copyright Cengage Learning. Powered by Cognero.
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REFERENCES: 1-4 The Main Financial Goal: Creating Value for Investors QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.01.04 - The Main Financial Goal: Creating Value for Investors NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - Students will understand and be - Students will understand and be able to articulate the goals of the firm, the role of the finance function in the enterprise's organization, and as an analyst using public information. TOPICS: Value and compensation KEYWORDS: Bloom's: Knowledge OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 3:16 PM DATE MODIFIED: 9/21/2017 3:16 PM 47. Which of the following actions would be most likely to reduce potential conflicts of interest between stockholders and managers? a. Pay managers large cash salaries and give them no stock options. b. Change the corporation's formal documents to make it easier for outside investors to acquire a controlling interest in the firm through a hostile takeover. c. Beef up the restrictive covenants in the firm's debt agreements. d. Eliminate a requirement that members of the board of directors must hold a high percentage of their personal wealth in the firm's stock. e. For a firm that compensates managers with stock options, reduce the time before options are vested, i.e., the time before options can be exercised and the shares that are received can be sold. ANSWER: b RATIONALE: Corporate takeovers are most likely to occur when a firm is underperforming. Managers who fear losing their jobs will try to maximize shareholder wealth. POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 1-5 Stockholder-Manager Conflicts QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.01.05 - Stockholder-Manager Conflicts NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - Students will understand and be - Students will understand and be able to articulate the goals of the firm, the role of the finance function in the enterprise's organization, and as an analyst using public information. TOPICS: Stockholder/manager conflicts KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 3:16 PM DATE MODIFIED: 9/21/2017 3:16 PM 48. Which of the following actions would be likely to reduce potential conflicts of interest between stockholders and managers? Copyright Cengage Learning. Powered by Cognero.
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a. Congress passes a law that severely restricts hostile takeovers. b. A firm's compensation system is changed so that managers receive larger cash salaries but fewer long-term options to buy stock. c. The company changes the way executive stock options are handled, with all options vesting after 2 years rather than having 20% of the options awarded vest every 2 years over a 10-year period. d. The company's outside auditing firm is given a lucrative year-by-year consulting contract with the company. e. The composition of the board of directors is changed from all inside directors to all outside directors, and the directors are compensated with stock rather than cash. ANSWER: e POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 1-5 Stockholder-Manager Conflicts QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.01.05 - Stockholder-Manager Conflicts NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - Students will understand and be - Students will understand and be able to articulate the goals of the firm, the role of the finance function in the enterprise's organization, and as an analyst using public information. TOPICS: Stockholder/manager conflicts KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 3:16 PM DATE MODIFIED: 9/21/2017 3:16 PM 49. Which of the following mechanisms would be most likely to help motivate managers to act in the best interests of shareholders? a. Decrease the use of restrictive covenants in bond agreements. b. Take actions that reduce the possibility of a hostile takeover. c. Elect a board of directors that allows managers greater freedom of action. d. Increase the proportion of executive compensation that comes from stock options and reduce the proportion that is paid as cash salaries. e. Eliminate a requirement that members of the board of directors have a substantial investment in the firm's stock. ANSWER: d POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 1-5 Stockholder-Manager Conflicts QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.01.05 - Stockholder-Manager Conflicts NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - Students will understand and be - Students will understand and be able to articulate the goals of the firm, the role of the finance function in the enterprise's organization, and as an analyst using public information. Copyright Cengage Learning. Powered by Cognero.
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TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
Stockholder/manager conflicts Bloom's: Comprehension Multiple Choice: Conceptual 9/21/2017 3:16 PM 9/21/2017 3:16 PM
50. Which of the following actions would be likely to encourage a firm's managers to make decisions that are in the best interests of shareholders? a. The percentage of executive compensation that comes in the form of cash is increased and the percentage coming from long-term stock options is reduced. b. The state legislature passes a law that makes it more difficult to successfully complete a hostile takeover. c. The percentage of the firm's stock that is held by institutional investors such as mutual funds, pension funds, and hedge funds rather than by small individual investors rises from 10% to 80%. d. The firm's founder, who is also president and chairman of the board, sells 90% of her shares. e. The firm's board of directors gives the firm's managers greater freedom to take whatever actions they think best without obtaining board approval. ANSWER: c RATIONALE: Small stockholders have little clout with management, while large institutional investors are better able to force managers to operate in stockholders' interests. POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 1-5 Stockholder-Manager Conflicts QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.01.05 - Stockholder-Manager Conflicts NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - Students will understand and be - Students will understand and be able to articulate the goals of the firm, the role of the finance function in the enterprise's organization, and as an analyst using public information. TOPICS: Stockholder/manager conflicts KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 3:16 PM DATE MODIFIED: 9/21/2017 3:16 PM 51. Which of the following actions would be most likely to reduce potential conflicts of interest between stockholders and bondholders? a. Compensating managers with stock options. b. Financing risky projects with additional debt. c. The threat of hostile takeovers. d. The use of covenants in bond agreements that limit the firm’s use of additional debt and constrain managers’ actions. e. Abolishing the Security and Exchange Commission. ANSWER: d RATIONALE: Stock options and the threat of takeovers reduce conflicts between managers and shareholders. Financing risky projects with additional debt increases the potential for Copyright Cengage Learning. Powered by Cognero.
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conflicts between stockholders and bondholders. Adding covenants to bond agreements will reduce conflicts between stockholders and bondholders. POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 1-6 Stockholder-Debtholder Conflicts QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.01.06 - Stockholder-Debtholder Conflicts NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - Students will understand and be - Students will understand and be able to articulate the goals of the firm, the role of the finance function in the enterprise's organization, and as an analyst using public information. TOPICS: Stockholder/debtholder conflicts KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 3:16 PM DATE MODIFIED: 9/21/2017 3:16 PM 52. Which of the following actions would be most likely to reduce potential conflicts between stockholders and bondholders? a. Including restrictive covenants in the company's bond indenture (which is the contract between the company and its bondholders). b. Compensating managers with more stock options and less cash income. c. The passage of laws that make it harder for hostile takeovers to succeed. d. A government regulation that banned the use of convertible bonds. e. The firm begins to use only long-term debt, e.g., debt that matures in 30 years or more, rather than debt that matures in less than one year. ANSWER: a POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 1-6 Stockholder-Debtholder Conflicts QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.01.06 - Stockholder-Debtholder Conflicts NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - Students will understand and be - Students will understand and be able to articulate the goals of the firm, the role of the finance function in the enterprise's organization, and as an analyst using public information. TOPICS: Stockholder/debtholder conflicts KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 3:16 PM DATE MODIFIED: 9/21/2017 3:16 PM 53. Which of the following statements is CORRECT? Copyright Cengage Learning. Powered by Cognero.
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a. If a lower level person in a firm does something illegal, like "cooking the books" to understate costs and thereby artificially increase profits because he or she was ordered to do so by a superior, the lower level person cannot be prosecuted but the superior can be prosecuted. b. There are many types of unethical business behavior. One example is where executives provide information that they know is incorrect to outsiders. It is illegal to provide such information to federally regulated banks, but it is not illegal to provide it to stockholders because they are the owners of the firm. c. If someone deliberately understates costs and thereby causes reported profits to increase, this can cause the stock price to rise above its intrinsic value. The stock will probably fall in the future. Both those who participated in the fraud and the firm itself can be prosecuted. d. Ethical behavior is not influenced by training and auditing procedures. People are either ethical or they are not, and this is what determines ethical behavior in business. e. Ethics is not an important consideration in business and in business schools. ANSWER: c POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 1-8 Business Ethics QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.01.08 - Business Ethics NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.02 - Ethics United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Business ethics KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 3:16 PM DATE MODIFIED: 9/21/2017 3:16 PM 54. With which of the following statements would most people in business agree? a. A corporation's short-run profits will almost always increase if the firm takes actions that the government has determined are in the best interests of the nation. b. Firms and government agencies almost always agree with one another regarding the restrictions that should be placed on hiring and firing employees. c. "Whistle blowers," because of the courage it takes to blow the whistle, are generally promoted more rapidly than other employees. d. It is not useful for large corporations to develop a formal set of rules defining ethical and unethical behavior. e. Although people's moral characters are probably developed before they are admitted to a business school, it is still useful for business schools to cover ethics, if only to give students an idea about the adverse consequences of unethical behavior to themselves, their firms, and the nation. ANSWER: e POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 1-8 Business Ethics QUESTION TYPE: Multiple Choice HAS VARIABLES: False Copyright Cengage Learning. Powered by Cognero.
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LEARNING OBJECTIVES: FOFM.BRIG.17.01.08 - Business Ethics NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.02 - Ethics United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - Students will understand and be - Students will understand and be able to articulate the goals of the firm, the role of the finance function in the enterprise's organization, and as an analyst using public information. TOPICS: Business ethics KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 3:16 PM DATE MODIFIED: 9/21/2017 3:16 PM 55. Which of the following statements is CORRECT? a. One of the ways in which firms can mitigate or reduce potential conflicts between bondholders and stockholders is by increasing the amount of debt in the firm's capital structure. b. The threat of takeover generally increases potential conflicts between stockholders and managers. c. Managerial compensation plans cannot be used to reduce potential conflicts between stockholders and managers. d. The threat of takeovers tends to reduce potential conflicts between stockholders and managers. e. The creation of the Securities and Exchange Commission (SEC) has eliminated conflicts between managers and stockholders. ANSWER: d POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.01.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - Students will understand and be - Students will understand and be able to articulate the goals of the firm, the role of the finance function in the enterprise's organization, and as an analyst using public information. TOPICS: Stockholder/manager/debtholder conflicts KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 3:16 PM DATE MODIFIED: 9/21/2017 3:16 PM 56. Which of the following statements is CORRECT? a. Corporations are taxed more favorably than proprietorships. b. Corporations have unlimited liability. c. Because of their size, large corporations face fewer regulations than smaller corporations and proprietorships. d. Reducing the threat of corporate takeover increases the likelihood that managers will act in shareholders' interests. e. Bond covenants are designed to protect bondholders and to reduce potential conflicts between stockholders Copyright Cengage Learning. Powered by Cognero.
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and bondholders. ANSWER: e POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.01.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - Students will understand and be - Students will understand and be able to articulate the goals of the firm, the role of the finance function in the enterprise's organization, and as an analyst using public information. TOPICS: Miscellaneous concepts KEYWORDS: Bloom's: Knowledge OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 3:16 PM DATE MODIFIED: 9/21/2017 3:16 PM 57. Which of the following statements is CORRECT? a. A good goal for a firm's management is the maximization of expected EPS. b. Most business in the U.S. is conducted by corporations, and corporations' popularity results primarily from their favorable tax treatment. c. Conflicts can exist between stockholders and managers, but potential conflicts are reduced by the possibility of hostile takeovers. d. Corporations and partnerships have an advantage over proprietorships because a proprietor is exposed to unlimited liability, but the liability of all investors in the other types of businesses is more limited. e. For a stock to be in equilibrium, its intrinsic value must be greater than the actual market price. ANSWER: c POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.01.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - Students will understand and be - Students will understand and be able to articulate the goals of the firm, the role of the finance function in the enterprise's organization, and as an analyst using public information. TOPICS: Miscellaneous concepts KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 3:16 PM DATE MODIFIED: 9/21/2017 3:16 PM Copyright Cengage Learning. Powered by Cognero.
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58. Which of the following statements is CORRECT? a. One disadvantage of organizing a business as a corporation rather than a partnership is that the equity investors in a corporation are exposed to unlimited liability. b. Using restrictive covenants in debt agreements is an effective way to reduce conflicts between stockholders and managers. c. Managers generally welcome hostile takeovers since the "raider" generally offers a price for the stock that is higher than the price before the takeover action started. d. The managers of established, stable companies sometimes attempt to get their state legislatures to impose rules that make it more difficult for raiders to succeed with hostile takeovers. e. Most business in U.S. is conducted by corporations, and corporations' popularity results primarily from their favorable tax treatment. ANSWER: d POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.01.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - Students will understand and be - Students will understand and be able to articulate the goals of the firm, the role of the finance function in the enterprise's organization, and as an analyst using public information. TOPICS: Miscellaneous concepts KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 3:16 PM DATE MODIFIED: 9/21/2017 3:16 PM 59. Which of the following statements is CORRECT? a. Well-designed bond covenants are useful for reducing potential conflicts between stockholders and managers. b. The bid price in a hostile takeover is generally above the price before the takeover attempt is announced, because otherwise there would be no incentive for the stockholders to sell to the hostile bidder and the takeover attempt would probably fail. c. Stockholders in general would be better off if managers never disclosed favorable events and therefore caused the price of the firm's stock to sell at a price below its intrinsic value. d. Takeovers are most likely to be attempted if the target firm's stock price is above its intrinsic value. e. The efficiency of the U.S. economy would probably be increased if hostile takeovers were absolutely forbidden. ANSWER: b POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.01.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking Copyright Cengage Learning. Powered by Cognero.
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STATE STANDARDS: LOCAL STANDARDS:
TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
United States - OH - DISC.FOFM.BRIG.17.06 - Finance function United States - OH - Default City - Students will understand and be - Students will understand and be able to articulate the goals of the firm, the role of the finance function in the enterprise's organization, and as an analyst using public information. Miscellaneous concepts Bloom's: Comprehension Multiple Choice: Conceptual 9/21/2017 3:16 PM 9/21/2017 3:16 PM
60. Which of the following statements is CORRECT? a. Hostile takeovers are most likely to occur when a firm's stock is selling below its intrinsic value as a result of poor management. b. The efficiency of the U.S. economy would probably be increased if hostile takeovers were absolutely forbidden. c. The managers of established, stable companies sometimes attempt to get their state legislatures to remove rules that make it more difficult for raiders to succeed with hostile takeovers. d. In general, it is more in bondholders' interests than stockholders' interests for a firm to shift its investment focus away from safe, stable investments and into risky investments, especially those that primarily involve research and development. e. Stockholders in general would be better off if managers never disclosed favorable events and therefore caused the price of the firm's stock to sell at a price below its intrinsic value. ANSWER: a RATIONALE: If a firm's stock is undervalued relative to its potential, then someone can profit by taking the firm over and doing a better job running it. POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.01.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - Students will understand and be - Students will understand and be able to articulate the goals of the firm, the role of the finance function in the enterprise's organization, and as an analyst using public information. TOPICS: Miscellaneous concepts KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 3:16 PM DATE MODIFIED: 9/21/2017 3:16 PM 61. Which of the following statements is CORRECT? a. One disadvantage of operating as a corporation rather than as a partnership is that corporate shareholders are exposed to more personal liability than are partners. b. Relative to proprietorships, corporations generally face fewer regulations, and they also find it easier to raise capital. c. There is no good reason to expect a firm's stockholders and bondholders to react differently to the types of Copyright Cengage Learning. Powered by Cognero.
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assets in which it invests. d. Stockholders should generally be happier than bondholders to have managers invest in risky projects with high potential returns as opposed to safe projects with lower expected returns. e. Stockholders in general would be better off if managers never disclosed favorable events and therefore caused the price of the firm's stock to sell at a price below its intrinsic value. ANSWER: d POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.01.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - Students will understand and be - Students will understand and be able to articulate the goals of the firm, the role of the finance function in the enterprise's organization, and as an analyst using public information. TOPICS: Miscellaneous concepts KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 3:16 PM DATE MODIFIED: 9/21/2017 3:16 PM 62. Which of the following statements is CORRECT? a. Because bankruptcy requires that corporate bondholders be paid in full before stockholders receive anything, bondholders generally prefer to see corporate managers invest in high risk/high return projects rather than low risk/low return projects. b. Since bondholders receive fixed payments, they do not share in the gains if risky projects turn out to be highly successful. However, they do share in the losses if risky projects fail and drive the firm into bankruptcy. Therefore, bondholders generally prefer to see corporate managers invest in low risk/low return projects rather than high risk/high return projects. c. One advantage of operating a business as a corporation is that stockholders can deduct their pro rata share of the taxes the firm pays, thereby eliminating the double taxation investors would face in a partnership. d. One drawback of forming a corporation is that you lose the limited liability that you would otherwise receive as a proprietor. e. Potential conflicts between stockholders and bondholders are increased if a firm's bonds are convertible into its common stock. ANSWER: b POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.01.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - Students will understand and be - Students will Copyright Cengage Learning. Powered by Cognero.
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TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
understand and be able to articulate the goals of the firm, the role of the finance function in the enterprise's organization, and as an analyst using public information. Miscellaneous concepts Bloom's: Comprehension Multiple Choice: Conceptual 9/21/2017 3:16 PM 9/21/2017 3:16 PM
63. Which of the following statements is CORRECT? a. Corporations face few regulations and more favorable tax treatment than do proprietorships and partnerships. b. Managers who face the threat of hostile takeovers are less likely to pursue policies that maximize shareholder value compared to managers who do not face the threat of hostile takeovers. c. Bond covenants are an effective way to resolve conflicts between shareholders and managers. d. Because of their simplified organization, it is easier for proprietors and partnerships to raise large amounts of outside capital than it is for corporations. e. One advantage to forming a corporation is that the owners of the firm have limited liability. ANSWER: e POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.01.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - Students will understand and be - Students will understand and be able to articulate the goals of the firm, the role of the finance function in the enterprise's organization, and as an analyst using public information. TOPICS: Miscellaneous concepts KEYWORDS: Bloom's: Knowledge OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 3:16 PM DATE MODIFIED: 9/21/2017 3:16 PM Multiple Choice: Problems 64. New Business is just being formed by 10 investors, each of whom will own 10% of the business. The firm is expected to earn $500,000 before taxes each year. The corporate tax rate is 34% and the personal tax rate for the firm's investors is 35%. The firm does not need to retain any earnings, so all of its after-tax income will be paid out as dividends to its investors. The investors will have to pay personal taxes on whatever they receive. How much additional spendable income will each investor have if the business is organized as a partnership rather than as a corporation? a. $11,050 b. $12,266 c. $10,056 d. $9,282 e. $11,713 ANSWER: a Copyright Cengage Learning. Powered by Cognero.
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RATIONALE:
Business income: Number of investors (N):
$500,000 Corporate tax rate (TC): 10 Personal tax rate (TP):
34% 35%
Corporation:
Corporate taxes Income after corporate tax, paid to investors (stockholders) as dividends Tax on dividends Spendable income
$ 170,000 330,000 115,500 $ 214,500
Partnership: Taxes paid by business Income received by investors (partners) Taxes paid by partners as personal income Spendable income
$
0 500,000 175,000 $ 325,000
Difference in spendable income: total gain from being a partnership
$ 110,500
Individual investor gain
$ 11,050
POINTS: 1 DIFFICULTY: EASY REFERENCES: 1-3 Forms of Business Organization QUESTION TYPE: Multiple Choice HAS VARIABLES: True PREFACE NAME: Problems LEARNING OBJECTIVES: FOFM.BRIG.17.01.03 - Forms of Business Organization NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - Students will understand and be - Students will understand and be able to articulate the goals of the firm, the role of the finance function in the enterprise's organization, and as an analyst using public information. TOPICS: Tax effects of organization KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 3:16 PM DATE MODIFIED: 9/21/2017 3:16 PM 65. Assume that the corporate tax rate is 34% and the personal tax rate is 30%. The founders of a newly formed business are debating between setting up the firm as a partnership versus a corporation. The firm will not need to retain any earnings, so all of its after-tax income will be paid out to its investors, who will have to pay personal taxes on whatever they receive. What is the difference in the percentage of the firm's pre-tax income that investors actually receive and can spend under the corporate and partnership forms of organization ? a. 22.61% b. 23.80% c. 21.90% d. 23.56% e. 28.56% Copyright Cengage Learning. Powered by Cognero.
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ANSWER: RATIONALE:
b Corporate tax rate (TC):
34%
Personal tax rate (TP):
30%
Corporation:
Corporate net Investors' net
= Business pre-tax income (1 - TC) = Corporate net (1 - TP) = Business pre-tax net (1 - TC) (1 - TP) = Business pre-tax net×66%×70%
46.2%
Partnership: The business pays no tax, but investors pay tax on business income.
Investors' net = Business pre-tax net (1 - TP) = Business pre-tax net (1 - TP) Difference POINTS: 1 DIFFICULTY: EASY REFERENCES: 1-3 Forms of Business Organization QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES FOFM.BRIG.17.01.03 - Forms of Business Organization : NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: LOCAL STANDARDS:
TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
70% 23.80%
United States - OH - DISC.FOFM.BRIG.17.06 - Finance function United States - OH - Default City - Students will understand and be - Students will understand and be able to articulate the goals of the firm, the role of the finance function in the enterprise's organization, and as an analyst using public information. Tax effects of organization Bloom's: Application Multiple Choice: Problem 9/21/2017 3:16 PM 9/21/2017 3:16 PM
66. Charleston Corporation (CC) now operates as a "regular" corporation, but it is considering a switch to S Corporation status. CC is owned by 100 stockholders who each hold 1% of the stock, and each faces a personal tax rate of 35%. The firm earns $2,800,000 per year before taxes, and since it has no need for retained earnings, it pays out all of its earnings as dividends. Assume that the corporate tax rate is 34% and the personal tax rate is 35%. How much more (or less) spendable income would each stockholder have if the firm elected S Corporation status? a. $6,436 b. $5,507 c. $6,188 d. $6,497 e. $6,250 ANSWER: c RATIONALE: Business income: $2,800,000 Corporate tax rate (TC): 34% Number of investors (N): 100 Personal tax rate (TP): 35% Corporation:
Corporate taxes Income after corporate tax, paid to investors (stockholders) as dividends Tax on dividends Copyright Cengage Learning. Powered by Cognero.
$952,000 1,848,000 646,800 Page 36
Spendable income, total Spendable income, each (100 investors)
$1,201,200 $ 12,012
S Corporation:
Taxes paid by business Income received by investors Taxes paid by investors as personal income Spendable income, total Spendable income, each (100 investors)
$ 0 2,800,000 980,000 $1,820,000 $ 18,200
Difference in spendable income: gain from being an S Corporation
$
6,188
POINTS: 1 DIFFICULTY: EASY REFERENCES: 1-3 Forms of Business Organization QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.01.03 - Forms of Business Organization NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - Students will understand and be - Students will understand and be able to articulate the goals of the firm, the role of the finance function in the enterprise's organization, and as an analyst using public information. TOPICS: Tax effects of organization KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 3:16 PM DATE MODIFIED: 9/21/2017 3:16 PM
Copyright Cengage Learning. Powered by Cognero.
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Chapter 2
Note that there is an overlap between the T/F and multiple-choice questions, as some of the T/F statements are used in multiple-choice questions. Multiple Choice: True/False 1. A financial intermediary is a corporation that takes funds from investors and then provides those funds to those who need capital. A bank that takes in demand deposits and then uses that money to make long-term mortgage loans is one example of a financial intermediary. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 2-1 The Capital Allocation Process QUESTION TYPE: True / False HAS VARIABLES: False PREFACE NAME: T/F LEARNING OBJECTIVES: FOFM.BRIG.17.02.01 - The Capital Allocation Process NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Financial intermediaries KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 3:17 PM DATE MODIFIED: 9/21/2017 3:17 PM 2. The NYSE is defined as a "spot" market purely and simply because it has a physical location. The NASDAQ, on the other hand, is not a spot market because it has no one central location. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 2-2 Financial Markets QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.02.02 - Financial Markets NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Financial markets KEYWORDS: Bloom's: Knowledge Copyright Cengage Learning. Powered by Cognero.
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DATE CREATED: DATE MODIFIED:
9/21/2017 3:17 PM 9/21/2017 3:17 PM
3. The NYSE is defined as a "primary" market because it is one of the largest and most important stock markets in the world. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 2-2 Financial Markets QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.02.02 - Financial Markets NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Financial markets KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 3:17 PM DATE MODIFIED: 9/21/2017 3:17 PM 4. Primary markets are large and important, while secondary markets are smaller and less important. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 2-2 Financial Markets QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.02.02 - Financial Markets NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Financial markets KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 3:17 PM DATE MODIFIED: 9/21/2017 3:17 PM 5. Private markets are those like the NYSE, where transactions are handled by members of the organization, while public markets are those like the NASDAQ, where anyone can make transactions. a. True b. False Copyright Cengage Learning. Powered by Cognero.
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ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 2-2 Financial Markets QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.02.02 - Financial Markets NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Financial markets KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 3:17 PM DATE MODIFIED: 9/21/2017 3:17 PM 6. A share of common stock is not a derivative, but an option to buy the stock is a derivative because the value of the option is derived from the value of the stock. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 2-2 Financial Markets QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.02.02 - Financial Markets NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Financial markets KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 3:17 PM DATE MODIFIED: 9/21/2017 3:17 PM 7. Financial institutions are more diversified today than they were in the past, when federal laws kept investment banks, commercial banks, insurance companies, and similar organizations quite separate. Today the larger financial services corporations offer a variety of services, ranging from checking accounts, to insurance, to underwriting securities, to stock brokerage. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 2-3 Financial Institutions Copyright Cengage Learning. Powered by Cognero.
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QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.02.03 - Financial Institutions NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Financial institutions KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 3:17 PM DATE MODIFIED: 9/21/2017 3:17 PM 8. Hedge funds are somewhat similar to mutual funds. The primary differences are that hedge funds are less highly regulated, have more flexibility regarding what they can buy, and restrict their investors to wealthy, sophisticated individuals and institutions. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 2-3 Financial Institutions QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.02.03 - Financial Institutions NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Financial institutions KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 3:17 PM DATE MODIFIED: 9/21/2017 3:17 PM 9. Trades on the NYSE are generally completed by having a brokerage firm acting as a "dealer" buy securities and adding them to its inventory or selling from its inventory. The NASDAQ, on the other hand, operates as an auction market, where buyers offer to buy, and sellers to sell, and the price is negotiated on the floor of the exchange. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 2-4 The Stock Market QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.02.04 - The Stock Market NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking Copyright Cengage Learning. Powered by Cognero.
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STATE STANDARDS: LOCAL STANDARDS: TOPICS: KEYWORDS: DATE CREATED: DATE MODIFIED:
United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. Stock market Bloom's: Knowledge 9/21/2017 3:17 PM 9/21/2017 3:17 PM
10. The "over-the-counter" market received its name years ago because brokerage firms would hold inventories of stocks and then sell them by literally passing them over the counter to the buyer. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 2-4 The Stock Market QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.02.04 - The Stock Market NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Stock market KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 3:17 PM DATE MODIFIED: 9/21/2017 3:17 PM 11. If you decide to buy 100 shares of Google, you would probably do so by calling your broker and asking him or her to execute the trade for you. This would be defined as a secondary market transaction, not a primary market transaction. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 2-5 The Market for Common Stock QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.02.05 - The Market for Common Stock NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Stock market transactions KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 3:17 PM Copyright Cengage Learning. Powered by Cognero.
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DATE MODIFIED:
9/21/2017 3:17 PM
12. The term IPO stands for "individual purchase order," as when an individual (as opposed to an institution) places an order to buy a stock. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 2-5 The Market for Common Stock QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.02.05 - The Market for Common Stock NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Stock market transactions KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 3:17 PM DATE MODIFIED: 9/21/2017 3:17 PM 13. In a "Dutch auction" for new stock, individual investors place bids for shares directly. Each potential bidder indicates the price he or she is willing to pay and how many shares he or she will purchase at that price. The highest price that permits the company to sell all the shares it wants to sell is determined, and this is the "market clearing price." All bidders who specified this price or higher are allowed to purchase their shares at the market clearing price. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 2-5 The Market for Common Stock QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.02.05 - The Market for Common Stock NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Stock market transactions KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 3:17 PM DATE MODIFIED: 9/21/2017 3:17 PM 14. When a corporation's shares are owned by a few individuals who are associated with the firm's management, we say that the stock is closely held. a. True Copyright Cengage Learning. Powered by Cognero.
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b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 2-5 The Market for Common Stock QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.02.05 - The Market for Common Stock NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Closely held stock KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 3:17 PM DATE MODIFIED: 9/21/2017 3:17 PM 15. A publicly owned corporation is a company whose shares are held by the investing public, which may include other corporations as well as institutional investors. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 2-5 The Market for Common Stock QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.02.05 - The Market for Common Stock NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Public company KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 3:17 PM DATE MODIFIED: 9/21/2017 3:17 PM 16. If you wanted to know what rate of return stocks have provided in the past, you could examine data on the Dow Jones Industrial Index, the S&P 500 Index, or the NASDAQ Index. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 2-6 Stock Markets and Returns QUESTION TYPE: True / False Copyright Cengage Learning. Powered by Cognero.
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HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.02.06 - Stock Markets and Returns NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Stock market returns KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 3:17 PM DATE MODIFIED: 9/21/2017 3:17 PM 17. The annual rate of return on any given stock can be found as the stock's dividend for the year plus the change in the stock's price during the year, divided by its beginning-of-year price. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 2-6 Stock Markets and Returns QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.02.06 - Stock Markets and Returns NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Stock market returns KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 3:17 PM DATE MODIFIED: 9/21/2017 3:17 PM 18. The annual rate of return on any given stock can be found as the stock's dividend for the year plus the change in the stock's price during the year, divided by its beginning-of-year price. If you obtain such data on a large portfolio of stocks, like those in the S&P 500, find the rate of return on each stock, and then average those returns, this would give you an idea of stock market returns for the year in question. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 2-6 Stock Markets and Returns QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.02.06 - Stock Markets and Returns NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates Copyright Cengage Learning. Powered by Cognero.
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LOCAL STANDARDS: TOPICS: KEYWORDS: DATE CREATED: DATE MODIFIED:
United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. Stock market returns Bloom's: Comprehension 9/21/2017 3:17 PM 9/21/2017 3:17 PM
19. Each stock's rate of return in a given year consists of a dividend yield (which might be zero) plus a capital gains yield (which could be positive, negative, or zero). Such returns are calculated for all the stocks in the S&P 500. A weighted average of those returns, using each stock's total market value, is then calculated, and that average return is often used as an indicator of the "return on the market." a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 2-6 Stock Markets and Returns QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.02.06 - Stock Markets and Returns NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Stock market returns KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 3:17 PM DATE MODIFIED: 9/21/2017 3:17 PM 20. Each stock's rate of return in a given year consists of a dividend yield (which might be zero) plus a capital gains yield (which could be positive, negative, or zero). Such returns are calculated for all the stocks in the S&P 500. A simple average of those returns (which gives equal weight to each company in the S&P 500) is then calculated. That average is called "the return on the S&P Index," and it is often used as an indicator of the "return on the market." a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 2-6 Stock Markets and Returns QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.02.06 - Stock Markets and Returns NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Stock market returns Copyright Cengage Learning. Powered by Cognero.
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KEYWORDS: DATE CREATED: DATE MODIFIED:
Bloom's: Comprehension 9/21/2017 3:17 PM 9/21/2017 3:17 PM
Multiple Choice: Conceptual 21. You recently sold 100 shares of Microsoft stock to your brother at a family reunion. At the reunion your brother gave you a check for the stock and you gave your brother the stock certificates. Which of the following best describes this transaction? a. This is an example of a direct transfer of capital. b. This is an example of a primary market transaction. c. This is an example of an exchange of physical assets. d. This is an example of a money market transaction. e. This is an example of a derivative market transaction. ANSWER: a POINTS: 1 DIFFICULTY: EASY REFERENCES: 2-1 The Capital Allocation Process QUESTION TYPE: Multiple Choice HAS VARIABLES: False PREFACE NAME: Conceptual LEARNING OBJECTIVES: FOFM.BRIG.17.02.01 - The Capital Allocation Process NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Capital allocation KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 3:17 PM DATE MODIFIED: 9/21/2017 3:17 PM 22. Which of the following statements is CORRECT? a. The NYSE does not exist as a physical location. Rather it represents a loose collection of dealers who trade stock electronically. b. An example of a primary market transaction would be your uncle transferring 100 shares of Walmart stock to you as a birthday gift. c. Capital market instruments include both long-term debt and common stocks. d. If your uncle in New York sold 100 shares of Microsoft through his broker to an investor in Los Angeles, this would be a primary market transaction. e. While the two frequently perform similar functions, investment banks generally specialize in lending money, whereas commercial banks generally help companies raise large blocks of capital from investors. ANSWER: c POINTS: 1 DIFFICULTY: EASY REFERENCES: 2-2 Financial Markets Copyright Cengage Learning. Powered by Cognero.
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QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.02.02 - Financial Markets NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Financial markets KEYWORDS: Bloom's: Knowledge OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 3:17 PM DATE MODIFIED: 9/21/2017 3:17 PM 23. Which of the following is a primary market transaction? a. You sell 200 shares of IBM stock on the NYSE through your broker. b. You buy 200 shares of IBM stock from your brother. The trade is not made through a broker; you just give him cash and he gives you the stock. c. IBM issues 2,000,000 shares of new stock and sells them to the public through an investment banker. d. One financial institution buys 200,000 shares of IBM stock from another institution. An investment banker arranges the transaction. e. IBM sells 2,000,000 shares of treasury stock to its employees when they exercise options that were granted in prior years. ANSWER: c POINTS: 1 DIFFICULTY: EASY REFERENCES: 2-2 Financial Markets QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.02.02 - Financial Markets NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Financial markets KEYWORDS: Bloom's: Knowledge OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 3:17 PM DATE MODIFIED: 9/21/2017 3:17 PM 24. Which of the following is an example of a capital market instrument? a. Commercial paper. b. Preferred stock. c. U.S. Treasury bills. d. Banker's acceptances. e. Money market mutual funds. ANSWER: b Copyright Cengage Learning. Powered by Cognero.
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POINTS: 1 DIFFICULTY: EASY REFERENCES: 2-2 Financial Markets QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.02.02 - Financial Markets NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Capital market instruments KEYWORDS: Bloom's: Knowledge OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 3:17 PM DATE MODIFIED: 9/21/2017 3:17 PM 25. Money markets are markets for a. Foreign currencies. b. Consumer automobile loans. c. Common stocks. d. Long-term bonds. e. Short-term debt securities such as Treasury bills and commercial paper. ANSWER: e POINTS: 1 DIFFICULTY: EASY REFERENCES: 2-2 Financial Markets QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.02.02 - Financial Markets NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Money markets KEYWORDS: Bloom's: Knowledge OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 3:17 PM DATE MODIFIED: 9/21/2017 3:17 PM 26. Which of the following statements is CORRECT? a. If you purchase 100 shares of Disney stock from your brother-in-law, this is an example of a primary market transaction. b. If Disney issues additional shares of common stock through an investment banker, this would be a secondary market transaction. c. The NYSE is an example of an over-the-counter market. d. Only institutions, and not individuals, can engage in derivative market transactions. Copyright Cengage Learning. Powered by Cognero.
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e. As they are generally defined, money market transactions involve debt securities with maturities of less than one year. ANSWER: e POINTS: 1 DIFFICULTY: EASY REFERENCES: 2-2 Financial Markets QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.02.02 - Financial Markets NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Financial market transactions KEYWORDS: Bloom's: Knowledge OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 3:17 PM DATE MODIFIED: 9/21/2017 3:17 PM 27. You recently sold 200 shares of Disney stock, and the transfer was made through a broker. This is an example of: a. A money market transaction. b. A primary market transaction. c. A secondary market transaction. d. A futures market transaction. e. An over-the-counter market transaction. ANSWER: c POINTS: 1 DIFFICULTY: EASY REFERENCES: 2-2 Financial Markets QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.02.02 - Financial Markets NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Financial market transactions KEYWORDS: Bloom's: Knowledge OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 3:17 PM DATE MODIFIED: 9/21/2017 3:17 PM 28. Which of the following statements is CORRECT? a. Hedge funds are legal in Europe and Asia, but they are not permitted to operate in the United States. b. Hedge funds are legal in the United States, but they are not permitted to operate in Europe or Asia. c. Hedge funds have more in common with investment banks than with any other type of financial institution. Copyright Cengage Learning. Powered by Cognero.
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d. Hedge funds have more in common with commercial banks than with any other type of financial institution. e. Hedge funds are not as highly regulated as most other types of financial institutions. The justification for this light regulation is that only "sophisticated" investors (i.e., those with high net worths and high incomes) are permitted to invest in these funds, and these investors supposedly can do any necessary "due diligence" on their own rather than have it done by the SEC or some other regulator. ANSWER: e POINTS: 1 DIFFICULTY: EASY REFERENCES: 2-3 Financial Institutions QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.02.03 - Financial Institutions NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Hedge funds KEYWORDS: Bloom's: Knowledge OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 3:17 PM DATE MODIFIED: 9/21/2017 3:17 PM 29. Which of the following statements is CORRECT? a. While the distinctions are becoming blurred, investment banks generally specialize in lending money, whereas commercial banks generally help companies raise capital from other parties. b. The NYSE operates as an auction market, whereas NASDAQ is an example of a dealer market. c. Money market mutual funds usually invest their money in a well-diversified portfolio of liquid common stocks. d. Money markets are markets for long-term debt and common stocks. e. A liquid security is a security whose value is derived from the price of some other "underlying" asset. ANSWER: b POINTS: 1 DIFFICULTY: EASY REFERENCES: 2-4 The Stock Market QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.02.04 - The Stock Market NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Financial makets and institutions KEYWORDS: Bloom's: Knowledge OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 3:17 PM DATE MODIFIED: 9/21/2017 3:17 PM Copyright Cengage Learning. Powered by Cognero.
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30. Which of the following statements is CORRECT? a. The New York Stock Exchange is an auction market, and it has a physical location. b. Home mortgage loans are traded in the money market. c. If an investor sells shares of stock through a broker, then it would be a primary market transaction. d. Capital markets deal only with common stocks and other equity securities. e. While the distinctions are blurring, investment banks generally specialize in lending money, whereas commercial banks generally help companies raise capital from other parties. ANSWER: a POINTS: 1 DIFFICULTY: EASY REFERENCES: 2-4 The Stock Market QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.02.04 - The Stock Market NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Financial markets KEYWORDS: Bloom's: Knowledge OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 3:17 PM DATE MODIFIED: 9/21/2017 3:17 PM 31. Which of the following statements is CORRECT? a. The term "IPO" stands for Introductory Price Offered, and it is the price at which shares of a new company are offered to the public. b. IPO prices are generally established by the market, and buyers of the new stock must pay the price that prevails at the close of trading on the day the stock is offered to the public. c. In a "Dutch auction," investors who want to buy shares in an IPO submit bids indicating how many shares they want to buy and the price they are willing to pay. The company determines how many shares it wants to sell. The highest price that enables the company to sell the desired number of shares is the price that all buyers must pay. d. It is possible that the price set in an IPO is so high that investors will refuse to buy the number of shares that the company wants to sell. In this situation, the IPO is said to be oversubscribed. e. It is possible that the price set in an IPO is so low that investors will want to buy more shares than the company wants to sell. In that case, the company will have to issue more shares than it wants to sell. ANSWER: c POINTS: 1 DIFFICULTY: EASY REFERENCES: 2-5 The Market for Common Stock QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.02.05 - The Market for Common Stock NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates Copyright Cengage Learning. Powered by Cognero.
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LOCAL STANDARDS: TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. IPOs Bloom's: Knowledge Multiple Choice: Conceptual 9/21/2017 3:17 PM 9/21/2017 3:17 PM
32. Which of the following statements is CORRECT? a. The most important difference between spot markets versus futures markets is the maturity of the instruments that are traded. Spot market transactions involve securities that have maturities of less than one year whereas futures markets transactions involve securities with maturities greater than one year. b. Capital market transactions involve only preferred stock or common stock. c. If General Electric were to issue new stock this year, this would be considered a secondary market transaction since the company already has stock outstanding. d. Both NASDAQ dealers and "specialists" on the NYSE hold inventories of stocks. e. Money market transactions do not involve securities denominated in currencies other than the U.S. dollar. ANSWER: d POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 2-4 The Stock Market QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.02.04 - The Stock Market NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Financial markets KEYWORDS: Bloom's: Knowledge OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 3:17 PM DATE MODIFIED: 9/21/2017 3:17 PM 33. Which of the following statements is NOT CORRECT? a. When a corporation's shares are owned by a few individuals, we say that the firm is "closely, or privately, held." b. "Going public" establishes a firm's true intrinsic value and ensures that a liquid market will always exist for the firm's shares. c. The stock of publicly owned companies must generally be registered with and reported to a regulatory agency such as the SEC. d. When stock in a closely held corporation is offered to the public for the first time, the transaction is called "going public, or an IPO," and the market for such stock is called the new issue or IPO market. e. It is possible for a firm to go public and yet not raise any additional new capital for the firm itself. ANSWER: b POINTS: 1 DIFFICULTY: CHALLENGING Copyright Cengage Learning. Powered by Cognero.
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REFERENCES: 2-5 The Market for Common Stock QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.02.05 - The Market for Common Stock NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Ownership and going public KEYWORDS: Bloom's: Knowledge OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 3:17 PM DATE MODIFIED: 9/21/2017 3:17 PM
This chapter has a lot of definitions. They are important, but we don't like to make students memorize too many of them early in the course. We let our students use the formula sheet that includes the key definitions. Note that there is an overlap between the T/F and multiple-choice questions, as some of the T/F statements are used in multiple-choice questions. Multiple Choice: True/False 1. The annual report contains four basic financial statements: the income statement, the balance sheet, the cash flow statement, and the statement of stockholders' equity. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 3-1 Financial Statements and Reports QUESTION TYPE: True / False HAS VARIABLES: False PREFACE NAME: T/F LEARNING OBJECTIVES: FOFM.BRIG.17.03.01 - Financial Statements and Reports NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Annual report KEYWORDS: Bloom's: Remember DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 11/8/2017 12:25 PM 2. The primary reason the annual report is important in finance is that it is used by investors when they form expectations about the firm's future earnings and dividends and the riskiness of those cash flows. a. True b. False Copyright Cengage Learning. Powered by Cognero.
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ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 3-1 Financial Statements and Reports QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.03.01 - Financial Statements and Reports NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Annual report KEYWORDS: Bloom's: Remember DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 11/8/2017 12:25 PM 3. Companies typically provide four basic financial statements: the fixed income statement, the current income statement, the balance sheet, and the cash flow statement. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 3-1 Financial Statements and Reports QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.03.01 - Financial Statements and Reports NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Financial statements KEYWORDS: Bloom's: Remember DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 11/8/2017 12:25 PM 4. On the balance sheet, total assets must always equal the sum of total liabilities and equity. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 3-2 The Balance Sheet QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.03.02 - The Balance Sheet Copyright Cengage Learning. Powered by Cognero.
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NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Balance sheet KEYWORDS: Bloom's: Remember DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 11/8/2017 12:25 PM 5. Assets other than cash are expected to produce cash over time, but the amount of cash they eventually produce could be higher or lower than the amounts at which the assets are carried on the books. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 3-2 The Balance Sheet QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.03.02 - The Balance Sheet NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Balance sheet KEYWORDS: Bloom's: Remember DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 11/8/2017 12:25 PM 6. The amount shown on the December 31, 2018 balance sheet as "retained earnings" is equal to the firm's net income for 2018 minus any dividends it paid a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 3-2 The Balance Sheet QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.03.02 - The Balance Sheet NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. Copyright Cengage Learning. Powered by Cognero.
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TOPICS: KEYWORDS: DATE CREATED: DATE MODIFIED:
Balance sheet. Bloom's: Remember 11/8/2017 8:54 AM 11/8/2017 12:25 PM
7. The income statement shows the difference between a firm's income and its costs—i.e., its profits—during a specified period of time. However, not all reported income comes in the form of cash, and reported costs likewise may not be consistent with cash outlays. Therefore, there may be a substantial difference between a firm's reported profits and its actual cash flow for the same period. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 3-3 The Income Statement QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.03.03 - The Income Statement NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Income statement KEYWORDS: Bloom's: Understand DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 11/8/2017 12:25 PM 8. The balance sheet represents a snapshot in time, whereas the income statement reports on operations over a period of time. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 3-3 The Income Statement QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.03.03 - The Income Statement NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Income statement KEYWORDS: Bloom's: Remember DATE CREATED: 11/8/2017 8:54 AM Copyright Cengage Learning. Powered by Cognero.
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DATE MODIFIED:
11/8/2017 12:25 PM
9. EBIT, often referred to as operating income, stands for "earnings before interest and taxes." a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 3-3 The Income Statement QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.03.03 - The Income Statement NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Income statement KEYWORDS: Bloom's: Remember DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 11/8/2017 12:25 PM 10. EBITDA stands for "earnings before interest, taxes, debt, and assets." a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 3-3 The Income Statement QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.03.03 - The Income Statement NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Income statement KEYWORDS: Bloom's: Remember DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 11/8/2017 12:25 PM 11. Consider the following balance sheet for Games Inc. Because Games has $800,000 of retained earnings, we know that the company would be able to pay cash to buy an asset with a cost of $200,000. Cash
$50,000
Accounts payable
$100,000
Inventory
$200,000
Accruals
$100,000
Copyright Cengage Learning. Powered by Cognero.
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Accounts receivable
$250,000
Total CL
$200,000
Total CA
$500,000
Long-term debt
$200,000
Net fixed assets
$900,000
Common stock
$200,000
Retained earnings
$800,000
Total L & E
$1,400,000
Total assets
$1,400,000
a. True b. False ANSWER: RATIONALE:
False Note that the firm has only $50,000 of cash. It would have to either sell assets or borrow $150,000 to pay cash for the new asset. That might not be possible. POINTS: 1 DIFFICULTY: EASY REFERENCES: 3-5 Statement of Stockholders' Equity QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.03.05 - Statement of Stockholders' Equity NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Retained earnings KEYWORDS: Bloom's: Understand DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 11/8/2017 12:25 PM 12. Typically, the statement of stockholders' equity starts with total stockholders' equity at the beginning of the year, adds net income, subtracts dividends paid, and ends with total stockholders' equity at the end of the year. Over time, a profitable company will have earnings in excess of the dividends it pays out, resulting in a substantial amount of retained earnings shown on the balance sheet. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 3-5 Statement of Stockholders' Equity QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.03.05 - Statement of Stockholders' Equity NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.17.06 - Finance function Copyright Cengage Learning. Powered by Cognero.
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LOCAL STANDARDS: TOPICS: KEYWORDS: DATE CREATED: DATE MODIFIED:
United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. Stockholders' equity statement Bloom's: Understand 11/8/2017 8:54 AM 11/8/2017 1:05 PM
13. Free cash flow (FCF) is, essentially, the cash flow that is available for interest and dividends after the company has made the investments in current and fixed assets that are necessary to sustain ongoing operations. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 3-7 Free Cash Flow QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.03.07 - Free Cash Flow NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Free cash flow KEYWORDS: Bloom's: Remember DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 11/8/2017 12:25 PM 14. The value of any asset is the present value of the cash flows the asset is expected to provide. The cash flows a business is able to provide to its investors is its free cash flow. This is the reason that FCF is so important in finance. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 3-7 Free Cash Flow QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.03.07 - Free Cash Flow NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Free cash flow KEYWORDS: Bloom's: Remember DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 11/8/2017 12:25 PM Copyright Cengage Learning. Powered by Cognero.
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15. If a firm is reporting its income in accordance with generally accepted accounting principles, then its net income as reported on the income statement should be equal to its free cash flow. a. True b. False ANSWER: False RATIONALE: There is no reason to think that net income would be equal to FCF. For example, a company that is not growing might report zero net income yet have high FCF because of depreciation. POINTS: 1 DIFFICULTY: EASY REFERENCES: 3-7 Free Cash Flow QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.03.07 - Free Cash Flow NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Free cash flow KEYWORDS: Bloom's: Understand DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 11/8/2017 12:25 PM 16. The fact that 70% of the interest income received by corporations is excluded from its taxable income encourages firms to finance with more debt than they would in the absence of this tax law provision. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 3-9 Income Taxes QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.03.09 - Income Taxes NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Income taxes KEYWORDS: Bloom's: Remember DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 11/8/2017 1:05 PM 17. Both interest and dividends paid by a corporation are deductible operating expenses, hence they decrease the firm's taxes. a. True Copyright Cengage Learning. Powered by Cognero.
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b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 3-9 Income Taxes QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.03.09 - Income Taxes NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Income taxes KEYWORDS: Bloom's: Remember DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 11/8/2017 1:05 PM 18. The balance sheet measures the flow of funds into and out of various accounts over time, while the income statement measures the firm's financial position at a point in time. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: Comprehensive QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.03.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Financial statements KEYWORDS: Bloom's: Remember DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 11/8/2017 12:25 PM 19. Assume that two firms are both following generally accepted accounting principles. Both firms commenced operations two years ago with $1 million of identical fixed assets, and neither firm sold any of those assets or purchased any new fixed assets. The two firms would be required to report the same amount of net fixed assets on their balance sheets as those statements are presented to investors. a. True b. False ANSWER: False RATIONALE: One firm might choose to use straight-line depreciation, the other an accelerated method, and this would lead to differences in reported depreciation and therefore reported net fixed assets. Copyright Cengage Learning. Powered by Cognero.
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POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 3-2 The Balance Sheet QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.03.02 - The Balance Sheet NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Retained earnings KEYWORDS: Bloom's: Understand DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 11/8/2017 12:25 PM 20. Net operating working capital is equal to current assets less excess cash minus the difference between current liabilities and notes payable. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 3-2 The Balance Sheet QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.03.02 - The Balance Sheet NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Net operating working capital KEYWORDS: Bloom's: Remember DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 12/13/2017 9:43 AM 21. The next-to-last line on the income statement shows the firm's earnings, while the last line shows the dividends the company paid. Therefore, the dividends are frequently called "the bottom line." a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 3-3 The Income Statement QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.03.03 - The Income Statement Copyright Cengage Learning. Powered by Cognero.
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NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Income statement KEYWORDS: Bloom's: Remember DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 11/8/2017 12:25 PM 22. The statement of cash flows has four main sections, one each for operating, investing, and financing activities, and one that shows a summary of the cash and cash equivalents at the end of the year. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 3-4 Statement of Cash Flows QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.03.04 - Statement of Cash Flows NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Statement of cash flows KEYWORDS: Bloom's: Remember DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 11/8/2017 12:25 PM 23. An increase in accounts payable represents an increase in net cash provided by operating activities, an effect similar to taking out a new bank loan. However, these two items show up in different sections of the statement of cash flows to reflect the difference between operating and financing activities. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 3-4 Statement of Cash Flows QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.03.04 - Statement of Cash Flows NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. Copyright Cengage Learning. Powered by Cognero.
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TOPICS: KEYWORDS: DATE CREATED: DATE MODIFIED:
Statement of cash flows Bloom's: Understand 11/8/2017 8:54 AM 11/8/2017 12:25 PM
24. An increase in accounts receivable represents an increase in net cash provided by operating activities because receivables will produce cash when they are collected. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 3-4 Statement of Cash Flows QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.03.04 - Statement of Cash Flows NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Statement of cash flows KEYWORDS: Bloom's: Understand DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 11/8/2017 12:25 PM 25. The first major section of a typical statement of cash flows is "Operating Activities," and the first entry in this section is "Net Income." Then, also in the first section, we show some items that represent increases or decreases to cash, and the last entry is called "Net Cash Provided by Operating Activities." This number can be either positive or negative, but if it is negative, the firm is almost certain to soon go bankrupt. a. True b. False ANSWER: False RATIONALE: Rapidly growing firms often require additions to inventory and receivables that are larger than net income, with the deficit being made up by borrowings and/or the sale of new stock. POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 3-4 Statement of Cash Flows QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.03.04 - Statement of Cash Flows NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Statement of cash flows Copyright Cengage Learning. Powered by Cognero.
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KEYWORDS: DATE CREATED: DATE MODIFIED:
Bloom's: Understand 11/8/2017 8:54 AM 11/8/2017 12:25 PM
26. To estimate the cash flow from operations, depreciation must be added back to net income because depreciation is a non-cash charge that has been deducted from revenue in the net income calculation. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 3-4 Statement of Cash Flows QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.03.04 - Statement of Cash Flows NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Statement of cash flows KEYWORDS: Bloom's: Remember DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 11/8/2017 12:25 PM 27. Two metrics that are used to measure a company's financial performance are net income and cash flow. Accountants emphasize net income as calculated in accordance with generally accepted accounting principles. Finance people generally put at least as much weight on cash flows as they do on net income. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 3-4 Statement of Cash Flows QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.03.04 - Statement of Cash Flows NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Cash flow and net income KEYWORDS: Bloom's: Remember DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 11/8/2017 12:25 PM 28. Its retained earnings is the actual cash that the firm has generated through operations less the cash that has been paid Copyright Cengage Learning. Powered by Cognero.
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out to stockholders as dividends. If the firm has sufficient retained earnings, it can purchase assets and pay for them with cash from retained earnings. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 3-5 Statement of Stockholders' Equity QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.03.05 - Statement of Stockholders' Equity NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Retained earnings KEYWORDS: Bloom's: Remember DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 11/8/2017 12:25 PM 29. The retained earnings account on the balance sheet does not represent cash. Rather, it represents part of the stockholders' claim against the firm's existing assets. Put another way, retained earnings are stockholders' reinvested earnings. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 3-5 Statement of Stockholders' Equity QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.03.05 - Statement of Stockholders' Equity NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Retained earnings KEYWORDS: Bloom's: Remember DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 11/8/2017 12:25 PM 30. In finance, we are generally more interested in cash flows than in accounting profits. Free cash flow (FCF) is calculated as after-tax operating income plus depreciation less the sum of capital expenditures and changes in net operating working capital. a. True b. False ANSWER: True Copyright Cengage Learning. Powered by Cognero.
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POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 3-7 Free Cash Flow QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.03.07 - Free Cash Flow NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Free cash flow KEYWORDS: Bloom's: Remember DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 11/8/2017 12:25 PM 31. Free cash flow is the amount of cash that, if withdrawn, would harm the firm's ability to operate and to produce future cash flows. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 3-7 Free Cash Flow QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.03.07 - Free Cash Flow NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Free cash flow KEYWORDS: Bloom's: Remember DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 11/8/2017 12:25 PM 32. If the tax laws were changed so that $0.50 out of every $1.00 of interest paid by a corporation was allowed as a taxdeductible expense, companies would be encouraged to use more debt financing than they presently do, other things held constant. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 3-9 Income Taxes QUESTION TYPE: True / False HAS VARIABLES: False Copyright Cengage Learning. Powered by Cognero.
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LEARNING OBJECTIVES: FOFM.BRIG.17.03.09 - Income Taxes NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Income taxes KEYWORDS: Bloom's: Understand DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 11/8/2017 12:25 PM 33. Interest paid by a corporation is a tax deduction for the paying corporation, but dividends paid are not deductible. This treatment, other things held constant, tends to encourage the use of debt financing by corporations. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 3-9 Income Taxes QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.03.09 - Income Taxes NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Income taxes KEYWORDS: Bloom's: Understand DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 11/8/2017 12:25 PM 34. Because the U.S. tax system is a progressive tax system, a taxpayer's marginal and average tax rates are the same. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 3-9 Income Taxes QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.03.09 - Income Taxes NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. Copyright Cengage Learning. Powered by Cognero.
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TOPICS: KEYWORDS: DATE CREATED: DATE MODIFIED:
Income taxes Bloom's: Remember 11/8/2017 8:54 AM 11/8/2017 12:25 PM
35. The alternative minimum tax (AMT) was created by Congress to make it more difficult for wealthy individuals to avoid paying taxes through the use of various deductions. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 3-9 Income Taxes QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.03.09 - Income Taxes NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Income taxes KEYWORDS: Bloom's: Remember DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 11/8/2017 12:25 PM 36. The time dimension is important in financial statement analysis. The balance sheet shows the firm's financial position at a given point in time, the income statement shows results over a period of time, and the statement of cash flows reflects specific changes in accounts over that period of time. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.03.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Financial statements KEYWORDS: Bloom's: Remember DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 11/8/2017 1:07 PM Copyright Cengage Learning. Powered by Cognero.
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Multiple Choice: Conceptual Please note that some of the answer choices, or answers that are very close, are used in different questions. This has caused us no difficulties, but please take this into account when you make up exams. 37. Which of the following statements is CORRECT? a. The four most important financial statements provided in the annual report are the balance sheet, income statement, cash budget, and the statement of stockholders' equity. b. The balance sheet gives us a picture of the firm’s financial position at a point in time. c. The income statement gives us a picture of the firm’s financial position at a point in time. d. The statement of cash flows tells us how much cash the firm must pay out in interest during the year. e. The statement of cash flows tells us how much cash the firm will require during some future period, generally a month or a year. ANSWER: b POINTS: 1 DIFFICULTY: EASY REFERENCES: 3-1 Financial Statements and Reports QUESTION TYPE: Multiple Choice HAS VARIABLES: False PREFACE NAME: Conceptual LEARNING OBJECTIVES: FOFM.BRIG.17.03.01 - Financial Statements and Reports NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Financial statements KEYWORDS: Bloom's: Remember OTHER: Multiple Choice: Conceptual DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 11/8/2017 12:25 PM 38. Which of the following statements is CORRECT? a. Assets other than cash are expected to produce cash over time, and the amounts of cash they eventually produce should be exactly the same as the amounts at which the assets are carried on the books. b. The primary reason the annual report is important in finance is that it is used by investors when they form expectations about the firm's future earnings and dividends and the riskiness of those cash flows. c. The annual report is an internal document prepared by a firm's managers solely for the use of its creditors/lenders. d. The four most important financial statements provided in the annual report are the balance sheet, income statement, cash budget, and the statement of stockholders' equity. e. Prior to the Enron scandal in the early 2000s, companies would put verbal information in their annual reports along with the financial statements. That verbal information was often misleading, so today annual reports can contain only quantitative information—audited financial statements. ANSWER: b POINTS: 1 DIFFICULTY: EASY REFERENCES: 3-1 Financial Statements and Reports Copyright Cengage Learning. Powered by Cognero.
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QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.03.01 - Financial Statements and Reports NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Financial statements KEYWORDS: Bloom's: Remember OTHER: Multiple Choice: Conceptual DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 11/8/2017 12:25 PM 39. Which of the following statements is CORRECT? a. The balance sheet for a given year is designed to give us an idea of what happened to the firm during that year. b. The balance sheet for a given year tells us how much money the company earned during that year. c. The difference between the total assets reported on the balance sheet and the liabilities reported on this statement tells us the current market value of the stockholders' equity, assuming the statements are prepared in accordance with generally accepted accounting principles (GAAP). d. If a company's statements were prepared in accordance with generally accepted accounting principles (GAAP), the market value of the stock equals the book value of the stock as reported on the balance sheet. e. The assets section of a typical company’s balance sheet begins with cash, then lists the assets in the order in which they will probably be converted to cash, with the longest-lived assets listed last. ANSWER: e POINTS: 1 DIFFICULTY: EASY REFERENCES: 3-2 The Balance Sheet QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.03.02 - The Balance Sheet NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Balance sheet KEYWORDS: Bloom's: Understand OTHER: Multiple Choice: Conceptual DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 11/8/2017 12:25 PM 40. Other things held constant, which of the following actions would increase the amount of cash on a company's balance sheet? a. The company repurchases common stock. b. The company pays a dividend. c. The company issues new common stock. d. The company gives customers more time to pay their bills. Copyright Cengage Learning. Powered by Cognero.
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e. The company purchases a new piece of equipment. ANSWER: c POINTS: 1 DIFFICULTY: EASY REFERENCES: 3-2 The Balance Sheet QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.03.02 - The Balance Sheet NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Balance sheet KEYWORDS: Bloom's: Understand OTHER: Multiple Choice: Conceptual DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 11/8/2017 1:07 PM 41. Which of the following items is NOT normally considered a current asset? a. Accounts receivable. b. Inventory. c. Bonds. d. Cash. e. Short-term, highly-liquid, marketable securities. ANSWER: c POINTS: 1 DIFFICULTY: EASY REFERENCES: 3-2 The Balance Sheet QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.03.02 - The Balance Sheet NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Current assets KEYWORDS: Bloom's: Understand OTHER: Multiple Choice: Conceptual DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 11/8/2017 1:07 PM 42. Which of the following items cannot be found on a firm’s balance sheet under current liabilities? a. Accounts payable. b. Short-term notes payable to the bank. Copyright Cengage Learning. Powered by Cognero.
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c. Accrued wages. d. Cost of goods sold. e. Accrued payroll taxes. ANSWER: d POINTS: 1 DIFFICULTY: EASY REFERENCES: 3-2 The Balance Sheet QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.03.02 - The Balance Sheet NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Current liabilities KEYWORDS: Bloom's: Understand OTHER: Multiple Choice: Conceptual DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 11/8/2017 1:08 PM 43. Which of the following statements is CORRECT? a. The focal point of the income statement is the cash account because that account cannot be manipulated by ―accounting tricks.‖ b. The reported income of two otherwise identical firms cannot be manipulated by different accounting procedures provided the firms follow generally accepted accounting principles (GAAP). c. The reported income of two otherwise identical firms must be identical if the firms are publicly owned, provided they follow procedures that are permitted by the Securities and Exchange Commission (SEC). d. If a firm follows generally accepted accounting principles (GAAP), then its reported net income will be identical to its reported cash flow. e. The income statement for a given year is designed to give us an idea of how much the firm earned during that year. ANSWER: e POINTS: 1 DIFFICULTY: EASY REFERENCES: 3-3 The Income Statement QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.03.03 - The Income Statement NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Income statement KEYWORDS: Bloom's: Understand Copyright Cengage Learning. Powered by Cognero.
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OTHER: DATE CREATED: DATE MODIFIED:
Multiple Choice: Conceptual 11/8/2017 8:54 AM 11/8/2017 1:08 PM
44. Below are the 2017 and 2018 year-end balance sheets for Tran Enterprises:
Assets: Cash Accounts receivable Inventories Total current assets Net fixed assets Total assets Liabilities and equity:
2018 $ 200,000 864,000 2,000,000 $3,064,000 6,000,000 $9,064,000
2017 $ 170,000 700,000 1,400,000 $2,270,000 5,600,000 $7,870,000
Accounts payable $1,400,000 $1,090,000 Notes payable to bank 1,600,000 1,800,000 Total current liabilities $3,000,000 $2,890,000 Long-term debt 2,400,000 2,400,000 Common stock 3,000,000 2,000,000 Retained earnings 664,000 580,000 Total common equity $3,664,000 $2,580,000 Total liabilities and equity $9,064,000 $7,870,000 The firm has never paid a dividend on its common stock, and it issued $2,400,000 of 10-year, non-callable, long-term debt in 2017. As of the end of 2018, none of the principal on this debt had been repaid. Assume that the company’s sales in 2017 and 2018 were the same. Which of the following statements must be CORRECT? a. The firm increased its short-term bank debt in 2018. b. The firm issued long-term debt in 2018. c. The firm issued new common stock in 2018. d. The firm repurchased some common stock in 2018. e. The firm had negative net income in 2018. ANSWER: c POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 3-2 The Balance Sheet QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.03.02 - The Balance Sheet NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Balance sheet KEYWORDS: Bloom's: Understand OTHER: Multiple Choice: Conceptual DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 11/8/2017 12:25 PM Copyright Cengage Learning. Powered by Cognero.
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45. Below is the common equity section (in millions) of Timeless Technology’s last two year-end balance sheets:
Common stock Retained earnings Total common equity
2018 2,000 2,000 $4,000
2017 1,000 2,340 $3,340
The firm has never paid a dividend to its common stockholders. Which of the following statements is CORRECT? a. The company’s net income in 2018 was higher than in 2017. b. The firm issued common stock in 2018. c. The market price of the firm's stock doubled in 2018. d. The firm had positive net income in both 2017 and 2018, but its net income in 2018 was lower than it was in 2017. e. The company has more equity than debt on its balance sheet. ANSWER: b POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 3-2 The Balance Sheet QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.03.02 - The Balance Sheet NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Balance sheet KEYWORDS: Bloom's: Understand OTHER: Multiple Choice: Conceptual DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 11/8/2017 12:25 PM 46. Which of the following statements is CORRECT? a. Typically, a firm’s DPS should exceed its EPS. b. Typically, a firm’s net income should exceed its EBIT. c. If a firm is more profitable than average, we would normally expect to see its stock price exceed its book value per share. d. If a firm is more profitable than most other firms, we would normally expect to see its book value per share exceed its stock price, especially after several years of high inflation. e. The more depreciation a firm has in a given year, the higher its EPS, other things held constant. ANSWER: c POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 3-3 The Income Statement QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.03.03 - The Income Statement Copyright Cengage Learning. Powered by Cognero.
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NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: EPS, DPS, BVPS, and stock price KEYWORDS: Bloom's: Understand OTHER: Multiple Choice: Conceptual DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 11/8/2017 12:25 PM 47. On its 12/31/18 balance sheet, Barnes Inc showed $510 million of retained earnings, and exactly that same amount was shown the previous year. Assuming that no earnings restatements were issued, which of the following statements is CORRECT? a. If the company lost money in 2018, it must have paid dividends. b. The company must have had zero net income in 2018. c. The company must have paid out half of its 2018 earnings as dividends. d. The company must have paid no dividends in 2018. e. Dividends could have been paid in 2018, but they would have had to equal the earnings for the year. ANSWER: e POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 3-2 The Balance Sheet QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.03.02 - The Balance Sheet NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Balance sheet KEYWORDS: Bloom's: Understand OTHER: Multiple Choice: Conceptual DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 12/11/2017 3:36 PM 48. Which of the following statements is CORRECT? a. The more depreciation a firm reports, the higher its tax bill, other things held constant. b. Because a firm’s cash flow is shown as the lowest entry on the income statement, people often call it "the bottom line.‖ c. Depreciation reduces a firm’s cash balance, so an increase in depreciation would normally lead to a reduction in the firm’s cash flow. d. Operating income is derived from the firm's regular core business. Operating income is calculated as Revenues less Operating costs. Operating costs do not include interest or taxes. e. Depreciation is not a cash charge, so it does not have an effect on a firm’s reported profits. ANSWER: d Copyright Cengage Learning. Powered by Cognero.
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POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 3-3 The Income Statement QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.03.03 - The Income Statement NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Depreciation, EBIT, and cash flow KEYWORDS: Bloom's: Understand OTHER: Multiple Choice: Conceptual DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 11/8/2017 12:25 PM 49. Which of the following factors would explain how a company's cash balance could have increased even though the company had a negative cash flow last year? a. The company sold a new issue of bonds. b. The company made a large investment in a new plant and equipment. c. The company paid a large dividend. d. The company had high depreciation expenses. e. The company repurchased 20% of its common stock. ANSWER: a POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 3-4 Statement of Cash Flows QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.03.04 - Statement of Cash Flows NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Cash flow KEYWORDS: Bloom's: Understand OTHER: Multiple Choice: Conceptual DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 11/8/2017 12:25 PM 50. Analysts who follow Howe Industries recently noted that, relative to the previous year, the company's net cash provided from operations increased, yet cash as reported on the balance sheet decreased. Which of the following factors could explain this situation? a. The company cut its dividend. Copyright Cengage Learning. Powered by Cognero.
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b. The company made large investments in fixed assets. c. The company sold a division and received cash in return. d. The company issued new common stock. e. The company issued new long-term debt. ANSWER: b POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 3-4 Statement of Cash Flows QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.03.04 - Statement of Cash Flows NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Cash flow KEYWORDS: Bloom's: Understand OTHER: Multiple Choice: Conceptual DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 11/8/2017 12:25 PM 51. Austin Financial recently announced that its net income increased sharply from the previous year, yet its net cash provided from operations declined. Which of the following could explain this performance? a. The company’s dividend payment to common stockholders declined. b. The company’s expenditures on fixed assets declined. c. The company’s cost of goods sold increased. d. The company’s depreciation expense declined. e. The company’s interest expense increased. ANSWER: d POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 3-4 Statement of Cash Flows QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.03.04 - Statement of Cash Flows NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Cash flow and net income KEYWORDS: Bloom's: Understand OTHER: Multiple Choice: Conceptual DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 11/8/2017 12:25 PM Copyright Cengage Learning. Powered by Cognero.
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52. Which of the following statements is CORRECT? a. The statement of cash flows reflects cash flows from operations, but it does not reflect the effects of buying or selling fixed assets. b. The statement of cash flows shows where the firm’s cash is located; indeed, it provides a listing of all banks and brokerage houses where cash is on deposit. c. The statement of cash flows reflects cash flows from continuing operations, but it does not reflect the effects of changes in working capital. d. The statement of cash flows reflects cash flows from operations and from borrowings, but it does not reflect cash obtained by selling new common stock. e. The statement of cash flows shows how much the firm’s cash--the total of currency, bank deposits, and shortterm liquid securities (or cash equivalents)--increased or decreased during a given year. ANSWER: e POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 3-4 Statement of Cash Flows QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.03.04 - Statement of Cash Flows NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Statement of cash flows KEYWORDS: Bloom's: Remember OTHER: Multiple Choice: Conceptual DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 11/8/2017 12:25 PM 53. Which of the following statements is CORRECT? a. In the statement of cash flows, a decrease in accounts receivable is subtracted from net income in the operating activities section. b. Dividends do not show up in the statement of cash flows because dividends are considered to be a financing activity, not an operating activity. c. In the statement of cash flows, a decrease in accounts payable is subtracted from net income in the operating activities section. d. In the statement of cash flows, depreciation is subtracted from net income in the operating activities section. e. In the statement of cash flows, a decrease in inventories is subtracted from net income in the operating activities section. ANSWER: c POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 3-4 Statement of Cash Flows QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.03.04 - Statement of Cash Flows NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic Copyright Cengage Learning. Powered by Cognero.
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STATE STANDARDS: LOCAL STANDARDS: TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.17.06 - Finance function United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. Statement of cash flows Bloom's: Understand Multiple Choice: Conceptual 11/8/2017 8:54 AM 11/8/2017 1:09 PM
54. Which of the following statements is CORRECT? a. Most rapidly growing companies have positive free cash flows because cash flows from existing operations generally exceed fixed asset purchases and changes to net operating working capital. b. Changes in working capital have no effect on free cash flow. c. Free cash flow (FCF) is defined as follows: FCF = EBIT(1 - T) + Depreciation - Capital expenditures required to sustain operations - Required changes in net operating working capital. d. Free cash flow (FCF) is defined as follows: FCF = EBIT(1 - T) + Capital expenditures. e. Managers should be less concerned with free cash flow than with accounting net income. Accounting net income is the "bottom line" and represents how much the firm can distribute to all its investors—both creditors and stockholders. ANSWER: c POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 3-7 Free Cash Flow QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.03.07 - Free Cash Flow NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Free cash flow KEYWORDS: Bloom's: Remember OTHER: Multiple Choice: Conceptual DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 11/8/2017 12:25 PM 55. Which of the following statements is CORRECT? a. Actions that increase reported net income will always increase cash flow. b. One way to increase EVA is to generate the same level of operating income but with less total invested capital. c. One drawback of EVA as a performance measure is that it mistakenly assumes that equity capital is free. d. One way to increase EVA is to achieve the same level of operating income but with more total invested capital obtained at a higher cost of capital. Copyright Cengage Learning. Powered by Cognero.
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e. If a firm reports positive net income, its EVA must also be positive. ANSWER: b RATIONALE: Statement b is true, because the EVA equation: EVA = EBIT (1 - T) - (After-tax cost of capital %) (Total invested capital) implies that lowering the operating capital, other things held constant, lowers capital costs and thus increases EVA. POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 3-8 MVA and EVA QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.03.08 - MVA and EVA NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: EVA, cash flow, and NI KEYWORDS: Bloom's: Understand OTHER: Multiple Choice: Conceptual DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 11/8/2017 12:25 PM 56. Which of the following statements is CORRECT? a. MVA stands for "market value added" and is defined as follows: MVA = (Shares outstanding)(Stock price) + Book value of common equity. b. The primary difference between EVA and accounting net income is that when net income is calculated, a deduction is made to account for the cost of common equity, whereas EVA represents net income before deducting the cost of the equity capital the firm uses. c. MVA gives us an idea about how much value a firm’s management has added during the last year. d. EVA gives us an idea about how much value a firm’s management has added over the firm’s life. e. EVA stands for "economic value added" and is defined as follows: EVA = NOPAT – (Total invested capital)(AT cost of capital %) ANSWER: e RATIONALE: Statement e gives the correct equation for EVA. The other statements are false. POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 3-8 MVA and EVA QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.03.08 - MVA and EVA NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: MVA and EVA KEYWORDS: Bloom's: Understand Copyright Cengage Learning. Powered by Cognero.
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OTHER: DATE CREATED: DATE MODIFIED:
Multiple Choice: Conceptual 11/8/2017 8:54 AM 11/8/2017 12:25 PM
57. Which of the following statements is CORRECT? a. Corporations are allowed to exclude 70% of their interest income from corporate taxes. b. Corporations are allowed to exclude 70% of their dividend income from corporate taxes. c. Individuals pay taxes on only 30% of the income realized from municipal bonds. d. Individuals are allowed to exclude 70% of their interest income from their taxes. e. Individuals are allowed to exclude 70% of their dividend income from their taxes. ANSWER: b RATIONALE: Statement a is false; corporations cannot exclude interest income from corporate taxes. Statement b is true because the 70% exclusion rule gets around the issue of triple taxation. Statements c, d, and e are false because individuals pay no taxes on municipal bond income, and individuals cannot exclude 70% of their income from either interest or dividends. POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 3-9 Income Taxes QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.03.09 - Income Taxes NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Income taxes KEYWORDS: Bloom's: Remember OTHER: Multiple Choice: Conceptual DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 11/8/2017 3:12 PM 58. A loss incurred by a corporation a. must be carried forward unless the company has had 2 loss years in a row. b. can be carried back 2 years, then carried forward up to 20 years following the loss. c. can be carried back 5 years and forward 3 years. d. cannot be used to reduce taxes in other years except with special permission from the IRS. e. can be carried back 3 years or forward 10 years, whichever is more advantageous to the firm. ANSWER: b POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 3-9 Income Taxes QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.03.09 - Income Taxes NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows Copyright Cengage Learning. Powered by Cognero.
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LOCAL STANDARDS: TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. Carry-back, carry-forward Bloom's: Remember Multiple Choice: Conceptual 11/8/2017 8:54 AM 11/8/2017 12:25 PM
59. Which of the following statements is CORRECT? a. Since companies can deduct dividends paid but not interest paid, our tax system favors the use of equity financing over debt financing, and this causes companies’ debt ratios to be lower than they would be if interest and dividends were both deductible. b. Interest paid to an individual is counted as income for federal tax purposes and taxed at the individual’s regular tax rate, which in 2018 could go up to 39.6%, but qualified dividends received are taxed at a maximum rate of 15% for most individuals. c. The maximum federal tax rate on corporate income in 2018 was 50%. d. Corporations obtain capital for use in their operations by borrowing and by raising equity capital, either by selling new common stock or by retaining earnings. The cost of debt capital is the interest paid on the debt, and the cost of the equity is the dividends paid on the stock. Both of these costs are deductible from income when calculating income for tax purposes. e. The maximum federal tax rate on personal income in 2018 was 50%. ANSWER: b POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 3-9 Income Taxes QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.03.09 - Income Taxes NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Income taxes KEYWORDS: Bloom's: Remember OTHER: Multiple Choice: Conceptual DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 11/8/2017 12:25 PM 60. Which of the following statements is CORRECT? a. The income of certain small corporations that qualify under the Tax Code is completely exempt from corporate income taxes. Thus, the federal government receives no tax revenue from these businesses, even though they report high accounting profits. b. All businesses, regardless of their legal form of organization, are taxed under the Business Tax Provisions of the Internal Revenue Code. c. Small corporations that qualify under the Tax Code can elect not to pay corporate taxes, but then each stockholder must report his or her pro rata shares of the firm’s income as personal income and pay taxes on that income. d. Congress recently changed the tax laws to make dividend income received by individuals exempt from income Copyright Cengage Learning. Powered by Cognero.
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taxes. Prior to the enactment of that law, corporate income was subject to double taxation, whereby the firm was taxed on the corporation's income and stockholders were taxed again on this income when it was paid to them as dividends. e. All corporations other than non-profits are subject to corporate income taxes, which are 15% for the lowest amounts of income and 38% for the highest income amounts. ANSWER: c POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 3-9 Income Taxes QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.03.09 - Income Taxes NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Income taxes KEYWORDS: Bloom's: Remember OTHER: Multiple Choice: Conceptual DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 11/8/2017 12:25 PM 61. Which of the following statements is CORRECT? a. Retained earnings, as reported on the balance sheet, represent the amount of cash a company has available to pay out as dividends to shareholders. b. 70% of the interest received by corporations is excluded from taxable income. c. 70% of the dividends received by corporations is excluded from taxable income. d. Because taxes on long-term capital gains are not paid until the gain is realized, investors must pay the top individual tax rate on that gain. e. The corporate tax system favors equity financing, as dividends paid are deductible from corporate taxes. ANSWER: c RATIONALE: Statement a is false, because retained earnings represent the cumulative accrued value to shareholders that a firm has amassed. Statement b is false, because interest income does not benefit from tax exclusion. Statement c is true, because dividend income does benefit from tax exclusion. Statement d is false, because long-term capital gains are taxed at the L-T capital gains rate, which depends upon the investor's taxable income but is usually significantly lower than personal tax rates. Statement e is false, because the tax deductibility of interest paid shows the tax system favors debt financing. POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 3-9 Income Taxes QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.03.09 - Income Taxes NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business Copyright Cengage Learning. Powered by Cognero.
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TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
School Outcomes, you do not need to include anything for this category. Tax concepts Bloom's: Remember Multiple Choice: Conceptual 11/8/2017 8:54 AM 11/8/2017 12:25 PM
62. Last year, Delip Industries had (1) negative cash flow from operations, (2) a negative free cash flow, and (3) an increase in cash as reported on its balance sheet. Which of the following factors could explain this situation? a. The company had a sharp increase in its inventories. b. The company had a sharp increase in its accrued liabilities. c. The company sold a new issue of common stock. d. The company made a large capital investment early in the year. e. The company had a sharp increase in depreciation expenses. ANSWER: c POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.03.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Cash flow and FCF KEYWORDS: Bloom's: Understand OTHER: Multiple Choice: Conceptual DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 11/8/2017 12:25 PM 63. Which of the following would be most likely to occur in the year after Congress, in an effort to increase tax revenue, passed legislation that forced companies to depreciate equipment over longer lives? Assume that sales, other operating costs, and tax rates were not affected, and assume that the same depreciation method was used for tax and stockholder reporting purposes. a. Companies’ after-tax operating profits would decline. b. Companies’ physical stocks of fixed assets would increase. c. Companies’ cash flows would increase. d. Companies’ cash positions would decline. e. Companies’ reported net incomes would decline. ANSWER: d POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice Copyright Cengage Learning. Powered by Cognero.
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HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.03.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Changes in depreciation KEYWORDS: Bloom's: Understand OTHER: Multiple Choice: Conceptual DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 11/8/2017 12:25 PM 64. Assume that Congress recently passed a provision that will enable Bev's Beverages Inc. (BBI) to double its depreciation expense for the upcoming year but will have no effect on its sales revenue or the tax rate. Prior to the new provision, BBI’s net income was forecasted to be $4 million. Which of the following best describes the impact of the new provision on BBI’s financial statements versus the statements without the provision? Assume that the company uses the same depreciation method for tax and stockholder reporting purposes. a. The provision will reduce the company’s cash flow. b. The provision will increase the company’s tax payments. c. The provision will increase the firm's operating income (EBIT). d. The provision will increase the company’s net income. e. Net fixed assets on the balance sheet will decrease. ANSWER: e POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.03.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Changes in depreciation KEYWORDS: Bloom's: Understand OTHER: Multiple Choice: Conceptual DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 11/8/2017 12:25 PM 65. The Nantell Corporation just purchased an expensive piece of equipment. Assume that the firm planned to depreciate the equipment over 5 years on a straight-line basis, but Congress then passed a provision that requires the company to depreciate the equipment on a straight-line basis over 7 years. Other things held constant, which of the following will occur as a result of this Congressional action? Assume that the company uses the same depreciation method for tax and stockholder reporting purposes. a. Nantell’s taxable income will be lower. Copyright Cengage Learning. Powered by Cognero.
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b. Nantell’s operating income (EBIT) will increase. c. Nantell’s cash position will improve (increase). d. Nantell’s reported net income for the year will be lower. e. Nantell’s tax liability for the year will be lower. ANSWER: b POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.03.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Changes in depreciation KEYWORDS: Bloom's: Understand OTHER: Multiple Choice: Conceptual DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 11/8/2017 12:25 PM 66. Assume that Besley Golf Equipment commenced operations on January 1, 2018 and was granted permission to use the same depreciation calculations for shareholder reporting and income tax purposes. The company planned to depreciate its fixed assets over 15 years, but in December 2018 management realized that the assets would last for only 10 years. The firm's accountants plan to report the 2018 financial statements based on this new information. How would the new depreciation assumption affect the company’s financial statements? a. The firm’s reported net fixed assets would increase. b. The firm’s EBIT would increase. c. The firm’s reported 2018 earnings per share would increase. d. The firm’s cash position in 2018 and 2019 would increase. e. The provision will increase the company's tax payments. ANSWER: d POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.03.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Changes in depreciation KEYWORDS: Bloom's: Understand Copyright Cengage Learning. Powered by Cognero.
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OTHER: DATE CREATED: DATE MODIFIED:
Multiple Choice: Conceptual 11/8/2017 8:54 AM 11/8/2017 12:25 PM
67. A start-up firm is making an initial investment in a new plant and equipment. Assume that currently its equipment must be depreciated on a straight-line basis over 10 years, but Congress is considering legislation that would require the firm to depreciate the equipment over 7 years. If the legislation becomes law, which of the following would occur in the year following the change? a. The firm’s operating income (EBIT) would increase. b. The firm’s taxable income would increase. c. The firm’s cash flow would increase. d. The firm’s tax payments would increase. e. The firm’s reported net income would increase. ANSWER: c POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.03.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Changes in depreciation KEYWORDS: Bloom's: Understand OTHER: Multiple Choice: Conceptual DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 11/8/2017 12:25 PM 68. Which of the following statements is CORRECT? a. Dividends paid reduce the net income that is reported on a company’s income statement. b. If a company uses some of its bank deposits to buy short-term, highly liquid marketable securities, its current assets as shown on the balance sheet will decline. c. If a company issues new long-term bonds to purchase fixed assets during the current year, its reported current assets and current liabilities at the end of the year will increase. d. Accounts receivable are reported as a current liability on the balance sheet. e. If a company pays more in dividends than it generates in net income, its retained earnings as reported on the balance sheet will decline from the previous year's balance. ANSWER: e POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.03.00 - Comprehensive Copyright Cengage Learning. Powered by Cognero.
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NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Financial statements KEYWORDS: Bloom's: Remember OTHER: Multiple Choice: Conceptual DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 11/8/2017 12:25 PM 69. For managerial purposes, i.e., making decisions regarding the firm's operations, the standard financial statements as prepared by accountants under generally accepted accounting principles (GAAP) are often modified and used to create alternative data and metrics that provide a somewhat different picture of a firm's operations. Related to these modifications, which of the following statements is CORRECT? a. The standard statements make adjustments to reflect the effects of inflation on asset values, and these adjustments are normally carried into any adjustment that managers make to the standard statements. b. The standard statements focus on accounting income for the entire corporation, not cash flows, and the two can be quite different during any given accounting period. However, the firm's value is based on its future cash flows because future cash flows indicate how much the firm can distribute to its investors. c. The standard statements provide useful information on the firm’s individual operating units, but management needs more information on the firm’s overall operations than the standard statements provide. d. The standard statements focus on cash flows, but managers should be less concerned with cash flows than with accounting income as defined by GAAP. e. The best feature of standard statements is that, if they are prepared under GAAP, the data are always consistent from firm to firm. Thus, under GAAP, there is no room for accountants to ―adjust‖ the results to make earnings look better. ANSWER: b POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.03.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Financial statements KEYWORDS: Bloom's: Remember OTHER: Multiple Choice: Conceptual DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 11/8/2017 12:25 PM 70. Which of the following statements is CORRECT? a. Since depreciation increases the firm's net cash provided by operating activities, the more depreciation a company has, the larger its retained earnings will be, other things held constant. b. A firm can show a large amount of retained earnings on its balance sheet yet need to borrow cash to make required payments. Copyright Cengage Learning. Powered by Cognero.
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c. Common equity includes common stock and retained earnings, less accumulated depreciation. d. The retained earnings account as reported on the balance sheet shows the amount of cash that is available for paying dividends. e. If a firm reports a loss on its income statement, then the retained earnings account as shown on the balance sheet will be negative. ANSWER: b POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.03.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Retained earnings KEYWORDS: Bloom's: Remember OTHER: Multiple Choice: Conceptual DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 11/8/2017 12:25 PM 71. Last year Besset Company’s operations provided a negative cash flow, yet the cash shown on its balance sheet increased. Which of the following statements could explain the increase in cash, assuming the company’s financial statements were prepared under generally accepted accounting principles (GAAP)? a. The company repurchased some of its common stock. b. The company dramatically increased its capital expenditures. c. The company retired a large amount of its long-term debt. d. The company sold some of its fixed assets. e. The company had high depreciation expenses. ANSWER: d POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 3-4 Statement of Cash Flows QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.03.04 - Statement of Cash Flows NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Cash flow KEYWORDS: Bloom's: Understand OTHER: Multiple Choice: Conceptual DATE CREATED: 11/8/2017 8:54 AM Copyright Cengage Learning. Powered by Cognero.
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DATE MODIFIED:
11/8/2017 1:10 PM
72. The CFO of Daves Industries plans to have the company issue $300 million of new common stock and use the proceeds to pay off some of the company's outstanding bonds that carry a 7% interest rate. Assume that the company, which does not pay any dividends, takes this action, and that total assets, operating income (EBIT), and tax rate all remain constant. Which of the following would occur? a. The company’s taxable income would fall. b. The company’s interest expense would remain constant. c. The company would have less common equity than before. d. The company’s net income would increase. e. The company would have to pay less taxes. ANSWER: d POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.03.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Changes in leverage KEYWORDS: Bloom's: Understand OTHER: Multiple Choice: Conceptual DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 11/8/2017 12:25 PM 73. Which of the following statements is CORRECT? a. Assume that two firms are both following generally accepted accounting principles. Both firms commenced operations two years ago with $1 million of identical fixed assets, and neither firm either sold any of those assets or purchased any new fixed assets. The two firms would be required to report the same amount of net fixed assets on their balance sheets as those statements are presented to investors. b. Assets other than cash are expected to produce cash over time, and the amount of cash they eventually produce must be the same as the amounts at which the assets are carried on the books. c. The income statement shows the difference between a firm's income and its costs—i.e., its profits—during a specified period of time. However, all reported income comes in the form of cash, and reported costs likewise are consistent with cash outlays. Therefore, there will not be a substantial difference between a firm's reported profits and its actual cash flow for the same period. d. The primary reason the annual report is important in finance is that it is used by investors when they form expectations about the firm's future earnings and dividends and the riskiness of those cash flows. e. EPS stands for "earnings per share," while DPS stands for "dividends per share." We would normally expect to see DPS exceed EPS. ANSWER: d POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: Comprehensive Copyright Cengage Learning. Powered by Cognero.
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QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.03.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Financial statements KEYWORDS: Bloom's: Remember OTHER: Multiple Choice: Conceptual DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 11/8/2017 12:25 PM 74. Which of the following statements is CORRECT? a. An increase in accounts receivable is added to net income in the operating activities section because if accounts receivable increase, then when they are collected cash will come into the firm. b. In finance, we are generally more interested in cash flows than in accounting profits. Free cash flow (FCF) is calculated as after-tax operating income plus depreciation less the sum of capital expenditures and the change in net operating working capital. Free cash flow is the amount of cash that could be withdrawn without harming the firm's ability to operate and to produce future cash flows. c. The first major section of a typical statement of cash flows is "Operating Activities," and the first entry in this section is "Net Income." Then, also in the first section, we show some items that add to or subtract from cash, and the last entry is called "Net Cash Provided by Operating Activities." This number can be either positive or negative, but if it is negative, the firm is almost certain to soon go bankrupt. d. The next-to-last line on the income statement shows the firm's earnings, while the last line shows the dividends the company paid. Therefore, the dividends are frequently called "the bottom line." e. Most rapidly growing companies have positive free cash flows because cash flows from existing operations will exceed fixed assets and working capital needed to support the growth. ANSWER: b POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.03.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Financial statements KEYWORDS: Bloom's: Remember OTHER: Multiple Choice: Conceptual DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 11/8/2017 12:25 PM 75. Which of the following statements is CORRECT? a. Free cash flow (FCF) is, essentially, the cash flow that is available for interest and dividends after the Copyright Cengage Learning. Powered by Cognero.
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company has made the investments in current and fixed assets that are necessary to sustain ongoing operations. b. After-tax operating income is calculated as EBIT(1 - T) + Depreciation. c. Two firms with identical sales and operating costs but with different amounts of debt and tax rates will have different operating incomes by definition. d. If a firm is reporting its income in accordance with generally accepted accounting principles, then its net income as reported on the income statement should be equal to its free cash flow. e. Retained earnings as reported on the balance sheet represent cash and are therefore available to distribute to stockholders as dividends or any other required cash payments to creditors and suppliers. ANSWER: a POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.03.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Financial statements KEYWORDS: Bloom's: Remember OTHER: Multiple Choice: Conceptual DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 11/8/2017 12:25 PM 76. Which of the following statements is CORRECT? a. The current cash flow from existing assets is highly relevant to investors. However, since the value of the firm depends primarily upon its growth opportunities, accounting net income projections from those opportunities are the only relevant future flows with which investors are concerned. b. Two metrics that are used to measure a company's financial performance are net income and free cash flow. Accountants tend to emphasize net income as calculated in accordance with generally accepted accounting principles. Finance people generally put at least as much weight on free cash flows as they do on net income. c. To estimate the net cash provided by operations, depreciation must be subtracted from net income because depreciation is a non-cash charge that has been added to revenue. d. Interest paid by a corporation is a tax deduction for the paying corporation, but dividends paid are not deductible. This treatment, other things held constant, tends to discourage the use of debt financing by corporations. e. If Congress changed depreciation allowances so that companies had to report higher depreciation levels for tax purposes in 2018, companies would have lower free cash flows in 2018. ANSWER: b POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.03.00 - Comprehensive Copyright Cengage Learning. Powered by Cognero.
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NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Cash flow and taxes KEYWORDS: Bloom's: Remember OTHER: Multiple Choice: Conceptual DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 11/8/2017 12:25 PM Multiple Choice: Problems A good bit of relatively simple arithmetic is involved in some of these problems, and although the calculations are simple, it will take students some time to set up the problem and do the arithmetic. We allow for this when assigning problems for a timed test. Also, students must use a number of definitions to answer some of the questions. To avoid excessive memorization, we provide students with a list of formulas and definitions for use on exams. Problems with * in the topic line are nonalgorithmic. 77. Bauer Software's current balance sheet shows total common equity of $5,125,000. The company has 520,000 shares of stock outstanding, and they sell at a price of $27.50 per share. By how much do the firm's market and book values per share differ? (Round your intermediate and final answer to two decimal places.) a. $15.00 b. $22.06 c. $16.41 d. $17.64 e. $17.47 ANSWER: d RATIONALE: Shares outstanding 520,000 Price per share $27.50 Total book common equity $5,125,000 Book value per share = Total book equity/Number of shares $9.86 Difference between market and book values $17.64 POINTS: 1 DIFFICULTY: EASY REFERENCES: 3-2 The Balance Sheet QUESTION TYPE: Multiple Choice HAS VARIABLES: True PREFACE NAME: Problems LEARNING OBJECTIVES: FOFM.BRIG.17.03.02 - The Balance Sheet NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Balance sheet KEYWORDS: Bloom's: Evaluate Copyright Cengage Learning. Powered by Cognero.
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OTHER: DATE CREATED: DATE MODIFIED:
Multiple Choice: Problem 11/8/2017 8:54 AM 11/8/2017 12:25 PM
78. Brown Fashions Inc.'s December 31, 2017 balance sheet showed total common equity of $4,050,000 and 195,000 shares of stock outstanding. During 2018, the firm had $450,000 of net income, and it paid out $100,000 as dividends. What was the book value per share at 12/31/18, assuming no common stock was either issued or retired during 2018? (Round your final answer to two decimal places.) a. $21.66 b. $19.86 c. $23.24 d. $26.17 e. $22.56 ANSWER: e RATIONALE: 12/31/17 common equity $4,050,000 2018 net income $450,000 2018 dividends $100,000 2018 addition to retained earnings $350,000 12/31/18 common equity $4,400,000 Shares outstanding 195,000 12/31/18 BVPS $22.56 POINTS: 1 DIFFICULTY: EASY REFERENCES: 3-2 The Balance Sheet QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.03.02 - The Balance Sheet NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Balance sheet KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Problem DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 11/8/2017 12:25 PM 79. Prezas Company's balance sheet showed total current assets of $2,500, all of which were required in operations. Its current liabilities consisted of $975 of accounts payable, $600 of 6% short-term notes payable to the bank, and $250 of accrued wages and taxes. What was its net operating working capital? a. $1,173 b. $1,199 c. $1,301 d. $1,326 e. $1,275 ANSWER: e RATIONALE: NOWC = Operating (Current liabilities Notes payable) Copyright Cengage Learning. Powered by Cognero.
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current assets $2,500
NOWC = ($1,825 $600) NOWC = $1,275 POINTS: 1 DIFFICULTY: EASY REFERENCES: 3-2 The Balance Sheet QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.03.02 - The Balance Sheet NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Net operating working capital KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Problem DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 12/11/2017 4:52 PM 80. Rao Construction recently reported $28.00 million of sales, $12.60 million of operating costs other than depreciation, and $3.00 million of depreciation. It had $8.50 million of bonds outstanding that carry a 7.0% interest rate, and its federalplus-state income tax rate was 40%. What was Rao's operating income, or EBIT, in millions? a. $11.66 b. $11.78 c. $12.15 d. $12.40 e. $13.52 ANSWER: d RATIONALE: Sales $28.00 Operating costs excluding depreciation 12.60 Depreciation 3.00 Operating income (EBIT) $12.40 Note that operating income is before interest and taxes. POINTS: 1 DIFFICULTY: EASY REFERENCES: 3-3 The Income Statement QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.03.03 - The Income Statement NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Income statement KEYWORDS: Bloom's: Analyze Copyright Cengage Learning. Powered by Cognero.
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OTHER: DATE CREATED: DATE MODIFIED:
Multiple Choice: Problem 11/8/2017 8:54 AM 11/8/2017 3:16 PM
81. Brown Office Supplies recently reported $18,000 of sales, $8,250 of operating costs other than depreciation, and $1,750 of depreciation. It had $9,000 of bonds outstanding that carry a 7.0% interest rate, and its federal-plus-state income tax rate was 40%. How much was the firm's earnings before taxes (EBT)? a. $5,749 b. $8,918 c. $7,370 d. $8,033 e. $7,223 ANSWER: c RATIONALE: Bonds $9,000 Interest rate 7.0% Sales $18,000 Operating costs excluding depr'n $8,250 Depreciation $1,750 Operating income (EBIT) $8,000 Interest charges -$630 EBT = Taxable income $7,370
POINTS: 1 DIFFICULTY: EASY REFERENCES: 3-3 The Income Statement QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.03.03 - The Income Statement NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Income statement KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Problem DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 11/8/2017 3:16 PM 82. Vasudevan Inc. recently reported operating income of $3.00 million, depreciation of $1.20 million, and had a tax rate of 40%. The firm's expenditures on fixed assets and net operating working capital totaled $0.60 million. How much was its free cash flow, in millions? a. $2.83 b. $1.82 c. $2.40 d. $2.50 e. $2.33 Copyright Cengage Learning. Powered by Cognero.
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ANSWER: RATIONALE:
c
DATE CREATED: DATE MODIFIED:
11/8/2017 8:54 AM 11/8/2017 3:17 PM
FCF = EBIT(1 - T) + Deprec - (Capex + NOWC) EBIT $3.00 Tax rate 40% Depreciation $1.20 $0.60 Capex + NOWC FCF = $2.40 POINTS: 1 DIFFICULTY: EASY REFERENCES: 3-7 Free Cash Flow QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.03.07 - Free Cash Flow NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Free cash flow KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Problem
83. Over the years, O'Brien Corporation's stockholders have provided $20,000,000 of capital, when they purchased new issues of stock and allowed management to retain some of the firm's earnings. The firm now has 1,000,000 shares of common stock outstanding, and it sells at a price of $32.00 per share. How much value has O'Brien's management added to stockholder wealth over the years, i.e., what is O'Brien's MVA? a. $9,000,000 b. $15,000,000 c. $14,400,000 d. $13,200,000 e. $12,000,000 ANSWER: e RATIONALE: Total book value of equity $20,000,000 Stock price per share $32.00 Shares outstanding 1,000,000 Market value of equity Stock price Number of shares $32,000,000 $12,000,000 MVA Market value of equity Book value of equity POINTS: 1 DIFFICULTY: EASY REFERENCES: 3-8 MVA and EVA QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.03.08 - MVA and EVA NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic Copyright Cengage Learning. Powered by Cognero.
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STATE STANDARDS: LOCAL STANDARDS: TOPICS: KEYWORDS: OTHER:
United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. MVA Bloom's: Analyze Multiple Choice: Problem
DATE CREATED: DATE MODIFIED:
11/8/2017 8:54 AM 11/8/2017 12:25 PM
84. Wu Systems has the following balance sheet. Assume that all current assets are used in operations. How much net operating working capital does the firm have? Cash Accounts receivable Inventory Current assets Net fixed assets
$ 100 650 550 $ 1,300 $ 1,000
Total assets
$ 2,300
a. $990 b. $911 c. $1,010 d. $1,168 e. $782 ANSWER: RATIONALE:
a Cash Accounts receivable Inventory Current assets Net fixed assets
Accounts payable Accruals Notes payable Current liabilities Long-term debt Common equity Retained earnings Total liab. & equity
$ 200 110 590 $ 900 600 300 500 $ 2,300
$100 650 550 $1,300 1,000
Accounts payable $200 Accruals 110 Notes payable 590 Current liabilities $ 900 Long-term debt 600 Common equity 300 Retained earnings 500 Total assets $ 2,300 Total liab. & equity $2,300 Net operating working capital = Operating current assets (Current liabilities – Notes payable) NOWC = $1,300 - $310 NOWC = $990
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 3-2 The Balance Sheet QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.03.02 - The Balance Sheet NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows Copyright Cengage Learning. Powered by Cognero.
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LOCAL STANDARDS: TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
United States - OH - DISC.FOFM.BRIG.17.06 - Finance function United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. Net operating working capital Bloom's: Analyze Multiple Choice: Problem 11/8/2017 8:54 AM 12/11/2017 5:06 PM
85. Emery Mining Inc. recently reported $125,000 of sales, $75,500 of operating costs other than depreciation, and $10,200 of depreciation. The company had $16,500 of outstanding bonds that carry a 7.25% interest rate, and its federalplus-state income tax rate was 35%. How much was the firm's net income? The firm uses the same depreciation expense for tax and stockholder reporting purposes. (Round your intermediate and final answers to two decimal places.) a. $20,556.97 b. $24,272.09 c. $26,005.81 d. $20,804.65 e. $24,767.44 ANSWER: e RATIONALE: Bonds $16,500 Interest rate 7.25% Tax rate 35% Sales $125,000 Operating costs excluding depr'n $75,500 Depreciation $10,200 Operating income (EBIT) $39,300 Interest charges -$1,196.25 Taxable income $38,103.75 Taxes -$13,336.31 Net income $24,767.44 POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 3-3 The Income Statement QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.03.03 - The Income Statement NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Income statement KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Problem DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 11/8/2017 3:18 PM 86. Last year Almazan Software reported $10.500 million of sales, $6.250 million of operating costs other than Copyright Cengage Learning. Powered by Cognero.
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depreciation, and $1.300 million of depreciation. The company had $5.000 million of bonds that carry a 6.5% interest rate, and its federal-plus-state income tax rate was 35%. This year's data are expected to remain unchanged except for one item, depreciation, which is expected to increase by $0.310 million. By how much will net income change as a result of the change in depreciation? The company uses the same depreciation calculations for tax and stockholder reporting purposes. (Round your final answer to 3 decimal places.) a. -$0.232 b. -$0.155 c. -$0.212 d. -$0.202 e. -$0.193 ANSWER: d RATIONALE: This problem can be worked very easily - just multiply the increase in depreciation by (1-T) to get the decrease in net income: Change in depreciation $0.310 Tax rate 0.350 Reduction in net income -$0.202 We can also get the answer a longer way, which explains things more clearly: Old New Change Bonds $5.000 $5.000 $0.000 Interest rate 0.065 0.065 0.000 Tax rate 0.350 0.350 0.000 Sales $10.500 $10.500 $0.000 Operating costs excluding depr'n $6.250 $6.250 $0.000 Depreciation $1.300 $1.610 $0.310 Operating income (EBIT) $2.950 $2.640 -$0.310 Interest charges $0.325 $0.325 $0.000 Taxable income $2.625 $2.315 -$0.310 Taxes $0.919 $0.810 -$0.109 Net income $1.706 $1.505 -$0.202 POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 3-3 The Income Statement QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.03.03 - The Income Statement NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Income statement KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Problem DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 11/8/2017 3:19 PM 87. On 12/31/18, Hite Industries reported retained earnings of $475,000 on its balance sheet, and it reported that it had $135,000 of net income during the year. On its previous balance sheet, at 12/31/17, the company had reported $445,000 of retained earnings. No shares were repurchased during 2018. How much in dividends did the firm pay during 2018? Copyright Cengage Learning. Powered by Cognero.
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a. $124,950 b. $127,050 c. $82,950 d. $111,300 e. $105,000 ANSWER: RATIONALE:
e 12/31/18 RE $475,000 12/31/17 RE $445,000 Change in RE $30,000 Net income for 2018 $135,000 Dividends = Net income - Change in RE $105,000 POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 3-5 Statement of Stockholder's Equity QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.03.05 - Statement of Stockholders' Equity NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Statement of stockholders' equity KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Problem DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 12/11/2017 5:30 PM 88. During 2018, Bascom Bakery paid out $33,525 of common dividends. It ended the year with $187,500 of retained earnings versus the prior year’s retained earnings of $159,600. How much net income did the firm earn during the year? a. $55,897 b. $49,140 c. $47,297 d. $61,425 e. $63,882 ANSWER: d RATIONALE: Net income = The change in retained earnings plus the dividends paid: Current RE $187,500 Previous RE = Current RE - increment $159,600 Change in RE $27,900 Plus dividends paid $33,525 Net income $61,425 POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 3-5 Statement of Stockholder's Equity QUESTION TYPE: Multiple Choice HAS VARIABLES: True Copyright Cengage Learning. Powered by Cognero.
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LEARNING OBJECTIVES: FOFM.BRIG.17.03.05 - Statement of Stockholders' Equity NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Statement of stockholders' equity KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Problem DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 11/8/2017 12:25 PM 89. C. F. Lee Inc. has the following income statement. How much after-tax operating income does the firm have? Sales Costs Depreciation EBIT Interest expense EBT Taxes (35%) Net income
$3,150.00 1,850.00 192.00 $1,108.00 285.00 $823.00 288.05 $534.95
a. $583.36 b. $900.25 c. $821.03 d. $720.20 e. $835.43 ANSWER: RATIONALE:
d Sales $3,150.00 Costs 1,850.00 Depreciation 192.00 EBIT $1,108.00 Interest expense 285.00 EBT $823.00 Taxes: rate = 35% 288.05 Net income $534.95 EBIT $1,108.00 Tax rate 35% EBIT(1 - T) $720.20 POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 3-7 Free Cash Flow QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.03.07 - Free Cash Flow NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.17.06 - Finance function Copyright Cengage Learning. Powered by Cognero.
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LOCAL STANDARDS: TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. After-tax operating income Bloom's: Analyze Multiple Choice: Problem 11/8/2017 8:54 AM 11/8/2017 12:25 PM
90. Kwok Enterprises has the following income statement. How much after-tax operating income does the firm have? Sales Costs Depreciation EBIT Interest expense EBT Taxes (40%) Net income a. $630 b. $643 c. $605 d. $743 e. $504 ANSWER: RATIONALE:
$2,700 1,400 250 $1,050 70 $980 392 $588
a
Sales $2,700 Costs 1,400 Depreciation 250 EBIT $1,050 Interest expense 70 EBT $980 Taxes 392 Net income $588 EBIT $1,050 Tax rate 40% EBIT (1 - T) $630 POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 3-7 Free Cash Flow QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.03.07 - Free Cash Flow NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: After-tax operating income Copyright Cengage Learning. Powered by Cognero.
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KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
Bloom's: Analyze Multiple Choice: Problem 11/8/2017 8:54 AM 12/11/2017 5:41 PM
91. Hartzell Inc. had the following data for 2017, in millions: Net income = $600; after-tax operating income [EBIT (1-T)] = $700; and Total assets = $2,000. Information for 2018 is as follows: Net income = $825; after-tax operating income [EBIT (1-T)] = $825; and Total assets = $2,500. Assume the firm had no excess cash. How much free cash flow did the firm generate during 2018? a. $397 b. $286 c. $257 d. $367 e. $325 ANSWER: e RATIONALE: 2017 2018 Change = Net invest. in FA + ΔNOWC Total assets $2,000 $2,500 $500 2018 FCF = EBIT(1 - T) (Net investment in FA + ΔNOWC) 2018 FCF = $825 $500 2018 FCF = $325 POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 3-7 Free Cash Flow QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.03.07 - Free Cash Flow NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Free cash flow KEYWORDS: Bloom's: Analyze OTHER: Multiple Choise: Problem DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 12/11/2017 8:13 PM 92. Shrives Publishing recently reported $13,000 of sales, $5,500 of operating costs other than depreciation, and $1,250 of depreciation. The company had $3,500 of bonds that carry a 6.25% interest rate, and its federal-plus-state income tax rate was 35%. During the year, the firm had expenditures on fixed assets and net operating working capital that totaled $1,550. These expenditures were necessary for it to sustain operations and generate future sales and cash flows. What was its free cash flow? (Round your intermediate and final answers to whole dollar amount.) a. $4,704 b. $2,898 c. $3,161 d. $3,763 Copyright Cengage Learning. Powered by Cognero.
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e. $3,086 ANSWER: RATIONALE:
d Bonds Interest rate Tax rate Sales Operating costs excluding depreciation Depreciation Operating income (EBIT) Capex + NOWC = FCF = EBIT(1 - T) FCF = $4,063 Free cash flow = $3,763
$3,500 6.25% 35% $13,000 $5,500 $1,250 $6,250 $1,550 + +
Deprec . $1,250
(Capex + NOWC) $1,550
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 3-7 Free Cash Flow QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.03.07 - Free Cash Flow NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Free cash flow KEYWORDS: Bloom's: Analyze OTHER: Multiple Choise: Problem DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 11/8/2017 3:21 PM 93. Houston Pumps recently reported $222,500 of sales, $140,500 of operating costs other than depreciation, and $9,250 of depreciation. The company had $35,250 of outstanding bonds that carry a 6.75% interest rate, and its federal-plus-state income tax rate was 35%. In order to sustain its operations and thus generate future sales and cash flows, the firm was required to spend $15,250 to buy new fixed assets and to invest $6,850 in net operating working capital. What was the firm's free cash flow? a. $34,438 b. $39,948 c. $26,517 d. $27,894 e. $33,060 ANSWER: a RATIONALE: Tax rate 35% Required addition to net operating working capital $6,850 Required capital expenditures (fixed assets) $15,250 Sales $222,500 Operating costs excluding depr'n $140,500 Depreciation $9,250 Copyright Cengage Learning. Powered by Cognero.
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Operating income (EBIT) FCF = EBIT(1 - T) FCF = $47,288 FCF = $34,438
$72,750 + +
Deprec. $9,250
Capex -$15,250
NOWC -$6,850
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 3-7 Free Cash Flow QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.03.07 - Free Cash Flow NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Free cash flow KEYWORDS: Bloom's: Analyze OTHER: Multiple Choise: Problem DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 11/8/2017 3:21 PM 94. Hayes Corporation has $300 million of common equity, with 6 million shares of common stock outstanding. If Hayes’ Market Value Added (MVA) is $192 million, what is the company’s stock price? (Round your final answer to two decimal places.) a. $82.00 b. $101.68 c. $93.48 d. $99.22 e. $82.82 ANSWER: a RATIONALE: Total book value of equity $300,000,000 Shares outstanding 6,000,000 Market Value Added $192,000,000 Market value Added Stock price Number of shares Total BV of Equity $192,000,000 Stock price 6,000,000 $300,000,000 Stock price $82.00 POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 3-8 MVA and EVA QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.03.08 - MVA and EVA NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business Copyright Cengage Learning. Powered by Cognero.
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TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
School Outcomes, you do not need to include anything for this category. MVA Bloom's: Analyze Multiple Choise: Problem 11/8/2017 8:54 AM 11/8/2017 12:25 PM
95. Byrd Lumber has 2 million shares of common stock outstanding that sell for $17 a share. If the company has $40 million of common equity on its balance sheet, what is the company’s Market Value Added (MVA)? Answer options are provided in whole dollar. a. -$6,000,000 b. -$5,100,000 c. -$7,200,000 d. -$5,400,000 e. -$6,600,000 ANSWER: a RATIONALE: Total book value of equity $40,000,000 Stock price per share $17 Shares outstanding 2,000,000 $34,000,000 Market value of equity Stock price Number of shares -$6,000,000 MVA Market value of equity Book value of equity POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 3-8 MVA and EVA QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.03.08 - MVA and EVA NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: MVA KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Problem DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 11/8/2017 12:25 PM 96. Scranton Shipyards has $8.0 million in total invested operating capital, and its WACC is 10%. Scranton has the following income statement: Sales Operating costs Operating income (EBIT) Interest expense Earnings before taxes (EBT) Taxes (40%) Net income Copyright Cengage Learning. Powered by Cognero.
$10.0 million 6.0 million $ 4.0 million 2.0 million $ 2.0 million 0.8 million $ 1.2 million Page 109
What is Scranton’s EVA? Answer options are provided in whole dollar. a. $1,840,000 b. $2,000,000 c. $1,600,000 d. $1,520,000 e. $1,440,000 ANSWER: c RATIONALE: EBIT Tax rate WACC Total invested capital EVA EVA EVA
EBIT(1 – T) $2,400,000
$4,000,000 40% 10% $8,000,000 (WACC $800,000
Total invested capital)
$1,600,000
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 3-8 MVA and EVA QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.03.08 - MVA and EVA NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: EVA KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Problem DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 12/12/2017 2:54 PM 97. Casey Motors recently reported the following information: ∙ Net income = $750,000. ∙ Tax rate = 40%. ∙ Interest expense = $200,000. ∙ Total invested capital employed = $9 million. ∙ After-tax cost of capital = 10%.
What is the company’s EVA? a. -$34,500 b. -$35,100 c. -$32,100 d. -$30,000 e. -$29,400 ANSWER: d Copyright Cengage Learning. Powered by Cognero.
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RATIONALE:
Net income Interest expense Total invested capital Tax rate After-tax cost of capital
$750,000 $200,000 $9,000,000 40% 10%
EBT EBT
Net income / (1 – T) $1,250,000
EBIT EBIT
EBT
EBIT(1 – T) EVA $870,000 EVA EVA -$30,000
Interest $1,450,000 (WACC $900,000
Total invested capital)
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 3-8 MVA and EVA QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.03.08 - MVA and EVA NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: EVA KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Problem DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 11/8/2017 3:23 PM 98. Your corporation has the following cash flows: Operating income Interest received Interest paid Dividends received Dividends paid
$250,000 $10,000 $45,000 $17,000 $50,000
If the applicable income tax rate is 40% (federal and state combined), and if 70% of dividends received are exempt from taxes, what is the corporation's tax liability? a. $87,160 b. $88,040 c. $80,116 d. $108,289 e. $77,475 ANSWER: b RATIONALE: Operating income $250,000 Interest received $10,000 Copyright Cengage Learning. Powered by Cognero.
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Interest paid $45,000 Dividends received $17,000 Dividend exclusion % 70% Dividends paid $50,000 Tax rate (T) 40% Taxable income = Oper. income + Interest received – Interest paid + Taxable dividends received Taxable income = Oper. income + Interest received – Interest paid + dividends received (1 – Div exclusion %) Taxable income = $220,100 Taxes paid = Taxable income Tax rate Taxes paid = $88,040 POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 3-9 Income Taxes QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.03.09 - Income Taxes NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Corporate taxes KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Problem DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 12/12/2017 4:37 PM 99. Your corporation has a marginal tax rate of 35% and has purchased preferred stock in another company. The beforetax dividend yield on the preferred stock is 8.75%. What is the company's after-tax return on the preferred, assuming a 70% dividend exclusion? (Round your final answer to two decimal places.) a. 9.63% b. 7.83% c. 5.95% d. 7.20% e. 9.55% ANSWER: b RATIONALE: Preferred dividend rate 8.75% Tax rate 35% Dividend exclusion % 70% After-tax dividend yield = Preferred dividend rate [1 – (1 – Div exclusion%)(T)] After-tax dividend yield = 7.83% POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 3-9 Income Taxes QUESTION TYPE: Multiple Choice Copyright Cengage Learning. Powered by Cognero.
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HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.03.09 - Income Taxes NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: After-tax returns KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Problem DATE CREATED: DATE MODIFIED:
11/8/2017 8:54 AM 11/8/2017 12:25 PM
100. Lovell Co. purchased preferred stock in another company. The preferred stock’s before-tax yield was 9.00%. The corporate tax rate is 40%. What is the after-tax return on the preferred stock, assuming a 70% dividend exclusion? (Round your final answer to two decimal places.) a. 7.92% b. 6.73% c. 6.57% d. 7.05% e. 8.87% ANSWER: a RATIONALE: Preferred dividend rate 9.00% Tax rate 40% Dividend exclusion % 70% If a company buys preferred stock in another company, 70% of the dividends are excluded from taxes. Therefore, the after-tax return will be: After-tax dividend yield = Preferred dividend rate [1 – (1 – Div exclusion%)(T)] After-tax dividend yield = 7.92% POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 3-9 Income Taxes QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.03.09 - Income Taxes NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: After-tax returns KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Problem DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 11/8/2017 12:25 PM 101. A company with a 15% tax rate buys preferred stock in another company. The preferred stock has a before-tax yield Copyright Cengage Learning. Powered by Cognero.
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of 7.50%. Assume a 70% dividend exclusion for tax on dividends. What is the preferred stock’s after-tax return? (Round your final answer to two decimal places.) a. 7.74% b. 6.95% c. 7.16% d. 5.94% e. 7.09% ANSWER: c RATIONALE: Preferred dividend rate 7.50% Tax rate 15% Dividend exclusion % 70% If a company buys preferred stock in another company, 70% of the dividends are excluded from taxes. Therefore, the after-tax return will be: After-tax dividend yield = Preferred dividend rate [1 – (1 – Div exclusion%)(T)] After-tax dividend yield = 7.16% POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 3-9 Income Taxes QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.03.09 - Income Taxes NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: After-tax returns KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Problem DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 11/8/2017 3:25 PM 102. Van Dyke Corporation has a corporate tax rate equal to 33%. The company recently purchased preferred stock in another company. The preferred stock has an 8% before-tax yield. What is Van Dyke’s after-tax yield on the preferred stock? Assume a 70% dividend exclusion for tax on dividends. (Round your final answer to two decimal places.) a. 6.27% b. 8.94% c. 7.28% d. 7.21% e. 7.42% ANSWER: d RATIONALE: Preferred dividend rate 8% Tax rate 33% Dividend exclusion % 70% If a company buys preferred stock in another company, 70% of the dividends are excluded from taxes. Therefore, the after-tax return will be: After-tax dividend yield = Preferred dividend rate [1 – (1 – Div exclusion%)(T)] After-tax dividend yield = 7.21% Copyright Cengage Learning. Powered by Cognero.
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POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 3-9 Income Taxes QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.03.09 - Income Taxes NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: After-tax returns KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Problem DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 11/8/2017 3:26 PM 103. Granville Co. recently purchased several shares of Kalvaria Electronics’ preferred stock. The preferred stock has a before-tax yield of 8.60%. If the company’s tax rate is 15%, what is Granville Co.’s after-tax yield on the preferred stock? Assume a 70% dividend exclusion for tax on dividends. (Round your final answer to two decimal places.) a. 7.47% b. 8.21% c. 8.95% d. 9.53% e. 8.79% ANSWER: b RATIONALE: Preferred dividend rate 8.60% Tax rate 15% Dividend exclusion % 70% If a company buys preferred stock in another company, 70% of the dividends are excluded from taxes. Therefore, the after-tax return will be: After-tax dividend yield = Preferred dividend rate [1 – (1 – Div exclusion%)(T)] After-tax dividend yield = 8.21% POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 3-9 Income Taxes QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.03.09 - Income Taxes NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: After-tax returns KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Problem Copyright Cengage Learning. Powered by Cognero.
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DATE CREATED: DATE MODIFIED:
11/8/2017 8:54 AM 11/8/2017 12:25 PM
104. Appalachian Airlines began operating in 2014. The company lost money the first year but has been profitable ever since. The company’s taxable income (EBT) for its first five years is listed below. Each year the company’s corporate tax rate has been 40%. Year Taxable Income 2014 -$3,250,000 2015 $1,000,000 2016 $2,000,000 2017 $3,000,000 2018 $5,000,000 Assume that the company has taken full advantage of the Tax Code’s carry-back, carry-forward provisions and that the current provisions were applicable in 2014. How much did the company pay in taxes in 2017? a. $1,199,000 b. $1,100,000 c. $1,067,000 d. $1,364,000 e. $1,155,000 ANSWER: b RATIONALE: Tax rate 40% EBT After Unused Carry-Forward Forward Carryable Taxable Year Used Applied Amount Income 2014 -$3,250,000 $0 $0 $3,250,000 2015 $1,000,000 $1,000,000 $0 $2,250,000 2016 $2,000,000 $2,000,000 $0 $250,000 2017 $3,000,000 $250,000 $2,750,000 $0 2018 $5,000,000 $0 $5,000,000 $0 2017 Tax liability = EBT Tax rate 2017 Tax liability = $1,100,000 POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 3-9 Income Taxes QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.03.09 - Income Taxes NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Carry-back, carry-forward KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Problem DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 11/8/2017 1:14 PM Copyright Cengage Learning. Powered by Cognero.
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105. Garner Grocers began operations in 2015. Garner has reported the following levels of taxable income (EBT) over the past several years. The corporate tax rate was 34% each year. Assume that the company has taken full advantage of the Tax Code’s carry-back, carry-forward provisions, and assume that the current provisions were applicable in 2015. What is the amount of taxes the company paid in 2018? Year 2015 2016 2017 2018
Taxable Income -$1,750,000 $200,000 $500,000 $2,800,000
a. $559,300 b. $493,850 c. $654,500 d. $595,000 e. $725,900 ANSWER: RATIONALE:
d Tax rate
34%
Year 2015 2016 2017 2018
EBT After Unused Carry-Forward Forward Carryable Taxable Income Used Applied Amount -$1,750,000 $0 $0 $1,750,000 $200,000 $200,000 $0 $1,550,000 $500,000 $500,000 $0 $1,050,000 $2,800,000 $1,050,000 $1,750,000 $0
2018 2018
Tax liability = Tax liability =
EBT Tax rate $595,000
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 3-9 Income Taxes QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.03.09 - Income Taxes NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Carry-back, carry-forward KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Problem DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 11/8/2017 1:15 PM 106. A corporation recently purchased some preferred stock that has a before-tax yield of 6.50%. The company has a tax rate of 38%. What is the after-tax return on the preferred stock? Assume a 70% dividend exclusion for tax on dividends. Copyright Cengage Learning. Powered by Cognero.
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(Round your final answer to two decimal places.) a. 5.87% b. 5.76% c. 6.05% d. 6.68% e. 6.85% ANSWER: b RATIONALE: Preferred dividend rate 6.50% Tax rate 38% Dividend exclusion % 70% After-tax dividend yield = Preferred dividend rate [1 – (1 – Div exclusion%)(T)] After-tax dividend yield = 5.76% POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 3-9 Income Taxes QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.03.09 - Income Taxes NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: After-tax returns KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Problem DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 11/8/2017 3:27 PM 107. A corporate bond currently yields 8.70%. Municipal bonds with the same risk, maturity, and liquidity currently yield 5.50%. At what tax rate would investors be indifferent between the two bonds? (Round your final answer to two decimal places.) a. 41.56% b. 41.93% c. 36.78% d. 33.10% e. 30.90% ANSWER: c RATIONALE: Bond yield 8.70% Municipal bond yield 5.50%
POINTS: DIFFICULTY: REFERENCES:
Municipal yield 5.50% 0.6322 T 1 MODERATE 3-9 Income Taxes
Copyright Cengage Learning. Powered by Cognero.
= = = =
After-tax bond yield 8.70% (1 – T) 36.78%
(1 – T)
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QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.03.09 - Income Taxes NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: After-tax returns KEYWORDS: Bloom's: Evaluate OTHER: Multiple Choice: Problem DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 11/8/2017 3:28 PM 108. A 7-year municipal bond yields 4.80%. Your marginal tax rate (including state and federal taxes) is 36.00%. What interest rate on a 7-year corporate bond of equal risk would provide you with the same after-tax return? (Round your final answer to two decimal places.) a. 6.08% b. 6.45% c. 9.30% d. 9.08% e. 7.50% ANSWER: e RATIONALE: Municipal bond yield 4.80% Tax rate 36.00% Municipal yield = After-tax bond yield 4.80% = BT yield (1 – T) 4.80% = BT yield 64.00% BT yield = 7.50% POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 3-9 Income Taxes QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.03.09 - Income Taxes NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: After-tax returns KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Problem DATE CREATED: DATE MODIFIED:
11/8/2017 8:54 AM 11/8/2017 3:28 PM
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109. A bond issued by the State of Pennsylvania provides a 5.75% yield. What yield on a Synthetic Chemical Company bond would cause the two bonds to provide the same after-tax rate of return to an investor in the 35.00% tax bracket? a. 9.02% b. 11.06% c. 8.85% d. 9.91% e. 7.70% ANSWER: c RATIONALE: Municipal bond yield 5.75% Tax rate 35.00% Municipal yield = After-tax bond yield 5.75% = BT yield (1 – T) 5.75% = BT yield 65.00% BT yield = 8.85% POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 3-9 Income Taxes QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.03.09 - Income Taxes NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: After-tax returns KEYWORDS: Bloom's: Evaluate OTHER: Multiple Choice: Problem DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 11/8/2017 3:29 PM 110. Carter Corporation has some money to invest, and its treasurer is choosing between City of Chicago municipal bonds and U.S. Treasury bonds. Both have the same maturity, and they are equally risky and liquid. If Treasury bonds yield 6.00%, and Carter’s marginal income tax rate is 15.00%, what yield on the Chicago municipal bonds would make Carter’s treasurer indifferent between the two? a. 4.79% b. 4.74% c. 5.10% d. 5.61% e. 6.38% ANSWER: c RATIONALE: Treasury bond yield 6.00% Tax rate 15.00% Remember that municipal bonds are tax exempt, so their BT yield = AT yield. Municipal yield = AT bond yield Municipal yield = BT bond yield (1 – T) Municipal yield = 5.10% Copyright Cengage Learning. Powered by Cognero.
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POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 3-9 Income Taxes QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.03.09 - Income Taxes NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: After-tax returns KEYWORDS: Bloom's: Evaluate OTHER: Multiple Choice: Problem DATE CREATED: DATE MODIFIED:
11/8/2017 8:54 AM 11/8/2017 12:25 PM
111. A 5-year corporate bond yields 10.70%. A 5-year municipal bond of equal risk yields 6.50%. Assume that the state tax rate is zero. At what federal tax rate are you indifferent between the two bonds? (Round your final answer to two decimal places.) a. 40.04% b. 34.93% c. 34.15% d. 47.50% e. 39.25% ANSWER: e RATIONALE: BT Bond yield 10.70% Municipal bond yield 6.50% Remember that municipal bonds are tax exempt, so their BT yield = AT yield. Municipal yield = After-tax bond yield 6.50% = 10.70% (1 – T) 0.6075 = (1 – T) T = 39.25% POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 3-9 Income Taxes QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.03.09 - Income Taxes NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: After-tax returns KEYWORDS: Bloom's: Evaluate Copyright Cengage Learning. Powered by Cognero.
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OTHER: DATE CREATED: DATE MODIFIED:
Multiple Choice: Problem 11/8/2017 8:54 AM 11/8/2017 3:30 PM
112. Last year, Stewart-Stern Inc. reported $11,250 of sales, $4,500 of operating costs other than depreciation, and $1,250 of depreciation. The company had $3,500 of bonds outstanding that carry a 6.50% interest rate, and its federal-plus-state income tax rate was 35.00%. During last year, the firm had expenditures on fixed assets and net operating working capital that totaled $2,000. These expenditures were necessary for it to sustain operations and generate future sales and cash flows. This year's data are expected to remain unchanged except for one item, depreciation, which is expected to increase by $1,225. By how much will the depreciation change cause (1) the firm's net income and (2) its free cash flow to change? Note that the company uses the same depreciation for tax and stockholder reporting purposes. Do not round the intermediate calculations. Net Income
Free Cash Flow
a. -$796.25; $428.75 b. -$772.36; $330.14 c. -$939.58; $437.33 d. -$724.59; $505.93 e. -$923.65; $475.91 ANSWER: a RATIONALE: This problem can be worked very easily--just multiply the increase in depreciation by (1-T) to get the decrease in net income, and then subtract this value from the change in depreciation to get the change in free cash flow: Change in depreciation $1,225 Tax rate 35.00% Reduction in net income = Change in Depr'n (1 - Tax rate) -$796.25 Increase in free cash flow = Change in Depr'n - Reduction in NI $428.75 We can also get the answer the long way, which explains things in more detail: Old New Change Bonds
$3,500
$3,500
$0.00
Interest rate
6.50%
6.50%
0.00%
Tax rate
35.00%
35.00%
0.00%
Capex + ΔNOWC
$2,000
$2,000
$0.00
Sales
$11,250 $11,250
$0.00
Operating costs excluding depreciation
$4,500
$4,500
$0.00
Depreciation
$1,250
$2,475 $1,225.00
Operating income (EBIT)
$5,500
$4,275 -$1,225.00
Interest charges
$228
Taxable income
$5,273
$4,048 -$1,225.00
Taxes
$1,845
$1,417
-$428.75
Net income
$3,427
$2,631
-$796.25
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$228
$0.00
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Free cash flow = EBIT(1 - T) + Deprec - [Capex + ΔNOWC]
$2,825
$3,254
$428.75 $428.75
Check on FCF: ΔFCF = Change in depreciation x Tax rate We like this problem because it illustrates that an increase in depreciation will decrease the firm's net income yet increase its free cash flow, and cash is king. POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 3-7 Free Cash Flow QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES FOFM.BRIG.17.03.07 - Free Cash Flow : NATIONAL STANDARDS United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic : STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Net income vs. FCF KEYWORDS: Bloom's: Evaluate OTHER: Multiple Choice: Problem DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 11/8/2017 1:16 PM
113. Watson Oil recently reported (in millions) $8,250 of sales, $5,750 of operating costs other than depreciation, and $1,100 of depreciation. The company had $3,200 of outstanding bonds that carry a 5% interest rate, and its federal-plusstate income tax rate was 35%. In order to sustain its operations and thus generate future sales and cash flows, the firm was required to make $1,250 of capital expenditures on new fixed assets and to invest $300 in net operating working capital. By how much did the firm's net income exceed its free cash flow? Do not round the intermediate calculations. a. $381 b. $346 c. $308 d. $284 e. $263 ANSWER: b RATIONALE: $3,200 Bonds Interest rate
5%
Tax rate
35%
Required capital expenditures (fixed assets) Required addition to net operating working capital
$1,250 $300
Sales
$8,250
Operating costs excluding depr'n
5,750
Depreciation
1,100
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Operating income (EBIT)
$1,400
Interest charges
160 $1,240
Taxable income (EBT) Taxes
434 $806
Net income FCF = EBIT(1 - T) + Depr'n - Capex - NOWC FCF = $910 + $1,100 -$1,250 -$300 = $460 Difference between net income and FCF = $346
POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 3-7 Free Cash Flow QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.03.07 - Free Cash Flow NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Net income vs. FCF KEYWORDS: Bloom's: Evaluate OTHER: Multiple Choice: Problem DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 11/8/2017 1:16 PM 114. For 2018, Bargain Basement Stores reported $11,500 of sales and $5,000 of operating costs (including depreciation). The company has $20,500 of total invested capital, the weighted average cost of that capital (the WACC) was 8%, and the federal-plus-state income tax rate was 40%. What was the firm's Economic Value Added (EVA), i.e., how much value did management add to stockholders' wealth during 2017? a. $2,599 b. $1,921 c. $2,712 d. $2,373 e. $2,260 ANSWER: e RATIONALE: WACC 8% Total invested capital $20,500 Sales $11,500 Operating costs including depreciation $5,000 Tax rate 40% EBIT EBIT
Sales
EVA
EBIT(1 – T)
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Operating costs $6,500 (WACC
Total invested capital) Page 124
$3,900 $1,640 EVA EVA = $2,260 POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 3-8 MVA and EVA QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.03.08 - MVA and EVA NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: EVA KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Problem DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 11/8/2017 12:25 PM 115. Allen Corporation can (1) build a new plant that should generate a before-tax return of 11.00%, or (2) invest the same funds in the preferred stock of Florida Power & Light (FPL), which should provide Allen with a before-tax return of 9.00%, all in the form of dividends. Assume that Allen’s marginal tax rate is 25.00%, and that 70.00% of dividends received are excluded from taxable income. If the plant project is divisible into small increments, and if the two investments are equally risky, what combination of these two possibilities will maximize Allen’s effective return on the money invested? (Round your final answer to two decimal places.) a. All in FPL preferred stock. b. 60% in FPL; 40% in the project. c. All in the plant project. d. 60% in the project; 40% in FPL. e. 50% in each. ANSWER: a RATIONALE: BT project return 11.00% BT preferred return 9.00% Tax rate 25.00% Dividend exclusion % 70.00% After-tax return on project = BT project return (1 – T) After-tax return on project = 8.25% After-tax return on pref. = BT pref. return [1 – (1 – Div exclusion%)(T)] After-tax return on pref. = 8.33% POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 3-9 Income Taxes QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.03.09 - Income Taxes NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.17.06 - Finance function Copyright Cengage Learning. Powered by Cognero.
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LOCAL STANDARDS: TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. After-tax returns-nonalgorithmic Bloom's: Evaluate Multiple Choice: Problem 11/8/2017 8:54 AM 11/8/2017 12:25 PM
116. Solarcell Corporation has $20,000 that it plans to invest in marketable securities. It is choosing between AT&T bonds that yield 11.00%, State of Florida municipal bonds that yield 8.00%, and AT&T preferred stock with a dividend yield of 9.00%. Solarcell’s corporate tax rate is 39.00%, and 70.00% of the preferred stock dividends it receives are tax exempt. Assuming that the investments are equally risky and that Solarcell chooses strictly on the basis of after-tax returns, which security should be selected? Answer by giving the after-tax rate of return on the highest yielding security. a. 8.00% b. 9.12% c. 8.24% d. 7.44% e. 6.08% ANSWER: a RATIONALE: BT bond yield 11.00% BT municipal bond yield 8.00% BT preferred yield 9.00% Tax rate 39.00% Dividend exclusion % 70.00% Since municipal bonds are exempt from federal taxes, its BT return = AT return AT municipal bond yield 8.00% AT bond yield = BT bond yield (1 – T) AT bond yield = 6.71% AT preferred yield = BT pref. return [1 – (1 – Div exclusion%)(T)] AT preferred yield = 7.95% Highest AT yield = 8.00% POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 3-9 Income Taxes QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.03.09 - Income Taxes NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: After-tax returns KEYWORDS: Bloom's: Evaluate OTHER: Multiple Choice: Problem DATE CREATED: DATE MODIFIED:
11/8/2017 8:54 AM 11/8/2017 12:25 PM
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117. A corporation can earn 7.50% if it invests in municipal bonds. The corporation can also earn 8.20% (before-tax) by investing in preferred stock. Assume that the two investments have equal risk. What is the break-even corporate tax rate that makes the corporation indifferent between the two investments? Assume a 70.00% dividend exclusion for tax on dividends. (Do not round your intermediate answer and round your final answer to two decimal places.) a. 28.74% b. 31.02% c. 28.46% d. 27.89% e. 35.28% ANSWER: c RATIONALE: BT Preferred stock yield 8.20% Municipal yield 7.50% Dividend exclusion % 70.00% Remember that municipal bonds are tax exempt, so their BT yield = AT yield. Municupal = After-tax preferred yield yield 7.50%
=
BT pref. return
7.50% 0.9146 T
= = =
8.20% [1 – 28.46%
[1 – (1 – Div exclusion%)(T)] [1 – 30.00%
30.00% (T)]
(T)]
POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 3-9 Income Taxes QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.03.09 - Income Taxes NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: After-tax returns KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Problem DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 11/8/2017 3:32 PM 118. Mantle Corporation is considering two equally risky investments: ∙ A $5,000 investment in preferred stock that yields 6.75%. ∙ A $5,000 investment in a corporate bond that yields 10.00%. What is the breakeven corporate tax rate that makes the company indifferent between the two investments? Assume a 70.00% dividend exclusion for tax on dividends. (Do not round your intermediate answer and round your final answer to two decimal places.) a. 46.87% b. 34.23% c. 37.08% Copyright Cengage Learning. Powered by Cognero.
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d. 40.75% e. 50.13% ANSWER: RATIONALE:
d BT Preferred stock yield 6.75% Dividend exclusion % 70.00% BT bond yield 10.00% AT bond yield = After - tax preferred yield BT bond yield (1 – T) = BT pref. return [1 – (1 - Div exclusion %) 10.00% (1 – T) = 6.75% [1 – 30.00% (T)] 3.25% = 7.98% (T) T = 40.75% POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 3-9 Income Taxes QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.03.09 - Income Taxes NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: After-tax returns KEYWORDS: Bloom's: Evaluate OTHER: Multiple Choice: Problem DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 11/8/2017 12:25 PM 119. West Corporation has $50,000 that it plans to invest in marketable securities. The corporation is choosing between the following three equally risky securities: Alachua County tax-free municipal bonds yielding 8.50%; Exxon Mobil bonds yielding 10.50%; and GM preferred stock with a dividend yield of 9.25%. West’s corporate tax rate is 32.00%. What is the after-tax return on the best investment alternative? Assume a 70.00% dividend exclusion for tax on dividends. (Assume the company chooses on the basis of after-tax returns. Round your final answer to 3 decimal places.) a. 9.690% b. 7.820% c. 8.585% d. 8.500% e. 10.625% ANSWER: d RATIONALE: BT municipal bond yield 8.50% BT bond yield 10.50% BT preferred yield 9.25% Tax rate 32.00% Dividend exclusion % 70.00% Since municipal bonds are exempt from federal taxes, its BT return = AT return AT municipal bond yield = 8.500% Copyright Cengage Learning. Powered by Cognero.
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AT bond yield = BT bond yield AT bond yield = 7.140%
(1 – T)
AT preferred yield = BT pref. return [1 – (1 – Div exclusion%)(T)] AT preferred yield = 8.362% Highest AT yield = 8.500% POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 3-9 Income Taxes QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.03.09 - Income Taxes NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: After-tax returns KEYWORDS: Bloom's: Evaluate OTHER: Multiple Choice: Problem DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 11/8/2017 12:25 PM 120. Arvo Corporation is trying to choose between three alternative investments. The three securities that the company is considering are as follows: ∙ ∙ ∙
Tax-free municipal bonds with a return of 8.80%. Wooli Corporation bonds with a return of 11.75%. CFI Corp. preferred stock with a return of 9.80%.
The company’s tax rate is 35.00%. What is the after-tax return on the best investment alternative? Assume a 70.00% dividend exclusion for tax on dividends. (Round your final answer to 3 decimal places.) a. 8.800% b. 8.624% c. 9.064% d. 8.448% e. 9.504% ANSWER: a RATIONALE: BT municipal bond yield 8.80% BT bond yield 11.75% BT preferred yield 9.80% Tax rate 35.00% Dividend exclusion % 70.00% Since municipal bonds are exempt from federal taxes, its BT return = AT return AT municipal bond yield = 8.800% AT bond yield = BT bond yield Copyright Cengage Learning. Powered by Cognero.
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AT bond yield = 7.638% AT preferred yield = BT pref. return [1 – (1 – Div exclusion%)(T)] AT preferred yield = 8.771% Highest AT yield = 8.800% POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 3-9 Income Taxes QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.03.09 - Income Taxes NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: After-tax returns KEYWORDS: Bloom's: Evaluate OTHER: Multiple Choice: Problem DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 11/8/2017 12:25 PM 121. Collins Co. began operations in 2015. The company lost money the first two years, but has been profitable ever since. The company’s taxable income (EBT) for its first four years are summarized below: Year 2015 2016 2017 2018
EBT -$7,000,000 -$5,200,000 $4,200,000 $8,300,000
The corporate tax rate has remained at 34%. Assume that the company has taken full advantage of the Tax Code’s carryback, carry-forward provisions, and assume that the current provisions were applicable in 2015. What is Collins’ tax liability for 2018? a. $76,500 b. $87,720 c. $125,460 d. $127,500 e. $102,000 ANSWER: e RATIONALE: Tax rate 34% EBT After Unused Carry-Forward Forward Carryable Year Taxable Income Used Applied Amount 2015 -$7,000,000 $0 $0 $7,000,000 2016 -$5,200,000 $0 $0 $12,200,000 2017 $4,200,000 $4,200,000 $0 $8,000,000 2018 $8,300,000 $8,000,000 $300,000 $0 2018 Tax liability = EBT Copyright Cengage Learning. Powered by Cognero.
Tax rate Page 130
2018 Tax liability = $102,000 POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 3-9 Income Taxes QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.03.09 - Income Taxes NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Carry-back, carry-forward KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Problem DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 11/8/2017 1:17 PM 122. Salinger Software was founded in 2015. The company lost money each of its first three years, but was able to turn a profit in 2018. Salinger’s operating income (EBIT) for its first four years of operations is reported below. Year 2015 2016 2017 2018
EBIT -$100,000,000 -$150,000,000 -$100,000,000 $700,000,000
The company has no debt, so operating income equals earnings before taxes. The corporate tax rate has remained constant at 35%. Assume that the company took full advantage of the carry-back, carry-forward provisions in the Tax Code, and assume that the current provisions were applicable in 2015. How much tax did the company pay in 2018? a. $121,275,000 b. $132,300,000 c. $135,975,000 d. $122,500,000 e. $101,675,000 ANSWER: RATIONALE:
d Tax rate
35% EBT After Carry-Forward Forward
Year 2015 2016 2017 2018
Taxable Used Applied Income -$100,000,000 $0 -$150,000,000 $0 -$100,000,000 $0 $700,000,000 $350,000,000
Unused Carryable Amount $0 $100,000,000 $0 $250,000,000 $0 $350,000,000 $350,000,000 $0
2018 Tax liability = EBT Tax rate 2018 Tax liability = $122,500,000 Copyright Cengage Learning. Powered by Cognero.
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POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 3-9 Income Taxes QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.03.09 - Income Taxes NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Carry-back, carry-forward KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Problem DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 11/8/2017 1:19 PM 123. Bradshaw Beverages began operations in 2014. The table below contains the company’s taxable income during each year of its operations. Notice that the company lost money in each of its first three years. The corporate tax rate has been 40% each year. Year 2014 2015 2016 2017 2018
Taxable Income -$100,000 -$500,000 -$200,000 $800,000 $1,000,000
Assume that the company has taken full advantage of the Tax Code’s carry-back, carry-forward provisions, and assume that the current provisions were applicable in 2014. How much did the company pay in taxes during 2018? a. $460,000 b. $400,000 c. $384,000 d. $372,000 e. $432,000 ANSWER: b RATIONALE: Tax rate 40% EBT After Unused Carry-Forward Forward Carryable Year Taxable Income Used Applied Amount 2014 -$100,000 $0 $0 $100,000 2015 -$500,000 $0 $0 $600,000 2016 -$200,000 $0 $0 $800,000 2017 $800,000 $800,000 $0 $0 2018 $1,000,000 $0 $1,000,000 $0
POINTS: DIFFICULTY:
2018 Tax liability = EBT Tax rate 2018 Tax liability = $400,000 1 CHALLENGING
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REFERENCES: 3-9 Income Taxes QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.03.09 - Income Taxes NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Carry-back, carry-forward KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Problem DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 11/8/2017 1:19 PM 124. Uniontown Books began operating in 2014. The company lost money its first three years of operations, but has had an operating profit during the past two years. The company’s operating income (EBIT) for its first five years was as follows: Year 2014 2015 2016 2017 2018
EBIT -$1,600,000 -$2,000,000 -$1,000,000 $1,200,000 $7,000,000
The company has no debt, and therefore, pays no interest expense. Its corporate tax rate has remained at 34% during this 5-year period. What was Uniontown’s tax liability for 2018? (Assume that the company has taken full advantage of the carry-back and carry-forward provisions, and assume that the current provisions were applicable in 2014.) a. $1,260,720 b. $1,077,120 c. $930,240 d. $1,224,000 e. $1,064,880 ANSWER: d RATIONALE: Tax rate 34% EBT After Unused Carry-Forward Forward Carryable Year Taxable Income Used Applied Amount 2014 -$1,600,000 $0 $0 $1,600,000 2015 -$2,000,000 $0 $0 $3,600,000 2016 -$1,000,000 $0 $0 $4,600,000 2017 $1,200,000 $1,200,000 $0 $3,400,000 2018 $7,000,000 $3,400,000 $3,600,000 $0
POINTS: DIFFICULTY: REFERENCES:
2018 Tax liability = EBT Tax rate 2018 Tax liability = $1,224,000 1 CHALLENGING 3-9 Income Taxes
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QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.03.09 - Income Taxes NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Carry-back, carry-forward KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Problem DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 11/8/2017 1:19 PM 125. Mays Industries was established in 2013. Since its inception, the company has generated the following levels of taxable income (EBT): Year 2013 2014 2015 2016 2017 2018
Taxable Income $50,000 $40,000 $30,000 $20,000 -$52,500 $60,000
Assume that each year the company has faced a 40% income tax rate. Also, assume that the company has taken full advantage of the Tax Code’s carry-back, carry-forward provisions, and assume that the current provisions were applicable in 2013. What is the company’s tax liability for 2018? a. $19,780 b. $27,830 c. $23,000 d. $25,990 e. $17,250 ANSWER: c RATIONALE: Tax rate 40% EBT After Unused Back and Carry-Back Carry-Forward Carryable Forward Year Taxable Income Used Used Applied Amount 2013 $50,000 $0 $0 $50,000 $0 2014 $40,000 $0 $0 $40,000 $0 2015 $30,000 $30,000 $0 $0 $22,500 2016 $20,000 $20,000 $0 $0 $2,500 2017 -$52,500 $0 $0 $0 $2,500 2018 $60,000 $0 $2,500 $57,500 $0 2018 Tax liability = EBT Tax rate 2018 Tax liability = $23,000 POINTS: 1 DIFFICULTY: CHALLENGING Copyright Cengage Learning. Powered by Cognero.
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REFERENCES: 3-9 Income Taxes QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.03.09 - Income Taxes NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Carry-back, carry-forward KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Problem DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 11/8/2017 1:20 PM 126. Moose Industries faces the following tax schedule: Taxable Income Tax on Base of Bracket Percentage on Excess above Base Up to $50,000 $0 15% $50,000-$75,000 7,500 25 $75,000-$100,000 13,750 34 $100,000-$335,000 22,250 39 $335,000-$10,000,000 113,900 34 $10,000,000-$15,000,000 3,400,000 35 $15,000,000-$18,333,333 5,150,000 38 Over $18,333,333 6,416,667 35 Last year the company realized $9,000,000 in operating income (EBIT). Its annual interest expense is $1,500,000. What was the company’s net income for the year? a. $4,158,000 b. $4,950,000 c. $5,197,500 d. $3,712,500 e. $3,960,000 ANSWER: b RATIONALE: Operating income $9,000,000 Interest expense $1,500,000 Taxable income = Operating income – Interest expense Taxable income = $9,000,000 – $1,500,000 Taxable income = $7,500,000 Taxable Income $0 $50,000 $75,000 $100,000 $335,000 $10,000,000 $15,000,000 $18,333,333 Copyright Cengage Learning. Powered by Cognero.
Tax on Base of Bracket $0 7,500 13,750 22,250 113,900 3,400,000 5,150,000 6,416,667
Percentage on Excess above Base 15% 25 34 39 34 35 38 35 Page 135
Tax on base = $113,900 Tax on excess base = $2,436,100 Tax liability = $2,550,000 Net income = Taxable income – Taxes Net income = $4,950,000 POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 3-9 Income Taxes QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.03.09 - Income Taxes NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Net income KEYWORDS: Bloom's: Analyze OTHER: Multilpe Choice: Problem DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 11/8/2017 12:25 PM 127. Corporations face the following tax schedule: Percentage on Excess above Base Up to $50,000 $0 15% $50,000-$75,000 7,500 25 $75,000-$100,000 13,750 34 $100,000-$335,000 22,250 39 $335,000-$10,000,000 113,900 34 $10,000,000-$15,000,000 3,400,000 35 $15,000,000-$18,333,333 5,150,000 38 Over $18,333,333 6,416,667 35 Company Z has $90,000 of taxable income from its operations, $5,000 of interest income, and $30,000 of dividend income from preferred stock it holds in other corporations. What is Company Z’s tax liability? Assume a 70% dividend exclusion for tax on dividends. a. $20,000 b. $23,096 c. $23,810 d. $19,286 e. $24,048 ANSWER: c RATIONALE: Taxable income $90,000 Interest income $5,000 Dividend income $30,000 Dividend exclusion % 70% Taxable Income
Tax on Base of Bracket
Total taxable income = Taxable income + Interest income + Taxable dividend income Copyright Cengage Learning. Powered by Cognero.
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Total taxable income = Taxable income + Interest income + Dividend income (1-Dividend exclusion %) Total taxable income = $104,000 Taxable Income $0 $50,000 $75,000 $100,000 $335,000 $10,000,000 $15,000,000 $18,333,333 Tax on base = Tax on excess base = Tax liability =
Tax on Base of Bracket $0 7,500 13,750 22,250 113,900 3,400,000 5,150,000 6,416,667
% on Excess above Base 15% 25 34 39 34 35 38 35
$22,250 $1,560 $23,810
POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 3-9 Income Taxes QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.03.09 - Income Taxes NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Corporate taxes KEYWORDS: Bloom's: Analyze OTHER: Multilpe Choice: Problem DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 11/8/2017 12:25 PM 128. Lintner Beverage Corp. reported the following information from their financial statements: Operating income (EBIT) = $10,500,000 Interest payments on long-term debt = $1,750,000 Dividend income = $1,000,000 Calculate Lintner's total tax liability using the corporate tax schedule below: Taxable Income $0-$50,000 $50,000-$75,000 $75,000-$100,000 $100,000-$335,000 $335,000-$10,000,000 $10,000,000-$15,000,000 $15,000,000-$18,333,333 Over $18,333,333
Tax on Base of Bracket $0 7,500 13,750 22,250 113,900 3,400,000 5,150,000 6,416,667
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Percentage on Excess above Base 15% 25 34 39 34 35 38 35 Page 137
Assume a 70% dividend exclusion for tax on dividends. a. $2,892,380 b. $3,692,400 c. $3,292,390 d. $2,738,530 e. $3,077,000 ANSWER: e RATIONALE: Operating income Interest payments Dividend income Dividend exclusion %
$10,500,000 $1,750,000 $1,000,000 70%
Taxable income = Operating income – Interest payments + Taxable dividend income Taxable income = Operating income – Interest payments + Dividend income (1 – Dividend exclusion%) Taxable income = $9,050,000 Taxable Income $0 $50,000 $75,000 $100,000 $335,000 $10,000,000 $15,000,000 $18,333,333 Tax on base = Tax on excess base = Tax liability =
Tax on Base of Bracket $0 7,500 13,750 22,250 113,900 3,400,000 5,150,000 6,416,667
% on Excess above Base 15% 25 34 39 34 35 38 35
$113,900 $2,963,100 $3,077,000
POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 3-9 Income Taxes QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.03.09 - Income Taxes NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Corporate taxes KEYWORDS: Bloom's: Analyze OTHER: Multilpe Choice: Problem DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 11/8/2017 12:25 PM 129. Last year, Martyn Company had $440,000 in taxable income from its operations, $50,000 in interest income, and $100,000 in dividend income. Using the corporate tax rate table given below, what was the company’s tax liability for the Copyright Cengage Learning. Powered by Cognero.
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year? Taxable Income $0-$50,000 $50,000-$75,000 $75,000-$100,000 $100,000-$335,000 $335,000-$10,000,000 $10,000,000-$15,000,000 $15,000,000-$18,333,333 Over $18,333,333
Tax on Base of Bracket $0 7,500 13,750 22,250 113,900 3,400,000 5,150,000 6,416,667
Percentage on Excess above Base 15% 25 34 39 34 35 38 35
Assume a 70% dividend exclusion for tax on dividends. a. $176,800 b. $221,000 c. $215,696 d. $160,888 e. $212,160 ANSWER: a RATIONALE: Operating income Interest income Dividend income Dividend exclusion %
$440,000 $50,000 $100,000 70%
Taxable income = Operating income + Interest income + Taxable dividend income Taxable income = Operating income + Interest income + Dividend income (1 – Dividend exclusion%) Taxable income = $520,000 Taxable Income $0 $50,000 $75,000 $100,000 $335,000 $10,000,000 $15,000,000 $18,333,333 Tax on base = Tax on excess base = Tax liability =
Tax on Base of Bracket $0 7,500 13,750 22,250 113,900 3,400,000 5,150,000 6,416,667
% on Excess above Base 15% 25 34 39 34 35 38 35
$113,900 $62,900 $176,800
POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 3-9 Income Taxes QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.03.09 - Income Taxes NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.17.06 - Finance function Copyright Cengage Learning. Powered by Cognero.
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LOCAL STANDARDS: TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. Corporate taxes Bloom's: Analyze Multilpe Choice: Problem 11/8/2017 8:54 AM 11/8/2017 3:33 PM
130. Griffey Communications recently realized $122,500 in operating income. The company had interest income of $25,000 and realized $70,000 in dividend income. The company’s interest expense was $40,000. Using the corporate tax schedule below, what is Griffey’s tax liability? Taxable Income Up to $50,000 $50,000-$75,000 $75,000-$100,000 $100,000-$335,000 $335,000-$10,000,000 $10,000,000-$15,000,000 $15,000,000-$18,333,333 Over $18,333,333
Tax on Base of Bracket $0 7,500 13,750 22,250 113,900 3,400,000 5,150,000 6,416,667
Assume a 70% dividend exclusion for tax on dividends. a. $37,702 b. $27,359 c. $33,365 d. $32,364 e. $36,702 ANSWER: c RATIONALE: Operating income Interest expense Interest income Dividend income Dividend exclusion %
Percentage on Excess above Base 15% 25 34 39 34 35 38 35
$122,500 $40,000 $25,000 $70,000 70%
Taxable income = Operating income – Interest expense + Interest income + Taxable dividend income Taxable income = Operating income – Interest expense + Interest income + Dividend income (1-Dividend exclusion %) Total taxable income = $128,500 Taxable Income $0 $50,000 $75,000 $100,000 $335,000 $10,000,000 $15,000,000 $18,333,333 Tax on base = Tax on excess base = Copyright Cengage Learning. Powered by Cognero.
Tax on Base of Bracket $0 7,500 13,750 22,250 113,900 3,400,000 5,150,000 6,416,667
% on Excess above Base 15% 25 34 39 34 35 38 35
$22,250 $11,115 Page 140
Tax liability =
$33,365
POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 3-9 Income Taxes QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.03.09 - Income Taxes NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.17.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Corporate taxes KEYWORDS: Bloom's: Analyze OTHER: Multilpe Choice: Problem DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 11/8/2017 3:34 PM 131. Maureen Smith is a single individual. She claims one exemption of $4,050 for herself and claims a standard deduction of $6,350. Her salary for the year was $68,800. What is her taxable income? a. $53,728 b. $58,400 c. $44,384 d. $43,800 e. $56,064 ANSWER: RATIONALE:
b Taxable income = Salary - Exemption - Standard Deduction Taxable income = $68,800 - $4,050 - $6,350 Taxable income = $58,400 POINTS: 1 DIFFICULTY: Easy REFERENCES: 3-9 Individual Taxes QUESTION TYPE: Multiple Choice HAS VARIABLES: True KEYWORDS: Bloom’s: Apply | BUSPROG: Analytic DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 12/12/2017 10:47 PM 132. Maureen Smith is a single individual. She claims one exemption of $4,050 for herself and claims a standard deduction of $6,350. Her salary for the year was $204,250. Assume the following tax table is applicable. Single Individuals If Your Taxable Income Is
You Pay This Amount on the Base of the Bracket
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Plus This Percentage on the Excess over the Base
Average Tax Rate at Top of Bracket Page 141
Up to $9,325 $9,325-$37,950 $37,950-$91,900 $91,900-$191,650 $191,650-$416,700 $416,700-$418,400 Over $418,400
$0.00 932.50 5,226.25 18,713.75 46,643.75 120,910.25 121,505.25
10.0% 15.0 25.0 28.0 33.0 35.0 39.6
10.0% 13.8 20.4 24.3 29.0 29.0 39.6
What is her marginal tax rate? a. 35.0% b. 15.0% c. 33.0% d. 25.0% e. 28.0% ANSWER: RATIONALE:
c Taxable income = Salary - Exemption - Standard Deduction Taxable income = $204,250 - $4,050 - $6,350 Taxable income = $193,850
The marginal tax rate is the tax rate applicable to the last unit of a person’s income. Since taxable income is $193,850, the marginal tax rate is shown in Column 3 for the income bracket that includes the taxable income amount - which is 33.0%. POINTS: 1 DIFFICULTY: Easy REFERENCES: 3-9 Individual Taxes QUESTION TYPE: Multiple Choice HAS VARIABLES: True KEYWORDS: Bloom’s: Apply | BUSPROG: Analytic DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 12/12/2017 11:12 PM 133. Maureen Smith is a single individual. She claims one exemption of $4,050 for herself and claims a standard deduction of $6,350. Her salary for the year was $146,350. Assume the following tax table is applicable. Single Individuals If Your Taxable Income Is Up to $9,325 $9,325-$37,950 $37,950-$91,900 $91,900-$191,650 $191,650-$416,700 $416,700-$418,400 Over $418,400
You Pay This Amount on the Base of the Bracket $0.00 932.50 5,226.25 18,713.75 46,643.75 120,910.25 121,505.25
Plus This Percentage on the Excess over the Base 10.0% 15.0 25.0 28.0 33.0 35.0 39.6
Average Tax Rate at Top of Bracket 10.0% 13.8 20.4 24.3 29.0 29.0 39.6
What is her federal tax liability? Copyright Cengage Learning. Powered by Cognero.
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a. $27,632.25 b. $23,907.75 c. $31,047.75 d. $25,770.75 e. $28,253.25 ANSWER: RATIONALE:
c Taxable income = Salary - Exemption - Standard Deduction Taxable income = $146,350 - $4,050 - $6,350 Taxable income = $135,950 The marginal tax rate is the tax rate applicable to the last unit of a person’s income. Since taxable income is $135,950, the marginal tax rate is shown in Column 3 for the income bracket that includes the taxable income amount - which is 28.0%.
Taxable income is $135,950, so the federal tax liability is calculated as follows: Federal tax liability = $18,713.75 + [(135,950 - 91,900) × 0.28] Federal tax liability = $18,713.75 + $12,334.00 = $31,047.75 POINTS: 1 DIFFICULTY: Medium REFERENCES: 3-9 Individual Taxes QUESTION TYPE: Multiple Choice HAS VARIABLES: True KEYWORDS: Bloom’s: Apply | BUSPROG: Analytic DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 12/12/2017 11:41 PM 134. Maureen Smith is a single individual. She claims one exemption of $4,050 for herself and claims a standard deduction of $6,350. Her salary for the year was $71,850. Assume the following tax table is applicable. Single Individuals You Pay This Amount on the Base of the Bracket $0.00 932.50 5,226.25 18,713.75 46,643.75 120,910.25 121,505.25
If Your Taxable Income Is Up to $9,325 $9,325-$37,950 $37,950-$91,900 $91,900-$191,650 $191,650-$416,700 $416,700-$418,400 Over $418,400
Plus This Percentage on the Excess over the Base 10.0% 15.0 25.0 28.0 33.0 35.0 39.6
Average Tax Rate at Top of Bracket 10.0% 13.8 20.4 24.3 29.0 29.0 39.6
What is her average tax rate? a. 19.87% b. 14.63% c. 17.70% d. 18.07% e. 19.33% ANSWER:
d
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RATIONALE:
Taxable income = Salary - Exemption - Standard Deduction Taxable income = $71,850 - $4,050 - $6,350 Taxable income = $61,450 The marginal tax rate is the tax rate applicable to the last unit of a person’s income. Since taxable income is $61,450, the marginal tax rate is shown in Column 3 for the income bracket that includes the taxable income amount - which is 25%. Taxable income is $61,450, so the federal tax liability is calculated as follows: Federal tax liability = $5,226.25 + [(61,450 - 37,950) × 0.25] Federal tax liability = $5,226.25 + $5,875.00 = $11,101.25
$11,101.25 was the tax paid and $61,450 is the taxable income, so the average tax rate is calculated as follows: Average tax rate = Tax paid/Taxable income Average tax rate = $11,101.25/$61,450 Average tax rate = 18.07% POINTS: 1 DIFFICULTY: Medium REFERENCES: 3-9 Individual Taxes QUESTION TYPE: Multiple Choice HAS VARIABLES: True KEYWORDS: Bloom’s: Apply | BUSPROG: Analytic DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 12/13/2017 12:01 AM 135. Alan and Sara Winthrop are a married couple who file a joint income tax return. They have two children, so they claim a total of 4 exemptions ($4,050 for each exemption). In addition, they have legitimate itemized deductions totaling $25,750. Their total income from wages is $168,100. What is the couple’s taxable income? a. $126,150 b. $138,750 c. $142,550 d. $103,400 e. $122,400 ANSWER: RATIONALE:
a First, calculate their exemption total: Exemptions = 4 × $4,050 = $16,200
Now, calculate their taxable income as follows: Taxable income = Salary - Exemptions - Itemized Deductions Taxable income = $168,100 - $16,200 - $25,750 Taxable income = $126,150 POINTS: 1 DIFFICULTY: Easy REFERENCES: 3-9 Individual Taxes QUESTION TYPE: Multiple Choice HAS VARIABLES: True KEYWORDS: Bloom’s: Apply | BUSPROG: Analytic DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 12/13/2017 12:09 AM Copyright Cengage Learning. Powered by Cognero.
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136. Alan and Sara Winthrop are a married couple who file a joint income tax return. They have two children, so they claim a total of 4 exemptions ($4,050 for each exemption). In addition, they have legitimate itemized deductions totaling $25,750. Their total income from wages is $213,900. Assume the following tax table is applicable: Married Couples Filing Joint Returns If Your Taxable Income Is Up to $18,650 $18,650-$75,900 $75,900-$153,100 $153,100-$233,350 $233,350-$416,700 $416,700-$470,700 Over $470,700
You Pay This Amount on the Base of the Bracket $0.00 1,865.00 10,452.50 29,752.50 52,222.50 112,728.00 131,628.00
Plus This Percentage on the Excess over the Base 10.0% 15.0 25.0 28.0 33.0 35.0 39.6
Average Tax Rate at Top of Bracket 10.0% 13.8 19.4 22.4 27.1 28.0 39.6
What is their marginal tax rate? a. 33.0% b. 35.0% c. 10.0% d. 28.0% e. 15.0% ANSWER: RATIONALE:
d First, calculate their exemption total: Exemptions = 4 × $4,050 = $16,200 Taxable income = Salary - Exemptions - Itemized Deductions Taxable income = $213,900 - $16,200 - $25,750 Taxable income = $171,950
The marginal tax rate is the tax rate applicable to the last unit of a person’s income. Since taxable income is $171,950, the marginal tax rate is shown in Column 3 for the income bracket that includes the taxable income amount - which is 28.0%. POINTS: 1 DIFFICULTY: Easy REFERENCES: 3-9 Individual Taxes QUESTION TYPE: Multiple Choice HAS VARIABLES: True KEYWORDS: Bloom’s: Apply | BUSPROG: Analytic DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 12/13/2017 12:28 AM 137. Alan and Sara Winthrop are a married couple who file a joint income tax return. They have two children, so they claim a total of 4 exemptions ($4,050 for each exemption). In addition, they have legitimate itemized deductions totaling $25,750. Their total income from wages is $213,500. Assume the following tax table is applicable: Married Couples Filing Joint Returns Copyright Cengage Learning. Powered by Cognero.
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If Your Taxable Income Is Up to $18,650 $18,650-$75,900 $75,900-$153,100 $153,100-$233,350 $233,350-$416,700 $416,700-$470,700 Over $470,700
You Pay This Amount on the Base of the Bracket $0.00 1,865.00 10,452.50 29,752.50 52,222.50 112,728.00 131,628.00
Plus This Percentage on the Excess over the Base 10.0% 15.0 25.0 28.0 33.0 35.0 39.6
Average Tax Rate at Top of Bracket 10.0% 13.8 19.4 22.4 27.1 28.0 39.6
What is their federal tax liability? a. $31,077.50 b. $33,522.25 c. $38,760.50 d. $36,664.00 e. $34,918.50 ANSWER: RATIONALE:
e First, calculate their exemption total: Exemptions = 4 × $4,050 = $16,200 Taxable income = Salary - Exemptions - Itemized Deductions Taxable income = $213,500 - $16,200 - $25,750 Taxable income = $171,550 The marginal tax rate is the tax rate applicable to the last unit of a person’s income. Since taxable income is $171,550, the marginal tax rate is shown in Column 3 for the income bracket that includes the taxable income amount - which is 28.0%.
Taxable income is $171,550, so the federal tax liability is calculated as follows: Federal tax liability = $29,752.50 + [($171,550 - $153,100) × 0.28] Federal tax liability = $29,752.50 + $5,166.00 = $34,918.50 POINTS: 1 DIFFICULTY: Medium REFERENCES: 3-9 Individual Taxes QUESTION TYPE: Multiple Choice HAS VARIABLES: True KEYWORDS: Bloom’s: Apply | BUSPROG: Analytic DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 12/13/2017 12:46 AM 138. Alan and Sara Winthrop are a married couple who file a joint income tax return. They have two children, so they claim a total of 4 exemptions ($4,050 for each exemption). In addition, they have legitimate itemized deductions totaling $25,750. Their total income from wages is $271,300. Assume the following tax table is applicable: Married Couples Filing Joint Returns If Your Taxable Income Is
You Pay This Amount on the Base of the Bracket
Copyright Cengage Learning. Powered by Cognero.
Plus This Percentage on the Excess over the Base
Average Tax Rate at Top of Bracket Page 146
Up to $18,650 $18,650-$75,900 $75,900-$153,100 $153,100-$233,350 $233,350-$416,700 $416,700-$470,700 Over $470,700
$0.00 1,865.00 10,452.50 29,752.50 52,222.50 112,728.00 131,628.00
10.0% 15.0 25.0 28.0 33.0 35.0 39.6
10.0% 13.8 19.4 22.4 27.1 28.0 39.6
What is their average tax rate? a. 22.28% b. 19.38% c. 22.95% d. 23.84% e. 16.71% ANSWER: RATIONALE:
a The marginal tax rate is the tax rate applicable to the last unit of a person’s income. Since taxable income is $229,350, the marginal tax rate is shown in Column 3 for the income bracket that includes the taxable income amount - which is 28.0%. Taxable income is $229,350, so the federal tax liability is calculated as follows: Federal tax liability = $29,752.50 + [($229,350 - $153,100) × 0.28] Federal tax liability = $29,752.50 + $21,350.00 = $51,102.50
$51,102.50 was the tax paid and $229,350 is the taxable income, so their average tax rate is calculated as follows: Average tax rate = Tax paid/Taxable income Average tax rate = $51,102.50/$229,350 Average tax rate = 22.28% POINTS: 1 DIFFICULTY: Medium REFERENCES: 3-9 Individual Taxes QUESTION TYPE: Multiple Choice HAS VARIABLES: True KEYWORDS: Bloom’s: Apply | BUSPROG: Analytic DATE CREATED: 11/8/2017 8:54 AM DATE MODIFIED: 12/13/2017 1:04 AM
To keep this chapter from involving too much memorization, we provide our students with a formula sheet for use on exams. That makes a few of the questions trivially easy, but most require some thought, and some are downright challenging. Even the very easy ones make students think about the ratios. The challenging questions are labeled CHALLENGING, and most students will agree with that designation. Some of these questions are just definitions, but others require real thought about the make-up of the ratios and relationships among the ratios. We tell our students that to answer some of these questions it is useful (1) to write out the relevant ratio or ratios, (2) then to think about how the ratios would change if the accounting data changed, and (3) occasionally to make up illustrative data to test their conclusions. Note that there is some overlap between the True/False and the multiple choice questions, as some T/F statements are used in the MC questions. 1. Ratio analysis involves analyzing financial statements to help appraise a firm's financial position and strength. Copyright Cengage Learning. Powered by Cognero.
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a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 4-1 Ratio Analysis QUESTION TYPE: True / False HAS VARIABLES: False PREFACE NAME: Chapter Opener LEARNING OBJECTIVES: FOFM.BRIG.17.04.01 - Ratio Analysis NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Ratio analysis KEYWORDS: Bloom's: Remember DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/3/2017 12:57 PM 2. The current and quick ratios help us measure a firm's liquidity. The current ratio measures the relationship of the firm's current assets to its current liabilities, while the quick ratio measures the firm’s ability to pay off short-term obligations without relying on the sale of inventories. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 4-2 Liquidity Ratios QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.04.02 - Liquidity Ratios NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Liquidity ratios KEYWORDS: Bloom's: Remember DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/3/2017 12:57 PM 3. Although a full liquidity analysis requires the use of a cash budget, the current and quick ratios provide fast and easyto-use estimates of a firm's liquidity position. a. True b. False Copyright Cengage Learning. Powered by Cognero.
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ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 4-2 Liquidity Ratios QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.04.02 - Liquidity Ratios NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Liquidity ratios KEYWORDS: Bloom's: Remember DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/3/2017 12:57 PM 4. High current and quick ratios always indicate that the firm is managing its liquidity position well. a. True b. False ANSWER: False RATIONALE: It might have too much liquidity. Liquid assets generally provide low returns. POINTS: 1 DIFFICULTY: EASY REFERENCES: 4-2 Liquidity Ratios QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.04.02 - Liquidity Ratios NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Current ratio KEYWORDS: Bloom's: Understand DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/3/2017 12:57 PM 5. If a firm sold some inventory for cash and left the funds in its bank account, its current ratio would probably not change much, but its quick ratio would decline. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 4-2 Liquidity Ratios Copyright Cengage Learning. Powered by Cognero.
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QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.04.02 - Liquidity Ratios NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Current and quick ratios KEYWORDS: Bloom's: Understand DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/3/2017 12:57 PM 6. If a firm sold some inventory on credit, its current ratio would probably not change much, but its quick ratio would increase. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 4-2 Liquidity Ratios QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.04.02 - Liquidity Ratios NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Current and quick ratios KEYWORDS: Bloom's: Understand DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/3/2017 12:57 PM 7. If a firm sold some inventory on credit as opposed to cash, there is no reason to think that either its current or quick ratio would change. a. True b. False ANSWER: False RATIONALE: The quick ratio would increase as receivables replaced inventory. POINTS: 1 DIFFICULTY: EASY REFERENCES: 4-2 Liquidity Ratios QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.04.02 - Liquidity Ratios Copyright Cengage Learning. Powered by Cognero.
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NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Current and quick ratios KEYWORDS: Bloom's: Understand DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/3/2017 12:57 PM 8. The inventory turnover ratio and days sales outstanding (DSO) are two ratios that are used to assess how effectively a firm is managing its current assets. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 4-3 Asset Management Ratios QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.04.03 - Asset Management Ratios NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Asset management ratios KEYWORDS: Bloom’s: Remember DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/3/2017 12:57 PM 9. A decline in a firm's inventory turnover ratio suggests that it is improving both its inventory management and its liquidity position, i.e., that it is becoming more liquid. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 4-3 Asset Management Ratios QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.04.03 - Asset Management Ratios NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. Copyright Cengage Learning. Powered by Cognero.
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TOPICS: KEYWORDS: DATE CREATED: DATE MODIFIED:
Inventory turnover ratio Bloom's: Understand 9/21/2017 5:19 PM 11/3/2017 4:31 PM
10. In general, it's better to have a low inventory turnover ratio than a high one, as a low ratio indicates that the firm has an adequate stock of inventory relative to sales and thus will not lose sales as a result of running out of stock. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 4-3 Asset Management Ratios QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.04.03 - Asset Management Ratios NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Inventory turnover ratio KEYWORDS: Bloom's: Understand DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/3/2017 12:57 PM 11. The days sales outstanding ratio tells us how long it takes, on average, to collect after a sale is made. The DSO can be compared with the firm's credit terms to get an idea of whether customers are paying on time. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 4-3 Asset Management Ratios QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.04.03 - Asset Management Ratios NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Days sales outstanding KEYWORDS: Bloom’s: Remember DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/3/2017 12:57 PM Copyright Cengage Learning. Powered by Cognero.
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12. If a firm's fixed assets turnover ratio is significantly higher than the average for its industry, then it could be that the firm uses its fixed assets very efficiently or is operating at over capacity and should probably add fixed assets. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 4-3 Asset Management Ratios QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.04.03 - Asset Management Ratios NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Fixed assets turnover ratio KEYWORDS: Bloom's: Understand DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/3/2017 12:57 PM 13. Debt management ratios show the extent to which a firm's managers are attempting to magnify returns on owners' capital through the use of financial leverage. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 4-4 Debt Management Ratios QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FFMC.BRIG.15.04.04 - Debt management ratios NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Debt management ratios KEYWORDS: Bloom’s: Remember DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/3/2017 12:57 PM 14. The more conservative a firm's management is, the higher the firm's total debt to total capital ratio [measured as (Short-term debt + Long-term debt)/(Debt + Preferred stock + Common equity)] is likely to be. a. True b. False ANSWER: False Copyright Cengage Learning. Powered by Cognero.
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POINTS: 1 DIFFICULTY: EASY REFERENCES: 4-4 Debt Management Ratios QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.04.04 - Debt Management Ratios NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Debt management ratios KEYWORDS: Bloom's: Understand DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/3/2017 12:57 PM 15. Other things held constant, the higher a firm's total debt to total capital ratio [measured as (Short-term debt + Longterm debt)/(Debt + Preferred stock + Common equity)], the higher its TIE ratio will be. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 4-4 Debt Management Ratios QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.04.04 - Debt Management Ratios NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Debt management ratios KEYWORDS: Bloom's: Understand DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/3/2017 12:57 PM 16. The times-interest-earned ratio measures the extent to which operating income can decline before the firm is unable to meet its annual interest costs. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 4-4 Debt Management Ratios QUESTION TYPE: True / False Copyright Cengage Learning. Powered by Cognero.
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HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.04.04 - Debt Management Ratios NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: TIE ratio KEYWORDS: Bloom’s: Remember DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/8/2017 2:27 PM 17. Profitability ratios show the combined effects of liquidity, asset management, and debt management on a firm's operating results. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 4-5 Profitability Ratios QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.04.05 - Profitability Ratios NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Profitability ratios KEYWORDS: Bloom’s: Remember DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/3/2017 12:57 PM 18. The basic earning power ratio (BEP) reflects the earning power of a firm's assets after giving consideration to financial leverage and tax effects. a. True b. False ANSWER: False RATIONALE: BEP = EBIT/Assets. EBIT reflects earnings before the effects of leverage (interest) and taxes, so the statement is false. POINTS: 1 DIFFICULTY: EASY REFERENCES: 4-5 Profitability Ratios QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.04.05 - Profitability Ratios Copyright Cengage Learning. Powered by Cognero.
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NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: BEP ratio KEYWORDS: Bloom’s: Remember DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/3/2017 4:32 PM 19. The operating margin measures operating income per dollar of assets. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 4-5 Profitability Ratios QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.04.05 - Profitability Ratios NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Operating margin KEYWORDS: Bloom’s: Remember DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/3/2017 12:57 PM 20. The profit margin measures net income per dollar of sales. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 4-5 Profitability Ratios QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.04.05 - Profitability Ratios NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Profit margin Copyright Cengage Learning. Powered by Cognero.
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KEYWORDS: DATE CREATED: DATE MODIFIED:
Bloom’s: Remember 9/21/2017 5:19 PM 11/3/2017 12:57 PM
21. The return on invested capital measures the total return that a company has provided for its investors. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 4-5 Profitability Ratios QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.04.05 - Profitability Ratios NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows TOPICS: ROIC ratio KEYWORDS: Bloom's: Remember DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/8/2017 2:28 PM 22. The "apparent," but not necessarily the "true," financial position of a company whose sales are seasonal can change dramatically during a given year, depending on the time of year when the financial statements are constructed. a. True b. False ANSWER: True RATIONALE: Many of the ratios show sales over some past period such as the last 12 months divided by an asset such as inventories as of a specific date. Assets like inventories vary at different times of the year for a seasonal business, thus leading to big changes in the ratio. POINTS: 1 DIFFICULTY: EASY REFERENCES: 4-10 Uses and Limitations of Ratios QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.04.10 - Uses and Limitations of Ratios NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Balance sheet changes KEYWORDS: Bloom's: Understand DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/3/2017 12:57 PM 23. Significant variations in accounting methods among firms make meaningful ratio comparisons between firms more Copyright Cengage Learning. Powered by Cognero.
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difficult than if all firms used the same or similar accounting methods. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 4-10 Uses and Limitations of Ratios QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.04.10 - Uses and Limitations of Ratios NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Ratio limitations KEYWORDS: Bloom’s: Remember DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/3/2017 12:57 PM 24. The inventory turnover and current ratio are related. The combination of a high current ratio and a low inventory turnover ratio, relative to industry norms, suggests that the firm has an above-average inventory level and/or that part of the inventory is obsolete or damaged. a. True b. False ANSWER: True RATIONALE: A high current ratio is consistent with a lot of inventory. A low inventory turnover is also consistent with a lot of inventory. If the CR exceeds industry norms and the turnover is below the norms, then the firm has more inventory than most other firms, given its sales. It could just be carrying a lot of good inventory, but it might also have a normal amount of "good" inventory plus some "bad" inventory that has not been written off. So the statement is true. POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 4-3 Asset Management Ratios QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.04.03 - Asset Management Ratios NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Inventory turnover ratio KEYWORDS: Bloom's: Understand DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/3/2017 12:57 PM Copyright Cengage Learning. Powered by Cognero.
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25. It is appropriate to use the fixed assets turnover ratio to appraise firms' effectiveness in managing their fixed assets if and only if all of the firms being compared have the same proportion of fixed assets to total assets. a. True b. False ANSWER: False RATIONALE: The FA turnover is Sales/FA, and it gives an indication of how effectively the firm utilizes its FA. The proportion of FA to TA is not relevant to this usage. POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 4-3 Asset Management Ratios QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.04.03 - Asset Management Ratios NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Fixed assets turnover KEYWORDS: Bloom’s: Remember DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/3/2017 4:33 PM 26. Other things held constant, the more debt a firm uses, the lower the firm's profit margin will be. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 4-5 Profitability Ratios QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.04.05 - Profitability Ratios NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Profit margin KEYWORDS: Bloom's: Understand DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/3/2017 12:57 PM 27. Suppose you are analyzing two firms in the same industry. Firm A has a profit margin of 10% versus a margin of 8% for Firm B. Firm A's total debt to total capital ratio [measured as (Short-term debt + Long-term debt)/(Debt + Preferred stock + Common equity)] is 70% versus 20% for Firm B. Based only on these two facts, you cannot reach a conclusion as to which firm is better managed, because the difference in debt, not better management, could be the cause of Firm A's Copyright Cengage Learning. Powered by Cognero.
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higher profit margin. a. True b. False ANSWER: RATIONALE:
False A's higher total debt to total capital ratio would tend to lower its profit margin. Since its margin is already higher, this indicates that A is the better managed company. POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 4-5 Profitability Ratios QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.04.05 - Profitability Ratios NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Profit margin KEYWORDS: Bloom's: Analyze DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/3/2017 12:57 PM 28. Other things held constant, a decline in sales accompanied by an increase in financial leverage must result in a lower profit margin. a. True b. False ANSWER: False RATIONALE: PM = NI / Sales. A decline in sales would, other things held constant, increase the PM. An increase in financial leverage would lead to higher interest charges, which would decrease net income, which would decrease the PM. So, the net effect could be an increase or a decrease in the PM, or no change. POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 4-5 Profitability Ratios QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.04.05 - Profitability Ratios NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Profit margin KEYWORDS: Bloom's: Understand DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/3/2017 4:33 PM Copyright Cengage Learning. Powered by Cognero.
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29. Other things held constant, the more debt a firm uses, the lower the firm's operating margin will be. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 4-5 Profitability Ratios QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.04.05 - Profitability Ratios NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Operating margin KEYWORDS: Bloom's: Understand DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/3/2017 12:57 PM 30. The advantage of the basic earning power ratio (BEP) over the return on total assets for judging a company's operating efficiency is that the BEP does not reflect the effects of debt and taxes. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 4-5 Profitability Ratios QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.04.05 - Profitability Ratios NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: BEP ratio KEYWORDS: Bloom's: Understand DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/3/2017 12:57 PM 31. Other things held constant, the more debt a firm uses, the lower the firm's return on total assets will be. a. True b. False ANSWER: True POINTS: 1 Copyright Cengage Learning. Powered by Cognero.
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DIFFICULTY: MODERATE REFERENCES: 4-5 Profitability Ratios QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.04.05 - Profitability Ratios NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: ROA KEYWORDS: Bloom's: Understand DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/3/2017 12:57 PM 32. Since the ROA measures the firm's effective utilization of assets without considering how these assets are financed, two firms with the same EBIT must have the same ROA. a. True b. False ANSWER: False RATIONALE: Two firms could have identical EBITs but different amounts of interest, tax rates, and assets, resulting in different ROAs. Example: A B EBIT = Sales revenues - Operating costs = EBIT $100.0 $100.0 Interest differs. B has more debt: Interest 10.0 20.0 EBT $ 90.0 $ 80.0 Both have 35% rate: Taxes 31.5 28.0 AT Inc. $ 58.5 $ 52.0 Assets differ: Assets $200.0 $500.0 ROA 29.3 % 10.4 % POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 4-5 Profitability Ratios QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.04.05 - Profitability Ratios NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: ROA KEYWORDS: Bloom's: Understand DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/3/2017 4:35 PM 33. The return on common equity (ROE) is generally regarded as being less significant, from a stockholder's viewpoint, than the return on total assets (ROA). Copyright Cengage Learning. Powered by Cognero.
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a. True b. False ANSWER: RATIONALE:
False Stockholders should, and generally do, consider the ROE as probably the single most important ratio based strictly on the financial statements. POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 4-5 Profitability Ratios QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.04.05 - Profitability Ratios NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: ROE KEYWORDS: Bloom’s: Remember DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/3/2017 12:57 PM 34. The return on invested capital (ROIC) differs from the return on assets (ROA). First, ROIC is based on total invested capital rather than total assets. Second, the numerator of the ROIC is after-tax operating income rather than net income. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 4-5 Profitability Ratios QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.04.05 - Profitability Ratios NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows TOPICS: ROIC and ROA KEYWORDS: Bloom's Remember DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/8/2017 2:30 PM 35. Market value ratios provide management with an indication of how investors view the firm's past performance and especially its future prospects. These ratios include the Price/Earnings, the Market/Book, and Enterprise Value/EBITDA ratios. a. True b. False ANSWER: True Copyright Cengage Learning. Powered by Cognero.
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POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 4-6 Market Value Ratios QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.04.06 - Market Value Ratios NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Market value ratios KEYWORDS: Bloom’s: Remember DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 12/13/2017 11:42 AM 36. In general, if investors believe that a company is relatively risky and/or has relatively poor growth prospects, then the company will have relatively high P/E, M/B, and EV/EBITDA ratios. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 4-6 Market Value Ratios QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.04.06 - Market Value Ratios NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Market value ratios KEYWORDS: Bloom's: Understand DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 12/13/2017 11:45 AM 37. The price/earnings (P/E) ratio tells us how much investors are willing to pay for a dollar of current earnings. In general, investors regard companies with higher P/E ratios as less risky and/or more likely to enjoy higher growth in the future. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 4-6 Market Value Ratios Copyright Cengage Learning. Powered by Cognero.
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QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.04.06 - Market Value Ratios NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: P/E ratio KEYWORDS: Bloom’s: Remember DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/3/2017 12:57 PM 38. The market/book (M/B) ratio tells us how much investors are willing to pay for a dollar of accounting book value. In general, investors regard companies with higher M/B ratios as less risky and/or more likely to enjoy higher growth in the future. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 4-6 Market Value Ratios QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.04.06 - Market Value Ratios NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: M/B ratio KEYWORDS: Bloom's: Understand DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/3/2017 12:57 PM 39. Suppose all firms follow similar financing policies, face similar risks, have equal access to capital, and operate in competitive product and capital markets. However, firms face different operating conditions because, for example, the grocery store industry is different from the airline industry. Under these conditions, firms with high profit margins will tend to have high asset turnover ratios, and firms with low profit margins will tend to have low turnover ratios. a. True b. False ANSWER: False RATIONALE: Think about the DuPont equation: ROE = PM × TATO × Equity multiplier. Similar financing policies will lead to similar Equity multipliers. Moreover, competition in the capital markets will cause ROEs to be similar, because otherwise capital would flow to industries with high ROEs and drive returns down toward the average, given similar risks. To have similar ROEs, firms with relatively high PMs must have relatively low TATOs, and vice versa. Therefore, the statement is false. Copyright Cengage Learning. Powered by Cognero.
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POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 4-7 Tying the Ratios Together: The DuPont Equation QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.04.07 - Tying the Ratios Together: The DuPont Equation NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: DuPont equation KEYWORDS: Bloom's: Understand DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/3/2017 12:57 PM 40. Klein Cosmetics has a profit margin of 5.0%, a total assets turnover ratio of 1.5 times, no debt and therefore an equity multiplier of 1.0, and an ROE of 7.5%. The CFO recommends that the firm borrow money, use the funds to buy back stock, and raise the equity multiplier to 2.0. The size of the firm (assets) would not change. She thinks that operations would not be affected, but interest on the new debt would lower the profit margin to 4.5%. This would probably be a good move, as it would increase the ROE from 7.5% to 13.5%. a. True b. False ANSWER: True RATIONALE: DuPont equation: ROE = PM × TATO × Equity multiplier. Given the data, the statement is true. PM X TATO X Eq Mult = ROE 5.0 % 1.5 1.0 7.5 % 4.5 % 1.5 2.0 13.5 % POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 4-7 Tying the Ratios Together: The DuPont Equation QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.04.07 - Tying the Ratios Together: The DuPont Equation NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: DuPont equation KEYWORDS: Bloom's: Apply DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/3/2017 12:57 PM 41. Determining whether a firm's financial position is improving or deteriorating requires analyzing more than the ratios for a given year. Trend analysis is one method of examining changes in a firm's performance over time. a. True Copyright Cengage Learning. Powered by Cognero.
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b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 4-9 Using Financial Ratios to Assess Performance QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.04.09 - Using Financial Ratios to Assess Performance NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Trend analysis KEYWORDS: Bloom’s: Remember DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/3/2017 12:57 PM 42. Even though Firm A's current ratio exceeds that of Firm B, Firm B's quick ratio might exceed that of A. However, if A's quick ratio exceeds B's, then we can be certain that A's current ratio is also larger than B's. a. True b. False ANSWER: False RATIONALE: This question can be answered by thinking carefully about the ratios: Demonstration that the first sentence is true:
A:
=
1.67
=
B:
=
1.50
=
Demonstration that the second sentence is false:
A:
=
1.00
=
B:
=
1.50
=
The key is inventory, which is in the CR but not in the QR. The firm with more inventory can have the higher CR but the lower QR. POINTS: DIFFICULTY: REFERENCES: QUESTION TYPE:
1 CHALLENGING 4-2 Liquidity Ratios True / False
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HAS VARIABLES: False LEARNING OBJECTIV FOFM.BRIG.17.04.02 - Liquidity Ratios ES: NATIONAL STANDAR United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic DS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Liquidity ratios KEYWORDS: Bloom's: Analyze DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/3/2017 12:57 PM 43. Firms A and B have the same current ratio, 0.75, the same amount of sales, and the same amount of current liabilities. However, Firm A has a higher inventory turnover ratio than B. Therefore, we can conclude that A's quick ratio must be smaller than B's. a. True b. False ANSWER: False RATIONALE: Firm A has the higher inventory turnover, S/I. So, given the same sales, A must have less inventory. Since the two firms have the same CR, A must have the higher QR, not the lower one. Therefore, the statement is false. POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 4-2 Liquidity Ratios QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.04.02 - Liquidity Ratios NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Liquidity ratios KEYWORDS: Bloom's: Analyze DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/3/2017 4:36 PM 44. Suppose a firm wants to maintain a specific TIE ratio. It knows the amount of its debt, the interest rate on that debt, the applicable tax rate, and its operating costs. With this information, the firm can calculate the amount of sales required to achieve its target TIE ratio. a. True b. False ANSWER: True RATIONALE: TIE = EBIT / Interest = (Sales – Op Cost) / (Debt × Interest Rate). If we know the op. costs, the amount of debt, and the interest rate, then we can solve for the sales level required to achieve the target TIE. POINTS: 1 Copyright Cengage Learning. Powered by Cognero.
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DIFFICULTY: CHALLENGING REFERENCES: 4-4 Debt Management Ratios QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.04.04 - Debt Management Ratios NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: TIE ratio KEYWORDS: Bloom's: Apply DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/3/2017 12:57 PM 45. Suppose Firms A and B have the same amount of assets, total assets are equal to total invested capital, pay the same interest rate on their debt, have the same basic earning power (BEP), finance with only debt and common equity, and have the same tax rate. However, Firm A has a higher debt to capital ratio. If BEP is greater than the interest rate on debt, Firm A will have a higher ROE as a result of its higher debt ratio. a. True b. False ANSWER: True RATIONALE: The easiest way to think about this problem is to realize that if you can borrow at a cost of 10% and invest the proceeds to earn 11%, you'll earn a surplus. If you were previously earning an ROE of 10%, then after raising and investing additional funds at 11%, your income will be higher, your equity will be the same, and thus your ROE will increase. Similarly, if a firm earns more on assets than the interest rate, there will be a surplus after paying interest on the debt that will go to the equity, thus increasing the ROE. So, if BEP > rd, then the firm can increase its expected ROE by using more debt leverage. The answer can also be seen by working out an example. The one below shows that leverage increases ROE if BEP > rd, but it could be varied to show no difference in ROE if interest rates and BEP are the same, and a reduction in ROE if the interest rate exceeds the BEP. Firm A: Uses Debt Firm B: No Debt Assets = Invested capital $ 100 Assets = Invested capital $ 100 Debt 60% Debt 0% Equity 40% Equity 100 % BEP 15% BEP 15 % 10% Interest rate, rd 10 % Interest rate, rd Tax rate 40% Tax rate 40 % EBIT = BEP × Assets $ 15.0 EBIT = BEP × Assets $ 15.0 Interest 6.0 Interest 0 Taxable income 9.0 Taxable income 15.0 Taxes 3.6 Taxes 6.0 NI 5.4 NI 9.0 ROE 13.50 % ROE 9.00 % POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 4-5 Profitability Ratios QUESTION TYPE: True / False Copyright Cengage Learning. Powered by Cognero.
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HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.04.05 - Profitability Ratios NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: BEP and ROE KEYWORDS: Bloom's: Analyze DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/3/2017 4:37 PM 46. If a firm's ROE is equal to 9% and its ROA is equal to 6%, its equity multiplier must be 1.5. a. True b. False ANSWER: True RATIONALE: Equity multiplier = ROE/ROA = 9%/6% = 1.5. Thus, the statement is true. POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 4-7 Tying the Ratios Together: The DuPont Equation QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.04.07 - Tying the Ratios Together: The DuPont Equation NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Equity multiplier KEYWORDS: Bloom's: Analyze DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/8/2017 2:31 PM 47. A firm's ROE is equal to 9% and its ROA is equal to 6%. The firm finances only with short-term debt, long-term debt, and common equity, so assets equal total invested capital. The firm's total debt to total capital ratio must be 50%. a. True b. False ANSWER: False RATIONALE: Equity multiplier = ROE/ROA = 9%/6% = 1.5 E/A = 1/1.5 = 0.6667 D/A = 1 – 0.6667 = 0.3333
POINTS: DIFFICULTY: REFERENCES:
Since assets = Total invested capital, Debt/Total invested capital = 33.33%. Therefore, the statement is false. 1 CHALLENGING 4-7 Tying the Ratios Together: The DuPont Equation
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QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.04.07 - Tying the Ratios Together: The DuPont Equation NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows TOPICS: Equity multiplier and leverage KEYWORDS: Bloom's: Analyze DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/8/2017 2:32 PM 48. One problem with ratio analysis is that relationships can sometimes be manipulated. For example, if our current ratio is greater than 1.5, then borrowing on a short-term basis and using the funds to build up our cash account would cause the current ratio to INCREASE. a. True b. False ANSWER: False RATIONALE: The key here is to recognize that if the CR is greater than 1.0, then a given increase in both current assets and current liabilities would lead to a decrease in the CR. The reverse would hold if the initial CR were less than 1.0. Here the initial CR is greater than 1.0, so borrowing on a short-term basis to build the cash account would lower the CR. For example: Original Plus $1 New CA/CL Old CR New CR CA/CL 3 1 4 CR falls if initial CR is greater than 1.50 1.33 2 1 3 1.0 2 3
1 1
3 4
0.67
0.75
CR rises if initial CR is less than 1.0
POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 4-10 Uses and Limitations of Ratios QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.04.10 - Uses and Limitations of Ratios NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Ratio limitations KEYWORDS: Bloom's: Understand DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/3/2017 4:37 PM 49. One problem with ratio analysis is that relationships can be manipulated. For example, we know that if our current ratio is less than 1.0, then using some of our cash to pay off some of our current liabilities would cause the current ratio to increase and thus make the firm look stronger. a. True Copyright Cengage Learning. Powered by Cognero.
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b. False ANSWER: RATIONALE:
False The key here is to recognize that if the CR is less than 1.0, then a given reduction in both current assets and current liabilities would lead to a decrease in the CR. The reverse would hold if the initial CR were greater than 1.0. In the question, the initial CR is less than 1.0, so using cash to reduce current liabilities would lower the CR. If the CR were greater than 1.0, the statement would have been true. Here's an illustration: Original Less $1 New CA/CL Old CR New CR CA/CL 2 -1 1 0.67 0.50 CR falls if initial CR is less than 1.0 3 -1 2 3 2
-1 -1
2 1
1.5
2.0
CR rises if initial CR is greater than 1.0
POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 4-10 Uses and Limitations of Ratios QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.04.10 - Uses and Limitations of Ratios NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Ratio limitations KEYWORDS: Bloom's: Understand DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/3/2017 4:38 PM Multiple Choice: Conceptual
50. Considered alone, which of the following would increase a company’s current ratio? a. An increase in net fixed assets. b. An increase in accrued liabilities. c. An increase in notes payable. d. An increase in accounts receivable. e. An increase in accounts payable. ANSWER: d POINTS: 1 DIFFICULTY: EASY REFERENCES: 4-2 Liquidity Ratios QUESTION TYPE: Multiple Choice HAS VARIABLES: False PREFACE NAME: Conceptual Copyright Cengage Learning. Powered by Cognero.
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LEARNING OBJECTIVES: FOFM.BRIG.17.04.02 - Liquidity Ratios NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Current ratio KEYWORDS: Bloom's: Understand OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/3/2017 4:38 PM 51. Which of the following would generally indicate an improvement in a company’s financial position, holding other things constant? a. The TIE declines. b. The DSO increases. c. The quick ratio increases. d. The current ratio declines. e. The total assets turnover decreases. ANSWER: c POINTS: 1 DIFFICULTY: EASY REFERENCES: 4-2 Liquidity Ratios QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.04.02 - Liquidity Ratios NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Current ratio KEYWORDS: Bloom's: Understand OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/3/2017 4:39 PM 52. A firm wants to strengthen its financial position. Which of the following actions would increase its current ratio? a. Reduce the company’s days’ sales outstanding to the industry average and use the resulting cash savings to purchase a new plant and equipment. b. Use cash to repurchase some of the company’s own stock. c. Borrow using short-term debt and use the proceeds to repay debt that has a maturity of more than one year. d. Issue new stock, then use some of the proceeds to purchase additional inventory and hold the remainder as cash. e. Use cash to increase inventory holdings. ANSWER: d Copyright Cengage Learning. Powered by Cognero.
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POINTS: 1 DIFFICULTY: EASY REFERENCES: 4-2 Liquidity Ratios QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.04.02 - Liquidity Ratios NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Current ratio KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/3/2017 4:39 PM 53. Which of the following statements is CORRECT? a. A reduction in inventories will have no effect on the current ratio. b. An increase in inventories will have no effect on the current ratio. c. If a firm increases its sales while holding its inventories constant, then, other things held constant, its inventory turnover ratio will increase. d. A reduction in the inventory turnover ratio will generally lead to an increase in the ROE. e. If a firm increases its sales while holding its inventories constant, then, other things held constant, its fixed assets turnover ratio will decline. ANSWER: c POINTS: 1 DIFFICULTY: EASY REFERENCES: 4-3 Asset Management Ratios QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.04.03 - Asset Management Ratios NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Inventories KEYWORDS: Bloom's: Understand OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/3/2017 12:57 PM 54. Companies E and P each reported the same earnings per share (EPS), but Company E’s stock trades at a higher price. Which of the following statements is CORRECT? a. Company E probably has fewer growth opportunities. Copyright Cengage Learning. Powered by Cognero.
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b. Company E is probably judged by investors to be riskier. c. Company E must have a higher market-to-book ratio. d. Company E must pay a lower dividend. e. Company E trades at a higher P/E ratio. ANSWER: e POINTS: 1 DIFFICULTY: EASY REFERENCES: 4-6 Market Value Ratios QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.04.06 - Market Value Ratios NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Financial statement analysis KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/3/2017 4:40 PM 55. Which of the following actions is an example of "window dressing?" a. Borrowing by using short-term notes payable and then using the proceeds to retire long-term debt. b. Borrowing on a long-term basis and using the proceeds to retire short-term debt. c. Offering discounts to customers who pay with cash rather than buy on credit and then using the funds that come in quicker to purchase fixed assets. d. Using some of the firm’s cash to reduce long-term debt. e. Any action that does not improve a firm’s fundamental long-run position and thus increases its intrinsic value. ANSWER: b POINTS: 1 DIFFICULTY: EASY REFERENCES: 4-10 Uses and Limitations of Ratios QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.04.10 - Uses and Limitations of Ratios NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Window dressing KEYWORDS: Bloom's: Understand OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/3/2017 12:57 PM Copyright Cengage Learning. Powered by Cognero.
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56. Casey Communications recently issued new common stock and used the proceeds to pay off some of its short-term notes payable. This action had no effect on the company’s total assets or operating income. Which of the following effects occurred as a result of this action? a. The company’s current ratio increased. b. The company’s times interest earned ratio decreased. c. The company’s basic earning power ratio increased. d. The company’s equity multiplier increased. e. The company’s total debt to total capital ratio increased. ANSWER: a POINTS: 1 DIFFICULTY: EASY REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.04.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Miscellaneous ratios KEYWORDS: Bloom's: Apply OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/3/2017 12:57 PM 57. A firm’s new president wants to strengthen the company’s financial position. Which of the following actions would make the company financially stronger? a. Increase accounts receivable while holding sales constant. b. Increase EBIT while holding sales and assets constant. c. Increase accounts payable while holding sales constant. d. Increase notes payable while holding sales constant. e. Increase inventories while holding sales constant. ANSWER: b POINTS: 1 DIFFICULTY: EASY REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.04.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. Copyright Cengage Learning. Powered by Cognero.
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TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
Miscellaneous ratios Bloom's: Apply Multiple Choice: Conceptual 9/21/2017 5:19 PM 11/3/2017 4:40 PM
58. If the CEO of a large and diversified firm were filling out a fitness report on a division manager (i.e., ―grading‖ the manager), which of the following situations would be likely to cause the manager to receive a better grade? In all cases, assume that other things are held constant. a. The division’s basic earning power ratio is above the average of other firms in its industry. b. The division’s total assets turnover ratio is below the average for other firms in its industry. c. The division’s total debt to total capital ratio is above the average for other firms in the industry. d. The division’s inventory turnover is 6×, whereas the average for its competitors is 8×. e. The division’s DSO (days’ sales outstanding) is 40 days, whereas the average for its competitors is 30 days. ANSWER: a POINTS: 1 DIFFICULTY: EASY REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.04.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Miscellaneous ratios KEYWORDS: Bloom's: Apply OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/3/2017 4:40 PM 59. Which of the following would indicate an improvement in a company’s financial position, holding other things constant? a. The inventory and total assets turnover ratios both decline. b. The total debt to total capital ratio increases. c. The profit margin declines. d. The times-interest-earned ratio declines. e. The current and quick ratios both increase. ANSWER: e POINTS: 1 DIFFICULTY: EASY REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.04.00 - Comprehensive Copyright Cengage Learning. Powered by Cognero.
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NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Miscellaneous ratios KEYWORDS: Bloom's: Apply OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/3/2017 4:41 PM 60. If a bank loan officer were considering a company’s loan request, which of the following statements would be CORRECT, other things held constant? a. The lower the company’s inventory turnover ratio, the lower the interest rate the bank should charge. b. The higher the days sales outstanding ratio, the lower the interest rate the bank should charge. c. The lower the total debt to total capital ratio, the lower the interest rate the bank should charge. d. The lower the company’s TIE ratio, the lower the interest rate the bank should charge. e. The lower the current ratio, the lower the interest rate the bank should charge. ANSWER: c POINTS: 1 DIFFICULTY: EASY REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.04.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Miscellaneous ratios KEYWORDS: Bloom's: Apply OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/3/2017 12:57 PM 61. Which of the following statements is CORRECT? a. The use of debt financing will tend to lower the basic earning power ratio, other things held constant. b. A firm that employs financial leverage will have a higher equity multiplier than an otherwise identical firm that has no debt in its capital structure. c. If two firms have identical sales, interest rates paid, operating costs, and assets, but differ in the way they are financed, the firm with less debt will generally have the higher expected ROE. d. The numerator used in the TIE ratio is earnings before taxes (EBT). EBT is used because interest is paid with post-tax dollars, so the firm's ability to pay current interest is affected by taxes. e. Other things held constant, increasing the total debt to total capital ratio will increase the ROA. ANSWER: b POINTS: 1 Copyright Cengage Learning. Powered by Cognero.
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DIFFICULTY: EASY REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.04.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Leverage effects KEYWORDS: Bloom's: Understand OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/3/2017 12:57 PM 62. A firm wants to strengthen its financial position. Which of the following actions would increase its quick ratio? a. Offer price reductions along with generous credit terms that would (1) enable the firm to sell some of its excess inventory and (2) lead to an increase in accounts receivable. b. Issue new common stock and use the proceeds to increase inventories. c. Speed up the collection of receivables and use the cash generated to increase inventories. d. Use some of its cash to purchase additional inventories. e. Issue new common stock and use the proceeds to acquire additional fixed assets. ANSWER: a POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 4-2 Liquidity Ratios QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.04.02 - Liquidity Ratios NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Quick ratio KEYWORDS: Bloom's: Apply OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/3/2017 4:41 PM 63. Amram Company’s current ratio is 2.0. Considered alone, which of the following actions would lower the current ratio? a. Borrow using short-term notes payable and use the proceeds to reduce accruals. b. Borrow using short-term notes payable and use the proceeds to reduce long-term debt. c. Use cash to reduce accruals. Copyright Cengage Learning. Powered by Cognero.
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d. Use cash to reduce short-term notes payable. e. Use cash to reduce accounts payable. ANSWER: b RATIONALE: A quick scan of the alternatives would indicate that b is obviously correct—it would lower the CR. Since there is only one correct answer, b must be the right answer. The following equation can also be used. If you add equal amounts to the numerator and denominator, then if Orig CR = or > 1.0, CR will decline, but if Orig CR < 1.0, CR will increase. Obviously, if you add to one but not the other, CR will increase or decrease in a predictable manner. This is the situation with choice b. CR = (Orig CA +/- Δ)/(Orig CL +/- Δ). a is false; it would leave the QR unchanged. b would obviously reduce the CR—CA remain constant and CL would increase. c is false, given that the initial CR > 1.0. d is false, given that the initial CR > 1.0. e is false, given that the initial CR > 1.0. POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 4-2 Liquidity Ratios QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.04.02 - Liquidity Ratios NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Current ratio KEYWORDS: Bloom's: Apply OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/3/2017 4:41 PM 64. Which of the following statements is CORRECT? a. If a security analyst saw that a firm’s days’ sales outstanding (DSO) was higher than the industry average and trending still higher, this would be interpreted as a sign of strength. b. A high average DSO indicates that none of the firm's customers are paying on time. In addition, it makes no sense to evaluate the firm's DSO with the firm's credit terms. c. There is no relationship between the days’ sales outstanding (DSO) and the average collection period (ACP). These ratios measure entirely different things. d. A reduction in accounts receivable would have no effect on the current ratio, but it would lead to an increase in the quick ratio. e. If a firm increases its sales while holding its accounts receivable constant, then its days’ sales outstanding will decline, other things held constant. ANSWER: e POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 4-3 Asset Management Ratios QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.04.03 - Asset Management Ratios NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic Copyright Cengage Learning. Powered by Cognero.
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STATE STANDARDS: LOCAL STANDARDS: TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. Accounts receivable Bloom's: Analyze Multiple Choice: Conceptual 9/21/2017 5:19 PM 11/3/2017 12:57 PM
65. Which of the following statements is CORRECT? a. If one firm has a higher total debt to total capital ratio than another, we can be certain that the firm with the higher total debt to total capital ratio will have the lower TIE ratio, as that ratio depends entirely on the amount of debt a firm uses. b. A firm's use of debt will have no effect on its profit margin. c. If two firms differ only in their use of debt—i.e., they have identical assets, identical total invested capital, sales, operating costs, interest rates on their debt, and tax rates—but one firm has a higher total debt to total capital ratio, then the firm that uses more debt will have a lower profit margin on sales and a lower return on assets. d. The total debt to total capital ratio as it is generally calculated makes an adjustment for the use of assets leased under operating leases, so the debt ratios of firms that lease different percentages of their assets are still comparable. e. If two firms differ only in their use of debt—i.e., they have identical assets, identical total invested capital, operating costs, and tax rates—but one firm has a higher total debt to total capital ratio, then the firm that uses more debt will have a higher operating margin and return on assets. ANSWER: c RATIONALE: a is false, because the TIE also depends on the interest rate and EBIT. b is false, because interest affects the profit margin. c is correct, because the more interest the lower the profits, hence the lower the profit margin and ROE. d is simply incorrect. e is incorrect. Operating margin would be identical because EBIT is in the numerator and return on assets would be lower. POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 4-4 Debt Management Ratios QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.04.04 - Debt Management Ratios NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Debt management KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/3/2017 12:57 PM Copyright Cengage Learning. Powered by Cognero.
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66. Which of the following statements is CORRECT? a. If Firms X and Y have the same P/E ratios, then their market-to-book ratios must also be equal. b. If Firms X and Y have the same net income, number of shares outstanding, and price per share, then their P/E ratios must also be the same. c. If Firms X and Y have the same earnings per share and market-to-book ratio, then they must have the same price/earnings ratio. d. If Firm X’s P/E ratio exceeds that of Firm Y, then Y is likely to be less risky and/or be expected to grow at a faster rate. e. If Firms X and Y have the same net income, number of shares outstanding, and price per share, then their market-to-book ratios must also be the same. ANSWER: b RATIONALE: No reason for a to be true. b must be true, as EPS and P will be equal. No reason for c to be true. Wrong, because high risk and low growth lead to low P/Es. No reason for e to be true. POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 4-6 Market Value Ratios QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.04.06 - Market Value Ratios NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Market value ratios KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/3/2017 12:57 PM 67. Which of the following statements is CORRECT? a. Suppose a firm’s total assets turnover ratio falls from 1.0 to 0.9, but at the same time its profit margin rises from 9% to 10% and its debt increases from 40% of total assets to 60%. The firm finances using only debt and common equity, and total assets equal total invested capital. Under these conditions, the ROE will increase. b. Suppose a firm’s total assets turnover ratio falls from 1.0 to 0.9, but at the same time its profit margin rises from 9% to 10% and its debt increases from 40% of total assets to 60%. The firm finances using only debt and common equity, and total assets equal total invested capital. Without additional information, we cannot tell what will happen to the ROE. c. The DuPont equation provides information about how operations affect the ROE, but the equation does not include the effects of debt on the ROE. d. Other things held constant, an increase in the total debt to total capital ratio will result in an increase in the profit margin. e. Suppose a firm’s total assets turnover ratio falls from 1.0 to 0.9, but at the same time its profit margin rises from 9% to 10%and its debt increases from 40% of total assets to 60%. The firm finances using only debt and common equity, and total assets equal total invested capital. Under these conditions, the ROE will decrease. ANSWER: a RATIONALE: PM × TATO × Eq. Mult. = ROE Copyright Cengage Learning. Powered by Cognero.
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Old 9% 1.0 1.66666667 15.0% New 10% 0.9 2.5 22.5% The changes in the PM and TATO offset one another, but the increase in the equity multiplier increases ROE. Since a is true, b and e must be false. We can also see that c and d are false. POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 4-7 Tying the Ratios Together: The DuPont Equation QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.04.07 - Tying the Ratios Together: The DuPont Equation NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: DuPont analysis KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/3/2017 12:57 PM 68. You observe that a firm’s ROE is above the industry average, but both its profit margin and equity multiplier are below the industry average. Which of the following statements is CORRECT? a. Its total assets turnover must be above the industry average. b. Its return on assets must equal the industry average. c. Its TIE ratio must be below the industry average. d. Its total assets turnover must be below the industry average. e. Its total assets turnover must equal the industry average. ANSWER: a RATIONALE: Thinking through the DuPont equation, we can see that if the firm's PM and equity multiplier are below the industry average, the only way its ROE can exceed the industry average is if its total assets turnover exceeds the industry average. The following data illustrate this point: Firm Industry
ROE 30% 25%
= PM 9% 10%
× TATO 2.0 1
× Eq. Mult. 1.67 2.50
ROA 18% 10%
The above demonstrates that a is correct, and that makes d and e incorrect. Now consider the following: NI/Assets = ROA =
POINTS:
NI/Sales PM
× Sales/Assets × TATO
If its ROA were equal to the industry average, then with its low equity multiplier (hence lower financial leverage and use of less debt) its ROE would also be below the industry average. So b is incorrect. With lower debt (since equity multiplier is less than industry average), its interest charges should also be low, which would increase its TIE ratio, making c incorrect. 1
Copyright Cengage Learning. Powered by Cognero.
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DIFFICULTY: MODERATE REFERENCES: 4-7 Tying the Ratios Together: The DuPont Equation QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.04.07 - Tying the Ratios Together: The DuPont Equation NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: DuPont analysis KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/3/2017 12:57 PM 69. Companies HD and LD are both profitable, and they have the same total assets (TA), total invested capital, sales (S), return on assets (ROA), and profit margin (PM). Both firms finance using only debt and common equity. However, Company HD has the higher total debt to total capital ratio. Which of the following statements is CORRECT? a. Company HD has a lower total assets turnover than Company LD. b. Company HD has a lower equity multiplier than Company LD. c. Company HD has a higher fixed assets turnover than Company LD. d. Company HD has a higher ROE than Company LD. e. Company HD has a lower operating income (EBIT) than Company LD. ANSWER: d RATIONALE: Rule out all answers except d because they are false. Alternative answer using the DuPont equation: ROE = PM × TATO × Eq multiplier ROE = NI/S × S/TA × TA/Equity The first two terms are the same, but HD has a higher equity multiplier due to its higher debt, hence higher ROE. POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 4-7 Tying the Ratios Together: The DuPont Equation QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.04.07 - Tying the Ratios Together: The DuPont Equation NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: DuPont analysis KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/3/2017 12:57 PM Copyright Cengage Learning. Powered by Cognero.
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70. Taggart Technologies is considering issuing new common stock and using the proceeds to reduce its outstanding debt. The stock issue would have no effect on total assets, the interest rate Taggart pays, EBIT, or the tax rate. Which of the following is likely to occur if the company goes ahead with the stock issue? a. The ROA will decline. b. Taxable income will decline. c. The tax bill will increase. d. Net income will decrease. e. The times-interest-earned ratio will decrease. ANSWER: c RATIONALE: a is false because reducing debt will lower interest, raise net income, and thus raise ROA. b is false for the above reason. c is true for the above reason. d is false The TIE will increase because interest charges will be smaller due to less debt. POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.04.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Financial statement analysis KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/3/2017 12:57 PM 71. Which of the following statements is CORRECT? a. The ratio of long-term debt to total capital is more likely to experience seasonal fluctuations than is either the DSO or the inventory turnover ratio. b. If two firms have the same ROA, the firm with the most debt can be expected to have the lower ROE. c. An increase in the DSO, other things held constant, could be expected to increase the total assets turnover ratio. d. An increase in the DSO, other things held constant, could be expected to increase the ROE. e. An increase in a firm’s total debt to total capital ratio, with no changes in its sales or operating costs, could be expected to lower its profit margin. ANSWER: e RATIONALE: a. Sales fluctuations would have more effects on the DSO and S/Inventory ratios. b. ROE = ROA × Equity multiplier, so the more debt, the higher ROE for a given ROA. c. DSO = Receivables/Sales per day. With sales constant, an increase in DSO would mean an increase in receivables, hence a decline, not a rise, in the TATO (S/TA). d. An increase in the DSO might increase or decrease ROE, depending on how it affected sales and costs. e. More debt would mean more interest, hence a lower NI, given a constant EBIT. This would lower the profit margin = NI/Sales. Copyright Cengage Learning. Powered by Cognero.
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POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.04.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Financial statement analysis KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/3/2017 12:57 PM 72. HD Corp and LD Corp have identical assets, sales, interest rates paid on their debt, tax rates, and EBIT. Both firms finance using only debt and common equity, and total assets equal total invested capital. However, HD uses more debt than LD. Which of the following statements is CORRECT? a. Without more information, we cannot tell if HD or LD would have a higher or lower net income. b. HD would have the lower equity multiplier for use in the DuPont equation. c. HD would have to pay more in income taxes. d. HD would have the lower net income as shown on the income statement. e. HD would have the higher operating margin. ANSWER: d RATIONALE: More debt would mean more interest, hence a lower NI, given a constant EBIT, so d is correct. Also, we can rule out a and e, and HD would also have the higher multiplier, which rules out b. And with more interest, HD would have to pay less taxes, not more. POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.04.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Financial statement analysis KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/3/2017 12:57 PM Copyright Cengage Learning. Powered by Cognero.
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73. Companies HD and LD have the same sales, tax rate, interest rate on their debt, total assets, and basic earning power. Both firms finance using only debt and common equity, and total assets equal total invested capital. Both companies have positive net incomes. Company HD has a higher total debt to total capital ratio and therefore a higher interest expense. Which of the following statements is CORRECT? a. Company HD pays less in taxes. b. Company HD has a lower equity multiplier. c. Company HD has a higher ROA. d. Company HD has a higher times-interest-earned (TIE) ratio. e. Company HD has more net income. ANSWER: a RATIONALE: Under the stated conditions, HD would have more interest charges, thus lower taxable income and taxes. Thus, a is correct. All of the other statements are incorrect. POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.04.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Leverage, taxes, ratios KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/3/2017 12:57 PM 74. Companies HD and LD have the same tax rate, sales, total assets, and basic earning power. Both companies have positive net incomes. Both firms finance using only debt and common equity, and total assets equal total invested capital. Company HD has a higher total debt to total capital ratio and therefore a higher interest expense. Which of the following statements is CORRECT? a. Company HD has a lower equity multiplier. b. Company HD has more net income. c. Company HD pays more in taxes. d. Company HD has a lower ROE. e. Company HD has a lower times-interest-earned (TIE) ratio. ANSWER: e RATIONALE: HD has higher interest charges. Basic earning power equals EBIT/Assets, and since assets and BEP are equal, EBIT must also be equal. TIE = EBIT/Interest. Therefore, HD's higher interest charges means that its TIE must be lower. Thus, e is correct. All of the other statements are incorrect. POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice Copyright Cengage Learning. Powered by Cognero.
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HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.04.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Leverage, taxes, ratios KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/3/2017 12:57 PM 75. Which of the following statements is CORRECT? a. If a firm has high current and quick ratios, then it must be managing its liquidity position well. b. If a firm sold some inventory for cash and left the funds in its bank account, then its current ratio would probably not change much, but its quick ratio would decline. c. If a firm sold some inventory on credit, then its current ratio would probably not change much, but its quick ratio would decline. d. If a firm sold some inventory on credit as opposed to cash, then there is no reason to think that either its current or quick ratio would change. e. The inventory turnover ratio and days sales outstanding (DSO) are two ratios that are used to assess how effectively a firm is managing its current assets. ANSWER: e POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.04.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Various ratios KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/3/2017 12:57 PM 76. Which of the following statements is CORRECT? a. A decline in a firm's inventory turnover ratio suggests that it is improving both its inventory management and its liquidity position, i.e., that it is becoming more liquid. b. In general, it's better to have a low inventory turnover ratio than a high one, as a low one indicates that the firm has an adequate stock of inventory relative to sales and thus will not lose sales as a result of running out of stock. Copyright Cengage Learning. Powered by Cognero.
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c. If a firm's fixed assets turnover ratio is significantly lower than the average for its industry, then it could be that the firm uses its fixed assets very efficiently or is operating at over capacity and should probably add fixed assets. d. The more conservative a firm's management is, the higher the firm's total debt to total capital ratio is likely to be. e. The days sales outstanding ratio tells us how long it takes, on average, to collect after a sale is made. The DSO can be compared with the firm's credit terms to get an idea of whether customers are paying on time. ANSWER: e POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.04.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Various ratios KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/3/2017 4:42 PM 77. Which of the following statements is CORRECT? a. Other things held constant, the more debt a firm uses, the higher its operating margin will be. b. Debt management ratios show the extent to which a firm's managers are attempting to magnify returns on owners' capital through the use of financial leverage. c. Other things held constant, the more debt a firm uses, the higher its profit margin will be. d. Other things held constant, the higher a firm's total debt to total capital ratio, the higher its TIE ratio will be. e. Debt management ratios show the extent to which a firm's managers are attempting to reduce risk through the use of financial leverage. The higher the total debt to total capital ratio, the lower the risk. ANSWER: b POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.04.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Various ratios KEYWORDS: Bloom's: Analyze Copyright Cengage Learning. Powered by Cognero.
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OTHER: DATE CREATED: DATE MODIFIED:
Multiple Choice: Conceptual 9/21/2017 5:19 PM 11/3/2017 12:57 PM
78. Which of the following statements is CORRECT? a. Other things held constant, the less debt a firm uses, the lower its return on total assets will be. b. The advantage of the basic earning power ratio (BEP) over the return on total assets for judging a company's operating efficiency is that the BEP does not reflect the effects of debt and taxes. c. The return on common equity (ROE) is generally considered less significant, from a stockholder's viewpoint, than the return on total assets (ROA). d. The price/earnings (P/E) ratio tells us how much investors are willing to pay for a dollar of current earnings. In general, investors regard companies with higher P/E ratios as more risky and/or less likely to enjoy higher future growth. e. Suppose you are analyzing two firms in the same industry. Firm A has a profit margin of 10% versus a margin of 8% for Firm B. Firm A's total debt to total capital ratio is 70% versus 20% for Firm B. Based only on these two facts, you cannot reach a conclusion as to which firm is better managed, because the difference in debt, not better management, could be the cause of Firm A's higher profit margin. ANSWER: b POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.04.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Various ratios KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/3/2017 12:57 PM 79. Which of the following statements is CORRECT? a. In general, if investors regard a company as relatively risky and/or having relatively poor growth prospects, then it will have relatively high P/E and M/B ratios. b. The basic earning power ratio (BEP) reflects the earning power of a firm's assets after giving consideration to financial leverage and tax effects. c. The "apparent," but not necessarily the "true," financial position of a company whose sales are seasonal can change dramatically during a given year, depending on the time of year when the financial statements are constructed. d. The market/book (M/B) ratio tells us how much investors are willing to pay for a dollar of accounting book value. In general, investors regard companies with higher M/B ratios as more risky and/or less likely to enjoy higher future growth. e. It is appropriate to use the fixed assets turnover ratio to appraise firms' effectiveness in managing their fixed assets if and only if all the firms being compared have the same proportion of fixed assets to total assets. Copyright Cengage Learning. Powered by Cognero.
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ANSWER: c POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.04.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Various ratios KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/3/2017 4:43 PM 80. Walter Industries’ current ratio is 0.5. Considered alone, which of the following actions would increase the company’s current ratio? a. Borrow using short-term notes payable and use the cash to increase inventories. b. Use cash to reduce accruals. c. Use cash to reduce accounts payable. d. Use cash to reduce short-term notes payable. e. Use cash to reduce long-term bonds outstanding. ANSWER: a RATIONALE: The following equation can be used. If you add equal amounts to the numerator and denominator, then if Orig CR = or > 1.0, CR will decline, but if Orig CR < 1.0, CR will increase. Obviously, if you add to one but not the other, CR will increase or decrease in a predictable manner. We see that a is correct. Example: Original CA/CL
Plus New $1 CA/CL
Old CR
New CR
0.50 0.67
CR rises if initial CR is less than 1.0
POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 4-2 Liquidity Ratios QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.04.02 - Liquidity Ratios NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business Copyright Cengage Learning. Powered by Cognero.
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TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
School Outcomes, you do not need to include anything for this category. Current ratio Bloom's: Understand Multiple Choice: Conceptual 9/21/2017 5:19 PM 11/3/2017 4:43 PM
81. Safeco’s current assets total to $20 million versus $10 million of current liabilities, while Risco’s current assets are $10 million versus $20 million of current liabilities. Both firms would like to ―window dress‖ their end-of-year financial statements, and to do so they tentatively plan to borrow $10 million on a short-term basis and to then hold the borrowed funds in their cash accounts. Which of the statements below best describes the results of these transactions? a. The transactions would improve Safeco’s financial strength as measured by its current ratio but lower Risco’s current ratio. b. The transactions would lower Safeco’s financial strength as measured by its current ratio but raise Risco’s current ratio. c. The transactions would have no effect on the firms’ financial strength as measured by their current ratios. d. The transactions would lower both firms’ financial strength as measured by their current ratios. e. The transactions would improve both firms’ financial strength as measured by their current ratios. ANSWER: b RATIONALE: The key here is to recognize that if the CR is less than 1.0, then a given increase to both
current assets and current liabilities will increase the CR, while the reverse will hold if the initial CR is greater than 1.0. Thus, the transactions would make Risco look stronger but Safeco look weaker. Here's an illustration: Safeco: Original CA/CL
Plus $10
New CA/CL
Old CR
New CR
20 10
10 10
30 20
2.00
1.50
Plus $10
New CA/CL
Old CR
New CR
CR falls because initial CR is greater than 1.0
Risco: Original CA/CL
10 10 20 0.50 0.67 CR rises because initial CR is less than 1.0 20 10 30 All of the statements except b are incorrect. POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 4-2 Liquidity Ratios QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIV FOFM.BRIG.17.04.02 - Liquidity Ratios ES: NATIONAL STANDAR United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic DS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. Copyright Cengage Learning. Powered by Cognero.
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TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
Current ratio Bloom's: Analyze Multiple Choice: Conceptual 9/21/2017 5:19 PM 11/3/2017 12:57 PM
82. Companies HD and LD have the same total assets, sales, operating costs, and tax rates, and they pay the same interest rate on their debt. Both firms finance using only debt and common equity, and total assets equal total invested capital. However, company HD has a higher total debt to total capital ratio. Which of the following statements is CORRECT? a. Given this information, LD must have the higher ROE. b. Company LD has a higher basic earning power ratio (BEP). c. Company HD has a higher basic earning power ratio (BEP). d. If the interest rate the companies pay on their debt is more than their basic earning power (BEP), then Company HD will have the higher ROE. e. If the interest rate the companies pay on their debt is less than their basic earning power (BEP), then Company HD will have the higher ROE. ANSWER: e RATIONALE: The companies have the same EBIT and assets, hence the same BEP ratio. If the interest rate is less than the BEP, then using more debt will raise the ROE. Therefore, statement e is correct. The others are all incorrect. POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.04.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Leverage effects KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/3/2017 4:44 PM 83. Which of the following statements is CORRECT? a. Even though Firm A's current ratio exceeds that of Firm B, Firm B's quick ratio might exceed that of A. However, if A's quick ratio exceeds B's, then we can be certain that A's current ratio is also larger than B's. b. Suppose a firm wants to maintain a specific TIE ratio. It knows the amount of its debt, the interest rate on that debt, the applicable tax rate, and its operating costs. With this information, the firm can calculate the amount of sales required to achieve its target TIE ratio. c. Since the ROA measures the firm's effective utilization of assets without considering how these assets are financed, two firms with the same EBIT must have the same ROA. d. Suppose all firms follow similar financing policies, face similar risks, have equal access to capital, and operate in competitive product and capital markets. However, firms face different operating conditions because, for example, the grocery store industry is different from the airline industry. Under these conditions, firms with Copyright Cengage Learning. Powered by Cognero.
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high profit margins will tend to have high asset turnover ratios, and firms with low profit margins will tend to have low turnover ratios. e. Klein Cosmetics has a profit margin of 5.0%, a total assets turnover ratio of 1.5 times, no debt and therefore an equity multiplier of 1.0, and an ROE of 7.5%. The CFO recommends that the firm borrow funds using longterm debt, use the funds to buy back stock, and raise the equity multiplier to 2.0. The size of the firm (assets) would not change. She thinks that operations would not be affected, but interest on the new debt would lower the profit margin to 4.5%. This would probably not be a good move, as it would decrease the ROE from 7.5% to 6.5%. ANSWER: b POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.04.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Various ratios KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/3/2017 12:57 PM Multiple Choice: Problems A good bit of relatively simple algebra is involved in these problems, and although the calculations are simple, it will take students some time to set up the problems and do the arithmetic. We allow for this when assigning problems for a timed test. Also, note that students must know the definitions of a number of ratios to answer the questions. We provide our students with a formula sheet on exams, using the relevant sections of Appendix C at the the end of the text. Otherwise, they spend too much time trying to memorize things rather than trying to understand the issues. The difficulty of the problems depends on (1) whether or not students are provided with a formula sheet and (2) the amount of time they have to work the problems. Our difficulty assessments assume that they have a formula sheet and a "reasonable" amount of time for the test. Note that a few of the problems are trivially easy if students have formula sheets. To work some of the problems, students must transpose equations and solve for items that are normally inputs. For example, the equation for the profit margin is given as Profit margin = Net income/Sales. We might have a problem where sales and the profit margin are given and then require students to find the firm's net income. We explain to our students in class before the exam that they will have to transpose terms in the formulas to work some problems. Problems 84 through 114 are all stand-alone problems with individualized data. Problems 115 through 133 are all based on a common set of financial statements, and they require students to calculate ratios and find items like EPS, TIE, and the like using this data set. The financial statements can be changed algorithmically, and this changes the calculated ratios and other items. 84. Ryngard Corp's sales last year were $43,000, and its total assets were $16,000. What was its total assets turnover ratio (TATO)? a. 2.50 b. 2.28 c. 2.71 d. 3.06 Copyright Cengage Learning. Powered by Cognero.
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e. 2.69 ANSWER: RATIONALE:
e Sales $43,000 Total assets $16,000 TATO = Sales/Total assets = 2.69 POINTS: 1 DIFFICULTY: EASY REFERENCES: 4-3 Asset Management Ratios QUESTION TYPE: Multiple Choice HAS VARIABLES: True PREFACE NAME: Problems LEARNING OBJECTIVES: FOFM.BRIG.17.04.03 - Asset Management Ratios NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Total assets turnover KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/8/2017 2:36 PM 85. Beranek Corp has $855,000 of assets (which equal total invested capital), and it uses no debt—it is financed only with common equity. The new CFO wants to employ enough debt to raise the total debt to total capital ratio to 40%, using the proceeds from borrowing to buy back common stock at its book value. How much must the firm borrow to achieve the target debt ratio? a. $287,280 b. $342,000 c. $318,060 d. $403,560 e. $277,020 ANSWER: b RATIONALE: Total assets = Total invested capital $855,000 Target total debt to total capital ratio 40% Debt to achieve target ratio = Amount borrowed = Target % × Invested Capital = $342,000 POINTS: 1 DIFFICULTY: EASY REFERENCES: 4-4 Debt Management Ratios QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.04.04 - Debt Management Ratios NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Debt to capital ratio Copyright Cengage Learning. Powered by Cognero.
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KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
Bloom's: Analyze Multiple Choice: Problem 9/21/2017 5:19 PM 11/8/2017 2:37 PM
86. Ajax Corp's sales last year were $400,000, its operating costs were $362,500, and its interest charges were $12,500. What was the firm's times-interest-earned (TIE) ratio? a. 3.00 b. 3.66 c. 2.46 d. 2.61 e. 3.48 ANSWER: a RATIONALE: Sales $400,000 Operating costs $362,500 Operating income $37,500 (EBIT) Interest charges $12,500 TIE ratio = EBIT/ 3.00 Interest =
POINTS: 1 DIFFICULTY: EASY REFERENCES: 4-4 Debt Management Ratios QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.04.04 - Debt Management Ratios NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Times interest earned KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/8/2017 2:37 PM 87. Royce Corp's sales last year were $250,000, and its net income was $23,000. What was its profit margin? a. 9.57% b. 8.37% c. 9.20% d. 11.32% e. 9.38% ANSWER: c RATIONALE: Sales $250,000 Copyright Cengage Learning. Powered by Cognero.
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Net income $23,000 Profit margin = NI/Sales 9.20% POINTS: 1 DIFFICULTY: EASY REFERENCES: 4-5 Profitability Ratios QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.04.05 - Profitability Ratios NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Profit margin KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/8/2017 2:38 PM 88. River Corp's total assets at the end of last year were $390,000 and its net income was $32,750. What was its return on total assets? a. 6.97% b. 8.82% c. 8.40% d. 8.99% e. 7.31% ANSWER: c RATIONALE: Total assets $390,000
Net income ROA = NI/Assets =
$32,750 8.40%
POINTS: 1 DIFFICULTY: EASY REFERENCES: 4-5 Profitability Ratios QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.04.05 - Profitability Ratios NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Return on total assets KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/3/2017 12:57 PM 89. X-1 Corp's total assets at the end of last year were $395,000 and its EBIT was $52,500. What was its basic earning Copyright Cengage Learning. Powered by Cognero.
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power (BEP) ratio? a. 11.30% b. 15.55% c. 11.70% d. 16.35% e. 13.29% ANSWER: RATIONALE:
e
Total assets EBIT BEP = EBIT / Assets =
$395,000 $52,500 13.29%
POINTS: 1 DIFFICULTY: EASY REFERENCES: 4-5 Profitability Ratios QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.04.05 - Profitability Ratios NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Basic earning power KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/3/2017 12:57 PM 90. Zero Corp's total common equity at the end of last year was $350,000 and its net income was $70,000. What was its ROE? a. 17.00% b. 20.00% c. 17.40% d. 24.20% e. 19.40% ANSWER: b RATIONALE:
Common equity Net income ROE = NI/Equity =
$350,000 $70,000 20.00%
POINTS: 1 DIFFICULTY: EASY REFERENCES: 4-5 Profitability Ratios QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.04.05 - Profitability Ratios Copyright Cengage Learning. Powered by Cognero.
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NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Return on equity KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/3/2017 12:57 PM 91. Your sister is thinking about starting a new business. The company would require $300,000 of assets, and it would be financed entirely with common stock. She will go forward only if she thinks the firm can provide a 13.5% return on the invested capital, which means that the firm must have an ROE of 13.5%. How much net income must be expected to warrant starting the business? a. $38,475 b. $44,145 c. $33,210 d. $40,500 e. $41,310 ANSWER: d RATIONALE:
Assets = Equity Target ROE Required net income = Target ROE × Equity =
$300,000 13.5% $40,500
POINTS: 1 DIFFICULTY: EASY REFERENCES: 4-5 Profitability Ratios QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.04.05 - Profitability Ratios NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Return on equity KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/3/2017 12:57 PM 92. Herring Corporation has operating income of $270,000 and a 40% tax rate. The firm has short-term debt of $119,000, long-term debt of $316,000, and common equity of $435,000. What is its return on invested capital? a. 17.37% b. 17.95% c. 18.62% d. 19.87% Copyright Cengage Learning. Powered by Cognero.
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e. 20.72% ANSWER: RATIONALE:
c
EBIT $270,000 Tax rate 40% Short-term debt $119,000 Long-term debt $316,000 Common equity $435,000 ROIC = [EBIT(1 – T)]/(STD + LTD + E) 18.62% POINTS: 1 DIFFICULTY: EASY REFERENCES: 4-5 Profitability Ratios QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.04.05 - Profitability Ratios NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows TOPICS: Return on invested capital KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/8/2017 2:40 PM 93. Song Corp's stock price at the end of last year was $28.75 and its earnings per share for the year were $1.30. What was its P/E ratio? a. 23.00 b. 18.80 c. 27.64 d. 22.12 e. 17.69 ANSWER: d RATIONALE:
Stock price EPS P/E = Stock price / EPS
$28.75 $1.30 22.12
POINTS: 1 DIFFICULTY: EASY REFERENCES: 4-6 Market Value Ratios QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.04.06 - Market Value Ratios NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Price/Earnings ratio KEYWORDS: Bloom's: Analyze Copyright Cengage Learning. Powered by Cognero.
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OTHER: DATE CREATED: DATE MODIFIED:
Multiple Choice: Problem 9/21/2017 5:19 PM 11/3/2017 12:57 PM
94. Hoagland Corp's stock price at the end of last year was $20.50, and its book value per share was $25.00. What was its market/book ratio? a. 0.94 b. 0.82 c. 0.69 d. 0.87 e. 0.67 ANSWER: b RATIONALE: Stock price $20.50
Book value per share M/B ratio = Stock price / Book value per share =
$25.00 0.82
POINTS: 1 DIFFICULTY: EASY REFERENCES: 4-6 Market Value Ratios QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.04.06 - Market Value Ratios NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Market/Book ratio KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/3/2017 12:57 PM 95. Precision Aviation had a profit margin of 6.25%, a total assets turnover of 1.5, and an equity multiplier of 1.8. What was the firm's ROE? a. 17.72% b. 20.93% c. 14.34% d. 13.84% e. 16.88% ANSWER: e RATIONALE: Profit margin 6.25% TATO 1.5 Equity multiplier 1.8 ROE = PM × TATO × Eq. Multiplier = 16.88% POINTS: DIFFICULTY:
1 EASY
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REFERENCES: 4-7 Tying the Ratios Together: The DuPont Equation QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.04.07 - Tying the Ratios Together: The DuPont Equation NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: DuPont equation KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/8/2017 2:42 PM 96. Meyer Inc's total invested capital is $610,000, and its total debt outstanding is $185,000. The new CFO wants to establish a total debt to total capital ratio of 55%. The size of the firm will not change. How much debt must the company add or subtract to achieve the target debt to capital ratio? a. $164,045 b. $150,500 c. $115,885 d. $165,550 e. $185,115 ANSWER: b RATIONALE: Total invested capital $610,000
Old debt Target debt to capital ratio Target amount of debt = Target debt % × Total invested capital = Change in amount of debt outstanding = Target debt – Old debt =
$185,000 55% $335,500 $150,500
POINTS: 1 DIFFICULTY: EASY/MODERATE REFERENCES: 4-4 Debt Management Ratios QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.04.04 - Debt Management Ratios NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Debt to capital ratio KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:19 PM Copyright Cengage Learning. Powered by Cognero.
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DATE MODIFIED:
11/8/2017 2:41 PM
97. Helmuth Inc's latest net income was $1,500,000, and it had 225,000 shares outstanding. The company wants to pay out 45% of its income. What dividend per share should it declare? Do not round your intermediate calculations. a. $3.24 b. $2.31 c. $3.21 d. $2.28 e. $3.00 ANSWER: e RATIONALE: Net income $1,500,000 Shares outstanding 225,000 Payout ratio 45% EPS = NI / shares outstanding = $6.67 DPS = EPS × Payout% = $3.00 POINTS: 1 DIFFICULTY: EASY/MODERATE REFERENCES: 4-6 Market Value Ratios QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.04.06 - Market Value Ratios NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: EPS, DPS, and payout KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/8/2017 2:42 PM 98. Garcia Industries has sales of $187,500 and accounts receivable of $18,500, and it gives its customers 25 days to pay. The industry average DSO is 27 days, based on a 365-day year. If the company changes its credit and collection policy sufficiently to cause its DSO to fall to the industry average, and if it earns 8.0% on any cash freed up by this change, how would that affect its net income, assuming other things are held constant? Assume all sales to be on credit. Do not round your intermediate calculations. a. $333.37 b. $311.15 c. $370.41 d. $422.27 e. $459.31 ANSWER: c RATIONALE: Rate of return on cash generated 8.0% Sales A/R Days in Year Sales/day = Sales/365 = Copyright Cengage Learning. Powered by Cognero.
$187,500 $18,500 365 $513.70 Page 203
Company DSO = Receivables/Sales per day = Industry DSO Difference = Company DSO –Industry DSO = Cash flow from reducing the DSO = Difference ×Sales/day = Additional Net Income = Return on cash ×Added cash flow =
36.0 27.0 9.0 $4,630.14 $370.41
Alternative Calculation: A/R at industry DSO Change in A/R Additional Net Income
$13,869.86 $4,630.14 $370.41
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 4-3 Asset Management Ratios QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.04.03 - Asset Management Ratios NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: DSO effect on net income KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/8/2017 2:44 PM 99. Faldo Corp sells on terms that allow customers 45 days to pay for merchandise. Its sales last year were $425,000, and its year-end receivables were $60,000. If its DSO is less than the 45-day credit period, then customers are paying on time. Otherwise, they are paying late. By how much are customers paying early or late? Base your answer on this equation: DSO – Credit Period = Days early or late, and use a 365-day year when calculating the DSO. A positive answer indicates late payments, while a negative answer indicates early payments. Assume all sales to be on credit. Do not round your intermediate calculations. a. 5.16 b. 8.10 c. 6.20 d. 6.53 e. 6.73 ANSWER: d RATIONALE: Credit period 45
Sales Sales/day = Sales / 365 = Receivables Company DSO = Receivables / Sales per day = Company DSO - Credit Period = Days early (-) or late (+) = POINTS: DIFFICULTY:
$425,000 $1,164.38 $60,000 51.53 6.53
1 MODERATE
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REFERENCES: 4-3 Asset Management Ratios QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.04.03 - Asset Management Ratios NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Days sales outstanding KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/3/2017 12:57 PM 100. Han Corp's sales last year were $440,000, and its year-end receivables were $52,500. The firm sells on terms that call for customers to pay 30 days after the purchase, but some delay payment beyond Day 30. On average, how many days late do customers pay? Base your answer on this equation: DSO – Allowed credit period = Average days late, and use a 365day year when calculating the DSO. Assume all sales to be on credit. Do not round your intermediate calculations. a. 11.65 b. 12.74 c. 12.33 d. 13.55 e. 15.58 ANSWER: d RATIONALE: Sales $440,000 Sales/day = Sales / 365 = $1,205.48 Receivables $52,500 Company DSO = Receivables / Sales per day = 43.55 Credit period 30 DSO - Credit period = Days late 13.55 POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 4-3 Asset Management Ratios QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.04.03 - Asset Management Ratios NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Days sales outstanding KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/8/2017 2:45 PM Copyright Cengage Learning. Powered by Cognero.
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101. Wie Corp's sales last year were $280,000, and its year-end total assets were $355,000. The average firm in the industry has a total assets turnover ratio (TATO) of 2.4. The firm's new CFO believes the firm has excess assets that can be sold so as to bring the TATO down to the industry average without affecting sales. By how much must the assets be reduced to bring the TATO to the industry average, holding sales constant? Do not round your intermediate calculations. a. $238,333 b. $178,750 c. $259,783 d. $193,050 e. $250,250 ANSWER: a RATIONALE: Sales $280,000 Actual total assets $355,000 Target TATO = Sales / Total assets = 2.4 Target assets = Sales / Target TATO = $116,667 Asset reduction = Actual assets - Target assets = $238,333 POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 4-3 Asset Management Ratios QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.04.03 - Asset Management Ratios NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Total assets turnover KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/8/2017 2:46 PM 102. A new firm is developing its business plan. It will require $735,000 of assets (which equals total invested capital), and it projects $450,000 of sales and $355,000 of operating costs for the first year. Management is reasonably sure of these numbers because of contracts with its customers and suppliers. It can borrow at a rate of 7.5%, but the bank requires it to have a TIE of at least 4.0, and if the TIE falls below this level the bank will call in the loan and the firm will go bankrupt. The firm will use only debt and common equity for financing. What is the maximum debt to capital ratio (measured as debt/total invested capital) the firm can use? (Hint: Find the maximum dollars of interest, then the debt that produces that interest, and then the related debt to capital ratio.) Do not round your intermediate calculations. a. 46.53% b. 38.78% c. 43.08% d. 34.90% e. 53.85% ANSWER: c RATIONALE: Assets = Total invested capital $735,000 Sales $450,000 Copyright Cengage Learning. Powered by Cognero.
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Operating costs Operating income (EBIT) Target TIE Maximum interest expense = EBIT / Target TIE Interest rate Max. debt = Max interest expense/Interest rate Maximum debt ratio = Debt/Assets
$355,000 $95,000 4.0 $23,750 7.5% $316,667 43.08%
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 4-4 Debt Management Ratios QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.04.04 - Debt Management Ratios NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Debt management KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/7/2017 1:48 PM 103. Duffert Industries has total assets of $1,050,000 and total current liabilities (consisting only of accounts payable and accruals) of $150,000. Duffert finances using only long-term debt and common equity. The interest rate on its debt is 9% and its tax rate is 40%. The firm's basic earning power ratio is 15% and its debt-to capital rate is 40%. What are Duffert's ROE and ROIC? Do not round your intermediate calculations. a. 9.04%; 8.93% b. 11.26%; 9.14% c. 12.65%; 10.19% d. 13.90%; 10.50% e. 16.12%; 11.66% ANSWER: d RATIONALE: Total assets $1,050,000 Balance sheet: Current liabilities Debt Common equity Total liabilities
$150,000 360,000 540,000 $1,050,000
D/(D+E) D/($1,050,000 – $150,000) = D=
0.4 0.4 $360,000
Now calculate EBIT: BEP = 0.15 = EBIT/TA = EBIT/$1,050,000 Copyright Cengage Learning. Powered by Cognero.
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EBIT = $157,500 Calculate ROIC: ROIC = [EBIT(1 – T)]/(D + E) = [$157,500(0.6)]/$900,000 = 10.50% Now determine net income from income statement: EBIT $157,500 Interest 32,400 (0.09×$360,000) EBT $125,100 Taxes (40%) 50,040 NI $75,060 ROE = NI/E = $75,060/$540,000 = 13.90%
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 4-5 Profitability Ratios QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.04.05 - Profitability Ratios NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows TOPICS: Return on invested capital and ROE KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/8/2017 2:47 PM 104. Chang Corp. has $375,000 of assets, and it uses only common equity capital (zero debt). Its sales for the last year were $550,000, and its net income was $25,000. Stockholders recently voted in a new management team that has promised to lower costs and get the return on equity up to 15%. What profit margin would the firm need in order to achieve the 15% ROE, holding everything else constant? Do not round your intermediate calculations. a. 10.13% b. 8.59% c. 10.23% d. 10.64% e. 9.92% ANSWER: c RATIONALE: Total assets = Equity because zero debt $375,000
Sales Net income Target ROE Net income req'd to achieve target ROE = Target ROE × Equity = Profit margin needed to achieve target ROE = NI / Sales = POINTS:
$550,000 $25,000 15% $56,250 10.23%
1
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DIFFICULTY: MODERATE REFERENCES: 4-5 Profitability Ratios QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.04.05 - Profitability Ratios NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Profit margin and ROE KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/3/2017 12:57 PM 105. Last year Ann Arbor Corp had $250,000 of assets (which equals total invested capital), $305,000 of sales, $20,000 of net income, and a debt-to-total-capital ratio of 37.5%. The new CFO believes that a new computer program will enable the company to reduce costs and thus raise net income to $33,000. The firm finances using only debt and common equity. Assets, total invested capital, sales, and the debt to capital ratio would not be affected. By how much would the cost reduction improve the ROE? Do not round your intermediate calculations. a. 8.15% b. 8.57% c. 8.82% d. 6.74% e. 8.32% ANSWER: e RATIONALE: Assets = Total invested capital $250,000 Debt to total capital ratio 37.5% Debt = Assets × Debt% = $93,750 Equity = Assets – Debt = $156,250 Sales $305,000 Old net income $20,000 New net income $33,000 New ROE = New NI / Equity = 21.12% Old ROE = Old NI / Equity = 12.80% Increase in ROE = New ROE – Old ROE = 8.32% POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 4-5 Profitability Ratios QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.04.05 - Profitability Ratios NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Cost reduction and ROE KEYWORDS: Bloom's: Analyze Copyright Cengage Learning. Powered by Cognero.
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OTHER: DATE CREATED: DATE MODIFIED:
Multiple Choice: Problem 9/21/2017 5:19 PM 11/8/2017 2:48 PM
106. Brookman Inc's latest EPS was $2.75, its book value per share was $22.75, it had 275,000 shares outstanding, and its debt/total invested capital ratio was 44%. The firm finances using only debt and common equity, and its total assets equal total invested capital. How much debt was outstanding? Do not round your intermediate calculations. a. $4,768,156 b. $4,571,531 c. $5,358,031 d. $5,013,938 e. $4,915,625 ANSWER: e RATIONALE: EPS $2.75
BVPS Shares outstanding Debt to total capital ratio Total equity = Shares outstanding × BVPS = Total assets = Total equity / (1 - Debt to total capital ratio) = Total debt = Total assets - Equity =
$22.75 275,000 44% $6,256,250 $11,171,875 $4,915,625
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 4-6 Market Value Ratios QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.04.06 - Market Value Ratios NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: EPS, book value, and debt KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/3/2017 12:57 PM 107. Last year Harrington Inc. had sales of $325,000 and a net income of $19,000, and its year-end assets were $250,000. The firm's total-debt-to-total-capital ratio was 17.5%. The firm finances using only debt and common equity, and its total assets equal total invested capital. Based on the DuPont equation, what was the ROE? Do not round your intermediate calculations. a. 11.52% b. 9.49% c. 9.21% d. 9.86% e. 7.74% Copyright Cengage Learning. Powered by Cognero.
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ANSWER: RATIONALE:
c
Sales $325,000 Assets = Total invested capital $250,000 Net income $19,000 Debt to total capital ratio 17.5% Debt = Debt% × Assets = $43,750 Equity = Assets - Debt = $206,250 Profit margin = NI / Sales = 5.85% TATO = Sales/Assets 1.30 Equity multiplier = Assets / Equity = 1.21 ROE 9.21%
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 4-7 Tying the Ratios Together: The DuPont Equation QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.04.07 - Tying the Ratios Together: The DuPont Equation NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: DuPont equation KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/3/2017 12:57 PM 108. Last year Rennie Industries had sales of $270,000, assets of $175,000 (which equals total invested capital), a profit margin of 5.3%, and an equity multiplier of 1.2. The CFO believes that the company could reduce its assets by $51,000 without affecting either sales or costs. The firm finances using only debt and common equity. Had it reduced its assets by this amount, and had the debt/total invested capital ratio, sales, and costs remained constant, how much would the ROE have changed? Do not round your intermediate calculations. a. 4.08% b. 3.03% c. 4.52% d. 3.07% e. 4.04% ANSWER: e RATIONALE: Old New Sales $270,000 $270,000 Original assets = Original capital $175,000 Reduction in assets = Reduction in capital $51,000 New assets = Old assets - Reduction = $124,000 TATO = Sales / Assets = 1.54 2.18 Profit margin 5.3% 5.3% Equity multiplier 1.2 1.2 ROE = PM × TATO × Eq Multiplier = 9.81% 13.85% Change in ROE 4.04% Copyright Cengage Learning. Powered by Cognero.
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POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 4-7 Tying the Ratios Together: The DuPont Equation QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.04.07 - Tying the Ratios Together: The DuPont Equation NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: DuPont equation KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/8/2017 2:49 PM 109. Last year Blease Inc had a total assets turnover of 1.33 and an equity multiplier of 1.75. Its sales were $270,000 and its net income was $10,600. The firm finances using only debt and common equity, and its total assets equal total invested capital. The CFO believes that the company could have operated more efficiently, lowered its costs, and increased its net income by $10,250 without changing its sales, assets, or capital structure. Had it cut costs and increased its net income by this amount, how much would the ROE have changed? Do not round your intermediate calculations. a. 9.10% b. 10.60% c. 10.25% d. 6.72% e. 8.84% ANSWER: e RATIONALE: Old New
Sales Original net income Increase in net income New net income Profit margin = NI / Sales = TATO Equity multiplier ROE = PM × TATO × Eq Multiplier = Change in ROE
$270,000 $270,000 $10,600 $10,600 $0 $10,250 $10,600 $20,850 3.93% 7.72% 1.33 1.33 1.75 1.75 9.14% 17.97% 8.84%
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 4-7 Tying the Ratios Together: The DuPont Equation QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.04.07 - Tying the Ratios Together: The DuPont Equation NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business Copyright Cengage Learning. Powered by Cognero.
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TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
School Outcomes, you do not need to include anything for this category. DuPont equation Bloom's: Analyze Multiple Choice: Problem 9/21/2017 5:19 PM 11/3/2017 12:57 PM
110. Last year Jandik Corp. had $295,000 of assets (which is equal to its total invested capital), $18,750 of net income, and a debt-to-total-capital ratio of 37%. Now suppose the new CFO convinces the president to increase the debt-to-totalcapital ratio to 48%. Sales, total assets and total invested capital will not be affected, but interest expenses would increase. However, the CFO believes that better cost controls would be sufficient to offset the higher interest expense and thus keep net income unchanged. By how much would the change in the capital structure improve the ROE? Do not round your intermediate calculations. a. 2.60% b. 2.37% c. 2.50% d. 2.13% e. 1.64% ANSWER: d RATIONALE: Assets = Total invested capital $295,000 Old debt to capital ratio 37% Old debt = Assets × Old debt% = $109,150 Old equity = Assets - Debt $185,850 New debt to capital ratio 48% New debt = Capital × New debt% = $141,600 New Equity = Assets - New debt = $153,400 Net income $18,750 New ROE = New income / New Equity 12.22% Old ROE = Old income / Old Equity 10.09% Increase in ROE 2.13% POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 4-7 Tying the Ratios Together: The DuPont Equation QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.04.07 - Tying the Ratios Together: The DuPont Equation NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: DuPont equation KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/8/2017 2:50 PM 111. Last year Kruse Corp had $380,000 of assets (which is equal to its total invested capital), $403,000 of sales, $28,250 of net income, and a debt-to-total-capital ratio of 39%. The new CFO believes the firm has excessive fixed assets and inventory that could be sold, enabling it to reduce its total assets and total invested capital to $252,500. The firm finances Copyright Cengage Learning. Powered by Cognero.
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using only debt and common equity. Sales, costs, and net income would not be affected, and the firm would maintain the same capital structure (but with less total debt). By how much would the reduction in assets improve the ROE? Do not round your intermediate calculations. a. 6.15% b. 6.28% c. 5.05% d. 7.63% e. 5.97% ANSWER: a RATIONALE: Original New Assets = Total invested capital $380,000 $252,500 Sales $403,000 $403,000 Net income $28,250 $28,250 Debt to capital ratio 39% 39% Debt = Capital × debt% = $148,200 $98,475 Equity = Assets - Debt = $231,800 $154,025 ROE = NI / Equity = 12.19% 18.34% Increase in ROE 6.15% POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.04.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Reducing assets and ROE KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/8/2017 2:51 PM 112. Jordan Inc has the following balance sheet and income statement data: Cash Receivables Inventories Total CA Net fixed assets Total assets Sales Net income
$14,000 70,000 280,000 $364,000 126,000 $490,000 $280,000 21,000
Accounts payable Other current liabilities Total CL Long-term debt Common equity Total liab. and equity
$42,000 28,000 $70,000 140,000 280,000 $490,000
The new CFO thinks that inventories are excessive and could be lowered sufficiently to cause the current ratio to equal the industry average, 2.15, without affecting either sales or net income. Assuming that inventories are sold off and not replaced to get the current ratio to the target level, and that the funds generated are used to buy back common stock at book value, by how much would the ROE change? Do not round your intermediate calculations. Copyright Cengage Learning. Powered by Cognero.
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a. 29.38% b. 19.50% c. 29.86% d. 25.04% e. 24.08% ANSWER: RATIONALE:
e Original balance sheet and income statement data: Cash $14,000 Accounts payable Receivables 70,000 Other current liabilities Inventories 280,000 Total CL Total CA $364,000 Long-term debt Net fixed assets 126,000 Common equity Total assets $490,000 Total liab. and equity Sales Net income
$42,0 28,0 $70,0 140,0 280,0 $490,0
$280,000 21,000
Actual current ratio Target current ratio
5.20 2.15
Old current assets = Current assets to have CR = Target: Target current ratio × Cur. Liab = Reduction in current assets = Old CA - New CA = Inventory reduction = Reduction in common equity = Reduction in inventory = New common equity = Old equity - Reduction =
$364,000 $150,500 $213,500 $213,500 $66,500
Orig ROE = NI/Old Equity: 7.50% New ROE = NI/New Equity: 31.58% Δ ROE = 24.08% POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 4-3 Asset Management Ratios QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVEFOFM.BRIG.17.04.03 - Asset Management Ratios S: NATIONAL STANDARD United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic S: STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: DSO and net income KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/3/2017 12:57 PM Copyright Cengage Learning. Powered by Cognero.
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113. Last year Hamdi Corp. had sales of $500,000, operating costs of $450,000, and year-end assets (which is equal to its total invested capital) of $385,000. The debt-to-total-capital ratio was 17%, the interest rate on the debt was 7.5%, and the firm's tax rate was 35%. The new CFO wants to see how the ROE would have been affected if the firm had used a 50% debt-to-total-capital ratio. Assume that sales, operating costs, total assets, total invested capital, and the tax rate would not be affected, but the interest rate would rise to 8.0%. By how much would the ROE change in response to the change in the capital structure? Do not round your intermediate calculations. a. 2.08% b. 2.46% c. 2.01% d. 2.51% e. 2.64% ANSWER: d RATIONALE: New Old
Interest rate Tax rate Assets = Total capital Debt-to-capital ratio Debt = Capital × Debt ratio = Equity = Assets - Debt =
7.5% 35% $385,000 17% $65,450 $319,550
Sales Operating costs EBIT = Sales - Operating costs = Interest paid = Interest rate × Debt = Taxable income Taxes Net income ROE Change in ROE
$500,000 450,000 $50,000 4,909 $45,091 15,782 $29,309 9.17%
8.0% 35% $385,000 50%
$192,500 $192,500 $500,000 450,000 $50,000 15,400 $34,600 12,110 $22,490 11.68% 2.51%
POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.04.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: ROE and debt KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/3/2017 12:57 PM 114. Quigley Inc. is considering two financial plans for the coming year. Management expects sales to be $300,000, Copyright Cengage Learning. Powered by Cognero.
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operating costs to be $265,000, assets (which is equal to its total invested capital) to be $200,000, and its tax rate to be 35%. Under Plan A it would finance the firm using 25% debt and 75% common equity. The interest rate on the debt would be 8.8%, but under a contract with existing bondholders the TIE ratio would have to be maintained at or above 5.5. Under Plan B, the maximum debt that met the TIE constraint would be employed. Assuming that sales, operating costs, assets, total invested capital, the interest rate, and the tax rate would all remain constant, by how much would the ROE change in response to the change in the capital structure? Do not round your intermediate calculations. a. 1.04% b. 1.32% c. 1.52% d. 1.11% e. 1.13% ANSWER: b RATIONALE: Work down the Plan A column, find the Max Debt, then use it to complete Plan B and the ROEs. Plan A Plan B Interest rate 8.8% 8.8% Tax rate 35% 35% Assets = Total capital $200,000 $200,000 Debt ratio: Plan A given, Plan B calculated 25% 36.2% Debt $50,000 $72,314 Equity $150,000 $127,686
Sales Constant Operating costs Constant EBIT Constant Interest Taxable income Taxes Net income ROE = NI / Equity = TIE = EBIT/Interest = Minimum TIE $ of Interest consistent with minimum TIE = EBIT/Min TIE = Max debt = Interest/interest rate = Change in ROE
$300,000 265,000 $35,000 4,400 $30,600 10,710 $19,890 13.26% 7.95
$300,000 265,000 $35,000 6,364 $28,636 10,023 $18,614 14.58% 5.50 $6,364 $72,314 1.32%
POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES FOFM.BRIG.17.04.00 - Comprehensive : Copyright Cengage Learning. Powered by Cognero.
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NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: LOCAL STANDARDS: TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. Debt management Bloom's: Analyze Multiple Choice: Problem 9/21/2017 5:19 PM 11/3/2017 12:57 PM
Exhibit 4.1 The balance sheet and income statement shown below are for Koski Inc. Note that the firm has no amortization charges, it does not lease any assets, none of its debt must be retired during the next 5 years, and the notes payable will be rolled over. Balance Sheet (Millions of $) Assets Cash and securities Accounts receivable Inventories Total current assets Net plant and equipment Total assets Liabilities and Equity Accounts payable Accruals Notes payable Total current liabilities
2018 $3,000 15,000 18,000 $36,000 $24,000 $60,000 $18,630 8,370 6,000 $33,000
Long-term bonds Total liabilities Common stock Retained earnings Total common equity Total liabilities and equity
$9,000 $42,000 $5,040 12,960 $18,000 $60,000
Income Statement (Millions of $) Net sales Operating costs except depreciation Depreciation Earnings before interest and taxes (EBIT) Less interest Earnings before taxes (EBT) Taxes Net income
2018 $84,000 78,120 1,680 $4,200 900 $3,300 1,320 $1,980
Other data: Shares outstanding (millions) Common dividends (millions of $) Int rate on notes payable & L-T bonds Federal plus state income tax rate Copyright Cengage Learning. Powered by Cognero.
500.00 $693.00 6% 40% Page 218
Year-end stock price
$47.52
115. Refer to Exhibit 4.1. What is the firm's current ratio? Do not round your intermediate calculations. a. 0.87 b. 0.85 c. 1.23 d. 1.09 e. 1.17 ANSWER: d RATIONALE: Current ratio = Current assets/Current liabilities = 1.09 POINTS: 1 DIFFICULTY: EASY REFERENCES: 4-2 Liquidity Ratios QUESTION TYPE: Multiple Choice HAS VARIABLES: True PREFACE NAME: Balance sheet LEARNING OBJECTIVES: FOFM.BRIG.17.04.02 - Liquidity Ratios NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Current ratio KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Multiple Parts DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/8/2017 2:53 PM 116. Refer to Exhibit 4.1. What is the firm's quick ratio? Do not round your intermediate calculations. a. 0.50 b. 0.55 c. 0.61 d. 0.52 e. 0.65 ANSWER: b RATIONALE: Quick ratio = (CA - Inventory)/CL = 0.55 POINTS: 1 DIFFICULTY: EASY REFERENCES: 4-2 Liquidity Ratios QUESTION TYPE: Multiple Choice HAS VARIABLES: True PREFACE NAME: Balance sheet LEARNING OBJECTIVES: FOFM.BRIG.17.04.02 - Liquidity Ratios NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business Copyright Cengage Learning. Powered by Cognero.
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TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
School Outcomes, you do not need to include anything for this category. Quick ratio Bloom's: Analyze Multiple Choice: Multiple Parts 9/21/2017 5:19 PM 11/8/2017 2:53 PM
117. Refer to Exhibit 4.1. What is the firm's days sales outstanding? Assume a 365-day year for this calculation. Do not round your intermediate calculations. a. 54.10 b. 76.91 c. 58.01 d. 50.19 e. 65.18 ANSWER: e RATIONALE: DSO = Accounts receivable/(Sales/365) = 65.18 POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 4-3 Asset Management Ratios QUESTION TYPE: Multiple Choice HAS VARIABLES: True PREFACE NAME: Balance sheet LEARNING OBJECTIVES: FOFM.BRIG.17.04.03 - Asset Management Ratios NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: DSO KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Multiple Parts DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/8/2017 2:54 PM 118. Refer to Exhibit 4.1. What is the firm's total assets turnover? Do not round your intermediate calculations. a. 1.51 b. 1.15 c. 1.40 d. 1.06 e. 1.71 ANSWER: c RATIONALE: Total assets turnover ratio = TATO = Sales/Total assets = 1.40 POINTS: 1 DIFFICULTY: EASY REFERENCES: 4-3 Asset Management Ratios QUESTION TYPE: Multiple Choice Copyright Cengage Learning. Powered by Cognero.
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HAS VARIABLES: True PREFACE NAME: Balance sheet LEARNING OBJECTIVES: FOFM.BRIG.17.04.03 - Asset Management Ratios NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Total assets turnover KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Multiple Parts DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/8/2017 2:55 PM 119. Refer to Exhibit 4.1. What is the firm's inventory turnover ratio? Do not round your intermediate calculations. a. 4.67 b. 3.78 c. 4.81 d. 5.46 e. 4.15 ANSWER: a RATIONALE: Inventory turnover ratio = Sales/Inventory = 4.67 POINTS: 1 DIFFICULTY: EASY REFERENCES: 4-3 Asset Management Ratios QUESTION TYPE: Multiple Choice HAS VARIABLES: True PREFACE NAME: Balance sheet LEARNING OBJECTIVES: FOFM.BRIG.17.04.03 - Asset Management Ratios NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Inventory turnover KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Multiple Parts DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/8/2017 2:56 PM 120. Refer to Exhibit 4.1. What is the firm's TIE? Do not round your intermediate calculations. a. 4.99 b. 4.81 c. 5.32 d. 4.67 e. 5.09 ANSWER: d Copyright Cengage Learning. Powered by Cognero.
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RATIONALE: TIE = EBIT/Interest charges = 4.67 POINTS: 1 DIFFICULTY: EASY REFERENCES: 4-4 Debt Management Ratios QUESTION TYPE: Multiple Choice HAS VARIABLES: True PREFACE NAME: Balance sheet LEARNING OBJECTIVES: FOFM.BRIG.17.04.04 - Debt Management Ratios NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Times interest earned KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Multiple Parts DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/8/2017 2:57 PM 121. Refer to Exhibit 4.1. What is the firm's total debt to total capital ratio? Do not round your intermediate calculations. a. 44.09% b. 39.09% c. 39.55% d. 38.18% e. 45.45% ANSWER: e RATIONALE: Debt to capital ratio = (ST Debt + LT Debt)/(ST Debt + LT Debt + Common Equity) = 45.45% POINTS: 1 DIFFICULTY: EASY REFERENCES: 4-4 Debt Management Ratios QUESTION TYPE: Multiple Choice HAS VARIABLES: True PREFACE NAME: Balance sheet LEARNING OBJECTIVES: FOFM.BRIG.17.04.04 - Debt Management Ratios NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Debt to capital ratio KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Multiple Parts DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 12/13/2017 6:22 PM 122. Refer to Exhibit 4.1. What is the firm's ROA? Do not round your intermediate calculations. a. 3.30% Copyright Cengage Learning. Powered by Cognero.
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b. 2.61% c. 2.97% d. 3.04% e. 3.10% ANSWER: a RATIONALE: ROA = Net income/Total assets = 3.30% POINTS: 1 DIFFICULTY: EASY REFERENCES: 4-5 Profitability Ratios QUESTION TYPE: Multiple Choice HAS VARIABLES: True PREFACE NAME: Balance sheet LEARNING OBJECTIVES: FOFM.BRIG.17.04.05 - Profitability Ratios NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Return on assets KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Multiple Parts DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/8/2017 2:58 PM 123. Refer to Exhibit 4.1. What is the firm's ROE? Do not round your intermediate calculations. a. 11.77% b. 11.00% c. 11.55% d. 10.89% e. 10.01% ANSWER: b RATIONALE: ROE = Net income/Common equity = 11.00% POINTS: 1 DIFFICULTY: EASY REFERENCES: 4-5 Profitability Ratios QUESTION TYPE: Multiple Choice HAS VARIABLES: True PREFACE NAME: Balance sheet LEARNING OBJECTIVES: FOFM.BRIG.17.04.05 - Profitability Ratios NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Return on equity KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Multiple Parts Copyright Cengage Learning. Powered by Cognero.
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DATE CREATED: DATE MODIFIED:
9/21/2017 5:19 PM 11/8/2017 2:59 PM
124. Refer to Exhibit 4.1. What is the firm's BEP? Do not round your intermediate calculations. a. 7.28% b. 6.72% c. 7.00% d. 7.63% e. 6.79% ANSWER: c RATIONALE: BEP = EBIT/Total assets = 7.00% POINTS: 1 DIFFICULTY: EASY REFERENCES: 4-5 Profitability Ratios QUESTION TYPE: Multiple Choice HAS VARIABLES: True PREFACE NAME: Balance sheet LEARNING OBJECTIVES: FOFM.BRIG.17.04.05 - Profitability Ratios NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Basic earning power KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Multiple Parts DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/8/2017 3:00 PM 125. Refer to Exhibit 4.1. What is the firm's profit margin? Do not round your intermediate calculations. a. 1.84% b. 2.48% c. 1.82% d. 2.36% e. 2.52% ANSWER: d RATIONALE: Profit margin = Net income/Sales = 2.36% POINTS: 1 DIFFICULTY: EASY REFERENCES: 4-5 Profitability Ratios QUESTION TYPE: Multiple Choice HAS VARIABLES: True PREFACE NAME: Balance sheet LEARNING OBJECTIVES: FOFM.BRIG.17.04.05 - Profitability Ratios NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows Copyright Cengage Learning. Powered by Cognero.
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LOCAL STANDARDS: TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. Profit margin Bloom's: Analyze Multiple Choice: Multiple Parts 9/21/2017 5:19 PM 11/8/2017 3:01 PM
126. Refer to Exhibit 4.1. What is the firm's return on invested capital? a. 7.64% b. 6.41% c. 8.32% d. 6.03% e. 8.63% ANSWER: a RATIONALE: Return on invested capital = [EBIT(1 – T)] / Total invested capital = 7.64% ROIC = [EBIT(1 – T)]/(/ST Debt + LT Debt + Common Equity) POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 4-5 Profitability Ratios QUESTION TYPE: Multiple Choice HAS VARIABLES: True PREFACE NAME: Balance sheet LEARNING OBJECTIVES: FOFM.BRIG.17.04.05 - Profitability Ratios NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows TOPICS: Return on invested capital KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Multiple Parts DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 12/13/2017 8:20 PM 127. Refer to Exhibit 4.1. What is the firm's operating margin? Do not round your intermediate calculations. a. 5.85% b. 4.55% c. 4.80% d. 4.10% e. 5.00% ANSWER: e RATIONALE: Operating margin = EBIT/Sales = 5.00% POINTS: 1 DIFFICULTY: EASY REFERENCES: 4-5 Profitability Ratios QUESTION TYPE: Multiple Choice HAS VARIABLES: True Copyright Cengage Learning. Powered by Cognero.
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PREFACE NAME: Balance sheet LEARNING OBJECTIVES: FOFM.BRIG.17.04.05 - Profitability Ratios NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Operating margin KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Multiple Parts DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/8/2017 3:02 PM 128. Refer to Exhibit 4.1. What is the firm's dividends per share? Do not round your intermediate calculations. a. $1.41 b. $1.39 c. $1.23 d. $1.37 e. $1.36 ANSWER: b RATIONALE: DPS = Common dividends paid/Shares outstanding = $1.39 POINTS: 1 DIFFICULTY: EASY REFERENCES: 4-6 Market Value Ratios QUESTION TYPE: Multiple Choice HAS VARIABLES: True PREFACE NAME: Balance sheet LEARNING OBJECTIVES: FOFM.BRIG.17.04.06 - Market Value Ratios NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: DPS KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Multiple Parts DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/8/2017 3:03 PM 129. Refer to Exhibit 4.1. What is the firm's EPS? Do not round your intermediate calculations. a. $3.72 b. $3.84 c. $3.96 d. $4.20 e. $3.80 ANSWER: c RATIONALE: EPS = Net income/Common shares outstanding = $3.96 Copyright Cengage Learning. Powered by Cognero.
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POINTS: 1 DIFFICULTY: EASY REFERENCES: 4-6 Market Value Ratios QUESTION TYPE: Multiple Choice HAS VARIABLES: True PREFACE NAME: Balance sheet LEARNING OBJECTIVES: FOFM.BRIG.17.04.06 - Market Value Ratios NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: EPS KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Multiple Parts DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/8/2017 3:03 PM 130. Refer to Exhibit 4.1. What is the firm's P/E ratio? Do not round your intermediate calculations. a. 12.0 b. 12.6 c. 13.2 d. 13.9 e. 14.6 ANSWER: a RATIONALE: P/E ratio = Price per share/Earnings per share = 12.0 We actually fixed the P/E ratio at 12 in order to get a stock price. Either the price or the P/E ratio must be fixed or the model becomes very complicated and a stock pricing equation is required. POINTS: 1 DIFFICULTY: EASY REFERENCES: 4-6 Market Value Ratios QUESTION TYPE: Multiple Choice HAS VARIABLES: False PREFACE NAME: Balance sheet LEARNING OBJECTIVES: FOFM.BRIG.17.04.06 - Market Value Ratios NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: P/E ratio KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Multiple Parts DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/8/2017 3:04 PM 131. Refer to Exhibit 4.1. What is the firm's book value per share? Do not round your intermediate calculations. Copyright Cengage Learning. Powered by Cognero.
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a. $37.44 b. $44.64 c. $38.88 d. $36.00 e. $29.16 ANSWER: d RATIONALE: BVPS = Common equity/Shares outstanding = $36.00 POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 4-6 Market Value Ratios QUESTION TYPE: Multiple Choice HAS VARIABLES: True PREFACE NAME: Balance sheet LEARNING OBJECTIVES: FOFM.BRIG.17.04.06 - Market Value Ratios NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Book value per share KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Multiple Parts DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/8/2017 3:05 PM 132. Refer to Exhibit 4.1. What is the firm's market-to-book ratio? Do not round your intermediate calculations. a. 1.35 b. 1.00 c. 1.65 d. 1.33 e. 1.32 ANSWER: e RATIONALE: Market/book ratio (M/B) = Price per share/BVPS = 1.32 POINTS: 1 DIFFICULTY: EASY REFERENCES: 4-6 Market Value Ratios QUESTION TYPE: Multiple Choice HAS VARIABLES: True PREFACE NAME: Balance sheet LEARNING OBJECTIVES: FOFM.BRIG.17.04.06 - Market Value Ratios NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Market/Book ratio KEYWORDS: Bloom's: Analyze Copyright Cengage Learning. Powered by Cognero.
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OTHER: DATE CREATED: DATE MODIFIED:
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133. Refer to Exhibit 4.1. What is the firm's equity multiplier? Do not round your intermediate calculations. a. 3.33 b. 3.43 c. 3.50 d. 3.40 e. 2.73 ANSWER: a RATIONALE: Equity multiplier = Total assets/Common equity = 3.33 POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 4-7 Tying the Ratios Together: The DuPont Equation QUESTION TYPE: Multiple Choice HAS VARIABLES: True PREFACE NAME: Balance sheet LEARNING OBJECTIVES: FOFM.BRIG.17.04.07 - Tying the Ratios Together: The DuPont Equation NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Equity multiplier KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Multiple Parts DATE CREATED: 9/21/2017 5:19 PM DATE MODIFIED: 11/8/2017 3:06 PM
Note that there is an overlap between the T/F and multiple-choice questions, as some of the T/F statements are used in multiple-choice questions. Multiple Choice: True/False 1. Starting to invest early for retirement increases the benefits of compound interest. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 5-2 Future Values QUESTION TYPE: True / False HAS VARIABLES: False PREFACE NAME: Chapter Opener LEARNING OBJECTIVES: FOFM.BRIG.17.05.02 - Future Values Copyright Cengage Learning. Powered by Cognero.
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NATIONAL STANDARDS: STATE STANDARDS: LOCAL STANDARDS: TOPICS: KEYWORDS: DATE CREATED: DATE MODIFIED:
United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money United States - OH - Default City - Tier 2: - Capital structure Compounding Bloom's: Knowledge 9/21/2017 5:21 PM 9/21/2017 5:21 PM
2. Starting to invest early for retirement reduces the benefits of compound interest. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 5-2 Future Values QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.05.02 - Future Values NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Compounding KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 3. A time line is meaningful even if all cash flows do not occur annually. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 5-2 Future Values QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.05.02 - Future Values NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Compounding KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 4. A time line is not meaningful unless all cash flows occur annually. Copyright Cengage Learning. Powered by Cognero.
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a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 5-2 Future Values QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.05.02 - Future Values NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Compounding KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 5. Time lines can be constructed in situations where some of the cash flows occur annually but others occur quarterly. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 5-2 Future Values QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.05.02 - Future Values NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Compounding KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 6. Time lines cannot be constructed in situations where some of the cash flows occur annually but others occur quarterly. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 5-2 Future Values QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.05.02 - Future Values Copyright Cengage Learning. Powered by Cognero.
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NATIONAL STANDARDS: STATE STANDARDS: LOCAL STANDARDS: TOPICS: KEYWORDS: DATE CREATED: DATE MODIFIED:
United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money United States - OH - Default City - Tier 2: - Capital structure Compounding Bloom's: Knowledge 9/21/2017 5:21 PM 9/21/2017 5:21 PM
7. Time lines can be constructed for annuities where the payments occur at either the beginning or the end of the periods. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 5-2 Future Values QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.05.02 - Future Values NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Compounding KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 8. Time lines cannot be constructed for annuities unless all the payments occur at the end of the periods. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 5-2 Future Values QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.05.02 - Future Values NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Compounding KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 9. Some of the cash flows shown on a time line can be in the form of annuity payments while others can be uneven amounts. Copyright Cengage Learning. Powered by Cognero.
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a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 5-2 Future Values QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.05.02 - Future Values NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Compounding KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 10. Some of the cash flows shown on a time line can be in the form of annuity payments but none can be uneven amounts. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 5-2 Future Values QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.05.02 - Future Values NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Compounding KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 11. If the discount (or interest) rate is positive, the present value of an expected series of payments will always exceed the future value of the same series. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 5-3 Present Values QUESTION TYPE: True / False HAS VARIABLES: False Copyright Cengage Learning. Powered by Cognero.
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LEARNING OBJECTIVES: FOFM.BRIG.17.05.03 - Present Values NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: PV versus FV KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 12. If the discount (or interest) rate is positive, the future value of an expected series of payments will always exceed the present value of the same series. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 5-3 Present Values QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.05.03 - Present Values NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: PV versus FV KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 13. Disregarding risk, if money has time value, it is impossible for the present value of a given sum to exceed its future value. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 5-3 Present Values QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.05.03 - Present Values NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: PV versus FV KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:21 PM Copyright Cengage Learning. Powered by Cognero.
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14. Disregarding risk, if money has time value, it is impossible for the future value of a given sum to exceed its present value. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 5-3 Present Values QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.05.03 - Present Values NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: PV versus FV KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 15. If a bank compounds savings accounts quarterly, the nominal rate will exceed the effective annual rate. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 5-16 Comparing Interest Rates QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.05.16 - Comparing Interest Rates NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Effective annual rate KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 16. If a bank compounds savings accounts quarterly, the effective annual rate will exceed the nominal rate. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 5-16 Comparing Interest Rates Copyright Cengage Learning. Powered by Cognero.
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QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.05.16 - Comparing Interest Rates NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Effective annual rate KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 17. The greater the number of compounding periods within a year, then (1) the greater the future value of a lump sum investment at Time 0 and (2) the greater the present value of a given lump sum to be received at some future date. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 5-2 Future Values QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.05.02 - Future Values NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Compounding KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 18. The greater the number of compounding periods within a year, then (1) the greater the future value of a lump sum investment at Time 0 and (2) the smaller the present value of a given lump sum to be received at some future date. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 5-2 Future Values QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.05.02 - Future Values NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Compounding Copyright Cengage Learning. Powered by Cognero.
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19. Suppose Sally Smith plans to invest $1,000. She can earn an effective annual rate of 5% on Security A, while Security B has an effective annual rate of 12%. After 11 years, the compounded value of Security B should be more than twice the compounded value of Security A. (Ignore risk, and assume that compounding occurs annually.) a. True b. False ANSWER: True RATIONALE: Work out the numbers with a calculator: PV 1000 $1,710.34 = Rate on A 5% 2× = $3,420.68 Rate on B 12% $3,478.55 = Years
11
> 2×
, so TRUE
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 5-2 Future Values QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.05.02 - Future Values NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Comparative compounding KEYWORDS: Bloom's: Evaluation DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 20. Suppose Randy Jones plans to invest $1,000. He can earn an effective annual rate of 5% on Security A, while Security B has an effective annual rate of 12%. After 11 years, the compounded value of Security B should be somewhat less than twice the compounded value of Security A. (Ignore risk, and assume that compounding occurs annually.) a. True b. False ANSWER: False RATIONALE: Work out the numbers with a calculator: PV 1000 $1,710.34 = Rate on A 5% $3,420.68 2× = Rate on B 12% $3,478.55 = Years 11 > 2× , so FALSE POINTS: DIFFICULTY: REFERENCES: QUESTION TYPE: HAS VARIABLES:
1 MODERATE 5-2 Future Values True / False False
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LEARNING OBJECTIVES: FOFM.BRIG.17.05.02 - Future Values NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Comparative compounding KEYWORDS: Bloom's: Evaluation DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 21. The present value of a future sum decreases as either the discount rate or the number of periods per year increases, other things held constant. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 5-3 Present Values QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.05.03 - Present Values NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: PV of a sum KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 22. The present value of a future sum increases as either the discount rate or the number of periods per year increases, other things held constant. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 5-3 Present Values QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.05.03 - Present Values NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: PV of a sum KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:21 PM Copyright Cengage Learning. Powered by Cognero.
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23. All other things held constant, the present value of a given annual annuity decreases as the number of periods per year increases. a. True b. False ANSWER: True RATIONALE: One could make up an example and see that the statement is true. Alternatively, one could simply recognize that the PV of an annuity declines as the discount rate increases and recognize that more frequent compounding increases the effective rate. POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 5-9 Present Value of an Ordinary Annuity QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.05.09 - Present Value of an Ordinary Annuity NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: PV of an annuity KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 24. All other things held constant, the present value of a given annual annuity increases as the number of periods per year increases. a. True b. False ANSWER: False RATIONALE: One could make up an example and see that the statement is false. Alternatively, one could simply recognize that the PV of an annuity declines as the discount rate increases and recognize that more frequent compounding increases the effective rate. POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 5-9 Present Value of an Ordinary Annuity QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.05.09 - Present Value of an Ordinary Annuity NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: PV of an annuity KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 25. If we are given a periodic interest rate, say a monthly rate, we can find the nominal annual rate by multiplying the Copyright Cengage Learning. Powered by Cognero.
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periodic rate by the number of periods per year. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 5-15 Semiannual and Other Compounding Periods QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.05.15 - Semiannual and Other Compounding Periods NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Periodic and nominal rates KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 26. If we are given a periodic interest rate, say a monthly rate, we can find the nominal annual rate by dividing the periodic rate by the number of periods per year. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 5-15 Semiannual and Other Compounding Periods QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.05.15 - Semiannual and Other Compounding Periods NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Periodic and nominal rates KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 27. As a result of compounding, the effective annual rate on a bank deposit (or a loan) is always equal to or greater than the nominal rate on the deposit (or loan). a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 5-16 Comparing Interest Rates QUESTION TYPE: True / False Copyright Cengage Learning. Powered by Cognero.
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HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.05.16 - Comparing Interest Rates NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Effective and nominal rates KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 28. As a result of compounding, the effective annual rate on a bank deposit (or a loan) is always equal to or less than the nominal rate on the deposit (or loan). a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 5-16 Comparing Interest Rates QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.05.16 - Comparing Interest Rates NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Effective and nominal rates KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 29. When a loan is amortized, a relatively high percentage of the payment goes to reduce the outstanding principal in the early years, and the principal repayment's percentage declines in the loan's later years. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 5-18 Amortized Loans QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.05.18 - Amortized Loans NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Amortization KEYWORDS: Bloom's: Comprehension Copyright Cengage Learning. Powered by Cognero.
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30. When a loan is amortized, a relatively low percentage of the payment goes to reduce the outstanding principal in the early years, and the principal repayment's percentage increases in the loan's later years. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 5-18 Amortized Loans QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.05.18 - Amortized Loans NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Amortization KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 31. The payment made each period on an amortized loan is constant, and it consists of some interest and some principal. The closer we are to the end of the loan's life, the greater the percentage of the payment that will be a repayment of principal. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 5-18 Amortized Loans QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.05.18 - Amortized Loans NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Amortization KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 32. The payment made each period on an amortized loan is constant, and it consists of some interest and some principal. The closer we are to the end of the loan's life, the smaller the percentage of the payment that will be a repayment of principal. a. True Copyright Cengage Learning. Powered by Cognero.
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b. False ANSWER: False POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 5-18 Amortized Loans QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.05.18 - Amortized Loans NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Amortization KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 33. Midway through the life of an amortized loan, the percentage of the payment that represents interest must be equal to the percentage that represents repayment of principal. This is true regardless of the original life of the loan or the interest rate on the loan. a. True b. False ANSWER: False RATIONALE: There is no reason to think that this statement would always be true. The portion of the payment representing interest declines, while the portion representing principal repayment increases. Therefore, the statement is false. We could also work out some numbers to prove this point. Here's an example for a 3-year loan at a 10% and a 41.45% annual interest rate. The interest component is not equal to the principal repayment component except at the high interest rate. Original loan $1,000 Original loan $1,000 Rate 10% Rate 41.45% Life 3 Life 3 Payment $402.11 Payment $640.98 Beg. End. Beg. End. Balance Interest Principal Bal. Balance Interest Principal Bal. 1 $1,000.00 $100.00 $302.11 $697.89 1 $1,000.00 $414.50 $226.48 $773.52 2 $697.89 $69.79 $332.33 $365.56 2 $773.52 $320.62 $320.36 $453.15 3 $365.56 $36.56 $365.56 $0.00 3 $453.15 $187.83 $453.15 $0.00 POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 5-18 Amortized Loans QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.05.18 - Amortized Loans NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Amortization Copyright Cengage Learning. Powered by Cognero.
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34. Midway through the life of an amortized loan, the percentage of the payment that represents interest could be equal to, less than, or greater than to the percentage that represents repayment of principal. The proportions depend on the original life of the loan and the interest rate. a. True b. False ANSWER: True RATIONALE: This statement is true. The portion of the payment representing interest declines, while the portion representing principal repayment increases. The interest portion could be equal to, greater than, or less than the principal portion. We can work out some numbers to prove this point. Here's an example for a 3-year loan at a 10% and a 41.45% annual interest rate. The interest component is less than the principal at 10%, equal at about 41.45%, and greater at rates above 41.45%. Original loan $1,000 Original loan $1,000 Rate 10% Rate 41.45% Life 3 Life 3 Payment $402.11 Payment $640.98 Beg. End. Beg. End. Balance Interest Principal Bal. Balance Interest Principal Bal. 1 $1,000.00 $100.00 $302.11 $697.89 1 $1,000.00 $414.50 $226.48 $773.52 2 $697.89 $69.79 $332.33 $365.56 2 $773.52 $320.62 $320.36 $453.15 3 $365.56 $36.56 $365.56 $0.00 3 $453.15 $187.83 $453.15 $0.00 POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 5-18 Amortized Loans QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.05.18 - Amortized Loans NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Amortization KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM Multiple Choice: Conceptual Please note that some of the answer choices, or answers that are very close, are used in different questions. This has caused us no difficulties, but please take this into account when you make up exams. 35. Which of the following statements is CORRECT? a. A time line is not meaningful unless all cash flows occur annually. b. Time lines are useful for visualizing complex problems prior to doing actual calculations. c. Time lines cannot be constructed in situations where some of the cash flows occur annually but others occur Copyright Cengage Learning. Powered by Cognero.
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quarterly. d. Time lines cannot be constructed for annuities where the payments occur at the beginning of the periods. e. Some of the cash flows shown on a time line can be in the form of annuity payments, but none can be uneven amounts. ANSWER: b POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 5-1 Time Lines QUESTION TYPE: Multiple Choice HAS VARIABLES: False PREFACE NAME: Conceptual LEARNING OBJECTIVES: FOFM.BRIG.17.05.01 - Time Lines NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Time lines KEYWORDS: Bloom's: Knowledge OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 36. Which of the following statements is CORRECT? a. A time line is not meaningful unless all cash flows occur annually. b. Time lines are not useful for visualizing complex problems prior to doing actual calculations. c. Time lines cannot be constructed in situations where some of the cash flows occur annually but others occur quarterly. d. Time lines can be constructed for annuities where the payments occur at either the beginning or the end of the periods. e. Some of the cash flows shown on a time line can be in the form of annuity payments, but none can be uneven amounts. ANSWER: d POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 5-1 Time Lines QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.05.01 - Time Lines NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Time lines KEYWORDS: Bloom's: Knowledge OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM Copyright Cengage Learning. Powered by Cognero.
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37. Which of the following statements is CORRECT? a. A time line is not meaningful unless all cash flows occur annually. b. Time lines are not useful for visualizing complex problems prior to doing actual calculations. c. Time lines can be constructed to deal with situations where some of the cash flows occur annually but others occur quarterly. d. Time lines can only be constructed for annuities where the payments occur at the end of the periods, i.e., for ordinary annuities. e. Time lines cannot be constructed where some of the payments constitute an annuity but others are unequal and thus are not part of the annuity. ANSWER: c POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 5-1 Time Lines QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.05.01 - Time Lines NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Time lines KEYWORDS: Bloom's: Knowledge OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 38. Which of the following statements is CORRECT? a. A time line is not meaningful unless all cash flows occur annually. b. Time lines are not useful for visualizing complex problems prior to doing actual calculations. c. Time lines cannot be constructed to deal with situations where some of the cash flows occur annually but others occur quarterly. d. Time lines can only be constructed for annuities where the payments occur at the end of the periods, i.e., for ordinary annuities. e. Time lines can be constructed where some of the payments constitute an annuity but others are unequal and thus are not part of the annuity. ANSWER: e POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 5-1 Time Lines QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.05.01 - Time Lines NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Time lines KEYWORDS: Bloom's: Knowledge Copyright Cengage Learning. Powered by Cognero.
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39. You plan to analyze the value of a potential investment by calculating the sum of the present values of its expected cash flows. Which of the following would lower the calculated value of the investment? a. The cash flows are in the form of a deferred annuity, and they total to $100,000. You learn that the annuity lasts for only 5 rather than 10 years, hence that each payment is for $20,000 rather than for $10,000. b. The discount rate increases. c. The riskiness of the investment's cash flows decreases. d. The total amount of cash flows remains the same, but more of the cash flows are received in the earlier years and less are received in the later years. e. The discount rate decreases. ANSWER: b POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 5-3 Present Values QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.05.03 - Present Values NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Effects of factors on PVs KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 40. You plan to analyze the value of a potential investment by calculating the sum of the present values of its expected cash flows. Which of the following would increase the calculated value of the investment? a. The cash flows are in the form of a deferred annuity, and they total to $100,000. You learn that the annuity lasts for 10 years rather than 5 years, hence that each payment is for $10,000 rather than for $20,000. b. The discount rate decreases. c. The riskiness of the investment's cash flows increases. d. The total amount of cash flows remains the same, but more of the cash flows are received in the later years and less are received in the earlier years. e. The discount rate increases. ANSWER: b POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 5-3 Present Values QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.05.03 - Present Values NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic Copyright Cengage Learning. Powered by Cognero.
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STATE STANDARDS: LOCAL STANDARDS: TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money United States - OH - Default City - Tier 2: - Capital structure Effects of factors on PVs Bloom's: Analysis Multiple Choice: Conceptual 9/21/2017 5:21 PM 9/21/2017 5:21 PM
41. Which of the following statements is CORRECT? a. The cash flows for an ordinary (or deferred) annuity all occur at the beginning of the periods. b. If a series of unequal cash flows occurs at regular intervals, such as once a year, then the series is by definition an annuity. c. The cash flows for an annuity due must all occur at the ends of the periods. d. The cash flows for an annuity must all be equal, and they must occur at regular intervals, such as once a year or once a month. e. If some cash flows occur at the beginning of the periods while others occur at the ends, then we have what the textbook defines as a variable annuity. ANSWER: d POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 5-6 Annuities QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.05.06 - Annuities NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Annuities KEYWORDS: Bloom's: Knowledge OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 42. Which of the following statements is CORRECT? a. The cash flows for an ordinary (or deferred) annuity all occur at the beginning of the periods. b. If a series of unequal cash flows occurs at regular intervals, such as once a year, then the series is by definition an annuity. c. The cash flows for an annuity due must all occur at the beginning of the periods. d. The cash flows for an annuity may vary from period to period, but they must occur at regular intervals, such as once a year or once a month. e. If some cash flows occur at the beginning of the periods while others occur at the ends, then we have what the textbook defines as a variable annuity. ANSWER: c POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 5-6 Annuities Copyright Cengage Learning. Powered by Cognero.
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QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.05.06 - Annuities NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Annuities KEYWORDS: Bloom's: Knowledge OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 43. Your bank account pays a 6% nominal rate of interest. The interest is compounded quarterly. Which of the following statements is CORRECT? a. The periodic rate of interest is 1.5% and the effective rate of interest is 3%. b. The periodic rate of interest is 6% and the effective rate of interest is greater than 6%. c. The periodic rate of interest is 1.5% and the effective rate of interest is greater than 6%. d. The periodic rate of interest is 3% and the effective rate of interest is 6%. e. The periodic rate of interest is 6% and the effective rate of interest is also 6%. ANSWER: c POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 5-16 Comparing Interest Rates QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.05.16 - Comparing Interest Rates NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Quarterly compounding KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 44. Your bank account pays an 8% nominal rate of interest. The interest is compounded quarterly. Which of the following statements is CORRECT? a. The periodic rate of interest is 2% and the effective rate of interest is 4%. b. The periodic rate of interest is 8% and the effective rate of interest is greater than 8%. c. The periodic rate of interest is 4% and the effective rate of interest is less than 8%. d. The periodic rate of interest is 2% and the effective rate of interest is greater than 8%. e. The periodic rate of interest is 8% and the effective rate of interest is also 8%. ANSWER: d POINTS: 1 DIFFICULTY: MODERATE Copyright Cengage Learning. Powered by Cognero.
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REFERENCES: 5-16 Comparing Interest Rates QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.05.16 - Comparing Interest Rates NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Quarterly compounding KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 45. A $50,000 loan is to be amortized over 7 years, with annual end-of-year payments. Which of these statements is CORRECT? a. The annual payments would be larger if the interest rate were lower. b. If the loan were amortized over 10 years rather than 7 years, and if the interest rate were the same in either case, the first payment would include more dollars of interest under the 7-year amortization plan. c. The proportion of each payment that represents interest as opposed to repayment of principal would be lower if the interest rate were lower. d. The last payment would have a higher proportion of interest than the first payment. e. The proportion of interest versus principal repayment would be the same for each of the 7 payments. ANSWER: c RATIONALE: a, d, and e can be ruled out as incorrect by simple reasoning. b is also incorrect because interest in the first year would be loan amount × interest rate regardless of the life of the loan, so the interest payment would be identical for the first payment. Think about the situation where r = 0%, statement c is the "most logical guess". One could also set up an amortization schedule and change the numbers to confirm that only c is correct. POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 5-18 Amortized Loans QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.05.18 - Amortized Loans NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Amortization KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 46. A $150,000 loan is to be amortized over 7 years, with annual end-of-year payments. Which of these statements is CORRECT? a. The annual payments would be larger if the interest rate were lower. b. If the loan were amortized over 10 years rather than 7 years, and if the interest rate were the same in either Copyright Cengage Learning. Powered by Cognero.
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case, the first payment would include more dollars of interest under the 7-year amortization plan. c. The proportion of each payment that represents interest as opposed to repayment of principal would be higher if the interest rate were lower. d. The proportion of each payment that represents interest versus repayment of principal would be higher if the interest rate were higher. e. The proportion of interest versus principal repayment would be the same for each of the 7 payments. ANSWER: d RATIONALE: a, c, and e are obviously incorrect. b is also incorrect because interest in the first year would be loan amount × interest rate regardless of the life of the loan. That makes d the "most logical guess". One could also set up an amortization schedule and change the numbers to confirm that only d is correct. POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 5-18 Amortized Loans QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.05.18 - Amortized Loans NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Amortization KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 47. Which of the following statements regarding a 15-year (180-month) $125,000, fixed-rate mortgage is CORRECT? (Ignore taxes and transactions costs.) a. The remaining balance after three years will be $125,000 less one third of the interest paid during the first three years. b. Because it is a fixed-rate mortgage, the monthly loan payments (which include both interest and principal payments) are constant. c. Interest payments on the mortgage will increase steadily over time, but the total amount of each payment will remain constant. d. The proportion of the monthly payment that goes towards repayment of principal will be lower 10 years from now than it will be the first year. e. The outstanding balance declines at a slower rate in the later years of the loan's life. ANSWER: b RATIONALE: b is the correct answer. Thinking through the question, the other answers can all be eliminated. One could also set up an amortization schedule to prove that only statement b is correct. POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 5-18 Amortized Loans QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.05.18 - Amortized Loans Copyright Cengage Learning. Powered by Cognero.
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NATIONAL STANDARDS: STATE STANDARDS: LOCAL STANDARDS: TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money United States - OH - Default City - Tier 2: - Capital structure Amortization Bloom's: Analysis Multiple Choice: Conceptual 9/21/2017 5:21 PM 9/21/2017 5:21 PM
48. Which of the following statements regarding a 15-year (180-month) $125,000, fixed-rate mortgage is CORRECT? (Ignore taxes and transactions costs.) a. The remaining balance after three years will be $125,000 less one third of the interest paid during the first three years. b. Because the outstanding balance declines over time, the monthly payments will also decline over time. c. Interest payments on the mortgage will increase steadily over time, but the total amount of each payment will remain constant. d. The proportion of the monthly payment that goes towards repayment of principal will be lower 10 years from now than it will be the first year. e. The outstanding balance declines at a faster rate in the later years of the loan's life. ANSWER: e RATIONALE: e is the correct answer. Thinking through the question, the other answers can all be eliminated. One could also set up an amortization schedule to prove that only statement e is correct. POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 5-18 Amortized Loans QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.05.18 - Amortized Loans NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Amortization KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 49. Which of the following statements regarding a 30-year monthly payment amortized mortgage with a nominal interest rate of 10% is CORRECT? a. The monthly payments will decline over time. b. A smaller proportion of the last monthly payment will be interest, and a larger proportion will be principal, than for the first monthly payment. c. The total dollar amount of principal being paid off each month gets smaller as the loan approaches maturity. d. The amount representing interest in the first payment would be higher if the nominal interest rate were 7% rather than 10%. e. Exactly 10% of the first monthly payment represents interest. Copyright Cengage Learning. Powered by Cognero.
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ANSWER: RATIONALE:
b b is correct. a is clearly wrong, as are c and d. It is not obvious whether e is correct or not, but we could set up an example to see: Loan 100000 Term 30 Rate 10% Periods/Year 12 Periodic rate 0.008333333 Total periods 360
Payment -$877.57 Interest, Month 1 $833.33 Interest as % of total #360 payment: 1% Interest, Month 360 $7.25 Principal as % of total #360 payment 99% Principal, Month 360 $870.32 POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 5-18 Amortized Loans QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES FOFM.BRIG.17.05.18 - Amortized Loans : NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: LOCAL STANDARDS: TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money United States - OH - Default City - Tier 2: - Capital structure Amortization Bloom's: Analysis Multiple Choice: Conceptual 9/21/2017 5:21 PM 9/21/2017 5:21 PM
50. Which of the following statements regarding a 30-year monthly payment amortized mortgage with a nominal interest rate of 10% is CORRECT? a. The monthly payments will increase over time. b. A larger proportion of the first monthly payment will be interest, and a smaller proportion will be principal, than for the last monthly payment. c. The total dollar amount of interest being paid off each month gets larger as the loan approaches maturity. d. The amount representing interest in the first payment would be higher if the nominal interest rate were 7% rather than 10%. e. Exactly 10% of the first monthly payment represents interest. ANSWER: b RATIONALE: b is correct. a is clearly wrong, as are c and d. It is not obvious whether e is correct or not, but we could set up an example to see: Loan 100000 Term 30 Rate 10% Periods/Year 12 Periodic rate 0.00833333 Total periods 360
POINTS: DIFFICULTY: REFERENCES: QUESTION TYPE:
Payment -$877.57 Interest as % of total payment: 95% 1 MODERATE 5-18 Amortized Loans Multiple Choice
Copyright Cengage Learning. Powered by Cognero.
Interest Month 1 $833.33 which is much larger than 10%.
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HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.05.18 - Amortized Loans NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Amortization KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 51. Which of the following investments would have the highest future value at the end of 10 years? Assume that the effective annual rate for all investments is the same and is greater than zero. a. Investment A pays $250 at the beginning of every year for the next 10 years (a total of 10 payments). b. Investment B pays $125 at the end of every 6-month period for the next 10 years (a total of 20 payments). c. Investment C pays $125 at the beginning of every 6-month period for the next 10 years (a total of 20 payments). d. Investment D pays $2,500 at the end of 10 years (just one payment). e. Investment E pays $250 at the end of every year for the next 10 years (a total of 10 payments). ANSWER: a RATIONALE: A dominates B because it provides the same total amount, but it comes faster, hence it can earn more interest over the 10 years. A also dominates C and E for the same reason, and it dominates D because with D no interest whatever is earned. We could also do these calculations to answer the question: A $4,382.79 Largest EFF% 10.00% 10 250 B $4,081.59 NOM% 9.76% 125 C $4,280.81 125 D $2,500.00 2500 E $3,984.36 250 POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.05.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Time value concepts KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 52. Which of the following investments would have the lowest present value? Assume that the effective annual rate for all investments is the same and is greater than zero. a. Investment A pays $250 at the end of every year for the next 10 years (a total of 10 payments). Copyright Cengage Learning. Powered by Cognero.
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b. Investment B pays $125 at the end of every 6-month period for the next 10 years (a total of 20 payments). c. Investment C pays $125 at the beginning of every 6-month period for the next 10 years (a total of 20 payments). d. Investment D pays $2,500 at the end of 10 years (just one payment). e. Investment E pays $250 at the beginning of every year for the next 10 years (a total of 10 payments). ANSWER: d A is smaller than E and B is smaller than C because the money comes in later. A is smaller RATIONALE: than B because a larger annuity is received later. So, now the choice comes down to either A or D. Since all of D is received at the end, this is the logical choice. We could also do these calculations to answer the question:
A $1,536.14 EFF% 10.00% 10 B $1,573.63 NOM% 9.76% C $1,650.44 D $ 963.86 Smallest E $1,689.76 POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.05.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Time value concepts KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM
250 125 125 2500 250
53. A U.S. Treasury bond will pay a lump sum of $1,000 exactly 3 years from today. The nominal interest rate is 6%, semiannual compounding. Which of the following statements is CORRECT? a. The periodic interest rate is greater than 3%. b. The periodic rate is less than 3%. c. The present value would be greater if the lump sum were discounted back for more periods. d. The present value of the $1,000 would be smaller if interest were compounded monthly rather than semiannually. e. The PV of the $1,000 lump sum has a higher present value than the PV of a 3-year, $333.33 ordinary annuity. ANSWER: d POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.05.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money Copyright Cengage Learning. Powered by Cognero.
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LOCAL STANDARDS: TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
United States - OH - Default City - Tier 2: - Capital structure Time value concepts Bloom's: Analysis Multiple Choice: Conceptual 9/21/2017 5:21 PM 9/21/2017 5:21 PM
54. A U.S. Treasury bond will pay a lump sum of $1,000 exactly 3 years from today. The nominal interest rate is 6%, semiannual compounding. Which of the following statements is CORRECT? a. The periodic interest rate is greater than 3%. b. The periodic rate is less than 3%. c. The present value would be greater if the lump sum were discounted back for more periods. d. The present value of the $1,000 would be larger if interest were compounded monthly rather than semiannually. e. The PV of the $1,000 lump sum has a smaller present value than the PV of a 3-year, $333.33 ordinary annuity. ANSWER: e POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.05.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Time value concepts KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 55. Which of the following statements is CORRECT, assuming positive interest rates and holding other things constant? a. The present value of a 5-year, $250 annuity due will be lower than the PV of a similar ordinary annuity. b. A 30-year, $150,000 amortized mortgage will have larger monthly payments than an otherwise similar 20-year mortgage. c. A bank loan's nominal interest rate will always be equal to or less than its effective annual rate. d. If an investment pays 10% interest, compounded annually, its effective annual rate will be less than 10%. e. Banks A and B offer the same nominal annual rate of interest, but A pays interest quarterly and B pays semiannually. Deposits in Bank B will provide the higher future value if you leave your funds on deposit. ANSWER: c POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.05.00 - Comprehensive Copyright Cengage Learning. Powered by Cognero.
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NATIONAL STANDARDS: STATE STANDARDS: LOCAL STANDARDS: TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money United States - OH - Default City - Tier 2: - Capital structure Time value concepts Bloom's: Analysis Multiple Choice: Conceptual 9/21/2017 5:21 PM 9/21/2017 5:21 PM
56. Which of the following statements is CORRECT, assuming positive interest rates and holding other things constant? a. The present value of a 5-year, $250 annuity due will be lower than the PV of a similar ordinary annuity. b. A 30-year, $150,000 amortized mortgage will have larger monthly payments than an otherwise similar 20-year mortgage. c. A bank loan's nominal interest rate will always be equal to or greater than its effective annual rate. d. If an investment pays 10% interest, compounded quarterly, its effective annual rate will be greater than 10%. e. Banks A and B offer the same nominal annual rate of interest, but A pays interest quarterly and B pays semiannually. Deposits in Bank B will provide the higher future value if you leave your funds on deposit. ANSWER: d POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.05.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Time value concepts KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 57. Which of the following statements is CORRECT? a. The present value of a 3-year, $150 annuity due will exceed the present value of a 3-year, $150 ordinary annuity. b. If a loan has a nominal annual rate of 8%, then the effective rate can never be greater than 8%. c. If a loan or investment has annual payments, then the effective, periodic, and nominal rates of interest will all be different. d. The proportion of the payment that goes toward interest on a fully amortized loan increases over time. e. An investment that has a nominal rate of 6% with semiannual payments will have an effective rate that is smaller than 6%. ANSWER: a POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive Copyright Cengage Learning. Powered by Cognero.
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QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.05.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Time value concepts KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 58. Which of the following statements is CORRECT? a. The present value of a 3-year, $150 ordinary annuity will exceed the present value of a 3-year, $150 annuity due. b. If a loan has a nominal annual rate of 8%, then the effective rate will never be less than 8%. c. If a loan or investment has annual payments, then the effective, periodic, and nominal rates of interest will all be different. d. The proportion of the payment that goes toward interest on a fully amortized loan increases over time. e. An investment that has a nominal rate of 6% with semiannual payments will have an effective rate that is smaller than 6%. ANSWER: b POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.05.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Time value concepts KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 59. You are considering two equally risky annuities, each of which pays $5,000 per year for 10 years. Investment ORD is an ordinary (or deferred) annuity, while Investment DUE is an annuity due. Which of the following statements is CORRECT? a. The present value of ORD must exceed the present value of DUE, but the future value of ORD may be less than the future value of DUE. b. The present value of DUE exceeds the present value of ORD, while the future value of DUE is less than the future value of ORD. c. The present value of ORD exceeds the present value of DUE, and the future value of ORD also exceeds the future value of DUE. d. The present value of DUE exceeds the present value of ORD, and the future value of DUE also exceeds the Copyright Cengage Learning. Powered by Cognero.
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future value of ORD. e. If the going rate of interest decreases from 10% to 0%, the difference between the present value of ORD and the present value of DUE would remain constant. ANSWER: d POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.05.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Annuities KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 60. You are considering two equally risky annuities, each of which pays $5,000 per year for 10 years. Investment ORD is an ordinary (or deferred) annuity, while Investment DUE is an annuity due. Which of the following statements is CORRECT? a. A rational investor would be willing to pay more for DUE than for ORD, so their market prices should differ. b. The present value of DUE exceeds the present value of ORD, while the future value of DUE is less than the future value of ORD. c. The present value of ORD exceeds the present value of DUE, and the future value of ORD also exceeds the future value of DUE. d. The present value of ORD exceeds the present value of DUE, while the future value of DUE exceeds the future value of ORD. e. If the going rate of interest decreases from 10% to 0%, the difference between the present value of ORD and the present value of DUE would remain constant. ANSWER: a POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.05.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Annuities KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM Copyright Cengage Learning. Powered by Cognero.
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61. Which of the following statements is CORRECT? a. If you have a series of cash flows, each of which is positive, you can solve for I, where the solution value of I causes the PV of the cash flows will be more than the cash flow at Time 0. b. If you have a series of cash flows, and CF0 is negative but each of the following CFs is positive, you can solve for I, but only if the sum of the undiscounted cash flows exceeds the cost. c. To solve for I, one must identify the value of I that causes the PV of the positive CFs to equal the absolute value of the PV of the negative CFs. This is, essentially, a trial-and-error procedure that is easy with a computer or financial calculator but quite difficult otherwise. d. If you solve for I and get a negative number, then you must have made a mistake. e. If CF0 is positive and all the other CFs are negative, then you cannot solve for I. ANSWER: c POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 5-14 Solving for I with Uneven Cash Flows QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.05.14 - Solving for I with Uneven Cash Flows NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Solving for I: Uneven CFs KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 62. Which of the following statements is CORRECT? a. If you have a series of cash flows, each of which is positive, you can solve for I, where the solution value of I causes the PV of the cash flows will be more than the cash flow at Time 0. b. If you have a series of cash flows, and CF0 is negative but each of the following CFs is positive, you can solve for I, but only if the sum of the undiscounted cash flows exceeds the cost. c. To solve for I, one must identify the value of I that causes the PV of the positive CFs to equal the absolute value of the FV of the negative CFs. It is impossible to find the value of I without a computer or financial calculator. d. If you solve for I and get a negative number, then you must have made a mistake. e. If CF0 is positive and all the other CFs are negative, then you can still solve for I. ANSWER: e POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 5-14 Solving for I with Uneven Cash Flows QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.05.14 - Solving for I with Uneven Cash Flows NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure Copyright Cengage Learning. Powered by Cognero.
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TOPICS: KEYWORDS: DATE CREATED: DATE MODIFIED:
Solving for I: Uneven CFs Bloom's: Analysis 9/21/2017 5:21 PM 9/21/2017 5:21 PM
63. Which of the following bank accounts has the highest effective annual return? a. An account that pays 8% nominal interest with monthly compounding. b. An account that pays 8% nominal interest with annual compounding. c. An account that pays 7% nominal interest with daily (365-day) compounding. d. An account that pays 7% nominal interest with monthly compounding. e. An account that pays 8% nominal interest with daily (365-day) compounding. ANSWER: e RATIONALE: By inspection, we can see that e dominates a and b, and that c dominates d because, with the same interest rate, the account with the most frequent compounding has the highest EFF%. Thus, the correct answer must be either e or c. Moreover, we can see by inspection that since c and e have the same compounding frequency yet e has the higher nominal rate, e must have the higher EFF%. You could also prove that e is the correct choice by calculating the EFF%s: 12-1 a. 8.300% = (1 + 0.08/12) 1-1 b. 8.000% = (1 + 0.08/1) 365-1 c. 7.250% = (1 + 0.07/365) 12-1 d. 7.229% = (1 + 0.07/12) 365-1 e. 8.328% = (1 + 0.08/365) POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 5-16 Comparing Interest Rates QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.05.16 - Comparing Interest Rates NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Effective annual rate KEYWORDS: Bloom's: Evaluation DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 64. Which of the following bank accounts has the lowest effective annual return? a. An account that pays 8% nominal interest with monthly compounding. b. An account that pays 8% nominal interest with annual compounding. c. An account that pays 7% nominal interest with daily (365-day) compounding. d. An account that pays 7% nominal interest with monthly compounding. e. An account that pays 8% nominal interest with daily (365-day) compounding. ANSWER: d RATIONALE: By inspection, we can see that b must have a lower EFF% than either a or e because they all pay the same nominal rate but b is compounded least frequently. Similarly, c and d pay the same rate, but d is compounded less frequently, hence d must have the lower EFF%. So, the Copyright Cengage Learning. Powered by Cognero.
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correct answer must be either b or d. It is not obvious which of these two has the lower EFF%, so we must do a quick calculation to determine the correct response. As the following calculations show, d is the correct answer. 12-1 a. 8.300% = (1 + 0.08/12) 1-1 b. 8.000% = (1 + 0.08/1) 365-1 c. 7.250% = (1 + 0.07/365) 12-1 d. 7.229% = (1 + 0.07/12) 365-1 e. 8.328% = (1 + 0.08/365) POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 5-16 Comparing Interest Rates QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.05.16 - Comparing Interest Rates NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Effective annual rate KEYWORDS: Bloom's: Evaluation DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 65. You plan to invest some money in a bank account. Which of the following banks provides you with the highest effective rate of interest? a. Bank 1; 6.1% with annual compounding. b. Bank 2; 6.0% with monthly compounding. c. Bank 3; 6.0% with annual compounding. d. Bank 4; 6.0% with quarterly compounding. e. Bank 5; 6.0% with daily (365-day) compounding. ANSWER: e RATIONALE: By inspection, we can see that e dominates b, c, and d because, with the same interest rate, the account with the most frequent compounding has the highest EFF%. Thus, the correct answer must be either a or e. However, we cannot tell by inspection whether a or e provides the higher EFF%. We know that with one compounding period a’s EFF% is 6.1%, so we can calculate e's EFF%. It is 6.183%, so e is the correct answer. 12-1 a. = (1 + 0.061/12) = 6.100% 365-1 e. = (1 + 0.061/365) = 6.183% POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 5-16 Comparing Interest Rates QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.05.16 - Comparing Interest Rates NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure Copyright Cengage Learning. Powered by Cognero.
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TOPICS: KEYWORDS: DATE CREATED: DATE MODIFIED:
Effective annual rate Bloom's: Evaluation 9/21/2017 5:21 PM 9/21/2017 5:21 PM
Multiple Choice: Problems
66. Sue now has $320. How much would she have after 8 years if she leaves it invested at 8.5% with annual compounding? a. $614.59 b. $731.37 c. $510.11 d. $590.01 e. $602.30 ANSWER: a RATIONALE: N 8
I/YR PV PMT FV
8.5% $320 $0 $614.59
POINTS: 1 DIFFICULTY: EASY REFERENCES: 5-2 Future Values QUESTION TYPE: Multiple Choice HAS VARIABLES: True PREFACE NAME: Problems LEARNING OBJECTIVES: FOFM.BRIG.17.05.02 - Future Values NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: FV of a lump sum KEYWORDS: Bloom's: Application DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 67. Jose now has $500. How much would he have after 6 years if he leaves it invested at 7.0% with annual compounding? a. $570.28 b. $892.93 c. $727.85 d. $750.37 e. $697.84 ANSWER: d RATIONALE: N 6
I/YR PV
7.0% $500
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PMT FV
$0 $750.37
POINTS: 1 DIFFICULTY: EASY REFERENCES: 5-2 Future Values QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.05.02 - Future Values NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: FV of a lump sum KEYWORDS: Bloom's: Application DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 68. Suppose you have $850 and plan to purchase a 5-year certificate of deposit (CD) that pays 3.5% interest, compounded annually. How much will you have when the CD matures? a. $837.91 b. $1,009.53 c. $888.39 d. $858.10 e. $777.34 ANSWER: b RATIONALE: N 5
I/YR PV PMT FV
3.5% $850 $0 $1,009.53
POINTS: 1 DIFFICULTY: EASY REFERENCES: 5-2 Future Values QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.05.02 - Future Values NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: FV of a lump sum KEYWORDS: Bloom's: Application DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 69. Suppose you have $2,000 and plan to purchase a 10-year certificate of deposit (CD) that pays 11.1% interest, compounded annually. How much will you have when the CD matures? Copyright Cengage Learning. Powered by Cognero.
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a. $7,105.46 b. $5,730.21 c. $6,818.95 d. $6,303.23 e. $4,526.87 ANSWER: RATIONALE:
b
N 10 I/YR 11.1% PV $2,000 PMT $0 FV $5,730.21 POINTS: 1 DIFFICULTY: EASY REFERENCES: 5-2 Future Values QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.05.02 - Future Values NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: FV of a lump sum KEYWORDS: Bloom's: Application DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 70. Last year Rocco Corporation's sales were $700 million. If sales grow at 6% per year, how large (in millions) will they be 5 years later? a. $974.23 b. $749.41 c. $1,133.48 d. $1,096.01 e. $936.76 ANSWER: e RATIONALE: N 5
I/YR PV PMT FV
6.0% $700.00 $0.00 $936.76
POINTS: 1 DIFFICULTY: EASY REFERENCES: 5-2 Future Values QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.05.02 - Future Values NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money Copyright Cengage Learning. Powered by Cognero.
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LOCAL STANDARDS: TOPICS: KEYWORDS: DATE CREATED: DATE MODIFIED:
United States - OH - Default City - Tier 2: - Capital structure FV of a lump sum Bloom's: Application 9/21/2017 5:21 PM 9/21/2017 5:21 PM
71. Last year Dania Corporation's sales were $525 million. If sales grow at 9.8% per year, how large (in millions) will they be 8 years later? a. $1,142.39 b. $1,109.12 c. $1,364.22 d. $1,131.30 e. $842.93 ANSWER: b RATIONALE: N 8
I/YR PV PMT FV
9.8% $525.00 $0.00 $1,109.12
POINTS: 1 DIFFICULTY: EASY REFERENCES: 5-2 Future Values QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.05.02 - Future Values NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: FV of a lump sum KEYWORDS: Bloom's: Application DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 72. How much would $1, growing at 13.7% per year, be worth after 75 years? a. $18,248.03 b. $15,206.70 c. $15,358.76 d. $13,533.96 e. $18,704.24 ANSWER: b RATIONALE: N 75
I/YR PV PMT FV POINTS:
13.7% $1.00 $0.00 $15,206.70
1
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DIFFICULTY: EASY REFERENCES: 5-2 Future Values QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.05.02 - Future Values NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: FV of a lump sum KEYWORDS: Bloom's: Application DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 73. How much would $100, growing at 5% per year, be worth after 10 years? a. $130.31 b. $138.46 c. $162.89 d. $169.41 e. $193.84 ANSWER: c RATIONALE: N 10
I/YR PV PMT FV
5.0% $100.00 $0.00 $162.89
POINTS: 1 DIFFICULTY: EASY REFERENCES: 5-2 Future Values QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.05.02 - Future Values NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: FV of a lump sum KEYWORDS: Bloom's: Application DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 74. You deposit $825 today in a savings account that pays 6% interest, compounded annually. How much will your account be worth at the end of 25 years? a. $4,213.54 b. $4,001.10 c. $3,965.69 d. $3,540.79 e. $3,257.53 Copyright Cengage Learning. Powered by Cognero.
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ANSWER: RATIONALE:
d
N I/YR PV PMT FV
25 6% $825 $0 $3,540.79
POINTS: 1 DIFFICULTY: EASY REFERENCES: 5-2 Future Values QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.05.02 - Future Values NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: FV of a lump sum KEYWORDS: Bloom's: Application DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 75. You deposit $500 today in a savings account that pays 6% interest, compounded annually. How much will your account be worth at the end of 40 years? a. $6,274.29 b. $5,091.43 c. $3,857.14 d. $5,760.00 e. $5,142.86 ANSWER: e RATIONALE: N 40
I/YR PV PMT FV
6% $500 $0 $5,142.86
POINTS: 1 DIFFICULTY: EASY REFERENCES: 5-2 Future Values QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.05.02 - Future Values NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: FV of a lump sum KEYWORDS: Bloom's: Application DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM Copyright Cengage Learning. Powered by Cognero.
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76. Suppose a State of New York bond will pay $1,000 ten years from now. If the going interest rate on these 10-year bonds is 5.0%, how much is the bond worth today? a. $613.91 b. $564.80 c. $736.70 d. $466.57 e. $724.42 ANSWER: a RATIONALE: N 10
I/YR PMT FV PV
5.0% $0 $1,000.00 $613.91
POINTS: 1 DIFFICULTY: EASY REFERENCES: 5-3 Present Values QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.05.03 - Present Values NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: PV of a lump sum KEYWORDS: Bloom's: Application DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 77. Suppose a State of California bond will pay $1,000 eight years from now. If the going interest rate on these 8-year bonds is 5.4%, how much is the bond worth today? a. $551.51 b. $768.18 c. $656.56 d. $518.68 e. $722.22 ANSWER: c RATIONALE: N 8
I/YR PMT FV PV POINTS: DIFFICULTY: REFERENCES: QUESTION TYPE: HAS VARIABLES:
5.4% $0 $1,000.00 $656.56
1 EASY 5-3 Present Values Multiple Choice True
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LEARNING OBJECTIVES: FOFM.BRIG.17.05.03 - Present Values NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: PV of a lump sum KEYWORDS: Bloom's: Application DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 78. How much would $20,000 due in 50 years be worth today if the discount rate were 7.5%? a. $618.45 b. $656.09 c. $451.74 d. $537.78 e. $661.47 ANSWER: d RATIONALE: N 50
I/YR PMT FV PV
7.5% $0 $20,000 $537.78
POINTS: 1 DIFFICULTY: EASY REFERENCES: 5-3 Present Values QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.05.03 - Present Values NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: PV of a lump sum KEYWORDS: Bloom's: Application DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 79. How much would $5,000 due in 20 years be worth today if the discount rate were 5.5%? a. $2,004.96 b. $1,713.64 c. $2,039.24 d. $2,073.51 e. $1,353.78 ANSWER: b RATIONALE: N 20
I/YR PMT FV
5.5% $0 $5,000
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PV
$1,713.64
POINTS: 1 DIFFICULTY: EASY REFERENCES: 5-3 Present Values QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.05.03 - Present Values NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: PV of a lump sum KEYWORDS: Bloom's: Application DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 80. Suppose a U.S. treasury bond will pay $1,050 five years from now. If the going interest rate on 5-year treasury bonds is 4.25%, how much is the bond worth today? a. $852.72 b. $878.31 c. $750.40 d. $656.60 e. $673.65 ANSWER: a RATIONALE: N 5
I/YR PMT FV PV
4.25% $0 $1,050.00 $852.72
POINTS: 1 DIFFICULTY: EASY REFERENCES: 5-3 Present Values QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.05.03 - Present Values NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: PV of a lump sum KEYWORDS: Bloom's: Application DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 81. Suppose an Exxon Corporation bond will pay $4,500 ten years from now. If the going interest rate on safe 10-year bonds is 7.00%, how much is the bond worth today? a. $1,807.18 b. $2,287.57 Copyright Cengage Learning. Powered by Cognero.
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c. $2,630.71 d. $1,921.56 e. $2,562.08 ANSWER: RATIONALE:
b
N I/YR PMT FV PV
10 7.00% $0 $4,500.00 $2,287.57
POINTS: 1 DIFFICULTY: EASY REFERENCES: 5-3 Present Values QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.05.03 - Present Values NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: PV of a lump sum KEYWORDS: Bloom's: Application DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 82. Suppose the U.S. Treasury offers to sell you a bond for $687.25. No payments will be made until the bond matures 5 years from now, at which time it will be redeemed for $1,000. What interest rate would you earn if you bought this bond at the offer price? a. 6.00% b. 8.96% c. 7.24% d. 6.39% e. 7.79% ANSWER: e RATIONALE: N 5
PV PMT FV I/YR
$687.25 $0 $1,000.00 7.79%
POINTS: 1 DIFFICULTY: EASY REFERENCES: 5-4 Finding the Interest Rate, I QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.05.04 - Finding the Interest Rate, I NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure Copyright Cengage Learning. Powered by Cognero.
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TOPICS: KEYWORDS: DATE CREATED: DATE MODIFIED:
Finding I Bloom's: Application 9/21/2017 5:21 PM 9/21/2017 5:21 PM
83. Suppose the U.S. Treasury offers to sell you a bond for $3,000. No payments will be made until the bond matures 10 years from now, at which time it will be redeemed for $4,100. What interest rate would you earn if you bought this bond at the offer price? a. 2.38% b. 3.55% c. 3.17% d. 3.20% e. 3.27% ANSWER: c RATIONALE: N 10
PV PMT FV I/YR
$3,000.00 $0 $4,100.00 3.17%
POINTS: 1 DIFFICULTY: EASY REFERENCES: 5-4 Finding the Interest Rate, I QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.05.04 - Finding the Interest Rate, I NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Finding I KEYWORDS: Bloom's: Application DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 84. Ten years ago, Lucas Inc. earned $0.50 per share. Its earnings this year were $5.00. What was the growth rate in earnings per share (EPS) over the 10-year period? a. 19.42% b. 21.75% c. 25.89% d. 32.11% e. 29.78% ANSWER: c RATIONALE: N 10
PV PMT FV I/YR Copyright Cengage Learning. Powered by Cognero.
$0.50 $0 $5.00 25.89% Page 273
POINTS: 1 DIFFICULTY: EASY REFERENCES: 5-4 Finding the Interest Rate, I QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.05.04 - Finding the Interest Rate, I NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Growth rate KEYWORDS: Bloom's: Application DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 85. Five years ago, Weed Go Inc. earned $2.70 per share. Its earnings this year were $3.20. What was the growth rate in earnings per share (EPS) over the 5-year period? a. 3.46% b. 4.11% c. 2.73% d. 3.08% e. 3.53% ANSWER: a RATIONALE: N 5
PV PMT FV
$2.70 $0 $3.20 3.46%
I/YR POINTS: 1 DIFFICULTY: EASY REFERENCES: 5-4 Finding the Interest Rate, I QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.05.04 - Finding the Interest Rate, I NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Growth rate KEYWORDS: Bloom's: Application DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 86. Janice has $5,000 invested in a bank that pays 6.2% annually. How long will it take for her funds to triple? a. 13.70 years b. 18.26 years c. 22.10 years d. 19.36 years Copyright Cengage Learning. Powered by Cognero.
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e. 15.16 years ANSWER: RATIONALE:
b
I/YR PV PMT FV N
6.2% $5,000.00 $0 $15,000.00 18.26
POINTS: 1 DIFFICULTY: EASY REFERENCES: 5-5 Finding the Number of Years, N QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.05.05 - Finding the Number of Years, N NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Finding N KEYWORDS: Bloom's: Application DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 87. Bob has $2,500 invested in a bank that pays 5.4% annually. How long will it take for his funds to double? a. 13.44 years b. 16.34 years c. 13.18 years d. 14.89 years e. 12.92 years ANSWER: c RATIONALE: I/YR 5.4%
PV PMT FV N
$2,500.00 $0 $5,000.00 13.18
POINTS: 1 DIFFICULTY: EASY REFERENCES: 5-5 Finding the Number of Years, N QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.05.05 - Finding the Number of Years, N NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Finding N KEYWORDS: Bloom's: Application DATE CREATED: 9/21/2017 5:21 PM Copyright Cengage Learning. Powered by Cognero.
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DATE MODIFIED:
9/21/2017 5:21 PM
88. Last year Thomson Inc's earnings per share were $3.50, and its growth rate during the prior 5 years was 6.6% per year. If that growth rate were maintained, how many years would it take for Thomson's EPS to triple? a. 15.99 b. 15.13 c. 17.19 d. 15.81 e. 13.41 ANSWER: c RATIONALE: I/YR 6.6%
PV PMT FV N
$3.50 $0 $10.50 17.19 years
POINTS: 1 DIFFICULTY: EASY REFERENCES: 5-5 Finding the Number of Years, N QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.05.05 - Finding the Number of Years, N NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Finding N KEYWORDS: Bloom's: Application DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 89. You plan to invest in securities that pay 11.2%, compounded annually. If you invest $5,000 today, how many years will it take for your investment to grow to $9,140.20? a. 6.36 b. 5.63 c. 4.60 d. 5.85 e. 5.68 ANSWER: e RATIONALE: I/YR 11.2%
PV PMT FV N POINTS: DIFFICULTY: REFERENCES: QUESTION TYPE:
$5,000.00 $0 $9,140.20 5.68 years
1 EASY 5-5 Finding the Number of Years, N Multiple Choice
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HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.05.05 - Finding the Number of Years, N NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Finding N KEYWORDS: Bloom's: Application DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 90. You plan to invest in bonds that pay 6.0%, compounded annually. If you invest $10,000 today, how many years will it take for your investment to grow to $15,000? a. 6.33 b. 5.64 c. 5.50 d. 6.96 e. 6.61 ANSWER: d RATIONALE: I/YR 6.0%
PV PMT FV N
$10,000.00 $0 $15,000.00 6.96 years
POINTS: 1 DIFFICULTY: EASY REFERENCES: 5-5 Finding the Number of Years, N QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.05.05 - Finding the Number of Years, N NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Finding N KEYWORDS: Bloom's: Application DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 91. You want to buy a new sports car 3 years from now, and you plan to save $6,200 per year, beginning one year from today. You will deposit your savings in an account that pays 5.2% interest. How much will you have just after you make the 3rd deposit, 3 years from now? a. $19,779.80 b. $17,233.89 c. $24,284.12 d. $19,583.96 e. $22,521.56 ANSWER: d Copyright Cengage Learning. Powered by Cognero.
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RATIONALE:
N I/YR PV PMT FV
3 5.2% $0.00 $6,200 $19,583.96
POINTS: 1 DIFFICULTY: EASY REFERENCES: 5-7 Future Value of an Ordinary Annuity QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.05.07 - Future Value of an Ordinary Annuity NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: FV of ordinary annuity KEYWORDS: Bloom's: Application DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 92. You want to buy a new ski boat 2 years from now, and you plan to save $6,400 per year, beginning one year from today. You will deposit your savings in an account that pays 6.2% interest. How much will you have just after you make the 2nd deposit, 2 years from now? a. $10,821 b. $13,197 c. $13,461 d. $11,481 e. $12,933 ANSWER: b RATIONALE: N 2
I/YR PV PMT FV
6.2% $0.00 $6,400 $13,197
POINTS: 1 DIFFICULTY: EASY REFERENCES: 5-7 Future Value of an Ordinary Annuity QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.05.07 - Future Value of an Ordinary Annuity NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: FV of ordinary annuity KEYWORDS: Bloom's: Application DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM Copyright Cengage Learning. Powered by Cognero.
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93. You want to go to Europe 5 years from now, and you can save $3,800 per year, beginning one year from today. You plan to deposit the funds in a mutual fund that you think will return 8.5% per year. Under these conditions, how much would you have just after you make the 5th deposit, 5 years from now? a. $19,364.12 b. $27,244.86 c. $19,814.45 d. $22,741.58 e. $22,516.42 ANSWER: e RATIONALE: N 5
I/YR PV PMT FV
8.5% $0.00 $3,800 $22,516.42
POINTS: 1 DIFFICULTY: EASY REFERENCES: 5-7 Future Value of an Ordinary Annuity QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.05.07 - Future Value of an Ordinary Annuity NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: FV of ordinary annuity KEYWORDS: Bloom's: Application DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 94. You want to quit your job and go back to school for a law degree 4 years from now, and you plan to save $8,800 per year, beginning immediately. You will make 4 deposits in an account that pays 5.7% interest. Under these assumptions, how much will you have 4 years from today? a. $32,408.12 b. $35,243.83 c. $34,838.73 d. $40,510.15 e. $48,207.08 ANSWER: d RATIONALE: BEGIN Mode
N I/YR PV PMT FV
4 5.7% $0.00 $8,800 $40,510.15
Alternative setup:
0 Copyright Cengage Learning. Powered by Cognero.
1
2
3
4 Page 279
$8,800
$8,800
$8,800
$8,800 FV = $40,510.15
POINTS: 1 DIFFICULTY: EASY REFERENCES: 5-8 Future Value of an Annuity Due QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.05.08 - Future Value of an Annuity Due NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: FV of annuity due KEYWORDS: Bloom's: Application DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 95. You want to quit your job and return to school for an MBA degree 3 years from now, and you plan to save $5,000 per year, beginning immediately. You will make 3 deposits in an account that pays 5.2% interest. Under these assumptions, how much will you have 3 years from today? a. $16,614.78 b. $17,943.97 c. $17,445.52 d. $18,442.41 e. $14,953.30 ANSWER: a RATIONALE: BEGIN Mode
N 3 I/YR 5.2% PV $0.00 PMT $5,000 FV $16,614.78 Alternative setup: 0 1 $5,000 $5,000
2 $5,000
3 FV = $16,614.78
POINTS: 1 DIFFICULTY: EASY REFERENCES: 5-8 Future Value of an Annuity Due QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.05.08 - Future Value of an Annuity Due NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic Copyright Cengage Learning. Powered by Cognero.
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STATE STANDARDS: LOCAL STANDARDS: TOPICS: KEYWORDS: DATE CREATED: DATE MODIFIED:
United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money United States - OH - Default City - Tier 2: - Capital structure FV of annuity due Bloom's: Application 9/21/2017 5:21 PM 9/21/2017 5:21 PM
96. What is the PV of an ordinary annuity with 10 payments of $7,700 if the appropriate interest rate is 5.5%? a. $52,816.14 b. $61,522.10 c. $51,655.35 d. $67,326.07 e. $58,039.72 ANSWER: e RATIONALE: N 10
I/YR PMT FV PV
5.5% $7,700 $0.00 $58,039.72
POINTS: 1 DIFFICULTY: EASY REFERENCES: 5-9 Present Value of an Ordinary Annuity QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.05.09 - Present Value of an Ordinary Annuity NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: PV of ordinary annuity KEYWORDS: Bloom's: Application DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 97. What is the PV of an ordinary annuity with 5 payments of $16,200 if the appropriate interest rate is 4.5%? a. $56,182.92 b. $81,785.27 c. $63,294.68 d. $71,117.62 e. $70,406.45 ANSWER: d RATIONALE: N 5
I/YR PMT FV PV POINTS:
4.5% $16,200 $0.00 $71,117.62
1
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DIFFICULTY: EASY REFERENCES: 5-9 Present Value of an Ordinary Annuity QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.05.09 - Present Value of an Ordinary Annuity NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: PV of ordinary annuity KEYWORDS: Bloom's: Application DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 98. You have a chance to buy an annuity that pays $13,700 at the end of each year for 3 years. You could earn 5.5% on your money in other investments with equal risk. What is the most you should pay for the annuity? a. $43,614.79 b. $31,417.43 c. $39,918.62 d. $39,549.01 e. $36,961.69 ANSWER: e RATIONALE: N 3
I/YR PMT FV PV
5.5% $13,700 $0.00 $36,961.69
POINTS: 1 DIFFICULTY: EASY REFERENCES: 5-9 Present Value of an Ordinary Annuity QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.05.09 - Present Value of an Ordinary Annuity NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: PV of ordinary annuity KEYWORDS: Bloom's: Application DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 99. You just inherited some money, and a broker offers to sell you an annuity that pays $18,200 at the end of each year for 20 years. You could earn 5% on your money in other investments with equal risk. What is the most you should pay for the annuity? a. $251,761.57 b. $269,906.55 c. $226,812.23 Copyright Cengage Learning. Powered by Cognero.
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d. $190,522.27 e. $222,275.98 ANSWER: RATIONALE:
c
N I/YR PMT FV PV
20 5.0% $18,200 $0.00 $226,812.23
POINTS: 1 DIFFICULTY: EASY REFERENCES: 5-9 Present Value of an Ordinary Annuity QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.05.09 - Present Value of an Ordinary Annuity NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: PV of ordinary annuity KEYWORDS: Bloom's: Application DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 100. Your aunt is about to retire, and she wants to sell some of her stock and buy an annuity that will provide her with income of $95,000 per year for 30 years, beginning a year from today. The going rate on such annuities is 7.25%. How much would it cost her to buy such an annuity today? a. $931,376.84 b. $1,172,844.91 c. $1,333,823.63 d. $1,149,847.96 e. $1,241,835.79 ANSWER: d RATIONALE: N 30
I/YR PMT FV PV
7.25% $95,000 $0.00 $1,149,847.96
POINTS: 1 DIFFICULTY: EASY REFERENCES: 5-9 Present Value of an Ordinary Annuity QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.05.09 - Present Value of an Ordinary Annuity NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: PV of ordinary annuity Copyright Cengage Learning. Powered by Cognero.
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KEYWORDS: DATE CREATED: DATE MODIFIED:
Bloom's: Application 9/21/2017 5:21 PM 9/21/2017 5:21 PM
101. What is the PV of an annuity due with 5 payments of $7,900 at an interest rate of 5.5%? a. $41,285.20 b. $40,573.38 c. $35,590.69 d. $43,776.54 e. $41,997.01 ANSWER: c RATIONALE: BEGIN Mode
N I/YR PMT FV PV
5 5.5% $7,900 $0.00 $35,590.69
POINTS: 1 DIFFICULTY: EASY REFERENCES: 5-9 Present Value of an Ordinary Annuity QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.05.09 - Present Value of an Ordinary Annuity NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: PV of annuity due KEYWORDS: Bloom's: Application DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 102. What's the present value of a perpetuity that pays $3,800 per year if the appropriate interest rate is 5%? a. $76,000.00 b. $72,960.00 c. $63,840.00 d. $60,040.00 e. $57,760.00 ANSWER: a RATIONALE: I/YR 5.0%
PMT PV POINTS: DIFFICULTY: REFERENCES: QUESTION TYPE: HAS VARIABLES:
$3,800 $76,000.00
1 EASY 5-11 Perpetuities Multiple Choice True
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LEARNING OBJECTIVES: FOFM.BRIG.17.05.11 - Perpetuities NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: PV of a perpetuity KEYWORDS: Bloom's: Application DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 103. What's the rate of return you would earn if you paid $1,780 for a perpetuity that pays $85 per year? a. 5.92% b. 4.25% c. 4.92% d. 4.63% e. 4.78% ANSWER: e RATIONALE: Cost (PV) $1,780
PMT I/YR
$85 4.78%
POINTS: 1 DIFFICULTY: EASY REFERENCES: 5-11 Perpetuities QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.05.11 - Perpetuities NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Return on a perpetuity KEYWORDS: Bloom's: Application DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 104. You have a chance to buy an annuity that pays $2,450 at the beginning of each year for 3 years. You could earn 5.5% on your money in other investments with equal risk. What is the most you should pay for the annuity? a. $6,973.48 b. $7,531.36 c. $6,903.75 d. $8,298.45 e. $8,228.71 ANSWER: a RATIONALE: BEGIN Mode
N I/YR PMT FV
3 5.5% $2,450 $0.00
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PV
$6,973.48
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 5-9 Present Value of an Ordinary Annuity QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.05.09 - Present Value of an Ordinary Annuity NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04DISC.FOFM.BR - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: PV of annuity due KEYWORDS: Bloom's: Application DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 105. You have a chance to buy an annuity that pays $43,000 at the beginning of each year for 5 years. You could earn 4.5% on your money in other investments with equal risk. What is the most you should pay for the annuity? a. $197,263.61 b. $215,017.33 c. $185,427.79 d. $244,606.87 e. $209,099.42 ANSWER: a RATIONALE: BEGIN Mode
N I/YR PMT FV PV
5 4.5% $43,000 $0.00 $197,263.61
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 5-9 Present Value of an Ordinary Annuity QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.05.09 - Present Value of an Ordinary Annuity NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: PV of annuity due KEYWORDS: Bloom's: Application DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 106. Your uncle is about to retire, and he wants to buy an annuity that will provide him with $80,000 of income a year for 20 years, with the first payment coming immediately. The going rate on such annuities is 5.25%. How much would it cost him to buy the annuity today? Copyright Cengage Learning. Powered by Cognero.
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a. $955,507.24 b. $1,202,089.76 c. $1,027,427.14 d. $1,243,186.84 e. $1,058,249.96 ANSWER: RATIONALE:
c
BEGIN Mode N 20 I/YR 5.25% PMT $80,000 FV $0.00 PV $1,027,427.14
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 5-9 Present Value of an Ordinary Annuity QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.05.09 - Present Value of an Ordinary Annuity NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: PV of annuity due KEYWORDS: Bloom's: Application DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 107. Your father is about to retire, and he wants to buy an annuity that will provide him with $84,000 of income a year for 25 years, with the first payment coming immediately. The going rate on such annuities is 5.15%. How much would it cost him to buy the annuity today? a. $1,471,632.01 b. $981,088.00 c. $1,348,996.01 d. $1,226,360.01 e. $1,508,422.81 ANSWER: d RATIONALE: BEGIN Mode
N I/YR PMT FV PV POINTS: DIFFICULTY: REFERENCES: QUESTION TYPE: HAS VARIABLES:
25 5.15% $84,000 $0.00 $1,226,360.01
1 MODERATE 5-9 Present Value of an Ordinary Annuity Multiple Choice True
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LEARNING OBJECTIVES: FOFM.BRIG.17.05.09 - Present Value of an Ordinary Annuity NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: PV of annuity due KEYWORDS: Bloom's: Application DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 108. You inherited an oil well that will pay you $39,000 per year for 25 years, with the first payment being made today. If you think a fair return on the well is 7.5%, how much should you ask for it if you decide to sell it? a. $565,476.20 b. $359,848.49 c. $387,888.64 d. $467,335.71 e. $579,496.27 ANSWER: d RATIONALE: BEGIN Mode
N I/YR PMT FV PV
25 7.5% $39,000 $0.00 $467,335.71
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 5-9 Present Value of an Ordinary Annuity QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.05.09 - Present Value of an Ordinary Annuity NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: PV of annuity due KEYWORDS: Bloom's: Application DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 109. Sam was injured in an accident, and the insurance company has offered him the choice of $24,000 per year for 15 years, with the first payment being made today, or a lump sum. If a fair return is 7.5%, how large must the lump sum be to leave him as well off financially as with the annuity? a. $248,236.26 b. $189,023.94 c. $234,571.88 d. $202,688.32 e. $227,739.69 ANSWER: e Copyright Cengage Learning. Powered by Cognero.
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RATIONALE:
BEGIN Mode N 15 I/YR 7.5% PMT $24,000 FV $0.00 PV $227,739.69
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 5-9 Present Value of an Ordinary Annuity QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.05.09 - Present Value of an Ordinary Annuity NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: PV of annuity due KEYWORDS: Bloom's: Application DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 110. What's the present value of a 4-year ordinary annuity of $2,250 per year plus an additional $2,400 at the end of Year 4 if the interest rate is 5%? a. $7,464.66 b. $9,952.87 c. $8,858.06 d. $12,341.56 e. $10,848.63 ANSWER: b RATIONALE: N 4
I/YR PMT FV PV
5.0% $2,250 $2,400 $9,952.87
Alternative setup: 0 1 2 3 $2,250$2,250$2,250 $2,250$2,250$2,250 PV = $9,952.87
4 $2,250 $2,400 $4,650
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 5-9 Present Value of an Ordinary Annuity QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.05.09 - Present Value of an Ordinary Annuity NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic Copyright Cengage Learning. Powered by Cognero.
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STATE STANDARDS: LOCAL STANDARDS: TOPICS: KEYWORDS: DATE CREATED: DATE MODIFIED:
United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money United States - OH - Default City - Tier 2: - Capital structure PV of ord. ann. and end. pmt. Bloom's: Application 9/21/2017 5:21 PM 9/21/2017 5:21 PM
111. Suppose you inherited $175,000 and invested it at 8.25% per year. How much could you withdraw at the end of each of the next 20 years? a. $14,888.75 b. $18,157.02 c. $18,883.30 d. $15,070.32 e. $21,606.85 ANSWER: b RATIONALE: N 20
I/YR PV FV PMT
8.25% $175,000 $0.00 $18,157.02
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 5-10 Finding Annuity Payments, Periods, and Interest Rates QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.05.10 - Finding Annuity Payments, Periods, and Interest Rates NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Ord. annuity payments KEYWORDS: Bloom's: Application DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 112. Your uncle has $795,000 and wants to retire. He expects to live for another 25 years and to earn 7.5% on his invested funds. How much could he withdraw at the end of each of the next 25 years and end up with zero in the account? a. $72,033.18 b. $79,878.38 c. $77,025.58 d. $71,319.98 e. $59,908.79 ANSWER: d RATIONALE: N 25
I/YR PV FV
7.5% $795,000 $0.00
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PMT
$71,319.98
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 5-10 Finding Annuity Payments, Periods, and Interest Rates QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.05.10 - Finding Annuity Payments, Periods, and Interest Rates NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Ord. annuity payments KEYWORDS: Bloom's: Application DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 113. Your uncle has $1,015,000 and wants to retire. He expects to live for another 25 years, and he also expects to earn 7.5% on his invested funds. How much could he withdraw at the beginning of each of the next 25 years and end up with zero in the account? a. $84,703.56 b. $82,162.46 c. $98,256.13 d. $105,032.42 e. $77,080.24 ANSWER: a RATIONALE: BEGIN Mode
N I/YR PV FV PMT
25 7.5% $1,015,000 $0.00 $84,703.56
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 5-10 Finding Annuity Payments, Periods, and Interest Rates QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.05.10 - Finding Annuity Payments, Periods, and Interest Rates NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Annuity due payments KEYWORDS: Bloom's: Application DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 114. Your grandmother just died and left you $47,500 in a trust fund that pays 6.5% interest. You must spend the money on your college education, and you must withdraw the money in 4 equal installments, beginning immediately. How much Copyright Cengage Learning. Powered by Cognero.
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could you withdraw today and at the beginning of each of the next 3 years and end up with zero in the account? a. $14,321.05 b. $10,415.31 c. $12,628.56 d. $9,894.54 e. $13,019.14 ANSWER: e RATIONALE: BEGIN Mode
N I/YR PV FV PMT
4 6.5% $47,500 $0.00 $13,019.14
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 5-10 Finding Annuity Payments, Periods, and Interest Rates QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.05.10 - Finding Annuity Payments, Periods, and Interest Rates NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Annuity due payments KEYWORDS: Bloom's: Application DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 115. Suppose you inherited $1,135,000 and invested it at 8.25% per year. How much could you withdraw at the beginning of each of the next 20 years? a. $93,556.25 b. $87,029.07 c. $82,677.62 d. $108,786.34 e. $126,192.16 ANSWER: d RATIONALE: BEGIN Mode
N I/YR PV FV PMT POINTS: DIFFICULTY: REFERENCES: QUESTION TYPE: HAS VARIABLES:
20 8.25% $1,135,000 $0.00 $108,786.34
1 MODERATE 5-10 Finding Annuity Payments, Periods, and Interest Rates Multiple Choice True
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LEARNING OBJECTIVES: FOFM.BRIG.17.05.10 - Finding Annuity Payments, Periods, and Interest Rates NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Annuity due payments KEYWORDS: Bloom's: Application DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 116. Your father's employer was just acquired, and he was given a severance payment of $365,000, which he invested at a 7.5% annual rate. He now plans to retire, and he wants to withdraw $35,000 at the end of each year, starting at the end of this year. How many years will it take to exhaust his funds, i.e., run the account down to zero? a. 25.29 b. 21.91 c. 18.54 d. 17.28 e. 21.07 ANSWER: e RATIONALE: I/YR 7.5%
PV PMT FV N
$365,000 $35,000 $0.00 21.07
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 5-10 Finding Annuity Payments, Periods, and Interest Rates QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.05.10 - Finding Annuity Payments, Periods, and Interest Rates NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Finding annuity periods KEYWORDS: Bloom's: Application DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 117. Your uncle has $260,000 invested at 7.5%, and he now wants to retire. He wants to withdraw $35,000 at the end of each year, starting at the end of this year. He also wants to have $25,000 left to give you when he ceases to withdraw funds from the account. For how many years can he make the $35,000 withdrawals and still have $25,000 left in the end? a. 9.59 b. 11.98 c. 13.90 d. 14.26 e. 12.58 ANSWER: b Copyright Cengage Learning. Powered by Cognero.
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RATIONALE:
I/YR PV PMT FV N
7.50% $260,000 $35,000 $25,000 11.98
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 5-10 Finding Annuity Payments, Periods, and Interest Rates QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.05.10 - Finding Annuity Payments, Periods, and Interest Rates NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Finding annuity periods KEYWORDS: Bloom's: Application DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 118. Your Aunt Ruth has $540,000 invested at 6.5%, and she plans to retire. She wants to withdraw $40,000 at the beginning of each year, starting immediately. How many years will it take to exhaust her funds, i.e., run the account down to zero? a. 25.65 b. 30.62 c. 28.41 d. 24.55 e. 27.58 ANSWER: e RATIONALE: BEGIN Mode
I/YR PV PMT FV N
6.5% $540,000 $40,000 $0.00 27.58
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 5-10 Finding Annuity Payments, Periods, and Interest Rates QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.05.10 - Finding Annuity Payments, Periods, and Interest Rates NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Finding annuity due periods KEYWORDS: Bloom's: Application DATE CREATED: 9/21/2017 5:21 PM Copyright Cengage Learning. Powered by Cognero.
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DATE MODIFIED:
9/21/2017 5:21 PM
119. Your aunt has $270,000 invested at 5.5%, and she now wants to retire. She wants to withdraw $45,000 at the beginning of each year, beginning immediately. She also wants to have $50,000 left to give you when she ceases to withdraw funds from the account. For how many years can she make the $45,000 withdrawals and still have $50,000 left in the end? a. 7.98 b. 8.30 c. 8.06 d. 8.94 e. 9.19 ANSWER: c RATIONALE: BEGIN Mode
I/YR PV PMT FV N
5.5% $270,000 $45,000 $50,000 8.06
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 5-10 Finding Annuity Payments, Periods, and Interest Rates QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.05.10 - Finding Annuity Payments, Periods, and Interest Rates NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Finding annuity due periods KEYWORDS: Bloom's: Application DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 120. Suppose you just won the state lottery, and you have a choice between receiving $3,025,000 today or a 20-year annuity of $250,000, with the first payment coming one year from today. What rate of return is built into the annuity? Disregard taxes. a. 4.12% b. 5.35% c. 2.45% d. 5.15% e. 4.84% ANSWER: b RATIONALE: N 20
PV PMT FV I/YR
$3,025,000 $250,000 $0.00 5.35%
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POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 5-10 Finding Annuity Payments, Periods, and Interest Rates QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.05.10 - Finding Annuity Payments, Periods, and Interest Rates NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money TOPICS: Finding I: annuity KEYWORDS: Bloom's: Application DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 121. Your girlfriend just won the Florida lottery. She has the choice of $11,500,000 today or a 20-year annuity of $1,050,000, with the first payment coming one year from today. What rate of return is built into the annuity? Disregard taxes. a. 7.69% b. 6.44% c. 5.13% d. 6.58% e. 5.59% ANSWER: d RATIONALE: N 20
PV PMT FV I/YR
$11,500,000 $1,050,000 $0.00 6.58%
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 5-10 Finding Annuity Payments, Periods, and Interest Rates QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.05.10 - Finding Annuity Payments, Periods, and Interest Rates NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Finding I: annuity KEYWORDS: Bloom's: Application DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 122. Assume that you own an annuity that will pay you $15,000 per year for 12 years, with the first payment being made today. You need money today to start a new business, and your uncle offers to give you $128,000 for the annuity. If you sell it, what rate of return would your uncle earn on his investment? a. 8.36% b. 6.77% Copyright Cengage Learning. Powered by Cognero.
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c. 5.73% d. 6.91% e. 5.32% ANSWER: RATIONALE:
d
BEGIN Mode N 12 PV $128,000 PMT $15,000 FV $0.00 I/YR 6.91%
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 5-10 Finding Annuity Payments, Periods, and Interest Rates QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.05.10 - Finding Annuity Payments, Periods, and Interest Rates NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Finding I: annuity due KEYWORDS: Bloom's: Application DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 123. What annual payment must you receive in order to earn a 6.5% rate of return on a perpetuity that has a cost of $4,800? a. $352.56 b. $255.84 c. $349.44 d. $283.92 e. $312.00 ANSWER: e RATIONALE: Cost (PV) $4,800
I/YR PMT
6.5% $312.00
Multiply Cost by I/YR.
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 5-11 Perpetuities QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.05.11 - Perpetuities NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Payments on a perpetuity KEYWORDS: Bloom's: Application Copyright Cengage Learning. Powered by Cognero.
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DATE CREATED: DATE MODIFIED:
9/21/2017 5:21 PM 9/21/2017 5:21 PM
124. What is the present value of the following cash flow stream at a rate of 12.00%? Years: CFs:
0 $0
a. $546.24 b. $402.03 c. $436.99 d. $511.28 e. $441.36 ANSWER: RATIONALE:
1 $75
2 $225
3 $0
4 $300
c
I/YR =
12.00% 0 1 2 3 CFs: $0 $75 $225 $0 PV of CFs: $0 $67 $179 $0 PV = $436.99 Found by summing individual PVs. PV = $436.99 Found using the Excel NPV function.
4 $300 $191
You can find the individual PVs and sum them. Alternately, you can automate the process using Excel or a calculator, by inputting the data into the cash flow register and pressing the NPV key.
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 5-12 Uneven Cash Flows QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.05.12 - Uneven Cash Flows NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: PV of uneven cash flows KEYWORDS: Bloom's: Application DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 125. What is the present value of the following cash flow stream at a rate of 15.0%? Years: CFs: a. $10,859 b. $10,261 c. $12,453 d. $9,962 e. $12,154 ANSWER: RATIONALE:
0 $0
1 2 3 4 $1,500 $3,000 $4,500 $6,000
d
I/YR = 15.0%
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0 1 2 3 CFs: $0 $1,500 $3,000 $4,500 PV of CFs: $0 $1,304 $2,268 $2,959 PV = $9,962.12 Found using the Excel NPV function Found by summing individual PVs. PV = $9,962 Found using the calculator NPV key. PV = $9,962.12
4 $6,000 $3,431
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 5-12 Uneven Cash Flows QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.05.12 - Uneven Cash Flows NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: PV of uneven cash flows KEYWORDS: Bloom's: Application DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 126. What is the present value of the following cash flow stream at a rate of 10.0%? Years: CFs:
0 1 2 3 $750 $2,450 $3,175 $4,400
a. $8,283.53 b. $10,777.50 c. $7,749.11 d. $10,866.57 e. $8,907.02 ANSWER: RATIONALE:
e
I/YR = 10.0% 0 1 2 3 CFs: $750 $2,450 $3,175 $4,400 PV of CFs: $750 $2,227 $2,624 $3,306 Found by summing PV = $8,907.02 individual PVs. Found with a calculator or Excel to automate the process. With a PV = $8,907.02 calculator, input the cash flows and I into the cash flow register, then press the NPV key.
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 5-12 Uneven Cash Flows QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.05.12 - Uneven Cash Flows NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic Copyright Cengage Learning. Powered by Cognero.
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STATE STANDARDS: LOCAL STANDARDS: TOPICS: KEYWORDS: DATE CREATED: DATE MODIFIED:
United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money United States - OH - Default City - Tier 2: - Capital structure PV of uneven cash flows Bloom's: Application 9/21/2017 5:21 PM 9/21/2017 5:21 PM
127. You sold a car and accepted a note with the following cash flow stream as your payment. What was the effective price you received for the car assuming an interest rate of 5.5%?
CFs:
0 $0
1 $1,000
a. $6,123 b. $6,062 c. $5,335 d. $5,214 e. $5,699 ANSWER: RATIONALE:
2 $2,000
3 $2,000
4 $2,000
b
I/YR = 5.5% 0 1 2 3 CFs: $0 $1,000 $2,000 $2,000 PV of CFs: $0 $948 $1,797 $1,703 PV = $6,062.43 Found using the Excel NPV function PV = $6,062 Found by summing individual PVs. PV = $6,062.43 Found using the calculator NPV key.
4 $2,000 $1,614
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 5-12 Uneven Cash Flows QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.05.12 - Uneven Cash Flows NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: PV of uneven cash flows KEYWORDS: Bloom's: Application DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 128. At a rate of 10.0%, what is the future value of the following cash flow stream? Years: CFs:
0 $0
1 $75
2 $225
3 $0
4 $300
a. $544 b. $820 c. $672 Copyright Cengage Learning. Powered by Cognero.
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d. $746 e. $726 ANSWER: RATIONALE:
c I/YR = 10.0%
0 $0 $0
1 $75 $100
2 $225 $272
3 $0 $0
4 $300 $300
CFs: FV of CFs: FV = Found by summing individual FVs. $672.08 FV = Found with the NFV key in some calculators. $672.08 FV = Found with a calculator by first finding the PV of the stream, then $672.08 finding the FV of that PV. PV of the stream: FV of the PV:
$459.04 $672.08
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 5-13 Future Value of an Uneven Cash Flow Stream QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.05.13 - Future Value of an Uneven Cash Flow Stream NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: FV of uneven cash flows KEYWORDS: Bloom's: Application DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 129. Your father paid $10,000 (CF at t = 0) for an investment that promises to pay $750 at the end of each of the next 5 years, then an additional lump sum payment of $10,250 at the end of the 5th year. What is the expected rate of return on this investment? a. 7.93% b. 3.16% c. 10.08% d. 8.39% e. 8.83% ANSWER: a RATIONALE: 0 1 2 3 4 5
CFs:
-$10,000
$750
$750
-$10,000
$750
$750
I/YR Copyright Cengage Learning. Powered by Cognero.
7.93%
$750
$750
$750 $10,250 $750 $750 $11,000 I is the discount rate that causes the PV of the inflows to equal the initial negative CF, Page 301
and is found with Excel's IRR function or by inputting the CFs into a calculator and pressing the IRR key. POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 5-14 Solving for I with Uneven Cash Flows QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.05.14 - Solving for I with Uneven Cash Flows NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Rate built into uneven cash flows KEYWORDS: Bloom's: Application DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 130. You are offered a chance to buy an asset for $4,500 that is expected to produce cash flows of $750 at the end of Year 1, $1,000 at the end of Year 2, $850 at the end of Year 3, and $6,250 at the end of Year 4. What rate of return would you earn if you bought this asset? a. 19.92% b. 22.87% c. 26.72% d. 22.64% e. 16.98% ANSWER: d RATIONALE: 0 1 2 3
CFs: I/YR
-$4,500 22.64%
4 $750 $1,000 $850 $6,250 I is the discount rate that causes the PV of the positive inflows to equ the initial negative CF. I can be found using Excel's IRR function or inputting the CFs into a calculator and pressing the IRR key.
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 5-14 Solving for I with Uneven Cash Flows QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVEFOFM.BRIG.17.05.14 - Solving for I with Uneven Cash Flows S: NATIONAL STANDARD United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic S: STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Rate in uneven cash flows KEYWORDS: Bloom's: Application DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM Copyright Cengage Learning. Powered by Cognero.
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131. What's the future value of $4,400 after 5 years if the appropriate interest rate is 6%, compounded semiannually? a. $5,381.04 b. $5,913.23 c. $7,214.14 d. $5,794.97 e. $4,612.32 ANSWER: b RATIONALE: Years 5
Periods/Yr 2 Nom. I/YR 6.0% N = Periods 10 PMT $0 I = I/Period 3.0% PV = $4,400 FV = $5,913.23
Could be found using a calculator, an equation, or Excel. Note that we must first convert to periods and rate per period.
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 5-15 Semiannual and Other Compounding Periods QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.05.15 - Semiannual and Other Compounding Periods NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: LOCAL STANDARDS: TOPICS: KEYWORDS: DATE CREATED: DATE MODIFIED:
United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money United States - OH - Default City - Tier 2: - Capital structure FV, semiannual compounding Bloom's: Application 9/21/2017 5:21 PM 9/21/2017 5:21 PM
132. What's the present value of $4,500 discounted back 5 years if the appropriate interest rate is 4.5%, compounded semiannually? a. $3,602.30 b. $4,178.66 c. $4,070.59 d. $4,358.78 e. $3,566.27 ANSWER: a RATIONALE: Years 5
Periods/Yr Nom. I/YR FV N = Periods PMT I = I/Period Copyright Cengage Learning. Powered by Cognero.
2 4.5% $4,500 10 $0 2.25%
Could be found using a calculator, the equation, or Excel. Page 303
PV =
$3,602.30
Note that we must first convert to periods and rate per period.
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 5-15 Semiannual and Other Compounding Periods QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.05.15 - Semiannual and Other Compounding Periods NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: FV, semiannual compounding KEYWORDS: Bloom's: Application DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 133. What's the future value of $1,300 after 5 years if the appropriate interest rate is 6%, compounded monthly? a. $1,385.27 b. $1,753.51 c. $1,841.18 d. $1,928.86 e. $1,683.36 ANSWER: b RATIONALE: Years 5
Periods/Yr 12 Nom. I/YR 6.0% N= 60 Periods PMT $0 I/Period 0.5% PV $1,300 Could be found using a calculator, the equation, or Excel. FV $1,753.51 Note that we must first convert to periods and rate per period. POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 5-15 Semiannual and Other Compounding Periods QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.05.15 - Semiannual and Other Compounding Periods NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: FV, monthly compounding KEYWORDS: Bloom's: Application DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM Copyright Cengage Learning. Powered by Cognero.
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134. What's the present value of $1,025 discounted back 5 years if the appropriate interest rate is 6%, compounded monthly? a. $767.51 b. $759.91 c. $721.91 d. $691.51 e. $729.51 ANSWER: b RATIONALE: Years 5
Periods/Yr 12 Nom. I/YR 6.0% N=Periods 60 PMT $0 I/Period 0.5% FV $1,025 N PV = $759.91 = FV / (1+rPer) PV = $759.91 Found using a calculator or Excel POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 5-15 Semiannual and Other Compounding Periods QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.05.15 - Semiannual and Other Compounding Periods NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: PV, monthly compounding KEYWORDS: Bloom's: Application DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 135. Master Card and other credit card issuers must by law print the Annual Percentage Rate (APR) on their monthly statements. If the APR is stated to be 24.50%, with interest paid monthly, what is the card's EFF%? a. 27.45% b. 23.06% c. 34.03% d. 28.82% e. 32.66% ANSWER: a RATIONALE: APR = Nominal rate 24.50%
Periods/yr N EFF% = (1+(rNOM/N)) 1= POINTS: DIFFICULTY: REFERENCES:
12 27.45%
1 MODERATE 5-16 Comparing Interest Rates
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QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.05.16 - Comparing Interest Rates NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: APR vs. EFF% KEYWORDS: Bloom's: Application DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 136. Riverside Bank offers to lend you $50,000 at a nominal rate of 6.5%, compounded monthly. The loan (principal plus interest) must be repaid at the end of the year. Midwest Bank also offers to lend you the $50,000, but it will charge an annual rate of 7.8%, with no interest due until the end of the year. How much higher or lower is the effective annual rate charged by Midwest versus the rate charged by Riverside? a. 1.02% b. 1.35% c. 1.10% d. 1.05% e. 1.24% ANSWER: c This problem can be worked using the interest conversion feature of a calculator or Excel. It could also RATIONALE: be worked using the conversion formula. We used the conversion formula.
Nominal rate, Riverside 6.5% Nominal rate, Midwest 7.8% Periods/yr, Riverside 12 Periods/yr, Midwest 1 N EFF% Riverside = (1 + (rNOM/N)) - 1 = 6.70% EFF% Midwest 7.8% Difference 1.10% POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 5-16 Comparing Interest Rates QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.05.16 - Comparing Interest Rates NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Comparing EFF% KEYWORDS: Bloom's: Analysis DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 137. Suppose Community Bank offers to lend you $10,000 for one year at a nominal annual rate of 6.50%, but you must make interest payments at the end of each quarter and then pay off the $10,000 principal amount at the end of the year. Copyright Cengage Learning. Powered by Cognero.
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What is the effective annual rate on the loan? a. 7.99% b. 5.39% c. 6.73% d. 6.66% e. 8.26% ANSWER: d RATIONALE: Nominal I/YR
6.50% 4
Periods/yr N EFF% = (1+(rNOM/N)) - 1 6.66% = You could also find the EFF% as follows: Interest paid each quarter = Loan × rate/4 = Qtrly PMT = $162.50 Then find the IRR as a quarterly rate and convert to an annual rate. This procedure is obviously longer.
0 10,000.00
1 –162.50
2 –162.50
3 –162.50
10,000.00 IRR (quarterly) = 1.63%
–162.50
–162.50
–162.50
CFs:
4 –162.50 -10,000.00 –10,163
Annual effective rate = 6.66% vs. nominal rate = 6.50%
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 5-16 Comparing Interest Rates QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.05.16 - Comparing Interest Rates NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Nominal rate vs. EFF% KEYWORDS: Bloom's: Application DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 138. Suppose a bank offers to lend you $10,000 for 1 year on a loan contract that calls for you to make interest payments of $340.00 at the end of each quarter and then pay off the principal amount at the end of the year. What is the effective annual rate on the loan? a. 14.31% b. 16.46% c. 17.31% d. 15.88% e. 15.02% ANSWER: a RATIONALE: Interest payment: $340.00
CFs: Copyright Cengage Learning. Powered by Cognero.
0 10,000
1 -340.00
2 -340.00
3 -340.00
4 -340.00 -10,000 Page 307
10,000 IRR (quarterly) = 3.40%
-340.00
-340.00
-340.00
-10,340
Annual effective rate = 14.31% vs. nominal rate = 13.60%
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 5-16 Comparing Interest Rates QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.05.16 - Comparing Interest Rates NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Nominal rate vs. EFF% KEYWORDS: Bloom's: Application DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 139. Charter Bank pays a 4.30% nominal rate on deposits, with monthly compounding. What effective annual rate (EFF%) does the bank pay? a. 4.39% b. 5.09% c. 5.04% d. 4.74% e. 5.44% ANSWER: a RATIONALE: Nominal I/YR 4.30%
Periods/yr 12 Periodic rate 0.36% N EFF% = (1+(rNOM/N)) – 1 4.39% = POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 5-16 Comparing Interest Rates QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.05.16 - Comparing Interest Rates NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Nominal rate vs. EFF% KEYWORDS: Bloom's: Application DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 140. Suppose your credit card issuer states that it charges a 24.00% nominal annual rate, but you must make monthly payments, which amounts to monthly compounding. What is the effective annual rate? Copyright Cengage Learning. Powered by Cognero.
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a. 21.19% b. 26.29% c. 26.82% d. 29.51% e. 31.12% ANSWER: RATIONALE:
c
Nominal I/YR = APR 24.00% Periods/yr 12 N EFF% = (1+(rNOM/N)) – 1 26.82% =
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 5-16 Comparing Interest Rates QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.05.16 - Comparing Interest Rates NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Nominal rate vs. EFF% KEYWORDS: Bloom's: Application DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 141. Pace Co. borrowed $10,000 at a rate of 7.25%, simple interest, with interest paid at the end of each month. The bank uses a 360-day year. How much interest would Pace have to pay in a 30-day month? a. $57.40 b. $47.13 c. $60.42 d. $73.10 e. $50.15 ANSWER: c RATIONALE: Nominal I/YR 7.25% Days in month 30
Days/yr 360 Amount borrowed $10,000 Interest per month = Interest/day × 30 $60.42 =
Daily rate Interest per day
0.020139% $2.01389
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 5-17 Fractional Time Periods QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES FOFM.BRIG.17.05.17 - Fractional Time Periods : Copyright Cengage Learning. Powered by Cognero.
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NATIONAL STANDARDS United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic : STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Simple interest KEYWORDS: Bloom's: Application DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 142. Suppose you deposited $26,000 in a bank account that pays 5.25% with daily compounding based on a 360-day year. How much would be in the account after 8 months, assuming each month has 30 days? a. $21,271.57 b. $25,579.74 c. $26,926.04 d. $33,119.03 e. $26,656.78 ANSWER: c RATIONALE: Nominal I/YR 5.25% Rate/day = r /360 = 0.0146% NOM
Number of months Days in year Days in month Amount deposited Ending amount
8 Days = Months × 30 = 240 360 30 $26,000 $26,926.04
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 5-17 Fractional Time Periods QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.05.17 - Fractional Time Periods NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Fractional time periods KEYWORDS: Bloom's: Application DATE CREATED: 9/21/2017 5:21 PM DATE MODIFIED: 9/21/2017 5:21 PM 143. Suppose you borrowed $37,000 at a rate of 9.0% and must repay it in 4 equal installments at the end of each of the next 4 years. How large would your payments be? a. $8,908.18 b. $11,420.74 c. $9,136.59 d. $10,735.50 e. $9,707.63 ANSWER: b RATIONALE: Years = N 4 Copyright Cengage Learning. Powered by Cognero.
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I/YR FV Amount borrowed = PV Payments = PMT
9.0% $0 $37,000 $11,420.74 Found with a calculator, as the PMT.
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 5-18 Amortized Loans QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.05.18 - Amortized Loans NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Amortization: payment KEYWORDS: Bloom's: Application DATE CREATED: 9/21/2017 5:22 PM DATE MODIFIED: 9/21/2017 5:22 PM 144. Suppose you are buying your first condo for $160,000, and you will make a $15,000 down payment. You have arranged to finance the remainder with a 30-year, monthly payment, amortized mortgage at a 6.5% nominal interest rate, with the first payment due in one month. What will your monthly payments be? a. $971.49 b. $962.32 c. $925.66 d. $769.86 e. $916.50 ANSWER: e RATIONALE: Years 30 N 360
Payments/year Nominal rate Purchase price Down payment
12 6.50% $160,000 $15,000
Periodic rate 0.54% PV $145,000 FV $0.00 PMT $916.50
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 5-18 Amortized Loans QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.05.18 - Amortized Loans NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Amortization: payment KEYWORDS: Bloom's: Application DATE CREATED: 9/21/2017 5:22 PM DATE MODIFIED: 9/21/2017 5:22 PM Copyright Cengage Learning. Powered by Cognero.
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145. Your uncle will sell you his bicycle shop for $170,000, with "seller financing," at a 6.0% nominal annual rate. The terms of the loan would require you to make 12 equal end-of-month payments per year for 4 years, and then make an additional final (balloon) payment of $50,000 at the end of the last month. What would your equal monthly payments be? a. $2,362.52 b. $3,068.20 c. $2,792.07 d. $3,681.84 e. $3,129.57 ANSWER: b Monthly annuity, so interest must be calculated on a monthly basis. RATIONALE:
Years 4 N 48 PV $170,000 FV $50,000
Payments/year Nominal rate I/period PMT
12 6.0% 0.5% $3,068.20
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 5-18 Amortized Loans QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.05.18 - Amortized Loans NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Amortization: payment KEYWORDS: Bloom's: Application DATE CREATED: 9/21/2017 5:22 PM DATE MODIFIED: 9/21/2017 5:22 PM 146. Suppose you borrowed $15,000 at a rate of 11.1% and must repay it in 5 equal installments at the end of each of the next 5 years. How much interest would you have to pay in the first year? a. $1,248.75 b. $1,481.85 c. $1,615.05 d. $1,665.00 e. $1,714.95 ANSWER: d RATIONALE: I/YR 11.1%
POINTS: DIFFICULTY: REFERENCES: QUESTION TYPE: HAS VARIABLES:
Years Amount borrowed
5 $15,000
Interest in Year 1
$1,665.00
Simply multiply the rate times the amount borrowed.
1 MODERATE 5-18 Amortized Loans Multiple Choice True
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LEARNING OBJECTIVES: FOFM.BRIG.17.05.18 - Amortized Loans NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money TOPICS: Amortization: interest KEYWORDS: Bloom's: Application DATE CREATED: 9/21/2017 5:22 PM DATE MODIFIED: 9/21/2017 5:22 PM 147. You plan to borrow $47,400 at a 7.5% annual interest rate. The terms require you to amortize the loan with 7 equal end-of-year payments. How much interest would you be paying in Year 2? a. $2,520.35 b. $2,835.40 c. $2,992.92 d. $3,150.44 e. $3,623.01 ANSWER: d Find the required payment: RATIONALE:
N I PV FV
7 7.5% $47,400 $0
PMT $8,949.13
Found with a calculator or Excel.
Amortization schedule (first 2 years)
Year 1 2
Beg. Balance Payment 47,400.00 8,949.13 42,005.87 8,949.13
Interest 3,555.00 3,150.44
Principal 5,394.13 5,798.70
End. Balance 42,005.87 36,207.17
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 5-18 Amortized Loans QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES FOFM.BRIG.17.05.18 - Amortized Loans : NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: TOPICS: KEYWORDS: DATE CREATED: DATE MODIFIED:
United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money Amortization: interest Bloom's: Application 9/21/2017 5:22 PM 9/21/2017 5:22 PM
148. Your bank offers to lend you $114,400 at an 8.5% annual interest rate to start your new business. The terms require you to amortize the loan with 10 equal end-of-year payments. How much interest would you be paying in Year 2? a. $7,254.82 b. $8,161.67 Copyright Cengage Learning. Powered by Cognero.
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c. $8,615.10 d. $9,068.53 e. $10,428.81 ANSWER: RATIONALE:
d Find the required payment:
N I PV FV
10 8.5% $114,400 $0
PMT $17,435.44
Found with a calculator or Excel.
Amortization schedule (first 2 years)
Year 1 2
Beg. Balance Payment 114,400.00 17,435.44 106,688.56 17,435.44
Interest 9,724.00 9,068.53
Principal 7,711.44 8,366.91
End. Balance 106,688.56 98,321.64
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 5-18 Amortized Loans QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES FOFM.BRIG.17.05.18 - Amortized Loans : NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: TOPICS: KEYWORDS: DATE CREATED: DATE MODIFIED:
United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money Amortization: interest Bloom's: Application 9/21/2017 5:22 PM 9/21/2017 5:22 PM
149. You are considering an investment in a Third World bank account that pays a nominal annual rate of 18%, compounded monthly. If you invest $5,000 at the beginning of each month, how many months would it take for your account to grow to $450,000? Round fractional months up. a. 47 b. 57 c. 67 d. 51 e. 70 ANSWER: b RATIONALE: BEGIN Mode
POINTS:
I/YR
18.00%
I/MO
1.50%
PV PMT FV N
$0 $5,000 $450,000 56.81 Rounded up: 57
Monthly annuity due, so interest must be calculated on monthly basis. rNOM / 12.
1
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DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.05.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: N, ann due, monthly comp. KEYWORDS: Bloom's: Application DATE CREATED: 9/21/2017 5:22 PM DATE MODIFIED: 9/21/2017 5:22 PM 150. You are considering investing in a bank account that pays a nominal annual rate of 7%, compounded monthly. If you invest $3,000 at the end of each month, how many months will it take for your account to grow to $310,000? a. 95.70 b. 90.84 c. 72.18 d. 81.11 e. 93.27 ANSWER: d RATIONALE: I/YR 7.00%
I/MO PV PMT FV N
0.58% $0 $3,000 $310,000 81.1051
Monthly annuity, so interest must be calculated on monthly basis
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.05.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: N, ann. due, monthly comp. KEYWORDS: Bloom's: Application DATE CREATED: 9/21/2017 5:22 PM DATE MODIFIED: 9/21/2017 5:22 PM 151. Your child's orthodontist offers you two alternative payment plans. The first plan requires a $4,000 immediate upfront payment. The second plan requires you to make monthly payments of $137.41, payable at the end of each month for 3 years. What nominal annual interest rate is built into the monthly payment plan? a. 17.81% b. 14.50% Copyright Cengage Learning. Powered by Cognero.
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c. 14.36% d. 13.50% e. 11.34% ANSWER: RATIONALE:
c
N PV PMT FV
36 $4,000 $137.41 $0
I/MO
1.20%
Monthly annuity, so interest must be calculated on monthly basis
I/YR = I/MO × 12 14.36% = POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.05.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Rate, ord. ann., monthly comp. KEYWORDS: Bloom's: Application DATE CREATED: 9/21/2017 5:22 PM DATE MODIFIED: 9/21/2017 5:22 PM 152. Your subscription to Investing Wisely Weekly is about to expire. You plan to subscribe to the magazine for the rest of your life, and you can renew it by paying $85 annually, beginning immediately, or you can get a lifetime subscription for $620, also payable immediately. Assuming that you can earn 6.0% on your funds and that the annual renewal rate will remain constant, how many years must you live to make the lifetime subscription the better buy? a. 6.95 b. 8.86 c. 9.14 d. 11.15 e. 10.60 ANSWER: c Find N for an annuity due with the indicated terms to determine how long you must live to make the RATIONALE: lifetime subscription worthwhile.
BEGIN Mode Interest rate (I/YR) Annual cost (PMT) Lifetime subscription cost (PV) Number of payments made (N) POINTS: DIFFICULTY: REFERENCES: QUESTION TYPE:
6.0% $85 $620 9.14
1 CHALLENGING 5-10 Finding Annuity Payments, Periods, and Interest Rates Multiple Choice
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HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.05.10 - Finding Annuity Payments, Periods, and Interest Rates NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: N, lifetime vs. yearly KEYWORDS: Bloom's: Analysis DATE CREATED: 9/21/2017 5:22 PM DATE MODIFIED: 9/21/2017 5:22 PM 153. You agree to make 24 deposits of $500 at the beginning of each month into a bank account. At the end of the 24th month, you will have $13,000 in your account. If the bank compounds interest monthly, what nominal annual interest rate will you be earning? a. 8.91% b. 6.63% c. 8.00% d. 5.79% e. 7.62% ANSWER: e RATIONALE: BEGIN Mode
N PV PMT FV I/MO I/YR
24 $0 $500 $13,000 0.63% 7.62%
POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 5-10 Finding Annuity Payments, Periods, and Interest Rates QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.05.10 - Finding Annuity Payments, Periods, and Interest Rates NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Finding I: annuity due KEYWORDS: Bloom's: Application DATE CREATED: 9/21/2017 5:22 PM DATE MODIFIED: 9/21/2017 5:22 PM 154. You just deposited $2,000 in a bank account that pays a 4.0% nominal interest rate, compounded quarterly. If you also add another $5,000 to the account one year (4 quarters) from now and another $7,500 to the account two years (8 quarters) from now, how much will be in the account three years (12 quarters) from now? a. $15,472.46 b. $19,340.58 c. $11,604.35 Copyright Cengage Learning. Powered by Cognero.
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d. $18,566.96 e. $14,234.67 ANSWER: RATIONALE:
a
Interest rate Periods/year Quarterly rate 1st deposit 2nd deposit 3rd deposit
4.0% 4 1.0% $2,000 $5,000 $7,500
Years on Quarters on Ending Deposit Deposit Amount 3 12 $ 2,253.65 2 8 5,414.28 1 4 7,804.53 Total $15,472.46
POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 5-15 Semiannual and Other Compounding Periods QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.05.15 - Semiannual and Other Compounding Periods NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Non-annual compounding KEYWORDS: Bloom's: Application DATE CREATED: 9/21/2017 5:22 PM DATE MODIFIED: 9/21/2017 5:22 PM 155. Farmers Bank offers to lend you $50,000 at a nominal rate of 5.0%, simple interest, with interest paid quarterly. Merchants Bank offers to lend you the $50,000, but it will charge 6.8%, simple interest, with interest paid at the end of the year. What's the difference in the effective annual rates charged by the two banks? a. 2.07% b. 2.00% c. 1.73% d. 1.71% e. 2.12% ANSWER: d Students must understand that "simple interest with interest paid quarterly" means that the bank gets RATIONALE: the interest at the end of each quarter, hence it can invest it, presumably at the same nominal rate. This results in the same effective rate as if it were stated as "5.0%, quarterly compounding."
Nominal rate, Farmers 5.0% Periods/yr, Farmers 4 Nominal rate, Merchants 6.8% Periods/yr, Merchants 1 EFF% Farmers 5.09% EFF% Merchants 6.80% Difference 1.71% POINTS: DIFFICULTY: REFERENCES: QUESTION TYPE:
1 CHALLENGING 5-16 Comparing Interest Rates Multiple Choice
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HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.05.16 - Comparing Interest Rates NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Comparing EFF% KEYWORDS: Bloom's: Analysis DATE CREATED: 9/21/2017 5:22 PM DATE MODIFIED: 9/21/2017 5:22 PM 156. Suppose you borrowed $25,000 at a rate of 8.5% and must repay it in 5 equal installments at the end of each of the next 5 years. By how much would you reduce the amount you owe in the first year? a. $5,804.89 b. $5,572.70 c. $4,469.77 d. $5,920.99 e. $5,108.30 ANSWER: a RATIONALE: Interest rate 8.5%
Years Amount borrowed Step 1: Find the PMT Step 2: Find the 1st year's interest Step 3: Subtract the interest from the payment; this is repayment of principal
5 $25,000 $6,344.14 $539.25 $5,804.89
POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 5-18 Amortized Loans QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.05.18 - Amortized Loans NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Amortization: princ. repaymt. KEYWORDS: Bloom's: Application DATE CREATED: 9/21/2017 5:22 PM DATE MODIFIED: 9/21/2017 5:22 PM 157. Suppose you borrowed $80,000 at a rate of 8.5% and must repay it in 5 equal installments at the end of each of the next 5 years. How much would you still owe at the end of the first year, after you have made the first payment? a. $66,338.29 b. $68,795.27 Copyright Cengage Learning. Powered by Cognero.
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c. $63,267.08 d. $61,424.35 e. $74,323.46 ANSWER: RATIONALE:
d
Interest rate 8.5% Years 5 Amount borrowed $80,000 Step 1: Find the PMT $20,301.26 Step 2: Find the 1st year's interest $1,725.61 Step 3: Subtract the interest from the payment; this is repayment of $18,575.65 principal Step 4: Subtract the repayment of principal from the beginning amount $61,424.35 owed
POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 5-18 Amortized Loans QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.05.18 - Amortized Loans NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Amortization: ending bal. KEYWORDS: Bloom's: Application DATE CREATED: 9/21/2017 5:22 PM DATE MODIFIED: 9/21/2017 5:22 PM 158. Your company has just taken out a 1-year installment loan for $72,500 at a nominal rate of 20.0% but with equal end-of-month payments. What percentage of the 2nd monthly payment will go toward the repayment of principal? a. 101.72% b. 71.70% c. 86.71% d. 83.37% e. 97.55% ANSWER: d RATIONALE:
N 12 20.0% rNOM Periodic r 1.6667% PV $72,500 PMT $6,716 FV $0
% prin. = Prin2 / PMT = 83.37%
Amortization schedule (first 4 months)
Month Beg. Balance Payment 1 $72,500.00 $6,716 2 $66,992.33 $6,716 3 $61,392.87 $6,716 Copyright Cengage Learning. Powered by Cognero.
Interest $1,116.54 $1,023.21 $928.33
Principal $5,507.67 $5,599.46 $5,692.79
Ending Balance $66,992.33 $61,392.87 $55,700.08 Page 320
4
$55,700.08
$6,716
$831.87
$5,787.67
$49,912.41
POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 5-18 Amortized Loans QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.05.18 - Amortized Loans NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Amortization KEYWORDS: Bloom's: Application DATE CREATED: 9/21/2017 5:22 PM DATE MODIFIED: 9/21/2017 5:22 PM 159. Your brother's business obtained a 30-year amortized mortgage loan for $300,000 at a nominal annual rate of 7.0%, with 360 end-of-month payments. The firm can deduct the interest paid for tax purposes. What will the interest tax deduction be for Year 1? a. $18,813.11 b. $24,248.01 c. $20,903.46 d. $20,485.39 e. $19,440.22 ANSWER: c RATIONALE: Years 30 Nominal r 7.00%
Periods/yr N (12 mo.) PV = Loan FV
12 360 $300,000
I/period PMT Interest Year 1
0.5833% $1,995.91 $20,903.46
$0
Amortization schedule(first 12 months)
Month Beg. Balance Payment Interest Principal End. Balance 1 $300,000.00 $1,995.91 $1,750.00 $245.91 $299,754.09 2 $299,754.09 $1,995.91 $1,748.57 $247.34 $299,506.75 3 $299,506.75 $1,995.91 $1,747.12 $248.78 $299,257.97 4 $299,257.97 $1,995.91 $1,745.67 $250.24 $299,007.73 5 $299,007.73 $1,995.91 $1,744.21 $251.70 $298,756.03 6 $298,756.03 $1,995.91 $1,742.74 $253.16 $298,502.87 7 $298,502.87 $1,995.91 $1,741.27 $254.64 $298,248.23 8 $298,248.23 $1,995.91 $1,739.78 $256.13 $297,992.10 9 $297,992.10 $1,995.91 $1,738.29 $257.62 $297,734.48 10 $297,734.48 $1,995.91 $1,736.78 $259.12 $297,475.36 11 $297,475.36 $1,995.91 $1,735.27 $260.63 $297,214.73 12 $297,214.73 $1,995.91 $1,733.75 $262.15 $296,952.57 $23,950.89$20,903.46 $3,047.43 Copyright Cengage Learning. Powered by Cognero.
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POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 5-18 Amortized Loans QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.05.18 - Amortized Loans NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Amortization: interest KEYWORDS: Bloom's: Application DATE CREATED: 9/21/2017 5:22 PM DATE MODIFIED: 9/21/2017 5:22 PM 160. Your sister turned 35 today, and she is planning to save $60,000 per year for retirement, with the first deposit to be made one year from today. She will invest in a mutual fund that's expected to provide a return of 7.5% per year. She plans to retire 30 years from today, when she turns 65, and she expects to live for 25 years after retirement, to age 90. Under these assumptions, how much can she spend each year after she retires? Her first withdrawal will be made at the end of her first retirement year. a. $495,339.99 b. $601,086.73 c. $567,693.03 d. $556,561.79 e. $539,864.94 ANSWER: d RATIONALE: Interest rate 7.5%
Years to retirement 30 Years in retirement 25 Amount saved per year $60,000 Step 1: Find the amount at age 65; use the FV function $6,203,964 Step 2: Find the PMT for a 25-year ordinary annuity using the FV you $556,561.79 just found as the PV. POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.05.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Retirement planning KEYWORDS: Bloom's: Application DATE CREATED: 9/21/2017 5:22 PM Copyright Cengage Learning. Powered by Cognero.
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DATE MODIFIED:
9/21/2017 5:22 PM
161. Steve and Ed are cousins who were both born on the same day, and both turned 25 today. Their grandfather began putting $2,100 per year into a trust fund for Steve on his 20th birthday, and he just made a 6th payment into the fund. The grandfather (or his estate's trustee) will make 40 more $2,100 payments until a 46th and final payment is made on Steve's 65th birthday. The grandfather set things up this way because he wants Steve to work, not be a "trust fund baby," but he also wants to ensure that Steve is provided for in his old age. Until now, the grandfather has been disappointed with Ed, hence has not given him anything. However, they recently reconciled, and the grandfather decided to make an equivalent provision for Ed. He will make the first payment to a trust for Ed today, and he has instructed his trustee to make 40 additional equal annual payments until Ed turns 65, when the 41st and final payment will be made. If both trusts earn an annual return of 8%, how much must the grandfather put into Ed's trust today and each subsequent year to enable him to have the same retirement nest egg as Steve after the last payment is made on their 65th birthday? Assume that all payments are made at the end of the year. a. $2,660 b. $3,255 c. $3,067 d. $3,129 e. $3,036 ANSWER: d RATIONALE: Steve's retirement account Ed's retirement account
No. of payments thus far, including today's payment
6
Number of remaining payments
40
N = total payments I/YR PV PMT =
46 8.0% $0 $2,100 $878,695 PMT =
FV = Steve's FV =
Payment today
1
Number of remaining payments N I/YR PV FV = Ed's FV =
POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIV FOFM.BRIG.17.05.00 - Comprehensive ES: NATIONAL STANDARD United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic S: STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Retirement planning KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:22 PM DATE MODIFIED: 9/21/2017 5:22 PM Copyright Cengage Learning. Powered by Cognero.
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40
41 8.0% $0 $878,6 $3,129
162. After graduation, you plan to work for Dynamo Corporation for 12 years and then start your own business. You expect to save and deposit $7,500 a year for the first 6 years (t = 1 through t = 6) and $15,000 annually for the following 6 years (t = 7 through t = 12). The first deposit will be made a year from today. In addition, your grandfather just gave you a $32,500 graduation gift which you will deposit immediately (t = 0). If the account earns 9% compounded annually, how much will you have when you start your business 12 years from now? a. $269,003 b. $292,914 c. $298,892 d. $286,936 e. $310,848 ANSWER: c There are 3 cash flow streams: the gift and the two annuities. The gift will grow for 12 years. Then RATIONALE: there is a 6-year annuity whose FV at the end of Year 6 will compound for an additional 6 years. Finally, there is a second 6-year annuity. The sum of the compounded values of those three sets of cash flows is the final amount.
Interest rate 1st annuity 2nd annuity Gift Total years Annuity years
9.0% $7,500 $15,000 $32,500 12 6
Amount
Amount
at end of Year 6
at end of Year 12
$56,425 Compound @ 9% NA NA
$94,630 $112,850 $91,412
Final amt:
$298,892
POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.05.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: FV of comb. CF lump sum and ann. KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:22 PM DATE MODIFIED: 9/21/2017 5:22 PM 163. You are negotiating to make a 7-year loan of $37,500 to Breck Inc. To repay you, Breck will pay $2,500 at the end of Year 1, $5,000 at the end of Year 2, and $7,500 at the end of Year 3, plus a fixed but currently unspecified cash flow, X, at the end of each year from Year 4 through Year 7. Breck is essentially riskless, so you are confident the payments will be made. You regard 8% as an appropriate rate of return on a low risk but illiquid 7-year loan. What cash flow must the investment provide at the end of each of the final 4 years, that is, what is X? a. $9,487.32 b. $8,348.84 c. $9,012.95 d. $9,202.70 Copyright Cengage Learning. Powered by Cognero.
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e. $7,684.73 ANSWER: RATIONALE:
a This is a relatively difficult problem for an efficient calculator solution or classroom exam, but it is appropriate for a challenging take-home or online exam.
I/YR = 8% 0 1 2 3 4 5 6 -$37,500 $2,500 $5,000 $7,500 X X X Calculator solution: Use the CF register to find the NPV of the 4 known cash Step 1. flows, CF0 to CF3: Find the FV of this NPV at the end of period 3, i.e., Step 2. compound the NPV you found for 3 years. Step 3. Now find the PMT for a 4-year annuity with this PV.
7 X -$24,944.75 -$31,423.20 $9,487.32
POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.05.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: CF for given return KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:22 PM DATE MODIFIED: 9/21/2017 5:22 PM 164. John and Daphne are saving for their daughter Ellen's college education. Ellen just turned 10 (at t = 0), and she will be entering college 8 years from now (at t = 8). College tuition and expenses at State U. are currently $14,500 a year, but they are expected to increase at a rate of 3.5% a year. Ellen should graduate in 4 years--if she takes longer or wants to go to graduate school, she will be on her own. Tuition and other costs will be due at the beginning of each school year (at t = 8, 9, 10, and 11). So far, John and Daphne have accumulated $12,000 in their college savings account (at t = 0). Their long-run financial plan is to add an additional $5,000 in each of the next 4 years (at t = 1, 2, 3, and 4). Then they plan to make 3 equal annual contributions in each of the following years, t = 5, 6, and 7. They expect their investment account to earn 9%. How large must the annual payments at t = 5, 6, and 7 be to cover Ellen's anticipated college costs? a. $3,758.85 b. $3,595.43 c. $4,085.71 d. $4,004.00 e. $4,698.57 ANSWER: c RATIONALE: Current college cost/year $14,500 College cost inflation 3.5% Return on investment account 9.0% Payments at t = 1, 2, 3, and 4 $5,000 Account balance at t = 0 $12,000 Copyright Cengage Learning. Powered by Cognero.
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1. Determine the cost of each year during college and its PV at t = 8, discounted at the return on investment. Cost PV at t-8 Year 1 (t = 8) = Current cost×(1+infl)^8 = -$19,093.73 -$19,093.73 Year 2 (t = 9) = Prior year×(1+infl) = -$19,762.01 -$18,130.29 Year 3 (t = 10) = Prior year×(1+infl) = -$20,453.68 -$17,215.45 Year 4 (t = 11) = Prior year×(1+infl) = -$21,169.56 -$16,346.79 Find PV (at t = 8) of all college costs = amount needed at t = 8: -$70,786.26 2. Create a time line with those cash flows, plus the known initial CFs, as shown below. Put × in for the unknown values for t = 5 - 7. We show the time line on two sets of rows. Ours now has the solution value, but it didn't originally. 0 1 2 3 4 5 Known values; X for $12,000.00 $5,000.00 $5,000.00 $5,000.00 $5,000.00 X unknown: Solution value for X: $4,085.78 Cash flows: $12,000.00 $5,000.00 $5,000.00 $5,000.00 $5,000.00 $4,085.78 6
7
X
X
8 9 10 11 $19,093.73 $19,762.01 $20,453.68 $21,169.56
$4,085.78 $4,085.78 Cash flows, continued: $4,085.78 $4,085.78
$19,093.73 $19,762.01 $20,453.68 $21,169.56
3. We found the PV of the college costs (t = 8-11) at t = 8 above. Their sum is -$70,786.26 shown to the right. 4. Find the FV of t = 0 & 4 positive CFs at t = 8: 0 $12,000.00 $21,936.47 1 $5,000.00 $9,140.20 2 $5,000.00 $8,385.50 3 $5,000.00 $7,693.12 4 $5,000.00 $7,057.91 $51,548.15 5. Find the difference between the positive and negative t = 8 values: -$13,393.37 6. Find PMT for a 3-year annuity due whose FV is equal to this $4,085.71 difference: POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES FOFM.BRIG.17.05.00 - Comprehensive : NATIONAL STANDARDS United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic : STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Saving for college KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:22 PM Copyright Cengage Learning. Powered by Cognero.
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DATE MODIFIED:
9/21/2017 5:22 PM
The difficulty of these questions as seen by students will depend on (1) what was discussed in class and (2) how long students have to answer the questions. If time is not an issue, then many of the questions could be classified as EASY, but under exam conditions with time pressure, many might be regarded as being CHALLENGING. So, consider the amount of time students have when selecting questions for an exam. Note that there is some overlap between the True/False and the multiple choice questions, as some T/F statements are used in the MC questions. 1. One of the four most fundamental factors that affect the cost of money as discussed in the text is the current state of the weather. If the weather is dark and stormy, the cost of money will be higher than if it is bright and sunny, other things held constant. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 6-1 The Cost of Money QUESTION TYPE: True / False HAS VARIABLES: False PREFACE NAME: Opener LEARNING OBJECTIVES: FOFM.BRIG.17.06.01 - The Cost of Money NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Cost of money KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:23 PM DATE MODIFIED: 9/21/2017 5:23 PM 2. One of the four most fundamental factors that affect the cost of money as discussed in the text is the expected rate of inflation. If inflation is expected to be relatively high, then interest rates will tend to be relatively low, other things held constant. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 6-1 The Cost of Money QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.06.01 - The Cost of Money NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business Copyright Cengage Learning. Powered by Cognero.
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TOPICS: KEYWORDS: DATE CREATED: DATE MODIFIED:
School Outcomes, you do not need to include anything for this category. Cost of money Bloom's: Knowledge 9/21/2017 5:23 PM 9/21/2017 5:23 PM
3. One of the four most fundamental factors that affect the cost of money as discussed in the text is the risk inherent in a given security. The higher the risk, the higher the security's required return, other things held constant. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 6-1 The Cost of Money QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.06.01 - The Cost of Money NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Cost of money KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:23 PM DATE MODIFIED: 9/21/2017 5:23 PM 4. One of the four most fundamental factors that affect the cost of money as discussed in the text is the time preference for consumption. The higher the time preference, the lower the cost of money, other things held constant. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 6-1 The Cost of Money QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.06.01 - The Cost of Money NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Cost of money KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:23 PM DATE MODIFIED: 9/21/2017 5:23 PM Copyright Cengage Learning. Powered by Cognero.
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5. The four most fundamental factors that affect the cost of money are (1) production opportunities, (2) time preferences for consumption, (3) risk, and (4) inflation. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 6-1 The Cost of Money QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.06.01 - The Cost of Money NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Cost of money KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:23 PM DATE MODIFIED: 9/21/2017 5:23 PM 6. The four most fundamental factors that affect the cost of money are (1) production opportunities, (2) time preferences for consumption, (3) risk, and (4) weather conditions. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 6-1 The Cost of Money QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.06.01 - The Cost of Money NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Cost of money KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:23 PM DATE MODIFIED: 9/21/2017 5:23 PM 7. The four most fundamental factors that affect the cost of money are (1) production opportunities, (2) time preferences for consumption, (3) risk, and (4) the skill level of the economy's labor force. a. True b. False ANSWER: False POINTS: 1 Copyright Cengage Learning. Powered by Cognero.
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DIFFICULTY: EASY REFERENCES: 6-1 The Cost of Money QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.06.01 - The Cost of Money NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Cost of money KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:23 PM DATE MODIFIED: 9/21/2017 5:23 PM 8. If the demand curve for funds increased but the supply curve remained constant, we would expect to see the total amount of funds supplied and demanded increase and interest rates in general also increase. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 6-2 Interest Rate Levels QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.06.02 - Interest Rate Levels NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Interest rate levels KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:23 PM DATE MODIFIED: 9/21/2017 5:23 PM 9. During periods when inflation is increasing, interest rates tend to increase, while interest rates tend to fall when inflation is declining. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 6-2 Interest Rate Levels QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.06.02 - Interest Rate Levels NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic Copyright Cengage Learning. Powered by Cognero.
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STATE STANDARDS: LOCAL STANDARDS: TOPICS: KEYWORDS: DATE CREATED: DATE MODIFIED:
United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. Interest rate levels Bloom's: Comprehension 9/21/2017 5:23 PM 9/21/2017 5:23 PM
10. If investors expect a zero rate of inflation, then the nominal rate of return on a very short-term U.S. Treasury bond should be equal to the real risk-free rate, r*. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 6-3 The Determinants of Market Interest Rates QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.06.03 - The Determinants of Market Interest Rates NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Interest rate determinants KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:23 PM DATE MODIFIED: 9/21/2017 5:23 PM 11. If investors expect the rate of inflation to increase sharply in the future, then we should not be surprised to see an upward sloping yield curve. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 6-3 The Determinants of Market Interest Rates QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.06.03 - The Determinants of Market Interest Rates NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Interest rate determinants KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:23 PM Copyright Cengage Learning. Powered by Cognero.
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12. The risk that interest rates will increase, and that increase will lead to a decline in the prices of outstanding bonds, is called "interest rate risk," or "price risk." a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 6-3 The Determinants of Market Interest Rates QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.06.03 - The Determinants of Market Interest Rates NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Interest rate determinants KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:23 PM DATE MODIFIED: 9/21/2017 5:23 PM 13. The risk that interest rates will decline, and that decline will lead to a decline in the income provided by a bond portfolio as interest and maturity payments are reinvested, is called "reinvestment rate risk." a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 6-3 The Determinants of Market Interest Rates QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.06.03 - The Determinants of Market Interest Rates NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Interest rate determinants KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:23 PM DATE MODIFIED: 9/21/2017 5:23 PM 14. The "yield curve" shows the relationship between bonds' maturities and their yields. a. True b. False ANSWER: True Copyright Cengage Learning. Powered by Cognero.
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POINTS: 1 DIFFICULTY: EASY REFERENCES: 6-4 The Term Structure of Interest Rates QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.06.04 - The Term Structure of Interest Rates NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Term structure KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:23 PM DATE MODIFIED: 9/21/2017 5:23 PM 15. Because the maturity risk premium is normally positive, the yield curve is normally upward sloping. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 6-4 The Term Structure of Interest Rates QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.06.04 - The Term Structure of Interest Rates NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Term structure KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:23 PM DATE MODIFIED: 9/21/2017 5:23 PM 16. Because the maturity risk premium is normally positive, the yield curve must have an upward slope. If you measure the yield curve and find a downward slope, you must have done something wrong. a. True b. False ANSWER: False RATIONALE: If the rate of inflation is expected to decline sharply in the future, this could offset the positive MRP and result in a downward-sloping yield curve. POINTS: 1 DIFFICULTY: EASY REFERENCES: 6-4 The Term Structure of Interest Rates QUESTION TYPE: True / False HAS VARIABLES: False Copyright Cengage Learning. Powered by Cognero.
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LEARNING OBJECTIVES: FOFM.BRIG.17.06.04 - The Term Structure of Interest Rates NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Term structure KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:23 PM DATE MODIFIED: 9/21/2017 5:23 PM 17. If the Treasury yield curve were downward sloping, the yield to maturity on a 10-year Treasury coupon bond would be higher than that on a 1-year T-bill. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 6-4 The Term Structure of Interest Rates QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.06.04 - The Term Structure of Interest Rates NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Term structure KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:23 PM DATE MODIFIED: 9/21/2017 5:23 PM 18. If the pure expectations theory is correct, a downward sloping yield curve indicates that interest rates are expected to decline in the future. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 6-4 The Term Structure of Interest Rates QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.06.04 - The Term Structure of Interest Rates NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Term structure Copyright Cengage Learning. Powered by Cognero.
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19. An upward-sloping yield curve is often call a "normal" yield curve, while a downward-sloping yield curve is called "abnormal." a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 6-4 The Term Structure of Interest Rates QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.06.04 - The Term Structure of Interest Rates NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Term structure KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:23 PM DATE MODIFIED: 9/21/2017 5:23 PM 20. Since yield curves are based on a real risk-free rate plus the expected rate of inflation, at any given time there can be only one yield curve, and it applies to both corporate and Treasury securities. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 6-5 What Determines the Shape of the Yeild Curve? QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.06.05 - What Determines the Shape of the Yield Curve? NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Yield curve shape KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:23 PM DATE MODIFIED: 9/21/2017 5:23 PM 21. Suppose the federal deficit increased sharply from one year to the next, and the Federal Reserve kept the money supply constant. Other things held constant, we would expect to see interest rates decline. Copyright Cengage Learning. Powered by Cognero.
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a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 6-7 Macroeconomic Factors That Influence Interest Rates QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.06.07 - Macroeconomic Factors That Influence Interest Rate Levels NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Macroeconomic factors KEYWORDS: Bloom's: Synthesis DATE CREATED: 9/21/2017 5:23 PM DATE MODIFIED: 9/21/2017 5:23 PM 22. The Federal Reserve tends to take actions to increase interest rates when the economy is very strong and to decrease rates when the economy is weak. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 6-7 Macroeconomic Factors That Influence Interest Rates QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.06.07 - Macroeconomic Factors That Influence Interest Rate Levels NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Macroeconomic factors KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:23 PM DATE MODIFIED: 9/21/2017 5:23 PM 23. One of the four most fundamental factors that affect the cost of money as discussed in the text is the availability of production opportunities and their expected rates of return. If production opportunities are relatively good, then interest rates will tend to be relatively high, other things held constant. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE Copyright Cengage Learning. Powered by Cognero.
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REFERENCES: 6-1 The Cost of Money QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFMC.BRIG.16.06.01 - The Cost of Money NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Cost of money KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:23 PM DATE MODIFIED: 9/21/2017 5:23 PM Multiple Choice: Conceptual 24. Assume that inflation is expected to decline steadily in the future, but that the real risk-free rate, r*, will remain constant. Which of the following statements is CORRECT, other things held constant? a. If the pure expectations theory holds, the Treasury yield curve must be downward sloping. b. If the pure expectations theory holds, the corporate yield curve must be downward sloping. c. If there is a positive maturity risk premium, the Treasury yield curve must be upward sloping. d. If inflation is expected to decline, there can be no maturity risk premium. e. The expectations theory cannot hold if inflation is decreasing. ANSWER: a POINTS: 1 DIFFICULTY: EASY/MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False PREFACE NAME: MC Conceptual LEARNING OBJECTIVES: FOFM.BRIG.17.06.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Yield curve KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:23 PM DATE MODIFIED: 9/21/2017 5:23 PM 25. Which of the following factors would be most likely to lead to an increase in nominal interest rates? a. Households reduce their consumption and increase their savings. b. A new technology like the Internet has just been introduced, and it increases investment opportunities. c. There is a decrease in expected inflation. d. The economy falls into a recession. e. The Federal Reserve decides to try to stimulate the economy. Copyright Cengage Learning. Powered by Cognero.
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ANSWER: RATIONALE:
b If the new technology were so efficient that it takes an underdeveloped economy from a subsistence level, where savings are necessarily low and rates high, to a level where people can afford to save, this might cause interest rates to decline. However, it would take time for this to occur. POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 6-2 Interest Rate Levels QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.06.02 - Interest Rate Levels NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Interest rate levels KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:23 PM DATE MODIFIED: 9/21/2017 5:23 PM 26. Which of the following statements is CORRECT, other things held constant? a. If companies have fewer good investment opportunities, interest rates are likely to increase. b. If individuals increase their savings rate, interest rates are likely to increase. c. If expected inflation increases, interest rates are likely to increase. d. Interest rates on all debt securities tend to rise during recessions because recessions increase the possibility of bankruptcy, hence the riskiness of all debt securities. e. Interest rates on long-term bonds are more volatile than rates on short-term debt securities like T-bills. ANSWER: c POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 6-2 Interest Rate Levels QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.06.02 - Interest Rate Levels NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Interest rate levels KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:23 PM DATE MODIFIED: 9/21/2017 5:23 PM 27. Which of the following would be most likely to lead to a higher level of interest rates in the economy? a. Households start saving a larger percentage of their income. b. Corporations step up their expansion plans and thus increase their demand for capital. Copyright Cengage Learning. Powered by Cognero.
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c. The level of inflation begins to decline. d. The economy moves from a boom to a recession. e. The Federal Reserve decides to try to stimulate the economy. ANSWER: b POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 6-2 Interest Rate Levels QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.06.02 - Interest Rate Levels NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Interest rate levels KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:23 PM DATE MODIFIED: 9/21/2017 5:23 PM 28. Suppose the U.S. Treasury issued $50 billion of short-term securities and sold them to the public. Other things held constant, what would be the most likely effect on short-term securities' prices and interest rates? a. Prices and interest rates would both rise. b. Prices would rise and interest rates would decline. c. Prices and interest rates would both decline. d. Prices would decline and interest rates would rise. e. There is no reason to expect a change in either prices or interest rates. ANSWER: d POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 6-2 Interest Rate Levels QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.06.02 - Interest Rate Levels NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Financial transactions KEYWORDS: Bloom's: Application DATE CREATED: 9/21/2017 5:23 PM DATE MODIFIED: 9/21/2017 5:23 PM 29. Assume that interest rates on 20-year Treasury and corporate bonds are as follows: T-bond = 7.72%
AAA = 8.72%
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A = 9.64%
BBB = 10.18% Page 339
The differences in these rates were probably caused primarily by: a. Tax effects. b. Default and liquidity risk differences. c. Maturity risk differences. d. Inflation differences. e. Real risk-free rate differences. ANSWER: b POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 6-3 The Determinants of Market Interest Rates QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.06.03 - The Determinants of Market Interest Rates NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Default risk premium KEYWORDS: Bloom's: Application DATE CREATED: 9/21/2017 5:23 PM DATE MODIFIED: 9/21/2017 5:23 PM 30. In the foreseeable future, the real risk-free rate of interest, r*, is expected to remain at 3%, inflation is expected to steadily increase, and the maturity risk premium is expected to be 0.1(t 1)%, where t is the number of years until the bond matures. Given this information, which of the following statements is CORRECT? a. The yield on 2-year Treasury securities must exceed the yield on 5-year Treasury securities. b. The yield on 5-year Treasury securities must exceed the yield on 10-year corporate bonds. c. The yield on 5-year corporate bonds must exceed the yield on 8-year Treasury bonds. d. The yield curve must be "humped." e. The yield curve must be upward sloping. ANSWER: e POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 6-4 The Term Structure of Interest Rates QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.06.04 - The Term Structure of Interest Rates NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Yield curve KEYWORDS: Bloom's: Synthesis DATE CREATED: 9/21/2017 5:23 PM DATE MODIFIED: 9/21/2017 5:23 PM Copyright Cengage Learning. Powered by Cognero.
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31. If the Treasury yield curve is downward sloping, how should the yield to maturity on a 10-year Treasury coupon bond compare to that on a 1-year T-bill? a. The yield on a 10-year bond would be less than that on a 1-year bill. b. The yield on a 10-year bond would have to be higher than that on a 1-year bill because of the maturity risk premium. c. It is impossible to tell without knowing the coupon rates of the bonds. d. The yields on the two securities would be equal. e. It is impossible to tell without knowing the relative risks of the two securities. ANSWER: a POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 6-4 The Term Structure of Interest Rates QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.06.04 - The Term Structure of Interest Rates NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Yield curve KEYWORDS: Bloom's: Synthesis DATE CREATED: 9/21/2017 5:23 PM DATE MODIFIED: 9/21/2017 5:23 PM 32. Assume the following: The real risk-free rate, r*, is expected to remain constant at 3%. Inflation is expected to be 3% next year and then to be constant at 2% a year thereafter. The maturity risk premium is zero. Given this information, which of the following statements is CORRECT? a. The yield curve for U.S. Treasury securities will be upward sloping. b. A 5-year corporate bond must have a lower yield than a 5-year Treasury security. c. A 5-year corporate bond must have a lower yield than a 7-year Treasury security. d. The real risk-free rate cannot be constant if inflation is not expected to remain constant. e. This problem assumed a zero maturity risk premium, but that is probably not valid in the real world. ANSWER: e POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 6-4 The Term Structure of Interest Rates QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.06.04 - The Term Structure of Interest Rates NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Yield curve KEYWORDS: Bloom's: Analysis DATE CREATED: 9/21/2017 5:23 PM Copyright Cengage Learning. Powered by Cognero.
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33. Which of the following statements is CORRECT? a. If the maturity risk premium (MRP) is greater than zero, the Treasury bond yield curve must be upward sloping. b. If the maturity risk premium (MRP) equals zero, the Treasury bond yield curve must be flat. c. If inflation is expected to increase in the future and the maturity risk premium (MRP) is greater than zero, the Treasury bond yield curve must be upward sloping. d. If the expectations theory holds, the Treasury bond yield curve will never be downward sloping. e. Because long-term bonds are riskier than short-term bonds, yields on long-term Treasury bonds will always be higher than yields on short-term T-bonds. ANSWER: c POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 6-4 The Term Structure of Interest Rates QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.06.04 - The Term Structure of Interest Rates NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Yield curve KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:23 PM DATE MODIFIED: 9/21/2017 5:23 PM 34. A bond trader observes the following information: The Treasury yield curve is downward sloping. Empirical data indicate that a positive maturity risk premium applies to both Treasury and corporate bonds. Empirical data also indicate that there is no liquidity premium for Treasury securities but that a positive liquidity premium is built into corporate bond yields. On the basis of this information, which of the following statements is most CORRECT? a. A 10-year corporate bond must have a higher yield than a 5-year Treasury bond. b. A 10-year Treasury bond must have a higher yield than a 10-year corporate bond. c. A 5-year corporate bond must have a higher yield than a 10-year Treasury bond. d. The corporate yield curve must be flat. e. Since the Treasury yield curve is downward sloping, the corporate yield curve must also be downward sloping. ANSWER: c POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 6-4 The Term Structure of Interest Rates QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.06.04 - The Term Structure of Interest Rates NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic Copyright Cengage Learning. Powered by Cognero.
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STATE STANDARDS: LOCAL STANDARDS: TOPICS: KEYWORDS: DATE CREATED: DATE MODIFIED:
United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. Yield curve Bloom's: Analysis 9/21/2017 5:23 PM 9/21/2017 5:23 PM
35. The real risk-free rate is expected to remain constant at 3% in the future, a 2% rate of inflation is expected for the next 2 years, after which inflation is expected to increase to 4%, and there is a positive maturity risk premium that increases with years to maturity. Given these conditions, which of the following statements is CORRECT? a. The yield on a 2-year T-bond must exceed that on a 5-year T-bond. b. The yield on a 5-year Treasury bond must exceed that on a 2-year Treasury bond. c. The yield on a 7-year Treasury bond must exceed that of a 5-year corporate bond. d. The conditions in the problem cannot all be true--they are internally inconsistent. e. The Treasury yield curve under the stated conditions would be humped rather than have a consistent positive or negative slope. ANSWER: b POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 6-4 The Term Structure of Interest Rates QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.06.04 - The Term Structure of Interest Rates NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Yield curve KEYWORDS: Bloom's: Analysis DATE CREATED: 9/21/2017 5:23 PM DATE MODIFIED: 9/21/2017 5:23 PM 36. Which of the following statements is CORRECT? a. The yield on a 3-year Treasury bond cannot exceed the yield on a 10-year Treasury bond. b. The yield on a 2-year corporate bond should always exceed the yield on a 2-year Treasury bond. c. The yield on a 3-year corporate bond should always exceed the yield on a 2-year corporate bond. d. The yield on a 10-year AAA-rated corporate bond should always exceed the yield on a 5-year AAA-rated corporate bond. e. The following represents a "possibly reasonable" formula for the maturity risk premium on bonds: MRP = 0.1%(t), where t is the years to maturity. ANSWER: b POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 6-4 The Term Structure of Interest Rates QUESTION TYPE: Multiple Choice Copyright Cengage Learning. Powered by Cognero.
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HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.06.04 - The Term Structure of Interest Rates NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Yield curve KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:23 PM DATE MODIFIED: 9/21/2017 5:23 PM 37. Which of the following statements is CORRECT? a. The yield on a 2-year corporate bond should always exceed the yield on a 2-year Treasury bond. b. The yield on a 3-year corporate bond should always exceed the yield on a 2-year corporate bond. c. The yield on a 3-year Treasury bond should always exceed the yield on a 2-year Treasury bond. d. If inflation is expected to increase, then the yield on a 2-year bond should exceed that on a 3-year bond. e. The real risk-free rate should increase if people expect inflation to increase. ANSWER: a POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 6-4 The Term Structure of Interest Rates QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.06.04 - The Term Structure of Interest Rates NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Yield curve KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:23 PM DATE MODIFIED: 9/21/2017 5:23 PM 38. Which of the following statements is CORRECT? a. If inflation is expected to increase in the future, and if the maturity risk premium (MRP) is greater than zero, then the Treasury yield curve will have an upward slope. b. If the maturity risk premium (MRP) is greater than zero, then the yield curve must have an upward slope. c. Because long-term bonds are riskier than short-term bonds, yields on long-term Treasury bonds will always be higher than yields on short-term T-bonds. d. If the maturity risk premium (MRP) equals zero, the yield curve must be flat. e. The yield curve can never be downward sloping. ANSWER: a RATIONALE: The slope of the yield curve depends primarily on expected inflation and the MRP. The greater the expected increase in inflation, and the higher the MRP, the steeper the slope of the yield curve. If inflation is expected to decline, then even if the MRP is positive, the curve could still have a downward slope. Copyright Cengage Learning. Powered by Cognero.
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POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 6-4 The Term Structure of Interest Rates QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.06.04 - The Term Structure of Interest Rates NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Yield curve KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:23 PM DATE MODIFIED: 9/21/2017 5:23 PM 39. Assume that the current corporate bond yield curve is upward sloping. Under this condition, then we could be sure that a. Inflation is expected to decline in the future. b. The economy is not in a recession. c. Long-term bonds are a better buy than short-term bonds. d. Maturity risk premiums could help to explain the yield curve’s upward slope. e. Long-term interest rates are more volatile than short-term rates. ANSWER: d POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 6-4 The Term Structure of Interest Rates QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.06.04 - The Term Structure of Interest Rates NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Yield curve KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:23 PM DATE MODIFIED: 9/21/2017 5:23 PM 40. Which of the following statements is CORRECT? a. The higher the maturity risk premium, the higher the probability that the yield curve will be inverted. b. The most likely explanation for an inverted yield curve is that investors expect inflation to increase. c. The most likely explanation for an inverted yield curve is that investors expect inflation to decrease. d. If the yield curve is inverted, short-term bonds have lower yields than long-term bonds. e. Inverted yield curves can exist for Treasury bonds, but because of default premiums, the corporate yield curve can never be inverted. ANSWER: c POINTS: 1 Copyright Cengage Learning. Powered by Cognero.
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DIFFICULTY: MODERATE REFERENCES: 6-4 The Term Structure of Interest Rates QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.06.04 - The Term Structure of Interest Rates NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Inverted yield curves KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:23 PM DATE MODIFIED: 9/21/2017 5:23 PM 41. Assume that the current corporate bond yield curve is upward sloping, or normal. Under this condition, we could be sure that a. Long-term interest rates are more volatile than short-term rates. b. Inflation is expected to decline in the future. c. The economy is not in a recession. d. Long-term bonds are a better buy than short-term bonds. e. Maturity risk premiums could help to explain the yield curve's upward slope. ANSWER: e POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 6-5 What Determines the Shape of the Yield Curve? QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.06.05 - What Determines the Shape of the Yield Curve? NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Yield curve shape KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:23 PM DATE MODIFIED: 9/21/2017 5:23 PM 42. Assuming that the term structure of interest rates is determined as posited by the pure expectations theory, which of the following statements is CORRECT? a. In equilibrium, long-term rates must be equal to short-term rates. b. An upward-sloping yield curve implies that future short-term rates are expected to decline. c. The maturity risk premium is assumed to be zero. d. Inflation is expected to be zero. e. Consumer prices as measured by an index of inflation are expected to rise at a constant rate. ANSWER: c POINTS: 1 Copyright Cengage Learning. Powered by Cognero.
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DIFFICULTY: MODERATE REFERENCES: 6-6 Using the Yield Curve to Estimate Future Interest Rates QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.06.06 - Using the Yield Curve to Estimate Future Interest Rates NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Expectations theory KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:23 PM DATE MODIFIED: 9/21/2017 5:23 PM 43. Assume that the rate on a 1-year bond is now 6%, but all investors expect 1-year rates to be 7% one year from now and then to rise to 8% two years from now. Assume also that the pure expectations theory holds, hence the maturity risk premium equals zero. Which of the following statements is CORRECT? a. The yield curve should be downward sloping, with the rate on a 1-year bond at 6%. b. The interest rate today on a 2-year bond should be approximately 6%. c. The interest rate today on a 2-year bond should be approximately 7%. d. The interest rate today on a 3-year bond should be approximately 7%. e. The interest rate today on a 3-year bond should be approximately 8%. ANSWER: d POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 6-6 Using the Yield Curve to Estimate Future Interest Rates QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.06.06 - Using the Yield Curve to Estimate Future Interest Rates NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Expectations theory KEYWORDS: Bloom's: Analysis DATE CREATED: 9/21/2017 5:23 PM DATE MODIFIED: 9/21/2017 5:23 PM 44. The real risk-free rate of interest is expected to remain constant at 3% for the foreseeable future. However, inflation is expected to increase steadily over the next 30 years, so the Treasury yield curve has an upward slope. Assume that the pure expectations theory holds. You are also considering two corporate bonds, one with a 5-year maturity and one with a 10-year maturity. Both have the same default and liquidity risks. Given these assumptions, which of these statements is CORRECT? a. Since the pure expectations theory holds, the 10-year corporate bond must have the same yield as the 5-year corporate bond. b. Since the pure expectations theory holds, all 5-year Treasury bonds must have higher yields than all 10-year Treasury bonds. Copyright Cengage Learning. Powered by Cognero.
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c. Since the pure expectations theory holds, all 10-year corporate bonds must have the same yield as 10-year Treasury bonds. d. The 10-year Treasury bond must have a higher yield than the 5-year corporate bond. e. The 10-year corporate bond must have a higher yield than the 5-year corporate bond. ANSWER: e POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 6-6 Using the Yield Curve to Estimate Future Interest Rates QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.06.06 - Using the Yield Curve to Estimate Future Interest Rates NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Expectations theory KEYWORDS: Bloom's: Synthesis DATE CREATED: 9/21/2017 5:23 PM DATE MODIFIED: 9/21/2017 5:23 PM 45. If the pure expectations theory of the term structure is correct, which of the following statements would be CORRECT? a. An upward-sloping yield curve would imply that interest rates are expected to be lower in the future. b. If a 1-year Treasury bill has a yield to maturity of 7% and a 2-year Treasury bill has a yield to maturity of 8%, this would imply the market believes that 1-year rates will be 7.5% one year from now. c. The yield on a 5-year corporate bond should always exceed the yield on a 3-year Treasury bond. d. Interest rate (price) risk is higher on long-term bonds, but reinvestment rate risk is higher on short-term bonds. e. Interest rate (price) risk is higher on short-term bonds, but reinvestment rate risk is higher on long-term bonds. ANSWER: d POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 6-6 Using the Yield Curve to Estimate Future Interest Rates QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.06.06 - Using the Yield Curve to Estimate Future Interest Rates NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Expectations theory KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:23 PM DATE MODIFIED: 9/21/2017 5:23 PM 46. Assuming the pure expectations theory is correct, which of the following statements is CORRECT? a. If 2-year Treasury bond rates exceed 1-year rates, then the market must expect interest rates to rise. Copyright Cengage Learning. Powered by Cognero.
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b. If both 2-year and 3-year Treasury rates are 7%, then 5-year rates must also be 7%. c. If 1-year rates are 6% and 2-year rates are 7%, then the market expects 1-year rates to be 6.5% in one year. d. Reinvestment rate risk is higher on long-term bonds, and interest rate (price) risk is higher on short-term bonds. e. Interest rate (price) risk and reinvestment rate risk are relevant to investors in corporate bonds, but these concepts do not apply to Treasury bonds. ANSWER: a POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 6-6 Using the Yield Curve to Estimate Future Interest Rates QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.06.06 - Using the Yield Curve to Estimate Future Interest Rates NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Expectations theory KEYWORDS: Bloom's: Synthesis DATE CREATED: 9/21/2017 5:23 PM DATE MODIFIED: 9/21/2017 5:23 PM 47. If the pure expectations theory holds, which of the following statements is CORRECT? a. The yield curve for both Treasury and corporate bonds should be flat. b. The yield curve for Treasury securities would be flat, but the yield curve for corporate securities might be downward sloping. c. The yield curve for Treasury securities cannot be downward sloping. d. The maturity risk premium would be zero. e. If 2-year bonds yield more than 1-year bonds, an investor with a 2-year time horizon would almost certainly end up with more money if he or she bought 2-year bonds. ANSWER: d POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 6-6 Using the Yield Curve to Estimate Future Interest Rates QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.06.06 - Using the Yield Curve to Estimate Future Interest Rates NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Expectations theory KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:23 PM DATE MODIFIED: 9/21/2017 5:23 PM Copyright Cengage Learning. Powered by Cognero.
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48. Which of the following statements is CORRECT? a. The yield on a 3-year Treasury bond cannot exceed the yield on a 10-year Treasury bond. b. The real risk-free rate is higher for corporate than for Treasury bonds. c. Most evidence suggests that the maturity risk premium is zero. d. Liquidity premiums are higher for Treasury than for corporate bonds. e. The pure expectations theory states that the maturity risk premium for long-term Treasury bonds is zero and that differences in interest rates across different Treasury maturities are driven by expectations about future interest rates. ANSWER: e POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.06.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Interest rates KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:23 PM DATE MODIFIED: 9/21/2017 5:23 PM 49. Which of the following statements is CORRECT? a. The maturity premiums embedded in the interest rates on U.S. Treasury securities are due primarily to the fact that the probability of default is higher on long-term bonds than on short-term bonds. b. Reinvestment rate risk is lower, other things held constant, on long-term than on short-term bonds. c. The pure expectations theory of the term structure states that borrowers generally prefer to borrow on a longterm basis while savers generally prefer to lend on a short-term basis, and as a result, the yield curve is normally upward sloping. d. If the maturity risk premium were zero and interest rates were expected to decrease in the future, then the yield curve for U.S. Treasury securities would, other things held constant, have an upward slope. e. Liquidity premiums are generally higher on Treasury than on corporate bonds. ANSWER: b POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.06.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Term structure Copyright Cengage Learning. Powered by Cognero.
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KEYWORDS: DATE CREATED: DATE MODIFIED:
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50. If the pure expectations theory is correct (that is, the maturity risk premium is zero), which of the following is CORRECT? a. An upward-sloping Treasury yield curve means that the market expects interest rates to decline in the future. b. A 5-year T-bond would always yield less than a 10-year T-bond. c. The yield curve for corporate bonds may be upward sloping even if the Treasury yield curve is flat. d. The yield curve for stocks must be above that for bonds, but both yield curves must have the same slope. e. If the maturity risk premium is zero for Treasury bonds, then it must be negative for corporate bonds. ANSWER: c POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.06.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Yield curve KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:23 PM DATE MODIFIED: 9/21/2017 5:23 PM 51. Which of the following statements is CORRECT? a. Even if the pure expectations theory is correct, there might at times be an inverted Treasury yield curve. b. If the yield curve is inverted, short-term bonds have lower yields than long-term bonds. c. The higher the maturity risk premium, the higher the probability that the yield curve will be inverted. d. Inverted yield curves can exist for Treasury bonds, but because of default premiums, the corporate yield curve cannot become inverted. e. The most likely explanation for an inverted yield curve is that investors expect inflation to increase in the future. ANSWER: a POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.06.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. Copyright Cengage Learning. Powered by Cognero.
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52. Inflation is expected to increase steadily over the next 10 years, there is a positive maturity risk premium on both Treasury and corporate bonds, and the real risk-free rate of interest is expected to remain constant. Which of the following statements is CORRECT? a. The yield on 10-year Treasury securities must exceed the yield on 7-year Treasury securities. b. The yield on any corporate bond must exceed the yields on all Treasury bonds. c. The yield on 7-year corporate bonds must exceed the yield on 10-year Treasury bonds. d. The stated conditions cannot all be true – they are internally inconsistent. e. The Treasury yield curve under the stated conditions would be humped rather than have a consistent positive or negative slope. ANSWER: a POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.06.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Yield curve KEYWORDS: Bloom's: Synthesis DATE CREATED: 9/21/2017 5:23 PM DATE MODIFIED: 9/21/2017 5:23 PM 53. Which of the following statements is CORRECT? a. Downward sloping yield curves are inconsistent with the expectations theory. b. The actual shape of the yield curve depends only on expectations about future inflation. c. If the pure expectations theory is correct, a downward sloping yield curve indicates that interest rates are expected to decline in the future. d. If the yield curve is upward sloping, the maturity risk premium must be positive and the inflation rate must be zero. e. Yield curves must be either upward or downward sloping - they cannot first rise and then decline. ANSWER: c POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.06.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic Copyright Cengage Learning. Powered by Cognero.
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STATE STANDARDS: LOCAL STANDARDS: TOPICS: KEYWORDS: DATE CREATED: DATE MODIFIED:
United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. Yield curve Bloom's: Comprehension 9/21/2017 5:23 PM 9/21/2017 5:23 PM
54. Short Corp just issued bonds that will mature in 10 years, and Long Corp issued bonds that will mature in 20 years. Both bonds promise to pay a semiannual coupon, they are not callable or corvertible, and they are equally liquid. Further assume that the Treasury yield curve is based only on the pure expectations theory. Under these conditions, which of the following statements is CORRECT? a. If the yield curve for Treasury securities is flat, Short's bond must under all conditions have the same yield as Long's bonds. b. If the yield curve for Treasury securities is upward sloping, Long's bonds must under all conditions have a higher yield than Short's bonds. c. If Long's and Short's bonds have the same default risk, their yields must under all conditions be equal. d. If the Treasury yield curve is upward sloping and Short has less default risk than Long, then Short's bonds must under all conditions have a lower yield than Long's bonds. e. If the Treasury yield curve is downward sloping, Long's bonds must under all conditions have the lower yield. ANSWER: d POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.06.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Corporate yield curve KEYWORDS: Bloom's: Analysis DATE CREATED: 9/21/2017 5:23 PM DATE MODIFIED: 9/21/2017 5:23 PM Multiple Choice: Problems Interest rates are important in finance, and it is important for all students to understand the basics of how they are determined. However, the chapter really has two aspects that become clear when we try to write test questions and problems for the chapter. First, the material on the fundamental determinants of interest rates - the real risk-free rate plus a set of premiums - is logical and intuitive, and easy in a testing sense. However, the second set of material, that dealing with the yield curve and the relationship between 1-year rates and longer-term rates, is more mathematical and less intuitive, and test questions dealing with it tend to be more difficult, especially for students who are not good at math. As a result, problems on the chapter tend to be either relatively easy or relatively difficult, with the difficult ones being as much exercises in algebra as in finance. In the test bank for prior editions, we tended to use primarily difficult problems that addressed the problem of forecasting forward rates based on yield curve data. In this edition, we leaned more toward easy problems that address intuitive aspects of interest rate theory. We should note one issue that can be confusing if it is not handled carefully - the use of arithmetic versus geometric Copyright Cengage Learning. Powered by Cognero.
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averages when bringing inflation into interest rate determination in yield curve related problems. It is easy to explain why a 2-year rate is an average of two 1-year rates, and it is logical to use a compounding process that is essentially a geometric average that includes the effects of cross-product terms. It is also easy to explain that average inflation rates should be calculated as geometric averages. However, when we combine inflation with interest rates, rather than using the formulation rRF = [(1 + r*)(1 + IP)] – 1, almost everyone, from Federal Reserve officials down to textbook authors, uses the approximation rRF = r* + IP. Understandably, this can confuse students when they start working problems. In both the text and test bank problems we make it clear to students which procedure to use. Quite a few of the problems are based on this basic equation: r = r* + IP + MRP + DRP + LP. We tell our students to keep this equation in mind, and that they will have to do some transposing of terms to solve some of the problems. The other key equation used in the problems is the one for finding the 1-year forward rate, given the current 1-year and 2 2 2-year rates: (1 + 2-year rate) = (1 + 1-year rate)(1 + X), which converts to X = (1 + 2yr) /(1 + 1yr) – 1, where X is the 1-year forward rate. This equation, which is used in a number of problems, assumes that the pure expectations theory is correct and thus the maturity risk premium is zero. 55. Suppose 1-year T-bills currently yield 7.00% and the future inflation rate is expected to be constant at 6.00% per year. What is the real risk-free rate of return, r*? Disregard any cross-product terms, i.e., if averaging is required, use the arithmetic average. a. 0.82% b. 1.15% c. 0.97% d. 0.85% e. 1.00% ANSWER: e RATIONALE: 1-year T-bill rate 7.00% Inflation 6.00% Difference = real risk-free rate, r* 1.00% POINTS: 1 DIFFICULTY: EASY REFERENCES: 6-3 The Determinants of Market Interest Rates QUESTION TYPE: Multiple Choice HAS VARIABLES: True PREFACE NAME: Problems LEARNING OBJECTIVES: FOFM.BRIG.17.06.03 - The Determinants of Market Interest Rates NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Real risk-free rate KEYWORDS: Bloom's: Evaluation DATE CREATED: 9/21/2017 5:23 PM DATE MODIFIED: 9/21/2017 5:23 PM 56. Suppose the real risk-free rate is 3.50% and the future rate of inflation is expected to be constant at 4.80%. What rate of return would you expect on a 1-year Treasury security, assuming the pure expectations theory is valid? Disregard crossproduct terms, i.e., if averaging is required, use the arithmetic average. a. 8.38% b. 9.79% c. 8.80% Copyright Cengage Learning. Powered by Cognero.
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d. 8.30% e. 9.38% ANSWER: RATIONALE:
d Real risk-free rate, r* 3.50% Inflation 4.80% Yield on 1-year T-bond 8.30%
POINTS: 1 DIFFICULTY: EASY REFERENCES: 6-3 The Determinants of Market Interest Rates QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.06.03 - The Determinants of Market Interest Rates NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Interest rates KEYWORDS: Bloom's: Evaluation DATE CREATED: 9/21/2017 5:23 PM DATE MODIFIED: 9/21/2017 5:23 PM 57. Suppose the real risk-free rate is 2.50% and the future rate of inflation is expected to be constant at 7.00%. What rate of return would you expect on a 5-year Treasury security, assuming the pure expectations theory is valid? Disregard crossproduct terms, i.e., if averaging is required, use the arithmetic average. a. 9.50% b. 11.59% c. 7.70% d. 7.41% e. 8.46% ANSWER: a RATIONALE: Real risk-free rate, r* 2.50% Inflation 7.00% Yield on 5-year T-bond 9.50% POINTS: 1 DIFFICULTY: EASY REFERENCES: 6-3 The Determinants of Market Interest Rates QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.06.03 - The Determinants of Market Interest Rates NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Interest rates KEYWORDS: Bloom's: Evaluation DATE CREATED: 9/21/2017 5:23 PM Copyright Cengage Learning. Powered by Cognero.
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58. The real risk-free rate is 3.05%, inflation is expected to be 3.60% this year, and the maturity risk premium is zero. Ignoring any cross-product terms, i.e., if averaging is required, use the arithmetic average, what is the equilibrium rate of return on a 1-year Treasury bond? a. 8.18% b. 6.65% c. 5.72% d. 5.32% e. 5.52% ANSWER: b RATIONALE: Real risk-free rate, r* 3.05% Inflation this year 3.60% 6.65% 1-year bond yield: rRF = r* + IP 6.760% The theoretically more precise answer is (1+r*)(1+IP) 1 = POINTS: 1 DIFFICULTY: EASY REFERENCES: 6-3 The Determinants of Market Interest Rates QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.06.03 - The Determinants of Market Interest Rates NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Interest rates KEYWORDS: Bloom's: Evaluation DATE CREATED: 9/21/2017 5:23 PM DATE MODIFIED: 9/21/2017 5:23 PM 59. Suppose the real risk-free rate is 3.00%, the average expected future inflation rate is 5.90%, and a maturity risk premium of 0.10% per year to maturity applies, i.e., MRP = 0.10%(t), where t is the number of years to maturity. What rate of return would you expect on a 1-year Treasury security, assuming the pure expectations theory is NOT valid? Disregard cross-product terms, i.e., if averaging is required, use the arithmetic average. a. 9.27% b. 8.91% c. 7.29% d. 9.00% e. 10.35% ANSWER: d RATIONALE: Real risk-free rate, 3.00% r* Inflation 5.90% MRP Years: 1 Per year: 0.10% 0.10% 9.00% 1-year bond yield: rRF = r* + IP + MRP POINTS:
1
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DIFFICULTY: EASY REFERENCES: 6-3 The Determinants of Market Interest Rates QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.06.03 - The Determinants of Market Interest Rates NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Interest rates and MRP KEYWORDS: Bloom's: Evaluation DATE CREATED: 9/21/2017 5:23 PM DATE MODIFIED: 9/21/2017 5:23 PM 60. Suppose the real risk-free rate is 4.20%, the average expected future inflation rate is 2.50%, and a maturity risk premium of 0.10% per year to maturity applies, i.e., MRP = 0.10%(t), where t is the number of years to maturity, hence the pure expectations theory is NOT valid. What rate of return would you expect on a 4-year Treasury security? Disregard cross-product terms, i.e., if averaging is required, use the arithmetic average. a. 7.67% b. 7.10% c. 7.53% d. 6.96% e. 5.40% ANSWER: b RATIONALE: Real risk-free rate, 4.20% r* Inflation 2.50% MRP Years: 4 Per year: 0.10% 0.40% Yield on t-year T-bond = r* + IPt + MRPt 7.10% POINTS: 1 DIFFICULTY: EASY REFERENCES: 6-3 The Determinants of Market Interest Rates QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.06.03 - The Determinants of Market Interest Rates NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Interest rates and MRP KEYWORDS: Bloom's: Evaluation DATE CREATED: 9/21/2017 5:23 PM DATE MODIFIED: 9/21/2017 5:23 PM 61. The real risk-free rate is 3.55%, inflation is expected to be 3.60% this year, and the maturity risk premium is zero. Taking account of the cross-product term, i.e., not ignoring it, what is the equilibrium rate of return on a 1-year Treasury Copyright Cengage Learning. Powered by Cognero.
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bond? (Round your final answer to 3 decimal places.) a. 8.224% b. 7.059% c. 6.914% d. 7.278% e. 8.442% ANSWER: d RATIONALE: Real risk-free rate, r* 3.55% Inflation this year 3.60% 7.278% 1-year bond yield: rRF = (1+r*)(1+IP) - 1 The approximation method, which ignores the cross product, is r* + IP= 7.150% POINTS: 1 DIFFICULTY: EASY REFERENCES: 6-5 What Determines the Shape of the Yield Curve? QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.06.05 - What Determines the Shape of the Yield Curve? NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Int. rates - cross product KEYWORDS: Bloom's: Evaluation DATE CREATED: 9/21/2017 5:23 PM DATE MODIFIED: 9/21/2017 5:23 PM 62. Suppose the yield on a 10-year T-bond is currently 5.05% and that on a 10-year Treasury Inflation Protected Security (TIPS) is 1.80%. Suppose further that the MRP on a 10-year T-bond is 0.90%, that no MRP is required on a TIPS, and that no liquidity premium is required on any T-bond. Given this information, what is the expected rate of inflation over the next 10 years? Disregard cross-product terms, i.e., if averaging is required, use the arithmetic average. a. 2.66% b. 1.88% c. 2.35% d. 2.00% e. 2.49% ANSWER: c RATIONALE: 10-year T-bond yield 5.05% 10-year TIPS yield = r* 1.80% MRP, 10-year T-bond only 0.90% Expected inflation = rT10 - r* - MRP 2.35% POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 6-3 The Determinants of Market Interest Rates QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.06.03 - The Determinants of Market Interest Rates Copyright Cengage Learning. Powered by Cognero.
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NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: TIPS and inflation KEYWORDS: Bloom's: Evaluation DATE CREATED: 9/21/2017 5:23 PM DATE MODIFIED: 9/21/2017 5:23 PM 63. Suppose the rate of return on a 10-year T-bond is 6.90%, the expected average rate of inflation over the next 10 years is 2.0%, the MRP on a 10-year T-bond is 0.9%, no MRP is required on a TIPS, and no liquidity premium is required on any Treasury security. Given this information, what should the yield be on a 10-year TIPS? Disregard cross-product terms, i.e., if averaging is required, use the arithmetic average. a. 4.60% b. 4.00% c. 3.04% d. 4.76% e. 3.92% ANSWER: b RATIONALE: 10-year T-bond yield 6.90% Expected inflation 2.00% MRP, 10-year T-bond only 0.90% 4.00% TIPS Yield = r* = rT10 - IP - MRP POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 6-3 The Determinants of Market Interest Rates QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.06.03 - The Determinants of Market Interest Rates NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Real risk-free rate of return and TIPS KEYWORDS: Bloom's: Evaluation DATE CREATED: 9/21/2017 5:23 PM DATE MODIFIED: 9/21/2017 5:23 PM 64. Suppose 10-year T-bonds have a yield of 5.30% and 10-year corporate bonds yield 6.65%. Also, corporate bonds have a 0.25% liquidity premium versus a zero liquidity premium for T-bonds, and the maturity risk premium on both Treasury and corporate 10-year bonds is 1.15%. What is the default risk premium on corporate bonds? a. 1.22% b. 1.10% c. 1.34% d. 0.86% e. 1.20% ANSWER: b Copyright Cengage Learning. Powered by Cognero.
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RATIONALE:
T-bond yield Corporate yield LP, corporate bond only rCorp = r* + IP + MRP + DRP + LP rT-bond = r* + IP + MRP + DRP + LP DRP = rCorp - rT-bond - LP =
5.30% 6.65% 0.25%
1.10%
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 6-5 What Determines the Shape of the Yield Curve? QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.06.05 - What Determines the Shape of the Yield Curve? NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Default risk premium KEYWORDS: Bloom's: Evaluation DATE CREATED: 9/21/2017 5:23 PM DATE MODIFIED: 9/21/2017 5:23 PM 65. If 10-year T-bonds have a yield of 6.2%, 10-year corporate bonds yield 7.9%, the maturity risk premium on all 10year bonds is 1.3%, and corporate bonds have a 0.4% liquidity premium versus a zero liquidity premium for T-bonds, what is the default risk premium on the corporate bond? a. 1.46% b. 1.30% c. 1.60% d. 1.51% e. 1.40% ANSWER: b RATIONALE: Basic equation: r = r* + IP + MRP + DRP + LP. r*, IP, and MRP are included in both bonds, hence are not relevant. Liquidity risk premium = LP is included in corporate only 0.40% Corporate bond yield = r = r* + IP + MRP + DRP + LP 7.90% 6.20% T-bond yield = rRF = r* + IP + MRP + 0 + 0. Difference = DRP + LP = DRP + 0.40% = 1.70% DRP = Difference - LP = 1.30% POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 6-5 What Determines the Shape of the Yield Curve? QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.06.05 - What Determines the Shape of the Yield Curve? NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business Copyright Cengage Learning. Powered by Cognero.
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School Outcomes, you do not need to include anything for this category. Default risk premium Bloom's: Evaluation 9/21/2017 5:23 PM 9/21/2017 5:23 PM
66. Koy Corporation's 5-year bonds yield 8.00%, and 5-year T-bonds yield 5.15%. The real risk-free rate is r* = 3.0%, the inflation premium for 5-year bonds is IP = 1.75%, the liquidity premium for Koy's bonds is LP = 0.75% versus zero for Tbonds, and the maturity risk premium for all bonds is found with the formula MRP = (t – 1) 0.1%, where t = number of years to maturity. What is the default risk premium (DRP) on Koy's bonds? a. 2.16% b. 2.10% c. 2.12% d. 2.48% e. 2.18% ANSWER: b RATIONALE: Basic equation: r = r* + IP + MRP + DRP + LP. Years to maturity: 5 r* In both bonds, so not needed in this problem 3.00% MRP In both bonds, so not needed in this problem 0.40% IP In both bonds, so not needed in this problem 1.75% 8.00% rKoy 5.15% rT-bond LP Included in corp. only 0.75% 2.10% DRP = rKoy - rT-bond - LP POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 6-5 What Determines the Shape of the Yield Curve? QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.06.05 - What Determines the Shape of the Yield Curve? NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Default risk premium KEYWORDS: Bloom's: Evaluation DATE CREATED: 9/21/2017 5:23 PM DATE MODIFIED: 9/21/2017 5:23 PM 67. Keys Corporation's 5-year bonds yield 5.10% and 5-year T-bonds yield 4.40%. The real risk-free rate is r* = 2.5%, the inflation premium for 5-year bonds is IP = 1.50%, the liquidity premium for Keys' bonds is LP = 0.5% versus zero for Tbonds, and the maturity risk premium for all bonds is found with the formula MRP = (t – 1) 0.1%, where t = number of years to maturity. What is the default risk premium (DRP) on Keys' bonds? a. 0.17% b. 0.20% Copyright Cengage Learning. Powered by Cognero.
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c. 0.24% d. 0.19% e. 0.22% ANSWER: RATIONALE:
b Maturity rKeys Yield rT-bond Yield r* Included in both bonds IP Included in both bonds MRP Included in both bonds (t - 1) × 0.1% LP Included in Keys only Included in Keys only. Must DRP find. rT-bond = r* + IP + MRP + DRP + LP rKeys = r* + IP + MRP + DRP + LP DRP = rKeys - r* - IP - MRP - LP = Or, rKeys - rT-bond - LP =
5 5.10% 4.40% 2.5% 1.5% 0.40% 0.50%
0.20% 0.20%
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 6-5 What Determines the Shape of the Yield Curve? QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.06.05 - What Determines the Shape of the Yield Curve? NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Default risk premium KEYWORDS: Bloom's: Evaluation DATE CREATED: 9/21/2017 5:23 PM DATE MODIFIED: 9/21/2017 5:23 PM 68. Kay Corporation's 5-year bonds yield 5.90% and 5-year T-bonds yield 4.40%. The real risk-free rate is r* = 2.5%, the inflation premium for 5-year bonds is IP = 1.50%, the default risk premium for Kay's bonds is DRP = 1.30% versus zero for T-bonds, and the maturity risk premium for all bonds is found with the formula MRP = (t – 1) 0.1%, where t = number of years to maturity. What is the liquidity premium (LP) on Kay's bonds? a. 0.23% b. 0.25% c. 0.19% d. 0.20% e. 0.17% ANSWER: d RATIONALE: Maturity 5 5.90% rKay Yield Copyright Cengage Learning. Powered by Cognero.
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rT-bond Yield r* Included in both bonds IP Included in both bonds DRP Included in Kay's only MRP Included in both bonds rT-bond = r* + IP + MRP + DRP + LP rKay = r* + IP + MRP + DRP + LP LP = rKay - r* - IP - MRP - DRP = Or, rKay - rT-bond - DRP =
(t - 1) × 0.1%
4.40% 2.50% 1.50% 1.30% 0.40%
0.20% 0.20%
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 6-5 What Determines the Shape of the Yield Curve? QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.06.05 - What Determines the Shape of the Yield Curve? NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Liquidity premium KEYWORDS: Bloom's: Evaluation DATE CREATED: 9/21/2017 5:23 PM DATE MODIFIED: 9/21/2017 5:23 PM 69. Niendorf Corporation's 5-year bonds yield 7.75%, and 5-year T-bonds yield 4.80%. The real risk-free rate is r* = 2.75%, the inflation premium for 5-year bonds is IP = 1.65%, the default risk premium for Niendorf's bonds is DRP = 1.20% versus zero for T-bonds, and the maturity risk premium for all bonds is found with the formula MRP = (t – 1) 0.1%, where t = number of years to maturity. What is the liquidity premium (LP) on Niendorf's bonds? a. 1.42% b. 2.10% c. 2.17% d. 1.75% e. 1.56% ANSWER: d RATIONALE: Basic equation: r = r* + IP + MRP + DRP + LP Years to maturity: 5 MRP In both bonds, so not needed in this problem 0.40% IP In both bonds, so not needed in this problem 1.65% r* In both bonds, so not needed in this problem 2.75% 7.75% rNie 4.80% rT-bond DRP Included in corp. only 1.20% 1.75% LP = rNie - rT-bond - DRP POINTS: DIFFICULTY:
1 MODERATE
Copyright Cengage Learning. Powered by Cognero.
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REFERENCES: 6-5 What Determines the Shape of the Yield Curve? QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.06.05 - What Determines the Shape of the Yield Curve? NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Liquidity premium KEYWORDS: Bloom's: Evaluation DATE CREATED: 9/21/2017 5:23 PM DATE MODIFIED: 9/21/2017 5:23 PM 70. Kern Corporation's 5-year bonds yield 7.50% and 5-year T-bonds yield 4.30%. The real risk-free rate is r* = 2.5%, the default risk premium for Kern's bonds is DRP = 1.90% versus zero for T-bonds, the liquidity premium on Kern's bonds is LP = 1.3%, and the maturity risk premium for all bonds is found with the formula MRP = (t – 1) 0.1%, where t = number of years to maturity. What is the inflation premium (IP) on all 5-year bonds? a. 1.40% b. 1.64% c. 1.32% d. 1.06% e. 1.19% ANSWER: a RATIONALE: Maturity 5 rKern Yield 7.50% rT-bond Yield 4.30% r* Included in both bonds 2.50% LP Included in Kern's only 1.30% DRP Included in Kern's only 1.90% MRP Included in both bonds (t - 1) × 0.1% 0.40% rT-bond = r* + IP + MRP + DRP + LP rKern = r* + IP + MRP + DRP + LP IP = rKern - r* - LP - MRP - DRP = 1.40% Or, IP = rT-bond - r* - MRP = 1.40% POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 6-5 What Determines the Shape of the Yield Curve? QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.06.05 - What Determines the Shape of the Yield Curve? NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Inflation premium KEYWORDS: Bloom's: Evaluation Copyright Cengage Learning. Powered by Cognero.
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71. Crockett Corporation's 5-year bonds yield 6.35%, and 5-year T-bonds yield 4.45%. The real risk-free rate is r* = 2.80%, the default risk premium for Crockett's bonds is DRP = 1.00% versus zero for T-bonds, the liquidity premium on Crockett's bonds is LP = 0.90% versus zero for T-bonds, and the maturity risk premium for all bonds is found with the formula MRP = (t – 1) 0.1%, where t = number of years to maturity. What inflation premium (IP) is built into 5-year bond yields? a. 1.40% b. 1.10% c. 1.11% d. 1.33% e. 1.25% ANSWER: e RATIONALE: Basic equation: r = r* + IP + MRP + DRP + LP. Not needed in this problem 6.35% rCrockett LP Not needed in this problem 0.90% DRP Not needed in this problem 1.00% Required data 4.45% rT-bond r* Required data 2.80% Years to maturity Required data 5 MRP = (t - 1)×0.1% = 0.40% 1.25% IP = rT-bond - r* - MRP POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 6-5 What Determines the Shape of the Yield Curve? QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.06.05 - What Determines the Shape of the Yield Curve? NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Inflation premium KEYWORDS: Bloom's: Evaluation DATE CREATED: 9/21/2017 5:23 PM DATE MODIFIED: 9/21/2017 5:23 PM 72. Kelly Inc's 5-year bonds yield 7.50% and 5-year T-bonds yield 5.80%. The real risk-free rate is r* = 2.5%, the default risk premium for Kelly's bonds is DRP = 0.40%, the liquidity premium on Kelly's bonds is LP = 1.3% versus zero on Tbonds, and the inflation premium (IP) is 1.5%. What is the maturity risk premium (MRP) on all 5-year bonds? a. 1.51% b. 1.80% c. 2.00% d. 1.46% e. 2.12% ANSWER: b Copyright Cengage Learning. Powered by Cognero.
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RATIONALE:
Maturity 5 7.50% rKelly Yield 5.80% rT-bond Yield r* Included in both bonds 2.50% LP Included in Kelly’s only 1.30% DRP Included in Kelly’s only 0.40% IP Included in both bonds 1.50% rT-bond = r* + IP + MRP + DRP + LP rKelly = r* + IP + MRP + DRP + LP 1.80% MRP = rKelly - r* - IP - LP - DRP = 1.80% Or, MRP = rT-bond - r* - IP = POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 6-5 What Determines the Shape of the Yield Curve? QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.06.05 - What Determines the Shape of the Yield Curve? NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Maturity risk premium KEYWORDS: Bloom's: Evaluation DATE CREATED: 9/21/2017 5:23 PM DATE MODIFIED: 9/21/2017 5:23 PM 73. Kop Corporation's 5-year bonds yield 6.50%, and T-bonds with the same maturity yield 5.90%. The default risk premium for Kop's bonds is DRP = 0.40%, the liquidity premium on Kop's bonds is LP = 0.20% versus zero on T-bonds, the inflation premium (IP) is 1.50%, and the maturity risk premium (MRP) on 5-year bonds is 0.40%. What is the real risk-free rate, r*? a. 3.64% b. 3.48% c. 3.00% d. 4.96% e. 4.00% ANSWER: e RATIONALE: Maturity 5 6.50% rKop Yield 5.90% rT-bond Yield DRP Included in Kop’s only 0.40% LP Included in Kop’s only 0.20% IP Included in both bonds 1.50% MRP Included in both bonds 0.40% rT-bond = r* + IP + MRP + DRP + LP rKop = r* + IP + MRP + DRP + LP 4.00% r* = rKop - IP - LP - MRP - DRP = 4.00% Or, r* = rT-bond - MRP - IP = Copyright Cengage Learning. Powered by Cognero.
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POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 6-5 What Determines the Shape of the Yield Curve? QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.06.05 - What Determines the Shape of the Yield Curve? NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Real risk-free rate KEYWORDS: Bloom's: Evaluation DATE CREATED: 9/21/2017 5:23 PM DATE MODIFIED: 9/21/2017 5:23 PM 74. 5-year Treasury bonds yield 4.4%. The inflation premium (IP) is 1.9%, and the maturity risk premium (MRP) on 5year T-bonds is 0.4%. There is no liquidity premium on these bonds. What is the real risk-free rate, r*? a. 2.10% b. 2.39% c. 2.21% d. 2.58% e. 1.91% ANSWER: a RATIONALE: Basic equation: r = r* + IP + MRP + DRP + LP. 4.40% rT-bond IP 1.90% MRP 0.40% LP and DRP 0.00% 2.10% r* = rT-bond - IP - MRP POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 6-5 What Determines the Shape of the Yield Curve? QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.06.05 - What Determines the Shape of the Yield Curve? NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Real risk-free rate KEYWORDS: Bloom's: Evaluation DATE CREATED: 9/21/2017 5:23 PM DATE MODIFIED: 9/21/2017 5:23 PM 75. Suppose 1-year T-bills currently yield 7.00% and the future inflation rate is expected to be constant at 2.00% per year. Copyright Cengage Learning. Powered by Cognero.
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What is the real risk-free rate of return, r*? The cross-product term should be considered , i.e., if averaging is required, use the geometric average. (Round your final answer to 2 decimal places.) a. 4.51% b. 4.85% c. 4.90% d. 3.87% e. 3.77% ANSWER: c RATIONALE: 7.00% 1-year T-bill rate (rRF) Inflation 2.00% 4.90% Real risk-free rate, r* = (1+ rRF)/(1+ IP) -1 = POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 6-5 What Determines the Shape of the Yield Curve? QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.06.05 - What Determines the Shape of the Yield Curve? NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Real risk-free rate of return - cross product KEYWORDS: Bloom's: Evaluation DATE CREATED: 9/21/2017 5:23 PM DATE MODIFIED: 9/21/2017 5:23 PM 76. Suppose the real risk-free rate is 3.50% and the future rate of inflation is expected to be constant at 4.10%. What rate of return would you expect on a 1-year Treasury security, assuming the pure expectations theory is valid? Include crossproduct terms, i.e., if averaging is required, use the geometric average. (Round your final answer to 2 decimal places.) a. 6.58% b. 7.74% c. 9.37% d. 6.50% e. 7.90% ANSWER: b RATIONALE: Real risk-free rate, r* 3.50% Inflation 4.10% Yield on 1-year T-bond = (1 + r*)(1 + IP) -1 = 7.74% POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 6-5 What Determines the Shape of the Yield Curve? QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.06.05 - What Determines the Shape of the Yield Curve? NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates Copyright Cengage Learning. Powered by Cognero.
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LOCAL STANDARDS: TOPICS: KEYWORDS: DATE CREATED: DATE MODIFIED:
United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. Int. rates - cross product Bloom's: Evaluation 9/21/2017 5:23 PM 9/21/2017 5:23 PM
77. Suppose the real risk-free rate is 3.00%, the average expected future inflation rate is 4.00%, and a maturity risk premium of 0.10% per year to maturity applies, i.e., MRP = 0.10%(t), where t is the years to maturity. What rate of return would you expect on a 1-year Treasury security, assuming the pure expectations theory is NOT valid? Include the crossproduct term, i.e., if averaging is required, use the geometric average. (Round your final answer to 2 decimal places.) a. 8.88% b. 7.15% c. 7.22% d. 7.80% e. 8.95% ANSWER: c RATIONALE: Real risk-free rate, r* 3.00% Inflation 4.00% MRP Years: 1 Per year: 0.10% 0.10% Yield on 1-year T-bond = (1 + r*)(1 + IP) - 1 + MRP 7.22% POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 6-5 What Determines the Shape of the Yield Curve? QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.06.05 - What Determines the Shape of the Yield Curve? NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Int. rates and MRP - cross product KEYWORDS: Bloom's: Evaluation DATE CREATED: 9/21/2017 5:23 PM DATE MODIFIED: 9/21/2017 5:23 PM 78. Suppose the interest rate on a 1-year T-bond is 5.00% and that on a 2-year T-bond is 6.90%. Assuming the pure expectations theory is correct, what is the market's forecast for 1-year rates 1 year from now? Round the intermediate calculations to 4 decimal places and final answer to 2 decimal places. a. 7.16 b. 8.83 c. 6.63 d. 7.42 e. 8.04 ANSWER: b RATIONALE: 1-year rate today 5.00% 2-year rate today 6.90% Copyright Cengage Learning. Powered by Cognero.
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Maturity of longer bond Ending return if buy the 2-year bond = needed return on series of 1-year bonds Rate of return, or yield, on a 1-year bond 1 year from now: X in this equation: (1.05)(1+X) = X = 1.1428/1.05 - 1 = POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 6-6 Using the Yield Curve to Estimate Future Interest Rates QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES FOFM.BRIG.17.06.06 - Using the Yield Curve to Estimate Future Interest Rates : NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: LOCAL STANDARDS: TOPICS: KEYWORDS: DATE CREATED: DATE MODIFIED:
2 1.1428 1.1428 8.83%
United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. Estimating forward rate Bloom's: Evaluation 9/21/2017 5:23 PM 9/21/2017 5:23 PM
79. Suppose 1-year Treasury bonds yield 4.00% while 2-year T-bonds yield 5.10%. Assuming the pure expectations theory is correct, and thus the maturity risk premium for T-bonds is zero, what is the yield on a 1-year T-bond expected to be one year from now? Round the intermediate calculations to 4 decimal places and final answer to 2 decimal places. a. 6.21 b. 7.39 c. 7.27 d. 5.47 e. 6.09 ANSWER: a RATIONALE: r1-year 4.00% r2-year 5.10% r1-year1 year from now X in the equation (1.04)(1+X) = (1.051)2 = 1.1046 2 6.21% X = (1.051) / (1.040) - 1.0 = r1-year in 1 yr POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 6-6 Using the Yield Curve to Estimate Future Interest Rates QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.06.06 - Using the Yield Curve to Estimate Future Interest Rates NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Estimating forward rate KEYWORDS: Bloom's: Evaluation Copyright Cengage Learning. Powered by Cognero.
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80. Suppose the real risk-free rate is 3.25%, the average future inflation rate is 4.35%, and a maturity risk premium of 0.07% per year to maturity applies to both corporate and T-bonds, i.e., MRP = 0.07%(t), where t is the number of years to maturity. Suppose also that a liquidity premium of 0.50% and a default risk premium of 2.40% apply to A-rated corporate bonds but not to T-bonds. How much higher would the rate of return be on a 10-year A-rated corporate bond than on a 5year Treasury bond? Here we assume that the pure expectations theory is NOT valid. Disregard cross-product terms, i.e., if averaging is required, use the arithmetic average. a. 3.48 b. 3.90 c. 3.25 d. 3.74 e. 3.84 ANSWER: RATIONALE:
c Real risk-free rate, r* IP MRP, 5-year T-bond Per year: MRP, 10-year Per year: corporate LP DRP T-bond yield A bond yield Difference
0.07%
Years: 5
3.25% 4.35% 0.35%
0.07%
Years: 10
0.70%
rT-bond= r* + IP + MRP +DRP + LP rCorp= r* + IP + MRP + DRP + LP
0.50% 2.40% 7.95% 11.20% 3.25%
POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 6-5 What Determines the Shape of the Yield Curve? QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVE FOFM.BRIG.17.06.05 - What Determines the Shape of the Yield Curve? S: NATIONAL STANDARD United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic S: STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Corp. vs. treasury yields KEYWORDS: Bloom's: Analysis DATE CREATED: 9/21/2017 5:23 PM DATE MODIFIED: 9/21/2017 5:23 PM 81. Suppose the real risk-free rate is 3.50%, the average future inflation rate is 2.50%, a maturity premium of 0.20% per year to maturity applies, i.e., MRP = 0.20%(t), where t is the number of years to maturity. Suppose also that a liquidity premium of 0.50% and a default risk premium of 2.70% applies to A-rated corporate bonds. What is the difference in the yields on a 5-year A-rated corporate bond and on a 10-year Treasury bond? Here we assume that the pure expectations theory is NOT valid, and disregard any cross-product terms, i.e., if averaging is required, use the arithmetic average. Copyright Cengage Learning. Powered by Cognero.
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a. 1.91 b. 2.20 c. 2.27 d. 2.13 e. 1.78 ANSWER: RATIONALE:
b Real risk-free rate, r* IP MRP, 10-year T-bond MRP, 5-year corporate LP DRP T-bond yield
Per year: Per year:
0.20% 0.20%
rT-bond = r* + IP + MRP + DRP + LP
Years: 10 Years: 5
3.50% 2.50% 2.00% 1.00% 0.50% 2.70% 8.00%
A bond yield 10.20% rCorp = r* + IP + MRP + DRP + LP Difference 2.20% POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 6-5 What Determines the Shape of the Yield Curve? QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.06.05 - What Determines the Shape of the Yield Curve? NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Corp. vs. treasury yields KEYWORDS: Bloom's: Analysis DATE CREATED: 9/21/2017 5:23 PM DATE MODIFIED: 9/21/2017 5:23 PM 82. Suppose the interest rate on a 1-year T-bond is 5.00% and that on a 2-year T-bond is 6.80%. Assume that the pure expectations theory is NOT valid, and the MRP is zero for a 1-year T-bond but 0.40% for a 2-year bond. What is the yield on a 1-year T-bond expected to be one year from now? Round the intermediate calculations to 4 decimal places and final answer to 2 decimal places. a. 7.43 b. 8.52 c. 6.57 d. 7.82 e. 5.86 ANSWER: d RATIONALE: 1-year rate today 5.00% 2-year rate today 6.80% MRP on 2-year bonds 0.40% Expected annualized return on a series of 1-year bonds = 2-year rate - MRP = 6.80% - 0.40% = 6.40% Compounded return on series of 1-year bonds at above rate = (1.064)(1.064) = 1.1321 Compounded return on series of 1-year bonds = (1.05)(1+X) =1.1321 Expected Yield on a 1-year bond 1 year from now: X in the equation: (1.05)(1+X) =1.1321 Copyright Cengage Learning. Powered by Cognero.
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X =1.1321/1.05 - 1 =
7.82%
POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 6-6 Using the Yield Curve to Estimate Future Interest Rates QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTI FOFM.BRIG.17.06.06 - Using the Yield Curve to Estimate Future Interest Rates VES: NATIONAL STANDA United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic RDS: STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS:United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Est. forward rate with MRP KEYWORDS: Bloom's: Evaluation DATE CREATED: 9/21/2017 5:23 PM DATE MODIFIED: 9/21/2017 5:23 PM
1. If a firm raises capital by selling new bonds, it could be called the "issuing firm," and the coupon rate is generally set equal to the required rate on bonds of equal risk. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 7-2 Key Characteristics of Bonds QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.07.02 - Key Characteristics of Bonds NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Coupon rate KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:23 PM DATE MODIFIED: 9/21/2017 5:23 PM 2. A call provision gives bondholders the right to demand, or "call for," repayment of a bond. Typically, companies call bonds if interest rates rise and do not call them if interest rates decline. a. True b. False ANSWER: False POINTS: 1 Copyright Cengage Learning. Powered by Cognero.
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DIFFICULTY: EASY REFERENCES: 7-2 Key Characteristics of Bonds QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.07.02 - Key Characteristics of Bonds NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Call provision KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:23 PM DATE MODIFIED: 9/21/2017 5:23 PM 3. Sinking funds are provisions included in bond indentures that require companies to retire bonds on a scheduled basis prior to their final maturity. Many indentures allow the company to acquire bonds for sinking fund purposes by either (1) purchasing bonds on the open market at the going market price or (2) selecting the bonds to be called by a lottery administered by the trustee, in which case the price paid is the bond's face value. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 7-2 Key Characteristics of Bonds QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.07.02 - Key Characteristics of Bonds NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Sinking funds KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:23 PM DATE MODIFIED: 9/21/2017 5:23 PM 4. A zero coupon bond is a bond that pays no interest and is offered (and initially sells) at par. These bonds provide compensation to investors in the form of capital appreciation. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 7-2 Key Characteristics of Bonds QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.07.02 - Key Characteristics of Bonds NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking Copyright Cengage Learning. Powered by Cognero.
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STATE STANDARDS: LOCAL STANDARDS: TOPICS: KEYWORDS: DATE CREATED: DATE MODIFIED:
United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds United States - OH - Default City - Tier 2: - Capital structure Zero coupon bond Bloom's: Knowledge 9/21/2017 5:23 PM 9/21/2017 5:23 PM
5. The desire for floating-rate bonds, and consequently their increased usage, arose out of the experience of the early 1980s, when inflation pushed interest rates up to very high levels and thus caused sharp declines in the prices of outstanding bonds. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 7-2 Key Characteristics of Bonds QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.07.02 - Key Characteristics of Bonds NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Floating-rate debt KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:23 PM DATE MODIFIED: 9/21/2017 5:23 PM 6. The market value of any real or financial asset, including stocks, bonds, or art work purchased in hope of selling it at a profit, may be estimated by determining future cash flows and then discounting them back to the present. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 7-3 Bond Valuation QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.07.03 - Bond Valuation NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Discounted cash flows KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:23 PM DATE MODIFIED: 9/21/2017 5:23 PM Copyright Cengage Learning. Powered by Cognero.
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7. The price sensitivity of a bond to a given change in interest rates is generally greater the longer the bond's remaining maturity. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 7-5 Changes in Bond Values over Time QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.07.05 - Changes in Bond Values Over Time NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Bond prices and int. rates KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:23 PM DATE MODIFIED: 9/21/2017 5:23 PM 8. A bond that had a 20-year original maturity with 1 year left to maturity has more price risk than a 10-year original maturity bond with 1 year left to maturity. (Assume that the bonds have equal default risk and equal coupon rates, and they cannot be called.) a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 7-7 Assessing a Bond's Riskiness QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.07.07 - Assessing a Bond's Riskiness NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Price risk KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:23 PM DATE MODIFIED: 9/21/2017 5:23 PM 9. Because short-term interest rates are much more volatile than long-term rates, you would, in the real world, generally be subject to much more price risk if you purchased a 30-day bond than if you bought a 30-year bond. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY Copyright Cengage Learning. Powered by Cognero.
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REFERENCES: 7-7 Assessing a Bond's Riskiness QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.07.07 - Assessing a Bond's Riskiness NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Price risk KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:23 PM DATE MODIFIED: 9/21/2017 5:23 PM 10. As a general rule, a company's debentures have higher required interest rates than its mortgage bonds because mortgage bonds are backed by specific assets while debentures are unsecured. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 7-8 Default Risk QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.07.08 - Default Risk NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Bonds and debentures KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:23 PM DATE MODIFIED: 9/21/2017 5:23 PM 11. Junk bonds are high-risk, high-yield debt instruments. They are often used to finance leveraged buyouts and mergers, and to provide financing to companies of questionable financial strength. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 7-8 Default Risk QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.07.08 - Default Risk NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure Copyright Cengage Learning. Powered by Cognero.
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12. There is an inverse relationship between bonds' quality ratings and their required rates of return. Thus, the required return is lowest for AAA-rated bonds, and required returns increase as the ratings get lower. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 7-8 Default Risk QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.07.08 - Default Risk NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Bond ratings and req. returns KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:23 PM DATE MODIFIED: 9/21/2017 5:23 PM 13. Income bonds pay interest only if the issuing company actually earns the indicated interest. Thus, these securities cannot bankrupt a company, and this makes them safer from an investor's perspective than regular bonds. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 7-2 Key Characteristics of Bonds QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.07.02 - Key Characteristics of Bonds NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Income bond KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:23 PM DATE MODIFIED: 9/21/2017 5:23 PM 14. You are considering 2 bonds that will be issued tomorrow. Both are rated triple B (BBB, the lowest investment-grade rating), both mature in 20 years, both have a 10% coupon, neither can be called except for sinking fund purposes, and both are offered to you at their $1,000 par values. However, Bond SF has a sinking fund while Bond NSF does not. Under the Copyright Cengage Learning. Powered by Cognero.
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sinking fund, the company must call and pay off 5% of the bonds at par each year. The yield curve at the time is upward sloping. The bond's prices, being equal, are probably not in equilibrium, as Bond SF, which has the sinking fund, would generally be expected to have a higher yield than Bond NSF. a. True b. False ANSWER: False RATIONALE: The sinking fund would give Bond SF a lower average maturity, and it would also lower its risk. Therefore, Bond SF should have a lower, not a higher, yield. POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 7-2 Key Characteristics of Bonds QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.07.02 - Key Characteristics of Bonds NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Sinking fund KEYWORDS: Bloom's: Application DATE CREATED: 9/21/2017 5:23 PM DATE MODIFIED: 9/21/2017 5:23 PM 15. Floating-rate debt is advantageous to investors because the interest rate moves up if market rates rise. Since floatingrate debt shifts price risk to companies, it offers no advantages to corporate issuers. a. True b. False ANSWER: False RATIONALE: Floating rates can benefit issuers if rates decline, so a company that thinks rates are likely to fall would want to issue such bonds. POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 7-2 Key Characteristics of Bonds QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.07.02 - Key Characteristics of Bonds NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Floating-rate debt KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:23 PM DATE MODIFIED: 9/21/2017 5:23 PM 16. A bond has a $1,000 par value, makes annual interest payments of $100, has 5 years to maturity, cannot be called, and is not expected to default. The bond should sell at a premium if market interest rates are below 10% and at a discount if interest rates are greater than 10%. a. True Copyright Cengage Learning. Powered by Cognero.
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b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 7-3 Bond Valuation QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.07.03 - Bond Valuation NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Bond premiums and discounts KEYWORDS: Bloom's: Application DATE CREATED: 9/21/2017 5:23 PM DATE MODIFIED: 9/21/2017 5:23 PM 17. You have funds that you want to invest in bonds, and you just noticed in the financial pages of the local newspaper that you can buy a $1,000 par value bond for $800. The coupon rate is 10% (with annual payments), and there are 10 years before the bond will mature and pay off its $1,000 par value. You should buy the bond if your required return on bonds with this risk is 12%. a. True b. False ANSWER: True RATIONALE: The bonds expected return (YTM) is 13.81%, which exceeds the 12% required return, so buy the bond. POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 7-3 Bond Valuation QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.07.03 - Bond Valuation NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Bond value - annual payment KEYWORDS: Bloom's: Evaluation DATE CREATED: 9/21/2017 5:23 PM DATE MODIFIED: 9/21/2017 5:23 PM 18. If the required rate of return on a bond (rd) is greater than its coupon interest rate and will remain above that rate, then the market value of the bond will always be below its par value until the bond matures, at which time its market value will equal its par value. (Accrued interest between interest payment dates should not be considered when answering this question.) a. True b. False ANSWER: True Copyright Cengage Learning. Powered by Cognero.
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POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 7-5 Changes in Bond Values over Time QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.07.05 - Changes in Bond Values Over Time NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Bond prices and returns KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:23 PM DATE MODIFIED: 9/21/2017 5:23 PM 19. The prices of high-coupon bonds tend to be less sensitive to a given change in interest rates than low-coupon bonds, other things held constant. a. True b. False ANSWER: True RATIONALE: The reason for this is that more of the cash flows of a low-coupon bond comes late in the bond's life (as the maturity payment), and later cash flows are impacted most heavily by changing market rates. POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 7-5 Changes in Bond Values over Time QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.07.05 - Changes in Bond Values Over Time NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Prices and interest rates KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:23 PM DATE MODIFIED: 9/21/2017 5:23 PM 20. Restrictive covenants are designed primarily to protect bondholders by constraining the actions of managers. Such covenants are spelled out in bond indentures. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 7-8 Default Risk QUESTION TYPE: True / False HAS VARIABLES: False Copyright Cengage Learning. Powered by Cognero.
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LEARNING OBJECTIVES: FOFM.BRIG.17.07.08 - Default Risk NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Restrictive covenants KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:23 PM DATE MODIFIED: 9/21/2017 5:23 PM 21. Other things equal, a firm will have to pay a higher coupon rate on its subordinated debentures than on its second mortgage bonds. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 7-8 Default Risk QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.07.08 - Default Risk NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Bonds and debentures KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:23 PM DATE MODIFIED: 9/21/2017 5:23 PM 22. A bond that is callable has a chance of being retired earlier than its stated term to maturity. Therefore, if the yield curve is upward sloping, an outstanding callable bond should have a lower yield to maturity than an otherwise identical noncallable bond. a. True b. False ANSWER: False RATIONALE: The callable bond will be called if rates fall far enough below the coupon rate, but it will not be called otherwise. Thus, the call provision can only harm bondholders. Therefore, callable bonds sell at higher yields than noncallable bonds, regardless of the slope of the yield curve. POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 7-4 Bond Yields QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.07.04 - Bond Yields NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure Copyright Cengage Learning. Powered by Cognero.
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23. Which of the following statements is CORRECT? a. You hold two bonds, a 10-year, zero coupon, issue and a 10-year bond that pays a 6% annual coupon. The same market rate, 6%, applies to both bonds. If the market rate rises from its current level, the zero coupon bond will experience the larger percentage decline. b. The time to maturity does not affect the change in the value of a bond in response to a given change in interest rates. c. You hold two bonds. One is a 10-year, zero coupon, bond and the other is a 10-year bond that pays a 6% annual coupon. The same market rate, 6%, applies to both bonds. If the market rate rises from the current level, the zero coupon bond will experience the smaller percentage decline. d. The shorter the time to maturity, the greater the change in the value of a bond in response to a given change in interest rates, other things held constant. e. The longer the time to maturity, the smaller the change in the value of a bond in response to a given change in interest rates. ANSWER: a POINTS: 1 DIFFICULTY: EASY REFERENCES: 7-5 Changes in Bond Values over Time QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.07.05 - Changes in Bond Values Over Time NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Interest rates KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:23 PM DATE MODIFIED: 9/21/2017 5:23 PM 24. Which of the following events would make it more likely that a company would call its outstanding callable bonds? a. The company’s bonds are downgraded. b. Market interest rates rise sharply. c. Market interest rates decline sharply. d. The company's financial situation deteriorates significantly. e. Inflation increases significantly. ANSWER: c POINTS: 1 DIFFICULTY: EASY REFERENCES: 7-7 Assessing a Bond's Riskiness QUESTION TYPE: Multiple Choice HAS VARIABLES: False Copyright Cengage Learning. Powered by Cognero.
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LEARNING OBJECTIVES: FOFM.BRIG.17.07.07 - Assessing a Bond's Riskiness NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Callable bonds KEYWORDS: Bloom's: Knowledge OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 25. Assume that interest rates on 20-year Treasury and corporate bonds with different ratings, all of which are noncallable, are as follows: T-bond = 7.72% A = 9.64% AAA = 8.72% BBB = 10.18% The differences in rates among these issues were most probably caused primarily by: a. Real risk-free rate differences. b. Tax effects. c. Default risk and liquidity differences. d. Maturity risk differences. e. Inflation differences. ANSWER: c POINTS: 1 DIFFICULTY: EASY REFERENCES: 7-8 Default Risk QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.07.08 - Default Risk NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Bond ratings KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 26. Under normal conditions, which of the following would be most likely to increase the coupon rate required for a bond to be issued at par? a. Adding additional restrictive covenants that limit management's actions. b. Adding a call provision. c. The rating agencies change the bond's rating from Baa to Aaa. d. Making the bond a first mortgage bond rather than a debenture. e. Adding a sinking fund. ANSWER: b POINTS: 1 Copyright Cengage Learning. Powered by Cognero.
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DIFFICULTY: MODERATE REFERENCES: 7-2 Key Characteristics of Bonds QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.07.02 - Key Characteristics of Bonds NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Bond coupon rate KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 27. Which of the following statements is CORRECT? a. Sinking fund provisions sometimes turn out to adversely affect bondholders, and this is most likely to occur if interest rates decline after the bond was issued. b. Most sinking funds require the issuer to provide funds to a trustee, who holds the money so that it will be available to pay off bondholders when the bonds mature. c. A sinking fund provision makes a bond more risky to investors at the time of issuance. d. Sinking fund provisions never require companies to retire their debt; they only establish ―targets‖ for the company to reduce its debt over time. e. If interest rates increase after a company has issued bonds with a sinking fund, the company will be less likely to buy bonds on the open market to meet its sinking fund obligation and more likely to call them in at the sinking fund call price. ANSWER: a POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 7-2 Key Characteristics of Bonds QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.07.02 - Key Characteristics of Bonds NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Sinking funds KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 28. Amram Inc. can issue a 20-year bond with a 6% annual coupon at par. This bond is not convertible, not callable, and has no sinking fund. Alternatively, Amram could issue a 20-year bond that is convertible into common equity, may be called, and has a sinking fund. Which of the following most accurately describes the coupon rate that Amram would have to pay on the second bond, the convertible, callable bond with the sinking fund, to have it sell initially at par? a. The coupon rate should be exactly equal to 6%. b. The coupon rate could be less than, equal to, or greater than 6%, depending on the specific terms set, but in the Copyright Cengage Learning. Powered by Cognero.
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real world the convertible feature would probably cause the coupon rate to be less than 6%. c. The rate should be slightly greater than 6%. d. The rate should be over 7%. e. The rate should be over 8%. ANSWER: b RATIONALE: The second bond's convertible feature and sinking fund would tend to lower its required rate of return, but the call feature would raise its rate. Given these opposing forces, the second bond's required coupon rate could be above or below that of the first bond. However, the convertible feature generally dominates in the real world, so convertibles' coupon rates are generally less than comparable non-convertible issues' rates. POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 7-2 Key Characteristics of Bonds QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.07.02 - Key Characteristics of Bonds NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Convertible, callable bonds KEYWORDS: Bloom's: Evaluation OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 29. Tucker Corporation is planning to issue new 20-year bonds. The current plan is to make the bonds non-callable, but this may be changed. If the bonds are made callable after 5 years at a 5% call premium, how would this affect their required rate of return? a. Because of the call premium, the required rate of return would decline. b. There is no reason to expect a change in the required rate of return. c. The required rate of return would decline because the bond would then be less risky to a bondholder. d. The required rate of return would increase because the bond would then be more risky to a bondholder. e. It is impossible to say without more information. ANSWER: d POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 7-4 Bond Yields QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.07.04 - Bond Yields NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Bond yields KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Conceptual Copyright Cengage Learning. Powered by Cognero.
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30. A 10-year corporate bond has an annual coupon of 9%. The bond is currently selling at par ($1,000). Which of the following statements is CORRECT? a. The bond’s expected capital gains yield is zero. b. The bond’s yield to maturity is above 9%. c. The bond’s current yield is above 9%. d. If the bond’s yield to maturity declines, the bond will sell at a discount. e. The bond’s current yield is less than its expected capital gains yield. ANSWER: a POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 7-4 Bond Yields QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.07.04 - Bond Yields NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Bond yields KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 31. Which of the following statements is CORRECT? a. A zero coupon bond's current yield is equal to its yield to maturity. b. If a bond’s yield to maturity exceeds its coupon rate, the bond will sell at par. c. All else equal, if a bond’s yield to maturity increases, its price will fall. d. If a bond’s yield to maturity exceeds its coupon rate, the bond will sell at a premium over par. e. All else equal, if a bond’s yield to maturity increases, its current yield will fall. ANSWER: c POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 7-4 Bond Yields QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.07.04 - Bond Yields NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Bond yields KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual Copyright Cengage Learning. Powered by Cognero.
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32. A 15-year bond with a face value of $1,000 currently sells for $850. Which of the following statements is CORRECT? a. The bond’s coupon rate exceeds its current yield. b. The bond’s current yield exceeds its yield to maturity. c. The bond’s yield to maturity is greater than its coupon rate. d. The bond’s current yield is equal to its coupon rate. e. If the yield to maturity stays constant until the bond matures, the bond’s price will remain at $850. ANSWER: c POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 7-4 Bond Yields QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.07.04 - Bond Yields NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Bond yields KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 33. Which of the following statements is CORRECT? a. If a bond is selling at a discount, the yield to call is a better measure of return than is the yield to maturity. b. On an expected yield basis, the expected capital gains yield will always be positive because an investor would not purchase a bond with an expected capital loss. c. On an expected yield basis, the expected current yield will always be positive because an investor would not purchase a bond that is not expected to pay any cash coupon interest. d. If a coupon bond is selling at par, its current yield equals its yield to maturity, and its expected capital gains yield is zero. e. The current yield on Bond A exceeds the current yield on Bond B; therefore, Bond A must have a higher yield to maturity than Bond B. ANSWER: d POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 7-4 Bond Yields QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.07.04 - Bond Yields NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Bond yields Copyright Cengage Learning. Powered by Cognero.
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34. Three $1,000 face value, 10-year, noncallable, bonds have the same amount of risk, hence their YTMs are equal. Bond 8 has an 8% annual coupon, Bond 10 has a 10% annual coupon, and Bond 12 has a 12% annual coupon. Bond 10 sells at par. Assuming that interest rates remain constant for the next 10 years, which of the following statements is CORRECT? a. Bond 8’s current yield will increase each year. b. Since the bonds have the same YTM, they should all have the same price, and since interest rates are not expected to change, their prices should all remain at their current levels until maturity. c. Bond 12 sells at a premium (its price is greater than par), and its price is expected to increase over the next year. d. Bond 8 sells at a discount (its price is less than par), and its price is expected to increase over the next year. e. Over the next year, Bond 8’s price is expected to decrease, Bond 10’s price is expected to stay the same, and Bond 12’s price is expected to increase. ANSWER: d RATIONALE: Note that Bond 10 sells at par, so the required return on all these bonds is 10%. Bond 10's price will remain constant; Bond 8 will sell initially at a discount and will rise, and Bond 12 will sell initially at a premium and will decline. Note too that since it has larger cash flows from its higher coupons, Bond 12 would be less sensitive to interest rate changes (i.e., it has less price risk. It has more default risk). POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 7-5 Changes in Bond Values over Time QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.07.05 - Changes in Bond Values Over Time NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Bond values over time KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 35. A 10-year bond pays an annual coupon, its YTM is 8%, and it currently trades at a premium. Which of the following statements is CORRECT? a. The bond’s current yield is less than 8%. b. If the yield to maturity remains at 8%, then the bond’s price will decline over the next year. c. The bond’s coupon rate is less than 8%. d. If the yield to maturity increases, then the bond’s price will increase. e. If the yield to maturity remains at 8%, then the bond’s price will remain constant over the next year. ANSWER: b RATIONALE: Answers c, d, and e are clearly wrong, and answer b is clearly correct. Answer a is also wrong, but this is not obvious to most people. We can demonstrate that a is incorrect by using Copyright Cengage Learning. Powered by Cognero.
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the following example. Par $1,000 YTM 8.00% Maturity 10 years Price $1,100 Payment $94.90 Coupon rate 9.49% Current yield 8.63% The current yield is greater than 8%. POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 7-5 Changes in Bond Values over Time QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.07.05 - Changes in Bond Values Over Time NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Int. rates and bond prices KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 36. A 12-year bond has an annual coupon of 9%. The coupon rate will remain fixed until the bond matures. The bond has a yield to maturity of 7%. Which of the following statements is CORRECT? a. If market interest rates decline, the price of the bond will also decline. b. The bond is currently selling at a price below its par value. c. If market interest rates remain unchanged, the bond’s price one year from now will be lower than it is today. d. The bond should currently be selling at its par value. e. If market interest rates remain unchanged, the bond’s price one year from now will be higher than it is today. ANSWER: c POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 7-5 Changes in Bond Values over Time QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.07.05 - Changes in Bond Values Over Time NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Int. rates and bond prices KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM Copyright Cengage Learning. Powered by Cognero.
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37. A 10-year Treasury bond has an 8% coupon, and an 8-year Treasury bond has a 10% coupon. Neither is callable, and both have the same yield to maturity. If the yield to maturity of both bonds increases by the same amount, which of the following statements would be CORRECT? a. The prices of both bonds will decrease by the same amount. b. Both bonds would decline in price, but the 10-year bond would have the greater percentage decline in price. c. The prices of both bonds would increase by the same amount. d. One bond's price would increase, while the other bond’s price would decrease. e. The prices of the two bonds would remain constant. ANSWER: b RATIONALE: We can tell by inspection that c, d, and e are all incorrect. a is also incorrect because the 10year bond will fall more due to its longer maturity and lower coupon. That leaves Answer b as the only possibly correct statement. Recognize that longer-term bonds, and ones where payments come late (like low coupon bonds) are most sensitive to changes in interest rates. Thus, the 10-year, 8% coupon bond should be more sensitive to a decline in rates. You could also do some calculations to confirm that b is correct. POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 7-5 Changes in Bond Values over Time QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.07.05 - Changes in Bond Values Over Time NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Int. rates and bond prices KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 38. You are considering two bonds. Bond A has a 9% annual coupon while Bond B has a 6% annual coupon. Both bonds have a 7% yield to maturity, and the YTM is expected to remain constant. Which of the following statements is CORRECT? a. The price of Bond B will decrease over time, but the price of Bond A will increase over time. b. The prices of both bonds will remain unchanged. c. The price of Bond A will decrease over time, but the price of Bond B will increase over time. d. The prices of both bonds will increase by 7% per year. e. The prices of both bonds will increase over time, but the price of Bond A will increase at a faster rate. ANSWER: c POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 7-5 Changes in Bond Values over Time QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.07.05 - Changes in Bond Values Over Time NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic Copyright Cengage Learning. Powered by Cognero.
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STATE STANDARDS: LOCAL STANDARDS: TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds United States - OH - Default City - Tier 2: - Capital structure Bond yields and prices Bloom's: Analysis Multiple Choice: Conceptual 9/21/2017 5:24 PM 9/21/2017 5:24 PM
39. Which of the following bonds would have the greatest percentage increase in value if all interest rates in the economy fall by 1%? a. 10-year, zero coupon bond. b. 20-year, 10% coupon bond. c. 20-year, 5% coupon bond. d. 1-year, 10% coupon bond. e. 20-year, zero coupon bond. ANSWER: e POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 7-7 Assessing a Bond's Riskiness QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.07.07 - Assessing a Bond's Riskiness NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Price risk KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 40. Assume that all interest rates in the economy decline from 10% to 9%. Which of the following bonds would have the largest percentage increase in price? a. An 8-year bond with a 9% coupon. b. A 1-year bond with a 15% coupon. c. A 3-year bond with a 10% coupon. d. A 10-year zero coupon bond. e. A 10-year bond with a 10% coupon. ANSWER: d POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 7-7 Assessing a Bond's Riskiness QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.07.07 - Assessing a Bond's Riskiness Copyright Cengage Learning. Powered by Cognero.
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NATIONAL STANDARDS: STATE STANDARDS: LOCAL STANDARDS: TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds United States - OH - Default City - Tier 2: - Capital structure Price risk Bloom's: Analysis Multiple Choice: Conceptual 9/21/2017 5:24 PM 9/21/2017 5:24 PM
41. Which of the following bonds has the greatest price risk? a. A 10-year $100 annuity. b. A 10-year, $1,000 face value, zero coupon bond. c. A 10-year, $1,000 face value, 10% coupon bond with annual interest payments. d. All 10-year bonds have the same price risk since they have the same maturity. e. A 10-year, $1,000 face value, 10% coupon bond with semiannual interest payments. ANSWER: b POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 7-7 Assessing a Bond's Riskiness QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.07.07 - Assessing a Bond's Riskiness NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Price risk KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 42. If its yield to maturity declined by 1%, which of the following bonds would have the largest percentage increase in value? a. A 1-year zero coupon bond. b. A 1-year bond with an 8% coupon. c. A 10-year bond with an 8% coupon. d. A 10-year bond with a 12% coupon. e. A 10-year zero coupon bond. ANSWER: e POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 7-7 Assessing a Bond's Riskiness QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.07.07 - Assessing a Bond's Riskiness Copyright Cengage Learning. Powered by Cognero.
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NATIONAL STANDARDS: STATE STANDARDS: LOCAL STANDARDS: TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds United States - OH - Default City - Tier 2: - Capital structure Price risk Bloom's: Analysis Multiple Choice: Conceptual 9/21/2017 5:24 PM 9/21/2017 5:24 PM
43. Which of the following statements is CORRECT? a. All else equal, high-coupon bonds have less reinvestment risk than low-coupon bonds. b. All else equal, long-term bonds have less price risk than short-term bonds. c. All else equal, low-coupon bonds have less price risk than high-coupon bonds. d. All else equal, short-term bonds have less reinvestment risk than long-term bonds. e. All else equal, long-term bonds have less reinvestment risk than short-term bonds. ANSWER: e POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 7-7 Assessing a Bond's Riskiness QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.07.07 - Assessing a Bond's Riskiness NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Price and reinvest. risk KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 44. Which of the following statements is CORRECT? a. One advantage of a zero coupon Treasury bond is that no one who owns the bond has to pay any taxes on it until it matures or is sold. b. Long-term bonds have less price risk but more reinvestment risk than short-term bonds. c. If interest rates increase, all bond prices will increase, but the increase will be greater for bonds that have less price risk. d. Relative to a coupon-bearing bond with the same maturity, a zero coupon bond has more price risk but less reinvestment risk. e. Long-term bonds have less price risk and also less reinvestment risk than short-term bonds. ANSWER: d POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 7-7 Assessing a Bond's Riskiness QUESTION TYPE: Multiple Choice HAS VARIABLES: False Copyright Cengage Learning. Powered by Cognero.
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LEARNING OBJECTIVES: FOFM.BRIG.17.07.07 - Assessing a Bond's Riskiness NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Price and reinvest. risk KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 45. Which of the following statements is CORRECT? a. All else equal, secured debt is more risky than unsecured debt. b. The expected return on a corporate bond must be greater than its promised return if the probability of default is greater than zero. c. All else equal, senior debt has more default risk than subordinated debt. d. A company’s bond rating is affected by its financial ratios but not by provisions in its indenture. e. Under Chapter 7 of the Bankruptcy Act, the assets of a firm that declares bankruptcy must be liquidated, and the sale proceeds must be used to pay off claims against it according to the priority of the claims as spelled out in the Act. ANSWER: e POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 7-8 Default Risk QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.07.08 - Default Risk NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Default and bankruptcy KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 46. Which of the following statements is CORRECT? a. If the maturity risk premium were zero and interest rates were expected to decrease in the future, then the yield curve for U.S. Treasury securities would, other things held constant, have an upward slope. b. Liquidity premiums are generally higher on Treasury than corporate bonds. c. The maturity premiums embedded in the interest rates on U.S. Treasury securities are due primarily to the fact that the probability of default is higher on long-term bonds than on short-term bonds. d. Default risk premiums are generally lower on corporate than on Treasury bonds. e. Reinvestment risk is lower, other things held constant, on long-term than on short-term bonds. ANSWER: e POINTS: 1 DIFFICULTY: MODERATE Copyright Cengage Learning. Powered by Cognero.
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REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.07.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds United States - OH - DISC.FOFM.BRIG.17.02 - Financial markets and interest rates LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Term structure KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 47. Which of the following statements is CORRECT? a. All else equal, senior debt generally has a lower yield to maturity than subordinated debt. b. An indenture is a bond that is less risky than a mortgage bond. c. The expected return on a corporate bond will generally exceed the bond's yield to maturity. d. If a bond’s coupon rate exceeds its yield to maturity, then its expected return to investors will also exceed its yield to maturity. e. Under our bankruptcy laws, any firm that is in financial distress will be forced to declare bankruptcy and then be liquidated. ANSWER: a POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.07.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Bonds and default risk KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 48. Which of the following statements is CORRECT? a. If a coupon bond is selling at par, its current yield equals its yield to maturity. b. If a coupon bond is selling at a discount, its price will continue to decline until it reaches its par value at maturity. c. If interest rates increase, the price of a 10-year coupon bond will decline by a greater percentage than the price of a 10-year zero coupon bond. d. If a bond’s yield to maturity exceeds its annual coupon, then the bond will trade at a premium. e. If a coupon bond is selling at a premium, its current yield equals its yield to maturity. Copyright Cengage Learning. Powered by Cognero.
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ANSWER: a POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.07.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Bond concepts OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 49. A 10-year bond with a 9% annual coupon has a yield to maturity of 8%. Which of the following statements is CORRECT? a. If the yield to maturity remains constant, the bond’s price one year from now will be higher than its current price. b. The bond is selling below its par value. c. The bond is selling at a discount. d. If the yield to maturity remains constant, the bond’s price one year from now will be lower than its current price. e. The bond’s current yield is greater than 9%. ANSWER: d POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.07.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Bond concepts KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 50. A Treasury bond has an 8% annual coupon and a 7.5% yield to maturity. Which of the following statements is CORRECT? a. The bond sells at a price below par. b. The bond has a current yield greater than 8%. c. The bond sells at a discount. d. The bond’s required rate of return is less than 7.5%. Copyright Cengage Learning. Powered by Cognero.
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e. If the yield to maturity remains constant, the price of the bond will decline over time. ANSWER: e POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.07.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Bond concepts KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 51. An investor is considering buying one of two 10-year, $1,000 face value, noncallable bonds: Bond A has a 7% annual coupon, while Bond B has a 9% annual coupon. Both bonds have a yield to maturity of 8%, and the YTM is expected to remain constant for the next 10 years. Which of the following statements is CORRECT? a. Bond B has a higher price than Bond A today, but one year from now the bonds will have the same price. b. One year from now, Bond A’s price will be higher than it is today. c. Bond A’s current yield is greater than 8%. d. Bond A has a higher price than Bond B today, but one year from now the bonds will have the same price. e. Both bonds have the same price today, and the price of each bond is expected to remain constant until the bonds mature. ANSWER: b POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.07.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Bond concepts KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 52. Which of the following statements is CORRECT? a. If a bond is selling at a discount to par, its current yield will be greater than its yield to maturity. b. All else equal, bonds with longer maturities have less price risk than bonds with shorter maturities. c. If a bond is selling at its par value, its current yield equals its capital gains yield. Copyright Cengage Learning. Powered by Cognero.
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d. If a bond is selling at a premium, its current yield will be less than its capital gains yield. e. All else equal, bonds with larger coupons have less price risk than bonds with smaller coupons. ANSWER: e POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.07.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Bond concepts KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 53. Which of the following statements is CORRECT? a. If a 10-year, $1,000 par, zero coupon bond were issued at a price that gave investors a 10% yield to maturity, and if interest rates then dropped to the point where rd = YTM = 5%, the bond would sell at a premium over its $1,000 par value. b. If a 10-year, $1,000 par, 10% coupon bond were issued at par, and if interest rates then dropped to the point where rd = YTM = 5%, we could be sure that the bond would sell at a premium above its $1,000 par value. c. Other things held constant, including the coupon rate, a corporation would rather issue noncallable bonds than callable bonds. d. Other things held constant, a callable bond would have a lower required rate of return than a noncallable bond because it would have a shorter expected life. e. Bonds are exposed to both reinvestment risk and price risk. Longer-term low-coupon bonds, relative to shorter-term high-coupon bonds, are generally more exposed to reinvestment risk than price risk. ANSWER: b POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.07.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Bond concepts KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM Copyright Cengage Learning. Powered by Cognero.
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54. Which of the following statements is CORRECT? a. If the Federal Reserve unexpectedly announces that it expects inflation to increase, then we would probably observe an immediate increase in bond prices. b. The total yield on a bond is derived from dividends plus changes in the price of the bond. c. Bonds are generally regarded as being riskier than common stocks, and therefore bonds have higher required returns. d. Bonds issued by larger companies always have lower yields to maturity (due to less risk) than bonds issued by smaller companies. e. The market price of a bond will always approach its par value as its maturity date approaches, provided the bond’s required return remains constant. ANSWER: e POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.07.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Bond concepts KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 55. Which of the following statements is CORRECT? a. If a coupon bond is selling at par, its current yield equals its yield to maturity. b. If rates fall after its issue, a zero coupon bond could trade at a price above its maturity (or par) value. c. If rates fall rapidly, a zero coupon bond’s expected appreciation could become negative. d. If a firm moves from a position of strength toward financial distress, its bonds’ yield to maturity would probably decline. e. If a bond is selling at a premium, this implies that its yield to maturity exceeds its coupon rate. ANSWER: a POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.07.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Bond concepts KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual Copyright Cengage Learning. Powered by Cognero.
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56. Bond X has an 8% annual coupon, Bond Y has a 10% annual coupon, and Bond Z has a 12% annual coupon. Each of the bonds is noncallable, has a maturity of 10 years, and has a yield to maturity of 10%. Which of the following statements is CORRECT? a. If the bonds' market interest rate remains at 10%, Bond Z’s price will be lower one year from now than it is today. b. Bond X has the greatest reinvestment risk. c. If market interest rates decline, the prices of all three bonds will increase, but Z's price will have the largest percentage increase. d. If market interest rates remain at 10%, Bond Z’s price will be 10% higher one year from today. e. If market interest rates increase, Bond X’s price will increase, Bond Z’s price will decline, and Bond Y’s price will remain the same. ANSWER: a POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.07.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Bond concepts KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 57. Bonds A, B, and C all have a maturity of 10 years and a yield to maturity of 7%. Bond A’s price exceeds its par value, Bond B’s price equals its par value, and Bond C’s price is less than its par value. None of the bonds can be called. Which of the following statements is CORRECT? a. If the yield to maturity on each bond decreases to 6%, Bond A will have the largest percentage increase in its price. b. Bond A has the most price risk. c. If the yield to maturity on the three bonds remains constant, the prices of the three bonds will remain the same over the next year. d. If the yield to maturity on each bond increases to 8%, the prices of all three bonds will decline. e. Bond C sells at a premium over its par value. ANSWER: d RATIONALE: A is a high coupon bond because it sells above par, C is a low coupon bond, and B yields the going market rate. Consider this when ruling out a, b, c, and e. d is obviously correct. POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice Copyright Cengage Learning. Powered by Cognero.
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HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.07.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Bond concepts KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 58. Which of the following statements is CORRECT? a. 10-year, zero coupon bonds have more reinvestment risk than 10-year, 10% coupon bonds. b. A 10-year, 10% coupon bond has less reinvestment risk than a 10-year, 5% coupon bond (assuming all else equal). c. The total (rate of) return on a bond during a given year is the sum of the coupon interest payments received during the year and the change in the value of the bond from the beginning to the end of the year, divided by the bond's price at the beginning of the year. d. The price of a 20-year, 10% bond is less sensitive to changes in interest rates than the price of a 5-year, 10% bond. e. A $1,000 bond with $100 annual interest payments that has 5 years to maturity and is not expected to default would sell at a discount if interest rates were below 9% and at a premium if interest rates were greater than 11%. ANSWER: c POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.07.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Bond concepts KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 59. Which of the following statements is CORRECT? a. The yield to maturity for a coupon bond that sells at a premium consists entirely of a positive capital gains yield; it has a zero current interest yield. b. The market value of a bond will always approach its par value as its maturity date approaches. This holds true even if the firm has filed for bankruptcy. c. Rising inflation makes the actual yield to maturity on a bond greater than a quoted yield to maturity that is based on market prices. d. The yield to maturity on a coupon bond that sells at its par value consists entirely of a current interest yield; it Copyright Cengage Learning. Powered by Cognero.
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has a zero expected capital gains yield. e. The expected capital gains yield on a bond will always be zero or positive because no investor would purchase a bond with an expected capital loss. ANSWER: d POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.07.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Bond yields KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 60. Which of the following statements is CORRECT? a. If a coupon bond is selling at a premium, then the bond's current yield is zero. b. If a coupon bond is selling at a discount, then the bond's expected capital gains yield is negative. c. If a bond is selling at a discount, the yield to call is a better measure of the expected return than the yield to maturity. d. The current yield on Bond A exceeds the current yield on Bond B. Therefore, Bond A must have a higher yield to maturity than Bond B. e. If a coupon bond is selling at par, its current yield equals its yield to maturity. ANSWER: e POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.07.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Bond yields KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 61. Which of the following statements is CORRECT? a. If two bonds have the same maturity, the same yield to maturity, and the same level of risk, the bonds should sell for the same price regardless of their coupon rates. Copyright Cengage Learning. Powered by Cognero.
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b. All else equal, an increase in interest rates will have a greater effect on the prices of short-term than long-term bonds. c. All else equal, an increase in interest rates will have a greater effect on higher-coupon bonds than it will have on lower-coupon bonds. d. If a bond’s yield to maturity exceeds its coupon rate, the bond’s price must be less than its maturity value. e. If a bond’s yield to maturity exceeds its coupon rate, the bond’s current yield must be less than its coupon rate. ANSWER: d POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.07.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Bond yields and prices KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 62. Bond A has a 9% annual coupon, while Bond B has a 7% annual coupon. Both bonds have the same maturity, a face value of $1,000, an 8% yield to maturity, and are noncallable. Which of the following statements is CORRECT? a. Bond A’s capital gains yield is greater than Bond B’s capital gains yield. b. Bond A trades at a discount, whereas Bond B trades at a premium. c. If the yield to maturity for both bonds remains at 8%, Bond A’s price one year from now will be higher than it is today, but Bond B’s price one year from now will be lower than it is today. d. If the yield to maturity for both bonds immediately decreases to 6%, Bond A’s bond will have a larger percentage increase in value. e. Bond A’s current yield is greater than that of Bond B. ANSWER: e POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.07.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Bond rates and prices KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM Copyright Cengage Learning. Powered by Cognero.
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63. Which of the following statements is CORRECT? a. Two bonds have the same maturity and the same coupon rate. However, one is callable and the other is not. The difference in prices between the bonds will be greater if the current market interest rate is below the coupon rate than if it is above the coupon rate. b. A callable 10-year, 10% bond should sell at a higher price than an otherwise similar noncallable bond. c. Corporate treasurers dislike issuing callable bonds because these bonds may require the company to raise additional funds earlier than would be true if noncallable bonds with the same maturity were used. d. Two bonds have the same maturity and the same coupon rate. However, one is callable and the other is not. The difference in prices between the bonds will be greater if the current market interest rate is above the coupon rate than if it is below the coupon rate. e. The actual life of a callable bond will always be equal to or less than the actual life of a noncallable bond with the same maturity. Therefore, if the yield curve is upward sloping, the required rate of return will be lower on the callable bond. ANSWER: a RATIONALE: a is correct because, with the current market rate below the coupon bond, both bonds will sell at a premium, but the premium will be larger for the noncallable bond. The same logic explains why d is false. POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.07.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Callable bonds KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 64. Which of the following statements is CORRECT? a. Senior debt is debt that has been more recently issued, and in bankruptcy it is paid off after junior debt because the junior debt was issued first. b. A company's subordinated debt has less default risk than its senior debt. c. Convertible bonds generally have lower coupon rates than non-convertible bonds of similar default risk because they offer the possibility of capital gains. d. Junk bonds typically provide a lower yield to maturity than investment-grade bonds. e. A debenture is a secured bond that is backed by some or all of the firm's fixed assets. ANSWER: c POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False Copyright Cengage Learning. Powered by Cognero.
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LEARNING OBJECTIVES: FOFM.BRIG.17.07.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Types of debt KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 65. Which of the following statements is CORRECT? a. One disadvantage of zero coupon bonds is that the issuing firm cannot realize any tax savings from the use of debt until the bonds mature. b. Other things held constant, a callable bond should have a lower yield to maturity than a noncallable bond. c. Once a firm declares bankruptcy, it must be liquidated by the trustee, who uses the proceeds to pay bondholders, unpaid wages, taxes, and legal fees. d. Income bonds must pay interest only if the company earns the interest. Thus, these securities cannot bankrupt a company prior to their maturity, and this makes them safer to the issuing corporation than "regular" bonds. e. A firm with a sinking fund that gives it the choice of calling the required bonds at par or buying the bonds in the open market would generally choose the open market purchase if the coupon rate exceeded the going interest rate. ANSWER: d POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.07.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Miscellaneous concepts KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 66. Which of the following statements is CORRECT? a. The total return on a bond during a given year is based only on the coupon interest payments received. b. All else equal, a bond that has a coupon rate of 10% will sell at a discount if the required return for bonds of similar risk is 8%. c. The price of a discount bond will increase over time, assuming that the bond’s yield to maturity remains constant. d. For a given firm, its debentures are likely to have a lower yield to maturity than its mortgage bonds. e. When large firms are in financial distress, they are almost always liquidated, whereas smaller firms are generally reorganized. ANSWER: c Copyright Cengage Learning. Powered by Cognero.
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POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.07.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Miscellaneous concepts KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 67. Which of the following statements is CORRECT? a. A bond is likely to be called if its coupon rate is below its YTM. b. A bond is likely to be called if its market price is below its par value. c. Even if a bond's YTC exceeds its YTM, an investor with an investment horizon longer than the bond's maturity would be worse off if the bond were called. d. A bond is likely to be called if its market price is equal to its par value. e. A bond is likely to be called if it sells at a discount below par. ANSWER: c RATIONALE: A bond would not be called unless the current rate was below the YTM, in which case it would sell at a premium, because only then would it be profitable to refund the bond. The investor would get the funds, then reinvest at the new low market rate. Thus, the investor would end up earning less than the YTM, even after receiving the call premium. POINTS: 1 DIFFICULTY: MODERATE/CHALLENGING REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.07.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Calling bonds KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 68. Which of the following statements is CORRECT? a. Assume that two bonds have equal maturities and are of equal risk, but one bond sells at par while the other sells at a premium above par. The premium bond must have a lower current yield and a higher capital gains yield than the par bond. Copyright Cengage Learning. Powered by Cognero.
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b. A bond’s current yield must always be either equal to its yield to maturity or between its yield to maturity and its coupon rate. c. If a bond sells at par, then its current yield will be less than its yield to maturity. d. If a bond sells for less than par, then its yield to maturity is less than its coupon rate. e. A discount bond’s price declines each year until it matures, when its value equals its par value. ANSWER: b RATIONALE: Answer a is incorrect because a premium bond must have a negative capital gains yield. Answer c is incorrect because a bond selling at par must have a current yield equal to its YTM. Answer d is incorrect because a bond selling at below par must have a YTM > the coupon rate. Answer e is incorrect because a discount bond's price must rise over time. That leaves answer b as the only possibly correct answer. Note that YTM = Current yield +/- Capital gains yield, so Current yield = YTM +/- Capital gains yield. The capital gains yield will be positive or negative depending on whether the coupon rate is above or below the YTM. That means that the current yield must either equal the YTM or be between the YTM and the coupon rate. b's correctness is also demonstrated below: Par bond Premium Discount Par $1,000 $1,000 $1,000 Maturity 10 10 10 Coup rate 10% 11% 9% YTM 10.00% 10.00% 10.00% Ann coup $100.00 $110.00 $90.00 Price $1,000.00 $1,061.45 $938.55 Cur Yield 10.00% 10.36% 9.59% Equal to or between YTM and coupon rate. Cap gain 0.00% -0.36% 0.41% POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 7-4 Bond Yields QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVE FOFM.BRIG.17.07.04 - Bond Yields S: NATIONAL STANDARDS United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic : STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Current yield and YTM KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 69. Assume that a noncallable 10-year T-bond has a 12% annual coupon, while a 15-year noncallable T-bond has an 8% annual coupon. Assume also that the yield curve is flat, and all Treasury securities have a 10% yield to maturity. Which of the following statements is CORRECT? a. If interest rates decline, the prices of both bonds would increase, but the 15-year bond would have a larger percentage increase in price. b. If interest rates decline, the prices of both bonds would increase, but the 10-year bond would have a larger percentage increase in price. c. The 10-year bond would sell at a discount, while the 15-year bond would sell at a premium. Copyright Cengage Learning. Powered by Cognero.
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d. The 10-year bond would sell at a premium, while the 15-year bond would sell at par. e. If the yield to maturity on both bonds remains at 10% over the next year, the price of the 10-year bond would increase, but the price of the 15-year bond would fall. ANSWER: a RATIONALE: We can tell by inspection that c, d, and e are all incorrect. That leaves answers a and b as the only possibly correct statements. Also, recognize that longer-term bonds, and also bonds whose payments come late (like low coupon bonds) are most sensitive to changes in interest rates. Thus, the 15-year, 8% coupon bond would be more sensitive to a decline in rates. Finally, we can do some calculations to confirm that a is the correct answer:
Par Maturity Coup rate YTM Ann coup Price % Gain
Current situation 10-year 15-year $1,000 $1,000 10 15 12% 8% 10.00% 10.00% $120 $80 $1,122.89 $847.88
Rates decline 10-year 15-year $1,000 $1,000 10 15 12% 8% 9.00% 9.00% $120 $80 $1,192.53 $919.39 6.2% 8.4%
POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 7-5 Changes in Bond Values over Time QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.07.05 - Changes in Bond Values Over Time NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: LOCAL STANDARDS: TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds United States - OH - Default City - Tier 2: - Capital structure Int. rates and bond prices Bloom's: Application Multiple Choice: Conceptual 9/21/2017 5:24 PM 9/21/2017 5:24 PM
70. Which of the following statements is CORRECT? a. A zero coupon bond of any maturity will have more price risk than any coupon bond, even a perpetuity. b. If their maturities and other characteristics were the same, a 5% coupon bond would have more price risk than a 10% coupon bond. c. A 10-year coupon bond would have more reinvestment risk than a 5-year coupon bond, but all 10-year coupon bonds have the same amount of reinvestment risk. d. A 10-year coupon bond would have more price risk than a 5-year coupon bond, but all 10-year coupon bonds have the same amount of price risk. e. If their maturities and other characteristics were the same, a 5% coupon bond would have less price risk than a 10% coupon bond. ANSWER: b POINTS: 1 Copyright Cengage Learning. Powered by Cognero.
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DIFFICULTY: CHALLENGING REFERENCES: 7-7 Assessing a Bond’s Riskiness QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.07.07 - Assessing a Bond's Riskiness NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Price and reinvest. risk KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 71. Listed below are some provisions that are often contained in bond indentures. Which of these provisions, viewed alone, would tend to reduce the yield to maturity that investors would otherwise require on a newly issued bond? 1. Fixed assets are used as security for a bond. 2. A given bond is subordinated to other classes of debt. 3. The bond can be converted into the firm's common stock. 4. The bond has a sinking fund. 5. The bond has a call provision. 6. The indenture contains covenants that restrict the use of additional debt. a. 1, 3, 4, 6 b. 1, 4, 6 c. 1, 2, 3, 4, 6 d. 1, 2, 3, 4, 5, 6 e. 1, 3, 4, 5, 6 ANSWER: a POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 7-8 Default Risk QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.07.08 - Default Risk NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Bond indenture KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 72. Suppose a new company decides to raise a total of $200 million, with $100 million as common equity and $100 million as long-term debt. The debt can be mortgage bonds or debentures, but by an iron-clad provision in its charter, the company can never raise any additional debt beyond the original $100 million. Given these conditions, which of the Copyright Cengage Learning. Powered by Cognero.
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following statements is CORRECT? a. The higher the percentage of debt represented by mortgage bonds, the riskier both types of bonds will be and, consequently, the higher the firm’s total dollar interest charges will be. b. If the debt were raised by issuing $50 million of debentures and $50 million of first mortgage bonds, we could be certain that the firm’s total interest expense would be lower than if the debt were raised by issuing $100 million of debentures. c. In this situation, we cannot tell for sure how, or even whether, the firm’s total interest expense on the $100 million of debt would be affected by the mix of debentures versus first mortgage bonds. The interest rate on each type of bond would increase as the percentage of mortgage bonds used was increased, but the average cost might well be such that the firm’s total interest charges would not be affected materially by the mix between the two. d. The higher the percentage of debentures, the greater the risk borne by each debenture, and thus the higher the required rate of return on the debentures. e. If the debt were raised by issuing $50 million of debentures and $50 million of first mortgage bonds, we could be certain that the firm’s total interest expense would be lower than if the debt were raised by issuing $100 million of first mortgage bonds. ANSWER: c RATIONALE: The higher the percentage of mortgage bonds, the less the collateral backing each bond, so these bonds' risk and thus required return would be higher. Also, the higher the percentage of mortgage bonds, the less free assets would be backing the debentures, so their risk and required return would also be higher. However, mortgage bonds are less risky than debentures, so mortgage bond rates are lower than rates on debentures. We end up with a situation where the greater the percentage of mortgage bonds, the higher the rate on both types of debt, but the average cost to the company could be higher, lower, or constant. Note that we could draw a graph of the situation, with % mortgage on the horizontal axis and rates on the vertical axis, the graph would look like the WACC graph in the cost of capital chapter. POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.07.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Costs of types of debt KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 73. A company is planning to raise $1,000,000 to finance a new plant. Which of the following statements is CORRECT? a. The company would be especially eager to have a call provision included in the indenture if its management thinks that interest rates are almost certain to rise in the foreseeable future. b. If debt is used to raise the million dollars, but $500,000 is raised as first mortgage bonds on the new plant and $500,000 as debentures, the interest rate on the first mortgage bonds would be lower than it would be if the entire $1 million were raised by selling first mortgage bonds. c. If two classes of debt are used (with one senior and the other subordinated to all other debt), the subordinated debt will carry a lower interest rate. Copyright Cengage Learning. Powered by Cognero.
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d. If debt is used to raise the million dollars, the cost of the debt would be lower if the debt were in the form of a fixed-rate bond rather than a floating-rate bond. e. If debt is used to raise the million dollars, the cost of the debt would be higher if the debt were in the form of a mortgage bond rather than an unsecured term loan. ANSWER: b RATIONALE: In statement b, note that if only $500,000 of 1st mortgage bonds were secured by $1 million of property, each of those bonds would be less risky than if there were $1 million of bonds backed by the $1 million of property. Note too that the cost of the total $1 million of debt would be an average of the cost of the mortgage bonds and the debentures, and that average cost could be higher, lower, or the same as if only mortgage bonds or only debentures were used. POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.07.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Costs of types of debt KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 74. Assuming all else is constant, which of the following statements is CORRECT? a. Other things held constant, a 20-year zero coupon bond has more reinvestment risk than a 20-year coupon bond. b. Other things held constant, for any given maturity, a 1.0 percentage point decrease in the market interest rate would cause a smaller dollar capital gain than the capital loss stemming from a 1.0 percentage point increase in the interest rate. c. From a corporate borrower’s point of view, interest paid on bonds is not tax-deductible. d. Other things held constant, price sensitivity as measured by the percentage change in price due to a given change in the required rate of return decreases as a bond’s maturity increases. e. For a bond of any maturity, a 1.0 percentage point increase in the market interest rate (rd) causes a larger dollar capital loss than the capital gain stemming from a 1.0 percentage point decrease in the interest rate. ANSWER: e RATIONALE: It is relatively easy to eliminate a, c, and d. When choosing between b and e, think about the graph that shows the relationship between a bond's price and the going interest rate. This curve is concave, indicating that at any interest rate, the decline in price from an increase in rates is less than the gain in price from a similar interest rate decline. It would be easy to confirm this statement with an example. POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False Copyright Cengage Learning. Powered by Cognero.
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LEARNING OBJECTIVES: FOFM.BRIG.17.07.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Bond concepts KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 75. Morin Company's bonds mature in 8 years, have a par value of $1,000, and make an annual coupon interest payment of $65. The market requires an interest rate of 6.1% on these bonds. What is the bond's price? a. $1,024.74 b. $1,147.71 c. $1,116.97 d. $1,096.47 e. $1,280.93 ANSWER: a RATIONALE: N 8 I/YR 6.1% PMT $65 FV $1,000 PV $1,024.74 POINTS: 1 DIFFICULTY: EASY REFERENCES: 7-3 Bond Valuation QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.07.03 - Bond Valuation NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Bond valuation: annual KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 76. Ryngaert Inc. recently issued noncallable bonds that mature in 15 years. They have a par value of $1,000 and an annual coupon of 5.7%. If the current market interest rate is 7.0%, at what price should the bonds sell? a. $1,040.28 b. $802.25 c. $1,013.84 d. $775.81 e. $881.60 ANSWER: e Copyright Cengage Learning. Powered by Cognero.
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RATIONALE:
Coupon rate 5.70% PMT $57.00 N 15 I/YR 7.00% FV $1,000 PV $881.60 POINTS: 1 DIFFICULTY: EASY REFERENCES: 7-3 Bond Valuation QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.07.03 - Bond Valuation NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Bond valuation: annual KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 77. Adams Enterprises’ noncallable bonds currently sell for $910. They have a 15-year maturity, an annual coupon of $85, and a par value of $1,000. What is their yield to maturity? a. 7.34% b. 9.66% c. 8.60% d. 9.95% e. 11.21% ANSWER: b RATIONALE: N 15 PV $910 PMT $85 FV $1,000 I/YR 9.66% POINTS: 1 DIFFICULTY: EASY REFERENCES: 7-4 Bond Yields QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.07.04 - Bond Yields NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Yield to maturity KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:24 PM Copyright Cengage Learning. Powered by Cognero.
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DATE MODIFIED:
9/21/2017 5:24 PM
78. Dyl Inc.'s bonds currently sell for $870 and have a par value of $1,000. They pay a $65 annual coupon and have a 15year maturity, but they can be called in 5 years at $1,100. What is their yield to maturity (YTM)? a. 8.02% b. 9.71% c. 6.66% d. 7.38% e. 8.66% ANSWER: a RATIONALE: N 15 PV $870 PMT $65 FV $1,000 I/YR 8.02% = YTM POINTS: 1 DIFFICULTY: EASY REFERENCES: 7-4 Bond Yields QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.07.04 - Bond Yields NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Yield to maturity KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 79. Radoski Corporation's bonds make an annual coupon interest payment of 7.35% every year. The bonds have a par value of $1,000, a current price of $920, and mature in 12 years. What is the yield to maturity on these bonds? a. 6.83% b. 9.53% c. 8.10% d. 7.25% e. 8.44% ANSWER: e RATIONALE: Coupon rate 7.35% N 12 PV = Price $920 PMT $73.50 FV = Par $1,000 I/YR 8.44% =YTM POINTS: 1 DIFFICULTY: EASY REFERENCES: 7-4 Bond Yields Copyright Cengage Learning. Powered by Cognero.
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QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.07.04 - Bond Yields NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Yield to maturity KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 80. Sadik Inc.'s bonds currently sell for $1,300 and have a par value of $1,000. They pay a $105 annual coupon and have a 15-year maturity, but they can be called in 5 years at $1,100. What is their yield to call (YTC)? a. 5.10% b. 5.31% c. 4.94% d. 6.00% e. 4.30% ANSWER: b RATIONALE: N 5 PV $1,300 PMT $105 FV $1,100 I/YR = YTC 5.31% POINTS: 1 DIFFICULTY: EASY REFERENCES: 7-4 Bond Yields QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.07.04 - Bond Yields NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Yield to call KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 81. Malko Enterprises’ bonds currently sell for $1,020. They have a 6-year maturity, an annual coupon of $75, and a par value of $1,000. What is their current yield? a. 6.91% b. 6.62% c. 8.46% d. 6.40% Copyright Cengage Learning. Powered by Cognero.
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e. 7.35% ANSWER: RATIONALE:
e PV PMT Current yield =
$1,020 $75 7.35%
POINTS: 1 DIFFICULTY: EASY REFERENCES: 7-4 Bond Yields QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.07.04 - Bond Yields NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Current yield KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 82. Assume that you are considering the purchase of a 20-year, noncallable bond with an annual coupon rate of 9.5%. The bond has a face value of $1,000, and it makes semiannual interest payments. If you require an 10.7% nominal yield to maturity on this investment, what is the maximum price you should be willing to pay for the bond? a. $721.44 b. $910.81 c. $901.80 d. $874.74 e. $1,000.99 ANSWER: c RATIONALE: Par value $1,000 Coupon rate 9.5% Periods/year 2 Yrs to maturity 20 40 Periods = Yrs to maturity Periods/year Required rate 10.7% Periodic rate = Required rate / 2 = I/YR 5.35% $47.50 PMT per period = Coupon rate/2 Par value Maturity value = FV $1,000 PV $901.80 POINTS: 1 DIFFICULTY: EASY REFERENCES: 7-6 Bonds with Semiannual Coupons QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.07.06 - Bonds with Semiannual Coupons NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic Copyright Cengage Learning. Powered by Cognero.
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STATE STANDARDS: LOCAL STANDARDS: TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds United States - OH - Default City - Tier 2: - Capital structure Bond valuation: semiannual Bloom's: Analysis Multiple Choice: Problem 9/21/2017 5:24 PM 9/21/2017 5:24 PM
83. Grossnickle Corporation issued 20-year, noncallable, 7.4% annual coupon bonds at their par value of $1,000 one year ago. Today, the market interest rate on these bonds is 5.5%. What is the current price of the bonds, given that they now have 19 years to maturity? a. $1,281.57 b. $1,000.85 c. $1,013.05 d. $1,220.55 e. $1,196.13 ANSWER: d RATIONALE: Par value = Maturity value = FV $1,000 Coupon rate 7.4% Years to maturity = N 19 Required rate = I/YR 5.5% (Coupon rate)(Par value) = PMT $74 PV $1,220.55
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 7-3 Bond Valuation QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.07.03 - Bond Valuation NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Bond valuation: annual KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 84. McCue Inc.'s bonds currently sell for $1,175. They pay a $90 annual coupon, have a 25-year maturity, and a $1,000 par value, but they can be called in 5 years at $1,050. Assume that no costs other than the call premium would be incurred to call and refund the bonds, and also assume that the yield curve is horizontal, with rates expected to remain at current levels on into the future. What is the difference between this bond's YTM and its YTC? (Subtract the YTC from the YTM; it is possible to get a negative answer.) a. 1.26% b. 1.47% Copyright Cengage Learning. Powered by Cognero.
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c. 1.74% d. 1.68% e. 1.88% ANSWER: RATIONALE:
d If held to maturity: N = Maturity Price = PV PMT FV = Par I/YR = YTM Difference: YTM - YTC =
25 $1,175 $90 $1,000 7.44% 1.68%
If called in 5 years: N = Call PV PMT FV = Call Price I/YR = YTC
5 $1,175 $90 $1,050 5.76%
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 7-4 Bond Yields QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.07.04 - Bond Yields NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: YTM and YTC KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 85. Taussig Corp.'s bonds currently sell for $960. They have a 6.35% annual coupon rate and a 20-year maturity, but they can be called in 5 years at $1,067.50. Assume that no costs other than the call premium would be incurred to call and refund the bonds, and also assume that the yield curve is horizontal, with rates expected to remain at current levels on into the future. Under these conditions, what rate of return should an investor expect to earn if he or she purchases these bonds? a. 5.51% b. 6.72% c. 6.52% d. 5.98% e. 7.46% ANSWER: b RATIONALE: If the coupon rate exceeds the YTM, then it is likely that the bonds will be called and replaced with new, lower coupon bonds. In that case, the YTC will be earned. Otherwise, one should expect to earn the YTM. If held to maturity: If called: Par value $1,000 Par value $1,000 Coupon 6.35% Coupon 6.35% N 20 N 5 Price = PV $960 PV $960 $63.50 $63.50 PMT PMT = Par Coupon FV $1,000.00 FV $1,067.50 I/YR = YTM 6.72% I/YR = YTC 8.50% Copyright Cengage Learning. Powered by Cognero.
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Expected rate of return = YTC if Coupon > YTM, otherwise it is YTM, so expected rate of return = YTM = 6.72% POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 7-4 Bond Yields QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.07.04 - Bond Yields NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: YTM and YTC KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 86. A 25-year, $1,000 par value bond has an 8.5% annual payment coupon. The bond currently sells for $925. If the yield to maturity remains at its current rate, what will the price be 5 years from now? a. $883.61 b. $744.09 c. $976.62 d. $930.11 e. $865.00 ANSWER: d RATIONALE: First find the YTM at this time, then use the YTM with the other data to find the bond's price 5 years hence. Par value $1,000 Coupon rate: 8.50% Value in 5 years: N 25 N 20 PV $925 I/YR 9.28% PMT $85 PMT $85 FV $1,000 FV $1,000 I/YR 9.28% PV $930.11 POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 7-5 Changes in Bond Values over Time QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.07.05 - Changes in Bond Values Over Time NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Future annual bond value KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:24 PM Copyright Cengage Learning. Powered by Cognero.
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DATE MODIFIED:
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87. Moerdyk Corporation's bonds have a 15-year maturity, a 7.25% semiannual coupon, and a par value of $1,000. The going interest rate (rd) is 5.00%, based on semiannual compounding. What is the bond’s price? a. $1,235.47 b. $976.02 c. $1,457.85 d. $1,050.15 e. $1,359.01 ANSWER: a RATIONALE: Par value = FV $1,000 Coupon rate 7.25% Periods/year 2 Yrs to maturity 15 30 Periods = Years 2 = N 5.00% Going annual rate = YTM = rd 2.50% Periodic rate = rd / 2 = I/YR $36.25 Coupon rate Par / 2 = PMT PV $1,235.47 POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 7-6 Bonds with Semiannual Coupons QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.07.06 - Bonds with Semiannual Coupons NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Bond valuation: semiannual KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 88. In order to accurately assess the capital structure of a firm, it is necessary to convert its balance sheet figures from historical book values to market values. KJM Corporation's balance sheet (book values) as of today is as follows: Long-term debt (bonds, at par) Preferred stock Common stock ($10 par) Retained earnings Total debt and equity
$23,500,000 2,000,000 10,000,000 4,000,000 $39,500,000
The bonds have a 8.3% coupon rate, payable semiannually, and a par value of $1,000. They mature exactly 10 years from today. The yield to maturity is 11%, so the bonds now sell below par. What is the current market value of the firm's debt? a. $19,708,741 b. $22,073,790 c. $24,241,752 Copyright Cengage Learning. Powered by Cognero.
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d. $21,679,615 e. $15,569,906 ANSWER: RATIONALE:
a Calculate the price of each bond: Coupon rate Par value = FV Yrs to maturity Periods/Yr. Periods = Years 2 = N Going annual rate = rd = YTM Periodic rate = rd / 2 = I/YR Coupon rate Par / 2 = PMT Price of the bonds = PV Determine the number of bonds: Book value on balance sheet Par value Number of bonds = Book value/Par value
8.3% $1,000 10 2 20 11.0% 5.5% $41.50 $838.67 $23,500,000 $1,000 23,500
Calculate the market value of bonds: $19,708,741 Mkt value = PV Number of bonds = POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 7-6 Bonds with Semiannual Coupons QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.07.06 - Bonds with Semiannual Coupons NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Market value: semiannual KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 89. Keenan Industries has a bond outstanding with 15 years to maturity, an 8.25% nominal coupon, semiannual payments, and a $1,000 par value. The bond has a 6.50% nominal yield to maturity, but it can be called in 6 years at a price of $1,045. What is the bond’s nominal yield to call? a. 6.77% b. 5.09% c. 4.42% d. 5.54% e. 5.59% ANSWER: e RATIONALE: First, use the given data to find the bond's current price. Then use that price to find the YTC. Coupon rate 8.25% YTM 6.50% Copyright Cengage Learning. Powered by Cognero.
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Maturity 15 Yrs to call 6 Par value $1,000 Call price $1,045 Periods/year 2 Determine the bond's YTC Determine the bond's price N 12 PMT/period $41.25 PV $1,166.09 N 30 PMT $41.25 I/YR 3.25% FV $1,045.00 FV $1,000.00 I/YR 2.80% PV = Price $1,166.09 Nom. YTC 5.59% POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 7-6 Bonds with Semiannual Coupons QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.07.06 - Bonds with Semiannual Coupons NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Semiannual YTM and YTC KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 90. O'Brien Ltd.'s outstanding bonds have a $1,000 par value, and they mature in 25 years. Their nominal annual, not semiannual yield to maturity is 9.25%, they pay interest semiannually, and they sell at a price of $875. What is the bond's nominal coupon interest rate? a. 6.37% b. 8.76% c. 7.96% d. 6.05% e. 6.69% ANSWER: c RATIONALE: First, use the data provided to find the dollar coupon payment per 6 months, then multiply by 2 to get the annual coupon, and then divide by the par value to find the coupon rate. One could use the indicated data and solve for the price. It would be $875, which confirms the rate. Par value = FV $1,000 Years to maturity 25 Periods/year 2 50 Years periods/year = N YTM 9.25% Periodic rate = YTM/2 = I/YR 4.625% Price today = PV $875 PMT, function of N, I/YR, PV, and FV = semiannual pymt $39.80 $79.59 Annual coupon payment = semiannual payment 2 = Coupon rate = Annual coupon payment / Par value = 7.96% POINTS: 1 DIFFICULTY: CHALLENGING Copyright Cengage Learning. Powered by Cognero.
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REFERENCES: 7-6 Bonds with Semiannual Coupons QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.07.06 - Bonds with Semiannual Coupons NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Semiannual bond coupon KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 91. Kebt Corporation's Class Semi bonds have a 12-year maturity and an 8.50% coupon paid semiannually (4.25% each 6 months), and those bonds sell at their $1,000 par value. The firm's Class Ann bonds have the same risk, maturity, nominal interest rate, and par value, but these bonds pay interest annually. Neither bond is callable. At what price should the annual payment bond sell? a. $957.25 b. $986.86 c. $878.30 d. $1,164.49 e. $907.91 ANSWER: b RATIONALE: These two bonds should provide the same EFF%. Therefore, we can find the EFF% for the semiannual bond and then use it as the YTM for the annual payment bond. At the calculated price, the two bonds will have YTMs with the same EFF%. Note too that the semiannual payment bond must have a higher price than the annual bond because then it receives the same cash flow, but faster. Therefore, the annual bond must sell at a price below the $1,000 par value at which the semiannual bond sells. Semiannual bond Annual bond Par value $1,000 Par value $1,000 Coupon rate=Nominal rate 8.50% Coupon rate 8.50% Payment per period $42.50 Pmt/Period $85.00 Years to maturity 12 Yrs to maturity 12 Periods/year 2 Periods/year 1 Total periods 24 Total periods 12 2 8.681% 8.681% EFF%=YTM EFF% = (1+Nom rate/2) - 1 Price $1,000.00 Price $986.86 POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 7-6 Bonds with Semiannual Coupons QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.07.06 - Bonds with Semiannual Coupons NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure Copyright Cengage Learning. Powered by Cognero.
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TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
Bonds: semiannual EFF% Bloom's: Analysis Multiple Choice: Problem 9/21/2017 5:24 PM 9/21/2017 5:24 PM
92. Moon Software Inc. is planning to issue two types of 25-year, noncallable bonds to raise a total of $6 million, $3 million from each type of bond. First, 3,000 bonds with a 10% semiannual coupon will be sold at their $1,000 par value to raise $3,000,000. These are called "par" bonds. Second, Original Issue Discount (OID) bonds, also with a 25-year maturity and a $1,000 par value, will be sold, but these bonds will have a semiannual coupon of only 6.75%. The OID bonds must be offered at below par in order to provide investors with the same effective yield as the par bonds. How many OID bonds must the firm issue to raise $3,000,000? Disregard flotation costs, and round your final answer up to a whole number of bonds. a. 3,370 b. 4,906 c. 3,285 d. 4,479 e. 4,266 ANSWER: e RATIONALE: The par bond has a coupon rate of 10% and a periodic rate of 5%, and it sells at par. Therefore, the going nominal rate must be 10% with an EFF% of 10.25%. The OID bond must provide the same EFF%, because it is equally risky. Therefore, it must be evaluated with the parameters shown below to find its price, which is then used to find the number of bonds to be issued. Note that if the OID bond is based on a 5% periodic rate, its EFF% will also be 10.25%. Bond B: Issued at a discount (OID Bond A: Issued at par: bonds): Par value $1,000 Par value $1,000 Coupon rate 10.00% Coupon rate 6.75% Periods/year 2 Periods/year 2 Periodic rate 5.00% Periodic rate 5.00% Years to maturity 25 Years to maturity 25 50 Years Period/year = N 50 Years Periods/year = N PMT per period = Coupon $50.00 $33.75 PMT per period = Coupon Par/2 Par/2 PV = Price $1,000 PV = Price $703.3412 Funds needed from OID bonds $3,000,000 Number of bonds = $3,000,000/OID 4,265.36 price Number of bonds, rounded up 4,266 POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 7-6 Bonds with Semiannual Coupons QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.07.06 - Bonds with Semiannual Coupons NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure Copyright Cengage Learning. Powered by Cognero.
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TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
Bonds: semiannual and OID Bloom's: Analysis Multiple Choice: Problem 9/21/2017 5:24 PM 9/21/2017 5:24 PM
1. The tighter the probability distribution of its expected future returns, the greater the risk of a given investment as measured by its standard deviation. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 8-2 Stand-Alone Risk QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.02 - Stand-Alone Risk NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Standard deviation KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 2. The coefficient of variation, calculated as the standard deviation of expected returns divided by the expected return, is a standardized measure of the risk per unit of expected return. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 8-2 Stand-Alone Risk QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.02 - Stand-Alone Risk NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Coefficient of variation KEYWORDS: Bloom’s: Knowledge DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 3. The standard deviation is a better measure of risk than the coefficient of variation if the expected returns of the Copyright Cengage Learning. Powered by Cognero.
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securities being compared differ significantly. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 8-2 Stand-Alone Risk QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.02 - Stand-Alone Risk NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: CV vs. SD KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 4. Risk-averse investors require higher rates of return on investments whose returns are highly uncertain, and most investors are risk averse. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 8-2 Stand-Alone Risk QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.02 - Stand-Alone Risk NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Risk aversion KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 5. When adding a randomly chosen new stock to an existing portfolio, the higher (or more positive) the degree of correlation between the new stock and stocks already in the portfolio, the less the additional stock will reduce the portfolio's risk. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 8-3 Risk in a Portfolio Context: The CAPM Copyright Cengage Learning. Powered by Cognero.
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QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.03 - Risk in a Portfolio Context: The CAPM NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Portfolio risk KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 6. Diversification will normally reduce the riskiness of a portfolio of stocks. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 8-3 Risk in a Portfolio Context: The CAPM QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.03 - Risk in a Portfolio Context: The CAPM NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Portfolio risk KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 7. In portfolio analysis, we often use ex post (historical) returns and standard deviations, despite the fact that we are really interested in ex ante (future) data. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 8-3 Risk in a Portfolio Context: The CAPM QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.03 - Risk in a Portfolio Context: The CAPM NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Portfolio risk KEYWORDS: Bloom's: Knowledge Copyright Cengage Learning. Powered by Cognero.
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DATE CREATED: DATE MODIFIED:
9/21/2017 5:24 PM 9/21/2017 5:24 PM
8. The realized return on a stock portfolio is the weighted average of the expected returns on the stocks in the portfolio. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 8-3 Risk in a Portfolio Context: The CAPM QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.03 - Risk in a Portfolio Context: The CAPM NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Portfolio return KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 9. Market risk refers to the tendency of a stock to move with the general stock market. A stock with above-average market risk will tend to be more volatile than an average stock, and its beta will be greater than 1.0. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 8-3 Risk in a Portfolio Context: The CAPM QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.03 - Risk in a Portfolio Context: The CAPM NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Market risk KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 10. An individual stock's diversifiable risk, which is measured by its beta, can be lowered by adding more stocks to the portfolio in which the stock is held. a. True b. False ANSWER: False POINTS: 1 Copyright Cengage Learning. Powered by Cognero.
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DIFFICULTY: EASY REFERENCES: 8-3 Risk in a Portfolio Context: The CAPM QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.03 - Risk in a Portfolio Context: The CAPM NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Market risk KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 11. Managers should under no conditions take actions that increase their firm's risk relative to the market, regardless of how much those actions would increase the firm's expected rate of return. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 8-3 Risk in a Portfolio Context: The CAPM QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.03 - Risk in a Portfolio Context: The CAPM NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Risk and expected returns KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 12. One key conclusion of the Capital Asset Pricing Model is that the value of an asset should be measured by considering both the risk and the expected return of the asset, assuming that the asset is held in a well-diversified portfolio. The risk of the asset held in isolation is not relevant under the CAPM. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 8-3 Risk in a Portfolio Context: The CAPM QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.03 - Risk in a Portfolio Context: The CAPM NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return Copyright Cengage Learning. Powered by Cognero.
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LOCAL STANDARDS: TOPICS: KEYWORDS: DATE CREATED: DATE MODIFIED:
United States - OH - Default City - Tier 2: - Capital structure CAPM and risk Bloom's: Comprehension 9/21/2017 5:24 PM 9/21/2017 5:24 PM
13. According to the Capital Asset Pricing Model, investors are primarily concerned with portfolio risk, not the risks of individual stocks held in isolation. Thus, the relevant risk of a stock is the stock's contribution to the riskiness of a welldiversified portfolio. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 8-3 Risk in a Portfolio Context: The CAPM QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.03 - Risk in a Portfolio Context: The CAPM NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: CAPM and risk KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 14. If investors become less averse to risk, the slope of the Security Market Line (SML) will increase. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 8-4 The Relationship Between Risk and Rates of Return QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.04 - The Relationship Between Risk and Rates of Return NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: SML and risk aversion KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 15. Most corporations earn returns for their stockholders by acquiring and operating tangible and intangible assets. The relevant risk of each asset should be measured in terms of its effect on the risk of the firm's stockholders. Copyright Cengage Learning. Powered by Cognero.
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a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 8-6 Some Concluding Thoughts: Implications for Corporate Managers and Investors QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.06 - Some Concluding Thoughts: Implications for Corporate Managers and Investors NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Physical assets KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 16. Variance is a measure of the variability of returns, and since it involves squaring the deviation of each actual return from the expected return, it is always larger than its square root, the standard deviation. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-2 Stand-Alone Risk QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.02 - Stand-Alone Risk NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Variance KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 17. Because of differences in the expected returns on different investments, the standard deviation is not always an adequate measure of risk. However, the coefficient of variation adjusts for differences in expected returns and thus allows investors to make better comparisons of investments' stand-alone risk. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-2 Stand-Alone Risk Copyright Cengage Learning. Powered by Cognero.
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QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.02 - Stand-Alone Risk NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Coefficient of variation KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 18. "Risk aversion" implies that investors require higher expected returns on riskier than on less risky securities. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-2 Stand-Alone Risk QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.02 - Stand-Alone Risk NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Risk aversion KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 19. If investors are risk averse and hold only one stock, we can conclude that the required rate of return on a stock whose standard deviation is 0.21 will be greater than the required return on a stock whose standard deviation is 0.10. However, if stocks are held in portfolios, it is possible that the required return could be higher on the stock with the lower standard deviation. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-2 Stand-Alone Risk QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.02 - Stand-Alone Risk NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Risk aversion Copyright Cengage Learning. Powered by Cognero.
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KEYWORDS: DATE CREATED: DATE MODIFIED:
Bloom's: Comprehension 9/21/2017 5:24 PM 9/21/2017 5:24 PM
20. Someone who is risk averse has a general dislike for risk and a preference for certainty. If risk aversion exists in the market, then investors in general are willing to accept somewhat lower returns on less risky securities. Different investors have different degrees of risk aversion, and the end result is that investors with greater risk aversion tend to hold securities with lower risk (and therefore a lower expected return) than investors who have more tolerance for risk. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-2 Stand-Alone Risk QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.02 - Stand-Alone Risk NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Risk prem. and risk aversion KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 21. A stock's beta measures its diversifiable risk relative to the diversifiable risks of other firms. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-3 Risk in a Portfolio Context: The CAPM QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.03 - Risk in a Portfolio Context: The CAPM NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Beta coefficient KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 22. A stock's beta is more relevant as a measure of risk to an investor who holds only one stock than to an investor who holds a well-diversified portfolio. a. True Copyright Cengage Learning. Powered by Cognero.
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b. False ANSWER: False POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-3 Risk in a Portfolio Context: The CAPM QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.03 - Risk in a Portfolio Context: The CAPM NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Beta coefficient KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 23. If the returns of two firms are negatively correlated, then one of them must have a negative beta. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-3 Risk in a Portfolio Context: The CAPM QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.03 - Risk in a Portfolio Context: The CAPM NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Beta coefficient KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 24. A stock with a beta equal to -1.0 has zero systematic (or market) risk. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-3 Risk in a Portfolio Context: The CAPM QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.03 - Risk in a Portfolio Context: The CAPM NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking Copyright Cengage Learning. Powered by Cognero.
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STATE STANDARDS: LOCAL STANDARDS: TOPICS: KEYWORDS: DATE CREATED: DATE MODIFIED:
United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return United States - OH - Default City - Tier 2: - Capital structure Beta coefficient Bloom's: Knowledge 9/21/2017 5:24 PM 9/21/2017 5:24 PM
25. It is possible for a firm to have a positive beta, even if the correlation between its returns and those of another firm is negative. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-3 Risk in a Portfolio Context: The CAPM QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.03 - Risk in a Portfolio Context: The CAPM NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Beta coefficient KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 26. Portfolio A has but one security, while Portfolio B has 100 securities. Because of diversification effects, we would expect Portfolio B to have the lower risk. However, it is possible for Portfolio A to be less risky. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-3 Risk in a Portfolio Context: The CAPM QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.03 - Risk in a Portfolio Context: The CAPM NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Portfolio risk KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 27. Portfolio A has only one stock, while Portfolio B consists of all stocks that trade in the market, each held in proportion Copyright Cengage Learning. Powered by Cognero.
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to its market value. Because of its diversification, Portfolio B will by definition be riskless. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-3 Risk in a Portfolio Context: The CAPM QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.03 - Risk in a Portfolio Context: The CAPM NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Portfolio risk KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 28. A portfolio's risk is measured by the weighted average of the standard deviations of the securities in the portfolio. It is this aspect of portfolios that allows investors to combine stocks and thus reduce the riskiness of their portfolios. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-3 Risk in a Portfolio Context: The CAPM QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.03 - Risk in a Portfolio Context: The CAPM NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Portfolio risk KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 29. The distributions of rates of return for Companies AA and BB are given below: State of the Economy Boom Normal Recession
Probability of This State Occurring 0.2 0.6 0.2
AA BB 30% -10% 10% 5% -5% 50%
We can conclude from the above information that any rational, risk-averse investor would be better off adding Security AA to a well-diversified portfolio over Security BB. a. True Copyright Cengage Learning. Powered by Cognero.
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b. False ANSWER: RATIONALE:
False The stocks have the same expected returns, but BB does badly in booms and well in recessions. Therefore, it would do more to reduce risk. POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-3 Risk in a Portfolio Context: The CAPM QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.03 - Risk in a Portfolio Context: The CAPM NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Portfolio risk and return KEYWORDS: Bloom's: Application DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 30. Even if the correlation between the returns on two securities is +1.0, if the securities are combined in the correct proportions, the resulting 2-asset portfolio will have less risk than either security held alone. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-3 Risk in a Portfolio Context: The CAPM QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.03 - Risk in a Portfolio Context: The CAPM NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Cor. coefficient and risk KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 31. Bad managerial judgments or unforeseen negative events that happen to a firm are defined as "company-specific," or "unsystematic," events, and their effects on investment risk can in theory be diversified away. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-3 Risk in a Portfolio Context: The CAPM QUESTION TYPE: True / False Copyright Cengage Learning. Powered by Cognero.
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HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.03 - Risk in a Portfolio Context: The CAPM NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Company-specific risk KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 32. We would generally find that the beta of a single security is more stable over time than the beta of a diversified portfolio. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-3 Risk in a Portfolio Context: The CAPM QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.03 - Risk in a Portfolio Context: The CAPM NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Portfolio beta KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 33. We would almost always find that the beta of a diversified portfolio is less stable over time than the beta of a single security. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-3 Risk in a Portfolio Context: The CAPM QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.03 - Risk in a Portfolio Context: The CAPM NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Portfolio beta KEYWORDS: Bloom's: Knowledge Copyright Cengage Learning. Powered by Cognero.
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DATE CREATED: DATE MODIFIED:
9/21/2017 5:24 PM 9/21/2017 5:24 PM
34. If an investor buys enough stocks, he or she can, through diversification, eliminate all of the market risk inherent in owning stocks, but as a general rule it will not be possible to eliminate all diversifiable risk. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-3 Risk in a Portfolio Context: The CAPM QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.03 - Risk in a Portfolio Context: The CAPM NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Diversification effects KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 35. The CAPM is built on historic conditions, although in most cases we use expected future data in applying it. Because betas used in the CAPM are calculated using expected future data, they are not subject to changes in future volatility. This is one of the strengths of the CAPM. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-3 Risk in a Portfolio Context: The CAPM QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.03 - Risk in a Portfolio Context: The CAPM NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: CAPM KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 36. Under the CAPM, the required rate of return on a firm's common stock is determined only by the firm's market risk. If its market risk is known, and if that risk is expected to remain constant, then analysts have all the information they need to calculate the firm's required rate of return. a. True Copyright Cengage Learning. Powered by Cognero.
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b. False ANSWER: False POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-4 The Relationship Between Risk and Rates of Return QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.04 - The Relationship Between Risk and Rates of Return NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Required return KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 37. A firm can change its beta through managerial decisions, including capital budgeting and capital structure decisions. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-4 The Relationship Between Risk and Rates of Return QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.04 - The Relationship Between Risk and Rates of Return NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Changes in beta KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 38. Any change in its beta is likely to affect the required rate of return on a stock, which implies that a change in beta will likely have an impact on the stock's price, other things held constant. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-4 The Relationship Between Risk and Rates of Return QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.04 - The Relationship Between Risk and Rates of Return Copyright Cengage Learning. Powered by Cognero.
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NATIONAL STANDARDS: STATE STANDARDS: LOCAL STANDARDS: TOPICS: KEYWORDS: DATE CREATED: DATE MODIFIED:
United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return United States - OH - Default City - Tier 2: - Capital structure Changes in beta Bloom's: Comprehension 9/21/2017 5:24 PM 9/21/2017 5:24 PM
39. The slope of the SML is determined by the value of beta. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-4 The Relationship Between Risk and Rates of Return QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.04 - The Relationship Between Risk and Rates of Return NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: SML KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 40. The slope of the SML is determined by investors' aversion to risk. The greater the average investor's risk aversion, the steeper the SML. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-4 The Relationship Between Risk and Rates of Return QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.04 - The Relationship Between Risk and Rates of Return NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: SML KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 41. If you plotted the returns of a company against those of the market and found that the slope of your line was negative, Copyright Cengage Learning. Powered by Cognero.
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the CAPM would indicate that the required rate of return on the stock should be less than the risk-free rate for a welldiversified investor, assuming that the observed relationship is expected to continue in the future. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-4 The Relationship Between Risk and Rates of Return QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.04 - The Relationship Between Risk and Rates of Return NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: SML KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 42. If you plotted the returns on a given stock against those of the market, and if you found that the slope of the regression line was negative, the CAPM would indicate that the required rate of return on the stock should be greater than the riskfree rate for a well-diversified investor, assuming that the observed relationship is expected to continue into the future. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-4 The Relationship Between Risk and Rates of Return QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.04 - The Relationship Between Risk and Rates of Return NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: SML KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 43. The Y-axis intercept of the SML represents the required return of a portfolio with a beta of zero, which is the risk-free rate. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE Copyright Cengage Learning. Powered by Cognero.
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REFERENCES: 8-4 The Relationship Between Risk and Rates of Return QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.04 - The Relationship Between Risk and Rates of Return NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: SML KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 44. The SML relates required returns to firms' systematic (or market) risk. The slope and intercept of this line can be influenced by a manager's actions. a. True b. False ANSWER: False RATIONALE: The slope and intercept of the SML are determined by the market, generally not the actions of a single firm. However, managers can influence their firms' beta, and thus their firms' required returns. POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-4 The Relationship Between Risk and Rates of Return QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.04 - The Relationship Between Risk and Rates of Return NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: SML KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 45. The Y-axis intercept of the SML indicates the required return on an individual asset whenever the realized return on an average (b = 1) stock is zero. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-4 The Relationship Between Risk and Rates of Return QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.04 - The Relationship Between Risk and Rates of Return NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking Copyright Cengage Learning. Powered by Cognero.
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46. If the price of money (e.g., interest rates and equity capital costs) increases due to an increase in anticipated inflation, the risk-free rate will also increase. If there is no change in investors' risk aversion, then the market risk premium (rM rRF) will remain constant. Also, if there is no change in stocks' betas, then the required rate of return on each stock as measured by the CAPM will increase by the same amount as the increase in expected inflation. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-4 The Relationship Between Risk and Rates of Return QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.04 - The Relationship Between Risk and Rates of Return NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: CAPM and inflation KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 47. Since the market return represents the expected return on an average stock, the market return reflects a certain amount of risk. As a result, there exists a market risk premium, which is the amount over and above the risk-free rate, that is required to compensate stock investors for assuming an average amount of risk. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-4 The Relationship Between Risk and Rates of Return QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.04 - The Relationship Between Risk and Rates of Return NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Market risk premium KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:24 PM Copyright Cengage Learning. Powered by Cognero.
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48. Assume that two investors each hold a portfolio, and that portfolio is their only asset. Investor A's portfolio has a beta of minus 2.0, while Investor B's portfolio has a beta of plus 2.0. Assuming that the unsystematic risks of the stocks in the two portfolios are the same, then the two investors face the same amount of risk. However, the holders of either portfolio could lower their risks, and by exactly the same amount, by adding some "normal" stocks with beta = 1.0. a. True b. False ANSWER: True RATIONALE: Both portfolios would be twice as risky as a portfolio of average stocks. Their risks would decline if they added b = 1.0 stocks, as those stocks would move the portfolios' betas toward 1.0. POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 8-3 Risk in a Portfolio Context: The CAPM QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.03 - Risk in a Portfolio Context: The CAPM NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Beta coefficient KEYWORDS: Bloom's: Application DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 49. The CAPM is a multi-period model that takes account of differences in securities' maturities, and it can be used to determine the required rate of return for any given level of systematic risk. a. True b. False ANSWER: False RATIONALE: The CAPM is a single-period model, and it does not take account of securities' maturities. POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 8-5 Some Concerns About Beta and the CAPM QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.05 - Some Concerns About Beta and the CAPM NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: CAPM KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 50. You have the following data on three stocks: Copyright Cengage Learning. Powered by Cognero.
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Stock Standard Deviation Beta A 20% 0.59 B 10% 0.61 C 12% 1.29 If you are a strict risk minimizer, you would choose Stock ____ if it is to be held in isolation and Stock ____ if it is to be held as part of a well-diversified portfolio. a. A; A. b. A; B. c. B; A. d. C; A. e. C; B. ANSWER: c POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-3 Risk in a Portfolio Context: The CAPM QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.03 - Risk in a Portfolio Context: The CAPM NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Risk aversion KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 51. Which is the best measure of risk for a single asset held in isolation, and which is the best measure for an asset held in a diversified portfolio? a. Variance; correlation coefficient. b. Standard deviation; correlation coefficient. c. Beta; variance. d. Coefficient of variation; beta. e. Beta; beta. ANSWER: d POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-3 Risk in a Portfolio Context: The CAPM QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.03 - Risk in a Portfolio Context: The CAPM NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Risk measures Copyright Cengage Learning. Powered by Cognero.
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52. A highly risk-averse investor is considering adding one additional stock to a 3-stock portfolio, to form a 4-stock portfolio. The three stocks currently held all have b = 1.0, and they are perfectly positively correlated with the market. Potential new Stocks A and B both have expected returns of 15%, are in equilibrium, and are equally correlated with the market, with r = 0.75. However, Stock A's standard deviation of returns is 12% versus 8% for Stock B. Which stock should this investor add to his or her portfolio, or does the choice not matter? a. Either A or B, i.e., the investor should be indifferent between the two. b. Stock A. c. Stock B. d. Neither A nor B, as neither has a return sufficient to compensate for risk. e. Add A, since its beta must be lower. ANSWER: c RATIONALE: With only 4 stocks in the portfolio, unsystematic risk matters, and B has less. POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-3 Risk in a Portfolio Context: The CAPM QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.03 - Risk in a Portfolio Context: The CAPM NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Stock selection in portfolio KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 53. Which of the following is NOT a potential problem when estimating and using betas, i.e., which statement is FALSE? a. The fact that a security or project may not have a past history that can be used as the basis for calculating beta. b. Sometimes, during a period when the company is undergoing a change such as toward more leverage or riskier assets, the calculated beta will be drastically different from the "true" or "expected future" beta. c. The beta of an "average stock," or "the market," can change over time, sometimes drastically. d. Sometimes the past data used to calculate beta do not reflect the likely risk of the firm for the future because conditions have changed. e. The beta coefficient of a stock is normally found by regressing past returns on a stock against past market returns. This calculated historical beta may differ from the beta that exists in the future. ANSWER: c POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-3 Risk in a Portfolio Context: The CAPM QUESTION TYPE: Multiple Choice Copyright Cengage Learning. Powered by Cognero.
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HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.03 - Risk in a Portfolio Context: The CAPM NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Beta coefficients KEYWORDS: Bloom's: Knowledge OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 54. Which of the following statements is CORRECT? a. The beta of a portfolio of stocks is always smaller than the betas of any of the individual stocks. b. If you found a stock with a zero historical beta and held it as the only stock in your portfolio, you would by definition have a riskless portfolio. c. The beta coefficient of a stock is normally found by regressing past returns on a stock against past market returns. One could also construct a scatter diagram of returns on the stock versus those on the market, estimate the slope of the line of best fit, and use it as beta. However, this historical beta may differ from the beta that exists in the future. d. The beta of a portfolio of stocks is always larger than the betas of any of the individual stocks. e. It is theoretically possible for a stock to have a beta of 1.0. If a stock did have a beta of 1.0, then, at least in theory, its required rate of return would be equal to the risk-free (default-free) rate of return, rRF. ANSWER: c POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-3 Risk in a Portfolio Context: The CAPM QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.03 - Risk in a Portfolio Context: The CAPM NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Beta coefficients KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 55. Which of the following statements is CORRECT? a. Collections Inc. is in the business of collecting past-due accounts for other companies, i.e., it is a collection agency. Collections' revenues, profits, and stock price tend to rise during recessions. This suggests that Collections Inc.'s beta should be quite high, say 2.0, because it does so much better than most other companies when the economy is weak. b. Suppose the returns on two stocks are negatively correlated. One has a beta of 1.2 as determined in a regression analysis using data for the last 5 years, while the other has a beta of -0.6. The returns on the stock with the negative beta must have been negatively correlated with returns on most other stocks during that 5year period. Copyright Cengage Learning. Powered by Cognero.
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c. Suppose you are managing a stock portfolio, and you have information that leads you to believe the stock market is likely to be very strong in the immediate future. That is, you are convinced that the market is about to rise sharply. You should sell your high-beta stocks and buy low-beta stocks in order to take advantage of the expected market move. d. You think that investor sentiment is about to change, and investors are about to become more risk averse. This suggests that you should re-balance your portfolio to include more high-beta stocks. e. If the market risk premium remains constant, but the risk-free rate declines, then the required returns on lowbeta stocks will rise while those on high-beta stocks will decline. ANSWER: b POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-3 Risk in a Portfolio Context: The CAPM QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.03 - Risk in a Portfolio Context: The CAPM NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Beta coefficients KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 56. Which of the following statements is CORRECT? a. If a company with a high beta merges with a low-beta company, the best estimate of the new merged company's beta is 1.0. b. Logically, it is easier to estimate the betas associated with capital budgeting projects than the betas associated with stocks, especially if the projects are closely associated with research and development activities. c. The beta of an "average stock," which is also "the market beta," can change over time, sometimes drastically. d. If a newly issued stock does not have a past history that can be used for calculating beta, then we should always estimate that its beta will turn out to be 1.0. This is especially true if the company finances with more debt than the average firm. e. During a period when a company is undergoing a change such as increasing its use of leverage or taking on riskier projects, the calculated historical beta may be drastically different from the beta that will exist in the future. ANSWER: e POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-3 Risk in a Portfolio Context: The CAPM QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.03 - Risk in a Portfolio Context: The CAPM NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Beta coefficients Copyright Cengage Learning. Powered by Cognero.
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57. Stock A's beta is 1.5 and Stock B's beta is 0.5. Which of the following statements must be true, assuming the CAPM is correct. a. Stock A would be a more desirable addition to a portfolio then Stock B. b. In equilibrium, the expected return on Stock B will be greater than that on Stock A. c. When held in isolation, Stock A has more risk than Stock B. d. Stock B would be a more desirable addition to a portfolio than A. e. In equilibrium, the expected return on Stock A will be greater than that on B. ANSWER: e POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-3 Risk in a Portfolio Context: The CAPM QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.03 - Risk in a Portfolio Context: The CAPM NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Beta coefficients KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 58. Stock X has a beta of 0.5 and Stock Y has a beta of 1.5. Which of the following statements must be true, according to the CAPM? a. If you invest $50,000 in Stock X and $50,000 in Stock Y, your 2-stock portfolio would have a beta significantly lower than 1.0, provided the returns on the two stocks are not perfectly correlated. b. Stock Y's realized return during the coming year will be higher than Stock X's return. c. If the expected rate of inflation increases but the market risk premium is unchanged, the required returns on the two stocks should increase by the same amount. d. Stock Y's return has a higher standard deviation than Stock X. e. If the market risk premium declines, but the risk-free rate is unchanged, Stock X will have a larger decline in its required return than will Stock Y. ANSWER: c POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-3 Risk in a Portfolio Context: The CAPM QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.03 - Risk in a Portfolio Context: The CAPM NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic Copyright Cengage Learning. Powered by Cognero.
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59. You have the following data on (1) the average annual returns of the market for the past 5 years and (2) similar information on Stocks A and B. Which of the possible answers best describes the historical betas for A and B? Years Market 1 0.03 2 -0.05 3 0.01 4 -0.10 5 0.06 a. bA > 0; bB = 1. b. bA > +1; bB = 0. c. bA = 0; bB = -1. d. bA < 0; bB = 0. e. bA < -1; bB = 1. ANSWER: RATIONALE:
Stock A 0.16 0.20 0.18 0.25 0.14
Stock B 0.05 0.05 0.05 0.05 0.05
d First, note that B's beta must be zero, so either b or d must be correct. Second, note that A's returns are highest when the market's returns are negative and lowest when the market's returns are positive. This indicates that A's beta is negative. Thus, d must be correct. POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-3 Risk in a Portfolio Context: The CAPM QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.03 - Risk in a Portfolio Context: The CAPM NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Beta coefficients KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 60. Which of the following statements is CORRECT? a. An investor can eliminate virtually all market risk if he or she holds a very large and well diversified portfolio of stocks. b. The higher the correlation between the stocks in a portfolio, the lower the risk inherent in the portfolio. c. It is impossible to have a situation where the market risk of a single stock is less than that of a portfolio that includes the stock. Copyright Cengage Learning. Powered by Cognero.
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d. Once a portfolio has about 40 stocks, adding additional stocks will not reduce its risk by even a small amount. e. An investor can eliminate virtually all diversifiable risk if he or she holds a very large, well-diversified portfolio of stocks. ANSWER: e POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-3 Risk in a Portfolio Context: The CAPM QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.03 - Risk in a Portfolio Context: The CAPM NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Portfolio risk KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 61. Which of the following statements is CORRECT? a. If you add enough randomly selected stocks to a portfolio, you can completely eliminate all of the market risk from the portfolio. b. If you were restricted to investing in publicly traded common stocks, yet you wanted to minimize the riskiness of your portfolio as measured by its beta, then according to the CAPM theory you should invest an equal amount of money in each stock in the market. That is, if there were 10,000 traded stocks in the world, the least risky possible portfolio would include some shares of each one. c. If you formed a portfolio that consisted of all stocks with betas less than 1.0, which is about half of all stocks, the portfolio would itself have a beta coefficient that is equal to the weighted average beta of the stocks in the portfolio, and that portfolio would have less risk than a portfolio that consisted of all stocks in the market. d. Market risk can be eliminated by forming a large portfolio, and if some Treasury bonds are held in the portfolio, the portfolio can be made to be completely riskless. e. A portfolio that consists of all stocks in the market would have a required return that is equal to the riskless rate. ANSWER: c POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-3 Risk in a Portfolio Context: The CAPM QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.03 - Risk in a Portfolio Context: The CAPM NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Portfolio risk and beta KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual Copyright Cengage Learning. Powered by Cognero.
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62. Inflation, recession, and high interest rates are economic events that are best characterized as being a. systematic risk factors that can be diversified away. b. company-specific risk factors that can be diversified away. c. among the factors that are responsible for market risk. d. risks that are beyond the control of investors and thus should not be considered by security analysts or portfolio managers. e. irrelevant except to governmental authorities like the Federal Reserve. ANSWER: c POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-3 Risk in a Portfolio Context: The CAPM QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.03 - Risk in a Portfolio Context: The CAPM NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Market risk KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 63. Which of the following statements is CORRECT? a. A stock's beta is less relevant as a measure of risk to an investor with a well-diversified portfolio than to an investor who holds only that one stock. b. If an investor buys enough stocks, he or she can, through diversification, eliminate all of the diversifiable risk inherent in owning stocks. Therefore, if a portfolio contained all publicly traded stocks, it would be essentially riskless. c. The required return on a firm's common stock is, in theory, determined solely by its market risk. If the market risk is known, and if that risk is expected to remain constant, then no other information is required to specify the firm's required return. d. Portfolio diversification reduces the variability of returns (as measured by the standard deviation) of each individual stock held in a portfolio. e. A security's beta measures its non-diversifiable, or market, risk relative to that of an average stock. ANSWER: e POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-3 Risk in a Portfolio Context: The CAPM QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.03 - Risk in a Portfolio Context: The CAPM NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic Copyright Cengage Learning. Powered by Cognero.
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64. Which of the following statements is CORRECT? a. A large portfolio of randomly selected stocks will always have a standard deviation of returns that is less than the standard deviation of a portfolio with fewer stocks, regardless of how the stocks in the smaller portfolio are selected. b. Diversifiable risk can be reduced by forming a large portfolio, but normally even highly-diversified portfolios are subject to market (or systematic) risk. c. A large portfolio of randomly selected stocks will have a standard deviation of returns that is greater than the standard deviation of a 1-stock portfolio if that one stock has a beta less than 1.0. d. A large portfolio of stocks whose betas are greater than 1.0 will have less market risk than a single stock with a beta = 0.8. e. If you add enough randomly selected stocks to a portfolio, you can completely eliminate all of the market risk from the portfolio. ANSWER: b POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-3 Risk in a Portfolio Context: The CAPM QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.03 - Risk in a Portfolio Context: The CAPM NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Risk and port. divers. KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 65. Which of the following statements is CORRECT? a. A two-stock portfolio will always have a lower standard deviation than a one-stock portfolio. b. A portfolio that consists of 40 stocks that are not highly correlated with "the market" will probably be less risky than a portfolio of 40 stocks that are highly correlated with the market, assuming the stocks all have the same standard deviations. c. A two-stock portfolio will always have a lower beta than a one-stock portfolio. d. If portfolios are formed by randomly selecting stocks, a 10-stock portfolio will always have a lower beta than a one-stock portfolio. e. A stock with an above-average standard deviation must also have an above-average beta. ANSWER: b POINTS: 1 Copyright Cengage Learning. Powered by Cognero.
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DIFFICULTY: MODERATE REFERENCES: 8-3 Risk in a Portfolio Context: The CAPM QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.03 - Risk in a Portfolio Context: The CAPM NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Port. risk, return, and beta KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 66. Consider the following information for three stocks, A, B, and C. The stocks' returns are positively but not perfectly positively correlated with one another, i.e., the correlations are all between 0 and 1. Expected Standard Stock Return Deviation Beta A 10% 20% 1.0 B 10% 10% 1.0 C 12% 12% 1.4 Portfolio AB has half of its funds invested in Stock A and half in Stock B. Portfolio ABC has one third of its funds invested in each of the three stocks. The risk-free rate is 5%, and the market is in equilibrium, so required returns equal expected returns. Which of the following statements is CORRECT? a. Portfolio AB has a standard deviation of 20%. b. Portfolio AB's coefficient of variation is greater than 2.0. c. Portfolio AB's required return is greater than the required return on Stock A. d. Portfolio ABC's expected return is 10.66667%. e. Portfolio ABC has a standard deviation of 20%. ANSWER: d POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-3 Risk in a Portfolio Context: The CAPM QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.03 - Risk in a Portfolio Context: The CAPM NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Portfolio risk concepts KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 67. Which of the following statements is CORRECT? Copyright Cengage Learning. Powered by Cognero.
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a. If the returns on two stocks are perfectly positively correlated (i.e., the correlation coefficient is +1.0) and these stocks have identical standard deviations, an equally weighted portfolio of the two stocks will have a standard deviation that is less than that of the individual stocks. b. A portfolio with a large number of randomly selected stocks would have more market risk than a single stock that has a beta of 0.5, assuming that the stock's beta was correctly calculated and is stable. c. If a stock has a negative beta, its expected return must be negative. d. A portfolio with a large number of randomly selected stocks would have less market risk than a single stock that has a beta of 0.5. e. According to the CAPM, stocks with higher standard deviations of returns must also have higher expected returns. ANSWER: b POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-3 Risk in a Portfolio Context: The CAPM QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.03 - Risk in a Portfolio Context: The CAPM NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Port. return, CAPM, and beta KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 68. For a portfolio of 40 randomly selected stocks, which of the following is most likely to be true? a. The riskiness of the portfolio is greater than the riskiness of each of the stocks if each was held in isolation. b. The riskiness of the portfolio is the same as the riskiness of each stock if it was held in isolation. c. The beta of the portfolio is less than the weighted average of the betas of the individual stocks. d. The beta of the portfolio is equal to the weighted average of the betas of the individual stocks. e. The beta of the portfolio is larger than the weighted average of the betas of the individual stocks. ANSWER: d POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-3 Risk in a Portfolio Context: The CAPM QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.03 - Risk in a Portfolio Context: The CAPM NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Portfolio risk and return KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:24 PM Copyright Cengage Learning. Powered by Cognero.
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69. Which of the following statements best describes what you should expect if you randomly select stocks and add them to your portfolio? a. Adding more such stocks will reduce the portfolio's unsystematic, or diversifiable, risk. b. Adding more such stocks will increase the portfolio's expected rate of return. c. Adding more such stocks will reduce the portfolio's beta coefficient and thus its systematic risk. d. Adding more such stocks will have no effect on the portfolio's risk. e. Adding more such stocks will reduce the portfolio's market risk but not its unsystematic risk. ANSWER: a POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-3 Risk in a Portfolio Context: The CAPM QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.03 - Risk in a Portfolio Context: The CAPM NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Portfolio risk and return KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 70. Bob has a $50,000 stock portfolio with a beta of 1.2, an expected return of 10.8%, and a standard deviation of 25%. Becky also has a $50,000 portfolio, but it has a beta of 0.8, an expected return of 9.2%, and a standard deviation that is also 25%. The correlation coefficient, r, between Bob's and Becky's portfolios is zero. If Bob and Becky marry and combine their portfolios, which of the following best describes their combined $100,000 portfolio? a. The combined portfolio's expected return will be less than the simple weighted average of the expected returns of the two individual portfolios, 10.0%. b. The combined portfolio's beta will be equal to a simple weighted average of the betas of the two individual portfolios, 1.0; its expected return will be equal to a simple weighted average of the expected returns of the two individual portfolios, 10.0%; and its standard deviation will be less than the simple average of the two portfolios' standard deviations, 25%. c. The combined portfolio's expected return will be greater than the simple weighted average of the expected returns of the two individual portfolios, 10.0%. d. The combined portfolio's standard deviation will be greater than the simple average of the two portfolios' standard deviations, 25%. e. The combined portfolio's standard deviation will be equal to a simple average of the two portfolios' standard deviations, 25%. ANSWER: b POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-3 Risk in a Portfolio Context: The CAPM QUESTION TYPE: Multiple Choice HAS VARIABLES: False Copyright Cengage Learning. Powered by Cognero.
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LEARNING OBJECTIVES: FOFM.BRIG.17.08.03 - Risk in a Portfolio Context: The CAPM NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Portfolio risk and return KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 71. Your portfolio consists of $50,000 invested in Stock X and $50,000 invested in Stock Y. Both stocks have an expected return of 15%, betas of 1.6, and standard deviations of 30%. The returns of the two stocks are independent, so the correlation coefficient between them, rXY, is zero. Which of the following statements best describes the characteristics of your 2-stock portfolio? a. Your portfolio has a standard deviation of 30%, and its expected return is 15%. b. Your portfolio has a standard deviation less than 30%, and its beta is greater than 1.6. c. Your portfolio has a beta equal to 1.6, and its expected return is 15%. d. Your portfolio has a beta greater than 1.6, and its expected return is greater than 15%. e. Your portfolio has a standard deviation greater than 30% and a beta equal to 1.6. ANSWER: c POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-3 Risk in a Portfolio Context: The CAPM QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.03 - Risk in a Portfolio Context: The CAPM NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Portfolio risk and return KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 72. Which of the following is most likely to occur as you add randomly selected stocks to your portfolio, which currently consists of 3 average stocks? a. The diversifiable risk of your portfolio will likely decline, but the expected market risk should not change. b. The expected return of your portfolio is likely to decline. c. The diversifiable risk will remain the same, but the market risk will likely decline. d. Both the diversifiable risk and the market risk of your portfolio are likely to decline. e. The total risk of your portfolio should decline, and as a result, the expected rate of return on the portfolio should also decline. ANSWER: a POINTS: 1 DIFFICULTY: MODERATE Copyright Cengage Learning. Powered by Cognero.
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REFERENCES: 8-3 Risk in a Portfolio Context: The CAPM QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.03 - Risk in a Portfolio Context: The CAPM NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Portfolio risk and return KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 73. Jane has a portfolio of 20 average stocks, and Dick has a portfolio of 2 average stocks. Assuming the market is in equilibrium, which of the following statements is CORRECT? a. Jane's portfolio will have less diversifiable risk and also less market risk than Dick's portfolio. b. The required return on Jane's portfolio will be lower than that on Dick's portfolio because Jane's portfolio will have less total risk. c. Dick's portfolio will have more diversifiable risk, the same market risk, and thus more total risk than Jane's portfolio, but the required (and expected) returns will be the same on both portfolios. d. If the two portfolios have the same beta, their required returns will be the same, but Jane's portfolio will have less market risk than Dick's. e. The expected return on Jane's portfolio must be lower than the expected return on Dick's portfolio because Jane is more diversified. ANSWER: c POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-3 Risk in a Portfolio Context: The CAPM QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.03 - Risk in a Portfolio Context: The CAPM NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Portfolio risk and return KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 74. Stocks A and B each have an expected return of 12%, a beta of 1.2, and a standard deviation of 25%. The returns on the two stocks have a correlation of +0.6. Portfolio P has 50% in Stock A and 50% in Stock B. Which of the following statements is CORRECT? a. Portfolio P has a beta that is greater than 1.2. b. Portfolio P has a standard deviation that is greater than 25%. c. Portfolio P has an expected return that is less than 12%. Copyright Cengage Learning. Powered by Cognero.
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d. Portfolio P has a standard deviation that is less than 25%. e. Portfolio P has a beta that is less than 1.2. ANSWER: d POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-3 Risk in a Portfolio Context: The CAPM QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.03 - Risk in a Portfolio Context: The CAPM NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Portfolio risk and return KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 75. Stocks A, B, and C all have an expected return of 10% and a standard deviation of 25%. Stocks A and B have returns that are independent of one another, i.e., their correlation coefficient, r, equals zero. Stocks A and C have returns that are negatively correlated with one another, i.e., r is less than 0. Portfolio AB is a portfolio with half of its money invested in Stock A and half in Stock B. Portfolio AC is a portfolio with half of its money invested in Stock A and half invested in Stock C. Which of the following statements is CORRECT? a. Portfolio AC has an expected return that is less than 10%. b. Portfolio AC has an expected return that is greater than 25%. c. Portfolio AB has a standard deviation that is greater than 25%. d. Portfolio AB has a standard deviation that is equal to 25%. e. Portfolio AC has a standard deviation that is less than 25%. ANSWER: e POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-3 Risk in a Portfolio Context: The CAPM QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.03 - Risk in a Portfolio Context: The CAPM NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Portfolio risk and return KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 76. Stocks A and B each have an expected return of 15%, a standard deviation of 20%, and a beta of 1.2. The returns on the two stocks have a correlation coefficient of +0.6. You have a portfolio that consists of 50% A and 50% B. Which of Copyright Cengage Learning. Powered by Cognero.
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the following statements is CORRECT? a. The portfolio's beta is less than 1.2. b. The portfolio's expected return is 15%. c. The portfolio's standard deviation is greater than 20%. d. The portfolio's beta is greater than 1.2. e. The portfolio's standard deviation is 20%. ANSWER: b POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-3 Risk in a Portfolio Context: The CAPM QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.03 - Risk in a Portfolio Context: The CAPM NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Portfolio risk and return KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 77. Stock A has a beta of 0.8, Stock B has a beta of 1.0, and Stock C has a beta of 1.2. Portfolio P has 1/3 of its value invested in each stock. Each stock has a standard deviation of 25%, and their returns are independent of one another, i.e., the correlation coefficients between each pair of stocks is zero. Assuming the market is in equilibrium, which of the following statements is CORRECT? a. Portfolio P's expected return is greater than the expected return on Stock B. b. Portfolio P's expected return is equal to the expected return on Stock A. c. Portfolio P's expected return is less than the expected return on Stock B. d. Portfolio P's expected return is equal to the expected return on Stock B. e. Portfolio P's expected return is greater than the expected return on Stock C. ANSWER: d POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-3 Risk in a Portfolio Context: The CAPM QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.03 - Risk in a Portfolio Context: The CAPM NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Portfolio risk and return KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:24 PM Copyright Cengage Learning. Powered by Cognero.
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78. In a portfolio of three randomly selected stocks, which of the following could NOT be true, i.e., which statement is false? a. The riskiness of the portfolio is less than the riskiness of each of the stocks if they were held in isolation. b. The riskiness of the portfolio is greater than the riskiness of one or two of the stocks. c. The beta of the portfolio is lower than the lowest of the three betas. d. The beta of the portfolio is higher than the beta of one or two of the stocks in the portfolio. e. The beta of the portfolio is calculated as a weighted average of the individual stocks’ betas. ANSWER: c POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-3 Risk in a Portfolio Context: The CAPM QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.03 - Risk in a Portfolio Context: The CAPM NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Portfolio risk and return KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 12/12/2017 2:05 PM 79. Stock A has a beta = 0.8, while Stock B has a beta = 1.6. Which of the following statements is CORRECT? a. Stock B's required return is double that of Stock A's. b. If the marginal investor becomes more risk averse, the required return on Stock B will increase by more than the required return on Stock A. c. An equally weighted portfolio of Stocks A and B will have a beta lower than 1.2. d. If the marginal investor becomes more risk averse, the required return on Stock A will increase by more than the required return on Stock B. e. If the risk-free rate increases but the market risk premium remains constant, the required return on Stock A will increase by more than that on Stock B. ANSWER: b POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-4 The Relationship Between Risk and Rates of Return QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.04 - The Relationship Between Risk and Rates of Return NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Port. risk and ret. relationships KEYWORDS: Bloom's: Analysis Copyright Cengage Learning. Powered by Cognero.
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80. Stock A has an expected return of 12%, a beta of 1.2, and a standard deviation of 20%. Stock B also has a beta of 1.2, but its expected return is 10% and its standard deviation is 15%. Portfolio AB has $900,000 invested in Stock A and $300,000 invested in Stock B. The correlation between the two stocks' returns is zero (that is, rA,B = 0). Which of the following statements is CORRECT? a. Portfolio AB's standard deviation is 17.5%. b. The stocks are not in equilibrium based on the CAPM; if A is valued correctly, then B is overvalued. c. The stocks are not in equilibrium based on the CAPM; if A is valued correctly, then B is undervalued. d. Portfolio AB's expected return is 11.0%. e. Portfolio AB's beta is less than 1.2. ANSWER: b POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-4 The Relationship Between Risk and Rates of Return QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.04 - The Relationship Between Risk and Rates of Return NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Port. risk and ret. relationships KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 81. Stock X has a beta of 0.7 and Stock Y has a beta of 1.3. The standard deviation of each stock's returns is 20%. The stocks' returns are independent of each other, i.e., the correlation coefficient, r, between them is zero. Portfolio P consists of 50% X and 50% Y. Given this information, which of the following statements is CORRECT? a. Portfolio P has a standard deviation of 20%. b. The required return on Portfolio P is equal to the market risk premium (rM – rRF). c. Portfolio P has a beta of 0.7. d. Portfolio P has a beta of 1.0 and a required return that is equal to the riskless rate, rRF. e. Portfolio P has the same required return as the market (rM). ANSWER: e POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-4 The Relationship Between Risk and Rates of Return QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.04 - The Relationship Between Risk and Rates of Return NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic Copyright Cengage Learning. Powered by Cognero.
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STATE STANDARDS: LOCAL STANDARDS: TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return United States - OH - Default City - Tier 2: - Capital structure Port. risk and return relationships Bloom's: Analysis Multiple Choice: Conceptual 9/21/2017 5:24 PM 9/21/2017 5:24 PM
82. Which of the following statements is CORRECT? (Assume that the risk-free rate is a constant.) a. If the market risk premium increases by 1%, then the required return will increase for stocks that have a beta greater than 1.0, but it will decrease for stocks that have a beta less than 1.0. b. The effect of a change in the market risk premium depends on the slope of the yield curve. c. If the market risk premium increases by 1%, then the required return on all stocks will rise by 1%. d. If the market risk premium increases by 1%, then the required return will increase by 1% for a stock that has a beta of 1.0. e. The effect of a change in the market risk premium depends on the level of the risk-free rate. ANSWER: d POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-4 The Relationship Between Risk and Rates of Return QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.04 - The Relationship Between Risk and Rates of Return NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Market risk premium KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 83. Over the past 89 years, we have observed that investments with the highest average annual returns also tend to have the highest standard deviations of annual returns. This observation supports the notion that there is a positive correlation between risk and return. Which of the following answers correctly ranks investments from highest to lowest risk (and return), where the security with the highest risk is shown first, the one with the lowest risk last? a. Small-company stocks, long-term corporate bonds, large-company stocks, long-term government bonds, U.S. Treasury bills. b. Large-company stocks, small-company stocks, long-term corporate bonds, U.S. Treasury bills, long-term government bonds. c. Small-company stocks, large-company stocks, long-term corporate bonds, long-term government bonds, U.S. Treasury bills. d. U.S. Treasury bills, long-term government bonds, long-term corporate bonds, small-company stocks, largecompany stocks. e. Large-company stocks, small-company stocks, long-term corporate bonds, long-term government bonds, U.S. Treasury bills. ANSWER: c Copyright Cengage Learning. Powered by Cognero.
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POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-4 The Relationship Between Risk and Rates of Return QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.04 - The Relationship Between Risk and Rates of Return NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Risk and ret. relationships KEYWORDS: Bloom's: Evaluation OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 84. During the coming year, the market risk premium (rM – rRF), is expected to fall, while the risk-free rate, rRF, is expected to remain the same. Given this forecast, which of the following statements is CORRECT? a. The required return will increase for stocks with a beta less than 1.0 and will decrease for stocks with a beta greater than 1.0. b. The required return on all stocks will remain unchanged. c. The required return will fall for all stocks, but it will fall more for stocks with higher betas. d. The required return for all stocks will fall by the same amount. e. The required return will fall for all stocks, but it will fall less for stocks with higher betas. ANSWER: c POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-4 The Relationship Between Risk and Rates of Return QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.04 - The Relationship Between Risk and Rates of Return NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Required return KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 85. The risk-free rate is 6%; Stock A has a beta of 1.0; Stock B has a beta of 2.0; and the market risk premium, rM – rRF, is positive. Which of the following statements is CORRECT? a. If the risk-free rate increases but the market risk premium stays unchanged, Stock B's required return will increase by more than Stock A's. b. Stock B's required rate of return is twice that of Stock A. c. If Stock A's required return is 11%, then the market risk premium is 5%. Copyright Cengage Learning. Powered by Cognero.
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d. If Stock B's required return is 11%, then the market risk premium is 5%. e. If the risk-free rate remains constant but the market risk premium increases, Stock A's required return will increase by more than Stock B's. ANSWER: c POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-4 The Relationship Between Risk and Rates of Return QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.04 - The Relationship Between Risk and Rates of Return NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: CAPM KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 86. Assume that in recent years both expected inflation and the market risk premium (rM – rRF) have declined. Assume also that all stocks have positive betas. Which of the following would be most likely to have occurred as a result of these changes? a. The required returns on all stocks have fallen, but the decline has been greater for stocks with lower betas. b. The required returns on all stocks have fallen, but the fall has been greater for stocks with higher betas. c. The average required return on the market, rM, has remained constant, but the required returns have fallen for stocks that have betas greater than 1.0. d. Required returns have increased for stocks with betas greater than 1.0 but have declined for stocks with betas less than 1.0. e. The required returns on all stocks have fallen by the same amount. ANSWER: b POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-4 The Relationship Between Risk and Rates of Return QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.04 - The Relationship Between Risk and Rates of Return NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: CAPM and required return KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 87. Assume that the risk-free rate is 5%. Which of the following statements is CORRECT? Copyright Cengage Learning. Powered by Cognero.
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a. If a stock has a negative beta, its required return under the CAPM would be less than 5%. b. If a stock's beta doubled, its required return under the CAPM would also double. c. If a stock's beta doubled, its required return under the CAPM would more than double. d. If a stock's beta were 1.0, its required return under the CAPM would be 5%. e. If a stock's beta were less than 1.0, its required return under the CAPM would be less than 5%. ANSWER: a POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-4 The Relationship Between Risk and Rates of Return QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.04 - The Relationship Between Risk and Rates of Return NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: CAPM and required return KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 88. Stock HB has a beta of 1.5 and Stock LB has a beta of 0.5. The market is in equilibrium, with required returns equaling expected returns. Which of the following statements is CORRECT? a. If expected inflation remains constant but the market risk premium (rM – rRF) declines, the required return of Stock LB will decline but the required return of Stock HB will increase. b. If both expected inflation and the market risk premium (rM – rRF) increase, the required return on Stock HB will increase by more than that on Stock LB. c. If both expected inflation and the market risk premium (rM – rRF) increase, the required returns of both stocks will increase by the same amount. d. Since the market is in equilibrium, the required returns of the two stocks should be the same. e. If expected inflation remains constant but the market risk premium (rM – rRF) declines, the required return of Stock HB will decline but the required return of Stock LB will increase. ANSWER: b POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-4 The Relationship Between Risk and Rates of Return QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.04 - The Relationship Between Risk and Rates of Return NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: CAPM and required return KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual Copyright Cengage Learning. Powered by Cognero.
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89. Stock A has a beta of 0.8, Stock B has a beta of 1.0, and Stock C has a beta of 1.2. Portfolio P has equal amounts invested in each of the three stocks. Each of the stocks has a standard deviation of 25%. The returns on the three stocks are independent of one another (i.e., the correlation coefficients all equal zero). Assume that there is an increase in the market risk premium, but the risk-free rate remains unchanged. Which of the following statements is CORRECT? a. The required return of all stocks will remain unchanged since there was no change in their betas. b. The required return on Stock A will increase by less than the increase in the market risk premium, while the required return on Stock C will increase by more than the increase in the market risk premium. c. The required return on the average stock will remain unchanged, but the returns of riskier stocks (such as Stock C) will increase while the returns of safer stocks (such as Stock A) will decrease. d. The required returns on all three stocks will increase by the amount of the increase in the market risk premium. e. The required return on the average stock will remain unchanged, but the returns on riskier stocks (such as Stock C) will decrease while the returns on safer stocks (such as Stock A) will increase. ANSWER: b POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-4 The Relationship Between Risk and Rates of Return QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.04 - The Relationship Between Risk and Rates of Return NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: CAPM and required return KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 90. Which of the following statements is CORRECT? a. If a company's beta doubles, then its required rate of return will also double. b. Other things held constant, if investors suddenly become convinced that there will be deflation in the economy, then the required returns on all stocks should increase. c. If a company's beta were cut in half, then its required rate of return would also be halved. d. If the risk-free rate rises by 0.5% but the market risk premium declines by that same amount, then the required rates of return on stocks with betas less than 1.0 will decline while returns on stocks with betas above 1.0 will increase. e. If the risk-free rate rises by 0.5% but the market risk premium declines by that same amount, then the required rate of return on an average stock will remain unchanged, but required returns on stocks with betas less than 1.0 will rise. ANSWER: e POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-4 The Relationship Between Risk and Rates of Return QUESTION TYPE: Multiple Choice Copyright Cengage Learning. Powered by Cognero.
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HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.04 - The Relationship Between Risk and Rates of Return NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: CAPM and required return KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 91. Assume that the risk-free rate is 6% and the market risk premium is 5%. Given this information, which of the following statements is CORRECT? a. An index fund with beta = 1.0 should have a required return of 11%. b. If a stock has a negative beta, its required return must also be negative. c. An index fund with beta = 1.0 should have a required return less than 11%. d. If a stock's beta doubles, its required return must also double. e. An index fund with beta = 1.0 should have a required return greater than 11%. ANSWER: a POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-4 The Relationship Between Risk and Rates of Return QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.04 - The Relationship Between Risk and Rates of Return NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: CAPM, beta, and req. return KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 92. Which of the following statements is CORRECT? a. The slope of the security market line is equal to the market risk premium. b. Lower beta stocks have higher required returns. c. A stock's beta indicates its diversifiable risk. d. Diversifiable risk cannot be completely diversified away. e. Two securities with the same stand-alone risk must have the same betas. ANSWER: a POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-4 The Relationship Between Risk and Rates of Return QUESTION TYPE: Multiple Choice Copyright Cengage Learning. Powered by Cognero.
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HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.04 - The Relationship Between Risk and Rates of Return NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: SML KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 93. Which of the following statements is CORRECT? a. Beta is measured by the slope of the security market line. b. If the risk-free rate rises, then the market risk premium must also rise. c. If a company's beta is halved, then its required return will also be halved. d. If a company's beta doubles, then its required return will also double. e. The slope of the security market line is equal to the market risk premium, (rM – rRF). ANSWER: e POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-4 The Relationship Between Risk and Rates of Return QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.04 - The Relationship Between Risk and Rates of Return NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: SML KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 94. Stock A has a beta of 1.2 and a standard deviation of 20%. Stock B has a beta of 0.8 and a standard deviation of 25%. Portfolio P has $200,000 consisting of $100,000 invested in Stock A and $100,000 in Stock B. Which of the following statements is CORRECT? (Assume that the stocks are in equilibrium.) a. Stock A's returns are less highly correlated with the returns on most other stocks than are B's returns. b. Stock B has a higher required rate of return than Stock A. c. Portfolio P has a standard deviation of 22.5%. d. More information is needed to determine the portfolio's beta. e. Portfolio P has a beta of 1.0. ANSWER: e POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-4 The Relationship Between Risk and Rates of Return Copyright Cengage Learning. Powered by Cognero.
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QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.04 - The Relationship Between Risk and Rates of Return NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: SML KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 95. Nile Food's stock has a beta of 1.4, while Elba Eateries' stock has a beta of 0.7. Assume that the risk-free rate, rRF, is 5.5% and the market risk premium, (rM – rRF), equals 4%. Which of the following statements is CORRECT? a. If the risk-free rate increases but the market risk premium remains unchanged, the required return will increase for both stocks but the increase will be larger for Nile since it has a higher beta. b. If the market risk premium increases but the risk-free rate remains unchanged, Nile's required return will increase because it has a beta greater than 1.0 but Elba's required return will decline because it has a beta less than 1.0. c. Since Nile's beta is twice that of Elba's, its required rate of return will also be twice that of Elba's. d. If the risk-free rate increases while the market risk premium remains constant, then the required return on an average stock will increase. e. If the market risk premium decreases but the risk-free rate remains unchanged, Nile's required return will decrease because it has a beta greater than 1.0 and Elba's will also decrease, but by more than Nile's because it has a beta less than 1.0. ANSWER: d POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-4 The Relationship Between Risk and Rates of Return QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.04 - The Relationship Between Risk and Rates of Return NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: SML KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 96. Stock X has a beta of 0.6, while Stock Y has a beta of 1.4. Which of the following statements is CORRECT? a. A portfolio consisting of $50,000 invested in Stock X and $50,000 invested in Stock Y will have a required return that exceeds that of the overall market. b. Stock Y must have a higher expected return and a higher standard deviation than Stock X. c. If expected inflation increases but the market risk premium is unchanged, then the required return on both Copyright Cengage Learning. Powered by Cognero.
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stocks will fall by the same amount. d. If the market risk premium declines but expected inflation is unchanged, the required return on both stocks will decrease, but the decrease will be greater for Stock Y. e. If expected inflation declines but the market risk premium is unchanged, then the required return on both stocks will decrease but the decrease will be greater for Stock Y. ANSWER: d POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-4 The Relationship Between Risk and Rates of Return QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.04 - The Relationship Between Risk and Rates of Return NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: SML KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 97. Stock A has a beta of 0.8 and Stock B has a beta of 1.2. 50% of Portfolio P is invested in Stock A and 50% is invested in Stock B. If the market risk premium (rM – rRF) were to increase but the risk-free rate (rRF) remained constant, which of the following would occur? a. The required return would increase for both stocks but the increase would be greater for Stock B than for Stock A. b. The required return would decrease by the same amount for both Stock A and Stock B. c. The required return would increase for Stock A but decrease for Stock B. d. The required return on Portfolio P would remain unchanged. e. The required return would increase for Stock B but decrease for Stock A. ANSWER: a POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-4 The Relationship Between Risk and Rates of Return QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.04 - The Relationship Between Risk and Rates of Return NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: SML KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM Copyright Cengage Learning. Powered by Cognero.
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98. Stock A has a beta of 0.7, whereas Stock B has a beta of 1.3. Portfolio P has 50% invested in both A and B. Which of the following would occur if the market risk premium increased by 1% but the risk-free rate remained constant? a. The required return on Portfolio P would increase by 1%. b. The required return on both stocks would increase by 1%. c. The required return on Portfolio P would remain unchanged. d. The required return on Stock A would increase by more than 1%, while the return on Stock B would increase by less than 1%. e. The required return for Stock A would fall, but the required return for Stock B would increase. ANSWER: a POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-4 The Relationship Between Risk and Rates of Return QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.04 - The Relationship Between Risk and Rates of Return NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: SML KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 99. Assume that the risk-free rate remains constant, but the market risk premium declines. Which of the following is most likely to occur? a. The required return on a stock with beta = 1.0 will not change. b. The required return on a stock with beta > 1.0 will increase. c. The return on "the market" will remain constant. d. The return on "the market" will increase. e. The required return on a stock with a positive beta < 1.0 will decline. ANSWER: e POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-4 The Relationship Between Risk and Rates of Return QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.04 - The Relationship Between Risk and Rates of Return NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: SML KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:24 PM Copyright Cengage Learning. Powered by Cognero.
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100. Which of the following statements is CORRECT? a. The slope of the SML is determined by the value of beta. b. The SML shows the relationship between companies' required returns and their diversifiable risks. The slope and intercept of this line cannot be influenced by a firm's managers, but the position of the company on the line can be influenced by its managers. c. Suppose you plotted the returns of a given stock against those of the market, and you found that the slope of the regression line was negative. The CAPM would indicate that the required rate of return on the stock should be less than the risk-free rate for a well diversified investor, assuming investors expect the observed relationship to continue on into the future. d. If investors become less risk averse, the slope of the Security Market Line will increase. e. If a company increases its use of debt, this is likely to cause the slope of its SML to increase, indicating a higher required return on the stock. ANSWER: c POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-4 The Relationship Between Risk and Rates of Return QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.04 - The Relationship Between Risk and Rates of Return NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: SML KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 101. Other things held constant, if the expected inflation rate decreases and investors also become more risk averse, the Security Market Line would be affected as follows: a. The y-axis intercept would decline, and the slope would increase. b. The x-axis intercept would decline, and the slope would increase. c. The y-axis intercept would increase, and the slope would decline. d. The SML would be affected only if betas changed. e. Both the y-axis intercept and the slope would increase, leading to higher required returns. ANSWER: a POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-4 The Relationship Between Risk and Rates of Return QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.04 - The Relationship Between Risk and Rates of Return NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return Copyright Cengage Learning. Powered by Cognero.
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LOCAL STANDARDS: TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
United States - OH - Default City - Tier 2: - Capital structure SML Bloom's: Comprehension Multiple Choice: Conceptual 9/21/2017 5:24 PM 9/21/2017 5:24 PM
102. Assume that the risk-free rate, rRF, increases but the market risk premium, (rM – rRF), declines with the net effect being that the overall required return on the market, rM, remains constant. Which of the following statements is CORRECT? a. The required return of all stocks will increase by the amount of the increase in the risk-free rate. b. The required return will decline for stocks that have a beta less than 1.0 but will increase for stocks that have a beta greater than 1.0. c. Since the overall return on the market stays constant, the required return on each individual stock will also remain constant. d. The required return will increase for stocks that have a beta less than 1.0 but decline for stocks that have a beta greater than 1.0. e. The required return of all stocks will fall by the amount of the decline in the market risk premium. ANSWER: d POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-4 The Relationship Between Risk and Rates of Return QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.04 - The Relationship Between Risk and Rates of Return NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: SML KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 103. Assume that to cool off the economy and decrease expectations for inflation, the Federal Reserve tightened the money supply, causing an increase in the risk-free rate, rRF. Investors also became concerned that the Fed's actions would lead to a recession, and that led to an increase in the market risk premium, (rM – rRF). Under these conditions, with other things held constant, which of the following statements is most correct? a. The required return on all stocks would increase by the same amount. b. The required return on all stocks would increase, but the increase would be greatest for stocks with betas of less than 1.0. c. Stocks' required returns would change, but so would expected returns, and the result would be no change in stocks' prices. d. The prices of all stocks would decline, but the decline would be greatest for high-beta stocks. e. The prices of all stocks would increase, but the increase would be greatest for high-beta stocks. ANSWER: d Copyright Cengage Learning. Powered by Cognero.
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POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-4 The Relationship Between Risk and Rates of Return QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.04 - The Relationship Between Risk and Rates of Return NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: SML KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 104. Which of the following statements is CORRECT? a. If a stock has a beta of to 1.0, its required rate of return will be unaffected by changes in the market risk premium. b. The slope of the Security Market Line is beta. c. Any stock with a negative beta must in theory have a negative required rate of return, provided rRF is positive. d. If a stock's beta doubles, its required rate of return must also double. e. If a stock's returns are negatively correlated with returns on most other stocks, the stock's beta will be negative. ANSWER: e POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-4 The Relationship Between Risk and Rates of Return QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.04 - The Relationship Between Risk and Rates of Return NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: SML, CAPM, and beta KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 105. Assume that investors have recently become more risk averse, so the market risk premium has increased. Also, assume that the risk-free rate and expected inflation have not changed. Which of the following is most likely to occur? a. The required rate of return for an average stock will increase by an amount equal to the increase in the market risk premium. b. The required rate of return will decline for stocks whose betas are less than 1.0. c. The required rate of return on the market, rM, will not change as a result of these changes. d. The required rate of return for each individual stock in the market will increase by an amount equal to the Copyright Cengage Learning. Powered by Cognero.
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increase in the market risk premium. e. The required rate of return on a riskless bond will decline. ANSWER: a POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-4 The Relationship Between Risk and Rates of Return QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.04 - The Relationship Between Risk and Rates of Return NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: SML and risk aversion KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 106. Which of the following statements is CORRECT? a. A graph of the SML as applied to individual stocks would show required rates of return on the vertical axis and standard deviations of returns on the horizontal axis. b. The CAPM has been thoroughly tested, and the theory has been confirmed beyond any reasonable doubt. c. If two "normal" or "typical" stocks were combined to form a 2-stock portfolio, the portfolio's expected return would be a weighted average of the stocks' expected returns, but the portfolio's standard deviation would probably be greater than the average of the stocks' standard deviations. d. If investors become more risk averse, then (1) the slope of the SML would increase and (2) the required rate of return on low-beta stocks would increase by more than the required return on high-beta stocks. e. An increase in expected inflation, combined with a constant real risk-free rate and a constant market risk premium, would lead to identical increases in the required returns on a riskless asset and on an average stock, other things held constant. ANSWER: e POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-4 The Relationship Between Risk and Rates of Return QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.04 - The Relationship Between Risk and Rates of Return NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: SML, CAPM, and port. risk KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM Copyright Cengage Learning. Powered by Cognero.
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107. For markets to be in equilibrium, that is, for there to be no strong pressure for prices to depart from their current levels, a. The expected rate of return must be equal to the required rate of return; that is, = . b. The past realized rate of return must be equal to the expected future rate of return; that is, = . c. The required rate of return must equal the past realized rate of return; that is, = . d. All three of the above statements must hold for equilibrium to exist; that is = = . e. None of the above statements is correct. ANSWER: a POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-4 The Relationship Between Risk and Rates of Return QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.04 - The Relationship Between Risk and Rates of Return NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Market equilibrium KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 108. Which of the following statements is CORRECT? a. When diversifiable risk has been diversified away, the inherent risk that remains is market risk, which is constant for all stocks in the market. b. Portfolio diversification reduces the variability of returns on an individual stock. c. Risk refers to the chance that some unfavorable event will occur, and a probability distribution is completely described by a listing of the likelihoods of unfavorable events. d. The SML relates a stock's required return to its market risk. The slope and intercept of this line cannot be controlled by the firms' managers, but managers can influence their firms' positions on the line by such actions as changing the firm's capital structure or the type of assets it employs. e. A stock with a beta of -1.0 has zero market risk if held in a 1-stock portfolio. ANSWER: d POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Risk concepts KEYWORDS: Bloom's: Comprehension Copyright Cengage Learning. Powered by Cognero.
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OTHER: DATE CREATED: DATE MODIFIED:
Multiple Choice: Conceptual 9/21/2017 5:24 PM 9/21/2017 5:24 PM
109. You observe the following information regarding Companies X and Y: —Company X has a higher expected return than Company Y. —Company X has a lower standard deviation of returns than Company Y. —Company X has a higher beta than Company Y. Given this information, which of the following statements is CORRECT? a. Company X has more diversifiable risk than Company Y. b. Company X has a lower coefficient of variation than Company Y. c. Company X has less market risk than Company Y. d. Company X's returns will be negative when Y's returns are positive. e. Company X's stock is a better buy than Company Y's stock. ANSWER: b POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Risk measures KEYWORDS: Bloom's: Evaluation OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 110. Stocks A and B both have an expected return of 10% and a standard deviation of returns of 25%. Stock A has a beta of 0.8 and Stock B has a beta of 1.2. The correlation coefficient, r, between the two stocks is +0.6. Portfolio P has 50% invested in Stock A and 50% invested in B. Which of the following statements is CORRECT? a. Portfolio P has a standard deviation of 25% and a beta of 1.0. b. Based on the information we are given, and assuming those are the views of the marginal investor, it is apparent that the two stocks are in equilibrium. c. Portfolio P has more market risk than Stock A but less market risk than B. d. Stock A should have a higher expected return than Stock B as viewed by the marginal investor. e. Portfolio P has a coefficient of variation equal to 2.5. ANSWER: c POINTS: 1 DIFFICULTY: MODERATE/CHALLENGING REFERENCES: 8-3 Risk in a Portfolio Context: The CAPM QUESTION TYPE: Multiple Choice HAS VARIABLES: False Copyright Cengage Learning. Powered by Cognero.
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LEARNING OBJECTIVES: FOFM.BRIG.17.08.03 - Risk in a Portfolio Context: The CAPM NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Portfolio risk KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 111. The risk-free rate is 6% and the market risk premium is 5%. Your $1 million portfolio consists of $700,000 invested in a stock that has a beta of 1.2 and $300,000 invested in a stock that has a beta of 0.8. Which of the following statements is CORRECT? a. If the stock market is efficient, your portfolio's expected return should equal the expected return on the market, which is 11%. b. The required return on the market is 10%. c. The portfolio's required return is less than 11%. d. If the risk-free rate remains unchanged but the market risk premium increases by 2%, your portfolio's required return will increase by more than 2%. e. If the market risk premium remains unchanged but expected inflation increases by 2%, your portfolio's required return will increase by more than 2%. ANSWER: d RATIONALE: d is correct. The portfolio's beta is 1.08. Therefore, if the market risk premium increases by 2.0% the portfolio's required return will increase by 2.16% POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 8-4 The Relationship Between Risk and Rates of Return QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.04 - The Relationship Between Risk and Rates of Return NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Port. risk and ret. relationships KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 112. Stock A has an expected return of 10% and a standard deviation of 20%. Stock B has an expected return of 13% and a standard deviation of 30%. The risk-free rate is 5% and the market risk premium, rM – rRF, is 6%. Assume that the market is in equilibrium. Portfolio AB has 50% invested in Stock A and 50% invested in Stock B. The returns of Stock A and Stock B are independent of one another, i.e., the correlation coefficient between them is zero. Which of the following statements is CORRECT? a. Stock A's beta is 0.8333. b. Since the two stocks have zero correlation, Portfolio AB is riskless. c. Stock B's beta is 1.0000. Copyright Cengage Learning. Powered by Cognero.
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d. Portfolio AB's required return is 11%. e. Portfolio AB's standard deviation is 25%. ANSWER: a RATIONALE: a is correct. Stock A's required return is 10% = 5% + b(6%), so b = 5%/6% = 0.83333. POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 8-4 The Relationship Between Risk and Rates of Return QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.04 - The Relationship Between Risk and Rates of Return NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Port. risk and ret. relationships KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 113. Stock A has a beta of 1.2 and a standard deviation of 25%. Stock B has a beta of 1.4 and a standard deviation of 20%. Portfolio AB was created by investing in a combination of Stocks A and B. Portfolio AB has a beta of 1.25 and a standard deviation of 18%. Which of the following statements is CORRECT? a. Stock A has more market risk than Portfolio AB. b. Stock A has more market risk than Stock B but less stand-alone risk. c. Portfolio AB has more money invested in Stock A than in Stock B. d. Portfolio AB has the same amount of money invested in each of the two stocks. e. Portfolio AB has more money invested in Stock B than in Stock A. ANSWER: c RATIONALE: c is correct. = %A(1.2) + %B(1.4) = 1.25. If 50% is in each stock, then we would have = 0.5(1.2) + 0.5(1.4) = 1.3. But < 1.3, so more money must be invested in the low-beta stock, A. POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 8-4 The Relationship Between Risk and Rates of Return QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.04 - The Relationship Between Risk and Rates of Return NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Port. risk and ret. relationships KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM Copyright Cengage Learning. Powered by Cognero.
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114. Which of the following statements is CORRECT? a. If Mutual Fund A held equal amounts of 100 stocks, each of which had a beta of 1.0, and Mutual Fund B held equal amounts of 10 stocks with betas of 1.0, then the two mutual funds would both have betas of 1.0. Thus, they would be equally risky from an investor's standpoint, assuming the investor's only asset is one or the other of the mutual funds. b. If investors become more risk averse but rRF does not change, then the required rate of return on high-beta stocks will rise and the required return on low-beta stocks will decline, but the required return on an averagerisk stock will not change. c. An investor who holds just one stock will generally be exposed to more risk than an investor who holds a portfolio of stocks, assuming the stocks are all equally risky. Since the holder of the 1-stock portfolio is exposed to more risk, he or she can expect to earn a higher rate of return to compensate for the greater risk. d. There is no reason to think that the slope of the yield curve would have any effect on the slope of the SML. e. Assume that the required rate of return on the market, rM, is given and fixed at 10%. If the yield curve were upward sloping, then the Security Market Line (SML) would have a steeper slope if 1-year Treasury securities were used as the risk-free rate than if 30-year Treasury bonds were used for rRF. ANSWER: e POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 8-4 The Relationship Between Risk and Rates of Return QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.08.04 - The Relationship Between Risk and Rates of Return NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: SML KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 115. Taggart Inc.'s stock has a 50% chance of producing a 36% return, a 30% chance of producing a 10% return, and a 20% chance of producing a -28% return. What is the firm's expected rate of return? Do not round your intermediate calculations. a. 15.86% b. 15.71% c. 15.40% d. 12.01% e. 14.01% ANSWER: c RATIONALE: Prob.
Conditions Good Average Poor
Prob.
Return
0.50 0.30 0.20 1.00
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36.0% 10.0% -28.0%
× Return 18.00% 3.00% -5.60% 15.40%
= Expected return Page 483
POINTS: 1 DIFFICULTY: EASY REFERENCES: 8-2 Stand-Alone Risk QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.08.02 - Stand-Alone Risk NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Expected return KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 116. Dothan Inc.'s stock has a 25% chance of producing a 16% return, a 50% chance of producing a 12% return, and a 25% chance of producing a -18% return. What is the firm's expected rate of return? Do not round your intermediate calculations. a. 4.51% b. 5.50% c. 4.68% d. 4.29% e. 6.38% ANSWER: b RATIONALE: Conditions Prob. Return Prob. × Return
Good Average Poor
0.25 0.50 0.25 1.00
16.0% 12.0% -18.0%
4.00% 6.00% -4.50% 5.50%
= Expected return
POINTS: 1 DIFFICULTY: EASY REFERENCES: 8-2 Stand-Alone Risk QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.08.02 - Stand-Alone Risk NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Expected return KEYWORDS: Bloom's: Analysis Copyright Cengage Learning. Powered by Cognero.
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OTHER: DATE CREATED: DATE MODIFIED:
Multiple Choice: Problem 9/21/2017 5:24 PM 9/21/2017 5:24 PM
117. Cheng Inc. is considering a capital budgeting project that has an expected return of 24% and a standard deviation of 30%. What is the project's coefficient of variation? Do not round your intermediate calculations. Round the final answer to 2 decimal places. a. 1.08 b. 1.40 c. 1.03 d. 1.25 e. 0.99 ANSWER: d RATIONALE: Expected return 24.0%
Standard deviation Coefficient of variation = std dev / expected return =
30.0% 1.25
POINTS: 1 DIFFICULTY: EASY REFERENCES: 8-2 Stand-Alone Risk QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.08.02 - Stand-Alone Risk NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Coefficient of variation KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 118. Bae Inc. is considering an investment that has an expected return of 45% and a standard deviation of 10%. What is the investment's coefficient of variation? Do not round your intermediate calculations. Round the final answer to 2 decimal places. a. 0.22 b. 0.27 c. 0.20 d. 0.26 e. 0.23 ANSWER: a RATIONALE: Expected return 45.0%
Standard deviation Coefficient of variation = std dev / expected return = POINTS: DIFFICULTY:
10.0% 0.22
1 EASY
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REFERENCES: 8-2 Stand-Alone Risk QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.08.02 - Stand-Alone Risk NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Coefficient of variation KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 119. Bill Dukes has $100,000 invested in a 2-stock portfolio. $62,500 is invested in Stock X and the remainder is invested in Stock Y. X's beta is 1.50 and Y's beta is 0.70. What is the portfolio's beta? Do not round your intermediate calculations. Round the final answer to 2 decimal places. a. 1.14 b. 0.90 c. 1.44 d. 1.20 e. 1.56 ANSWER: d RATIONALE: Company Investment Weight Beta Weight × beta
X Y
$62,500 $37,500
0.625 0.375
$100,000
1.00
1.50 0.70
0.94 0.26 1.20
= Portfolio beta
POINTS: 1 DIFFICULTY: EASY REFERENCES: 8-3 Risk in a Portfolio Context: The CAPM QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.08.03 - Risk in a Portfolio Context: The CAPM NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Portfolio beta KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:24 PM DATE MODIFIED: 9/21/2017 5:24 PM 120. Tom O'Brien has a 2-stock portfolio with a total value of $100,000. $47,500 is invested in Stock A with a beta of 0.75 and the remainder is invested in Stock B with a beta of 1.42. What is his portfolio's beta? Do not round your Copyright Cengage Learning. Powered by Cognero.
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intermediate calculations. Round your final answer to 2 decimal places. a. 1.04 b. 1.10 c. 1.09 d. 1.06 e. 1.05 ANSWER: b RATIONALE:
Company
Investment
Stock A Stock B
$47,500 $52,500
Port. weight 0.475 0.525
$100,000
1.00
Weight × beta
Beta 0.75 1.42
0.36 0.75 1.10
= Portfolio beta
POINTS: 1 DIFFICULTY: EASY REFERENCES: 8-3 Risk in a Portfolio Context: The CAPM QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.08.03 - Risk in a Portfolio Context: The CAPM NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Portfolio beta KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:25 PM DATE MODIFIED: 9/21/2017 5:25 PM 121. Assume that you hold a well-diversified portfolio that has an expected return of 11.0% and a beta of 1.20. You are in the process of buying 1,000 shares of Alpha Corp at $10 a share and adding it to your portfolio. Alpha has an expected return of 21.5% and a beta of 1.70. The total value of your current portfolio is $90,000. What will the expected return and beta on the portfolio be after the purchase of the Alpha stock? Do not round your intermediate calculations. a. 13.98%; 1.28 b. 12.29%; 1.48 c. 12.41%; 1.56 d. 12.05%; 1.25 e. 9.40%; 1.34 ANSWER: d RATIONALE: Old portfolio return 11.0%
Old portfolio beta New stock return New stock beta % of portfolio in new stock = $ in New / ($ in old + $ in new) = $10,000/$100,000= Copyright Cengage Learning. Powered by Cognero.
1.20 21.5% 1.70 10% Page 487
New expected portfolio return = rp = 0.1 × 21.5% + 0.9 × 11% = New expected portfolio beta = bp = 0.1 × 1.70 + 0.9 × 1.20 =
12.05% 1.25
POINTS: 1 DIFFICULTY: EASY REFERENCES: 8-3 Risk in a Portfolio Context: The CAPM QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.08.03 - Risk in a Portfolio Context: The CAPM NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Portfolio beta KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:25 PM DATE MODIFIED: 9/21/2017 5:25 PM 122. Calculate the required rate of return for Climax Inc., assuming that (1) investors expect a 4.0% rate of inflation in the future, (2) the real risk-free rate is 3.0%, (3) the market risk premium is 5.0%, (4) the firm has a beta of 2.30, and (5) its realized rate of return has averaged 15.0% over the last 5 years. Do not round your intermediate calculations. a. 20.91% b. 18.87% c. 16.28% d. 17.76% e. 18.50% ANSWER: e RATIONALE: Real rate (r*): 3.00%
IP : RPM: Beta: Required return = rRF + b(RPM) = r* + IP + b(RPM) =
4.00% 5.00% 2.30 18.50%
POINTS: 1 DIFFICULTY: EASY REFERENCES: 8-4 The Relationship Between Risk and Rates of Return QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.08.04 - The Relationship Between Risk and Rates of Return NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure Copyright Cengage Learning. Powered by Cognero.
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TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
CAPM: req. rate of return Bloom's: Analysis Multiple Choice: Problem 9/21/2017 5:25 PM 9/21/2017 5:25 PM
123. Cooley Company's stock has a beta of 1.28, the risk-free rate is 2.25%, and the market risk premium is 5.50%. What is the firm's required rate of return? Do not round your intermediate calculations. a. 9.29% b. 9.94% c. 10.96% d. 8.55% e. 11.52% ANSWER: a RATIONALE: Beta 1.28
Risk-free rate Market risk premium Required return
2.25% 5.50% 9.29%
POINTS: 1 DIFFICULTY: EASY REFERENCES: 8-4 The Relationship Between Risk and Rates of Return QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.08.04 - The Relationship Between Risk and Rates of Return NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: CAPM: req. rate of return KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:25 PM DATE MODIFIED: 9/21/2017 5:25 PM 124. Porter Inc's stock has an expected return of 12.50%, a beta of 1.25, and is in equilibrium. If the risk-free rate is 2.00%, what is the market risk premium? Do not round your intermediate calculations. a. 10.50% b. 8.48% c. 7.98% d. 8.40% e. 6.80% ANSWER: d RATIONALE: Use the SML to determine the market risk premium with the given data.
rs = rRF + bStock × RPM 12.50% = 2.00% + 1.25 × RPM 10.50% = RPM × 1.25 Copyright Cengage Learning. Powered by Cognero.
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8.40% = RPM POINTS: 1 DIFFICULTY: EASY REFERENCES: 8-4 The Relationship Between Risk and Rates of Return QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.08.04 - The Relationship Between Risk and Rates of Return NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Market risk premium KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:25 PM DATE MODIFIED: 9/21/2017 5:25 PM 125. Roenfeld Corp believes the following probability distribution exists for its stock. What is the coefficient of variation on the company's stock? Do not round your intermediate calculations. State of the Economy Boom Normal Recession
Probability Stock's of State Expected Occurring Return 0.19 25% 0.50 15% 0.31 5%
a. 0.6565 b. 0.6060 c. 0.5050 d. 0.4545 e. 0.4292 ANSWER: RATIONALE:
c This is a relatively technical problem. It should be used only if calculations are emphasized in class, or on a take-home exam where students have time to look up formulas.
Probability of This state 0.19 0.50 0.31 Expected return =
Return This state 25.00% 15.00% 5.00% 13.80%
Deviation from Mean 11.20% 1.20% –8.80%
Squared Deviation 1.25 0.01 0.77
State Prob × Sq Dev 0.2383 0.0072 0.2401 0.4856= E
σ = 6.97% Coefficient of variation = σ / Expected return = 0.5050 POINTS: DIFFICULTY: REFERENCES:
1 MODERATE 8-2 Stand-Alone Risk
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QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJEC FOFM.BRIG.17.08.02 - Stand-Alone Risk TIVES: NATIONAL STAND United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic ARDS: STATE STANDARDS United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return : LOCAL STANDARD United States - OH - Default City - Tier 2: - Capital structure S: TOPICS: Coefficient of variation KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:25 PM DATE MODIFIED: 9/21/2017 5:25 PM 126. Jim Angel holds a $200,000 portfolio consisting of the following stocks: Stock A B C D Total
Investment $50,000 $50,000 $50,000 $50,000 $200,000
Beta 1.20 0.80 1.00 1.20
What is the portfolio's beta? Do not round your intermediate calculations. a. 1.239 b. 1.040 c. 0.861 d. 0.809 e. 1.050 ANSWER: e RATIONALE: Stock Investment Percentage Beta
A B C D
$50,000 $50,000 $50,000 $50,000
25.00% 25.00% 25.00% 25.00%
Total
$200,000
100.00%
1.20 0.80 1.00 1.20
Product 0.300 0.200 0.250 0.300 1.050
= Portfolio Beta
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-3 Risk in a Portfolio Context: The CAPM QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.08.03 - Risk in a Portfolio Context: The CAPM Copyright Cengage Learning. Powered by Cognero.
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NATIONAL STANDARDS: STATE STANDARDS: LOCAL STANDARDS: TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return United States - OH - Default City - Tier 2: - Capital structure Portfolio beta Bloom's: Analysis Multiple Choice: Problem 9/21/2017 5:25 PM 9/21/2017 5:25 PM
127. Jill Angel holds a $200,000 portfolio consisting of the following stocks. The portfolio's beta is 0.88. Stock A B C D Total
Investment $50,000 $50,000 $50,000 $50,000 $200,000
Beta 0.50 0.80 1.00 1.20
If Jill replaces Stock A with another stock, E, which has a beta of 1.45, what will the portfolio's new beta be? Do not round your intermediate calculations. a. 1.39 b. 1.28 c. 0.83 d. 1.22 e. 1.11 ANSWER: e RATIONALE: Original Portfolio New Portfolio
Stock Investment Percentage Beta Product A $50,000 25.00% 0.50 0.13 B $50,000 25.00% 0.80 0.20 C $50,000 25.00% 1.00 0.25 D $50,000 25.00% 1.20 0.30 E Total
$200,000
100.00%
0.88
Percentage Beta 25.00% 25.00% 25.00%
0.80 1.00 1.20 1.45
25.00% New Portfolio Beta =
Product 0.20 0.25 0.30 0.36 1.11
Alternative solution: (bE - bA)(%A) + bOld = 1.12 POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-3 Risk in a Portfolio Context: The CAPM QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.08.03 - Risk in a Portfolio Context: The CAPM NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Portfolio beta KEYWORDS: Bloom's: Analysis Copyright Cengage Learning. Powered by Cognero.
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OTHER: DATE CREATED: DATE MODIFIED:
Multiple Choice: Problem 9/21/2017 5:25 PM 9/21/2017 5:25 PM
128. Mike Flannery holds the following portfolio: Stock A B C D Total
Investment $150,000 $10,000 $140,000 $75,000 $375,000
Beta 1.40 0.80 1.00 1.20
What is the portfolio's beta? Do not round your intermediate calculations. a. 1.19 b. 1.36 c. 1.30 d. 1.47 e. 1.45 ANSWER: a RATIONALE: Stock Investment Percentage Beta
A B C D Total
$150,000 $10,000 $140,000 $75,000 $375,000
40.00% 2.67% 37.33% 20.00% 100.00%
Product 1.40 0.80 1.00 1.20
0.56 0.02 0.37 0.24 1.19 = Portfolio Beta
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-3 Risk in a Portfolio Context: The CAPM QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.08.03 - Risk in a Portfolio Context: The CAPM NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Portfolio beta KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:25 PM DATE MODIFIED: 9/21/2017 5:25 PM 129. Tom Noel holds the following portfolio: Stock A B
Investment $150,000 $50,000
Beta 1.40 0.80
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C D Total
$100,000 $75,000 $375,000
1.00 1.20
Tom plans to sell Stock A and replace it with Stock E, which has a beta of 0.80. By how much will the portfolio beta change? Do not round your intermediate calculations. a. –0.240 b. –0.194 c. –0.290 d. –0.271 e. –0.230 ANSWER: a RATIONALE: Original Portfolio New Portfolio
Stock A B C D E Total
Investment Percentage Beta Product $150,000 40.00% 1.400 0.560 $50,000 13.33% 0.800 0.107 $100,000 26.67% 1.000 0.267 $75,000 20.00% 1.200 0.240 $375,000
100.00%
Old b =
Percentage Beta 13.33% 26.67% 20.00% 40.00%
1.173
0.800 1.000 1.200 0.800 New b =
Product 0.107 0.267 0.240 0.320 0.933
Change in beta = New - Old = –0.240 Alternative solution: (bE-bA) × %A = –0.240
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-3 Risk in a Portfolio Context: The CAPM QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.08.03 - Risk in a Portfolio Context: The CAPM NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Portfolio beta KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:25 PM DATE MODIFIED: 9/21/2017 5:25 PM 130. You hold a diversified $100,000 portfolio consisting of 20 stocks with $5,000 invested in each. The portfolio's beta is 1.12. You plan to sell a stock with b = 0.90 and use the proceeds to buy a new stock with b = 1.50. What will the portfolio's new beta be? Do not round your intermediate calculations. a. 1.093 b. 1.185 c. 1.127 d. 1.150 Copyright Cengage Learning. Powered by Cognero.
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e. 1.242 ANSWER: RATIONALE:
d
% in each stock: Old stock's beta: New stock's beta: Old port. beta: New beta = (bnew - bold) × %A + bOld =
5% 0.90 1.50 1.12 1.150
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-3 Risk in a Portfolio Context: The CAPM QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.08.03 - Risk in a Portfolio Context: The CAPM NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Portfolio beta KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:25 PM DATE MODIFIED: 9/21/2017 5:25 PM 131. Mikkelson Corporation's stock had a required return of 12.50% last year, when the risk-free rate was 3% and the market risk premium was 4.75%. Then an increase in investor risk aversion caused the market risk premium to rise by 2%. The risk-free rate and the firm's beta remain unchanged. What is the company's new required rate of return? (Hint: First calculate the beta, then find the required return.) Do not round your intermediate calculations. a. 12.87% b. 16.50% c. 13.04% d. 12.71% e. 14.36% ANSWER: b RATIONALE: Risk-free rate 3.00%
Old market risk premium Old required return b = (old return - rRF)/old RPM New market risk premium New required return = rRF + b(RPM) =
4.75% 12.50% 2.00 6.75% 16.50%
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-4 The Relationship Between Risk and Rates of Return QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.08.04 - The Relationship Between Risk and Rates of Return Copyright Cengage Learning. Powered by Cognero.
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NATIONAL STANDARDS: STATE STANDARDS: LOCAL STANDARDS: TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return United States - OH - Default City - Tier 2: - Capital structure CAPM: req. rate of return Bloom's: Analysis Multiple Choice: Problem 9/21/2017 5:25 PM 9/21/2017 5:25 PM
132. Company A has a beta of 0.70, while Company B's beta is 1.45. The required return on the stock market is 9.00%, and the risk-free rate is 2.25%. What is the difference between A's and B's required rates of return? (Hint: First find the market risk premium, then find the required returns on the stocks.) Do not round your intermediate calculations. a. 5.06% b. 5.01% c. 4.71% d. 4.30% e. 4.25% ANSWER: a RATIONALE: Beta: A 0.70
Beta: B Market return Risk-free rate Market risk premium Required return A = rRF + bA(RPM) = Required return B = rRF + bB(RPM) = Difference
1.45 9.00% 2.25% 6.75% 6.98% 12.04% 5.06%
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-4 The Relationship Between Risk and Rates of Return QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.08.04 - The Relationship Between Risk and Rates of Return NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: CAPM: req. rate of return KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:25 PM DATE MODIFIED: 9/21/2017 5:25 PM 133. Stock A's stock has a beta of 1.30, and its required return is 13.75%. Stock B's beta is 0.80. If the risk-free rate is 2.75%, what is the required rate of return on B's stock? (Hint: First find the market risk premium.) Do not round your Copyright Cengage Learning. Powered by Cognero.
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intermediate calculations. a. 9.33% b. 9.52% c. 10.66% d. 11.33% e. 8.57% ANSWER: RATIONALE:
b
Beta: A Beta: B A's required return Risk-free rate RPM = (A's return - rRF)/betaA = B's required return = rRF + b(RPM) =
1.30 0.80 13.75% 2.75% 8.46% 9.52%
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-4 The Relationship Between Risk and Rates of Return QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.08.04 - The Relationship Between Risk and Rates of Return NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: CAPM: req. rate of return KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:25 PM DATE MODIFIED: 9/21/2017 5:25 PM 134. Kollo Enterprises has a beta of 0.70, the real risk-free rate is 2.00%, investors expect a 3.00% future inflation rate, and the market risk premium is 4.70%. What is Kollo's required rate of return? Do not round your intermediate calculations. a. 7.96% b. 7.30% c. 6.47% d. 6.96% e. 8.29% ANSWER: e RATIONALE: Real risk-free rate, r* 2.00%
Expected inflation, IP Market risk premium, RPM Beta, b Risk-free rate = r* + IP = Kollo's required return = rRF + b(RPM) = POINTS:
3.00% 4.70% 0.70 5.00% 8.29%
1
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DIFFICULTY: MODERATE REFERENCES: 8-4 The Relationship Between Risk and Rates of Return QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.08.04 - The Relationship Between Risk and Rates of Return NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: CAPM: req. rate of return KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:25 PM DATE MODIFIED: 9/21/2017 5:25 PM 135. Linke Motors has a beta of 1.30, the T-bill rate is 3.00%, and the T-bond rate is 6.5%. The annual return on the stock market during the past 3 years was 15.00%, but investors expect the annual future stock market return to be 10.00%. Based on the SML, what is the firm's required return? Do not round your intermediate calculations. a. 11.05% b. 13.48% c. 12.71% d. 10.17% e. 10.50% ANSWER: a RATIONALE: Use SML to determine the market risk premium. Note that rRF is based on T-bonds, not short-term Tbills.
rs = rRF + RPM 10.00% = 6.50% + RPM 3.50% = RPM Use the SML to determine Linke's required return using the RPM calculated above:
rs = rRF + RPM × b = 6.50% + 3.50% × 1.30 = 11.05% POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-4 The Relationship Between Risk and Rates of Return QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.08.04 - The Relationship Between Risk and Rates of Return NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: CAPM: req. rate of return KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:25 PM Copyright Cengage Learning. Powered by Cognero.
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DATE MODIFIED:
9/21/2017 5:25 PM
136. Nagel Equipment has a beta of 0.88 and an expected dividend growth rate of 4.00% per year. The T-bill rate is 4.00%, and the T-bond rate is 5.25%. The annual return on the stock market during the past 4 years was 10.25%. Investors expect the average annual future return on the market to be 14.75%. Using the SML, what is the firm's required rate of return? Do not round your intermediate calculations. a. 13.61% b. 11.57% c. 12.25% d. 14.70% e. 12.11% ANSWER: a RATIONALE: Use SML to determine the market risk premium. Note that rRF is based on T-bonds, not short-term Tbills. Also, note that the dividend growth rate is not needed.
rs = rRF + RPM 14.75% = 5.25% + RPM RPM = 9.50% Use SML to determine Nagel's required return using RPM calculated above
rs = rRF + RPM = 5.25% + 9.50% = 13.61%
× b × 0.88
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-4 The Relationship Between Risk and Rates of Return QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.08.04 - The Relationship Between Risk and Rates of Return NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: CAPM: req. rate of return KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:25 PM DATE MODIFIED: 9/21/2017 5:25 PM 137. Consider the following information and then calculate the required rate of return for the Global Investment Fund, which holds 4 stocks. The market's required rate of return is 17.50%, the risk-free rate is 3.00%, and the Fund's assets are as follows (Do not round your intermediate calculations.): Stock A B C D
Investment $ 200,000 300,000 500,000 $1,000,000
Beta 1.50 -0.50 1.25 0.75
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a. 14.06% b. 15.46% c. 14.76% d. 15.18% e. 13.35% ANSWER: RATIONALE:
a
17.50% 3.00%
rM rRF
Find portfolio beta:
$200,000 $300,000 $500,000 $1,000,000
Weight 0.100 0.150 0.250 0.500
$2,000,000
1.000
Beta 1.50 -0.50 1.25 0.75
Product 0.1500 -0.0750 0.3125 0.3750 0.7625
= portfolio beta
Find RPM = rM - rRF = 14.50% rs = rRF + b(RPM) = 14.06%
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-4 The Relationship Between Risk and Rates of Return QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.08.04 - The Relationship Between Risk and Rates of Return NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: CAPM: req. rate of return KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:25 PM DATE MODIFIED: 9/21/2017 5:25 PM 138. Data for Dana Industries is shown below. Now Dana acquires some risky assets that cause its beta to increase by 30.0%. In addition, expected inflation increases by 0.80%. What is the stock's new required rate of return? Do not round your intermediate calculations. Initial beta Initial required return (rs) Market risk premium, RPM Percentage increase in beta Increase in inflation premium, IP
1.00 10.20% 6.00% 30.00% 0.80%
a. 12.80% b. 15.87% Copyright Cengage Learning. Powered by Cognero.
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c. 16.00% d. 9.98% e. 11.90% ANSWER: RATIONALE:
a
Old beta: Old rs = rRF + b(RPM) RPM Percentage increase in beta: Increase in IP: Find new beta after increase = Find old rRF: Old rs = rRF+ b(RPM): 10.2% = rRF + 1.0(6.0%): rRF = 10.2% - 6.0% = Find new rRF: Old rRF + increase in IP = Find new rs = new rRF + new beta(RPM) =
1.00 10.20% 6.00% 30.00% 0.80% 1.30
4.20% 5.00% 12.80%
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-4 The Relationship Between Risk and Rates of Return QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.08.04 - The Relationship Between Risk and Rates of Return NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: CAPM: req. rate of return KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:25 PM DATE MODIFIED: 9/21/2017 5:25 PM 139. Mulherin's stock has a beta of 1.23, its required return is 11.75%, and the risk-free rate is 2.30%. What is the required rate of return on the market? (Hint: First find the market risk premium.) Do not round your intermediate calculations. a. 7.69% b. 8.19% c. 9.98% d. 12.38% e. 10.58% ANSWER: c RATIONALE: Beta 1.23
Risk-free rate Required return on stock RPM = (rstock - rRF)/beta Required return on market = rRF + RPM = Copyright Cengage Learning. Powered by Cognero.
2.30% 11.75% 7.68% 9.98% Page 501
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8-4 The Relationship Between Risk and Rates of Return QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.08.04 - The Relationship Between Risk and Rates of Return NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Return on the market KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:25 PM DATE MODIFIED: 9/21/2017 5:25 PM 140. Suppose you hold a portfolio consisting of a $10,000 investment in each of 8 different common stocks. The portfolio's beta is 1.25. Now suppose you decided to sell one of your stocks that has a beta of 1.00 and to use the proceeds to buy a replacement stock with a beta of 1.55. What would the portfolio's new beta be? Do not round your intermediate calculations. a. 1.60 b. 1.32 c. 1.58 d. 1.61 e. 1.38 ANSWER: b RATIONALE: Number of stocks 8
Percent in each stock = 1/number of stocks = Portfolio beta Beta (stock that's sold), b1 Beta (stock that's bought), b2
Change in portfolio's beta = 0.125 × (b2 - b1) = New portfolio beta
12.50% 1.25 1.00 1.55 0.0688 1.32
POINTS: 1 DIFFICULTY: MODERATE/CHALLENGING REFERENCES: 8-3 Risk in a Portfolio Context: The CAPM QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.08.03 - Risk in a Portfolio Context: The CAPM NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Portfolio beta Copyright Cengage Learning. Powered by Cognero.
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KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
Bloom's: Analysis Multiple Choice: Problem 9/21/2017 5:25 PM 9/21/2017 5:25 PM
141. Returns for the Dayton Company over the last 3 years are shown below. What's the standard deviation of the firm's returns? (Hint: This is a sample, not a complete population, so the sample standard deviation formula should be used.) Do not round your intermediate calculations. Year 2013 2012 2011 a. 30.02% b. 18.79% c. 23.43% d. 27.09% e. 24.41% ANSWER: RATIONALE:
Return 21.00% 12.50% 35.00%
e This is a relatively technical problem. It should be used only if calculations are emphasized in class or on a take-home exam where students have time to look up formulas or to use Excel or their calculator functions.
Year 2013 2012 2011 Expected return SQRT = σ = 24.41%
Return 21.00% -12.50% 35.00% 14.50%
Deviation from Mean 6.50% –27.00% 20.50%
Squared Deviation 0.42 7.29 4.20 11.92 5.96
Sum sqd deviations Sum / (N - 1)
24.41% with Excel
POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 8-2 Stand-Alone Risk QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES FOFM.BRIG.17.08.02 - Stand-Alone Risk : NATIONAL STANDARDS United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic : STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Std. dev., historical returns KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:25 PM DATE MODIFIED: 9/21/2017 5:25 PM Copyright Cengage Learning. Powered by Cognero.
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142. Carson Inc.'s manager believes that economic conditions during the next year will be strong, normal, or weak, and she thinks that the firm's returns will have the probability distribution shown below. What's the standard deviation of the estimated returns? (Hint: Use the formula for the standard deviation of a population, not a sample.) Do not round your intermediate calculations. Economic Conditions Strong Normal Weak a. 21.71% b. 25.18% c. 22.58% d. 17.59% e. 24.75% ANSWER: RATIONALE:
Prob. 30% 40% 30%
Return 40.0% 10.0% -16.0%
a This is a relatively technical problem. It should be used only if calculations are emphasized in class, or on a take-home exam where students have time to look up formulas or to use Excel or their calculator functions.
Economic
Return
Dev. from
Squared
Sqd. dev. ×
This Mean Dev. Prob state 30% 40.0% 28.80% 8.29 40% 10.0% –1.20% 0.01 30% -16.0% –27.20% 7.40 100% 11.2% Variance
Conditions Prob. Strong Normal Weak Total
2.49 0.01 2.22 4.71
σ = Sqrt of variance = 21.71%
POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 8-2 Stand-Alone Risk QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.08.02 - Stand-Alone Risk NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Std. dev., prob. data KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:25 PM DATE MODIFIED: 9/21/2017 5:25 PM 143. Assume that your uncle holds just one stock, East Coast Bank (ECB), which he thinks has very little risk. You agree that the stock is relatively safe, but you want to demonstrate that his risk would be even lower if he were more diversified. You obtain the following returns data for West Coast Bank (WCB). Both banks have had less variability than most other stocks over the past 5 years. Measured by the standard deviation of returns, by how much would your uncle's risk have Copyright Cengage Learning. Powered by Cognero.
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been reduced if he had held a portfolio consisting of 54% in ECB and the remainder in WCB? (Hint: Use the sample standard deviation formula.) Do not round your intermediate calculations. Year 1
3
ECB 40.00% 10.00% 35.00%
4
-5.00%
5
15.00%
-5.00% 10.00% 35.00%
Average return = Standard deviation =
15.00% 22.64%
15.00% 22.64%
2
a. 3.59% b. 4.27% c. 2.99% d. 3.99% e. 4.51% ANSWER: RATIONALE:
WCB 40.00% 15.00%
d This is a relatively technical problem. It should be used only if calculations are emphasized in class or on a take-home exam where students have time to look up formulas or to use Excel or their calculator functions.
% ECB:
Year
ECB
WCB
54%
2010 2011 2012 2013 2014
40.00% -10.00% 35.00% -5.00% 15.00%
40.00% 15.00% -5.00% -10.00% 35.00%
Portfolio ECB/WCB 40.00% 1.50% 16.60% –7.30% 24.2%
Average return = 15.00% Standard deviation = 22.64% Reduction in the SD vs. ECB's SD:
15.00% 22.64%
15.00% 18.65%
3.99%
POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 8-3 Risk in a Portfolio Context: The CAPM QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.08.03 - Risk in a Portfolio Context: The CAPM NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Portfolio risk reduction KEYWORDS: Bloom's: Evaluation OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:25 PM Copyright Cengage Learning. Powered by Cognero.
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DATE MODIFIED:
9/21/2017 5:25 PM
144. Assume that you manage a $10.00 million mutual fund that has a beta of 1.05 and a 9.50% required return. The riskfree rate is 2.20%. You now receive another $14.50 million, which you invest in stocks with an average beta of 0.65. What is the required rate of return on the new portfolio? (Hint: You must first find the market risk premium, then find the new portfolio beta.) Do not round your intermediate calculations. a. 6.81% b. 7.82% c. 6.56% d. 7.31% e. 6.31% ANSWER: e RATIONALE: % of New Port.
Old funds (millions) New funds (millions) Total portfolio Req'd return, old stocks Risk-free rate Market risk premium: RPM =
$10.00 $14.50 $24.50
40.82% 59.18% 100.00%
9.50% 2.20% rP = rRF + b(RPM) 9.50% = 2.20% + 1.05(RPM) (9.50% - 2.20%) / 1.05 =
6.95%
New portfolio
Old portfolio's beta New stocks' beta New portfolio beta New portfolio required return = rRF + new beta(RPM) =
1.05 0.65 0.81 6.31%
POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 8-3 Risk in a Portfolio Context: The CAPM QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.08.03 - Risk in a Portfolio Context: The CAPM NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Portfolio beta KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:25 PM DATE MODIFIED: 9/21/2017 5:25 PM 145. A mutual fund manager has a $40.00 million portfolio with a beta of 1.00. The risk-free rate is 4.25%, and the market risk premium is 6.00%. The manager expects to receive an additional $29.50 million which she plans to invest in Copyright Cengage Learning. Powered by Cognero.
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additional stocks. After investing the additional funds, she wants the fund's required and expected return to be 13.00%. What must the average beta of the new stocks be to achieve the target required rate of return? Do not round your intermediate calculations. a. 2.08 b. 2.18 c. 2.60 d. 1.66 e. 1.87 ANSWER: a RATIONALE: Old funds (millions) $40.00 57.55%
New funds (millions) Total new funds
$29.50 42.45% $69.50 100.00%
Beta on existing portfolio Risk-free rate Market risk premium Desired required return
1.00 4.25% 6.00% 13.00% 13% = rRF + b(RPM); b = (13% – rRF)/RPM
Required new portfolio beta Required beta on new stocks
1.4583 beta = (return – risk-free)/RPM 2.08 Req b = (old$/total$) × old b + (new$/total$) × new
Beta on new stocks = (Req b – (old$/total$) × old b)/(new$/total$)
POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 8-3 Risk in a Portfolio Context: The CAPM QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIV FOFM.BRIG.17.08.03 - Risk in a Portfolio Context: The CAPM ES: NATIONAL STANDAR United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic DS: STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Portfolio beta KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:25 PM DATE MODIFIED: 9/21/2017 5:25 PM 146. Assume that you are the portfolio manager of the SF Fund, a $3 million hedge fund that contains the following stocks. The required rate of return on the market is 11.00% and the risk-free rate is 2.00%. What rate of return should investors expect (and require) on this fund? Do not round your intermediate calculations. Stock A B
Amount $1,075,000 $675,000
Beta 1.20 0.50
Copyright Cengage Learning. Powered by Cognero.
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C D
$750,000 $500,000 $3,000,000
a. 11.16% b. 10.82% c. 9.93% d. 9.37% e. 9.71% ANSWER: RATIONALE:
1.40 0.75
a
Company Stock A Stock B Stock C Stock D
Amount Weight Beta Wt × beta $1,075,000 0.358 1.20 0.43 $675,000 0.225 0.50 0.11 $750,000 0.250 1.40 0.35 $500,000 0.167 0.75 0.13 $3,000,000
1.000
bPortfolio= 1.02
Required market return Risk free rate Market risk premium = rMarket – rRF =
11.00% 2.00% 9.00%
Portfolio's required return = rRF + b(RPM)=
11.16%
Intermediate step
POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 8-4 The Relationship Between Risk and Rates of Return QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.08.04 - The Relationship Between Risk and Rates of Return NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Port. beta and req. ret. KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:25 PM DATE MODIFIED: 9/21/2017 5:25 PM 147. CCC Corp has a beta of 1.5 and is currently in equilibrium. The required rate of return on the stock is 12.00% versus a required return on an average stock of 10.00%. Now the required return on an average stock increases by 30.0% (not percentage points). Neither betas nor the risk-free rate change. What would CCC's new required return be? Do not round your intermediate calculations. a. 16.34% b. 18.15% c. 14.19% d. 16.50% Copyright Cengage Learning. Powered by Cognero.
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e. 14.69% ANSWER: RATIONALE:
d This problem requires some algebra:
CCC's beta CCC's initial required return Percentage Increase in required market return: Initial required return on the market New required return on the market
1.50 12.00% 30.0% 10.00% 13.00%
Now for the algebra: rStock = rRF + b(RPM) = rRF + 1.5(RPM) rMarket = rRF + b(RPM) = rRF + 1.0(RPM) Now insert known data and transpose: 12% = rRF + 1.5(RPM) 12% - rRF = 1.5(RPM) 10% = rRF + 1.0(RPM) 10% - rRF = 1.0(RPM) Now subtract the second equation from the first. rRF and one of the RPMs cancel, leaving: 2% = 0.5(RPM)
Now solve for RPM: RPM = 2%/0.5 =
4.00%
Now find the risk-free rate: rRF = Initial rMarket – RPM= 10% - 4% =
6.00%
New RPM = New required return on the market – rRF =
7.00%
Now find the new return on CCC = rRF + b(new RPM) =
16.50%
POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 8-4 The Relationship Between Risk and Rates of Return QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.08.04 - The Relationship Between Risk and Rates of Return NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.07 - Risk and return LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: CAPM: req. rate of return KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:25 PM DATE MODIFIED: 9/21/2017 5:25 PM
1. A proxy is a document giving one party the authority to act for another party, including the power to vote shares of common stock. Proxies can be important tools relating to control of firms. a. True b. False ANSWER: True Copyright Cengage Learning. Powered by Cognero.
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POINTS: 1 DIFFICULTY: EASY REFERENCES: 9-1 Legal Rights and Privileges of Common Stockholders QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.09.01 - Legal Rights and Privileges of Common Stockholders NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Proxy KEYWORDS: Bloom's: Remember DATE CREATED: 9/21/2017 5:25 PM DATE MODIFIED: 11/8/2017 1:45 PM 2. The preemptive right gives current stockholders the right to purchase, on a pro rata basis, any new shares issued by the firm. This right helps protect current stockholders against both dilution of control and dilution of value. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 9-1 Legal Rights and Privileges of Common Stockholders QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.09.01 - Legal Rights and Privileges of Common Stockholders NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Preemptive right KEYWORDS: Bloom's: Remember DATE CREATED: 9/21/2017 5:25 PM DATE MODIFIED: 11/8/2017 1:45 PM 3. If a firm's stockholders are given the preemptive right, then they can call for a meeting to vote to replace the management. Without the preemptive right, dissident stockholders have to seek a change in management through a proxy fight. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 9-1 Legal Rights and Privileges of Common Stockholders QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.09.01 - Legal Rights and Privileges of Common Stockholders NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking Copyright Cengage Learning. Powered by Cognero.
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STATE STANDARDS: LOCAL STANDARDS: TOPICS: KEYWORDS: DATE CREATED: DATE MODIFIED:
United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds United States - OH - Default City - Tier 2: - Capital structure Preemptive right Bloom's: Understand 9/21/2017 5:25 PM 11/8/2017 2:03 PM
4. Classified stock differentiates various classes of common stock. Using it is one way companies can meet special needs, such as when owners of a start-up firm need additional equity capital but don't want to relinquish voting control. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 9-2 Types of Common Stock QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.09.02 - Types of Common Stock NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Classified stock KEYWORDS: Bloom's: Remember DATE CREATED: 9/21/2017 5:25 PM DATE MODIFIED: 11/8/2017 2:04 PM 5. Founders' shares, a type of classified stock owned by the firm's founders, generally have more votes per share than the other classes of common stock. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 9-2 Types of Common Stock QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.09.02 - Types of Common Stock NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Founders' shares KEYWORDS: Bloom's: Remember DATE CREATED: 9/21/2017 5:25 PM DATE MODIFIED: 11/8/2017 1:47 PM 6. The total return on a share of stock refers to the dividend yield less any commissions paid when the stock is purchased Copyright Cengage Learning. Powered by Cognero.
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and sold. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 9-4 The Discounted Dividend Model QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.09.04 - The Discounted Dividend Model NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Total stock returns KEYWORDS: Bloom's: Remember DATE CREATED: 9/21/2017 5:25 PM DATE MODIFIED: 11/8/2017 1:47 PM 7. The cash flows associated with common stock are more difficult to estimate than those related to bonds because stock has a residual claim against the company versus a contractual obligation for a bond. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 9-4 The Discounted Dividend Model QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.09.04 - The Discounted Dividend Model NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Common stock cash flows KEYWORDS: Bloom's: Understand DATE CREATED: 9/21/2017 5:25 PM DATE MODIFIED: 11/8/2017 1:48 PM 8. According to the basic DCF stock valuation model, the value an investor should assign to a share of stock is dependent on the length of time he or she plans to hold the stock. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 9-4 The Discounted Dividend Model QUESTION TYPE: True / False Copyright Cengage Learning. Powered by Cognero.
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HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.09.04 - The Discounted Dividend Model NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Stock valuation KEYWORDS: Bloom's: Remember DATE CREATED: 9/21/2017 5:25 PM DATE MODIFIED: 11/8/2017 1:48 PM 9. When a new issue of stock is brought to market, the marginal investor determines the price at which the stock will trade. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 9-4 The Discounted Dividend Model QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.09.04 - The Discounted Dividend Model NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Marginal investor and price KEYWORDS: Bloom's: Remember DATE CREATED: 9/21/2017 5:25 PM DATE MODIFIED: 11/8/2017 1:48 PM 10. The constant growth DCF model used to evaluate the prices of common stocks is conceptually similar to the model used to find the price of perpetual preferred stock or other perpetuities. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 9-5 Constant Growth Stocks QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.09.05 - Constant Growth Stocks NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Constant growth model KEYWORDS: Bloom's: Understand Copyright Cengage Learning. Powered by Cognero.
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DATE CREATED: DATE MODIFIED:
9/21/2017 5:25 PM 11/8/2017 1:49 PM
11. According to the nonconstant growth model discussed in the textbook, the discount rate used to find the present value of the expected cash flows during the initial growth period is the same as the discount rate used to find the PVs of cash flows during the subsequent constant growth period. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 9-6 Valuing Nonconstant Growth Stocks QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.09.06 - Valuing Nonconstant Growth Stocks NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Nonconstant growth model KEYWORDS: Bloom's: Understand DATE CREATED: 9/21/2017 5:25 PM DATE MODIFIED: 11/8/2017 1:50 PM 12. The corporate valuation model can be used only when a company doesn't pay dividends. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 9-7 Enterprise-Based Approach to Valuation QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.09.07 - Enterprise-Based Approach to Valuation NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Corporate valuation model KEYWORDS: Bloom's: Understand DATE CREATED: 9/21/2017 5:25 PM DATE MODIFIED: 11/8/2017 1:50 PM 13. The corporate valuation model cannot be used unless a company pays dividends. a. True b. False ANSWER: False POINTS: 1 Copyright Cengage Learning. Powered by Cognero.
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DIFFICULTY: EASY REFERENCES: 9-7 Enterprise-Based Approach to Valuation QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.09.07 - Enterprise-Based Approach to Valuation NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Corporate valuation model KEYWORDS: Bloom's: Understand DATE CREATED: 9/21/2017 5:25 PM DATE MODIFIED: 11/8/2017 1:51 PM 14. Projected free cash flows should be discounted at the firm's weighted average cost of capital to find the firm’s total corporate value. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 9-7 Enterprise-Based Approach to Valuation QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.09.07 - Enterprise-Based Approach to Valuation NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Free cash flows and valuation KEYWORDS: Bloom's: Remember DATE CREATED: 9/21/2017 5:25 PM DATE MODIFIED: 11/8/2017 1:51 PM 15. Preferred stock is a hybrid—a cross between a common stock and a bond—in the sense that it pays dividends that normally increase annually (like a stock), but its payments are contractually guaranteed (like interest on a bond). a. True b. False ANSWER: False RATIONALE: Preferred dividends don't normally grow, and they are not guaranteed. POINTS: 1 DIFFICULTY: EASY REFERENCES: 9-8 Preferred Stock QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.09.08 - Preferred Stock NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking Copyright Cengage Learning. Powered by Cognero.
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STATE STANDARDS: LOCAL STANDARDS: TOPICS: KEYWORDS: DATE CREATED: DATE MODIFIED:
United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds United States - OH - Default City - Tier 2: - Capital structure Preferred stock Bloom's: Remember 9/21/2017 5:25 PM 11/8/2017 1:52 PM
16. From an investor's perspective, a firm's preferred stock is generally considered to be less risky than its common stock but more risky than its bonds. However, from a corporate issuer's standpoint, these risk relationships are reversed: bonds are the most risky for the firm, preferred is next, and common is least risky. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 9-8 Preferred Stock QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.09.08 - Preferred Stock NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Preferred stock KEYWORDS: Bloom's: Understand DATE CREATED: 9/21/2017 5:25 PM DATE MODIFIED: 11/8/2017 1:52 PM 17. If a stock's expected return as seen by the marginal investor exceeds his or her required return, then the investor will buy the stock until its price has risen enough to bring the expected return down to equal the required return. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 9A Stock Market Equilibrium QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.09.09A - Stock Market Equilibrium NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds TOPICS: Stock market equilibrium KEYWORDS: Bloom's: Understand DATE CREATED: 9/21/2017 5:25 PM DATE MODIFIED: 11/8/2017 1:53 PM 18. If a stock's market price exceeds its intrinsic value as seen by the marginal investor, then the investor will sell the Copyright Cengage Learning. Powered by Cognero.
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stock until its price has fallen down to the level of the investor's estimate of the intrinsic value. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 9A Stock Market Equilibrium QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.09.09A - Stock Market Equilibrium NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds TOPICS: Stock market equilibrium KEYWORDS: Bloom's: Understand DATE CREATED: 9/21/2017 5:25 PM DATE MODIFIED: 11/8/2017 1:53 PM 19. For a stock to be in equilibrium, two conditions are necessary: (1) The stock's market price must equal its intrinsic value as seen by the marginal investor, and (2) the expected return as seen by the marginal investor must equal his or her required return. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 9A Stock Market Equilibrium QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.09.09A - Stock Market Equilibrium NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds TOPICS: Stock market equilibrium KEYWORDS: Bloom’s: Remember DATE CREATED: 9/21/2017 5:25 PM DATE MODIFIED: 11/8/2017 1:54 PM 20. Two conditions are used to determine whether a stock is in equilibrium: (1) Does the stock's market price equal its intrinsic value as seen by the marginal investor, and (2) does the expected return on the stock as seen by the marginal investor equal his or her required return? If either of these conditions, but not necessarily both, holds, then the stock is said to be in equilibrium. a. True b. False ANSWER: False RATIONALE: If one condition holds, then the other must also hold. POINTS: 1 DIFFICULTY: EASY Copyright Cengage Learning. Powered by Cognero.
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REFERENCES: 9A Stock Market Equilibrium QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.09.09A - Stock Market Equilibrium NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds TOPICS: Stock market equilibrium KEYWORDS: Bloom’s: Remember DATE CREATED: 9/21/2017 5:25 PM DATE MODIFIED: 11/8/2017 1:55 PM 21. Which of the following statements is CORRECT? a. The constant growth model is often appropriate for evaluating start-up companies that do not have a stable history of growth but are expected to reach stable growth within the next few years. b. If a stock has a required rate of return rs = 12% and its dividend is expected to grow at a constant rate of 5%, then the stock’s dividend yield is also 5%. c. The stock valuation model, P0 = D1/(rs - g), can be used to value firms whose dividends are expected to decline at a constant rate, i.e., to grow at a negative rate. d. The price of a stock is the present value of all expected future dividends, discounted at the dividend growth rate. e. The constant growth model cannot be used for a zero growth stock, wherein the dividend is expected to remain constant over time. ANSWER: c POINTS: 1 DIFFICULTY: EASY REFERENCES: 9-5 Constant Growth Stocks QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.09.05 - Constant Growth Stocks NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Constant growth model KEYWORDS: Bloom's: Remember OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:25 PM DATE MODIFIED: 11/8/2017 1:56 PM 22. An increase in a firm’s expected growth rate would cause its required rate of return to a. increase. b. decrease. c. fluctuate less than before. d. fluctuate more than before. e. possibly increase, possibly decrease, or possibly remain constant. ANSWER: e POINTS: 1 Copyright Cengage Learning. Powered by Cognero.
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DIFFICULTY: EASY REFERENCES: 9-5 Constant Growth Stocks QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.09.05 - Constant Growth Stocks NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Required return KEYWORDS: Bloom's: Understand OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:25 PM DATE MODIFIED: 11/8/2017 1:57 PM 23. If a given investor believes that a stock’s expected return exceeds its required return, then the investor most likely believes that a. the stock is experiencing supernormal growth. b. the stock should be sold. c. the stock is a good buy. d. management is probably not trying to maximize the price per share. e. dividends are not likely to be declared. ANSWER: c POINTS: 1 DIFFICULTY: EASY REFERENCES: 9-5 Constant Growth Stocks QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.09.05 - Constant Growth Stocks NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Required return KEYWORDS: Bloom's: Understand OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:25 PM DATE MODIFIED: 11/8/2017 1:57 PM 24. The preemptive right is important to shareholders because it a. allows managers to buy additional shares below the current market price. b. will result in higher dividends per share. c. is included in every corporate charter. d. protects the current shareholders against a dilution of their ownership interests. e. protects bondholders and thus enables the firm to issue debt with a relatively low interest rate. ANSWER: d POINTS: 1 Copyright Cengage Learning. Powered by Cognero.
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DIFFICULTY: MODERATE REFERENCES: 9-1 Legal Rights and Privileges of Common Stockholders QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.09.01 - Legal Rights and Privileges of Common Stockholders NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Preemptive right KEYWORDS: Bloom's: Understand OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:25 PM DATE MODIFIED: 11/8/2017 1:58 PM 25. If markets are in equilibrium, which of the following conditions will exist? a. Each stock's expected return should equal its realized return as seen by the marginal investor. b. Each stock's expected return should equal its required return as seen by the marginal investor. c. All stocks should have the same expected return as seen by the marginal investor. d. The expected and required returns on stocks and bonds should be equal. e. All stocks should have the same realized return during the coming year. ANSWER: b RATIONALE: Statement b is true, because if the expected return does not equal the required return, then markets are not in equilibrium and buying/selling will occur until the expected return equals the required return. POINTS: 1 DIFFICULTY: EASY REFERENCES: 9A Stock Market Equilibrium QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.09.09A - Stock Market Equilibrium NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds TOPICS: Market equilibrium KEYWORDS: Bloom's: Understand OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:25 PM DATE MODIFIED: 11/8/2017 1:59 PM 26. Companies can issue different classes of common stock. Which of the following statements concerning stock classes is CORRECT? a. All common stocks fall into one of three classes: A, B, and C. b. All common stocks, regardless of class, must have the same voting rights. c. All firms have several classes of common stock. d. All common stock, regardless of class, must pay the same dividend. e. Some class or classes of common stock are entitled to more votes per share than other classes. ANSWER: e Copyright Cengage Learning. Powered by Cognero.
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POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 9-2 Types of Common Stock QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.09.02 - Types of Common Stock NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Classified stock KEYWORDS: Bloom's: Remember OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:25 PM DATE MODIFIED: 11/8/2017 1:59 PM 27. Stocks A and B have the following data. Assuming the stock market is efficient and the stocks are in equilibrium, which of the following statements is CORRECT?
Required return Market price Expected growth
A 10% $25 7%
B 12% $40 9%
a. These two stocks should have the same price. b. These two stocks must have the same dividend yield. c. These two stocks should have the same expected return. d. These two stocks must have the same expected capital gains yield. e. These two stocks must have the same expected year-end dividend. ANSWER: b RATIONALE: The following calculations show that answer b is correct. All the others are wrong. A B Expected return
10%
12%
Expected growth
7%
9%
Dividend yield
3%
3%
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 9-5 Constant Growth Stocks QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.09.05 - Constant Growth Stocks NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Required return KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Conceptual Copyright Cengage Learning. Powered by Cognero.
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DATE CREATED: DATE MODIFIED:
9/21/2017 5:25 PM 11/8/2017 2:00 PM
28. Stocks A and B have the following data. Assuming the stock market is efficient and the stocks are in equilibrium, which of the following statements is CORRECT?
Price Expected growth Expected return
A $25 7% 10%
B $40 9% 12%
a. The two stocks should have the same expected dividend. b. The two stocks could not be in equilibrium with the numbers given in the question. c. A's expected dividend is $0.50. d. B's expected dividend is $0.75. e. A's expected dividend is $0.75 and B's expected dividend is $1.20. ANSWER: e RATIONALE: The following calculations show that answer e is correct. The others are all wrong. A B Price $25 $40 Expected growth 7% 9% Expected return 10% 12% A = P0= D1/(r – g) = D1= P0(r) – P0(g) = $0.75 B = P0= D1/(r – g) = D1= P0(r) – P0(g) = $1.20 POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 9-5 Constant Growth Stocks QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.09.05 - Constant Growth Stocks NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Required return KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:25 PM DATE MODIFIED: 11/8/2017 2:01 PM 29. Stocks A and B have the same price and are in equilibrium, but Stock A has the higher required rate of return. Which of the following statements is CORRECT? a. If Stock A has a lower dividend yield than Stock B, then its expected capital gains yield must be higher than Stock B’s. b. Stock B must have a higher dividend yield than Stock A. c. Stock A must have a higher dividend yield than Stock B. d. If Stock A has a higher dividend yield than Stock B, then its expected capital gains yield must be lower than Stock B’s. e. Stock A must have both a higher dividend yield and a higher capital gains yield than Stock B. Copyright Cengage Learning. Powered by Cognero.
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ANSWER: RATIONALE:
a Statement a is true, because if the required return for Stock A is higher than that of Stock B, and if the dividend yield for Stock A is lower than Stock B’s, the growth rate for Stock A must be higher to offset this. POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 9-5 Constant Growth Stocks QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.09.05 - Constant Growth Stocks NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Dividend yield and g KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:25 PM DATE MODIFIED: 12/14/2017 10:27 AM 30. Two constant growth stocks are in equilibrium, have the same price, and have the same required rate of return. Which of the following statements is CORRECT? a. The two stocks must have the same dividend per share. b. If one stock has a higher dividend yield, then it must also have a lower dividend growth rate. c. If one stock has a higher dividend yield, then it must also have a higher dividend growth rate. d. The two stocks must have the same dividend growth rate. e. The two stocks must have the same dividend yield. ANSWER: b POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 9-5 Constant Growth Stocks QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.09.05 - Constant Growth Stocks NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Dividend yield and g KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:25 PM DATE MODIFIED: 11/8/2017 2:02 PM 31. Which of the following statements is CORRECT, assuming stocks are in equilibrium? a. The dividend yield on a constant growth stock must equal its expected total return minus its expected capital gains yield. b. Assume that the required return on a given stock is 13%. If the stock’s dividend is growing at a constant rate Copyright Cengage Learning. Powered by Cognero.
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of 5%, then its expected dividend yield is 5% as well. c. A stock’s dividend yield can never exceed its expected growth rate. d. A required condition for one to use the constant growth model is that the stock’s expected growth rate exceed its required rate of return. e. Other things held constant, the higher a company’s beta coefficient, the lower its required rate of return. ANSWER: a POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 9-5 Constant Growth Stocks QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.09.05 - Constant Growth Stocks NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Dividend yield and g KEYWORDS: Bloom's: Understand OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:25 PM DATE MODIFIED: 11/6/2017 6:19 PM 32. A stock is expected to pay a year-end dividend of $2.00, i.e., D1 = $2.00. The dividend is expected to decline at a rate of 5% a year forever (g = -5%). If the company is in equilibrium and its expected and required rate of return is 15%, then which of the following statements is CORRECT? a. The company’s current stock price is $20. b. The company’s dividend yield 5 years from now is expected to be 10%. c. The constant growth model cannot be used because the growth rate is negative. d. The company’s expected capital gains yield is 5%. e. The company’s expected stock price at the beginning of next year is $9.50. ANSWER: e RATIONALE: Note that P0 = $2/(0.15 + 0.05) = $10. That price is expected to decline by 5% each year, so P1 must be $10(0.95) = $9.50. Therefore, answer e is correct, while all the others are false. POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 9-5 Constant Growth Stocks QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.09.05 - Constant Growth Stocks NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Declining constant growth KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:25 PM Copyright Cengage Learning. Powered by Cognero.
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DATE MODIFIED:
11/8/2017 2:07 PM
33. Which of the following statements is CORRECT? a. The constant growth model takes into consideration the capital gains investors expect to earn on a stock. b. Two firms with the same expected dividend and growth rate must also have the same stock price. c. It is appropriate to use the constant growth model to estimate a stock's value even if its growth rate is never expected to become constant. d. If a stock has a required rate of return rs = 12%, and if its dividend is expected to grow at a constant rate of 5%, then the stock’s dividend yield is also 5%. e. The price of a stock is the present value of all expected future dividends, discounted at the dividend growth rate. ANSWER: a RATIONALE: Statement a is true, because the expected growth rate is also the expected capital gains yield. All the other statements are false. POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 9-5 Constant Growth Stocks QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.09.05 - Constant Growth Stocks NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Constant growth model KEYWORDS: Bloom's: Understand OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:25 PM DATE MODIFIED: 11/6/2017 6:19 PM 34. If a stock’s dividend is expected to grow at a constant rate of 5% a year, then which of the following statements is CORRECT? The stock is in equilibrium. a. The expected return on the stock is 5% a year. b. The stock’s dividend yield is 5%. c. The price of the stock is expected to decline in the future. d. The stock’s required return must be equal to or less than 5%. e. The stock’s price one year from now is expected to be 5% above the current price. ANSWER: e RATIONALE: Statement e is true, because the stock price is expected to grow at the dividend growth rate. POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 9-5 Constant Growth Stocks QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.09.05 - Constant Growth Stocks NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds Copyright Cengage Learning. Powered by Cognero.
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LOCAL STANDARDS: TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
United States - OH - Default City - Tier 2: - Capital structure Constant growth model Bloom's: Understand Multiple Choice: Conceptual 9/21/2017 5:25 PM 11/6/2017 6:19 PM
35. Stocks A and B have the following data. Assuming the stock market is efficient and the stocks are in equilibrium, which of the following statements is CORRECT?
Price Expected growth (constant) Required return
A $25 10% 15%
B $25 5% 15%
a. Stock A's expected dividend at t = 1 is only half that of Stock B. b. Stock A has a higher dividend yield than Stock B. c. Currently the two stocks have the same price, but over time Stock B's price will pass that of A. d. Since Stock A’s growth rate is twice that of Stock B, Stock A’s future dividends will always be twice as high as Stock B’s. e. The two stocks should not sell at the same price. If their prices are equal, then a disequilibrium must exist. ANSWER: a RATIONALE: Statement a is correct, because if both stocks have the same price and the same required return, and A’s growth rate is twice that of B, then A’s dividend and dividend yield must be half that of B. This point is illustrated with the following example. A B Price $25 $25 g 10% 5% r 15% 15% Div. Yield = r - g = 5% 10% $1.25 $2.50 D1= P(Div Yield) = POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 9-5 Constant Growth Stocks QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.09.05 - Constant Growth Stocks NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Constant growth model KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:25 PM DATE MODIFIED: 11/6/2017 6:19 PM 36. Stocks X and Y have the following data. Assuming the stock market is efficient and the stocks are in equilibrium, which of the following statements is CORRECT? Copyright Cengage Learning. Powered by Cognero.
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X $30 6% 12%
Price Expected growth (constant) Required return
Y $30 4% 10%
a. Stock X has a higher dividend yield than Stock Y. b. Stock Y has a higher dividend yield than Stock X. c. One year from now, Stock X’s price is expected to be higher than Stock Y’s price. d. Stock X has the higher expected year-end dividend. e. Stock Y has a higher capital gains yield. ANSWER: c RATIONALE: The correct answer is statement c. Both prices are currently the same, but X's price should grow at 6% vs. 4% for Y, so X's price should be higher a year from now. POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 9-5 Constant Growth Stocks QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.09.05 - Constant Growth Stocks NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Constant growth model KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:25 PM DATE MODIFIED: 11/6/2017 6:19 PM 37. Stock X has the following data. Assuming the stock market is efficient and the stock is in equilibrium, which of the following statements is CORRECT? Expected dividend, D1 Current Price, P0 Expected constant growth rate
$3.00 $50 6.0%
a. The stock’s required return is 10%. b. The stock’s expected dividend yield and growth rate are equal. c. The stock’s expected dividend yield is 5%. d. The stock’s expected capital gains yield is 5%. e. The stock’s expected price 10 years from now is $100.00. ANSWER: b RATIONALE: The correct answer choice is b. One could quickly calculate the dividend yield and see that it equals the growth rate, but here are some numbers that provide more information. $3.00 6.0% D1 D1/P0 $50.00 12.0% P0 rX POINTS: DIFFICULTY:
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REFERENCES: 9-5 Constant Growth Stocks QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.09.05 - Constant Growth Stocks NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Constant growth model KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:25 PM DATE MODIFIED: 11/6/2017 6:19 PM 38. Stocks X and Y have the following data. Assuming the stock market is efficient and the stocks are in equilibrium, which of the following statements is CORRECT?
Price Expected dividend yield Required return
X $25 5% 12%
Y $25 3% 10%
a. Stock Y pays a higher dividend per share than Stock X. b. Stock X pays a higher dividend per share than Stock Y. c. One year from now, Stock X should have the higher price. d. Stock Y has a lower expected growth rate than Stock X. e. Stock Y has the higher expected capital gains yield. ANSWER: b RATIONALE: Dividend = Yield × Price: X Dividend = $1.25 Y dividend = $0.75 Stock X has a dividend yield of 5% versus a dividend yield of 3% for Y. Since they both have the same stock price, X must pay a higher dividend. POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 9-5 Constant Growth Stocks QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.09.05 - Constant Growth Stocks NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Constant growth model KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:25 PM DATE MODIFIED: 11/6/2017 6:19 PM 39. The expected return on Natter Corporation’s stock is 14%. The stock’s dividend is expected to grow at a constant rate of 8%, and it currently sells for $50 a share. Which of the following statements is CORRECT? Copyright Cengage Learning. Powered by Cognero.
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a. The stock’s dividend yield is 7%. b. The stock’s dividend yield is 8%. c. The current dividend per share is $4.00. d. The stock price is expected to be $54 a share one year from now. e. The stock price is expected to be $57 a share one year from now. ANSWER: d RATIONALE: P1 = P0(1 + g) = $54. Therefore, d is correct. All the other answers are false. P1 = $54.00 POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 9-5 Constant Growth Stocks QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.09.05 - Constant Growth Stocks NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Constant growth model KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:25 PM DATE MODIFIED: 11/6/2017 6:19 PM 40. Stocks A and B have the following data. The market risk premium is 6.0% and the risk-free rate is 6.4%. Assuming the stock market is efficient and the stocks are in equilibrium, which of the following statements is CORRECT?
Beta Constant growth rate
A 1.10 7.00%
B 0.90 7.00%
a. Stock A must have a higher stock price than Stock B. b. Stock A must have a higher dividend yield than Stock B. c. Stock B’s dividend yield equals its expected dividend growth rate. d. Stock B must have the higher required return. e. Stock B could have the higher expected return. ANSWER: b RATIONALE: Statement b is true, because Stock A has a higher required return but the stocks have the same growth rate, so Stock A must have the higher dividend yield. Here are some calculations to demonstrate the point. beta rRF RPM rStock A 6.40% + 1.10 × 6.00% = 13.00% B 6.40% + 0.90 × 6.00% = 11.80% Div Yld g rStock A D1/P0 + 7.00% = 13.00% D1/P0= r - g = 6.00% B D1/P0 + 7.00% = 11.80% D1/P0= r - g = 4.80% POINTS: DIFFICULTY:
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REFERENCES: 9-5 Constant Growth Stocks QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.09.05 - Constant Growth Stocks NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Constant growth model and CAPM KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:25 PM DATE MODIFIED: 11/6/2017 6:19 PM 41. Which of the following statements is NOT CORRECT? a. The corporate valuation model can be used both for companies that pay dividends and those that do not pay dividends. b. The corporate valuation model discounts free cash flows by the required return on equity. c. The corporate valuation model can be used to find the value of a division. d. An important step in applying the corporate valuation model is forecasting the firm's pro forma financial statements. e. Free cash flows are assumed to grow at a constant rate beyond a specified date in order to find the horizon, or continuing, value. ANSWER: b POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 9-7 Enterprise-Based Approach to Valuation QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.09.07 - Enterprise-Based Approach to Valuation NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Corporate valuation model KEYWORDS: Bloom's: Remember OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:25 PM DATE MODIFIED: 11/7/2017 5:15 PM 42. Which of the following statements is CORRECT? a. To implement the corporate valuation model, we discount projected free cash flows at the weighted average cost of capital. b. To implement the corporate valuation model, we discount net operating profit after taxes (NOPAT) at the weighted average cost of capital. c. To implement the corporate valuation model, we discount projected net income at the weighted average cost of capital. d. To implement the corporate valuation model, we discount projected free cash flows at the cost of equity Copyright Cengage Learning. Powered by Cognero.
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capital. e. The corporate valuation model requires the assumption of a constant growth rate in all years. ANSWER: a POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 9-7 Enterprise-Based Approach to Valuation QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.09.07 - Enterprise-Based Approach to Valuation NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Corporate valuation model KEYWORDS: Bloom's: Remember OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:25 PM DATE MODIFIED: 11/6/2017 6:19 PM 43. Which of the following statements is CORRECT? a. Preferred stockholders have a priority over bondholders to the income in the event of a bankruptcy, but not to the proceeds in the event of a liquidation. b. The preferred stock of a given firm is generally less risky to investors than the same firm’s common stock. c. Corporations cannot buy the preferred stocks of other corporations. d. Preferred dividends are not generally cumulative. e. A big advantage of preferred stock is that dividends on preferred stocks are tax deductible by the issuing corporation. ANSWER: b POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 9-8 Preferred Stock QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.09.08 - Preferred Stock NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Preferred stock concepts KEYWORDS: Bloom's: Remember OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:25 PM DATE MODIFIED: 11/6/2017 6:19 PM 44. Which of the following statements is CORRECT? a. A major disadvantage of financing with preferred stock is that preferred stockholders typically have supernormal voting rights. b. Preferred stock is normally expected to provide steadier, more reliable income to investors than the same Copyright Cengage Learning. Powered by Cognero.
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firm’s common stock. As a result, the expected after-tax yield on the preferred is lower than the after-tax expected return on the common stock. c. The preemptive right is a provision in all corporate charters that gives preferred stockholders the right to purchase (on a pro rata basis) new issues of preferred stock. d. One of the disadvantages to a corporation of owning preferred stock is that 70% of the dividends received represent taxable income to the corporate recipient, whereas interest income earned on bonds is tax free. e. One of the advantages to financing with preferred stock is that 70% of the dividends paid out are tax deductible to the issuer. ANSWER: b POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 9-8 Preferred Stock QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.09.08 - Preferred Stock NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Preferred stock concepts KEYWORDS: Bloom's: Understand OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:25 PM DATE MODIFIED: 11/6/2017 6:19 PM 45. For a stock to be in equilibrium—that is, for there to be no long-term pressure for its price to change—the a. expected future return must be less than the most recent past realized return. b. past realized return must be equal to the expected return during the same period. c. required return must equal the realized return in all periods. d. expected return must be equal to both the required future return and the past realized return. e. expected future return must be equal to the required return. ANSWER: e POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 9A Stock Market Equilibrium QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.09.09A - Stock Market Equilibrium NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds TOPICS: Market equilibrium KEYWORDS: Bloom's: Understand OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:25 PM DATE MODIFIED: 11/6/2017 6:19 PM 46. Which of the following statements is CORRECT? Copyright Cengage Learning. Powered by Cognero.
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a. If a company has two classes of common stock, Class A and Class B, then the stocks may pay different dividends, but under all state charters the two classes must have the same voting rights. b. The preemptive right gives stockholders the right to approve or disapprove of a merger between their company and some other company. c. The preemptive right is a provision in the corporate charter that gives common stockholders the right to purchase (on a pro rata basis) new issues of the firm's common stock. d. The stock valuation model, P0 = D1/(rs - g), cannot be used for firms that have negative growth rates. e. The stock valuation model, P0 = D1/(rs - g), can be used only for firms whose growth rates exceed their required returns. ANSWER: c RATIONALE: Statement a is false--a number of companies have different classes of stock with different voting rights. Statement b is simply false. Statement c is true. Statements d and e are false, because the constant growth model can be used anytime as long as the constant growth rate is less than the required return (even if the growth rate is negative). POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.09.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Common stock concepts KEYWORDS: Bloom's: Remember OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:25 PM DATE MODIFIED: 11/6/2017 6:19 PM 47. The required returns of Stocks X and Y are rX = 10% and rY = 12%. Which of the following statements is CORRECT? a. If the market is in equilibrium, and if Stock Y has the lower expected dividend yield, then it must have the higher expected growth rate. b. If Stock Y and Stock X have the same dividend yield, then Stock Y must have a lower expected capital gains yield than Stock X. c. If Stock X and Stock Y have the same current dividend and the same expected dividend growth rate, then Stock Y must sell for a higher price. d. The stocks must sell for the same price. e. Stock Y must have a higher dividend yield than Stock X. ANSWER: a RATIONALE: Since X has the lower required return, if Y has a lower dividend yield it must have a higher expected growth rate. POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice Copyright Cengage Learning. Powered by Cognero.
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HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.09.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Common stock concepts KEYWORDS: Bloom's: Understand OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:25 PM DATE MODIFIED: 11/7/2017 5:16 PM 48. A stock is expected to pay a dividend of $0.75 at the end of the year. The required rate of return is rs = 10.5%, and the expected constant growth rate is g = 8.2%. What is the stock's current price? a. $27.39 b. $29.02 c. $32.61 d. $38.80 e. $27.07 ANSWER: c RATIONALE: $0.75 D 1
10.5% rS g 8.2% P0 = D1/(rS - g) $32.61 POINTS: 1 DIFFICULTY: EASY REFERENCES: 9-5 Constant Growth Stocks QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.09.05 - Constant Growth Stocks NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Constant growth valuation KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:25 PM DATE MODIFIED: 11/6/2017 6:19 PM 49. A stock just paid a dividend of D0 = $1.50. The required rate of return is rs = 14.1%, and the constant growth rate is g = 4.0%. What is the current stock price? a. $19.15 b. $12.97 c. $12.82 d. $18.84 e. $15.45 Copyright Cengage Learning. Powered by Cognero.
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ANSWER: RATIONALE:
e
$1.50 D0 14.1% rS g 4.0% D1 = D0(1 + g) = $1.56 $15.45 P0 = D1/(rs - g) POINTS: 1 DIFFICULTY: EASY REFERENCES: 9-5 Constant Growth Stocks QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.09.05 - Constant Growth Stocks NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Constant growth valuation KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:25 PM DATE MODIFIED: 12/14/2017 12:10 PM 50. A share of common stock just paid a dividend of $1.00. If the expected long-run growth rate for this stock is 5.4%, and if investors' required rate of return is 14.2%, then what is the stock price? a. $12.70 b. $11.98 c. $14.61 d. $10.66 e. $12.10 ANSWER: b RATIONALE: $1.00 Last dividend (D0) Long-run growth rate 5.4% Required return 14.2% $1.054 D1 = D0(1 + g) = $11.98 P0 = D1/(rs - g) POINTS: 1 DIFFICULTY: EASY REFERENCES: 9-5 Constant Growth Stocks QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.09.05 - Constant Growth Stocks NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Constant growth valuation KEYWORDS: Bloom's: Analyze Copyright Cengage Learning. Powered by Cognero.
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OTHER: DATE CREATED: DATE MODIFIED:
Multiple Choice: Problem 9/21/2017 5:25 PM 12/14/2017 12:13 PM
51. If D1 = $1.25, g (which is constant) = 4.7%, and P0 = $22.00, then what is the stock’s expected dividend yield for the coming year? a. 5.40% b. 6.25% c. 5.68% d. 6.08% e. 4.26% ANSWER: c RATIONALE: $1.25 D1 g 4.7% $22.00 P0 5.68% Dividend yield = D1/P0 = POINTS: 1 DIFFICULTY: EASY REFERENCES: 9-5 Constant Growth Stocks QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.09.05 - Constant Growth Stocks NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Expected dividend yield KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:25 PM DATE MODIFIED: 11/6/2017 6:19 PM 52. If D0 = $2.25, g (which is constant) = 3.5%, and P0 = $54, then what is the stock’s expected dividend yield for the coming year? a. 4.23% b. 3.45% c. 3.75% d. 4.31% e. 5.05% ANSWER: d RATIONALE: $2.25 D0 g 3.5% $54.00 P0 $2.329 D1 = D0(1 + g) = 4.31% Dividend yield = D1/P0 = POINTS: 1 Copyright Cengage Learning. Powered by Cognero.
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DIFFICULTY: EASY REFERENCES: 9-5 Constant Growth Stocks QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.09.05 - Constant Growth Stocks NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Expected dividend yield KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:25 PM DATE MODIFIED: 11/6/2017 6:19 PM 53. If D1 = $1.50, g (which is constant) = 2.1%, and P0 = $56, then what is the stock’s expected capital gains yield for the coming year? a. 2.50% b. 2.39% c. 2.08% d. 2.10% e. 1.66% ANSWER: d RATIONALE: $1.50 D1 g 2.1% $56.00 P0 Capital gains yield = g = 2.10% POINTS: 1 DIFFICULTY: EASY REFERENCES: 9-5 Constant Growth Stocks QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.09.05 - Constant Growth Stocks NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Expected cap. gains yield KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:25 PM DATE MODIFIED: 11/8/2017 2:10 PM 54. If D1 = $1.25, g (which is constant) = 5.5%, and P0 = $40, then what is the stock’s expected total return for the coming year? a. 8.80% b. 10.09% Copyright Cengage Learning. Powered by Cognero.
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c. 6.47% d. 10.35% e. 8.63% ANSWER: RATIONALE:
e
$1.25 D1 g 5.5% $40.00 P0 Total return = rs = D1/P0 + g 8.63% POINTS: 1 DIFFICULTY: EASY REFERENCES: 9-5 Constant Growth Stocks QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.09.05 - Constant Growth Stocks NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Expected total return KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:25 PM DATE MODIFIED: 12/14/2017 12:19 PM 55. If D0 = $1.75, g (which is constant) = 3.6%, and P0 = $40.00, then what is the stock’s expected total return for the coming year? a. 6.42% b. 8.13% c. 9.92% d. 7.64% e. 7.48% ANSWER: b RATIONALE: $1.75 D0 g 3.6% $40.00 P0 $1.81 D1 = D0(1 + g) = Total return = rs = D1/P0 + g 8.13% POINTS: 1 DIFFICULTY: EASY REFERENCES: 9-5 Constant Growth Stocks QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.09.05 - Constant Growth Stocks NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds Copyright Cengage Learning. Powered by Cognero.
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LOCAL STANDARDS: TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
United States - OH - Default City - Tier 2: - Capital structure Expected total return Bloom's: Analyze Multiple Choice: Problem 9/21/2017 5:25 PM 12/14/2017 12:22 PM
56. Gray Manufacturing is expected to pay a dividend of $1.25 per share at the end of the year (D1 = $1.25). The stock sells for $27.50 per share, and its required rate of return is 10.5%. The dividend is expected to grow at some constant rate, g, forever. What is the equilibrium expected growth rate? a. 6.01% b. 5.54% c. 6.07% d. 6.91% e. 5.95% ANSWER: e RATIONALE: $1.25 Expected dividend (D1) Stock price $27.50 Required return 10.5% Dividend yield 4.55% Growth rate = rs - D1/P0 = 5.95% POINTS: 1 DIFFICULTY: EASY REFERENCES: 9-5 Constant Growth Stocks QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.09.05 - Constant Growth Stocks NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Constant growth rate KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:25 PM DATE MODIFIED: 12/14/2017 12:24 PM 57. Reddick Enterprises' stock currently sells for $24.50 per share. The dividend is projected to increase at a constant rate of 5.50% per year. The required rate of return on the stock, rs, is 9.00%. What is the stock's expected price 3 years from today? a. $31.65 b. $24.45 c. $28.77 d. $33.66 e. $26.76 ANSWER: c RATIONALE: Stock price $24.50 Copyright Cengage Learning. Powered by Cognero.
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Growth rate 5.50% Years in the future 3 3 P3 = P0(1 + g) = $28.77 POINTS: 1 DIFFICULTY: EASY REFERENCES: 9-5 Constant Growth Stocks QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.09.05 - Constant Growth Stocks NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Constant growth: future price KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:25 PM DATE MODIFIED: 12/15/2017 9:27 AM 58. Whited Inc.'s stock currently sells for $35.25 per share. The dividend is projected to increase at a constant rate of 5.25% per year. The required rate of return on the stock, rs, is 11.50%. What is the stock's expected price 5 years from now? a. $45.53 b. $52.81 c. $40.06 d. $39.15 e. $47.80 ANSWER: a RATIONALE: Growth rate 5.25%
Years in the future 5 Stock price $35.25 5 P5 = P0(1 + g) = $45.53 POINTS: 1 DIFFICULTY: EASY REFERENCES: 9-5 Constant Growth Stocks QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.09.05 - Constant Growth Stocks NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Constant growth: future price KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:25 PM DATE MODIFIED: 11/6/2017 6:19 PM Copyright Cengage Learning. Powered by Cognero.
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59. Mooradian Corporation’s free cash flow during the just-ended year (t = 0) was $250 million, and its FCF is expected to grow at a constant rate of 5.0% in the future. Assume the firm has zero non-operating assets. If the weighted average cost of capital is 12.5%, what is the firm’s total corporate value, in millions? a. $3,500 b. $2,695 c. $3,255 d. $4,130 e. $3,850 ANSWER: a RATIONALE: $250 FCF0 g 5.0% WACC 12.5% $262.50 FCF1 = FCF0(1 + g) = Total corporate value = FCF1/(WACC – g) = $3,500.00 POINTS: 1 DIFFICULTY: EASY REFERENCES: 9-5 Constant Growth Stocks QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.09.05 - Constant Growth Stocks NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Corporate valuation model KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:25 PM DATE MODIFIED: 12/15/2017 9:36 AM 60. Suppose Boyson Corporation’s projected free cash flow for next year is FCF1 = $100,000, and FCF is expected to grow at a constant rate of 6.5%. Assume the firm has zero non-operating assets. If the company’s weighted average cost of capital is 11.5%, then what is the firm’s total corporate value? a. $1,560,000 b. $1,900,000 c. $2,000,000 d. $1,980,000 e. $1,920,000 ANSWER: c RATIONALE: $100,000 FCF1 g 6.50% WACC 11.50% $2,000,000 Total corporate value = FCF1/(WACC – g) = POINTS: 1 DIFFICULTY: EASY REFERENCES: 9-7 Enterprise-Based Approach to Valuation Copyright Cengage Learning. Powered by Cognero.
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QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.09.07 - Enterprise-Based Approach to Valuation NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Corporate valuation model KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:25 PM DATE MODIFIED: 12/15/2017 9:40 AM 61. Molen Inc. has an outstanding issue of perpetual preferred stock with an annual dividend of $2.00 per share. If the required return on this preferred stock is 6.5%, then at what price should the stock sell? a. $30.77 b. $32.92 c. $38.15 d. $23.38 e. $27.38 ANSWER: a RATIONALE: Preferred dividend $2.00 Required return 6.5% $30.77 Preferred price = DP/rP = POINTS: 1 DIFFICULTY: EASY REFERENCES: 9-8 Preferred Stock QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.09.08 - Preferred Stock NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Preferred stock valuation KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:25 PM DATE MODIFIED: 11/6/2017 6:19 PM 62. The Francis Company is expected to pay a dividend of D1 = $1.25 per share at the end of the year, and that dividend is expected to grow at a constant rate of 6.00% per year in the future. The company's beta is 1.70, the market risk premium is 5.50%, and the risk-free rate is 4.00%. What is the company's current stock price? Do not round intermediate calculations. a. $13.44 b. $12.93 c. $17.01 d. $14.80 Copyright Cengage Learning. Powered by Cognero.
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e. $18.03 ANSWER: RATIONALE:
c
$1.25 D1 b 1.70 4.00% rRF 5.50% RPM g 6.00% 13.35% rs = rRF + b(RPM) = $17.01 P0 = D1/(rs - g) POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 9-5 Constant Growth Stocks QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.09.05 - Constant Growth Stocks NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Constant growth valuation: CAPM KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:25 PM DATE MODIFIED: 12/15/2017 9:54 AM 63. The Isberg Company just paid a dividend of $0.75 per share, and that dividend is expected to grow at a constant rate of 5.50% per year in the future. The company's beta is 1.90, the market risk premium is 5.00%, and the risk-free rate is 4.00%. What is the company's current stock price, P0? Do not round intermediate calculations. a. $10.19 b. $9.89 c. $9.10 d. $7.52 e. $10.98 ANSWER: b RATIONALE: $0.75 D0 b 1.90 4.0% rRF 5.0% RPM g 5.5% $0.7913 D1 = D0(1 + g) = rs = rRF + b(RPM) = 13.50% $9.89 P0 = D1/(rs - g) POINTS: DIFFICULTY: REFERENCES: QUESTION TYPE:
1 MODERATE 9-5 Constant Growth Stocks Multiple Choice
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HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.09.05 - Constant Growth Stocks NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Constant growth valuation: CAPM KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:25 PM DATE MODIFIED: 12/15/2017 9:57 AM 64. Schnusenberg Corporation just paid a dividend of D0 = $0.75 per share, and that dividend is expected to grow at a constant rate of 6.50% per year in the future. The company's beta is 1.70, the required return on the market is 10.50%, and the risk-free rate is 4.50%. What is the company's current stock price? Do not round intermediate calculations. a. $10.52 b. $7.40 c. $7.89 d. $9.74 e. $7.70 ANSWER: d RATIONALE: $0.75 D0 b 1.70 4.5% rRF 10.5% rM g 6.5% $0.7988 D1 = D0(1 + g) = 14.7% rs = rRF + b(rM - rRF) = $9.74 P0 = D1/(rs - g) POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 9-5 Constant Growth Stocks QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.09.05 - Constant Growth Stocks NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Constant growth valuation: CAPM KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:25 PM DATE MODIFIED: 12/15/2017 8:44 PM 65. Goode Inc.'s stock has a required rate of return of 11.50%, and it sells for $29.00 per share. Goode's dividend is Copyright Cengage Learning. Powered by Cognero.
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expected to grow at a constant rate of 7.00%. What was the last dividend, D0? a. $0.95 b. $1.38 c. $1.37 d. $1.22 e. $1.06 ANSWER: d RATIONALE: Stock price $29.00 Required return 11.50% Growth rate 7.00% P0 = D1/(rs - g), so D1 = P0(rs - g) = $1.3050 $1.22 Last dividend = D0 = D1/(1 + g) POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 9-5 Constant Growth Stocks QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.09.05 - Constant Growth Stocks NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Constant growth dividend KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:25 PM DATE MODIFIED: 12/15/2017 8:47 PM 66. Francis Inc.'s stock has a required rate of return of 10.25%, and it sells for $87.50 per share. The dividend is expected to grow at a constant rate of 6.00% per year. What is the expected year-end dividend, D1? a. $3.72 b. $2.79 c. $4.65 d. $3.16 e. $3.90 ANSWER: a RATIONALE: Stock price $87.50 Required return 10.25% Growth rate 6.00% P0 = D1/(rs - g), so D1 = P0(rs - g) $3.72 Expected dividend = D1 = P0(rs - g) = POINTS: DIFFICULTY: REFERENCES: QUESTION TYPE: HAS VARIABLES:
1 MODERATE 9-5 Constant Growth Stocks Multiple Choice True
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LEARNING OBJECTIVES: FOFM.BRIG.17.09.05 - Constant Growth Stocks NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Constant growth dividend KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:25 PM DATE MODIFIED: 12/15/2017 8:50 PM 67. Sorenson Corp.’s expected year-end dividend is D1 = $4.00, its required return is rs = 11.00%, its dividend yield is 6.00%, and its growth rate is expected to be constant in the future. What is Sorenson's expected stock price in 7 years, i.e., what is
? Do not round intermediate calculations.
a. $90.05 b. $85.36 c. $87.24 d. $76.92 e. $93.81 ANSWER: RATIONALE:
e $4.00 Next expected dividend = D1 = Required return 11.0% 6.0% Dividend yield = D1/P0 = Find the growth rate: g = rs - Div yield = 5.0% $66.67 Find P0 = D1/(rs - g) = Years in the future 7 = P0(1 + g)
7
$93.81
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 9-5 Constant Growth Stocks QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.09.05 - Constant Growth Stocks NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Constant growth: future price KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:25 PM DATE MODIFIED: 12/15/2017 8:55 PM 68. Gupta Corporation is undergoing a restructuring, and its free cash flows are expected to vary considerably during the next few years. However, the FCF is expected to be $85.00 million in Year 5, and the FCF growth rate is expected to be a Copyright Cengage Learning. Powered by Cognero.
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constant 6.5% beyond that point. The weighted average cost of capital is 12.0%. What is the horizon (or continuing) value (in millions) at t = 5? a. $1,432 b. $1,662 c. $2,041 d. $1,646 e. $1,234 ANSWER: d RATIONALE: $85.00 FCF 5
g 6.5% WACC 12.0% $90.5250 FCF6 = FCF5(1 + g) = HV5 = FCF6/(WACC – g) $1,646 = POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 9-7 Enterprise-Based Approach to Valuation QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.09.07 - Enterprise-Based Approach to Valuation NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Corporate valuation model KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:25 PM DATE MODIFIED: 11/6/2017 6:19 PM 69. Misra Inc. forecasts a free cash flow of $55 million in Year 3, i.e., at t = 3, and it expects FCF to grow at a constant rate of 5.5% thereafter. If the weighted average cost of capital (WACC) is 10.0% and the cost of equity is 15.0%, then what is the horizon, or continuing, value in millions at t = 3? a. $1,289 b. $1,148 c. $1,212 d. $1,186 e. $1,083 ANSWER: a RATIONALE: $55.00 FCF3 g 5.5% WACC 10.0% $58.0250 FCF4 = FCF3(1 + g) = HV3 = FCF4/(WACC – g) = $1,289 POINTS: DIFFICULTY:
1 MODERATE
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REFERENCES: 9-7 Enterprise-Based Approach to Valuation QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.09.07 - Enterprise-Based Approach to Valuation NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Corporate valuation model KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:25 PM DATE MODIFIED: 11/7/2017 2:15 PM 70. You must estimate the intrinsic value of Noe Technologies’ stock. The end-of-year free cash flow (FCF1) is expected to be $24.50 million, and it is expected to grow at a constant rate of 7.0% a year thereafter. The company’s WACC is 10.0%, it has $125.0 million of long-term debt plus preferred stock outstanding, and there are 15.0 million shares of common stock outstanding. Assume the firm has zero non-operating assets. What is the firm's estimated intrinsic value per share of common stock? Do not round intermediate calculations. a. $47.96 b. $46.11 c. $38.27 d. $40.12 e. $34.58 ANSWER: b RATIONALE: $24.50 FCF1 Constant growth rate 7.0% WACC 10.0% Debt & preferred stock $125 Shares outstanding 15 $816.67 Total firm value = FCF1/(WACC - g) = Less: Value of debt & preferred stock -$125.00 Value of equity $691.67 Number of shares 15 Value per share = Equity value/Shares = $46.11 POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 9-7 Enterprise-Based Approach to Valuation QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.09.07 - Enterprise-Based Approach to Valuation NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Corporate valuation model KEYWORDS: Bloom's: Analyze Copyright Cengage Learning. Powered by Cognero.
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OTHER: DATE CREATED: DATE MODIFIED:
Multiple Choice: Problem 9/21/2017 5:25 PM 12/15/2017 9:02 PM
71. You have been assigned the task of using the corporate, or free cash flow, model to estimate Petry Corporation's intrinsic value. The firm's WACC is 10.00%, its end-of-year free cash flow (FCF1) is expected to be $70.0 million, the FCFs are expected to grow at a constant rate of 5.00% a year in the future, the company has $200 million of long-term debt and preferred stock, and it has 30 million shares of common stock outstanding. Assume the firm has zero nonoperating assets. What is the firm's estimated intrinsic value per share of common stock? Do not round intermediate calculations. a. $48.80 b. $34.40 c. $36.80 d. $49.60 e. $40.00 ANSWER: e RATIONALE: $70.00 FCF1 Constant growth rate 5.0% WACC 10.0% Debt & preferred stock $200 Shares outstanding 30 $1,400.00 Total firm value = FCF1/(WACC - g) = Less: Value of debt & preferred stock -$200.00 Value of equity $1,200.00 Number of shares 30 Value per share = Equity value/Shares = $40.00 POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 9-7 Enterprise-Based Approach to Valuation QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.09.07 - Enterprise-Based Approach to Valuation NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Corporate valuation model KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:25 PM DATE MODIFIED: 12/15/2017 9:06 PM 72. Kedia Inc. forecasts a negative free cash flow for the coming year, FCF1 = -$10 million, but it expects positive numbers thereafter, with FCF2 = $34 million. After Year 2, FCF is expected to grow at a constant rate of 4% forever. Assume the firm has zero non-operating assets. If the weighted average cost of capital is 14.0%, what is the firm’s total corporate value, in millions? Do not round intermediate calculations. a. $335.10 Copyright Cengage Learning. Powered by Cognero.
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b. $275.00 c. $319.14 d. $289.47 e. $303.95 ANSWER: RATIONALE:
d FCF1 FCF2 g WACC
-$10 $34 4% 14%
First, find the horizon, or continuing, value at t = 2: HV2 = FCF2(1 + g)/(WACC – g) = $34(1.04)/(0.14 – 0.04) = $35.36/0.10 = $353.60 Then find the PV of the free cash flows and the horizon value: 1 2 Total corporate value = -$10/(1.14) + ($34 + $353.60)/(1.14) Total corporate value = -$8.772 + $298.246 = $289.47 POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 9-7 Enterprise-Based Approach to Valuation QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.09.07 - Enterprise-Based Approach to Valuation NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Corporate valuation model KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:25 PM DATE MODIFIED: 12/15/2017 9:09 PM 73. Kale Inc. forecasts the free cash flows (in millions) shown below. Assume the firm has zero non-operating assets. If the weighted average cost of capital is 11.0% and FCF is expected to grow at a rate of 5.0% after Year 2, then what is the firm’s total corporate value (in millions)? Do not round intermediate calculations. Year Free Cash flow a. $1,530 b. $1,833 c. $1,295 d. $1,446 e. $1,682 ANSWER: RATIONALE:
1 -$50
2 $115
e FCF1 FCF2 g WACC
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-$50 $115 5% 11% Page 550
First, find the horizon, or continuing, value: HV2= FCF2(1 + g)/(WACC – g) = $115(1.05)/(0.11 – 0.05) = $2,012.50 Then find the PV of the free cash flows and the horizon value: 2 Total corporate value = -$50/(1.11) + ($115 + $2,012.50)/(1.11) = $1,681.68 POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 9-7 Enterprise-Based Approach to Valuation QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.09.07 - Enterprise-Based Approach to Valuation NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Corporate valuation model KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:25 PM DATE MODIFIED: 12/15/2017 9:13 PM 74. Ryan Enterprises forecasts the free cash flows (in millions) shown below. Assume the firm has zero non-operating assets. The weighted average cost of capital is 13.0%, and the FCFs are expected to continue growing at a 5.0% rate after Year 3. What is the firm’s total corporate value (in millions)? Do not round intermediate calculations. Year FCF a. $268.01 b. $196.22 c. $217.75 d. $272.79 e. $239.29 ANSWER: RATIONALE:
1 -$15.0
2 $10.0
3 $25.0
e g 5% WACC 13% Year FCF Horizon, or continuing, value
1 2 -$15.00 $10.00
3 $25.00
4 $26.25
$328.13 = FCF3(1 + g)/(WACC – g)
Annual FCF -$15.00 $10.00 $353.13 PVs at 13% -$13.27 $7.83 $244.73 Total corporate value = $239.29 Sum =
POINTS:
1
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DIFFICULTY: MODERATE REFERENCES: 9-7 Enterprise-Based Approach to Valuation QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.09.07 - Enterprise-Based Approach to Valuation NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Corporate valuation model KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:25 PM DATE MODIFIED: 12/15/2017 9:25 PM 75. Based on the corporate valuation model, Wang Inc.’s total corporate value is $750 million. Its balance sheet shows $100 million notes payable, $200 million of long-term debt, $40 million of common stock (par plus paid-in-capital), and $160 million of retained earnings. What is the best estimate for the firm’s value of equity (in millions)? a. $423 b. $450 c. $531 d. $522 e. $360 ANSWER: b RATIONALE: Assuming that the book value of debt is close to its market value, the total market value of the company is: Total corporate value $750 Notes payable -$100 Long-term debt -$200 Value of equity = $450 The book value of equity figures are irrelevant for this problem. POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 9-7 Enterprise-Based Approach to Valuation QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.09.07 - Enterprise-Based Approach to Valuation NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Corporate valuation model KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:25 PM DATE MODIFIED: 11/6/2017 6:19 PM 76. Based on the corporate valuation model, Gray Entertainment's total corporate value is $1,150 million. The company’s balance sheet shows $120 million of notes payable, $300 million of long-term debt, $50 million of preferred stock, $180 Copyright Cengage Learning. Powered by Cognero.
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million of retained earnings, and $800 million of total common equity. If the company has 30 million shares of stock outstanding, what is the best estimate of its price per share? a. $22.44 b. $17.68 c. $22.67 d. $18.81 e. $26.07 ANSWER: c Assuming that the book value of debt is close to its market value, the total market value of the firm’s RATIONALE: equity is:
Total corporate value Notes payable Long-term debt Preferred stock MV equity Shares outstanding
$1,150 -$120 -$300 -$50 $680 30
Stock price = Value of equity/Shares outstanding = $22.67 The book value of equity figures are irrelevant for this problem.
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 9-7 Enterprise-Based Approach to Valuation QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.09.07 - Enterprise-Based Approach to Valuation NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Corporate valuation model KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:25 PM DATE MODIFIED: 11/6/2017 6:19 PM 77. Based on the corporate valuation model, the total corporate value of Chen Lin Inc. is $500 million. Its balance sheet shows $110 million in notes payable, $90 million in long-term debt, $20 million in preferred stock, $140 million in retained earnings, and $280 million in total common equity. If the company has 25 million shares of stock outstanding, what is the best estimate of its stock price per share? a. $11.20 b. $9.74 c. $9.18 d. $11.54 e. $11.98 ANSWER: a Assuming that the book value of debt is close to its market value, the total market value of the firm’s RATIONALE: equity is:
Total corporate value
$500
Notes payable
-$110
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Long-term debt
-$90
Preferred stock
-$20
MV equity
$280
Shares outstanding
25
Stock price = Value of equity/Shares outstanding = $11.20 The book value of equity figures are irrelevant for this problem.
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 9-7 Enterprise-Based Approach to Valuation QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.09.07 - Enterprise-Based Approach to Valuation NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Corporate valuation model KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:25 PM DATE MODIFIED: 11/6/2017 6:19 PM 78. Based on the corporate valuation model, Morgan Inc.’s total corporate value is $200 million. The balance sheet shows $90 million of notes payable, $30 million of long-term debt, $40 million of preferred stock, and $100 million of common equity. The company has 10 million shares of stock outstanding. What is the best estimate of the stock’s price per share? a. $3.80 b. $3.36 c. $3.88 d. $4.00 e. $4.12 ANSWER: d Assuming that the book value of debt is close to its market value, the total market value of the firm’s RATIONALE: equity is:
Total corporate value Notes payable Long-term debt Preferred stock MV equity Shares outstanding
$200 -$90 -$30 -$40 $40 10
Stock price = Value of equity/Shares outstanding = $4.00 The book value of equity figures are irrelevant for this problem.
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 9-7 Enterprise-Based Approach to Valuation QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.09.07 - Enterprise-Based Approach to Valuation Copyright Cengage Learning. Powered by Cognero.
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NATIONAL STANDARDS: STATE STANDARDS: LOCAL STANDARDS: TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds United States - OH - Default City - Tier 2: - Capital structure Corporate valuation model Bloom's: Analyze Multiple Choice: Problem 9/21/2017 5:25 PM 11/6/2017 6:19 PM
79. Carter's preferred stock pays a dividend of $1.00 per quarter. If the price of the stock is $57.50, what is its nominal (not effective) annual rate of return? a. 7.03% b. 8.56% c. 6.75% d. 5.84% e. 6.96% ANSWER: e RATIONALE: Pref. quarterly dividend $1.00 Annual dividend = Qtrly dividend × 4 = $4.00 Preferred stock price $57.50 Nom. required return = Annual dividend/Price = 6.96% POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 9-8 Preferred Stock QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.09.08 - Preferred Stock NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Preferred required return KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:25 PM DATE MODIFIED: 11/7/2017 5:19 PM 80. Rebello's preferred stock pays a dividend of $1.00 per quarter, and it sells for $55.00 per share. What is its effective annual (not nominal) rate of return? a. 6.95% b. 5.61% c. 7.17% d. 7.70% e. 7.47% ANSWER: e RATIONALE: Periods per year = 4 Pref. quarterly dividend $1.00 Copyright Cengage Learning. Powered by Cognero.
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Preferred stock price $55.00 N Eff% required return = (1+ (Qt Div/P)) - 1 = 7.47% POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 9-8 Preferred Stock QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.09.08 - Preferred Stock NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Preferred required return KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:25 PM DATE MODIFIED: 11/7/2017 5:19 PM 81. Nachman Industries just paid a dividend of D0 = $3.75. Analysts expect the company's dividend to grow by 30% this year, by 10% in Year 2, and at a constant rate of 5% in Year 3 and thereafter. The required return on this low-risk stock is 9.00%. What is the best estimate of the stock’s current market value? Do not round intermediate calculations. a. $144.04 b. $135.11 c. $127.47 d. $151.68 e. $130.01 ANSWER: c RATIONALE: rs = 9.0% Year Growth rates: Dividend Horizon value = D3/(rs - g3) = Total CFs PV of CFs Stock price = $127.47
0 $3.75
1 30.0% $4.875 $4.875 $4.472
2 10.0% $5.363 140.766 $146.128 $122.993
POINTS: 1 DIFFICULTY: MODERATE/CHALLENGING REFERENCES: 9-6 Valuing Nonconstant Growth Stocks QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVE FOFM.BRIG.17.09.06 - Valuing Nonconstant Growth Stocks S: NATIONAL STANDARD United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic S: STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds Copyright Cengage Learning. Powered by Cognero.
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5.0 $5.6
LOCAL STANDARDS: TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
United States - OH - Default City - Tier 2: - Capital structure Nonconstant growth valuation Bloom's: Analyze Multiple Choice: Problem 9/21/2017 5:25 PM 12/15/2017 9:41 PM
82. Church Inc. is presently enjoying relatively high growth because of a surge in the demand for its new product. Management expects earnings and dividends to grow at a rate of 22% for the next 4 years, after which competition will probably reduce the growth rate in earnings and dividends to zero, i.e., g = 0. The company’s last dividend, D0, was $1.25, its beta is 1.20, the market risk premium is 5.50%, and the risk-free rate is 3.00%. What is the current price of the common stock? Do not round intermediate calculations. a. $26.57 b. $32.69 c. $28.97 d. $23.39 e. $27.37 ANSWER: a RATIONALE: $1.25 Last dividend (D0) Short-run growth rate 22% Long-run growth rate 0% Beta 1.20 Market risk premium 5.50% Risk-free rate 3.00% 9.60% Required return = rs = rRF + b(RPM) = Year Dividend
0 $1.2500
1 22% $1.5250
2 22% $1.8605
Horizon value = D5/(rs - g5) = Total CFs $1.5250 $1.8605 PV of the CFs $1.3914 $1.5488 Price = Sum of PVs = $26.57 POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 9-6 Valuing Nonconstant Growth Stocks QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVE FOFM.BRIG.17.09.06 - Valuing Nonconstant Growth Stocks S: NATIONAL STANDARD United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic S: STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Nonconstant growth valuation KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Problem Copyright Cengage Learning. Powered by Cognero.
3 22% $2.2698 $2.2698 $1.7241
4 22% $2.7692 28.8455 $31.6147 $21.9102
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0 $2.769
DATE CREATED: DATE MODIFIED:
9/21/2017 5:25 PM 12/15/2017 9:47 PM
83. The Ramirez Company's last dividend was $1.75. Its dividend growth rate is expected to be constant at 24% for 2 years, after which dividends are expected to grow at a rate of 6% forever. Its required return (rs) is 12%. What is the best estimate of the current stock price? Do not round intermediate calculations. a. $36.94 b. $52.47 c. $41.98 d. $31.90 e. $45.34 ANSWER: c RATIONALE: $1.75 Last dividend (D0) Short-run growth rate 24% Long-run growth rate 6% Required return 12% Year
0
1 24.00% $2.1700
2 24.00% $2.6908 47.5375 $50.2283 $40.0417
Dividend $1.7500 Horizon value = D3/(rs - g3) = Total CFs $2.1700 PV of CFs $1.9375 Price = Sum of PVs = $41.98 POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 9-6 Valuing Nonconstant Growth Stocks QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.09.06 - Valuing Nonconstant Growth Stocks NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Nonconstant growth valuation KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:25 PM DATE MODIFIED: 12/15/2017 9:50 PM
3 6.00% $2.8522
84. Ackert Company's last dividend was $4.00. The dividend growth rate is expected to be constant at 1.5% for 2 years, after which dividends are expected to grow at a rate of 8.0% forever. The firm's required return (rs) is 12.0%. What is the best estimate of the current stock price? Do not round intermediate calculations. a. $87.00 b. $95.61 c. $89.87 d. $80.31 e. $104.21 Copyright Cengage Learning. Powered by Cognero.
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ANSWER: RATIONALE:
b Last dividend (D0) Short-run growth rate Long-run growth rate Required return
$4.00 1.50% 8.00% 12.00%
Year Dividend Horizon value = D3/(rs - g3) = Total CFs PV of CFs Price = Sum of PVs = $95.61
0 $4.0000
1 1.50% $4.0600
2 1.50% $4.1209 111.2643 $4.0600 $115.3852 $3.6250 $91.9844
3 8.00% $4.4506
POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 9-6 Valuing Nonconstant Growth Stocks QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.09.06 - Valuing Nonconstant Growth Stocks NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Nonconstant growth valuation KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:25 PM DATE MODIFIED: 12/15/2017 9:57 PM 85. Huang Company's last dividend was $1.25. The dividend growth rate is expected to be constant at 27.5% for 3 years, after which dividends are expected to grow at a rate of 6% forever. If the firm's required return (rs) is 11%, what is its current stock price? Do not round intermediate calculations. a. $41.08 b. $40.63 c. $36.11 d. $45.14 e. $52.36 ANSWER: d RATIONALE: Required return 11.0% Short-run growth rate 27.5% Long-run growth rate 6.0% $1.25 Last dividend (D0) Year Dividend Horizon value = D4/(rs - g4) = Total CFs PV of CFs Price = Sum of PVs = $45.14 Copyright Cengage Learning. Powered by Cognero.
0 $1.2500
1 $1.5938
2 $2.0320
$1.5938 $1.4358
$2.0320 $1.6492
3 $2.5908 54.9258 $57.5166 $42.0557
4 $2.7463
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POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 9-6 Valuing Nonconstant Growth Stocks QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.09.06 - Valuing Nonconstant Growth Stocks NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Nonconstant growth valuation KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:25 PM DATE MODIFIED: 12/15/2017 10:03 PM 86. Agarwal Technologies was founded 10 years ago. It has been profitable for the last 5 years, but it has needed all of its earnings to support growth and thus has never paid a dividend. Management has indicated that it plans to pay a $0.25 dividend 3 years from today, then to increase it at a relatively rapid rate for 2 years, and then to increase it at a constant rate of 8.00% thereafter. Management's forecast of the future dividend stream, along with the forecasted growth rates, is shown below. Assuming a required return of 11.00%, what is your estimate of the stock's current value? Use the dividend values provided in the table below for your calculations. Do not round your intermediate calculations. Year Growth rate Dividends a. $15.62 b. $17.18 c. $11.87 d. $12.97 e. $14.22 ANSWER: RATIONALE:
0 NA $0.000
1 NA $0.000
2 NA $0.000
3 NA $0.250
a Required return = 11.00% Year Dividend Horizon value = D6/(rs - g6) = Total CFs PV of CFs Price = $15.62
POINTS: DIFFICULTY: REFERENCES: QUESTION TYPE:
4 90.00% $0.475
0
1
5 45.00% $0.689
2
3
$0.000 $0.000 $0.000 $0.250 $0.000 $0.000 $0.250 $0.000 $0.000 $0.183
6 8.00% $0.744
4 90.00% $0.475
5 45.00% $0.689 24.800 $0.475 $25.489 $0.313 $15.126
1 CHALLENGING 9-6 Valuing Nonconstant Growth Stocks Multiple Choice
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8.00 $0.7
HAS VARIABLES: True LEARNING OBJECTIVE FOFM.BRIG.17.09.06 - Valuing Nonconstant Growth Stocks S: NATIONAL STANDARD United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic S: STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Nonconstant growth valuation KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:25 PM DATE MODIFIED: 12/15/2017 10:06 PM 87. Savickas Petroleum’s stock has a required return of 12.00%, and the stock sells for $36.00 per share. The firm just paid a dividend of $1.00, and the dividend is expected to grow by 30.00% per year for the next 4 years, so D4 = 4 $1.00(1.30) = $2.8561. After t = 4, the dividend is expected to grow at a constant rate of X% per year forever. What is the stock’s expected constant growth rate after t = 4, i.e., what is X? Do not round your intermediate calculations. a. 5.63% b. 4.39% c. 6.20% d. 4.96% e. 5.69% ANSWER: a RATIONALE: Stock price $36.00 $1.00 Paid dividend (D0) Short-run growth rate 30.00% Required return 12.00% Forecasted LR growth rate, X 5.63% Arbitrarily set at 5% initially. Year
0
1 30.00% $1.3000
2 30.00% $1.6900
3 30.00% $2.1970
4 30.00% $2.8561
5 5.63% $3.0170
Dividend $1.0000 Horizon value = D5/(rs 47.38 g5): Total CFs $1.30 $1.69 $2.20 $50.24 PV of CFs $1.16 $1.35 $1.56 $31.93 Stock price = $36.00. Must equal $36. Change the forecasted growth rate till reach $36. We must solve for the long-run growth rate. We can forecast the dividends in Years 1-4, so they are inserted in the time line. We need a growth rate to find D5 and the HV. We begin with a guess of say 5.0%, which we insert in the forecast cell. We then find the PV of the forecasted CFs and sum them. If the sum equals the given price, then our growth rate would be correct. If not, we need to substitute in different g's until we find the one that works. We used Excel's Goal Seek function to simplify the process, but one could use trial and error. POINTS: DIFFICULTY: REFERENCES: QUESTION TYPE:
1 CHALLENGING 9-6 Valuing Nonconstant Growth Stocks Multiple Choice
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HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.09.06 - Valuing Nonconstant Growth Stocks NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Nonconstant growth rate - nonalgorithmic KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:25 PM DATE MODIFIED: 12/15/2017 10:12 PM 88. Your boss, Sally Maloney, treasurer of Fred Clark Enterprises (FCE), asked you to help her estimate the intrinsic value of the company's stock. FCE just paid a dividend of $1.00, and the stock now sells for $17.50 per share. Sally asked a number of security analysts what they believe FCE's future dividends will be, based on their analysis of the company. The consensus is that the dividend will be increased by 10% during Years 1 to 3, and it will be increased at a rate of 5% per year in Year 4 and thereafter. Sally asked you to use that information to estimate the required rate of return on the stock, rs, and she provided you with the following template for use in the analysis. Estimated rs =
10.00%
(must be changed to force Calculated Price to equal the Actual Market Price)
Actual Market Price, P0: $17.50 Normal growth 3 4 5 10% 5% 5% ? ? ? ? ? ? ? ? ? ? A positive number will be here when dividends are $0.00 estimated. Calculated Price = P0 = Sum of PVs = The Calculated Price will equal the Actual Market Price once the correct rs has been found. Sally told you that the growth rates in the template were just put in as a trial, and that you must replace them with the analysts' forecasted rates to get the correct forecasted dividends and then the estimated HV. She also notes that the estimated value for rs, at the top of the template, is also just a guess, and you must replace it with a value that will cause the Calculated Price shown at the bottom to equal the Actual Market Price. She suggests that, after you have put in the correct dividends, you can manually calculate the price, using a series of guesses as to the Estimated rs. The value of rs that causes the calculated price to equal the actual price is the correct one. She notes, though, that this trial-and-error process is quite tedious, and that the correct rs could be found much faster with a simple Excel model, especially if you use Goal Seek. What is the value of rs? a. 12.44% b. 9.83% c. 13.97% d. 10.54% e. 11.84% ANSWER: e RATIONALE: Finding the discount rate when we know the dividends and the actual stock price is complicated if Year Dividend growth rate (insert correct values) Calculated dividends (D0 has been paid) HV3 = D4/(rs - g4). Find using Estimated rs. Total CFs PVs of CFs when discounted at Estimated rs
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Rapid growth 1 2 10% 10% $1.00 ? ? 0
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the growth rate is not constant, and an iterative solution is required. 11.84% Estimated rS = $17.50 Actual Market Price, P0: Rapid growth Normal growth 0 1 2 3 4 5 10% 10% 10% 5% 5% $1.00 $1.100 $1.210 $1.331 $1.398 $20.42 $1.10 $1.21 $21.75 $0.98 $0.97 $15.55
Year Dividend growth rate Dividends (D0 has been paid) HV3 = D4/(rS - g4). Use Estimated rS. Total CFs PVs of CFs when discounted at Estimated rs Calculated Price = P0 = Sum of PVs = $17.50 We generally start with pointer on the "Set cell," then get to Goa Goal Seek. Then fill in box as indicated. Cell with Calculated Price Input the value we want to achieve Input the cell with the Estimated rS, which we want to force t
Click OK to cause the target value to go to $17.5 and also fin
POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 9-6 Valuing Nonconstant Growth Stocks QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJEC FOFM.BRIG.17.09.06 - Valuing Nonconstant Growth Stocks TIVES: NATIONAL STAND United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic ARDS: STATE STANDARD United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds S: LOCAL STANDARD United States - OH - Default City - Tier 2: - Capital structure S: TOPICS: Nonconstant valuation - use Excel - nonalgorithmic KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:25 PM DATE MODIFIED: 12/15/2017 10:16 PM 89. Wall Inc. forecasts that it will have the free cash flows (in millions) shown below. Assume the firm has zero nonoperating assets. If the weighted average cost of capital is 14% and the free cash flows are expected to continue growing at the same rate after Year 3 as from Year 2 to Year 3, what is the firm’s total corporate value, in millions? Do not round intermediate calculations. Year Free cash flow
1 -$20.00
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2 $48.00
3 $50.50 Page 563
a. $535.20 b. $553.65 c. $572.11 d. $549.04 e. $461.38 ANSWER: RATIONALE:
e Year 1 2 3 Free cash flow -$20.00 $48.00 $50.50 WACC = 14.00% First, find the growth rate: g = FCF3/FCF2 - 1 = 5.208% Second, find the horizon, or continuing, value, at Year 2: HV2 = FCF3/(WACC – g) = $574.41 Now find the PV of the FCFs and the horizon value: 2 Total corporate value = FCF1/(1.14) + (FCF2 + HV2)/(1.14) = $461.38 POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 9-7 Enterprise-Based Approach to Valuation QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.09.07 - Enterprise-Based Approach to Valuation NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Corporate valuation model KEYWORDS: Bloom's: Analyze OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:25 PM DATE MODIFIED: 12/15/2017 10:35 PM
1. "Capital" is sometimes defined as funds supplied to a firm by investors. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 10-1 An Overview of the Weighted Average Cost of Capital (WACC) QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.10.01 - An Overview of the Weighted Average Cost of Capital (WACC) NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. Copyright Cengage Learning. Powered by Cognero.
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TOPICS: KEYWORDS: DATE CREATED: DATE MODIFIED:
Capital Bloom's: Knowledge 9/21/2017 5:30 PM 9/21/2017 5:30 PM
2. The cost of capital used in capital budgeting should reflect the average cost of the various sources of investor-supplied funds a firm uses to acquire assets. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 10-1 An Overview of the Weighted Average Cost of Capital (WACC) QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.10.01 - An Overview of the Weighted Average Cost of Capital (WACC) NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Cost of capital KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:30 PM DATE MODIFIED: 9/21/2017 5:30 PM 3. Suppose you are the president of a small, publicly-traded corporation. Since you believe that your firm's stock price is temporarily depressed, all additional capital funds required during the current year will be raised using debt. In this case, the appropriate marginal cost of capital for use in capital budgeting during the current year is the after-tax cost of debt. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 10-1 An Overview of the Weighted Average Cost of Capital (WACC) QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.10.01 - An Overview of the Weighted Average Cost of Capital (WACC) NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Specific capital cost KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:30 PM DATE MODIFIED: 9/21/2017 5:30 PM Copyright Cengage Learning. Powered by Cognero.
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4. The component costs of capital are market-determined variables in the sense that they are based on investors' required returns. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 10-2 Basic Definitions QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.10.02 - Basic Definitions NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Component capital costs KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:30 PM DATE MODIFIED: 9/21/2017 5:30 PM 5. The before-tax cost of debt, which is lower than the after-tax cost, is used as the component cost of debt for purposes of developing the firm's WACC. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 10-3 Cost of Debt rd(1 – T) QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.10.03 - Cost of Debt, rd(l – T) NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Cost of debt KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:30 PM DATE MODIFIED: 9/21/2017 5:30 PM 6. The cost of debt is equal to one minus the marginal tax rate multiplied by the average coupon rate on all outstanding debt. a. True b. False ANSWER: False POINTS: 1 Copyright Cengage Learning. Powered by Cognero.
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DIFFICULTY: EASY REFERENCES: 10-3 Cost of Debt rd(1 – T) QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.10.03 - Cost of Debt, rd(l – T) NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Cost of debt KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:30 PM DATE MODIFIED: 9/21/2017 5:30 PM 7. The cost of debt is equal to one minus the marginal tax rate multiplied by the interest rate on new debt. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 10-3 Cost of Debt rd(1 – T) QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.10.03 - Cost of Debt, rd(l – T) NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Cost of debt KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:30 PM DATE MODIFIED: 9/21/2017 5:30 PM 8. The cost of preferred stock to a firm must be adjusted to an after-tax figure because 70% of dividends received by a corporation may be excluded from the receiving corporation's taxable income. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 10-4 Cost of Preferred Stock, rp QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.10.04 - Cost of Preferred Stock, rp NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital Copyright Cengage Learning. Powered by Cognero.
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LOCAL STANDARDS: TOPICS: KEYWORDS: DATE CREATED: DATE MODIFIED:
United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. Cost of preferred Bloom's: Knowledge 9/21/2017 5:30 PM 9/21/2017 5:30 PM
9. The cost of perpetual preferred stock is found as the preferred's annual dividend divided by the market price of the preferred stock. No adjustment is needed for taxes because preferred dividends, unlike interest on debt, are not deductible by the issuing firm. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 10-4 Cost of Preferred Stock, rp QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.10.04 - Cost of Preferred Stock, rp NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Cost of preferred KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:30 PM DATE MODIFIED: 9/21/2017 5:30 PM 10. The cost of common equity obtained by retaining earnings is the rate of return the marginal stockholder requires on the firm's common stock. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 10-5 The Cost of Retained Earnings, rs QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.10.05 - The Cost of Retained Earnings, rs NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Cost of common KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:30 PM Copyright Cengage Learning. Powered by Cognero.
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11. For capital budgeting and cost of capital purposes, the firm should always consider retained earnings as the first source of capital (i.e., use these funds first) because retained earnings have no cost to the firm. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 10-5 The Cost of Retained Earnings, rs QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.10.05 - The Cost of Retained Earnings, rs NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Cost of retained earnings KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:30 PM DATE MODIFIED: 9/21/2017 5:30 PM 12. Funds acquired by the firm through retaining earnings have no cost because there are no dividend or interest payments associated with them, and no flotation costs are required to raise them, but capital raised by selling new stock or bonds does have a cost. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 10-5 The Cost of Retained Earnings, rs QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.10.05 - The Cost of Retained Earnings, rs NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Cost of retained earnings KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:30 PM DATE MODIFIED: 9/21/2017 5:30 PM 13. The cost of equity raised by retaining earnings can be less than, equal to, or greater than the cost of external equity raised by selling new issues of common stock, depending on tax rates, flotation costs, the attitude of investors, and other factors. a. True Copyright Cengage Learning. Powered by Cognero.
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b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 10-5 The Cost of Retained Earnings, rs QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.10.05 - The Cost of Retained Earnings, rs NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Cost of retained earnings KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:30 PM DATE MODIFIED: 9/21/2017 5:30 PM 14. The firm's cost of external equity raised by issuing new stock is the same as the required rate of return on the firm's outstanding common stock. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 10-6 Cost of New Common Stock, re QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.10.06 - Cost of New Common Stock, re NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Cost of new common KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:30 PM DATE MODIFIED: 9/21/2017 5:30 PM 15. For capital budgeting and cost of capital purposes, the firm should assume that each dollar of capital is obtained in accordance with its target capital structure, which for many firms means partly as debt, partly as preferred stock, and partly common equity. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 10-7 Composite, or Weighted Average, Cost of Capital, WACC Copyright Cengage Learning. Powered by Cognero.
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QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.10.07 - Composite, or Weighted Average, Cost of Capital, WACC NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: WACC KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:30 PM DATE MODIFIED: 9/21/2017 5:30 PM 16. The higher the firm's flotation cost for new common equity, the more likely the firm is to use preferred stock, which has no flotation cost, and retained earnings, whose cost is the average return on the assets that are acquired. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: Comprehensive QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.10.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Flotation and capital KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:30 PM DATE MODIFIED: 9/21/2017 5:30 PM 17. In general, firms should use their weighted average cost of capital (WACC) to evaluate capital budgeting projects because most projects are funded with general corporate funds, which come from a variety of sources. However, if the firm plans to use only debt or only equity to fund a particular project, it should use the after-tax cost of that specific type of capital to evaluate that project. a. True b. False ANSWER: False RATIONALE: In general, this statement is false, because the firm should be viewed as an ongoing entity, and using debt (or equity) to fund a given project will change the capital structure, and this factor should be recognized by basing the cost of capital for all projects on a target capital structure. Under some special circumstances, where a project is set up as a separate entity, then "project financing" may be used, and only the project's specific situation is considered. This is a specific situation, however, and not the "in general" case. POINTS: 1 DIFFICULTY: MODERATE Copyright Cengage Learning. Powered by Cognero.
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REFERENCES: 10-1 An Overview of the Weighted Average Cost of Capital (WACC) QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.10.01 - An Overview of the Weighted Average Cost of Capital (WACC) NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Specific capital cost KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:30 PM DATE MODIFIED: 9/21/2017 5:30 PM 18. If a firm's marginal tax rate is increased, this would, other things held constant, lower the cost of debt used to calculate its WACC. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 10-3 Cost of Debt rd(1 – T) QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.10.03 - Cost of Debt, rd(l – T) NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: After-tax cost of debt KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:30 PM DATE MODIFIED: 9/21/2017 5:30 PM 19. The reason why retained earnings have a cost equal to rs is because investors think they can (i.e., expect to) earn rs on investments with the same risk as the firm's common stock, and if the firm does not think that it can earn rs on the earnings that it retains, it should pay those earnings out to its investors. Thus, the cost of retained earnings is based on the opportunity cost principle. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 10-5 The Cost of Retained Earnings, rs QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.10.05 - The Cost of Retained Earnings, rs Copyright Cengage Learning. Powered by Cognero.
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NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Retained earnings KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:30 PM DATE MODIFIED: 9/21/2017 5:30 PM 20. The text identifies three methods for estimating the cost of common stock from retained earnings: the CAPM method, the DCF method, and the bond-yield-plus-risk-premium method. However, only the DCF method is widely used in practice. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 10-5 The Cost of Retained Earnings, rs QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.10.05 - The Cost of Retained Earnings, rs NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Cost of equity estimates KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:30 PM DATE MODIFIED: 9/21/2017 5:30 PM 21. The text identifies three methods for estimating the cost of common stock from retained earnings: the CAPM method, the DCF method, and the bond-yield-plus-risk-premium method. However, only the CAPM method always provides an accurate and reliable estimate. a. True b. False ANSWER: False RATIONALE: None of the methods always provides accurate and reliable estimates. With the CAPM, we don't know the beta that investors are using, we are not totally sure of what rRF to use, and we don't know if the CAPM is truly correct. POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 10-5 The Cost of Retained Earnings, rs QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.10.05 - The Cost of Retained Earnings, rs NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking Copyright Cengage Learning. Powered by Cognero.
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STATE STANDARDS: LOCAL STANDARDS: TOPICS: KEYWORDS: DATE CREATED: DATE MODIFIED:
United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. Cost of equity estimates Bloom's: Knowledge 9/21/2017 5:30 PM 9/21/2017 5:30 PM
22. The text identifies three methods for estimating the cost of common stock from retained earnings: the CAPM method, the DCF method, and the bond-yield-plus-risk-premium method. Since we cannot be sure that the estimate obtained with any of these methods is correct, it is often appropriate to use all three methods, then consider all three estimates, and end up using a judgmental estimate when calculating the WACC. a. True b. False ANSWER: True RATIONALE: Unfortunately, this is true. POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 10-5 The Cost of Retained Earnings, rs QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.10.05 - The Cost of Retained Earnings, rs NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Cost of equity estimates KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:30 PM DATE MODIFIED: 9/21/2017 5:30 PM 23. When estimating the cost of equity by use of the CAPM, three potential problems are (1) whether to use long-term or short-term rates for rRF, (2) whether or not the historical beta is the beta that investors use when evaluating the stock, and (3) how to measure the market risk premium, RPM. These problems leave us unsure of the true value of rs. a. True b. False ANSWER: True RATIONALE: Unfortunately, this is true. POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 10-5 The Cost of Retained Earnings, rs QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.10.05 - The Cost of Retained Earnings, rs NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital Copyright Cengage Learning. Powered by Cognero.
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LOCAL STANDARDS: TOPICS: KEYWORDS: DATE CREATED: DATE MODIFIED:
United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. Cost of equity estimates Bloom's: Knowledge 9/21/2017 5:30 PM 9/21/2017 5:30 PM
24. When estimating the cost of equity by use of the DCF method, the single biggest potential problem is to determine the growth rate that investors use when they estimate a stock's expected future rate of return. This problem leaves us unsure of the true value of rs. a. True b. False ANSWER: True RATIONALE: Unfortunately, this is true. POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 10-5 The Cost of Retained Earnings, rs QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.10.05 - The Cost of Retained Earnings, rs NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Cost of equity estimates KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:30 PM DATE MODIFIED: 9/21/2017 5:30 PM 25. When estimating the cost of equity by use of the bond-yield-plus-risk-premium method, we can generally get a good idea of the interest rate on new long-term debt, but we cannot be sure that the risk premium we add is appropriate. This problem leaves us unsure of the true value of rs. a. True b. False ANSWER: True RATIONALE: Unfortunately, this is true. POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 10-5 The Cost of Retained Earnings, rs QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.10.05 - The Cost of Retained Earnings, rs NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. Copyright Cengage Learning. Powered by Cognero.
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26. If a firm is privately owned, and its stock is not traded in public markets, then we cannot measure its beta for use in the CAPM model, we cannot observe its stock price for use in the DCF model, and we don't know what the risk premium is for use in the bond-yield-plus-risk-premium method. All this makes it especially difficult to estimate the cost of equity for a private company. a. True b. False ANSWER: True RATIONALE: True, but data on comparable publicly owned firms can often be obtained and used as proxies for private firms. POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 10-5 The Cost of Retained Earnings, rs QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.10.05 - The Cost of Retained Earnings, rs NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Cost of equity estimates KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:30 PM DATE MODIFIED: 9/21/2017 5:30 PM 27. The cost of external equity capital raised by issuing new common stock (re) is defined as follows, in words: "The cost of external equity equals the cost of equity capital from retaining earnings (rs), divided by one minus the percentage flotation cost required to sell the new stock, (1 - F)." a. True b. False ANSWER: False This statement is true only if the expected growth rate is zero. Here are some illustrative RATIONALE: numbers that show that the statement is true if g = 0 but false otherwise. Positive g Zero g Price $10.00 $10.00 Dividend $0.50 $0.50 Growth 6.00% 0.00% Flotation 5.00% 5.00% 11.00% 5.00% rs = D1/P0 + g 11.263% 5.263%Equal only if g = zero. re = D1/P0(1 − F) + g 11.579% 5.263% rs/(1 − F)
POINTS: DIFFICULTY: REFERENCES:
1 MODERATE 10-6 Cost of New Common Stock, re
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QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.10.06 - Cost of New Common Stock, re NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Cost of new common KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:30 PM DATE MODIFIED: 9/21/2017 5:30 PM 28. If the expected dividend growth rate is zero, then the cost of external equity capital raised by issuing new common stock (re) is equal to the cost of equity capital from retaining earnings (rs) divided by one minus the percentage flotation cost required to sell the new stock, (1 - F). If the expected growth rate is not zero, then the cost of external equity must be found using a different formula. a. True b. False ANSWER: True This statement is true. Here are some illustrative numbers to demonstrate this point. RATIONALE: Price Dividend Growth Flotation rs = D1/P0 + g re = D1/P0(1 − F) + g rs/(1 − F)
Positive g $10.00 $0.50 6.00% 5.00% 11.00% 11.263% 11.579%
Zero g $10.00 $0.50 0.00% 5.00% 5.00% 5.263%Equal only if g = zero. 5.263%
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 10-6 Cost of New Common Stock, re QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.10.06 - Cost of New Common Stock, re NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Cost of new common KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:30 PM DATE MODIFIED: 9/21/2017 5:30 PM 29. Suppose the debt ratio is 50%, the interest rate on new debt is 8%, the current cost of equity is 16%, and the tax rate is 40%. An increase in the debt ratio to 60% would have to decrease the weighted average cost of capital (WACC). a. True b. False ANSWER: False Copyright Cengage Learning. Powered by Cognero.
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POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 10-8 Factors That Affect the WACC QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.10.08 - Factors That Affect the WACC NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Factors affecting WACC KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:30 PM DATE MODIFIED: 9/21/2017 5:30 PM 30. Firms raise capital at the total corporate level by retaining earnings and by obtaining funds in the capital markets. They then provide funds to their different divisions for investment in capital projects. The divisions may vary in risk, and the projects within the divisions may also vary in risk. Therefore, it is conceptually correct to use different risk-adjusted costs of capital for different capital budgeting projects. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 10-9 Adjusting the Cost of Capital for Risk QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.10.09 - Adjusting the Cost of Capital for Risk NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Risk-adjusted capital cost KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:30 PM DATE MODIFIED: 9/21/2017 5:30 PM 31. The cost of debt, rd, is normally less than rs, so rd(1 - T) will normally be much less than rs. Therefore, as long as the firm is not completely debt financed, the weighted average cost of capital (WACC) will normally be greater than rd(1 - T). a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: True / False Copyright Cengage Learning. Powered by Cognero.
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HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.10.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: WACC KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:30 PM DATE MODIFIED: 9/21/2017 5:30 PM 32. The lower the firm's tax rate, the lower will be its after-tax cost of debt and also its WACC, other things held constant. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.10.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Taxes, cost of debt, and WACC KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:30 PM DATE MODIFIED: 9/21/2017 5:30 PM 33. Since 70% of the preferred dividends received by a corporation are excluded from taxable income, the component cost of equity for a company that pays half of its earnings out as common dividends and half as preferred dividends should, theoretically, be Cost of equity = rs(0.30)(0.50) + rps(1 - T)(0.70)(0.50). a. True b. False ANSWER: False RATIONALE: The preferred dividend exclusion is a benefit to the holder of the preferred, not the issuer, hence this statement is not true. It actually is just nonsense anyway! POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.10.00 - Comprehensive Copyright Cengage Learning. Powered by Cognero.
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NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Cost of equity KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:30 PM DATE MODIFIED: 9/21/2017 5:30 PM 34. If expectations for long-term inflation rose, but the slope of the SML remained constant, this would have a greater impact on the required rate of return on equity, rs, than on the interest rate on long-term debt, rd, for most firms. Therefore, the percentage point increase in the cost of equity would be greater than the increase in the interest rate on long-term debt. a. True b. False ANSWER: False RATIONALE: Increased inflation results in a parallel upward shift in the SML, which means equal percentage increases in the required returns on debt and equity. POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.10.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Inflation effects KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:30 PM DATE MODIFIED: 9/21/2017 5:30 PM 35. If investors' aversion to risk rose, causing the slope of the SML to increase, this would have a greater impact on the required rate of return on equity, rs, than on the interest rate on long-term debt, rd, for most firms. Other things held constant, this would lead to an increase in the use of debt and a decrease in the use of equity. However, other things would not stay constant if firms used a lot more debt, as that would increase the riskiness of both debt and equity and thus limit the shift toward debt. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.10.00 - Comprehensive Copyright Cengage Learning. Powered by Cognero.
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NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Inflation effects KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:30 PM DATE MODIFIED: 9/21/2017 5:30 PM 36. Which of the following is NOT a capital component when calculating the weighted average cost of capital (WACC) for use in capital budgeting? a. Long-term debt. b. Accounts payable. c. Retained earnings. d. Common stock. e. Preferred stock. ANSWER: b POINTS: 1 DIFFICULTY: EASY REFERENCES: 10-2 Basic Definitions QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.10.02 - Basic Definitions NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Capital components KEYWORDS: Bloom's: Knowledge OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:30 PM DATE MODIFIED: 9/21/2017 5:30 PM 37. Bankston Corporation forecasts that if all of its existing financial policies are followed, its proposed capital budget would be so large that it would have to issue new common stock. Since new stock has a higher cost than retained earnings, Bankston would like to avoid issuing new stock. Which of the following actions would REDUCE its need to issue new common stock? a. Increase the dividend payout ratio for the upcoming year. b. Increase the percentage of debt in the target capital structure. c. Increase the proposed capital budget. d. Reduce the amount of short-term bank debt in order to increase the current ratio. e. Reduce the percentage of debt in the target capital structure. ANSWER: b RATIONALE: Statement b is correct, because if more debt is used, then less equity will be needed to fund the capital budget, so the need for a stock issue would be reduced. POINTS: 1 Copyright Cengage Learning. Powered by Cognero.
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DIFFICULTY: EASY REFERENCES: 10-6 Cost of New Common Stock, re QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.10.06 - Cost of New Common Stock, re NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Internal vs. external common KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:30 PM DATE MODIFIED: 9/21/2017 5:30 PM 38. Schalheim Sisters Inc. has always paid out all of its earnings as dividends, hence the firm has no retained earnings. This same situation is expected to persist in the future. The company uses the CAPM to calculate its cost of equity, its target capital structure consists of common stock, preferred stock, and debt. Which of the following events would REDUCE its WACC? a. The market risk premium declines. b. The flotation costs associated with issuing new common stock increase. c. The company’s beta increases. d. Expected inflation increases. e. The flotation costs associated with issuing preferred stock increase. ANSWER: a POINTS: 1 DIFFICULTY: EASY REFERENCES: 10-8 Factors That Affect the WACC QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.10.08 - Factors That Affect the WACC NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Factors affecting WACC KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:30 PM DATE MODIFIED: 9/21/2017 5:30 PM 39. For a typical firm, which of the following sequences is CORRECT? All rates are after taxes, and assume that the firm operates at its target capital structure. a. rs > re > rd > WACC. b. re > rs > WACC > rd. c. WACC > re > rs > rd. Copyright Cengage Learning. Powered by Cognero.
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d. rd > re > rs > WACC. e. WACC > rd > rs > re. ANSWER: b POINTS: 1 DIFFICULTY: EASY REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.10.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Capital components KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:30 PM DATE MODIFIED: 9/21/2017 5:30 PM 40. When working with the CAPM, which of the following factors can be determined with the most precision? a. The market risk premium (RPM). b. The beta coefficient, bi, of a relatively safe stock. c. The most appropriate risk-free rate, rRF. d. The expected rate of return on the market, rM. e. The beta coefficient of ―the market,‖ which is the same as the beta of an average stock. ANSWER: e RATIONALE: By definition, both the market and an average stock have betas of 1.0. Since we know this to be the case, we can obviously determine beta for the market or an average stock with precision. POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 10-5 The Cost of Retained Earnings, rs QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.10.05 - The Cost of Retained Earnings, rs NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Cost of equity: CAPM KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:30 PM DATE MODIFIED: 9/21/2017 5:30 PM Copyright Cengage Learning. Powered by Cognero.
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41. Duval Inc. uses only equity capital, and it has two equally-sized divisions. Division A’s cost of capital is 10.0%, Division B’s cost is 14.0%, and the corporate (composite) WACC is 12.0%. All of Division A’s projects are equally risky, as are all of Division B's projects. However, the projects of Division A are less risky than those of Division B. Which of the following projects should the firm accept? a. A Division B project with a 13% return. b. A Division B project with a 12% return. c. A Division A project with an 11% return. d. A Division A project with a 9% return. e. A Division B project with an 11% return. ANSWER: c RATIONALE: The correct answer is statement c. Division A should accept only projects with returns greater than 10%, and Division B should accept only projects with returns greater than 14%. Only statement c meets this criterion. POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 10-9 Adjusting the Cost of Capital for Risk QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.10.09 - Adjusting the Cost of Capital for Risk NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Divisional risk KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:30 PM DATE MODIFIED: 9/21/2017 5:30 PM 42. LaPango Inc. estimates that its average-risk projects have a WACC of 10%, its below-average risk projects have a WACC of 8%, and its above-average risk projects have a WACC of 12%. Which of the following projects (A, B, and C) should the company accept? a. Project B, which is of below-average risk and has a return of 8.5%. b. Project C, which is of above-average risk and has a return of 11%. c. Project A, which is of average risk and has a return of 9%. d. None of the projects should be accepted. e. All of the projects should be accepted. ANSWER: a RATIONALE: Project B has a return greater than its risk-adjusted cost of capital, so it should be accepted. POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 10-9 Adjusting the Cost of Capital for Risk QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.10.09 - Adjusting the Cost of Capital for Risk NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic Copyright Cengage Learning. Powered by Cognero.
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STATE STANDARDS: LOCAL STANDARDS: TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. Risk and projects Bloom's: Analysis Multiple Choice: Conceptual 9/21/2017 5:30 PM 9/21/2017 5:30 PM
43. Norris Enterprises, an all-equity firm, has a beta of 2.0. The chief financial officer is evaluating a project with an expected return of 14%, before any risk adjustment. The risk-free rate is 5%, and the market risk premium is 4%. The project being evaluated is riskier than the firm’s average project, in terms of both its beta risk and its total risk. Which of the following statements is CORRECT? a. The project should definitely be accepted because its expected return (before any risk adjustments) is greater than its required return. b. The project should definitely be rejected because its expected return (before risk adjustment) is less than its required return. c. Riskier-than-average projects should have their expected returns increased to reflect their higher risk. Clearly, this would make the project acceptable regardless of the amount of the adjustment. d. The accept/reject decision depends on the firm's risk-adjustment policy. If Norris' policy is to increase the required return on a riskier-than-average project to 3% over rs, then it should reject the project. e. Capital budgeting projects should be evaluated solely on the basis of their total risk. Thus, insufficient information has been provided to make the accept/reject decision. ANSWER: d RATIONALE: Statement d is correct. Here is the proof: rs = 5% + 4%(2.0) = 5% + 8% = 13%. Required return for risky projects = 13% + 3% = 16%. Project return = 14% < adjusted rs = 16%. Thus, the project should be rejected. POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 10-9 Adjusting the Cost of Capital for Risk QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.10.09 - Adjusting the Cost of Capital for Risk NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Risk and projects KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:30 PM DATE MODIFIED: 9/21/2017 5:30 PM 44. The MacMillen Company has equal amounts of low-risk, average-risk, and high-risk projects. The firm's overall WACC is 12%. The CFO believes that this is the correct WACC for the company’s average-risk projects, but that a lower rate should be used for lower-risk projects and a higher rate for higher-risk projects. The CEO disagrees, on the grounds that even though projects have different risks, the WACC used to evaluate each project should be the same because the Copyright Cengage Learning. Powered by Cognero.
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company obtains capital for all projects from the same sources. If the CEO’s position is accepted, what is likely to happen over time? a. The company will take on too many high-risk projects and reject too many low-risk projects. b. The company will take on too many low-risk projects and reject too many high-risk projects. c. Things will generally even out over time, and, therefore, the firm’s risk should remain constant over time. d. The company’s overall WACC should decrease over time because its stock price should be increasing. e. The CEO’s recommendation would maximize the firm’s intrinsic value. ANSWER: a RATIONALE: Low-risk projects will tend to have low expected returns and vice versa for high-risk projects due to competition in the economy. By not adjusting the cost of capital for project risk, the firm will tend to reject low-risk projects even though they earn higher returns than their riskadjusted costs of capital, and vice versa for high-risk projects. In addition, as the firm takes on more high-risk projects, its correct WACC will increase over time. Therefore, statement a is correct. POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 10-9 Adjusting the Cost of Capital for Risk QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.10.09 - Adjusting the Cost of Capital for Risk NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Risk-adjusted capital cost KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:30 PM DATE MODIFIED: 9/21/2017 5:30 PM 45. If a typical U.S. company correctly estimates its WACC at a given point in time and then uses that same cost of capital to evaluate all projects for the next 10 years, then the firm will most likely a. become riskier over time, but its intrinsic value will be maximized. b. become less risky over time, and this will maximize its intrinsic value. c. accept too many low-risk projects and too few high-risk projects. d. become more risky and also have an increasing WACC. Its intrinsic value will not be maximized. e. continue as before, because there is no reason to expect its risk position or value to change over time as a result of its use of a single cost of capital. ANSWER: d RATIONALE: Low-risk projects will tend to have low expected returns and vice versa for high-risk projects due to competition in the economy. By not adjusting the cost of capital for project risk, the firm will tend to reject low-risk projects even though they earn higher returns than their riskadjusted costs of capital, and vice versa for high-risk projects. As the firm takes on more high-risk projects, its true WACC will increase over time. Of course, the true WACC might change over time due to changes in market conditions, but that could cause the true WACC to either rise or decline. Therefore, statement d is correct. POINTS: 1 DIFFICULTY: MODERATE Copyright Cengage Learning. Powered by Cognero.
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REFERENCES: 10-9 Adjusting the Cost of Capital for Risk QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.10.09 - Adjusting the Cost of Capital for Risk NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Risk-adjusted capital cost KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:30 PM DATE MODIFIED: 9/21/2017 5:30 PM 46. Which of the following statements is CORRECT? a. When calculating the cost of preferred stock, a company needs to adjust for taxes, because preferred stock dividends are deductible by the paying corporation. b. All else equal, an increase in a company’s stock price will increase its marginal cost of retained earnings, rs. c. All else equal, an increase in a company’s stock price will increase its marginal cost of new common equity, re. d. Since the money is readily available, the after-tax cost of retained earnings is usually much lower than the after-tax cost of debt. e. If a company’s tax rate increases but the YTM on its noncallable bonds remains the same, the after-tax cost of its debt will fall. ANSWER: e RATIONALE: Statement e is true, because the after-tax cost of debt is rd(1 − T). So, if rd remains constant but T increases, rd(1 − T) will decline. The other statements are all false. POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.10.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Capital components KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:30 PM DATE MODIFIED: 9/21/2017 5:30 PM 47. Which of the following statements is CORRECT? a. When calculating the cost of debt, a company needs to adjust for taxes, because interest payments are deductible by the paying corporation. Copyright Cengage Learning. Powered by Cognero.
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b. When calculating the cost of preferred stock, companies must adjust for taxes, because dividends paid on preferred stock are deductible by the paying corporation. c. Because of tax effects, an increase in the risk-free rate will have a greater effect on the after-tax cost of debt than on the cost of common stock as measured by the CAPM. d. If a company’s beta increases, this will increase the cost of equity used to calculate the WACC, but only if the company does not have enough retained earnings to take care of its equity financing and hence must issue new stock. e. Higher flotation costs reduce investors' expected returns, and that leads to a reduction in a company’s WACC. ANSWER: a RATIONALE: Statement a is true, because interest payments on debt are tax deductible. The other statements are false. POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.10.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Capital components KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:30 PM DATE MODIFIED: 9/21/2017 5:30 PM 48. Which of the following statements is CORRECT? a. In the WACC calculation, we must adjust the cost of preferred stock (the market yield) to reflect the fact that 70% of the dividends received by corporate investors are excluded from their taxable income. b. We should use historical measures of the component costs from prior financings that are still outstanding when estimating a company’s WACC for capital budgeting purposes. c. The cost of new equity (re) could possibly be lower than the cost of retained earnings (rs) if the market risk premium, risk-free rate, and the company’s beta all decline by a sufficiently large amount. d. Its cost of retained earnings is the rate of return stockholders require on a firm’s common stock. e. The component cost of preferred stock is expressed as rp(1 - T), because preferred stock dividends are treated as fixed charges, similar to the treatment of interest on debt. ANSWER: d POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.10.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital Copyright Cengage Learning. Powered by Cognero.
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LOCAL STANDARDS: TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. Capital components Bloom's: Analysis Multiple Choice: Conceptual 9/21/2017 5:30 PM 9/21/2017 5:30 PM
49. Which of the following statements is CORRECT? a. The WACC as used in capital budgeting is an estimate of a company’s before-tax cost of capital. b. The percentage flotation cost associated with issuing new common equity is typically smaller than the flotation cost for new debt. c. The WACC as used in capital budgeting is an estimate of the cost of all the capital a company has raised to acquire its assets. d. There is an ―opportunity cost‖ associated with using retained earnings, hence they are not ―free.‖ e. The WACC as used in capital budgeting would be simply the before-tax cost of debt if the firm plans to use only debt to finance its capital budget during the coming year. ANSWER: d POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.10.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: WACC KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:30 PM DATE MODIFIED: 9/21/2017 5:30 PM 50. Which of the following statements is CORRECT? a. A change in a company’s target capital structure cannot affect its WACC. b. WACC calculations should be based on the before-tax costs of all the individual capital components. c. Flotation costs associated with issuing new common stock normally reduce the WACC. d. If a company’s tax rate increases, then, all else equal, its weighted average cost of capital will decline. e. An increase in the risk-free rate will normally lower the marginal costs of both debt and equity financing. ANSWER: d RATIONALE: Statement d is true, because the cost of debt for WACC purposes = rd(1 − T), so if T POINTS: DIFFICULTY: REFERENCES:
increases, then rd(1 − T) declines. 1 MODERATE Comprehensive
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QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.10.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: WACC KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:30 PM DATE MODIFIED: 9/21/2017 5:30 PM 51. Which of the following statements is CORRECT? a. The WACC is calculated using before-tax costs for all components. b. The after-tax cost of debt usually exceeds the after-tax cost of equity. c. For a given firm, the after-tax cost of debt is always more expensive than the after-tax cost of non-convertible preferred stock. d. Retained earnings that were generated in the past and are reported on the firm’s balance sheet are available to finance the firm’s capital budget during the coming year. e. The WACC that should be used in capital budgeting is the firm’s marginal, after-tax cost of capital. ANSWER: e POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.10.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: WACC and cap. components KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:30 PM DATE MODIFIED: 9/21/2017 5:30 PM 52. For a company whose target capital structure calls for 50% debt and 50% common equity, which of the following statements is CORRECT? a. The interest rate used to calculate the WACC is the average after-tax cost of all the company's outstanding debt as shown on its balance sheet. b. The WACC is calculated on a before-tax basis. c. The WACC exceeds the cost of equity. d. The cost of equity is always equal to or greater than the cost of debt. e. The cost of retained earnings typically exceeds the cost of new common stock. Copyright Cengage Learning. Powered by Cognero.
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ANSWER: RATIONALE:
d Statement d is true, because equity is more risky than debt and hence investors require a higher return on equity. Also, interest on debt is deductible, and this further reduces the cost of debt. The other statements are false. POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.10.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: WACC and cap. components KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:30 PM DATE MODIFIED: 9/21/2017 5:30 PM 53. Which of the following statements is CORRECT? a. Since debt capital can cause a company to go bankrupt but equity capital cannot, debt is riskier than equity, and thus the after-tax cost of debt is always greater than the cost of equity. b. The tax-adjusted cost of debt is always greater than the interest rate on debt, provided the company does in fact pay taxes. c. If a company assigns the same cost of capital to all of its projects regardless of each project’s risk, then the company is likely to reject some safe projects that it actually should accept and to accept some risky projects that it should reject. d. Because no flotation costs are required to obtain capital as retained earnings, the cost of retained earnings is generally lower than the after-tax cost of debt. e. Higher flotation costs tend to reduce the cost of equity capital. ANSWER: c POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.10.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Cost of capital concepts KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:30 PM Copyright Cengage Learning. Powered by Cognero.
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DATE MODIFIED:
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54. Which of the following statements is CORRECT? a. The "break point" as discussed in the text refers to the point where the firm's tax rate increases. b. The "break point" as discussed in the text refers to the point where the firm has raised so much capital that it is simply unable to borrow any more money. c. The "break point" as discussed in the text refers to the point where the firm is taking on investments that are so risky the firm is in serious danger of going bankrupt if things do not go exactly as planned. d. The "break point" as discussed in the text refers to the point where the firm has raised so much capital that it has exhausted its supply of additions to retained earnings and thus must raise equity by issuing stock. e. The "break point" as discussed in the text refers to the point where the firm has exhausted its supply of additions to retained earnings and thus must begin to finance with preferred stock. ANSWER: d POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.10.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: MCC break points KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:30 PM DATE MODIFIED: 9/21/2017 5:30 PM 55. Cranberry Corp. has two divisions of equal size: a computer manufacturing division and a data processing division. Its CFO believes that stand-alone data processor companies typically have a WACC of 8%, while stand-alone computer manufacturers typically have a 12% WACC. He also believes that the data processing and manufacturing divisions have the same risk as their typical peers. Consequently, he estimates that the composite, or corporate, WACC is 10%. A consultant has suggested using an 8% hurdle rate for the data processing division and a 12% hurdle rate for the manufacturing division. However, the CFO disagrees, and he has assigned a 10% WACC to all projects in both divisions. Which of the following statements is CORRECT? a. While the decision to use just one WACC will result in its accepting more projects in the manufacturing division and fewer projects in its data processing division than if it followed the consultant’s recommendation, this should not affect the firm’s intrinsic value. b. The decision not to adjust for risk means, in effect, that it is favoring the data processing division. Therefore, that division is likely to become a larger part of the consolidated company over time. c. The decision not to adjust for risk means that the company will accept too many projects in the manufacturing division and too few in the data processing division. This will lead to a reduction in the firm’s intrinsic value over time. d. The decision not to risk adjust means that the company will accept too many projects in the data processing business and too few projects in the manufacturing business. This will lead to a reduction in its intrinsic value over time. e. The decision not to risk adjust means that the company will accept too many projects in the manufacturing business and too few projects in the data processing business. This may affect the firm’s capital structure but it Copyright Cengage Learning. Powered by Cognero.
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will not affect its intrinsic value. ANSWER: c RATIONALE: By not making the risk adjustment, the firm will accept too many projects in the manufacturing division and too few in the data processing division. As a result, the company will become riskier overall, raising its cost of capital. Investors will discount the firm's cash flows at a higher rate, and the firm’s intrinsic value will fall. Therefore, statement c is true and all other statements are false. POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 10-9 Adjusting the Cost of Capital for Risk QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.10.09 - Adjusting the Cost of Capital for Risk NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Risk-adjusted capital cost KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:30 PM DATE MODIFIED: 9/21/2017 5:30 PM 56. Safeco Company and Risco Inc are identical in size and capital structure. However, the riskiness of their assets and cash flows are somewhat different, resulting in Safeco having a WACC of 10% and Risco a WACC of 12%. Safeco is considering Project X, which has an IRR of 10.5% and is of the same risk as a typical Safeco project. Risco is considering Project Y, which has an IRR of 11.5% and is of the same risk as a typical Risco project. Now assume that the two companies merge and form a new company, Safeco/Risco Inc. Moreover, the new company's market risk is an average of the pre-merger companies' market risks, and the merger has no impact on either the cash flows or the risks of Projects X and Y. Which of the following statements is CORRECT? a. If the firm evaluates these projects and all other projects at the new overall corporate WACC, it will probably become riskier over time. b. If evaluated using the correct post-merger WACC, Project X would have a negative NPV. c. After the merger, Safeco/Risco would have a corporate WACC of 11%. Therefore, it should reject Project X but accept Project Y. d. Safeco/Risco’s WACC, as a result of the merger, would be 10%. e. After the merger, Safeco/Risco should select Project Y but reject Project X. If the firm does this, its corporate WACC will fall to 10.5%. ANSWER: a POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 10-9 Adjusting the Cost of Capital for Risk QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.10.09 - Adjusting the Cost of Capital for Risk NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital Copyright Cengage Learning. Powered by Cognero.
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LOCAL STANDARDS: TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. Div. risk and projects Bloom's: Application Multiple Choice: Conceptual 9/21/2017 5:30 PM 9/21/2017 5:30 PM
57. Which of the following statements is CORRECT? a. The component cost of preferred stock is expressed as rp(1 - T). This follows because preferred stock dividends are treated as fixed charges, and as such they can be deducted by the issuer for tax purposes. b. A cost should be assigned to retained earnings due to the opportunity cost principle, which refers to the fact that the firm’s stockholders would themselves expect to earn a return on earnings that were paid out rather than retained and reinvested. c. No cost should be assigned to retained earnings because the firm does not have to pay anything to raise them. They are generated as cash flows by operating assets that were raised in the past, hence they are ―free.‖ d. Suppose a firm has been losing money and thus is not paying taxes, and this situation is expected to persist into the foreseeable future. In this case, the firm’s before-tax and after-tax costs of debt for purposes of calculating the WACC will both be equal to the interest rate on the firm’s currently outstanding debt, provided that debt was issued during the past 5 years. e. If a firm has enough retained earnings to fund its capital budget for the coming year, then there is no need to estimate either a cost of equity or a WACC. ANSWER: b POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.10.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Capital components KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:30 PM DATE MODIFIED: 9/21/2017 5:30 PM 58. Which of the following statements is CORRECT? a. The cost of capital used to evaluate a project should be the cost of the specific type of financing used to fund that project, i.e., it is the after-tax cost of debt if debt is to be used to finance the project or the cost of equity if the project will be financed with equity. b. The after-tax cost of debt that should be used as the component cost when calculating the WACC is the average after-tax cost of all the firm’s outstanding debt. c. Suppose some of a publicly-traded firm’s stockholders are not diversified; they hold only the one firm’s stock. In this case, the CAPM approach will result in an estimated cost of equity that is too low in the sense that if it is used in capital budgeting, projects will be accepted that will reduce the firm’s intrinsic value. Copyright Cengage Learning. Powered by Cognero.
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d. The cost of equity is generally harder to measure than the cost of debt because there is no stated, contractual cost number on which to base the cost of equity. e. The bond-yield-plus-risk-premium approach is the most sophisticated and objective method for estimating a firm’s cost of equity capital. ANSWER: d POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.10.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Cost of capital KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:30 PM DATE MODIFIED: 9/21/2017 5:30 PM 59. Which of the following statements is CORRECT? a. Although some methods used to estimate the cost of equity are subject to severe limitations, the CAPM is a simple, straightforward, and reliable model that consistently produces accurate cost of equity estimates. In particular, academics and corporate finance people generally agree that its key inputs—beta, the risk-free rate, and the market risk premium—can be estimated with little error. b. The DCF model is generally preferred by academics and financial executives over other models for estimating the cost of equity. This is because of the DCF model’s logical appeal and also because accurate estimates for its key inputs, the dividend yield and the growth rate, are easy to obtain. c. The bond-yield-plus-risk-premium approach to estimating the cost of equity may not always be accurate, but it has the advantage that its two key inputs, the firm’s own cost of debt and its risk premium, can be found by using standardized and objective procedures. d. Surveys indicate that the CAPM is the most widely used method for estimating the cost of equity. However, other methods are also used because CAPM estimates may be subject to error, and people like to use different methods as checks on one another. If all of the methods produce similar results, this increases the decision maker's confidence in the estimated cost of equity. e. The DCF model is preferred by academics and finance practitioners over other cost of capital models because it correctly recognizes that the expected return on a stock consists of a dividend yield plus an expected capital gains yield. ANSWER: d POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.10.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital Copyright Cengage Learning. Powered by Cognero.
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LOCAL STANDARDS: TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. Cost of equity Bloom's: Analysis Multiple Choice: Conceptual 9/21/2017 5:30 PM 9/21/2017 5:30 PM
60. Which of the following statements is CORRECT? a. The discounted cash flow method of estimating the cost of equity cannot be used unless the growth rate, g, is expected to be constant forever. b. If the calculated beta underestimates the firm’s true investment risk—i.e., if the forward-looking beta that investors think exists exceeds the historical beta—then the CAPM method based on the historical beta will produce an estimate of rs and thus WACC that is too high. c. Beta measures market risk, which is, theoretically, the most relevant risk measure for a publicly-owned firm that seeks to maximize its intrinsic value. This is true even if not all of the firm’s stockholders are well diversified. d. An advantage shared by both the DCF and CAPM methods when they are used to estimate the cost of equity is that they are both "objective" as opposed to "subjective," hence little or no judgment is required. e. The specific risk premium used in the CAPM is the same as the risk premium used in the bond-yield-plus-riskpremium approach. ANSWER: c POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.10.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: CAPM and DCF KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:30 PM DATE MODIFIED: 9/21/2017 5:30 PM 61. Which of the following statements is CORRECT? a. The bond-yield-plus-risk-premium approach to estimating the cost of common equity involves adding a risk premium to the interest rate on the company’s own long-term bonds. The size of the risk premium for bonds with different ratings is published daily in The Wall Street Journal or is available online. b. The WACC is calculated using a before-tax cost for debt that is equal to the interest rate that must be paid on new debt, along with the after-tax costs for common stock and for preferred stock if it is used. c. An increase in the risk-free rate is likely to reduce the marginal costs of both debt and equity. d. The relevant WACC can change depending on the amount of funds a firm raises during a given year. Moreover, the WACC at each level of funds raised is a weighted average of the marginal costs of each capital component, with the weights based on the firm’s target capital structure. Copyright Cengage Learning. Powered by Cognero.
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e. Beta measures market risk, which is generally the most relevant risk measure for a publicly-owned firm that seeks to maximize its intrinsic value. However, this is not true unless all of the firm’s stockholders are well diversified. ANSWER: d RATIONALE: Statement d is true—the WACC will increase if the firm raises more funds than can be supported by retained earnings. POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.10.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: WACC KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:30 PM DATE MODIFIED: 9/21/2017 5:30 PM 62. Which of the following statements is CORRECT? a. Since the costs of internal and external equity are related, an increase in the flotation cost required to sell a new issue of stock will increase the cost of retained earnings. b. Since its stockholders are not directly responsible for paying a corporation’s income taxes, corporations should focus on before-tax cash flows when calculating the WACC. c. An increase in a firm’s tax rate will increase the component cost of debt, provided the YTM on the firm’s bonds is not affected by the change in the tax rate. d. When the WACC is calculated, it should reflect the costs of new common stock, retained earnings, preferred stock, long-term debt, short-term bank loans if the firm normally finances with bank debt, and accounts payable if the firm normally has accounts payable on its balance sheet. e. If a firm has been suffering accounting losses that are expected to continue into the foreseeable future, and therefore its tax rate is zero, then it is possible for the after-tax cost of preferred stock to be less than the aftertax cost of debt. ANSWER: e RATIONALE: Statement e is true. The firm would get no tax savings on interest, so its cost of debt would not be reduced by the tax factor. However, corporate investors would get to deduct 70% of the preferred dividends they receive, which would make them willing to accept a lower before-tax yield on preferred stock than on bonds. Put another way, the market yield on its preferred could be lower than the interest rate on its debt because of the 70% exclusion, and with a zero tax rate, there is no reduction in the cost of debt. POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.10.00 - Comprehensive Copyright Cengage Learning. Powered by Cognero.
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NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: WACC KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:30 PM DATE MODIFIED: 9/21/2017 5:30 PM 63. Which of the following statements is CORRECT? Assume that the firm is a publicly-owned corporation and is seeking to maximize shareholder wealth. a. If a firm has a beta that is less than 1.0, say 0.9, this would suggest that the expected returns on its assets are negatively correlated with the returns on most other firms’ assets. b. If a firm’s managers want to maximize the value of the stock, they should, in theory, concentrate on project risk as measured by the standard deviation of the project’s expected future cash flows. c. If a firm evaluates all projects using the same cost of capital, and the CAPM is used to help determine that cost, then its risk as measured by beta will probably decline over time. d. Projects with above-average risk typically have higher-than-average expected returns. Therefore, to maximize a firm’s intrinsic value, its managers should favor high-beta projects over those with lower betas. e. Project A has a standard deviation of expected returns of 20%, while Project B’s standard deviation is only 10%. A’s returns are negatively correlated with both the firm’s other assets and the returns on most stocks in the economy, while B’s returns are positively correlated. Therefore, Project A is less risky to a firm and should be evaluated with a lower cost of capital. ANSWER: e RATIONALE: The fact that A’s returns are negatively correlated means that it serves as a sort of insurance policy to the firm. The fact that its SD is high is actually good, because the negative correlation will cause the project’s beta versus the market and also with the firm’s other assets to be relatively low, denoting a low risk and thus justifying a relatively low cost of capital. This answer is theoretically always true, and it is especially true if the firm is large, has many projects, and Project A is not a "bet the company" project. POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.10.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Beta and project risk KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:30 PM DATE MODIFIED: 9/21/2017 5:30 PM 64. Firm M's earnings and stock price tend to move up and down with other firms in the S&P 500, while Firm W's Copyright Cengage Learning. Powered by Cognero.
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earnings and stock price move counter cyclically with M and other S&P companies. Both M and W estimate their costs of equity using the CAPM, they have identical market values, their standard deviations of returns are identical, and they both finance only with common equity. Which of the following statements is CORRECT? a. M should have the lower WACC because it is like most other companies, and investors like that fact. b. M and W should have identical WACCs because their risks as measured by the standard deviation of returns are identical. c. If M and W merge, then the merged firm MW should have a WACC that is a simple average of M's and W's WACCs. d. Without additional information, it is impossible to predict what the merged firm's WACC would be if M and W merged. e. Since M and W move counter cyclically to one another, if they merged, the merged firm's WACC would be less than the simple average of the two firms' WACCs. ANSWER: c RATIONALE: Statement c is true. The merged firm would have a beta that is a simple average of M's and W's betas, and that would result in a cost of equity that is an average of the two firms' costs of equity. Since they are financed only with equity, their WACCs could also be averaged to find the merged firm's WACC. POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.10.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: MCC break points KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:30 PM DATE MODIFIED: 9/21/2017 5:30 PM 65. Bosio Inc.'s perpetual preferred stock sells for $85.00 per share, and it pays an $8.50 annual dividend. If the company were to sell a new preferred issue, it would incur a flotation cost of 4.00% of the price paid by investors. What is the company's cost of preferred stock for use in calculating the WACC? a. 8.75% b. 12.81% c. 11.35% d. 8.44% e. 10.42% ANSWER: e RATIONALE: Preferred stock price $85.00
Preferred dividend Flotation cost rp = Dp/(Pp(1 - F)) POINTS:
$8.50 4.00% 10.42%
1
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DIFFICULTY: EASY REFERENCES: 10-4 Cost of Preferred Stock, rp QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.10.04 - Cost of Preferred Stock, rp NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Cost of preferred KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:30 PM DATE MODIFIED: 9/21/2017 5:30 PM 66. A company’s perpetual preferred stock currently sells for $102.50 per share, and it pays an $8.00 annual dividend. If the company were to sell a new preferred issue, it would incur a flotation cost of 5.00% of the issue price. What is the firm's cost of preferred stock? a. 8.22% b. 9.28% c. 6.90% d. 9.53% e. 7.97% ANSWER: a RATIONALE: Preferred stock price $102.50
Preferred dividend Flotation cost rp = Dp/(Pp(1 - F))
$8.00 5.00% 8.22%
POINTS: 1 DIFFICULTY: EASY REFERENCES: 10-4 Cost of Preferred Stock, rp QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.10.04 - Cost of Preferred Stock, rp NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Cost of preferred KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:30 PM DATE MODIFIED: 9/21/2017 5:30 PM 67. O'Brien Inc. has the following data: rRF = 5.00%; RPM = 6.00%; and b = 0.70. What is the firm's cost of equity from retained earnings based on the CAPM? Copyright Cengage Learning. Powered by Cognero.
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a. 6.90% b. 9.02% c. 10.58% d. 11.41% e. 9.20% ANSWER: RATIONALE:
e
5.00% rRF 6.00% RPM b 0.70 rs = rRF + b(RPM) 9.20%
POINTS: 1 DIFFICULTY: EASY REFERENCES: 10-5 The Cost of Retained Earnings, rs QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.10.05 - The Cost of Retained Earnings, rs NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Cost of RE: CAPM KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:30 PM DATE MODIFIED: 9/21/2017 5:30 PM 68. Scanlon Inc.'s CFO hired you as a consultant to help her estimate the cost of capital. You have been provided with the following data: rRF = 4.10%; RPM = 5.25%; and b = 0.70. Based on the CAPM approach, what is the cost of equity from retained earnings? a. 9.25% b. 7.00% c. 8.47% d. 7.08% e. 7.78% ANSWER: e RATIONALE: 4.10% r RF
5.25% RPM b 0.70 rs = rRF + b(RPM) 7.78% POINTS: DIFFICULTY: REFERENCES: QUESTION TYPE: HAS VARIABLES:
1 EASY 10-5 The Cost of Retained Earnings, rs Multiple Choice True
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LEARNING OBJECTIVES: FOFM.BRIG.17.10.05 - The Cost of Retained Earnings, rs NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Cost of RE: CAPM KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:30 PM DATE MODIFIED: 9/21/2017 5:30 PM 69. Assume that you are a consultant to Broske Inc., and you have been provided with the following data: D1 = $0.67; P0 = $45.00; and g = 8.00% (constant). What is the cost of equity from retained earnings based on the DCF approach? a. 7.59% b. 9.49% c. 11.10% d. 10.15% e. 8.63% ANSWER: b RATIONALE: $0.67 D 1
$45.00 P0 g 8.00% rs = D1/P0 + g 9.49% POINTS: 1 DIFFICULTY: EASY REFERENCES: 10-5 The Cost of Retained Earnings, rs QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.10.05 - The Cost of Retained Earnings, rs NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Cost of RE: DCF KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:30 PM DATE MODIFIED: 9/21/2017 5:30 PM 70. Teall Development Company hired you as a consultant to help them estimate its cost of capital. You have been provided with the following data: D1 = $1.45; P0 = $19.00; and g = 6.50% (constant). Based on the DCF approach, what is the cost of equity from retained earnings? a. 10.88% b. 15.26% c. 14.41% Copyright Cengage Learning. Powered by Cognero.
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d. 13.00% e. 14.13% ANSWER: RATIONALE:
e
D1 P0 g rs = D1/P0 + g
$1.45 $19.00 6.50% 14.13%
POINTS: 1 DIFFICULTY: EASY REFERENCES: 10-5 The Cost of Retained Earnings, rs QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.10.05 - The Cost of Retained Earnings, rs NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Cost of RE: DCF KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:30 PM DATE MODIFIED: 9/21/2017 5:30 PM 71. A. Butcher Timber Company hired your consulting firm to help them estimate the cost of equity. The yield on the firm's bonds is 6.75%, and your firm's economists believe that the cost of equity can be estimated using a risk premium of 3.85% over a firm's own cost of debt. What is an estimate of the firm's cost of equity from retained earnings? a. 10.60% b. 9.54% c. 12.19% d. 12.51% e. 7.95% ANSWER: a RATIONALE: Bond yield 6.75%
Risk premium 3.85% rs = rd + Risk premium 10.60% POINTS: 1 DIFFICULTY: EASY REFERENCES: 10-5 The Cost of Retained Earnings, rs QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.10.05 - The Cost of Retained Earnings, rs NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. Copyright Cengage Learning. Powered by Cognero.
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TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
Bond-yield-plus-risk premium Bloom's: Analysis Multiple Choice: Problem 9/21/2017 5:30 PM 9/21/2017 5:30 PM
72. You were hired as a consultant to Giambono Company, whose target capital structure is 40% debt, 15% preferred, and 45% common equity. The after-tax cost of debt is 6.00%, the cost of preferred is 7.50%, and the cost of retained earnings is 12.00%. The firm will not be issuing any new stock. What is its WACC? a. 8.93% b. 7.59% c. 6.96% d. 7.68% e. 6.69% ANSWER: a Weights Costs RATIONALE: Debt Preferred Common WACC = wd × rd × (1 − T) + wp × r p + wc × rs
40% 15% 45%
6.00% 7.50% 12.00% 8.93%
POINTS: 1 DIFFICULTY: EASY REFERENCES: 10-7 Composite, or Weighted Average, Cost of Capital, WACC QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.10.07 - Composite, or Weighted Average, Cost of Capital, WACC NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: WACC KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:30 PM DATE MODIFIED: 9/21/2017 5:30 PM 73. To help finance a major expansion, Castro Chemical Company sold a noncallable bond several years ago that now has 20 years to maturity. This bond has a 9.25% annual coupon, paid semiannually, sells at a price of $1,025, and has a par value of $1,000. If the firm's tax rate is 40%, what is the component cost of debt for use in the WACC calculation? Do not round your intermediate calculations. a. 5.93% b. 5.93% c. 5.39% d. 6.09% e. 4.69% ANSWER: c RATIONALE: Coupon rate 9.25% Copyright Cengage Learning. Powered by Cognero.
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Periods/year Maturity (yr) Bond price Par value Tax rate
2 20 $1,025.00 $1,000 40%
Calculator inputs:
N = 2 × 20 PV = Bond's price PMT = Coupon rate × Par / 2 FV = Par = Maturity value
40 -$1,025.00 $46.25 $1,000 4.49% 8.98% 5.39%
Calculator output: I/YR, semiannual rate Annual rate = 2 × (I/YR) = Before-tax cost of debt After-tax cost of debt = rd(1 – T)
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 10-3 Cost of Debt rd(1 – T) QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.10.03 - Cost of Debt, rd(l – T) NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Cost of debt KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:30 PM DATE MODIFIED: 9/21/2017 5:30 PM 74. Several years ago the Jakob Company sold a $1,000 par value, noncallable bond that now has 20 years to maturity and a 7.00% annual coupon that is paid semiannually. The bond currently sells for $875, and the company’s tax rate is 40%. What is the component cost of debt for use in the WACC calculation? Do not round your intermediate calculations. a. 4.58% b. 4.97% c. 3.78% d. 4.92% e. 5.87% ANSWER: b RATIONALE: Coupon rate 7.00%
Periods/year Maturity (yr) Bond price Par value Tax rate
2 20 $875.00 $1,000 40%
Calculator inputs:
N = 2 × 20 Copyright Cengage Learning. Powered by Cognero.
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PV = Bond's price PMT = Coupon rate × Par / 2 FV = Par = Maturity value I/YR Times periods/yr = before-tax cost of debt After-tax cost of debt = rd(1 – T)
-$875.00 $35 $1,000 4.15% 8.29% 4.97%
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 10-3 Cost of Debt rd(1 – T) QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.10.03 - Cost of Debt, rd(l – T) NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Cost of debt KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:30 PM DATE MODIFIED: 9/21/2017 5:30 PM 75. Assume that Kish Inc. hired you as a consultant to help estimate its cost of capital. You have obtained the following data: D0 = $0.90; P0 = $47.50; and g = 7.00% (constant). Based on the DCF approach, what is the cost of equity from retained earnings? Do not round your intermediate calculations. a. 8.85% b. 10.38% c. 10.02% d. 8.03% e. 9.03% ANSWER: e RATIONALE: $0.90 D 0
P0 g D1 = D0 × (1 + g) rs = D1/P0 + g
$47.50 7.00% $0.963 9.03%
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 10-5 The Cost of Retained Earnings, rs QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.10.05 - The Cost of Retained Earnings, rs NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business Copyright Cengage Learning. Powered by Cognero.
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TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
School Outcomes, you do not need to include anything for this category. Cost of RE: DCF Bloom's: Analysis Multiple Choice: Problem 9/21/2017 5:30 PM 9/21/2017 5:30 PM
76. Rivoli Inc. hired you as a consultant to help estimate its cost of capital. You have been provided with the following data: D0 = $0.80; P0 = $57.50; and g = 8.00% (constant). Based on the DCF approach, what is the cost of equity from retained earnings? Do not round your intermediate calculations. a. 11.02% b. 10.17% c. 9.50% d. 10.07% e. 7.98% ANSWER: c RATIONALE: $0.80 D 0
P0 g D1 = D0 × (1 + g) rs = D1/P0 + g
$57.50 8.00% $0.864 9.50%
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 10-5 The Cost of Retained Earnings, rs QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.10.05 - The Cost of Retained Earnings, rs NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Cost of RE: DCF KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:30 PM DATE MODIFIED: 9/21/2017 5:30 PM 77. Trahan Lumber Company hired you to help estimate its cost of capital. You obtained the following data: D1 = $1.25; P0 = $22.50; g = 5.00% (constant); and F = 6.00%. What is the cost of equity raised by selling new common stock? a. 8.84% b. 10.91% c. 11.78% d. 10.58% e. 11.35% ANSWER: b Copyright Cengage Learning. Powered by Cognero.
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RATIONALE:
D1 P0 g F re = D1/(P0 × (1 - F)) + g =
$1.25 $22.50 5.00% 6.00% 10.91%
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 10-6 Cost of New Common Stock, re QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.10.06 - Cost of New Common Stock, re NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Cost of new common stock based on DCF, D1 KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:30 PM DATE MODIFIED: 9/21/2017 5:30 PM 78. You were recently hired by Scheuer Media Inc. to estimate its cost of capital. You obtained the following data: D1 = $1.75; P0 = $115.00; g = 7.00% (constant); and F = 5.00%. What is the cost of equity raised by selling new common stock? a. 9.98% b. 10.49% c. 8.52% d. 8.60% e. 7.05% ANSWER: d RATIONALE: $1.75 D 1
P0 g F re = D1/(P0 × (1 - F)) + g
$115.00 7.00% 5.00% 8.60%
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 10-6 Cost of New Common Stock, re QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.10.06 - Cost of New Common Stock, re NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. Copyright Cengage Learning. Powered by Cognero.
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TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
Cost of new common stock based on DCF, D1 Bloom's: Analysis Multiple Choice: Problem 9/21/2017 5:30 PM 9/21/2017 5:30 PM
79. Weaver Chocolate Co. expects to earn $3.50 per share during the current year, its expected dividend payout ratio is 65%, its expected constant dividend growth rate is 6.0%, and its common stock currently sells for $30.00 per share. New stock can be sold to the public at the current price, but a flotation cost of 5% would be incurred. What would be the cost of equity from new common stock? Do not round your intermediate calculations. a. 13.98% b. 16.36% c. 13.70% d. 11.33% e. 11.47% ANSWER: a RATIONALE: $3.50 Expected EPS 1
Payout ratio Expected dividend, D1 = EPS × Payout Current stock price g F re = D1/(P0 × (1 - F)) + g
65% $2.275 $30.00 6.00% 5.00% 13.98%
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 10-6 Cost of New Common Stock, re QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.10.06 - Cost of New Common Stock, re NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Cost of new common KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:30 PM DATE MODIFIED: 9/21/2017 5:30 PM 80. Sorensen Systems Inc. is expected to pay a $2.50 dividend at year end (D1 = $2.50), the dividend is expected to grow at a constant rate of 5.50% a year, and the common stock currently sells for $37.50 a share. The before-tax cost of debt is 7.50%, and the tax rate is 40%. The target capital structure consists of 45% debt and 55% common equity. What is the company’s WACC if all the equity used is from retained earnings? Do not round your intermediate calculations. a. 9.41% b. 8.72% c. 7.58% Copyright Cengage Learning. Powered by Cognero.
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d. 9.94% e. 8.80% ANSWER: RATIONALE:
b
D1 g P0 rd Tax rate Weight debt Weight equity rd(1 - T) rs = D1/P0 + g WACC = wd (rd)(1 - T) + wc (rs) =
$2.50 5.50% $37.50 7.50% 40% 45% 55% 4.50% 12.17% 8.72%
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 10-7 Composite, or Weighted Average, Cost of Capital, WACC QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.10.07 - Composite, or Weighted Average, Cost of Capital, WACC NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: WACC KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:30 PM DATE MODIFIED: 9/21/2017 5:30 PM 81. You were hired as a consultant to Quigley Company, whose target capital structure is 35% debt, 10% preferred, and 55% common equity. The interest rate on new debt is 6.50%, the yield on the preferred is 6.00%, the cost of retained earnings is 14.75%, and the tax rate is 40%. The firm will not be issuing any new stock. What is Quigley's WACC? Round final answer to two decimal places. Do not round your intermediate calculations. a. 12.19% b. 8.36% c. 9.17% d. 10.08% e. 8.87% ANSWER: d RATIONALE: Tax rate = 40%
Debt Preferred Common WACC Copyright Cengage Learning. Powered by Cognero.
Weights 35% 10% 55% 100%
BT Costs AT Costs 6.50% 3.90% 6.00% 6.00% 14.75% 14.75%
Product 1.365% 0.60% 8.1125% 10.08% Page 610
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 10-7 Composite, or Weighted Average, Cost of Capital, WACC QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.10.07 - Composite, or Weighted Average, Cost of Capital, WACC NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: WACC and target cap. struc. KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:30 PM DATE MODIFIED: 9/21/2017 5:30 PM 82. Keys Printing plans to issue a $1,000 par value, 20-year noncallable bond with a 7.00% annual coupon, paid semiannually. The company's marginal tax rate is 40.00%, but Congress is considering a change in the corporate tax rate to 45.00%. By how much would the component cost of debt used to calculate the WACC change if the new tax rate was adopted? Do not round your intermediate calculations. a. –0.36% b. –0.42% c. –0.44% d. –0.30% e. –0.35% ANSWER: e RATIONALE: Tax Rate
Coupon rate Periods/year Maturity (yr) Bond price = Par value Old and New tax rates
Old rate, 40.00% 7.00% 2 20 $1,000.00 40.00%
New rate, 45.00% 7.00% 2 20 $1,000.00 45.00%
Calculator inputs:
N = 2 × 20 PV = Bond's price PMT = Coupon rate × Par / 2 FV = Par = Maturity value I/YR Times periods/yr = before-tax cost of debt After-tax cost of debt = rd(1 – T) Copyright Cengage Learning. Powered by Cognero.
40 -$1,000.00 $35.00 $1,000 3.50% 7.00% 4.20%
40 -$1,000.00 $35.00 $1,000 3.50% 7.00% 3.85% Page 611
Difference = Cost at new rate - Cost at old rate =
–0.35%
POINTS: 1 DIFFICULTY: MODERATE/CHALLENGING REFERENCES: 10-3 Cost of Debt rd(1 – T) QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.10.03 - Cost of Debt, rd(l – T) NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Taxes and cost of debt KEYWORDS: Bloom's: Evaluation OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:30 PM DATE MODIFIED: 9/21/2017 5:30 PM 83. S. Bouchard and Company hired you as a consultant to help estimate its cost of capital. You have obtained the following data: D0 = $0.85; P0 = $22.00; and g = 6.00% (constant). The CEO thinks, however, that the stock price is temporarily depressed, and that it will soon rise to $34.00. Based on the DCF approach, by how much would the cost of equity from retained earnings change if the stock price changes as the CEO expects? Do not round your intermediate calculations. a. –1.45% b. –1.72% c. –1.11% d. –1.40% e. –1.36% ANSWER: a RATIONALE: Old Price New Price
D0 P0 g D1 = D0 x (1 + g) rs = D1/P0 + g Difference, rs1 - rs0
$0.85 $22.00 6.00% $0.901 10.10% –1.45%
$0.85 $34.00 6.00% $0.901 8.65%
POINTS: 1 DIFFICULTY: MODERATE/CHALLENGING REFERENCES: 10-5 The Cost of Retained Earnings, rs QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.10.05 - The Cost of Retained Earnings, rs NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital Copyright Cengage Learning. Powered by Cognero.
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LOCAL STANDARDS: TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. Cost of RE: DCF Bloom's: Evaluation Multiple Choice: Problem 9/21/2017 5:30 PM 9/21/2017 5:30 PM
84. Sapp Trucking’s balance sheet shows a total of noncallable $45 million long-term debt with a coupon rate of 7.00% and a yield to maturity of 6.00%. This debt currently has a market value of $50 million. The balance sheet also shows that the company has 10 million shares of common stock, and the book value of the common equity (common stock plus retained earnings) is $65 million. The current stock price is $22.50 per share; stockholders' required return, rs, is 14.00%; and the firm's tax rate is 40%. The CFO thinks the WACC should be based on market value weights, but the president thinks book weights are more appropriate. What is the difference between these two WACCs? a. 2.48% b. 2.25% c. 2.36% d. 2.95% e. 1.77% ANSWER: c RATIONALE: $22.50 P0 Shares outstanding (millions) bond coupon rate (not used) YTM = rd rs Tax rate BV debt (millions) BV equity (millions) MV debt (millions) MV equity (millions) = # sh × P0 = AT cost of debt = rd(1 − T)
Debt Equity Total
Debt Equity Total
10 7.00% 6.00% 14.00% 40% $45.00 $65.00 $50.00 $225.00 3.60%
Book-value weights—WRONG!!! Capital Weights Cost rates $45.00 40.91% 3.60% $65.00 59.09% 14.00% $110.00 100.00% WACC =
Product 1.47% 8.27% 9.75%
Market-value weights—RIGHT!!! Capital Weights Cost rates $50.00 18.18% 3.60% $225.00 81.82% 14.00% $275.00 100.00% WACC = Difference =
Product 0.65% 11.45% 12.11% 2.36%
POINTS: 1 DIFFICULTY: MODERATE/CHALLENGING REFERENCES: 10-7 Composite, or Weighted Average, Cost of Capital, WACC QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.10.07 - Composite, or Weighted Average, Cost of Capital, WACC NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic Copyright Cengage Learning. Powered by Cognero.
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STATE STANDARDS: LOCAL STANDARDS: TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. WACC and market cap. struc. Bloom's: Evaluation Multiple Choice: Problem 9/21/2017 5:30 PM 9/21/2017 5:30 PM
85. The CFO of Lenox Industries hired you as a consultant to help estimate its cost of capital. You have obtained the following data: (1) rd = yield on the firm’s bonds = 7.00% and the risk premium over its own debt cost = 4.00%. (2) rRF = 5.00%, RPM = 6.00%, and b = 1.50. (3) D1 = $1.20, P0 = $35.00, and g = 8.00% (constant). You were asked to estimate the cost of equity based on the three most commonly used methods and then to indicate the difference between the highest and lowest of these estimates. What is that difference? a. 3.00% b. 3.54% c. 2.61% d. 3.72% e. 2.67% ANSWER: a RATIONALE: Bond yield 7.00%
Risk premium rs
4.00% 11.00%
rRF RPM b rs
5.00% 6.00% 1.50 14.00%
D1 P0 g rs
$1.20 $35.00 8.00% 11.43%
Max Min Difference
14.00% 11.00% 3.00%
POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 10-5 The Cost of Retained Earnings, rs QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.10.05 - The Cost of Retained Earnings, rs NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business Copyright Cengage Learning. Powered by Cognero.
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TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
School Outcomes, you do not need to include anything for this category. Risk premium, CAPM, and DCF Bloom's: Evaluation Multiple Choice: Problem 9/21/2017 5:30 PM 9/21/2017 5:30 PM
86. Eakins Inc.’s common stock currently sells for $15.00 per share, the company expects to earn $2.75 per share during the current year, its expected payout ratio is 70%, and its expected constant growth rate is 6.00%. New stock can be sold to the public at the current price, but a flotation cost of 8% would be incurred. By how much would the cost of new stock exceed the cost of retained earnings? Do not round your intermediate calculations. a. 0.78% b. 1.12% c. 0.67% d. 1.45% e. 0.89% ANSWER: b RATIONALE: $2.75 Expected EPS 1
Payout ratio Current stk price g F D1 rs = D1/P0 + g re = D1/(P0 × (1 - F)) + g Difference = re - rs
70% $15.00 6.00% 8.00% $1.925 18.83% 19.95% 1.12%
POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 10-6 Cost of New Common Stock, re QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.10.06 - Cost of New Common Stock, re NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Cost of new common equity (internal equity) vs. cost of new common stock (external equity) KEYWORDS: Bloom's: Evaluation OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:30 PM DATE MODIFIED: 9/21/2017 5:30 PM 87. Bolster Foods’ (BF) balance sheet shows a total of $25 million long-term debt with a coupon rate of 8.50%. The yield to maturity on this debt is 8.00%, and the debt has a total current market value of $27 million. The balance sheet also shows that the company has 10 million shares of stock, and the stock has a book value per share of $5.00. The current stock price is $20.00 per share, and stockholders' required rate of return, rs, is 12.00%. The company recently decided that Copyright Cengage Learning. Powered by Cognero.
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its target capital structure should have 35% debt, with the balance being common equity. The tax rate is 40%. Calculate WACCs based on book, market, and target capital structures, and then find the sum of these three WACCs. Do not round your intermediate calculations. a. 27.81% b. 26.60% c. 36.27% d. 24.78% e. 30.22% ANSWER: e RATIONALE: Tax rate Target wd Target wce Coupon rate YTM = rd rd(1 − T) rs Number of shares (millions)
40% 35.00% 65.00% 8.50% 8.00% 4.80% 12.00% 10
Price per share $20.00 BV per share $5.00 Book equity = BV/sh × No. Shs (millions) $50.00 $200.00 Market equity = P0 × No. Shs (millions) Book value of debt (millions) $25.00 Market value of debt (millions) $27.00 BOOK-VALUE WEIGHTS Capital Weights Cost rates Debt $25.00 33.33% 4.80% Equity $50.00 66.67% 12.00% Total capital $75.00 100.00% WACC =
Product 1.60% 8.00% 9.60%
Debt Equity Total capital
Capital $27.00 $200.00 $227.00
MARKET-VALUE WEIGHTS Weights Cost rates 11.89% 4.80% 88.11% 12.00% 100.00% WACC =
Product 0.57% 10.57% 11.14%
Debt Equity Total capital
Capital NA NA NA
TARGET WEIGHTS Weights Cost rates 35.00% 4.80% 65.00% 12.00% 100.00% WACC =
Product 1.68% 7.80% 9.48%
Sum of the 3 WACCs =
30.22%
POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 10-7 Composite, or Weighted Average, Cost of Capital, WACC QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.10.07 - Composite, or Weighted Average, Cost of Capital, WACC NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business Copyright Cengage Learning. Powered by Cognero.
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TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
School Outcomes, you do not need to include anything for this category. WACC and capital structure Bloom's: Analysis Multiple Choice: Problem 9/21/2017 5:30 PM 9/21/2017 5:30 PM
88. Daves Inc. recently hired you as a consultant to estimate the company’s WACC. You have obtained the following information. (1) The firm's noncallable bonds mature in 20 years, have an 8.00% annual coupon, a par value of $1,000, and a market price of $1,225.00. (2) The company’s tax rate is 40%. (3) The risk-free rate is 4.50%, the market risk premium is 5.50%, and the stock’s beta is 1.20. (4) The target capital structure consists of 35% debt and the balance is common equity. The firm uses the CAPM to estimate the cost of equity, and it does not expect to issue any new common stock. What is its WACC? Do not round your intermediate calculations. a. 8.48% b. 10.01% c. 7.80% d. 6.79% e. 7.63% ANSWER: a RATIONALE: Coupon rate 8.00%
Maturity Bond price Par value Tax rate rRF RPM b Weight debt Weight equity Bond yield After-tax cost of debt = rd(1 – T) Cost of equity, rs = rRF + b(RPM) WACC = wd (rd)(1 - T) + wc (rs) =
20 $1,225.00 $1,000 40% 4.50% 5.50% 1.20 35% 65% 6.03% 3.62% 11.10% 8.48%
POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 10-7 Composite, or Weighted Average, Cost of Capital, WACC QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.10.07 - Composite, or Weighted Average, Cost of Capital, WACC NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: WACC and equity from RE KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem Copyright Cengage Learning. Powered by Cognero.
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DATE CREATED: DATE MODIFIED:
9/21/2017 5:30 PM 9/21/2017 5:30 PM
89. Assume that you are on the financial staff of Vanderheiden Inc., and you have collected the following data: The yield on the company’s outstanding bonds is 7.75%, its tax rate is 40%, the next expected dividend is $0.65 a share, the dividend is expected to grow at a constant rate of 6.00% a year, the price of the stock is $17.00 per share, the flotation cost for selling new shares is F = 10%, and the target capital structure is 45% debt and 55% common equity. What is the firm's WACC, assuming it must issue new stock to finance its capital budget? a. 9.51% b. 6.65% c. 6.18% d. 5.80% e. 7.73% ANSWER: e RATIONALE: YTM 7.75%
Tax rate D1 g P0 F Weight debt Weight equity
40% $0.65 6.00% $17.00 10.00% 45% 55%
After-tax cost of debt = rd(1 – T)
4.65%
re = D1/(P0 × (1 - F)) + g
10.25% 7.73%
WACC = wd (rd)(1 - T) + wc (rs) =
POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 10-7 Composite, or Weighted Average, Cost of Capital, WACC QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.10.07 - Composite, or Weighted Average, Cost of Capital, WACC NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: WACC and equity from RE KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:30 PM DATE MODIFIED: 9/21/2017 5:30 PM 90. Vang Enterprises, which is debt-free and finances only with equity from retained earnings, is considering 7 equalsized capital budgeting projects. Its CFO hired you to assist in deciding whether none, some, or all of the projects should be accepted. You have the following information: rRF = 4.50%; RPM = 5.50%; and b = 0.98. The company adds or subtracts a specified percentage to the corporate WACC when it evaluates projects that have above- or below-average risk. Data on the 7 projects are shown below. If these are the only projects under consideration, how large should the capital budget be? Copyright Cengage Learning. Powered by Cognero.
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Project 1 2 3 4 5 6 7
Expected return 7.60% 9.15% 10.10% 10.40% 10.80% 10.90% 13.00%
Risk Risk factor Very low -2.00% Low -1.00% Average 0.00% High 1.00% Very high 2.00% Very high 2.00% Very high 2.00%
a. $100 million b. $125 million c. $25 million d. $50 million e. $75 million ANSWER: RATIONALE:
Cost (millions) $25 $25 $25 $25 $25 $25 $25
e
rRF RPM b Cost of equity, rs = rRF + b(RPM) Project cost of capital = rs + factor Projects' cost Project 1 2 3 4 5 6 7
Risk Adder -2.00% -1.00% 0.00% 1.00% 2.00% 2.00% 2.00%
Cap cost 7.89% 8.89% 9.89% 10.89% 11.89% 11.89% 11.89%
4.50% 5.50% 0.98 9.89% varies $25.00 Exp. return 7.60% 9.15% 10.10% 10.40% 10.80% 10.90% 13.00% Total capital budget:
Amt Invested $0 $25 $25 $0 $0 $0 $25 $75
POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 10-9 Adjusting the Cost of Capital for Risk QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES FOFM.BRIG.17.10.09 - Adjusting the Cost of Capital for Risk : NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: LOCAL STANDARDS:
United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category.
Copyright Cengage Learning. Powered by Cognero.
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TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
Project risk Bloom's: Evaluation Multiple Choice: Problem 9/21/2017 5:30 PM 9/21/2017 5:30 PM
Exhibit 10.1 Assume that you have been hired as a consultant by CGT, a major producer of chemicals and plastics, including plastic grocery bags, styrofoam cups, and fertilizers, to estimate the firm's weighted average cost of capital. The balance sheet and some other information are provided below. Assets Current assets Net plant, property, and equipment Total assets
$38,000,000 $101,000,000 $139,000,000
Liabilities and Equity Accounts payable $10,000,000 Accruals $9,000,000 Current liabilities $19,000,000 Long-term debt (40,000 bonds, $1,000 par value) $40,000,000 Total liabilities $59,000,000 Common stock (10,000,000 shares) $30,000,000 Retained earnings $50,000,000 Total shareholders' equity $80,000,000 Total liabilities and shareholders' equity $139,000,000 The stock is currently selling for $17.75 per share, and its noncallable $3,319.97 par value, 20-year, 1.70% bonds with semiannual payments are selling for $881.00. The beta is 1.29, the yield on a 6-month Treasury bill is 3.50%, and the yield on a 20-year Treasury bond is 5.50%. The required return on the stock market is 11.50%, but the market has had an average annual return of 14.50% during the past 5 years. The firm's tax rate is 40%. 91. Refer to Exhibit 10.1. What is the best estimate of the after-tax cost of debt? a. 5.62% b. 6.07% c. 6.39% d. 6.77% e. 7.11% ANSWER: c RATIONALE:
Coupon rate Periods/year Maturity (yr) Bond price Par value Tax rate
1.70% 2 20 $881.00 $3,319.97 40%
Calculator inputs: N = 2 × Years = PV = -Bond Price = PMT = (Coupon rate × Par)/2 = FV = Par value = Yield = I/YR, which we solve for =
40 -$881.00 $28.27 $3,319.97 5.33%
Before-tax cost of debt = rd = yield × 2 10.65% = After-tax cost of debt = rd(1 - T) = POINTS:
6.39%
1
Copyright Cengage Learning. Powered by Cognero.
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DIFFICULTY: MODERATE REFERENCES: 10-2 Basic Definitions QUESTION TYPE: Multiple Choice HAS VARIABLES: True PREFACE NAME: Balance Sheet LEARNING OBJECTIVES: FOFM.BRIG.17.10.02 - Basic Definitions NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital TOPICS: After-tax cost of debt KEYWORDS: Bloom’s: Application OTHER: Multiple Choice: Multiple Parts DATE CREATED: 9/21/2017 5:30 PM DATE MODIFIED: 9/21/2017 5:30 PM 92. Refer to Exhibit 10.1. Based on the CAPM, what is the firm's cost of equity? a. 11.78% b. 12.18% c. 12.84% d. 13.24% e. 13.50% ANSWER: d RATIONALE: 5.50% r RF
Expected rM RPM = rM - rRF = b rs = rRF + b(RPM)
11.50% 6.00% 1.29 13.24%
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 10-5 The Cost of Retained Earnings, rs QUESTION TYPE: Multiple Choice HAS VARIABLES: True PREFACE NAME: Balance Sheet LEARNING OBJECTIVES: FOFM.BRIG.17.10.05 - The Cost of Retained Earnings, rs NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital TOPICS: CAPM cost of equity KEYWORDS: Bloom’s: Application OTHER: Multiple Choice: Multiple Parts DATE CREATED: 9/21/2017 5:30 PM DATE MODIFIED: 9/21/2017 5:30 PM 93. Refer to Exhibit 10.1. Which of the following is the best estimate for the weight of debt for use in calculating the WACC? Do not round your intermediate calculations. a. 16.56% Copyright Cengage Learning. Powered by Cognero.
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b. 17.23% c. 17.57% d. 17.92% e. 18.64% ANSWER: RATIONALE:
a
Bond price Number of bonds MV of debt = D Stock price = P0 Shares outstanding MV of equity = E Total MV = D + E Weight debt = wd = D/Total MV
$881.00 40,000 $35,240,000 $17.75 10,000,000 $177,500,000 $212,740,000 16.56%
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 10-7 Composite, or Weighted Average, Cost of Capital, WACC QUESTION TYPE: Multiple Choice HAS VARIABLES: True PREFACE NAME: Balance Sheet LEARNING OBJECTIVES: FOFM.BRIG.17.10.07 - Composite, or Weighted Average, Cost of Capital, WACC NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital TOPICS: Weights for WACC KEYWORDS: Bloom’s: Application OTHER: Multiple Choice: Multiple Parts DATE CREATED: 9/21/2017 5:30 PM DATE MODIFIED: 9/21/2017 5:30 PM 94. Refer to Exhibit 10.1. What is the best estimate of the firm's WACC? Do not round your intermediate calculations. a. 11.26% b. 11.74% c. 12.11% d. 12.59% e. 12.97% ANSWER: c RATIONALE: 16.56% w d
rd(1 - T) wc = 100.00% - wd = rs WACC = wd(rd)(1 - T) + wc(rs) = POINTS: DIFFICULTY: REFERENCES: QUESTION TYPE:
6.39% 83.44% 13.24% 12.11%
1 MODERATE 10-7 Composite, or Weighted Average, Cost of Capital, WACC Multiple Choice
Copyright Cengage Learning. Powered by Cognero.
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HAS VARIABLES: True PREFACE NAME: Balance Sheet LEARNING OBJECTIVES: FOFM.BRIG.17.10.07 - Composite, or Weighted Average, Cost of Capital, WACC NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital TOPICS: WACC KEYWORDS: Bloom’s: Application OTHER: Multiple Choice: Multiple Parts DATE CREATED: 9/21/2017 5:30 PM DATE MODIFIED: 9/21/2017 5:30 PM
1. A firm should never accept a project if its acceptance would lead to an increase in the firm's cost of capital (its WACC). a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 11-1 An Overview of Capital Budgeting QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.11.01 - An Overview of Capital Budgeting NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Capital budget KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:31 PM DATE MODIFIED: 9/21/2017 5:31 PM 2. Because "present value" refers to the value of cash flows that occur at different points in time, a series of present values of cash flows should not be summed to determine the value of a capital budgeting project. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 11-2 Net Present Value (NPV) QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.11.02 - Net Present Value (NPV) NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. Copyright Cengage Learning. Powered by Cognero.
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TOPICS: KEYWORDS: DATE CREATED: DATE MODIFIED:
PV of cash flows Bloom's: Knowledge 9/21/2017 5:31 PM 9/21/2017 5:31 PM
3. Assuming that their NPVs based on the firm's cost of capital are equal, the NPV of a project whose cash flows accrue relatively rapidly will be more sensitive to changes in the discount rate than the NPV of a project whose cash flows come in later in its life. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 11-2 Net Present Value (NPV) QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.11.02 - Net Present Value (NPV) NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: NPV KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:31 PM DATE MODIFIED: 9/21/2017 5:31 PM 4. A basic rule in capital budgeting is that if a project's NPV exceeds its IRR, then the project should be accepted. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 11-2 Net Present Value (NPV) QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.11.02 - Net Present Value (NPV) NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: NPV KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:31 PM DATE MODIFIED: 9/21/2017 5:31 PM 5. Conflicts between two mutually exclusive projects occasionally occur, where the NPV method ranks one project higher Copyright Cengage Learning. Powered by Cognero.
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but the IRR method puts the other one first. In theory, such conflicts should be resolved in favor of the project with the higher NPV. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 11-2 Net Present Value (NPV) QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.11.02 - Net Present Value (NPV) NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Mutually exclusive projects KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:31 PM DATE MODIFIED: 9/21/2017 5:31 PM 6. Conflicts between two mutually exclusive projects occasionally occur, where the NPV method ranks one project higher but the IRR method puts the other one first. In theory, such conflicts should be resolved in favor of the project with the higher IRR. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 11-2 Net Present Value (NPV) QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.11.02 - Net Present Value (NPV) NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Mutually exclusive projects KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:31 PM DATE MODIFIED: 9/21/2017 5:31 PM 7. The internal rate of return is that discount rate that equates the present value of the cash outflows (or costs) with the present value of the cash inflows. a. True b. False ANSWER: True Copyright Cengage Learning. Powered by Cognero.
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POINTS: 1 DIFFICULTY: EASY REFERENCES: 11-3 Internal Rate of Return (IRR) QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.11.03 - Internal Rate of Return (IRR) NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: IRR KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:31 PM DATE MODIFIED: 9/21/2017 5:31 PM 8. Other things held constant, an increase in the cost of capital will result in a decrease in a project's IRR. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 11-3 Internal Rate of Return (IRR) QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.11.03 - Internal Rate of Return (IRR) NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: IRR KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:31 PM DATE MODIFIED: 9/21/2017 5:31 PM 9. Under certain conditions, a project may have more than one IRR. One such condition is when, in addition to the initial investment at time = 0, a negative cash flow (or cost) occurs at the end of the project's life. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 11-4 Multiple Internal Rates of Return QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.11.04 - Multiple Internal Rates of Return NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking Copyright Cengage Learning. Powered by Cognero.
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STATE STANDARDS: LOCAL STANDARDS: TOPICS: KEYWORDS: DATE CREATED: DATE MODIFIED:
United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. Multiple IRRs Bloom's: Knowledge 9/21/2017 5:31 PM 9/21/2017 5:31 PM
10. The phenomenon called "multiple internal rates of return" arises when two or more mutually exclusive projects that have different lives are being compared. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 11-4 Multiple Internal Rates of Return QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.11.04 - Multiple Internal Rates of Return NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Multiple IRRs KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:31 PM DATE MODIFIED: 9/21/2017 5:31 PM 11. The NPV method is based on the assumption that projects' cash flows are reinvested at the project's risk-adjusted cost of capital. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 11-5 Reinvestment Rate Assumptions QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.11.05 - Reinvestment Rate Assumptions NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Reinvestment rate assumption KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:31 PM Copyright Cengage Learning. Powered by Cognero.
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DATE MODIFIED:
9/21/2017 5:31 PM
12. The IRR method is based on the assumption that projects' cash flows are reinvested at the project's risk-adjusted cost of capital. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 11-5 Reinvestment Rate Assumptions QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.11.05 - Reinvestment Rate Assumptions NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Reinvestment rate assumption KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:31 PM DATE MODIFIED: 9/21/2017 5:31 PM 13. The NPV method's assumption that cash inflows are reinvested at the cost of capital is generally more reasonable than the IRR's assumption that cash flows are reinvested at the IRR. This is an important reason why the NPV method is generally preferred over the IRR method. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 11-5 Reinvestment Rate Assumptions QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.11.05 - Reinvestment Rate Assumptions NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Reinvestment rate assumption KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:31 PM DATE MODIFIED: 9/21/2017 5:31 PM 14. For a project with one initial cash outflow followed by a series of positive cash inflows, the modified IRR (MIRR) method involves compounding the cash inflows out to the end of the project's life, summing those compounded cash flows to form a terminal value (TV), and then finding the discount rate that causes the PV of the TV to equal the project's cost. a. True Copyright Cengage Learning. Powered by Cognero.
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b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 11-6 Modified Internal Rate of Return (MIRR) QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.11.06 - Modified Internal Rate of Return (MIRR) NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Modified IRR KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:31 PM DATE MODIFIED: 9/21/2017 5:31 PM 15. Both the regular and the modified IRR (MIRR) methods have wide appeal to professors, but most business executives prefer the NPV method to either of the IRR methods. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 11-6 Modified Internal Rate of Return (MIRR) QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.11.06 - Modified Internal Rate of Return (MIRR) NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Modified IRR KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:31 PM DATE MODIFIED: 9/21/2017 5:31 PM 16. When evaluating mutually exclusive projects, the modified IRR (MIRR) always leads to the same capital budgeting decisions as the NPV method, regardless of the relative lives or sizes of the projects being evaluated. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 11-6 Modified Internal Rate of Return (MIRR) QUESTION TYPE: True / False Copyright Cengage Learning. Powered by Cognero.
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HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.11.06 - Modified Internal Rate of Return (MIRR) NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Modified IRR KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:31 PM DATE MODIFIED: 9/21/2017 5:31 PM 17. One advantage of the payback method for evaluating potential investments is that it provides information about a project's liquidity and risk. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 11-8 Payback Period QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.11.08 - Payback Period NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Payback period KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:31 PM DATE MODIFIED: 9/21/2017 5:31 PM 18. When considering two mutually exclusive projects, the firm should always select the project whose internal rate of return is the highest, provided the projects have the same initial cost. This statement is true regardless of whether the projects can be repeated or not. a. True b. False ANSWER: False RATIONALE: Think about the following equally risky projects. The cost of capital is WACC = 10% 0 1 2 3 4 5 6 S -1000.00 1400.00 L -1000.00 378.34 378.34 378.34 378.34 378.34 378.34 IRRS = IRRL =
40.0% 30.0%
NPVS = NPVL =
$272.73 $647.77
S has the higher IRR, but L has a much higher NPV and is therefore preferable. If the project could be repeated, though, S would turn out to be better—it would have both a higher NPV and IRR. Copyright Cengage Learning. Powered by Cognero.
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POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 11-2 Net Present Value (NPV) QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.11.02 - Net Present Value (NPV) NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Mutually exclusive projects KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:31 PM DATE MODIFIED: 9/21/2017 5:31 PM 19. The primary reason that the NPV method is conceptually superior to the IRR method for evaluating mutually exclusive investments is that multiple IRRs may exist, and when that happens, we don't know which IRR is relevant. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 11-5 Reinvestment Rate Assumptions QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.11.05 - Reinvestment Rate Assumptions NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: NPV and IRR KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:31 PM DATE MODIFIED: 9/21/2017 5:31 PM 20. The NPV and IRR methods, when used to evaluate two independent and equally risky projects, will lead to different accept/reject decisions and thus capital budgets if the projects' IRRs are greater than their costs of capital. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 11-5 Reinvestment Rate Assumptions QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.11.05 - Reinvestment Rate Assumptions Copyright Cengage Learning. Powered by Cognero.
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NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: NPV and IRR KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:31 PM DATE MODIFIED: 9/21/2017 5:31 PM 21. The NPV and IRR methods, when used to evaluate two equally risky but mutually exclusive projects, will lead to different accept/reject decisions and thus capital budgets if the cost of capital at which the projects' NPV profiles cross is greater than the crossover rate. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 11-7 NPV Profiles QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.11.07 - NPV Profiles NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: NPV profiles KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:31 PM DATE MODIFIED: 9/21/2017 5:31 PM 22. A conflict will exist between the NPV and IRR methods, when used to evaluate two equally risky but mutually exclusive projects, if the projects' cost of capital is less than the rate at which the projects' NPV profiles cross. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 11-7 NPV Profiles QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.11.07 - NPV Profiles NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: NPV profiles Copyright Cengage Learning. Powered by Cognero.
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KEYWORDS: DATE CREATED: DATE MODIFIED:
Bloom's: Comprehension 9/21/2017 5:31 PM 9/21/2017 5:31 PM
23. Project S has a pattern of high cash flows in its early life, while Project L has a longer life, with large cash flows late in its life. Neither has negative cash flows after Year 0, and at the current cost of capital, the two projects have identical NPVs. Now suppose interest rates and money costs decline. Other things held constant, this change will cause L to become preferred to S. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 11-7 NPV Profiles QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.11.07 - NPV Profiles NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: NPV profiles KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:31 PM DATE MODIFIED: 9/21/2017 5:31 PM 24. The regular payback method is deficient in that it does not take account of cash flows beyond the payback period. The discounted payback method corrects this fault. a. True b. False ANSWER: False RATIONALE: The discounted payback corrects the fault of not considering the timing of cash flows, but it does not account for after-payback cash flows. POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 11-8 Payback Period QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.11.08 - Payback Period NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Discounted payback KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:31 PM Copyright Cengage Learning. Powered by Cognero.
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25. In theory, capital budgeting decisions should depend solely on forecasted cash flows and the opportunity cost of capital. The decision criterion should not be affected by managers' tastes, choice of accounting method, or the profitability of other independent projects. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 11-9 Conclusions on Capital Budgeting Methods QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.11.09 - Conclusions on Capital Budgeting Methods NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Ranking methods KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:31 PM DATE MODIFIED: 9/21/2017 5:31 PM 26. If you were evaluating two mutually exclusive projects for a firm with a zero cost of capital, the payback method and NPV method would always lead to the same decision on which project to undertake. a. True b. False ANSWER: False RATIONALE: One project might have cash flows that extend well past the payback year, leading to different rankings. POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 11-9 Conclusions on Capital Budgeting Methods QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.11.09 - Conclusions on Capital Budgeting Methods NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Ranking methods KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:31 PM DATE MODIFIED: 9/21/2017 5:31 PM 27. Small businesses make less use of DCF capital budgeting techniques than large businesses. This may reflect a lack of knowledge on the part of small firms' managers, but it may also reflect a rational conclusion that the costs of using DCF Copyright Cengage Learning. Powered by Cognero.
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analysis outweigh the benefits of these methods for very small firms. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 11-10 Decision Criteria Used in Practice QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.11.10 - Decision Criteria Used in Practice NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Small business practices KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:31 PM DATE MODIFIED: 9/21/2017 5:31 PM 28. An increase in the firm's WACC will decrease projects' NPVs, which could change the accept/reject decision for any potential project. However, such a change would have no impact on projects' IRRs. Therefore, the accept/reject decision under the IRR method is independent of the cost of capital. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.11.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: NPV and IRR KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:31 PM DATE MODIFIED: 9/21/2017 5:31 PM 29. The IRR of normal Project X is greater than the IRR of normal Project Y, and both IRRs are greater than zero. Also, the NPV of X is greater than the NPV of Y at the cost of capital. If the two projects are mutually exclusive, Project X should definitely be selected, and the investment made, provided we have confidence in the data. Put another way, it is impossible to draw NPV profiles that would suggest not accepting Project X. a. True b. False ANSWER: False Copyright Cengage Learning. Powered by Cognero.
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RATIONALE:
Project X may have a negative NPV if r > IRR. The NPV profile line crosses the horizontal axis, and the NPV at the cost of capital is in the lower right quadrant.
POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 11-7 NPV Profiles QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.11.07 - NPV Profiles NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: NPV profiles KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:31 PM DATE MODIFIED: 9/21/2017 5:31 PM 30. Normal Projects S and L have the same NPV when the discount rate is zero. However, Project S's cash flows come in faster than those of L. Therefore, we know that at any discount rate greater than zero, L will have the higher NPV. a. True b. False ANSWER: False RATIONALE: We can see from the graph that S has the higher NPV if r > 0.
POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 11-7 NPV Profiles QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.11.07 - NPV Profiles NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking Copyright Cengage Learning. Powered by Cognero.
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STATE STANDARDS: LOCAL STANDARDS: TOPICS: KEYWORDS: DATE CREATED: DATE MODIFIED:
United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. NPV profiles Bloom's: Comprehension 9/21/2017 5:31 PM 9/21/2017 5:31 PM
31. If the IRR of normal Project X is greater than the IRR of mutually exclusive (and also normal) Project Y, we can conclude that the firm should always select X rather than Y if X has NPV > 0. a. True b. False ANSWER: False RATIONALE: We do not know if the cost of capital is to the right or left of the crossover point. Therefore, NPVX may be either higher or lower than NPVY. POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 11-7 NPV Profiles QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.11.07 - NPV Profiles NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: NPV profiles KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:31 PM DATE MODIFIED: 9/21/2017 5:31 PM 32. Which of the following statements is CORRECT? Assume that the project being considered has normal cash flows, with one outflow followed by a series of inflows. a. A project’s NPV is found by compounding the cash inflows at the IRR to find the terminal value (TV), then discounting the TV at the WACC. b. The lower the WACC used to calculate it, the lower the calculated NPV will be. c. If a project’s NPV is less than zero, then its IRR must be less than the WACC. d. If a project’s NPV is greater than zero, then its IRR must be less than zero. e. The NPV of a relatively low-risk project should be found using a relatively high WACC. ANSWER: c POINTS: 1 DIFFICULTY: EASY REFERENCES: 11-2 Net Present Value (NPV) QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.11.02 - Net Present Value (NPV) NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic Copyright Cengage Learning. Powered by Cognero.
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STATE STANDARDS: LOCAL STANDARDS: TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. NPV Bloom's: Comprehension Multiple Choice: Conceptual 9/21/2017 5:31 PM 9/21/2017 5:31 PM
33. Which of the following statements is CORRECT? a. One defect of the IRR method is that it does not take account of cash flows over a project’s full life. b. One defect of the IRR method is that it does not take account of the time value of money. c. One defect of the IRR method is that it does not take account of the cost of capital. d. One defect of the IRR method is that it values a dollar received today the same as a dollar that will not be received until sometime in the future. e. One defect of the IRR method is that it assumes that the cash flows to be received from a project can be reinvested at the IRR itself, and that assumption is often not valid. ANSWER: e RATIONALE: The IRR assumes reinvestment at the IRR, and that is generally not as valid as assuming reinvestment at the WACC, which is the reinvestment rate assumption of the NPV method. POINTS: 1 DIFFICULTY: EASY REFERENCES: 11-3 Internal Rate of Return (IRR) QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.11.03 - Internal Rate of Return (IRR) NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: IRR KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:31 PM DATE MODIFIED: 9/21/2017 5:31 PM 34. Which of the following statements is CORRECT? a. One defect of the IRR method versus the NPV is that the IRR does not take account of cash flows over a project’s full life. b. One defect of the IRR method versus the NPV is that the IRR does not take account of the time value of money. c. One defect of the IRR method versus the NPV is that the IRR does not take account of the cost of capital. d. One defect of the IRR method versus the NPV is that the IRR values a dollar received today the same as a dollar that will not be received until sometime in the future. e. One defect of the IRR method versus the NPV is that the IRR does not take proper account of differences in the sizes of projects. ANSWER: e Copyright Cengage Learning. Powered by Cognero.
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RATIONALE:
The IRR would rank a project that cost $100 and had a 100% IRR ahead of a project that cost $1,000,000 and had an IRR of 90%. The larger project would increase the firm's value more, as the NPV would demonstrate. POINTS: 1 DIFFICULTY: EASY REFERENCES: 11-3 Internal Rate of Return (IRR) QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.11.03 - Internal Rate of Return (IRR) NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: IRR KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:31 PM DATE MODIFIED: 9/21/2017 5:31 PM 35. Which of the following statements is CORRECT? Assume that the project being considered has normal cash flows, with one outflow followed by a series of inflows. a. A project’s regular IRR is found by compounding the cash inflows at the WACC to find the terminal value (TV), then discounting this TV at the WACC. b. A project’s regular IRR is found by discounting the cash inflows at the WACC to find the present value (PV), then compounding this PV to find the IRR. c. If a project’s IRR is greater than the WACC, then its NPV must be negative. d. To find a project’s IRR, we must solve for the discount rate that causes the PV of the inflows to equal the PV of the project’s costs. e. To find a project’s IRR, we must find a discount rate that is equal to the WACC. ANSWER: d POINTS: 1 DIFFICULTY: EASY REFERENCES: 11-3 Internal Rate of Return (IRR) QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.11.03 - Internal Rate of Return (IRR) NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: IRR KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:31 PM DATE MODIFIED: 9/21/2017 5:31 PM 36. Which of the following statements is CORRECT? Assume that the project being considered has normal cash flows, Copyright Cengage Learning. Powered by Cognero.
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with one outflow followed by a series of inflows. a. A project’s regular IRR is found by compounding the initial cost at the WACC to find the terminal value (TV), then discounting the TV at the WACC. b. A project’s regular IRR is found by compounding the cash inflows at the WACC to find the present value (PV), then discounting the TV to find the IRR. c. If a project’s IRR is smaller than the WACC, then its NPV will be positive. d. A project’s IRR is the discount rate that causes the PV of the inflows to equal the project’s cost. e. If a project’s IRR is positive, then its NPV must also be positive. ANSWER: d POINTS: 1 DIFFICULTY: EASY REFERENCES: 11-3 Internal Rate of Return (IRR) QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.11.03 - Internal Rate of Return (IRR) NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: IRR KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:31 PM DATE MODIFIED: 9/21/2017 5:31 PM 37. Which of the following statements is CORRECT? a. If a project has ―normal‖ cash flows, then its IRR must be positive. b. If a project has ―normal‖ cash flows, then its MIRR must be positive. c. If a project has ―normal‖ cash flows, then it will have exactly two real IRRs. d. The definition of ―normal‖ cash flows is that the cash flow stream has one or more negative cash flows followed by a stream of positive cash flows and then one negative cash flow at the end of the project’s life. e. If a project has ―normal‖ cash flows, then it can have only one real IRR, whereas a project with "nonnormal" cash flows might have more than one real IRR. ANSWER: e POINTS: 1 DIFFICULTY: EASY REFERENCES: 11-4 Multiple Internal Rates of Return QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.11.04 - Multiple Internal Rates of Return NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Normal vs. nonnormal CFs KEYWORDS: Bloom's: Comprehension Copyright Cengage Learning. Powered by Cognero.
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OTHER: DATE CREATED: DATE MODIFIED:
Multiple Choice: Conceptual 9/21/2017 5:31 PM 9/21/2017 5:31 PM
38. Which of the following statements is CORRECT? a. Projects with ―normal‖ cash flows can have only one real IRR. b. Projects with ―normal‖ cash flows can have two or more real IRRs. c. Projects with ―normal‖ cash flows must have two changes in the sign of the cash flows, e.g., from negative to positive to negative. If there are more than two sign changes, then the cash flow stream is ―nonnormal.‖ d. The ―multiple IRR problem‖ can arise if a project’s cash flows are ―normal.‖ e. Projects with ―nonnormal‖ cash flows are almost never encountered in the real world. ANSWER: a POINTS: 1 DIFFICULTY: EASY REFERENCES: 11-4 Multiple Internal Rates of Return QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.11.04 - Multiple Internal Rates of Return NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Normal vs. nonnormal CFs KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:31 PM DATE MODIFIED: 9/21/2017 5:31 PM 39. Which of the following statements is CORRECT? a. The regular payback method recognizes all cash flows over a project’s life. b. The discounted payback method recognizes all cash flows over a project’s life, and it also adjusts these cash flows to account for the time value of money. c. The regular payback method was, years ago, widely used, but virtually no companies even calculate the payback today. d. The regular payback is useful as an indicator of a project’s liquidity because it gives managers an idea of how long it will take to recover the funds invested in a project. e. The regular payback does not consider cash flows beyond the payback year, but the discounted payback overcomes this defect. ANSWER: d RATIONALE: Statement d is true. The payback does indicate how long it should take to recover the investment; hence, it is a measure of liquidity. POINTS: 1 DIFFICULTY: EASY REFERENCES: 11-8 Payback Period QUESTION TYPE: Multiple Choice HAS VARIABLES: False Copyright Cengage Learning. Powered by Cognero.
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LEARNING OBJECTIVES: FOFM.BRIG.17.11.08 - Payback Period NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Payback KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:31 PM DATE MODIFIED: 9/21/2017 5:31 PM 40. Which of the following statements is CORRECT? Assume that the project being considered has normal cash flows, with one outflow followed by a series of inflows. a. The longer a project’s payback period, the more desirable the project is normally considered to be by this criterion. b. One drawback of the payback criterion for evaluating projects is that this method does not properly account for the time value of money. c. If a project’s payback is positive, then the project should be rejected because it must have a negative NPV. d. The regular payback ignores cash flows beyond the payback period, but the discounted payback method overcomes this problem. e. If a company uses the same payback requirement to evaluate all projects, say it requires a payback of 4 years or less, then the company will tend to reject projects with relatively short lives and accept long-lived projects, and this will cause its risk to increase over time. ANSWER: b POINTS: 1 DIFFICULTY: EASY REFERENCES: 11-8 Payback Period QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.11.08 - Payback Period NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Payback KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:31 PM DATE MODIFIED: 9/21/2017 5:31 PM 41. Which of the following statements is CORRECT? a. The shorter a project’s payback period, the less desirable the project is normally considered to be by this criterion. b. One drawback of the payback criterion is that this method does not take account of cash flows beyond the payback period. c. If a project’s payback is positive, then the project should be accepted because it must have a positive NPV. d. The regular payback ignores cash flows beyond the payback period, but the discounted payback method Copyright Cengage Learning. Powered by Cognero.
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overcomes this problem. e. One drawback of the discounted payback is that this method does not consider the time value of money, while the regular payback overcomes this drawback. ANSWER: b POINTS: 1 DIFFICULTY: EASY REFERENCES: 11-8 Payback Period QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.11.08 - Payback Period NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Payback KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:31 PM DATE MODIFIED: 9/21/2017 5:31 PM 42. Assume a project has normal cash flows. All else equal, which of the following statements is CORRECT? a. A project’s IRR increases as the WACC declines. b. A project’s NPV increases as the WACC declines. c. A project’s MIRR is unaffected by changes in the WACC. d. A project’s regular payback increases as the WACC declines. e. A project’s discounted payback increases as the WACC declines. ANSWER: b POINTS: 1 DIFFICULTY: EASY REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.11.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Ranking methods KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:31 PM DATE MODIFIED: 9/21/2017 5:31 PM 43. Which of the following statements is CORRECT? a. The internal rate of return method (IRR) is generally regarded by academics as being the best single method for evaluating capital budgeting projects. Copyright Cengage Learning. Powered by Cognero.
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b. The payback method is generally regarded by academics as being the best single method for evaluating capital budgeting projects. c. The discounted payback method is generally regarded by academics as being the best single method for evaluating capital budgeting projects. d. The net present value method (NPV) is generally regarded by academics as being the best single method for evaluating capital budgeting projects. e. The modified internal rate of return method (MIRR) is generally regarded by academics as being the best single method for evaluating capital budgeting projects. ANSWER: d POINTS: 1 DIFFICULTY: EASY REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.11.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Ranking methods KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:31 PM DATE MODIFIED: 9/21/2017 5:31 PM 44. Which of the following statements is CORRECT? a. An NPV profile graph shows how a project’s payback varies as the cost of capital changes. b. The NPV profile graph for a normal project will generally have a positive (upward) slope as the life of the project increases. c. An NPV profile graph is designed to give decision makers an idea about how a project’s risk varies with its life. d. An NPV profile graph is designed to give decision makers an idea about how a project’s contribution to the firm’s value varies with the cost of capital. e. We cannot draw a project’s NPV profile unless we know the appropriate WACC for use in evaluating the project’s NPV. ANSWER: d POINTS: 1 DIFFICULTY: EASY/MODERATE REFERENCES: 11-7 NPV Profiles QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.11.07 - NPV Profiles NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: NPV profiles Copyright Cengage Learning. Powered by Cognero.
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KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
Bloom's: Analysis Multiple Choice: Conceptual 9/21/2017 5:31 PM 9/21/2017 5:31 PM
45. Which of the following statements is CORRECT? Assume that the project being considered has normal cash flows, with one outflow followed by a series of inflows. a. A project’s NPV is generally found by compounding the cash inflows at the WACC to find the terminal value (TV), then discounting the TV at the IRR to find its PV. b. The higher the WACC used to calculate the NPV, the lower the calculated NPV will be. c. If a project’s NPV is greater than zero, then its IRR must be less than the WACC. d. If a project’s NPV is greater than zero, then its IRR must be less than zero. e. The NPVs of relatively risky projects should be found using relatively low WACCs. ANSWER: b POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 11-2 Net Present Value (NPV) QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.11.02 - Net Present Value (NPV) NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: NPV KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:31 PM DATE MODIFIED: 9/21/2017 5:31 PM 46. Which of the following statements is CORRECT? a. For a project to have more than one IRR, then both IRRs must be greater than the WACC. b. If two projects are mutually exclusive, then they are likely to have multiple IRRs. c. If a project is independent, then it cannot have multiple IRRs. d. Multiple IRRs can occur only if the signs of the cash flows change more than once. e. If a project has two IRRs, then the smaller one is the one that is most relevant, and it should be accepted and relied upon. ANSWER: d POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 11-4 Multiple Internal Rates of Return QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.11.04 - Multiple Internal Rates of Return NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital Copyright Cengage Learning. Powered by Cognero.
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LOCAL STANDARDS: TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. Multiple IRRs Bloom's: Analysis Multiple Choice: Conceptual 9/21/2017 5:31 PM 9/21/2017 5:31 PM
47. Which of the following statements is CORRECT? a. The NPV method assumes that cash flows will be reinvested at the WACC, while the IRR method assumes reinvestment at the IRR. b. The NPV method assumes that cash flows will be reinvested at the risk-free rate, while the IRR method assumes reinvestment at the IRR. c. The NPV method assumes that cash flows will be reinvested at the WACC, while the IRR method assumes reinvestment at the risk-free rate. d. The NPV method does not consider all relevant cash flows, particularly cash flows beyond the payback period. e. The IRR method does not consider all relevant cash flows, particularly cash flows beyond the payback period. ANSWER: a POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 11-5 Reinvestment Rate Assumptions QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.11.05 - Reinvestment Rate Assumptions NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: NPV and IRR KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:31 PM DATE MODIFIED: 9/21/2017 5:31 PM 48. Which of the following statements is CORRECT? Assume that the project being considered has normal cash flows, with one outflow followed by a series of inflows. a. If Project A has a higher IRR than Project B, then Project A must have the lower NPV. b. If Project A has a higher IRR than Project B, then Project A must also have a higher NPV. c. The IRR calculation implicitly assumes that all cash flows are reinvested at the WACC. d. The IRR calculation implicitly assumes that cash flows are withdrawn from the business rather than being reinvested in the business. e. If a project has normal cash flows and its IRR exceeds its WACC, then the project’s NPV must be positive. ANSWER: e POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 11-5 Reinvestment Rate Assumptions Copyright Cengage Learning. Powered by Cognero.
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QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.11.05 - Reinvestment Rate Assumptions NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: NPV and IRR KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:31 PM DATE MODIFIED: 9/21/2017 5:31 PM 49. Assume that the economy is in a mild recession, and as a result interest rates and money costs generally are relatively low. The WACC for two mutually exclusive projects that are being considered is 8%. Project S has an IRR of 20% while Project L's IRR is 15%. The projects have the same NPV at the 8% current WACC. However, you believe that the economy is about to recover, and money costs and thus your WACC will also increase. You also think that the projects will not be funded until the WACC has increased, and their cash flows will not be affected by the change in economic conditions. Under these conditions, which of the following statements is CORRECT? a. You should reject both projects because they will both have negative NPVs under the new conditions. b. You should delay a decision until you have more information on the projects, even if this means that a competitor might come in and capture this market. c. You should recommend Project L, because at the new WACC it will have the higher NPV. d. You should recommend Project S, because at the new WACC it will have the higher NPV. e. You should recommend Project L because it will have the higher IRR at the new WACC. ANSWER: d POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 11-5 Reinvestment Rate Assumptions QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.11.05 - Reinvestment Rate Assumptions NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: NPV and IRR KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:31 PM DATE MODIFIED: 9/21/2017 5:31 PM 50. Assume that the economy is enjoying a strong boom, and as a result interest rates and money costs generally are relatively high. The WACC for two mutually exclusive projects that are being considered is 12%. Project S has an IRR of 20% while Project L's IRR is 15%. The projects have the same NPV at the 12% current WACC. However, you believe that the economy will soon fall into a mild recession, and money costs and thus your WACC will soon decline. You also think that the projects will not be funded until the WACC has decreased, and their cash flows will not be affected by the change in economic conditions. Under these conditions, which of the following statements is CORRECT? Copyright Cengage Learning. Powered by Cognero.
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a. You should reject both projects because they will both have negative NPVs under the new conditions. b. You should delay a decision until you have more information on the projects, even if this means that a competitor might come in and capture this market. c. You should recommend Project L, because at the new WACC it will have the higher NPV. d. You should recommend Project S, because at the new WACC it will have the higher NPV. e. You should recommend Project L because it will have both a higher IRR and a higher NPV under the new conditions. ANSWER: c POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 11-5 Reinvestment Rate Assumptions QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.11.05 - Reinvestment Rate Assumptions NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: NPV and IRR KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:31 PM DATE MODIFIED: 9/21/2017 5:31 PM 51. Which of the following statements is CORRECT? a. The NPV method was once the favorite of academics and business executives, but today most authorities regard the MIRR as being the best indicator of a project’s profitability. b. If the cost of capital declines, this lowers a project’s NPV. c. The NPV method is regarded by most academics as being the best indicator of a project’s profitability, hence most academics recommend that firms use only this one method and disregard other methods. d. A project’s NPV depends on the total amount of cash flows the project produces, but because the cash flows are discounted at the WACC, it does not matter if the cash flows occur early or late in the project’s life. e. The NPV and IRR methods may give different recommendations regarding which of two mutually exclusive projects should be accepted, but they always give the same recommendation regarding the acceptability of a normal, independent project. ANSWER: e RATIONALE: Statement e is correct. The others are all false. If you draw an NPV profile for one project, you will see that if the WACC is less than the IRR, the NPV will be positive. POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 11-5 Reinvestment Rate Assumptions QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.11.05 - Reinvestment Rate Assumptions NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital Copyright Cengage Learning. Powered by Cognero.
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LOCAL STANDARDS: TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. NPV and IRR Bloom's: Comprehension Multiple Choice: Conceptual 9/21/2017 5:31 PM 9/21/2017 5:31 PM
52. Projects A and B have identical expected lives and identical initial cash outflows (costs). However, most of one project's cash flows come in the early years, while most of the other project's cash flows occur in the later years. The two NPV profiles are given below:
Which of the following statements is CORRECT? a. More of Project A's cash flows occur in the later years. b. More of Project B's cash flows occur in the later years. c. We must have information on the cost of capital in order to determine which project has the larger early cash flows. d. The NPV profile graph is inconsistent with the statement made in the problem. e. The crossover rate, i.e., the rate at which Projects A and B have the same NPV, is greater than either project's IRR. ANSWER: a RATIONALE: Statement a is true and the other statements are false. Distant cash flows are more severely penalized by high discount rates, so if the NPV profile line has a steep slope, this indicates that cash flows occur relatively late. POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 11-7 NPV Profiles QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.11.07 - NPV Profiles NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital TOPICS: NPV profiles KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:31 PM DATE MODIFIED: 9/21/2017 5:31 PM Copyright Cengage Learning. Powered by Cognero.
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53. Projects S and L both have an initial cost of $10,000, followed by a series of positive cash inflows. Project S’s undiscounted net cash flows total $20,000, while L’s total undiscounted flows are $30,000. At a WACC of 10%, the two projects have identical NPVs. Which project’s NPV is more sensitive to changes in the WACC? a. Project S. b. Project L. c. Both projects are equally sensitive to changes in the WACC since their NPVs are equal at all costs of capital. d. Neither project is sensitive to changes in the discount rate, since both have NPV profiles that are horizontal. e. The solution cannot be determined because the problem gives us no information that can be used to determine the projects’ relative IRRs. ANSWER: b RATIONALE: Statement b is true, while the other statements are false. Since Project L's undiscounted CFs are larger, they must occur in the more distant future, and since distant cash flows are impacted more by changes in the discount rate, L's NPV profile must be steeper. One can also see this in an NPV profile graph. The higher Y-axis intercept indicates more undiscounted CFs, and for the profiles to cross, the one with the higher intercept must be steeper. POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 11-7 NPV Profiles QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.11.07 - NPV Profiles NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: NPV profiles KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:31 PM DATE MODIFIED: 9/21/2017 5:31 PM 54. Projects C and D are mutually exclusive and have normal cash flows. Project C has a higher NPV if the WACC is less than 12%, whereas Project D has a higher NPV if the WACC exceeds 12%. Which of the following statements is CORRECT? a. Project D probably has a higher IRR. b. Project D is probably larger in scale than Project C. c. Project C probably has a faster payback. d. Project C probably has a higher IRR. e. The crossover rate between the two projects is below 12%. ANSWER: a RATIONALE: The NPV profiles cross at 12%. To the left, or at lower discount rates, C has the higher NPV, so its slope is steeper, causing its profile to hit the X axis sooner. This means that C has the lower IRR, hence D has the higher IRR. POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 11-7 NPV Profiles QUESTION TYPE: Multiple Choice Copyright Cengage Learning. Powered by Cognero.
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HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.11.07 - NPV Profiles NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: NPV profiles KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:31 PM DATE MODIFIED: 9/21/2017 5:31 PM 55. Suppose a firm relies exclusively on the payback method when making capital budgeting decisions, and it sets a 4year payback regardless of economic conditions. Other things held constant, which of the following statements is most likely to be true? a. It will accept too many short-term projects and reject too many long-term projects (as judged by the NPV). b. It will accept too many long-term projects and reject too many short-term projects (as judged by the NPV). c. The firm will accept too many projects in all economic states because a 4-year payback is too low. d. The firm will accept too few projects in all economic states because a 4-year payback is too high. e. If the 4-year payback results in accepting just the right set of projects under average economic conditions, then this payback will result in too few long-term projects when the economy is weak. ANSWER: e RATIONALE: Statement e is correct. In a weak economy, the interest rates and the WACC are likely to be low, and these conditions favor long-term projects. But the constant 4-year payback would not recognize this situation. POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 11-8 Payback Period QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.11.08 - Payback Period NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Payback KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:31 PM DATE MODIFIED: 9/21/2017 5:31 PM 56. Four of the following statements are truly disadvantages of the regular payback method, but one is not a disadvantage of this method. Which one is NOT a disadvantage of the payback method? a. Lacks an objective, market-determined benchmark for making decisions. b. Ignores cash flows beyond the payback period. c. Does not directly account for the time value of money. d. Does not provide any indication regarding a project’s liquidity or risk. Copyright Cengage Learning. Powered by Cognero.
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e. Does not take account of differences in size among projects. ANSWER: d POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 11-8 Payback Period QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.11.08 - Payback Period NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Payback KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:31 PM DATE MODIFIED: 9/21/2017 5:31 PM 57. Which of the following statements is CORRECT? a. If a project with normal cash flows has an IRR greater than the WACC, the project must also have a positive NPV. b. If Project A’s IRR exceeds Project B’s, then A must have the higher NPV. c. A project’s MIRR can never exceed its IRR. d. If a project with normal cash flows has an IRR less than the WACC, the project must have a positive NPV. e. If the NPV is negative, the IRR must also be negative. ANSWER: a POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.11.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: NPV, IRR, and MIRR KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:31 PM DATE MODIFIED: 9/21/2017 5:31 PM 58. Which of the following statements is CORRECT? a. The MIRR and NPV decision criteria can never conflict. b. The IRR method can never be subject to the multiple IRR problem, while the MIRR method can be. c. One reason some people prefer the MIRR to the regular IRR is that the MIRR is based on a generally more Copyright Cengage Learning. Powered by Cognero.
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reasonable reinvestment rate assumption. d. The higher the WACC, the shorter the discounted payback period. e. The MIRR method assumes that cash flows are reinvested at the crossover rate. ANSWER: c POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.11.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: NPV, IRR, and MIRR KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:31 PM DATE MODIFIED: 9/21/2017 5:31 PM 59. Which of the following statements is CORRECT? a. The NPV, IRR, MIRR, and discounted payback (using a payback requirement of 3 years or less) methods always lead to the same accept/reject decisions for independent projects. b. For mutually exclusive projects with normal cash flows, the NPV and MIRR methods can never conflict, but their results could conflict with the discounted payback and the regular IRR methods. c. Multiple IRRs can exist, but not multiple MIRRs. This is one reason some people favor the MIRR over the regular IRR. d. If a firm uses the discounted payback method with a required payback of 4 years, then it will accept more projects than if it used a regular payback of 4 years. e. The percentage difference between the MIRR and the IRR is equal to the project’s WACC. ANSWER: c POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.11.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: NPV, IRR, and MIRR KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:31 PM DATE MODIFIED: 9/21/2017 5:31 PM Copyright Cengage Learning. Powered by Cognero.
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60. Which of the following statements is CORRECT? a. For a project with normal cash flows, any change in the WACC will change both the NPV and the IRR. b. To find the MIRR, we first compound cash flows at the regular IRR to find the TV, and then we discount the TV at the WACC to find the PV. c. The NPV and IRR methods both assume that cash flows can be reinvested at the WACC. However, the MIRR method assumes reinvestment at the MIRR itself. d. If two projects have the same cost, and if their NPV profiles cross in the upper right quadrant, then the project with the higher IRR probably has more of its cash flows coming in the later years. e. If two projects have the same cost, and if their NPV profiles cross in the upper right quadrant, then the project with the lower IRR probably has more of its cash flows coming in the later years. ANSWER: e POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.11.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: NPV, IRR, and MIRR KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:31 PM DATE MODIFIED: 9/21/2017 5:31 PM 61. Which of the following statements is CORRECT? a. One advantage of the NPV over the IRR is that NPV takes account of cash flows over a project’s full life whereas IRR does not. b. One advantage of the NPV over the IRR is that NPV assumes that cash flows will be reinvested at the WACC, whereas IRR assumes that cash flows are reinvested at the IRR. The NPV assumption is generally more appropriate. c. One advantage of the NPV over the MIRR method is that NPV takes account of cash flows over a project’s full life whereas MIRR does not. d. One advantage of the NPV over the MIRR method is that NPV discounts cash flows whereas the MIRR is based on undiscounted cash flows. e. Since cash flows under the IRR and MIRR are both discounted at the same rate (the WACC), these two methods always rank mutually exclusive projects in the same order. ANSWER: b RATIONALE: Statement b is correct, and the others are false. Cash flows from a project can be used to replace funds that would be raised in the market at the WACC, so the WACC is the opportunity cost for reinvested cash flows. Since the NPV assumes reinvestment at the WACC while the IRR assumes reinvestment at the IRR, NPV is generally the better method. POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive Copyright Cengage Learning. Powered by Cognero.
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QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.11.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Ranking methods: NPV KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:31 PM DATE MODIFIED: 9/21/2017 5:31 PM 62. Which of the following statements is CORRECT? a. The IRR method appeals to some managers because it gives an estimate of the rate of return on projects rather than a dollar amount, which the NPV method provides. b. The discounted payback method eliminates all of the problems associated with the payback method. c. When evaluating independent projects, the NPV and IRR methods often yield conflicting results regarding a project's acceptability. d. To find the MIRR, we discount the TV at the IRR. e. A project’s NPV profile must intersect the X-axis at the project’s WACC. ANSWER: a POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.11.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Miscellaneous concepts KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:31 PM DATE MODIFIED: 9/21/2017 5:31 PM 63. Projects S and L are equally risky, mutually exclusive, and have normal cash flows. Project S has an IRR of 15%, while Project L’s IRR is 12%. The two projects have the same NPV when the WACC is 7%. Which of the following statements is CORRECT? a. If the WACC is 10%, both projects will have positive NPVs. b. If the WACC is 6%, Project S will have the higher NPV. c. If the WACC is 13%, Project S will have the lower NPV. d. If the WACC is 10%, both projects will have a negative NPV. e. Project S’s NPV is more sensitive to changes in WACC than Project L's. Copyright Cengage Learning. Powered by Cognero.
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ANSWER: RATIONALE:
a The easiest way to think about this question is to begin by drawing an NPV profile as shown below, then using it to decide which statement is correct.
Statement a is true, because both projects have an IRR greater than the WACC and thus will have a positive NPV. Statement b is false, because at 6%, the WACC is less than the crossover rate and Project L has a higher NPV than S. Statement c is false, because at 13% the WACC is greater than the crossover rate and S would have a higher NPV than L. Statement d is false, because of reasons mentioned for statement a. Statement e is false, because Project L’s NPV profile is steeper, which means Project L’s NPV is more sensitive to changes in WACC. POINTS: 1 DIFFICULTY: MODERATE/CHALLENGING REFERENCES: 11-7 NPV Profiles QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.11.07 - NPV Profiles NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: NPV profiles KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:31 PM DATE MODIFIED: 9/21/2017 5:31 PM 64. Westchester Corp. is considering two equally risky, mutually exclusive projects, both of which have normal cash flows. Project A has an IRR of 11%, while Project B's IRR is 14%. When the WACC is 8%, the projects have the same NPV. Given this information, which of the following statements is CORRECT? a. If the WACC is 13%, Project A’s NPV will be higher than Project B’s. b. If the WACC is 9%, Project A’s NPV will be higher than Project B’s. c. If the WACC is 6%, Project B’s NPV will be higher than Project A’s. d. If the WACC is greater than 14%, Project A’s IRR will exceed Project B’s. e. If the WACC is 9%, Project B’s NPV will be higher than Project A’s. ANSWER: e RATIONALE: Statement e is true, while the others are false.
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POINTS: 1 DIFFICULTY: MODERATE/CHALLENGING REFERENCES: 11-7 NPV Profiles QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.11.07 - NPV Profiles NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: NPV profiles KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:31 PM DATE MODIFIED: 9/21/2017 5:31 PM 65. You are considering two mutually exclusive, equally risky, projects. Both have IRRs that exceed the WACC. Which of the following statements is CORRECT? Assume that the projects have normal cash flows, with one outflow followed by a series of inflows. a. If the two projects' NPV profiles do not cross, then there will be a sharp conflict as to which one should be selected. b. If the cost of capital is greater than the crossover rate, then the IRR and the NPV criteria will not result in a conflict between the projects. One project will rank higher by both criteria. c. If the cost of capital is less than the crossover rate, then the IRR and the NPV criteria will not result in a conflict between the projects. One project will rank higher by both criteria. d. For a conflict to exist between NPV and IRR, the initial investment cost of one project must exceed the cost of the other. e. For a conflict to exist between NPV and IRR, one project must have an increasing stream of cash flows over time while the other has a decreasing stream. If both sets of cash flows are increasing or decreasing, then it would be impossible for a conflict to exist, even if one project is larger than the other. ANSWER: b Again, it is useful to draw NPV profiles that fit the description given in the question. Any RATIONALE: numbers that meet the criteria will do.
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Statement a is false, because if the profiles do not cross, then one will dominate the other, with both a higher IRR and a higher NPV at every discount rate. Statement b is true. Statement c is false. Statement d is false because a conflict can result from differences in the timing of the cash flows. Statement e is false because scale differences can result in profile crossovers and thus conflicts.
POINTS: 1 DIFFICULTY: MODERATE/CHALLENGING REFERENCES: 11-7 NPV Profiles QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.11.07 - NPV Profiles NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: NPV profiles KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:31 PM DATE MODIFIED: 9/21/2017 5:31 PM 66. Project X’s IRR is 19% and Project Y’s IRR is 17%. The projects have the same risk and the same lives, and each has constant cash flows during each year of their lives. If the WACC is 10%, Project Y has a higher NPV than X. Given this information, which of the following statements is CORRECT? a. The crossover rate must be less than 10%. b. The crossover rate must be greater than 10%. c. If the WACC is 8%, Project X will have the higher NPV. d. If the WACC is 18%, Project Y will have the higher NPV. e. Project X is larger in the sense that it has the higher initial cost. ANSWER: b Again, it is useful to draw NPV profiles that fit the description given in the question. Any RATIONALE: number that meets the criteria will do.
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As we can see from the graph, statement b is true, but the other statements are false.
POINTS: 1 DIFFICULTY: MODERATE/CHALLENGING REFERENCES: 11-7 NPV Profiles QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.11.07 - NPV Profiles NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: NPV profiles KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:31 PM DATE MODIFIED: 9/21/2017 5:31 PM 67. You are on the staff of Camden Inc. The CFO believes project acceptance should be based on the NPV, but Steve Camden, the president, insists that no project should be accepted unless its IRR exceeds the project’s risk-adjusted WACC. Now you must make a recommendation on a project that has a cost of $15,000 and two cash flows: $110,000 at the end of Year 1 and -$100,000 at the end of Year 2. The president and the CFO both agree that the appropriate WACC for this project is 10%. At 10%, the NPV is $2,355.37, but you find two IRRs, one at 6.33% and one at 527.01%, and a MIRR of 11.32%. Which of the following statements best describes your optimal recommendation, i.e., the analysis and recommendation that is best for the company and least likely to get you in trouble with either the CFO or the president? a. You should recommend that the project be rejected because its NPV is negative and its IRR is less than the WACC. b. You should recommend that the project be rejected because, although its NPV is positive, it has an IRR that is less than the WACC. c. You should recommend that the project be accepted because (1) its NPV is positive and (2) although it has two IRRs, in this case it would be better to focus on the MIRR, which exceeds the WACC. You should explain this to the president and tell him that that the firm’s value will increase if the project is accepted. d. You should recommend that the project be rejected because (1) its NPV is positive and (2) it has two IRRs, one of which is less than the WACC, which indicates that the firm’s value will decline if the project is accepted. e. You should recommend that the project be rejected because, although its NPV is positive, its MIRR is less than the WACC, and that indicates that the firm’s value will decline if it is accepted. ANSWER: c RATIONALE: Statement c is true, while the other statements are false. It is not necessary to calculate the two IRRs and the MIRR as the data in the problem are correct, but we show the Excel calculations below. Copyright Cengage Learning. Powered by Cognero.
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WACC Years CF
10% 0 1 -$15,000 $110,000
2 -$100,000
NPV $2,355.37 6.33% IRR1 527.01% IRR2 MIRR 11.32% POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 11-4 Multiple Internal Rates of Return QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.11.04 - Multiple Internal Rates of Return NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Multiple IRRs KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:31 PM DATE MODIFIED: 9/21/2017 5:31 PM 68. Which of the following statements is CORRECT? Assume that the project being considered has normal cash flows, with one cash outflow at t = 0 followed by a series of positive cash flows. a. A project’s MIRR is always greater than its regular IRR. b. A project’s MIRR is always less than its regular IRR. c. If a project’s IRR is greater than its WACC, then its MIRR will be greater than the IRR. d. To find a project’s MIRR, we compound cash inflows at the regular IRR and then find the discount rate that causes the PV of the terminal value to equal the initial cost. e. To find a project’s MIRR, the textbook procedure compounds cash inflows at the WACC and then finds the discount rate that causes the PV of the terminal value to equal the initial cost. ANSWER: e RATIONALE: Answer e is essentially the definition of the MIRR, hence it is correct. POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 11-6 Modified Internal Rate of Return (MIRR) QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.11.06 - Modified Internal Rate of Return (MIRR) NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: MIRR Copyright Cengage Learning. Powered by Cognero.
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KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
Bloom's: Comprehension Multiple Choice: Conceptual 9/21/2017 5:31 PM 9/21/2017 5:31 PM
69. Which of the following statements is CORRECT? Assume that the project being considered has normal cash flows, with one outflow followed by a series of inflows. a. A project’s MIRR is always greater than its regular IRR. b. A project’s MIRR is always less than its regular IRR. c. If a project’s IRR is greater than its WACC, then the MIRR will be less than the IRR. d. If a project’s IRR is greater than its WACC, then the MIRR will be greater than the IRR. e. To find a project’s MIRR, we compound cash inflows at the IRR and then discount the terminal value back to t = 0 at the WACC. ANSWER: c RATIONALE: One could prove that (1) if the IRR is equal to the WACC, then the MIRR and the IRR will be equal, (2) if the IRR is greater than the WACC, the MIRR will be less than the IRR, and (3) the MIRR will be greater than the IRR if the IRR is less than the WACC. This situation exists because the MIRR assumes reinvestment at the WACC and therefore compounds at that rate, while the IRR assumes reinvestment at the IRR itself and therefore compounds at the IRR. Therefore, if the IRR exceeds the WACC, the TV found under the IRR method will be larger, and vice versa. The IRR and the MIRR are found as the rate that causes the PV of the TV to equal the cost. Therefore, if the IRR exceeds the WACC, causing the IRR's TV to be larger, then the IRR will exceed the MIRR, and vice versa. As a result, statement c is correct--if the IRR exceeds the WACC, the IRR will exceed the MIRR. The other statements are false. Note too that this answer could also be confirmed with a numerical example. POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 11-6 Modified Internal Rate of Return (MIRR) QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.11.06 - Modified Internal Rate of Return (MIRR) NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: MIRR KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:31 PM DATE MODIFIED: 9/21/2017 5:31 PM 70. Projects S and L both have normal cash flows, and the projects have the same risk, hence both are evaluated with the same WACC, 10%. However, S has a higher IRR than L. Which of the following statements is CORRECT? a. Project S must have a higher NPV than Project L. b. If Project S has a positive NPV, Project L must also have a positive NPV. c. If the WACC falls, each project’s IRR will increase. d. If the WACC increases, each project’s IRR will decrease. e. If Projects S and L have the same NPV at the current WACC, 10%, then Project L, the one with the lower Copyright Cengage Learning. Powered by Cognero.
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IRR, would have a higher NPV if the WACC used to evaluate the projects declined. ANSWER: e Refer to the NPV profile below. Statement a is false, because you do not know which project RATIONALE: has the higher NPV unless you know the WACC. Statement b is false, because if the WACC is greater than IRRL but less than IRRS then Project S will have a positive NPV and Project L's NPV will be negative. Statements c and d are false, because IRR is independent of WACC. Statement e is true, because Project S has the higher IRR, so Project L's NPV profile is above Project S's when the WACC is less than the crossover rate.
POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 11-7 NPV Profiles QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.11.07 - NPV Profiles NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: NPV profiles KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:31 PM DATE MODIFIED: 9/21/2017 5:31 PM 71. Which of the following statements is CORRECT? Assume that all projects being considered have normal cash flows and are equally risky. a. If a project’s IRR is equal to its WACC, then, under all reasonable conditions, the project’s NPV must be negative. b. If a project’s IRR is equal to its WACC, then under all reasonable conditions, the project’s IRR must be negative. c. If a project’s IRR is equal to its WACC, then under all reasonable conditions the project’s NPV must be zero. d. There is no necessary relationship between a project’s IRR, its WACC, and its NPV. e. When evaluating mutually exclusive projects, those projects with relatively long lives will tend to have relatively high NPVs when the cost of capital is relatively high. ANSWER: c Recall that the very definition of the IRR is the discount rate at which the NPV is zero. RATIONALE:
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Therefore, statement c is true. All the other statements are false.
POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 11-7 NPV Profiles QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.11.07 - NPV Profiles NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: NPV profiles KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:31 PM DATE MODIFIED: 9/21/2017 5:31 PM 72. A company is choosing between two projects. The larger project has an initial cost of $100,000, annual cash flows of $30,000 for 5 years, and an IRR of 15.24%. The smaller project has an initial cost of $51,600, annual cash flows of $16,000 for 5 years, and an IRR of 16.65%. The projects are equally risky. Which of the following statements is CORRECT? a. Since the smaller project has the higher IRR, the two projects’ NPV profiles cannot cross, and the smaller project's NPV will be higher at all positive values of WACC. b. Since the smaller project has the higher IRR, the two projects’ NPV profiles will cross, and the larger project will look better based on the NPV at all positive values of WACC. c. If the company uses the NPV method, it will tend to favor smaller, shorter-term projects over larger, longerterm projects, regardless of how high or low the WACC is. d. Since the smaller project has the higher IRR but the larger project has the higher NPV at a zero discount rate, the two projects’ NPV profiles will cross, and the larger project will have the higher NPV if the WACC is less than the crossover rate. e. Since the smaller project has the higher IRR and the larger NPV at a zero discount rate, the two projects’ NPV profiles will cross, and the smaller project will look better if the WACC is less than the crossover rate. ANSWER: d Statement d is true; the other statements are false. RATIONALE:
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POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 11-7 NPV Profiles QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.11.07 - NPV Profiles NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: NPV profiles KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:31 PM DATE MODIFIED: 9/21/2017 5:31 PM 73. McCall Manufacturing has a WACC of 10%. The firm is considering two normal, equally risky, mutually exclusive, but not repeatable projects. The two projects have the same investment costs, but Project A has an IRR of 15%, while Project B has an IRR of 20%. Assuming the projects' NPV profiles cross in the upper right quadrant, which of the following statements is CORRECT? a. Each project must have a negative NPV. b. Since the projects are mutually exclusive, the firm should always select Project B. c. If the crossover rate is 8%, Project B will have the higher NPV. d. Only one project has a positive NPV. e. If the crossover rate is 8%, Project A will have the higher NPV. ANSWER: c RATIONALE: Statement c is true, while the other statements are false. If we draw an NPV profile graph, we would see that A must have the steeper slope. If the crossover is 8% and the WACC is 10%, then B will have the higher NPV. POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 11-7 NPV Profiles QUESTION TYPE: Multiple Choice Copyright Cengage Learning. Powered by Cognero.
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HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.11.07 - NPV Profiles NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: NPV profiles KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:31 PM DATE MODIFIED: 9/21/2017 5:31 PM 74. Projects A and B are mutually exclusive and have normal cash flows. Project A has an IRR of 15% and B's IRR is 20%. The company’s WACC is 12%, and at that rate Project A has the higher NPV. Which of the following statements is CORRECT? a. The crossover rate for the two projects must be less than 12%. b. Assuming the timing pattern of the two projects’ cash flows is the same, Project B probably has a higher cost (and larger scale). c. Assuming the two projects have the same scale, Project B probably has a faster payback than Project A. d. The crossover rate for the two projects must be 12%. e. Since B has the higher IRR, then it must also have the higher NPV if the crossover rate is less than the WACC of 12%. ANSWER: c Consider the following NPV profile graph: RATIONALE:
We can see that statements a, d, and e are all incorrect. Statement b is also incorrect, because if the projects have the same timing pattern, then A must have the higher cost. That leaves statement c as being correct, and that conclusion is confirmed by noting that since A has the steeper slope, its cash flows must come in slower, hence B has the faster cash flows and thus the faster payback.
POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 11-7 NPV Profiles QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.11.07 - NPV Profiles NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: NPV profiles Copyright Cengage Learning. Powered by Cognero.
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KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
Bloom's: Application Multiple Choice: Conceptual 9/21/2017 5:31 PM 9/21/2017 5:31 PM
75. Anderson Systems is considering a project that has the following cash flow and WACC data. What is the project's NPV? Note that if a project's projected NPV is negative, it should be rejected. WACC: 11.00% Year 0 Cash flows -$1,000 a. 0259.57 b. 0257.35 c. 0241.82 d. 0221.86 e. 0195.23 ANSWER: RATIONALE:
1 $500
2 $500
3 $500
d
WACC: 11.00% Year 0 Cash flows -$1,000
1 $500
2 $500
3 $500
NPV = 0221.86
POINTS: 1 DIFFICULTY: EASY REFERENCES: 11-2 Net Present Value (NPV) QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.11.02 - Net Present Value (NPV) NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: NPV KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:31 PM DATE MODIFIED: 9/21/2017 5:31 PM 76. Tuttle Enterprises is considering a project that has the following cash flow and WACC data. What is the project's NPV? Note that if a project's projected NPV is negative, it should be rejected. WACC: 11.50% Year 0 Cash flows -$1,000 a. 084.03 b. 064.70 c. 059.49
1 $350
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2 $350
3 $350
4 $350
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d. 082.54 e. 074.36 ANSWER: RATIONALE:
e
WACC: 11.50% Year 0 Cash flows -$1,000
1 $350
2 $350
3 $350
4 $350
NPV = 074.36
POINTS: 1 DIFFICULTY: EASY REFERENCES: 11-2 Net Present Value (NPV) QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.11.02 - Net Present Value (NPV) NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: NPV KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:31 PM DATE MODIFIED: 9/21/2017 5:31 PM 77. Harry's Inc. is considering a project that has the following cash flow and WACC data. What is the project's NPV? Note that if a project's projected NPV is negative, it should be rejected. WACC: 9.50% Year 0 Cash flows -$1,000 a. 0120.01 b. 0135.20 c. 0151.91 d. 0179.26 e. 0133.68 ANSWER: RATIONALE:
1 $300
2 $300
3 $300
4 $300
5 $300
c
WACC: 9.50% Year 0 Cash flows -$1,000
1 $300
2 $300
3 $300
4 $300
5 $300
NPV = 0151.91
POINTS: 1 DIFFICULTY: EASY REFERENCES: 11-2 Net Present Value (NPV) QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.11.02 - Net Present Value (NPV) Copyright Cengage Learning. Powered by Cognero.
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NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: NPV KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:31 PM DATE MODIFIED: 9/21/2017 5:31 PM 78. Simms Corp. is considering a project that has the following cash flow data. What is the project's IRR? Note that a project's projected IRR can be less than the WACC or negative, in both cases it will be rejected. Year Cash flows a. 9.64% b. 10.82% c. 12.58% d. 11.29% e. 11.76% ANSWER: RATIONALE:
0 -$1,025
1 $425
2 $425
3 $425
e
Year Cash flows
0 -$1,025
1 $425
2 $425
3 $425
IRR = 11.76%
POINTS: 1 DIFFICULTY: EASY REFERENCES: 11-3 Internal Rate of Return (IRR) QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.11.03 - Internal Rate of Return (IRR) NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: IRR KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:31 PM DATE MODIFIED: 9/21/2017 5:31 PM 79. Warr Company is considering a project that has the following cash flow data. What is the project's IRR? Note that a project's projected IRR can be less than the WACC or negative, in both cases it will be rejected. Year Cash flows
0 -$1540
1 $400
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2 $400
3 $400
4 $400 Page 668
a. 4.13% b. 0.99% c. 5.41% d. 3.58% e. 1.22% ANSWER: RATIONALE:
c
Year Cash flows
0 -$1540
1 $400
2 $400
3 $400
4 $400
IRR = 5.41%
POINTS: 1 DIFFICULTY: EASY REFERENCES: 11-3 Internal Rate of Return (IRR) QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.11.03 - Internal Rate of Return (IRR) NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital TOPICS: IRR KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:31 PM DATE MODIFIED: 9/21/2017 5:31 PM 80. Thorley Inc. is considering a project that has the following cash flow data. What is the project's IRR? Note that a project's projected IRR can be less than the WACC or negative, in both cases it will be rejected. Year Cash flows a. 14.59% b. 15.18% c. 11.24% d. 16.20% e. 13.43% ANSWER: RATIONALE:
0 -$1,100
1 $325
2 $325
3 $325
4 $325
5 $325
a
Year Cash flows
0 -$1,100
1 $325
2 $325
3 $325
4 $325
5 $325
IRR = 14.59%
POINTS: 1 DIFFICULTY: EASY REFERENCES: 11-3 Internal Rate of Return (IRR) QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.11.03 - Internal Rate of Return (IRR) Copyright Cengage Learning. Powered by Cognero.
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NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: IRR KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:31 PM DATE MODIFIED: 9/21/2017 5:31 PM 81. Taggart Inc. is considering a project that has the following cash flow data. What is the project's payback? Year 0 Cash flows -$1,075 a. 2.15 years b. 1.70 years c. 2.11 years d. 1.81 years e. 2.45 years ANSWER: RATIONALE:
1 $500
2 $500
3 $500
a
Year Cash flows Cumulative CF
0 -$1,075 -$1,075
1 $500 -$575
2 $500 -$75
3 $500* $425*
-
-
-
2.15*
Payback = 2.15 Payback = last year before cum CF turns * positive + abs. val. last neg. cum CF/CF * in payback year.
POINTS: 1 DIFFICULTY: EASY REFERENCES: 11-8 Payback Period QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.11.08 - Payback Period NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Payback KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:31 PM DATE MODIFIED: 9/21/2017 5:31 PM 82. Resnick Inc. is considering a project that has the following cash flow data. What is the project's payback? Copyright Cengage Learning. Powered by Cognero.
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Year Cash flows a. 2.61 years b. 1.97 years c. 2.42 years d. 2.26 years e. 2.38 years ANSWER: RATIONALE:
0 -$475
1 $200
2 $200
3 $200
e
Year Cash flows Cumulative CF
0 -$475 -$475 -
1 $200 -$275 -
2 $2000 -$750 -0
3 $200* 0$125* 2.38*
Payback = 2.38
Payback = last year before cum CF turns * positive + abs. val. last neg. cum CF/CF * in payback year.
POINTS: 1 DIFFICULTY: EASY REFERENCES: 11-8 Payback Period QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.11.08 - Payback Period NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Payback KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:31 PM DATE MODIFIED: 9/21/2017 5:31 PM 83. Susmel Inc. is considering a project that has the following cash flow data. What is the project's payback? Year Cash flows a. 2.42 years b. 1.96 years c. 2.88 years d. 2.47 years e. 2.85 years ANSWER: RATIONALE:
0 -$475
1 $150
2 $200
3 $300
a
Year Cash flows Cumulative CF
0 1 2 3 -$475 $150 $2000 $300* -$475 -$325 -$1250 $175* -0 2.42*
Payback = 2.42 Copyright Cengage Learning. Powered by Cognero.
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Payback = last year before cum CF turns * positive + abs. val. last neg. cum CF/CF * in payback year. POINTS: 1 DIFFICULTY: EASY REFERENCES: 11-8 Payback Period QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.11.08 - Payback Period NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Payback KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:31 PM DATE MODIFIED: 9/21/2017 5:31 PM 84. Mansi Inc. is considering a project that has the following cash flow data. What is the project's payback? Year Cash flows a. 1.28 years b. 1.58 years c. 1.83 years d. 1.62 years e. 1.49 years ANSWER: RATIONALE:
0 -$500
1 $300
2 $325
3 $350
d
Year Cash flows Cumulative CF
0 1 2 3 -$500 $300 $325* $3500 -$500 -$200 0$125* $4750 - 1.62* -0
Payback = 1.62
Payback = last year before cum CF turns * positive + abs. val. last neg. cum CF/CF * in payback year.
POINTS: 1 DIFFICULTY: EASY REFERENCES: 11-8 Payback Period QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.11.08 - Payback Period NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business Copyright Cengage Learning. Powered by Cognero.
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TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
School Outcomes, you do not need to include anything for this category. Payback Bloom's: Analysis Multiple Choice: Problem 9/21/2017 5:31 PM 9/21/2017 5:31 PM
85. Cornell Enterprises is considering a project that has the following cash flow and WACC data. What is the project's NPV? Note that a project's projected NPV can be negative, in which case it will be rejected. WACC: 10.00% Year 0 Cash flows -$1,275 a. -$106.10 b. -$132.63 c. -$139.26 d. -$125.99 e. -$165.78 ANSWER: RATIONALE:
1 $450
2 $460
3 $470
b
WACC: 10.00% Year 0 Cash flows -$1,275
1 $450
2 $460
3 $470
NPV = -$132.63
POINTS: 1 DIFFICULTY: EASY/MODERATE REFERENCES: 11-2 Net Present Value (NPV) QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.11.02 - Net Present Value (NPV) NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: NPV KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:31 PM DATE MODIFIED: 9/21/2017 5:31 PM 86. Warnock Inc. is considering a project that has the following cash flow and WACC data. What is the project's NPV? Note that a project's projected NPV can be negative, in which case it will be rejected. WACC: 10.00% Year 0 Cash flows -$1,050 a. -$47.38 b. -$39.09
1 $500
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2 $400
3 $300
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c. -$29.61 d. -$40.27 e. -$39.48 ANSWER: RATIONALE:
e
WACC: Year Cash flows
10.00% 0 -$1,050
1 $500
2 $400
3 $300
NPV = -$39.48
POINTS: 1 DIFFICULTY: EASY/MODERATE REFERENCES: 11-2 Net Present Value (NPV) QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.11.02 - Net Present Value (NPV) NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: NPV KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:31 PM DATE MODIFIED: 9/21/2017 5:31 PM 87. Jazz World Inc. is considering a project that has the following cash flow and WACC data. What is the project's NPV? Note that a project's projected NPV can be negative, in which case it will be rejected. WACC: 9.75% Year 0 Cash flows -$1,200 a. 0$222.13 b. 0$185.11 c. 0$157.34 d. 0$174.00 e. 0$198.07 ANSWER: RATIONALE:
1 $400
2 $425
3 $450
9.75% 0 -$1,200
1 $400
4 $475
b
WACC: Year Cash flows
2 $425
3 $450
4 $475
NPV = 0$185.11
POINTS: 1 DIFFICULTY: EASY/MODERATE REFERENCES: 11-2 Net Present Value (NPV) QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.11.02 - Net Present Value (NPV) Copyright Cengage Learning. Powered by Cognero.
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NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: NPV KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:31 PM DATE MODIFIED: 9/21/2017 5:31 PM 88. Barry Company is considering a project that has the following cash flow and WACC data. What is the project's NPV? Note that a project's projected NPV can be negative, in which case it will be rejected. WACC: 11.75% Year 0 Cash flows -$1,100 a. 0$286.36 b. 0$294.95 c. 0$349.36 d. 0$309.27 e. 0$355.08 ANSWER: RATIONALE:
1 $400
2 $390
3 $380
4 $370
5 $360
2 $390
3 $380
a
WACC: 11.75% Year 0 Cash flows -$1,100
1 $400
4 $370
5 $360
NPV = 0$286.36
POINTS: 1 DIFFICULTY: EASY/MODERATE REFERENCES: 11-2 Net Present Value (NPV) QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.11.02 - Net Present Value (NPV) NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: NPV KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:31 PM DATE MODIFIED: 9/21/2017 5:31 PM 89. Datta Computer Systems is considering a project that has the following cash flow data. What is the project's IRR? Note that a project's projected IRR can be less than the WACC (and even negative), in which case it will be rejected. Year Cash flows
0 -$1,050
1 $450
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2 $470
3 $490 Page 675
a. 12.69% b. 13.98% c. 15.58% d. 18.15% e. 16.07% ANSWER: RATIONALE:
e
Year Cash flows
0 -$1,050
1 $450
2 $470
3 $490
IRR = 16.07%
POINTS: 1 DIFFICULTY: EASY/MODERATE REFERENCES: 11-3 Internal Rate of Return (IRR) QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.11.03 - Internal Rate of Return (IRR) NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: IRR KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:31 PM DATE MODIFIED: 9/21/2017 5:31 PM 90. Simkins Renovations Inc. is considering a project that has the following cash flow data. What is the project's IRR? Note that a project's projected IRR can be less than the WACC (and even negative), in which case it will be rejected. Year Cash flows a. 29.04% b. 32.63% c. 24.55% d. 30.83% e. 29.94% ANSWER: RATIONALE:
0 -$625
1 $300
2 $290
3 $280
4 $270
e
Year Cash flows
0 -$625
1 $300
2 $290
3 $280
4 $270
IRR = 29.94%
POINTS: DIFFICULTY: REFERENCES:
1 EASY/MODERATE 11-3 Internal Rate of Return (IRR)
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QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.11.03 - Internal Rate of Return (IRR) NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: IRR KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:31 PM DATE MODIFIED: 9/21/2017 5:31 PM 91. Maxwell Feed & Seed is considering a project that has the following cash flow data. What is the project's IRR? Note that a project's projected IRR can be less than the WACC (and even negative), in which case it will be rejected. Year Cash flows a. 15.45% b. 17.17% c. 13.74% d. 15.61% e. 12.96% ANSWER: RATIONALE:
0 -$6,750
1 $2,000
2 $2,025
3 $2,050
4 $2,075
5 $2,100
d
Year Cash flows
0 -$6,750
1 $2,000
2 $2,025
3 $2,050
4 $2,075
5 $2,100
IRR = 15.61%
POINTS: 1 DIFFICULTY: EASY/MODERATE REFERENCES: 11-3 Internal Rate of Return (IRR) QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.11.03 - Internal Rate of Return (IRR) NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: IRR KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:31 PM DATE MODIFIED: 9/21/2017 5:31 PM 92. Last month, Lloyd's Systems analyzed the project whose cash flows are shown below. However, before the decision to accept or reject the project, the Federal Reserve took actions that changed interest rates and therefore the firm's WACC. Copyright Cengage Learning. Powered by Cognero.
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The Fed's action did not affect the forecasted cash flows. By how much did the change in the WACC affect the project's forecasted NPV? Note that a project's projected NPV can be negative, in which case it should be rejected. Old WACC: 10.00% New WACC: 9.50% Year 0 1 2 3 Cash flows -$1,000 $410 $410 $410 a. 0$9.04 b. 0$11.12 c. 0$10.22 d. 0$10.85 e. 0$10.13 ANSWER: a RATIONALE: Old WACC: 10.00% New WACC: 9.50%
Year Cash flows
0 -$1,000
1 $410
2 $410
3 $410
Old NPV = $19.61 New NPV = 0$28.65 Change = 0$9.04
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 11-2 Net Present Value (NPV) QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.11.02 - Net Present Value (NPV) NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: NPV sensitivity to WACC KEYWORDS: Bloom's: Evaluation OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:31 PM DATE MODIFIED: 9/21/2017 5:31 PM 93. Lasik Vision Inc. recently analyzed the project whose cash flows are shown below. However, before Lasik decided to accept or reject the project, the Federal Reserve took actions that changed interest rates and therefore the firm's WACC. The Fed's action did not affect the forecasted cash flows. By how much did the change in the WACC affect the project's forecasted NPV? Note that a project's projected NPV can be negative, in which case it should be rejected. Old WACC: 8.00% Year 0 Cash flows -$1,000 a. -$30.55 b. -$34.12 c. -$32.50 d. -$28.60 e. -$29.25 ANSWER:
New WACC: 9.75% 1 2 3 $410 $410 $410
c
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RATIONALE:
Old WACC: 8.00% Year 0 Cash flows -$1,000
1 $410
New WACC: 9.75% 2 3 $410 $410
Old NPV = $56.61 New NPV = 0$24.11 Change = -$32.50
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 11-2 Net Present Value (NPV) QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.11.02 - Net Present Value (NPV) NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: NPV sensitivity to WACC KEYWORDS: Bloom's: Evaluation OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:31 PM DATE MODIFIED: 9/21/2017 5:31 PM 94. Ehrmann Data Systems is considering a project that has the following cash flow and WACC data. What is the project's MIRR? Note that a project's projected MIRR can be less than the WACC (and even negative), in which case it will be rejected. WACC: 9.00% Year 0 1 Cash flows -$1,000 $450 a. 13.84% b. 14.53% c. 17.29% d. 13.28% e. 13.70% ANSWER: a RATIONALE: WACC:
2 $450
3 $450
9.00% Year Cash flows Compounded values, FVs
0 -$1,000
1 2 3 $450 $450 $450 $534.65 $490.50 $450.00
TV = Sum of compounded inflows: $1,475.15 MIRR = 13.84% MIRR = 13.84% Copyright Cengage Learning. Powered by Cognero.
Found as discount rate that equates PV of TV to cost, discounted back 3 years @ WACC Alternative calculation, using Excel's MIRR function. Page 679
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 11-6 Modified Internal Rate of Return (MIRR) QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.11.06 - Modified Internal Rate of Return (MIRR) NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: MIRR KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:31 PM DATE MODIFIED: 9/21/2017 5:31 PM 95. Ingram Electric Products is considering a project that has the following cash flow and WACC data. What is the project's MIRR? Note that a project's projected MIRR can be less than the WACC (and even negative), in which case it will be rejected. WACC: 7.00% Year 0 1 Cash flows -$800 $350 a. 14.93% b. 10.00% c. 12.04% d. 13.97% e. 9.15% ANSWER: c RATIONALE: WACC:
2 $350
Year Cash flows Compounded values, FVs
3 $350
7.00% 0 -$800
1 2 3 $350 $350 $350 $400.72 $374.50 $350.00
TV = Sum of compounded inflows: $1,125.22 MIRR =12.04% MIRR =12.04% POINTS: DIFFICULTY: REFERENCES: QUESTION TYPE: HAS VARIABLES:
Found as discount rate that equates PV of TV to cost, discounted back 3 years @ WACC Alternative calculation, using Excel's MIRR function
1 MODERATE 11-6 Modified Internal Rate of Return (MIRR) Multiple Choice True
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LEARNING OBJECTIV FOFM.BRIG.17.11.06 - Modified Internal Rate of Return (MIRR) ES: NATIONAL STANDAR United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic DS: STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: MIRR KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:31 PM DATE MODIFIED: 9/21/2017 5:31 PM 96. Malholtra Inc. is considering a project that has the following cash flow and WACC data. What is the project's MIRR? Note that a project's projected MIRR can be less than the WACC (and even negative), in which case it will be rejected. WACC: 10.00% Year 0 Cash flows -$975 a. 14.45% b. 12.92% c. 12.57% d. 11.28% e. 11.75% ANSWER: RATIONALE:
1 $300
2 $320
3 $340
4 $360
e
WACC: 10.00% Year 0 1 2 3 4 Cash flows -$975 $300 $320 $340 $360 Compounded values, FVs $399.30 $387.20 $374.00 $360.00 TV = Sum of comp'ed inflows: $1,520.50 Found as discount rate that equates PV of TV to MIRR = 11.75% cost, discounted back 4 years @ WACC Alternative calculation, using Excel's MIRR MIRR = 11.75% function
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 11-6 Modified Internal Rate of Return (MIRR) QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.11.06 - Modified Internal Rate of Return (MIRR) NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: MIRR KEYWORDS: Bloom's: Analysis Copyright Cengage Learning. Powered by Cognero.
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OTHER: DATE CREATED: DATE MODIFIED:
Multiple Choice: Problem 9/21/2017 5:31 PM 9/21/2017 5:31 PM
97. Hindelang Inc. is considering a project that has the following cash flow and WACC data. What is the project's MIRR? Note that a project's projected MIRR can be less than the WACC (and even negative), in which case it will be rejected. WACC: 12.50% Year 0 Cash flows -$850 a. 15.00% b. 12.83% c. 16.67% d. 13.33% e. 20.66% ANSWER: RATIONALE:
1 $300
2 $320
3 $340
4 $360
c
WACC: Year Cash flows Compounded values, FVs
12.50% 0 1 2 3 4 -$850 $300 $320 $340 $360 $427.15 $405.00 $382.50 $360.00
TV = Sum of comp'ed inflows: $1,574.65 Found as discount rate that equates PV of TV to cost, MIRR = 16.67% discounted back 4 years @ WACC MIRR = 16.67% Alternative calculation, using Excel's MIRR function POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 11-6 Modified Internal Rate of Return (MIRR) QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.11.06 - Modified Internal Rate of Return (MIRR) NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: MIRR KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:31 PM DATE MODIFIED: 9/21/2017 5:31 PM 98. Stern Associates is considering a project that has the following cash flow data. What is the project's payback? Year Cash flows a. 2.54 years
0 -$975
1 $300
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2 $310
3 $320
4 $330
5 $340
Page 682
b. 2.42 years c. 3.83 years d. 3.14 years e. 3.61 years ANSWER: RATIONALE:
d
Year Cash flows Cumulative CF
0 -$975 -$975 -
1 $300 -$675 -
2 $310 -$365 -
3 $320 -$45 -
4 $330 0$285 3.14
5 $340 $625 -
Payback = 3.14
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 11-8 Payback Period QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.11.08 - Payback Period NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Payback KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:31 PM DATE MODIFIED: 9/21/2017 5:31 PM 99. Fernando Designs is considering a project that has the following cash flow and WACC data. What is the project's discounted payback? WACC: 10.00% Year 0 Cash flows -$650 a. 1.62 years b. 1.58 years c. 1.15 years d. 1.47 years e. 1.24 years ANSWER: RATIONALE:
1 $500
2 $500
3 $500
d
WACC: Year Cash flows PV of CFs Cumulative CF
10.00% 0 -$650 -$650 -$650 -
1 $500 $455 -$195 -
2 $500 $413 0$218 1.47
3 $500 $376 0$593 -
Payback = 1.47 Copyright Cengage Learning. Powered by Cognero.
Page 683
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 11-8 Payback Period QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.11.08 - Payback Period NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Discounted payback KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:31 PM DATE MODIFIED: 9/21/2017 5:31 PM 100. Masulis Inc. is considering a project that has the following cash flow and WACC data. What is the project's discounted payback? WACC: Year Cash flows a. 2.40 years b. 2.14 years c. 2.25 years d. 1.95 years e. 1.86 years ANSWER: RATIONALE:
10.00% 0 -$925
1 $525
2 $485
3 $445
4 $405
b
WACC: Year Cash flows PV of CFs Cumulative CF
10.00% 0 1 -$925 $525 -$925 $477 -$925 -$448 -
2 $485 $401 -$47 -
3 $445 $334 0$287 2.14
4 $405 $277 0$564 -
Payback = 2.14
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 11-8 Payback Period QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.11.08 - Payback Period NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. Copyright Cengage Learning. Powered by Cognero.
Page 684
TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
Discounted payback Bloom's: Analysis Multiple Choice: Problem 9/21/2017 5:31 PM 9/21/2017 5:31 PM
101. Tesar Chemicals is considering Projects S and L, whose cash flows are shown below. These projects are mutually exclusive, equally risky, and not repeatable. The CEO believes the IRR is the best selection criterion, while the CFO advocates the NPV. If the decision is made by choosing the project with the higher IRR rather than the one with the higher NPV, how much, if any, value will be forgone, i.e., what's the chosen NPV versus the maximum possible NPV? Note that (1) "true value" is measured by NPV, and (2) under some conditions the choice of IRR vs. NPV will have no effect on the value gained or lost. WACC:
7.75%
CFS CFL a. $102.07 b. $118.25 c. $124.47 d. $95.84 e. $133.18 ANSWER: RATIONALE:
0 -$1,100 -$2,700
1 $550 $650
2 $600 $725
3 $100 $800
4 $100 $1,400
c First, recognize that NPV makes theoretically correct capital budgeting decisions, so the highest NPV tells us how much value could be added. We calculate the two projects' NPVs, IRRs, and MIRRs, but the MIRR information is not needed for this problem. We then see what NPV would result if the decision were based on the IRR (and the MIRR). The difference between the NPV is the loss incurred if the IRR criterion is used. Of course, it's possible that IRR could choose the correct project.
WACC:
Year CFS
7.75% 0 $1,100
Compounded CFs: CFL Compounded CFs:
1 $550
2 $600
688.04 $2,700
$725
813.14
TV
MIRR
$800 $1,400
841.73 862.00 1400.00$3,916.87 9.7473%
MIRR, L =9.75%
IRR, L =10.71181%
MIRR, S =9.69%
IRR, S =12.24157%
MIRR Choice: L NPV using MIRR: $205.83
IRR Choice: S NPV using IRR: $81.36
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4 $100
696.60 107.75 100.00$1,592.40 9.6894%
$650
Lost value using IRR versus MIRR: Lost value using MIRR versus NPV: Lost value using IRR versus NPV:
3 $100
$124.47 $0.00 $124.47
NPV, L = $205.8284 NPV, S = $81.3585 NPV Choice: L NPV using NPV: $205.83 Loss below: 7.9850% Loss below: 10.1638% Loss below: 10.1638% Page 685
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.11.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: NPV and IRR KEYWORDS: Bloom's: Evaluation OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:31 PM DATE MODIFIED: 9/21/2017 5:31 PM 102. A firm is considering Projects S and L, whose cash flows are shown below. These projects are mutually exclusive, equally risky, and not repeatable. The CEO wants to use the IRR criterion, while the CFO favors the NPV method. You were hired to advise the firm on the best procedure. If the wrong decision criterion is used, how much potential value would the firm lose? WACC:
6.75%
CFS CFL a. $214.44 b. $186.47 c. $218.17 d. $182.74 e. $220.03 ANSWER: RATIONALE:
0 -$1,025 -$2,150
1 $380 $765
2 $380 $765
3 $380 $765
4 $380 $765
b
WACC: 6.75% CFS CFL IRR, L IRR, S NPV, L NPV, S
0 1 2 3 -$1,025 $380 $380 $380 -$2,150 $765 $765 $765 15.781% 17.861% $455.91 $269.44 $186.47 = Value lost if use the IRR criterion
0% 2% 4% 6% Copyright Cengage Learning. Powered by Cognero.
4 $380 $765
S 269.4 495.0 421.9 354.4 291.7
L
455.9 910.0 762.9 626.9 500.8 Page 686
8% 233.6 10% 179.5 12% 129.2 13.860% 85.4 14% 82.2 16% 38.3 18% -2.8 20% -41.3 22% -77.4 24% -111.4
383.8 274.9 173.6 85.4 79.0 -9.4 -92.1 -169.6 -242.4 -310.7
Note that the WACC is constrained to be less than the crossover point, so there is a conflict between NPV and IRR, hence following the IRR rule results in a loss of value.
POINTS: 1 DIFFICULTY: MODERATE/CHALLENGING REFERENCES: 11-5 Reinvestment Rate Assumptions QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.11.05 - Reinvestment Rate Assumptions NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: NPV and IRR KEYWORDS: Bloom's: Evaluation OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:31 PM DATE MODIFIED: 9/21/2017 5:31 PM 103. Sexton Inc. is considering Projects S and L, whose cash flows are shown below. These projects are mutually exclusive, equally risky, and not repeatable. If the decision is made by choosing the project with the higher IRR, how much value will be forgone? Note that under certain conditions choosing projects on the basis of the IRR will not cause any value to be lost because the one with the higher IRR will also have the higher NPV, so no value will be lost if the IRR method is used. WACC:
9.50%
CFS CFL a. $188.91 b. $145.46 c. $228.58 d. $226.70 e. $230.47 ANSWER: RATIONALE:
0 -$2,050 -$4,300
1 $750 $1,500
2 $760 $1,518
3 $770 $1,536
4 $780 $1,554
a
WACC: 9.50%
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13.275% = crossover Page 687
0 -$2,050 -$4,300
CFS CFL IRR, L IRR, S
1 $750 $1,500
2 $760 $1,518
3 $770 $1,536
4 $780 $1,554
15.58% 18.06%
NPV, L NPV, S
0$586.71 $397.80 $188.91 = Value lost if use the IRR criterion
Note that the WACC is not constrained to be less than the crossover point, so there may not be a conflict between NPV and IRR, hence following the IRR rule may not result in a loss of value. In that case, the correct answer is $188.91.
POINTS: 1 DIFFICULTY: MODERATE/CHALLENGING REFERENCES: 11-5 Reinvestment Rate Assumptions QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.11.05 - Reinvestment Rate Assumptions NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: NPV and IRR KEYWORDS: Bloom's: Evaluation OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:31 PM DATE MODIFIED: 9/21/2017 5:31 PM 104. Moerdyk & Co. is considering Projects S and L, whose cash flows are shown below. These projects are mutually exclusive, equally risky, and not repeatable. If the decision is made by choosing the project with the higher IRR, how much value will be forgone? Note that under certain conditions choosing projects on the basis of the IRR will not cause any value to be lost because the one with the higher IRR will also have the higher NPV, i.e., no conflict will exist. WACC: CFS CFL a. $62.75 b. $59.20 c. $53.28 d. $51.51 e. $65.71 ANSWER: RATIONALE:
6.75% 0 -$1,025 -$1,025
1 $650 $100
2 $450 $300
3 $250 $500
4 $50 $700
b
WACC: 6.75%
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10.549% = crossover Page 688
CFS CFL
0 -$1,025 -$1,025
1 $650 $100
2 $450 $300
3 $250 $500
IRR, L IRR, S
15.66% 19.86%
NPV, L NPV, S
$282.01 $222.80 $59.20 = Value lost if use the IRR criterion
4 $50 $700
Note that the WACC is not constrained to be less than the crossover point, so there may not be a conflict between NPV and IRR, hence following the IRR rule may not result in a loss of value. In that case, the correct answer is $59.20.
POINTS: 1 DIFFICULTY: MODERATE/CHALLENGING REFERENCES: 11-5 Reinvestment Rate Assumptions QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.11.05 - Reinvestment Rate Assumptions NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: NPV and IRR KEYWORDS: Bloom's: Evaluation OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:31 PM DATE MODIFIED: 9/21/2017 5:31 PM 105. Kosovski Company is considering Projects S and L, whose cash flows are shown below. These projects are mutually exclusive, equally risky, and are not repeatable. If the decision is made by choosing the project with the higher IRR, how much value will be forgone? Note that under some conditions choosing projects on the basis of the IRR will cause $0.00 value to be lost. WACC: CFS CFL a. $29.26 b. $35.69 c. $34.82 d. $26.33 e. $31.31 ANSWER: RATIONALE:
6.25% 0 -$1,050 -$1,050
1 $675 $360
2 $650 $360
3
4
$360
$360
a
WACC:
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6.25%
8.994% = crossover Page 689
CFS CFL
0 -$1,050 -$1,050
1 $675 $360
2 $650 $360
3
4
$360
$360
IRR, L IRR, S
13.95% 17.13%
NPV, L NPV, S
$190.33 $161.07 $29.26 = Value lost if use the IRR criterion
Note that the WACC is not constrained to be less than the crossover point, so there may not be a conflict between NPV and IRR, hence following the IRR rule may not result in a loss of value. In that case, the correct answer is $29.26.
POINTS: 1 DIFFICULTY: MODERATE/CHALLENGING REFERENCES: 11-5 Reinvestment Rate Assumptions QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.11.05 - Reinvestment Rate Assumptions NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: NPV and IRR KEYWORDS: Bloom's: Evaluation OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:31 PM DATE MODIFIED: 9/21/2017 5:31 PM 106. Nast Inc. is considering Projects S and L, whose cash flows are shown below. These projects are mutually exclusive, equally risky, and not repeatable. If the decision is made by choosing the project with the higher MIRR rather than the one with the higher NPV, how much value will be forgone? Note that under some conditions choosing projects on the basis of the MIRR will cause $0.00 value to be lost. WACC:
10.75%
CFS CFL a. $6.49 b. $9.40 c. $0.00 d. $7.66 e. $6.66 ANSWER: RATIONALE:
0 -$1,100 -$2,200
1 $375 $725
2 $375 $725
3 $375 $725
4 $375 $725
c
WACC:
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10.75%
Crossover = 10.396% Page 690
0 -$1,100
1 $375 509.40 -$2,200 $725 984.85
CFS CFL
2 $375 459.96 $725 889.25
3 4 TV $375 $375 415.31 375.00 $1,759.68 $725 $725 802.94 725.00 $3,402.04
MIRR, L MIRR, S
11.51% 12.46%
NPV, L NPV, S
$61.33 $69.65 $0.00 = Value lost if use the MIRR criterion
MIRR 12.46% 11.51%
Note that the WACC is not constrained to be less than the crossover point, so there may not be a conflict between NPV and IRR, hence following the MIRR rule may not result in a loss of value. In that case, the correct answer is $0.00.
POINTS: 1 DIFFICULTY: MODERATE/CHALLENGING REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.11.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: NPV and MIRR KEYWORDS: Bloom's: Evaluation OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:31 PM DATE MODIFIED: 9/21/2017 5:31 PM 107. Yonan Inc. is considering Projects S and L, whose cash flows are shown below. These projects are mutually exclusive, equally risky, and not repeatable. If the decision is made by choosing the project with the shorter payback, some value may be forgone. How much value will be lost in this instance? Note that under some conditions choosing projects on the basis of the shorter payback will not cause value to be lost. WACC:
10.25% 0 -$950 -$2,100
CFS CFL
1 $500 $400
2 $800 $800
3 $0 $800
4 $0 $1,000
a. $39.40 b. $33.11 c. $41.39 d. $28.47 e. $37.74 Copyright Cengage Learning. Powered by Cognero.
Page 691
ANSWER: RATIONALE:
b
WACC:
10.25%
CFS CFL Cumulative CF, S Cumulative CF, L Payback S = 1.56 Payback L = 3.10
0 -$950 -$2,100 -$950 -$2,100 -
Crossover = 11.093% 1 2 3 $500 $800 $0 $400 $800 $800 -$450 $350 $350 -$1,700 -$900 -$100 1.56 -
4 $0 $1,000 $350 $900 3.10
NPV, L = 0$194.79 NPV, S = $161.68 Value lost = $33.11 Note that the WACC is not constrained to be less than the crossover point, so there may not be a conflict between NPV and payback, hence following the IRR rule may not result in a loss of value, so the correct answer may be $33.11.
POINTS: 1 DIFFICULTY: MODERATE/CHALLENGING REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.11.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: NPV vs. payback KEYWORDS: Bloom's: Evaluation OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:31 PM DATE MODIFIED: 9/21/2017 5:31 PM 108. Noe Drilling Inc. is considering Projects S and L, whose cash flows are shown below. These projects are mutually exclusive, equally risky, and not repeatable. The CEO believes the IRR is the best selection criterion, while the CFO advocates the MIRR. If the decision is made by choosing the project with the higher IRR rather than the one with the higher MIRR, how much, if any, value will be forgone, i.e., what's the NPV of the chosen project versus the maximum possible NPV? Note that (1) "true value" is measured by NPV, and (2) under some conditions the choice of IRR vs. MIRR will have no effect on the value lost. WACC:
9.00% 0 -$1,100 -$2,750
CFS CFL
1 $550 $725
2 $600 $725
3 $100 $800
4 $100 $1,400
a. $73.38 b. $79.56 c. $0.00 d. $96.55 e. $78.01 Copyright Cengage Learning. Powered by Cognero.
Page 692
ANSWER: RATIONALE:
c First, recognize that NPV makes theoretically correct capital budgeting decisions, so the higher NPV tells us how much value could be added. We calculate the two projects' NPVs, IRRs, and MIRRs. We then see what NPV would result if the decision were based on the IRR and the MIRR. Under some conditions, MIRR will choose the project with the higher NPV while the IRR chooses the lower NPV project. Then, the difference between the NPVs is the loss incurred if the IRR criterion is used. Of course, it's possible that both the MIRR and the IRR could choose the wrong project; with this set of cash flows, that happens at WACC > 8.62133%.
WACC: CFS Compounded CFs: CFL Compounded CFs:
9.00% 0 -$1,100
-$2,750
1 2 $550 $600 712.27 712.86
3 4 TV IRR/MIRR $100 $100 12.2416% 109.00 100.00 $1,634.13 10.4011%
$725 $725 938.90 861.37
$800 $1,400 10.9810% 872.00 1,400.00 $4,072.27 10.3128% 0.0882%
MIRR, S = 10.4011% MIRR, L = 10.3128% MIRR Choice: L NPV based on MIRR: $57.66
IRR, S = 12.2416% NPV, S = $57.66 IRR, L = 10.9810% NPV, L = $134.90 IRR Choice: S NPV Choice: L NPV based on IRR: $57.66 NPV using NPV: $134.90
Lost value using IRR versus MIRR: NPVL − NPV S = $0.00
MIRR, S =
10.4011%
IRR, S = 12.2416%
MIRR, L =
10.3128%
IRR, L = 10.9810%
MIRR choice: L NPV based on $57.66 MIRR:
10.4011%
IRR, S = 12.2416%
MIRR, L =
10.3128%
IRR, L = 10.9810%
10.4011%
IRR, S = 12.2416%
MIRR, L =
10.3128%
IRR, L = 10.9810%
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NPV, S $57.66 = NPV, L $134.90 =
IRR choice: S NPVchoice: L NPV based on $57.66 NPV using NPV: $134.90 IRR:
MIRR, S =
MIRR choice: L NPV based on $57.66 MIRR:
NPV, S $57.66 = NPV, L $134.90 =
IRR choice: S NPVchoice: L NPV based on $57.66 NPV using NPV: $134.90 IRR:
MIRR, S =
MIRR choice: L NPV based on $57.66 MIRR:
Loss below: 8.6213%
NPV, S $57.66 = NPV, L $134.90 =
IRR choice: S NPVchoice: L NPV based on $57.66 NPV using NPV: $134.90 IRR: Page 693
MIRR, S =
10.4011%
IRR, S = 12.2416%
MIRR, L =
10.3128%
IRR, L = 10.9810%
MIRR choice: L NPV based on $57.66 MIRR:
NPV, S $57.66 = NPV, L $134.90 =
IRR choice: S NPVchoice: L NPV based on $57.66 NPV using NPV: $134.90 IRR:
POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.11.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: IRR vs. MIRR KEYWORDS: Bloom's: Evaluation OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:31 PM DATE MODIFIED: 9/21/2017 5:31 PM
1. Because of improvements in forecasting techniques, estimating the cash flows associated with a project has become the easiest step in the capital budgeting process. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 12-1 Conceptual Issues in Cash Flow Estimation QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.12.01 - Conceptual Issues in Cash Flow Estimation NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.01 - Stocks and bonds United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Cash flow estimation KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:57 PM DATE MODIFIED: 9/21/2017 5:57 PM 2. Estimating project cash flows is generally the most important, but also the most difficult, step in the capital budgeting Copyright Cengage Learning. Powered by Cognero.
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process. Methodology, such as the use of NPV versus IRR, is important, but less so than obtaining a reasonably accurate estimate of projects' cash flows. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 12-1 Conceptual Issues in Cash Flow Estimation QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.12.01 - Conceptual Issues in Cash Flow Estimation NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.01 - Stocks and bonds United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Cash flow estimation KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:57 PM DATE MODIFIED: 9/21/2017 5:57 PM 3. Although it is extremely difficult to make accurate forecasts of the revenues that a project will generate, projects' initial outlays and subsequent costs can be forecasted with great accuracy. This is especially true for large product development projects. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 12-1 Conceptual Issues in Cash Flow Estimation QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.12.01 - Conceptual Issues in Cash Flow Estimation NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.01 - Stocks and bonds United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Cash flow estimation KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:57 PM DATE MODIFIED: 9/21/2017 5:57 PM 4. Since the focus of capital budgeting is on cash flows rather than on net income, changes in noncash balance sheet accounts such as inventory are not included in a capital budgeting analysis. a. True b. False Copyright Cengage Learning. Powered by Cognero.
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ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 12-1 Conceptual Issues in Cash Flow Estimation QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.12.01 - Conceptual Issues in Cash Flow Estimation NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.01 - Stocks and bonds United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital TOPICS: Relevant cash flows KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:57 PM DATE MODIFIED: 9/21/2017 5:57 PM 5. If an investment project would make use of land which the firm currently owns, the project should be charged with the opportunity cost of the land. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 12-1 Conceptual Issues in Cash Flow Estimation QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.12.01 - Conceptual Issues in Cash Flow Estimation NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.01 - Stocks and bonds United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Relevant cash flows KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:57 PM DATE MODIFIED: 9/21/2017 5:57 PM 6. If debt is to be used to finance a project, then when cash flows for a project are estimated, interest payments should be included in the analysis. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 12-1 Conceptual Issues in Cash Flow Estimation QUESTION TYPE: True / False HAS VARIABLES: False Copyright Cengage Learning. Powered by Cognero.
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LEARNING OBJECTIVES: FOFM.BRIG.16.12.01 - Conceptual Issues in Cash Flow Estimation NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.01 - Stocks and bonds United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Relevant cash flows KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:57 PM DATE MODIFIED: 9/21/2017 5:57 PM 7. Any cash flows that can be classified as incremental to a particular project - i.e., results directly from the decision to undertake the project - should be reflected in the capital budgeting analysis. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 12-1 Conceptual Issues in Cash Flow Estimation QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.12.01 - Conceptual Issues in Cash Flow Estimation NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.01 - Stocks and bonds United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Relevant cash flows KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:57 PM DATE MODIFIED: 9/21/2017 5:57 PM 8. We can identify the cash costs and cash inflows to a company that will result from a project. These could be called "direct inflows and outflows," and the net difference is the direct net cash flow. If there are other costs and benefits that do not flow from or to the firm, but to other parties, these are called externalities, and they need not be considered as a part of the capital budgeting analysis. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 12-1 Conceptual Issues in Cash Flow Estimation QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.12.01 - Conceptual Issues in Cash Flow Estimation NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital Copyright Cengage Learning. Powered by Cognero.
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LOCAL STANDARDS: TOPICS: KEYWORDS: DATE CREATED: DATE MODIFIED:
United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. Externalities Bloom's: Knowledge 9/21/2017 5:57 PM 9/21/2017 5:57 PM
9. In cash flow estimation, the existence of externalities should be taken into account if those externalities have any effects on the firm's long-run cash flows. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 12-1 Conceptual Issues in Cash Flow Estimation QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.12.01 - Conceptual Issues in Cash Flow Estimation NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Externalities KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:57 PM DATE MODIFIED: 9/21/2017 5:57 PM 10. Suppose a firm's CFO thinks that an externality is present in a project, but that it cannot be quantified with any precision estimates of its effect would really just be guesses. In this case, the externality should be ignored - i.e., not considered at all - because if it were considered it would make the analysis appear more precise than it really is. a. True b. False ANSWER: False RATIONALE: If the externality is potentially important, it should not be ignored, because then a large error might be made. At the very least, it should be discussed, and possibly the analysis should be done using several scenarios of its possible effects. POINTS: 1 DIFFICULTY: EASY REFERENCES: 12-1 Conceptual Issues in Cash Flow Estimation QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.12.01 - Conceptual Issues in Cash Flow Estimation NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. Copyright Cengage Learning. Powered by Cognero.
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TOPICS: KEYWORDS: DATE CREATED: DATE MODIFIED:
Externalities Bloom's: Comprehension 9/21/2017 5:57 PM 9/21/2017 5:57 PM
11. Changes in net operating working capital should not be reflected in a capital budgeting cash flow analysis because capital budgeting relates to fixed assets, not working capital. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 12-2 Analysis of an Expansion Project QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.12.02 - Analysis of an Expansion Project NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Changes in NOWC KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:57 PM DATE MODIFIED: 9/21/2017 5:57 PM 12. The primary advantage to using accelerated rather than straight-line depreciation is that with accelerated depreciation the total amount of depreciation that can be taken, assuming the asset is used for its full tax life, is greater. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 12-2 Analysis of an Expansion Project QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.12.02 - Analysis of an Expansion Project NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.01 - Stocks and bonds United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Depreciation cash flows KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:57 PM DATE MODIFIED: 9/21/2017 5:57 PM Copyright Cengage Learning. Powered by Cognero.
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13. The primary advantage to using accelerated rather than straight-line depreciation is that with accelerated depreciation the present value of the tax savings provided by depreciation will be higher, other things held constant. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 12-2 Analysis of an Expansion Project QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.12.02 - Analysis of an Expansion Project NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.01 - Stocks and bonds United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Depreciation cash flows KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:57 PM DATE MODIFIED: 9/21/2017 5:57 PM 14. Typically, a project will have a higher NPV if the firm uses accelerated rather than straight-line depreciation. This is because the total cash flows over the project's life will be higher if accelerated depreciation is used, other things held constant. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 12-2 Analysis of an Expansion Project QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.12.02 - Analysis of an Expansion Project NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.01 - Stocks and bonds United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Depreciation cash flows KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:57 PM DATE MODIFIED: 9/21/2017 5:57 PM 15. A firm that bases its capital budgeting decisions on either NPV or IRR will be more likely to accept a given project if it uses accelerated depreciation than if it uses straight-line depreciation, other things being equal. a. True b. False Copyright Cengage Learning. Powered by Cognero.
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ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 12-2 Analysis of an Expansion Project QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.12.02 - Analysis of an Expansion Project NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.01 - Stocks and bonds United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Depreciation cash flows KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:57 PM DATE MODIFIED: 9/21/2017 5:57 PM 16. Accelerated depreciation has an advantage for profitable firms in that it moves some cash flows forward, thus increasing their present value. On the other hand, using accelerated depreciation generally lowers the reported current year's profits because of the higher depreciation expenses. However, the reported profits problem can be solved by using different depreciation methods for tax and stockholder reporting purposes. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 12-2 Analysis of an Expansion Project QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.12.02 - Analysis of an Expansion Project NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.01 - Stocks and bonds United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Depreciation cash flows KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:57 PM DATE MODIFIED: 9/21/2017 5:57 PM 17. If a firm's projects differ in risk, then one way of handling this problem is to evaluate each project with the appropriate risk-adjusted discount rate. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY Copyright Cengage Learning. Powered by Cognero.
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REFERENCES: 12-4 Risk Analysis in Capital Budgeting QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.12.04 - Risk Analysis in Capital Budgeting NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Risk-adjusted discount rate KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:57 PM DATE MODIFIED: 9/21/2017 5:57 PM 18. Superior analytical techniques, such as NPV, used in combination with risk-adjusted cost of capital estimates, can overcome the problem of poor cash flow estimation and lead to generally correct accept/reject decisions for capital budgeting projects. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 12-1 Conceptual Issues in Cash Flow Estimation QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.12.01 - Conceptual Issues in Cash Flow Estimation NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.01 - Stocks and bonds United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Cash flow estimation KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:57 PM DATE MODIFIED: 9/21/2017 5:57 PM 19. It is extremely difficult to estimate the revenues and costs associated with large, complex projects that take several years to develop. This is why subjective judgment is often used for such projects along with discounted cash flow analysis. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 12-1 Conceptual Issues in Cash Flow Estimation QUESTION TYPE: True / False HAS VARIABLES: False Copyright Cengage Learning. Powered by Cognero.
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LEARNING OBJECTIVES: FOFM.BRIG.16.12.01 - Conceptual Issues in Cash Flow Estimation NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.15.03 - Capital budgeting and cost of capital United States - OH - DISC.FOFM.BRIG.16.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Cash flow estimation KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:57 PM DATE MODIFIED: 9/21/2017 5:57 PM 20. The two cardinal rules that financial analysts should follow to avoid errors are: (1) in the NPV equation, the numerator should use income calculated in accordance with generally accepted accounting principles, and (2) all incremental cash flows should be considered when making accept/reject decisions for capital budgeting projects. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 12-1 Conceptual Issues in Cash Flow Estimation QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.12.01 - Conceptual Issues in Cash Flow Estimation NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.01 - Stocks and bonds United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Relevant cash flows KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:57 PM DATE MODIFIED: 9/21/2017 5:57 PM 21. Opportunity costs include those cash inflows that could be generated from assets the firm already owns if those assets are not used for the project being evaluated. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 12-1 Conceptual Issues in Cash Flow Estimation QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.12.01 - Conceptual Issues in Cash Flow Estimation NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital Copyright Cengage Learning. Powered by Cognero.
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LOCAL STANDARDS: TOPICS: KEYWORDS: DATE CREATED: DATE MODIFIED:
United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. Opportunity costs Bloom's: Knowledge 9/21/2017 5:57 PM 9/21/2017 5:57 PM
22. Suppose Walker Publishing Company is considering bringing out a new finance text whose projected revenues include some revenues that will be taken away from another of Walker's books. The lost sales on the older book are a sunk cost and as such should not be considered in the analysis for the new book. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 12-1 Conceptual Issues in Cash Flow Estimation QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.12.01 - Conceptual Issues in Cash Flow Estimation NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Sunk costs KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:57 PM DATE MODIFIED: 9/21/2017 5:57 PM 23. The change in net operating working capital associated with new projects is always positive, because new projects mean that more operating working capital will be required. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 12-2 Analysis of an Expansion Project QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.12.02 - Analysis of an Expansion Project NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: NOWC KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:57 PM Copyright Cengage Learning. Powered by Cognero.
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DATE MODIFIED:
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24. The use of accelerated versus straight-line depreciation causes net income reported to stockholders to be lower, and cash flows higher, during every year of a project's life, other things held constant. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 12-2 Analysis of an Expansion Project QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.12.02 - Analysis of an Expansion Project NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.01 - Stocks and bonds United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Depreciation cash flows KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:57 PM DATE MODIFIED: 9/21/2017 5:57 PM 25. Sensitivity analysis measures a project's stand-alone risk by showing how much the project's NPV (or IRR) is affected by a small change in one of the input variables, say sales. Other things held constant, with the size of the independent variable graphed on the horizontal axis and the NPV on the vertical axis, the steeper the graph of the relationship line, the more risky the project, other things held constant. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 12-5 Measuring Stand-Alone Risk QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.12.05 - Measuring Stand-Alone Risk NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Sensitivity analysis KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:57 PM DATE MODIFIED: 9/21/2017 5:57 PM 26. Replacement chain or EAA analysis is required when analyzing projects that have different lives. This is true regardless of whether the projects are mutually exclusive or independent of one another. Copyright Cengage Learning. Powered by Cognero.
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a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 12-7 Unequal Project Lives QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.12.07 - Unequal Project Lives NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital TOPICS: Replacement chain KEYWORDS: Bloom’s: Comprehension DATE CREATED: 9/21/2017 5:57 PM DATE MODIFIED: 9/21/2017 5:57 PM 27. Although the replacement chain approach is appealing for dealing with mutually exclusive projects that have different lives, it is not used in practice because not projects meet the assumptions the method requires. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 12-7 Unequal Project Lives QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.12.07 - Unequal Project Lives NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital TOPICS: Replacement chains KEYWORDS: Bloom’s: Knowledge DATE CREATED: 9/21/2017 5:57 PM DATE MODIFIED: 9/21/2017 5:57 PM 28. Extending the lives of projects with different lives out to a common life for comparison purposes, while theoretically appealing, is valid only if there is a reasonably high probability that the projects will actually be repeated beyond their initial lives. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 12-7 Unequal Project Lives QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.12.07 - Unequal Project Lives Copyright Cengage Learning. Powered by Cognero.
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NATIONAL STANDARDS: STATE STANDARDS: TOPICS: KEYWORDS: DATE CREATED: DATE MODIFIED:
United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital Common-life comparisons Bloom’s: Knowledge 9/21/2017 5:57 PM 9/21/2017 5:57 PM
29. The two methods discussed in the text for dealing with unequal project lives are (1) the replacement chain approach and (2) the equivalent annual annuity (EAA) approach. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 12-7 Unequal Project Lives QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.12.07 - Unequal Project Lives NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital TOPICS: Common life and EAA KEYWORDS: Bloom’s: Knowledge DATE CREATED: 9/21/2017 5:57 PM DATE MODIFIED: 9/21/2017 5:57 PM 30. The two methods discussed in the text for dealing with unequal project lives are (1) the replacement chain approach and (2) the present value approach. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 12-7 Unequal Project Lives QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.12.07 - Unequal Project Lives NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital TOPICS: Common life and EAA KEYWORDS: Bloom’s: Knowledge DATE CREATED: 9/21/2017 5:57 PM DATE MODIFIED: 9/21/2017 5:57 PM 31. Which of the following is NOT a relevant cash flow and thus should NOT be reflected in the analysis of a capital budgeting project? a. Changes in net operating working capital. Copyright Cengage Learning. Powered by Cognero.
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b. Shipping and installation costs for machinery acquired. c. Cannibalization effects. d. Opportunity costs. e. Sunk costs that have been expensed for tax purposes. ANSWER: e POINTS: 1 DIFFICULTY: EASY REFERENCES: 12-1 Conceptual Issues in Cash Flow Estimation QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.12.01 - Conceptual Issues in Cash Flow Estimation NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.01 - Stocks and bonds United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Cash flow issues KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:57 PM DATE MODIFIED: 9/21/2017 5:57 PM 32. The relative risk of a proposed project is best accounted for by which of the following procedures? a. Adjusting the discount rate upward if the project is judged to have above-average risk. b. Adjusting the discount rate upward if the project is judged to have below-average risk. c. Reducing the NPV by 10% for risky projects. d. Picking a risk factor equal to the average discount rate. e. Ignoring risk because project risk cannot be measured accurately. ANSWER: a POINTS: 1 DIFFICULTY: EASY REFERENCES: 12-4 Risk Analysis in Capital Budgeting QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.12.04 - Risk Analysis in Capital Budgeting NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Risk adjustment KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:57 PM DATE MODIFIED: 9/21/2017 5:57 PM 33. Suppose Tapley Inc. uses a WACC of 8% for below-average risk projects, 10% for average-risk projects, and 12% for Copyright Cengage Learning. Powered by Cognero.
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above-average risk projects. Which of the following independent projects should Tapley accept, assuming that the company uses the NPV method when choosing projects? a. Project A, which has average risk and an IRR = 9%. b. Project B, which has below-average risk and an IRR = 8.5%. c. Project C, which has above-average risk and an IRR = 11%. d. Without information about the projects' NPVs we cannot determine which one or ones should be accepted. e. All of these projects should be accepted as they will produce a positive NPV. ANSWER: b POINTS: 1 DIFFICULTY: EASY REFERENCES: 12-4 Risk Analysis in Capital Budgeting QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.12.04 - Risk Analysis in Capital Budgeting NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Risk and project selection KEYWORDS: Bloom's: Evaluation OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:57 PM DATE MODIFIED: 9/21/2017 5:57 PM 34. Which of the following statements is CORRECT? a. A sunk cost is any cost that must be expended in order to complete a project and bring it into operation. b. A sunk cost is any cost that was expended in the past but can be recovered if the firm decides not to go forward with the project. c. A sunk cost is a cost that was incurred and expensed in the past and cannot be recovered if the firm decides not to go forward with the project. d. Sunk costs were formerly hard to deal with, but once the NPV method came into wide use, it became possible to simply include sunk costs in the cash flows and then calculate the project’s NPV. e. A good example of a sunk cost is a situation where Home Depot opens a new store, and that leads to a decline in sales of one of the firm’s existing stores. ANSWER: c POINTS: 1 DIFFICULTY: EASY/MODERATE REFERENCES: 12-1 Conceptual Issues in Cash Flow Estimation QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.12.01 - Conceptual Issues in Cash Flow Estimation NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Sunk costs Copyright Cengage Learning. Powered by Cognero.
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KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
Bloom's: Comprehension Multiple Choice: Conceptual 9/21/2017 5:57 PM 9/21/2017 5:57 PM
35. Which of the following statements is CORRECT? a. An example of a sunk cost is the cost associated with restoring the site of a strip mine once the ore has been depleted. b. Sunk costs must be considered if the IRR method is used but not if the firm relies on the NPV method. c. A good example of a sunk cost is a situation where a bank opens a new office, and that new office leads to a decline in deposits of the bank’s other offices. d. A good example of a sunk cost is money that a banking corporation spent last year to investigate the site for a new office, then expensed that cost for tax purposes, and now is deciding whether to go forward with the project. e. If sunk costs are considered and reflected in a project’s cash flows, then the project’s calculated NPV will be higher than it otherwise would have been had the sunk costs been ignored. ANSWER: d POINTS: 1 DIFFICULTY: EASY/MODERATE REFERENCES: 12-1 Conceptual Issues in Cash Flow Estimation QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.12.01 - Conceptual Issues in Cash Flow Estimation NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Sunk costs KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:57 PM DATE MODIFIED: 9/21/2017 5:57 PM 36. Which of the following statements is CORRECT? a. An externality is a situation where a project would have an adverse effect on some other part of the firm’s overall operations. If the project would have a favorable effect on other operations, then this is not an externality. b. An example of an externality is a situation where a bank opens a new office, and that new office causes deposits in the bank’s other offices to decline. c. The NPV method automatically deals correctly with externalities, even if the externalities are not specifically identified, but the IRR method does not. This is another reason to favor the NPV. d. Both the NPV and IRR methods deal correctly with externalities, even if the externalities are not specifically identified. However, the payback method does not. e. Identifying an externality can never lead to an increase in the calculated NPV. ANSWER: b POINTS: 1 DIFFICULTY: EASY/MODERATE Copyright Cengage Learning. Powered by Cognero.
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REFERENCES: 12-1 Conceptual Issues in Cash Flow Estimation QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.12.01 - Conceptual Issues in Cash Flow Estimation NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Externalities KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:57 PM DATE MODIFIED: 9/21/2017 5:57 PM 37. Which of the following statements is CORRECT? a. An externality is a situation where a project would have an adverse effect on some other part of the firm’s overall operations. If the project would have a favorable effect on other operations, then this is not an externality. b. An example of an externality is a situation where a bank opens a new office, and that new office causes deposits in the bank’s other offices to increase. c. The NPV method automatically deals correctly with externalities, even if the externalities are not specifically identified, but the IRR method does not. This is another reason to favor the NPV. d. Both the NPV and IRR methods deal correctly with externalities, even if the externalities are not specifically identified. However, the payback method does not. e. Identifying an externality can never lead to an increase in the calculated NPV. ANSWER: b POINTS: 1 DIFFICULTY: EASY/MODERATE REFERENCES: 12-1 Conceptual Issues in Cash Flow Estimation QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.12.01 - Conceptual Issues in Cash Flow Estimation NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Externalities KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:57 PM DATE MODIFIED: 9/21/2017 5:57 PM 38. Which of the following statements is CORRECT? a. If a firm is found guilty of cannibalization in a court of law, then it is judged to have taken unfair advantage of its competitors. Thus, cannibalization is dealt with by society through the antitrust laws. b. If a firm is found guilty of cannibalization in a court of law, then it is judged to have taken unfair advantage of its customers. Thus, cannibalization is dealt with by society through the antitrust laws. Copyright Cengage Learning. Powered by Cognero.
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c. If cannibalization exists, then the cash flows associated with the project must be increased to offset these effects. Otherwise, the calculated NPV will be biased downward. d. If cannibalization is determined to exist, then this means that the calculated NPV if cannibalization is considered will be higher than the NPV if this effect is not recognized. e. Cannibalization, as described in the text, is a type of externality that is not against the law, and any harm it causes is done to the firm itself. ANSWER: e POINTS: 1 DIFFICULTY: EASY/MODERATE REFERENCES: 12-1 Conceptual Issues in Cash Flow Estimation QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.12.01 - Conceptual Issues in Cash Flow Estimation NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Externalities KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:57 PM DATE MODIFIED: 9/21/2017 5:57 PM 39. Which of the following statements is CORRECT? a. Using accelerated depreciation rather than straight line would normally have no effect on a project’s total projected cash flows but it would affect the timing of the cash flows and thus the NPV. b. Under current laws and regulations, corporations must use straight-line depreciation for all assets whose lives are 5 years or longer. c. Corporations must use the same depreciation method (e.g., straight line or accelerated) for stockholder reporting and tax purposes. d. Since depreciation is not a cash expense, it has no effect on cash flows and thus no effect on capital budgeting decisions. e. Under accelerated depreciation, higher depreciation charges occur in the early years, and this reduces the early cash flows and thus lowers a project's projected NPV. ANSWER: a POINTS: 1 DIFFICULTY: EASY/MODERATE REFERENCES: 12-2 Analysis of an Expansion Project QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.12.02 - Analysis of an Expansion Project NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Depreciation KEYWORDS: Bloom's: Comprehension Copyright Cengage Learning. Powered by Cognero.
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OTHER: DATE CREATED: DATE MODIFIED:
Multiple Choice: Conceptual 9/21/2017 5:57 PM 9/21/2017 5:57 PM
40. Which of the following statements is CORRECT? a. Since depreciation is a cash expense, the faster an asset is depreciated, the lower the projected NPV from investing in the asset. b. Under current laws and regulations, corporations must use straight-line depreciation for all assets whose lives are 5 years or longer. c. Corporations must use the same depreciation method for both stockholder reporting and tax purposes. d. Using accelerated depreciation rather than straight line normally has the effect of speeding up cash flows and thus increasing a project’s forecasted NPV. e. Using accelerated depreciation rather than straight line normally has the effect of slowing down cash flows and thus reducing a project’s forecasted NPV. ANSWER: d POINTS: 1 DIFFICULTY: EASY/MODERATE REFERENCES: 12-2 Analysis of an Expansion Project QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.12.02 - Analysis of an Expansion Project NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Depreciation KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:57 PM DATE MODIFIED: 9/21/2017 5:57 PM 41. Which of the following statements is CORRECT? a. Since depreciation is not a cash expense, and since cash flows and not accounting income are the relevant input, depreciation plays no role in capital budgeting. b. Under current laws and regulations, corporations must use straight-line depreciation for all assets whose lives are 3 years or longer. c. If they use accelerated depreciation, firms will write off assets slower than they would under straight-line depreciation, and as a result projects’ forecasted NPVs are normally lower than they would be if straight-line depreciation were required for tax purposes. d. If they use accelerated depreciation, firms can write off assets faster than they could under straight-line depreciation, and as a result projects’ forecasted NPVs are normally lower than they would be if straight-line depreciation were required for tax purposes. e. If they use accelerated depreciation, firms can write off assets faster than they could under straight-line depreciation, and as a result projects’ forecasted NPVs are normally higher than they would be if straight-line depreciation were required for tax purposes. ANSWER: e POINTS: 1 DIFFICULTY: EASY/MODERATE Copyright Cengage Learning. Powered by Cognero.
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REFERENCES: 12-2 Analysis of an Expansion Project QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.12.02 - Analysis of an Expansion Project NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Depreciation KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:57 PM DATE MODIFIED: 9/21/2017 5:57 PM 42. Other things held constant, which of the following would increase the NPV of a project being considered? a. A shift from straight-line to MACRS depreciation. b. Making the initial investment in the first year rather than spreading it over the first three years. c. An increase in the discount rate associated with the project. d. An increase in required net operating working capital. e. The project would decrease sales of another product line. ANSWER: a POINTS: 1 DIFFICULTY: EASY\MODERATE REFERENCES: 12A Tax Depreciation QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.12.12A - Tax Depreciation NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital TOPICS: NPV and depreciation KEYWORDS: Bloom's: Evaluation OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:57 PM DATE MODIFIED: 9/21/2017 5:57 PM 43. A company is considering a new project. The CFO plans to calculate the project’s NPV by estimating the relevant cash flows for each year of the project’s life (i.e., the initial investment cost, the annual operating cash flows, and the terminal cash flows), then discounting those cash flows at the company’s overall WACC. Which one of the following factors should the CFO be sure to INCLUDE in the cash flows when estimating the relevant cash flows? a. All sunk costs that have been incurred relating to the project. b. All interest expenses on debt used to help finance the project. c. The additional investment in net operating working capital required to operate the project, even if that investment will be recovered at the end of the project’s life. d. Sunk costs that have been incurred relating to the project, but only if those costs were incurred prior to the current year. e. Effects of the project on other divisions of the firm, but only if those effects lower the project’s own direct Copyright Cengage Learning. Powered by Cognero.
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cash flows. ANSWER: c POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 12-1 Conceptual Issues in Cash Flow Estimation QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.12.01 - Conceptual Issues in Cash Flow Estimation NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.01 - Stocks and bonds United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Relevant cash flows KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:57 PM DATE MODIFIED: 9/21/2017 5:57 PM 44. Which of the following factors should be included in the cash flows used to estimate a project’s NPV? a. All costs associated with the project that have been incurred prior to the time the analysis is being conducted. b. Interest on funds borrowed to help finance the project. c. The end-of-project recovery of any additional net operating working capital required to operate the project. d. Cannibalization effects, but only if those effects increase the project’s projected cash flows. e. Expenditures to date on research and development related to the project, provided those costs have already been expensed for tax purposes. ANSWER: c POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 12-1 Conceptual Issues in Cash Flow Estimation QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.12.01 - Conceptual Issues in Cash Flow Estimation NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.01 - Stocks and bonds United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Relevant cash flows KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:57 PM DATE MODIFIED: 9/21/2017 5:57 PM 45. When evaluating a new project, firms should include in the projected cash flows all of the following EXCEPT: a. Changes in net operating working capital attributable to the project. Copyright Cengage Learning. Powered by Cognero.
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b. Previous expenditures associated with a market test to determine the feasibility of the project, provided those costs have been expensed for tax purposes. c. The value of a building owned by the firm that will be used for this project. d. A decline in the sales of an existing product, provided that decline is directly attributable to this project. e. The salvage value of assets used for the project that will be recovered at the end of the project’s life. ANSWER: b POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 12-1 Conceptual Issues in Cash Flow Estimation QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.12.01 - Conceptual Issues in Cash Flow Estimation NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.01 - Stocks and bonds United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Relevant cash flows KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:57 PM DATE MODIFIED: 9/21/2017 5:57 PM 46. Rowell Company spent $3 million two years ago to build a plant for a new product. It then decided not to go forward with the project, so the building is available for sale or for a new product. Rowell owns the building free and clear - there is no mortgage on it. Which of the following statements is CORRECT? a. Since the building has been paid for, it can be used by another project with no additional cost. Therefore, it should not be reflected in the cash flows of the capital budgeting analysis for any new project. b. If the building could be sold, then the after-tax proceeds that would be generated by any such sale should be charged as a cost to any new project that would use it. c. This is an example of an externality, because the very existence of the building affects the cash flows for any new project that Rowell might consider. d. Since the building was built in the past, its cost is a sunk cost and thus need not be considered when new projects are being evaluated, even if it would be used by those new projects. e. If there is a mortgage loan on the building, then the interest on that loan would have to be charged to any new project that used the building. ANSWER: b POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 12-1 Conceptual Issues in Cash Flow Estimation QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.12.01 - Conceptual Issues in Cash Flow Estimation NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.01 - Stocks and bonds United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business Copyright Cengage Learning. Powered by Cognero.
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TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
School Outcomes, you do not need to include anything for this category. Relevant cash flows Bloom's: Application Multiple Choice: Conceptual 9/21/2017 5:57 PM 9/21/2017 5:57 PM
47. Which of the following should be considered when a company estimates the cash flows used to analyze a proposed project? a. The new project is expected to reduce sales of one of the company’s existing products by 5%. b. Since the firm’s director of capital budgeting spent some of her time last year to evaluate the new project, a portion of her salary for that year should be charged to the project’s initial cost. c. The company has spent and expensed $1 million on research and development costs associated with the new project. d. The company spent and expensed $10 million on a marketing study before its current analysis regarding whether to accept or reject the project. e. The firm would borrow all the money used to finance the new project, and the interest on this debt would be $1.5 million per year. ANSWER: a POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 12-1 Conceptual Issues in Cash Flow Estimation QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.12.01 - Conceptual Issues in Cash Flow Estimation NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.01 - Stocks and bonds United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Relevant cash flows KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:57 PM DATE MODIFIED: 9/21/2017 5:57 PM 48. Dalrymple Inc. is considering production of a new product. In evaluating whether to go ahead with the project, which of the following items should NOT be explicitly considered when cash flows are estimated? a. The company will produce the new product in a vacant building that was used to produce another product until last year. The building could be sold, leased to another company, or used in the future to produce another of the firm's products. b. The project will utilize some equipment the company currently owns but is not now using. A used equipment dealer has offered to buy the equipment. c. The company has spent and expensed for tax purposes $3 million on research related to the new product. These funds cannot be recovered, but the research may benefit other projects that might be proposed in the future. d. The new product will cut into sales of some of the firm’s other products. e. If the project is accepted, the company must invest an additional $2 million in net operating working capital. Copyright Cengage Learning. Powered by Cognero.
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However, all of these funds will be recovered at the end of the project’s life. ANSWER: c POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 12-1 Conceptual Issues in Cash Flow Estimation QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.12.01 - Conceptual Issues in Cash Flow Estimation NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.01 - Stocks and bonds United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Relevant cash flows KEYWORDS: Bloom's: Evaluation OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:57 PM DATE MODIFIED: 9/21/2017 5:57 PM 49. Which of the following rules is CORRECT for capital budgeting analysis? a. The interest paid on funds borrowed to finance a project must be included in estimates of the project’s cash flows. b. Only incremental cash flows, which are the cash flows that would result if a project is accepted, are relevant when making accept/reject decisions for capital budgeting projects. c. Sunk costs are not included in the annual cash flows, but they must be deducted from the PV of the project’s other costs when reaching the accept/reject decision. d. A proposed project’s estimated net income as determined by the firm’s accountants, using generally accepted accounting principles (GAAP), is discounted at the WACC, and if the PV of this income stream exceeds the project’s cost, the project should be accepted. e. If a product is competitive with some of the firm’s other products, this fact should be incorporated into the estimate of the relevant cash flows. However, if the new product is complementary to some of the firm’s other products, this fact need not be reflected in the analysis. ANSWER: b POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 12-1 Conceptual Issues in Cash Flow Estimation QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.12.01 - Conceptual Issues in Cash Flow Estimation NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.01 - Stocks and bonds United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Relevant cash flows KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual Copyright Cengage Learning. Powered by Cognero.
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50. Which of the following statements is CORRECT? a. In a capital budgeting analysis where part of the funds used to finance the project would be raised as debt, failure to include interest expense as a cost when determining the project’s cash flows will lead to an upward bias in the NPV. b. In a capital budgeting analysis where part of the funds used to finance the project would be raised as debt, failure to include interest expense as a cost when determining the project’s cash flows will lead to a downward bias in the NPV. c. The existence of any type of ―externality‖ will reduce the calculated NPV versus the NPV that would exist without the externality. d. If one of the assets to be used by a potential project is already owned by the firm, and if that asset could be sold or leased to another firm if the new project were not undertaken, then the net proceeds that could be obtained should be charged as a cost to the project under consideration. e. If one of the assets to be used by a potential project is already owned by the firm but is not being used, then any costs associated with that asset is a sunk cost and should be ignored. ANSWER: d RATIONALE: Regarding a and b, note that since interest should not be considered, exclusion will not lead to any type of bias, positive or negative. POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 12-1 Conceptual Issues in Cash Flow Estimation QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.12.01 - Conceptual Issues in Cash Flow Estimation NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.01 - Stocks and bonds United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Relevant cash flows KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:57 PM DATE MODIFIED: 9/21/2017 5:57 PM 51. Which one of the following would NOT result in incremental cash flows and thus should NOT be included in the capital budgeting analysis for a new product? a. A firm has a parcel of land that can be used for a new plant site or be sold, rented, or used for agricultural purposes. b. A new product will generate new sales, but some of those new sales will be from customers who switch from one of the firm’s current products. c. A firm must obtain new equipment for the project, and $1 million is required for shipping and installing the new machinery. d. A firm has spent $2 million on research and development associated with a new product. These costs have been expensed for tax purposes, and they cannot be recovered regardless of whether the new project is accepted or rejected. Copyright Cengage Learning. Powered by Cognero.
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e. A firm can produce a new product, and the existence of that product will stimulate sales of some of the firm’s other products. ANSWER: d POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 12-1 Conceptual Issues in Cash Flow Estimation QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.12.01 - Conceptual Issues in Cash Flow Estimation NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.01 - Stocks and bonds United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Incremental cash flows KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:57 PM DATE MODIFIED: 9/21/2017 5:57 PM 52. Which one of the following would NOT result in incremental cash flows and thus should NOT be included in the capital budgeting analysis for a new product? a. Using some of the firm's high-quality factory floor space that is currently unused to produce the proposed new product. This space could be used for other products if it is not used for the project under consideration. b. Revenues from an existing product would be lost as a result of customers switching to the new product. c. Shipping and installation costs associated with a machine that would be used to produce the new product. d. The cost of a study relating to the market for the new product that was completed last year. The results of this research were positive, and they led to the tentative decision to go ahead with the new product. The cost of the research was incurred and expensed for tax purposes last year. e. It is learned that land the company owns and would use for the new project, if it is accepted, could be sold to another firm. ANSWER: d POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 12-1 Conceptual Issues in Cash Flow Estimation QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.12.01 - Conceptual Issues in Cash Flow Estimation NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.01 - Stocks and bonds United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Incremental cash flows KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:57 PM Copyright Cengage Learning. Powered by Cognero.
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53. A company is considering a proposed new plant that would increase productive capacity. Which of the following statements is CORRECT? a. In calculating the project's operating cash flows, the firm should not deduct financing costs such as interest expense, because financing costs are accounted for by discounting at the WACC. If interest were deducted when estimating cash flows, this would, in effect, ―double count‖ it. b. Since depreciation is a non-cash expense, the firm does not need to deal with depreciation when calculating the operating cash flows. c. When estimating the project’s operating cash flows, it is important to include both opportunity costs and sunk costs, but the firm should ignore the cash flow effects of externalities since they are accounted for in the discounting process. d. Capital budgeting decisions should be based on before-tax cash flows because WACC is calculated on a before-tax basis. e. The WACC used to discount cash flows in a capital budgeting analysis should be calculated on a before-tax basis. To do otherwise would bias the NPV upward. ANSWER: a POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 12-2 Analysis of an Expansion Project QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.12.02 - Analysis of an Expansion Project NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.01 - Stocks and bonds United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: New project cash flows KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:57 PM DATE MODIFIED: 9/21/2017 5:57 PM 54. Taussig Technologies is considering two potential projects, X and Y. In assessing the projects’ risks, the company estimated the beta of each project versus both the company’s other assets and the stock market, and it also conducted thorough scenario and simulation analyses. This research produced the following data: Project X Project Y Expected NPV $350,000 $350,000 $100,000 $150,000 Standard deviation (σNPV) Project beta (vs. market) 1.4 0.8 Correlation of the project cash flows Cash flows are not correlated Cash flows are highly correlated with cash flows from currently with the cash flows from with the cash flows from existing projects. existing projects. existing projects. Which of the following statements is CORRECT? a. Project X has more stand-alone risk than Project Y. b. Project X has more corporate (or within-firm) risk than Project Y. Copyright Cengage Learning. Powered by Cognero.
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c. Project X has more market risk than Project Y. d. Project X has the same level of corporate risk as Project Y. e. Project X has the same market risk as Project Y since its cash flows are not correlated with the cash flows of existing projects. ANSWER: c RATIONALE: Statement c is true, while the other statements are false. Stand-alone risk is measured by standard deviation. Therefore, since Y’s standard deviation is higher than X’s, Y has higher stand-alone risk than X. Statement b is false because corporate risk is affected by the correlation of project cash flows with other company cash flows, and since Y’s cash flows are more highly correlated with the cash flows of existing projects than X’s, Y has more corporate risk than X. Market risk is measured by beta. Therefore, since X’s beta is greater than Y’s, statement c is true. POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 12-4 Risk Analysis in Capital Budgeting QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.12.04 - Risk Analysis in Capital Budgeting NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Risk analysis KEYWORDS: Bloom's: Evaluation OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:57 PM DATE MODIFIED: 9/21/2017 5:57 PM 55. Currently, Powell Products has a beta of 1.0, and its sales and profits are positively correlated with the overall economy. The company estimates that a proposed new project would have a higher standard deviation and coefficient of variation than an average company project. Also, the new project’s sales would be countercyclical in the sense that they would be high when the overall economy is down and low when the overall economy is strong. On the basis of this information, which of the following statements is CORRECT? a. The proposed new project would have more stand-alone risk than the firm’s typical project. b. The proposed new project would increase the firm’s corporate risk. c. The proposed new project would increase the firm’s market risk. d. The proposed new project would not affect the firm’s risk at all. e. The proposed new project would have less stand-alone risk than the firm’s typical project. ANSWER: a RATIONALE: Statement a is true because the project has a relatively high standard deviation and thus more stand-alone risk than average. The project's revenues would be countercyclical to the rest of the firm's and to other firms' revenues; hence, its within-firm and market risks would be relatively low. POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 12-4 Risk Analysis in Capital Budgeting QUESTION TYPE: Multiple Choice HAS VARIABLES: False Copyright Cengage Learning. Powered by Cognero.
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LEARNING OBJECTIVES: FOFM.BRIG.16.12.04 - Risk Analysis in Capital Budgeting NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Risk analysis KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:57 PM DATE MODIFIED: 9/21/2017 5:57 PM 56. A firm is considering a new project whose risk is greater than the risk of the firm’s average project, based on all methods for assessing risk. In evaluating this project, it would be reasonable for management to do which of the following? a. Increase the estimated IRR of the project to reflect its greater risk. b. Increase the estimated NPV of the project to reflect its greater risk. c. Reject the project, since its acceptance would increase the firm’s risk. d. Ignore the risk differential if the project would amount to only a small fraction of the firm’s total assets. e. Increase the cost of capital used to evaluate the project to reflect its higher-than-average risk. ANSWER: e POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 12-4 Risk Analysis in Capital Budgeting QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.12.04 - Risk Analysis in Capital Budgeting NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Project's effect on firm risk KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:57 PM DATE MODIFIED: 9/21/2017 5:57 PM 57. Which of the following statements is CORRECT? a. Sensitivity analysis is a good way to measure market risk because it explicitly takes into account diversification effects. b. One advantage of sensitivity analysis relative to scenario analysis is that it explicitly takes into account the probability of specific effects occurring, whereas scenario analysis cannot account for probabilities. c. Well-diversified stockholders do not need to consider market risk when determining required rates of return. d. Market risk is important, but it does not have a direct effect on stock prices because it only affects beta. e. Simulation analysis is a computerized version of scenario analysis where input variables are selected randomly on the basis of their probability distributions. ANSWER: e Copyright Cengage Learning. Powered by Cognero.
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POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 12-5 Measuring Stand-Alone Risk QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.12.05 - Measuring Stand-Alone Risk NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Risk techniques KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:57 PM DATE MODIFIED: 9/21/2017 5:57 PM 58. Which of the following statements is CORRECT? a. Sensitivity analysis as it is generally employed is incomplete in that it fails to consider the probability of occurrence of the key input variables. b. In comparing two projects using sensitivity analysis, the one with the steeper lines would be considered less risky, because a small error in estimating a variable such as unit sales would produce only a small error in the project’s NPV. c. The primary advantage of simulation analysis over scenario analysis is that scenario analysis requires a relatively powerful computer, coupled with an efficient financial planning software package, whereas simulation analysis can be done efficiently using a PC with a spreadsheet program or even with just a calculator. d. Sensitivity analysis is a type of risk analysis that considers both the sensitivity of NPV to changes in key input variables and the probability of occurrence of these variables' values. e. As computer technology advances, simulation analysis becomes increasingly obsolete and thus less likely to be used than sensitivity analysis. ANSWER: a POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 12-5 Measuring Stand-Alone Risk QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.12.05 - Measuring Stand-Alone Risk NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Risk techniques KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:57 PM DATE MODIFIED: 9/21/2017 5:57 PM Copyright Cengage Learning. Powered by Cognero.
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59. Which of the following statements is CORRECT? a. If an asset is sold for less than its book value at the end of a project’s life, it will generate a loss for the firm, hence its terminal cash flow will be negative. b. Only incremental cash flows are relevant in project analysis, the proper incremental cash flows are the reported accounting profits, and thus reported accounting income should be used as the basis for investor and managerial decisions. c. It is unrealistic to believe that any increases in net operating working capital required at the start of an expansion project can be recovered at the project’s completion. Operating working capital like inventory is almost always used up in operations. Thus, cash flows associated with operating working capital should be included only at the start of a project’s life. d. If equipment is expected to be sold for more than its book value at the end of a project’s life, this will result in a profit. In this case, despite taxes on the profit, the end-of-project cash flow will be greater than if the asset had been sold at book value, other things held constant. e. Changes in net operating working capital refer to changes in current assets and current liabilities, not to changes in long-term assets and liabilities, hence they should not be considered in a capital budgeting analysis. ANSWER: d POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.12.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.01 - Stocks and bonds United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: CFs and accounting measures KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:57 PM DATE MODIFIED: 9/21/2017 5:57 PM 60. Which of the following statement completions is NOT CORRECT? For a profitable firm, when MACRS accelerated depreciation is compared to straight-line depreciation, MACRS accelerated allowances produce a. Higher depreciation charges in the early years of an asset's life. b. Larger cash flows in the earlier years of an asset's life. c. Larger total undiscounted profits from the project over the project's life. d. Smaller accounting profits in the early years, assuming the company uses the same depreciation method for tax and book purposes. e. Lower tax payments in the earlier years of an asset's life. ANSWER: c POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 12A Tax Depreciation QUESTION TYPE: Multiple Choice HAS VARIABLES: False Copyright Cengage Learning. Powered by Cognero.
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LEARNING OBJECTIVES: FOFM.BRIG.16.12.12A - Tax Depreciation NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital TOPICS: Depreciation cash flows KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:57 PM DATE MODIFIED: 9/21/2017 5:57 PM 61. As assistant to the CFO of Boulder Inc., you must estimate the Year 1 cash flow for a project with the following data. What is the Year 1 cash flow? Do not round the intermediate calculations and round the final answer to the nearest whole number. Sales revenues Depreciation Other operating costs Tax rate a. $6,015 b. $6,797 c. $6,436 d. $6,496 e. $5,414 ANSWER: RATIONALE:
$13,100 $4,000 $6,000 35.0%
a
Sales revenues – Operating costs (excl. depr.) – Depreciation Operating income (EBIT) – Taxes rate =35% EBIT(1 – T) + Depreciation Cash flow, Year 1
$13,100 6,000 4,000 $3,100 1,085 $2,015 4,000 $6,015
POINTS: 1 DIFFICULTY: EASY REFERENCES: 12-2 Analysis of an Expansion Project QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.16.12.02 - Analysis of an Expansion Project NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.01 - Stocks and bonds United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Annual CF KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem Copyright Cengage Learning. Powered by Cognero.
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DATE CREATED: DATE MODIFIED:
9/21/2017 5:57 PM 9/21/2017 5:57 PM
62. Your company, RMU Inc., is considering a new project whose data are shown below. What is the project's Year 1 cash flow? Sales revenues Depreciation Other operating costs Tax rate a. $8,798 b. $11,933 c. $10,416 d. $10,113 e. $11,225 ANSWER: RATIONALE:
$23,250 $8,000 $12,000 35.0%
d
Sales revenues $23,250 – Operating costs (excl. depr.) 12,000 – Depreciation 8,000 Operating income (EBIT) $3,250 – Taxes rate = 35.0% 1,138 EBIT(1 – T) $2,113 + Depreciation 8,000 Cash flow, Year 1 $10,113
POINTS: 1 DIFFICULTY: EASY REFERENCES: 12-2 Analysis of an Expansion Project QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.16.12.02 - Analysis of an Expansion Project NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.01 - Stocks and bonds United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Annual CF KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:57 PM DATE MODIFIED: 9/21/2017 5:57 PM 63. Clemson Software is considering a new project whose data are shown below. The required equipment has a 3-year tax life, after which it will be worthless, and it will be depreciated by the straight-line method over 3 years. Revenues and other operating costs are expected to be constant over the project's 3-year life. What is the project's Year 1 cash flow? Do not round the intermediate calculations and round the final answer to the nearest whole number. Copyright Cengage Learning. Powered by Cognero.
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Equipment cost (depreciable basis) Straight-line depreciation rate Sales revenues, each year Operating costs (excl. depr.) Tax rate a. $31,682 b. $29,979 c. $30,660 d. $36,792 e. $34,067 ANSWER: RATIONALE:
$97,000 33.333% $60,000 $25,000 35.0%
e
Equipment life, years Equipment cost Depreciation: rate = 33.333% Sales revenues – Basis × rate = depreciation – Operating costs (excl. depr.) Operating income (EBIT) – Taxes rate = 35.0 % EBIT(1 – T) + Depreciation Cash flow, Year 1
3 $97,000 $32,333 $60,000 32,333 25,000 $2,667 933 $1,733 32,333 $34,067
POINTS: 1 DIFFICULTY: EASY REFERENCES: 12-2 Analysis of an Expansion Project QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.16.12.02 - Analysis of an Expansion Project NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.01 - Stocks and bonds United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Annual CF KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:57 PM DATE MODIFIED: 9/21/2017 5:57 PM 64. As a member of UA Corporation's financial staff, you must estimate the Year 1 cash flow for a proposed project with the following data. What is the Year 1 cash flow? Do not round the intermediate calculations and round the final answer to the nearest whole number. Sales revenues, each year Depreciation Other operating costs Interest expense Tax rate Copyright Cengage Learning. Powered by Cognero.
$36,750 $10,000 $17,000 $4,000 35.0% Page 728
a. $14,704 b. $19,442 c. $17,808 d. $16,338 e. $20,095 ANSWER: RATIONALE:
d This problem is a bit harder than some of the other ones because it provides information on interest, and some students might incorrectly include it as an input. We like this wrinkle because it's important for students to know not to include financing costs in the calculation of cash flows since they will be discounted at the WACC in determining a project's NPV.
Sales revenues – Operating costs (excl. depr.) – Depreciation Operating income (EBIT) – Taxes rate = 35% EBIT(1 – T) + Depreciation Cash flow, Year 1
$36,750 17,000 10,000 $9,750 3,413 $6,338 10,000 $16,338
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 12-2 Analysis of an Expansion Project QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.16.12.02 - Analysis of an Expansion Project NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.01 - Stocks and bonds United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Annual CF KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:57 PM DATE MODIFIED: 9/21/2017 5:57 PM 65. You work for Whittenerg Inc., which is considering a new project whose data are shown below. What is the project's Year 1 cash flow? Sales revenues, each year Depreciation Other operating costs Interest expense Tax rate
$67,000 $8,000 $25,000 $8,000 35.0%
a. $33,110 b. $32,809 c. $30,100 Copyright Cengage Learning. Powered by Cognero.
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d. $35,819 e. $27,692 ANSWER: RATIONALE:
c This problem is a bit harder than some of the other ones because it provides information on interest, and some students might incorrectly include it as an input. We like this wrinkle because it's important for students to know not to include financing costs in the cash flows.
Sales revenues – Operating costs (excl. depr.) – Depreciation Operating income (EBIT) – Taxes Rate = 35% EBIT(1 – T) + Depreciation Cash flow, Year 1
$67,000 25,000 8,000 $34,000 11,900 $22,100 8,000 $30,100
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 12-2 Analysis of an Expansion Project QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.16.12.02 - Analysis of an Expansion Project NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.01 - Stocks and bonds United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Annual CF KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:57 PM DATE MODIFIED: 9/21/2017 5:57 PM 66. Fool Proof Software is considering a new project whose data are shown below. The equipment that would be used has a 3-year tax life, and the allowed depreciation rates for such property are 33%, 45%, 15%, and 7% for Years 1 through 4. Revenues and other operating costs are expected to be constant over the project's 10-year expected life. What is the Year 1 cash flow? Equipment cost (depreciable basis) Sales revenues, each year Operating costs (excl. depr.) Tax rate a. $29,426 b. $33,387 c. $28,294 d. $28,860 e. $29,709 ANSWER:
$48,000 $60,000 $25,000 35.0%
c
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RATIONALE:
Equipment cost Depreciation rate Sales revenues – Operating costs (excl. depr.) – Depreciation Operating income (EBIT) – Taxes rate = 35% EBIT(1 – T) + Depreciation Cash flow, Year 1
$48,000 33.0% $60,000 25,000 15,840 $19,160 6,706 $12,454 15,840 $28,294
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 12-2 Analysis of an Expansion Project QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.16.12.02 - Analysis of an Expansion Project NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.01 - Stocks and bonds United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Annual CF; MACRS KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:57 PM DATE MODIFIED: 9/21/2017 5:57 PM 67. Your company, CSUS Inc., is considering a new project whose data are shown below. The required equipment has a 3-year tax life, and the accelerated rates for such property are 33%, 45%, 15%, and 7% for Years 1 through 4. Revenues and other operating costs are expected to be constant over the project's 10-year expected operating life. What is the project's Year 4 cash flow? Equipment cost (depreciable basis) Sales revenues, each year Operating costs (excl. depr.) Tax rate a. $8,700 b. $6,884 c. $7,565 d. $7,716 e. $8,473 ANSWER: RATIONALE:
$70,000 $34,000 $25,000 35.0%
c
Equipment cost Depreciation rate, Year 4 Sales revenues – Operating costs (excl. depr.) – Depreciation
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$70,000 7.0% $34,000 25,000 4,900 Page 731
Operating income (EBIT) – Taxes rate = 35% EBIT(1 – T) + Depreciation Cash flow, Year 4
$4,100 1,435 $2,665 4,900 $7,565
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 12-2 Analysis of an Expansion Project QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.16.12.02 - Analysis of an Expansion Project NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital United States - OH - DISC.FOFM.BRIG.16.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Annual CF; MACRS KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:57 PM DATE MODIFIED: 9/21/2017 5:57 PM 68. Temple Corp. is considering a new project whose data are shown below. The equipment that would be used has a 3year tax life, would be depreciated by the straight-line method over its 3-year life, and would have a zero salvage value. No change in net operating working capital would be required. Revenues and other operating costs are expected to be constant over the project's 3-year life. What is the project's NPV? Do not round the intermediate calculations and round the final answer to the nearest whole number. Risk-adjusted WACC Net investment cost (depreciable basis) Straight-line depr. rate Sales revenues, each year Annual operating costs (excl. depr.) Tax rate a. $25,831 b. $33,377 c. $34,828 d. $29,023 e. $22,928 ANSWER: RATIONALE:
10.0% $65,000 33.3333% $71,500 $25,000 35.0%
d
WACC 10.0% Years Investment cost Sales revenues – Operating costs (excl. depr.) – Depreciation Rate = 33.3333% Copyright Cengage Learning. Powered by Cognero.
0 -$65,000
1
2
3
$71,500 25,000
$71,500 25,000
$71,500 25,000
21,667
21,667
21,667 Page 732
Operating income (EBIT) – Taxes Rate = 35.0% EBIT(1 – T) + Depreciation Project CFs
-$65,000 2
$24,833 8,692 $16,141 21,667 $37,808
$24,833 8,692 $16,141 21,667 $37,808
$24,833 8,692 $16,141 21,667 $37,808
3
NPV = -$65,000 + $37,808/1.1 + $37,808/1.1 + $37,808/1.1 = $29,023 POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 12-2 Analysis of an Expansion Project QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.16.12.02 - Analysis of an Expansion Project NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.01 - Stocks and bonds United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Project NPV KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:57 PM DATE MODIFIED: 9/21/2017 5:57 PM 69. Liberty Services is now at the end of the final year of a project. The equipment originally cost $26,500, of which 75% has been depreciated. The firm can sell the used equipment today for $6,000, and its tax rate is 40%. What is the equipment’s after-tax salvage value for use in a capital budgeting analysis? Note that if the equipment's final market value is less than its book value, the firm will receive a tax credit as a result of the sale. a. $6,250 b. $6,125 c. $6,625 d. $5,563 e. $7,750 ANSWER: a RATIONALE: % depreciated on equip. 75%
Tax rate Equipment cost – Accumulated depr. Current book value of equipment Market value of equipment Gain (or loss): Market value – Book value Taxes paid on gain (–) or credited (+) on loss AT salvage value = market value +/– taxes
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40% $26,500 19,875 $6,625 6,000 -625 0250 $6,250
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POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 12-2 Analysis of an Expansion Project QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.16.12.02 - Analysis of an Expansion Project NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Salvage value KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:57 PM DATE MODIFIED: 9/21/2017 5:57 PM 70. Marshall-Miller & Company is considering the purchase of a new machine for $50,000, installed. The machine has a tax life of 5 years, and it can be depreciated according to the depreciation rates below. The firm expects to operate the machine for 4 years and then to sell it for $2,500. If the marginal tax rate is 40%, what will the after-tax salvage value be when the machine is sold at the end of Year 4? Year 1 2 3 4 5 6 a. $4,508 b. $4,998 c. $5,488 d. $4,900 e. $4,655 ANSWER: RATIONALE:
Depreciation Rate 0.20 0.32 0.19 0.12 0.11 0.06
d
Year 1 2 3 4 5 6
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Depr. Rate 0.20 0.32 0.19 0.12 0.11 0.06 1.00
Basis $50,000 $50,000 $50,000 $50,000 $50,000 $50,000
Annual Year-end Depr. Book Value $10,000 $40,000 $16,000 $24,000 $9,500 $6,000 $5,500 $3,000 $50,000
$14,500 $8,500 $3,000
$0
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Gross sales proceeds Book value, end of Year 4 Profit Tax on profit Rate = 40% AT salvage value = market value +/– taxes
$2,500 8,500 -$6,000 –2,400 $4,900
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 12-2 Analysis of an Expansion Project QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.16.12.02 - Analysis of an Expansion Project NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Salvage value KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:57 PM DATE MODIFIED: 9/21/2017 5:57 PM 71. Mulroney Corp. is considering two mutually exclusive projects. Both require an initial investment of $10,800 at t = 0. Project X has an expected life of 2 years with after-tax cash inflows of $6,600 and $7,400 at the end of Years 1 and 2, respectively. In addition, Project X can be repeated at the end of Year 2 with no changes in its cash flows. Project Y has an expected life of 4 years with after-tax cash inflows of $4,300 at the end of each of the next 4 years. Each project has a WACC of 8%. Using the replacement chain approach, what is the NPV of the most profitable project? Do not round the intermediate calculations and round the final answer to the nearest whole number. a. $3,442 b. $3,718 c. $3,408 d. $3,339 e. $2,960 ANSWER: a RATIONALE:
WACC = 8% Project X CFs Extended CFs Total Project X CFs
0 -10,800 -10,800
1 6,600
2 7,400 -10,800 6,600 –3,400
3
4
6,600 6,600
7,400 7,400
4,300
4,300
4,300
Project X, extended NPV = 0$2,852 Project Y CFs
-10,800
4,300
Project Y, NPV = 0$3,535.78 NPV of most profitable project, Project Y = $3,442 >> 0$543.
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POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 12-7 Unequal Project Lives QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.16.12.07 - Unequal Project Lives NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital TOPICS: Replacement chain approach KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:57 PM DATE MODIFIED: 9/21/2017 5:57 PM 72. Wilson Co. is considering two mutually exclusive projects. Both require an initial investment of $9,100 at t = 0. Project X has an expected life of 2 years with after-tax cash inflows of $5,500 and $8,200 at the end of Years 1 and 2, respectively. In addition, Project X can be repeated at the end of Year 2 with no changes in its cash flows. Project Y has an expected life of 4 years with after-tax cash inflows of $4,800 at the end of each of the next 4 years. Each project has a WACC of 11%. What is the equivalent annual annuity of the most profitable project? Do not round intermediate calculations. a. $2,502 b. $1,885.50 c. $1,553.77 d. $1,680.15 e. $1,465.82 ANSWER: a RATIONALE: WACC = 11%
Project X CFs
0 -9,100
1 5,500
2 8,200
Project X, NPV = $2,510.26
Determine Project X EAA: N I/YR PV FV PMT = EAAX Project Y CFs
0 -9,100
2 11% $2,510.26 0 $1,465.82 1 4,800
2 4,800
3 4,800
4 4,800
Project Y, NPV = $5,791.74
Determine Project Y EAA: N I/YR Copyright Cengage Learning. Powered by Cognero.
4 11% Page 736
PV FV PMT = EAAY
$5,791.74 0 $1,866.83
EAA of most profitable project, Project Y = $2,502 POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 12-7 Unequal Project Lives QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.16.12.07 - Unequal Project Lives NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital TOPICS: Equivalent annual annuity KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:57 PM DATE MODIFIED: 9/21/2017 5:57 PM 73. Carlyle Inc. is considering two mutually exclusive projects. Both require an initial investment of $14,200 at t = 0. Project S has an expected life of 2 years with after-tax cash inflows of $7,400 and $13,600 at the end of Years 1 and 2, respectively. In addition, Project S can be repeated at the end of Year 2 with no changes in its cash flows. Project L has an expected life of 4 years with after-tax cash inflows of $6,000 at the end of each of the next 4 years. Each project has a WACC of 9%. What is the equivalent annual annuity of the most profitable project? Do not round your intermediate calculations. a. $2,294.25 b. $2,156.59 c. $1,358.20 d. $2,454.85 e. $1,616.90 ANSWER: a RATIONALE: WACC = 9.00%
Project S:
0
1 2 $7,400 $13,600 $14,200
CFs NPVS $4,035.84
EAAS: Enter the following inputs in your financial calculator:
N = 2; I/YR = 9; PV = -4,035.84; FV = 0; and solve for PMT = EAA = $2,294.25. Project L: CFs
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0
1
2
3
4
$6,000 $6,000 $6,000 $6,000 $14,200 Page 737
NPVL
$5,238.32
EAAL: Enter the following inputs in your financial calculator:
N = 4; I/YR = 9; PV = -5,238.32; FV = 0; and solve for PMT = EAA = $1,616.90. The most profitable project is the one with the higher EAA. Since EAAS > EAAL, choose Project S with EAA = $2,294.25. POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 12-7 Unequal Project Lives QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVEFOFM.BRIG.16.12.07 - Unequal Project Lives S: NATIONAL STANDARD United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills S: STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital TOPICS: Equivalent annual annuity KEYWORDS: Bloom’s: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:57 PM DATE MODIFIED: 9/21/2017 5:57 PM 74. TexMex Food Company is considering a new salsa whose data are shown below. The equipment to be used would be depreciated by the straight-line method over its 3-year life and would have a zero salvage value, and no change in net operating working capital would be required. Revenues and other operating costs are expected to be constant over the project's 3-year life. However, this project would compete with other TexMex products and would reduce their pre-tax annual cash flows. What is the project's NPV? (Hint: Cash flows are constant in Years 1-3.) Do not round the intermediate calculations and round the final answer to the nearest whole number. WACC Pre-tax cash flow reduction for other products (cannibalization) Investment cost (depreciable basis) Straight-line depr. rate Annual sales revenues Annual operating costs (excl. depr.) Tax rate a. 01,529 b. 01,094 c. 01,403 d. 01,347 e. 01,684 ANSWER: RATIONALE:
10.0% -$5,000 $80,000 33.333% $66,000 -$25,000 35.0%
c
t=0 Investment (Basis)
Copyright Cengage Learning. Powered by Cognero.
WACC = 10.0%
t=1
t=2
t=3
$80,000 Page 738
Sales revenues – Cannibalization cost – Operating costs (excl. depr.) – Basis × rate = depr.
rate = 33.333%
$66,000
$66,000
-5,000
-5,000
-5,000
-25,000
-25,000
-25,000
-26,666.67 -26,666.67 -26,666.67
Operating income (EBIT) – Taxes
$66,000
$9,333.33 $9,333.33 $9,333.33 rate = 35.0%
3,266.67
EBIT(1 – T) + Depreciation
3,266.67
3,266.67
$6,066.67 $6,066.67 $6,066.67 26,666.67 26,666.67 26,666.67 $32,733.33 $32,733.33 $32,733.33 $80,000
Project CFs
2
3
NPV = -$80,000 + $32,733.33/1.1 + $32,733.33/1.1 + $32,733.33/1.1 =01,403
POINTS: 1 DIFFICULTY: MODERATE/CHALLENGING REFERENCES: 12-2 Analysis of an Expansion Project QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.16.12.02 - Analysis of an Expansion Project NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.01 - Stocks and bonds United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Project NPV KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:57 PM DATE MODIFIED: 9/21/2017 5:57 PM 75. Sub-Prime Loan Company is thinking of opening a new office, and the key data are shown below. The company owns the building that would be used, and it could sell it for $100,000 after taxes if it decides not to open the new office. The equipment for the project would be depreciated by the straight-line method over the project's 3-year life, after which it would be worth nothing and thus it would have a zero salvage value. No change in net operating working capital would be required, and revenues and other operating costs would be constant over the project's 3-year life. What is the project's NPV? (Hint: Cash flows are constant in Years 1-3.) Do not round the intermediate calculations and round the final answer to the nearest whole number. WACC Opportunity cost Net equipment cost (depreciable basis) Copyright Cengage Learning. Powered by Cognero.
10.0% $100,000 $65,000 Page 739
Straight-line depr. rate for equipment Annual sales revenues Annual operating costs (excl. depr.) Tax rate a. 020,353 b. 022,592 c. 021,168 d. 021,575 e. 017,707 ANSWER: RATIONALE:
33.333% $128,000 $25,000 35%
a Investment (Basis) Opportunity cost Sales revenues – Operating costs (excl. depr.)
WACC = 10.0%
– Basis × rate = depr.
rate = 33.333%
Operating income (EBIT) – Taxes EBIT(1 – T) + Depreciation
t=0 $65,000 -100,000
t=1
$165,000 2
$74,533
$74,533
3
NPV = -$165,000 + $74,533/1.1 + $74,533/1.1 + $74,533/1.1 = 020,353
POINTS: 1 DIFFICULTY: MODERATE/CHALLENGING REFERENCES: 12-2 Analysis of an Expansion Project QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVEFOFM.BRIG.16.12.02 - Analysis of an Expansion Project S: NATIONAL STANDARD United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills S: STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.01 - Stocks and bonds United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Project NPV KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem Copyright Cengage Learning. Powered by Cognero.
t=3
$128,000 $128,000 $128,0 -25,000 -25,000 -25,0 26,666.67 26,666.67 26,666. $81,333 $81,333 $81,3 28,467 28,467 28,4 $52,867 $52,867 $52,8 26,666.67 26,666.67 26,666.
rate = 35%
Project CFs
t=2
Page 740
$74,5
DATE CREATED: DATE MODIFIED:
9/21/2017 5:57 PM 9/21/2017 5:57 PM
76. Atlas Corp. is considering two mutually exclusive projects. Both require an initial investment of $11,500 at t = 0. Project S has an expected life of 2 years with after-tax cash inflows of $5,800 and $7,700 at the end of Years 1 and 2, respectively. Project L has an expected life of 4 years with after-tax cash inflows of $4,136 at the end of each of the next 4 years. Each project has a WACC of 9.25%, and Project S can be repeated with no changes in its cash flows. The controller prefers Project S, but the CFO prefers Project L. How much value will the firm gain or lose if Project L is selected over Project S, i.e., what is the value of NPVL - NPVS? a. $1,064.93 b. $1,199.73 c. $367 d. $1,428.90 e. $1,321.06 ANSWER: c RATIONALE: WACC = 9.25%
Project S: CFs Extended CFs Total CFs
0 -$11,500
1 $5,800
-$11,500
$5,800
2 $7,700 -11,500 -$3,800
0 -$11,500
1 $4,136
2 $4,136
3
4
$5,800 $5,800
$7,700 $7,700
3 $4,136
4 $4,136
NPVS = $478.27
Project L: CFs NPVL = $1,826.28
NPVL – NPVS = $367 POINTS: 1 DIFFICULTY: MODERATE/CHALLENGING REFERENCES: 12-7 Unequal Project Lives QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.16.12.07 - Unequal Project Lives NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital TOPICS: Replacement chain approach KEYWORDS: Bloom’s: Evaluation OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:57 PM DATE MODIFIED: 9/21/2017 5:57 PM 77. Desai Industries is analyzing an average-risk project, and the following data have been developed. Unit sales will be constant, but the sales price should increase with inflation. Fixed costs will also be constant, but variable costs should rise with inflation. The project should last for 3 years, it will be depreciated on a straight-line basis, and there will be no salvage value. No change in net operating working capital would be required. This is just one of many projects for the firm, so any losses on this project can be used to offset gains on other firm projects. What is the project's expected Copyright Cengage Learning. Powered by Cognero.
Page 741
NPV? Do not round the intermediate calculations and round the final answer to the nearest whole number. WACC Net investment cost (depreciable basis) Units sold Average price per unit, Year 1 Fixed op. cost excl. depr. (constant) Variable op. cost/unit, Year 1 Annual depreciation rate Expected inflation rate per year Tax rate a. -$72,673 b. -$73,970 c. -$66,833 d. -$64,886 e. -$60,993 ANSWER: RATIONALE:
10.0% $200,000 39,000 $25.00 $150,000 $20.20 33.333% 5.00% 40.0%
d
t=0 Investment cost
WACC = 10%
t=1
5.0% 5.0% 5.0 $25.00 $26.25 $27 $20.20 $21.21 $22 39,000 39,000 39,0 $975,000 $1,023,750 $1,074,9 150,000 150,000 150,0 787,800 827,190 868,5 66,667 66,667 66,6 -$29,467 -$20,107 -$10,2 –11,787 –8,043 –4,1 -$17,680 -$12,064 -$6,1 66,667 66,667 66,6 $48,987 $200,000
2
$54,603
3
NPV = -$200,000 + $48,987/1.1 + $54,603/1.1 + $60,499/1.1 = -$64,886 POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 12-2 Analysis of an Expansion Project QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVEFOFM.BRIG.16.12.02 - Analysis of an Expansion Project S: NATIONAL STANDARD United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills S: STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.01 - Stocks and bonds United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital Copyright Cengage Learning. Powered by Cognero.
t=3
$200,000
Inflation Price per unit VC per unit Units sold Sales revenues – Fixed op. cost (excl. depr.) – Variable op costs – Depreciation rate = 33.333% Operating income (EBIT) – Taxes rate = 40% EBIT(1 – T) + Depreciation Project CFs
t=2
Page 742
$60,4
LOCAL STANDARDS: TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. NPV including inflation Bloom's: Analysis Multiple Choice: Problem 9/21/2017 5:57 PM 9/21/2017 5:57 PM
78. Poulsen Industries is analyzing an average-risk project, and the following data have been developed. Unit sales will be constant, but the sales price should increase with inflation. Fixed costs will also be constant, but variable costs should rise with inflation. The project should last for 3 years, it will be depreciated on a straight-line basis, and there will be no salvage value. No change in net operating working capital would be required. This is just one of many projects for the firm, so any losses on this project can be used to offset gains on other firm projects. The marketing manager does not think it is necessary to adjust for inflation since both the sales price and the variable costs will rise at the same rate, but the CFO thinks an inflation adjustment is required. What is the difference in the expected NPV if the inflation adjustment is made versus if it is not made? Do not round the intermediate calculations and round the final answer to the nearest whole number. WACC Net investment cost (depreciable basis) Units sold Average price per unit, Year 1 Fixed op. cost excl. depr. (constant) Variable op. cost/unit, Year 1 Annual depreciation rate Expected inflation Tax rate a. $461,378 b. $433,696 c. $456,765 d. $410,627 e. $373,717 ANSWER: RATIONALE:
10.0% $201,400 48,200 $28.50 $153,000 $20.40 33.333% 4.00% 40.0%
a NPV with no adjustment
t=0 Investment cost
WACC = 10.0%
Inflation (set to 0%) Price per unit VC per unit Units sold Sales revenues - Fixed op. cost (excl. deprec.) - Variable op costs - Depreciation Copyright Cengage Learning. Powered by Cognero.
t=1
t=2
t=3
$201,400 0.00% 0.00% 0.00% $28.50 $28.50 $28.50 $20.40 $20.40 $20.40 48,200 48,200 48,200 $1,373,700 $1,373,700 $1,373,700
per unit = $20.40 Rate = 33.333%
153,000
153,000
153,000
983,280
983,280
983,280
67,133
67,133
67,133 Page 743
Operating income (EBIT) - Taxes
Rate = 40.0%
EBIT(1 - T) + Depreciation
$170,287
$170,287
$170,287
68,115
68,115
68,115
$102,172 67,133
$102,172
$102,172
t=1
t=2
67,133 67,133 $169,305 $169,305 $169,305 $201,400
Project CFs NPV w/o infl. adjustment = 0$219,637 NPV with adjustment
t=0 Investment cost
WACC = 10.0%
Inflation Price per unit VC per unit Units sold Sales revenues - Fixed op. cost (excl. deprec.) - Variable op costs - Depreciation
$201,400 4.00% 4.00% 4.00% $28.50 $29.64 $30.83 $20.40 $21.22 $22.06 48,200 48,200 48,200 $1,373,700 $1,428,648 $1,485,794 153,000
153,000
153,000
983,280 1,022,611 1,063,516 Rate = 33.333%
Operating income (EBIT) - Taxes
t=3
67,133
67,133
67,133
$170,287 $185,904 $202,146 Rate = 40.0%
EBIT(1 - T) + Depreciation Project CFs
68,115
74,362
80,858
$102,172 $111,542 $121,287 67,133 67,133 67,133 $169,305 $178,675 $188,420 $201,400
NPV w/infl. adjustment = $241,742 Increase w/infl. adjustment = $461,378
POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 12-2 Analysis of an Expansion Project QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.16.12.02 - Analysis of an Expansion Project NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.01 - Stocks and bonds United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital Copyright Cengage Learning. Powered by Cognero.
Page 744
LOCAL STANDARDS: TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. NPV including inflation Bloom's: Evaluation Multiple Choice: Problem 9/21/2017 5:57 PM 9/21/2017 5:57 PM
79. Foley Systems is considering a new investment whose data are shown below. The equipment would be depreciated on a straight-line basis over the project's 3-year life, would have a zero salvage value, and would require additional net operating working capital that would be recovered at the end of the project's life. Revenues and other operating costs are expected to be constant over the project's life. What is the project's NPV? (Hint: Cash flows from operations are constant in Years 1 to 3.) Do not round the intermediate calculations and round the final answer to the nearest whole number. WACC Net investment in fixed assets (basis) Required net operating working capital Straight-line depreciation rate Annual sales revenues Annual operating costs (excl. depr.) Tax rate a. -$6,860 b. -$7,615 c. -$6,380 d. -$7,683 e. -$6,106 ANSWER: RATIONALE:
10.0% $75,000 $15,000 33.333% $56,000 $25,000 35.0%
a
t=0 Investment in fixed assets Investment in NOWC Sales revenues – Operating costs (excl. depr.)
WACC = 10%
– Depr.
rate = 33.333%
Operating income (EBIT) – Taxes EBIT(1 – T) + Depreciation EBIT(1 – T) + DEP Recovery of NOWC Project CFs
t=1
t=2
t=3
-$75,000 -$15,000 $56,000 $56,000 $56,000
rate = 35%
25,000
25,000
25,000
25,000
25,000
25,000
$6,000
$6,000
$6,000
2,100 2,100 2,100 $3,900 $3,900 $3,900 25,000 25,000 25,000 -$90,000 $28,900 $28,900 $28,900 15,000 -$90,000 $28,900 $28,900 $43,900 2
3
NPV = -$90,000 + $28,900/1.1 + $28,900/1.1 + $43,900/1.1 = -$6,860
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Page 745
POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 12-2 Analysis of an Expansion Project QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.16.12.02 - Analysis of an Expansion Project NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.15.03 - Capital budgeting and cost of capital United States - OH - DISC.FOFM.BRIG.16.06 - Finance function LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Project NPV KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:57 PM DATE MODIFIED: 9/21/2017 5:57 PM 80. Thomson Media is considering some new equipment whose data are shown below. The equipment has a 3-year tax life and would be fully depreciated by the straight-line method over 3 years, but it would have a positive pre-tax salvage value at the end of Year 3, when the project would be closed down. Also, additional net operating working capital would be required, but it would be recovered at the end of the project's life. Revenues and other operating costs are expected to be constant over the project's 3-year life. What is the project's NPV? Do not round the intermediate calculations and round the final answer to the nearest whole number. WACC Net investment in fixed assets (depreciable basis) Required net operating working capital Straight-line depreciation rate Annual sales revenues Annual operating costs (excl. depreciation) Expected pre-tax salvage value Tax rate a. 0$14,922 b. 0$17,011 c. 0$12,982 d. 0$15,668 e. 0$14,773 ANSWER: RATIONALE:
10.0% $70,000 $10,000 33.333% $70,000 $30,000 $5,000 35.0%
a
t=0 Investment in fixed assets Investment in NOWC Sales revenues – Operating costs (excl. depr.)
WACC = 10.0%
– Depreciation
rate = 33.333%
Copyright Cengage Learning. Powered by Cognero.
t=1
t=2
t=3
-$70,000 -10,000 $70,000 $70,000 $70,000 30,000
30,000
30,000
23,333
23,333
23,333 Page 746
Operating income (EBIT) – Taxes rate = 35.0% EBIT(1 – T) + Depreciation EBIT(1 – T) + DEP -$80,000 Recovery of NOWC Salvage value, pre-tax – Tax on salvage value rate = 35.0% Project CFs -$80,000 2
016,667 016,667 016,667 5,833 5,833 5,833 010,833 010,833 010,833 23,333 23,333 23,333 $34,167 $34,167 $34,167 10,000 5,000 1,750 $34,167 $34,167 $47,417 3
NPV = -$80,000 + $34,167/1.1 + $34,167/1.1 + $47,417/1.1 =0$14,922
POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 12-2 Analysis of an Expansion Project QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.16.12.02 - Analysis of an Expansion Project NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.01 - Stocks and bonds United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Project NPV KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:57 PM DATE MODIFIED: 9/21/2017 5:57 PM 81. Florida Car Wash is considering a new project whose data are shown below. The equipment to be used has a 3-year tax life, would be depreciated on a straight-line basis over the project's 3-year life, and would have a zero salvage value after Year 3. No change in net operating working capital would be required. Revenues and other operating costs will be constant over the project's life, and this is just one of the firm's many projects, so any losses on it can be used to offset profits in other units. If the number of cars washed declined by 40% from the expected level, by how much would the project's NPV change? (Hint: Note that cash flows are constant at the Year 1 level, whatever that level is.) Do not round the intermediate calculations and round the final answer to the nearest whole number. WACC Net investment cost (depreciable basis) Number of cars washed Average price per car Fixed op. cost (excl. depr.) Variable op. cost/unit (i.e., VC per car washed) Annual depreciation Tax rate Copyright Cengage Learning. Powered by Cognero.
10.0% $60,000 2,960 $25.00 $10,000 $5.375 $20,000 35.0% Page 747
a. -$37,560 b. -$37,184 c. -$39,814 d. -$38,687 e. -$36,433 ANSWER: RATIONALE:
a
Base Case Calculations Investment cost
t=0 WACC: 10.0%
t=1
– Depreciation Operating income (EBIT) – Taxes EBIT(1 – T) + Depreciation Project CFs
t=3
-$60,000
Cars washed Price per car Variable cost/unit Sales revenues – Fixed op. cost (excl. depr.) – Variable op costs
t=2
2,960 2,960 2,960 $25.00 $25.00 $25.00 $5.375 $5.375 $5.375 $74,000 $74,000 $74,000
per unit = $5.375 rate = 33.333%
10,000
10,000
10,000
15,910
15,910
15,910
20,000
20,000
20,000
$28,090 $28,090 $28,090 rate = 35.0%
9,832 9,832 9,832 $18,259 $18,259 $18,259 20,000 20,000 20,000 -$60,000 $38,259 $38,259 $38,259 2
3
Base-Case NPV = -$60,000 + $38,259/1.1 + $38,259/1.1 + $38,259/1.1 = $35,143
Bad Case Investment cost Cars washed Price per car Variable cost/unit Sales revenues – Fixed op. cost (excl. depr.) – Variable op costs – Depreciation Operating income (EBIT) – Taxes EBIT(1 – T) + Depreciation Project CFs
t=0 -$60,000 Declines by: 40%
t=1
t=2
t=3
1,776
1,776
1,776
$25 $25 $25 $5.375 $5.375 $5.375 $44,400 $44,400 $44,400 10,000
10,000
10,000
9,546 20,000
9,546 20,000
9,546 20,000
$4,854
$4,854
$4,854
1,699 1,699 1,699 $3,155 $3,155 $3,155 20,000 20,000 20,000 -$60,000 $23,155 $23,155 $23,155 2
3
Bad-Case NPV = -$60,000 + $23,155/1.1 + $23,155/1.1 + $23,155/1.1 = -$2,417 Copyright Cengage Learning. Powered by Cognero.
Page 748
Change in NPV = -$37,560
Excel Data Table % NPV Decline decline 0% $35,143 $0 10% $25,753 -$9,390 20% $16,363 $18,780 30% 0$6,973 $28,170 40% -$2,417 $37,560 50% $11,807 $46,950 60% $21,197 $56,340 70% $30,587 $65,730 80% $39,977 $75,120 90% $49,367 $84,510 100% x axis - % Unit Decline y axis - NPV $58,757 $93,900
POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 12-5 Measuring Stand-Alone Risk QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.16.12.05 - Measuring Stand-Alone Risk NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.01 - Stocks and bonds United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Sensitivity analysis KEYWORDS: Bloom's: Evaluation OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:57 PM DATE MODIFIED: 9/21/2017 5:57 PM Copyright Cengage Learning. Powered by Cognero.
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1. Real options exist whenever managers have the opportunity, after a project has been implemented, to make operating changes in response to changed conditions that modify the project's cash flows. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 13-1 Introduction to Real Options QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.13.01 - Introduction to Real Options NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital TOPICS: Real options KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:58 PM DATE MODIFIED: 9/21/2017 5:58 PM 2. Traditional discounted cash flow (DCF) analysis--where a project's cash flows are estimated and then discounted to obtain an expected NPV--has been the cornerstone of capital budgeting since the 1950s. However, in recent years, it has been demonstrated that DCF techniques do not always lead to proper capital budgeting decisions due to the existence of real options. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 13-1 Introduction to Real Options QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.13.01 - Introduction to Real Options NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital TOPICS: Real options KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:58 PM DATE MODIFIED: 9/21/2017 5:58 PM 3. Real options are options to buy real assets, especially stocks, rather than interest-bearing assets, like bonds. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 13-1 Introduction to Real Options Copyright Cengage Learning. Powered by Cognero.
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QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.13.01 - Introduction to Real Options NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital TOPICS: Real options KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:58 PM DATE MODIFIED: 9/21/2017 5:58 PM 4. The following are all examples of real options that are discussed in the text: (1) growth options, (2) flexibility options, (3) timing options, and (4) abandonment options. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 13-1 Introduction to Real Options QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.13.01 - Introduction to Real Options NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital TOPICS: Real options KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:58 PM DATE MODIFIED: 9/21/2017 5:58 PM 5. The following are all examples of real options that are discussed in the text: (1) protection options, (2) flexibility options, (3) timing options, and (4) abandonment options. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 13-1 Introduction to Real Options QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.13.01 - Introduction to Real Options NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital TOPICS: Real options KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:58 PM DATE MODIFIED: 9/21/2017 5:58 PM Copyright Cengage Learning. Powered by Cognero.
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6. The following are all examples of real options that are discussed in the text: (1) natural resource options, (2) flexibility options, (3) timing options, and (4) abandonment options. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 13-1 Introduction to Real Options QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.13.01 - Introduction to Real Options NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital TOPICS: Real options KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:58 PM DATE MODIFIED: 9/21/2017 5:58 PM 7. The option to abandon a project is a real option, but a call option on a stock is not a real option. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 13-1 Introduction to Real Options QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.13.01 - Introduction to Real Options NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital TOPICS: Real options KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:58 PM DATE MODIFIED: 9/21/2017 5:58 PM 8. The true expected value of a project with a growth option is the expected NPV of the project (including the value of the option) less the cost of obtaining that option. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 13-2 Growth (Expansion) Options QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.13.02 - Growth (Expansion) Options Copyright Cengage Learning. Powered by Cognero.
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NATIONAL STANDARDS: STATE STANDARDS: TOPICS: KEYWORDS: DATE CREATED: DATE MODIFIED:
United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital Growth options Bloom's: Knowledge 9/21/2017 5:58 PM 9/21/2017 5:58 PM
9. It is not possible for abandonment options to decrease a project's risk as measured by the project's coefficient of variation. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 13-3 Abandonment/Shutdown Options QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.13.03 - Abandonment/Shutdown Options NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital TOPICS: Abandonment options KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:58 PM DATE MODIFIED: 9/21/2017 5:58 PM 10. Traditionally, an NPV analysis assumes that projects will be accepted or rejected, which implies that they will be undertaken now or never. However, in practice, companies sometimes have a third choice--delay the decision until later, when more information will be available. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 13-4 Investment Timing Options QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.13.04 - Investment Timing Options NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital TOPICS: Investment timing options KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:58 PM DATE MODIFIED: 9/21/2017 5:58 PM 11. For planning purposes, managers must forecast the total capital budget because the amount of capital raised affects the WACC. Copyright Cengage Learning. Powered by Cognero.
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a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 13-6 The Optimal Capital Budget QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.13.06 - The Optimal Capital Budget NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital TOPICS: Optimal capital budget KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:58 PM DATE MODIFIED: 9/21/2017 5:58 PM 12. The optimal capital budget is the size of the capital budget where the rate of return on the marginal project is equal to the marginal cost of capital. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 13-6 The Optimal Capital Budget QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.13.06 - The Optimal Capital Budget NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital TOPICS: Optimal capital budget KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:58 PM DATE MODIFIED: 9/21/2017 5:58 PM 13. Capital rationing is the situation in which a firm can raise only a specified, limited amount of capital regardless of how many good projects it has. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 13-6 The Optimal Capital Budget QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.13.06 - The Optimal Capital Budget Copyright Cengage Learning. Powered by Cognero.
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NATIONAL STANDARDS: STATE STANDARDS: TOPICS: KEYWORDS: DATE CREATED: DATE MODIFIED:
United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital Capital rationing Bloom's: Knowledge 9/21/2017 5:58 PM 9/21/2017 5:58 PM
14. An important part of the capital budgeting process is the post-audit, which involves comparing the actual results with those predicted by the project's sponsors and explaining why any differences occurred. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 13-7 The Post-Audit QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.13.07 - The Post-Audit NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital TOPICS: Post-audit KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:58 PM DATE MODIFIED: 9/21/2017 5:58 PM 15. Real options are most valuable when the underlying source of risk--such as uncertainty about unit sales, or the sales price, or input costs--is very low. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: Comprehensive QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.13.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital TOPICS: Real options KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:58 PM DATE MODIFIED: 9/21/2017 5:58 PM 16. Real options are valuable, and that value is correctly captured by a traditional NPV analysis. Therefore, there is no reason to consider real options separately from the NPV analysis. a. True Copyright Cengage Learning. Powered by Cognero.
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b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: Comprehensive QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.13.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital TOPICS: Real options KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:58 PM DATE MODIFIED: 9/21/2017 5:58 PM 17. Real options can affect the size of a project's expected NPV but not project's risk as measured by the standard deviation or coefficient of variation of the NPV. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: Comprehensive QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.13.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital TOPICS: Real options KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:58 PM DATE MODIFIED: 9/21/2017 5:58 PM 18. Traditionally, an NPV analysis assumes that projects will be accepted or rejected, which implies that they will be undertaken now or never. However, in practice, companies sometimes have a third choice--delay the decision until later, when more information will be available. Because the analysis extends out at least one additional year from the original analysis, it is unlikely that the firm would ever delay a project--particularly given the loss of the "first mover advantage." a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 13-4 Investment Timing Options QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.13.04 - Investment Timing Options Copyright Cengage Learning. Powered by Cognero.
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NATIONAL STANDARDS: STATE STANDARDS: TOPICS: KEYWORDS: DATE CREATED: DATE MODIFIED:
United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital Investment timing options Bloom's: Comprehension 9/21/2017 5:58 PM 9/21/2017 5:58 PM
19. A firm's optimal capital budget consists of all independent projects with positive NPVs plus those mutually exclusive projects that have the highest positive NPVs. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 13-6 The Optimal Capital Budget QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.13.06 - The Optimal Capital Budget NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital TOPICS: Optimal capital budget KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 5:58 PM DATE MODIFIED: 9/21/2017 5:58 PM 20. If a firm practices capital rationing, this means that it is accepting fewer projects than would be theoretically optimal; hence, it is not maximizing its theoretical value. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 13-6 The Optimal Capital Budget QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.13.06 - The Optimal Capital Budget NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital TOPICS: Capital rationing KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 5:58 PM DATE MODIFIED: 9/21/2017 5:58 PM 21. Which one of the following is an example of a "flexibility" option? a. A company has an option to invest in a project today or to wait for a year before making the commitment. b. A company has an option to close down an operation if it turns out to be unprofitable. Copyright Cengage Learning. Powered by Cognero.
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c. A company agrees to pay more to build a plant in order to be able to change the plant's inputs and/or outputs at a later date if conditions change. d. A company invests in a project today to gain knowledge that may enable it to expand into different markets at a later date. e. A company invests in a jet aircraft so that its CEO, who must travel frequently, can arrive for distant meetings feeling less tired than if he had to fly a commercial airline. ANSWER: c POINTS: 1 DIFFICULTY: EASY REFERENCES: 13-5 Flexibility Options QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.13.05 - Flexibility Options NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital TOPICS: Flexibility option KEYWORDS: Bloom's: Knowledge OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:58 PM DATE MODIFIED: 9/21/2017 5:58 PM 22. Which one of the following is NOT a real option? a. The option to expand production if the product is successful. b. The option to buy shares of stock if its price is expected to increase. c. The option to expand into a new geographic region. d. The option to abandon a project if cash flows turn out to be lower than expected. e. The option to switch the type of fuel used in an industrial furnace to lower the cost of production. ANSWER: b POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 13-1 Introduction to Real Options QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.13.01 - Introduction to Real Options NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital TOPICS: Real options KEYWORDS: Bloom's: Knowledge OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:58 PM DATE MODIFIED: 9/21/2017 5:58 PM 23. Which one of the following statements best describes the most likely impact that a profitable abandonment option would have on a project's expected cash flow and risk? a. No impact on the PV of expected cash flows, but risk will increase. b. The PV of expected cash flows increases and risk decreases. Copyright Cengage Learning. Powered by Cognero.
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c. The PV of expected cash flows increases and risk increases. d. The PV of expected cash flows decreases and risk decreases. e. The PV of expected cash flows decreases and risk increases. ANSWER: b POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 13-3 Abandonment/Shutdown Options QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.13.03 - Abandonment/Shutdown Options NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital TOPICS: Abandonment options KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:58 PM DATE MODIFIED: 9/21/2017 5:58 PM 24. Sheehan Inc. is deciding whether to invest in a project today or to postpone the decision until next year. The project has a positive expected NPV, but its cash flows might turn out to be lower than expected, in which case the NPV could be negative. No competitors are likely to invest in a similar project if the firm decides to wait. Which of the following statements best describes the issues that the firm faces when considering this investment timing option? a. The investment timing option would not affect the cash flows and therefore would have no impact on the project's risk. b. The more uncertainty about the future cash flows, the more logical it is to go ahead with this project today. c. Since the project has a positive expected NPV today, this means that its expected NPV will be even higher if the firm chooses to wait a year. d. Since the project has a positive expected NPV today, this means that it should be accepted in order to lock in that NPV. e. Waiting would probably reduce the project's risk. ANSWER: e POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 13-4 Investment Timing Options QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.13.04 - Investment Timing Options NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital TOPICS: Investment timing option KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:58 PM DATE MODIFIED: 9/21/2017 5:58 PM 25. Langston Labs has an overall (composite) WACC of 10%, which reflects the cost of capital for its average asset. Its Copyright Cengage Learning. Powered by Cognero.
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assets vary widely in risk, and Langston evaluates low-risk projects with a WACC of 8%, average-risk projects at 10%, and high-risk projects at 12%. The company is considering the following projects: Project A B C D E
Risk High Average High Low Low
Expected Return 15% 12% 11% 9% 6%
Which set of projects would maximize shareholder wealth? a. A and B. b. A, B, and C. c. A, B, and D. d. A, B, C, and D. e. A, B, C, D, and E. ANSWER: c RATIONALE: Statement c is true; the others are false. The following table shows the required return for each project on the basis of its risk level. Expected Req'd Return Project Risk Return for This Risk Decision A High 15% 12% Accept B Average 12% 10% Accept C High 11% 12% Reject D Low 9% 8% Accept E Low 6% 8% Reject POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 13-6 The Optimal Capital Budget QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.13.06 - The Optimal Capital Budget NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital TOPICS: Risk and project selection KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:58 PM DATE MODIFIED: 9/21/2017 5:58 PM 26. Which one of the following will NOT increase the value of a real option? a. Lengthening the time during which a real option must be exercised. b. An increase in the volatility of the underlying source of risk. c. An increase in the risk-free rate. d. An increase in the cost of obtaining the real option. e. A decrease in the probability that a competitor will enter the market of the project in question. ANSWER: d POINTS: 1 DIFFICULTY: MODERATE Copyright Cengage Learning. Powered by Cognero.
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REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.13.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital TOPICS: Real options KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:58 PM DATE MODIFIED: 9/21/2017 5:58 PM 27. Which one of the following statements is most CORRECT? a. Real options change the size, but not the risk, of projects' expected NPVs. b. Real options change the risk, but not the size, of projects' expected NPVs. c. Real options can reduce the cost of capital that should be used to discount a project's expected cash flows. d. Very few projects actually have real options. They are theoretically interesting but of little practical importance. e. Real options are more valuable when there is very little uncertainty about the true values of future sales and costs. ANSWER: c POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.13.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital TOPICS: Real options KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:58 PM DATE MODIFIED: 9/21/2017 5:58 PM 28. Gleason Research regularly takes real options into account when evaluating its proposed projects. Specifically, it considers the option to abandon a project whenever it turns out to be unsuccessful (the abandonment option), and it evaluates whether it is better to invest in a project today or to wait and collect more information (the investment timing option). Assume the proposed projects can be abandoned at any time without penalty. Which of the following statements is CORRECT? a. The abandonment option tends to reduce a project's NPV. b. The abandonment option tends to reduce a project's risk. c. If there are important first-mover advantages, this tends to increase the value of waiting a year to collect more information before proceeding with a proposed project. d. A project can either have an abandonment option or an investment timing option, but never both. e. Investment timing options always increase the value of a project. Copyright Cengage Learning. Powered by Cognero.
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ANSWER: b POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.13.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital TOPICS: Real options KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:58 PM DATE MODIFIED: 9/21/2017 5:58 PM 29. Which of the following statements is CORRECT? a. In general, the more uncertainty there is about market conditions, the more attractive it may be to wait before making an investment. b. In general, the greater the strategic advantages of being the first competitor to enter a given market, the more attractive it probably is to wait before making an investment. c. In general, the higher the discount rate, the more attractive it probably is to wait before making an investment. d. In general, investment timing options are more valuable than abandonment options. e. In general, abandonment options are rarely seen in the real world. ANSWER: a POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.13.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital TOPICS: Real options KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:58 PM DATE MODIFIED: 9/21/2017 5:58 PM 30. Weisbach Electronics is considering investing in India. Which of the following factors would make the company less likely to proceed with the investment? a. The company would have the option to withdraw from the investment after 2 years if it turns out to be unprofitable. b. The investment would increase the odds of the company being able to subsequently make a successful entry into China. c. The investment would preclude the company from being able to make a profitable investment in China. d. Competitors are considering similar investments in India, and the firm can discourage them from trying by Copyright Cengage Learning. Powered by Cognero.
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entering now. e. The new plant could be easily retrofitted to manufacture many of the firm's other products. ANSWER: c POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.13.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital TOPICS: Real options KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:58 PM DATE MODIFIED: 9/21/2017 5:58 PM 31. Wahal Corporation uses the NPV method when selecting projects, and it does a reasonably good job of estimating projects' sales and costs. However, it never considers any real options that might be associated with projects. Which of the following statements is most likely to describe its situation? a. Its estimated capital budget is probably too small, because projects' NPVs are often larger when real options are taken into account. b. Its estimated capital budget is probably too large due to its failure to consider abandonment and growth options. c. Failing to consider abandonment and flexibility options probably makes the optimal capital budget too large, but failing to consider growth and timing options probably makes the optimal capital budget too small, so it is unclear what impact the failure to consider real options has on the overall capital budget. d. Failing to consider abandonment and flexibility options probably makes the optimal capital budget too small, but failing to consider growth and timing options probably makes the optimal capital budget too large, so it is unclear what impact not considering real options has on the overall capital budget. e. Real options should not have any effect on the size of the optimal capital budget. ANSWER: a POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.13.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital TOPICS: Real options KEYWORDS: Bloom's: Synthesis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:58 PM DATE MODIFIED: 9/21/2017 5:58 PM 32. Tutor.com is considering a plan to develop an online finance tutoring package that has the cost and revenue Copyright Cengage Learning. Powered by Cognero.
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projections shown below. One of Tutor's larger competitors, Online Professor (OP), is expected to do one of two things in Year 5: (1) develop its own competing program, which will put Tutor's program out of business, or (2) offer to buy Tutor's program if it decides that this would be less expensive than developing its own program. Tutor thinks there is a 35% probability that its program will be purchased for $7.0 million and a 65% probability that it won't be bought, and thus the program will simply be closed down with no salvage value. What is the estimated net present value of the project (in thousands) at a WACC = 9.0%, giving consideration to the potential future purchase? Do not round intermediate calculations. WACC = Original project: Future Buys Doesn't buy a. 0$532.65 b. 0$468.73 c. 0$426.12 d. 0$511.35 e. 0$383.51 ANSWER: RATIONALE:
9.0% 0 −$3,500
1 $600
2 $600
3 $600
4 $600
5 $600
Prob. 35% 65%
$7,000 $0
c
(Dollars in thousands) WACC = Original project:
9.00% 0 −$3,500
OP's action: Prob. Buys 35% Doesn't buy 65% Expected future cash flow Total expected cash -$3,500 flows
NPV =
1 $600
2 $600
3 $600
4 $600
5 $ 600
7,000 $0 $2,450 $600
$600
$600
$600
$3,050
0$426.12
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 13-2 Growth (Expansion) Options QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.16.13.02 - Growth (Expansion) Options NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital TOPICS: Growth option: NPV KEYWORDS: Bloom's: Analysis Copyright Cengage Learning. Powered by Cognero.
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OTHER: DATE CREATED: DATE MODIFIED:
Multiple Choice: Problem 9/21/2017 5:58 PM 9/21/2017 5:58 PM
33. Chrustuba Inc. is evaluating a new project that would cost $8.6 million at t = 0. There is a 50% chance that the project would be highly successful and generate annual after-tax cash flows of $5.6 million during Years 1, 2, and 3. However, there is a 50% chance that it would be less successful and would generate only $1 million for each of the 3 years. If the project is highly successful, it would open the door for another investment of $11 million at the end of Year 2, and this new investment could be sold for $22 million at the end of Year 3. Assuming a WACC of 9.5%, what is the project's expected NPV (in thousands) after taking into account this growth option? Do not round intermediate calculations. a. 0$3,123 b. 0$3,471 c. 0$4,165 d. 0$2,603 e. 0$2,950 ANSWER: RATIONALE:
b
(Dollars in thousands) WACC Original Project Cost Annual AT CFs (good) Annual AT CFs (bad)
−$8,600 $5,600 $1,000
Second Project Cost Annual AT CFs
−$11,000 $22,000
Good CFs Growth option
9.5%
Prob. 0 50% −$8,600
−$8,600
Bad CFs
Prob. 0 50% −$8,600
1 $5,600
2 $5,600
3 $5,600
−11,000
22,000
$5,600 –$5,400 $27,600 1 $1,000
2 $1,000
Expected NPV=
POINTS: DIFFICULTY: REFERENCES: QUESTION TYPE: HAS VARIABLES:
3 $ 1,000
NPV
0 $13,032 -$6,091 0$3,471
1 CHALLENGING 13-2 Growth (Expansion) Options Multiple Choice True
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LEARNING OBJECTIVES: FOFM.BRIG.16.13.02 - Growth (Expansion) Options NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital TOPICS: Growth option: NPV KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:58 PM DATE MODIFIED: 9/21/2017 5:58 PM 34. Carlson Inc. is evaluating a project in India that would require a $5.8 million investment today (t = 0). The after-tax cash flows would depend on whether India imposes a new property tax. There is a 50-50 chance that the tax will pass, in which case the project will produce after-tax cash flows of $1,350,000 at the end of each of the next 5 years. If the tax doesn't pass, the after-tax cash flows will be $1,800,000 for 5 years. The project has a WACC of 10.4%. The firm would have the option to abandon the project 1 year from now, and if it is abandoned, the firm would receive the expected $1.35 million cash flow at t = 1 and would also sell the property for $4.45 million at t = 1. If the project is abandoned, the company would receive no further cash inflows from it. What is the value (in thousands) of this abandonment option? Do not round intermediate calculations. a. $99 b. $70 c. $94 d. $108 e. $89 ANSWER: c RATIONALE:
(Dollars in thousands) WACC Initial investment CFs, no tax CFs, with tax Salvage value at t = 1
10.4% $5,800 $1,800 $1,350 $4,450
Without Abandonment Prob. 0 1 2 3 4 5 NPV No tax 50% −$5,800 $1,800 $1,800 $1,800 $1,800 $1,800 0$954 New tax 50% −$5,800 $1,350 $1,350 $1,350 $1,350 $1,350 -$734 Expected NPV 0$110 With Abandonment Prob. 0 1 2 3 4 5 NPV No tax 50% −$5,800 $1,800 $1,800 $1,800 $1,800 $1,800 0$954 New tax: abandon 50% −$5,800 $1,350 $0 $0 $0 $0 $4,450 Net CFs −$5,800 $5,800 $0 $0 $0 $0 -$546 Expected NPV 0$204 The value of the abandonment option is the difference between the expected value of the project with and without the abandonment option. However, if the NPV of the project without the option is negative, then the value of the option is simply the NPV of the project with the option (because the project wouldn't be undertaken otherwise). Option value = NPV with option − NPV w/o option = $94
POINTS: DIFFICULTY:
1 CHALLENGING
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REFERENCES: 13-3 Abandonment/Shutdown Options QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.16.13.03 - Abandonment/Shutdown Options NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital TOPICS: Abandonment option: option value KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:58 PM DATE MODIFIED: 9/21/2017 5:58 PM 35. High Roller Properties is considering building a new casino at a cost of $10.0 million at t = 0. The after-tax cash flows the casino generates will depend on whether the state imposes a new income tax, and there is a 50-50 chance the tax will pass. If it passes, after-tax cash flows will be $1.875 million per year for the next 5 years. If it doesn't pass, the after-tax cash flows will be $3.75 million per year for the next 5 years. The project's WACC is 11.0%. If the tax is passed, the firm will have the option to abandon the project 1 year from now, in which case the property could be sold to net $6.7 million after tax at t = 1. What is the value (in thousands) of this abandonment option? Do not round intermediate calculations. a. $437 b. $457 c. $318 d. $418 e. $398 ANSWER: RATIONALE:
e
(Dollars in thousands) WACC Investment cost CFs, no tax CFs, with tax Salvage value Without Abandonment Prob. 0 No tax 50% −$10,000 New tax 50% −$10,000
With Abandonment Prob. 0 No tax 50% −$10,000 New tax: abandon 50% −$10,000 −$10,000
11.0% $10,000 $3,750 $1,875 $6,700 1 $3,750 $1,875
2 $3,750 $1,875
3 4 5 NPV $3,750 $3,750 $3,750 $3,860 $1,875 $1,875 $1,875 –3,070 Expected NPV $ 395
1 $3,750
2 $3,750
3 $3,750
1,875 6,700 $8,575
$0
4 5 NPV $3,750 $3,750 $3,860
$0 $0 $0 Expected NPV
–2,275 $792
Option value = NPV with option − NPV w/o option = $398
POINTS: DIFFICULTY:
1 CHALLENGING
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REFERENCES: 13-3 Abandonment/Shutdown Options QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.16.13.03 - Abandonment/Shutdown Options NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital TOPICS: Abandonment option: option value KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:58 PM DATE MODIFIED: 9/21/2017 5:58 PM 36. Lindley Corp. is considering a new product that would require an investment of $10.5 million now, at t = 0. If the new product is well received, then the project would produce after-tax cash flows of $5.3 million at the end of each of the next 3 years (t = 1, 2, 3), but if the market did not like the product, then the cash flows would be only $2.6 million per year. There is a 50% probability that the market will be good. The firm could delay the project for a year while it conducts a test to determine if demand is likely to be strong or weak. The project's cost and expected annual cash flows would be the same whether the project is delayed or not. The project's WACC is 9.2%. What is the value (in thousands) of the project after considering the investment timing option? Do not round intermediate calculations. a. $1,248 b. $985 c. $1576 d. $1,445 e. $1,313 ANSWER: RATIONALE:
e (Dollars in thousands) Project cost Good CFs Bad CFs WACC
−$10,500 $5,300 $2,600 9.2%
Go ahead today Good CFs Bad CFs
Prob. 0 50% −$10,500 50% −$10,500
1 $5,300 $2,600
2 $5,300 $2,600
3 NPV $5,300 0$2,868 $2,600 -$3,942
Expected NPV w/o timing option
-$537
Wait one year Prob. Good CFs Bad CFs
50% 50%
0
NPV @ t =0 −$10,500 $5,300 $5,300 $5,300 $2,627 0 Expected NPV with timing option* = $1,313 1
2
3
4
*There is a 50% probability of a negative test; hence, no investment and thus a $0 NPV and a 50% probability of a positive NPV. The expected NPV is a weighted average of the two.
POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 13-4 Investment Timing Options QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.16.13.04 - Investment Timing Options Copyright Cengage Learning. Powered by Cognero.
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NATIONAL STANDARDS: STATE STANDARDS: TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital Investment timing option: NPV Bloom's: Analysis Multiple Choice: Problem 9/21/2017 5:58 PM 9/21/2017 5:58 PM
37. Winters Corp. is considering a new product that would require an investment of $22 million now, at t = 0. If the new product is well received, then the project would produce after-tax cash flows of $11.0 million at the end of each of the next 3 years (t = 1, 2, 3), but if the market did not like the product, then the cash flows would be only $4 million per year. There is a 50% probability that the market will be good. The firm could delay the project for a year while it conducts a test to determine if demand is likely to be strong or weak, but it would have to incur costs to obtain this timing option. The project's cost and expected annual cash flows would be the same whether the project is delayed or not. The project's WACC is 10.0%. What is the value (in thousands) of the option to delay the project? Do not round intermediate calculations. a. $2,678 b. $1,826 c. $2,556 d. $2,191 e. $2,434 ANSWER: RATIONALE:
e
(Dollars in thousands) Project cost Good CFs Bad CFs WACC
−$22,000 $11,000 $4,000 10.0%
Go ahead today Prob. 0 1 2 3 Good −$22,000 $11,000 $11,000 $11,000 CFs 50% Bad −$22,000 $4,000 $4,000 $4,000 CFs 50% Expected NPV w/o timing option
NPV $5,355 –12,053 -$3,349
Wait one year Prob. 0 Good CFs 50% Bad CFs 50%
1
2
3
4
NPV @ t=0
−$22,000 $11,000 $11,000 $11,000 $4,869 0
Expected NPV with timing option* =
$2,434
*There is a 50% probability of a negative test; hence, no investment and thus a $0 NPV and a 50% probability of a positive NPV. The expected NPV is a weighted average. The value of the timing option is the difference between the expected value of the project with the timing option and without this option. However, if the NPV of the project without the option is negative, then the value of the option is simply the NPV of the project with the option Copyright Cengage Learning. Powered by Cognero.
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(because the project wouldn't be undertaken otherwise). Value of timing option = Value with option − Value w/o option = $2,434
POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 13-4 Investment Timing Options QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.16.13.04 - Investment Timing Options NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital TOPICS: Investment timing option: NPV KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:58 PM DATE MODIFIED: 9/21/2017 5:58 PM 38. Games Unlimited Inc. is considering a new game that would require an investment of $21.0 million. If the new game is well received, then the project would produce cash flows of $9.5 million a year for 3 years. However, if the market does not like the new game, then the cash flows would be only $6.8 million per year. There is a 50% probability of both good and bad market conditions. The firm could delay the project for a year while it conducts a test to determine if demand would be strong or weak. The project's cost and expected annual cash flows would be the same whether the project is delayed or not. If the WACC is 9.6%, what is the value (in thousands) of the investment timing option? Do not round intermediate calculations. a. $1,274 b. $1,083 c. $1,592 d. $1,019 e. $1,147 ANSWER: RATIONALE:
a
(Dollars in thousands) WACC Project cost Good CFs Bad CFs Proceed now Prob. Good 50% CFs Bad CFs 50%
0
9.6% −$21,000 $9,500 $6,800 1
2
3
NPV
−$21,000
$9,500
$9,500
$9,500
$2,792
−$21,000
$6,800 $6,800 $6,800 Expected NPV w/o option
–3,970 -$589
Option to wait one year
Good
Prob. 50%
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0
1 −$21,000
2 $9,500
3 $9,500
4 $9,500
NPV @ t = 0 $2,548 Page 770
CFs Expected NPV with option
$1,274
The value of the timing option is the difference between the expected value of the project with the timing option and without this option. However, if the NPV of the project without the option is negative, then the value of the option is simply the NPV of the project with the option (because the project wouldn't be undertaken otherwise). Option value = NPV with option − NPV w/o option = $1,274
POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 13-4 Investment Timing Options QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.16.13.04 - Investment Timing Options NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital TOPICS: Investment timing option: option value KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:58 PM DATE MODIFIED: 9/21/2017 5:58 PM 39. Norris Production Company (NPC) is considering a project that has an up-front cost at t = 0 of $2,400. (All dollars in this problem are in thousands.) The project's subsequent cash flows are critically dependent on whether a competitor's product is approved by the Food and Drug Administration. If the FDA rejects the competitive product, NPC's product will have high sales and cash flows, but if the competitive product is approved, that will negatively impact NPC. There is a 50% chance that the competitive product will be rejected, in which case NPC's expected cash flows will be $700 at the end of each of the next seven years (t = 1 to 7). There is a 50% chance that the competitor's product will be approved, in which case the expected cash flows will be only $50 at the end of each of the next seven years (t = 1 to 7). NPC will know for sure one year from today whether the competitor's product has been approved. NPC is considering whether to make the investment today or to wait a year to find out about the FDA's decision. If it waits a year, the project's up-front cost at t = 1 will remain at $2,400, the subsequent cash flows will remain at $700 per year if the competitor's product is rejected and $50 per year if the alternative product is approved. However, if NPC decides to wait, the subsequent cash flows will be received only for six years (t = 2 ... 7). In addition, once NPC knows the outcome of the FDA's decision, it will not take on the project if its NPV is negative. This is a risky project, so a WACC of 16.0% is to be used. If NPC chooses to wait a year before proceeding, what is the value (in thousand) of the timing option today? Do not round intermediate calculations. a. $88.88 b. $92.75 c. $73.43 d. $77.29 e. $57.97 ANSWER: RATIONALE:
d Invest immediately:
0 Copyright Cengage Learning. Powered by Cognero.
1
2
3
4
5
Cost of capital: 6
16.0% 7
NPV
Product: Page 771
50%
Good -$2,400 50% Bad
$700
$700
$700
$700
$700
$50
$50
$50
$50
$50
$700
$700
$427.00
NPV x Prob. $213.50
$50 $50 -$2,198.07 -$1,099.04 Expected NPV if Go Now -$885.54
Delay, then invest in period 1 if the outlook is good:
1 50%
Good
50%
Bad
2 $700
3 $700
$0
$0
4 $700
5 $700
6 $700
Product: NPV x 7 NPV* Prob. $700 $154.58 $77.29
-$2,400 $0 $0 $0 $0 $0.00 Expected NPV if delay to get more information Option value = NPV Wait - NPV Go Now =
$0.00 $77.29
$77.29
*The NPV under the delay option occurs one year later, so it must be discounted back to t = 0 at the cost of capital to make the NPVs comparable. The value of the timing option is the difference between the expected value of the project with and without the timing option. However, if the NPV of the project without the option is negative, then the value of the option is simply the NPV of the project with the option (because the project wouldn't be undertaken otherwise). Cost of capital: 16.0% Product: 0 1 2 3 4 5 6 7 NPV NPV x Prob. 75% Good $750 $750 $750 $750 $750 $750 $750 $528.92 $369.69 -$2500 25% Bad $50 $50 $50 $50 $50 $50 $50 -$2289.07 -$574.52 Expected NPV if Go Now -$177.82 Cost of capital: 16.0% Product: 0 1 2 3 4 5 6 7 NPV NPV x Prob. 75% Good $750 $750 $750 $750 $750 $750 $750 $528.92 $369.69 -$2500 25% Bad $50 $50 $50 $50 $50 $50 $50 -$2289.07 -$574.52 Expected NPV if Go Now -$177.82
Cost of capital: 16.0%
01234567NPVProduct: NPV x Prob.75% Good$750$750$750$750$750$750$750$528.92$369.69 -$2500 25% Bad$50$50$50$50$50$50$50-$2289.07-$574.52 Expected NPV if Go Now-$177.82
0 Copyright Cengage Learning. Powered by Cognero.
1
2
3
4
5
Cost of capital: 6 7
16.0% NPV
Product: Page 772
75% 25%
Good -$2500 Bad
$750
$750
$750
$750
$750
$50
$50
$50
$50
$50
$750
$750
$50 $50 -$2289.07 -$574.52 Expected NPV if Go Now -$177.82 Cost of capital:
75% 25%
NPV x Prob. $528.92 $369.69
0
1
2
3
4
5
6
7
Good -$2500 Bad
$750
$750
$750
$750
$750
$750
$750
$50
$50
$50
$50
$50
16.0% Product: NPV x Prob. $528.92 $369.69
NPV
$50 $50 -$2289.07 -$574.52 Expected NPV if Go Now -$177.82
POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 13-4 Investment Timing Options QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.16.13.04 - Investment Timing Options NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital TOPICS: Investment timing option: decision trees KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:58 PM DATE MODIFIED: 9/21/2017 5:58 PM Multiple Part: The following 2 problems must be kept together. The first problem can be used alone, but use the second problem ONLY if the first problem is also used. Exhibit 13.1 Texas Wildcatters Inc. (TWI) is in the business of finding and developing oil properties, then selling the successful ones to major oil companies. It is now considering a new potential field, and its geologists have developed the following data, shown in thousands of dollars. * t = 0 A $350 feasibility study would be conducted at t = 0. The results of this study would determine if the company should commence drilling operations or make no further investment and abandon the project. There is an 80% probability that the feasibility study would indicate that an exploratory well should be drilled. There is a 20% probability that no further work would be done. * t = 1 If the feasibility study indicates good potential, the firm would spend $1,200 at t = 1 to drill an exploratory well. The best estimate is that there is a 60% probability that the exploratory well would indicate good potential and thus that further work would be done, and a 40% probability that the outlook would be poor and the project would be abandoned. * t = 2 If the exploratory well tests positive, the firm would go ahead and spend $8,000 to obtain an accurate estimate of the amount of oil in the field at t = 2. * t = 3 If the full drilling program is carried out, there is a 50% probability of finding a lot of oil and receiving $25,000 cash inflow at t = 3, and a 50% probability of finding less oil and then receiving only a $8,000 inflow. * Since the project is considered to be quite risky, a 18.00% cost of capital is used. Copyright Cengage Learning. Powered by Cognero.
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40. Refer to Exhibit 13.1. What is the project's expected NPV, in thousands of dollars? a. 0$1,033.81 b. 0$719.18 c. 0$854.02 d. 0$898.97 e. 0$943.92 ANSWER: RATIONALE:
d
Cost of capital: Invest this period:
18.00% Invest this period:
0
Invest this period:
1
2
CF this perid: Possible Joint 3 NPVs* Prob.** 50% $25,000 8,103.35 24%
Product 0$1,944.80
$8,000 –2,243.38
24%
-$538.41
–1,366.95
32%
-$437.42
−350.00 20% Expected NPV =
−$70.00 0$898.97
60% −$8,000 80% -$1,200 -$350
50% 40%
20%
$0
$0
*Here are the cash flows of the four potential outcomes. Find the potential outcomes' NPVs as the PVs of these cash flows, discounted at the 18.00% cost of capital:
NPV-1 = NPV-2 = NPV-3 = NPV-4 =
0 −$350 −$350 −$350 −$350
1 −$1,200 −$1,200 −$1,200 $0
2 −$8,000 −$8,000 $0 $0
3 NPV $25,000 0$8,103.35 $8,000 -$2,243.38 $ 0 -$1,366.95 $ 0 −$ 350.00
**Joint probabilities: Probs 1 and 2 = 0.8 × 0.6 × 0.5 = 0.24; Prob 3 = 0.8 × 0.4 = 0.32; Prob 4 = 0.2.
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 13-2 Growth (Expansion) Options QUESTION TYPE: Multiple Choice HAS VARIABLES: False PREFACE NAME: Multiple Part correct LEARNING OBJECTIVES: FOFM.BRIG.16.13.02 - Growth (Expansion) Options NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital TOPICS: Decision tree: expected NPV KEYWORDS: Bloom's: Analysis OTHER: Multiple Part DATE CREATED: 9/21/2017 5:58 PM Copyright Cengage Learning. Powered by Cognero.
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41. Refer to Exhibit 13.1 and to the previous problem. Calculate the project's coefficient of variation. (Hint: Use the expected NPV as found in previous problem.) a. 5.47 b. 3.42 c. 4.56 d. 3.87 e. 4.33 ANSWER: c RATIONALE: The CV = SD/Expected NPV. NPVi− Squared Squared Dev. Prob. NPV E(NPV) Deviation ×Probability 24% 0$8,103.35 $7,204.38 51,903,066 12,456,736 24% –2,243.38 –3,142.35 9,874,342 2,369,842 32% –1,366.95 –2,265.92 5,134,385 1,643,003 20% −350.00 –1,248.97 1,559,924 311,985 100% 0$898.97 Variance 16,781,566 Standard deviation = $4,096.53 CV = 4.56
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 13-2 Growth (expansion) Options QUESTION TYPE: Multiple Choice HAS VARIABLES: False PREFACE NAME: Multiple Part correct LEARNING OBJECTIVES: FOFM.BRIG.16.13.02 - Growth (Expansion) Options NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital TOPICS: Decision tree: SD and CV KEYWORDS: Bloom's: Analysis OTHER: Multiple Part DATE CREATED: 9/21/2017 5:58 PM DATE MODIFIED: 9/21/2017 5:58 PM
1. A firm's business risk is largely determined by the financial characteristics of its industry, especially by the amount of debt the average firm in the industry uses. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 14-2 Business and Financial Risk QUESTION TYPE: True / False HAS VARIABLES: False Copyright Cengage Learning. Powered by Cognero.
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LEARNING OBJECTIVES: FOFM.BRIG.17.13.02 - Business and Financial Risk NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Business risk KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 6:07 PM DATE MODIFIED: 9/26/2017 11:34 AM 2. Financial risk refers to the extra risk borne by stockholders as a result of a firm's use of debt as compared with their risk if the firm had used no debt. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 14-2 Business and Financial Risk QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.13.02 - Business and Financial Risk NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Financial risk KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 6:07 PM DATE MODIFIED: 9/26/2017 11:34 AM 3. A firm's capital structure does not affect its free cash flows as discussed in the text, because FCF reflects only operating cash flows, which are available to service debt, to pay dividends to stockholders, and for other purposes. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 14-2 Business and Financial Risk QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.13.02 - Business and Financial Risk NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Financial risk KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 6:07 PM Copyright Cengage Learning. Powered by Cognero.
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4. If a firm borrows money, it is using financial leverage. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 14-2 Business and Financial Risk QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.13.02 - Business and Financial Risk NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Financial leverage KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 6:07 PM DATE MODIFIED: 9/26/2017 11:34 AM 5. Other things held constant, an increase in financial leverage will increase a firm's market (or systematic) risk as measured by its beta coefficient. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 14-2 Business and Financial Risk QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.13.02 - Business and Financial Risk NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Financial leverage KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 6:07 PM DATE MODIFIED: 9/26/2017 11:34 AM 6. The graphical probability distribution of ROE for a firm that uses financial leverage would tend to be more peaked than the distribution if the firm used no leverage, other things held constant. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY Copyright Cengage Learning. Powered by Cognero.
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REFERENCES: 14-2 Business and Financial Risk QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.13.02 - Business and Financial Risk NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Use of financial leverage KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 6:07 PM DATE MODIFIED: 9/26/2017 11:34 AM 7. Provided a firm does not use an extreme amount of debt, operating leverage typically affects only EPS, while financial leverage affects both EPS and EBIT. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 14-2 Business and Financial Risk QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.13.02 - Business and Financial Risk NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Operating and financial leverage KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 6:07 PM DATE MODIFIED: 9/26/2017 11:34 AM 8. The trade-off theory states that capital structure decisions involve a tradeoff between the costs and benefits of debt financing. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 14-4 Capital Structure Theory QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.13.04 - Capital Structure Theory NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure Copyright Cengage Learning. Powered by Cognero.
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TOPICS: KEYWORDS: DATE CREATED: DATE MODIFIED:
Trade-off theory Bloom's: Knowledge 9/21/2017 6:07 PM 9/26/2017 11:34 AM
9. Different borrowers have different risks of bankruptcy, and if a borrower goes bankrupt, its lenders will probably not get back the full amount of funds that they loaned. Therefore, lenders charge higher rates to borrowers judged to be more likely to go bankrupt. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 14-4 Capital Structure Theory QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.13.04 - Capital Structure Theory NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Bankruptcy costs KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 6:07 PM DATE MODIFIED: 9/26/2017 11:34 AM 10. Modigliani and Miller (MM) won Nobel Prizes for their work on capital structure theory. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 14-4 Capital Structure Theory QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.13.04 - Capital Structure Theory NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: MM KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 6:07 PM DATE MODIFIED: 9/26/2017 11:34 AM 11. Modigliani and Miller's first article led to the conclusion that capital structure is "irrelevant" because it has no effect on a firm's value. a. True Copyright Cengage Learning. Powered by Cognero.
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b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 14-4 Capital Structure Theory QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.13.04 - Capital Structure Theory NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: MM KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 6:07 PM DATE MODIFIED: 9/26/2017 11:34 AM 12. Modigliani and Miller's first article led to the conclusion that capital structure is extremely important, and that every firm has an optimal capital structure that maximizes its value and minimizes its cost of capital. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 14-4 Capital Structure Theory QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.13.04 - Capital Structure Theory NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: MM KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 6:07 PM DATE MODIFIED: 9/26/2017 11:34 AM 13. It is possible for Firms A and B to have identical financial and operating leverage, yet for Firm A to have more risk as measured by the variability of EPS. This would occur if Firm A has more business risk than Firm B. a. True b. False ANSWER: True RATIONALE: If Firm A's sales are more volatile than those of Firm B, then A would have greater EPS variability in spite of identical financial and operating leverage. Operating leverage is only one factor that affects business risk. POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 14-2 Business and Financial Risk Copyright Cengage Learning. Powered by Cognero.
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QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.13.02 - Business and Financial Risk NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Operating and financial leverage KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 6:07 PM DATE MODIFIED: 9/26/2017 11:34 AM 14. As the text indicates, a firm's financial risk can and should be divided into separate market and diversifiable risk components. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 14-2 Business and Financial Risk QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.13.02 - Business and Financial Risk NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Financial risk KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 6:07 PM DATE MODIFIED: 9/26/2017 11:34 AM 15. If two firms have the same expected earnings per share (EPS) and the same standard deviation of expected EPS, then they must have the same amount of business risk. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 14-2 Business and Financial Risk QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.13.02 - Business and Financial Risk NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Business risk Copyright Cengage Learning. Powered by Cognero.
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16. In a world with no taxes, Modigliani and Miller (MM) show that a firm's capital structure does not affect its value. However, when taxes are considered, MM show a positive relationship between debt and value, i.e., the firm's value rises as it uses more and more debt, other things held constant. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 14-4 Capital Structure Theory QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.13.04 - Capital Structure Theory NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: MM KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 6:07 PM DATE MODIFIED: 9/26/2017 11:34 AM 17. According to Modigliani and Miller (MM), in a world without taxes the optimal capital structure for a firm is approximately 100% debt financing. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 14-4 Capital Structure Theory QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.13.04 - Capital Structure Theory NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: MM KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 6:07 PM DATE MODIFIED: 9/26/2017 11:34 AM 18. According to Modigliani and Miller (MM), in a world with corporate income taxes the optimal capital structure calls for approximately 100% debt financing. a. True Copyright Cengage Learning. Powered by Cognero.
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b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 14-4 Capital Structure Theory QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.13.04 - Capital Structure Theory NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: MM KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 6:07 PM DATE MODIFIED: 9/26/2017 11:34 AM 19. According to Modigliani and Miller (MM), in a world without corporate income taxes the use of debt has no effect on the firm's value. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 14-4 Capital Structure Theory QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.13.04 - Capital Structure Theory NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: MM KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 6:07 PM DATE MODIFIED: 9/26/2017 11:34 AM 20. Modigliani and Miller's first article led to the conclusion that capital structure is "irrelevant" because it has no effect on a firm's value. However, that article was criticized because it assumed that no taxes existed. MM then revised their original article to include corporate taxes, and this model led to the conclusion that a firm's value would be maximized if it used (almost) 100% debt. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 14-4 Capital Structure Theory QUESTION TYPE: True / False Copyright Cengage Learning. Powered by Cognero.
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HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.13.04 - Capital Structure Theory NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: MM KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 6:07 PM DATE MODIFIED: 9/26/2017 11:34 AM 21. Modigliani and Miller's second article, which assumed the existence of corporate income taxes, led to the conclusion that a firm's value would be maximized, and its cost of capital minimized, if it used (almost) 100% debt. However, this model did not take account of bankruptcy costs. The existence of bankruptcy costs leads to the assumption of an optimal capital structure where the debt ratio is less than 100%. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 14-4 Capital Structure Theory QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.13.04 - Capital Structure Theory NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: MM KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 6:07 PM DATE MODIFIED: 9/26/2017 11:34 AM 22. The Miller model begins with the Modigliani and Miller (MM) model with corporate taxes and then adds personal taxes. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 14-4 Capital Structure Theory QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.13.04 - Capital Structure Theory NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Miller model Copyright Cengage Learning. Powered by Cognero.
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23. The Miller model begins with the Modigliani and Miller (MM) model without corporate taxes and then adds personal taxes. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 14-4 Capital Structure Theory QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.13.04 - Capital Structure Theory NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Miller model KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 6:07 PM DATE MODIFIED: 9/26/2017 11:34 AM 24. The Modigliani and Miller (MM) articles implicitly assumed that bankruptcy did not exist. That led to the development of the "trade-off" model, where the firm's value first rises with the use of debt due to the tax shelter of debt, but later falls as more debt is added because the potential costs of bankruptcy begin to more than offset the tax shelter benefits. Under the trade-off theory, an optimal capital structure exists. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 14-4 Capital Structure Theory QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.13.04 - Capital Structure Theory NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Trade-off theory KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 6:07 PM DATE MODIFIED: 9/26/2017 11:34 AM 25. Modigliani and Miller (MM), in their second article, took account of taxes, bankruptcy, and other factors that were assumed away in their original article. Once they took account of all these assumptions, they concluded that every firm has a unique optimal capital structure. Moreover, a manager can use the second MM model to determine his or her firm's Copyright Cengage Learning. Powered by Cognero.
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optimal debt ratio. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 14-4 Capital Structure Theory QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.13.04 - Capital Structure Theory NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Trade-off theory KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 6:07 PM DATE MODIFIED: 9/26/2017 11:34 AM 26. Some people--including the former chairman of the Federal Reserve Board of Governors (Ben Bernanke) --have argued that one advantage of corporate debt from the stockholders' standpoint is that the existence of debt forces managers to focus on cash flow and to refrain from spending too much of the firm's money on private plane and other "perks." This is one of the factors that led to the rise of LBOs and private equity firms. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 14-4 Capital Structure Theory QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.13.04 - Capital Structure Theory NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Trade-off theory KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 6:07 PM DATE MODIFIED: 9/26/2017 11:34 AM 27. The Modigliani and Miller (MM) articles implicitly assumed, among other things, that outside stockholders have the same information about a firm's future prospects as its managers. That was called "symmetric information," and it is questionable. The introduction of "asymmetric information" led to the development of the "signaling" theory of capital structure, which postulated that firms are reluctant to issue new stock because investors will interpret such an act as a signal that the firm's managers are worried about its future. Other actions give off different signals, and the end result is that capital structure is affected by managers' perceptions about how their financing decisions will affect investors' views of the firm and thus its value. a. True Copyright Cengage Learning. Powered by Cognero.
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b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 14-4 Capital Structure Theory QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.13.04 - Capital Structure Theory NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Signaling theory KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 6:07 PM DATE MODIFIED: 9/26/2017 11:34 AM 28. According to the signaling theory of capital structure, firms first use common equity for their capital, then use debt if and only if they can raise no more equity on "reasonable" terms. This occurs because the use of debt financing signals to investors that the firm's managers think that the future does not look good. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 14-4 Capital Structure Theory QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.13.04 - Capital Structure Theory NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Signaling theory KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 6:07 PM DATE MODIFIED: 9/26/2017 11:34 AM 29. Other things held constant, firms with more stable and predictable sales tend to use more debt than firms with less stable sales. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 14-5 Checklist for Capital Structure Decisions QUESTION TYPE: True / False HAS VARIABLES: False Copyright Cengage Learning. Powered by Cognero.
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LEARNING OBJECTIVES: FOFM.BRIG.17.13.05 - Checklist for Capital Structure Decisions NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Capital structure KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 6:07 PM DATE MODIFIED: 9/26/2017 11:34 AM 30. Other things held constant, firms that use assets that can be sold easily (like trucks) tend to use more debt than firms whose assets are harder to sell (like those engaged in research and development). a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 14-5 Checklist for Capital Structure Decisions QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.13.05 - Checklist for Capital Structure Decisions NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Capital structure KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 6:07 PM DATE MODIFIED: 9/26/2017 11:34 AM 31. Other things held constant, the lower a firm's tax rate, the more logical it is for the firm to use debt. a. True b. False ANSWER: False RATIONALE: This is false. The lower the tax rate, the less valuable the tax shelter from debt. Think about the cost of debt in the WACC: rd(1 - T). If T is low, then the cost of debt is not reduced as much as when T is high. POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 14-5 Checklist for Capital Structure Decisions QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.13.05 - Checklist for Capital Structure Decisions NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Capital structure Copyright Cengage Learning. Powered by Cognero.
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32. A firm's treasurer likes to be in a position to raise funds to support operations whenever such funds are needed, even in "bad times". This is called "financial flexibility," and the lower the firm's debt ratio, the greater its financial flexibility, other things held constant. a. True b. False ANSWER: True RATIONALE: This is true, because if times are bad--which is when financial flexibility is important-investors are much more willing to lend a firm money than to buy its stock, because if the firm fails, debt holders are first in line to get their money back. POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 14-5 Checklist for Capital Structure Decisions QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.13.05 - Checklist for Capital Structure Decisions NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Capital structure KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 6:07 PM DATE MODIFIED: 9/26/2017 11:34 AM 33. If a firm utilizes debt financing, a 10% decline in earnings before interest and taxes (EBIT) will result in a decline in earnings per share that is larger than 10%, and the higher the debt ratio, the larger this difference will be. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 14-2 Business and Financial Risk QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.13.02 - Business and Financial Risk NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Use of debt in financing KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 6:07 PM DATE MODIFIED: 9/26/2017 11:34 AM Copyright Cengage Learning. Powered by Cognero.
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34. An increase in the debt ratio will generally have no effect on which of these items? a. Business risk. b. Total risk. c. Financial risk. d. Market risk. e. The firm's beta. ANSWER: a POINTS: 1 DIFFICULTY: EASY REFERENCES: 14-2 Business and Financial Risk QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.13.02 - Business and Financial Risk NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Business risk KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 6:07 PM DATE MODIFIED: 9/26/2017 11:34 AM 35. Business risk is affected by a firm's operations. Which of the following is NOT directly associated with (or does not directly contribute to) business risk? a. Demand variability. b. Sales price variability. c. The extent to which operating costs are fixed. d. The extent to which interest rates on the firm's debt fluctuate. e. Input price variability. ANSWER: d POINTS: 1 DIFFICULTY: EASY REFERENCES: 14-2 Business and Financial Risk QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.13.02 - Business and Financial Risk NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Business risk KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:07 PM DATE MODIFIED: 9/26/2017 11:34 AM 36. Which of the following statements is CORRECT? Copyright Cengage Learning. Powered by Cognero.
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a. Since debt financing raises the firm's financial risk, increasing the target debt ratio will always increase the WACC. b. Since debt financing is cheaper than equity financing, raising a company's debt ratio will always reduce its WACC. c. Increasing a company's debt ratio will typically reduce the marginal costs of both debt and equity financing. However, this action still may raise the company's WACC. d. Increasing a company's debt ratio will typically increase the marginal costs of both debt and equity financing. However, this action still may lower the company's WACC. e. Since a firm's beta coefficient is not affected by its use of financial leverage, leverage does not affect the cost of equity. ANSWER: d POINTS: 1 DIFFICULTY: EASY REFERENCES: 14-3 Determining the Optimal Capital Structure QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.13.03 - Determining the Optimal Capital Structure NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Capital structure and WACC KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:07 PM DATE MODIFIED: 9/26/2017 11:34 AM 37. Which of the following statements is CORRECT? a. The capital structure that maximizes expected EPS also maximizes the price per share of common stock. b. The capital structure that minimizes the interest rate on debt also maximizes the expected EPS. c. The capital structure that minimizes the required return on equity also maximizes the stock price. d. The capital structure that minimizes the WACC also maximizes the price per share of common stock. e. The capital structure that gives the firm the best bond rating also maximizes the stock price. ANSWER: d POINTS: 1 DIFFICULTY: EASY REFERENCES: 14-3 Determining the Optimal Capital Structure QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.13.03 - Determining the Optimal Capital Structure NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Optimal capital structure KEYWORDS: Bloom's: Knowledge OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:07 PM Copyright Cengage Learning. Powered by Cognero.
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38. Based on the information below, what is the firm's optimal capital structure? a. Debt = 40%; Equity = 60%; EPS = $2.95; Stock price = $26.50. b. Debt = 50%; Equity = 50%; EPS = $3.05; Stock price = $28.90. c. Debt = 60%; Equity = 40%; EPS = $3.18; Stock price = $31.20. d. Debt = 80%; Equity = 20%; EPS = $3.42; Stock price = $30.40. e. Debt = 70%; Equity = 30%; EPS = $3.31; Stock price = $30.00. ANSWER: c POINTS: 1 DIFFICULTY: EASY REFERENCES: 14-3 Determining the Optimal Capital Structure QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.13.03 - Determining the Optimal Capital Structure NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Optimal capital structure KEYWORDS: Bloom's: Evaluation OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:07 PM DATE MODIFIED: 9/26/2017 11:34 AM 39. Which of the following statements best describes the optimal capital structure? a. The optimal capital structure is the mix of debt, equity, and preferred stock that maximizes the company's earnings per share (EPS). b. The optimal capital structure is the mix of debt, equity, and preferred stock that maximizes the company's stock price. c. The optimal capital structure is the mix of debt, equity, and preferred stock that minimizes the company's cost of equity. d. The optimal capital structure is the mix of debt, equity, and preferred stock that minimizes the company's cost of debt. e. The optimal capital structure is the mix of debt, equity, and preferred stock that minimizes the company's cost of preferred stock. ANSWER: b POINTS: 1 DIFFICULTY: EASY REFERENCES: 14-3 Determining the Optimal Capital Structure QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.13.03 - Determining the Optimal Capital Structure NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Optimal capital structure Copyright Cengage Learning. Powered by Cognero.
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40. Which of the following events is likely to encourage a company to raise its target debt ratio, other things held constant? a. An increase in the corporate tax rate. b. An increase in the personal tax rate. c. An increase in the company's operating leverage. d. The Federal Reserve tightens interest rates in an effort to fight inflation. e. The company's stock price hits a new high. ANSWER: a POINTS: 1 DIFFICULTY: EASY REFERENCES: 14-5 Checklist for Capital Structure Decisions QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.13.05 - Checklist for Capital Structure Decisions NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Leverage and capital structure KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:07 PM DATE MODIFIED: 9/26/2017 11:34 AM 41. Which of the following would tend to increase a firm's target debt ratio, other things held constant? a. The costs associated with filing for bankruptcy increase. b. The corporate tax rate is increased. c. The personal tax rate is increased. d. The Federal Reserve tightens interest rates in an effort to fight inflation. e. The company's stock price hits a new low. ANSWER: b POINTS: 1 DIFFICULTY: EASY REFERENCES: 14-5 Checklist for Capital Structure Decisions QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.13.05 - Checklist for Capital Structure Decisions NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Leverage and capital structure Copyright Cengage Learning. Powered by Cognero.
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42. Which of the following statements is CORRECT? a. As a rule, the optimal capital structure is found by determining the debt-equity mix that maximizes expected EPS. b. The optimal capital structure simultaneously maximizes EPS and minimizes the WACC. c. The optimal capital structure minimizes the cost of equity, which is a necessary condition for maximizing the stock price. d. The optimal capital structure simultaneously minimizes the cost of debt, the cost of equity, and the WACC. e. The optimal capital structure simultaneously maximizes the stock price and minimizes the WACC. ANSWER: e POINTS: 1 DIFFICULTY: EASY/MODERATE REFERENCES: 14-3 Determining the Optimal Capital Structure QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.13.03 - Determining the Optimal Capital Structure NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Optimal capital structure KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:07 PM DATE MODIFIED: 9/26/2017 11:34 AM 43. The firm's target capital structure should do which of the following? a. Maximize the earnings per share (EPS). b. Minimize the cost of debt (rd). c. Obtain the highest possible bond rating. d. Minimize the cost of equity (rs). e. Minimize the weighted average cost of capital (WACC). ANSWER: e POINTS: 1 DIFFICULTY: EASY/MODERATE REFERENCES: 14-3 Determining the Optimal Capital Structure QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.13.03 - Determining the Optimal Capital Structure NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure Copyright Cengage Learning. Powered by Cognero.
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44. Which of the following statements is CORRECT? a. A firm's business risk is determined solely by the financial characteristics of its industry. b. The factors that affect a firm's business risk include industry characteristics and economic conditions, both of which are generally beyond the firm's control. c. One of the benefits to a firm of being at or near its target capital structure is that this generally minimizes the risk of bankruptcy. d. A firm's financial risk can be minimized by diversification. e. The amount of debt in its capital structure can under no circumstances affect a company's EBIT and business risk. ANSWER: b POINTS: 1 DIFFICULTY: EASY/MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.13.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Capital structure concepts KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:07 PM DATE MODIFIED: 9/26/2017 11:34 AM 45. Which of the following statements is CORRECT? As a firm increases the operating leverage used to produce a given quantity of output, this a. normally leads to an increase in its fixed assets turnover ratio. b. normally leads to a decrease in its business risk. c. normally leads to a decrease in the standard deviation of its expected EBIT. d. normally leads to a decrease in the variability of its expected EPS. e. normally leads to a reduction in its fixed assets turnover ratio. ANSWER: e RATIONALE: More operating leverage generally means a greater use of automation, which means more fixed assets. If fixed assets increase proportionately more than sales, then the fixed assets turnover (S/FA) will decline. POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 14-2 Business and Financial Risk QUESTION TYPE: Multiple Choice Copyright Cengage Learning. Powered by Cognero.
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HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.13.02 - Business and Financial Risk NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Operating leverage KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:07 PM DATE MODIFIED: 9/26/2017 11:34 AM 46. A firm's CFO is considering increasing the target debt ratio, which would also increase the company's interest expense. New bonds would be issued and the proceeds would be used to buy back shares of common stock. Neither total assets nor operating income would change, but expected earnings per share (EPS) would increase. Assuming the CFO's estimates are correct, which of the following statements is CORRECT? a. Since the proposed plan increases the firm's financial risk, the stock price might fall even if EPS increases. b. If the plan reduces the WACC, the stock price is likely to decline. c. Since the plan is expected to increase EPS, this implies that net income is also expected to increase. d. If the plan does increase the EPS, the stock price will automatically increase at the same rate. e. Under the plan there will be more bonds outstanding, and that will increase their liquidity and thus lower the interest rate on the currently outstanding bonds. ANSWER: a POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 14-2 Business and Financial Risk QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.13.02 - Business and Financial Risk NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Financial leverage and EPS KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:07 PM DATE MODIFIED: 9/26/2017 11:34 AM 47. Which of the following statements is CORRECT? a. Increasing its use of financial leverage is one way to increase a firm's return on investors’ capital (ROIC). b. If a firm lowered its fixed costs but increased its variable costs by just enough to hold total costs at the present level of sales constant, this would increase its operating leverage. c. The debt ratio that maximizes expected EPS generally exceeds the debt ratio that maximizes share price. d. If a company were to issue debt and use the money to repurchase common stock, this would reduce its return on investors’ capital (ROIC). (Assume that the repurchase has no impact on the company's operating income.) e. If a change in the bankruptcy code made bankruptcy less costly to corporations, this would tend to reduce corporations' debt ratios. Copyright Cengage Learning. Powered by Cognero.
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ANSWER: c POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 14-2 Business and Financial Risk QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.13.02 - Business and Financial Risk NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Financial leverage and EPS KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:07 PM DATE MODIFIED: 9/26/2017 11:34 AM 48. Your firm has $500 million of investor-supplied capital, its return on investors’ capital (ROIC) is 15%, and it currently has no debt in its capital structure (i.e., wd = 0). The CFO is contemplating a recapitalization where it would issue debt at an after-tax cost of 10% and use the proceeds to buy back some of its common stock, such that the percentage of common equity in the capital structure (wc) is 1 - wd. If the company goes ahead with the recapitalization, its operating income, the size of the firm (i.e., total assets), total investor-supplied capital, and tax rate would remain unchanged. Which of the following is most likely to occur as a result of the recapitalization? a. The ROA would increase. b. The ROA would remain unchanged. c. The return on investors’ capital would decline. d. The return on investors’ capital would increase. e. The ROE would increase. ANSWER: e POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 14-2 Business and Financial Risk QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.13.02 - Business and Financial Risk NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Financial leverage and ratios KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:07 PM DATE MODIFIED: 9/26/2017 11:34 AM 49. Companies HD and LD have identical tax rates, total assets, total investor-supplied capital, and returns on investors’ capital (ROIC), and their ROICs exceed their after-tax costs of debt, rd(1 – T). However, Company HD has a higher debt ratio and thus more interest expense than Company LD. Which of the following statements is CORRECT? Copyright Cengage Learning. Powered by Cognero.
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a. Company HD has a higher net income than Company LD. b. Company HD has a lower ROA than Company LD. c. Company HD has a lower ROE than Company LD. d. The two companies have the same ROA. e. The two companies have the same ROE. ANSWER: b POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 14-2 Business and Financial Risk QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.13.02 - Business and Financial Risk NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Financial leverage and ratios KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:07 PM DATE MODIFIED: 9/26/2017 11:34 AM 50. Firms U and L each have the same amount of assets, investor-supplied capital, and both have a return on investors’ capital (ROIC) of 12%. Firm U is unleveraged, i.e., it is 100% equity financed, while Firm L is financed with 50% debt and 50% equity. Firm L's debt has an after-tax cost of 8%. Both firms have positive net income and a 35% tax rate. Which of the following statements is CORRECT? a. The two companies have the same times interest earned (TIE) ratio. b. Firm L has a lower ROA than Firm U. c. Firm L has a lower ROE than Firm U. d. Firm L has the higher times interest earned (TIE) ratio. e. Firm L has a higher EBIT than Firm U. ANSWER: b POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 14-2 Business and Financial Risk QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.13.02 - Business and Financial Risk NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Financial leverage and ratios KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:07 PM DATE MODIFIED: 9/26/2017 11:34 AM Copyright Cengage Learning. Powered by Cognero.
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51. Your firm is currently 100% equity financed. The CFO is considering a recapitalization plan under which the firm would issue long-term debt with an after-tax yield of 9% and use the proceeds to repurchase some of its common stock. The recapitalization would not change the company's total investor-supplied capital, the size of the firm (i.e., total assets), and it would not affect the firm's return on investors’ capital (ROIC), which is 15%. The CFO believes that this recapitalization would reduce the firm's WACC and increase its stock price. Which of the following would be likely to occur if the company goes ahead with the recapitalization plan? a. The company's net income would increase. b. The company's earnings per share would decline. c. The company's cost of equity would increase. d. The company's ROA would increase. e. The company's ROE would decline. ANSWER: c POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 14-3 Determining the Optimal Capital Structure QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.13.03 - Determining the Optimal Capital Structure NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Leverage and capital structure KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:07 PM DATE MODIFIED: 9/26/2017 11:34 AM 52. A major contribution of the Miller model is that it demonstrates, other things held constant, that a. personal taxes increase the value of using corporate debt. b. personal taxes lower the value of using corporate debt. c. personal taxes have no effect on the value of using corporate debt. d. financial distress and agency costs reduce the value of using corporate debt. e. debt costs increase with financial leverage. ANSWER: b POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 14-4 Capital Structure Theory QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.13.04 - Capital Structure Theory NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Miller model KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual Copyright Cengage Learning. Powered by Cognero.
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53. Which of the following statements is CORRECT, holding other things constant? a. Firms whose assets are relatively liquid tend to have relatively low bankruptcy costs, hence they tend to use relatively little debt. b. An increase in the personal tax rate is likely to increase the debt ratio of the average corporation. c. If changes in the bankruptcy code make bankruptcy less costly to corporations, then this would likely lead to lower debt ratios for corporations. d. An increase in the company's degree of operating leverage would tend to encourage the firm to use more debt in its capital structure so as to keep its total risk unchanged. e. An increase in the corporate tax rate would in theory encourage companies to use more debt in their capital structures. ANSWER: e POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 14-5 Checklist for Capital Structure Decisions QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.13.05 - Checklist for Capital Structure Decisions NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Leverage and capital structure KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:07 PM DATE MODIFIED: 9/26/2017 11:34 AM 54. Other things held constant, which of the following events would be most likely to encourage a firm to increase the amount of debt in its capital structure? a. Its sales are projected to become less stable in the future. b. The bankruptcy laws are changed in a way that would make bankruptcy more costly to the firm and its stockholders. c. Management believes that the firm's stock is currently overvalued. d. The firm decides to automate its factory with specialized equipment and thus increase its use of operating leverage. e. The corporate tax rate is increased. ANSWER: e POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 14-5 Checklist for Capital Structure Decisions QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.13.05 - Checklist for Capital Structure Decisions NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic Copyright Cengage Learning. Powered by Cognero.
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STATE STANDARDS: LOCAL STANDARDS: TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
United States - OH - DISC.FOFM.BRIG.17.10 - Capital structure United States - OH - Default City - Tier 2: - Capital structure Leverage and capital structure Bloom's: Comprehension Multiple Choice: Conceptual 9/21/2017 6:07 PM 9/26/2017 11:34 AM
55. Which of the following statements is CORRECT? a. A firm can use retained earnings without paying a flotation cost. Therefore, while the cost of retained earnings is not zero, its cost is generally lower than the after-tax cost of debt. b. The capital structure that minimizes a firm's weighted average cost of capital is also the capital structure that maximizes its stock price. c. The capital structure that minimizes the firm's weighted average cost of capital is also the capital structure that maximizes its earnings per share. d. If a firm finds that the cost of debt is less than the cost of equity, increasing its debt ratio must reduce its WACC. e. Other things held constant, if corporate tax rates declined, then the Modigliani-Miller tax-adjusted theory would suggest that firms should increase their use of debt. ANSWER: b POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.13.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Capital structure concepts KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:07 PM DATE MODIFIED: 9/26/2017 11:34 AM 56. Which of the following statements is CORRECT? a. The capital structure that maximizes the stock price is also the capital structure that minimizes the cost of equity from retained earnings (rS). b. The capital structure that maximizes the stock price is also the capital structure that maximizes earnings per share. c. The capital structure that maximizes the stock price is also the capital structure that maximizes the firm's times interest earned (TIE) ratio. d. If a company increases its debt ratio, this will typically increase the marginal costs of both debt and equity, but it still may reduce the company's WACC. e. If Congress were to pass legislation that increases the personal tax rate but decreases the corporate tax rate, this would encourage companies to increase their debt ratios. ANSWER: d Copyright Cengage Learning. Powered by Cognero.
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POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.13.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Capital structure concepts KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:07 PM DATE MODIFIED: 9/26/2017 11:34 AM 57. Which of the following statements is CORRECT? a. In general, a firm with low operating leverage also has a small proportion of its total costs in the form of fixed costs. b. There is no reason to think that changes in the personal tax rate would affect firms' capital structure decisions. c. A firm with a relatively high business risk is more likely to increase its use of financial leverage than a firm with low business risk, assuming all else equal. d. If a firm's after-tax cost of equity exceeds its after-tax cost of debt, it can always reduce its WACC by increasing its use of debt. e. Suppose a firm has less than its optimal amount of debt. Increasing its use of debt to the point where it is at its optimal capital structure will decrease the costs of both debt and equity. ANSWER: a POINTS: 1 DIFFICULTY: MODERATE/CHALLENGING REFERENCES: 14-2 Business and Financial Risk QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.13.02 - Business and Financial Risk NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Capital structure concepts KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:07 PM DATE MODIFIED: 9/26/2017 11:34 AM 58. Companies HD and LD have identical amounts of assets, investor-supplied capital, operating income (EBIT), tax rates, and business risk. Company HD, however, has a higher debt ratio than LD. Company HD's return on investors’ capital (ROIC) exceeds its after-tax cost of debt, rd(1 – T). Which of the following statements is CORRECT? a. Company HD has a higher return on assets (ROA) than Company LD. b. Company HD has a higher times interest earned (TIE) ratio than Company LD. Copyright Cengage Learning. Powered by Cognero.
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c. Company HD has a higher return on equity (ROE) than Company LD, and its risk as measured by the standard deviation of ROE is also higher than LD's. d. The two companies have the same ROE. e. Company HD's ROE would be higher if it had no debt. ANSWER: c POINTS: 1 DIFFICULTY: MODERATE/CHALLENGING REFERENCES: 14-2 Business and Financial Risk QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.13.02 - Business and Financial Risk NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Financial leverage and ratios KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:07 PM DATE MODIFIED: 9/26/2017 11:34 AM 59. Companies HD and LD have the same total assets, total investor-supplied capital, operating income (EBIT), tax rate, and business risk. Company HD, however, has a much higher debt ratio than LD. Also, both companies' returns on investors’ capital (ROIC) exceed their after-tax costs of debt, rd(1 – T). Which of the following statements is CORRECT? a. HD should have a higher return on assets (ROA) than LD. b. HD should have a higher times interest earned (TIE) ratio than LD. c. HD should have a higher return on equity (ROE) than LD, but its risk, as measured by the standard deviation of ROE, should also be higher than LD's. d. Given that ROIC > rd(1 – T), HD's stock price must exceed that of LD. e. Given that ROIC > rd(1 – T), LD's stock price must exceed that of HD. ANSWER: c POINTS: 1 DIFFICULTY: MODERATE/CHALLENGING REFERENCES: 14-2 Business and Financial Risk QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.13.02 - Business and Financial Risk NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Financial leverage and ratios KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:07 PM DATE MODIFIED: 9/26/2017 11:34 AM Copyright Cengage Learning. Powered by Cognero.
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60. Which of the following statements is CORRECT? a. If Congress lowered corporate tax rates while other things were held constant, and if the Modigliani-Miller tax-adjusted theory of capital structure were correct, this would tend to cause corporations to decrease their use of debt. b. A change in the personal tax rate should not affect firms' capital structure decisions. c. "Business risk" is differentiated from "financial risk" by the fact that financial risk reflects only the use of debt, while business risk reflects both the use of debt and such factors as sales variability, cost variability, and operating leverage. d. The optimal capital structure is the one that simultaneously (1) maximizes the price of the firm's stock, (2) minimizes its WACC, and (3) maximizes its EPS. e. If changes in the bankruptcy code made bankruptcy less costly to corporations, this would likely reduce the average corporation's debt ratio. ANSWER: a POINTS: 1 DIFFICULTY: MODERATE/CHALLENGING REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.13.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Capital structure concepts KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:07 PM DATE MODIFIED: 9/26/2017 11:34 AM 61. Which of the following statements is CORRECT? a. When a company increases its debt ratio, the costs of equity and debt both increase. Therefore, the WACC must also increase. b. The capital structure that maximizes the stock price is generally the capital structure that also maximizes earnings per share. c. All else equal, an increase in the corporate tax rate would tend to encourage companies to increase their debt ratios. d. Since debt financing raises the firm's financial risk, increasing a company's debt ratio will always increase its WACC. e. Since the cost of debt is generally fixed, increasing the debt ratio tends to stabilize net income. ANSWER: c POINTS: 1 DIFFICULTY: MODERATE/CHALLENGING REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.13.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.10 - Capital structure Copyright Cengage Learning. Powered by Cognero.
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LOCAL STANDARDS: TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
United States - OH - Default City - Tier 2: - Capital structure Leverage and capital structure Bloom's: Comprehension Multiple Choice: Conceptual 9/21/2017 6:07 PM 9/26/2017 11:34 AM
62. Which of the following statements is CORRECT? a. Generally, debt ratios do not vary much among different industries, although they do vary among firms within a given industry. b. Electric utilities generally have very high common equity ratios because their revenues are more volatile than those of firms in most other industries. c. Airline companies tend to have very volatile earnings, and as a result they generally have high target debt-toequity ratios. d. Wide variations in capital structures exist both between industries and among individual firms within given industries. These differences are caused by differing business risks and also managerial attitudes. e. Since most stocks sell at or very close to their book values, book value capital structures are typically adequate for use in estimating firms' weighted average costs of capital. ANSWER: d POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 14-6 Variations in Capital Structures QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.13.06 - Variations in Capital Structures NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Variations in capital structures KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:07 PM DATE MODIFIED: 9/26/2017 11:34 AM 63. Longstreet Inc. has fixed operating costs of $300,000, variable costs of $2.50 per unit produced, and its product sells for $3.70 per unit. What is the company's break-even point, i.e., at what unit sales volume would income equal costs? a. 250,000 b. 232,500 c. 222,500 d. 220,000 e. 255,000 ANSWER: a RATIONALE:
Fixed operating costs (F) Variable costs per unit (V) Sales price per unit (P)
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$300,000 $2.50 $3.70
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QBE = F / (P - V) = 250,000
POINTS: 1 DIFFICULTY: EASY REFERENCES: 14-2 Business and Financial Risk QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.13.02 - Business and Financial Risk NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Break-even analysis KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:07 PM DATE MODIFIED: 9/26/2017 11:34 AM 64. Your uncle is considering investing in a new company that will produce high quality stereo speakers. The sales price would be set at 1.70 times the variable cost per unit; the variable cost per unit is estimated to be $75.00; and fixed costs are estimated at $1,170,000. What sales volume would be required to break even, i.e., to have EBIT = zero? a. 23,400 b. 25,851 c. 18,051 d. 17,160 e. 22,286 ANSWER: e RATIONALE:
Variable costs per unit (V) Price multiple over VC Sales price per unit (P) Fixed costs (F)
$75.00 1.70 $127.50 $1,170,000
QBE = F / (P - V) = 22,286
POINTS: 1 DIFFICULTY: EASY REFERENCES: 14-2 Business and Financial Risk QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.13.02 - Business and Financial Risk NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Break-even analysis KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:07 PM Copyright Cengage Learning. Powered by Cognero.
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65. Southwest U's campus book store sells course packs for $18 each, the variable cost per pack is $8, fixed costs to produce the packs are $200,000, and expected annual sales are 51,000 packs. What are the pre-tax profits from sales of course packs? a. $285,200 b. $310,000 c. $306,900 d. $248,000 e. $372,000 ANSWER: b RATIONALE:
Sales price per unit (P) Variable costs per unit (V) Annual sales (Q) Fixed costs (F)
$18.00 $8.00 51,000 $200,000
Profit = PQ – VQ – F = EBIT = $918,000 - $408,000 - $200,000 = $310,000
POINTS: 1 DIFFICULTY: EASY REFERENCES: 14-2 Business and Financial Risk QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.13.02 - Business and Financial Risk NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Break-even analysis KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:07 PM DATE MODIFIED: 9/26/2017 11:34 AM 66. Southwest U's campus book store sells course packs for $19 each. The variable cost per pack is $12, and at current annual sales of 43,000 packs, the store earns $75,000 before taxes on course packs. How much are the fixed costs of producing the course packs? a. $203,400 b. $277,980 c. $253,120 d. $226,000 e. $221,480 ANSWER: d RATIONALE:
Sales price per unit (P) Variable costs per unit (V) Annual sales (Q) Profit = PQ – VQ – F
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$19.00 $12.00 43,000 $75,000
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F = PQ – VQ – EBIT = $817,000 - $516,000 - $75,000 = $226,000
POINTS: 1 DIFFICULTY: EASY REFERENCES: 14-2 Business and Financial Risk QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.13.02 - Business and Financial Risk NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Breakeven: FC KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:07 PM DATE MODIFIED: 9/26/2017 11:34 AM 67. Assume that you and your brother plan to open a business that will make and sell a newly designed type of sandal. Two robotic machines are available to make the sandals, Machine A and Machine B. The price per pair will be $30.00 regardless of which machine is used. The fixed and variable costs associated with the two machines are shown below. What is the difference between the break-even points for Machines A and B? Do not round your intermediate calculations. (Hint: Find BEB - BEA) Price per pair (P) Fixed costs (F) Variable cost/unit (V) a. 3,035 b. 2,235 c. 2,069 d. 2,621 e. 2,759 ANSWER: RATIONALE:
Machine A Machine B $30.00 $30.00 $25,000 $100,000 $7.00 $4.00
e
Sales price per pair (P) Fixed costs (F) Variable costs per unit (V) QBE = F / (P – V)
Machine A $30.00 $25,000 $7.00 1,087
Machine B $30.00 $100,000 $4.00 3,846
Difference = BEB – BEA = 2,759
POINTS: 1 DIFFICULTY: EASY REFERENCES: 14-2 Business and Financial Risk QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.13.02 - Business and Financial Risk Copyright Cengage Learning. Powered by Cognero.
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NATIONAL STANDARDS: STATE STANDARDS: LOCAL STANDARDS: TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic United States - OH - DISC.FOFM.BRIG.17.10 - Capital structure United States - OH - Default City - Tier 2: - Capital structure Breakeven: operating plans Bloom's: Evaluation Multiple Choice: Problem 9/21/2017 6:07 PM 9/26/2017 11:34 AM
68. Your company plans to produce a new product, a wireless computer mouse. Two machines can be used to make the mouse, Machines A and B. The price per mouse will be $25.00 regardless of which machine is used. The fixed and variable costs associated with the two machines are shown below. At the expected sales level of 30,000 units, how much higher or lower will the firm's expected EBIT be if it uses Machine B with high fixed costs rather than Machine A with low fixed costs, i.e., what is EBITB - EBITA ? Machine A Machine B $25.00 $25.00 $100,000 $400,000 $17.00 $11.00 30,000 30,000
Price per mouse (P) Fixed costs (F) Variable cost/unit (V) Exp. unit sales (Q) a. -$102,000 b. -$129,600 c. -$93,600 d. -$118,800 e. -$120,000 ANSWER: RATIONALE:
e
Sale price per mouse (P) Fixed costs (F) Variable costs per unit (V) Expected unit sales (Q) Expected EBIT = (P – V)Q – F
Machine A Machine B $25.00 $25.00 $100,000 $400,000 $17.00 $11.00 30,000 30,000 $140,000 $20,000
Difference = EBITB – EBITA = -$120,000
POINTS: 1 DIFFICULTY: EASY REFERENCES: 14-2 Business and Financial Risk QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.13.02 - Business and Financial Risk NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Breakeven: operating plans KEYWORDS: Bloom's: Evaluation Copyright Cengage Learning. Powered by Cognero.
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OTHER: DATE CREATED: DATE MODIFIED:
Multiple Choice: Problem 9/21/2017 6:07 PM 9/26/2017 11:34 AM
69. Your company, which is financed entirely with common equity, plans to manufacture a new product, a cell phone that can be worn like a wristwatch. Two robotic machines are available to make the phone, Machine A and Machine B. The price per phone will be $260.00 regardless of which machine is used to make it. The fixed and variable costs associated with the two machines are shown below, along with the capital (all equity) that must be invested to purchase each machine. The expected sales level is 27,000 units. Your company has tax loss carry-forwards that will cause its tax rate to be zero for the life of the project, so T = 0. How much higher or lower will the project's ROE be if you select the machine that produces the higher ROE, i.e., what is ROEB - ROEA? (Hint: Since the firm uses no debt and its tax rate is zero, ROE = EBIT/Required investment.) Machine A
Machine B $260.00 $260.00 $1,000,000 $2,000,000 $210.00 $160.00 27,000 27,000 $2,500,000 $3,000,000
Price per phone (P) Fixed costs (F) Variable cost/unit (V) Expected unit sales (Q) Required equity investment a. 11.20% b. 8.87% c. 7.84% d. 7.75% e. 9.33% ANSWER: RATIONALE:
e
Sales price per phone (P) Fixed costs (F) Variable costs per unit (V) Expected unit sales (Q) Required equity investment Exp. profit = EBIT = (P – V)Q – F Return on investment = ROE
Machine A Machine B $260.00 $260.00 $1,000,000 $2,000,000 $210.00 $160.00 27,000 27,000 $2,500,000 $3,000,000 $350,000 $700,000 14.00% 23.33%
Difference = ROEB – ROEA = 9.33%
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 14-2 Business and Financial Risk QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.13.02 - Business and Financial Risk NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: ROEs and operating plans KEYWORDS: Bloom's: Evaluation Copyright Cengage Learning. Powered by Cognero.
Page 810
OTHER: DATE CREATED: DATE MODIFIED:
Multiple Choice: Problem 9/21/2017 6:07 PM 9/26/2017 11:34 AM
70. You work for the CEO of a new company that plans to manufacture and sell a new product, a watch that has an embedded TV set and a magnifying glass crystal. The issue now is how to finance the company, with only equity or with a mix of debt and equity. Expected operating income is $510,000. Other data for the firm are shown below. How much higher or lower will the firm's expected ROE be if it uses some debt rather than all equity, i.e., what is ROEL - ROEU? Do not round your intermediate calculations.
Oper. income (EBIT) Required investment % Debt $ of Debt $ of Common equity Interest rate Tax rate a. 10.65% b. 10.14% c. 8.11% d. 12.68% e. 7.10% ANSWER: RATIONALE:
0% Debt, U $510,000 $2,500,000 0.0% $0.00 $2,500,000 NA 35%
60% Debt, L $510,000 $2,500,000 60.0% $1,500,000 $1,000,000 10.00% 35%
b
0% Debt, U Required investment $2,500,000 % Debt 0.00% $ of Debt $0 $ of Common equity $2,500,000 Interest rate NA Tax rate 35.00% Operating income (EBIT) $510,000 Interest 0 Taxable income $510,000 Taxes 178,500 Net income ROE
$331,500 13.26%
60% Debt, L $2,500,000 60.00% $1,500,000 $1,000,000 10.00% 35.00% $510,000 150,000 $360,000 126,000 $234,000 23.40%
Difference in ROEs = 10.14%
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 14-2 Business and Financial Risk QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.13.02 - Business and Financial Risk NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic Copyright Cengage Learning. Powered by Cognero.
Page 811
STATE STANDARDS: LOCAL STANDARDS: TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
United States - OH - DISC.FOFM.BRIG.17.10 - Capital structure United States - OH - Default City - Tier 2: - Capital structure ROEs and financing plans Bloom's: Evaluation Multiple Choice: Problem 9/21/2017 6:07 PM 9/26/2017 11:34 AM
71. You work for the CEO of a new company that plans to manufacture and sell a new type of laptop computer. The issue now is how to finance the company, with only equity or with a mix of debt and equity. Expected operating income is $690,000. Other data for the firm are shown below. How much higher or lower will the firm's expected EPS be if it uses some debt rather than only equity, i.e., what is EPSL - EPSU?
Oper. income (EBIT) Required investment % Debt $ of Debt $ of Common equity Shares issued, $10/share Interest rate Tax rate a. $1.29 b. $1.97 c. $2.23 d. $1.72 e. $1.63 ANSWER: RATIONALE:
0% Debt, U $690,000 $2,500,000 0.0% $0.00 $2,500,000 250,000 NA 35%
60% Debt, L $690,000 $2,500,000 60.0% $1,500,000 $1,000,000 100,000 10.00% 35%
d
Required investment % Debt $ of Debt $ of Common equity Shares issued at $10/share Interest rate Tax rate Operating income (EBIT) Interest Taxable income Taxes Net income Earnings per share (EPS)
0% Debt, U $2,500,000 0.00% $0 $2,500,000 250,000 NA 35.00% $690,000 0 $690,000 241,500 $448,500 $1.79
60% Debt, L $2,500,000 60.00% $1,500,000 $1,000,000 100,000 10.00% 35.00% $690,000 150,000 $540,000 189,000 $351,000 $3.51
Difference in EPS = $01.72
POINTS: DIFFICULTY:
1 MODERATE
Copyright Cengage Learning. Powered by Cognero.
Page 812
REFERENCES: 14-2 Business and Financial Risk QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.13.02 - Business and Financial Risk NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: EPS and financing plans KEYWORDS: Bloom's: Evaluation OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:07 PM DATE MODIFIED: 9/26/2017 11:34 AM 72. Confu Inc. expects to have the following data during the coming year. What is the firm's expected ROE? Capital Debt/Capital, book value EBIT a. 10.51% b. 14.52% c. 14.39% d. 12.51% e. 12.39% ANSWER: RATIONALE:
$200,000 65% $25,000
Interest rate Tax rate
8% 40%
d
Capital Debt/Capital EBIT Interest rate Tax rate Debt = (Debt/Capital) × Capital
$200,000 65% $25,000 8% 40%
EBIT - Interest = rate × debt = Earnings before taxes - Taxes Net income
$25,000 10,400 $14,600 5,840 $8,760
$130,000
NI / Equity = ROE =
12.51%
Equity = Assets – Debt
$70,000
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 14-2 Business and Financial Risk QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.13.02 - Business and Financial Risk NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Debt and ROE KEYWORDS: Bloom's: Analysis Copyright Cengage Learning. Powered by Cognero.
Page 813
OTHER: DATE CREATED: DATE MODIFIED:
Multiple Choice: Problem 9/21/2017 6:07 PM 9/26/2017 11:34 AM
73. Senate Inc. is considering two alternative methods for producing playing cards. Method 1 involves using a machine with a fixed cost (mainly depreciation) of $17,000 and variable costs of $1.00 per deck of cards. Method 2 would use a less expensive machine with a fixed cost of only $5,000, but it would require a variable cost of $1.50 per deck. The sales price per deck would be the same under each method. At what unit output level would the two methods provide the same operating income (EBIT)? a. 24,960 b. 28,080 c. 24,000 d. 26,880 e. 28,320 ANSWER: c RATIONALE:
Price/unit (P) V F
Method 1 Method 2 $2.00 $2.00 $1.00 $1.50 $17,000 $5,000
EBIT = PQ – VQ – F Insert data for Methods 1 and 2, then set the 2 equations equal to one another, and then solve for Q. EBIT1 = PQ – Q(V1) – F1 EBIT2 = PQ – Q(V2) – F2 The PQs cancel, divide by -1, and we are left with: Q(V1) + F1 = Q(V2) + F2. This reduces to: Q(V2 – V1) = F1 – F2 Q = (F1 – F2)/(V2 – V1) = 24,000
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 14-2 Business and Financial Risk QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.13.02 - Business and Financial Risk NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Operating income KEYWORDS: Bloom's: Evaluation OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:07 PM DATE MODIFIED: 9/26/2017 11:34 AM 74. A group of venture investors is considering putting money into Lemma Books, which wants to produce a new reader for electronic books. The variable cost per unit is estimated at $250, the sales price would be set at twice the VC/unit, or $500, and fixed costs are estimated at $350,000. The investors will put up the funds if the project is likely to have an operating income of $500,000 or more. What sales volume would be required in order to meet the minimum profit goal? (Hint: Use the break-even formula, but include the required profit in the numerator.) Copyright Cengage Learning. Powered by Cognero.
Page 814
a. 3,706 b. 3,400 c. 2,958 d. 3,094 e. 4,216 ANSWER: RATIONALE:
b
Variable costs per unit (V) Sale price per unit (P) Fixed costs (F) Required minimum profit
$250 $500 $350,000 $500,000
Volume (units) required to meet profit goal = (F + Profit) / (P - V) =
3,400
Check: Op profit = (P - V) × Units - F = $500,000
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 14-2 Business and Financial Risk QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.13.02 - Business and Financial Risk NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Required unit sales KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:07 PM DATE MODIFIED: 9/26/2017 11:34 AM 75. El Capitan Foods has a capital structure of 36% debt and 64% equity, its tax rate is 35%, and its beta (leveraged) is 1.40. Based on the Hamada equation, what would the firm's beta be if it used no debt, i.e., what is its unlevered beta, bU? a. 1.03 b. 1.29 c. 0.80 d. 0.88 e. 1.15 ANSWER: a RATIONALE:
bL wd Tax rate D/E = wd / (1 – wd) bU = bL / (1 + (D/E) × (1 - T)) = Copyright Cengage Learning. Powered by Cognero.
1.40 0.36 35% 0.56 1.03
Page 815
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 14-3 Determining the Optimal Capital Structure QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.13.03 - Determining the Optimal Capital Structure NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Calculating unlevered beta KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:07 PM DATE MODIFIED: 9/26/2017 11:34 AM 76. Gator Fabrics Inc. currently has zero debt (i.e., wd = 0). It is a zero growth company, and additional firm data are shown below. Now the company is considering using some debt, moving to the new capital structure indicated below. The money raised would be used to repurchase stock at the current price. It is estimated that the increase in risk resulting from the additional leverage would cause the required rate of return on equity to rise somewhat, as indicated below. If this plan were carried out, by how much would the WACC change, i.e., what is WACCOld - WACCNew? Do not round your intermediate calculations. 40% 60% 6.0%
wd wc Interest rate new = rd a. 2.29% b. 1.96% c. 2.04% d. 1.65% e. 2.16% ANSWER: RATIONALE:
10.0% 11.0% 40%
Orig cost of equity, rs New cost of equity = rs Tax rate
b
wd wc Tax rate
40% 60% 40%
Interest rate = rd New cost of equity = rs Old cost of equity
6.0% 11.0% 10.0%
WACCOLD = wd(1 - T)rd + wcrs = 0.00% + 10.00% = 10.00% WACCNEW= wd(1 - T)rd + wcrs = 1.44% + 6.60% = 8.04% Change in WACC = WACC old – WACC new = 1.96%
POINTS: DIFFICULTY: REFERENCES: QUESTION TYPE: HAS VARIABLES:
1 MODERATE 14-3 Determining the Optimal Capital Structure Multiple Choice True
Copyright Cengage Learning. Powered by Cognero.
Page 816
LEARNING OBJECTIVES: FOFM.BRIG.17.13.03 - Determining the Optimal Capital Structure NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: WACC and recapitalization KEYWORDS: Bloom's: Evaluation OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:07 PM DATE MODIFIED: 9/26/2017 11:34 AM 77. As a consultant to First Responder Inc., you have obtained the following data (dollars in millions). The company plans to pay out all of its earnings as dividends, hence g = 0. Also, no net new investment in operating capital is needed because growth is zero. The CFO believes that a move from zero debt to 80.0% debt would cause the cost of equity to increase from 10.0% to 12.0%, and the interest rate on the new debt would be 9.0%. What would the firm's total market value be if it makes this change? Hints: Find the FCF, which is equal to NOPAT = EBIT(1 - T) because no new operating capital is needed, and then divide by (WACC - g). Do not round your intermediate calculations. Oper. income (EBIT) New cost of equity (rs) Interest rate (rd) a. $7,143 b. $8,000 c. $7,357 d. $5,357 e. $5,929 ANSWER: RATIONALE:
$800 12.00% 9.00%
Tax rate New wd
40.0% 80.0%
a
Operating income (EBIT) New cost of equity (rs) Interest rate (rd) New WACC
$800 12.00% 9.00%
Tax rate New wd
40.0% 80.0%
= wd × rd (1 - T) + wc × rs = 4.32% + 2.40% = 6.72%
FCF = EBIT (1 - T) because there is no investment in new operating capital. FCF = EBIT (1 - T) = $800 × 0.6 = $480.0 Firm value = FCF/(WACC – g) = $480.0 / 6.72% = $7,143 (rounded) POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.13.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure Copyright Cengage Learning. Powered by Cognero.
Page 817
TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
Capital structure & firm value Bloom's: Analysis Multiple Choice: Problem 9/21/2017 6:07 PM 9/26/2017 11:34 AM
78. You plan to invest in one of two home delivery pizza companies, High and Low, that were recently founded and are about to commence operations. They are identical except for their use of debt (wd) and the interest rates on their debt-High uses more debt and thus must pay a higher interest rate. Based on the data given below, how much higher or lower will High's expected EPS be versus that of Low, i.e., what is EPSHigh – EPSLow? Do not round your intermediate calculations. Applicable to Both Firms Capital $3,000,000 EBIT $565,000 Tax rate 35% a. $01.16 b. $00.67 c. $01.07 d. $00.80 e. $00.89 ANSWER: RATIONALE:
Firm High's Data wd Shares Int. rate
70% 90,000 12%
Firm Low's Data 20% wd Shares 240,000 Int. rate 10%
e
Applicable to Both Firms Capital $3,000,000 EBIT $565,000 Tax rate 35%
EBIT Interest = I = Debt × rate Taxable income = EBIT - I Taxes NI EPS = NI / Shares outstanding
Firm High's Data 70% wd Shares 90,000 Int. rate 12% Debt $2,100,000
Firm Low's Data 20% wd Shares 240,000 Int. rate 10% Debt $600,000
$565,000
$565,000
252,000
60,000
$313,000
$505,000
109,550 $203,450
176,750 $328,250
$2.26
$1.37
Difference in EPS = $00.89
POINTS: 1 DIFFICULTY: MODERATE/CHALLENGING REFERENCES: 14-3 Determining the Optimal Capital Structure QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.13.03 - Determining the Optimal Capital Structure NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic Copyright Cengage Learning. Powered by Cognero.
Page 818
STATE STANDARDS: LOCAL STANDARDS: TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
United States - OH - DISC.FOFM.BRIG.17.10 - Capital structure United States - OH - Default City - Tier 2: - Capital structure EPS and capital structure Bloom's: Evaluation Multiple Choice: Problem 9/21/2017 6:07 PM 9/26/2017 11:34 AM
79. Firms HD and LD are identical except for their use of debt and the interest rates they pay--HD has more debt and thus must pay a higher interest rate. Based on the data given below, how much higher or lower will HD's ROE be versus that of LD, i.e., what is ROEHD - ROELD? Do not round your intermediate calculations. Applicable to Both Firms Capital $3,000,000 wd EBIT $595,000 Int. rate Tax rate 35% a. 11.31% b. 13.37% c. 8.74% d. 10.28% e. 10.80% ANSWER: RATIONALE:
Firm HD's Data Firm LD's Data 70% wd 12% Int. rate
20% 10%
d
Applicable to Both Firms Capital $3,000,000 EBIT $595,000 Tax rate 35% EBIT Interest = I = Debt × rate Taxable income = EBIT – I Taxes NI = (Taxable Income)(1 – T) Equity = (1 – wd)(Capital) ROE = NI / Equity
Firm HD's Data wd Int. rate Debt
70% 12% $2,100,000 $595,000 252,000 $343,000 120,050 $222,950 $900,000 24.77%
Firm LD's Data 20 wd Int. rate 10 Debt $600,00
$595,0 60,0 $535,0 187,2 $347,7 $2,400,0 14.49
Difference in ROEs = 10.28%
POINTS: 1 DIFFICULTY: MODERATE/CHALLENGING REFERENCES: 14-3 Determining the Optimal Capital Structure QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVE FOFM.BRIG.17.13.03 - Determining the Optimal Capital Structure S: NATIONAL STANDARD United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic S: STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.10 - Capital structure Copyright Cengage Learning. Powered by Cognero.
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LOCAL STANDARDS: TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
United States - OH - Default City - Tier 2: - Capital structure ROE and capital structure Bloom's: Evaluation Multiple Choice: Problem 9/21/2017 6:07 PM 9/26/2017 11:34 AM
80. Firm A is very aggressive in its use of debt to leverage up its earnings for common stockholders, whereas Firm NA is not aggressive and uses no debt. The two firms' operations are identical--they have the same total investor-supplied capital, sales, operating costs, and EBIT. Thus, they differ only in their use of financial leverage (wd). Based on the following data, how much higher or lower is A's ROE than that of NA, i.e., what is ROEA - ROENA? Do not round your intermediate calculations. Applicable to Both Firms Capital $210,000 EBIT $40,000 Tax rate 35% a. 4.90% b. 3.71% c. 4.58% d. 5.54% e. 3.76% ANSWER: RATIONALE:
Firm A's Data wd Int. rate
Firm NA's Data 50% 12%
0% 10%
wd Int. rate
c
Applicable to Both Firms Capital $210,000 EBIT $40,000 Tax rate 35% EBIT Interest = I = Debt × rate Taxable income = EBIT - I Taxes NI = (Taxable Income)(1 - T) Equity = (1 – wd)(Capital) ROE = NI / Equity
Firm A's Data wd Int. rate Debt
50% 12% $105,000 $40,000 12,600 $27,400 9,590 $17,810 $105,000 16.96%
Firm NA's Data wd Int. rate Debt
0% 10% $0 $40,000 0 $40,000 14,000 $26,000 $210,000 12.38%
Difference in ROEs = 4.58%
POINTS: 1 DIFFICULTY: MODERATE/CHALLENGING REFERENCES: 14-3 Determining the Optimal Capital Structure QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.13.03 - Determining the Optimal Capital Structure NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.10 - Capital structure Copyright Cengage Learning. Powered by Cognero.
Page 820
LOCAL STANDARDS: TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
United States - OH - Default City - Tier 2: - Capital structure ROE and capital structure Bloom's: Evaluation Multiple Choice: Problem 9/21/2017 6:07 PM 9/26/2017 11:34 AM
81. Your firm's debt ratio is only 5.00%, but the new CFO thinks that more debt should be employed. She wants to sell bonds and use the proceeds to buy back and retire common shares so the percentage of common equity in the capital structure (wc) = 1 – wd. Other things held constant, and based on the data below, if the firm increases the percentage of debt in its capital structure (wd) to 60.0%, by how much would the ROE change, i.e., what is ROENew - ROEOld? Do not round your intermediate calculations. Operating Data
Other Data
Capital
$150,000
Old wd
5%
ROIC = EBIT (1 – T)/Capital
20.00%
Old interest rate
10%
New wd
60%
New interest rate
12%
Tax rate
a. 14.95% b. 19.17% c. 17.59% d. 21.64% e. 14.42% ANSWER: RATIONALE:
35%
c
Operating Data Capital ROIC Tax rate
Other Data $150,000 20.00% 35%
New wd Old wd New interest rate Old interest rate
60% 5% 12% 10%
Debt
New wd $90,000
Old wd $7,500
EBIT = (ROIC)(Capital)/(1 – T) Interest = rate × debt Taxable income = EBIT - I
$46,154 10,800 $35,354
$46,154 750 $45,404
Taxes NI = Tax. income - Taxes Equity = Assets - Debt ROE = NI / Equity
12,374 $22,980 $60,000 38.30%
15,891 $29,513 $142,500 20.71%
Difference in ROEs = 17.59%
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Page 821
POINTS: 1 DIFFICULTY: MODERATE/CHALLENGING REFERENCES: 14-3 Determining the Optimal Capital Structure QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.13.03 - Determining the Optimal Capital Structure NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: ROE and capital structure KEYWORDS: Bloom's: Evaluation OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:07 PM DATE MODIFIED: 9/26/2017 11:34 AM 82. You have been hired by a new firm that is just being started. The CFO wants to finance with 60% debt, but the president thinks it would be better to hold the percentage of debt in the capital structure (wd) to only 10%. Other things held constant, and based on the data below, if the firm uses more debt, by how much would the ROE change, i.e., what is ROEHigher - ROELower? Do not round your intermediate calculations. Operating Data Capital ROIC = EBIT(1 – T)/Capital Tax rate
a. 10.31% b. 11.59% c. 10.43% d. 9.15% e. 10.54% ANSWER: RATIONALE:
Other Data $4,000 17.00% 35%
Higher wd Higher interest rate Lower wd Lower interest rate
60% 13% 10% 9%
b
Operating Data Capital ROIC = EBIT(1 – T)/Capital Tax rate
Debt EBIT = (ROIC)(Capital)/(1 – T) Interest = Rate × Debt Taxable income = EBIT – I Taxes Copyright Cengage Learning. Powered by Cognero.
Other Data Higher wd Higher interest rate Lower wd Lower interest rate
$4,000 17.00% 35%
60% 13% 10% 9%
Lower wd $400
Higher wd $2,400
$1,046.15
36.00 $1,010.15
$1,046.15 312.00 $734.15
353.55
256.95 Page 822
NI = Taxable income – Taxes Equity = (1 – wd)(Capital) ROE = NI / Equity
$656.60 $3,600 18.24%
$477.20 $1,600 29.83%
Difference in ROEs = 11.59%
POINTS: 1 DIFFICULTY: MODERATE/CHALLENGING REFERENCES: 14-3 Determining the Optimal Capital Structure QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVE FOFM.BRIG.17.13.03 - Determining the Optimal Capital Structure S: NATIONAL STANDARDS United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic : STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: ROE and capital structure KEYWORDS: Bloom's: Evaluation OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:07 PM DATE MODIFIED: 9/26/2017 11:34 AM 83. Your girlfriend plans to start a new company to make a new type of cat litter. Her father will finance the operation, but she will have to pay him back. You are helping her, and the issue now is how to finance the company, with equity only or with a mix of debt and equity. The price per unit will be $10.00 regardless of how the firm is financed. The expected fixed and variable operating costs, along with other information, are shown below. How much higher or lower will the firm's expected EPS be if it uses some debt rather than only equity, i.e., what is EPSL - EPSU? Do not round your intermediate calculations. 0% Debt, U 290,000 $10.00 $1,000,000 $3.50 $2,500,000 250,000 0.00% $0 $2,500,000 NA 35.00%
Expected unit sales Price per unit Fixed costs Variable cost/unit Required investment Shares issued at $10/share % Debt Debt, $ Equity, $ Interest rate Tax rate a. $02.48 b. $02.35 c. $03.10 d. $02.85 e. $02.60 ANSWER: RATIONALE:
60% Debt, L 290,000 $10.00 $1,000,000 $3.50 $2,500,000 100,000 60.00% $1,500,000 $1,000,000 10.00% 35.00%
a
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Page 823
Expected unit sales Price per unit Fixed operating costs Variable operating cost/unit Required investment % Debt Debt, $ $ of common equity Shares of stock issued at $10/share Interest rate Tax rate Sales revenues Fixed costs Variable costs Operating income Interest Taxable income Taxes Net income Earnings per share (EPS)
0% Debt, U 290,000 $10.00 $1,000,000 $3.50 $2,500,000 0.00% $0 $2,500,000 250,000 NA 35.00%
60% Debt, L 290,000 $10.00 $1,000,000 $3.50 $2,500,000 60.00% $1,500,000 $1,000,000 100,000 10.00% 35.00%
$2,900,000 1,000,000 1,015,000 $885,000 0 $885,000 309,750
$2,900,000 1,000,000 1,015,000 $885,000 150,000 $735,000 257,250
$575,250 $2.30
$477,750 $4.78
Difference in EPS = $02.48
POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 14-2 Business and Financial Risk QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.13.02 - Business and Financial Risk NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: EPS and financing plans KEYWORDS: Bloom's: Evaluation OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:07 PM DATE MODIFIED: 9/26/2017 11:34 AM 84. Southeast U's campus book store sells course packs for $15.00 each, the variable cost per pack is $11.00, fixed costs for this operation are $300,000, and annual sales are 75,000 packs. The unit variable cost consists of a $4.00 royalty payment, VR , per pack to professors plus other variable costs of VO = $7.00. The royalty payment is negotiable. The book store's directors believe that the store should earn a profit margin of 10% on sales, and they want the store's managers to pay a royalty rate that will produce that profit margin. What royalty per pack would permit the store to earn a 10% profit margin on course packs, other things held constant? Do not round your intermediate calculations. a. $2.50 b. $1.88 Copyright Cengage Learning. Powered by Cognero.
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c. $2.78 d. $2.25 e. $2.00 ANSWER: RATIONALE:
a
Sales price (P) Target profit margin
$15.00 10%
Current royalty component of variable costs (VR) Other variable costs (VO) Total variable costs (V)
$4.00 $7.00 $11.00
Annual sales (Q) Fixed costs (F)
75,000 $300,000 Current profit= PQ – VRQ – VOQ – F = $1,125,000 – $300,000 – $525,000 – $300,000 = $0
Target Profit (TP) = 0.10(PQ) = $112,500 Target Profit (TP) = PQ – VR Q – VO Q – F = 0.10(PQ) = $112,500 Target VR = P – 0.1P – VO – F/Q = 0.9P – VO – F/Q = $2.50 Check: Profit with VR= P × Q - VR × Q - VO × Q - FC = 10% of Sales $1,125,000 - $187,500 - $525,000 - $300,000 = $112,500 POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 14-2 Business and Financial Risk QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.13.02 - Business and Financial Risk NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Break-even analysis KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:07 PM DATE MODIFIED: 9/26/2017 11:34 AM 85. Dye Industries currently uses no debt, but its new CFO is considering changing the capital structure to 49.0% debt (wd) by issuing bonds and using the proceeds to repurchase and retire some common shares so the percentage of common equity in the capital structure (wc) = 1 – wd. Given the data shown below, by how much would this recapitalization change the firm's cost of equity, i.e., what is rL - rU? Do not round your intermediate calculations. Copyright Cengage Learning. Powered by Cognero.
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6.00% 3.00% 1.30
Risk-free rate, rRF Market risk prem, RPM Current beta, bU a. 2.59% b. 1.91% c. 2.92% d. 1.57% e. 2.25% ANSWER: RATIONALE:
Tax rate, T Current wd Target wd
40% 0% 49.0%
e
Risk-free rate, rRF Mkt risk prem, RPM Current beta, bU Target D/E = wd/(1 – wd) bL = bU [(1 + (D/E)(1 – T)] rU = rRF + bU(RPM ) rL = rRF + bL(RPM ) Change in equity cost =
6.00% 3.00% 1.30
Tax rate, T
40% 0% 49.0%
Current wd Target wd 0.96 2.05 9.90% 12.15% 2.25%
POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 14-3 Determining the Optimal Capital Structure QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.13.03 - Determining the Optimal Capital Structure NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Levered beta and rs KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
Bloom's: Evaluation Multiple Choice: Problem 9/21/2017 6:07 PM 9/26/2017 11:34 AM
86. Dyson Inc. currently finances with 20.0% debt (i.e., wd = 20%), but its new CFO is considering changing the capital structure so wd = 36.0% by issuing additional bonds and using the proceeds to repurchase and retire common shares so the percentage of common equity in the capital structure (wc) = 1 – wd. Given the data shown below, by how much would this recapitalization change the firm's cost of equity? Do not round your intermediate calculations. (Hint: You must unlever the current beta and then use the unlevered beta to solve the problem.) Risk-free rate, rRF
5.00% Tax rate, T
40%
Market risk prem, RPM
6.00% Current wd 1.65 Target wd
20%
Current beta, bL1
Copyright Cengage Learning. Powered by Cognero.
36.0% Page 826
a. 1.61% b. 1.66% c. 1.24% d. 1.68% e. 1.69% ANSWER: RATIONALE:
a
Risk-free rate, rRF Market risk prem, RPM Current beta, bL1
5.00% 6.00% 1.65
Tax rate, T Current wd Target wd
Current D/E = wd/(1 – wd) Target D/E using target wd = wd/(1 – wd) Unleveraged beta: Found with current data: bU = bL1 / [1 + (1 T)(D/E)] Beta at new capital structure = bL2 = bU [(1 + (D/E)(1 - T)] Original cost of equity = rsL1 = rRF + bL1(RPM) New cost of equity = rsL2 = rRF + bL2(RPM)
40% 20% 36.0% 0.25 0.56 1.43 1.92 14.90% 16.51%
Change in equity cost = 1.61% POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 14-3 Determining the Optimal Capital Structure QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.13.03 - Determining the Optimal Capital Structure NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Levered beta and rs KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
Bloom's: Evaluation Multiple Choice: Problem 9/21/2017 6:07 PM 9/26/2017 11:34 AM
87. Monroe Inc. is an all-equity firm with 500,000 shares outstanding. It has $2,000,000 of EBIT, and EBIT is expected to remain constant in the future. The company pays out all of its earnings, so earnings per share (EPS) equal dividends per share (DPS), and its tax rate is 40%. The company is considering issuing $4,500,000 of 9.00% bonds and using the proceeds to repurchase stock. The risk-free rate is 4.5%, the market risk premium is 5.0%, and the firm's beta is currently 1.10. However, the CFO believes the beta would rise to 1.30 if the recapitalization occurs. Assuming the shares could be repurchased at the price that existed prior to the recapitalization, what would the price per share be following the recapitalization? (Hint: P0 = EPS/rs because EPS = DPS.) a. $34.52 b. $27.84 Copyright Cengage Learning. Powered by Cognero.
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c. $21.44 d. $28.12 e. $29.51 ANSWER: RATIONALE:
b
Interest rate Risk-free rate, rRF Mkt risk prem, RPM Beta, before recap Beta, after recap
9% 4.5% 5.0% 1.10 1.30
Shares outstanding initially 500,000 EBIT $2,000,000 Dividend payout ratio 100% Tax rate 40% Bonds issued = stock repurchased $4,500,000
Before the recapitalization
DPS = EPS = (EBIT)(1 – T)/Shares rs = rRF + bold(RPM ) P0 = DPS/rs Shares repurchased = Bonds issued/P0
$2.40 10.00% $24.00 187,500
After the recapitalization
DPS = EPS = (EBIT – rd × Bonds)(1 – T) / Shares rs = rRF + bnew(RPM ) P0 = DPS/rs
$3.06 11.00% $27.84
POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 14-3 Determining the Optimal Capital Structure QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.13.03 - Determining the Optimal Capital Structure NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Recapitalization KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:07 PM DATE MODIFIED: 9/26/2017 11:34 AM 88. You were hired as the CFO of a new company that was founded by three professors at your university. The company plans to manufacture and sell a new product, a cell phone that can be worn like a wrist watch. The issue now is how to finance the company, with equity only or with a mix of debt and equity. The price per phone will be $250.00 regardless of how the firm is financed. The expected fixed and variable operating costs, along with other data, are shown below. How much higher or lower will the firm's expected ROE be if it uses 60% debt rather than only equity, i.e., what is ROEL ROEU? 0% Debt, U Expected unit sales (Q) Price per phone (P) Fixed costs (F) Variable cost/unit (V) Copyright Cengage Learning. Powered by Cognero.
32,000 $250.00 $1,000,000 $200.00
60% Debt, L 32,000 $250.00 $1,000,000 $200.00 Page 828
Required investment % Debt Debt, $ Equity, $ Interest rate Tax rate a. 16.52% b. 13.65% c. 11.33% d. 15.70% e. 12.56% ANSWER: RATIONALE:
$2,500,000 0.00% $0 $2,500,000 NA 35.00%
$2,500,000 60.00% $1,500,000 $1,000,000 10.00% 35.00%
b
Expected unit sales Price per phone Fixed operating costs Variable operating cost/unit Required investment % Debt Debt, $ Equity, $ Interest rate Tax rate Sales revenues Fixed costs Variable costs Operating income Interest Taxable income Taxes Net income ROE
0% Debt, U 32,000 $250.00 $1,000,000 $200.00 $2,500,000 0.00% $0 $2,500,000 NA 35.00%
60% Debt, L 32,000 $250.00 $1,000,000 $200.00 $2,500,000 60.00% $1,500,000 $1,000,000 10.00% 35.00%
$8,000,000 1,000,000 6,400,000 $600,000 0 $600,000 210,000 $390,000 15.60%
$8,000,000 1,000,000 6,400,000 $600,000 150,000 $450,000 157,500 $292,500 29.25%
Difference in ROEs = 13.65%
POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 14-3 Determining the Optimal Capital Structure QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.13.03 - Determining the Optimal Capital Structure NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: ROE and financing plans Copyright Cengage Learning. Powered by Cognero.
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KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
Bloom's: Evaluation Multiple Choice: Problem 9/21/2017 6:07 PM 9/26/2017 11:34 AM
1. The optimal distribution policy strikes that balance between current dividends and capital gains that maximizes the firm's stock price. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 15-1 Dividends Versus Capital Gains: What Do Investors Prefer? QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.14.01 - Dividends Versus Capital Gains: What Do Investors Prefer? NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.11 - Dividend policy LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Optimal distribution policy KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 6:09 PM DATE MODIFIED: 9/26/2017 6:09 PM 2. Other things held constant, the higher a firm's target payout ratio, the higher its expected growth rate should be. a. True b. False ANSWER: False RATIONALE: The higher the payout ratio, the less of its earnings the firm reinvests in the business, and the lower the reinvestment rate, the lower the firm’s growth rate. POINTS: 1 DIFFICULTY: EASY REFERENCES: 15-1 Dividends Versus Capital Gains: What Do Investors Prefer? QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.14.01 - Dividends Versus Capital Gains: What Do Investors Prefer? NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.11 - Dividend policy LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Target payout ratio KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 6:09 PM DATE MODIFIED: 9/26/2017 6:09 PM 3. Miller and Modigliani's dividend irrelevance theory says that the percentage of its earnings a firm pays out in dividends Copyright Cengage Learning. Powered by Cognero.
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has no effect on either its cost of capital or its stock price. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 15-1 Dividends Versus Capital Gains: What Do Investors Prefer? QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.14.01 - Dividends Versus Capital Gains: What Do Investors Prefer? NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.11 - Dividend policy LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Dividend irrelevance KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 6:09 PM DATE MODIFIED: 9/26/2017 6:09 PM 4. Miller and Modigliani's dividend irrelevance theory says that the percentage of its earnings a firm pays out in dividends has no effect on its cost of capital, but it does affect its stock price. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 15-1 Dividends Versus Capital Gains: What Do Investors Prefer? QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.14.01 - Dividends Versus Capital Gains: What Do Investors Prefer? NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.11 - Dividend policy LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Dividend irrelevance KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 6:09 PM DATE MODIFIED: 9/26/2017 6:09 PM 5. If investors prefer firms that retain most of their earnings, then a firm that wants to maximize its stock price should set a low payout ratio. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 15-1 Dividends Versus Capital Gains: What Do Investors Prefer? QUESTION TYPE: True / False Copyright Cengage Learning. Powered by Cognero.
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HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.14.01 - Dividends Versus Capital Gains: What Do Investors Prefer? NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.11 - Dividend policy LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Investors' dividend preferences KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 6:09 PM DATE MODIFIED: 9/26/2017 6:09 PM 6. A 100% stock dividend and a 2:1 stock split should, at least conceptually, have the same effect on the firm's stock price. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 15-6 Stock Dividends and Stock Splits QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.14.06 - Stock Dividends and Stock Splits NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.11 - Dividend policy LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Stock dividends and splits KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 6:09 PM DATE MODIFIED: 9/26/2017 6:09 PM 7. A "reverse split" reduces the number of shares outstanding. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 15-6 Stock Dividends and Stock Splits QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.14.06 - Stock Dividends and Stock Splits NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.11 - Dividend policy LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Reverse split KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 6:09 PM DATE MODIFIED: 9/26/2017 6:09 PM Copyright Cengage Learning. Powered by Cognero.
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8. The announcement of an increase in the cash dividend should, according to MM, lead to an increase in the price of the firm's stock, other things held constant. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 15-1 Dividends Versus Capital Gains: What Do Investors Prefer? QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.14.01 - Dividends Versus Capital Gains: What Do Investors Prefer? NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.11 - Dividend policy LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Dividends and stock prices KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 6:09 PM DATE MODIFIED: 9/26/2017 6:09 PM 9. The federal government sometimes taxes dividends and capital gains at different rates. Other things held constant, an increase in the tax rate on dividends relative to that on capital gains would logically lead to an increase in dividend payout ratios. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 15-1 Dividends Versus Capital Gains: What Do Investors Prefer? QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.14.01 - Dividends Versus Capital Gains: What Do Investors Prefer? NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.11 - Dividend policy LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Dividends and stock prices KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 6:09 PM DATE MODIFIED: 9/26/2017 6:09 PM 10. The federal government sometimes taxes dividends and capital gains at different rates. Other things held constant, if the tax rate on dividends is high relative to that on capital gains, then individuals with low taxable incomes should favor stocks with low payouts and high-income individuals should favor high-payout companies. a. True b. False ANSWER: False Copyright Cengage Learning. Powered by Cognero.
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POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 15-1 Dividends Versus Capital Gains: What Do Investors Prefer? QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.14.01 - Dividends Versus Capital Gains: What Do Investors Prefer? NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.11 - Dividend policy LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Dividends and stock prices KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 6:09 PM DATE MODIFIED: 9/26/2017 6:09 PM 11. It has been argued that investors prefer high-payout companies because dividends are more certain (less risky) than the capital gains that are supposed to come from retained earnings. However, Miller and Modigliani say that this argument is incorrect, and they call it the "bird-in-the-hand fallacy." MM base their argument on the belief that most dividends are reinvested in stocks, hence are exposed to the same risks as reinvested earnings. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 15-1 Dividends Versus Capital Gains: What Do Investors Prefer? QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.14.01 - Dividends Versus Capital Gains: What Do Investors Prefer? NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.11 - Dividend policy LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Dividends and stock prices KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 6:09 PM DATE MODIFIED: 9/26/2017 6:09 PM 12. Underlying the dividend irrelevance theory proposed by Miller and Modigliani is their argument that the value of the firm is determined only by its basic earning power and its business risk. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 15-1 Dividends Versus Capital Gains: What Do Investors Prefer? QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.14.01 - Dividends Versus Capital Gains: What Do Investors Prefer? Copyright Cengage Learning. Powered by Cognero.
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NATIONAL STANDARDS: STATE STANDARDS: LOCAL STANDARDS: TOPICS: KEYWORDS: DATE CREATED: DATE MODIFIED:
United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking United States - OH - DISC.FOFM.BRIG.17.11 - Dividend policy United States - OH - Default City - Tier 2: - Capital structure Dividend irrelevance Bloom's: Knowledge 9/21/2017 6:09 PM 9/26/2017 6:09 PM
13. One implication of the bird-in-the-hand theory of dividends is that a given reduction in dividend yield must be offset by a more than proportionate increase in growth in order to keep a firm's required return constant, other things held constant. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 15-1 Dividends Versus Capital Gains: What Do Investors Prefer? QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.14.01 - Dividends Versus Capital Gains: What Do Investors Prefer? NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.11 - Dividend policy LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Dividend-growth tradeoff KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 6:09 PM DATE MODIFIED: 9/26/2017 6:09 PM 14. If a retired individual lives on his or her investment income, then it would make sense for this person to prefer stocks with high payouts so he or she could receive cash without going to the trouble and expense of selling stocks. On the other hand, it would make sense for an individual who would just reinvest any dividends received to prefer a low-payout company because that would save him or her taxes and brokerage costs. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 15-2 Other Dividend Policy Issues QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.14.02 - Other Dividend Policy Issues NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.11 - Dividend policy LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Dividends and stock prices KEYWORDS: Bloom's: Comprehension Copyright Cengage Learning. Powered by Cognero.
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DATE CREATED: DATE MODIFIED:
9/21/2017 6:09 PM 9/26/2017 6:09 PM
15. Some investors prefer dividends to retained earnings (and the capital gains retained earnings bring), while others prefer retained earnings to dividends. Other things held constant, it makes sense for a company to establish its dividend policy and stick to it, and then it will attract a clientele of investors who like that policy. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 15-2 Other Dividend Policy Issues QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.14.02 - Other Dividend Policy Issues NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.11 - Dividend policy LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Dividends and stock prices KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 6:09 PM DATE MODIFIED: 9/26/2017 6:09 PM 16. Suppose a firm that has been earning $2 and paying a dividend of $1.00, or a 50% dividend payout, announces that it is increasing the dividend to $1.50. The stock price then jumps from $20 to $30. Some people would argue that this is proof that investors prefer dividends to retained earnings. Miller and Modigliani would agree with this argument. a. True b. False ANSWER: False RATIONALE: MM would disagree. They would say that investors took the dividend increase as a signal that the firm's management expected higher future earnings. MM say dividends have information content regarding future earnings. POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 15-2 Other Dividend Policy Issues QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.14.02 - Other Dividend Policy Issues NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.11 - Dividend policy LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Dividends and stock prices KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 6:09 PM DATE MODIFIED: 9/26/2017 6:09 PM 17. If the information content, or signaling, hypothesis is correct, then a change in a firm's dividend policy can have an Copyright Cengage Learning. Powered by Cognero.
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important effect on its stock price and cost of equity. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 15-2 Other Dividend Policy Issues QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.14.02 - Other Dividend Policy Issues NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.11 - Dividend policy LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Signaling hypothesis KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 6:09 PM DATE MODIFIED: 9/26/2017 6:09 PM 18. If a firm uses the residual dividend model to set dividend policy, then dividends are determined as a residual after providing for the equity required to fund the capital budget. Under this model, the better the firm's investment opportunities, the lower its payout ratio will be, other things held constant. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 15-3 Establishing the Dividend Policy in Practice QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.14.03 - Establishing the Dividend Policy in Practice NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.11 - Dividend policy LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Residual dividend model KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 6:09 PM DATE MODIFIED: 9/26/2017 6:09 PM 19. If a firm uses the residual dividend model to set dividend policy, then dividends are determined as a residual after providing for the equity required to fund the capital budget. Under this model, the higher the firm's debt ratio, the lower its payout ratio will be, other things held constant. a. True b. False ANSWER: False RATIONALE: The higher the debt ratio, the more dollars of debt will be used to fund a given capital budget. So, the higher the debt ratio, the less equity will be needed, and this results in a higher Copyright Cengage Learning. Powered by Cognero.
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dividend payout ratio according to the residual dividend model. POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 15-3 Establishing the Dividend Policy in Practice QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.14.03 - Establishing the Dividend Policy in Practice NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.11 - Dividend policy LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Residual dividend model KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 6:09 PM DATE MODIFIED: 9/26/2017 6:09 PM 20. If management wants to maximize its stock price, and if it believes that the dividend irrelevance theory is correct, then it must adhere to the residual dividend policy. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 15-3 Establishing the Dividend Policy in Practice QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.14.03 - Establishing the Dividend Policy in Practice NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.11 - Dividend policy LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Residual dividend model KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 6:09 PM DATE MODIFIED: 9/26/2017 6:09 PM 21. If on January 3 a company declares a dividend of $1.50 per share, payable on January 31 then the price of the stock should drop by approximately $1.50 on January 31. a. True b. False ANSWER: False RATIONALE: This is false. The stock price will drop on the ex-dividend date, which is two days prior to the holder of record date, which is well before the actual January 31 payment date. Also, because the dividend is taxable, the price decline is generally somewhat less than the full amount of the dividend. POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 15-3 Establishing the Dividend Policy in Practice Copyright Cengage Learning. Powered by Cognero.
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QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.14.03 - Establishing the Dividend Policy in Practice NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.11 - Dividend policy LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Dividend payment procedures KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 6:09 PM DATE MODIFIED: 9/26/2017 6:09 PM 22. If on January 3 a company declares a dividend of $1.50 per share, payable on January 31 to holders of record on January 17, then the price of the stock should drop by approximately $1.50 on January 15, which is the ex-dividend date. a. True b. False ANSWER: True RATIONALE: This is true. The stock price will drop on the ex-dividend date, which is two days prior to the holder of record date, which is well before the actual January 31 payment date. Note, though, that because the dividend is taxable, the price decline may be somewhat less than the full amount of the dividend. POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 15-3 Establishing the Dividend Policy in Practice QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.14.03 - Establishing the Dividend Policy in Practice NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.11 - Dividend policy LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Dividend payment procedures KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 6:09 PM DATE MODIFIED: 9/26/2017 6:09 PM 23. One advantage of dividend reinvestment plans is that they allow shareholders to delay paying taxes on the dividends that they choose to reinvest. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 15-4 Dividend Reinvestment Plans QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.14.04 - Dividend Reinvestment Plans NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking Copyright Cengage Learning. Powered by Cognero.
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STATE STANDARDS: LOCAL STANDARDS: TOPICS: KEYWORDS: DATE CREATED: DATE MODIFIED:
United States - OH - DISC.FOFM.BRIG.17.11 - Dividend policy United States - OH - Default City - Tier 2: - Capital structure Dividend reinvestment plans Bloom's: Knowledge 9/21/2017 6:09 PM 9/26/2017 6:09 PM
24. There are two types of dividend reinvestment plans. Under one type of plan, the firm uses the cash that would have been paid as dividends to buy stock on the open market. Under the other type, the company issues new stock, keeps the cash that would have been paid out, and in effect sells new stock to those investors who choose to reinvest their dividends. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 15-4 Dividend Reinvestment Plans QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.14.04 - Dividend Reinvestment Plans NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.11 - Dividend policy LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Dividend reinvestment plans KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 6:09 PM DATE MODIFIED: 9/26/2017 6:09 PM 25. If a firm pays out all of its earnings as dividends and its stockholders then elect to have all of their dividends reinvested, the company should reconsider its dividend policy and possibly move to a lower dividend payout ratio. a. True b. False ANSWER: True RATIONALE: This is true, because if the company retains its earnings rather than paying them out, investors should receive capital gains rather than dividend income, and the taxes on those gains will be deferred until the stock is sold. Note that the money will be reinvested by the company in either case, so the risk to stockholders under dividend reinvestment and retained earnings should be the same. POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 15-4 Dividend Reinvestment Plans QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.14.04 - Dividend Reinvestment Plans NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.11 - Dividend policy LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure Copyright Cengage Learning. Powered by Cognero.
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TOPICS: KEYWORDS: DATE CREATED: DATE MODIFIED:
Dividend reinvestment plans Bloom's: Comprehension 9/21/2017 6:09 PM 9/26/2017 6:09 PM
26. If a firm declares a 20:1 stock split, and the pre-split price was $500, then we might expect the post-split price to be $25. However, it often turns out that the post-split price will be higher than $25. This higher price could be due to signaling effects investors believe that management split the stock because they think the firm is going to do better in the future. The higher price could also be because investors like lower-priced shares. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 15-6 Stock Dividends and Stock Splits QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.14.06 - Stock Dividends and Stock Splits NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.11 - Dividend policy LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Stock split KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 6:09 PM DATE MODIFIED: 9/26/2017 6:09 PM 27. Your firm uses the residual dividend model to set dividend policy. Market interest rates suddenly rise, and stock prices decline. Your firm's earnings, investment opportunities, and capital structure do not change. If the firm follows the residual dividend model, then its dividend payout ratio would increase. a. True b. False ANSWER: True RATIONALE: (1) The firm's WACC would increase, (2) this would cause fewer projects to be accepted, (3) this would lead to a smaller capital budget, (4) thus less money would be needed to fund the capital budget, (5) thus less equity would be needed, so (6) the dividend payout ratio would increase. POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 15-3 Establishing the Dividend Policy in Practice QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.14.03 - Establishing the Dividend Policy in Practice NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.11 - Dividend policy LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Residual dividend model KEYWORDS: Bloom's: Comprehension Copyright Cengage Learning. Powered by Cognero.
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28. Suppose you plotted a curve which showed a Firm U's WACC on the vertical axis and its debt ratio on the horizontal axis. Then you plotted a similar curve for Firm V. The curve for firm U resembled a shallow "U," while that for Firm V resembled a sharp "V." Both firms have debt ratios that cause their WACCs to be minimized. Other things held constant, it would be easier for Firm V than for Firm U to maintain a steady dividend in the face of varying investment opportunities and earnings from year to year. a. True b. False ANSWER: False RATIONALE: Firm U could fund its capital budget with varying amounts of debt without causing large changes in its WACC and thus in its value and stock price. Firm V could not vary its debt ratio without increasing its WACC. Thus, Firm V would have to raise and lower its dividend payout in order to obtain the equity it needed to support its capital budget. Firm U, on the other hand, could maintain a stable, steady dividend, and let the debt ratio vary without causing much harm to its stock price. POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 15-5 Summary of Factors Influencing Dividend Policy QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.14.05 - Summary of Factors Influencing Dividend Policy NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.11 - Dividend policy LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: WACC and dividend policy KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 6:09 PM DATE MODIFIED: 9/26/2017 6:09 PM 29. In the real world, dividends a. are usually more stable than earnings. b. fluctuate more widely than earnings. c. tend to be a lower percentage of earnings for mature firms. d. are usually changed every year to reflect earnings changes, and these changes are randomly higher to lower, depending on whether earnings increased or decreased. e. are usually set as a fixed percentage of earnings, e.g., at 40% of earnings, so if EPS = $2.00, then DPS would equal $0.80. Once the percentage is set, then dividend policy is on "automatic pilot" and the dividend actually paid depends strictly on earnings. ANSWER: a POINTS: 1 DIFFICULTY: EASY REFERENCES: 15-3 Establishing the Dividend Policy in Practice QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.14.03 - Establishing the Dividend Policy in Practice Copyright Cengage Learning. Powered by Cognero.
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NATIONAL STANDARDS: STATE STANDARDS: LOCAL STANDARDS: TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic United States - OH - DISC.FOFM.BRIG.17.11 - Dividend policy United States - OH - Default City - Tier 2: - Capital structure Dividend payout Bloom's: Comprehension Multiple Choice: Conceptual 9/21/2017 6:09 PM 9/26/2017 6:09 PM
30. You own 100 shares of Troll Brothers' stock, which currently sells for $120 a share. The company is about to declare a 2-for-1 stock split. Which of the following best describes your likely position after the split? a. You will have 200 shares of stock, and the stock will trade at or near $120 a share. b. You will have 200 shares of stock, and the stock will trade at or near $60 a share. c. You will have 100 shares of stock, and the stock will trade at or near $60 a share. d. You will have 50 shares of stock, and the stock will trade at or near $120 a share. e. You will have 50 shares of stock, and the stock will trade at or near $600 a share. ANSWER: b POINTS: 1 DIFFICULTY: EASY REFERENCES: 15-6 Stock Dividends and Stock Splits QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.14.06 - Stock Dividends and Stock Splits NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.11 - Dividend policy LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Stock split KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:09 PM DATE MODIFIED: 9/26/2017 6:09 PM 31. Myron Gordon and John Lintner believe that the required return on equity increases as the dividend payout ratio is lowered. Their argument is based on the assumption that a. investors are indifferent between dividends and capital gains. b. investors require that the dividend yield plus the capital gains yield equal a constant. c. capital gains are taxed at a higher rate than dividends. d. investors view dividends as being less risky than potential future capital gains. e. investors prefer a dollar of expected capital gains to a dollar of expected dividends because of the lower tax rate on capital gains. ANSWER: d POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 15-1 Dividends Versus Capital Gains: What Do Investors Prefer? QUESTION TYPE: Multiple Choice HAS VARIABLES: False Copyright Cengage Learning. Powered by Cognero.
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LEARNING OBJECTIVES: FOFM.BRIG.17.14.01 - Dividends Versus Capital Gains: What Do Investors Prefer? NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.11 - Dividend policy LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Investors' div. preferences KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:09 PM DATE MODIFIED: 9/26/2017 6:09 PM 32. Your firm adheres strictly to the residual dividend model. All else equal, which of the following factors would be most likely to lead to an increase in the firm's dividend per share? a. The firm's net income increases. b. The company increases the percentage of equity in its target capital structure. c. The number of profitable potential projects increases. d. Congress lowers the tax rate on capital gains, leaving the rest of the tax code unchanged. e. Earnings are unchanged, but the firm issues new shares of common stock. ANSWER: a POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 15-3 Establishing the Dividend Policy in Practice QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.14.03 - Establishing the Dividend Policy in Practice NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.11 - Dividend policy LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Residual dividend model KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:09 PM DATE MODIFIED: 9/26/2017 6:09 PM 33. If a firm adheres strictly to the residual dividend policy, and if its optimal capital budget requires the use of all earnings for a given year (along with new debt according to the optimal debt/assets ratio), then the firm should pay a. the same dividend as it paid the prior year. b. no dividends to common stockholders. c. dividends only out of funds raised by the sale of new common stock. d. dividends only out of funds raised by borrowing money (i.e., issuing debt). e. dividends only out of funds raised by selling off fixed assets. ANSWER: b POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 15-3 Establishing the Dividend Policy in Practice QUESTION TYPE: Multiple Choice Copyright Cengage Learning. Powered by Cognero.
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HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.14.03 - Establishing the Dividend Policy in Practice NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.11 - Dividend Policy LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Residual dividend model KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:09 PM DATE MODIFIED: 9/26/2017 6:09 PM 34. If a firm adheres strictly to the residual dividend model, the issuance of new common stock would suggest that a. the dividend payout ratio has remained constant. b. the dividend payout ratio is increasing. c. no dividends will be paid during the year. d. the dividend payout ratio is decreasing. e. the dollar amount of capital investments had decreased. ANSWER: c POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 15-3 Establishing the Dividend Policy in Practice QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.14.03 - Establishing the Dividend Policy in Practice NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.11 - Dividend policy LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Residual dividend model KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:09 PM DATE MODIFIED: 9/26/2017 6:09 PM 35. Which of the following does NOT normally influence a firm's dividend policy decision? a. The firm's ability to accelerate or delay investment projects without adverse consequences. b. A strong preference by most of its shareholders for current cash income versus potential future capital gains. c. Constraints imposed by the firm's bond indenture. d. The fact that much of the firm's equipment is leased rather than bought and owned. e. The fact that Congress is considering changes in the tax law regarding the taxation of dividends versus capital gains. ANSWER: d POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 15-5 Summary of Factors Influencing Dividend Policy QUESTION TYPE: Multiple Choice Copyright Cengage Learning. Powered by Cognero.
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HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.14.05 - Summary of Factors Influencing Dividend Policy NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.11 - Dividend policy LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Factors in dividend policy KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:09 PM DATE MODIFIED: 9/26/2017 6:09 PM 36. Which of the following would be most likely to lead to a decrease in a firm's dividend payout ratio? a. Its earnings become more stable. b. Its access to the capital markets increases. c. Its research and development efforts pay off, and it now has more high-return investment opportunities. d. Its accounts receivable decrease due to a change in its credit policy. e. Its stock price has increased over the last year by a greater percentage than the increase in the broad stock market averages. ANSWER: c POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 15-5 Summary of Factors Influencing Dividend Policy QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.14.05 - Summary of Factors Influencing Dividend Policy NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.11 - Dividend policy LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Factors in dividend policy KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:09 PM DATE MODIFIED: 9/26/2017 6:09 PM 37. Which of the following statements is CORRECT? a. When firms are deciding on the size of stock splits--say whether to declare a 2-for-1 split or a 3-for-1 split, it is best to declare the smaller one, in this case the 2-for-1 split, because then the after-split price will be higher than if the 3-for-1 split had been used. b. Back before the SEC was created in the 1930s, companies would declare reverse splits in order to boost their stock prices. However, this was determined to be a deceptive practice, and reverse splits are illegal today. c. Stock splits create more administrative problems for investors than stock dividends, especially determining the tax basis of their shares when they decide to sell them, so today stock dividends are used far more often than stock splits. d. When a company declares a stock split, the price of the stock typically declines--for example, by about 50% after a 2-for-1 split--and this necessarily reduces the total market value of the firm's equity. e. If a firm's stock price is quite high relative to most stocks--say $500 per share--then it can declare a stock split of say 20-for-1 so as to bring the price down to something close to $25. Moreover, if the price is relatively Copyright Cengage Learning. Powered by Cognero.
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low--say $2 per share--then it can declare a "reverse split" of say 1-for-10 so as to bring the price up to somewhere around $20 per share. ANSWER: e POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 15-6 Stock Dividends and Stock Splits QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.14.06 - Stock Dividends and Stock Splits NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.11 - Dividend policy LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Stock dividends and splits KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:09 PM DATE MODIFIED: 9/26/2017 6:09 PM 38. Which of the following statements about dividend policies is CORRECT? a. Miller and Modigliani argued that investors prefer dividends to capital gains because dividends are more certain than capital gains. They call this the "bird-in-the-hand" effect. b. One reason that companies tend to favor distributing excess cash as dividends rather than by repurchasing stock is that dividends are normally taxed at a lower rate than gains on repurchased stock. c. One advantage of dividend reinvestment plans is that they allow shareholders to delay paying taxes on the dividends that they choose to reinvest. d. One key advantage of the residual dividend model is that it enables a company to follow a stable dividend policy. e. The clientele effect suggests that companies should follow a stable dividend policy. ANSWER: e POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.14.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.11 - Dividend policy LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Dividend theories KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:09 PM DATE MODIFIED: 9/26/2017 6:09 PM 39. Which of the following statements is CORRECT? a. One disadvantage of dividend reinvestment plans is that they increase transactions costs for investors who Copyright Cengage Learning. Powered by Cognero.
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want to increase their investment in the company. b. One advantage of dividend reinvestment plans is that they enable investors to postpone paying taxes on the dividends credited to their account. c. Stock repurchases can be used by a firm that wants to increase its debt ratio. d. Stock repurchases make sense if a company expects to have a lot of profitable new projects to fund over the next few years, provided investors are aware of these investment opportunities. e. One advantage of an open market dividend reinvestment plan is that it provides new equity capital and increases the shares outstanding. ANSWER: c POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.14.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.11 - Dividend policy LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Repurchases and DRIPS KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:09 PM DATE MODIFIED: 9/26/2017 6:09 PM 40. Which of the following statements is CORRECT? a. Under the tax laws as they existed in 2017, a dollar received by an individual taxpayer as interest income is taxed at the same rate as a dollar received as dividends. b. One nice feature of dividend reinvestment plans (DRIPs) is that they reduce the taxes investors would have to pay if they received cash dividends. c. Empirical research indicates that, in general, companies send a negative signal to the marketplace when they announce an increase in the dividend. As a result, share prices fall when dividend increases are announced because investors interpret the increase as a signal that the firm expects fewer good investment opportunities in the future. d. If a company needs to raise new equity capital, a new-stock dividend reinvestment plan would make sense. However, if the firm does not need new equity, then an open market purchase dividend reinvestment plan would probably make more sense. e. Dividend reinvestment plans have not caught on in most industries, and today over 99% of all DRIPs are offered by utilities. ANSWER: d POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.14.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.11 - Dividend policy Copyright Cengage Learning. Powered by Cognero.
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LOCAL STANDARDS: TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
United States - OH - Default City - Tier 2: - Capital structure Divs., DRIPs, and repurch. Bloom's: Comprehension Multiple Choice: Conceptual 9/21/2017 6:09 PM 9/26/2017 6:09 PM
41. Which of the following statements is CORRECT? a. Historically, the tax code has encouraged companies to pay dividends rather than retain earnings. b. If a company uses the residual dividend model to determine its dividend payments, dividend payout will tend to increase whenever its profitable investment opportunities increase relatively rapidly. c. The more a firm's management believes in the clientele effect, the more likely the firm is to adhere strictly to the residual dividend model. d. Large stock repurchases financed by debt tend to increase expected earnings per share, but they also tend to increase the firm's financial risk. e. A dollar paid out to repurchase stock has the same tax benefit as a dollar paid out in dividends. Thus, both companies and investors should be indifferent between distributing cash through dividends and stock repurchase programs. ANSWER: d POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.14.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.11 - Dividend policy LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Dividend policy and repurchases KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:09 PM DATE MODIFIED: 9/26/2017 6:09 PM 42. Which of the following statements is CORRECT? a. If a company has a 2-for-1 stock split, its stock price should roughly double. b. Capital gains earned on shares repurchased are taxed less favorably than dividends, which is why companies typically pay dividends and avoid share repurchases. c. Very often, a company's stock price will rise when it announces that it plans to commence a share repurchase program. Such an announcement could lead to a stock price decline, but this does not normally happen. d. Stock repurchases increase the number of outstanding shares. e. The clientele effect is the best explanation for why companies tend to vary their dividend payments from quarter to quarter. ANSWER: c RATIONALE: c is correct, but perhaps the easiest way to answer this question is to eliminate the other choices, which are obviously wrong. POINTS: 1 Copyright Cengage Learning. Powered by Cognero.
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DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.14.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.11 - Dividend policy LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Dividend concepts KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:09 PM DATE MODIFIED: 9/26/2017 6:09 PM 43. Which of the following statements is CORRECT? a. Firms with a lot of good investment opportunities and a relatively small amount of cash tend to have aboveaverage dividend payout ratios. b. One advantage of the residual dividend model is that it leads to a stable dividend payout, which investors like. c. An increase in the stock price when a company cuts its dividend is consistent with signaling theory as postulated by MM. d. If the "clientele effect" is correct, then for a company whose earnings fluctuate, a policy of paying a constant percentage of net income will probably maximize its stock price. e. Stock repurchases make the most sense at times when a company believes its stock is undervalued. ANSWER: e POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.14.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.11 - Dividend policy LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Dividend concepts KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:09 PM DATE MODIFIED: 9/26/2017 6:09 PM 44. Which of the following statements is CORRECT? a. One advantage of dividend reinvestment plans is that they enable investors to avoid paying taxes on the dividends they receive. b. If a company has an established clientele of investors who prefer a high dividend payout, and if management wants to keep stockholders happy, it should not adhere strictly to the residual dividend model. c. If a firm adheres strictly to the residual dividend model, then, holding all else constant, its dividend payout ratio will tend to rise whenever its investment opportunities improve. Copyright Cengage Learning. Powered by Cognero.
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d. If Congress eliminates taxes on capital gains but leaves the personal tax rate on dividends unchanged, this would motivate companies to increase their dividend payout ratios. e. Despite its drawbacks, following the residual dividend model will tend to stabilize actual cash dividends, and this will make it easier for firms to attract a clientele that prefers high dividends, such as retirees. ANSWER: b POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.14.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.11 - Dividend policy LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Dividend concepts KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:09 PM DATE MODIFIED: 9/26/2017 6:09 PM 45. Firm M is a mature company in a mature industry. Its annual net income and cash flows are consistently high and stable. However, M's growth prospects are quite limited, so its capital budget is small relative to its net income. Firm N is a relatively new company in a new and growing industry. Its markets and products have not stabilized, so its annual operating income fluctuates considerably. However, N has substantial growth opportunities, and its capital budget is expected to be large relative to its net income for the foreseeable future. Which of the following statements is CORRECT? a. Firm M probably has a lower target debt ratio than Firm N. b. Firm M probably has a higher target dividend payout ratio than Firm N. c. If the corporate tax rate increases, the debt ratio of both firms is likely to decline. d. The two firms are equally likely to pay high dividends. e. Firm N is likely to have a clientele of shareholders who want a consistent, stable dividend income. ANSWER: b POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.14.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.11 - Dividend policy LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Dividend concepts KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:09 PM DATE MODIFIED: 9/26/2017 6:09 PM Copyright Cengage Learning. Powered by Cognero.
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46. Which of the following statements is CORRECT? a. If a firm repurchases some of its stock in the open market, then shareholders who sell their stock for more than they paid for it will be subject to capital gains taxes. b. An open-market dividend reinvestment plan will be most attractive to companies that need new equity and would otherwise have to issue additional shares of common stock through investment bankers. c. Stock repurchases tend to reduce financial leverage. d. If a company declares a 2-for-1 stock split, its stock price should roughly double. e. One advantage of adopting the residual dividend model is that this makes it easier for corporations to meet the requirements of Modigliani and Miller's dividend clientele theory. ANSWER: a POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.14.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.11 - Dividend policy LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Dividend concepts KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:09 PM DATE MODIFIED: 9/26/2017 6:09 PM 47. Which of the following actions will best enable a company to raise additional equity capital, other things held constant? a. Refund long-term debt with lower cost short-term debt. b. Declare a stock split. c. Begin an open-market purchase dividend reinvestment plan. d. Initiate a stock repurchase program. e. Begin a new-stock dividend reinvestment plan. ANSWER: e POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.14.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.11 - Dividend policy LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Dividend concepts KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:09 PM Copyright Cengage Learning. Powered by Cognero.
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DATE MODIFIED:
9/26/2017 6:09 PM
48. Which of the following statements is NOT CORRECT? a. Stock repurchases can be used by a firm as part of a plan to change its capital structure. b. After a 3-for-1 stock split, a company's price per share should fall, but the number of shares outstanding will rise. c. Investors may interpret a stock repurchase program as a signal that the firm's managers believe the stock is undervalued, or, alternatively, as a signal that the firm does not have many good investment opportunities. d. A company can repurchase stock to distribute a large one-time cash inflow, say from the sale of a division, to stockholders without having to increase its regular dividend. e. Stockholders pay no income tax on dividends if the dividends are used to purchase stock through a dividend reinvestment plan. ANSWER: e POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.14.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.11 - Dividend policy LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Repurchases and splits KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:09 PM DATE MODIFIED: 9/26/2017 6:09 PM 49. Which of the following statements is CORRECT? a. If a firm follows the residual dividend model, then a sudden increase in the number of profitable projects would be likely to lead to a reduction of the firm's dividend payout ratio. b. The clientele effect explains why so many firms change their dividend policies so often. c. One advantage of adopting the residual dividend model is that this policy makes it easier for a corporation to attract a specific and well-identified dividend clientele. d. New-stock dividend reinvestment plans are similar to stock dividends because they both increase the number of shares outstanding but don't change the firm's total amount of book equity. e. Investors who receive stock dividends must pay taxes on the value of the new shares in the year the stock dividends are received. ANSWER: a POINTS: 1 DIFFICULTY: MODERATE/CHALLENGING REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.14.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.11 - Dividend policy Copyright Cengage Learning. Powered by Cognero.
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LOCAL STANDARDS: TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
United States - OH - Default City - Tier 2: - Capital structure Dividend concepts Bloom's: Comprehension Multiple Choice: Conceptual 9/21/2017 6:09 PM 9/26/2017 6:09 PM
50. Which of the following statements is CORRECT? a. Suppose a firm that has been earning $2 and paying a dividend of $1.00, or a 50% dividend payout, announces that it is increasing the dividend to $1.50. The stock price then jumps from $20 to $30. Some people would argue that this is proof that investors prefer dividends to retained earnings. Miller and Modigliani would agree with this argument. b. Other things held constant, the higher a firm's target dividend payout ratio, the higher its expected growth rate should be. c. Miller and Modigliani's dividend irrelevance theory says that the percentage of its earnings that a firm pays out in dividends has no effect on its cost of capital, but it does affect its stock price. d. The federal government sometimes taxes dividends and capital gains at different rates. Other things held constant, an increase in the tax rate on dividends relative to that on capital gains would logically lead to a decrease in dividend payout ratios. e. If investors prefer firms that retain most of their earnings, then a firm that wants to maximize its stock price should set a high dividend payout ratio. ANSWER: d POINTS: 1 DIFFICULTY: MODERATE/CHALLENGING REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.14.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.11 - Dividend policy LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Dividend concepts KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:09 PM DATE MODIFIED: 9/26/2017 6:09 PM 51. Portland Plastics Inc. has the following data. If it follows the residual dividend model, what is its forecasted dividend payout ratio? Capital budget % Debt Net income (NI)
$12,000 40% $13,600
a. 51.29% b. 37.18% c. 48.47% d. 47.06% Copyright Cengage Learning. Powered by Cognero.
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e. 45.18% ANSWER: RATIONALE:
d
Capital budget Net income (NI) % Debt % Equity = 1.0 – % Debt = Equity needed to support the capital budget = % Equity × Capital budget = Dividends paid = NI – Equity needed if positive, otherwise $0.0
Payout ratio = Dividends paid / NI POINTS: 1 DIFFICULTY: EASY REFERENCES: 15-3 Establishing the Dividend Policy in Practice QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.14.03 - Establishing the Dividend Policy in Practice NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.11 - Dividend policy LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Residual dividend model KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:09 PM DATE MODIFIED: 9/26/2017 6:09 PM
$12,000 $13,600 40% 60% $7,200 $6,400 47.06%
52. Becker Financial recently declared a 2-for-1 stock split. Prior to the split, the stock sold for $60 per share. If the firm's total market value is unchanged by the split, what will the stock price be following the split? a. $30.60 b. $29.10 c. $30.00 d. $24.30 e. $23.70 ANSWER: c RATIONALE: Number of new shares 2
Number of old shares Old (pre-split) price New price = Old price × (Old shares / New shares) =
1 $60 $30.00
POINTS: 1 DIFFICULTY: EASY REFERENCES: 15-6 Stock Dividends and Stock Splits QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.14.06 - Stock Dividends and Stock Splits NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.11 - Dividend policy Copyright Cengage Learning. Powered by Cognero.
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LOCAL STANDARDS: TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
United States - OH - Default City - Tier 2: - Capital structure Stock split Bloom's: Analysis Multiple Choice: Problem 9/21/2017 6:09 PM 9/26/2017 6:09 PM
53. Toombs Media Corp. recently completed a 3-for-1 stock split. Prior to the split, its stock sold for $170 per share. The firm's total market value was unchanged by the split. Other things held constant, what is the best estimate of the stock's post-split price? a. $57.23 b. $65.73 c. $64.60 d. $63.47 e. $56.67 ANSWER: e RATIONALE: Number of new shares 3
Number of old shares Pre-split stock price Post-split stock price: P0 / New per old =
1 $170.00 $56.67
POINTS: 1 DIFFICULTY: EASY REFERENCES: 15-6 Stock Dividends and Stock Splits QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.14.06 - Stock Dividends and Stock Splits NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.11 - Dividend policy LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Stock split KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:09 PM DATE MODIFIED: 9/26/2017 6:09 PM 54. Mid-State BankCorp recently declared a 7-for-2 stock split. Prior to the split, the stock sold for $100 per share. If the firm's total market value is unchanged by the split, what will the stock price be following the split? a. $35.71 b. $28.57 c. $28.86 d. $26.29 e. $25.43 ANSWER: b RATIONALE: Number of new shares 7
Number of old shares Old (pre-split) price Copyright Cengage Learning. Powered by Cognero.
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New price = Old price × (Old shares / New shares) = $28.57 POINTS: 1 DIFFICULTY: EASY REFERENCES: 15-6 Stock Dividends and Stock Splits QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.14.06 - Stock Dividends and Stock Splits NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.11 - Dividend policy LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Stock split KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:09 PM DATE MODIFIED: 9/26/2017 6:09 PM 55. Fauver Industries plans to have a capital budget of $600,000. It wants to maintain a target capital structure of 40% debt and 60% equity, and it also wants to pay a dividend of $300,000. If the company follows the residual dividend model, how much net income must it earn to meet its investment requirements, pay the dividend, and keep the capital structure in balance? a. $660,000 b. $514,800 c. $600,600 d. $712,800 e. $580,800 ANSWER: a RATIONALE: Capital budget $600,000
% Equity Dividends to be paid Required net income = Dividends + (Capital budget × % Equity) =
60% $300,000 $660,000
POINTS: 1 DIFFICULTY: EASY/MODERATE REFERENCES: 15-3 Establishing the Dividend Policy in Practice QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.14.03 - Establishing the Dividend Policy in Practice NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.11 - Dividend policy LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Residual dividend model KEYWORDS: Bloom's: Evaluation OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:09 PM DATE MODIFIED: 9/26/2017 6:09 PM Copyright Cengage Learning. Powered by Cognero.
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56. Ring Technology has a capital budget of $875,000, it wants to maintain a target capital structure of 35% debt and 65% equity, and it also wants to pay a dividend of $575,000. If the company follows the residual dividend model, how much net income must it earn to meet its capital budgeting requirements and pay the dividend, all while keeping its capital structure in balance? a. $1,395,375 b. $1,075,125 c. $1,212,375 d. $1,143,750 e. $869,250 ANSWER: d RATIONALE: Capital budget $875,000
Equity ratio 65% Dividends to be paid $575,000 Required net income = Dividends + (Capital budget × % $1,143,750 Equity) = POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 15-3 Establishing the Dividend Policy in Practice QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.14.03 - Establishing the Dividend Policy in Practice NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.11 - Dividend policy LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Residual dividend model KEYWORDS: Bloom's: Evaluation OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:09 PM DATE MODIFIED: 9/26/2017 6:09 PM 57. D. Paul Inc. forecasts a capital budget of $700,000. The CFO wants to maintain a target capital structure of 45% debt and 55% equity, and she also wants to pay a dividend of $350,000. If the company follows the residual dividend model, how much income must it earn, and what will its dividend payout ratio be? a. $742,350; 47.15% b. $639,450; 54.73% c. $801,150; 43.69% d. $735,000; 47.62% e. $911,400; 38.40% ANSWER: d RATIONALE: Capital budget $700,000
Equity ratio 55% Dividends to be paid $350,000 NI = Dividends + (Capital budget × % Equity) = $735,000 Payout = Dividends / NI = 47.62% POINTS: DIFFICULTY:
1 MODERATE
Copyright Cengage Learning. Powered by Cognero.
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REFERENCES: 15-3 Establishing the Dividend Policy in Practice QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.14.03 - Establishing the Dividend Policy in Practice NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.11 - Dividend policy LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Residual dividend model KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:09 PM DATE MODIFIED: 9/26/2017 6:09 PM 58. Banerjee Inc. wants to maintain a target capital structure with 30% debt and 70% equity. Its forecasted net income is $825,000, and its board of directors has decreed that no new stock can be issued during the coming year. If the firm follows the residual dividend model, what is the maximum capital budget that is consistent with maintaining the target capital structure? a. $1,143,214 b. $954,643 c. $1,178,571 d. $1,296,429 e. $1,437,857 ANSWER: c RATIONALE: % Debt 30%
% Equity Net income Max capital budget = NI / % Equity =
70% $825,000 $1,178,571
Check: Is calculated Max capital budget × % Equity = Net income? $825,000 = Net income
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 15-3 Establishing the Dividend Policy in Practice QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.14.03 - Establishing the Dividend Policy in Practice NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.11 - Dividend policy LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Residual dividend model KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:09 PM DATE MODIFIED: 9/26/2017 6:09 PM 59. Dentaltech Inc. projects the following data for the coming year. If the firm follows the residual dividend model and also maintains its target capital structure, what will its dividend payout ratio be? Copyright Cengage Learning. Powered by Cognero.
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EBIT Interest rate Debt outstanding Shares outstanding a. 75.4% b. 86.7% c. 58.8% d. 88.2% e. 89.0% ANSWER: RATIONALE:
$3,000,000 Capital budget 10% % Debt $4,600,000 % Equity 5,000,000 Tax rate
$625,000 40% 60% 40%
a
EBIT Interest rate Debt outstanding Shares outstanding
$3,000,000 10% $4,600,000 5,000,000
Capital budget % Debt % Equity Tax rate
$625,000 40% 60% 40%
EBIT
$3,000,000 – Interest expense = Interest rate × Debt 460,000 Taxable income $2,540,000 – Taxes = Tax rate × Income 1,016,000 Net income (NI) $1,524,000 – Equity needed for capital budget = % Equity × Capital Budget 375,000 Dividends = NI – Equity needed $1,149,000 Payout ratio = Dividends / NI = 75.39%
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 15-3 Establishing the Dividend Policy in Practice QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.14.03 - Establishing the Dividend Policy in Practice NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.11 - Dividend policy LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Residual dividend model KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:09 PM DATE MODIFIED: 9/26/2017 6:09 PM 60. Mortal Inc. expects to have a capital budget of $450,000 next year. The company wants to maintain a target capital structure with 35% debt and 65% equity, and its forecasted net income is $400,000. If the company follows the residual dividend model, how much in dividends, if any, will it pay? a. $101,050 b. $87,075 c. $84,925 d. $107,500 e. $105,350 Copyright Cengage Learning. Powered by Cognero.
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ANSWER: RATIONALE:
d
% Debt % Equity Capital budget Net income Equity requirement = Capital budget × % Equity Dividends = NI – Equity requirement =
35% 65% $450,000 $400,000 $292,500 $107,500
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 15-3 Establishing the Dividend Policy in Practice QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.14.03 - Establishing the Dividend Policy in Practice NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.11 - Dividend policy LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Residual dividend model KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:09 PM DATE MODIFIED: 9/26/2017 6:09 PM 61. Torrence Inc. has the following data. If it uses the residual dividend model, how much total dividends, if any, will it pay out? Capital budget % Debt Net income (NI) a. $316,200 b. $211,650 c. $234,600 d. $255,000 e. $193,800 ANSWER: RATIONALE:
POINTS: DIFFICULTY: REFERENCES: QUESTION TYPE: HAS VARIABLES:
$1,025,000 60% $665,000
d
Capital budget $1,025,000 Net income (NI) $665,000 % Debt 60% % Equity = 1.0 – % Debt 40% Equity needed to support the capital budget = % Equity × Capital $410,000 budget Dividends paid = NI – Equity needed if positive (otherwise, $0.0) = $255,000 1 MODERATE 15-3 Establishing the Dividend Policy in Practice Multiple Choice True
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LEARNING OBJECTIVES: FOFM.BRIG.17.14.03 - Establishing the Dividend Policy in Practice NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.11 - Dividend policy LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Residual dividend model KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:09 PM DATE MODIFIED: 9/26/2017 6:09 PM 62. NY Fashions has the following data. If it follows the residual dividend model, how much total dividends, if any, will it pay out? Capital budget % Debt Net income (NI) a. $231,000 b. $258,500 c. $291,500 d. $335,500 e. $275,000 ANSWER: RATIONALE:
$1,000,000 65% $625,000
e
Capital budget Net income (NI) % Debt % Equity = 1.0 – % Debt Equity needed to support the capital budget = % Equity × Capital budget
$1,000,000 $625,000 65% 35% $350,000
Dividends paid = NI – Equity needed if positive (otherwise, $0.0) = $275,000
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 15-3 Establishing the Dividend Policy in Practice QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.14.03 - Establishing the Dividend Policy in Practice NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.11 - Dividend policy LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Residual dividend model KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:09 PM DATE MODIFIED: 9/26/2017 6:09 PM 63. Chicago Brewing has the following data, dollars in thousands. If it follows the residual dividend model, what will its dividend payout ratio be? Copyright Cengage Learning. Powered by Cognero.
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Capital budget % Debt Net income (NI) a. 68.93% b. 56.50% c. 55.37% d. 44.07% e. 46.90% ANSWER: RATIONALE:
$5,800 40% $8,000
b
Capital budget Net income (NI) % Debt % Equity = 1.0 – % Debt Equity needed to support the capital budget = % Equity × Capital budget Dividends paid = NI – Equity needed if positive (otherwise, $0.0)
$5,800 $8,000 40% 60% $3,480 $4,520
Payout ratio = Dividends paid / NI = 56.50%
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 15-3 Establishing the Dividend Policy in Practice QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.14.03 - Establishing the Dividend Policy in Practice NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.11 - Dividend policy LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Residual dividend model KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:09 PM DATE MODIFIED: 9/26/2017 6:09 PM 64. LA Moving Company has the following data, dollars in thousands. If it follows the residual dividend model, what will its dividend payout ratio be? Capital budget % Debt Net income (NI) a. 46.71% b. 60.97% c. 36.88% d. 44.26% e. 49.17% ANSWER: RATIONALE:
$6,700 45% $7,250
e
Capital budget Net income (NI)
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$6,700 $7,250 Page 863
% Debt % Equity = 1.0 – % Debt Equity needed to support the capital budget = % Equity × Capital budget Dividends paid = NI – Equity needed if positive (otherwise, $0.0)
45% 55% $3,685 $3,565
Payout ratio = Dividends paid / NI = 49.17%
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 15-3 Establishing the Dividend Policy in Practice QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.14.03 - Establishing the Dividend Policy in Practice NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.11 - Dividend policy LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Residual dividend model KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:09 PM DATE MODIFIED: 9/26/2017 6:09 PM 65. New Orleans Builders Inc. has the following data. If it follows the residual dividend model, what is its forecasted dividend payout ratio? Capital budget % Debt Net income (NI) a. 46.80% b. 30.00% c. 43.20% d. 32.00% e. 40.00% ANSWER: RATIONALE:
$7,500 40% $7,500
e
Capital budget Net income (NI) % Debt % Equity = 1.0 – % Debt Equity needed to support the capital budget = % Equity × Capital budget Dividends paid = NI – Equity needed if positive (otherwise, $0.0)
$7,500 $7,500 40% 60% $4,500 $3,000
Payout ratio = Dividends paid / NI = 40.00%
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 15-3 Establishing the Dividend Policy in Practice QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.14.03 - Establishing the Dividend Policy in Practice Copyright Cengage Learning. Powered by Cognero.
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NATIONAL STANDARDS: STATE STANDARDS: LOCAL STANDARDS: TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic United States - OH - DISC.FOFM.BRIG.17.11 - Dividend policy United States - OH - Default City - Tier 2: - Capital structure Residual dividend model Bloom's: Application Multiple Choice: Problem 9/21/2017 6:09 PM 9/26/2017 6:09 PM
66. Ross-Jordan Financial has suffered losses in recent years, and its stock currently sells for only $0.60 per share. Management wants to use a reverse split to get the price up to a more "reasonable" level, which it thinks is $12 per share. How many of the old shares must be given up for one new share to achieve the $12 price, assuming this transaction has no effect on total market value? a. 18.00 b. 20.80 c. 16.20 d. 20.00 e. 15.60 ANSWER: d RATIONALE: Current price $0.60
Target price
$12.00
Old shares surrendered per 1 new share = Target price / Old price = 20.00
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 15-6 Stock Dividends and Stock Splits QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.14.06 - Stock Dividends and Stock Splits NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.11 - Dividend policy LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Stock split KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:09 PM DATE MODIFIED: 9/26/2017 6:09 PM 67. Keys Financial has done extremely well in recent years, and its stock now sells for $65 per share. Management wants to get the price down to a more typical level, which it thinks is $40.00 per share. What stock split would be required to get to this price, assuming the transaction has no effect on the total market value? Put another way, how many new shares should be given per one old share? a. 1.54 b. 1.30 c. 1.63 d. 1.46 e. 2.11 ANSWER: c Copyright Cengage Learning. Powered by Cognero.
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RATIONALE:
Current price Target price
$65.00 $40.00
No. of new shares per 1 old share = Current price / Target price = 1.63
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 15-6 Stock Dividends and Stock Splits QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.14.06 - Stock Dividends and Stock Splits NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.11 - Dividend policy LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Stock split KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:09 PM DATE MODIFIED: 9/26/2017 6:09 PM 68. Whited Products recently completed a 4-for-1 stock split. Prior to the split, its stock sold for $75 per share. If the firm's total market value increased by 6% as a result of increased liquidity and favorable signaling effects, what was the stock price following the split? a. $19.28 b. $16.10 c. $16.89 d. $19.88 e. $21.86 ANSWER: d RATIONALE: New shares per 1 old share 4
Pre-split stock price % value increase
$75 6%
Post-split stock price = [(P0 / New shares per old shares) × (1 + % Value increase)] = $19.88
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 15-5 Summary of Factors Influencing Dividend Policy QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.14.06 - Stock Dividends and Stock Splits NATIONAL STANDARDS: STATE STANDARDS: LOCAL STANDARDS: TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic United States - OH - DISC.FOFM.BRIG.17.11 - Dividend policy United States - OH - Default City - Tier 2: - Capital structure Stock split Bloom's: Analysis Multiple Choice: Problem 9/21/2017 6:09 PM 9/26/2017 6:09 PM
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69. Clark Farms Inc. has the following data, and it follows the residual dividend model. Currently, it finances with 15% debt. Some Clark family members would like for the dividends to be increased. If Clark increased its debt ratio, which the firm's treasurer thinks is feasible, by how much could the dividend be increased, holding other things constant? Capital budget Net income (NI) % Debt now % Debt after change a. $2,957,400 b. $2,718,900 c. $1,860,300 d. $2,385,000 e. $1,955,700 ANSWER: RATIONALE:
$4,500,000 $5,000,000 15% 68%
d
% Debt % Equity = 1.0 – % Debt Capital budget Net income (NI) Equity needed to support the capital budget = % Equity × Capital budget Dividends paid = NI – Equity needed if positive (otherwise, $0.0)
Old New 15% 68% 85% 32% $4,500,000$4,500,000 $5,000,000$5,000,000 $3,825,000$1,440,000 $1,175,000$3,560,000
Increase in dividends paid = $2,385,000
POINTS: 1 DIFFICULTY: MODERATE/CHALLENGING REFERENCES: 15-3 Establishing the Dividend Policy in Practice QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.14.03 - Establishing the Dividend Policy in Practice NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.11 - Dividend policy LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Residual dividend model KEYWORDS: Bloom's: Evaluation OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:09 PM DATE MODIFIED: 9/26/2017 6:09 PM 70. Purcell Farms Inc. has the following data, and it follows the residual dividend model. Currently, it finances with 15% debt. Some Purcell family members would like for the dividend payout ratio to be increased. If Purcell increased its debt ratio, which the firm's treasurer thinks is feasible, by how much could the dividend payout ratio be increased, holding other things constant? Capital budget Net income (NI) % Debt now % Debt after change
$5,000,000 $5,500,000 15% 80%
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a. 68.5% b. 60.9% c. 60.3% d. 63.8% e. 59.1% ANSWER: RATIONALE:
e
% Debt % Equity = 1.0 – % Debt Capital budget Net income (NI) Equity needed to support the capital budget = % Equity × Capital budget Dividends paid = NI – Equity needed if positive (otherwise, $0.0) Dividend payout ratio
Old New 15% 80% 85% 20% $5,000,000$5,000,000 $5,500,000$5,500,000 $4,250,000$1,000,000 $1,250,000$4,500,000 22.7%
81.8%
Increase in dividend payout ratio = 59.1%
POINTS: 1 DIFFICULTY: MODERATE/CHALLENGING REFERENCES: 15-3 Establishing the Dividend Policy in Practice QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.14.03 - Establishing the Dividend Policy in Practice NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.11 - Dividend policy LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Residual dividend model KEYWORDS: Bloom's: Evaluation OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:09 PM DATE MODIFIED: 9/26/2017 6:09 PM 71. Whitman Antique Cars Inc. has the following data, and it follows the residual dividend model. Some Whitman family members would like more dividends, and they also think that the firm's capital budget includes too many projects whose NPVs are close to zero. If Whitman reduced its capital budget to the indicated level, by how much could dividends be increased, holding other things constant? Original capital budget New capital budget Net income % Debt
$3,000,000 $1,900,000 $3,500,000 30%
a. $521,700 b. $404,200 c. $493,500 d. $484,100 e. $470,000 Copyright Cengage Learning. Powered by Cognero.
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ANSWER: RATIONALE:
e
% Debt % Equity = 1.0 – % Debt Capital budget Net income (NI) Equity needed to support the capital budget = % Equity × Capital budget Dividends paid = NI – Equity needed if positive (otherwise, $0.0)
Old New 30% 30% 70% 70% $3,000,000$1,900,000 $3,500,000$3,500,000 $1,980,000$1,330,000 $1,820,000$2,170,000
Increase in dividends paid = $470,000
POINTS: 1 DIFFICULTY: MODERATE/CHALLENGING REFERENCES: 15-3 Establishing the Dividend Policy in Practice QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.14.03 - Establishing the Dividend Policy in Practice NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.11 - Dividend policy LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Residual dividend model KEYWORDS: Bloom's: Evaluation OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:09 PM DATE MODIFIED: 9/26/2017 6:09 PM 72. Pavlin Corp.'s projected capital budget is $2,000,000, its target capital structure is 40% debt and 60% equity, and its forecasted net income is $1,150,000. If the company follows the residual dividend model, how much dividends will it pay or, alternatively, how much new stock must it issue? a. $00; $50,000 b. $42,500; $39,500 c. $52,500; $50,500 d. $40,500; $48,500 e. $52,500; $56,000 ANSWER: a RATIONALE: Capital budget $2,000,000
% Equity 60% Net income (NI) $1,150,000 Equity required for capital budget = % Equity × Capital budget $1,200,000 Dividends = NI – Equity required if > 0 (otherwise, 0) = $0 Required new stock = Equity required – NI if (NI – Equity $50,000 required) < 0 (otherwise, 0) = Dividends paid = NI – [% Equity × (Capital budget)], stock issued if dividends zero or neg = Copyright Cengage Learning. Powered by Cognero.
Dividends: or new stock: $0 $50,000 Page 869
POINTS: 1 DIFFICULTY: MODERATE/CHALLENGING REFERENCES: 15-3 Establishing the Dividend Policy in Practice QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES FOFM.BRIG.17.14.03 - Establishing the Dividend Policy in Practice : NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: LOCAL STANDARDS: TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
United States - OH - DISC.FOFM.BRIG.17.11 - Dividend policy United States - OH - Default City - Tier 2: - Capital structure Residual dividend model Bloom's: Application Multiple Choice: Problem 9/21/2017 6:09 PM 9/26/2017 6:09 PM
73. Grullon Co. is considering a 7-for-3 stock split. The current stock price is $97.50 per share, and the firm believes that its total market value would increase by 7% as a result of the improved liquidity that should follow the split. What is the stock's expected price following the split? a. $42.92 b. $53.65 c. $49.63 d. $44.71 e. $38.00 ANSWER: d RATIONALE: Number of new shares 7
Number of old shares Old (pre-split) price % Increase in value New price before value increase = Old price/(New shares/Old shares)
3 $97.50 7% $41.79
New price after value increase = Prior × (1 + %Value increase) = $44.71
POINTS: 1 DIFFICULTY: MODERATE/CHALLENGING REFERENCES: 15-6 Stock Dividends and Stock Splits QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.14.06 - Stock Dividends and Stock Splits NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.11 - Dividend policy LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Stock split KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:09 PM Copyright Cengage Learning. Powered by Cognero.
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DATE MODIFIED:
9/26/2017 6:09 PM
74. Walter Industries is a family owned concern. It has been using the residual dividend model, but family members who hold a majority of the stock want more cash dividends, even if that means a slower future growth rate. Neither the net income nor the capital structure will change during the coming year as a result of a dividend policy change to the indicated target payout ratio. By how much would the capital budget have to be cut to enable the firm to achieve the new target dividend payout ratio? Do not round intermediate calculations. % Debt % Equity = 1.0 – % Debt Capital budget under the residual dividend model Net income; it will not change this year even if dividends increase Equity to support the capital budget = % Equity × Capital budget Dividends paid = NI – Equity needed Currently projected dividend payout ratio Target dividend payout ratio a. -$3,516,949 b. -$4,044,492 c. -$3,727,966 d. -$4,079,661 e. -$2,919,068 ANSWER: RATIONALE:
41% 59% $5,000,000 $3,500,000 $2,950,000 $550,000 84.3% 75%
a
New Old $3,500,000$3,500,000 41% 41% 59% 59% 75% $2,625,000 $875,000 $1,483,051
Net income (NI) % Debt % Equity = 1.0 – % Debt New target dividend payout ratio Target dividend = Target dividend payout × NI Target retained earnings (RE) = NI – Dividends Max. capital budget = RE / % Equity Check: % Equity × Capital budget consistent = calculated RE? $875,000 Yes New capital budget – Old capital budget = $1,483,051 – $5,000,000 = -$3,516,949
POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 15-3 Establishing the Dividend Policy in Practice QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.14.03 - Establishing the Dividend Policy in Practice NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.11 - Dividend policy LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Residual dividend model KEYWORDS: Bloom's: Evaluation OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:09 PM DATE MODIFIED: 9/26/2017 6:09 PM Copyright Cengage Learning. Powered by Cognero.
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75. Sheehan Corp. is forecasting an EPS of $5.00 for the coming year on its 500,000 outstanding shares of stock. Its capital budget is forecasted at $700,000, and it is committed to maintaining a $4.00 dividend per share. It finances with debt and common equity, but it wants to avoid issuing any new common stock during the coming year. Given these constraints, what percentage of the capital budget must be financed with debt? a. 23.14% b. 35.43% c. 31.43% d. 29.43% e. 28.57% ANSWER: e RATIONALE: EPS $5.00
Shares outstanding DPS Capital budget Net income = EPS × Shares outstanding Dividends paid = DPS × Shares outstanding Retained earnings available Capital budget – Retained earnings = Debt needed
500,000 $4.00 $700,000 $2,500,000 $2,000,000 $500,000 $200,000
Debt needed / Capital budget = % Debt financing = 28.6%
POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 15-3 Establishing the Dividend Policy in Practice QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.14.03 - Establishing the Dividend Policy in Practice NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.11 - Dividend policy LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Residual dividend model KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:09 PM DATE MODIFIED: 9/26/2017 6:09 PM 76. Del Grasso Fruit Company has more positive NPV projects than it can finance under its current policies without issuing new stock, but its board of directors had decreed that it cannot issue any new shares in the foreseeable future. Your boss, the CFO, wants to know how the capital budget would be affected by changes in capital structure policy and/or the target dividend payout policy. You obtained the following data, which shows the firm's projected net income (NI), its current capital structure and dividend payout policies, and three possible new policies. Projected net income for the coming year will not be affected by a policy change. How much larger could the capital budget be if (1) the target debt ratio were raised to the indicated amount, other things held constant, (2) the target payout ratio were lowered to the indicated amount, other things held constant, or (3) the debt ratio and dividend payout were both changed by the indicated amounts?
Projected NI % Debt
Policy Changes Current policy Increase debt Lower payout Do both $237.5 $237.5 $237.5 $237.5 25.0% 75.0% 25.0% 75.0%
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% Equity % Payout
75.0% 65.0%
25.0% 65.0%
75.0% 20.0%
a. 221.7; 142.5; 649.2 b. 277.1; 129.7; 525.8 c. 166.3; 146.8; 506.4 d. 219.5; 172.4; 616.7 e. 268.2; 108.3; 694.6 ANSWER: a RATIONALE: Found as: NI % Debt % Equity % Payout Dividends Ret earnings, RE Max. cap budget
Given " " " Payout % × NI NI – Dividends RE / % Equity
Increase: New max. – Current max. = Percentage increase: New max / current max – 1.0 =
25.0% 20.0%
Current New Maximum If New Maximum If New Maximum Maximum Increase Debt Lower Payout If Do Both $237.5 $237.5 $237.5 $237.5 25.0% 75.0% 25.0% 75.0% 75.0% 25.0% 75.0% 25.0% 65.0% 65.0% 20.0% 20.0% $154.4 $154.4 $47.5 $47.5 $83.1 $83.1 $190.0 $190.0 $110.8 $332.5 $253.3 $760.0 $221.7 200.0%
$142.5 128.6%
$649.2 585.7%
POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 15-3 Establishing the Dividend Policy in Practice QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES FOFM.BRIG.17.14.03 - Establishing the Dividend Policy in Practice : NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: LOCAL STANDARDS: TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
United States - OH - DISC.FOFM.BRIG.17.11 - Dividend policy United States - OH - Default City - Tier 2: - Capital structure Residual dividend model Bloom's: Evaluation Multiple Choice: Problem 9/21/2017 6:09 PM 9/26/2017 6:09 PM
1. Net operating working capital, defined as operating current assets minus the difference between current liabilities and notes payable, is equal to the current ratio minus the quick ratio. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 16-1 Background on Working Capital QUESTION TYPE: True / False HAS VARIABLES: False Copyright Cengage Learning. Powered by Cognero.
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LEARNING OBJECTIVES: FOFM.BRIG.17.15.01 - Background on Working Capital NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Net operating working capital KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 12/18/2017 9:34 AM 2. Net working capital is defined as current assets divided by current liabilities. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 16-1 Background on Working Capital QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.15.01 - Background on Working Capital NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Net working capital KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 9/26/2017 6:15 PM 3. An increase in any current asset must be accompanied by an equal increase in some current liability. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 16-1 Background on Working Capital QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.15.01 - Background on Working Capital NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Working capital KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 9/26/2017 6:15 PM
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4. The three alternative current asset investment policies discussed in the text differ regarding the size of current asset holdings. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 16-2 Current Asset Investment Policies QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.15.02 - Current Assets Investment Policies NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Current asset investment KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 9/26/2017 6:15 PM 5. The concept of permanent current assets reflects the fact that some components of current assets do not shrink to zero even when a business is at its seasonal or cyclical low. Thus, permanent current assets represent a minimum level of current assets that must be financed. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 16-3 Current Asset Financing Policies QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.15.03 - Current Assets Financing Policies NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Permanent current assets KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 9/26/2017 6:15 PM 6. A conservative financing approach to working capital will result in permanent current assets and some seasonal current assets being financed using long-term securities. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY Copyright Cengage Learning. Powered by Cognero.
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REFERENCES: 16-3 Current Assets Financing Policies QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.15.03 - Current Assets Financing Policies NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Conservative financing KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 9/26/2017 6:15 PM 7. Although short-term interest rates have historically averaged less than long-term rates, the heavy use of short-term debt is considered to be an aggressive current asset financing strategy because of the inherent risks of using short-term financing. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 16-3 Current Assets Financing Policies QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.15.03 - Current Assets Financing Policies NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Current asset financing KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 9/26/2017 6:15 PM 8. If a firm takes actions that reduce its days sales outstanding (DSO), then, other things held constant, this will lengthen its cash conversion cycle (CCC) and cause a deterioration in its cash position. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 16-4 The Cash Conversion Cycle QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.15.04 - The Cash Conversion Cycle NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure Copyright Cengage Learning. Powered by Cognero.
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TOPICS: KEYWORDS: DATE CREATED: DATE MODIFIED:
Cash conversion cycle Bloom's: Comprehension 9/21/2017 6:10 PM 9/26/2017 6:15 PM
9. Other things held constant, if a firm "stretches" (i.e., delays paying) its accounts payable, this will lengthen its cash conversion cycle (CCC). a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 16-4 The Cash Conversion Cycle QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.15.04 - The Cash Conversion Cycle NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Cash conversion cycle KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 9/26/2017 6:15 PM 10. Shorter-term cash budgets (such as a daily cash budget for the next month) are generally used for actual cash control while longer-term cash budgets (such as a monthly cash budgets for the next year) are generally used for planning purposes. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 16-5 The Cash Budget QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.15.05 - The Cash Budget NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Cash budget KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 9/26/2017 6:15 PM 11. Setting up a lockbox arrangement is one way for a firm to speed up the collection of payments from its customers. a. True Copyright Cengage Learning. Powered by Cognero.
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b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 16-6 Cash and Marketable Securities QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.15.06 - Cash and Marketable Securities NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Lockbox KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 9/26/2017 6:15 PM 12. Inventory management is largely self-contained in the sense that very little coordination among the sales, purchasing, and production personnel is required for successful inventory management. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 16-7 Inventories QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.15.07 - Inventories NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Inventory management KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 9/26/2017 6:15 PM 13. The average accounts receivables balance is a function of both the volume of credit sales and the days sales outstanding. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 16-8 Accounts Receivable QUESTION TYPE: True / False HAS VARIABLES: False Copyright Cengage Learning. Powered by Cognero.
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LEARNING OBJECTIVES: FOFM.BRIG.17.15.08 - Accounts Receivable NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Receivables balance KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 9/26/2017 6:15 PM 14. The four primary elements in a firm's credit policy are (1) credit standards, (2) discounts offered, (3) credit period, and (4) collection policy. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 16-8 Accounts Receivable QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.15.08 - Accounts Receivable NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Credit policy KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 9/26/2017 6:15 PM 15. Changes in a firm's collection policy can affect sales, working capital, and profits. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 16-8 Accounts Receivable QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.15.08 - Accounts Receivable NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Collection policy KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 9/26/2017 6:15 PM Copyright Cengage Learning. Powered by Cognero.
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16. Not taking cash discounts is costly, and as a result, firms that do not take them are usually those that are performing poorly and have inadequate cash balances. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 16-9 Accounts Payable (Trade Credit) QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.15.09 - Accounts Payable (Trade Credit) NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Taking discounts KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 9/26/2017 6:15 PM 17. If a firm buys on terms of 2/10, net 30, it should pay as early as possible during the discount period to lower its cost of trade credit. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 16-9 Accounts Payable (Trade Credit) QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.15.09 - Accounts Payable (Trade Credit) NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Trade credit KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 9/26/2017 6:15 PM 18. Trade credit can be separated into two components: free trade credit, which is credit received after the discount period ends, and costly trade credit, which is the cost of discounts not taken. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 16-9 Accounts Payable (Trade Credit) Copyright Cengage Learning. Powered by Cognero.
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QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.15.09 - Accounts Payable (Trade Credit) NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Trade credit KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 9/26/2017 6:15 PM 19. As a rule, managers should try to always use the free component of trade credit but should use the costly component only if the cost of this credit is lower than the cost of credit from other sources. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 16-9 Accounts Payable (Trade Credit) QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.15.09 - Accounts Payable (Trade Credit) NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Trade credit KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 9/26/2017 6:15 PM 20. If a firm's suppliers stop offering discounts, then its use of trade credit is more likely to increase than to decrease other things held constant. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 16-9 Accounts Payable (Trade Credit) QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.15.09 - Accounts Payable (Trade Credit) NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Trade credit Copyright Cengage Learning. Powered by Cognero.
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KEYWORDS: DATE CREATED: DATE MODIFIED:
Bloom's: Comprehension 9/21/2017 6:10 PM 9/26/2017 6:15 PM
21. When deciding whether or not to take a trade discount, the cost of borrowing from a bank or other source should be compared to the cost of trade credit to determine if the cash discount should be taken. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 16-9 Accounts Payable (Trade Credit) QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.15.09 - Accounts Payable (Trade Credit) NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Trade credit KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 9/26/2017 6:15 PM 22. The calculated cost of trade credit can be reduced by paying late. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 16-9 Accounts Payable (Trade Credit) QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.15.09 - Accounts Payable (Trade Credit) NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Cost of trade credit KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 9/26/2017 6:15 PM 23. The calculated cost of trade credit for a firm that buys on terms of 2/10, net 30, is lower (other things held constant) if the firm plans to pay in 40 days than in 30 days. a. True b. False ANSWER: True Copyright Cengage Learning. Powered by Cognero.
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POINTS: 1 DIFFICULTY: EASY REFERENCES: 16-9 Accounts Payable (Trade Credit) QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.15.09 - Accounts Payable (Trade Credit) NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Cost of trade credit KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 9/26/2017 6:15 PM 24. One of the effects of ceasing to take trade credit discounts is that the firm's accounts payable will rise, other things held constant. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 16-9 Accounts Payable (Trade Credit) QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.15.09 - Accounts Payable (Trade Credit) NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Cost of trade credit KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 9/26/2017 6:15 PM 25. "Stretching" accounts payable is a widely accepted, entirely ethical, and costless financing technique, which is particularly useful when suppliers’ production plants are at full capacity . a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 16-9 Accounts Payable (Trade Credit) QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.15.09 - Accounts Payable (Trade Credit) NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking Copyright Cengage Learning. Powered by Cognero.
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STATE STANDARDS: LOCAL STANDARDS: TOPICS: KEYWORDS: DATE CREATED: DATE MODIFIED:
United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management United States - OH - Default City - Tier 2: - Capital structure Stretching accts payables Bloom's: Knowledge 9/21/2017 6:10 PM 9/26/2017 6:15 PM
26. An informal line of credit and a revolving credit agreement are similar except that the line of credit creates a legal obligation for the bank and thus is a more reliable source of funds for the borrower than the revolving credit agreement. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 16-10 Bank Loans QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.15.10 - Bank Loans NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Bank loans KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 9/26/2017 6:15 PM 27. The maturity of most bank loans is short term. Bank loans to businesses are frequently made as 90-day notes which are often rolled over, or renewed, rather than repaid when they mature. However, if the borrower's financial situation deteriorates, then the bank may refuse to roll over the loan. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 16-10 Bank Loans QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.15.10 - Bank Loans NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Bank loans KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 9/26/2017 6:15 PM Copyright Cengage Learning. Powered by Cognero.
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28. A line of credit can be either a formal or an informal agreement between a borrower and a bank regarding the maximum amount of credit the bank will extend to the borrower during some future period, assuming the borrower maintains its financial strength. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 16-10 Bank Loans QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.15.10 - Bank Loans NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Line of credit KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 9/26/2017 6:15 PM 29. If a firm has set up a revolving credit agreement with a bank, the risk to the firm of being unable to obtain funds when needed is lower than if it had an informal line of credit. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 16-10 Bank Loans QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.15.10 - Bank Loans NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Revolving credit KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 9/26/2017 6:15 PM 30. Accruals arise automatically from a firm's operations and are "free" capital in the sense that no explicit interest must normally be paid on accrued liabilities. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY Copyright Cengage Learning. Powered by Cognero.
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REFERENCES: 16-12 Accruals (Accrued Liabilities) QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.15.12 - Accruals (Accrued Liabilities) NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Accruals KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 9/26/2017 6:15 PM 31. Accruals are "spontaneous" funds arising automatically from a firm's operations, but unfortunately, due to law and economic forces, firms have little control over the level of these accounts. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 16-12 Accruals (Accrued Liabilities) QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.15.12 - Accruals (Accrued Liabilities) NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Accruals KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 9/26/2017 6:15 PM 32. The facts that (1) no explicit interest is paid on accruals and (2) the firm can vary the level of these accounts at will makes them an attractive source of funding to meet the firm’s working capital needs. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 16-12 Accruals (Accrued Liabilities) QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.15.12 - Accruals (Accrued Liabilities) NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure Copyright Cengage Learning. Powered by Cognero.
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TOPICS: KEYWORDS: DATE CREATED: DATE MODIFIED:
Accruals Bloom's: Knowledge 9/21/2017 6:10 PM 9/26/2017 6:15 PM
33. Uncertainty about the exact lives of assets prevents precise maturity matching in an ex post (i.e., after the fact) sense even though it is possible to match maturities on an ex ante (expected) basis. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 16-3 Current Assets Financing Policies QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.15.03 - Current Assets Financing Policies NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Maturity matching KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 9/26/2017 6:15 PM 34. The maturity matching, or "self-liquidating", approach to financing involves obtaining the funds for permanent current assets with a combination of long-term capital and short-term capital that varies depending on the level of interest rates. When short-term rates are relatively high, short-term assets will be financed with long-term debt to reduce costs. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 16-3 Current Assets Financing Policies QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.15.03 - Current Assets Financing Policies NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Maturity matching KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 9/26/2017 6:15 PM 35. A firm that follows an aggressive working capital financing approach uses primarily short-term credit and thus is more exposed to an unexpected increase in interest rates than is a firm that uses long-term capital and thus follows a Copyright Cengage Learning. Powered by Cognero.
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conservative financing policy. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 16-3 Current Assets Financing Policies QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.15.03 - Current Assets Financing Policies NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Aggressive financing KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 9/26/2017 6:15 PM 36. The relative profitability of a firm that employs an aggressive working capital financing policy will improve if the yield curve changes from upward sloping to downward sloping. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 16-3 Current Assets Financing Policies QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.15.03 - Current Assets Financing Policies NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Aggressive financing KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 9/26/2017 6:15 PM 37. If the yield curve is upward sloping, then short-term debt will be cheaper than long-term debt. Thus, if a firm's CFO expects the yield curve to continue to have an upward slope, this would tend to cause the current ratio to be relatively low, other things held constant. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 16-3 Current Assets Financing Policies Copyright Cengage Learning. Powered by Cognero.
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QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.15.03 - Current Assets Financing Policies NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Short-term financing KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 9/26/2017 6:15 PM 38. The risk to the firm of borrowing using short-term credit is usually greater than if it used long-term debt. Added risk stems from (1) the greater variability of interest costs on short-term than long-term debt and (2) the fact that even if its long-term prospects are good, the firm's lenders may not be willing to renew short-term loans if the firm is temporarily unable to repay those loans. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 16-3 Current Assets Financing Policies QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.15.03 - Current Assets Financing Policies NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Short-term financing KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 9/26/2017 6:15 PM 39. Long-term loan agreements always contain provisions, or covenants, that constrain the firm's future actions. Shortterm credit agreements are just as restrictive in order to protect the interest of the lender. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 16-3 Current Assets Financing Policies QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.15.03 - Current Assets Financing Policies NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure Copyright Cengage Learning. Powered by Cognero.
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TOPICS: KEYWORDS: DATE CREATED: DATE MODIFIED:
Short-term financing Bloom's: Knowledge 9/21/2017 6:10 PM 9/26/2017 6:15 PM
40. A firm constructing a new manufacturing plant and financing it with short-term loans, which are scheduled to be converted to first mortgage bonds when the plant is completed, would want to separate the construction loan from its current liabilities associated with working capital when calculating net working capital. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 16-3 Current Assets Financing Policies QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.15.03 - Current Assets Financing Policies NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Short-term financing KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 9/26/2017 6:15 PM 41. The longer its customers normally hold inventory, the longer the credit period supplier firms normally offer. Still, suppliers have some flexibility in the credit terms they offer. If a supplier lengthens the credit period offered, this will shorten the customer's cash conversion cycle but lengthen the supplier firm's own CCC. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 16-4 The Cash Conversion Cycle QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.15.04 - The Cash Conversion Cycle NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Cash conversion cycle KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 9/26/2017 6:15 PM 42. The cash conversion cycle (CCC) combines three factors: The inventory conversion period, the receivables collection Copyright Cengage Learning. Powered by Cognero.
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period, and the payables deferral period, and its purpose is to show how long a firm must finance its working capital. Other things held constant, the shorter the CCC, the more effective the firm's working capital management. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 16-4 The Cash Conversion Cycle QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.15.04 - The Cash Conversion Cycle NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Cash conversion cycle KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 9/26/2017 6:15 PM 43. The target cash balance is typically (and logically) set so that it does not need to be adjusted for either seasonal patterns or unanticipated random fluctuations. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 16-5 The Cash Budget QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.15.05 - The Cash Budget NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Seasonal cash patterns KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 9/26/2017 6:15 PM 44. A firm's peak borrowing needs will probably be overstated if it bases its monthly cash budget on the assumption that both cash receipts and cash payments occur uniformly over the month but in reality payments are concentrated at the beginning of each month. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: MODERATE Copyright Cengage Learning. Powered by Cognero.
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REFERENCES: 16-5 The Cash Budget QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.15.05 - The Cash Budget NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Cash budget KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 9/26/2017 6:15 PM 45. A firm's peak borrowing needs will probably be overstated if it bases its monthly cash budget on the assumption that both cash receipts and cash payments occur uniformly over the month but in reality receipts are concentrated at the beginning of each month. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 16-5 The Cash Budget QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.15.05 - The Cash Budget NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Cash budget KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 9/26/2017 6:15 PM 46. The cash budget and the capital budget are handled separately, and although they are both important, they are developed completely independently of one another. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 16-5 The Cash Budget QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.15.05 - The Cash Budget NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure Copyright Cengage Learning. Powered by Cognero.
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TOPICS: KEYWORDS: DATE CREATED: DATE MODIFIED:
Cash and capital budgets Bloom's: Knowledge 9/21/2017 6:10 PM 9/26/2017 6:15 PM
47. Since depreciation is a non-cash charge, it neither appears on nor has any effect on the cash budget. Thus, if the depreciation charge for the coming year doubled or halved, this would have no effect on the cash budget. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 16-5 The Cash Budget QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.15.05 - The Cash Budget NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Cash budget and depreciation KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 9/26/2017 6:15 PM 48. Synchronization of cash flows is an important cash management technique, as proper synchronization can reduce the required cash balance and increase a firm's profitability. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 16-6 Cash and Marketable Securities QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.15.06 - Cash and Marketable Securities NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Cash flow synchronization KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 9/26/2017 6:15 PM 49. On average, a firm collects checks totaling $250,000 per day. It takes the firm approximately 4 days from the day the checks were mailed until they result in usable cash for the firm. Assume that (1) a lockbox system could be employed which would reduce the cash conversion procedure to 2 1/2 days and (2) the firm could invest any additional cash Copyright Cengage Learning. Powered by Cognero.
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generated at 6% after taxes. The lockbox system would be a good buy if it costs $25,000 annually. a. True b. False ANSWER: False RATIONALE: Funds generated = Days saved Checks per day = $375,000 Return on funds generated = Funds generated Rate of return = $22,500 < $25,000 POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 16-6 Cash and Marketable Securities QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.15.06 - Cash and Marketable Securities NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Lockbox KEYWORDS: Bloom's: Evaluation DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 9/26/2017 6:15 PM 50. Since receivables and payables both result from sales transactions, a firm with a high receivables-to-sales ratio must also have a high payables-to-sales ratio. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 16-8 Accounts Receivable QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.15.08 - Accounts Receivable NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Receivables balance KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 9/26/2017 6:15 PM 51. Dimon Products' sales are expected to be $5 million this year, with 90% on credit and 10% for cash. Sales are expected to grow at a stable, steady rate of 10% annually in the future. Dimon's accounts receivable balance will remain constant at the current level, because the 10% cash sales can be used to support the 10% growth rate, other things held constant. a. True b. False ANSWER: False Copyright Cengage Learning. Powered by Cognero.
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RATIONALE:
Accounts receivable will increase by 10%. That percentage increase would occur regardless of the level of the cash sales. Even if cash sales were 90%, receivables would still increase by 10% under the assumptions in the question. POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 16-8 Accounts Receivable QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.15.08 - Accounts Receivable NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Receivables and growth KEYWORDS: Bloom's: Analysis DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 9/26/2017 6:15 PM 52. For a zero-growth firm, it is possible to increase the percentage of sales that are made on credit and still keep accounts receivable at their current level, provided the firm can shorten the length of its collection period sufficiently. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 16-8 Accounts Receivable QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.15.08 - Accounts Receivable NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Receivables and growth KEYWORDS: Bloom's: Analysis DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 9/26/2017 6:15 PM 53. A firm's collection policy, i.e., the procedures it follows to collect accounts receivable, plays an important role in keeping its average collection period short, although too strict a collection policy can reduce profits due to lost sales. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 16-8 Accounts Receivable QUESTION TYPE: True / False HAS VARIABLES: False Copyright Cengage Learning. Powered by Cognero.
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LEARNING OBJECTIVES: FOFM.BRIG.17.15.08 - Accounts Receivable NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Collection policy KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 9/26/2017 6:15 PM 54. Because money has time value, a cash sale is always more profitable than a credit sale. a. True b. False ANSWER: False RATIONALE: Department stores, auto dealers, and many others sell on credit, using interest-bearing notes payable. The interest rate on this credit can exceed the firm's cost of capital, making credit sales more profitable than cash sales. POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 16-8 Accounts Receivable QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.15.08 - Accounts Receivable NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Cash vs. credit sales KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 9/26/2017 6:15 PM 55. If a firm sells on terms of 2/10, net 30 days, and its DSO is 28 days, then the fact that the 28-day DSO is less than the 30-day credit period tell us that the credit department is functioning efficiently and there are no past due accounts. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 16-8 Accounts Receivable QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.15.08 - Accounts Receivable NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: DSO and past due accounts KEYWORDS: Bloom's: Evaluation Copyright Cengage Learning. Powered by Cognero.
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DATE CREATED: DATE MODIFIED:
9/21/2017 6:10 PM 9/26/2017 6:15 PM
56. If a firm switched from taking trade credit discounts to paying on the net due date, this might cost the firm some money, but such a policy would probably have only a negligible effect on the income statement and no effect whatever on the balance sheet. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 16-9 Accounts Payable (Trade Credit) QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.15.09 - Accounts Payable (Trade Credit) NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Trade credit KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 9/26/2017 6:15 PM 57. If a profitable firm finds that it simply must "stretch" its accounts payable, then this suggests that it is undercapitalized, i.e., that it needs more working capital to support its operations. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 16-9 Accounts Payable (Trade Credit) QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.15.09 - Accounts Payable (Trade Credit) NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Stretching accts payables KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 9/26/2017 6:15 PM 58. If one of your firm's customers is "stretching" its accounts payable, this may be a nuisance but it does not represent a real financial cost to your firm as long as the customer periodically pays off its entire balance. a. True b. False Copyright Cengage Learning. Powered by Cognero.
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ANSWER: False POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 16-9 Accounts Payable (Trade Credit) QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.15.09 - Accounts Payable (Trade Credit) NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Stretching accts payables KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 9/26/2017 6:15 PM 59. The prime rate charged by big money center banks at any one time is likely to vary greatly (for example, as much as 2 to 4 percentage points) across banks due to banks' ability to differentiate themselves and because different banks operate in different parts of the country. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 16-10 Bank Loans QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.15.10 - Bank Loans NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Prime rate KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 9/26/2017 6:15 PM 60. A revolving credit agreement is a formal line of credit. The firm must generally pay a fee on the unused balance of the committed funds to compensate the bank for the commitment to extend those funds. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 16-10 Bank Loans QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.15.10 - Bank Loans Copyright Cengage Learning. Powered by Cognero.
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NATIONAL STANDARDS: STATE STANDARDS: LOCAL STANDARDS: TOPICS: KEYWORDS: DATE CREATED: DATE MODIFIED:
United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management United States - OH - Default City - Tier 2: - Capital structure Revolving credit Bloom's: Knowledge 9/21/2017 6:10 PM 9/26/2017 6:15 PM
61. Other things held constant, which of the following will cause an increase in net working capital? a. Cash is used to buy marketable securities. b. A cash dividend is declared and paid. c. Merchandise is sold at a profit, but the sale is on credit. d. Long-term bonds are retired with the proceeds of a preferred stock issue. e. Missing inventory is written off against retained earnings. ANSWER: c POINTS: 1 DIFFICULTY: EASY REFERENCES: 16-1 Background on Working Capital QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.15.01 - Background on Working Capital NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Net working capital KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 9/26/2017 6:15 PM 62. Firms generally choose to finance temporary current assets with short-term debt because a. matching the maturities of assets and liabilities reduces risk under some circumstances, and also because shortterm debt is often less expensive than long-term capital. b. short-term interest rates have traditionally been more stable than long-term interest rates. c. a firm that borrows heavily on a long-term basis is more apt to be unable to repay the debt than a firm that borrows short term. d. the yield curve is normally downward sloping. e. short-term debt has a higher cost than equity capital. ANSWER: a POINTS: 1 DIFFICULTY: EASY REFERENCES: 16-3 Current Assets Financing Policies QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.15.03 - Current Assets Financing Policies Copyright Cengage Learning. Powered by Cognero.
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NATIONAL STANDARDS: STATE STANDARDS: LOCAL STANDARDS: TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management United States - OH - Default City - Tier 2: - Capital structure Current asset financing Bloom's: Comprehension Multiple Choice: Conceptual 9/21/2017 6:10 PM 9/26/2017 6:15 PM
63. Helena Furnishings wants to reduce its cash conversion cycle. Which of the following actions should it take? a. Increases average inventory without increasing sales. b. Take steps to reduce the DSO. c. Start paying its bills sooner, which would reduce the average accounts payable but not affect sales. d. Sell common stock to retire long-term bonds. e. Sell an issue of long-term bonds and use the proceeds to buy back some of its common stock. ANSWER: b POINTS: 1 DIFFICULTY: EASY REFERENCES: 16-4 The Cash Conversion Cycle QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.15.04 - The Cash Conversion Cycle NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Cash conversion cycle KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 9/26/2017 6:15 PM 64. A lockbox plan is a. used to protect cash, i.e., to keep it from being stolen. b. used to identify inventory safety stocks. c. used to slow down the collection of checks our firm writes. d. used to speed up the collection of checks received. e. used primarily by firms where currency is used frequently in transactions, such as fast food restaurants, and less frequently by firms that receive payments as checks. ANSWER: d POINTS: 1 DIFFICULTY: EASY REFERENCES: 16-6 Cash and Marketable Securities QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.15.06 - Cash and Marketable Securities Copyright Cengage Learning. Powered by Cognero.
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NATIONAL STANDARDS: STATE STANDARDS: LOCAL STANDARDS: TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management United States - OH - Default City - Tier 2: - Capital structure Lockbox Bloom's: Knowledge Multiple Choice: Conceptual 9/21/2017 6:10 PM 9/26/2017 6:15 PM
65. A lockbox plan is most beneficial to firms that a. have suppliers who operate in many different parts of the country. b. have widely dispersed manufacturing facilities. c. have a large marketable securities portfolio, and cash, to protect. d. receive payments in the form of currency, such as fast food restaurants, rather than in the form of checks. e. have customers who operate in many different parts of the country. ANSWER: e POINTS: 1 DIFFICULTY: EASY REFERENCES: 16-6 Cash and Marketable Securities QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.15.06 - Cash and Marketable Securities NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Lockbox KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 9/26/2017 6:15 PM 66. Which of the following is NOT commonly regarded as being a credit policy variable? a. Credit period. b. Collection policy. c. Credit standards. d. Cash discounts. e. Payments deferral period. ANSWER: e POINTS: 1 DIFFICULTY: EASY REFERENCES: 16-8 Accounts Receivable QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.15.08 - Accounts Receivable NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic Copyright Cengage Learning. Powered by Cognero.
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STATE STANDARDS: LOCAL STANDARDS: TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management United States - OH - Default City - Tier 2: - Capital structure Credit policy Bloom's: Knowledge Multiple Choice: Conceptual 9/21/2017 6:10 PM 9/26/2017 6:15 PM
67. Swim Suits Unlimited is in a highly seasonal business, and the following summary balance sheet data show its assets and liabilities at peak and off-peak seasons (in thousands of dollars): Cash Marketable securities Accounts receivable Inventories Net fixed assets Total assets
Peak $50 0 40 100 500 $690
Off-Peak $30 20 20 50 500 $620
Payables and accruals Short-term bank debt Long-term debt Common equity Total claims
$30 50 300 310 $690
$10 0 300 310 $620
From this data we may conclude that a. Swim Suits' current asset financing policy calls for exactly matching asset and liability maturities. b. Swim Suits' current asset financing policy is relatively aggressive; that is, the company finances some of its permanent assets with short-term discretionary debt. c. Swim Suits follows a relatively conservative approach to current asset financing; that is, some of its short-term needs are met by permanent capital. d. Without income statement data, we cannot determine the aggressiveness or conservatism of the company's current asset financing policy. e. Without cash flow data, we cannot determine the aggressiveness or conservatism of the company's current asset financing policy. ANSWER: c POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 16-3 Current Assets Financing Policies QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.15.03 - Current Assets Financing Policies NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Current asset financing KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:10 PM Copyright Cengage Learning. Powered by Cognero.
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DATE MODIFIED:
9/26/2017 6:15 PM
68. Which of the following statements is CORRECT? a. Net working capital is defined as operating current assets minus the difference between current liabilities and notes payable, and any increase in the current ratio automatically indicates that net working capital has increased. b. Although short-term interest rates have historically averaged less than long-term rates, the heavy use of shortterm debt is considered to be an aggressive strategy because of the inherent risks associated with using shortterm financing. c. If a company follows a policy of ―matching maturities‖, this means that it matches its use of common stock with its use of long-term debt as opposed to short-term debt. d. Net working capital is defined as operating current assets minus the difference between current liabilities and notes payable, and any decrease in the current ratio automatically indicates that net working capital has decreased. e. If a company follows a policy of ―matching maturities‖, this means that it matches its use of short-term debt with its use of long-term debt. ANSWER: b POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 16-3 Current Assets Financing Policies QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.15.03 - Current Assets Financing Policies NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Current asset financing KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 12/18/2017 9:41 AM 69. Other things held constant, which of the following would tend to reduce the cash conversion cycle? a. Carry a constant amount of receivables as sales decline. b. Place larger orders for raw materials to take advantage of price breaks. c. Take all discounts that are offered. d. Continue to take all discounts that are offered and pay on the net date. e. Offer longer payment terms to customers. ANSWER: d POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 16-4 The Cash Conversion Cycle QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.15.04 - The Cash Conversion Cycle NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management Copyright Cengage Learning. Powered by Cognero.
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LOCAL STANDARDS: TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
United States - OH - Default City - Tier 2: - Capital structure Cash conversion cycle Bloom's: Analysis Multiple Choice: Conceptual 9/21/2017 6:10 PM 9/26/2017 6:15 PM
70. Which of the following actions would be likely to shorten the cash conversion cycle? a. Adopt a new manufacturing process that speeds up the conversion of raw materials to finished goods from 20 days to 10 days. b. Change the credit terms offered to customers from 3/10, net 30 to 1/10, net 50. c. Begin to take discounts on inventory purchases; we buy on terms of 2/10, net 30. d. Adopt a new manufacturing process that saves some labor costs but slows down the conversion of raw materials to finished goods from 10 days to 20 days. e. Change the credit terms offered to customers from 2/10, net 30 to 1/10, net 60. ANSWER: a POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 16-4 The Cash Conversion Cycle QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.15.04 - The Cash Conversion Cycle NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Cash conversion cycle KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 9/26/2017 6:15 PM 71. Which of the following is NOT directly reflected in the cash budget of a firm that is in the zero tax bracket? a. Payment lags. b. Payment for plant construction. c. Cumulative cash. d. Repurchases of common stock. e. Writing off bad debts. ANSWER: e POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 16-5 The Cash Budget QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.15.05 - The Cash Budget NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic Copyright Cengage Learning. Powered by Cognero.
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STATE STANDARDS: LOCAL STANDARDS: TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management United States - OH - Default City - Tier 2: - Capital structure Cash budget Bloom's: Comprehension Multiple Choice: Conceptual 9/21/2017 6:10 PM 9/26/2017 6:15 PM
72. Which of the following is NOT directly reflected in the cash budget of a firm that is in the zero tax bracket? a. Payments lags. b. Depreciation. c. Cumulative cash. d. Repurchases of common stock. e. Payment for plant construction. ANSWER: b POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 16-5 The Cash Budget QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.15.05 - The Cash Budget NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Cash budget KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 9/26/2017 6:15 PM 73. Which of the following statements concerning the cash budget is CORRECT? a. Depreciation expense is not explicitly included, but depreciation's effects are reflected in the estimated tax payments. b. Cash budgets do not include financial items such as interest and dividend payments. c. Cash budgets do not include cash inflows from long-term sources such as the issuance of bonds. d. Changes that affect the DSO do not affect the cash budget. e. Capital budgeting decisions have no effect on the cash budget until projects go into operation and start producing revenues. ANSWER: a POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 16-5 The Cash Budget QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.15.05 - The Cash Budget Copyright Cengage Learning. Powered by Cognero.
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NATIONAL STANDARDS: STATE STANDARDS: LOCAL STANDARDS: TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management United States - OH - Default City - Tier 2: - Capital structure Cash budget Bloom's: Comprehension Multiple Choice: Conceptual 9/21/2017 6:10 PM 9/26/2017 6:15 PM
74. Which of the following items should a company report directly in its monthly cash budget? a. Its monthly depreciation expense. b. Cash proceeds from selling one of its divisions. c. Accrued interest on zero coupon bonds that it issued. d. New shares issued in a stock split. e. New shares issued in a stock dividend. ANSWER: b POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 16-5 The Cash Budget QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.15.05 - The Cash Budget NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Cash budget KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 9/26/2017 6:15 PM 75. Which of the following statements is CORRECT? a. Shorter-term cash budgets, in general, are used primarily for planning purposes, while longer-term budgets are used for actual cash control. b. The cash budget and the capital budget are developed separately, and although they are both important to the firm, one does not affect the other. c. Since depreciation is a non-cash charge, it neither appears on nor has any effect on the cash budget. d. The target cash balance should be set such that it need not be adjusted for seasonal patterns and unanticipated fluctuations in receipts, although it should be changed to reflect long-term changes in the firm's operations. e. The typical cash budget reflects interest paid on loans as well as income from the investment of surplus cash. These numbers, as well as other items on the cash budget, are expected values; hence, actual results might vary from the budgeted amounts. ANSWER: e POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 16-5 The Cash Budget Copyright Cengage Learning. Powered by Cognero.
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QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.15.05 - The Cash Budget NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Cash budget KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 9/26/2017 6:15 PM 76. Which of the following is NOT a situation that might lead a firm to increase its holdings of short-term marketable securities? a. The firm must make a known future payment, such as paying for a new plant that is under construction. b. The firm is going from its peak sales season to its slack season, so its receivables and inventories will experience a seasonal decline. c. The firm is going from its slack season to its peak sales season, so its receivables and inventories will experience seasonal increases. d. The firm has just sold long-term securities and has not yet invested the proceeds in operating assets. e. The firm just won a product liability suit one of its customers had brought against it. ANSWER: c POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 16-6 Cash and Marketable Securities QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.15.06 - Cash and Marketable Securities NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Marketable securities KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 9/26/2017 6:15 PM 77. Which of the following statement completions is CORRECT? If the yield curve is upward sloping, then the marketable securities held in a firm's portfolio, assumed to be held for emergencies, should a. consist mainly of long-term securities because they pay higher rates. b. consist mainly of short-term securities because they pay higher rates. c. consist mainly of U.S. Treasury securities to minimize interest rate risk. d. consist mainly of short-term securities to minimize interest rate risk. e. be balanced between long- and short-term securities to minimize the adverse effects of either an upward or a downward trend in interest rates. ANSWER: d Copyright Cengage Learning. Powered by Cognero.
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POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 16-6 Cash and Marketable Securities QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.15.06 - Cash and Marketable Securities NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Marketable securities KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 9/26/2017 6:15 PM 78. Which of the following statements is most consistent with efficient inventory management? The firm has a a. below-average inventory turnover ratio. b. low incidence of production schedule disruptions. c. below-average total assets turnover ratio. d. relatively high current ratio. e. relatively low DSO. ANSWER: b POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 16-7 Inventories QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.15.07 - Inventories NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Inventory management KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 9/26/2017 6:15 PM 79. Which of the following statements is CORRECT? a. A firm that makes 90% of its sales on credit and 10% for cash is growing at a constant rate of 10% annually. Such a firm will be able to keep its accounts receivable at the current level, since the 10% cash sales can be used to finance the 10% growth rate. b. In managing a firm's accounts receivable, it is possible to increase credit sales per day yet still keep accounts receivable fairly steady, provided the firm can shorten the length of its collection period (its DSO) sufficiently. c. Because of the costs of granting credit, it is not possible for credit sales to be more profitable than cash sales. d. Since receivables and payables both result from sales transactions, a firm with a high receivables-to-sales ratio must also have a high payables-to-sales ratio. Copyright Cengage Learning. Powered by Cognero.
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e. Other things held constant, if a firm can shorten its DSO, this will lead to a higher current ratio. ANSWER: b POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 16-8 Accounts Receivable QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.15.08 - Accounts Receivable NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Receivables management KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 9/26/2017 6:15 PM 80. Which of the following statements is CORRECT? a. Other things held constant, the higher a firm's days sales outstanding (DSO), the better its credit department. b. If a firm that sells on terms of net 30 changes its policy to 2/10, net 30, and if no change in sales volume occurs, then the firm's DSO will probably increase. c. If a firm sells on terms of 2/10, net 30, and its DSO is 30 days, then the firm probably has some past due accounts. d. If a firm sells on terms of net 60, and if its sales are highly seasonal, with a sharp peak in December, then its DSO as it is typically calculated (with sales per day = Sales for past 12 months/365) would probably be lower in January than in July. e. If a firm changed the credit terms offered to its customers from 2/10, net 30 to 2/10, net 60, then its sales should increase, and this should lead to an increase in sales per day, and that should lead to a decrease in the DSO. ANSWER: c POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 16-8 Accounts Receivable QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.15.08 - Accounts Receivable NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Days sales outstanding (DSO) KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 9/26/2017 6:15 PM 81. Which of the following statements is CORRECT? Copyright Cengage Learning. Powered by Cognero.
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a. Trade credit is provided only to relatively large, strong firms. b. Commercial paper is a form of short-term financing that is primarily used by large, strong, financially stable companies. c. Short-term debt is favored by firms because, while it is generally more expensive than long-term debt, it exposes the borrowing firm to less risk than long-term debt. d. Commercial paper can be issued by virtually any firm so long as it is willing to pay the going interest rate. e. Commercial paper is typically offered at a long-term maturity of at least five years. ANSWER: b POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.15.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Current asset financing KEYWORDS: Bloom's: Knowledge OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 9/26/2017 6:15 PM 82. Which of the following statements is NOT CORRECT? a. Commercial paper can be issued by virtually any firm so long as it is willing to pay the going interest rate. b. Accruals are ―free‖ in the sense that no explicit interest is paid on these funds. c. A conservative approach to working capital management will result in most if not all permanent assets being financed with long-term capital. d. The risk to a firm that borrows with short-term credit is usually greater than if it borrowed using long-term debt. This added risk stems from the greater variability of interest costs on short-term debt and possible difficulties with rolling over short-term debt. e. Bank loans generally carry a higher interest rate than commercial paper. ANSWER: a POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.15.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Current asset financing KEYWORDS: Bloom's: Knowledge OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:10 PM Copyright Cengage Learning. Powered by Cognero.
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83. Which of the following statements is CORRECT? a. Under normal conditions, a firm's expected ROE would probably be higher if it financed with short-term rather than with long-term debt, but using short-term debt would probably increase the firm's risk. b. Conservative firms generally use no short-term debt and thus have zero current liabilities. c. A short-term loan can usually be obtained more quickly than a long-term loan, but the cost of short-term debt is normally higher than that of long-term debt. d. If a firm that can borrow from its bank at a 6% interest rate buys materials on terms of 2/10, net 30, and if it must pay by Day 30 or else be cut off, then we would expect to see zero accounts payable on its balance sheet. e. If one of your firm's customers is "stretching" its accounts payable, this may be a nuisance but it will not have an adverse financial impact on your firm if the customer periodically pays off its entire balance. ANSWER: a POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.15.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Short-term financing KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 9/26/2017 6:15 PM 84. Which of the following statements is NOT CORRECT? a. A company may hold a relatively large amount of cash and marketable securities if it is uncertain about its volume of sales, profits, and cash flows during the coming year. b. Credit policy has an impact on working capital because it influences both sales and the time before receivables are collected. c. The cash budget is useful to help estimate future financing needs, especially the need for short-term working capital loans. d. If a firm wants to generate more cash flow from operations in the next month or two, it could change its credit policy from 2/10, net 30 to net 60. e. Managing working capital is important because it influences financing decisions and the firm's profitability. ANSWER: d POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.15.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management Copyright Cengage Learning. Powered by Cognero.
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LOCAL STANDARDS: TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
United States - OH - Default City - Tier 2: - Capital structure Working capital policy Bloom's: Comprehension Multiple Choice: Conceptual 9/21/2017 6:10 PM 9/26/2017 6:15 PM
85. Which of the following statements is CORRECT? a. Depreciation is included in the estimate of free cash flows (FCF = EBIT(1 – T) + Depreciation – [Capital expenditures + ΔNOWC]), hence depreciation is set forth on a separate line in the cash budget. b. If cash inflows from collections occur in equal daily amounts but most payments must be made on the 10th of each month, then a regular monthly cash budget will be misleading. The problem can be corrected by using a daily cash budget. c. Sound working capital policy is designed to maximize the time between cash expenditures on materials and the collection of cash on sales. d. If a firm wants to generate more cash flow from operations in the next month or two, it could change its credit policy from 2/10, net 30 to net 60. e. If a firm sells on terms of net 90, and if its sales are highly seasonal, with 80% of its sales in September, then its DSO as it is typically calculated (with sales per day = Sales for past 12 months/365) would probably be lower in October than in August. ANSWER: b POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.15.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Working capital concepts KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 9/26/2017 6:15 PM 86. Which of the following statements is CORRECT? a. Accruals are an expensive but commonly used way to finance working capital. b. A conservative financing policy is one where the firm finances part of its fixed assets with short-term capital and all of its net working capital with short-term funds. c. If a company receives trade credit under terms of 2/10, net 30, this implies that the company has 10 days of free trade credit. d. One cannot tell if a firm has a conservative, aggressive, or moderate current asset financing policy without an examination of its cash budget. e. If a firm has a relatively aggressive current asset financing policy vis-à-vis other firms in its industry, then its current ratio will probably be relatively high. ANSWER: c Copyright Cengage Learning. Powered by Cognero.
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POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.15.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Working capital concepts KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 9/26/2017 6:15 PM 87. Halka Company is a no-growth firm. Its sales fluctuate seasonally, causing total assets to vary from $345,000 to $410,000, but fixed assets remain constant at $260,000. If the firm follows a maturity matching (or moderate) working capital financing policy, what is the most likely total of long-term debt plus equity capital? a. $345,000 b. $307,050 c. $262,200 d. $369,150 e. $379,500 ANSWER: a RATIONALE:
Lower total asset range Upper total asset range
$345,000 $410,000
Minimum total assets = FA + Min. CA = $345,000 = LT Debt + Equity A maturity matching policy implies that fixed assets and permanent current assets are financed with long-term sources. This is its most likely level of long-term financing.
POINTS: 1 DIFFICULTY: EASY REFERENCES: 16-3 Current Assets Financing Policies QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.15.03 - Current Assets Financing Policies NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Maturity matching KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 9/26/2017 6:15 PM Copyright Cengage Learning. Powered by Cognero.
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88. Cass & Company has the following data. What is the firm's cash conversion cycle? Inventory Conversion Period = Receivables Collection Period = Payables Deferral Period = a. 46 days b. 30 days c. 45 days d. 39 days e. 38 days ANSWER: RATIONALE:
47 days 17 days 25 days
d
Inventory Conversion Period = Receivables Collection Period = Payables Deferral Period =
47 days 17 days 25 days
CCC = Inv. Conv. Period + Rec. Coll. Period - Pay. Def. Period = 39 days POINTS: 1 DIFFICULTY: EASY REFERENCES: 16-4 The Cash Conversion Cycle QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.15.04 - The Cash Conversion Cycle NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Cash conversion cycle KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 9/26/2017 6:15 PM 89. Romano Inc. has the following data. What is the firm's cash conversion cycle? Inventory Conversion Period = Receivables Collection Period = Payables Deferral Period = a. 21 days b. 24 days c. 19 days d. 22 days e. 14 days ANSWER: RATIONALE:
38 days 19 days 38 days
c
Inventory Conversion Period = Receivables Collection Period = Payables Deferral Period =
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CCC = Inv. Conv. Period + Rec. Coll. Period - Pay. Def. Period = 19 days POINTS: 1 DIFFICULTY: EASY REFERENCES: 16-4 The Cash Conversion Cycle QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.15.04 - The Cash Conversion Cycle NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Cash conversion cycle KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 9/26/2017 6:15 PM 90. Whittington Inc. has the following data. What is the firm's cash conversion cycle? Inventory Conversion Period = Receivables Collection Period = Payables Deferral Period = a. 28 days b. 24 days c. 27 days d. 21 days e. 31 days ANSWER: RATIONALE:
41 days 25 days 38 days
a
Inventory Conversion Period = Receivables Collection Period = Payables Deferral Period =
41 days 25 days 38 days
CCC = Inv. Conv. Period + Rec. Coll. Period - Pay. Def. Period = 28 days POINTS: 1 DIFFICULTY: EASY REFERENCES: 16-4 The Cash Conversion Cycle QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.15.04 - The Cash Conversion Cycle NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Cash conversion cycle KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Problem Copyright Cengage Learning. Powered by Cognero.
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DATE CREATED: DATE MODIFIED:
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91. Inmoo Company’s average age of accounts receivable is 68 days, the average age of accounts payable is 40 days, and the average age of inventory is 69 days. Assuming a 365-day year, what is the length of its cash conversion cycle? a. 113 days b. 76 days c. 97 days d. 104 days e. 114 days ANSWER: c RATIONALE: CCC = Inv. Conv. Period + Rec. Coll. Period - Pay. Deferral. Period
Age of receivables = Rec. Coll. Period = Age of inventory = Inv. Conv. Period = Age of payables = Pay. Def. Period =
68 days 69 days 40 days
CCC = Inv. Conv. Period + Rec. Coll. Period - Pay. Deferral. Period =
97 days
POINTS: 1 DIFFICULTY: EASY REFERENCES: 16-4 The Cash Conversion Cycle QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.15.04 - The Cash Conversion Cycle NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Cash conversion cycle KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 9/26/2017 6:15 PM 92. Singal Inc. is preparing its cash budget. It expects to have sales of $30,000 in January, $35,000 in February, and $20,000 in March. If 20% of sales are for cash, 40% are credit sales paid in the month after the sale, and another 40% are credit sales paid 2 months after the sale, what are the expected cash receipts for March? a. $27,600 b. $34,200 c. $30,000 d. $24,600 e. $28,200 ANSWER: c RATIONALE: Payments:
Cash Pay 2nd month Pay 3rd month Copyright Cengage Learning. Powered by Cognero.
20% 40% 40% Page 916
Sales for month $30,000 $35,000 $20,000
January February March Total collections for month:
January
Collections February
March
$6,000
$12,000 $7,000
$12,000 $14,000 $4,000
$6,000
$19,000
$30,000
POINTS: 1 DIFFICULTY: EASY REFERENCES: 16-5 The Cash Budget QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.15.05 - The Cash Budget NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Cash budget KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 9/26/2017 6:15 PM 93. Dyl Pickle Inc. had credit sales of $4,000,000 last year and its days sales outstanding was DSO = 35 days. What was its average receivables balance, based on a 365-day year. a. $441,096 b. $471,781 c. $368,219 d. $318,356 e. $383,562 ANSWER: e RATIONALE: Sales $4,000,000
DSO
35 days
Receivables = (Sales per day)(DSO) = Sales/365
DSO = $383,562
POINTS: 1 DIFFICULTY: EASY REFERENCES: 16-8 Accounts Receivable QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.15.08 - Accounts Receivable NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management Copyright Cengage Learning. Powered by Cognero.
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LOCAL STANDARDS: TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
United States - OH - Default City - Tier 2: - Capital structure Accounts receivable balance Bloom's: Analysis Multiple Choice: Problem 9/21/2017 6:10 PM 9/26/2017 6:15 PM
94. Edwards Enterprises follows a moderate current asset investment policy, but it is now considering a change, perhaps to a restricted or maybe to a relaxed policy. The firm’s annual sales are $400,000; its fixed assets are $100,000; its target capital structure calls for 50% debt and 50% equity; its EBIT is $39,000; the interest rate on its debt is 10%; and its tax rate is 40%. With a restricted policy, current assets will be 15% of sales, while under a relaxed policy they will be 25% of sales. What is the difference in the projected ROEs between the restricted and relaxed policies? Do not round intermediate calculations. a. 4.91% b. 4.50% c. 5.85% d. 4.45% e. 4.68% ANSWER: c RATIONALE: Sales $400,000 Debt ratio 50% Interest rate 10%
Fixed assets CA/Sales, restricted
$100,000 EBIT CA/Sales, 15% relaxed Restricted $60,000 100,000 $160,000
Relaxed $100,000 100,000 $200,000
Debt Equity Total liab & equity
$80,000 80,000 $160,000
$100,000 100,000 $200,000
EBIT Interest EBT Taxes NI
$39,000 8,000 $31,000 12,400 $18,600
$39,000 10,000 $29,000 11,600 $17,400
ROE
23.25%
17.40%
CA FA Total assets
$39,000 Tax rate
40%
25%
Difference in ROE = 5.85%
POINTS: DIFFICULTY: REFERENCES: QUESTION TYPE:
1 MODERATE 16-2 Current Asset Investment Policies Multiple Choice
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HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.15.02 - Current Assets Investment Policies NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: LOCAL STANDARDS: TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management United States - OH - Default City - Tier 2: - Capital structure ROE and WC policy Bloom's: Evaluation Multiple Choice: Problem 9/21/2017 6:10 PM 9/26/2017 6:15 PM
95. Data on Shick Inc. for last year are shown below, along with the days sales outstanding of the firms against which it benchmarks. The firm's new CFO believes that the company could reduce its receivables enough to reduce its DSO to the benchmarks' average. If this were done, by how much would receivables decline? Use a 365-day year. Do not round your intermediate calculations. Sales Accounts receivable Days Sales Outstanding (DSO) Benchmarks' Days Sales Outstanding (DSO) a. $9,124 b. $8,331 c. $12,100 d. $9,918 e. $7,538 ANSWER: RATIONALE:
$111,000 $16,000 52.61 20.000
d
Original
Sales Receivables and DSO
Data Related DSO $111,000 $16,000 52.61
Benchmarks' DSO
Receivables at Benchmark Level
20.000
New receivables = DSO (Sales/365) = Reduction in receivables = Original Receivables – New Receivables = Alternative solution: (Change in DSO/Original DSO) Original receivables =
$6,082 $9,918 $10,740
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 16-4 The Cash Conversion Cycle QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES FOFM.BRIG.17.15.04 - The Cash Conversion Cycle : NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS:
United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management
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LOCAL STANDARDS: TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
United States - OH - Default City - Tier 2: - Capital structure Days sales outstanding (DSO) Bloom's: Evaluation Multiple Choice: Problem 9/21/2017 6:10 PM 9/26/2017 6:15 PM
96. Your firm's cost of goods sold (COGS) average $2,000,000 per month, and it keeps inventory equal to 50% of its monthly COGS on hand at all times. Using a 365-day year, what is its inventory conversion period? a. 15.2 days b. 14.0 days c. 15.7 days d. 13.7 days e. 14.8 days ANSWER: a RATIONALE: Monthly COGS = $2,000,000
Inventory/COGS = Annual COGS = Avg. Inventory =
50.0% $24,000,000 $1,000,000
Inv Conv Period = Inv/COGS per day = Inv / (Annual COGS/365) = 15.2 days
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 16-4 The Cash Conversion Cycle QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.15.04 - The Cash Conversion Cycle NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Inventory conv. period KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 9/26/2017 6:15 PM 97. Data on Shin Inc for last year are shown below, along with the inventory conversion period (ICP) of the firms against which it benchmarks. The firm's new CFO believes that the company could reduce its inventory enough to reduce its ICP to the benchmarks' average. If this were done, by how much would inventories decline? Use a 365-day year. Do not round your intermediate calculations. Cost of goods sold = Inventory = Inventory Conversion Period (ICP) = Benchmark Inventory Conversion Period (ICP) =
$71,000 $20,000 102.82 38.00
a. $12,608 b. $14,752 Copyright Cengage Learning. Powered by Cognero.
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c. $11,221 d. $11,347 e. $12,482 ANSWER: RATIONALE:
a
Original Data
Related ICP Benchmarks' ICP
ICP at Benchmark Level
Cost of goods sold $71,000 Inventory and ICP $20,000 102.82 38.00 New inventory = ICP (COGS/365) = Reduction in inventories = Original Inv. – New Inv. = Alternative solution: (Change in ICP/Original ICP) Orig. Inv =
$7,392 $12,608 $12,192
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 16-4 The Cash Conversion Cycle QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.15.04 - The Cash Conversion Cycle NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Inventory conversion period KEYWORDS: Bloom's: Evaluation OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 9/26/2017 6:15 PM 98. Data on Wentz Inc. for last year are shown below, along with the payables deferral period (PDP) for the firms against which it benchmarks. The firm's new CFO believes that the company could delay payments enough to increase its PDP to the benchmarks' average. If this were done, by how much would payables increase? Use a 365-day year. Do not round your intermediate calculations. Cost of goods sold = Payables = Payables Deferral Period (PDP) = Benchmark Payables Deferral Period = a. $1,036 b. $1,382 c. $1,342 d. $1,648 e. $1,329 ANSWER: RATIONALE:
$77,000 $5,000 23.70 30.000
e
Original Payables at
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Data
Related PDP Benchmarks' PDP
Benchmark Levels
Cost of goods sold $77,000 Payables and PDP $5,000 23.70 30.000 New payables = PDP (COGS/365) = Increase in payables = New Payables – Original Payables = Alternative solution: (Change in PDP/Original PDP) Orig. payables =
$6,329 $1,329 $1,657
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 16-4 The Cash Conversion Cycle QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.15.04 - The Cash Conversion Cycle NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Payables deferral period KEYWORDS: Bloom's: Evaluation OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 9/26/2017 6:15 PM 99. Your consulting firm was recently hired to improve the performance of Shin-Soenen Inc, which is highly profitable but has been experiencing cash shortages due to its high growth rate. As one part of your analysis, you want to determine the firm’s cash conversion cycle. Using the following information and a 365-day year, what is the firm’s present cash conversion cycle? Do not round intermediate calculations. Average inventory = Annual sales = Annual cost of goods sold = Average accounts receivable = Average accounts payable = a. 128.4 days b. 121.5 days c. 87.1 days d. 114.6 days e. 88.2 days ANSWER: RATIONALE:
$75,000 $775,000 $465,000 $160,000 $25,000
d
Avg. inventory = Avg. receivables = Avg. payables =
$75,000 $160,000 $25,000
Annual sales = Annual COGS = Days in year =
Inv Conv Period = Inv/(COGS/365) + DSO = Receivables/(Sales/365) – Payables deferral = Payables/(COGS/365) Cash Conversion Cycle (CCC) Copyright Cengage Learning. Powered by Cognero.
$775,000 $465,000 365
58.9 days 75.4 days –19.6 days 114.6 days Page 922
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 16-4 The Cash Conversion Cycle QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.15.04 - The Cash Conversion Cycle NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Cash conversion cycle KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 9/26/2017 6:15 PM 100. Dewey Corporation has the following data, in thousands. Assuming a 365-day year, what is the firm's cash conversion cycle? Do not round intermediate calculations. Round your answer to the nearest day. Annual sales = Annual cost of goods sold = Inventory = Accounts receivable = Accounts payable = a. 29 days b. 25 days c. 30 days d. 36 days e. 33 days ANSWER: RATIONALE:
$53,000 $37,100 $4,000 $2,000 $2,400
c
Annual sales Annual cost of goods sold (COGS) Inventory Accounts receivable Accounts payable Days in year Sales per day = COGS per day = Inv Conv Period = Inv/COGS per day = Average Coll Period = Receivables/Sales per day = Pay. Def. Period = Accounts payable/COGS per day =
$53,000 $37,100 $4,000 $2,000 $2,400 365 $145.21 $101.64 39.35 days 13.77 days 23.61 days
CCC = Inv Conv Period + Receivables Coll Period - Pay Def Period = 29.51 days
POINTS: DIFFICULTY:
1 MODERATE
Copyright Cengage Learning. Powered by Cognero.
Page 923
REFERENCES: 16-4 The Cash Conversion Cycle QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.15.04 - The Cash Conversion Cycle NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Cash conversion cycle KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 9/26/2017 6:15 PM 101. Zervos Inc. had the following data for last year (in millions). The new CFO believes (1) that an improved inventory management system could lower the average inventory by $4,000, (2) that improvements in the credit department could reduce receivables by $2,000, and (3) that the purchasing department could negotiate better credit terms and thereby increase accounts payable by $2,000. Furthermore, she thinks that these changes would not affect either sales or the costs of goods sold. If these changes were made, by how many days would the cash conversion cycle be lowered? Do not round your intermediate calculations.
Annual sales: unchanged Cost of goods sold: unchanged Average inventory: lowered by $4,000 Average receivables: lowered by $2,000 Average payables: increased by $2,000 Days in year a. 40.3 days b. 37.6 days c. 39.7 days d. 33.6 days e. 32.6 days ANSWER: RATIONALE:
Original $117,000 $80,000 $20,000 $16,000 $10,000 365
Revised $117,000 $80,000 $16,000 $14,000 $12,000 365
d
Annual sales: unchanged Cost of goods sold: unchanged Average inventory: lowered by $4,000 Average receivables: lowered by $2,000 Average payables: increased by $2,000 Days in year Inv Conv Period = Inv/(COGS/365) = DSO = Receivables/(Sales/365) = Payables deferral = Payables/(COGS/365) = CCC = Inv Conv + DSO - Pay Def Period =
Original $117,000 $80,000 $20,000 $16,000 $10,000 365 91.25 days 49.91 days 45.63 days 95.53 days
Revised $117,000 $80,000 $16,000 $14,000 $12,000 365 73.00 days 43.68 days 54.75 days 61.93 days
Change = 33.61 days
POINTS: DIFFICULTY:
1 MODERATE
Copyright Cengage Learning. Powered by Cognero.
Page 924
REFERENCES: 16-4 The Cash Conversion Cycle QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.15.04 - The Cash Conversion Cycle NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Cash conversion cycle KEYWORDS: Bloom's: Evaluation OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 9/26/2017 6:15 PM 102. Desai Inc. has the following data, in thousands. Assuming a 365-day year, what is the firm's cash conversion cycle? Do not round intermediate calculations. Round to the nearest whole day. Annual sales = Annual cost of goods sold = Inventory = Accounts receivable = Accounts payable = a. 47 days b. 56 days c. 52 days d. 54 days e. 58 days ANSWER: RATIONALE:
$45,000 $22,500 $4,500 $1,800 $2,500
a
Annual sales Annual cost of goods sold (COGS) Inventory Accounts receivable Accounts payable Days in year Sales per day = COGS per day = Inv Conv Period = Inv/COGS per day = Average Coll Period = Receivables/Sales per day = Pay. Def. Period = Accounts payable/COGS per day =
$45,000 $22,500 $4,500 $1,800 $2,500 365 $123.29 $61.64 73.00 days 14.60 days 40.56 days
CCC = Inv. Conv. Period + Receivables Coll Period - Pay. Def. Period = 47.04 days
POINTS: DIFFICULTY: REFERENCES: QUESTION TYPE: HAS VARIABLES:
1 MODERATE 16-4 The Cash Conversion Cycle Multiple Choice True
Copyright Cengage Learning. Powered by Cognero.
Page 925
LEARNING OBJECTIVES: FOFM.BRIG.17.15.04 - The Cash Conversion Cycle NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Cash conversion cycle KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 9/26/2017 6:15 PM 103. Edison Inc. has annual sales of $41,610,000, or $114,000 a day on a 365-day basis. The firm's cost of goods sold are 75% of sales. On average, the company has $9,000,000 in inventory and $8,000,000 in accounts receivable. The firm is looking for ways to shorten its cash conversion cycle. Its CFO has proposed new policies that would result in a 20% reduction in both average inventories and accounts receivable. She also anticipates that these policies would reduce sales by 10%, while the payables deferral period would remain unchanged at 35 days. What effect would these policies have on the company's cash conversion cycle? Do not round intermediate calculations. Round to the nearest whole day. a. –16 days b. –21 days c. –17 days d. –19 days e. –22 days ANSWER: d RATIONALE: Original New
Annual sales Days in year Sales per day COGS/Sales COGS per day Inventory Accounts receivable Pay deferral period % reduction in Inv % reduction in Rec. % reduction in sales
$41,610,000 365 $114,000 75% $85,500 $9,000,000 $8,000,000 35 days
$37,449,000 365 $102,600 75% $76,950 $7,200,000 $6,400,000 35 days 20% 20% 10%
Cash conversion cycle = Inv. conversion period + Receivables collection period – Pay deferral period CCC Orig = 105.26 + 70.18 - 35.00 = 140.44 days CCC New = 93.57 + 62.38 - 35.00 = 120.95 days CCC New – CCC Orig = 120.95 – 140.44 = –19.49 days
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 16-4 The Cash Conversion Cycle QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.15.04 - The Cash Conversion Cycle NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management Copyright Cengage Learning. Powered by Cognero.
Page 926
LOCAL STANDARDS: TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
United States - OH - Default City - Tier 2: - Capital structure Cash conversion cycle Bloom's: Evaluation Multiple Choice: Problem 9/21/2017 6:10 PM 9/26/2017 6:15 PM
104. Van Den Borsh Corp. has annual sales of $68,735,000, an average inventory level of $15,012,000, and average accounts receivable of $10,008,000. The firm's cost of goods sold is 85% of sales. The company makes all purchases on credit and has always paid on the 30th day. However, it now plans to take full advantage of trade credit and to pay its suppliers on the 40th day. The CFO also believes that sales can be maintained at the existing level but inventory can be lowered by $1,946,000 and accounts receivable by $1,946,000. What will be the net change in the cash conversion cycle, assuming a 365-day year? Do not round intermediate calculations. Round to the nearest whole day. a. –34 days b. –27 days c. –31 days d. –25 days e. –32 days ANSWER: e RATIONALE: Original New
Annual sales Days in year Sales per day COGS/Sales COGS per day Inventory Accounts receivable Pay deferral period $ reduction in Inv $ reduction in Rec.
$68,735,000 365 $188,315 85.00% $160,068 $15,012,000 $10,008,000 30 days
$68,735,000 365 $188,315 85.00% $160,068 $13,066,000 $8,062,000 40 days $1,946,000 $1,946,000
Cash conversion cycle = Inv. conversion period + Receivables collection period – Pay deferral period. CCC Orig = 93.79 + 53.14 - 30.00 = 116.93 days CCC New = 81.63 + 42.81 - 40.00 = 84.44 days CCC New – CCC Orig = 84.44 – 116.93 = –32.49 days
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 16-4 The Cash Conversion Cycle QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.15.04 - The Cash Conversion Cycle NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Cash conversion cycle KEYWORDS: Bloom's: Evaluation Copyright Cengage Learning. Powered by Cognero.
Page 927
OTHER: DATE CREATED: DATE MODIFIED:
Multiple Choice: Problem 9/21/2017 6:10 PM 9/26/2017 6:15 PM
105. Nogueiras Corp’s budgeted monthly sales are $10,500, and they are constant from month to month. 40% of its customers pay in the first month and take the 2% discount, while the remaining 60% pay in the month following the sale and do not receive a discount. The firm has no bad debts. Purchases for next month’s sales are constant at 50% of projected sales for the next month. "Other payments", which include wages, rent, and taxes, are 25% of sales for the current month. Construct a cash budget for a typical month and calculate the average cash gain or loss during the month. Do not round intermediate calculations. a. $2,007 b. $2,236 c. $2,998 d. $2,541 e. $1,931 ANSWER: d RATIONALE: Monthly sales $10,500
Monthly purchase % Other payments: Payment pattern: Discount: Cash budget: Sales
50% 25% Sales month 40% 2% Last Month $10,500
Next month 60%
Current Month $10,500
Collections, same month’s sales: (% of sales)(sales)(1Discount): Collections (last month’s sales) Total collections Purchases payments Other payments Total payments Net cash gain (loss)
Next Month $10,500 $4,116 6,300 $10,416 5,250 2,625 $7,875 $2,541
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 16-5 The Cash Budget QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.15.05 - The Cash Budget NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Cash budget KEYWORDS: Bloom's: Application Copyright Cengage Learning. Powered by Cognero.
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OTHER: DATE CREATED: DATE MODIFIED:
Multiple Choice: Problem 9/21/2017 6:10 PM 9/26/2017 6:15 PM
106. Whitmer Inc. sells to customers all over the U.S., and all receipts come in to its headquarters in New York City. The firm's average accounts receivable balance is $2.5 million, and they are financed by a bank loan at an 6.75% annual interest rate. The firm is considering setting up a regional lockbox system to speed up collections, and it believes this would reduce receivables by 20%. If the annual cost of the system is $15,000, what pre-tax net annual savings would be realized? a. $22,313 b. $16,313 c. $18,750 d. $21,375 e. $20,438 ANSWER: c RATIONALE: Average accounts receivable balance $2,500,000
Annual interest rate to finance A/R % Reduction in A/R Annual lockbox cost
6.75% 20.00% $15,000
Reduction in A/R = % reduction in A/R Avg. A/R balance Reduction in A/R = 20.00% $2,500,000 Reduction in A/R = $500,000 Annual int savings = Reduction in A/R Annual interest rate Annual int savings = $500,000 6.75% Annual int savings = $33,750 Pre-tax net annual savings = Annual interest savings – Annual lockbox cost Pre-tax net annual savings = $33,750 – $15,000 Pre-tax net annual savings = $18,750 POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 16-6 Cash and Marketable Securities QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.15.06 - Cash and Marketable Securities NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Lockbox KEYWORDS: Bloom's: Evaluation OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 9/26/2017 6:15 PM Copyright Cengage Learning. Powered by Cognero.
Page 929
107. A firm buys on terms of 3/15, net 45. It does not take the discount, and it generally pays after 85 days. What is the nominal annual percentage cost of its non-free trade credit, based on a 365-day year? a. 17.58% b. 15.00% c. 18.55% d. 16.13% e. 13.22% ANSWER: d RATIONALE: Discount % 3% Net days 45
Discount days
15 Actual days to payment
85
Nom. % cost = Disc %/(100 - Disc %) (365/(Actual days - Disc days)) Nom. % cost = 3.09% 5.21 = 16.13% The effective discount % is earned N times per year; the product is the nominal annual cost rate.
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 16-9 Accounts Payable (Trade Credit) QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.15.09 - Accounts Payable (Trade Credit) NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Trade credit: nom. cost KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 9/26/2017 6:15 PM 108. Atlanta Cement, Inc. buys on terms of 2/15, net 30. It does not take discounts, and it typically pays 65 days after the invoice date. Net purchases amount to $720,000 per year. What is the nominal annual percentage cost of its non-free trade credit, based on a 365-day year? a. 16.83% b. 14.90% c. 11.17% d. 12.51% e. 14.60% ANSWER: b RATIONALE: Discount % 2% Net days 30
Discount days
15 Actual days to payment
65
Nom. % cost = Disc %/(100 - Disc %) (365/(Actual days - Disc days)) Nom. % cost = 2.04% 7.30 = 14.90% The effective discount % is earned N times per year; the product is the nominal annual cost rate. Copyright Cengage Learning. Powered by Cognero.
Page 930
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 16-9 Accounts Payable (Trade Credit) QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.15.09 - Accounts Payable (Trade Credit) NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Trade credit: nom. cost KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 9/26/2017 6:15 PM 109. Your company has been offered credit terms of 4/30, net 90 days. What will be the nominal annual percentage cost of its non-free trade credit if it pays 145 days after the purchase? (Assume a 365-day year.) a. 14.81% b. 15.74% c. 13.22% d. 11.77% e. 13.89% ANSWER: c RATIONALE: Discount % 4% Net days 90
Discount days
30 Actual days to payment
Nom. % cost = Disc %/(100 - Disc %)
145
(365/(Actual days - Disc days)) = 13.22%
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 16-9 Accounts Payable (Trade Credit) QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.15.09 - Accounts Payable (Trade Credit) NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Trade credit: nom. cost KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 9/26/2017 6:15 PM 110. Bumpas Enterprises purchases $4,562,500 in goods per year from its sole supplier on terms of 2/15, net 55. If the firm chooses to pay on time but does not take the discount, what is the effective annual percentage cost of its non-free trade credit? (Assume a 365-day year.) Copyright Cengage Learning. Powered by Cognero.
Page 931
a. 24.49% b. 20.24% c. 19.03% d. 18.62% e. 17.00% ANSWER: RATIONALE:
b
Discount % Discount days
2% Net days 15 Actual days to payment
EAR = [ 1 + Disc %/(100 – Disc %)]
[365/(Actual days – Disc. Period)]
55 55
– 1 = 20.24%
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 16-9 Accounts Payable (Trade Credit) QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.15.09 - Accounts Payable (Trade Credit) NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Trade credit: EAR cost KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 9/26/2017 6:15 PM 111. A firm buys on terms of 2/8, net 45 days, it does not take discounts, and it actually pays after 85 days. What is the effective annual percentage cost of its non-free trade credit? (Use a 365-day year.) a. 10.05% b. 10.55% c. 7.84% d. 8.64% e. 9.55% ANSWER: a RATIONALE: Discount % 2% Net days 45
Discount days
8 Actual days to payment
EAR = [ 1 + Disc %/(100 – Disc %)]
[365/(Actual days – Disc. Period)]
85
– 1 = 10.05%
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 16-9 Accounts Payable (Trade Credit) QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.15.09 - Accounts Payable (Trade Credit) Copyright Cengage Learning. Powered by Cognero.
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NATIONAL STANDARDS: STATE STANDARDS: LOCAL STANDARDS: TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management United States - OH - Default City - Tier 2: - Capital structure Trade credit: EAR cost Bloom's: Analysis Multiple Choice: Problem 9/21/2017 6:10 PM 9/26/2017 6:15 PM
112. Buskirk Construction buys on terms of 2/15, net 60 days. It does not take discounts, and it typically pays on time, 60 days after the invoice date. Net purchases amount to $500,000 per year. On average, how much ―free‖ trade credit does the firm receive during the year? (Assume a 365-day year, and note that purchases are net of discounts.) a. $24,863 b. $19,315 c. $16,644 d. $20,548 e. $18,699 ANSWER: d RATIONALE: Purchases $500,000 Net days 60
Discount % Discount days
2% Days to payment 15 Days/Year
60 365
Purchases/day = $500,000 / 365 = $1,370 Free credit = Disc days Purchases/day = $20,548
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 16-9 Accounts Payable (Trade Credit) QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.15.09 - Accounts Payable (Trade Credit) NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Free trade credit KEYWORDS: Bloom's: Evaluation OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 9/26/2017 6:15 PM 113. Ingram Office Supplies, Inc., buys on terms of 2/15, net 50 days. It does not take discounts, and it typically pays on time, 50 days after the invoice date. Net purchases amount to $800,000 per year. On average, what is the dollar amount of costly trade credit (total credit – free credit) the firm receives during the year? (Assume a 365-day year, and note that purchases are net of discounts.) Do not round intermediate calculations. a. $91,288 b. $76,712 c. $83,616 Copyright Cengage Learning. Powered by Cognero.
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d. $79,781 e. $93,589 ANSWER: RATIONALE:
b
Purchases Discount % Discount days
$800,000 Net days 2% Days to payment 15 Days/Year
50 50 365
Purchases/day = $800,000/365 = $2,192 Avg. trade credit = Average A/P = Days to payment Net purchases/day = $109,589 Free trade credit = Discount days Purchases/day = $32,877 Costly trade credit = Total credit - Free credit = $76,712 Alternatively, Costly TC = (Days to pmt – Disc days) (Purchases/day) = $76,712
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 16-9 Accounts Payable (Trade Credit) QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES FOFM.BRIG.17.15.09 - Accounts Payable (Trade Credit) : NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: LOCAL STANDARDS: TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management United States - OH - Default City - Tier 2: - Capital structure Costly trade credit Bloom's: Analysis Multiple Choice: Problem 9/21/2017 6:10 PM 9/26/2017 6:15 PM
114. Roton Inc. purchases merchandise on terms of 2/15, net 40, and its gross purchases (i.e., purchases before taking off the discount) are $675,000 per year. What is the maximum dollar amount of costly trade credit the firm could get, assuming it abides by the supplier’s credit terms? (Assume a 365-day year.) Do not round intermediate calculations. a. $41,684 b. $51,198 c. $48,027 d. $38,965 e. $45,308 ANSWER: e RATIONALE: Discount 2% Gross purchases $675,000
Discount days Net days
15 Days in year
365
40
Net purchases = Gross (1 - Disc %) = $661,500 Net purchase per day = Net / 365 = $1,812 Copyright Cengage Learning. Powered by Cognero.
Page 934
Total trade credit = Net days Net per day = $72,493 Free credit = Net per day Discount days = $27,185 Costly credit = Total credit - Free credit = $45,308 POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 16-9 Accounts Payable (Trade Credit) QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.15.09 - Accounts Payable (Trade Credit) NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Costly trade credit KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 9/26/2017 6:15 PM 115. Kirk Development buys on terms of 2/15, net 60 days. It does not take discounts, and it typically pays on time, 60 days after the invoice date. Net purchases amount to $650,000 per year. On average, what is the dollar amount of total trade credit (costly + free) the firm receives during the year, i.e., what are its average accounts payable? (Assume a 365day year, and note that purchases are net of discounts.) a. $106,849 b. $125,014 c. $117,534 d. $123,945 e. $107,918 ANSWER: a RATIONALE: Purchases $650,000 Net days 60
Discount % Discount days
2% Days to payment 15 Days/Year
Purchases/day = $650,000 / 365 = $1,781 Average trade credit = Average A/P = Days to payment
60 365
Net purchases/day = $106,849
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 16-9 Accounts Payable (Trade Credit) QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.15.09 - Accounts Payable (Trade Credit) NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Total trade credit Copyright Cengage Learning. Powered by Cognero.
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KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
Bloom's: Analysis Multiple Choice: Problem 9/21/2017 6:10 PM 9/26/2017 6:15 PM
116. Affleck Inc.'s business is booming, and it needs to raise more capital. The company purchases supplies on terms of 1/10, net 20, and it currently takes the discount. One way of acquiring the needed funds would be to forgo the discount, and the firm's owner believes she could delay payment to 60 days without adverse effects. What would be the effective annual percentage cost of funds raised by this action? (Assume a 365-day year.) a. 9.14% b. 6.24% c. 7.61% d. 7.23% e. 8.98% ANSWER: c RATIONALE: Discount % 1% Net days 20
Discount days
10 Actual days to payment
EAR = [ 1 + Disc %/(100 – Disc %)]
[365/(Actual days – Disc. Period)]
60 – 1 = 7.61%
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 16-9 Accounts Payable (Trade Credit) QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.15.09 - Accounts Payable (Trade Credit) NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Stretching accounts payable KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 9/26/2017 6:15 PM 117. Weiss Inc. arranged a $9,000,000 revolving credit agreement with a group of banks. The firm paid an annual commitment fee of 0.5% on the unused balance of the loan commitment. On the used portion of the revolver, it paid 1.5% above prime for the funds actually borrowed on a simple interest basis. The prime rate was 9% during the year. If the firm borrowed $6,000,000 immediately after the agreement was signed and repaid the loan at the end of one year, what was the total dollar annual cost of the revolver? Do not round intermediate calculations. a. $715,950 b. $793,350 c. $645,000 d. $735,300 e. $703,050 ANSWER: c RATIONALE: Total commitment $9,000,000 Copyright Cengage Learning. Powered by Cognero.
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Fee on unused balance Prime rate Premium over prime Amount borrowed
0.5% 9.0% 1.5% $6,000,000
Interest rate on borrowed funds = Prime + Premium = Cost of used portion = Amount borrowed Rate = Cost of unused portion: Unused balance Fee = Total annual cost of loan agreement =
10.5% $630,000 $15,000 $645,000
Alternative solution: Rate per day = 10.5%/365 = Interest per day = (Rate per day)(Amount borrowed) = Interest per year = (Interest per day)(365) = Cost of unused portion: Unused balance Fee = Total annual cost of loan agreement =
0.0287671% $1,726 $630,000 $15,000 $645,000
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 16-10 Bank Loans QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.15.10 - Bank Loans NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Revolving credit agreement KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 9/26/2017 6:15 PM 118. Soenen Inc. had the following data for last year (in millions). The new CFO believes that the company could improve its working capital management sufficiently to bring its net working capital and cash conversion cycle up to the benchmark companies' level without affecting either sales or the costs of goods sold. Soenen finances its net working capital with a bank loan at an 8% annual interest rate, and it uses a 365-day year. If these changes had been made, by how much would the firm's pre-tax income have increased? Do not round your intermediate calculations.
Sales Cost of goods sold Inventory (ICP) Receivables (DSO) Payables (PDP)
Original Data $99,000 $80,000 $20,000 $16,000 $5,000
Related CCC
Benchmarks' CCC
91.25 58.99 22.81 127.43
38.00 20.00 30.00 28.00
a. $1,467 b. $1,906 c. $1,810 Copyright Cengage Learning. Powered by Cognero.
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d. $2,058 e. $1,849 ANSWER: RATIONALE:
b
Sales Cost of goods sold Inventory = ICP(COGS/365) = Receivables = DSO(Sales/365) = Payables = PDP(COGS/365) =
Original Related Benchmarks' Benchmarks' Data CCC CCC Levels $99,000 $80,000 $20,000 91.25 days 38.00 days $8,329 $16,000 58.99 days 20.00 days $5,425 $5,000 22.81 days 30.00 days $6,575
New and old NWC $31,000 127.43 days Reduction in NWC = Old – New = Interest rate = 8% Savings = Interest rate Reduction in NWC =
28.00 days
$7,179 $23,821 $1,906
POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 16-4 The Cash Conversion Cycle QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.15.04 - The Cash Conversion Cycle NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Cash conversion cycle KEYWORDS: Bloom's: Evaluation OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 9/26/2017 6:15 PM 119. Margetis Inc. carries an average inventory of $750,000. Its annual sales are $10 million, its cost of goods sold are 75% of annual sales, and its receivables collection period is twice as long as its inventory conversion period. The firm buys on terms of net 30 days, and it pays on time. Its new CFO wants to decrease the cash conversion cycle by 18 days, based on a 365-day year. He believes he can reduce the average inventory to $605,885 with no effect on sales. By how much must the firm also reduce its accounts receivable to meet its goal in the reduction of its cash conversion cycle? Do not round your intermediate calculations. a. $300,997 b. $234,778 c. $249,828 d. $325,077 e. $310,027 ANSWER: a RATIONALE: Original New
Inventory Copyright Cengage Learning. Powered by Cognero.
$750,000
$605,885 Page 938
Annual sales Days/year COGS/Sales Payables deferral period (PDP) Rec collection period (DSO) = Cost of goods sold Inv Conv Period (ICP) DSO (calculated) Receivables (A/R)
$10,000,000 365 75.00%
$10,000,000 365 75.00%
30.00 days
30.00 days
$7,500,000 36.50 days 73.00 days $2,000,000
$7,500,000 29.49 days 62.01 days $1,699,003
CCC = DSO + ICP – PDP =
79.50 days
61.50 days
2 × ICP
Decrease in CCC New CCC
CHECK on CCC
18 days 61.50 days
Reduction in A/R = Orig. A/R – New A/R = $300,997
POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 16-4 The Cash Conversion Cycle QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.15.04 - The Cash Conversion Cycle NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Cash conversion cycle KEYWORDS: Bloom's: Evaluation OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 9/26/2017 6:15 PM 120. Suppose the credit terms offered to your firm by its suppliers are 2/10, net 30 days. Your firm is not taking discounts, but is paying after 22 days instead of Day 30. You point out that the nominal cost of not taking the discount and paying on Day 30 is approximately 37%. But since your firm is neither taking discounts nor paying on the due date, what is the effective annual percentage cost (not the nominal cost) of its costly trade credit, using a 365-day year? a. 88.3% b. 70.4% c. 77.2% d. 78.9% e. 84.9% ANSWER: e RATIONALE: Discount % 2% Net days 30
Discount days
10 Actual days to payment
EAR = [ 1 + Disc %/(100 – Disc %)]
Copyright Cengage Learning. Powered by Cognero.
[365/(Actual days – Disc. Period)]
22
- 1 = 84.87%
Page 939
POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 16-9 Accounts Payable (Trade Credit) QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.15.09 - Accounts Payable (Trade Credit) NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Trade credit: EAR cost KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 9/26/2017 6:15 PM 121. Aggarwal Inc. buys on terms of 2/10, net 30, and it always pays on the 30th day. The CFO calculates that the average amount of costly trade credit carried is $350,000. What is the firm's average accounts payable balance? Assume a 365-day year. a. $425,250 b. $504,000 c. $525,000 d. $556,500 e. $514,500 ANSWER: c RATIONALE: Discount % 2% Net days 30
Discount days Costly trade credit
10 Actual days to payment $350,000 Years/day
30 365
Costly trade credit= Purchases per day (Days credit is outstanding – Discount period) $350,000= Purchases per day 20 Purchases per day= $17,500 Free trade credit = Free trade credit = Free trade credit = Total trade credit = Total trade credit = Total trade credit = POINTS: DIFFICULTY: REFERENCES: QUESTION TYPE:
Purchases per day period $17,500 10 $175,000
Discount
Costly trade credit + Free trade credit $350,000+ $175,000 $525,000
1 CHALLENGING 16-9 Accounts Payable (Trade Credit) Multiple Choice
Copyright Cengage Learning. Powered by Cognero.
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HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.15.09 - Accounts Payable (Trade Credit) NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Accounts payable balance KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 9/26/2017 6:15 PM 122. Gonzales Company currently uses maximum trade credit by not taking discounts on its purchases. The standard industry credit terms offered by all its suppliers are 2/10, net 38 days, and the firm pays on time. The new CFO is considering borrowing from its bank, using short-term notes payable, and then taking discounts. The firm wants to determine the effect of this policy change on its net income. Its net purchases are $11,760 per day, using a 365-day year. The interest rate on the notes payable is 10%, and the tax rate is 40%. If the firm implements the plan, what is the expected change in net income? Do not round intermediate calculations. a. $32,803 b. $36,084 c. $33,787 d. $32,147 e. $38,052 ANSWER: a RATIONALE: Discount % 2% Net days 38
Discount days Net purchases/day Annual interest rate
10 Actual days to payment $11,760 Days/year 10.00% Tax rate
A/P No disc. = Net purchases/day A/P No disc. = $11,760 38 A/P No disc. = $446,880 A/P Disc. = Net purchases/day A/P Disc. = $11,760 10 A/P Disc. = $117,600
38 365 40.00%
Actual days to payment
Discount days
Amount needed to be financed = A/P No disc. – A/P Disc. Amount needed to be financed = $446,880 – $117,600 Amount needed to be financed = $329,280 Additional interest cost = Amount needed to be financed
Additional interest
rate
Additional interest cost = $329,280 10.00% Additional interest cost = $32,928 Copyright Cengage Learning. Powered by Cognero.
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Gross purchases = (Net purchases/day 365)/(1-Disc. %) Gross purchases = $11,760 365 / 98.00% Gross purchases (at the end of the first year) = $4,380,000 Discounts lost = Gross purchases Discount % Discounts lost = $4,380,000 2.00% Discounts lost (at the end of the first year) = $87,600 Pre-tax savings = Discounts lost –Additional interest Pre-tax savings = $87,600 – $32,928 Pre-tax savings = $54,672 After-tax savings = Pre-tax savings (1– T) After-tax savings = $54,672 60.00% After-tax savings = $32,803
POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 16-9 Accounts Payable (Trade Credit) QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.15.09 - Accounts Payable (Trade Credit) NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Fin. stmts. and trade credit KEYWORDS: Bloom's: Evaluation OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 9/26/2017 6:15 PM 123. Zarruk Construction’s DSO is 50 days (on a 365-day basis), accounts receivable are $100 million, and its balance sheet shows inventory of $170 million. What is the inventory turnover ratio? a. 4.98 b. 3.86 c. 4.29 d. 5.20 e. 3.22 ANSWER: c RATIONALE: DSO 50 Days/year 365
Receivables
$100 Inventory
$170
Use DSO equation to find sales: DSO = Receivables/(Sales/365) Sales = 365(Receivables)/DSO = $730 Inventory turnover = Sales / Inventory = 4.29 Copyright Cengage Learning. Powered by Cognero.
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POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.15.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Inventory turnover and DSO KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 9/26/2017 6:15 PM 124. Madura Inc. wants to increase its free cash flow by $180 million during the coming year, which should result in a higher EVA and stock price. The CFO has made these projections for the upcoming year: · EBIT is projected to equal $960 million. Gross capital expenditures are expected to total to $360 million versus depreciation of $120 million, so its net · capital expenditures should total $240 million. · The tax rate is 40%. There will be no changes in cash or marketable securities, nor will there be any changes in notes payable or · accruals. What increase in net operating working capital (in millions of dollars) would enable the firm to meet its target increase in FCF? a. $176 b. $156 c. $117 d. $161 e. $137 ANSWER: b RATIONALE: EBIT $960
Gross capital expenditures Depreciation Tax rate Target increase in FCF
$360 $120 40% $180
= EBIT(1 – T) FCF + Deprec. – Capex – NOWC
$180 = $576+ $120 – $360 – = $336– $180
NOWC
NOWC
-$156= – NOWC NOWC = $156 Copyright Cengage Learning. Powered by Cognero.
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POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.15.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Working capital, FCF KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 9/26/2017 6:15 PM Exhibit 15.1 Zorn Corporation is deciding whether to pursue a restricted or relaxed working capital investment policy. The firm's annual sales are expected to total $4,400,000, its fixed assets turnover ratio equals 4.0, and its debt and common equity are each 50% of total assets. EBIT is $150,000, the interest rate on the firm's debt is 10%, and the tax rate is 40%. If the company follows a restricted policy, its total assets turnover will be 2.5. Under a relaxed policy its total assets turnover will be 2.2. 125. Refer to Exhibit 15.1. If the firm adopts a restricted policy, how much lower would its interest expense be than under the relaxed policy? Do not round intermediate calculations. a. $13,320 b. $14,520 c. $12,000 d. $11,400 e. $13,920 ANSWER: RATIONALE:
c
Annual sales Fixed assets turnover (FATO) Debt/TA Equity/TA EBIT Interest rate Tax rate Total assets turnover (restricted) Total assets turnover (relaxed)
$4,400,000 4.0 50.00% 50.00% $150,000 10.00% 40.00% 2.5 2.2
FA turnover = Sales / Net FA = $4,400,000 / Net 4.0 FA
Net FA = $1,100,000 Restricted: TATO = Sales / Total assets 2.5 = $4,400,000 / Total assets Copyright Cengage Learning. Powered by Cognero.
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Total assets = $1,760,000 Relaxed: TATO = Sales / Total assets 2.2 = $4,400,000 / Total assets Total assets = $2,000,000 Balance Sheets: Current assets Fixed assets Total assets Debt Equity Total liab. & Equity Interest:
Restricted $660,000 1,100,000 $1,760,000
Relaxed $900,000 1,100,000 $2,000,000
$880,000 880,000
$1,000,000
$1,760,000
$2,000,000
$88,000
$100,000
1,000,000
Difference in interest = $12,000 POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 16-3 Current Assets Financing Policies QUESTION TYPE: Multiple Choice HAS VARIABLES: True PREFACE NAME: MULTI-PART LEARNING OBJECTIVES: FOFM.BRIG.17.15.03 - Current Assets Financing Policies NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: WC investment policy KEYWORDS: Bloom's: Evaluation OTHER: Multiple Choice: Multiple Parts DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 9/26/2017 6:15 PM 126. Refer to Exhibit 15.1. What's the difference in the projected ROEs under the restricted and relaxed policies? Do not round intermediate calculations. a. 1.52% b. 0.97% c. 1.23% d. 1.25% e. 1.26% ANSWER: RATIONALE:
c
EBIT Interest EBT Copyright Cengage Learning. Powered by Cognero.
Restricted $150,000 88,000 $62,000
Relaxed $150,000 100,000 $50,000 Page 945
Taxes Net income
24,800 $37,200
20,000 $30,000
ROE = Net income/Equity
4.23%
3.00%
Difference in ROEs = 1.23% POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 16-3 Current Assets Financing Policies QUESTION TYPE: Multiple Choice HAS VARIABLES: True PREFACE NAME: MULTI-PART LEARNING OBJECTIVES: FOFM.BRIG.17.15.03 - Current Assets Financing Policies NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: WC investment, ROE KEYWORDS: Bloom's: Evaluation OTHER: Multiple Choice: Multiple Parts DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 9/26/2017 6:15 PM 127. Refer to Exhibit 16.1. Assume now that the company believes that if it adopts a restricted policy, its sales will fall by 15% and EBIT will fall by 10%, but its total assets turnover, debt ratio, interest rate, and tax rate will all remain the same. In this situation, what's the difference between the projected ROEs under the restricted and relaxed policies? Do not round intermediate calculations. a. 1.83% b. 1.88% c. 2.21% d. 1.55% e. 2.12% ANSWER: a RATIONALE: % Change in sales -15.00%
% Change in EBIT New sales New EBIT
-10.00% $3,740,000 $135,000
Restricted: TATO = Sales / Total assets 2.5 = $3,740,000/ Total assets Total assets = $1,496,000 Balance Sheet: Total assets Debt Copyright Cengage Learning. Powered by Cognero.
Restricted $1,496,000 $748,000 Page 946
Equity 748,000 Total liab. & Eqty $1,496,000 Income Statement: EBIT Interest EBT Taxes Net income
Restricted $135,000 74,800 $60,200 24,080 $36,120
ROE = Net income/Equity4.83% Relaxed ROE:
3.00%
Difference in ROE = 1.83% POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 16-3 Current Assets Financing Policies QUESTION TYPE: Multiple Choice HAS VARIABLES: True PREFACE NAME: MULTI-PART LEARNING OBJECTIVES: FOFM.BRIG.17.15.03 - Current Assets Financing Policies NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.12 - Working capital management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: WC investment, ROE KEYWORDS: Bloom's: Evaluation OTHER: Multiple Choice: Multiple Parts DATE CREATED: 9/21/2017 6:10 PM DATE MODIFIED: 9/26/2017 6:15 PM
1. The first, and most critical, step in constructing a set of forecasted financial statements is the sales forecast. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 17-2 The Sales Forecast QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.16.02 - The Sales Forecast NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Sales forecast KEYWORDS: Bloom's: Knowledge Copyright Cengage Learning. Powered by Cognero.
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DATE CREATED: DATE MODIFIED:
9/21/2017 6:12 PM 9/26/2017 6:18 PM
2. A typical sales forecast, though concerned with future events, will usually be based on recent historical trends and events as well as on forecasts of economic prospects. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 17-2 The Sales Forecast QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.16.02 - The Sales Forecast NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Sales forecast KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 6:12 PM DATE MODIFIED: 9/26/2017 6:18 PM 3. Errors in the sales forecast can be offset by similar errors in costs and income forecasts. Thus, as long as the errors are not large, sales forecast accuracy is not critical to the firm. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 17-2 The Sales Forecast QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.16.02 - The Sales Forecast NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Sales forecast KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 6:12 PM DATE MODIFIED: 9/26/2017 6:18 PM 4. As a firm's sales grow, its current assets also tend to increase. For instance, as sales increase, the firm's inventories generally increase, and purchases of inventories result in more accounts payable. Thus, spontaneously generated funds arise from transactions brought on by sales increases. a. True Copyright Cengage Learning. Powered by Cognero.
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b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 17-3 The AFN Equation QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.16.03 - The AFN Equation NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Spontaneously generated funds KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 6:12 PM DATE MODIFIED: 9/26/2017 6:18 PM 5. The term "spontaneously generated funds" generally refers to increases in the cash account that result from growth in sales, assuming the firm is operating with a positive profit margin. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 17-3 The AFN Equation QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.16.03 - The AFN Equation NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Spontaneously generated funds KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 6:12 PM DATE MODIFIED: 9/26/2017 6:18 PM 6. A rapid build-up of inventories normally requires additional financing, unless the increase is matched by an equally large decrease in some other asset. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 17-3 The AFN Equation QUESTION TYPE: True / False Copyright Cengage Learning. Powered by Cognero.
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HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.16.03 - The AFN Equation NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Asset increase KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 6:12 PM DATE MODIFIED: 9/26/2017 6:18 PM 7. If a firm wants to maintain its ratios at their existing levels, then if it has a positive sales growth rate of any amount, it will require some amount of external funding. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 17-3 The AFN Equation QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.16.03 - The AFN Equation NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Additional funds needed KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 6:12 PM DATE MODIFIED: 9/26/2017 6:18 PM 8. To determine the amount of additional funds needed (AFN), you may subtract the expected increase in liabilities, which represents a source of funds, from the sum of the expected increases in retained earnings and assets, both of which are uses of funds. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 17-3 The AFN Equation QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.16.03 - The AFN Equation NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business Copyright Cengage Learning. Powered by Cognero.
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TOPICS: KEYWORDS: DATE CREATED: DATE MODIFIED:
School Outcomes, you do not need to include anything for this category. Additional funds needed Bloom's: Knowledge 9/21/2017 6:12 PM 9/26/2017 6:18 PM
9. When developing forecasted financial statements there are some inputs that management controls such as the growth rate and operating costs/sales ratio, while other inputs such as the tax rate and interest rate are not under its control. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 17-4 Forecasted Financial Statements QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.16.04 - Forecasted Financial Statements NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Forecasted statements KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 6:12 PM DATE MODIFIED: 9/26/2017 6:18 PM 10. If a firm with a positive net worth is operating its fixed assets at full capacity, if its dividend payout ratio is 100%, and if it wants to hold all financial ratios constant, then for any positive growth rate in sales, it will require external financing. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 17-3 The AFN Equation QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.16.03 - The AFN Equation NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Additional funds needed KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 6:12 PM DATE MODIFIED: 9/26/2017 6:18 PM Copyright Cengage Learning. Powered by Cognero.
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11. A firm's profit margin is 5%, its debt ratio is 56%, and its dividend payout ratio is 40%. If the firm is operating at less than full capacity, then sales could increase to some extent without the need for external funds, but if it is operating at full capacity with respect to all assets, including fixed assets, then any positive growth in sales will require some external financing. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 17-3 The AFN Equation QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.16.03 - The AFN Equation NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Additional funds needed KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 6:12 PM DATE MODIFIED: 9/26/2017 6:18 PM 12. Two firms with identical capital intensity ratios are generating the same amount of sales. However, Firm A is operating at full capacity, while Firm B is operating below capacity. If the two firms expect the same growth in sales during the next period, then Firm A is likely to need more additional funds than Firm B, other things held constant. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 17-3 The AFN Equation QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.16.03 - The AFN Equation NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Capital intensity ratio KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 6:12 PM DATE MODIFIED: 9/26/2017 6:18 PM *
13. If a firm's capital intensity ratio (A /S0) decreases as sales increase, use of the AFN formula is likely to understate the amount of additional funds required, other things held constant. a. True Copyright Cengage Learning. Powered by Cognero.
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b. False ANSWER: False POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 17-3 The AFN Equation QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.16.03 - The AFN Equation NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Capital intensity ratio KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 6:12 PM DATE MODIFIED: 9/26/2017 6:18 PM 14. The fact that long-term debt and common stock are raised infrequently and in large amounts lessens the need for the firm to forecast those accounts on a continual basis. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 17-4 Forecasted Financial Statements QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.16.04 - Forecasted Financial Statements NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Financial forecasting KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 6:12 PM DATE MODIFIED: 9/26/2017 6:18 PM 15. When we use the AFN equation to forecast the additional funds needed (AFN), we are implicitly assuming that all financial ratios are constant. If financial ratios are not constant, regression techniques can be used to improve the financial forecast. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 17-5 Using Regression to Improve Forecasts Copyright Cengage Learning. Powered by Cognero.
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QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.16.05 - Using Regression to Improve Forecasts NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: AFN and linear regression KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 6:12 PM DATE MODIFIED: 9/26/2017 6:18 PM 16. Which of the following is NOT a key element in strategic planning as it is described in the text? a. The mission statement. b. The statement of the corporate scope. c. The statement of cash flows. d. The statement of corporate objectives. e. The operating plan. ANSWER: c POINTS: 1 DIFFICULTY: EASY REFERENCES: 17-1 Strategic Planning QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.16.01 - Strategic Planning NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Strategic planning KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:12 PM DATE MODIFIED: 9/26/2017 6:18 PM 17. Which of the following assumptions is embodied in the AFN equation? a. All balance sheet accounts are tied directly to sales. b. Accounts payable and accruals are tied directly to sales. c. Common stock and long-term debt are tied directly to sales. d. Fixed assets, but not current assets, are tied directly to sales. e. Last year’s total assets were not optimal for last year’s sales. ANSWER: b POINTS: 1 DIFFICULTY: EASY REFERENCES: 17-3 The AFN Equation Copyright Cengage Learning. Powered by Cognero.
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QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.16.03 - The AFN Equation NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: AFN equation KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:12 PM DATE MODIFIED: 9/26/2017 6:18 PM 18. Jefferson City Computers has developed a forecasting model to estimate its AFN for the upcoming year. All else being equal, which of the following factors is most likely to lead to an increase of the additional funds needed (AFN)? a. A sharp increase in its forecasted sales. b. A sharp reduction in its forecasted sales. c. The company reduces its dividend payout ratio. d. The company switches its materials purchases to a supplier that sells on terms of 1/5, net 90, from a supplier whose terms are 3/15, net 35. e. The company discovers that it has excess capacity in its fixed assets. ANSWER: a RATIONALE: Answer a is obviously correct. Also, note that with purchase terms of 1/5 net 90, the nominal cost of non-free trade credit is only 4.34%, whereas with 3/15, net 35, the nominal cost of trade credit is over 56.44%. Therefore, the firm should have been taking discounts originally, hence should have had few accounts payable, whereas it would probably not take discounts and thus have more accounts payable with the new supplier. That change would lower its AFN. POINTS: 1 DIFFICULTY: EASY/MODERATE REFERENCES: 17-3 The AFN Equation QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.16.03 - The AFN Equation NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Additional funds needed KEYWORDS: Bloom's: Evaluation OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:12 PM DATE MODIFIED: 9/26/2017 6:18 PM 19. The term ―additional funds needed (AFN)‖ is generally defined as follows: a. Funds that are obtained automatically from routine business transactions. b. Funds that a firm must raise externally from non-spontaneous sources, i.e., by borrowing or by selling new Copyright Cengage Learning. Powered by Cognero.
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stock, to support operations. c. The amount of assets required per dollar of sales. d. The amount of internally generated cash in a given year minus the amount of cash needed to acquire the new assets needed to support growth. e. A forecasting approach in which the forecasted percentage of sales for each balance sheet account is held constant. ANSWER: b POINTS: 1 DIFFICULTY: EASY/MODERATE REFERENCES: 17-3 The AFN Equation QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.16.03 - The AFN Equation NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Additional funds needed KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:12 PM DATE MODIFIED: 9/26/2017 6:18 PM 20. The capital intensity ratio is generally defined as follows: a. Sales divided by total assets, i.e., the total assets turnover ratio. b. The percentage of liabilities that increase spontaneously as a percentage of sales. c. The ratio of sales to current assets. d. The ratio of current assets to sales. e. The amount of assets required per dollar of sales, or A0*/S0. ANSWER: e POINTS: 1 DIFFICULTY: EASY/MODERATE REFERENCES: 17-3 The AFN Equation QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.16.03 - The AFN Equation NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Capital intensity ratio KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:12 PM DATE MODIFIED: 9/26/2017 6:18 PM Copyright Cengage Learning. Powered by Cognero.
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21. Which of the following is NOT one of the steps taken in the financial planning process? a. Assumptions are made about future levels of sales, costs, and interest rates for use in the forecast. b. The entire financial plan is reexamined, assumptions are reviewed, and the management team considers how additional changes in operations might improve results. c. Projected ratios are calculated and analyzed. d. Develop a set of projected financial statements. e. Consult with key competitors about the optimal set of prices to charge, i.e., the prices that will maximize profits for our firm and its competitors. ANSWER: e POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 17-1 Strategic Planning QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.16.01 - Strategic Planning NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Financial planning KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:12 PM DATE MODIFIED: 9/26/2017 6:18 PM 22. Spontaneously generated funds are generally defined as follows: a. Assets required per dollar of sales. b. A forecasting approach in which the forecasted percentage of sales for each item is held constant. c. Funds that a firm must raise externally through borrowing or by selling new common or preferred stock. d. Funds that arise out of normal business operations from its suppliers, employees, and the government, and they include spontaneous increases in accounts payable and accruals. e. The amount of cash raised in a given year minus the amount of cash needed to finance the additional capital expenditures and working capital needed to support the firm’s growth. ANSWER: d POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 17-3 The AFN Equation QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.16.03 - The AFN Equation NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Spontaneously generated funds KEYWORDS: Bloom's: Comprehension Copyright Cengage Learning. Powered by Cognero.
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OTHER: DATE CREATED: DATE MODIFIED:
Multiple Choice: Conceptual 9/21/2017 6:12 PM 9/26/2017 6:18 PM
23. A company expects sales to increase during the coming year, and it is using the AFN equation to forecast the additional capital that it must raise. Which of the following conditions would cause the AFN to increase? a. The company previously thought its fixed assets were being operated at full capacity, but now it learns that it actually has excess capacity. b. The company increases its dividend payout ratio. c. The company begins to pay employees monthly rather than weekly. d. The company’s profit margin increases. e. The company decides to stop taking discounts on purchased materials. ANSWER: b POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 17-3 The AFN Equation QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.16.03 - The AFN Equation NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Additional funds needed KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:12 PM DATE MODIFIED: 9/26/2017 6:18 PM 24. Which of the following statements is CORRECT? a. Perhaps the most important step when developing forecasted financial statements is to determine the breakdown of common equity between common stock and retained earnings. b. The first, and perhaps the most critical, step in forecasting financial requirements is to forecast future sales. c. Forecasted financial statements, as discussed in the text, are used primarily as a part of the managerial compensation program, where management’s historical performance is evaluated. d. The capital intensity ratio gives us an idea of the physical condition of the firm’s fixed assets. e. The AFN equation produces more accurate forecasts than the forecasted financial statement method, especially if fixed assets are lumpy and economies of scale exist. ANSWER: b POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.16.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic Copyright Cengage Learning. Powered by Cognero.
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STATE STANDARDS: LOCAL STANDARDS: TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. Forecasting concepts Bloom's: Comprehension Multiple Choice: Conceptual 9/21/2017 6:12 PM 9/26/2017 6:18 PM
25. Which of the following statements is CORRECT? a. Once a firm has defined its purpose, scope, and objectives, it must develop a strategy or strategies for achieving its goals. The statement of corporate strategies sets forth detailed plans rather than broad approaches for achieving a firm's goals. b. A firm’s corporate purpose states the general philosophy of the business and provides managers with specific operational objectives. c. Operating plans provide management with detailed implementation guidance, consistent with the corporate strategy, to help meet the corporate objectives. These operating plans can be developed for any time horizon, but many companies use a 5-year horizon. d. A firm’s mission statement defines its lines of business and geographic area of operations. e. The corporate scope is a condensed version of the entire set of strategic plans. ANSWER: c POINTS: 1 DIFFICULTY: MODERATE/CHALLENGING REFERENCES: 17-1 Strategic Planning QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.16.01 - Strategic Planning NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Strategic planning KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:12 PM DATE MODIFIED: 9/26/2017 6:18 PM 26. Which of the following statements is CORRECT? a. Since accounts payable and accrued liabilities must eventually be paid off, as these accounts increase, AFN as calculated by the AFN equation must also increase. b. Suppose a firm is operating its fixed assets at below 100% of capacity, but it has no excess current assets. Based on the AFN equation, its AFN will be larger than if it had been operating with excess capacity in both fixed and current assets. c. If a firm retains all of its earnings, then it cannot require any additional funds to support sales growth. d. Additional funds needed (AFN) are typically raised using a combination of notes payable, long-term debt, and common stock. Such funds are non-spontaneous in the sense that they require explicit financing decisions to obtain them. Copyright Cengage Learning. Powered by Cognero.
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e. If a firm has a positive free cash flow, then it must have either a zero or a negative AFN. ANSWER: d POINTS: 1 DIFFICULTY: MODERATE/CHALLENGING REFERENCES: 17-3 The AFN Equation QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.16.03 - The AFN Equation NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Additional funds needed KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:12 PM DATE MODIFIED: 9/26/2017 6:18 PM 27. Which of the following statements is CORRECT? a. Any forecast of financial requirements involves determining how much money the firm will need, and this need is determined by adding together increases in assets and spontaneous liabilities and then subtracting operating income. b. The AFN equation for forecasting funds requirements requires only a forecast of the firm’s balance sheet. Although a forecasted income statement may help clarify the results, income statement data are not essential because funds needed relate only to the balance sheet. c. Dividends are paid with cash taken from the accumulated retained earnings account, hence dividend policy does not affect the AFN forecast. d. A negative AFN indicates that retained earnings and spontaneous capital are far more than sufficient to finance the additional assets needed. e. If assets and spontaneously generated liabilities are not projected to grow at the same rate as sales, then the AFN method will provide more accurate forecasts than the projected financial statement method. ANSWER: d POINTS: 1 DIFFICULTY: MODERATE/CHALLENGING REFERENCES: 17-3 The AFN Equation QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.16.03 - The AFN Equation NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Additional funds needed KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:12 PM Copyright Cengage Learning. Powered by Cognero.
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DATE MODIFIED:
9/26/2017 6:18 PM
28. Which of the following statements is CORRECT? a. The sustainable growth rate is the maximum achievable growth rate without the firm having to raise external funds. In other words, it is the growth rate at which the firm's AFN equals zero. b. If a firm’s assets are growing at a positive rate, but its retained earnings are not increasing, then it would be impossible for the firm’s AFN to be negative. c. If a firm increases its dividend payout ratio in anticipation of higher earnings, but sales and earnings actually decrease, then the firm’s actual AFN must, mathematically, exceed the previously calculated AFN. d. Higher sales usually require higher asset levels, and this leads to what we call AFN. However, the AFN will be zero if the firm chooses to retain all of its profits, i.e., to have a zero dividend payout ratio. e. Dividend policy does not affect the requirement for external funds based on the AFN equation. ANSWER: a POINTS: 1 DIFFICULTY: MODERATE/CHALLENGING REFERENCES: 17-3 The AFN Equation QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.16.03 - The AFN Equation NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: AFN equation KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:12 PM DATE MODIFIED: 9/26/2017 6:18 PM 29. Which of the following statements is CORRECT? a. When we use the AFN equation, we assume that the ratios of assets and liabilities to sales (A0*/S0 and L0*/S0) vary from year to year in a stable, predictable manner. b. When fixed assets are added in large, discrete units as a company grows, the assumption of constant ratios is more appropriate than if assets are relatively small and can be added in small increments as sales grow. c. Firms whose fixed assets are ―lumpy‖ frequently have excess capacity, and this should be accounted for in the financial forecasting process. d. For a firm that uses lumpy assets, it is impossible to have small increases in sales without expanding fixed assets. e. Regression techniques cannot be used in situations where excess capacity or economies of scale exist. ANSWER: c POINTS: 1 DIFFICULTY: MODERATE/CHALLENGING REFERENCES: 17-5 Using Regression to Improve Forecasts QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.16.05 - Using Regression to Improve Forecasts NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic Copyright Cengage Learning. Powered by Cognero.
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STATE STANDARDS: LOCAL STANDARDS: TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. Forecasting fin. reqmts. Bloom's: Comprehension Multiple Choice: Conceptual 9/21/2017 6:12 PM 9/26/2017 6:18 PM
30. Last year Godinho Corp. had $420 million of sales, and it had $75 million of fixed assets that were being operated at 80% of capacity. In millions, how large could sales have been if the company had operated at full capacity? a. $551.3 b. $462.0 c. $509.3 d. $656.3 e. $525.0 ANSWER: e RATIONALE: Sales $420
Fixed assets % of capacity utilized
$75 80%
Full capacity sales = Actual sales / % of capacity used = $525.0
POINTS: 1 DIFFICULTY: EASY REFERENCES: 17-3 The AFN Equation QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.16.03 - The AFN Equation NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Excess capacity KEYWORDS: Bloom's: Evaluation OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:12 PM DATE MODIFIED: 9/26/2017 6:18 PM 31. Kamath-Meier Corporation's CFO uses this equation, which was developed by regressing inventories on sales over the past 5 years, to forecast inventory requirements: Inventories = $22.0 + 0.125(Sales). The company expects sales of $275.0 million during the current year, and it expects sales to grow by 30% next year. What is the inventory forecast for next year? All dollars are in millions. a. $59.4 b. $60.0 c. $54.7 Copyright Cengage Learning. Powered by Cognero.
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d. $66.7 e. $82.0 ANSWER: RATIONALE:
d
Current year's sales Growth rate Projected Sales
$275.0 30% $357.5
Required inventories
= $22.0 + 0.125 × Projected sales = $22.0 + 0.125 × $357.5 = $66.7
POINTS: 1 DIFFICULTY: EASY REFERENCES: 17-5 Using Regression to Improve Forecasts QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.16.05 - Using Regression to Improve Forecasts NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Forecasting inv. - regression KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:12 PM DATE MODIFIED: 9/26/2017 6:18 PM 32. Last year Wei Guan Inc. had $625 million of sales, and it had $270 million of fixed assets that were used at 65% of capacity. In millions, by how much could Wei Guan's sales increase before it is required to increase its fixed assets? a. $316.35 b. $302.88 c. $289.42 d. $400.48 e. $336.54 ANSWER: e RATIONALE: Sales $625
Fixed assets (not used in calculations) % of capacity utilized Sales at full capacity = Actual sales / % of capacity used =
$270 65% $961.54
Additional sales without adding FA = Full capacity sales - Actual sales = $336.54
POINTS: DIFFICULTY: REFERENCES: QUESTION TYPE:
1 MODERATE 17-3 The AFN Equation Multiple Choice
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HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.16.03 - The AFN Equation NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Excess capacity KEYWORDS: Bloom's: Evaluation OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:12 PM DATE MODIFIED: 9/26/2017 6:18 PM 33. Last year Handorf-Zhu Inc. had $850 million of sales, and it had $425 million of fixed assets that were used at only 85% of capacity. What is the maximum sales growth rate the company could achieve before it had to increase its fixed assets? a. 16.94% b. 17.47% c. 19.06% d. 18.88% e. 17.65% ANSWER: e RATIONALE: Sales $850
Fixed assets (not used in calculations) $425 % of capacity utilized 85% Sales at full capacity = Actual sales / % of capacity used = $1,000.00 Additional sales without adding FA = Full capacity sales - Actual sales = $150.00 Percent growth in sales = Additional sales / Old sales = 17.65%
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 17-3 The AFN Equation QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.16.03 - The AFN Equation NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Excess capacity KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:12 PM DATE MODIFIED: 9/26/2017 6:18 PM 34. Last year Jain Technologies had $250 million of sales and $100 million of fixed assets, so its Fixed Assets/Sales ratio was 40%. However, its fixed assets were used at only 40% of capacity. Now the company is developing its financial Copyright Cengage Learning. Powered by Cognero.
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forecast for the coming year. As part of that process, the company wants to set its target Fixed Assets/Sales ratio at the level, it would have had, had it been operating at full capacity. What target Fixed Assets/Sales ratio should the company set? a. 19.0% b. 14.6% c. 16.0% d. 15.4% e. 14.2% ANSWER: c RATIONALE: Sales $250
Fixed assets % of capacity utilized Sales at full capacity = Actual sales / % of capacity used =
$100 40% $625.00
Target FA/Sale ratio = Actual FA/Full capacity sales = 16.0%
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 17-3 The AFN Equation QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.16.03 - The AFN Equation NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Finding target FA/S ratio KEYWORDS: Bloom's: Evaluation OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:12 PM DATE MODIFIED: 9/26/2017 6:18 PM 35. Fairchild Garden Supply expects $700 million of sales this year, and it forecasts a 15% increase for next year. The CFO uses this equation to forecast inventory requirements at different levels of sales: Inventories = $30.2 + 0.25(Sales). All dollars are in millions. What is the projected inventory turnover ratio for the coming year? a. 2.78 times b. 2.82 times c. 4.35 times d. 3.79 times e. 3.48 times ANSWER: e RATIONALE: Current yr.'s sales $700
Growth rate Projected sales
15% $805.0
Req. inventories = $30.2 + 0.25 × Projected sales = $30.2 + 0.25 × $805.0 = $231.5 Inventory turnover ratio = Sales / Inventories = 3.48 times Copyright Cengage Learning. Powered by Cognero.
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POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 17-5 Using Regression to Improve Forecasts QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.16.05 - Using Regression to Improve Forecasts NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Forecasting inv. turnover KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:12 PM DATE MODIFIED: 9/26/2017 6:18 PM 36. Clayton Industries is planning its operations for next year. Ronnie Clayton, the CEO, wants you to forecast the firm's additional funds needed (AFN). Data for use in your forecast are shown below. Based on the AFN equation, what is the AFN for the coming year? Dollars are in millions. Last year's sales = S0 Sales growth rate = g * Last year's total assets = A0 Last year's prof margin = PM a. $67.0 b. $78.7 c. $63.9 d. $77.9 e. $91.1 ANSWER: RATIONALE:
$350 30% $360 5%
Last yr's accounts payable Last yr's notes payable Last yr's accruals Target payout ratio
$40 $50 $30 60%
d
Last year's sales = S0 Sales growth rate = g Forecasted sales = S0 × (1 + g) ΔS = change in sales = S1 - S0 = S0 × g * Last year's total assets = A0 since full capacity * * Forecasted total assets = A1 = A0 × (1 + g) Last year's accounts payable Last year's notes payable. Not spontaneous, so does not enter AFN calculation Last year's accruals * L0 = payables + accruals Profit margin = PM Target payout ratio Retention ratio = (1 - payout)
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$350 30% $455 $105 $360 $468 $40 $50 $30 $70 5.0% 60.0% 40.0% Page 966
*
*
AFN = (A0 /S0)Δ S - (L0 /S0)Δ S - Profit margin × S1 × (1 - Payout) AFN = $108.0 - $21.0 - $9.1 = $77.9
POINTS: 1 DIFFICULTY: MODERATE/CHALLENGING REFERENCES: 17-3 The AFN Equation QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.16.03 - The AFN Equation NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Positive AFN KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:12 PM DATE MODIFIED: 9/26/2017 6:18 PM 37. Chua Chang & Wu Inc. is planning its operations for next year, and the CEO wants you to forecast the firm's additional funds needed (AFN). Data for use in your forecast are shown below. Based on the AFN equation, what is the AFN for the coming year? Last year's sales = S0 Sales growth rate = g * Last year's total assets = A0 Last year's profit margin = PM a. -$14,820 b. -$23,180 c. -$19,000 d. -$21,280 e. -$20,520 ANSWER: RATIONALE:
$200,000 40% $127,500 20.0%
Last year's accounts payable $50,000 Last year's notes payable $15,000 Last year's accruals $20,000 Target payout ratio 25.0%
c
Last year's sales = S0 Sales growth rate = g Forecasted sales = S0 × (1 + g) ΔS = change in sales = S1 - S0 = S0 × g * Last year's total assets = A0 since full capacity * * Forecasted total assets = A1 = A0 × (1 + g) Last year's accounts payable Last year's notes payable. Not spontaneous, so does not enter AFN calculation Last year's accruals * L0 = payables + accruals
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$200,000 40% $280,000 $80,000 $127,500 $178,500 $50,000 $15,000 $20,000 $70,000 Page 967
Profit margin = PM Target payout ratio Retention ratio = (1 - Payout) *
20.0% 25.0% 75.0%
*
AFN = (A0 /S0)ΔS - (L0 /S0)ΔS - Profit margin × S1 × (1 - Payout) AFN = $51,000 - $28,000 - $42,000 = -$19,000
POINTS: 1 DIFFICULTY: MODERATE/CHALLENGING REFERENCES: 17-3 The AFN Equation QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.16.03 - The AFN Equation NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Negative AFN KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:12 PM DATE MODIFIED: 9/26/2017 6:18 PM 38. Howton & Howton Worldwide (HHW) is planning its operations for the coming year, and the CEO wants you to forecast the firm's additional funds needed (AFN). Data for use in the forecast are shown below. However, the CEO is concerned about the impact of a change in the payout ratio from the 10% that was used in the past to 50%, which the firm's investment bankers have recommended. Based on the AFN equation, by how much would the AFN for the coming year change if HHW increased the payout from 10% to the new and higher level? All dollars are in millions. Last year's sales = S0 Sales growth rate = g * Last year's total assets = A0 Last year's profit margin = PM
a. $28.2 b. $33.6 c. $26.9 d. $30.9 e. $25.5 ANSWER: RATIONALE:
$300 40% $500 20%
Last year's accounts payable Last year's notes payable Last year's accruals Initial payout ratio New payout ratio
$50 $15 $20 10% 50%
b
Last year's sales = S0 Sales growth rate = g Forecasted sales = S0 × (1 + g) ΔS = change in sales = S1 - S0 = S0 × g * Last year's total assets = A0 since full capacity * * Forecasted total assets = A1 = A0 × (1 + g)
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$300 40% $420 $120 $500 $700 Page 968
Last year's accounts payable Last year's notes payable. Not spontaneous, so does not enter AFN calculation Last year's accruals * L0 = payables + accruals Profit margin = PM Initial payout ratio New payout ratio Initial retention ratio = (1 - payout) New retention ratio = (1 - payout) *
$50 $15 $20 $70 20% 10% 50% 90% 50%
*
AFN = (A0 /S0)ΔS - (L0 /S0) ΔS - Profit margin × S1 × (1 - Payout) Old AFN = $200.0 $28.0 $75.6 = $96.4 New AFN = $200.0 $28.0 $42.0 = $130.0 Change in AFN = $33.6
POINTS: 1 DIFFICULTY: MODERATE/CHALLENGING REFERENCES: 17-3 The AFN Equation QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.16.03 - The AFN Equation NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: AFN - changing div. payout KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:12 PM DATE MODIFIED: 9/26/2017 6:18 PM 39. Last year Emery Industries had $450 million of sales and $225 million of fixed assets, so its Fixed Assets/Sales ratio was 50%. However, its fixed assets were used at only 65% of capacity. If the company had been able to sell off enough of its fixed assets at book value so that it was operating at full capacity, with sales held constant at $450 million, how much cash (in millions) would it have generated? a. $66.94 b. $78.75 c. $63.00 d. $74.81 e. $75.60 ANSWER: b RATIONALE: Sales $450
Fixed assets % of capacity utilized Sales at full capacity = Actual sales / % of capacity used = Copyright Cengage Learning. Powered by Cognero.
$225 65% $692.31 Page 969
Target FA/Sale ratio = Actual FA/Full Capacity sales 32.50% = Optimal FA = Sales × Target FA/Sales ratio = $146.25 Cash generated = Actual FA - Optimal FA = $78.75 POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 17-3 The AFN Equation QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.16.03 - The AFN Equation NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.05 - DISC: Financial analysis and cash flows LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Finding target FA/S ratio KEYWORDS: Bloom's: Evaluation OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:12 PM DATE MODIFIED: 9/26/2017 6:18 PM
1. One objective of risk management can be to reduce the volatility of a firm's cash flows. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 18-1 Reasons to Manage Risk QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.18.01 - Reasons to Manage Risk NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.09 - Derivatives TOPICS: Risk management KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 6:02 PM DATE MODIFIED: 9/21/2017 6:02 PM 2. In theory, reducing the volatility of its cash flows will always increase a company's value. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 18-1 Reasons to Manage Risk QUESTION TYPE: True / False Copyright Cengage Learning. Powered by Cognero.
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HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.18.01 - Reasons to Manage Risk NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.09 - Derivatives TOPICS: Risk management KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 6:02 PM DATE MODIFIED: 9/21/2017 6:02 PM 3. Interest rate swaps allow a firm to exchange fixed for floating-rate payments, but a swap cannot reduce actual net interest expenses. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 18-7 Other Types of Derivatives QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.18.07 - Other Types of Derivatives NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.09 - Derivatives TOPICS: Swaps KEYWORDS: Bloom’s: Comprehension DATE CREATED: 9/21/2017 6:02 PM DATE MODIFIED: 9/21/2017 6:02 PM 4. Speculative risks are symmetrical in the sense that they offer the chance of a gain as well as a loss, while pure risks are those that can only lead to losses. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 18-9 Risk Management QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.18.09 - Risk Management NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.09 - Derivatives TOPICS: Speculative vs. pure risk KEYWORDS: Bloom’s: Knowledge DATE CREATED: 9/21/2017 6:02 PM DATE MODIFIED: 9/21/2017 6:02 PM 5. The two basic types of hedges involving the futures market are long hedges and short hedges, where the words "long" Copyright Cengage Learning. Powered by Cognero.
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and "short" refer to the maturity of the hedging instrument. For example, a long hedge might use Treasury bonds, while a short hedge might use 3-month T-bills. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 18-8 Using Derivatives to Reduce Risks QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.18.08 - Using Derivatives to Reduce Risks NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.09 - Derivatives TOPICS: Futures market hedging KEYWORDS: Bloom’s: Comprehension DATE CREATED: 9/21/2017 6:02 PM DATE MODIFIED: 9/21/2017 6:02 PM 6. Which of the following is NOT an example of a derivative security? a. Futures. b. Options. c. Swaps. d. Forward contracts. e. Preferred stock. ANSWER: e POINTS: 1 DIFFICULTY: EASY REFERENCES: 18-1 Reasons to Manage Risk QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.18.01 - Reasons to Manage Risk NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.09 - Derivatives TOPICS: Derivatives KEYWORDS: Bloom’s: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:02 PM DATE MODIFIED: 9/21/2017 6:02 PM 7. The value of a stock option depends on all of the following EXCEPT: a. Exercise price. b. Variability of the stock price. c. Length of time until option expiration. d. Risk-free rate of interest. e. Bond price. Copyright Cengage Learning. Powered by Cognero.
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ANSWER: e POINTS: 1 DIFFICULTY: EASY REFERENCES: 18-3 Options QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.18.03 - Options NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.09 - Derivatives TOPICS: Option value KEYWORDS: Bloom’s: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:02 PM DATE MODIFIED: 9/21/2017 6:02 PM 8. Which of the following statements concerning risk management is NOT CORRECT? a. Risk management can reduce the volatility of cash flows, and this decreases the probability of bankruptcy. b. Risk management makes sense for firms directly engaged in activities that involve commodities whose values can be hedged, but it doesn't make much sense for most other firms. c. Companies with volatile earnings pay more taxes than companies with more stable earnings due to the treatment of tax credits and the rules governing corporate loss carry-forwards and carry-backs. Therefore, our tax system encourages risk management to stabilize earnings. d. Risk management can reduce the likelihood of low cash flows, and therefore reduce the probability of financial distress. e. Risk management involves identifying events that could have adverse financial consequences and then taking actions to prevent and/or to minimize the damage caused by these events. ANSWER: b POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 18-1 Reasons to Manage Risk QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.18.01 - Reasons to Manage Risk NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.09 - Derivatives TOPICS: Risk management KEYWORDS: Bloom’s: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:02 PM DATE MODIFIED: 9/21/2017 6:02 PM 9. Which of the following is NOT a way risk management can be used to increase the value of a firm? a. Risk management can increase debt capacity. b. Risk management can help a firm maintain its optimal capital budget. c. Risk management can reduce the expected costs of financial distress. d. Risk management can help firms minimize taxes. Copyright Cengage Learning. Powered by Cognero.
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e. Risk management can allow managers to defer receipt of their bonuses and thus postpone tax payments. ANSWER: e POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 18-1 Reasons to Manage Risk QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.18.01 - Reasons to Manage Risk NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.09 - Derivatives TOPICS: Risk management KEYWORDS: Bloom’s: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:02 PM DATE MODIFIED: 9/21/2017 6:02 PM 10. An option that gives the holder the right to sell a stock at a specified price at some time in the future is called a(n) a. Call option. b. Put option. c. Out-of-the-money option. d. Naked option. e. Covered option. ANSWER: b POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 18-3 Options QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.18.03 - Options NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.09 - Derivatives TOPICS: Options KEYWORDS: Bloom’s: Knowledge OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:02 PM DATE MODIFIED: 9/21/2017 6:02 PM 11. An option that gives the holder the right to buy a stock at a specified price at some time in the future is called a(n) a. Call option. b. Put option. c. Out-of-the-money option. d. Naked option. e. Covered option. ANSWER: a POINTS: 1 Copyright Cengage Learning. Powered by Cognero.
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DIFFICULTY: MODERATE REFERENCES: 18-3 Options QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.18.03 - Options NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.09 - Derivatives TOPICS: Options KEYWORDS: Bloom’s: Knowledge OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:02 PM DATE MODIFIED: 9/21/2017 6:02 PM 12. A call option whose underlying stock value is less than the corresponding exercise price is an example of a(n) a. Straddle option. b. Put option. c. Out-of-the-money option. d. Naked option. e. Covered option. ANSWER: c POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 18-3 Options QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.18.03 - Options NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.09 - Derivatives TOPICS: Options KEYWORDS: Bloom’s: Knowledge OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:02 PM DATE MODIFIED: 9/21/2017 6:02 PM 13. An investor who "writes" a call option without the stock in his or her portfolio to back it up is selling a(n) a. Call option. b. Put option. c. Out-of-the-money option. d. Naked option. e. Covered option. ANSWER: d POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 18-3 Options QUESTION TYPE: Multiple Choice Copyright Cengage Learning. Powered by Cognero.
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HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.18.03 - Options NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.09 - Derivatives TOPICS: Options KEYWORDS: Bloom’s: Knowledge OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:02 PM DATE MODIFIED: 9/21/2017 6:02 PM 14. An investor who "writes" a call option against stock held in his or her portfolio is selling a(n) a. Straddle option. b. Put option. c. Out-of-the-money option. d. Naked option. e. Covered option. ANSWER: e POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 18-3 Options QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.18.03 - Options NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.09 - Derivatives TOPICS: Options KEYWORDS: Bloom’s: Knowledge OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:02 PM DATE MODIFIED: 9/21/2017 6:02 PM 15. Deeble Construction Co.'s stock is trading at $30 a share. There are also call options on the company's stock, some with an exercise price of $25 and some with an exercise price of $35. All options expire in 3 months. Which of the following best describes the value of these options? a. If Deeble's stock price rose by $5, the exercise value of the options with the $25 exercise price would also increase by $5. b. The options with the $25 exercise price will sell for less than the options with the $35 exercise price. c. The options with the $25 exercise price have an exercise value greater than $5. d. The options with the $35 exercise price have an exercise value greater than $0. e. The options with the $25 exercise price will sell for $5. ANSWER: a POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 18-3 Options QUESTION TYPE: Multiple Choice HAS VARIABLES: False Copyright Cengage Learning. Powered by Cognero.
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LEARNING OBJECTIVES: FOFM.BRIG.16.18.03 - Options NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.09 - Derivatives TOPICS: Option value KEYWORDS: Bloom’s: Application OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:02 PM DATE MODIFIED: 9/21/2017 6:02 PM 16. Which of the following statements is most CORRECT? a. One advantage of forward contracts is that they are default free. b. Futures contracts generally trade on an organized exchange and are marked to market daily. c. Goods are never delivered under forward contracts, but are almost always delivered under futures contracts. d. Forward contracts are generally standardized instruments, whereas futures contracts are generally tailor-made for the 2 parties of the contract. e. Essentially there are no differences between forward and futures contracts, except that forward contracts are used only for financial assets while futures contracts are used only for commodities. ANSWER: b POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 18-6 Forward and Futures Contracts QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.18.06 - Forward and Futures Contracts NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.09 - Derivatives TOPICS: Forwards vs. futures KEYWORDS: Bloom’s: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:02 PM DATE MODIFIED: 9/21/2017 6:02 PM 17. A swap is a method used to reduce financial risk. Which of the following statements about swaps, if any, is NOT CORRECT? a. A swap involves the exchange of cash payment obligations. b. The earliest swaps were currency swaps, in which companies traded debt denominated in different currencies, say dollars and pounds. c. Swaps are very often arranged by a financial intermediary, who may or may not take the position of one of the counterparties. d. A problem with swaps is that no standardized contracts exist, which has prevented the development of a secondary market. e. Swaps can involve side payments in order to get the counterparty to agree to the swap. ANSWER: d POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 18-7 Other Types of Derivatives Copyright Cengage Learning. Powered by Cognero.
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QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.18.07 - Other Types of Derivatives NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.09 - Derivatives TOPICS: Swaps KEYWORDS: Bloom’s: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:02 PM DATE MODIFIED: 9/21/2017 6:02 PM 18. A commercial bank recognizes that its net income suffers whenever interest rates increase. Which of the following strategies would protect the bank against rising interest rates? a. Buying inverse floaters. b. Entering into an interest rate swap where the bank receives a fixed payment stream, and in return agrees to make payments that float with market interest rates. c. Purchase principal only (PO) strips that decline in value whenever interest rates rise. d. Enter into a short hedge where the bank agrees to sell interest rate futures. e. Sell some of the bank's floating-rate loans and use the proceeds to make fixed-rate loans. ANSWER: d POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 18-8 Using Derivatives to Reduce Risks QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.18.08 - Using Derivatives to Reduce Risks NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.09 - Derivatives TOPICS: Hedging KEYWORDS: Bloom’s: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:02 PM DATE MODIFIED: 9/21/2017 6:02 PM 19. Which of the following statements is CORRECT? a. Put options give investors the right to buy a stock at a certain exercise price before a specified date. b. Call options give investors the right to sell a stock at a certain exercise price before a specified date. c. Options typically sell for less than their exercise value. d. LEAPS are very short-term options that have begun trading on the exchanges in recent years. e. Option holders are not entitled to receive dividends unless they choose to exercise their option. ANSWER: e POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice Copyright Cengage Learning. Powered by Cognero.
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HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.18.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.09 - Derivatives TOPICS: Option concepts KEYWORDS: Bloom’s: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:02 PM DATE MODIFIED: 9/21/2017 6:02 PM 20. There are call options on the common stock of XYZ Corporation. Which of the following best describes the factors that affect call option values? a. The price of call options will rise if XYZ's stock price rises. b. The higher the strike price, the higher the call option price. c. Assuming the same strike price, a call option that expires in 1 month will sell for a higher price than one that expires in 3 months. d. The less volatile a stock's price, the more valuable a call option on the stock is. e. If the risk-free rate of interest increases, the value of call options will decrease. ANSWER: a POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.18.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.09 - Derivatives TOPICS: Option concepts KEYWORDS: Bloom’s: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:02 PM DATE MODIFIED: 9/21/2017 6:02 PM 21. Which of the following events is likely to decrease the value of call options on the common stock of GCC Company? a. An increase in GCC's stock price. b. An increase in the exercise price of the option. c. An increase in the amount of time until the option expires. d. An increase in the risk-free rate. e. GCC's stock price becomes more risky (higher variance). ANSWER: b POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False Copyright Cengage Learning. Powered by Cognero.
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LEARNING OBJECTIVES: FOFM.BRIG.16.18.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.09 - Derivatives TOPICS: Option concepts KEYWORDS: Bloom’s: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:02 PM DATE MODIFIED: 9/21/2017 6:02 PM 22. Which of the following statements regarding factors that affect call option prices is CORRECT? a. The longer the time until the call option expires the smaller its value and the smaller its premium. b. An option on an extremely volatile stock is worth less than one on a very stable stock. c. The price of a call option increases as the risk-free rate increases. d. Two call options on the same stock will have the same value even if they have different strike prices. e. If you observe that a put option on a stock increases in value, then a call option on that same stock also increases in value. ANSWER: c POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.18.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.09 - Derivatives TOPICS: Option concepts KEYWORDS: Bloom’s: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:02 PM DATE MODIFIED: 9/21/2017 6:02 PM 23. Which of the following statements is CORRECT? a. An option's value is determined by its exercise value, which is the market price of the stock less its strike price. Thus, an option can't sell for more than its exercise value. b. As a stock's price increases, the premium portion of an option on that stock increases because the difference between the stock price and the fixed strike price increases. c. If the company is consistently profitable, its call options will always be in the money. d. The market value of an option depends in part on the option's length of time until expiration and on the variability of the underlying stock's price. e. The potential loss on an option decreases as the option sells at higher and higher prices because the profit margin becomes larger. ANSWER: d POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 18-3 Options QUESTION TYPE: Multiple Choice Copyright Cengage Learning. Powered by Cognero.
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HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.18.03 - Options NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.09 - Derivatives TOPICS: Options KEYWORDS: Bloom’s: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:02 PM DATE MODIFIED: 9/21/2017 6:02 PM 24. Warnes Motors' stock is trading at $20 a share. Three-month call options with an exercise price of $20 have a price of $1.50. Which of the following will occur if the stock price increases 10% to $22 a share? a. The price of the call option will increase by $2. b. The price of the call option will increase by less than $2, but the percentage increase in price will be more than 10%. c. The price of the call option will increase by less than $2, and the percentage increase in price will be less than 10%. d. The price of the call option will increase by more than $2. e. The price of the call option will increase by more than $2, but the percentage increase in price will be less than 10%. ANSWER: b POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 18-3 Options QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.18.03 - Options NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.09 - Derivatives TOPICS: Option value KEYWORDS: Bloom’s: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:02 PM DATE MODIFIED: 9/21/2017 6:02 PM 25. A riskless hedge can best be defined as a. A situation in which aggregate risk can be reduced by derivatives transactions between two parties. b. A hedge in which an investor buys a stock and simultaneously sells a call option on that stock and ends up with a riskless position. c. Standardized contracts that are traded on exchanges and are "marked to market" daily, but where physical delivery of the underlying asset is virtually never taken. d. Two parties agree to exchange obligations to make specified payment streams. e. Simultaneously buying and selling a call option with the same exercise price. ANSWER: b POINTS: 1 DIFFICULTY: CHALLENGING Copyright Cengage Learning. Powered by Cognero.
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REFERENCES: 18-4 Introduction to Option Pricing Models QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.18.04 - Introduction to Option Pricing Models NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.09 - Derivatives TOPICS: Riskless hedge KEYWORDS: Bloom’s: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:02 PM DATE MODIFIED: 9/21/2017 6:02 PM 26. A 6-month call option on Romer Technologies' stock has a strike price of $41.00 and sells in the market for $8.25. Romer's current stock price is $47.00. What is the exercise value of the option? Do not round your intermediate calculations. a. $6.00 b. $6.06 c. $5.46 d. $7.32 e. $6.66 ANSWER: RATIONALE:
a
Strike price Option value Stock price
$41.00 $8.25 $47.00
Exercise value = Current price of stock − Strike price Exercise value = $47.00 − $41.00 Exercise value = $6.00
POINTS: 1 DIFFICULTY: EASY REFERENCES: 18-3 Options QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.16.18.03 - Options NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.09 - Derivatives TOPICS: Call exercise value KEYWORDS: Bloom’s: Evaluation OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:02 PM DATE MODIFIED: 9/21/2017 6:02 PM 27. A 6-month call option on Meyers Inc.'s stock has a strike price of $45.00 and sells in the market for $8.75. Meyers' current stock price is $48.00. What is the option premium? Do not round your intermediate calculations. a. $5.06 b. $4.95 Copyright Cengage Learning. Powered by Cognero.
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c. $5.75 d. $5.46 e. $5.69 ANSWER: RATIONALE:
c
Strike price Option value Stock price
$45.00 $8.75 $48.00
Exercise value = Current price of stock − Strike price Exercise value = $48.00 − $45.00 Exercise value = $3.00 Option premium = Option value − Exercise value Option premium = $8.75 − $3.00 Option premium = $5.75
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 18-3 Options QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.16.18.03 - Options NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.09 - Derivatives TOPICS: Call option premium KEYWORDS: Bloom’s: Evaluation OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:02 PM DATE MODIFIED: 9/21/2017 6:02 PM 28. A 6-month put option on Makler Corp.'s stock has a strike price of $50.00 and sells in the market for $8.50. Makler's current stock price is $39.00. What is the exercise value of the option? Do not round your intermediate calculations. a. $8.36 b. $8.25 c. $12.32 d. $12.98 e. $11.00 ANSWER: e RATIONALE:
Strike price Option value Stock price
$50.00 $8.50 $39.00
Put exercise value = Strike price − Current price of stock Put exercise value = $50.00 − $39.00 Put exercise value = $11.00
POINTS: DIFFICULTY: REFERENCES: QUESTION TYPE: HAS VARIABLES:
1 MODERATE 18-3 Options Multiple Choice True
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LEARNING OBJECTIVES: FOFM.BRIG.16.18.03 - Options NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.09 - Derivatives TOPICS: Put option exercise value KEYWORDS: Bloom’s: Evaluation OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:02 PM DATE MODIFIED: 9/21/2017 6:02 PM 29. A 6-month put option on Smith Corp.'s stock has a strike price of $46.00 and sells in the market for $8.50. Smith's current stock price is $40.00. What is the option premium? Do not round your intermediate calculations. a. $2.90 b. $2.50 c. $2.18 d. $2.28 e. $2.93 ANSWER: RATIONALE:
b
Strike price Option value Stock price
$46.00 $8.50 $40.00
Exercise value = Strike price − Current price of stock Exercise value = $46.00 − $40.00 Exercise value = $6.00 Option premium = Option value − Exercise value Option premium = $8.50 − $6.00 Option premium = $2.50
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 18-3 Options QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.16.18.03 - Options NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.09 - Derivatives TOPICS: Put option premium KEYWORDS: Bloom’s: Evaluation OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:02 PM DATE MODIFIED: 9/21/2017 6:02 PM 30. Lissa Co.'s stock price is currently $30.00. A 6-month call option on Lissa's stock has a strike price of $25.75 and has an expected volatility of 40% (i.e., expected standard deviation = 40%). The risk-free rate is 6%. According to the BlackScholes option pricing model, what is the value of the option? Do not round your intermediate calculations. a. $5.16 b. $6.46 c. $7.21 Copyright Cengage Learning. Powered by Cognero.
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d. $6.22 e. $5.66 ANSWER: RATIONALE:
d
Stock price, P Strike price, X rRF Time to expiration Std deviation
$30.00 $25.75 0.06 0.50 0.40
d1 N(d1) d2 N(d2) Option value
0.7876 0.7845 0.5047 0.6931 -r
t
P[N(d1)] - Xe RF [N(d2)]
= $30.00(0.7845)−$25.75e = $23.5350−$17.3199 = $6.2151≈$6.22
(-0.03)
(0.6931)
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 18-5 The Black-Scholes Option Pricing Model (OPM) QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.16.18.05 - The Black-Scholes Option Pricing Model (OPM) NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.09 - Derivatives TOPICS: Black-Scholes–Use Excel KEYWORDS: Bloom’s: Evaluation OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:02 PM DATE MODIFIED: 9/21/2017 6:02 PM 31. Looking at The Wall Street Journal you observe that the settlement price on a hypothetical 7-year, semiannual payment, 6% coupon Treasury note is 105-210. If the note has a $1,000 par value, what is the implied Treasury note rate? Do not round your intermediate calculations. a. 5.04% b. 4.33% c. 5.34% d. 3.83% e. 4.28% ANSWER: RATIONALE:
a
Contract Data:
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Years Periods/Yrs. Par Value Coupon rate Quote: Value = N PV FV PMT I/YR/2
7 2 $1,000 6% (1.05 + 0.21/32)×$1,000 $1,056.56
14 $1,056.56 $1,000 $30 2.52%
Annual rate: I/YR = 5.04%
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 18-6 Forward and Futures Contracts QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.16.18.06 - Forward and Futures Contracts NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.09 - Derivatives TOPICS: T-note futures contracts KEYWORDS: Bloom’s: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:02 PM DATE MODIFIED: 9/21/2017 6:02 PM 32. Suppose a hypothetical CBOT 13-year U.S., semiannual payment, 6% coupon Treasury note futures contract has a quoted price of 89-090. If the note has a $1,000 par value, what is the implied annual interest rate inherent in this futures contract? Do not round your intermediate calculations. a. 7.35% b. 8.30% c. 7.28% d. 8.15% e. 5.97% ANSWER: RATIONALE:
c
Contract Data: Years Periods/Yrs. Par Value Coupon rate Quote: Value = N PV FV
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13 2 $1,000 6% (0.89 + 0.09/32)×$1,000 $892.81 26 $892.81 $1,000 Page 986
PMT I/YR/2
$30 3.64%
Annual rate: I/YR = 7.28%
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 18-6 Forward and Futures Contracts QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.16.18.06 - Forward and Futures Contracts NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.09 - Derivatives TOPICS: T-note futures contracts KEYWORDS: Bloom’s: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:02 PM DATE MODIFIED: 9/21/2017 6:02 PM 33. Suppose a hypothetical CBOT 12-year U.S., semiannual payment, 7% coupon Treasury note futures contract has a quoted price of 103-180. If the note has a $1,000 par value, what is the implied annual interest rate inherent in the futures contract? Do not round your intermediate calculations. a. 6.43% b. 5.25% c. 5.12% d. 6.56% e. 7.15% ANSWER: RATIONALE:
d
Contract Data: Years Periods/Yrs. Par Value Coupon rate Quote: Value = N PV FV PMT I/YR/2
12 2 $1,000 7% (1.03 + 0.18/32)×$1,000 $1,035.63 24 $1,035.63 $1,000 $35 3.28%
Annual rate: I/YR = 6.56%
POINTS: DIFFICULTY:
1 MODERATE
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REFERENCES: 18-6 Forward and Futures Contracts QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.16.18.06 - Forward and Futures Contracts NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.09 - Derivatives TOPICS: T-note futures contracts KEYWORDS: Bloom’s: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:02 PM DATE MODIFIED: 9/21/2017 6:02 PM 34. Suppose a hypothetical CBOT 13-year U.S., semiannual payment, 6% coupon Treasury note futures contract has a quoted price of 103-180. If annual interest rates go up by 1.00 percentage point, what is the gain or loss on the futures contract? (Assume a $1,000 par value, round the new interest rate to 4 decimal places when written as a decimal, and round the change in price up to the nearest whole dollar.) Do not round other intermediate calculations. a. −$111 b. −$94 c. −$85 d. −$71 e. −$89 ANSWER: RATIONALE:
e
Contract Data: Years Periods/Yrs. Par Value Coupon rate Quote: Value = N PV FV PMT I/YR/2
13 2 $1,000 6% (1.03 + 0.18/32)×$1,000 $1,035.63 26 $1,035.63 $1,000 $30 2.81%
Annual rate: I/YR = 5.62%
Increase in annual rate: N PMT FV New semiannual rate = (Old rate + Increase)/2 = New price =
0.01 26 $30 $1,000 3.31% $946.51
Change in price = −$89
POINTS: DIFFICULTY:
1 CHALLENGING
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REFERENCES: 18-6 Forward and Futures Contracts QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.16.18.06 - Forward and Futures Contracts NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.09 - Derivatives TOPICS: T-note futures contracts KEYWORDS: Bloom’s: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:02 PM DATE MODIFIED: 9/21/2017 6:02 PM 35. Suppose a hypothetical CBOT 7-year U.S., semiannual payment, 6% coupon Treasury note futures contract has a quoted price of 88-300. If annual interest rates go down by 1.00 percentage point, what is the gain or loss on the futures contract? (Assume a $1,000 par value, round the new interest rate to 4 decimal places when written as a decimal, and round the change in price up to the nearest whole dollar.) Do not round other intermediate calculations. a. $38 b. $55 c. $51 d. $56 e. $45 ANSWER: RATIONALE:
c
Contract Data: Years Periods/Yrs. Par Value Coupon rate Quote: Value =
7 2 $1,000 6% (0.88 + 0.30/32)×$1,000 $889.38
N PV FV PMT I/YR/2
14 $889.38 $1,000 $30 4.05%
Annual rate: I/YR = 8.10%
Increase in annual rate: N PMT FV New semiannual rate = (Old rate + Increase)/2 = New price =
−0.01 14 $30 $1,000 3.55% $940.14
Change in price = $51
POINTS: DIFFICULTY: REFERENCES:
1 CHALLENGING 18-6 Forward and Futures Contracts
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QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.16.18.06 - Forward and Futures Contracts NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.09 - Derivatives TOPICS: T-note futures contracts KEYWORDS: Bloom’s: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:02 PM DATE MODIFIED: 9/21/2017 6:02 PM
1. Multinational financial management requires that financial analysts consider the effects of changing currency values. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 19-2 Multinational Versus Domestic Financial Management QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.17.02 - Multinational Versus Domestic Financial Management NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Multinational fin. mgmt. KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 6:13 PM DATE MODIFIED: 9/26/2017 6:22 PM 2. Legal and economic differences among countries, although important, do NOT pose significant problems for most multinational corporations when they coordinate and control worldwide operations and subsidiaries. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 19-2 Multinational Versus Domestic Financial Management QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.17.02 - Multinational Versus Domestic Financial Management NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Multinational fin. mgmt. Copyright Cengage Learning. Powered by Cognero.
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KEYWORDS: DATE CREATED: DATE MODIFIED:
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3. When the value of the U.S. dollar appreciates against another country's currency, we may purchase more of the foreign currency with the U.S. dollar. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 19-3 The International Monetary System QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.17.03 - The International Monetary System NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Currency appreciation KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 6:13 PM DATE MODIFIED: 9/26/2017 6:22 PM 4. The United States and most other major industrialized nations currently operate under a system of floating exchange rates. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 19-3 The International Monetary System QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.17.03 - The International Monetary System NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Floating exchange rates KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 6:13 PM DATE MODIFIED: 9/26/2017 6:22 PM 5. Exchange rate quotations consist solely of direct quotations. a. True b. False ANSWER: False Copyright Cengage Learning. Powered by Cognero.
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POINTS: 1 DIFFICULTY: EASY REFERENCES: 19-4 Foreign Exchange Rate Quotations QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.17.04 - Foreign Exchange Rate Quotations NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Exchange rates KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 6:13 PM DATE MODIFIED: 9/26/2017 6:22 PM 6. Calculating a currency cross rate involves determining the exchange rate for two currencies by using a third currency as a base. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 19-4 Foreign Exchange Rate Quotations QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.17.04 - Foreign Exchange Rate Quotations NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Cross rates KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 6:13 PM DATE MODIFIED: 9/26/2017 6:22 PM 7. A Eurodollar is a U.S. dollar deposited in a bank outside the United States. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 19-9 International Money and Capital Markets QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.17.09 - International Money and Capital Markets NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management Copyright Cengage Learning. Powered by Cognero.
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LOCAL STANDARDS: TOPICS: KEYWORDS: DATE CREATED: DATE MODIFIED:
United States - OH - Default City - Tier 2: - Capital structure Eurodollars Bloom's: Knowledge 9/21/2017 6:13 PM 9/26/2017 6:22 PM
8. LIBOR is an acronym for London Interbank Offered Rate, which is an average of interest rates offered by London banks to smaller U.S. corporations on all deposits. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 19-9 International Money and Capital Markets QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.17.09 - International Money and Capital Markets NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: LIBOR KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 6:13 PM DATE MODIFIED: 9/26/2017 6:22 PM 9. Exchange rate risk is the risk that the cash flows from a foreign project, when converted to the parent company's currency, will be worth less than was originally projected because of exchange rate changes. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 19-10 Investing Overseas QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.17.10 - Investing Overseas NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Exchange rate risk KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 6:13 PM DATE MODIFIED: 9/26/2017 6:22 PM 10. Because political risk is seldom negotiable, it cannot be explicitly addressed in multinational corporate financial analysis. Copyright Cengage Learning. Powered by Cognero.
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a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 19-11 International Capital Budgeting QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.17.11 - International Capital Budgeting NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Political risk KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 6:13 PM DATE MODIFIED: 9/26/2017 6:22 PM 11. Individuals and corporations can buy or sell forward currencies to hedge their exchange rate exposure. Essentially, the process involves simultaneously selling the currency expected to appreciate in value and buying the currency expected to depreciate. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 19-5 Trading in Foreign Exchange QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.17.05 - Trading in Foreign Exchange NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Forward market hedge KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 6:13 PM DATE MODIFIED: 9/26/2017 6:22 PM 12. If an investor can obtain more of a foreign currency for a dollar in the forward market than in the spot market, then the forward currency is said to be selling at a discount to the spot rate. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 19-5 Trading in Foreign Exchange QUESTION TYPE: True / False Copyright Cengage Learning. Powered by Cognero.
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HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.17.05 - Trading in Foreign Exchange NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Discount on forward rate KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 6:13 PM DATE MODIFIED: 9/26/2017 6:22 PM 13. If a dollar will buy fewer units of a foreign currency in the forward market than in the spot market, then the forward currency is said to be selling at a premium to the spot rate. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 19-5 Trading in Foreign Exchange QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.17.05 - Trading in Foreign Exchange NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Premium on forward rate KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 6:13 PM DATE MODIFIED: 9/26/2017 6:22 PM 14. A foreign currency will, on average, depreciate against the U.S. dollar at a percentage rate approximately equal to the amount by which its inflation rate exceeds that of the United States. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 19-8 Inflation, Interest Rates, and Exchange Rates QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.17.08 - Inflation, Interest Rates, and Exchange Rates NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Currency value and inflation KEYWORDS: Bloom's: Comprehension Copyright Cengage Learning. Powered by Cognero.
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DATE CREATED: DATE MODIFIED:
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15. The cash flows relevant for a foreign investment should, from the parent company's perspective, include the financial cash flows that the subsidiary can legally send back to the parent company plus the cash flows that must remain in the foreign country. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 19-11 International Capital Budgeting QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.17.11 - International Capital Budgeting NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Relevant investment CFs KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 6:13 PM DATE MODIFIED: 9/26/2017 6:22 PM 16. The cost of capital may be different for a foreign project than for an equivalent domestic project because foreign projects may be more or less risky. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 19-11 International Capital Budgeting QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.17.11 - International Capital Budgeting NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Foreign project COC KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 6:13 PM DATE MODIFIED: 9/26/2017 6:22 PM 17. When considering the risk of a foreign investment, a higher risk might arise from exchange rate risk and political risk while lower risk might result from international diversification. a. True b. False Copyright Cengage Learning. Powered by Cognero.
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ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 19-11 International Capital Budgeting QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.17.11 - International Capital Budgeting NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Risk and int'l. investment KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 6:13 PM DATE MODIFIED: 9/26/2017 6:22 PM 18. Which of the following are reasons why companies move into international operations? a. To take advantage of lower production costs in regions where labor costs are relatively low. b. To develop new markets for the firm's products. c. To better serve their primary customers. d. Because important raw materials are located abroad. e. All of the above. ANSWER: e POINTS: 1 DIFFICULTY: EASY REFERENCES: 19-1 Multinational, or Global, Corporations QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.17.01 - Multinational, or Global, Corporations NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Motive for going global KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:13 PM DATE MODIFIED: 9/26/2017 6:22 PM 19. Multinational financial management requires that a. the effects of changing currency values be included in financial analyses. b. legal and economic differences need not be considered in financial decisions because these differences are insignificant. c. political risk should be excluded from multinational corporate financial analyses. d. traditional U.S. and European financial models incorporating the existence of a competitive marketplace not be recast when analyzing projects in other parts of the world. e. cultural differences need not be accounted for when considering firm goals and employee management. Copyright Cengage Learning. Powered by Cognero.
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ANSWER: a POINTS: 1 DIFFICULTY: EASY REFERENCES: 19-2 Multinational Versus Domestic Financial Management QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.17.02 - Multinational Versus Domestic Financial Management NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Multinational fin. mgmt. KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:13 PM DATE MODIFIED: 9/26/2017 6:22 PM 20. In Japan, 90-day securities have a 4% annualized return and 180-day securities have a 5% annualized return. In the United States, 90-day securities have a 4% annualized return and 180-day securities have an annualized return of 4.5%. All securities are of equal risk, and Japanese securities are denominated in terms of the Japanese yen. Assuming that interest rate parity holds in all markets, which of the following statements is most CORRECT? a. The yen-dollar spot exchange rate equals the yen-dollar exchange rate in the 90-day forward market. b. The yen-dollar spot exchange rate equals the yen-dollar exchange rate in the 180-day forward market. c. The yen-dollar exchange rate in the 90-day forward market equals the yen-dollar exchange rate in the 180-day forward market. d. The yen-dollar exchange rate in the 180-day forward market equals the yen-dollar exchange rate in the 90-day spot market. e. The relationship between spot and forward interest rates cannot be inferred. ANSWER: a POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 19-6 Interest Rate Parity QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.17.06 - Interest Rate Parity NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Interest rate parity KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:13 PM DATE MODIFIED: 9/26/2017 6:22 PM 21. If the inflation rate in the United States is greater than the inflation rate in Britain, other things held constant, the British pound will a. appreciate against the U.S. dollar. Copyright Cengage Learning. Powered by Cognero.
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b. depreciate against the U.S. dollar. c. remain unchanged against the U.S. dollar. d. appreciate against other major currencies. e. appreciate against the dollar and other major currencies. ANSWER: a POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 19-8 Inflation, Interest Rates, and Exchange Rates QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.17.08 - Inflation, Interest Rates, and Exchange Rates NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Currency depreciation KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:13 PM DATE MODIFIED: 9/26/2017 6:22 PM 22. Which of the following statements is NOT CORRECT? a. Any bond sold outside the country of the borrower is called an international bond. b. Foreign bonds and Eurobonds are two important types of international bonds. c. Foreign bonds are bonds sold by a foreign borrower but denominated in the currency of the country in which the issue is sold. d. The term Eurobond applies only to foreign bonds denominated in U.S. currency. e. A Eurodollar is a U.S. dollar deposited in a bank outside the U.S. ANSWER: d POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 19-9 International Money and Capital Markets QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.17.09 - International Money and Capital Markets NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Int'l. bond markets KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:13 PM DATE MODIFIED: 9/26/2017 6:22 PM 23. Currently, a U.S. trader notes that in the 6-month forward market, the Japanese yen is selling at a premium (that is, you receive more dollars per yen in the forward market than you do in the spot market), while the British pound is selling at a discount. Which of the following statements is CORRECT? Copyright Cengage Learning. Powered by Cognero.
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a. If interest rate parity holds, 6-month interest rates should be the same in the U.S., Britain, and Japan. b. If interest rate parity holds among the three countries, the United States should have the highest 6-month interest rates and Japan should have the lowest rates. c. If interest rate parity holds among the three countries, Britain should have the highest 6-month interest rates and Japan should have the lowest rates. d. If interest rate parity holds among the three countries, Japan should have the highest 6-month interest rates and Britain should have the lowest rates. e. If interest rate parity holds among the three countries, the United States should have the highest 6-month interest rates and Britain should have the lowest rates. ANSWER: c RATIONALE: As the yen is selling at a premium, this means that the interest rates in Japan are lower than in the U.S. Thus, when you invest in yen, you get part of your return from the interest rate and part when you convert back to dollars. The opposite is true of the rates in Britain. POINTS: 1 DIFFICULTY: MODERATE/CHALLENGING REFERENCES: 19-6 Interest Rate Parity QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.17.06 - Interest Rate Parity NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Interest rate parity KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:13 PM DATE MODIFIED: 9/26/2017 6:22 PM 24. Today in the spot market $1 = 1.82 Swiss francs and $1 = 130 Japanese yen. In the 90-day forward market, $1 = 1.84 Swiss francs and $1 = 127 Japanese yen. Assume that interest rate parity holds worldwide. Which of the following statements is most CORRECT? a. Interest rates on 90-day risk-free U.S. securities are higher than the interest rates on 90-day risk-free Swiss securities. b. Interest rates on 90-day risk-free U.S. securities are higher than the interest rates on 90-day risk-free Japanese securities. c. Interest rates on 90-day risk-free U.S. securities equal the interest rates on 90-day risk-free Japanese securities. d. Since interest rate parity holds interest rates should be the same in all three countries. e. Interest rates on 90-day risk-free U.S. securities equal the interest rates on 90-day risk-free Swiss securities. ANSWER: b RATIONALE: The easiest way to do this is to make an example up. Assume the annual interest rate in the U.S. is 16%. Suppose in the U.S. you start off with $1.00, so after 90 days you will have $1.00 (1 + 0.16/4) = $1.04. In Switzerland, you will start with 1.00 1.82 = SF 1.82 and end up with 1.04 1.84 = SF 1.9136. The return in Switzerland is 1.9136/1.82 – 1 = 5.14%. (This is higher than the 4% U.S. rate.) In Japan, you will start with 1.00 130 = 130 yen and end up with 1.04 127 = 132.08 yen. The return is 132.08/130 – 1 = 1.6%. (This is lower than the 4% U.S. rate.) POINTS: 1 Copyright Cengage Learning. Powered by Cognero.
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DIFFICULTY: CHALLENGING REFERENCES: 19-6 Interest Rate Parity QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.17.06 - Interest Rate Parity NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Interest rate parity KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:13 PM DATE MODIFIED: 9/26/2017 6:22 PM 25. If one Swiss franc can purchase 0.85 U.S. dollar, how many Swiss francs can one U.S. dollar buy? a. 1.0471 b. 1.1765 c. 1.0706 d. 1.3294 e. 1.2706 ANSWER: b RATIONALE: 1 Swiss franc = 0.85 U.S. dollar
U.S. dollar = 1/0.85 Swiss francs 1 U.S. $ can purchase 1.1765 Swiss francs
POINTS: 1 DIFFICULTY: EASY REFERENCES: 19-4 Foreign Exchange Rate Quotations QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.17.04 - Foreign Exchange Rate Quotations NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Exchange rates KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:13 PM DATE MODIFIED: 9/26/2017 6:22 PM 26. If one U.S. dollar buys 1.59 Canadian dollars, how many U.S. dollars can you purchase for one Canadian dollar? a. 0.6667 b. 0.7547 c. 0.5786 Copyright Cengage Learning. Powered by Cognero.
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d. 0.5346 e. 0.6289 ANSWER: RATIONALE:
e
1 U.S. dollar = 1.59 Canadian dollars Canadian dollar = 1/1.59 U.S. dollars 1 C$ can purchase 0.6289 U.S. dollar
POINTS: 1 DIFFICULTY: EASY REFERENCES: 19-4 Foreign Exchange Rate Quotations QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.17.04 - Foreign Exchange Rate Quotations NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Exchange rates KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:13 PM DATE MODIFIED: 9/26/2017 6:22 PM 27. If one British pound can purchase $2.00 U.S. dollars, how many British pounds can one U.S. dollar buy? a. 0.5600 b. 0.5550 c. 0.4000 d. 0.5000 e. 0.4850 ANSWER: d RATIONALE: 1 British pound = 2.00 U.S. dollar
U.S. dollar = 1/2.00 British pounds 1 U.S. $ can purchase 0.5000 British pound
POINTS: 1 DIFFICULTY: EASY REFERENCES: 19-4 Foreign Exchange Rate Quotations QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.17.04 - Foreign Exchange Rate Quotations NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Exchange rates Copyright Cengage Learning. Powered by Cognero.
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KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
Bloom's: Analysis Multiple Choice: Problem 9/21/2017 6:13 PM 9/26/2017 6:22 PM
28. If one U.S. dollar buys 0.61 euro, how many dollars can you purchase for one euro? a. 1.5574 b. 1.4262 c. 1.6393 d. 1.2623 e. 1.4590 ANSWER: c RATIONALE: 1 U.S. dollar = 0.61 euro
Euro = 1/0.610 U.S. dollar 1 euro can purchase 1.6393 U.S. dollars
POINTS: 1 DIFFICULTY: EASY REFERENCES: 19-4 Foreign Exchange Rate Quotations QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.17.04 - Foreign Exchange Rate Quotations NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Exchange rates KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:13 PM DATE MODIFIED: 9/26/2017 6:22 PM 29. If one U.S. dollar sells for 0.53 British pound, how many dollars should one British pound sell for? a. 2.0566 b. 2.0943 c. 1.6792 d. 1.4906 e. 1.8868 ANSWER: e RATIONALE: 1 U.S. dollar = 0.53 pound
Pound = 1/0.530 U.S. dollar 1 pound can sell for 1.8868 U.S. dollars
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POINTS: 1 DIFFICULTY: EASY REFERENCES: 19-4 Foreign Exchange Rate Quotations QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.17.04 - Foreign Exchange Rate Quotations NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Exchange rates KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:13 PM DATE MODIFIED: 9/26/2017 6:22 PM 30. Suppose 144 yen could be purchased in the foreign exchange market for one U.S. dollar today. If the yen depreciates by 13.0% tomorrow, how many yen could one U.S. dollar buy tomorrow? a. 143.1936 b. 138.3120 c. 175.7376 d. 162.7200 e. 183.8736 ANSWER: d RATIONALE: One dollar = 144 yen
Depreciation 13% If yen depreciates against the dollar, the dollar will purchase more yen.
U.S. dollar (Tomorrow) = 144 (1 + 0.13) U.S. dollar (Tomorrow) = 162.7200 yen
POINTS: 1 DIFFICULTY: EASY REFERENCES: 19-5 Trading in Foreign Exchange QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.17.05 - Trading in Foreign Exchange NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Currency appreciation KEYWORDS: Bloom's: Analysis Copyright Cengage Learning. Powered by Cognero.
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OTHER: DATE CREATED: DATE MODIFIED:
Multiple Choice: Problem 9/21/2017 6:13 PM 9/26/2017 6:22 PM
31. Suppose a foreign investor who holds tax-exempt Eurobonds paying 10.50% is considering investing in an equivalentrisk domestic bond in a country with a 28.00% withholding tax on interest paid to foreigners. If 10.50% after-tax is the investor's required return, what before-tax rate would the domestic bond need to pay to provide the required after-tax return? a. 15.46% b. 16.33% c. 16.92% d. 12.83% e. 14.58% ANSWER: e RATIONALE: 10.50% Tax rate 28.00% r AT d
rd BT = rd BT = rd BT =
rd AT / (1 – T) 10.50% / 72.00% 14.58%
POINTS: 1 DIFFICULTY: EASY REFERENCES: 19-9 International Money and Capital Markets QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.17.09 - International Money and Capital Markets NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Eurobonds vs domestic bonds KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:13 PM DATE MODIFIED: 9/26/2017 6:22 PM 32. Suppose DeGraw Corporation, a U.S. exporter, sold a solar heating station to a Japanese customer at a price of 130.5 million yen, when the exchange rate was 140.0 yen per dollar. In order to close the sale, DeGraw agreed to make the bill payable in yen, thus agreeing to take some exchange rate risk for the transaction. The terms were net 6 months. If the yen fell against the dollar such that one dollar would buy 154.4 yen when the invoice was paid, what dollar amount would DeGraw actually receive after it exchanged yen for U.S. dollars? a. $845,207.25 b. $1,039,604.92 c. $1,048,056.99 d. $676,165.80 e. $659,261.66 ANSWER: a RATIONALE: Spot rate at t = 0 140.0 yen Copyright Cengage Learning. Powered by Cognero.
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per $ 154.4 yen Exchange rate at t = 0.5 per $ (Numbers in millions)
Years
0
Payable
0.5 130.5 yen
Dollar value of payable = Payable in Yen/Yen Exchange rate at t = 0.5
$ Value at t = 0.5
$845,207.25
POINTS: 1 DIFFICULTY: EASY REFERENCES: 19-10 Investing Overseas QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.17.10 - Investing Overseas NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Exchange rate risk KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:13 PM DATE MODIFIED: 9/26/2017 6:22 PM 33. Suppose the exchange rate between U.S. dollars and Swiss francs is SF 1.41 = $1.00, and the exchange rate between the U.S. dollar and the euro is $1.00 = 0.70 euro. What is the cross rate of Swiss francs to euros? (In other words, how many Swiss francs are needed to purchase one euro?) Do not round the intermediate calculations and round the final answer to four decimal places. a. 2.2963 b. 2.5179 c. 2.0143 d. 2.0949 e. 1.6316 ANSWER: RATIONALE:
c
One U.S. dollar 1.41 SF = One U.S. dollar 0.70 € = SF/€ SF/€ SF/€
POINTS:
= SF/$ $/€ = 1.4100 1.4286 = 2.0143
1
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DIFFICULTY: MODERATE REFERENCES: 19-4 Foreign Exchange Rate Quotations QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.17.04 - Foreign Exchange Rate Quotations NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Cross rates KEYWORDS: Bloom's: Evaluation OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:13 PM DATE MODIFIED: 9/26/2017 6:22 PM 34. Suppose that currently, 1 British pound equals 1.98 U.S. dollars and 1 U.S. dollar equals 1.25 Swiss francs. How many Swiss francs are needed to purchase 1 pound? a. 2.1285 b. 2.3760 c. 1.9058 d. 2.5988 e. 2.4750 ANSWER: e RATIONALE:
£ = $1.98 $ = 1.25 SF SF/£ = SF/£ = SF/£ =
SF/$ 1.2500 2.4750
$/£ 1.98
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 19-4 Foreign Exchange Rate Quotations QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.17.04 - Foreign Exchange Rate Quotations NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Cross rates KEYWORDS: Bloom's: Evaluation OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:13 PM DATE MODIFIED: 9/26/2017 6:22 PM 35. A currency trader observes the following quotes in the spot market: Copyright Cengage Learning. Powered by Cognero.
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1 U.S. dollar = 1.34 Japanese yen 1 British pound = 2.25 Swiss francs 1 British pound = 1.65 U.S. dollars Given this information, how many yen can be purchased for 1 Swiss franc? Do not round the intermediate calculations and round the final answer to four decimal places. a. 0.8156 b. 1.1301 c. 0.7370 d. 0.8844 e. 0.9827 ANSWER: e RATIONALE: £= 2.25 SF
£= $=
$1.65 1.34 ¥
¥/SF = ¥/$ $/£ £/SF ¥/SF = 1.3400 1.6500 0.4444 ¥/SF = 0.9827 POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 19-4 Foreign Exchange Rate Quotations QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.17.04 - Foreign Exchange Rate Quotations NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Cross rates KEYWORDS: Bloom's: Evaluation OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:13 PM DATE MODIFIED: 9/26/2017 6:22 PM 36. A currency trader observes the following quotes in the spot market: 1 U.S. dollar = 10.875 Mexican pesos 1 British pound = 7.500 Danish krone 1 British pound = 1.65 U.S. dollars Given this information, how many Mexican pesos can be purchased for 1 Danish krone? a. 2.3446 b. 2.0097 c. 2.9188 d. 2.0815 e. 2.3925 ANSWER: e RATIONALE: £ = 7.500 DK
£ = $1.65 Copyright Cengage Learning. Powered by Cognero.
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$ = 10.875 MP MP/DK = MP/$ MP/DK = 10.8750 MP/DK = 2.3925
$/£ 1.6500
£/DK 0.1333
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 19-4 Foreign Exchange Rate Quotations QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.17.04 - Foreign Exchange Rate Quotations NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Cross rates KEYWORDS: Bloom's: Evaluation OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:13 PM DATE MODIFIED: 9/26/2017 6:22 PM 37. In 1985, a given Japanese imported automobile sold for 1,476,000 yen, or $8,200. If the car still sold for the same amount of yen today but the current exchange rate is 141 yen per dollar, what would the car be selling for today in U.S. dollars? a. $10,259 b. $12,980 c. $12,562 d. $10,468 e. $11,515 ANSWER: d RATIONALE: 1985 price in yen of automobile 1,476,000 yen
1985 price in dollars of automobile $8,200 Today's exchange rate: ¥/$ 141 Today's $ price = Today's $ price = Today's $ price =
yen
1985 yen price / Today's exchange rate 1,476,000 / 141 $10,468
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 19-4 Foreign Exchange Rate Quotations QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.17.04 - Foreign Exchange Rate Quotations NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Exchge rates and asset value Copyright Cengage Learning. Powered by Cognero.
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KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
Bloom's: Application Multiple Choice: Problem 9/21/2017 6:13 PM 9/26/2017 6:22 PM
38. Suppose one year ago, Hein Company had inventory in Britain valued at 240,000 pounds. The exchange rate for dollars to pounds was 1£ = 2.00 U.S. dollars. This year the exchange rate is 1£ = 1.82 U.S. dollars. The inventory in Britain is still valued at 240,000 pounds. What is the U.S. dollar gain or loss in inventory value as a result of the change in exchange rates? a. -$43,200.00 b. -$48,816.00 c. -$36,288.00 d. -$50,544.00 e. -$32,400.00 ANSWER: a RATIONALE: Inventory value £240,000
Spot rate, $/£ 1 yr. ago $2.00 Current spot rate $/£ $1.82
Dollar value of inventory this year =
Dollar value of inventory last year =
£ inv. value £ Last year's spot rate $/£ inv. value Current Spot rate $/£
= $436,800.00
= $480,000.00
Change in inv. value = -$43,200.00 POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 19-4 Foreign Exchange Rate Quotations QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVE FOFM.BRIG.17.17.04 - Foreign Exchange Rate Quotations S: NATIONAL STANDARDSUnited States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic : STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Inventory and exchge rates KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:13 PM DATE MODIFIED: 9/26/2017 6:22 PM 39. If the spot rate of the Israeli shekel is 5.51 shekels per dollar and the 180-day forward rate is 5.76 shekels per dollar, then the forward rate for the Israeli shekel is selling at a(n) ______________ to the spot rate. a. 3.68% premium b. 3.72% premium Copyright Cengage Learning. Powered by Cognero.
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c. 4.99% discount d. 4.54% discount e. 5.58% discount ANSWER: RATIONALE:
d
Spot rate: $ = 180-day forward rate
5.51 5.76
shekels shekels
Because one can obtain more Israeli shekels for a dollar in the forward market, the forward currency is selling at a discount to the spot rate. The amount of the discount is calculated as: (Forward rate -
Spot rate)/Spot rate
% Discount =
4.54%
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 19-5 Trading in Foreign Exchange QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.17.05 - Trading in Foreign Exchange NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Forward rates - nonalgorithmic KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:13 PM DATE MODIFIED: 9/26/2017 6:22 PM 40. Suppose one British pound can purchase 1.86 U.S. dollars today in the foreign exchange market, and currency forecasters predict that the U.S. dollar will depreciate by 12.00% against the pound over the next 30 days. How many dollars will a pound buy in 30 days? a. $2.1665 b. $2.2082 c. $1.8957 d. $2.0832 e. $2.3540 ANSWER: d RATIONALE: 1 British pound $1.86
Dollar depreciation
12.00%
The British pound will appreciate against the dollar by 12.00% British pound = $/£ (1 + % $ depreciation) British pound = $2.0832
POINTS: DIFFICULTY: REFERENCES: QUESTION TYPE: HAS VARIABLES:
1 MODERATE 19-5 Trading in Foreign Exchange Multiple Choice True
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LEARNING OBJECTIVES: FOFM.BRIG.17.17.05 - Trading in Foreign Exchange NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Currency depreciation KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:13 PM DATE MODIFIED: 9/26/2017 6:22 PM 41. Stover Corporation, a U.S. based importer, makes a purchase of crystal glassware from a firm in Switzerland for 39,960 Swiss francs, or $24,000, at the spot rate of 1.665 Swiss francs per dollar. The terms of the purchase are net 90 days, and the U.S. firm wants to cover this trade payable with a forward market hedge to eliminate its exchange rate risk. Suppose the firm completes a forward hedge at the 90-day forward rate of 1.682 Swiss francs. If the spot rate in 90 days is actually 1.615 Swiss francs, how much in U.S. dollars will the U.S. firm have saved or lost by hedging its exchange rate exposure? Do not round the intermediate calculations and round the final answer to the nearest cent. a. $1,212.29 b. $926.47 c. $985.60 d. $965.89 e. $916.61 ANSWER: c RATIONALE: Price of glassware in SF 39,960 SF
Dollar price of glassware Spot rate, SF/$ 90-day forward rate, SF/$ Spot rate in 90 days, SF/$
$24,000 1.665 SF 1.682 SF 1.6150 SF 0
30
60
Price of glassware in SF
90 39,960.00
$ Cost at spot in 90 days Forward contract ($) Savings from forward contract
$24,743.03 $23,357.43 $985.60
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 19-5 Trading in Foreign Exchange QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.17.05 - Trading in Foreign Exchange NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Forward market hedge Copyright Cengage Learning. Powered by Cognero.
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KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
Bloom's: Application Multiple Choice: Problem 9/21/2017 6:13 PM 9/26/2017 6:22 PM
42. Suppose a U.S. firm buys $200,000 worth of television tubes from a Mexican manufacturer for delivery in 60 days with payment to be made in 90 days (30 days after the goods are received). The rising U.S. deficit has caused the dollar to depreciate against the peso recently. The current exchange rate is 5.68 pesos per U.S. dollar. The 90-day forward rate is 5.45 pesos/dollar. The firm goes into the forward market today and buys enough Mexican pesos at the 90-day forward rate to completely cover its trade obligation. Assume the spot rate in 90 days is 5.30 Mexican pesos per U.S. dollar. How much in U.S. dollars did the firm save by eliminating its foreign exchange currency risk with its forward market hedge? Do not round the intermediate calculations and round the final answer to the nearest cent. a. $4,542.43 b. $5,899.26 c. $5,309.33 d. $5,840.26 e. $6,725.15 ANSWER: RATIONALE:
b
Television tubes Spot rate, MP/$ 90-day forward rate, MP/$ Spot rate in 90 days, MP/$
$200,000 5.6800 MP 5.45 MP 5.30 MP 0
Trade obligation in MP (Tubes $ Cost at spot in 90 days Forward contract ($) Savings from forward contract
Spot rate)
30
60
90 1,136,000.00 $214,339.62 $208,440.37 $5,899.26
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 19-5 Trading in Foreign Exchange QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.17.05 - Trading in Foreign Exchange NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Forward market hedge KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:13 PM DATE MODIFIED: 9/26/2017 6:22 PM 43. Suppose 90-day investments in Britain have a 6.00% annualized return and a 1.50% quarterly (90-day) return. In the Copyright Cengage Learning. Powered by Cognero.
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U.S., 90-day investments of similar risk have a 4.00% annualized return and a 1.00% quarterly (90-day) return. In the 90day forward market, 1 British pound equals $1.70. If interest rate parity holds, what is the spot exchange rate ($/£)? Do not round the intermediate calculations and round the final answer to four decimal places. a. $1.7084 b. $1.8280 c. $1.8109 d. $1.8793 e. $2.0159 ANSWER: a RATIONALE: 1.50% 90-day r , (Annual/4) f
1.00% 90-day rh , (Annual/4) 90-day forward rate ($/£) $1.70 Forward exchange rate
(1 + rh)
=
Spot exchange rate $1.70 Spot exchange rate
(1 + rf) =
1.0100 1.0150
$1.70 Spot exchange rate
=
0.995074
$1.70
=
$1.7084
=
0.995074 Spot exchange rate
Spot exchange rate
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 19-6 Interest Rate Parity QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.17.06 - Interest Rate Parity NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Interest rate parity KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:13 PM DATE MODIFIED: 9/26/2017 6:22 PM 44. Suppose hockey skates sell in Canada for 113 Canadian dollars, and 1 Canadian dollar equals 0.71 U.S. dollar. If purchasing power parity (PPP) holds, what is the price of hockey skates in the United States? a. $60.17 b. $90.66 c. $82.64 d. $93.07 e. $80.23 Copyright Cengage Learning. Powered by Cognero.
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ANSWER: RATIONALE:
e
Price of skates, C$ Spot exchange rate, $/C$ Ph
=
Pf
Ph Ph
= =
113 $80.23
113 C$ $0.71 Spot rate $0.71
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 19-7 Purchasing Power Parity QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.17.07 - Purchasing Power Parity NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Purchasing power parity KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:13 PM DATE MODIFIED: 9/26/2017 6:22 PM 45. Suppose 6 months ago a Swiss investor bought a 6-month U.S. Treasury bill at a price of $9,708.74, with a maturity value of $10,000.00. The exchange rate at that time was 1.441 Swiss francs per dollar. Today, at maturity, the exchange rate is 1.324 Swiss francs per dollar. What is the annualized rate of return to the Swiss investor? Do not round the intermediate calculations and round the final answer to two decimal places. a. –11.26% b. –10.73% c. –9.98% d. –9.76% e. –10.83% ANSWER: b RATIONALE: 6-mos. Treasury bill,
VB Maturity value Spot rate, SF/$ 6-mos Fwd rate, SF/$
$9,708.74
$10,000.00 1.441 SF 1.324 SF
Time 0 6 months CF, in $ -$9,708.74 $10,000.00 CF, in SF –13,990.29 13,240.00 Now, calculate the 6-month return to the Swiss investor after exchanging US $ for SF:
N PV Copyright Cengage Learning. Powered by Cognero.
1 –13,990.29 Page 1015
PMT FV I/YR, 6-mos.
0 13,240.00 –5.36%
Annual rate =
2
6 mos. return
Annual rate = –10.73%
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 19-10 Investing Overseas QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.17.10 - Investing Overseas NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Exchange fluctuations KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:13 PM DATE MODIFIED: 9/26/2017 6:22 PM 46. A product sells for $750 in the United States. The spot exchange rate is $1 to 1.56 Swiss francs. If purchasing power parity (PPP) holds, what is the price of the product in Switzerland? a. 1,462.50 b. 1,392.30 c. 1,228.50 d. 1,170.00 e. 947.70 ANSWER: d RATIONALE: Product price in U.S. $750
Spot rate, SF/$
1.56
SF
Formula below requires spot rate to be home currency/foreign currency, so need inverse of spot rate given.
Ph = Pf $750 = Pf Pf = 1,170.00
Spot rate, $/SF 0.6410
POINTS: 1 DIFFICULTY: MODERATE/CHALLENGING REFERENCES: 19-7 Purchasing Power Parity QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.17.07 - Purchasing Power Parity NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic Copyright Cengage Learning. Powered by Cognero.
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STATE STANDARDS: LOCAL STANDARDS: TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management United States - OH - Default City - Tier 2: - Capital structure Purchasing power parity Bloom's: Application Multiple Choice: Problem 9/21/2017 6:13 PM 9/26/2017 6:22 PM
47. A box of candy costs 28.80 Swiss francs in Switzerland and $21.80 in the United States. Assuming that purchasing power parity (PPP) holds, how many Swiss francs are required to purchase one U.S. dollar? Do not round the intermediate calculations and round the final answer to four decimal places. a. 1.0701 b. 1.1097 c. 1.3211 d. 1.6382 e. 1.2286 ANSWER: c RATIONALE: Price of candy in 28.80 SF
SF Price of candy in $
$21.80
Spot rate Ph = Pf $21.80 = 28.80 Spot rate Spot rate. = $0.7569 per SF $/SF Note that the spot rate above gives the number of dollars required to purchase one SF. However, the problem asks for the number of SFs required to purchase one U.S. dollar. Therefore, we need to calculate the inverse of the spot rate above.
Spot rate, SF/$ = 1/Spot rate, $/SF Spot rate, SF/$ = 1.3211 POINTS: 1 DIFFICULTY: MODERATE/CHALLENGING REFERENCES: 19-7 Purchasing Power Parity QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.17.07 - Purchasing Power Parity NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Purchasing power parity KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:13 PM DATE MODIFIED: 9/26/2017 6:22 PM Copyright Cengage Learning. Powered by Cognero.
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48. One year ago, a U.S. investor converted dollars to yen and purchased 100 shares of stock in a Japanese company at a price of 3,150 yen per share. The stock's total purchase cost was 315,000 yen. At the time of purchase, in the currency market 1 yen equaled $0.00952. Today, the stock is selling at a price of 3,465 yen per share, and in the currency market $1 equals 145 yen. The stock does not pay a dividend. If the investor were to sell the stock today and convert the proceeds back to dollars, what would be his realized return on his initial dollar investment from holding the stock? a. –22.14% b. –20.31% c. –18.08% d. –23.77% e. –22.55% ANSWER: b RATIONALE: Shares bought 100 Last year's stock price/share in yen 3,150 ¥
$/yen exchange rate at purchase Current stock price/share in yen Yen/$ spot exhange rate $ investment in stock
=
No. of shares
$ investment in stock
=
100
$ investment in stock
=
$2,998.80
$ proceeds of sale
=
$ proceeds of sale $ proceeds of sale
= =
Return = Return = Return =
($ Proceeds ($2,389.66 –20.31%
(No. of shares 100 $2,389.66 – –
$0.00952 3,465 ¥ 145 ¥ Yen purchase price
$/yen rate at purchase 3,150 x $0.00952
Current yen stock / (Yen/$ spot rate) price) 3,465 / 145
$ Investment) / $ Investment $2,998.80 ) / $2,998.80
POINTS: 1 DIFFICULTY: MODERATE/CHALLENGING REFERENCES: 19-9 International Money and Capital Markets QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES FOFM.BRIG.17.17.09 - International Money and Capital Markets : NATIONAL STANDARDS United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic : STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Exchg. rates and req. return KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:13 PM DATE MODIFIED: 9/26/2017 6:22 PM 49. Suppose in the spot market 1 U.S. dollar equals 1.3750 Canadian dollars. 6-month Canadian securities have an Copyright Cengage Learning. Powered by Cognero.
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annualized return of 6.00% (and thus a 6-month periodic return of 3.00%). 6-month U.S. securities have an annualized return of 6.50% and a periodic return of 3.25%. If interest rate parity holds, what is the U.S. dollar-Canadian dollar exchange rate in the 180-day forward market? In other words, how many Canadian dollars are required to purchase one U.S. dollar in the 180-day forward market? Do not round the intermediate calculations and round the final answer to four decimal places. a. 1.1660 b. 1.1385 c. 1.4540 d. 1.3717 e. 1.2345 ANSWER: d RATIONALE: Spot rate: C$/$ 1.3750 C$
3.00% 3.25%
6-mos rf, (Annual/2) 6-mos rh, (Annual/2)
Note that the spot rate is in terms of C$/$. However, the formula below needs the spot rate in terms of $/C$, so we need to use the inverse of this spot rate in the formula below.
Forward exchange rate Spot exchange rate, $/C$
=
Forward exchange rate 0.7273
=
Forward exchange rate 0.7273
=
Forward rate, $/C$
(1 + rh) (1 + rf) 1.0325 1.0300 1.0024 =
$0.7290
Note that the forward exchange rate gives the number of U.S dollars for 1 Canadian dollar, but the problem asks for the number of Canadian dollars per U.S. dollar. So, we need the inverse of the number above.
Forward exchange rate C$/$ = 1/Forward exchange rate, $/C$ Forward exchange rate C$/$ = 1.3717 POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 19-6 Interest Rate Parity QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.17.06 - Interest Rate Parity NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Interest rate parity KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:13 PM DATE MODIFIED: 9/26/2017 6:22 PM Copyright Cengage Learning. Powered by Cognero.
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50. Blenman Corporation, based in the United States, arranged a 2-year, $1,000,000 loan to fund a project in Mexico. The loan is denominated in Mexican pesos, carries a 6.5% nominal rate, and requires equal semiannual payments. The exchange rate at the time of the loan was 5.75 pesos per dollar, but it dropped to 5.10 pesos per dollar before the first payment came due. The loan was not hedged in the foreign exchange market. Thus, Blenman must convert U.S. funds to Mexican pesos to make its payments. If the exchange rate remains at 5.10 pesos per dollar through the end of the loan period, what effective annual interest rate will Blenman end up paying on the loan? Do not round the intermediate calculations and round the final answer to two decimal places. a. 14.14% b. 13.25% c. 21.21% d. 19.62% e. 17.67% ANSWER: e RATIONALE: Loan value ($) $1,000,000
Length of maturity (years) No. of payments/year Nominal rate Spot rate at loan date (MP/$) Spot rate before 1st pymt (MP/$)
2 2 6.50% 5.75 MP 5.10 MP
Calculate MP loan payment: N 4 I/YR 3.250% PV FV PMT
5,750,000 MP Calculated as loan value spot rate at loan date 0 MP Loan will be paid off at maturity, so FV = 0 1,556,164 MP
Cash Flows: 0 1 2 3 4 6 mos. periods MP 5,750,000 -1,556,164 -1,556,164 -1,556,164 -1,556,164 (Spot at loan date) $
1,000,000
-305,130
-305,130
-305,130 -305,130 Changed spot rate
$ payments are determined by dividing peso payments by the changed spot rate.
Calculate I/YR for $ CFs: N 4 PV $1,000,000 Use original loan value here FV $0 PMT -$305,130 This is the nominal semiannual rate, I/YR 8.48% rNOM/N Calculate EAR of loan from periodic rate calculated above:
EAR% = (1+(rNOM/N))^N - 1 = 17.67% POINTS: DIFFICULTY:
1 CHALLENGING
Copyright Cengage Learning. Powered by Cognero.
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REFERENCES: 19-9 International Money and Capital Markets QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.17.09 - International Money and Capital Markets NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: EAR on foreign debt KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:13 PM DATE MODIFIED: 9/26/2017 6:22 PM 51. Multinational financial management requires that financial analysts consider the effects of changing currency values. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 19-2 Multinational Versus Domestic Financial Management QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.17.02 - Multinational Versus Domestic Financial Management NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Multinational fin. mgmt. KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 6:14 PM DATE MODIFIED: 9/26/2017 6:22 PM 52. Legal and economic differences among countries, although important, do NOT pose significant problems for most multinational corporations when they coordinate and control worldwide operations and subsidiaries. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 19-2 Multinational Versus Domestic Financial Management QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.17.02 - Multinational Versus Domestic Financial Management NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management Copyright Cengage Learning. Powered by Cognero.
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LOCAL STANDARDS: TOPICS: KEYWORDS: DATE CREATED: DATE MODIFIED:
United States - OH - Default City - Tier 2: - Capital structure Multinational fin. mgmt. Bloom's: Knowledge 9/21/2017 6:14 PM 9/26/2017 6:22 PM
53. When the value of the U.S. dollar appreciates against another country's currency, we may purchase more of the foreign currency with the U.S. dollar. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 19-3 The International Monetary System QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.17.03 - The International Monetary System NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Currency appreciation KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 6:14 PM DATE MODIFIED: 9/26/2017 6:22 PM 54. The United States and most other major industrialized nations currently operate under a system of floating exchange rates. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 19-3 The International Monetary System QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.17.03 - The International Monetary System NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Floating exchange rates KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 6:14 PM DATE MODIFIED: 9/26/2017 6:22 PM 55. Exchange rate quotations consist solely of direct quotations. a. True Copyright Cengage Learning. Powered by Cognero.
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b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 19-4 Foreign Exchange Rate Quotations QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.17.04 - Foreign Exchange Rate Quotations NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Exchange rates KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 6:14 PM DATE MODIFIED: 9/26/2017 6:22 PM 56. Calculating a currency cross rate involves determining the exchange rate for two currencies by using a third currency as a base. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 19-4 Foreign Exchange Rate Quotations QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.17.04 - Foreign Exchange Rate Quotations NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Cross rates KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 6:14 PM DATE MODIFIED: 9/26/2017 6:22 PM 57. A Eurodollar is a U.S. dollar deposited in a bank outside the United States. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 19-9 International Money and Capital Markets QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.17.09 - International Money and Capital Markets Copyright Cengage Learning. Powered by Cognero.
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NATIONAL STANDARDS: STATE STANDARDS: LOCAL STANDARDS: TOPICS: KEYWORDS: DATE CREATED: DATE MODIFIED:
United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management United States - OH - Default City - Tier 2: - Capital structure Eurodollars Bloom's: Knowledge 9/21/2017 6:14 PM 9/26/2017 6:22 PM
58. LIBOR is an acronym for London Interbank Offered Rate, which is an average of interest rates offered by London banks to smaller U.S. corporations on all deposits. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 19-9 International Money and Capital Markets QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.17.09 - International Money and Capital Markets NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: LIBOR KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 6:14 PM DATE MODIFIED: 9/26/2017 6:22 PM 59. Exchange rate risk is the risk that the cash flows from a foreign project, when converted to the parent company's currency, will be worth less than was originally projected because of exchange rate changes. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 19-10 Investing Overseas QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.17.10 - Investing Overseas NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Exchange rate risk KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 6:14 PM DATE MODIFIED: 9/26/2017 6:22 PM Copyright Cengage Learning. Powered by Cognero.
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60. Because political risk is seldom negotiable, it cannot be explicitly addressed in multinational corporate financial analysis. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 19-11 International Capital Budgeting QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.17.11 - International Capital Budgeting NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Political risk KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 6:14 PM DATE MODIFIED: 9/26/2017 6:22 PM 61. Individuals and corporations can buy or sell forward currencies to hedge their exchange rate exposure. Essentially, the process involves simultaneously selling the currency expected to appreciate in value and buying the currency expected to depreciate. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 19-5 Trading in Foreign Exchange QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.17.05 - Trading in Foreign Exchange NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Forward market hedge KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 6:14 PM DATE MODIFIED: 9/26/2017 6:22 PM 62. If an investor can obtain more of a foreign currency for a dollar in the forward market than in the spot market, then the forward currency is said to be selling at a discount to the spot rate. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE Copyright Cengage Learning. Powered by Cognero.
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REFERENCES: 19-5 Trading in Foreign Exchange QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.17.05 - Trading in Foreign Exchange NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Discount on forward rate KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 6:14 PM DATE MODIFIED: 9/26/2017 6:22 PM 63. If a dollar will buy fewer units of a foreign currency in the forward market than in the spot market, then the forward currency is said to be selling at a premium to the spot rate. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 19-5 Trading in Foreign Exchange QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.17.05 - Trading in Foreign Exchange NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Premium on forward rate KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 6:14 PM DATE MODIFIED: 9/26/2017 6:22 PM 64. A foreign currency will, on average, depreciate against the U.S. dollar at a percentage rate approximately equal to the amount by which its inflation rate exceeds that of the United States. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 19-8 Inflation, Interest Rates, and Exchange Rates QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.17.08 - Inflation, Interest Rates, and Exchange Rates NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure Copyright Cengage Learning. Powered by Cognero.
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TOPICS: KEYWORDS: DATE CREATED: DATE MODIFIED:
Currency value and inflation Bloom's: Comprehension 9/21/2017 6:14 PM 9/26/2017 6:22 PM
65. The cash flows relevant for a foreign investment should, from the parent company's perspective, include the financial cash flows that the subsidiary can legally send back to the parent company plus the cash flows that must remain in the foreign country. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 19-11 International Capital Budgeting QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.17.11 - International Capital Budgeting NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Relevant investment CFs KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 6:14 PM DATE MODIFIED: 9/26/2017 6:22 PM 66. The cost of capital may be different for a foreign project than for an equivalent domestic project because foreign projects may be more or less risky. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 19-11 International Capital Budgeting QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.17.11 - International Capital Budgeting NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Foreign project COC KEYWORDS: Bloom's: Knowledge DATE CREATED: 9/21/2017 6:14 PM DATE MODIFIED: 9/26/2017 6:22 PM 67. When considering the risk of a foreign investment, a higher risk might arise from exchange rate risk and political risk while lower risk might result from international diversification. Copyright Cengage Learning. Powered by Cognero.
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a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 19-11 International Capital Budgeting QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.17.11 - International Capital Budgeting NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Risk and int'l. investment KEYWORDS: Bloom's: Comprehension DATE CREATED: 9/21/2017 6:14 PM DATE MODIFIED: 9/26/2017 6:22 PM 68. Which of the following are reasons why companies move into international operations? a. To take advantage of lower production costs in regions where labor costs are relatively low. b. To develop new markets for the firm's products. c. To better serve their primary customers. d. Because important raw materials are located abroad. e. All of the above. ANSWER: e POINTS: 1 DIFFICULTY: EASY REFERENCES: 19-1 Multinational, or Global, Corporations QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.17.01 - Multinational, or Global, Corporations NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Motive for going global KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:14 PM DATE MODIFIED: 9/26/2017 6:22 PM 69. Multinational financial management requires that a. the effects of changing currency values be included in financial analyses. b. legal and economic differences need not be considered in financial decisions because these differences are insignificant. c. political risk should be excluded from multinational corporate financial analyses. d. traditional U.S. and European financial models incorporating the existence of a competitive marketplace not Copyright Cengage Learning. Powered by Cognero.
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be recast when analyzing projects in other parts of the world. e. cultural differences need not be accounted for when considering firm goals and employee management. ANSWER: a POINTS: 1 DIFFICULTY: EASY REFERENCES: 19-2 Multinational Versus Domestic Financial Management QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.17.02 - Multinational Versus Domestic Financial Management NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Multinational fin. mgmt. KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:14 PM DATE MODIFIED: 9/26/2017 6:22 PM 70. In Japan, 90-day securities have a 4% annualized return and 180-day securities have a 5% annualized return. In the United States, 90-day securities have a 4% annualized return and 180-day securities have an annualized return of 4.5%. All securities are of equal risk, and Japanese securities are denominated in terms of the Japanese yen. Assuming that interest rate parity holds in all markets, which of the following statements is most CORRECT? a. The yen-dollar spot exchange rate equals the yen-dollar exchange rate in the 90-day forward market. b. The yen-dollar spot exchange rate equals the yen-dollar exchange rate in the 180-day forward market. c. The yen-dollar exchange rate in the 90-day forward market equals the yen-dollar exchange rate in the 180-day forward market. d. The yen-dollar exchange rate in the 180-day forward market equals the yen-dollar exchange rate in the 90-day spot market. e. The relationship between spot and forward interest rates cannot be inferred. ANSWER: a POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 19-6 Interest Rate Parity QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.17.06 - Interest Rate Parity NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Interest rate parity KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:14 PM DATE MODIFIED: 9/26/2017 6:22 PM 71. If the inflation rate in the United States is greater than the inflation rate in Britain, other things held constant, the Copyright Cengage Learning. Powered by Cognero.
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British pound will a. appreciate against the U.S. dollar. b. depreciate against the U.S. dollar. c. remain unchanged against the U.S. dollar. d. appreciate against other major currencies. e. appreciate against the dollar and other major currencies. ANSWER: a POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 19-8 Inflation, Interest Rates, and Exchange Rates QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.17.08 - Inflation, Interest Rates, and Exchange Rates NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Currency depreciation KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:14 PM DATE MODIFIED: 9/26/2017 6:22 PM 72. Which of the following statements is NOT CORRECT? a. Any bond sold outside the country of the borrower is called an international bond. b. Foreign bonds and Eurobonds are two important types of international bonds. c. Foreign bonds are bonds sold by a foreign borrower but denominated in the currency of the country in which the issue is sold. d. The term Eurobond applies only to foreign bonds denominated in U.S. currency. e. A Eurodollar is a U.S. dollar deposited in a bank outside the U.S. ANSWER: d POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 19-9 International Money and Capital Markets QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.17.09 - International Money and Capital Markets NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Int'l. bond markets KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:14 PM DATE MODIFIED: 9/26/2017 6:22 PM
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73. Currently, a U.S. trader notes that in the 6-month forward market, the Japanese yen is selling at a premium (that is, you receive more dollars per yen in the forward market than you do in the spot market), while the British pound is selling at a discount. Which of the following statements is CORRECT? a. If interest rate parity holds, 6-month interest rates should be the same in the U.S., Britain, and Japan. b. If interest rate parity holds among the three countries, the United States should have the highest 6-month interest rates and Japan should have the lowest rates. c. If interest rate parity holds among the three countries, Britain should have the highest 6-month interest rates and Japan should have the lowest rates. d. If interest rate parity holds among the three countries, Japan should have the highest 6-month interest rates and Britain should have the lowest rates. e. If interest rate parity holds among the three countries, the United States should have the highest 6-month interest rates and Britain should have the lowest rates. ANSWER: c RATIONALE: As the yen is selling at a premium, this means that the interest rates in Japan are lower than in the U.S. Thus, when you invest in yen, you get part of your return from the interest rate and part when you convert back to dollars. The opposite is true of the rates in Britain. POINTS: 1 DIFFICULTY: MODERATE/CHALLENGING REFERENCES: 19-6 Interest Rate Parity QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.17.06 - Interest Rate Parity NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Interest rate parity KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:14 PM DATE MODIFIED: 9/26/2017 6:22 PM 74. Today in the spot market $1 = 1.82 Swiss francs and $1 = 130 Japanese yen. In the 90-day forward market, $1 = 1.84 Swiss francs and $1 = 127 Japanese yen. Assume that interest rate parity holds worldwide. Which of the following statements is most CORRECT? a. Interest rates on 90-day risk-free U.S. securities are higher than the interest rates on 90-day risk-free Swiss securities. b. Interest rates on 90-day risk-free U.S. securities are higher than the interest rates on 90-day risk-free Japanese securities. c. Interest rates on 90-day risk-free U.S. securities equal the interest rates on 90-day risk-free Japanese securities. d. Since interest rate parity holds interest rates should be the same in all three countries. e. Interest rates on 90-day risk-free U.S. securities equal the interest rates on 90-day risk-free Swiss securities. ANSWER: b RATIONALE: The easiest way to do this is to make an example up. Assume the annual interest rate in the U.S. is 16%. Suppose in the U.S. you start off with $1.00, so after 90 days you will have $1.00 (1 + 0.16/4) = $1.04. In Switzerland, you will start with 1.00 1.82 = SF 1.82 and end up with 1.04 1.84 = SF 1.9136. The return in Switzerland is 1.9136/1.82 – 1 = 5.14%. (This is higher than the 4% U.S. rate.) In Japan, you will start with 1.00 130 = 130 yen and end up with 1.04 127 = 132.08 yen. The return is 132.08/130 – 1 = 1.6%. (This is lower Copyright Cengage Learning. Powered by Cognero.
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than the 4% U.S. rate.) POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 19-6 Interest Rate Parity QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.17.06 - Interest Rate Parity NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Interest rate parity KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:14 PM DATE MODIFIED: 9/26/2017 6:22 PM 75. If one Swiss franc can purchase 0.85 U.S. dollar, how many Swiss francs can one U.S. dollar buy? a. 1.0471 b. 1.1765 c. 1.0706 d. 1.3294 e. 1.2706 ANSWER: b RATIONALE: 1 Swiss franc = 0.85 U.S. dollar
U.S. dollar = 1/0.85 Swiss francs 1 U.S. $ can purchase 1.1765 Swiss francs
POINTS: 1 DIFFICULTY: EASY REFERENCES: 19-4 Foreign Exchange Rate Quotations QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.17.04 - Foreign Exchange Rate Quotations NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Exchange rates KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:14 PM DATE MODIFIED: 9/26/2017 6:22 PM 76. If one U.S. dollar buys 1.59 Canadian dollars, how many U.S. dollars can you purchase for one Canadian dollar? a. 0.6667 Copyright Cengage Learning. Powered by Cognero.
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b. 0.7547 c. 0.5786 d. 0.5346 e. 0.6289 ANSWER: RATIONALE:
e
1 U.S. dollar = 1.59 Canadian dollars Canadian dollar = 1/1.59 U.S. dollars 1 C$ can purchase 0.6289 U.S. dollar
POINTS: 1 DIFFICULTY: EASY REFERENCES: 19-4 Foreign Exchange Rate Quotations QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.17.04 - Foreign Exchange Rate Quotations NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Exchange rates KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:14 PM DATE MODIFIED: 9/26/2017 6:22 PM 77. If one British pound can purchase $2.00 U.S. dollars, how many British pounds can one U.S. dollar buy? a. 0.5600 b. 0.5550 c. 0.4000 d. 0.5000 e. 0.4850 ANSWER: d RATIONALE: 1 British pound = 2.00 U.S. dollar
U.S. dollar = 1/2.00 British pounds 1 U.S. $ can purchase 0.5000 British pound
POINTS: 1 DIFFICULTY: EASY REFERENCES: 19-4 Foreign Exchange Rate Quotations QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.17.04 - Foreign Exchange Rate Quotations NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management Copyright Cengage Learning. Powered by Cognero.
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LOCAL STANDARDS: TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
United States - OH - Default City - Tier 2: - Capital structure Exchange rates Bloom's: Analysis Multiple Choice: Problem 9/21/2017 6:14 PM 9/26/2017 6:22 PM
78. If one U.S. dollar buys 0.61 euro, how many dollars can you purchase for one euro? a. 1.5574 b. 1.4262 c. 1.6393 d. 1.2623 e. 1.4590 ANSWER: c RATIONALE: 1 U.S. dollar = 0.61 euro
Euro = 1/0.610 U.S. dollar 1 euro can purchase 1.6393 U.S. dollars
POINTS: 1 DIFFICULTY: EASY REFERENCES: 19-4 Foreign Exchange Rate Quotations QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.17.04 - Foreign Exchange Rate Quotations NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Exchange rates KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:14 PM DATE MODIFIED: 9/26/2017 6:22 PM 79. If one U.S. dollar sells for 0.53 British pound, how many dollars should one British pound sell for? a. 2.0566 b. 2.0943 c. 1.6792 d. 1.4906 e. 1.8868 ANSWER: e RATIONALE: 1 U.S. dollar = 0.53 pound
Pound = 1/0.530 U.S. dollar Copyright Cengage Learning. Powered by Cognero.
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1 pound can sell for 1.8868 U.S. dollars
POINTS: 1 DIFFICULTY: EASY REFERENCES: 19-4 Foreign Exchange Rate Quotations QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.17.04 - Foreign Exchange Rate Quotations NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Exchange rates KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:14 PM DATE MODIFIED: 9/26/2017 6:22 PM 80. Suppose 144 yen could be purchased in the foreign exchange market for one U.S. dollar today. If the yen depreciates by 13.0% tomorrow, how many yen could one U.S. dollar buy tomorrow? a. 143.1936 b. 138.3120 c. 175.7376 d. 162.7200 e. 183.8736 ANSWER: d RATIONALE: One dollar = 144 yen
Depreciation 13% If yen depreciates against the dollar, the dollar will purchase more yen.
U.S. dollar (Tomorrow) = 144 (1 + 0.13) U.S. dollar (Tomorrow) = 162.7200 yen
POINTS: 1 DIFFICULTY: EASY REFERENCES: 19-5 Trading in Foreign Exchange QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.17.05 - Trading in Foreign Exchange NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure Copyright Cengage Learning. Powered by Cognero.
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TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
Currency appreciation Bloom's: Analysis Multiple Choice: Problem 9/21/2017 6:14 PM 9/26/2017 6:22 PM
81. Suppose a foreign investor who holds tax-exempt Eurobonds paying 10.50% is considering investing in an equivalentrisk domestic bond in a country with a 28.00% withholding tax on interest paid to foreigners. If 10.50% after-tax is the investor's required return, what before-tax rate would the domestic bond need to pay to provide the required after-tax return? a. 15.46% b. 16.33% c. 16.92% d. 12.83% e. 14.58% ANSWER: e RATIONALE: 10.50% Tax rate 28.00% r AT d
rd BT = rd BT = rd BT =
rd AT / (1 – T) 10.50% / 72.00% 14.58%
POINTS: 1 DIFFICULTY: EASY REFERENCES: 19-9 International Money and Capital Markets QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.17.09 - International Money and Capital Markets NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Eurobonds vs domestic bonds KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:14 PM DATE MODIFIED: 9/26/2017 6:22 PM 82. Suppose DeGraw Corporation, a U.S. exporter, sold a solar heating station to a Japanese customer at a price of 130.5 million yen, when the exchange rate was 140.0 yen per dollar. In order to close the sale, DeGraw agreed to make the bill payable in yen, thus agreeing to take some exchange rate risk for the transaction. The terms were net 6 months. If the yen fell against the dollar such that one dollar would buy 154.4 yen when the invoice was paid, what dollar amount would DeGraw actually receive after it exchanged yen for U.S. dollars? a. $845,207.25 b. $1,039,604.92 c. $1,048,056.99 d. $676,165.80 e. $659,261.66 Copyright Cengage Learning. Powered by Cognero.
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ANSWER: RATIONALE:
a
140.0 yen per $ 154.4 yen Exchange rate at t = 0.5 per $ Spot rate at t = 0
(Numbers in millions)
Years
0
Payable
0.5 130.5 yen
Dollar value of payable = Payable in Yen/Yen Exchange rate at t = 0.5
$ Value at t = 0.5
$845,207.25
POINTS: 1 DIFFICULTY: EASY REFERENCES: 19-10 Investing Overseas QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.17.10 - Investing Overseas NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Exchange rate risk KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:14 PM DATE MODIFIED: 9/26/2017 6:22 PM 83. Suppose the exchange rate between U.S. dollars and Swiss francs is SF 1.41 = $1.00, and the exchange rate between the U.S. dollar and the euro is $1.00 = 0.70 euro. What is the cross rate of Swiss francs to euros? (In other words, how many Swiss francs are needed to purchase one euro?) Do not round the intermediate calculations and round the final answer to four decimal places. a. 2.2963 b. 2.5179 c. 2.0143 d. 2.0949 e. 1.6316 ANSWER: RATIONALE:
c
One U.S. dollar 1.41 SF = One U.S. dollar 0.70 € = SF/€ SF/€
= SF/$ $/€ = 1.4100 1.4286
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SF/€
= 2.0143
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 19-4 Foreign Exchange Rate Quotations QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.17.04 - Foreign Exchange Rate Quotations NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Cross rates KEYWORDS: Bloom's: Evaluation OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:14 PM DATE MODIFIED: 9/26/2017 6:22 PM 84. Suppose that currently, 1 British pound equals 1.98 U.S. dollars and 1 U.S. dollar equals 1.25 Swiss francs. How many Swiss francs are needed to purchase 1 pound? a. 2.1285 b. 2.3760 c. 1.9058 d. 2.5988 e. 2.4750 ANSWER: e RATIONALE:
£ = $1.98 $ = 1.25 SF SF/£ = SF/£ = SF/£ =
SF/$ 1.2500 2.4750
$/£ 1.98
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 19-4 Foreign Exchange Rate Quotations QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.17.04 - Foreign Exchange Rate Quotations NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Cross rates KEYWORDS: Bloom's: Evaluation OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:14 PM DATE MODIFIED: 9/26/2017 6:22 PM Copyright Cengage Learning. Powered by Cognero.
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85. A currency trader observes the following quotes in the spot market: 1 U.S. dollar = 1.34 Japanese yen 1 British pound = 2.25 Swiss francs 1 British pound = 1.65 U.S. dollars Given this information, how many yen can be purchased for 1 Swiss franc? Do not round the intermediate calculations and round the final answer to four decimal places. a. 0.8156 b. 1.1301 c. 0.7370 d. 0.8844 e. 0.9827 ANSWER: e RATIONALE: £= 2.25 SF
£= $=
$1.65 1.34 ¥
¥/SF = ¥/$ $/£ £/SF ¥/SF = 1.3400 1.6500 0.4444 ¥/SF = 0.9827 POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 19-4 Foreign Exchange Rate Quotations QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.17.04 - Foreign Exchange Rate Quotations NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Cross rates KEYWORDS: Bloom's: Evaluation OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:14 PM DATE MODIFIED: 9/26/2017 6:22 PM 86. A currency trader observes the following quotes in the spot market: 1 U.S. dollar = 10.875 Mexican pesos 1 British pound = 7.500 Danish krone 1 British pound = 1.65 U.S. dollars Given this information, how many Mexican pesos can be purchased for 1 Danish krone? a. 2.3446 b. 2.0097 c. 2.9188 d. 2.0815 e. 2.3925 ANSWER: e Copyright Cengage Learning. Powered by Cognero.
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RATIONALE:
£ = 7.500 DK £ = $1.65 $ = 10.875 MP MP/DK = MP/$ MP/DK = 10.8750 MP/DK = 2.3925
$/£ 1.6500
£/DK 0.1333
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 19-4 Foreign Exchange Rate Quotations QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.17.04 - Foreign Exchange Rate Quotations NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Cross rates KEYWORDS: Bloom's: Evaluation OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:14 PM DATE MODIFIED: 9/26/2017 6:22 PM 87. In 1985, a given Japanese imported automobile sold for 1,476,000 yen, or $8,200. If the car still sold for the same amount of yen today but the current exchange rate is 141 yen per dollar, what would the car be selling for today in U.S. dollars? a. $10,259 b. $12,980 c. $12,562 d. $10,468 e. $11,515 ANSWER: d RATIONALE: 1985 price in yen of automobile 1,476,000 yen
1985 price in dollars of automobile $8,200 Today's exchange rate: ¥/$ 141 Today's $ price = Today's $ price = Today's $ price =
yen
1985 yen price / Today's exchange rate 1,476,000 / 141 $10,468
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 19-4 Foreign Exchange Rate Quotations QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.17.04 - Foreign Exchange Rate Quotations NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management Copyright Cengage Learning. Powered by Cognero.
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LOCAL STANDARDS: TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
United States - OH - Default City - Tier 2: - Capital structure Exchge rates and asset value Bloom's: Application Multiple Choice: Problem 9/21/2017 6:14 PM 9/26/2017 6:22 PM
88. Suppose one year ago, Hein Company had inventory in Britain valued at 240,000 pounds. The exchange rate for dollars to pounds was 1£ = 2.00 U.S. dollars. This year the exchange rate is 1£ = 1.82 U.S. dollars. The inventory in Britain is still valued at 240,000 pounds. What is the U.S. dollar gain or loss in inventory value as a result of the change in exchange rates? a. -$43,200.00 b. -$48,816.00 c. -$36,288.00 d. -$50,544.00 e. -$32,400.00 ANSWER: a RATIONALE: Inventory value £240,000
Spot rate, $/£ 1 yr. ago $2.00 Current spot rate $/£ $1.82
Dollar value of inventory this year =
Dollar value of inventory last year =
£ inv. value £ Last year's spot rate $/£ inv. value Current Spot rate $/£
= $436,800.00
= $480,000.00
Change in inv. value = -$43,200.00 POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 19-4 Foreign Exchange Rate Quotations QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVE FOFM.BRIG.17.17.04 - Foreign Exchange Rate Quotations S: NATIONAL STANDARDSUnited States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic : STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Inventory and exchge rates KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:14 PM DATE MODIFIED: 9/26/2017 6:22 PM 89. If the spot rate of the Israeli shekel is 5.51 shekels per dollar and the 180-day forward rate is 5.76 shekels per dollar, then the forward rate for the Israeli shekel is selling at a(n) ______________ to the spot rate. Copyright Cengage Learning. Powered by Cognero.
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a. 3.68% premium b. 3.72% premium c. 4.99% discount d. 4.54% discount e. 5.58% discount ANSWER: RATIONALE:
d
Spot rate: $ = 180-day forward rate
5.51 5.76
shekels shekels
Because one can obtain more Israeli shekels for a dollar in the forward market, the forward currency is selling at a discount to the spot rate. The amount of the discount is calculated as: (Forward rate -
Spot rate)/Spot rate
% Discount =
4.54%
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 19-5 Trading in Foreign Exchange QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.17.05 - Trading in Foreign Exchange NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Forward rates - nonalgorithmic KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:14 PM DATE MODIFIED: 9/26/2017 6:22 PM 90. Suppose one British pound can purchase 1.86 U.S. dollars today in the foreign exchange market, and currency forecasters predict that the U.S. dollar will depreciate by 12.00% against the pound over the next 30 days. How many dollars will a pound buy in 30 days? a. $2.1665 b. $2.2082 c. $1.8957 d. $2.0832 e. $2.3540 ANSWER: d RATIONALE: 1 British pound $1.86
Dollar depreciation
12.00%
The British pound will appreciate against the dollar by 12.00% British pound = $/£ (1 + % $ depreciation) British pound = $2.0832
POINTS: DIFFICULTY: REFERENCES:
1 MODERATE 19-5 Trading in Foreign Exchange
Copyright Cengage Learning. Powered by Cognero.
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QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.17.05 - Trading in Foreign Exchange NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Currency depreciation KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:14 PM DATE MODIFIED: 9/26/2017 6:22 PM 91. Stover Corporation, a U.S. based importer, makes a purchase of crystal glassware from a firm in Switzerland for 39,960 Swiss francs, or $24,000, at the spot rate of 1.665 Swiss francs per dollar. The terms of the purchase are net 90 days, and the U.S. firm wants to cover this trade payable with a forward market hedge to eliminate its exchange rate risk. Suppose the firm completes a forward hedge at the 90-day forward rate of 1.682 Swiss francs. If the spot rate in 90 days is actually 1.615 Swiss francs, how much in U.S. dollars will the U.S. firm have saved or lost by hedging its exchange rate exposure? Do not round the intermediate calculations and round the final answer to the nearest cent. a. $1,212.29 b. $926.47 c. $985.60 d. $965.89 e. $916.61 ANSWER: c RATIONALE: Price of glassware in SF 39,960 SF
Dollar price of glassware Spot rate, SF/$ 90-day forward rate, SF/$ Spot rate in 90 days, SF/$
$24,000 1.665 SF 1.682 SF 1.6150 SF 0
30
60
Price of glassware in SF
90 39,960.00
$ Cost at spot in 90 days Forward contract ($) Savings from forward contract
$24,743.03 $23,357.43 $985.60
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 19-5 Trading in Foreign Exchange QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.17.05 - Trading in Foreign Exchange NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management Copyright Cengage Learning. Powered by Cognero.
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LOCAL STANDARDS: TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
United States - OH - Default City - Tier 2: - Capital structure Forward market hedge Bloom's: Application Multiple Choice: Problem 9/21/2017 6:14 PM 9/26/2017 6:22 PM
92. Suppose a U.S. firm buys $200,000 worth of television tubes from a Mexican manufacturer for delivery in 60 days with payment to be made in 90 days (30 days after the goods are received). The rising U.S. deficit has caused the dollar to depreciate against the peso recently. The current exchange rate is 5.68 pesos per U.S. dollar. The 90-day forward rate is 5.45 pesos/dollar. The firm goes into the forward market today and buys enough Mexican pesos at the 90-day forward rate to completely cover its trade obligation. Assume the spot rate in 90 days is 5.30 Mexican pesos per U.S. dollar. How much in U.S. dollars did the firm save by eliminating its foreign exchange currency risk with its forward market hedge? Do not round the intermediate calculations and round the final answer to the nearest cent. a. $4,542.43 b. $5,899.26 c. $5,309.33 d. $5,840.26 e. $6,725.15 ANSWER: RATIONALE:
b
Television tubes Spot rate, MP/$ 90-day forward rate, MP/$ Spot rate in 90 days, MP/$
$200,000 5.6800 MP 5.45 MP 5.30 MP 0
Trade obligation in MP (Tubes $ Cost at spot in 90 days Forward contract ($) Savings from forward contract
Spot rate)
30
60
90 1,136,000.00 $214,339.62 $208,440.37 $5,899.26
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 19-5 Trading in Foreign Exchange QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.17.05 - Trading in Foreign Exchange NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Forward market hedge KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:14 PM DATE MODIFIED: 9/26/2017 6:22 PM Copyright Cengage Learning. Powered by Cognero.
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93. Suppose 90-day investments in Britain have a 6.00% annualized return and a 1.50% quarterly (90-day) return. In the U.S., 90-day investments of similar risk have a 4.00% annualized return and a 1.00% quarterly (90-day) return. In the 90day forward market, 1 British pound equals $1.70. If interest rate parity holds, what is the spot exchange rate ($/£)? Do not round the intermediate calculations and round the final answer to four decimal places. a. $1.7084 b. $1.8280 c. $1.8109 d. $1.8793 e. $2.0159 ANSWER: a RATIONALE: 1.50% 90-day r , (Annual/4) f
1.00% 90-day rh , (Annual/4) 90-day forward rate ($/£) $1.70 Forward exchange rate
(1 + rh) (1 + rf)
=
Spot exchange rate $1.70 Spot exchange rate
=
1.0100 1.0150
$1.70 Spot exchange rate
=
0.995074
$1.70
=
$1.7084
=
0.995074 Spot exchange rate
Spot exchange rate
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 19-6 Interest Rate Parity QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.17.06 - Interest Rate Parity NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Interest rate parity KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:14 PM DATE MODIFIED: 9/26/2017 6:22 PM 94. Suppose hockey skates sell in Canada for 113 Canadian dollars, and 1 Canadian dollar equals 0.71 U.S. dollar. If purchasing power parity (PPP) holds, what is the price of hockey skates in the United States? a. $60.17 b. $90.66 c. $82.64 d. $93.07 Copyright Cengage Learning. Powered by Cognero.
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e. $80.23 ANSWER: RATIONALE:
e
Price of skates, C$ Spot exchange rate, $/C$ Ph
=
Pf
Ph Ph
= =
113 $80.23
113 C$ $0.71 Spot rate $0.71
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 19-7 Purchasing Power Parity QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.17.07 - Purchasing Power Parity NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Purchasing power parity KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:14 PM DATE MODIFIED: 9/26/2017 6:22 PM 95. Suppose 6 months ago a Swiss investor bought a 6-month U.S. Treasury bill at a price of $9,708.74, with a maturity value of $10,000.00. The exchange rate at that time was 1.441 Swiss francs per dollar. Today, at maturity, the exchange rate is 1.324 Swiss francs per dollar. What is the annualized rate of return to the Swiss investor? Do not round the intermediate calculations and round the final answer to two decimal places. a. –11.26% b. –10.73% c. –9.98% d. –9.76% e. –10.83% ANSWER: b RATIONALE: 6-mos. Treasury bill,
VB Maturity value Spot rate, SF/$ 6-mos Fwd rate, SF/$
$9,708.74
$10,000.00 1.441 SF 1.324 SF
Time 0 6 months CF, in $ -$9,708.74 $10,000.00 CF, in SF –13,990.29 13,240.00 Now, calculate the 6-month return to the Swiss investor after exchanging US $ for SF:
N Copyright Cengage Learning. Powered by Cognero.
1 Page 1046
PV PMT FV I/YR, 6-mos.
–13,990.29 0 13,240.00 –5.36%
Annual rate =
2
6 mos. return
Annual rate = –10.73%
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 19-10 Investing Overseas QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.17.10 - Investing Overseas NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Exchange fluctuations KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:14 PM DATE MODIFIED: 9/26/2017 6:22 PM 96. A product sells for $750 in the United States. The spot exchange rate is $1 to 1.56 Swiss francs. If purchasing power parity (PPP) holds, what is the price of the product in Switzerland? a. 1,462.50 b. 1,392.30 c. 1,228.50 d. 1,170.00 e. 947.70 ANSWER: d RATIONALE: Product price in U.S. $750
Spot rate, SF/$
1.56
SF
Formula below requires spot rate to be home currency/foreign currency, so need inverse of spot rate given.
Ph = Pf $750 = Pf Pf = 1,170.00
Spot rate, $/SF 0.6410
POINTS: 1 DIFFICULTY: MODERATE/CHALLENGING REFERENCES: 19-7 Purchasing Power Parity QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.17.07 - Purchasing Power Parity Copyright Cengage Learning. Powered by Cognero.
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NATIONAL STANDARDS: STATE STANDARDS: LOCAL STANDARDS: TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management United States - OH - Default City - Tier 2: - Capital structure Purchasing power parity Bloom's: Application Multiple Choice: Problem 9/21/2017 6:14 PM 9/26/2017 6:22 PM
97. A box of candy costs 28.80 Swiss francs in Switzerland and $21.80 in the United States. Assuming that purchasing power parity (PPP) holds, how many Swiss francs are required to purchase one U.S. dollar? Do not round the intermediate calculations and round the final answer to four decimal places. a. 1.0701 b. 1.1097 c. 1.3211 d. 1.6382 e. 1.2286 ANSWER: c RATIONALE: Price of candy in 28.80 SF
SF Price of candy in $
$21.80
Spot rate Ph = Pf $21.80 = 28.80 Spot rate Spot rate. = $0.7569 per SF $/SF Note that the spot rate above gives the number of dollars required to purchase one SF. However, the problem asks for the number of SFs required to purchase one U.S. dollar. Therefore, we need to calculate the inverse of the spot rate above.
Spot rate, SF/$ = 1/Spot rate, $/SF Spot rate, SF/$ = 1.3211 POINTS: 1 DIFFICULTY: MODERATE/CHALLENGING REFERENCES: 19-7 Purchasing Power Parity QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.17.07 - Purchasing Power Parity NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Purchasing power parity KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:14 PM DATE MODIFIED: 9/26/2017 6:22 PM Copyright Cengage Learning. Powered by Cognero.
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98. One year ago, a U.S. investor converted dollars to yen and purchased 100 shares of stock in a Japanese company at a price of 3,150 yen per share. The stock's total purchase cost was 315,000 yen. At the time of purchase, in the currency market 1 yen equaled $0.00952. Today, the stock is selling at a price of 3,465 yen per share, and in the currency market $1 equals 145 yen. The stock does not pay a dividend. If the investor were to sell the stock today and convert the proceeds back to dollars, what would be his realized return on his initial dollar investment from holding the stock? a. –22.14% b. –20.31% c. –18.08% d. –23.77% e. –22.55% ANSWER: b RATIONALE: Shares bought 100 Last year's stock price/share in yen 3,150 ¥
$/yen exchange rate at purchase Current stock price/share in yen Yen/$ spot exhange rate $ investment in stock
=
No. of shares
$ investment in stock
=
100
$ investment in stock
=
$2,998.80
$ proceeds of sale
=
$ proceeds of sale $ proceeds of sale
= =
Return = Return = Return =
($ Proceeds ($2,389.66 –20.31%
(No. of shares 100 $2,389.66 – –
$0.00952 3,465 ¥ 145 ¥ Yen purchase price
$/yen rate at purchase 3,150 x $0.00952
Current yen stock / (Yen/$ spot rate) price) 3,465 / 145
$ Investment) / $ Investment $2,998.80 ) / $2,998.80
POINTS: 1 DIFFICULTY: MODERATE/CHALLENGING REFERENCES: 19-9 International Money and Capital Markets QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES FOFM.BRIG.17.17.09 - International Money and Capital Markets : NATIONAL STANDARDS United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic : STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Exchg. rates and req. return KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:14 PM DATE MODIFIED: 9/26/2017 6:22 PM Copyright Cengage Learning. Powered by Cognero.
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99. Suppose in the spot market 1 U.S. dollar equals 1.3750 Canadian dollars. 6-month Canadian securities have an annualized return of 6.00% (and thus a 6-month periodic return of 3.00%). 6-month U.S. securities have an annualized return of 6.50% and a periodic return of 3.25%. If interest rate parity holds, what is the U.S. dollar-Canadian dollar exchange rate in the 180-day forward market? In other words, how many Canadian dollars are required to purchase one U.S. dollar in the 180-day forward market? Do not round the intermediate calculations and round the final answer to four decimal places. a. 1.1660 b. 1.1385 c. 1.4540 d. 1.3717 e. 1.2345 ANSWER: d RATIONALE: Spot rate: C$/$ 1.3750 C$
3.00% 3.25%
6-mos rf, (Annual/2) 6-mos rh, (Annual/2)
Note that the spot rate is in terms of C$/$. However, the formula below needs the spot rate in terms of $/C$, so we need to use the inverse of this spot rate in the formula below.
Forward exchange rate Spot exchange rate, $/C$
=
Forward exchange rate 0.7273
=
Forward exchange rate 0.7273
=
Forward rate, $/C$
(1 + rh) (1 + rf) 1.0325 1.0300 1.0024 =
$0.7290
Note that the forward exchange rate gives the number of U.S dollars for 1 Canadian dollar, but the problem asks for the number of Canadian dollars per U.S. dollar. So, we need the inverse of the number above.
Forward exchange rate C$/$ = 1/Forward exchange rate, $/C$ Forward exchange rate C$/$ = 1.3717 POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 19-6 Interest Rate Parity QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.17.06 - Interest Rate Parity NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Interest rate parity KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:14 PM Copyright Cengage Learning. Powered by Cognero.
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DATE MODIFIED:
9/26/2017 6:22 PM
100. Blenman Corporation, based in the United States, arranged a 2-year, $1,000,000 loan to fund a project in Mexico. The loan is denominated in Mexican pesos, carries a 6.5% nominal rate, and requires equal semiannual payments. The exchange rate at the time of the loan was 5.75 pesos per dollar, but it dropped to 5.10 pesos per dollar before the first payment came due. The loan was not hedged in the foreign exchange market. Thus, Blenman must convert U.S. funds to Mexican pesos to make its payments. If the exchange rate remains at 5.10 pesos per dollar through the end of the loan period, what effective annual interest rate will Blenman end up paying on the loan? Do not round the intermediate calculations and round the final answer to two decimal places. a. 14.14% b. 13.25% c. 21.21% d. 19.62% e. 17.67% ANSWER: e RATIONALE: Loan value ($) $1,000,000
Length of maturity (years) No. of payments/year Nominal rate Spot rate at loan date (MP/$) Spot rate before 1st pymt (MP/$)
2 2 6.50% 5.75 MP 5.10 MP
Calculate MP loan payment: N 4 I/YR 3.250% PV FV PMT
5,750,000 MP Calculated as loan value spot rate at loan date 0 MP Loan will be paid off at maturity, so FV = 0 1,556,164 MP
Cash Flows: 0 1 2 3 4 6 mos. periods MP 5,750,000 -1,556,164 -1,556,164 -1,556,164 -1,556,164 (Spot at loan date) $
1,000,000
-305,130
-305,130
-305,130 -305,130 Changed spot rate
$ payments are determined by dividing peso payments by the changed spot rate.
Calculate I/YR for $ CFs: N 4 PV $1,000,000 Use original loan value here FV $0 PMT -$305,130 This is the nominal semiannual rate, I/YR 8.48% rNOM/N Calculate EAR of loan from periodic rate calculated above:
EAR% = (1+(rNOM/N))^N - 1 = 17.67% POINTS:
1
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DIFFICULTY: CHALLENGING REFERENCES: 19-9 International Money and Capital Markets QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.17.09 - International Money and Capital Markets NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.13 - Multinational financial management LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: EAR on foreign debt KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:14 PM DATE MODIFIED: 9/26/2017 6:22 PM
1. The "preferred" feature of preferred stock means that it will normally provide a higher expected return than will common stock. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 20-1 Preferred Stock QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.20.01 - Preferred Stock NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.08 - Investments TOPICS: Preferred stock KEYWORDS: Bloom’s: Remember DATE CREATED: 9/21/2017 6:03 PM DATE MODIFIED: 11/8/2017 1:16 PM 2. Unlike with bonds, the cost of preferred stock to the issuing firm is the same on a before-tax and after-tax basis. This is because dividends on preferred stock are not tax deductible, whereas interest on bonds is deductible. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 20-1 Preferred Stock QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.20.01 - Preferred Stock NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking Copyright Cengage Learning. Powered by Cognero.
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STATE STANDARDS: TOPICS: KEYWORDS: DATE CREATED: DATE MODIFIED:
United States - OH - DISC.FOFM.BRIG.17.08 - Investments Cost of preferred stock Bloom’s: Remember 9/21/2017 6:03 PM 11/8/2017 1:16 PM
3. A sale and leaseback arrangement is a type of financial, or capital, lease. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 20-2 Leasing QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.20.02 - Leasing NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.08 - Investments TOPICS: Types of leases KEYWORDS: Bloom’s: Remember DATE CREATED: 9/21/2017 6:03 PM DATE MODIFIED: 11/8/2017 1:16 PM 4. Operating leases help to shift the risk of obsolescence from the user to the lessor. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 20-2 Leasing QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.20.02 - Leasing NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.08 - Investments TOPICS: Operating lease KEYWORDS: Bloom’s: Understand DATE CREATED: 9/21/2017 6:03 PM DATE MODIFIED: 11/8/2017 1:16 PM 5. Under a sale and leaseback arrangement, the seller of the leased property is the lessee and the buyer is the lessor. a. True b. False ANSWER: True POINTS: 1 Copyright Cengage Learning. Powered by Cognero.
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DIFFICULTY: EASY REFERENCES: 20-2 Leasing QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.20.02 - Leasing NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.08 - Investments TOPICS: Sale and leaseback KEYWORDS: Bloom’s: Remember DATE CREATED: 9/21/2017 6:03 PM DATE MODIFIED: 11/8/2017 1:16 PM 6. The full amount of a lease payment is tax deductible provided the contract qualifies as a true lease under IRS guidelines. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 20-2 Leasing QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.20.02 - Leasing NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.08 - Investments TOPICS: Lease payments KEYWORDS: Bloom’s: Remember DATE CREATED: 9/21/2017 6:03 PM DATE MODIFIED: 11/8/2017 1:16 PM 7. Historically, leasing was often referred to as off-balance-sheet financing because lease payments were shown as operating expenses on a firm's income statement, and leased assets and associated liabilities did not appear on the firm's balance sheet under certain conditions. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 20-2 Leasing QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.20.02 - Leasing NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.08 - Investments TOPICS: Off-balance-sheet leasing KEYWORDS: Bloom’s: Understand Copyright Cengage Learning. Powered by Cognero.
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DATE CREATED: DATE MODIFIED:
9/21/2017 6:03 PM 12/16/2017 9:53 PM
8. A warrant is an option, and as such it cannot be used as a "sweetener." a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 20-3 Warrants QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.20.03 - Warrants NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.08 - Investments TOPICS: Warrants KEYWORDS: Bloom’s: Remember DATE CREATED: 9/21/2017 6:03 PM DATE MODIFIED: 11/8/2017 1:16 PM 9. A warrant holder is not entitled to vote, but he or she does receive any cash dividends paid on the underlying stock. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 20-3 Warrants QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.20.03 - Warrants NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.08 - Investments TOPICS: Warrants KEYWORDS: Bloom’s: Remember DATE CREATED: 9/21/2017 6:03 PM DATE MODIFIED: 11/8/2017 1:16 PM 10. The sale of call options cannot give rise to the problem of dilution of stockholders' earnings, but the use of warrants can. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 20-3 Warrants QUESTION TYPE: True / False Copyright Cengage Learning. Powered by Cognero.
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HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.20.03 - Warrants NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.08 - Investments TOPICS: Warrants KEYWORDS: Bloom’s: Understand DATE CREATED: 9/21/2017 6:03 PM DATE MODIFIED: 11/8/2017 1:16 PM 11. A detachable warrant is a warrant that can be removed from the security with which it was issued and traded separately from it. Most traded warrants are originally attached to bonds or preferred stocks. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 20-3 Warrants QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.20.03 - Warrants NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.08 - Investments TOPICS: Detachable warrant KEYWORDS: Bloom’s: Remember DATE CREATED: 9/21/2017 6:03 PM DATE MODIFIED: 11/8/2017 1:16 PM 12. The owner of a convertible bond owns, in effect, both a bond and a call option. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 20-4 Convertibles QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.20.04 - Convertibles NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.08 - Investments TOPICS: Convertibles KEYWORDS: Bloom’s: Remember DATE CREATED: 9/21/2017 6:03 PM DATE MODIFIED: 11/8/2017 1:16 PM 13. A convertible debenture can never sell for more than its conversion value or less than its bond value. a. True Copyright Cengage Learning. Powered by Cognero.
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b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 20-4 Convertibles QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.20.04 - Convertibles NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.08 - Investments TOPICS: Convertibles KEYWORDS: Bloom’s: Understand DATE CREATED: 9/21/2017 6:03 PM DATE MODIFIED: 11/8/2017 1:16 PM 14. Most convertible securities are bonds or preferred stocks that, under specified terms and conditions, can be exchanged for common stock at the option of the holder. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 20-4 Convertibles QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.20.04 - Convertibles NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.08 - Investments TOPICS: Convertibles KEYWORDS: Bloom’s: Remember DATE CREATED: 9/21/2017 6:03 PM DATE MODIFIED: 11/8/2017 1:16 PM 15. Firms generally do not call their convertibles unless the conversion value is greater than the call price. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 20-4 Convertibles QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.20.04 - Convertibles NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.08 - Investments Copyright Cengage Learning. Powered by Cognero.
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TOPICS: KEYWORDS: DATE CREATED: DATE MODIFIED:
Convertibles Bloom’s: Understand 9/21/2017 6:03 PM 11/8/2017 1:16 PM
16. Preferred stock normally has no voting rights. However, most preferred issues stipulate that the preferred stockholders can elect a minority number of the directors if the preferred dividend is omitted. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 20-1 Preferred Stock QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.20.01 - Preferred Stock NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.08 - Investments TOPICS: Preferred stock KEYWORDS: Bloom’s: Remember DATE CREATED: 9/21/2017 6:03 PM DATE MODIFIED: 11/8/2017 1:16 PM 17. Preferred stockholders have priority over common stockholders with respect to dividends, because dividends must be paid on preferred stock before they can be paid on common stock. However, preferred and common stockholders normally have equal priority with respect to liquidating proceeds in the event of bankruptcy. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 20-1 Preferred Stock QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.20.01 - Preferred Stock NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.08 - Investments TOPICS: Preferred stock KEYWORDS: Bloom’s: Understand DATE CREATED: 9/21/2017 6:03 PM DATE MODIFIED: 11/8/2017 1:16 PM 18. Preferred stock typically has a par value, and the dividend is often stated as a percentage of par. The par value is also important in the event of liquidation, as the preferred stockholders are generally entitled to receive the par value before anything is given to the common stockholders. a. True Copyright Cengage Learning. Powered by Cognero.
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b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 20-1 Preferred Stock QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.20.01 - Preferred Stock NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.08 - Investments TOPICS: Preferred stock KEYWORDS: Bloom’s: Understand DATE CREATED: 9/21/2017 6:03 PM DATE MODIFIED: 11/8/2017 1:16 PM 19. Preferred stock can provide a financing alternative for some firms when market conditions are such that the firms cannot issue either pure debt or common stock at any reasonable cost. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 20-1 Preferred Stock QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.20.01 - Preferred Stock NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.08 - Investments TOPICS: Preferred stock KEYWORDS: Bloom’s: Understand DATE CREATED: 9/21/2017 6:03 PM DATE MODIFIED: 11/8/2017 1:16 PM 20. Corporations that invest surplus funds in floating-rate preferred stock benefit from a relatively stable price and from the 70% tax exemption on preferred dividends received. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 20-1 Preferred Stock QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.20.01 - Preferred Stock NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking Copyright Cengage Learning. Powered by Cognero.
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STATE STANDARDS: TOPICS: KEYWORDS: DATE CREATED: DATE MODIFIED:
United States - OH - DISC.FOFM.BRIG.17.08 - Investments Floating-rate preferred Bloom’s: Understand 9/21/2017 6:03 PM 11/8/2017 1:16 PM
21. Leasing is typically a financing decision rather than a capital budgeting decision. The decision to acquire the asset is a "done deal" before the lease analysis begins. Therefore, in a lease analysis, we are concerned simply with whether to finance the asset with a lease or with a loan. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 20-2 Leasing QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.20.02 - Leasing NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.08 - Investments TOPICS: Lease financing KEYWORDS: Bloom’s: Understand DATE CREATED: 9/21/2017 6:03 PM DATE MODIFIED: 11/8/2017 1:16 PM 22. If a leased asset has a negative residual value (e.g. as a result of a statutory requirement to dispose of an asset in an environmentally sound manner), then the lessee of the asset could reasonably expect to pay a lower lease rate because the asset does not have a positive residual value. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 20-2 Leasing QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.20.02 - Leasing NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.08 - Investments TOPICS: Residual value and leases KEYWORDS: Bloom’s: Understand DATE CREATED: 9/21/2017 6:03 PM DATE MODIFIED: 11/8/2017 1:16 PM 23. Assume that a piece of leased equipment has a relatively high expected residual value. From the lessee's viewpoint, it might be better to own the asset rather than lease it because with a high residual value the lessee will likely face a higher lease rate. Copyright Cengage Learning. Powered by Cognero.
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a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 20-2 Leasing QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.20.02 - Leasing NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.08 - Investments TOPICS: Residual value and leases KEYWORDS: Bloom’s: Understand DATE CREATED: 9/21/2017 6:03 PM DATE MODIFIED: 11/8/2017 1:16 PM 24. From the lessee viewpoint, the riskiness of the cash flows, with the possible exception of the residual value, is about the same as the riskiness of the lessee's a. equity cash flows. b. capital budgeting project cash flows. c. debt cash flows. d. pension fund cash flows. e. sales. ANSWER: c POINTS: 1 DIFFICULTY: EASY REFERENCES: 20-2 Leasing QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.20.02 - Leasing NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.08 - Investments TOPICS: Lease cash flows KEYWORDS: Bloom’s: Remember OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:03 PM DATE MODIFIED: 11/8/2017 1:16 PM 25. Operating leases often have terms that include a. maintenance of the equipment by the lessor. b. full amortization over the life of the lease. c. very high penalties if the lease is cancelled. d. restrictions on how much the leased property can be used. e. much longer lease periods than for most financial leases. ANSWER: a Copyright Cengage Learning. Powered by Cognero.
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POINTS: 1 DIFFICULTY: EASY REFERENCES: 20-2 Leasing QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.20.02 - Leasing NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.08 - Investments TOPICS: Operating lease KEYWORDS: Bloom’s: Remember OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:03 PM DATE MODIFIED: 11/8/2017 1:16 PM 26. Which of the following statements is CORRECT? a. Preferred stock generally has a higher component cost of capital to the firm than does common stock. b. By law in most states, all preferred stock must be cumulative, meaning that the compounded total of all unpaid preferred dividends must be paid before any dividends can be paid on the firm's common stock. c. From the issuer's point of view, preferred stock is less risky than bonds. d. Whereas common stock has an indefinite life, preferred stocks always have a specific maturity date, generally 25 years or less. e. Unlike bonds, preferred stock cannot have a convertible feature. ANSWER: c POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 20-1 Preferred Stock QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.20.01 - Preferred Stock NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.08 - Investments TOPICS: Preferred stock KEYWORDS: Bloom’s: Understand OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:03 PM DATE MODIFIED: 11/8/2017 1:16 PM 27. Which of the following is CORRECT? a. Firms that use "off-balance-sheet" financing, such as leasing, would show lower debt ratios if the effects of their leases were reflected in their financial statements. b. Capitalizing a lease means that the firm issues equity capital in proportion to its current capital structure, in an amount sufficient to support the lease payment obligation. c. The fixed charges associated with a lease can be as high as, but never greater than, the fixed payments associated with a loan. d. Capital, or financial, leases generally provide for maintenance by the lessor. e. A key difference between a capital lease and an operating lease is that with a capital lease, the lease payments Copyright Cengage Learning. Powered by Cognero.
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provide the lessor with a return of the funds invested in the asset plus a return on the invested funds, whereas with an operating lease the lessor depends on the residual value to realize a full return of and on the investment. ANSWER: e POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 20-2 Leasing QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.20.02 - Leasing NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.08 - Investments TOPICS: Leasing KEYWORDS: Bloom’s: Understand OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:03 PM DATE MODIFIED: 11/8/2017 1:16 PM 28. Accounting Standards Codification Topic 840 (also known as ASC 840) requires that for an unqualified audit report, financial (or capital) leases must be included in the balance sheet by reporting the a. residual value as a fixed asset. b. residual value as a liability. c. present value of future lease payments as an asset and also showing this same amount as an offsetting liability. d. undiscounted sum of future lease payments as an asset and as an offsetting liability. e. undiscounted sum of future lease payments, less the residual value, as an asset and as an offsetting liability. ANSWER: c POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 20-2 Leasing QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.20.02 - Leasing NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.08 - Investments TOPICS: Capitalizing leases KEYWORDS: Bloom’s: Remember OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:03 PM DATE MODIFIED: 12/16/2017 10:15 PM 29. Heavy use of off-balance-sheet lease financing will tend to a. make a company appear more risky than it actually is because its stated debt ratio will be increased. b. make a company appear less risky than it actually is because its stated debt ratio will appear lower. c. affect a company's cash flows but not its degree of risk. d. have no effect on either cash flows or risk because the cash flows are already reflected in the income statement. Copyright Cengage Learning. Powered by Cognero.
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e. affect the lessee's cash flows but only due to tax effects. ANSWER: b POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 20-2 Leasing QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.20.02 - Leasing NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.08 - Investments TOPICS: Off-balance-sheet leasing KEYWORDS: Bloom’s: Understand OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:03 PM DATE MODIFIED: 11/8/2017 1:16 PM 30. In the lease-versus-buy decision, leasing is often preferable a. because it has no effect on the firm's ability to borrow to make other investments. b. because a down payment is generally not required and there are no indirect interest costs. c. because lease obligations do not affect the firm's risk as seen by investors. d. because the lessee owns the property at the end of the lease term. e. because the lessee may have greater flexibility in abandoning the project in which the leased property is used than if the lessee bought and owned the asset. ANSWER: e POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 20-2 Leasing QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.20.02 - Leasing NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.08 - Investments TOPICS: Lease decision KEYWORDS: Bloom’s: Understand OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:03 PM DATE MODIFIED: 11/8/2017 1:16 PM 31. A lease-versus-purchase analysis should compare the cost of leasing to the cost of owning, assuming that the asset purchased a. is financed with short-term debt. b. is financed with long-term debt. c. is financed with debt whose maturity matches the term of the lease. d. is financed with a mix of debt and equity based on the firm's target capital structure, i.e., at the WACC. e. is financed with retained earnings. Copyright Cengage Learning. Powered by Cognero.
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ANSWER: c POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 20-2 Leasing QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.20.02 - Leasing NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.08 - Investments TOPICS: Lease analysis discount rate KEYWORDS: Bloom’s: Understand OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:03 PM DATE MODIFIED: 11/8/2017 1:16 PM 32. Which of the following statements about convertibles is CORRECT? a. The coupon interest rate on a firm's convertibles is generally set higher than the market yield on its otherwise similar straight debt. b. One advantage of convertibles over warrants is that the issuer receives additional cash money when convertibles are converted. c. Investors are willing to accept a lower interest rate on a convertible than on otherwise similar straight debt because convertibles are less risky than straight debt. d. At the time it is issued, a convertible's conversion (or exercise) price is generally set equal to or below the underlying stock's price. e. For equilibrium to exist, the expected return on a convertible bond must normally be between the expected return on the firm's otherwise similar straight debt and the expected return on its common stock. ANSWER: e POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 20-4 Convertibles QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.20.04 - Convertibles NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.08 - Investments TOPICS: Convertibles KEYWORDS: Bloom’s: Understand OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:03 PM DATE MODIFIED: 11/8/2017 1:16 PM 33. Which of the following statements concerning warrants is CORRECT? a. Bonds with warrants and convertible bonds both have option features that their holders can exercise if the underlying stock's price increases. However, if the option is exercised, the issuing company's debt declines if warrants are used but remains the same if convertibles are used. b. Warrants are long-term put options that have value because holders can sell the firm's common stock at the exercise price regardless of how low the market price drops. Copyright Cengage Learning. Powered by Cognero.
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c. Warrants are long-term call options that have value because holders can buy the firm's common stock at the exercise price regardless of how high the stock's price has risen. d. A firm's investors would generally prefer to see it issue bonds with warrants than straight bonds because the warrants dilute the value of new shareholders, and that value is transferred to existing shareholders. e. A drawback to using warrants is that if the firm is very successful, investors will be less likely to exercise the warrants, and this will deprive the firm of receiving any new capital. ANSWER: c POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 20-4 Convertibles QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.20.04 - Convertibles NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.08 - Investments TOPICS: Warrants and convertibles KEYWORDS: Bloom’s: Understand OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:03 PM DATE MODIFIED: 11/8/2017 1:16 PM 34. Which of the following statements is CORRECT? a. Warrants have an option feature, but convertibles do not. b. One important difference between warrants and convertibles is that convertibles bring in additional funds when they are converted, but exercising warrants does not bring in any additional funds. c. The coupon rate on convertible debt is normally set below the coupon rate that would be set on otherwise similar straight debt, even though investing in convertibles is more risky than investing in straight debt. d. The value of a warrant to buy a safe, stable stock should exceed the value of a warrant to buy a risky, volatile stock, other things held constant. e. Warrants can sometimes be detached and traded separately from the security with which they were issued, but this is unusual. ANSWER: c POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 20-4 Convertibles QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.20.04 - Convertibles NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.08 - Investments TOPICS: Warrants and convertibles KEYWORDS: Bloom’s: Understand OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:03 PM DATE MODIFIED: 11/8/2017 1:16 PM Copyright Cengage Learning. Powered by Cognero.
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35. Orient Airlines' common stock currently sells for $32, and its 8.0% convertible debentures (issued at par, or $1,000) sell for $850. Each debenture can be converted into 26 shares of common stock at any time before 2028. What is the conversion value of the bond? Do not round your intermediate calculations. a. $915.20 b. $1,040.00 c. $956.80 d. $832.00 e. $748.80 ANSWER: d RATIONALE: Stock price $32 Coupon rate 8.00% Bond price $850 Par value $1,000 Conversion ratio 26.00 Conversion value = Conversion ratio × Stock price = $832.00 POINTS: 1 DIFFICULTY: EASY REFERENCES: 20-4 Convertibles QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.20.04 - Convertibles NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.08 - Investments TOPICS: Convertibles: straight-debt value KEYWORDS: Bloom’s: Evaluate OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:03 PM DATE MODIFIED: 11/8/2017 1:16 PM 36. Chocolate Factory's convertible debentures were issued at their $1,000.00 par value in 2018. At any time prior to maturity on February 1, 2038, a debenture holder can exchange a bond for 21 shares of common stock. What is the conversion price of the common stock, Pc? Do not round your intermediate calculations. a. $47.62 b. $54.76 c. $52.38 d. $38.10 e. $42.86 ANSWER: a RATIONALE: Par value $1,000.00 Conversion ratio 21.00 Conversion price = Par value/Conversion ratio = $47.62
POINTS: DIFFICULTY: REFERENCES: QUESTION TYPE:
1 EASY 20-4 Convertibles Multiple Choice
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HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.20.04 - Convertibles NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.08 - Investments TOPICS: Conversion price KEYWORDS: Bloom’s: Analyze OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:03 PM DATE MODIFIED: 12/16/2017 10:47 PM 37. Moniker Manufacturing's bonds were recently issued at their $1,000 par value. At any time prior to maturity (20 years from now), a bondholder can exchange a bond for a share of common stock at a conversion price of $10. What is the conversion ratio? Do not round your intermediate calculations. a. 85.00 b. 120.00 c. 100.00 d. 110.00 e. 75.00 ANSWER: c RATIONALE: Par value $1,000.00 Conversion price $10.00 Conversion ratio = Par value/Conversion price = 100.00 POINTS: 1 DIFFICULTY: EASY REFERENCES: 20-4 Convertibles QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.20.04 - Convertibles NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.08 - Investments TOPICS: Conversion ratio KEYWORDS: Bloom’s: Analyze OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:03 PM DATE MODIFIED: 12/16/2017 10:59 PM 38. Its investment bankers have told Donner Corporation that it can issue a 25-year, 7.6% annual payment bond at par. They also stated that the company can sell an issue of annual payment preferred stock to corporate investors who are in the 40% tax bracket. The corporate investors require an after-tax return on the preferred that exceeds their after-tax return on the bonds by 1.3%, which would represent an after-tax risk premium. What coupon rate must be set on the preferred in order to issue it at par? Do not round your intermediate calculations. a. 6.66% b. 4.99% c. 5.99% d. 7.33% Copyright Cengage Learning. Powered by Cognero.
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e. 7.66% ANSWER: RATIONALE:
a
Maturity Coupon rate Risk premium
25 7.60% 1.30%
Dividend Exclusion Tax rate
70% 40.00%
Bond yield After Tax = Before Tax yield(1 − T) = 4.56% Preferred yield After Tax = After Tax bond yield + RP = 5.86% After Tax Preferred Dividend Yield = Before Tax Preferred Dividend Yield − Before Tax Preferred Dividend Yield(1 − Exclusion)(Tax rate) Preferred yield Before Tax = 5.86%/[1 −(0.3)(0.4)] = 6.66%
Check: After Tax Preferred Dividend Yield
= 6.66%−Tax = 6.66%−6.66%(1−Exclusion)(Tax rate) = 6.66%−6.66%(0.30)(0.40) = 6.66%−6.66%(0.12) = 6.66%−0.80%
After Tax Preferred = 5.86% Dividend Yield POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 20-1 Preferred Stock QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.20.01 - Preferred Stock NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.08 - Investments TOPICS: Preferred vs. bond yields KEYWORDS: Bloom’s: Analyze OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:03 PM DATE MODIFIED: 11/8/2017 1:16 PM 39. Sutton Corporation, which has a zero tax rate due to tax loss carry-forwards, is considering a 5-year, $6,000,000 bank loan to finance service equipment. The loan has an interest rate of 8.8% and would be amortized over 5 years, with 5 endof-year payments. Sutton can also lease the equipment for 5 end-of-year payments of $1,750,000 each. How much larger or smaller is the bank loan payment than the lease payment? Note: Subtract the loan payment from the lease payment. Do not round your intermediate calculations. a. $183,126 b. $226,214 c. $215,442 d. $204,670 e. $258,530 ANSWER: c RATIONALE: Years (N) 5 Copyright Cengage Learning. Powered by Cognero.
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Interest rate (I/YR) Loan amount (PV) Lease payment
Loan:
0 6,000,000
8.8% $6,000,000 $1,750,000 1 −PMT
2 −PMT
3 −PMT
4 −PMT
5 −PMT
Inputs: N = 5; I/YR = 8.8%; PV = 6,000,000; FV = 0 Loan payment = PMT = $1,534,558 Difference in payments = Lease payment − Loan payment = $215,442 POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 20-2 Leasing QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.20.02 - Leasing NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.08 - Investments TOPICS: Difference in loan/lease payments KEYWORDS: Bloom’s: Evaluate OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:03 PM DATE MODIFIED: 11/8/2017 1:16 PM 40. Ballentine Inc., which has a zero tax rate due to tax loss carry-forwards, is considering a 6-year, $5,200,000 bank loan in order to buy a new piece of equipment. The loan will be amortized over 6 years with end-of-year payments and has an interest rate of 8.5%. Alternatively, Ballentine can also lease the equipment for an end-of-year payment of $1,220,000. By how much does the lease payment exceed the loan payment? Do not round your intermediate calculations. a. $70,239 b. $93,652 c. $58,532 d. $66,337 e. $78,043 ANSWER: e RATIONALE: Loan length (N) 6 Bank loan (PV) $5,200,000 Interest rate on loan (I/YR) 8.5% Lease payment $1,220,000
Loan:
0 1 5,200,000 −PMT
2 −PMT
3 −PMT
4 −PMT
5 −PMT
6 −PMT
Find the loan payment: Inputs: N = 6; I/YR = 8.5%; PV = 5,200,000; FV = 0 Loan payment = PMT = $1,141,957 Difference in payments = Lease payment − Loan payment = $78,043 POINTS: DIFFICULTY: REFERENCES:
1 MODERATE 20-2 Leasing
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QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.20.02 - Leasing NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.08 - Investments TOPICS: Comparing loan and lease payments KEYWORDS: Bloom’s: Evaluate OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:03 PM DATE MODIFIED: 11/8/2017 1:16 PM 41. Kohers Inc. is considering a leasing arrangement to finance some manufacturing tools that it needs for the next 3 years. The tools will be obsolete and worthless after 3 years. The firm will depreciate the cost of the tools on a straightline basis over their 3-year life. It can borrow $5,400,000, the purchase price, at 9.6% and buy the tools, or it can make 3 equal end-of-year lease payments of $1,900,000 each and lease them. The loan obtained from the bank is a 3-year simple interest loan, with interest paid at the end of the year. The firm's tax rate is 40%. Annual maintenance costs associated with ownership are estimated at $240,000 payable at the end of the year, but this cost would be borne by the lessor if the equipment were leased. What is the net advantage to leasing (NAL), in thousands? (Suggestion: Delete 3 zeros from dollars and work in thousands.) Do not round your intermediate calculations. a. $634 b. $793 c. $674 d. $872 e. $951 ANSWER: b RATIONALE: (Dollars in Thousands) Years 3 Tax rate 40% Loan amount = equipment cost $5,400 Maintenance costs $240 Interest rate 9.6% Salvage value $0 Lease payment $1,900 After-tax cost of debt = Rate×(1−T) = Annual depreciation = Cost/Yrs. = Tax savings from deprec. = Deprec.×T =
5.76% $1,800 $720 0
Purchase analysis: Net purchase price Maintenance cost Maint. tax savings = Maint×T Deprec. tax savings Cash flow PV cost of owning (5.76%) Leasing analysis: Lease payment Tax savings from lease Cash flow PV cost of leasing (5.76%) Copyright Cengage Learning. Powered by Cognero.
1
2
3
−240 96 720
−240 96 720
−240 96 720
576
576
576
−$5,400
−5,400 –3,853.48
−1,900 −1,900 −1,900 760 760 760 –1,140 –1,140 –1,140 –3,060.82 Page 1071
NAL = PV cost of leasing − PV cost of owning = $793 POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 20-2 Leasing QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.20.02 - Leasing NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.08 - Investments TOPICS: Net advantage to leasing KEYWORDS: Bloom’s: Analyze OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:03 PM DATE MODIFIED: 11/8/2017 1:16 PM 42. Warren Corporation's stock sells for $38.00 per share. The company wants to sell some 20-year, annual interest, $1,000 par value bonds. Each bond would have 85 warrants attached to it, each exercisable into one share of stock at an exercise price of $50.00. The firm's straight bonds yield 11.6%. Each warrant is expected to have a market value of $1.80 given that the stock sells for $38.00. What coupon interest rate must the company set on the bonds in order to sell the bonds-with-warrants at par? Do not round your intermediate calculations. a. 8.64% b. 9.60% c. 11.04% d. 10.08% e. 11.52% ANSWER: b RATIONALE:
Stock price Exercise price No. of warrants Value of warrants Total value $1,000 VB
$38.00 $50.00 85 $1.80
Bond par value Bond maturity Straight-debt yield
$1,000 20 11.6%
= Straight-debt value + Warrant value = Bond value + $153 = $1,000−$153 = $847
Set N = 20, I/YR = 11.6%, PV = −847, FV = 1,000 and solve for PMT: $96.03 To get this payment on a $1,000 bond, the coupon rate = PMT/$1,000 = 9.60%
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 20-3 Warrants QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.20.03 - Warrants NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic Copyright Cengage Learning. Powered by Cognero.
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STATE STANDARDS: TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
United States - OH - DISC.FOFM.BRIG.17.08 - Investments Warrants: coupon Bloom’s: Analyze Multiple Choice: Problem 9/21/2017 6:03 PM 11/8/2017 1:16 PM
43. Curry Corporation is setting the terms on a new issue of bonds with warrants. The bonds will have a 30-year maturity and annual interest payments. Each bond will come with 18 warrants that give the holder the right to purchase one share of stock per warrant. The investment bankers estimate that each warrant will have a value of $13.90. A similar straightdebt issue would require a 12.0% coupon. What coupon rate should be set on the bonds-with-warrants so that the package would sell for $1,000? Do not round your intermediate calculations. a. 7.12% b. 11.12% c. 9.78% d. 8.89% e. 7.56% ANSWER: d RATIONALE:
Bond par value Bond maturity Straight-debt yield Total value $1,000 VB
$1,000 No. of warrants 30 Value of warrants 12.0%
18 $13.90
= Straight-debt value (VB) + Warrant value = $1,000 = VB+ $250.20 = $1,000−$250.20 = $749.80
Set N = 30, I/YR = 12.0%, PV = −749.80, and FV = 1,000. Then solve for PMT: $88.94 To get this payment on a $1,000 bond, the coupon rate = PMT/$1,000 = 8.89%
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 20-3 Warrants QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.20.03 - Warrants NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.08 - Investments TOPICS: Warrants: coupon KEYWORDS: Bloom’s: Analyze OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:03 PM DATE MODIFIED: 11/8/2017 1:16 PM 44. Upstate Water Company just sold a bond with 57 warrants attached. The bonds have a 20-year maturity and an annual coupon of 11.4%, and they were issued at their $1,000 par value. The current yield on similar straight bonds is 17%. What is the implied value of each warrant? Do not round your intermediate calculations. a. $5.53 Copyright Cengage Learning. Powered by Cognero.
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b. $6.08 c. $5.25 d. $6.91 e. $4.42 ANSWER: RATIONALE:
a
Bond par value Bond maturity Straight-debt yield
$1,000 No. of warrants 20 Coupon rate 17.0% PMT
57 11.4% $114
Find the straight-debt value: N = 20, I/YR = 17%, PMT = −114, and FV = −1,000. PV = $684.85
Total value $1,000 $315.15 Warrant value
= Straight-debt value (VB) + Warrant value = $1,000 = $684.85 + 57×Warrant value = 57×Warrant value = $5.53
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 20-3 Warrants QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.20.03 - Warrants NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.08 - Investments TOPICS: Warrants: value KEYWORDS: Bloom’s: Evaluate OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:03 PM DATE MODIFIED: 11/8/2017 1:16 PM 45. Curran Contracting is issuing new 25-year bonds that have warrants attached. If not for the attached warrants, the bonds would carry an 11.2% annual interest rate. However, with the warrants attached the bonds will pay a 9.5% annual coupon. There are 31 warrants attached to each bond, which have a par value of $1,000. What is the implied value of each warrant? Do not round your intermediate calculations. a. $4.10 b. $4.55 c. $5.23 d. $3.87 e. $5.46 ANSWER: b RATIONALE:
Bond par value Bond maturity Straight-debt yield
$1,000 No. of warrants 25 Coupon rate 11.2% PMT
31 9.5% $95
Find the straight-debt value: N = 25, I/YR = 11.2%, PMT = −95, and FV = −1,000. PV = $858.90
Total value $1,000 $141.10 Copyright Cengage Learning. Powered by Cognero.
= Straight-debt value (VB) + Warrant value = $1,000 = $858.90 + 31×Warrant value = 31×Warrant value Page 1074
Warrant value
= $4.55
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 20-3 Warrants QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.20.03 - Warrants NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.08 - Investments TOPICS: Warrants: value KEYWORDS: Bloom’s: Evaluate OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:03 PM DATE MODIFIED: 11/8/2017 1:16 PM 46. Herbert Engineering is issuing new 22-year bonds that have warrants attached. If not for the attached warrants, the bonds would carry a 10.3% annual interest rate. However, with the warrants attached the bonds will pay a 6.3% annual coupon. There are 30 warrants attached to each bond, which has a par value of $1,000. What is the value of the straightdebt portion of the bonds? Do not round your intermediate calculations. a. $558.10 b. $656.58 c. $623.75 d. $689.41 e. $525.27 ANSWER: b RATIONALE: Bond par value $1,000 No. of warrants 30 Bond maturity 22 Coupon rate 6.3% Straight-debt yield 10.3% PMT $63 Find the straight-debt value: N = 22, I/YR = 10.3%, PMT = −63, and FV = −1,000. PV = $656.58 POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 20-3 Warrants QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.20.03 - Warrants NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.08 - Investments TOPICS: Warrants: straight-debt value KEYWORDS: Bloom’s: Evaluate OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:03 PM DATE MODIFIED: 11/8/2017 2:20 PM 47. Thomson Engineering is issuing new 19-year bonds that have warrants attached. If not for the attached warrants, the Copyright Cengage Learning. Powered by Cognero.
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bonds would carry a 12.3% annual interest rate. However, with the warrants attached the bonds will pay an 8.2% annual coupon. There are 30 warrants attached to each bond, which have a par value of $1,000. What is the value of the straightdebt portion of the bonds? Do not round your intermediate calculations. a. $738.62 b. $773.80 c. $668.28 d. $703.45 e. $844.14 ANSWER: d RATIONALE: Bond par value $1,000 No. of warrants 30 Bond maturity 19 Coupon rate 8.2% Straight-debt yield 12.3% PMT $82 Find the straight-debt value: N = 19, I/YR = 12.3%, PMT = −82, and FV = −1,000. PV = $703.45 POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 20-3 Warrants QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.20.03 - Warrants NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.08 - Investments TOPICS: Warrants: straight-debt value KEYWORDS: Bloom’s: Evaluate OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:03 PM DATE MODIFIED: 11/8/2017 2:21 PM 48. Herring Inc. is considering issuing 18-year, 9.0% semiannual coupon, $1,000 face value convertible bonds at a price of $1,000 each. Each bond would be convertible into 25 shares of common stock. If the bonds were not convertible, investors would require an annual nominal yield of 11.8%. What is the straight-debt value of each bond at the time of issue? Do not round your intermediate calculations. a. $911.77 b. $713.56 c. $753.20 d. $792.84 e. $951.41 ANSWER: d RATIONALE: Bond par value $1,000 Straight-debt yield 11.8% Maturity Years 18 I/YR 5.9% No. of periods/yr. 2 Convertible coupon 9.0% N 36 PMT 45 Conv. ratio (CR) 25 Find the straight-debt value: N = 36, I/YR = 5.9%, PMT = −45, and FV = −1,000. PV = $792.84 Copyright Cengage Learning. Powered by Cognero.
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POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 20-4 Convertibles QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.20.04 - Convertibles NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.08 - Investments TOPICS: Convertibles: straight-debt value KEYWORDS: Bloom’s: Evaluate OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:03 PM DATE MODIFIED: 11/8/2017 2:22 PM 49. Cannon Manufacturing is considering issuing 18-year, 7.8% annual coupon, $1,000 face value convertible bonds at a price of $1,000 each. Each bond would be convertible into 22 shares of common stock. If the bonds were not convertible, investors would require an annual yield of 11.8%. The stock's current price is $22.00, its expected dividend is $2.60, and its expected growth rate is 5.9%. The bonds are noncallable for 10 years. What is the bond's conversion value in Year 5? Do not round your intermediate calculations. a. $709.12 b. $773.58 c. $644.65 d. $547.95 e. $676.88 ANSWER: c RATIONALE: Bond par value $1,000 Bond maturity 18 Conv. ratio (CR) 22 Straight-debt yield 11.8% $22 Convertible coupon 7.8% P0 Growth rate (g) 5.9% PMT $78 Conversion year, t 5 t
Conversion value = P0 × CR × (1 + g) 5 Conversion value = $22 × 22 × (1.059) Conversion value = $644.65 POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 20-4 Convertibles QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.20.04 - Convertibles NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.08 - Investments TOPICS: Convertibles: conversion value KEYWORDS: Bloom’s: Evaluate OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:03 PM Copyright Cengage Learning. Powered by Cognero.
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DATE MODIFIED:
12/16/2017 11:41 PM
50. Ellis Enterprises is considering whether to lease or buy some necessary equipment it needs for a project that will last the next 3 years. If the firm buys the equipment, it will borrow $4,800,000 at 8.0% interest. The firm's tax rate is 35%, and the firm's before-tax cost of debt is 8.0%. Annual maintenance costs associated with ownership are estimated to be $400,000, and the equipment will be depreciated on a straight-line basis over 3 years. What is the annual end-of-year lease payment (in thousands of dollars) for a 3-year lease that would make the firm indifferent between buying or leasing the equipment? (Suggestion: Delete 3 zeros from dollars and work in thousands.) Do not round your intermediate calculations. a. $2,599 b. $2,147 c. $2,260 d. $1,695 e. $1,808 ANSWER: c RATIONALE: (Dollars in Thousands) Life of equipment 3 Tax rate 35% Loan amount = equip. cost $4,800 Maint. costs $400 BT cost of debt 8.0% Purchase analysis: 0 1 2 3 Totals Straight-line factor 0.3333 0.3333 0.3333 1.00 Depreciation 1,600 1,600 1,600 4,800 Equipment purchase −$4,800 Maintenance −400 −400 −400 Maint. tax savings (Maint.×T) 140 140 140 Deprec. tax savings (Deprec×T) _____ 560 560 560 Cash flows −4,800 300 300 300 PV cost at I(1−T) = 5.20% –3,986 Calculate lease PMT that has same PV as owning: N 3 I/YR 5.20% PV –3,986 FV 0 PMT = AT leasing PMT = $1,469 BT leasing PMT = AT PMT/(1 − T) = $2,260 POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 20-2 Leasing QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.20.02 - Leasing NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.08 - Investments TOPICS: Break-even lease payment KEYWORDS: Bloom’s: Analyze OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:03 PM Copyright Cengage Learning. Powered by Cognero.
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DATE MODIFIED:
11/8/2017 1:16 PM
51. Carolina Trucking Company (CTC) is evaluating a potential lease for a truck with a 4-year life that costs $41,000 and falls into the MACRS 3-year class. If the firm borrows and buys the truck, the loan rate would be 9.6%, and the loan would be amortized over the truck's 4-year life. The loan payments would be made at the end of each year. The truck will be used for 4 years, at the end of which it will be sold at an estimated residual value of $12,800. If CTC buys the truck, it would purchase a maintenance contract that costs $1,900 per year, payable at the end of each year. The lease terms, which include maintenance, call for a $10,000 lease payment (4 payments total) at the beginning of each year. CTC's tax rate is 35%. What is the net advantage to leasing? (Note: MACRS rates for Years 1 to 4 are 0.33, 0.45, 0.15, and 0.07.) Do not round your intermediate calculations. a. $2,490 b. $1,840 c. $2,707 d. $2,165 e. $1,732 ANSWER: d RATIONALE: Life of equipment 4 Tax rate 35% Equipment cost $41,000 Maint. costs $1,900 Interest rate 9.6% Residual value $12,800 Lease payment $10,000 Purchase analysis: MACRS factor Depreciation
0
1 0.33 13,530
Equipment purchase −$41,000 Maintenance Maint. tax savings (Maint. × T) Deprec. tax savings (Deprec. × T) Residual value Tax on residual AT residual value ____ Total CFs −41,000
2 3 0.45 0.15 18,450 6,150
−1,900 −1,900 −1,900 −1,900 665 665 665 665 4,736
____ 3,501
PV cost of buying at I(1−T)
6.24% –25,962.99
Lease analysis: Lease payment Tax savings on pmt AT lease pmt
0 −10,000 3,500 −6,500
PV cost of leasing at I(1−T) NAL = $2,165
6.24% –23,797.71
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4 0.07 2,870
6,458
2,153
____ 5,223
12,800 −4,480 ____ 8,320 918 8,090
1 2 3 −10,000 −10,000 −10,000 3,500 3,500 3,500 −6,500 −6,500 −6,500
1,005
4 0 0 0
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POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 20-2 Leasing QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.20.02 - Leasing NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.08 - Investments TOPICS: Net advantage to leasing KEYWORDS: Bloom’s: Analyze OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:03 PM DATE MODIFIED: 12/17/2017 12:05 AM 52. Bev's Beverages is negotiating a lease on a new piece of equipment that would cost $87,000 if purchased. The equipment falls into the MACRS 3-year class, and it would be used for 3 years and then sold, because the firm plans to move to a new facility at that time. The estimated value of the equipment after 3 years is $33,000. A maintenance contract on the equipment would cost $2,700 per year, payable at the beginning of each year. Alternatively, the firm could lease the equipment for 3 years for a lease payment of $20,200 per year, payable at the beginning of each year. The lease would include maintenance. The firm is in the 20% tax bracket, and it could obtain a 3-year simple interest loan, interest payable at the end of the year, to purchase the equipment at a before-tax cost of 8.3%. If there is a positive Net Advantage to Leasing, then the firm will lease the equipment. Otherwise, the firm will buy it. What is the NAL? (Note: MACRS rates for Years 1 to 4 are 0.33, 0.45, 0.15, and 0.07.)Do not round your intermediate calculations. a. $10,365 b. $10,884 c. $8,811 d. $7,774 e. $9,847 ANSWER: a RATIONALE: Life of equipment 3 Tax rate 20% Equipment cost $87,000 Maint. costs $2,700 Interest rate 8.3% Residual value $33,000 Lease payment $20,200 Purchase analysis: MACRS factor Depreciation
Equipment cost Maintenance Maint. tax savings (Maint.×T) Deprec. tax savings (Deprec.×T) Residual value before taxes Book value (Cost−Total deprec.) Taxable residual value Copyright Cengage Learning. Powered by Cognero.
0
1 0.33 28,710
2 0.45 39,150
−$87,000 −2,700
−2,700
−2,700
540
540
540
5,742
7,830
3 Totals 0.15 0.93 13,050 80,910
2,610 33,000 6,090 26,910 Page 1080
Tax on residual value AT residual value Cash flows
−89,160
PV cost at I(1−T) =
6.64% –55,889.35
Lease analysis: Lease payment Tax saving on pmt AT lease pmt
0 −20,200 4,040 −16,160
3,582
1 −20,200 4,040 −16,160
5,670
−5,382 27,618 30,228
2 −20,200 4,040 −16,160
3 0 0 0
PV cost of leasing at I(1−T) –45,524.02 NAL = $10,365
POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 20-2 Leasing QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.20.02 - Leasing NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.08 - Investments TOPICS: Net advantage to leasing KEYWORDS: Bloom’s: Analyze OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:03 PM DATE MODIFIED: 12/18/2017 1:28 PM 53. Emerson Electrical Engineering Inc. is issuing new 20-year bonds that have warrants attached. If not for the attached warrants, the bonds would carry a 12.0% interest rate. However, with the warrants attached the bonds will pay a 10.0% annual coupon. There are 22 warrants attached to each bond, which have a par value of $1,000. The exercise price of the warrants is $23.00, and the expected stock price 10 years from now (when the warrants may be exercised) is $47.87. What is the investor's expected overall pre-tax rate of return for this bond-with-warrants issue? Do not round your intermediate calculations. a. 14.19% b. 9.26% c. 12.34% d. 9.87% e. 11.11% ANSWER: c RATIONALE: Bond par value $1,000 Conversion ratio (shares) 22 Bond maturity 20 Coupon rate 10.0% Straight-debt yield 12.0% Exercise price $23.00 $47.87 P10 Value gained from exercise in Yr. 10 per $24.87 Copyright Cengage Learning. Powered by Cognero.
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warrant Total value gained in Year 10 CF0 CF1 CF2 CF3 CF4 CF5 CF6 CF7 CF8 CF9 CF10
−$1,000 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 647.14
547.14 CF11 CF12 CF13 CF14 CF15 CF16 CF17 CF18 CF19 CF20
100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 1,100.00
IRR 12.34% POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 20-3 Warrants QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.20.03 - Warrants NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.08 - Investments TOPICS: Warrants: return KEYWORDS: Bloom’s: Analyze OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:03 PM DATE MODIFIED: 11/8/2017 1:16 PM 54. Atlas Anglers Inc. is considering issuing a 16-year convertible bond that will be priced at its $1,000 par value. The bonds have a 7.5% annual coupon rate, and each bond can be converted into 21 shares of common stock. The stock currently sells at $38.00 a share, has an expected dividend in the coming year of $3.80, and has an expected constant growth rate of 5.9%. What is the estimated floor price of the convertible at the end of Year 3 if the required rate of return on a similar straight-debt issue is 9.8%? Do not round your intermediate calculations. a. $947.74 b. $758.19 c. $1,184.68 d. $1,089.90 e. $852.97 ANSWER: a RATIONALE: Bond par value $1,000 Convertible coupon 7.5% Bond maturity 16 PMT $75 Evaluation year, t 3 Conversion ratio (shares) 21 N 13 Stock price $38.00 Straight-debt yield 9.8% Dividend per share $3.80 Growth rate 5.9% Copyright Cengage Learning. Powered by Cognero.
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Find the straight-debt value: N = 13, I/YR = 9.8%, PMT = −75, and FV = −1,000. PV = $834.92 t Conversion value = P0 × CR × (1 + g) 3 Conversion value = $38.00 × 21 × (1.059) Conversion value = $947.74 The floor value is the higher of the bond value or the conversion value, so it is $947.74. POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 20-4 Convertibles QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.20.04 - Convertibles NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.08 - Investments TOPICS: Convertibles: floor value KEYWORDS: Bloom’s: Analyze OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:03 PM DATE MODIFIED: 12/17/2017 12:47 AM 55. Valdes Enterprises is considering issuing a 10-year convertible bond that would be priced at its $1,000 par value. The bonds would have a 7.1% annual coupon, and each bond could be converted into 31 shares of common stock. The required rate of return on an otherwise similar nonconvertible bond is 10.1%. The stock currently sells for $43.00 a share, has an expected dividend in the coming year of $2.80, and has an expected constant growth rate of 6.0%. What is the estimated floor price of the convertible at the end of Year 4? Do not round your intermediate calculations. a. $1,514.59 b. $1,935.31 c. $2,103.60 d. $1,682.88 e. $1,767.03 ANSWER: d RATIONALE: Bond par value $1,000 Conversion ratio (shares), CR 31 Bond maturity 10 $43.00 Stock price, P0 Evaluation year, t 4 Dividend per share $2.80 N 6 Growth rate 6.0% Straight-debt yield, I/YR 10.1% Convertible coupon 7.1% PMT $71
POINTS: DIFFICULTY:
Find the straight-debt value: N = 6, I/YR = 10.1%, PMT = −71, and FV = −1,000. PV = $869.72 t Conversion value = P0 × CR × (1 + g) 4 Conversion value = $43 × 31 × (1.060) Conversion value = $1,682.88 The floor value is the higher of the bond value or the conversion value, so it is $1,682.88. 1 CHALLENGING
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REFERENCES: 20-4 Convertibles QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.20.04 - Convertibles NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.08 - Investments TOPICS: Convertibles: floor value KEYWORDS: Bloom’s: Analyze OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:03 PM DATE MODIFIED: 12/17/2017 12:53 AM 56. Quaid Co.'s common stock sells for $34.00, pays a dividend of $2.30, and has an expected long-term growth rate of 5.8%. The firm's straight-debt bonds yield an 11.20% return. Quaid is planning a convertible bond issue. The bonds will have a 20-year maturity, pay a 10.20% annual coupon, have a par value of $1,000, and a conversion ratio of 25 shares per bond. The bonds will sell for $1,000 and will be callable after 10 years. Assuming that the bonds will be converted at Year 10, when they become callable, what will be the expected return on the convertible when it is issued? Do not round your intermediate calculations. a. 12.25% b. 15.47% c. 12.89% d. 14.18% e. 13.53% ANSWER: c RATIONALE: Yield on similar straight 11.20% Stock price $34.00 debt Maturity 20 Expected dividend $2.30 Coupon rate 10.20% Expected growth rate 5.80% Par value $1,000 Conversion ratio 25 PMT $102 Convertible after year 10 Find the straight-debt value in Year 10: N = 20 − 10 = 10, I/YR = 11.2%, PMT = −102, and FV = −1,000. PV = $941.60 t Conversion value = P0 × CR × (1 + g) 10 Conversion value = $34 × 25 × (1.058) Conversion value = $1,493.74 The floor value is the higher of the bond value or the conversion value, so it is $1,493.74.
POINTS:
CF0 CF1 CF2 CF3 CF4 CF5
−$1,000 $102.00 $102.00 $102.00 $102.00 $102.00
IRR 1
12.89%
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CF6 CF7 CF8 CF9 CF10
$102.00 $102.00 $102.00 $102.00 $1,595.74
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DIFFICULTY: CHALLENGING REFERENCES: 20-4 Convertibles QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.20.04 - Convertibles NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.08 - Investments TOPICS: Convertibles: return KEYWORDS: Bloom’s: Analyze OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:03 PM DATE MODIFIED: 12/17/2017 1:05 AM Multiple Part: The next 4 problems must be kept together; all use the data in Exhibit 20.1. Exhibit 20.1 The following data apply to Saunders Corporation's convertible bonds: Maturity 13 Stock price Par value $1,000 Conversion price Annual coupon 5.20% Straight-debt yield 57. Refer to Exhibit 20.1. What is the bond's conversion ratio? a. 22.09 b. 23.26 c. 19.77 d. 17.44 e. 24.42 ANSWER: b RATIONALE: Years to maturity 13 Par value $1,000 Annual coupon 5.20%
$34.00 $43.00 9.80%
Stock price Conversion price Straight-debt yield
$34.00 $43.00 9.80%
Conversion ratio = Par value/Conversion price = 23.26 POINTS: 1 DIFFICULTY: EASY REFERENCES: 20-4 Convertibles QUESTION TYPE: Multiple Choice HAS VARIABLES: True PREFACE NAME: Exhibit 20.1 LEARNING OBJECTIVES: FOFM.BRIG.17.20.04 - Convertibles NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.08 - Investments TOPICS: Conversion ratio KEYWORDS: Bloom’s: Analyze Copyright Cengage Learning. Powered by Cognero.
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OTHER: NOTES: DATE CREATED: DATE MODIFIED:
Multiple Choice: Problem The problems referring to Exhibit 20.1 must be kept together. 9/21/2017 6:03 PM 11/8/2017 1:16 PM
58. Refer to Exhibit 20.1. What is the bond's initial conversion value when issued? a. $672.09 b. $830.23 c. $593.02 d. $909.30 e. $790.70 ANSWER: e RATIONALE: Conversion value = Conversion ratio × Market price of stock = $790.70 POINTS: 1 DIFFICULTY: EASY REFERENCES: 20-4 Convertibles QUESTION TYPE: Multiple Choice HAS VARIABLES: True PREFACE NAME: Exhibit 20.1 LEARNING OBJECTIVES: FOFM.BRIG.17.20.04 - Convertibles NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.08 - Investments TOPICS: Conversion value KEYWORDS: Bloom’s: Analyze OTHER: Multiple Choice: Problem NOTES: The problems referring to Exhibit 20.1 must be kept together. DATE CREATED: 9/21/2017 6:03 PM DATE MODIFIED: 11/8/2017 1:16 PM 59. Refer to Exhibit 20.1. What is the bond's straight-debt value at the time of issue? a. $703.32 b. $535.87 c. $502.37 d. $669.83 e. $803.80 ANSWER: d RATIONALE: Inputs: N = 13; I/YR = 9.80%; PMT = Coupon rate × Par value = 52; FV = 1,000. PV = $669.83 POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 20-4 Convertibles QUESTION TYPE: Multiple Choice HAS VARIABLES: True PREFACE NAME: Exhibit 20.1 LEARNING OBJECTIVES: FOFM.BRIG.17.20.04 - Convertibles Copyright Cengage Learning. Powered by Cognero.
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NATIONAL STANDARDS: STATE STANDARDS: TOPICS: KEYWORDS: OTHER: NOTES: DATE CREATED: DATE MODIFIED:
United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic United States - OH - DISC.FOFM.BRIG.17.08 - Investments Convertibles: straight-debt value Bloom’s: Analyze Multiple Choice: Problem The problems referring to Exhibit 20.1 must be kept together. 9/21/2017 6:03 PM 11/8/2017 1:16 PM
60. Refer to Exhibit 20.1. What is the minimum price (or "floor" price) at which the Saunders' bonds should sell? a. $669.83 b. $632.56 c. $830.23 d. $869.77 e. $790.70 ANSWER: e RATIONALE: The floor price is the higher of the bond's conversion value or straight-debt value. Those values are as follows:
Conversion value Straight-debt value
$790.70 $669.83
Maximum of the two = minimum price = floor value = $790.70
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 20-4 Convertibles QUESTION TYPE: Multiple Choice HAS VARIABLES: True PREFACE NAME: Exhibit 20.1 LEARNING OBJECTIVES: FOFM.BRIG.17.20.04 - Convertibles NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.08 - Investments TOPICS: Convertibles: floor price KEYWORDS: Bloom’s: Analyze OTHER: Multiple Choice: Problem NOTES: The problems referring to Exhibit 20.1 must be kept together. DATE CREATED: 9/21/2017 6:03 PM DATE MODIFIED: 11/8/2017 1:16 PM
1. In a merger with true synergies, the post-merger value exceeds the sum of the separate companies' pre-merger values. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 21-1 Rationale for Mergers QUESTION TYPE: True / False Copyright Cengage Learning. Powered by Cognero.
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HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.21.01 - Rationale for Mergers NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.15 - Mergers and acquisitions TOPICS: Synergistic merger KEYWORDS: Bloom’s: Knowledge DATE CREATED: 9/21/2017 6:03 PM DATE MODIFIED: 9/21/2017 6:03 PM 2. Synergistic benefits can arise from a number of different sources, including operating economies of scale, financial economies, and increased managerial efficiency. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 21-1 Rationale for Mergers QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.21.01 - Rationale for Mergers NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.15 - Mergers and acquisitions TOPICS: Sources of synergy KEYWORDS: Bloom’s: Comprehension DATE CREATED: 9/21/2017 6:03 PM DATE MODIFIED: 9/21/2017 6:03 PM 3. Most defensive mergers occur as a result of managers' actions to maximize shareholders' wealth. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 21-1 Rationale for Mergers QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.21.01 - Rationale for Mergers NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.15 - Mergers and acquisitions TOPICS: Defensive mergers KEYWORDS: Bloom’s: Knowledge DATE CREATED: 9/21/2017 6:03 PM DATE MODIFIED: 9/21/2017 6:03 PM 4. A conglomerate merger occurs when two firms with either a horizontal or a vertical business relationship combine. a. True Copyright Cengage Learning. Powered by Cognero.
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b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 21-2 Types of Mergers QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.21.02 - Types of Mergers NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.15 - Mergers and acquisitions TOPICS: Conglomerate merger KEYWORDS: Bloom’s: Knowledge DATE CREATED: 9/21/2017 6:03 PM DATE MODIFIED: 9/21/2017 6:03 PM 5. Merger activity is likely to heat up when interest rates are high because target firms can expect to receive an especially high premium over the pre-announcement stock price. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 21-3 Level of Merger Activity QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.21.03 - Level of Merger Activity NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.15 - Mergers and acquisitions TOPICS: Mergers and interest rates KEYWORDS: Bloom’s: Comprehension DATE CREATED: 9/21/2017 6:03 PM DATE MODIFIED: 9/21/2017 6:03 PM 6. A company seeking to fight off a hostile takeover might employ the services of an investment banking firm to develop a defensive strategy. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 21-4 Hostile Versus Friendly Takeovers QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.21.04 - Hostile Versus Friendly Takeovers NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking Copyright Cengage Learning. Powered by Cognero.
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STATE STANDARDS: TOPICS: KEYWORDS: DATE CREATED: DATE MODIFIED:
United States - OH - DISC.FOFM.BRIG.16.15 - Mergers and acquisitions Defensive tactics Bloom’s: Knowledge 9/21/2017 6:03 PM 9/21/2017 6:03 PM
7. Post-merger control and the negotiated price paid by the acquirer are two of the most important issues in the terms to merger agreements. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 21-5 Merger Analysis QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.21.05 - Merger Analysis NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.15 - Mergers and acquisitions TOPICS: Merger terms KEYWORDS: Bloom’s: Comprehension DATE CREATED: 9/21/2017 6:03 PM DATE MODIFIED: 9/21/2017 6:03 PM 8. Since the primary rationale for any operating merger is synergy, in planning such mergers the development of accurate pro forma cash flows is the single most important task. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 21-5 Merger Analysis QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.21.05 - Merger Analysis NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.15 - Mergers and acquisitions TOPICS: Merger analysis KEYWORDS: Bloom’s: Knowledge DATE CREATED: 9/21/2017 6:03 PM DATE MODIFIED: 9/21/2017 6:03 PM 9. Borrowing funds on terms that would require immediate repayment of all loans if the firm is acquired, selling off at bargain prices the assets that originally made the firm a desirable target, and granting huge "golden parachutes" that open if the firm is acquired are 3 procedures used to defend against hostile takeovers. These strategies are known as "poison pills." Copyright Cengage Learning. Powered by Cognero.
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a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 21-6 The Role of Investment Bankers QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.21.06 - The Role of Investment Bankers NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.15 - Mergers and acquisitions TOPICS: Poison pills KEYWORDS: Bloom’s: Knowledge DATE CREATED: 9/21/2017 6:03 PM DATE MODIFIED: 9/21/2017 6:03 PM 10. A joint venture is one in which two, or sometimes more, independent companies agree to combine resources in order to achieve a specific objective, usually limited in scope. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 21-8 Corporate Alliances QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.21.08 - Corporate Alliances NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.15 - Mergers and acquisitions TOPICS: Joint ventures KEYWORDS: Bloom’s: Knowledge DATE CREATED: 9/21/2017 6:03 PM DATE MODIFIED: 9/21/2017 6:03 PM 11. Leveraged buyouts (LBOs) occur when a firm's managers, generally backed by private equity groups, try to gain control of a publicly owned company by buying shares in the company using large amounts of borrowed money. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 21-9 Private Equity Investments QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.21.09 - Private Equity Investments Copyright Cengage Learning. Powered by Cognero.
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NATIONAL STANDARDS: STATE STANDARDS: TOPICS: KEYWORDS: DATE CREATED: DATE MODIFIED:
United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking United States - OH - DISC.FOFM.BRIG.16.15 - Mergers and acquisitions Leveraged buyouts Bloom’s: Knowledge 9/21/2017 6:03 PM 9/21/2017 6:03 PM
12. A spin-off is a type of divestiture in which the assets of a division are sold to another firm. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 21-10 Divestitures QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.21.10 - Divestitures NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.15 - Mergers and acquisitions TOPICS: Spin-off KEYWORDS: Bloom’s: Knowledge DATE CREATED: 9/21/2017 6:03 PM DATE MODIFIED: 9/21/2017 6:03 PM 13. The purchase of assets at below their replacement cost and tax considerations are two factors that motivate mergers. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 21-1 Rationale for Mergers QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.21.01 - Rationale for Mergers NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.15 - Mergers and acquisitions TOPICS: Merger motivation KEYWORDS: Bloom’s: Knowledge DATE CREATED: 9/21/2017 6:03 PM DATE MODIFIED: 9/21/2017 6:03 PM 14. The primary reason given by managers for most mergers is the acquisition of more assets so as to increase sales and market share. a. True b. False ANSWER: False Copyright Cengage Learning. Powered by Cognero.
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POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 21-1 Rationale for Mergers QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.21.01 - Rationale for Mergers NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.15 - Mergers and acquisitions TOPICS: Merger motivation KEYWORDS: Bloom’s: Comprehension DATE CREATED: 9/21/2017 6:03 PM DATE MODIFIED: 9/21/2017 6:03 PM 15. Since managers' central goal is to maximize stock price, managers' personal incentives do not interfere with mergers that would benefit the target firm's stockholders. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 21-1 Rationale for Mergers QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.21.01 - Rationale for Mergers NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.15 - Mergers and acquisitions TOPICS: Managerial incentives KEYWORDS: Bloom’s: Comprehension DATE CREATED: 9/21/2017 6:03 PM DATE MODIFIED: 9/21/2017 6:03 PM 16. If a petrochemical firm that used oil as feedstock merged with an oil producer that had large oil reserves and a drilling subsidiary, this would be a vertical merger. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 21-2 Types of Mergers QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.21.02 - Types of Mergers NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.15 - Mergers and acquisitions TOPICS: Vertical merger Copyright Cengage Learning. Powered by Cognero.
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KEYWORDS: DATE CREATED: DATE MODIFIED:
Bloom’s: Comprehension 9/21/2017 6:03 PM 9/21/2017 6:03 PM
17. A congeneric merger is one where the merging firms operate in related businesses but do not necessarily produce the same products or have a producer-supplier relationship. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 21-2 Types of Mergers QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.21.02 - Types of Mergers NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.15 - Mergers and acquisitions TOPICS: Congeneric merger KEYWORDS: Bloom’s: Knowledge DATE CREATED: 9/21/2017 6:03 PM DATE MODIFIED: 9/21/2017 6:03 PM 18. One of the main reasons why foreign firms are interested in buying U.S. companies is to gain entrance to the U.S. market. A decline in the value of the dollar relative to most foreign currencies makes this competitive strategy especially attractive. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 21-3 Level of Merger Activity QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.21.03 - Level of Merger Activity NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.15 - Mergers and acquisitions TOPICS: Cross-border mergers KEYWORDS: Bloom’s: Comprehension DATE CREATED: 9/21/2017 6:03 PM DATE MODIFIED: 9/21/2017 6:03 PM 19. Since a manager's central goal is to maximize the firm's stock price, any merger offer that provides stockholders with significant gains over the current stock price will be approved by the current management team. a. True b. False ANSWER: False Copyright Cengage Learning. Powered by Cognero.
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POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 21-4 Hostile Versus Friendly Takeovers QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.21.04 - Hostile Versus Friendly Takeovers NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.15 - Mergers and acquisitions TOPICS: Managerial opposition KEYWORDS: Bloom’s: Comprehension DATE CREATED: 9/21/2017 6:03 PM DATE MODIFIED: 9/21/2017 6:03 PM 20. Only if a target firm's value is greater to the acquiring firm than its market value as a separate entity will a merger be financially justified. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 21-5 Merger Analysis QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.21.05 - Merger Analysis NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.15 - Mergers and acquisitions TOPICS: Merger analysis KEYWORDS: Bloom’s: Comprehension DATE CREATED: 9/21/2017 6:03 PM DATE MODIFIED: 9/21/2017 6:03 PM 21. Discounted cash flow methods are not appropriate for evaluating mergers because the cash flows are uncertain and the discount rate can only be determined after the merger is consummated. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 21-5 Merger Analysis QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.21.05 - Merger Analysis NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.15 - Mergers and acquisitions TOPICS: Merger cash flows Copyright Cengage Learning. Powered by Cognero.
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KEYWORDS: DATE CREATED: DATE MODIFIED:
Bloom’s: Comprehension 9/21/2017 6:03 PM 9/21/2017 6:03 PM
22. In a financial merger, the relevant post-merger cash flows are simply the sum of the expected cash flows of the two companies, measured as if they were operated independently. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 21-5 Merger Analysis QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.21.05 - Merger Analysis NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.15 - Mergers and acquisitions TOPICS: Merger cash flows KEYWORDS: Bloom’s: Knowledge DATE CREATED: 9/21/2017 6:03 PM DATE MODIFIED: 9/21/2017 6:03 PM 23. The rate used to discount projected merger cash flows should be the overall cost of capital of the new consolidated firm because it incorporates the actual capital structure of the new firm. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 21-5 Merger Analysis QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.21.05 - Merger Analysis NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.15 - Mergers and acquisitions TOPICS: Merger analysis KEYWORDS: Bloom’s: Knowledge DATE CREATED: 9/21/2017 6:03 PM DATE MODIFIED: 9/21/2017 6:03 PM 24. The distribution of synergistic gains between the stockholders of two merged firms is almost always based strictly on their respective market values before the announcement of the merger. a. True b. False ANSWER: False POINTS: 1 Copyright Cengage Learning. Powered by Cognero.
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DIFFICULTY: MODERATE REFERENCES: 21-7 Do Mergers Create Value? The Empirical Evidence QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.21.07 - Do Mergers Create Value? The Empirical Evidence NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.15 - Mergers and acquisitions TOPICS: Synergistic gain KEYWORDS: Bloom’s: Comprehension DATE CREATED: 9/21/2017 6:03 PM DATE MODIFIED: 9/21/2017 6:03 PM 25. The value of the target firm is calculated by discounting residual cash flows that belong to the acquiring firm's shareholders at the target's cost of equity reflecting any changes to its capital structure as a result of the merger. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 21-5 Merger Analysis QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.21.05 - Merger Analysis NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.15 - Mergers and acquisitions TOPICS: Merger analysis KEYWORDS: Bloom’s: Comprehension DATE CREATED: 9/21/2017 6:03 PM DATE MODIFIED: 9/21/2017 6:03 PM 26. The text gives a number of valid, acceptable reasons for companies to merge. Which of the following is NOT acceptable? a. Synergistic benefits arising from mergers. b. Reduction in competition resulting from mergers. c. Acquisition of assets at below replacement value. d. Attempts to minimize taxes by acquiring a firm with large accumulated losses that can be used immediately. e. Using surplus cash to acquire another firm and prevent unfavorable tax consequences for shareholders. ANSWER: b POINTS: 1 DIFFICULTY: EASY REFERENCES: 21-1 Rationale for Mergers QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.21.01 - Rationale for Mergers NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills Copyright Cengage Learning. Powered by Cognero.
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STATE STANDARDS: TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
United States - OH - DISC.FOFM.BRIG.16.15 - Mergers and acquisitions Mergers Bloom’s: Comprehension Multiple Choice: Conceptual 9/21/2017 6:03 PM 9/21/2017 6:03 PM
27. Firms use defensive tactics to fight off undesired mergers. These tactics do NOT include a. raising antitrust issues. b. developing poison pills. c. getting white knights to bid for the firm. d. repurchasing their own stock. e. engaging in risk arbitrage. ANSWER: e POINTS: 1 DIFFICULTY: EASY REFERENCES: 21-6 The Role of Investment Bankers QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.21.06 - The Role of Investment Bankers NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.15 - Mergers and acquisitions TOPICS: Defensive tactics KEYWORDS: Bloom’s: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:03 PM DATE MODIFIED: 9/21/2017 6:03 PM 28. Which of the following actions does NOT help managers defend against a hostile takeover? a. Establishing a poison pill provision. b. Granting lucrative golden parachutes to senior managers. c. Establishing a super-majority provision in the company's bylaws to raise the percentage of the board of directors that must approve an acquisition from 50% to 75%. d. Retiring long-term debt early to reduce total debt on the balance sheet which will increase the firm's financial position. e. Finding a "white squire" that will buy enough of the target firm's shares to block the hostile takeover. ANSWER: d POINTS: 1 DIFFICULTY: EASY REFERENCES: 21-6 The Role of Investment Bankers QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.21.06 - The Role of Investment Bankers NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.15 - Mergers and acquisitions Copyright Cengage Learning. Powered by Cognero.
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TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
Defensive strategies Bloom’s: Comprehension Multiple Choice: Conceptual 9/21/2017 6:03 PM 9/21/2017 6:03 PM
29. Which of the following statements is most CORRECT? a. A conglomerate merger is one where a firm combines with another firm in the same industry. b. Regulations in the United States prohibit acquiring firms from using common stock to purchase another firm. c. Defensive mergers are designed to make a company less vulnerable to a takeover. d. The equity residual method values a target firm by discounting residual cash flows at the acquiring firm's overall cost of capital reflecting the combined firm's post-merger capital structure. e. A financial merger occurs when the operations of the firms involved are integrated in the hope of achieving synergistic benefits. ANSWER: c POINTS: 1 DIFFICULTY: EASY REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.21.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.15 - Mergers and acquisitions TOPICS: Merger concepts KEYWORDS: Bloom’s: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:03 PM DATE MODIFIED: 9/21/2017 6:03 PM 30. Which of the following statements is most CORRECT? a. Tax considerations often play a part in mergers. If one firm has excess cash, purchasing another firm exposes the purchasing firm to additional taxes. Thus, firms with excess cash rarely undertake mergers. b. The smaller the synergistic benefits of a particular merger, the greater the scope for striking a bargain in negotiations, and the higher the probability that the merger will be completed. c. Since mergers are frequently financed by debt rather than equity, a lower cost of debt or a greater debt capacity are rarely relevant considerations when considering a merger. d. Managers who purchase other firms often assert that the new combined firm will enjoy benefits from diversification, including more stable earnings. However, since shareholders are free to diversify their own holdings, and at what's probably a lower cost, research of U.S. firms suggests that in most cases, diversification through mergers does not increase the firm's value. e. Research of U.S. firms suggests that managers' personal motivations have had little, if any, impact on firms' decisions to merge. ANSWER: d POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 21-1 Rationale for Mergers QUESTION TYPE: Multiple Choice Copyright Cengage Learning. Powered by Cognero.
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HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.21.01 - Rationale for Mergers NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.15 - Mergers and acquisitions TOPICS: Merger motivation KEYWORDS: Bloom’s: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:03 PM DATE MODIFIED: 9/21/2017 6:03 PM 31. Which of the following statements is most CORRECT? a. The high value of the U.S. dollar relative to Japanese and European currencies in the 1980s, made U.S. companies comparatively inexpensive to foreign buyers, spurring many mergers. b. During the 1980s, the Reagan and Bush administrations tried to foster greater competition and they were adamant about preventing the loss of competition; thus, most large mergers were disallowed. c. The expansion of the junk bond market made debt more freely available for large acquisitions and LBOs in the 1980s, and thus, it resulted in an increased level of merger activity. d. Increased nationalization of business and a desire to scale down and focus on producing in one's home country has virtually halted cross-border mergers today. e. Because strategic alliances and joint ventures are easy to form and enable firms to compete better in the global economy than would mergers, merger activity has virtually come to a halt in the 21st century. ANSWER: c POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 21-3 Level of Merger Activity QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.21.03 - Level of Merger Activity NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.15 - Mergers and acquisitions TOPICS: Level of merger activity KEYWORDS: Bloom’s: Application OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:03 PM DATE MODIFIED: 9/21/2017 6:03 PM 32. Which of the following statements is most CORRECT? a. The acquiring firm's required rate of return in most horizontal mergers will not be affected, because the two firms will have similar betas. b. The goal of merger valuation is to value the target firm's total capital at the target firm's weighted average cost of capital because a firm is acquired from all of its investors--both shareholders and creditors. c. The basic rationale for any financial merger is synergy and, thus, the estimation of pro forma cash flows is the single most important part of the analysis. d. In most mergers, the benefits of synergy and the premium the acquirer pays over the market price are summed and then divided equally between the shareholders of the acquiring and target firms. e. The primary rationale for most operating mergers is synergy. ANSWER: e Copyright Cengage Learning. Powered by Cognero.
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POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 21-5 Merger Analysis QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.21.05 - Merger Analysis NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.15 - Mergers and acquisitions TOPICS: Merger analysis KEYWORDS: Bloom’s: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:03 PM DATE MODIFIED: 9/21/2017 6:03 PM 33. Which of the following statements is most CORRECT? a. Leveraged buyouts (LBOs) occur when a firm issues equity and uses the proceeds to take a firm public. b. In a typical LBO, bondholders do well but shareholders see their value decline. c. Firms are forbidden by law to sell any assets during the first five years following a leverage buyout. d. Not all target firms are acquired by publicly traded corporations. In recent years, an increasing number of firms have been acquired by private equity firms. Private equity firms raise capital from wealthy individuals and look for opportunities to make profitable investments. e. In an LBO sometimes the acquiring group plans to run the acquired company for a number of years, boost its sales and profits, and then take it public again as a stronger company. In other instances, the LBO firm plans to sell off divisions to other firms that can gain synergies. In either case, the acquiring group expects to make a substantial profit from the LBO, but the inherent risks are small due to the heavy use of venture capital and very little debt. ANSWER: d POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 21-9 Private Equity Investments QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.21.09 - Private Equity Investments NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.15 - Mergers and acquisitions TOPICS: LBOs KEYWORDS: Bloom’s: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:03 PM DATE MODIFIED: 9/21/2017 6:03 PM 34. Which of the following statements is most CORRECT? a. If a company that produces military equipment merges with a company that manages a chain of motels, this is an example of a horizontal merger. b. A defensive merger is one where the firm's managers decide to merge with another firm to avoid or lessen the possibility of being acquired through a hostile takeover. c. Acquiring firms send a signal that their stock is undervalued if they choose to use stock to pay for the Copyright Cengage Learning. Powered by Cognero.
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acquisition. d. In a liquidation, the firm's existing stockholders are given new stock representing separate ownership rights in the division that was divested. The division establishes its own board of directors and officers, and it becomes a separate company. e. If there are no synergistic benefits to be gained from a merger, the acquiring company will stop its plans for the merger. However, if synergistic gains are large, plans for the merger will continue. In fact, the greater the synergistic gains, the smaller the gap between the target's current price and the maximum the acquiring company could pay because of the acquiring company's upper hand in the merger. ANSWER: b POINTS: 1 DIFFICULTY: MODERATE REFERENCES: Comprehensive QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.21.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.15 - Mergers and acquisitions TOPICS: Merger concepts KEYWORDS: Bloom’s: Application OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:03 PM DATE MODIFIED: 9/21/2017 6:03 PM 35. Simpson Inc. is considering a vertical merger with The Lachey Company. Simpson currently has a required return of 9%, while Lachey's required return is 14%. The market risk premium is 5.10% and the risk-free rate is 5%. Assume the market is in equilibrium. If Simpson is going to make up 67% of the new firm (and Lachey will comprise the remaining 33%), what will be the beta of the new merged firm? There will be no additional infusion of debt in the merger. Do not round your intermediate calculations. a. 1.05 b. 1.38 c. 1.11 d. 0.83 e. 1.16 ANSWER: c RATIONALE: Simpson:
Required return Weight Lachey: Required return Weight rRF RPM
14% 0.33 5.00% 5.10%
Simpson's beta Lachey's beta
0.78 1.76
Merged firm's beta Copyright Cengage Learning. Powered by Cognero.
9% 0.67
1.11 Page 1102
Calculate the Simpson's beta: (Rs / BS = rRF) (9% 5.00%) / BS = 0.78 BS =
RPM 5.10%
Calculate the Lachey's beta: BL = BL = BL =
(Rl (14% 1.76
-
/ rRF) 5.00%) /
RPM 5.10%
Calculate the merged firm's beta; Bm = BS*0.67 + BL*0.33 Bm = 0.53 + 0.58 Bm = 1.11
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 21-5 Merger Analysis QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.16.21.05 - Merger Analysis NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.15 - Mergers and acquisitions TOPICS: Merged firm beta KEYWORDS: Bloom’s: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:03 PM DATE MODIFIED: 9/21/2017 6:03 PM 36. Gekko Properties is considering purchasing Teldar Properties. Gekko's analysts project that the merger will result in incremental after-tax cash flows of $2 million, $4 million, $5 million, and $10 million over the next four years. The horizon value of the firm's operations, as of Year 4, is expected to be $108 million. Assume all cash flows occur at the end of the year. The acquisition would be made immediately, if it is undertaken. Teldar's post-merger beta is estimated to be 2.0, and its post-merger tax rate would be 35.00%. The risk-free rate is 6.00%, and the market risk premium is 5.70%. What is the value of Teldar to Gekko Properties? Do not round intermediate calculations. a. $78,888,332 b. $69,812,683 c. $76,793,952 d. $82,378,966 e. $56,548,273 ANSWER: b RATIONALE: $2,000,000 CF 1
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$4,000,000 $5,000,000 $10,000,000 $108,000,000 2.0 35.00% 6.00% 5.70%
CF2 CF3 CF4 Horizon value (Year 4) Post-merger beta Tax rate Risk-free rate Market risk premium
17.40% Teldar's post-merger rs Years: 0 1 2 3 4 CFs 2,000,000 4,000,000 5,000,000 10,000,000 Horizon 108,000,000 value Total 0 2,000,000 4,000,000 5,000,000 118,000,000 CFs Teldar's value to Gekko $69,812,683 Calculate the Teldar's post-merger rs: rs= rs= rs=
rRF 6.00% 17.40%
+ +
Calculate the total CF4; + CF4= CF4 10,000,000 + CF4 = 118,000,000 CF4 =
RPM 5.70%
b 2.0
Hv 108,000,000
Calculate the Teldar's value to Gekko: Value = CF1/(1+rs/100) + CF2/(1+rs/100)^2 + CF3/(1+rs/100)^3 + CF4/(1+rs/100)^4 Value = 2,000,000/(1+0.17) + 4,000,000/(1+0.17)^2 + 5,000,000/(1+0.17)^3 + 118,000,000/(1+0.17)^4 Value = $69,812,683
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 21-5 Merger Analysis QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.16.21.05 - Merger Analysis NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills Copyright Cengage Learning. Powered by Cognero.
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STATE STANDARDS: TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
United States - OH - DISC.FOFM.BRIG.16.15 - Mergers and acquisitions Target firm's value Bloom’s: Evaluation Multiple Choice: Problem 9/21/2017 6:03 PM 9/21/2017 6:03 PM
37. At the beginning of the year Ham Inc.'s management is considering making an offer to buy Egg Corporation. Egg's projected operating income (EBIT) for the current year is $25.0 million, but Ham believes that if the two firms were merged, it could consolidate some operations, reduce Egg's expenses, and raise its EBIT to $39.0 million. Neither company uses any debt, and they both pay income taxes at a 40% rate. Ham has a better reputation among investors, who regard it as better managed and also less risky, so Ham's stock has a P/E ratio of 18 versus a P/E of 12 for Egg. Since Ham's management will be running the entire enterprise after a merger, investors will value the resulting corporation based on Ham's P/E. Based on expected market values, how much synergy should the merger create? Do not round your intermediate calculations. a. $301.50 million b. $277.38 million c. $241.2 million d. $205.02 million e. $229.14 million ANSWER: c RATIONALE:
EBIT (millions) Tax rate Net income = EBIT(1−T) (millions) P/E ratio applied to earnings Egg's market value (millions)
Before After Merger Merger $25.0 $ 39.0 40% 40% $ 15.0 $ 23.4 ×12 ×18 $180.0 $421.2
Increase in value = Synergy = $421.2 −$180.0 =$241.2 million
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 21-7 Do Mergers Create Value? The Empirical Evidence QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.16.21.07 - Do Mergers Create Value? The Empirical Evidence NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.15 - Mergers and acquisitions TOPICS: Merger synergy KEYWORDS: Bloom’s: Evaluation OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:03 PM DATE MODIFIED: 9/21/2017 6:03 PM 38. At the beginning of the year Giant Inc.'s management is considering making an offer to buy Micro Corporation. Micro's projected operating income (EBIT) for the current year is $31.0 million, but Giant believes that if the two firms were merged, it could consolidate some operations, reduce Micro's expenses, and raise its EBIT to $37.0 million. Neither company uses any debt, and they both pay income taxes at a 35% rate. Giant has a better reputation among investors, who Copyright Cengage Learning. Powered by Cognero.
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regard it as very well managed and not very risky, so its stock has a P/E ratio of 13 versus a P/E of 9 for Micro. Since Giant's management would be running the entire enterprise after a merger, investors would value the resulting corporation based on Giant's P/E. If Micro has 10 million shares outstanding, by how much should the merger increase its share price, assuming all of the synergy will go to its stockholders? Do not round your intermediate calculations. a. $15.10 b. $11.16 c. $16.41 d. $13.79 e. $13.13 ANSWER: e RATIONALE:
EBIT (millions) Tax rate Net income = EBIT(1−T) (millions) Shares outstanding (millions) Calculated EPS P/E ratio applied to earnings Micro's market value
Before Merger $31.0 35% $20.15 ÷10 $ 2.015 ×9 $18.14
After Merger $37.0 35% $24.05 ÷10 $2.405 ×13 $31.27
Increase in value = Synergy = $31.27 − $18.14 = $13.13
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 21-7 Do Mergers Create Value? The Empirical Evidence QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.16.21.07 - Do Mergers Create Value? The Empirical Evidence NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.15 - Mergers and acquisitions TOPICS: Merger synergy KEYWORDS: Bloom’s: Evaluation OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:03 PM DATE MODIFIED: 9/21/2017 6:03 PM 39. Anacott Steel is acquiring Terafly Incorporated. Terafly is expected to provide Anacott with operating cash flows of $12, $21, $16, and $9 million over the next four years, respectively. In addition, the horizon value of all remaining cash flows at the end of Year 4 is estimated at $18 million. The merger will cost Anacott $47 million today. If the value of the merger is estimated at $8.00 per share and Anacott has 1,000,000 shares outstanding, what equity discount rate must the firm be using to value this acquisition? a. 11.88% b. 10.22% c. 14.31% d. 12.77% e. 12.65% ANSWER: d RATIONALE: Cash Flows to Calculate Copyright Cengage Learning. Powered by Cognero.
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CF1 CF2 CF3 CF4 Horizon value (Year 4)
−$47,000,000 $12,000,000 $21,000,000 $16,000,000 $9,000,000 $18,000,000
Shares outstanding Value of merger per share Total value of merger
1,000,000 $8.00 $8,000,000
Cost of acquisition
IRR CF0−$55,000,000 CF1 $12,000,000 CF2 $21,000,000 CF3 $16,000,000 CF4 $27,000,000 Discount rate (IRR) =
12.77%
Calculate the total value of merger; V1 = Sh * V0 V1= 1,000,000 * $8.00 V1= $8,000,000 Calculate the CF0; CF0 = Cost of acquisition CF0= $47,000,000 CF0=
+ V1 + $8,000,000
$55,000,000
IRR=12.77%
POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 21-5 Merger Analysis QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.16.21.05 - Merger Analysis NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.15 - Mergers and acquisitions TOPICS: Merger discount rate KEYWORDS: Bloom’s: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:03 PM DATE MODIFIED: 9/21/2017 6:03 PM
1. If you receive $15,000 today and can invest it at a 4.25% annual rate compounded continuously, what will be your ending value after 20 years? a. $41,060.80 b. $43,517.43 c. $35,094.70 d. $28,426.71 Copyright Cengage Learning. Powered by Cognero.
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e. $36,849.44 ANSWER: RATIONALE:
c
N PV = I I×N FV = FV =
20 $15,000 4.25% 0.8500 I×N PV(e ) $35,094.70
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 5A Continuous Compounding and Discounting QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.05.05A - Continuous Compounding and Discounting NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: FV, continuous compounding KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:53 PM DATE MODIFIED: 9/21/2017 5:53 PM 2. In six years' time, you are scheduled to receive money from a trust established by your grandparents. When the trust matures there will be $100,000 in the account. If the account earns 5.75% compounded continuously, how much is in the account today? a. $82,153.56 b. $69,405.59 c. $61,615.17 d. $70,822.04 e. $59,490.51 ANSWER: d RATIONALE:
N FV I I×N PV = PV =
POINTS: DIFFICULTY: REFERENCES: QUESTION TYPE: HAS VARIABLES:
6 $100,000 5.75% 0.3450 I×N FV/(e ) $70,822.04
1 MODERATE 5A Continuous Compounding and Discounting Multiple Choice True
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LEARNING OBJECTIVES: FOFM.BRIG.17.05.05A - Continuous Compounding and Discounting NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: PV, continuous discounting KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:53 PM DATE MODIFIED: 9/21/2017 5:53 PM 3. Assume one bank offers you a nominal annual interest rate of 6.00% compounded daily while another bank offers you continuous compounding at a 5.90% nominal annual rate. You decide to deposit $1,050 with each bank. Exactly two years later you withdraw your funds from both banks. What is the difference in your withdrawal amounts between the two banks? Assume 365 days in a year. Do not round your intermediate calculations. a. $1.77 b. $2.24 c. $2.35 d. $2.71 e. $2.94 ANSWER: c RATIONALE: N 2
PV
$1,050 6.00% 365 5.90% 0.1180
INOM
M IContinuous ICont×N Daily compounding:
FV = FVDaily=
M×N
PV×(1 + INOM/M) $1,183.860
Continuous compounding: I
FV =
×N
PV×(e Cont ) FVContinuous= $1,181.506 Difference = $2.35
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 5A Continuous Compounding and Discounting QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.05.05A - Continuous Compounding and Discounting NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic Copyright Cengage Learning. Powered by Cognero.
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STATE STANDARDS: LOCAL STANDARDS: TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money United States - OH - Default City - Tier 2: - Capital structure FV, continuous compounding Bloom's: Evaluation Multiple Choice: Problem 9/21/2017 5:53 PM 9/21/2017 5:53 PM
4. You have $5,436.60 in an account that pays 9.40% interest, compounded continuously. If you deposited some funds 12 years ago, how much was your original deposit? Round your answer to the nearest dollar. a. $1,637 b. $1,760 c. $1,566 d. $2,006 e. $1,461 ANSWER: b RATIONALE:
N FV I I×N PV = PV =
12 $5,436.60 9.40% 1.1280 I×N FV/(e ) $1,759.72
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 5A Continuous Compounding and Discounting QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.05.05A - Continuous Compounding and Discounting NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: PV, continuous discounting KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:53 PM DATE MODIFIED: 9/21/2017 5:53 PM 5. How much should you be willing to pay for an account today that will have a value of $1,000 in 24 years under continuous compounding if the nominal rate is 8.20%? a. $111.79 b. $139.74 c. $156.50 d. $171.88 e. $167.68 ANSWER: b Copyright Cengage Learning. Powered by Cognero.
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RATIONALE:
N FV I I×N PV = PV =
24 $1,000 8.20% 1.9680 I×N FV/(e ) $139.74
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 5A Continuous Compounding and Discounting QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.05.05A - Continuous Compounding and Discounting NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: PV, continuous discounting KEYWORDS: Bloom's: Evaluation OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:53 PM DATE MODIFIED: 9/21/2017 5:53 PM 6. You need a down payment of $17,200 in order to purchase your first home 4 years from today. You currently have $14,014 to invest. In order to achieve your goal, what nominal interest rate, compounded continuously, must you earn on this investment? Do not round your intermediate calculations. a. 5.48% b. 5.12% c. 3.84% d. 4.46% e. 6.20% ANSWER: b RATIONALE:
N PV FV FV =
4 $14,014 $17,200 I×N PV×(e ) I×N e = 1.22734 4I ln e = ln1.22734 4I = 0.2049 I = 5.12%
POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 5A Continuous Compounding and Discounting QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.05.05A - Continuous Compounding and Discounting NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic Copyright Cengage Learning. Powered by Cognero.
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STATE STANDARDS: LOCAL STANDARDS: TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money United States - OH - Default City - Tier 2: - Capital structure Continuous compounded int. rate Bloom's: Application Multiple Choice: Problem 9/21/2017 5:53 PM 9/21/2017 5:53 PM
7. You place $1,000 in an account that pays 7.00% interest compounded continuously. You plan to hold the account exactly 3 years. Simultaneously, in another account you deposit money that earns 7.40% compounded semiannually. If the accounts are to have the same amount at the end of the 3 years, how much of an initial deposit do you need to make now in the account that pays 7.40% interest compounded semiannually? Do not round your intermediate calculations. a. $1,150.77 b. $882.92 c. $992.04 d. $1,220.21 e. $744.03 ANSWER: c RATIONALE:
N PV INOM M IContinuous ICont×N
3 $1,000 7.40% 2 7.00% 0.2100
Continuous compounding: I×N
FV =
PV×(e ) FVContinuous=$1,233.68 Now, calculate the initial deposit:
N I/YR PMT FV PV
6 3.70% 0 $1,233.68 $992.04
POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 5A Continuous Compounding and Discounting QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.05.05A - Continuous Compounding and Discounting NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Cont. and semiann. comp. Copyright Cengage Learning. Powered by Cognero.
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KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
Bloom's: Application Multiple Choice: Problem 9/21/2017 5:53 PM 9/21/2017 5:53 PM
8. For a 10-year deposit, what annual rate payable semiannually will produce the same effective rate as 5.00% compounded continuously? Do not round your intermediate calculations. a. 4.46% b. 5.06% c. 4.10% d. 4.81% e. 4.91% ANSWER: b RATIONALE: N 10
M IContinuous
2 5.00%
0.5000 ICont × N Continuous compounding: ×N NM = (1+INOM/M) eICont 0.5000 20 = (1+INOM/2) e e 1.02531512
0.0250
= 1+INOM/2 = 1+INOM/2
0.02531512
= INOM/2
INOM
= 5.06%
POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 5A Continuous Compounding and Discounting QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.05.05A - Continuous Compounding and Discounting NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.04 - Time value of money LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Cont. compounding and nom. rate KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:53 PM DATE MODIFIED: 9/21/2017 5:53 PM
1. Which of the following statements is CORRECT? a. If interest rates increase, a 10-year zero coupon bond's price will drop by a greater percentage than will a 10year, 8% coupon bond. Copyright Cengage Learning. Powered by Cognero.
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b. One nice thing about zero coupon bonds is that individual investors do not have to pay any taxes on a zero coupon bond until it matures, even if they are not holding the bonds as part of a tax-deferred account. c. If a bond with a sinking fund provision has a yield to maturity greater than its coupon rate, the issuing company would prefer to comply with the sinking fund by calling the bonds in at par rather than buying the bonds back in the open market. d. Because of the IRS's tax treatment of zero coupon bonds, pension funds and other tax-exempt entities rarely, if ever, invest in zero coupon bonds. e. Interest must be paid on a zero coupon bond's accrued value, but while the first year's interest is taxable at the ordinary income tax rate, subsequent years are taxed at the long-term capital gains rate (since they are received after more than a year). ANSWER: a The 10-year bond has payments that come sooner than the zero coupon bond's payments. Therefore, RATIONALE: some of the 10-year bond's cash flows will be discounted for fewer periods and will lose less of their value. Therefore, the value of the 10-year zero coupon bond will drop by more than the 8% coupon bond. Therefore, statement a is correct. Statement b used to be true, but the IRS caught on that people were trying to avoid taxes by buying zero coupon bonds, and they changed the Tax Code. Therefore, statement b is false. If the YTM is higher than the coupon rate, then the bond is selling at a discount. The company pays less buying it on the open market than purchasing it at par value. So statement c is false. Statement d is false because zero coupon bonds require the holder to pay taxes on accrued capital gains before any gain is realized, it is pension funds and other tax-exempt entities that are the most likely holders. Statement e is false because all interest payments on accrued value are taxed at the ordinary income tax rate.
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 7A Zero Coupon Bonds QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FFMC.BRIG.15.05.07A - Zero coupon bonds NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Zero coupon bond concepts KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:54 PM DATE MODIFIED: 9/21/2017 5:54 PM 2. Consider each of the following bonds: Bond A: 8-year maturity with a 7% annual coupon. Bond B: 10-year maturity with a 9% annual coupon. Bond C: 12-year maturity with a zero coupon. Each bond has a face value of $1,000 and a yield to maturity of 8%. Which of the following statements is NOT correct? a. Bond A sells at a discount, while Bond B sells at a premium. b. If the yield to maturity on each bond falls to 7%, Bond C will have the largest percentage increase in its price. c. Bond C has the most reinvestment risk. d. Bond C has the most price risk. e. If the yield to maturity is constant, the price of Bond A will continue to increase over its life until it finally sells at par. Copyright Cengage Learning. Powered by Cognero.
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ANSWER: RATIONALE:
c Statement a is true, because if the YTM is 8%, Bond A sells at a discount (because its coupon rate < YTM), while Bond B sells at a premium (coupon rate > YTM). Statements b and d are true, because the most sensitive bond to interest rates (the bond with the most price risk) is the one with the longest maturity and smallest coupon. Statement c is false, because the bond with the most reinvestment risk is the bond with the shortest maturity and the largest coupon (either Bond A or Bond B). Statement e is true, because if rates stay the same, discount bond prices increase steadily over time, until maturity when it sells at par. POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 7A Zero Coupon Bonds QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.07.07A - Zero Coupon Bonds NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Coupon and zero coupon bonds OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:54 PM DATE MODIFIED: 9/21/2017 5:54 PM 3. McGwire Company's pension fund projects that most of its employees will take advantage of an early retirement program the company plans to offer in 5 years. Anticipating the need to fund these pensions, the firm bought zero coupon U.S. Treasury Trust Certificates maturing in 5 years. When these instruments were originally issued, they were 12% coupon, 30-year U.S. Treasury bonds. The stripped Treasuries are currently priced to yield 5.00%. Their total maturity value is $6,000,000. What is their total cost (price) to McGwire today? Do not round your intermediate calculations. a. $4,795,180 b. $4,137,018 c. $5,594,377 d. $5,641,388 e. $4,701,157 ANSWER: e RATIONALE: N 5
I/YR PMT FV PV
5.00% $0 $6,000,000 $4,701,157
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 7A Zero Coupon Bonds QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.07.07A - Zero Coupon Bonds NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds Copyright Cengage Learning. Powered by Cognero.
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LOCAL STANDARDS: TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
United States - OH - Default City - Tier 2: - Capital structure Stripped U.S. Treasury bond Bloom's: Application Multiple Choice: Problem 9/21/2017 5:54 PM 9/21/2017 5:54 PM
4. At the beginning of the year, you purchased a 5-year zero coupon bond with a yield to maturity of 6.80% and a face value of $1,000. Your tax rate is 30.00%. What is the total tax that you will have to pay on the bond during the first year? Do not round your intermediate calculations. a. $18.06 b. $12.63 c. $14.68 d. $13.65 e. $13.36 ANSWER: c Calculate what was paid for the bond: RATIONALE:
N I/YR PMT FV PV
5 6.80% $0 $1,000 $719.69
Accrued interest = PV Accrued interest = $719.69 Accrued interest = $48.94 Personal tax rate: Taxes paid = Taxes paid = Taxes paid =
× ×
Interest rate 6.80%
30.00% Accrued interest × $48.94 × $14.68
Tax rate 30.00%
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 7A Zero Coupon Bonds QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.07.07A - Zero Coupon Bonds NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Zero coupon bond KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:54 PM DATE MODIFIED: 9/21/2017 5:54 PM 5. You just purchased a 12-year, $1,000 face value, zero coupon bond with a yield to maturity of 9.00%. If your tax rate is 17.00%, how much in taxes will you have to pay at the end of the first year of holding the bond? Do not round your Copyright Cengage Learning. Powered by Cognero.
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intermediate calculations. a. $5.11 b. $6.15 c. $6.31 d. $4.90 e. $5.44 ANSWER: RATIONALE:
e Calculate what was paid for the bond:
N I/YR PMT FV PV
12 9.00% $0 $1,000 $355.53
Accrued interest = PV Accrued interest = $355.53 Accrued interest = $32.00 Personal tax rate: Taxes paid = Taxes paid = Taxes paid =
× ×
17.00% Accrued interest × $32.00 × $5.44
Interest rate 9.00%
Tax rate 17.00%
POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 7A Zero Coupon Bonds QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.07.07A - Zero Coupon Bonds NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Zero coupon bond KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:54 PM DATE MODIFIED: 9/21/2017 5:54 PM 6. S. Claus & Co. is planning a zero coupon bond issue that has a par value of $1,000 and matures in 2 years. The bonds will be sold today at a price of $930.00. If the firm's marginal tax rate is 40.00%, what is the annual after-tax cost of debt to the company on this issue? Do not round your intermediate calculations. a. 2.75% b. 2.73% c. 2.22% d. 2.28% e. 1.84% ANSWER: c RATIONALE: Tax rate 40.00%
N
2
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PV PMT FV I/YR (rd)
$930.00 $0 $1,000 3.70%
After-tax rd= After-tax rd= After-tax rd=
rd 3.70% 2.22%
(1 – T) 60.00%
× ×
POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 7A Zero Coupon Bonds QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.07.07A - Zero Coupon Bonds NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Zero coupon bond KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:54 PM DATE MODIFIED: 9/21/2017 5:54 PM 7. A 16-year, $1,000 face value, zero coupon bond has a yield to maturity of 8%. What is the amount of tax an investor in the 33% tax bracket will pay the first year of the bond? Do not round your intermediate calculations. a. $8.55 b. $6.16 c. $7.71 d. $7.17 e. $9.09 ANSWER: c Calculate what was paid for the bond: RATIONALE:
N I/YR PMT FV PV
16 8% $0 $1,000 $291.89
Accrued interest = PV Accrued interest = $291.89 Accrued interest = $23.35
× ×
Personal tax rate: 33% Taxes paid = Accrued interest × Taxes paid = $23.35 × Taxes paid = $7.71 Copyright Cengage Learning. Powered by Cognero.
Interest rate 8%
Tax rate 33% Page 1118
POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 7A Zero Coupon Bonds QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.07.07A - Zero Coupon Bonds NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Zero coupon bond KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:54 PM DATE MODIFIED: 9/21/2017 5:54 PM 8. On January 1st Julie bought a 7-year, zero coupon bond with a face value of $1,000 and a yield to maturity of 5.60%. Assume that Julie's tax rate is 25.00%. How much tax will Julie have to pay on the bond the first year she owns it? Do not round your intermediate calculations. a. $9.94 b. $11.38 c. $10.80 d. $9.56 e. $8.13 ANSWER: d Calculate what was paid for the bond: RATIONALE:
N I/YR PMT FV PV
7 5.60% $0 $1,000 $682.89
Accrued interest = PV × Accrued interest = $682.89 × Accrued interest = $38.24
Interest rate 5.60%
Personal tax rate: 25.00% Taxes paid = Accrued interest × Taxes paid = $38.24 × Taxes paid = $9.56
Tax rate 25.00%
POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 7A Zero Coupon Bonds QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.07.07A - Zero Coupon Bonds NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds Copyright Cengage Learning. Powered by Cognero.
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LOCAL STANDARDS: TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
United States - OH - Default City - Tier 2: - Capital structure Zero coupon bond Bloom's: Application Multiple Choice: Problem 9/21/2017 5:54 PM 9/21/2017 5:54 PM
9. U.S. Delay Corporation, a subsidiary of the Postal Service, must decide whether to issue zero coupon bonds or quarterly payment bonds to fund construction of new facilities. The $1,000.00 par value quarterly payment bonds would sell at $795.54, have a 4.50% coupon rate, and mature in 10 years. At what price would the zero coupon bonds with a maturity of 10 years have to sell to earn the same effective annual rate as the quarterly payment bonds? Do not round your intermediate calculations. a. $551.68 b. $561.28 c. $479.72 d. $369.39 e. $527.70 ANSWER: c Quarterly payment bonds, calculate nominal and effective annual rates: RATIONALE:
M Years Coupon N PV PMT FV I/YR rNOM
4 10 4.50% 40 $795.54 $11.25 $1,000.00 1.85% 7.41%
P/YR rNOM EFF%
4 7.41% 7.62%
Calculate price of zero coupon bond issued at EFF% calculated above:
N PMT FV I/YR PV
10 $0.00 $1,000.00 7.62% $479.72
POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 7A Zero Coupon Bonds QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.07.07A - Zero Coupon Bonds NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic Copyright Cengage Learning. Powered by Cognero.
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STATE STANDARDS: LOCAL STANDARDS: TOPICS: KEYWORDS: OTHER: NOTES: DATE CREATED: DATE MODIFIED:
United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds United States - OH - Default City - Tier 2: - Capital structure Zero coupon bond and EAR Bloom's: Application Multiple Choice: Problem Bloom's: Application 9/21/2017 5:54 PM 9/21/2017 5:54 PM
10. Recycler Battery Corporation (RBC) issued zero coupon bonds 5 years ago at a price of $214.50 per bond. RBC's zeros had a 20-year original maturity, with a $1,000.00 par value. The bonds were callable 10 years after the issue date at a price 8% over their accrued value on the call date. If the bonds sell for $235.00 in the market today, what annual rate of return should an investor who buys the bonds today expect to earn on them? a. 9.63% b. 11.76% c. 10.03% d. 9.73% e. 10.14% ANSWER: e RATIONALE: Find interest rate at which bonds were originally issued:
N PV PMT FV I/YR
20 $214.50 $0.00 $1,000.00 8.00%
Find interest rate investors would earn if purchased today:
Yrs passed 5 N 15 PV $235.00 PMT $0.00 FV $1,000.00 I/YR 10.14% POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 7A Zero Coupon Bonds QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.07.07A - Zero Coupon Bonds NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Callable zero coupon bond KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Problem Copyright Cengage Learning. Powered by Cognero.
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DATE CREATED: DATE MODIFIED:
9/21/2017 5:54 PM 9/21/2017 5:54 PM
11. Vogril Company issued 20-year, zero coupon bonds with an expected yield to maturity of 6.60%. The bonds have a par value of $1,000 and were sold for $278.52 each. What is the expected interest expense on these bonds for Year 8? Do not round your intermediate calculations. a. $35.94 b. $22.43 c. $33.64 d. $28.75 e. $32.49 ANSWER: d Calculate value of bond in Year 7: RATIONALE:
N PV PMT I/YR FV
7 $278.52 $0.00 6.60% $435.67
Calculate value of bond in Year 8:
N PV PMT I/YR FV
8 $278.52 $0.00 6.60% $464.42
Accrued interest = Accrued interest =
$464.42 $28.75
–
$435.67
POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 7A Zero Coupon Bonds QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.07.07A - Zero Coupon Bonds NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Accrued value and int. expense KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:54 PM DATE MODIFIED: 9/21/2017 5:54 PM 12. A 2-year, zero coupon Treasury bond with a maturity value of $1,000.00 has a price of $881.6593. A 1-year, zero coupon Treasury bond with a maturity value of $1,000.00 has a price of $943.3962. If the pure expectations theory is correct, for what price should 1-year, zero coupon Treasury bonds sell one year from now? Do not round your intermediate calculations. Copyright Cengage Learning. Powered by Cognero.
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a. $1,112.13 b. $943.90 c. $831.76 d. $766.34 e. $934.56 ANSWER: RATIONALE:
e Calculate yield on 1-year Treasury zero bond:
N PV PMT FV I/YR
1 $943.3962 $0.00 $1,000.00 6.00%
Calculate yield on 2-year Treasury zero bond:
N PV PMT FV I/YR
2 $881.6593 $0.00 $1,000.00 6.50%
Calculate interest rate on 1-year zeros 1 year from now: 2
1.060 (1 + X) (1 + X) X
× = = =
(1 + X) 2
1.065 1.070023585 7.00%
= 1.065 / 1.060
Determine price of 1-year zero, one year from now:
N I/YR PMT FV PV
1 7.00% $0.00 $1,000.00 $934.56
POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 7A Zero Coupon Bonds QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.07.07A - Zero Coupon Bonds NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Zeros and expectations–nonalgorithmic KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:54 PM DATE MODIFIED: 9/21/2017 5:54 PM 13. A 4-year, zero coupon Treasury bond sells at a price of $774.4104. A 3-year, zero coupon Treasury bond sells at a price of $837.2475. Assuming the expectations theory is correct, what does the market believe the price of 1-year, zero coupon bonds will be in 3 years? Do not round your intermediate calculations. Copyright Cengage Learning. Powered by Cognero.
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a. $998.94 b. $869.45 c. $971.20 d. $1,156.19 e. $924.95 ANSWER: RATIONALE:
e Calculate yield on 4-year Treasury zero bond:
N PV PMT FV I/YR
4 $774.4104 $0.00 $1,000.00 6.60%
Calculate yield on 3-year Treasury zero bond:
N PV PMT FV I/YR
3 $837.2475 $0.00 $1,000.00 6.10%
Calculate interest rate on 1-year zeros 3 years from now: 3 4
1.061 (1 + X) (1 + X) X
× = = =
(1 + X) 4
1.066 1.081141821 8.11%
= /
1.066 3 1.061
Determine price of 1-year zero, 3 years from now:
N I/YR PMT FV PV
1 8.11% $0.00 $1,000.00 $924.95
POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 7A Zero Coupon Bonds QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.07.07A - Zero Coupon Bonds NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Zeros and expectations–nonalgorithmic KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:54 PM DATE MODIFIED: 9/21/2017 5:54 PM 14. Assume that the State of Florida sold tax-exempt, zero coupon bonds with a $1,000.00 maturity value 5 years ago. The bonds had a 25-year maturity when they were issued, and the interest rate built into the issue was a nominal 4.40%, compounded semiannually. The bonds are now callable at a premium of 4.00% over the accrued value. What effective annual rate of return would an investor who bought the bonds when they were issued and who still owns them earn if they Copyright Cengage Learning. Powered by Cognero.
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were called today? Do not round your intermediate calculations. a. 5.75% b. 3.95% c. 5.27% d. 6.48% e. 5.01% ANSWER: c Calculate the value of the zero at the time issued: RATIONALE:
M Years INOM N I/YR PMT FV PV
2 25 4.40% 50 2.20% $0.00 $1,000.00 $336.86
Calculate the accrued value at Year 5:
N
5
Accrued value Yr. 5 =
PV × (1 + INOM/M)
Accrued value Yr. 5 =
$336.86 × 1.022
MN
10
$418.76 Accrued value Yr. 5 = Calculate the call value at Year 5: Premium 4.00% Call value = Accrued value Yr. 5 Call value = $418.76 Call value = $435.51
× 1.04 × 1.04
Calculate the effective annual rate if called:
M 2 Yrs to call 5 N 10 PMT $0.00 FV $435.51 PV $336.86 I/YRPER 2.60% P/YR rNOM EFF%
2 5.20% 5.27%
POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 7A Zero Coupon Bonds QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.07.07A - Zero Coupon Bonds NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure Copyright Cengage Learning. Powered by Cognero.
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TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
Zero coupon bond Bloom's: Application Multiple Choice: Problem 9/21/2017 5:54 PM 9/21/2017 5:54 PM
15. Assume that the City of Tampa sold an issue of $1,000.00 maturity value, tax-exempt (muni), zero coupon bonds 5 years ago. The bonds had a 25-year maturity when they were issued, and the interest rate built into the issue was a nominal 4.40%, but with semiannual compounding. The bonds are now callable at a premium of 10.00% over the accrued value. What effective annual rate of return would an investor who bought the bonds when they were issued and who still owns them earn if they were called today? a. 7.81% b. 6.20% c. 6.39% d. 6.46% e. 5.36% ANSWER: d RATIONALE: Calculate the value of the zero at the time issued: M 2 Years 25 4.40% INOM N 50 I/YR 2.20% PMT $0.00 FV $1,000.00 PV $336.86 Calculate the accrued value at Year 5:
N
5
Accrued value Yr. 5 = PV × (1 + INOM/M) Accrued value Yr. 5 = $336.86 × 1.022
MN
10
Accrued value Yr. 5 = $418.76 Calculate the call value at Year 5: Premium 10.00% Call value = Accrued value Yr. 5 × Call value = $418.76 × Call value = $460.63 Calculate the effective annual rate if called: M 2 Yrs to call 5 N 10 PMT $0.00 FV $460.63 PV $336.86 I/YRPER 3.18% P/YR rNOM EFF%
1.10 1.10
2 6.36% 6.46%
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POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 7A Zero Coupon Bonds QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.07.07A - Zero Coupon Bonds NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Zero coupon bond KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:54 PM DATE MODIFIED: 9/21/2017 5:54 PM 16. Schiffauer Electronics plans to issue 10-year, zero coupon bonds with a par value of $1,000.00 and a yield to maturity of 5.00%. The company has a tax rate of 30.00%. How much extra in taxes would the company pay (or save) the second year (at t = 2) if it goes ahead and issues the bonds? Do not round your intermediate calculations. a. $8.80 b. $10.35 c. $9.96 d. $7.45 e. $9.67 ANSWER: e RATIONALE: Since zero coupon bonds do not make annual interest payments, the tax deduction is determined by the accumulated (but unpaid) interest on the bond over the year. To determine this we will calculate the value of the bond at t = 1 and t = 2. Original maturity = 10 Calculate the value of the zero in Year 1:
N I/YR PMT FV PV
9 5.00% $0.00 $1,000.00 $644.61
Calculate the value of the zero in Year 2:
N I/YR PMT FV PV
8 5.00% $0.00 $1,000.00 $676.84
Tax rate 30.00% Accumulated interest = $676.84 Accumulated interest = $32.23 Tax savings = Tax savings = POINTS:
$32.23 $9.67
×
–
$644.61
30.00%
1
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DIFFICULTY: CHALLENGING REFERENCES: 7A Zero Coupon Bonds QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.17.07.07A - Zero Coupon Bonds NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Taxes on zero coupon bond KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 5:54 PM DATE MODIFIED: 9/21/2017 5:54 PM Exhibit 7A.1 Gargoyle Unlimited is planning to issue a zero coupon bond to fund a project that will yield its first positive cash flow in 3 years. That cash flow will be sufficient to pay off the entire debt issue. The bond's par value will be $1000, it will mature in 3 years, and it will sell in the market for $785.00. The firm's marginal tax rate is 40.00%. 17. Refer to Exhibit 7A.1. What is the expected after-tax cost of this debt issue? Do not round your intermediate calculations. a. 5.55% b. 4.89% c. 6.20% d. 5.04% e. 5.09% ANSWER: d RATIONALE: Calculate the yield on the
bond: N PV PMT FV I/YR (rd) Tax rate:
3 $785.00 $0 $1000 8.40% 40.00%
After-tax rd = rd × (1 – T) After-tax rd = 8.40% × 60.00% After-tax rd = 5.04% POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 7A Zero Coupon Bonds QUESTION TYPE: Multiple Choice HAS VARIABLES: True PREFACE NAME: Multiple Part LEARNING OBJECTIVES: FOFM.BRIG.17.07.07A - Zero Coupon Bonds Copyright Cengage Learning. Powered by Cognero.
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NATIONAL STANDARDS: STATE STANDARDS: TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds After-tax cost of debt Bloom's: Application Multiple Choice: Multiple Parts 9/21/2017 5:54 PM 9/21/2017 5:54 PM
18. Refer to Exhibit 7A.1. What is the nominal dollar value of the interest tax savings to the firm in the third year of the issue? Do not round your intermediate calculations. a. $54.42 b. $45.12 c. $46.51 d. $36.28 e. $50.70 ANSWER: c RATIONALE: Calculate the yield on the
bond: N PV PMT FV I/YR
3 $785.00 $0 $1000 8.40%
Calculate the accrued value at Year 2: N 2 N Accrued value Yr. 2 = PV × (1 + INOM) 2
Accrued value Yr. 2 = $785.00 × 1.08404 Accrued value Yr. 2 = $922.48 Calculate the accrued value at Year 3: N 3 N
Accrued value Yr. 3
= PV × (1 + INOM)
Accrued value Yr. 3
=$785.00 × 1.08404
Accrued value Yr. 3
= $1,000.00
3
Interest = $1,000.00 - $922.48 = $77.52 Tax rate: 40.00% Tax savings = Interest × Tax rate Tax savings = $77.52 × 40.00% Tax savings = $46.51 POINTS: DIFFICULTY: REFERENCES:
1 CHALLENGING 7A Zero Coupon Bonds
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QUESTION TYPE: Multiple Choice HAS VARIABLES: True PREFACE NAME: Multiple Part LEARNING OBJECTIVES: FOFM.BRIG.17.07.07A - Zero Coupon Bonds NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.03 - BUSPROG: Analytic STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Zero coupon int. tax shield KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Multiple Parts DATE CREATED: 9/21/2017 5:54 PM DATE MODIFIED: 9/21/2017 5:54 PM
1. Chapter 7 of the Bankruptcy Act is designed to do all of the following EXCEPT: a. Provides safeguards against the withdrawal of assets by the owners of the bankrupt firm. b. Allows insolvent debtors to discharge all of their obligations and to start over unhampered by a burden of prior debt. c. Provides for an equitable distribution of the assets among the creditors. d. Details the procedures to be followed when a firm is liquidated. e. Establishes the rules of reorganization for firms with projected cash flows that eventually will be sufficient to meet debt payments. ANSWER: e POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 7C Bankruptcy and Reorganization QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.07.07C - Bankruptcy and Reorganization NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Liquidation procedures KEYWORDS: Bloom's: Knowledge OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:55 PM DATE MODIFIED: 9/21/2017 5:55 PM 2. Which of the following statements is most CORRECT? a. Our bankruptcy laws were enacted in the 1800s, revised in the 1930s, and have remained unaltered since that time. b. Federal bankruptcy law deals only with corporate bankruptcies. Municipal and personal bankruptcy are governed solely by state laws. c. All bankruptcy petitions are filed by creditors seeking to protect their claims on firms in financial distress. Thus, all bankruptcy petitions are involuntary as viewed from the perspective of the firm's management. d. Chapters 11 and 7 are the most important bankruptcy chapters for financial management purposes. If a Copyright Cengage Learning. Powered by Cognero.
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reorganization plan cannot be worked out under Chapter 11, then the company will be liquidated as prescribed in Chapter 7 of the Act. e. "Restructuring" a firm's debt can involve forgiving a certain portion of the debt but does not involve changing the debt's maturity or its contractual interest rate. ANSWER: d POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 7C Bankruptky and Reorganization QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.07.07C - Bankruptcy and Reorganization NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Bankruptcy law KEYWORDS: Bllom's: Knowledge OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:55 PM DATE MODIFIED: 9/21/2017 5:55 PM 3. Which of the following statements is most CORRECT? a. The primary test of feasibility in a reorganization is whether every claimant agrees with the reorganization plan. b. The basic doctrine of fairness states that all debt holders must be treated equally. c. Since the primary issue in bankruptcy is to determine the sharing of losses between owners and creditors, the "public interest" is not a relevant concern. d. While the firm is in bankruptcy, the existing management is always allowed to remain in control of the firm, though the court monitors its actions closely. e. To a large extent, the decision to dissolve a firm through liquidation or to keep it alive through reorganization depends upon the value of the firm if it is rehabilitated versus its value if its assets are sold off individually. ANSWER: e POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 7C Bankruptky and Reorganization QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.07.07C - Bankruptcy and Reorganization NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Bankruptcy issues KEYWORDS: Bloom's: Knowledge OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:55 PM DATE MODIFIED: 9/21/2017 5:55 PM Copyright Cengage Learning. Powered by Cognero.
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4. What would be the priority of the claims as to the distribution of assets in a liquidation under Chapter 7 of the Bankruptcy Act? 1. Trustees' costs to administer and operate the firm. 2. Common stockholders. 3. General, or unsecured, creditors. Secured creditors who have claim to the proceeds from the sale of a specific property 4. pledged for a mortgage. 5. Taxes due to federal and state governments. a. 1, 4, 3, 5, 2 b. 5, 4, 1, 3, 2 c. 4, 1, 5, 3, 2 d. 5, 1, 4, 2, 3 e. 1, 5, 4, 3, 2 ANSWER: c POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 7C Bankruptky and Reorganization QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.17.07.07C - Bankruptcy and Reorganization NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.17.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.17.01 - Stocks and bonds LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Priority of claims KEYWORDS: Bloom's: Knowledge OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 5:55 PM DATE MODIFIED: 9/21/2017 5:55 PM
1. Which of the following statements is CORRECT? a. The CAPM is an ex ante model, which means that all of the variables should be historical values that can reasonably be projected into the future. b. The beta coefficient used in the SML equation should reflect the expected volatility of a given stock's return versus the return on the market during some future period. c. The general equation: Y = a + bX + e, is the standard form of a simple linear regression where b = beta, and X equals the independent return on an individual security being compared to Y, the return on the market, which is the dependent variable. d. The rise-over-run method is not a legitimate method of estimating beta because it measures changes in an individual security's return regressed against time. e. The Security Market Line (SML) shows the relationship between risk as measured by beta and the required rate of return for all securities. ANSWER: b POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8A Calculating Beta Coefficients QUESTION TYPE: Multiple Choice HAS VARIABLES: False Copyright Cengage Learning. Powered by Cognero.
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LEARNING OBJECTIVES: FOFM.BRIG.16.08.08A - Calculating Beta Coefficients NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.07 - Risk and return TOPICS: Beta coefficient KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:15 PM DATE MODIFIED: 9/21/2017 6:15 PM 2. Given the following returns on Stock J and the "market" during the last three years, what is the beta coefficient of Stock J? (Hint: Think rise over run.) Year Stock J Market 1 –11.26% –7.55% 2 22.57% 12.06% 3 34.71% 19.88% a. 1.66 b. 1.54 c. 1.73 d. 1.74 e. 1.85 ANSWER: RATIONALE:
c Rise/Run using Yr. 1 & Yr. 2 data: beta = (Y2 − Y1)/(X2 − X1) beta = 33.83%/19.61% beta = 1.73
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8A Calculating Beta Coefficients QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.16.08.08A - Calculating Beta Coefficients NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.07 - Risk and return TOPICS: Beta calculation KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:15 PM DATE MODIFIED: 9/21/2017 6:15 PM 3. Stock X and the "market" have had the following rates of returns over the past four years. Year Stock X Market 1 12.00% 13.80% 2 5.00% 1.65% 3 11.00% 13.70% 4 –7.00% –2.72% 62% of your portfolio is invested in Stock X and the remaining 38% is invested in Stock Y. The risk-free rate is 5.24% and the market risk premium is also 5.24%. You estimate that 14.11% is the required rate of return on your portfolio. What is the beta of Stock Y? Copyright Cengage Learning. Powered by Cognero.
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a. 2.76 b. 2.91 c. 2.88 d. 2.41 e. 2.82 ANSWER: RATIONALE:
b Calculate beta of Stock X using Excel Data Analysis: SUMMARY OUTPUT Regression Statistics
Multiple R R Square Adjusted R Square Standard Error Observations
0.94774 0.86687 0.8403 0.0349 4
ANOVA df 1 2 3
Regression Residual Total
SS 0.01983 0.00244 0.02288
Coefficients Intercept
–0.00758
X Variable 1
1.00862
Standard Error 0.02698 0.27668
MS 0.02004 0.00122
F Significance F 12.62395 0.05473
t Stat –0.80682
P-value Lower 95% 0.50446
3.55302 0.064
–0.12584
Upper 95% 0.0959
Lower 95.0%
–0.20741 1.98747
– 0.12584 – 0.20741
Calculate beta of portfolio using CAPM:
5.24% 5.24% 14.11%
rRF RPM rp rp 14.11% 8.87% betap
= rRF+ RPM×betap = 5.24% + 5.24%×betap = 5.24%×betap = 1.69
% invested, X % invested, Y
62% 38%
Calculate beta Y:
betap 1.69 1.1047 beta Y
= 0.62(beta X) + 0.38(beta Y) = 0.62×1.00862 + 0.38(beta Y) = 0.38(beta Y) = 2.91
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U 95
1
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8A Calculating Beta Coefficients QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIV FOFM.BRIG.16.08.08A - Calculating Beta Coefficients ES: NATIONAL STANDAR United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills DS: STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.07 - Risk and return TOPICS: Beta calculation KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:15 PM DATE MODIFIED: 9/21/2017 6:15 PM 4. Hanratty Inc.'s stock and the stock market have generated the following returns over the past five years: Year 1 2 3 4 5
Hanratty 13.00% 18.00% –5.00% 23.00% 6.00%
Market (r M) 9.00% 15.00% –2.00% 19.00% 12.00%
What is the estimated beta of Hanratty Inc.'s stock? a. 1.65837 b. 0.89297 c. 1.27567 d. 1.46702 e. 0.95675 ANSWER: c Calculate beta of Hanratty using Excel Data Analysis: RATIONALE: SUMMARY OUTPUT Regression Statistics
Multiple R R Square Adjusted R Square Standard Error Observations
0.92845 0.86201 0.81602 0.04689 5
ANOVA df 1 3 4
Regression Residual Total
SS MS 0.04120 0.04120 0.00660 0.00220 0.04780
Coefficients Copyright Cengage Learning. Powered by Cognero.
Standard Error
F 18.74106
t Stat
Significance F 0.02273
P-value Lower 95%
Upper 95%
Lower 95.0% Page 1135
Intercept X Variable 1
–0.02522 0.03762 1.27567 0.29467
BetaHanratty=
1.27567
–0.67039 0.55060 4.32909 0.02273
–0.14495 0.09451 0.33789 2.21346
–0.14495 0.33789
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8A Calculating Beta Coefficients QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTI FOFM.BRIG.16.08.08A - Calculating Beta Coefficients VES: NATIONAL STANDAR United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills DS: STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.07 - Risk and return TOPICS: Beta calculation–nonalgorithmic KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:15 PM DATE MODIFIED: 9/21/2017 6:15 PM 5. Below are the returns for the past five years for Stock S and for the overall market: Year 1 2 3 4 5
Stock S 14.00% 36.00% –27.00% –9.00% 47.00%
Market (r M) 8.00% 30.00% −20.00% −4.00% 32.00%
What is the estimated beta of Stock S? a. 1.36854 b. 1.50539 c. 1.77910 d. 1.02641 e. 1.16326 ANSWER: a RATIONALE: Calculate beta of Stock S using Excel Data Analysis: SUMMARY OUTPUT Regression Statistics
Multiple R R Square Adjusted R Square Standard Error Observations
0.99841 0.98488 0.97984 0.04358 5
ANOVA df Copyright Cengage Learning. Powered by Cognero.
SS
MS
F
Significance F Page 1136
Regression Residual Total
1 3 4
0.37098 0.00570 0.37668
0.3710 195.36648 0.0019
0.00079
Standard Upper P-value Lower 95% t Stat Error 95% –0.00391 0.02147 –0.18191 0.86725 –0.07223 0.06442 1.36854 0.09791 13.97736 0.00079 1.05694 1.68013 1.36854
Coefficients Intercept X Variable1 BetaS=
Lower U 95.0% 9 –0.07223 0. 1.05694 1.
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8A Calculating Beta Coefficients QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIV FOFM.BRIG.16.08.08A - Calculating Beta Coefficients ES: NATIONAL STANDAR United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills DS: STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.07 - Risk and return TOPICS: Beta calculation–nonalgorithmic KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:15 PM DATE MODIFIED: 9/21/2017 6:15 PM 6. Given the following returns on Stock Q and "the market" during the last three years, what is the difference in the calculated beta coefficient of Stock Q when Year 1 and Year 2 data are used as compared to Year 2 and Year 3 data? (Hint: Think rise over run.) Year 1 2 3 a. 9.00 b. 10.26 c. 7.20 d. 7.65 e. 9.72 ANSWER: RATIONALE:
Stock Q 6.74% –4.08% 21.28%
Market 7.93% 13.90% 17.43%
a Rise/Run using Yr. 1 & Yr. 2 data: beta = (Y2 − Y1)/(X2 − X1) beta = –10.82%/5.97% beta = –1.81 Rise/Run using Yr. 2 & Yr. 3 data: beta = (Y3 − Y2)/(X3 − X2) beta = 25.36%/ 3.53% beta = 7.18
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Difference = 7.18 − (–1.81) Difference = 9.00
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8A Calculating Beta Coefficients QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.16.08.08A - Calculating Beta Coefficients NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.07 - Risk and return TOPICS: Beta and base-year sensitivity KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:15 PM DATE MODIFIED: 9/21/2017 6:15 PM Exhibit 8A.1 You have been asked to use a CAPM analysis to choose between Stocks R and S, with your choice being the one whose expected rate of return exceeds its required return by the widest margin. The risk-free rate is 4.00%, and the required return on an average stock (or the "market") is 10.00%. Your security analyst tells you that Stock S's expected rate of return is equal to 11.00%, while Stock R's expected rate of return is equal to 12.00%. The CAPM is assumed to be a valid method for selecting stocks, but the expected return for any given investor (such as you) can differ from the required rate of return for a given stock. The following past rates of return are to be used to calculate the two stocks' beta coefficients, which are then to be used to determine the stocks' required rates of return: Year Stock R Stock S Market 1 –22.00% –3.00% –11.00% 2 3.00% 6.00% 8.00% 3 21.00% 15.00% 25.00% Note: The averages of the historical returns are not needed, and they are generally not equal to the expected future returns. 7. Refer to Exhibit 8A.1. Calculate both stocks' betas. What is the difference between the betas? That is, what is the value of betaR − betaS? (Hint: The graphical method of calculating the rise over run, or (Y2 − Y1) divided by (X2 − X1) may aid you.) a. 0.7785 b. 0.8493 c. 0.7864 d. 0.8178 e. 0.6606 ANSWER: c Rise/Run using Yr. 1 & Yr. 2 data: RATIONALE: betaR = (Y2 − Y1)/(X2 − X1) betaR = 25.00%/19.00% betaR = 1.32 Rise/Run using Yr. 2 & Yr. 3 data: betaS = (Y3 − Y2)/(X3 − X2) betaS = 9.00%/17.00% betaS = 0.53 Copyright Cengage Learning. Powered by Cognero.
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Difference = 1.32 − 0.53 Difference = 0.79
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8A Calculating Beta Coefficients QUESTION TYPE: Multiple Choice HAS VARIABLES: True PREFACE NAME: Exhibit 8A.1 LEARNING OBJECTIVES: FOFM.BRIG.16.08.08A - Calculating Beta Coefficients NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.07 - Risk and return TOPICS: Beta calculation KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Multiple Parts DATE CREATED: 9/21/2017 6:15 PM DATE MODIFIED: 9/21/2017 6:15 PM 8. Refer to Exhibit 8A.1. Set up the SML equation and use it to calculate both stocks' required rates of return, and compare those required returns with the expected returns given above. You should invest in the stock whose expected return exceeds its required return by the widest margin. What is the widest positive margin, or greatest excess return (expected return − required return)? a. 3.59% b. 2.94% c. 2.98% d. 2.91% e. 3.82% ANSWER: e Calculated the required returns for Stocks R and S: RATIONALE:
Exp. rR Exp. rS rRF rM RPM= rM−rRF
12.00% 11.00% 4.00% 10.00% 6.00%
rR = rRF + RPM × betaR rR = 4.00% + 6.00% × 1.32 rR = 11.89% rS = rRF + RPM × betaS rS = 4.00% + 6.00% × 0.53 rS = 7.18% Stock R: Expected rR − rR = 12.00% −11.89%
Expected rR− rR = 0.11% Stock S: Copyright Cengage Learning. Powered by Cognero.
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Expected rR − rR = 11.00% −7.18% Expected rR− rR = 3.82% Widest margin = 3.82%
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 8A Calculating Beta Coefficients QUESTION TYPE: Multiple Choice HAS VARIABLES: True PREFACE NAME: Exhibit 8A.1 LEARNING OBJECTIVES: FOFM.BRIG.16.08.08A - Calculating Beta Coefficients NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.07 - Risk and return TOPICS: Required rate of return KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Multiple Parts DATE CREATED: 9/21/2017 6:15 PM DATE MODIFIED: 9/21/2017 6:15 PM
1. Sunshine Inc. has two equally-sized divisions. Division A has a beta of 0.8 and Division B has a beta of 1.2. The company is 100% equity financed. The risk-free rate is 6% and the market risk premium is 5%. Sunshine assigns different hurdle rates to each division based on each division's market risk. Which of the following statements is CORRECT? a. Sunshine's composite WACC is 10%. b. Division B has a lower WACC than Division A. c. If the same WACC is used for each division, the firm would select too many Division A projects and reject too many Division B projects. d. If the same WACC is used for each division, the firm would select too many Division B projects and reject too many Division A projects. e. Sunshine's composite WACC is 12%. ANSWER: d RATIONALE: Statements a and e are false, because the composite WACC is 6% + 5% (1.0) = 11%. Statement b is false, because Division B has the higher WACC, since it is riskier and its beta is higher. Statement c is false and statement d is true, because risky projects with returns greater than the WACC but less than Division B's WACC would be accepted and safe projects with returns less than the composite WACC but greater than Division A's WACC would be rejected. As a result, too many risky projects and not enough less-risky projects would be accepted. POINTS: 1 DIFFICULTY: EASY REFERENCES: 12C Using the CAPM to Estimate the Risk-Adjusted Cost of Capital QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.12.12C - Using the CAPM to Estimate the Risk-Adjusted Cost of Capital NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business Copyright Cengage Learning. Powered by Cognero.
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TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
School Outcomes, you do not need to include anything for this category. Risk and div. costs of capital Bloom's: Evaluation Multiple Choice: Conceptual 9/21/2017 6:17 PM 9/21/2017 6:17 PM
2. If the firm is being operated so as to maximize shareholder wealth, and if our basic assumptions concerning the relationship between risk and return are true, then which of the following should be true? a. If an asset's beta is larger than the firm's beta, then the required return on the asset is less than the required return on the firm. b. If the beta of the asset is smaller than the firm's beta, then the required return on the asset is greater than the required return on the firm. c. If the beta of the asset is greater than the firm's beta prior to the addition of that asset, then the firm's beta after the purchase of the asset will be smaller than the original firm's beta. d. If the beta of an asset is larger than the firm's beta prior to the addition of that asset, then the required return on the firm will be greater after the purchase of that asset than prior to its purchase. e. None of the statements is true. ANSWER: d POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 12C Using the CAPM to Estimate the Risk-Adjusted Cost of Capital QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.12.12C - Using the CAPM to Estimate the Risk-Adjusted Cost of Capital NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Risk and project betas KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:17 PM DATE MODIFIED: 9/21/2017 6:17 PM 3. Using the Security Market Line concept in capital budgeting, which of the following statements is CORRECT? a. If the expected rate of return on a given capital project lies above the SML, the project should be accepted even if its beta is greater than the beta of the firm's average project. b. If a project's return lies below the SML, it should be rejected if it has a beta greater than the firm's existing beta but accepted if its beta is below the firm's beta. c. If two mutually exclusive projects' expected returns are both above the SML, the project with the lower risk should be accepted. d. If a project's expected rate of return is greater than the expected rate of return on an average project, it should be accepted. e. None of the statements is correct. ANSWER: a POINTS: 1 Copyright Cengage Learning. Powered by Cognero.
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DIFFICULTY: MODERATE REFERENCES: 12C Using the CAPM to Estimate the Risk-Adjusted Cost of Capital QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.12.12C - Using the CAPM to Estimate the Risk-Adjusted Cost of Capital NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: SML and capital budgeting KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:17 PM DATE MODIFIED: 9/21/2017 6:17 PM 4. Louisiana Enterprises, an all-equity firm, is considering a new capital investment. Analysis has indicated that the proposed investment has a beta of 0.55 and will generate an expected return of 5.00%. The firm currently has a required return of 10.75% and a beta of 1.25. The investment, if undertaken, will double the firm's total assets. If rRF is 7.00% and the market risk premium is 5%, should the firm undertake the investment? a. Yes; the beta of the asset will reduce the risk of the firm. b. No; the expected return of the asset is less than the firm's required return, which is 10.75%. c. No; the expected return of the asset (5.00%) is less than the required return (9.64%). d. No; the risk of the asset (beta) will increase the firm's beta. e. Yes; the expected return of the asset (5.00%) exceeds the required return (4.50%). ANSWER: c RATIONALE: Calculate the investment's required return and compare to its expected return. Exp return 5.00% 7.00% rRF 5% RPM beta 0.55 rs = rs = rs =
rRF 7.00% 9.64%
+ RPM 5% + REJECT
beta 0.55
POINTS: 1 DIFFICULTY: EASY REFERENCES: 12C Using the CAPM to Estimate the Risk-Adjusted Cost of Capital QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.16.12.12C - Using the CAPM to Estimate the Risk-Adjusted Cost of Capital NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Project cost of capital–nonalgorithmic KEYWORDS: Bloom's: Application Copyright Cengage Learning. Powered by Cognero.
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OTHER: DATE CREATED: DATE MODIFIED:
Multiple Choice: Problem 9/21/2017 6:17 PM 9/21/2017 6:17 PM
5. Assume you are the director of capital budgeting for an all-equity firm. The firm's current cost of equity is 17.50%; the risk-free rate is 0.25%; and the market risk premium is 7%. You are considering a new project that has 50.00% more beta risk than your firm's assets currently have, that is, its beta is 50.00% larger than the firm's existing beta. The expected return on the new project is 18.00%. Should the project be accepted if beta risk is the appropriate risk measure? Choose the correct statement. a. No; a 50.00% increase in beta risk gives a risk-adjusted required return of 24.00%. b. Yes; its expected return is greater than the firm's WACC. c. No; the project's risk-adjusted required return is 8.13% above its expected return. d. Yes; the project's risk-adjusted required return is less than its expected return. e. No; the project's risk-adjusted required return is 9.13% above its expected return. ANSWER: c RATIONALE: Calculate the beta of the firm, and use to calculate project beta: 17.50% rs 0.25% rRF 7% RPM = rs 17.50% = 17.25% = 2.46 =
rRF 0.25% 7%
+ +
RPM 7%
betaFirm betaFirm
betaFirm
betaFirm
bProject increase = = bProject = bProject = bProject
50.00% betaFirm 2.46 3.70
1.50 1.50
Calculate required return on project and compare to its expected return: Expected project return = 18.00% = + RPM rProject rRF betaProject = 0.25% + 7% 3.70 rProject = 26.13% REJECT rProject POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 12C Using the CAPM to Estimate the Risk-Adjusted Cost of Capital QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.16.12.12C - Using the CAPM to Estimate the Risk-Adjusted Cost of Capital NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Project cost of capital–nonalgorithmic Copyright Cengage Learning. Powered by Cognero.
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KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
Bloom's: Application Multiple Choice: Problem 9/21/2017 6:17 PM 9/21/2017 6:17 PM
1. Which of the following methods involves calculating an average beta for comparable firms and using that beta to determine a project's beta? a. Risk premium method b. Pure play method c. Accounting beta method d. CAPM method e. Discounted cash flow model ANSWER: b POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 12D Techniques for Measuring Beta Risk QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.12.12D - Techniques for Measuring Beta Risk NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Pure play method KEYWORDS: Bloom’s: Knowledge OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:18 PM DATE MODIFIED: 9/21/2017 6:18 PM 2. Northern Conglomerate has two divisions, Division A and Division B. Northern looks at competing pure-play firms to estimate the betas of each of the two divisions. After this analysis, Northern concludes that Division A has a beta of 0.9 and Division B has a beta of 1.6. The two divisions are the same size. The risk-free rate is 5.00% and the market risk premium is 5.80%. Assume that Northern is 100% equity financed. What is the overall composite WACC for Northern Conglomerate? a. 12.86% b. 14.09% c. 12.25% d. 11.64% e. 10.41% ANSWER: c RATIONALE: 50.00% w A
wB rRF RPM bA Copyright Cengage Learning. Powered by Cognero.
50.00% 5.00% 5.80% 0.9 Page 1144
bB
1.6
Calculate the cost of capital for Division A: + rA= rRF RPM bA 5.00% + 5.80% 0.9 rA= 10.22% rA= Calculate the cost of capital for Division B: + rB= rRF RPM bB 5.00% + 5.80% 1.6 rB= 14.28% rB= WACC = wArA + WACC = 5.11% + WACC = 12.25%
wBrB 7.14%
POINTS: 1 DIFFICULTY: EASY REFERENCES: 12D Techniques for Measuring Beta Risk QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.16.12.12D - Techniques for Measuring Beta Risk NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Corporate WACC with divisions KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:18 PM DATE MODIFIED: 9/21/2017 6:18 PM 3. Interstate Transport has a target capital structure of 50% debt and 50% common equity. The firm is considering a new independent project that has a return of 13% and is not related to transportation. However, a pure-play proxy firm has been identified that has a beta of 1.34. Both firms have a marginal tax rate of 40%, and Interstate's before-tax cost of debt is 12%. The risk-free rate is 10% and the market risk premium is 6%. The firm should: a. Be indifferent between accepting or rejecting; the firm's required rate of return on the project equals its expected return. b. Accept the project; its return exceeds the risk-free rate and the before-tax cost of debt. c. Accept the project; its return is greater than the firm's required rate of return on the project of 12.62%. d. Reject the project; its return is less than the firm's required rate of return on the project of 16.9%. e. Reject the project; its return is only 13%. ANSWER: c RATIONALE: 50% wd wc rd T Copyright Cengage Learning. Powered by Cognero.
50% 12% 40% Page 1145
bProject rRF RPM Exp. project return
1.34 10% 6% 13%
Calculate the project's cost of equity and use it to calculate the WACC: + rProject = rRF RPM bProject 10% + 6% 1.34 rProject = rProject = 18.04% WACCProject = wdrd(1 – T) + wcrs + 9.02% WACCProject = 3.60% ACCEPT WACCProject = 12.62%
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 12D Techniques for Measuring Beta Risk QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.16.12.12D - Techniques for Measuring Beta Risk NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital LOCAL STANDARDS: United States - OH - Default City - N/A - Since we still do not have the Cengage Business School Outcomes, you do not need to include anything for this category. TOPICS: Pure play method–nonalgorithmic KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:18 PM DATE MODIFIED: 9/21/2017 6:18 PM
1. A company currently sells 75,000 units annually. At this sales level, its EBIT is $4 million, and its degree of total leverage is 2.0. The firm's debt consists of $15 million in bonds with a 9.5% coupon. The company is considering a new production method which will entail an increase in fixed costs but a decrease in variable costs, and will result in a degree of operating leverage of 1.375. The president, who is concerned about the stand-alone risk of the firm, wants to keep the degree of total leverage at 2.0. If EBIT remains at $4 million, what dollar amount of bonds must be retired to accomplish this? Do not round intermediate calculations. a. $2,118,421.05 b. $1,381,578.95 c. $1,842,105.26 d. $1,528,947.37 e. $2,192,105.26 ANSWER: c RATIONALE: Q 75,000 EBIT $4,000,000 DTL 2.0 Copyright Cengage Learning. Powered by Cognero.
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Debt Coupon rate New DOL
$15,000,000 9.5% 1.375
Determine DFL: DTL = DOL 2.00 = 1.38 DFL = 1.4545
DFL DFL
Calculate interest from DFL equation: EBIT DFL = EBIT – I 1.4545 =
$4,000,000 $4,000,000 – I
$4,000,000 = = 1.4545 I I =
$5,818,182 $1,818,182 $1,250,000
–I
1.4545
Calculate dollar amount of debt from interest expense: Debt = Interest expense / Coupon rate Debt = $1,250,000 / 9.5% Debt = $13,157,894.74 Calculate debt that needs to be retired: $15,000,000.00 – $13,157,894.74
=
$1,842,105.26
POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 14A Degree of Leverage QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.16.14.14A - Degree of Leverage NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: DFL KEYWORDS: Bloom's: Evaluation OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:19 PM DATE MODIFIED: 9/21/2017 6:19 PM 2. Your firm's EPS last year was $1.00. You expect sales to increase by 32.50% during the coming year. If your firm has a degree of operating leverage equal to 1.25 and a degree of financial leverage equal to 3.50, then what is its expected EPS? Do not round intermediate calculations. a. $1.86 Copyright Cengage Learning. Powered by Cognero.
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b. $2.42 c. $2.40 d. $1.82 e. $2.03 ANSWER: RATIONALE:
b
$1.00 32.50% 1.25 3.50
EPS0 %ΔSales DOL DFL
Calculate DTL from data given:
DTL = DTL =
DOL 4.38
×
DFL
EPS1=
EPS0
+
EPS0 ×
EPS1= EPS1=
$1.00 $2.42
+
$1.00 ×
[DTL × %ΔSales] 1.42188
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 14A Degree of Leverage QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.16.14.14A - Degree of Leverage NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Change in EPS KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:19 PM DATE MODIFIED: 9/21/2017 6:19 PM 3. Which of the following statements is CORRECT? a. An increase in fixed costs, (holding sales and variable costs constant) will reduce the company's degree of operating leverage. b. An increase in interest expense will reduce the company's degree of financial leverage. c. If the company has no debt outstanding, then its degree of total leverage equals its degree of operating leverage. d. If a firm's degree of operating leverage increases, its degree of financial leverage must also have increased. e. If the company has no debt outstanding, then its degree of total leverage equals its degree of financial leverage. ANSWER: c POINTS: 1 Copyright Cengage Learning. Powered by Cognero.
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DIFFICULTY: MODERATE REFERENCES: 14A Degree of Leverage QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.14.14A - Degree of Leverage NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: DOL, DFL, and DTL KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:19 PM DATE MODIFIED: 9/21/2017 6:19 PM 4. The Quick Company expects its sales to increase by 50% in the coming year. The firm's current EPS is $2.50. Its degree of operating leverage is 1.6, while its degree of financial leverage is 2.1. What is the firm's projected EPS for the coming year using the DTL approach? Do not round intermediate calculations. a. $6.70 b. $6.83 c. $5.36 d. $6.90 e. $8.17 ANSWER: a RATIONALE:
EPS0 %ΔSales DOL DFL
$2.50 50% 1.6 2.1
Calculate DTL from data given:
DTL = DOL × DTL = 3.36
DFL
EPS1= EPS0
+
EPS0 ×
EPS1= $2.50 EPS1= $6.70
+
$2.50 ×
[DTL × %ΔSales] 1.68
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 14A Degree of Leverage QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.16.14.14A - Degree of Leverage NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.10 - Capital structure Copyright Cengage Learning. Powered by Cognero.
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LOCAL STANDARDS: TOPICS: KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
United States - OH - Default City - Tier 2: - Capital structure DTL and forecast EPS Bloom's: Application Multiple Choice: Problem 9/21/2017 6:19 PM 9/21/2017 6:19 PM
5. Alvarez Technologies has sales of $3,000,000. The company's fixed operating costs total $500,000 and its variable costs equal 45.00% of sales, so the company's current operating income is $1,150,000. The company's interest expense is $500,000. What is the company's degree of total leverage (DTL)? a. 3.0715 b. 2.9700 c. 2.1069 d. 2.5385 e. 3.0208 ANSWER: d RATIONALE: Sales $3,000,000
FC VC % EBIT Interest DTL = DTL = DTL =
$500,000 45.00% $1,150,000 $500,000 (S – VC) / $1,650,000 / 2.5385
(EBIT – I) $650,000
POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 14A Degree of Leverage QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.16.14.14A - Degree of Leverage NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: DTL KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:19 PM DATE MODIFIED: 9/21/2017 6:19 PM 6. Which of the following statements is CORRECT? a. The degree of operating leverage (DOL) depends on a company's fixed costs, variable costs, and sales. The DOL formula assumes (1) that fixed costs are constant and (2) that variable costs are a constant proportion of sales. b. The degree of total leverage (DTL) is equal to the DOL plus the degree of financial leverage (DFL). c. Arithmetically, financial leverage and operating leverage offset one another so as to keep the degree of total leverage constant. Therefore, the formula shows that the greater the degree of financial leverage, the smaller Copyright Cengage Learning. Powered by Cognero.
Page 1150
the degree of operating leverage. d. For a given change in sales, the corresponding percentage change in net income could be more or less than the percentage change in operating income. e. The degree of total leverage (DTL) is equal to the DFL divided by the degree of operating leverage (DOL). ANSWER: a POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 14A Degree of Leverage QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.14.14A - Degree of Leverage NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Operating and fin. leverage KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:19 PM DATE MODIFIED: 9/21/2017 6:19 PM 7. Assume that a firm currently has EBIT of $2,000,000, a degree of total leverage of 6.000, and a degree of financial leverage of 1.875. If sales decline by 20% next year, then what will be the firm's expected EBIT in one year? Do not round intermediate calculations. a. $619,200 b. $720,000 c. $871,200 d. $763,200 e. $813,600 ANSWER: b RATIONALE: $2,000,000 EBIT0 DTL 6.000 DFL 1.875 -20% % Sales Determine DOL DOL = DTL/DFL DOL = 3.200 Determine change in EBIT with decrease in sales: DOL EBIT0 EBIT = % Sales 3.200 $2,000,000 EBIT = -20% EBIT = -$1,280,000 Calculate expected EBIT in one year: + EBIT1 = EBIT0 EBIT (EBIT1 = $2,000,000 + $1,280,000) Copyright Cengage Learning. Powered by Cognero.
Page 1151
EBIT1 = $720,000
POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 14A Degree of Leverage QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.16.14.14A - Degree of Leverage NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Expected EBIT KEYWORDS: Bloom's: Evaluation OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:19 PM DATE MODIFIED: 9/21/2017 6:19 PM 8. The degree of operating leverage has which of the following characteristics? a. The closer the firm is operating to the breakeven quantity, the smaller the DOL. b. A change in quantity demanded will produce the same percentage change in EBIT as an identical change in price per unit of output, other things held constant. c. The DOL is not a fixed number for a given firm, but will depend upon the time zero values of the economic variable Q (Quantity), P (Price), and V (Volume). d. The DOL relates the change in net income to the change in operating income. e. If the firm has no debt, the DOL will equal 1. ANSWER: c POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 14A Degree of Leverage QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.14.14A - Degree of Leverage NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: DOL KEYWORDS: Bloom’s: Knowledge OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:19 PM DATE MODIFIED: 9/21/2017 6:19 PM 9. Maxvill Motors has annual sales of $14,900. Its variable costs equal 60% of its sales and its fixed costs equal $1,000. If the company's sales increase 10%, what will be the percentage increase in the company's earnings before interest and taxes (EBIT)? Copyright Cengage Learning. Powered by Cognero.
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a. 10.69% b. 12.02% c. 14.54% d. 11.30% e. 9.37% ANSWER: RATIONALE:
b
Sales VC% FC % ΔSales New Sales
$14,900 60% $1,000 10% $16,390
Calculate EBIT before sales increase: EBIT0 = Sales − Variable costs − Fixed costs EBIT0 = $14,900 − $8,940 − $1,000 EBIT0 = $4,960 Calculate EBIT after sales increase: EBIT1 = Sales − Variable costs − Fixed costs EBIT1 = $16,390 − $9,834 − $1,000 EBIT1 = $5,556 %ΔEBIT = (EBIT1 − EBIT0)/EBIT0 % ΔEBIT = $596/$4,960 % ΔEBIT = 12.02%
POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 14A Degree of Leverage QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.16.14.14A - Degree of Leverage NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: DOL and changes in EBIT KEYWORDS: Bloom's: Evaluation OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:19 PM DATE MODIFIED: 9/21/2017 6:19 PM 10. Coats Corp. generates $10,000,000 in sales. Its variable costs equal 85.00% of sales and its fixed costs are $500,000. Therefore, the company's operating income (EBIT) equals $1,000,000. The company estimates that if its sales were to increase 9.5%, its net income and EPS would increase 17.50%. What is the company's interest expense? Do not round intermediate calculations. a. $193,143 b. $176,429 c. $185,714 Copyright Cengage Learning. Powered by Cognero.
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d. $202,429 e. $163,429 ANSWER: RATIONALE:
c Sales VC % FC EBIT % Sales NI & EPS Incr.
$10,000,000 85.00% $500,000 $1,000,000 9.50% 17.50%
Determine DTL from data given: DTL = % NI / % Sales DTL = 17.50% / 9.50% DTL = 1.84 Calculate Interest from DTL formula: DTL = (S – VC) / (S – VC – FC – I) 1.84 = $1,500,000 / ($1,000,000 – I) $1,500,000 = $1,842,105 – 1.84I 1.84I = $342,105 I = $185,714 POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 14A Degree of Leverage QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.16.14.14A - Degree of Leverage NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: DTL and interest expense KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:19 PM DATE MODIFIED: 9/21/2017 6:19 PM 11. PQR Manufacturing Corporation has $1,500,000 in debt outstanding. The company's before-tax cost of debt is 10%. Sales for the year totaled $3,500,000 and variable costs were 60% of sales. Net income was equal to $600,000 and the company's tax rate was 30%. If PQR's degree of total leverage is equal to 1.30, what is its degree of operating leverage? Do not round intermediate calculations. a. 0.8962 b. 1.2281 c. 1.0179 d. 1.3719 e. 1.1064 ANSWER: e RATIONALE: Debt $1,500,000 Copyright Cengage Learning. Powered by Cognero.
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rd Sales VC % Net income Tax rate DTL
10% $3,500,000 60% $600,000 30.00% 1.30
Set up the firm's income statement working from the bottom up to determine its EBIT to use in the DFL equation: EBIT $1,007,143 Calculate as EBT + Interest Interest 150,000 EBT $857,143 Calculate as NI/(1 – T) Taxes 257,143 Net income $600,000 DFL = EBIT / DFL = $1,007,143 / DFL = 1.1750 DTL = DOL 1.30 = DOL DOL = 1.1064
(EBIT – I) $857,143
DFL 1.1750
POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 14A Degree of Leverage QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.16.14.14A - Degree of Leverage NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: DOL, DFL, and DTL KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:19 PM DATE MODIFIED: 9/21/2017 6:19 PM 12. Kulwicki Corporation wants to determine the effect of an expansion of its sales on its operating income (EBIT). The firm's current degree of operating leverage is 2.75. It projects new unit sales to be 170,000, an increase of 45,000 over last year's level of 125,000 units. Last year's EBIT was $60,000. Based on a degree of operating leverage of 2.75, what is this year's expected EBIT with the increase in sales? a. $119,400 b. $120,594 c. $97,908 d. $138,504 Copyright Cengage Learning. Powered by Cognero.
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e. $146,862 ANSWER: RATIONALE:
a DOL New Q Units Old Q EBIT0
2.75 170,000 45,000 125,000 $60,000
Set up the DOL equation, letting X be the unknown new EBIT: % EBIT DOL = % Sales DOL = 2.75 =
(X – $60,000) / $60,000 45,000 / 125,000 (X –$60,000) / $60,000 0.36
0.99 = (X – $60,000) / $59,400 = X – $60,000 X = $119,400
$60,000
POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 14A Degree of Leverage QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.16.14.14A - Degree of Leverage NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Expected EBIT KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:19 PM DATE MODIFIED: 9/21/2017 6:19 PM 13. Bell Brothers has $3,000,000 in sales. Fixed costs are estimated to be $100,000 and variable costs are equal to 50.00% of sales. The company has $1,000,000 in debt outstanding at a before-tax cost of 13.5%. If Bell Brothers' sales were to increase by 20.00%, how much of a percentage increase would you expect in the company's net income? Do not round intermediate calculations. a. 19.68% b. 23.72% c. 27.98% d. 19.45% e. 21.34% ANSWER: b RATIONALE: Sales $3,000,000 FC $100,000 Copyright Cengage Learning. Powered by Cognero.
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VC % Debt rd % Sales
50.00% $1,000,000 13.50% 20.00%
Find DTL: DTL = (S – VC) / DTL = $1,500,000 / DTL = 1.1858
(S – VC – FC – I) $1,265,000
Find percentage increase in net income: DTL % NI = % Sales % NI = 23.72% POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 14A Degree of Leverage QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.16.14.14A - Degree of Leverage NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: DTL and change in NI KEYWORDS: Bloom's: Evaluation OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:19 PM DATE MODIFIED: 9/21/2017 6:19 PM 14. Monroe Corporation currently sells 150,000 units a year at a price of $4.00 a unit. Its variable costs are approximately 40.0% of sales, and its fixed costs amount to 50.00% of revenues at its current output level. Although fixed costs are based on revenues at the current output level, the cost level is fixed. What is Monroe's degree of operating leverage in sales dollars? a. 4.8000 b. 6.3000 c. 7.3200 d. 5.6400 e. 6.0000 ANSWER: e RATIONALE:
Units (Q) Price (P) VC % (V) FC % (F) DOL = DOL = DOL =
150,000 $4.00 40.00% 50.00%
(PQ – VPQ) / $360,000 / 6.0000
Copyright Cengage Learning. Powered by Cognero.
(PQ – VPQ – FPQ) $60,000
Page 1157
POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 14A Degree of Leverage QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.16.14.14A - Degree of Leverage NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: DOL in sales dollars KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:19 PM DATE MODIFIED: 9/21/2017 6:19 PM 15. A company has an EBIT of $4 million, and its degree of total leverage is 2.4. The firm's debt consists of $20 million in bonds with a YTM of 11.60%. The company is considering a new production process that will require an increase in fixed costs but a decrease in variable costs. If adopted, the new process will result in a degree of operating leverage of 1.4. The president wants to keep the degree of total leverage at 2.4. If EBIT remains at $4 million, what dollar amount of bonds must be outstanding to accomplish this (assuming the yield to maturity remains at 11.60% and is equal to the coupon rate)? Do not round intermediate calculations. a. $14,367,816 b. $16,091,954 c. $16,810,345 d. $16,666,667 e. $15,229,885 ANSWER: a RATIONALE: EBIT $4,000,000 DTL 2.4 Debt $20,000,000 YTM 11.60% New DOL 1.4 Determine DFL: DTL = DOL 2.4 = 1.4 DFL = 1.7143
DFL DFL
Calculate interest from DFL equation: EBIT DFL = EBIT – I 1.7143
=
$4,000,000 Copyright Cengage Learning. Powered by Cognero.
$4,000,000 $4,000,000 – I =
$6,857,143
–I
1.7143 Page 1158
1.7143 I
I
= =
$2,857,143 $1,666,667
Calculate dollar amount of debt from interest expense: Debt = Interest expense / YTM Debt = $1,666,667 / 11.60% Debt = $14,367,816
POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 14A Degree of Leverage QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.16.14.14A - Degree of Leverage NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Fin. leverage, DOL, and DTL KEYWORDS: Bloom's: Evaluation OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:19 PM DATE MODIFIED: 9/21/2017 6:19 PM 16. The use of financial leverage by the firm has a potential impact on which of the following? (1) (2) (3) (4) (5)
The risk associated with the firm. The return experienced by the shareholder. The variability of net income. The degree of operating leverage. The degree of financial leverage. a. 1, 3, 5 b. 1, 2, 5 c. 2, 3, 5 d. 2, 3, 4, 5 e. 1, 2, 3, 5 ANSWER: e POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 14A Degree of Leverage QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.14.14A - Degree of Leverage NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Financial leverage Copyright Cengage Learning. Powered by Cognero.
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KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
Bloom's: Evaluation Multiple Choice: Conceptual 9/21/2017 6:19 PM 9/21/2017 6:19 PM
17. Assume that a firm has a degree of financial leverage of 1.65. If sales increase by 20%, the firm will experience a 60% increase in EPS, and it will have an EBIT of $100,000. What will be the EBIT for this firm if sales do not increase? Do not round intermediate calculations. a. $86,533 b. $71,867 c. $73,333 d. $90,200 e. $89,467 ANSWER: c RATIONALE: DFL 1.65 20% % Sales 60% % EPS $100,000 EBIT1 Determine DTL: DTL = % EPS DTL = 60% DTL = 3.0000
/ /
% Sales 20%
Determine DOL: DOL = DTL/DFL DOL = 1.8182 EBIT1 $100,000 $100,000 EBIT0
= EBIT0 = EBIT0 = EBIT0 = $73,333
[1 + [1 + 1.3636
DOL 1.8182
% Sales] 20%]
POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 14A Degree of Leverage QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.16.14.14A - Degree of Leverage NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Expected EBIT KEYWORDS: Bloom's: Analysis Copyright Cengage Learning. Powered by Cognero.
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OTHER: DATE CREATED: DATE MODIFIED:
Multiple Choice: Problem 9/21/2017 6:19 PM 9/21/2017 6:19 PM
18. Which of the following is a key benefit of using the degree of leverage concept in financial analysis? a. It allows decision makers a relatively clear assessment of the consequences of alternative actions. b. It establishes the optimal capital structure for the firm. c. It shows how a given change in leverage will affect sales. d. It identifies, with certainty, the future net income based upon sales projections about the future. e. None of the above statements is correct. ANSWER: a POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 14A Degree of Leverage QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.14.14A - Degree of Leverage NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Degree of leverage KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:19 PM DATE MODIFIED: 9/21/2017 6:19 PM 19. If a firm uses debt financing (Debt ratio = 0.40) and sales change from the current level, which of the following statements is CORRECT? a. The percentage change in operating income (EBIT) resulting from the change in sales will exceed the percentage change in net income. b. The percentage change in EBIT will equal the percentage change in net income. c. The percentage change in net income relative to the percentage change in sales (and in EBIT) will not depend on the interest rate paid on the debt. d. The percentage change in operating income will be less than the percentage change in net income. e. Since debt is used, the degree of operating leverage must be greater than 1. ANSWER: d POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 14A Degree of Leverage QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.14.14A - Degree of Leverage NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Financial leverage Copyright Cengage Learning. Powered by Cognero.
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KEYWORDS: OTHER: DATE CREATED: DATE MODIFIED:
Bloom's: Comprehension Multiple Choice: Conceptual 9/21/2017 6:19 PM 9/21/2017 6:19 PM
20. Stromburg Corporation makes surveillance equipment for intelligence organizations. Its sales are $75,000,000. Fixed costs, including research and development, are $40,000,000, while variable costs amount to 30% of sales. Stromburg plans an expansion which will generate additional fixed costs of $15,000,000, decrease variable costs to 25% of sales, and also permit sales to increase to $93,000,000. What is Stromburg's degree of operating leverage at the new projected sales level? a. 4.2086 b. 3.7831 c. 4.7288 d. 4.0668 e. 5.3436 ANSWER: c RATIONALE: $75,000,000 Sales 0
FC0 VC0% Sales1 FC1 VC1%
$40,000,000 30% $93,000,000 $55,000,000 25%
DOL (S– VC) / (S– VC– F) = DOL $69,750,000 / $14,750,000 = DOL 4.7288 = POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 14A Degree of Leverage QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.16.14.14A - Degree of Leverage NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: DOL change KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:19 PM DATE MODIFIED: 9/21/2017 6:19 PM 21. Lincoln Lodging Inc. estimates that if its sales increase 10.00% then its net income will increase 15.00%. The Copyright Cengage Learning. Powered by Cognero.
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company's EBIT equals $2.4 million, and its interest expense is $400,000. The company's operating costs include fixed and variable costs. What is the level of the company's fixed operating costs? Do not round your intermediate calculations. a. $720,000 b. $558,000 c. $624,000 d. $600,000 e. $534,000 ANSWER: d RATIONALE: 10.00% % Sales
15.00% $2,400,000 $400,000
% NI EBIT Interest Calculate DTL:
DTL = DOL % EBIT DTL = % Sales DTL =
% NI % Sales
DTL =
15.00% 10.00%
DFL % NI % EBIT
DTL = 1.50 Calculate DFL:
DFL =
EBIT EBIT – I
DFL =
$2,400,000 $2,000,000
DFL = 1.20 Calculate DOL:
DTL = 1.50 = DOL =
DOL DOL 1.25
DFL 1.20
Now, calculate fixed costs: EBIT = S – VC – FC, so
DOL =
S – VC S –VC – FC
DOL =
S – VC EBIT
1.25 =
S – VC $2,400,000
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$3,000,000 = S – VC FC = $3,000,000 – $2,400,000 FC = $600,000
POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 14A Degree of Leverage QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.16.14.14A - Degree of Leverage NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: DOL, DFL, and fixed oper. costs KEYWORDS: Bloom's: Evaluation OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:19 PM DATE MODIFIED: 9/21/2017 6:19 PM 22. The "degree of leverage" concept is designed to show how changes in sales will affect EBIT and EPS. If a 20.00% increase in sales causes EPS to increase from $1.00 to $1.50, and if the firm uses no debt, then what is its degree of operating leverage? Do not round intermediate calculations. a. 2.1250 b. 2.8500 c. 2.4750 d. 2.5000 e. 2.0000 ANSWER: d RATIONALE:
EPS0 EPS1 %ΔSales Debt DFL
$1.00 $1.50 20.00% 0 1*
* By definition, if debt = 0 then DFL =1
EPS1 $1.50 $1.50 $0.50 DTL
=
EPS0
+
= = = =
$1.00 + $1.00 + $0.2000 DTL 2.5000
[DTL × × $1.00 × DTL × $0.2000 DTL EPS0
%ΔSales]
20.00%
DTL = DOL × DFL 2.5000 = DOL × 1 Copyright Cengage Learning. Powered by Cognero.
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DOL = 2.5000 POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 14A Degree of Leverage QUESTION TYPE: Multiple Choice HAS VARIABLES: True LEARNING OBJECTIVES: FOFM.BRIG.16.14.14A - Degree of Leverage NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: DOL KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Problem DATE CREATED: 9/21/2017 6:19 PM DATE MODIFIED: 9/21/2017 6:19 PM 23. Company D has a 50% debt ratio, whereas Company E has no debt financing. The two companies have the same level of sales and the same degree of operating leverage. Which of the following statements is most CORRECT? a. If sales increase 10% for both companies, then Company D will have a larger percentage increase in its net income. b. If sales increase 10% for both companies, then Company D will have a larger percentage increase in its operating income (EBIT). c. If EBIT increases 10% for both companies, then Company D's net income will rise by more than 10%, while Company E's net income will rise by less than 10%. d. Company E has a higher degree of financial leverage. e. The two companies have the same degree of total leverage. ANSWER: a POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 14A Degree of Leverage QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FOFM.BRIG.16.14.14A - Degree of Leverage NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.10 - Capital structure LOCAL STANDARDS: United States - OH - Default City - Tier 2: - Capital structure TOPICS: Debt ratio and DOL KEYWORDS: Bloom's: Evaluation OTHER: Multiple Choice: Conceptual DATE CREATED: 9/21/2017 6:19 PM DATE MODIFIED: 9/21/2017 6:19 PM
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