Fin 534 midterm exam – strayer new

FIN 534 Week 5 Midterm Exam â&#x20AC;&#x201C; Strayer New Click On The Link Below To Purchase Instant Download http://www.budapp.net/FIN-534-Midterm-Exam-Strayer-New-FIN534W5E.htm 1 Which of the following statements is CORRECT? <span style="font-size: 13px;"> </span> The New York Stock Exchange is an auction market with a physical location. &nbsp; Capital market transactions involve only the purchase and sale of equity securities, i.e., common stocks. &nbsp; If an investor sells shares of stock through a broker, then this would be a primary market transaction. &nbsp; Consumer automobile loans are evidenced by legal documents called "promissory notes," and these individual notes are traded in the money market. &nbsp; While the distinctions are blurring as investment banks are today buying commercial banks, and vice versa, investment banks generally specialize in lending money, whereas commercial banks generally help companies raise capital from other parties. &nbsp; 2 Which of the following statements is CORRECT? &nbsp; &nbsp; It is usually easier to transfer ownership in a corporation than it is to transfer ownership in a sole proprietorship. &nbsp; Corporate shareholders are exposed to unlimited liability. &nbsp;

Corporations generally face fewer regulations than sole proprietorships. &nbsp; Corporate shareholders are exposed to unlimited liability, and this factor may be compounded by the tax disadvantages of incorporation. &nbsp; Shareholders in a regular corporation (not an S corporation) pay higher taxes than owners of an otherwise identical proprietorship. &nbsp; &nbsp; 3 Which of the following statements is CORRECT? &nbsp; &nbsp; While the distinctions are blurring, investment banks generally specialize in lending money, whereas commercial banks generally help companies raise capital from other parties. &nbsp; A security whose value is derived from the price of some other "underlying" asset is called a liquid security. &nbsp; Money market mutual funds usually invest most of their money in a well-diversified portfolio of liquid common stocks. &nbsp; Money markets are markets for common stocks and long-term debt. &nbsp; The NYSE operates as an auction market, whereas the Nasdaq is a dealer market. &nbsp; 4 Which of the following statements is CORRECT? &nbsp;

&nbsp; Capital market instruments include both long-term debt and common stocks. &nbsp; An example of a primary market transaction would be your uncle transferring 100 shares of Wal-Mart stock to you as a birthday gift. &nbsp; The NYSE does not exist as a physical location; rather, it represents a loose collection of dealers who trade stocks electronically. &nbsp; 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. &nbsp; 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. &nbsp; &nbsp; 5 Which of the following could explain why a business might choose to operate as a corporation rather than as a sole proprietorship or a partnership? &nbsp; &nbsp; Corporations generally find it relatively difficult to raise large amounts of capital. &nbsp; Less of a corporation's income is generally subjected to taxes than would be true if the firm were a partnership. &nbsp; Corporate shareholders escape liability for the firm's debts, but this factor may be offset by the tax disadvantages of the corporate form of organization. &nbsp;

Corporate investors are exposed to unlimited liability. &nbsp; Corporations generally face relatively few regulations. &nbsp; &nbsp; 6 You recently sold 100 shares of your new company, XYZ Corporation, 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 statements best describes this transaction? &nbsp; &nbsp; This is an example of an exchange of physical assets. &nbsp; This is an example of a primary market transaction. &nbsp; This is an example of a direct transfer of capital. &nbsp; This is an example of a money market transaction. &nbsp; This is an example of a derivatives market transaction &nbsp; &nbsp; 7 Money markets are markets for &nbsp; &nbsp; Foreign stocks.

&nbsp; Consumer automobile loans. &nbsp; U.S. stocks. &nbsp; Short-term debt securities. &nbsp; Long-term bonds. &nbsp; &nbsp; 8 Which of the following statements is CORRECT? &nbsp; &nbsp; If Apple issues additional shares of common stock through an investment banker, this would be a secondary market transaction. &nbsp; If you purchased 100 shares of Apple stock from your sister-in-law, this would be an example of a primary market transaction. &nbsp; The IPO market is a subset of the secondary market. &nbsp; Only institutions, and not individuals, can participate in derivatives market transactions. &nbsp; As they are generally defined, money market transactions involve debt securities with maturities of less than one year. &nbsp;

9 DeYoung Devices Inc., a new high-tech instrumentation firm, is building and equipping a new manufacturing facility. 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? &nbsp; &nbsp; The firm's reported net income would increase. &nbsp; The firm's operating income (EBIT) would increase. &nbsp; The firm's taxable income would increase. &nbsp; The firm's net cash flow would increase. &nbsp; The firm's tax payments would increase. &nbsp; &nbsp; 10 Which of the following factors could explain why Regal Industrial Fixtures had a negative net cash flow last year, even though the cash on its balance sheet increased? &nbsp; &nbsp; The company repurchased 20% of its common stock. &nbsp; The company sold a new issue of bonds. &nbsp; The company made a large investment in new plant and equipment.

&nbsp; The company paid a large dividend. &nbsp; The company had high amortization expenses. &nbsp; &nbsp; 11 Which of the following statements is CORRECT? &nbsp; &nbsp; The statement of cash flows shows how much the firm's cashâ&#x17D;Żthe total of currency, bank deposits, and short-term liquid securities (or cash equivalents)â&#x17D;Żincreased or decreased during a given year. &nbsp; The statement of cash flows reflects cash flows from operations, but it does not reflect the effects of buying or selling fixed assets. &nbsp; 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. &nbsp; The statement of cash flows reflects cash flows from continuing operations, but it does not reflect the effects of changes in working capital. &nbsp; 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. &nbsp; &nbsp; 12 Which of the following statements is CORRECT? &nbsp;

&nbsp; One way to increase EVA is to achieve the same level of operating income but with more investor-supplied capital. &nbsp; If a firm reports positive net income, its EVA must also be positive. &nbsp; One drawback of EVA as a performance measure is that it mistakenly assumes that equity capital is free. &nbsp; One way to increase EVA is to generate the same level of operating income but with less investor-supplied capital. &nbsp; Actions that increase reported net income will always increase net cash flow. &nbsp; &nbsp; 13 The LeMond Corporation just purchased a new production line. 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. &nbsp; &nbsp; LeMond's tax liability for the year will be lower. &nbsp; LeMond's taxable income will be lower. &nbsp; LeMond's net fixed assets as shown on the balance sheet will be higher at the end of the year.

&nbsp; LeMond's cash position will improve (increase). &nbsp; LeMond's reported net income after taxes for the year will be lower. &nbsp; &nbsp; 14 Other things held constant, which of the following actions would increase the amount of cash on a company's balance sheet? &nbsp; &nbsp; The company purchases a new piece of equipment. &nbsp; The company repurchases common stock. &nbsp; The company pays a dividend. &nbsp; The company issues new common stock. &nbsp; The company gives customers more time to pay their bills. &nbsp; &nbsp; 15 Which of the following statements is CORRECT? &nbsp; &nbsp; All corporations other than non-profit corporations are subject to corporate income taxes, which are 15% for the lowest amounts of income and 35% for the highest amounts of income.

&nbsp; 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. &nbsp; All businesses, regardless of their legal form of organization, are taxed under the Business Tax Provisions of the Internal Revenue Code. &nbsp; Small businesses that qualify under the Tax Code can elect not to pay corporate taxes, but then their owners must report their pro rata shares of the firm's income as personal income and pay taxes on that income. &nbsp; Congress recently changed the tax laws to make dividend income received by individuals exempt from income taxes. Prior to the enactment of that law, corporate income was subject to double taxation, where the firm was first taxed on the income and stockholders were taxed again on the income when it was paid to them as dividends. &nbsp; &nbsp; 16 Which of the following statements is CORRECT? &nbsp; &nbsp; 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. &nbsp; MVA gives us an idea about how much value a firm's management has added during the last year. &nbsp; MVA stands for market value added, and it is defined as follows:

MVA = (Shares outstanding)(Stock price) + Book value of common equity. &nbsp; EVA stands for economic value added, and it is defined as follows: EVA = EBIT(1 - T) - (Investor-supplied op. capital) x (A - T cost of capital). &nbsp; EVA gives us an idea about how much value a firm's management has added over the firm's life. &nbsp; &nbsp; 17 Which of the following items cannot be found on a firm's balance sheet under current liabilities? &nbsp; &nbsp; Accrued payroll taxes. &nbsp; Accounts payable. &nbsp; Short-term notes payable to the bank. &nbsp; Accrued wages. &nbsp; Cost of goods sold. &nbsp; &nbsp; 18 Which of the following statements is CORRECT? &nbsp;

&nbsp; If a firm increases its sales and cost of goods sold while holding its inventories constant, then, other things held constant, its inventory turnover ratio will decrease. &nbsp; A reduction in inventories held would have no effect on the current ratio. &nbsp; An increase in inventories would have no effect on the current ratio. &nbsp; If a firm increases its sales and cost of goods sold while holding its inventories constant, then, other things held constant, its inventory turnover ratio will increase. &nbsp; A reduction in the inventory turnover ratio will generally lead to an increase in the ROE. &nbsp; &nbsp; 19 Which of the following would, generally, indicate an improvement in a company's financial position, holding other things constant? &nbsp; &nbsp; The total assets turnover decreases. &nbsp; The TIE declines. &nbsp; The DSO increases. &nbsp; The EBITDA coverage ratio increases. &nbsp;

The current and quick ratios both decline. &nbsp; &nbsp; 20 Cordelion Communications 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 Cordelion pays, EBIT, or the tax rate. Which of the following is likely to occur if the company goes ahead with the stock issue? &nbsp; &nbsp; The times interest earned ratio will decrease. &nbsp; The ROA will decline. &nbsp; Taxable income will decrease. &nbsp; The tax bill will increase. &nbsp; Net income will decrease. &nbsp; &nbsp; 21 Which of the following would indicate an improvement in a company's financial position, holding other things constant? &nbsp; &nbsp; The current and quick ratios both increase. &nbsp; The inventory and total assets turnover ratios both decline.

&nbsp; The debt ratio increases. &nbsp; The profit margin declines. &nbsp; The EBITDA coverage ratio declines. &nbsp; &nbsp; 22 The Cavendish Company 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 would occur as a result of this action? &nbsp; &nbsp; The company's debt ratio increased. &nbsp; The company's current ratio increased. &nbsp; The company's times interest earned ratio decreased. &nbsp; The company's basic earning power ratio increased. &nbsp; The company's equity multiplier increased. &nbsp; &nbsp; 23 If a bank loan officer were considering a company's request for a loan, which of the following statements would you consider to be CORRECT?

&nbsp; &nbsp; Other things held constant, the lower the current ratio, the lower the interest rate the bank would charge the firm. &nbsp; The lower the company's EBITDA coverage ratio, other things held constant, the lower the interest rate the bank would charge the firm. &nbsp; Other things held constant, the higher the debt ratio, the lower the interest rate the bank would charge the firm. &nbsp; Other things held constant, the lower the debt ratio, the lower the interest rate the bank would charge the firm. &nbsp; The lower the company's TIE ratio, other things held constant, the lower the interest rate the bank would charge the firm. &nbsp; &nbsp; 24 Arshadi Corp.'s sales last year were $52,000, and its total assets were $22,000.

What was its total assets turnover ratio (TATO)? &nbsp; &nbsp; 2.03 &nbsp; 2.13 &nbsp; 2.25 &nbsp;

2.36 &nbsp; 2.48 &nbsp; &nbsp; 25 Companies A and C each reported the same earnings per share (EPS), but Company A's stock trades at a higher price. Which of the following statements is CORRECT? &nbsp; &nbsp; Company A trades at a higher P/E ratio. &nbsp; Company A probably has fewer growth opportunities. &nbsp; Company A is probably judged by investors to be riskier. &nbsp; Company A must have a higher market-to-book ratio. &nbsp; Company A must pay a lower dividend. &nbsp; &nbsp; FIN 534 Midterm Exam Part 2 &nbsp; 1 Which of the following statements regarding a 20-year (240-month) $225,000, fixed-rate mortgage is CORRECT? (Ignore taxes and transactions costs.) &nbsp; &nbsp;

The outstanding balance declines at a slower rate in the later years of the loan's life. &nbsp; The remaining balance after three years will be $225,000 less one third of the interest paid during the first three years. &nbsp; Because it is a fixed-rate mortgage, the monthly loan payments (which include both interest and principal payments) are constant. &nbsp; Interest payments on the mortgage will increase steadily over time, but the total amount of each payment will remain constant. &nbsp; 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. &nbsp; 2 Which of the following statements is CORRECT, assuming positive interest rates and holding other things constant? &nbsp; &nbsp; 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. &nbsp; The present value of a 5-year, $250 annuity due will be lower than the PV of a similar ordinary annuity. &nbsp; A 30-year, $150,000 amortized mortgage will have larger monthly payments than an otherwise similar 20-year mortgage. &nbsp; A bank loan's nominal interest rate will always be equal to or less than its effective annual rate.

&nbsp; If an investment pays 10% interest, compounded annually, its effective annual rate will be less than 10%. &nbsp; &nbsp; 3 Ellen now has $125. How much would she have after 8 years if she leaves it invested at 8.5% with annual compounding? &nbsp; &nbsp; $205.83 &nbsp; $216.67 &nbsp; $228.07 &nbsp; $240.08 &nbsp; $252.08 &nbsp; &nbsp; 4 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? &nbsp; &nbsp; The discount rate increases. &nbsp;

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. &nbsp; The discount rate decreases. &nbsp; The riskiness of the investment's cash flows increases. &nbsp; 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. &nbsp; &nbsp; 5 Which of the following statements is CORRECT? &nbsp; &nbsp; An investment that has a nominal rate of 6% with semiannual payments will have an effective rate that is smaller than 6%. &nbsp; The present value of a 3-year, $150 ordinary annuity will exceed the present value of a 3-year, $150 annuity due. &nbsp; If a loan has a nominal annual rate of 7%, then the effective rate will never be less than 7%. &nbsp; If a loan or investment has annual payments, then the effective, periodic, and nominal rates of interest will all be different. &nbsp; The proportion of the payment that goes toward interest on a fully amortized loan increases over time.

&nbsp; &nbsp; 6 A $150,000 loan is to be amortized over 6 years, with annual end-of-year payments.

Which of these statements is CORRECT? &nbsp; &nbsp; The proportion of interest versus principal repayment would be the same for each of the 7 payments. &nbsp; The annual payments would be larger if the interest rate were lower. &nbsp; If the loan were amortized over 10 years rather than 6 years, and if the interest rate were the same in either case, the first payment would include more dollars of interest under the 6-year amortization plan. &nbsp; The proportion of each payment that represents interest as opposed to repayment of principal would be higher if the interest rate were lower. &nbsp; The proportion of each payment that represents interest versus repayment of principal would be higher if the interest rate were higher. &nbsp; &nbsp; 7 Which of the following statements is CORRECT? &nbsp; &nbsp; 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. &nbsp;

Other things held constant, a corporation would rather issue noncallable bonds than callable bonds. &nbsp; Other things held constant, a callable bond would have a lower required rate of return than a noncallable bond. &nbsp; Reinvestment rate risk is worse from an investor's standpoint than interest rate price risk if the investor has a short investment time horizon. &nbsp; 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. &nbsp; &nbsp; 8 A 10-year bond with a 9% annual coupon has a yield to maturity of 8%. Which of the following statements is CORRECT? &nbsp; &nbsp; The bond is selling below its par value. &nbsp; The bond is selling at a discount. &nbsp; If the yield to maturity remains constant, the bond's price one year from now will be lower than its current price. &nbsp; The bond's current yield is greater than 9%. &nbsp; If the yield to maturity remains constant, the bond's price one year from now will be higher than its current price.

&nbsp; &nbsp; 9 Which of the following statements is NOT CORRECT? &nbsp; &nbsp; All else equal, bonds with longer maturities have more interest rate (price) risk than bonds with shorter maturities. &nbsp; If a bond is selling at its par value, its current yield equals its yield to maturity. &nbsp; If a bond is selling at a premium, its current yield will be greater than its yield to maturity. &nbsp; All else equal, bonds with larger coupons have greater interest rate (price) risk than bonds with smaller coupons. &nbsp; If a bond is selling at a discount to par, its current yield will be less than its yield to maturity. &nbsp; &nbsp; 10 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 NOT CORRECT? &nbsp; &nbsp; The bond's yield to maturity is 9%. &nbsp; The bond's current yield is 9%.

&nbsp; If the bond's yield to maturity remains constant, the bond will continue to sell at par. &nbsp; The bond's current yield exceeds its capital gains yield. &nbsp; The bond's expected capital gains yield is positive. &nbsp; &nbsp; 11 Which of the following statements is CORRECT? &nbsp; &nbsp; If a coupon bond is selling at a discount, its price will continue to decline until it reaches its par value at maturity. &nbsp; 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. &nbsp; If a bond's yield to maturity exceeds its annual coupon, then the bond will trade at a premium. &nbsp; If a coupon bond is selling at a premium, its current yield equals its yield to maturity. &nbsp; If a coupon bond is selling at par, its current yield equals its yield to maturity. &nbsp; &nbsp;

12 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? &nbsp; &nbsp; If the yield to maturity remains at 8%, then the bond's price will decline over the next year. &nbsp; The bond's coupon rate is less than 8%. &nbsp; If the yield to maturity increases, then the bond's price will increase. &nbsp; If the yield to maturity remains at 8%, then the bond's price will remain constant over the next year. &nbsp; The bond's current yield is less than 8%. &nbsp; &nbsp; 13 Bonds A and B are 15-year, $1,000 face value 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%, which is expected to remain constant for the next 15 years. Which of the following statements is CORRECT? &nbsp; &nbsp; One year from now, Bond A's price will be higher than it is today. &nbsp; Bond A's current yield is greater than 8%. &nbsp; Bond A has a higher price than Bond B today, but one year from now the bonds will have the same price.

&nbsp; Both bonds have the same price today, and the price of each bond is expected to remain constant until the bonds mature. &nbsp; Bond B has a higher price than Bond A today, but one year from now the bonds will have the same price. &nbsp; &nbsp; 14 Which of the following statements is CORRECT? &nbsp; &nbsp; 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. &nbsp; 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. &nbsp; If investors become less risk averse, the slope of the Security Market Line will increase. &nbsp; 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. &nbsp; The slope of the SML is determined by the value of beta. &nbsp;

&nbsp; 15 Which of the following statements is CORRECT? &nbsp; &nbsp; 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. &nbsp; A two-stock portfolio will always have a lower beta than a one-stock portfolio. &nbsp; If portfolios are formed by randomly selecting stocks, a 10-stock portfolio will always have a lower beta than a one-stock portfolio. &nbsp; A stock with an above-average standard deviation must also have an above-average beta. &nbsp; A two-stock portfolio will always have a lower standard deviation than a one-stock portfolio. &nbsp; &nbsp; 16 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. Your portfolio consists of 50% A and 50% B. Which of the following statements is CORRECT? &nbsp; &nbsp; The portfolio's expected return is 15%. &nbsp; The portfolio's standard deviation is greater than 20%.

&nbsp; The portfolio's beta is greater than 1.2. &nbsp; The portfolio's standard deviation is 20%. &nbsp; The portfolio's beta is less than 1.2. &nbsp; &nbsp; 17 Stock X has a beta of 0.7 and Stock Y has a beta of 1.7. Which of the following statements must be true, according to the CAPM? &nbsp; &nbsp; Stock Y's realized return during the coming year will be higher than Stock X's return. &nbsp; 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. &nbsp; Stock Y's return has a higher standard deviation than Stock X. &nbsp; 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. &nbsp; 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. &nbsp; &nbsp;

18 Assume that the risk-free rate remains constant, but the market risk premium declines. Which of the following is most likely to occur? &nbsp; &nbsp; The required return on a stock with beta &gt; 1.0 will increase. &nbsp; The return on "the market" will remain constant. &nbsp; The return on "the market" will increase. &nbsp; The required return on a stock with beta &lt; 1.0 will decline. &nbsp; The required return on a stock with beta = 1.0 will not change. &nbsp; &nbsp; 19 Which of the following statements is CORRECT? &nbsp; &nbsp; The higher the correlation between the stocks in a portfolio, the lower the risk inherent in the portfolio. &nbsp; An investor can eliminate almost all risk if he or she holds a very large and well diversified portfolio of stocks. &nbsp; Once a portfolio has about 40 stocks, adding additional stocks will not reduce its risk by even a small amount. &nbsp;

An investor can eliminate almost all diversifiable risk if he or she holds a very large, well-diversified portfolio of stocks. &nbsp; An investor can eliminate almost all market risk if he or she holds a very large and well diversified portfolio of stocks. &nbsp; &nbsp; 20 Franklin Corporation is expected to pay a dividend of $1.25 per share at the end of the year (D1 = $1.25). The stock sells for $32.50 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? &nbsp; &nbsp; 6.01% &nbsp; 6.17% &nbsp; 6.33% &nbsp; 6.49% &nbsp; 6.65% &nbsp; &nbsp; &nbsp; 21 A stock just paid a dividend of D0 = $1.50. The required rate of return is rs = 10.1%, and the constant growth rate is g = 4.0%. What is the current stock price? &nbsp;

&nbsp; $23.11 &nbsp; $23.70 &nbsp; $24.31 &nbsp; $24.93 &nbsp; $25.57 &nbsp; &nbsp; 22 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? &nbsp; &nbsp; Stock B must have a higher dividend yield than Stock A. &nbsp; Stock A must have a higher dividend yield than Stock B. &nbsp; If Stock A has a higher dividend yield than Stock B, its expected capital gains yield must be lower than Stock B's. &nbsp; Stock A must have both a higher dividend yield and a higher capital gains yield than Stock B. &nbsp;

If Stock A has a lower dividend yield than Stock B, its expected capital gains yield must be higher than Stock B's. &nbsp; &nbsp; 23 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? &nbsp; A

B

Price $25

$40

Expected growth

7%

9%

Expected return

10%

12%

&nbsp; &nbsp; The two stocks could not be in equilibrium with the numbers given in the question. &nbsp; A's expected dividend is $0.50. &nbsp; B's expected dividend is $0.75. &nbsp; A's expected dividend is $0.75 and B's expected dividend is $1.20. &nbsp; The two stocks should have the same expected dividend. &nbsp; &nbsp; 24 Which of the following statements is NOT CORRECT? &nbsp;

&nbsp; The corporate valuation model discounts free cash flows by the required return on equity. &nbsp; The corporate valuation model can be used to find the value of a division. &nbsp; An important step in applying the corporate valuation model is forecasting the firm's pro forma financial statements. &nbsp; Free cash flows are assumed to grow at a constant rate beyond a specified date in order to find the horizon, or terminal, value. &nbsp; The corporate valuation model can be used both for companies that pay dividends and those that do not pay dividends. &nbsp; &nbsp; 25 Which of the following statements is CORRECT? &nbsp; &nbsp; Preferred stock is normally expected to provide steadier, more reliable income to investors than the same firm's common stock, and, as a result, the expected after-tax yield on the preferred is lower than the after-tax expected return on the common stock. &nbsp; 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. &nbsp; 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 would be tax free.

&nbsp; One of the advantages to financing with preferred stock is that 70% of the dividends paid out are tax deductible to the issuer. &nbsp; A major disadvantage of financing with preferred stock is that preferred stockholders typically have supernormal voting rights. &nbsp; FIN 534 Midterm Exam Solution

CHAPTER 1—AN OVERVIEW OF FINANCIAL MANAGEMENT AND THE FINANCIAL ENVIRONMENT TRUE/FALSE 1.The form of organization for a business is not an important issue, as this decision has very little effect on the income and wealth of the firm's owners.

ANS:FPTS:1DIF:Difficulty: EasyOBJ:LO: 1-2NAT:BUSPROG: Reflective ThinkingSTA:DISC: Goals of the firm, role of finance, and analysis of public informationLOC:TBATOP:Firm organizationKEY:Bloom’s: Knowledge 2.The major advantage of a regular partnership or a corporation as a form of business organization is the fact that both offer their owners limited liability, whereas proprietorships do not.

ANS:FPTS:1DIF:Difficulty: EasyOBJ:LO: 1-2NAT:BUSPROG: Reflective ThinkingSTA:DISC: Goals of the firm, role of finance, and analysis of public informationLOC:TBATOP:Firm organizationKEY:Bloom’s: Knowledge 3.There are three primary disadvantages of a regular partnership: (1) unlimited liability, (2) limited life of the organization, and (3) difficulty of transferring ownership. These combine to make it difficult for partnerships to attract large amounts of capital and thus to grow to a very large size.

ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 1-2NAT:BUSPROG: Reflective ThinkingSTA:DISC: Goals of the firm, role of finance, and analysis of public informationLOC:TBATOP:PartnershipKEY:Bloom’s: Knowledge 4.Two disadvantages of a proprietorship are (1) the relative difficulty of raising new capital and (2) the owner's unlimited personal liability for the business' debts.

ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 1-2NAT:BUSPROG: Reflective ThinkingSTA:DISC: Goals of the firm, role of finance, and analysis of public informationLOC:TBATOP:ProprietorshipKEY:Bloom’s: Knowledge 5.One key value of limited liability is that it lowers owners' risks and thereby enhances a firm's value.

ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 1-2NAT:BUSPROG: Reflective ThinkingSTA:DISC: Goals of the firm, role of finance, and analysis of public informationLOC:TBATOP:Limited liabilityKEY:Bloom’s: Knowledge 6.If a firm's goal is to maximize its earnings per share, this is the best way to maximize the price of the common stock and thus shareholders' wealth.

ANS:FPTS:1DIF:Difficulty: EasyOBJ:LO: 1-3NAT:BUSPROG: Reflective ThinkingSTA:DISC: Goals of the firm, role of finance, and analysis of public informationLOC:TBATOP:Value maximizationKEY:Bloom’s: Knowledge 7.If Firm A's business is to obtain savings from individuals and then invest them in financial assets issued by other firms or individuals, Firm A is a financial intermediary.

ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 1-4NAT:BUSPROG: Reflective ThinkingSTA:DISC: Goals of the firm, role of finance, and analysis of public informationLOC:TBATOP:Financial intermediariesKEY:Bloom’s: Knowledge 8.If an individual investor buys or sells a currently outstanding stock through a broker, this is a primary market transaction.

ANS:FPTS:1DIF:Difficulty: EasyOBJ:LO: 1-8NAT:BUSPROG: Reflective ThinkingSTA:DISC: Financial markets, institutions, and interest ratesLOC:TBATOP:Financial marketsKEY:Bloom’s: Knowledge 9.Recently, Hale Corporation announced the sale of 2.5 million newly issued shares of its stock at a price of $21 per share. Hale sold the stock to an investment banker, who in turn sold it to individual and institutional investors. This is a primary market transaction.

ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 1-8NAT:BUSPROG: Reflective ThinkingSTA:DISC: Financial markets, institutions, and interest ratesLOC:TBATOP:Financial marketsKEY:Bloom’s: Knowledge 10.One of the functions of NYSE specialists is to facilitate trading by keeping an inventory of shares of the stocks in which they specialize, buying when investors want to sell and selling when they want to buy. They change the bid and ask prices of the securities so as to keep supply and demand in balance.

ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 1-11NAT:BUSPROG: Reflective ThinkingSTA:DISC: Financial markets, institutions, and interest ratesLOC:TBATOP:Stock market transactionsKEY:Bloom’s: Knowledge 11.The disadvantages associated with a proprietorship are similar to those under a partnership. One exception relates to the more formal nature of the partnership agreement and the commitment of all partners' personal assets. As a result, partnerships do not have difficulty raising large amounts of capital.

ANS:FPTS:1DIF:Difficulty: ModerateOBJ:LO: 1-2NAT:BUSPROG: Reflective ThinkingSTA:DISC: Goals of the firm, role of finance, and analysis of public informationLOC:TBATOP:PartnershipKEY:Bloom’s: Comprehension 12.The facts that a proprietorship, as a business, pays no corporate income tax, and that it is easily and inexpensively formed, are two key advantages to that form of business.

ANS:TPTS:1DIF:Difficulty: ModerateOBJ:LO: 1-2NAT:BUSPROG: Reflective ThinkingSTA:DISC: Goals of the firm, role of finance, and analysis of public informationLOC:TBATOP:ProprietorshipKEY:Bloom’s: Comprehension MULTIPLE CHOICE 13.Which of the following statements is CORRECT?a.One of the disadvantages of incorporating a business is that the owners then become subject to liabilities in the event the firm goes bankrupt.b.Sole proprietorships are subject to more regulations than corporations.c.In any type of partnership, every partner has the same rights, privileges, and liability exposure as every other partner.d.Sole proprietorships and partnerships generally have a tax advantage over many corporations, especially large ones.e.Corporations of all types are subject to the corporate income tax.

ANS:D PTS:1DIF:Difficulty: EasyOBJ:LO: 1-2NAT:BUSPROG: AnalyticSTA:DISC: Goals of the firm, role of finance, and analysis of public informationLOC:TBATOP:Firm organizationKEY:Bloom’s: ComprehensionMSC:TYPE: Multiple Choice: Conceptual 14.Which of the following statements is CORRECT?a.One of the disadvantages of a sole proprietorship is that the proprietor is exposed to unlimited liability.b.It is generally easier to transfer one's ownership interest in a partnership than in a corporation.c.One of the advantages of the corporate form of organization is that it avoids double taxation.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.

ANS:APTS:1DIF:Difficulty: EasyOBJ:LO: 1-2NAT:BUSPROG: AnalyticSTA:DISC: Goals of the firm, role of finance, and analysis of public informationLOC:TBATOP:Firm organizationKEY:Bloom’s: ComprehensionMSC:TYPE: Multiple Choice: Conceptual 15.Which of the following statements is CORRECT?a.It is generally more expensive to form a proprietorship than a corporation because, with a proprietorship, extensive legal documents are required.b.Corporations face fewer regulations than sole proprietorships.c.One disadvantage of operating a business as a sole proprietorship is that the firm is subject to double taxation, at both the firm level and the owner level.d.One advantage of forming a corporation is that equity investors are usually exposed to less liability than in a regular partnership.e.If a regular partnership goes bankrupt, each partner is exposed to liabilities only up to the amount of his or her investment in the business.

ANS:D PTS:1DIF:Difficulty: EasyOBJ:LO: 1-2NAT:BUSPROG: AnalyticSTA:DISC: Goals of the firm, role of finance, and analysis of public informationLOC:TBATOP:Firm organizationKEY:Bloom’s: ComprehensionMSC:TYPE: Multiple Choice: Conceptual 16.Cheers Inc. operates as a partnership. Now the partners have decided to convert the business into a regular corporation. Which of the following statements is CORRECT? a.Assuming Cheers is profitable, less of its income will be subject to federal income taxes.b.Cheers will now be subject to fewer regulations.c.Cheers' shareholders (the ex-partners) will now be exposed to less liability.d.Cheers' investors will be exposed to less liability, but they will find it more difficult to transfer their ownership.e.Cheers will find it more difficult to raise additional capital.

ANS:CPTS:1DIF:Difficulty: EasyOBJ:LO: 1-2NAT:BUSPROG: AnalyticSTA:DISC: Goals of the firm, role of finance, and analysis of public informationLOC:TBATOP:Firm organizationKEY:Bloom’s: ComprehensionMSC:TYPE: Multiple Choice: Conceptual 17.Which of the following statements is CORRECT?a.It is usually easier to transfer ownership in a corporation than it is to transfer ownership in a sole proprietorship.b.Corporate shareholders are exposed to unlimited liability.c.Corporations generally face fewer regulations than sole proprietorships.d.Corporate shareholders are exposed to unlimited liability, and this factor may be compounded by the tax disadvantages of incorporation.e.Shareholders in a regular corporation (not an S corporation) pay higher taxes than owners of an otherwise identical proprietorship.

ANS:A PTS:1DIF:Difficulty: EasyOBJ:LO: 1-2NAT:BUSPROG: AnalyticSTA:DISC: Goals of the firm, role of finance, and analysis of public informationLOC:TBATOP:Firm organizationKEY:Bloom’s: ComprehensionMSC:TYPE: Multiple Choice: Conceptual 18.Which of the following could explain why a business might choose to operate as a corporation rather than as a sole proprietorship or a partnership?a.Corporations generally find it relatively difficult to raise large amounts of capital.b.Less of a corporation's income is generally subjected to taxes than would be true if the firm were a partnership.c.Corporate shareholders escape liability for the firm's debts, but this factor may be offset by the tax disadvantages of the corporate form of organization.d.Corporate investors are exposed to unlimited liability.e.Corporations generally face relatively few regulations.

ANS:CPTS:1DIF:Difficulty: EasyOBJ:LO: 1-2NAT:BUSPROG: AnalyticSTA:DISC: Goals of the firm, role of finance, and analysis of public informationLOC:TBATOP:Corporate form of organizationKEY:Bloom’s: ComprehensionMSC:TYPE: Multiple Choice: Conceptual 19.You recently sold 100 shares of your new company, XYZ Corporation, 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 statements best describes this transaction?a.This is an example of an exchange of physical assets.b.This is an example of a primary market transaction.c.This is an example of a direct transfer of capital.d.This is an example of a money market transaction.e.This is an example of a derivatives market transaction ANS:CPTS:1DIF:Difficulty: EasyOBJ:LO: 1-4NAT:BUSPROG: AnalyticSTA:DISC: Financial markets, institutions, and interest ratesLOC:TBATOP:Financial transactionsKEY:Bloom’s: ComprehensionMSC:TYPE: Multiple Choice: Conceptual 20.Which of the following statements is CORRECT?a.If expected inflation increases, interest rates are likely to increase.b.If individuals in general increase the percentage of their income that they save, interest rates are likely to increase.c.If companies have fewer good investment opportunities, 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 Tbills.

ANS:APTS:1DIF:Difficulty: EasyOBJ:LO: 1-6NAT:BUSPROG: AnalyticSTA:DISC: Financial markets, institutions, and interest ratesLOC:TBATOP:Interest ratesKEY:Bloom’s: ComprehensionMSC:TYPE: Multiple Choice: Conceptual 21.Which of the following statements is CORRECT?a.In Europe and Asia hedge funds are legal, but they are not permitted to operate in the United States.b.Hedge funds have more in common with commercial banks than with any other type of financial institution.c.Hedge funds have more in common with investment banks than with any other type of financial institution.d.In the United States hedge funds are legal, but in Europe and Asia they are not permitted to operate.e.The justification for the "light" regulation of hedge funds is that only "sophisticated" investors with high net worths and high incomes are permitted to invest in these funds, and such investors

supposedly can do the necessary "due diligence" on their own rather than have it done by the SEC or some other regulator.

ANS:EPTS:1DIF:Difficulty: EasyOBJ:LO: 1-7NAT:BUSPROG: AnalyticSTA:DISC: Investments and hybrid financingLOC:TBATOP:Hedge fundsKEY:Bloom’s: ComprehensionMSC:TYPE: Multiple Choice: Conceptual 22.Money markets are markets fora.Foreign stocks.b.Consumer automobile loans.c.U.S. stocks.d.Short-term debt securities.e.Long-term bonds.

ANS:DPTS:1DIF:Difficulty: EasyOBJ:LO: 1-8NAT:BUSPROG: AnalyticSTA:DISC: Investments and hybrid financingLOC:TBATOP:Money marketsKEY:Bloom’s: ComprehensionMSC:TYPE: Multiple Choice: Conceptual 23.Which of the following is a primary market transaction?a.You sell 200 shares of Johnson &amp; Johnson stock on the NYSE through your broker.b.Johnson &amp; Johnson issues 2,000,000 shares of new stock and sells them to the public through an investment banker.c.You buy 200 shares of Johnson &amp; Johnson stock from your younger brother. You just give him cash and he gives you the stock⎯the trade is not made through a broker.d.One financial institution buys 200,000 shares of Johnson &amp; Johnson stock from another institution. An investment banker arranges the transaction.e.You invest $10,000 in a mutual fund, which then uses the money to buy $10,000 of Johnson &amp; Johnson shares on the NYSE. ANS: PTS:1DIF:Difficulty: EasyOBJ:LO: 1-8NAT:BUSPROG: AnalyticSTA:DISC: Financial markets, institutions, and interest ratesLOC:TBATOP:Financial marketsKEY:Bloom’s: ComprehensionMSC:TYPE: Multiple Choice: Conceptual 24.Which of the following statements is CORRECT?a.If Apple issues additional shares of common stock through an investment banker, this would be a secondary market transaction.b.If you purchased 100 shares of Apple stock from your sister-inlaw, this would be an example of a primary market transaction.c.The IPO market is a subset of the secondary market.d.Only institutions, and not individuals, can participate in derivatives market transactions.e.As they are generally defined, money market transactions involve debt securities with maturities of less than one year.

ANS:EPTS:1DIF:Difficulty: EasyOBJ:LO: 1-8NAT:BUSPROG: AnalyticSTA:DISC: Financial markets, institutions, and interest ratesLOC:TBATOP:Financial marketsKEY:Bloom’s: ComprehensionMSC:TYPE: Multiple Choice: Conceptual 25.You recently sold 200 shares of Apple stock to your brother. The transfer was made through a broker, and the trade occurred on the NYSE. This is an example of:a.A futures market transaction.b.A primary market transaction.c.A secondary market transaction.d.A money market transaction.e.An over-the-counter market transaction.

ANS:C PTS:1DIF:Difficulty: EasyOBJ:LO: 1-8NAT:BUSPROG: AnalyticSTA:DISC: Financial markets, institutions, and interest ratesLOC:TBATOP:Financial marketsKEY:Bloom’s: ComprehensionMSC:TYPE: Multiple Choice: Conceptual 26.Which of the following statements is CORRECT?a.The New York Stock Exchange is an auction market with a physical location.b.Capital market transactions involve only the purchase and sale of equity securities, i.e., common stocks.c.If an investor sells shares of stock through a broker, then this would be a primary market

transaction.d.Consumer automobile loans are evidenced by legal documents called "promissory notes," and these individual notes are traded in the money market.e.While the distinctions are blurring as investment banks are today buying commercial banks, and vice versa, investment banks generally specialize in lending money, whereas commercial banks generally help companies raise capital from other parties.

ANS:APTS:1DIF:Difficulty: EasyOBJ:LO: 1-9NAT:BUSPROG: AnalyticSTA:DISC: Financial markets, institutions, and interest ratesLOC:TBATOP:Financial marketsKEY:Bloom’s: ComprehensionMSC:TYPE: Multiple Choice: Conceptual 27.Which of the following statements is CORRECT?a.Capital market instruments include both long-term debt and common stocks.b.An example of a primary market transaction would be your uncle transferring 100 shares of Wal-Mart stock to you as a birthday gift.c.The NYSE does not exist as a physical location; rather, it represents a loose collection of dealers who trade stocks electronically.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.

ANS:APTS:1DIF:Difficulty: EasyOBJ:LO: 1-9NAT:BUSPROG: AnalyticSTA:DISC: Financial markets, institutions, and interest ratesLOC:TBATOP:Financial marketsKEY:Bloom’s: ComprehensionMSC:TYPE: Multiple Choice: Conceptual 28.Which of the following statements is CORRECT?a.While the distinctions are blurring, investment banks generally specialize in lending money, whereas commercial banks generally help companies raise capital from other parties.b.A security whose value is derived from the price of some other "underlying" asset is called a liquid security.c.Money market mutual funds usually invest most of their money in a well-diversified portfolio of liquid common stocks.d.Money markets are markets for common stocks and long-term debt.e.The NYSE operates as an auction market, whereas the Nasdaq is a dealer market.

ANS:EPTS:1DIF:Difficulty: EasyOBJ:LO: 1-9NAT:BUSPROG: AnalyticSTA:DISC: Financial markets, institutions, and interest ratesLOC:TBATOP:Financial marketsKEY:Bloom’s: ComprehensionMSC:TYPE: Multiple Choice: Conceptual 29.One drawback of switching from a partnership to the corporate form of organization is the following:a.It subjects the firm to additional regulations.b.It cannot affect the amount of the firm's operating income that goes to taxes.c.It makes it more difficult for the firm to raise additional capital.d.It makes the firm's investors subject to greater potential personal liabilities.e.It makes it more difficult for the firm's investors to transfer their ownership interests.

ANS:APTS:1DIF:Difficulty: ModerateOBJ:LO: 1-2NAT:BUSPROG: AnalyticSTA:DISC: Goals of the firm, role of finance, and analysis of public informationLOC:TBATOP:Corporate form of organizationKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 30.Which of the following statements is CORRECT?a.The main method of transferring ownership interest in a corporation is by means of a hostile takeover.b.Two key advantages of the corporate form over other forms of business

organization are unlimited liability and limited life.c.A corporation is a legal entity that is generally created by a state; its life and existence is separate from the lives of its individual owners and managers.d.Limited liability of its stockholders is an advantage of the corporate form of organization, but corporations have more trouble raising money in financial markets because of the complexity of this form of organization.e.Although its stockholders are insulated by limited legal liability, the corporation's legal status does not protect the firm's managers in the same way; i.e., bondholders can sue its managers if the firm defaults on its debt, even if the default is the result of poor economic conditions.

ANS:CPTS:1DIF:Difficulty: ModerateOBJ:LO: 1-2NAT:BUSPROG: AnalyticSTA:DISC: Goals of the firm, role of finance, and analysis of public informationLOC:TBATOP:Corporate form of organizationKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 31.Which of the following statements is CORRECT?a.In a regular partnership, liability for other partners' misdeeds is limited to the amount of a particular partner's investment in the business.b.Attracting large amounts of capital is more difficult for partnerships than for 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.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.The limited partners in a limited partnership have voting control, while the general partner has operating control over the business. Also, the limited partners are individually responsible, on a pro rata basis, for the firm's debts in the event of bankruptcy.e.A major disadvantage of all partnerships compared to all corporations is the fact that federal income taxes must be paid by the partners rather than by the firm itself.

ANS:BPTS:1DIF:Difficulty: ModerateOBJ:LO: 1-2NAT:BUSPROG: AnalyticSTA:DISC: Goals of the firm, role of finance, and analysis of public informationLOC:TBATOP:Partnership form of organizationKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 32.Which of the following statements is CORRECT?a.Corporations are at a disadvantage relative to partnerships because they have to file more reports to state and federal agencies, including the Securities and Exchange Administration, even if they are not publicly owned.b.In a regular partnership, liability for the firm's debts is limited to the amount a particular partner has invested in the business.c.A fast-growth company would be more likely to set up as a partnership for its business organization than would a slow-growth company.d.Partnerships have difficulty attracting capital in part because of their unlimited liability, the lack of impermanence of the organization, and difficulty in transferring ownership.e.A major disadvantage of a partnership relative to a corporation as a form of business organization is the high cost and practical difficulty of its formation.

ANS:DPTS:1DIF:Difficulty: ModerateOBJ:LO: 1-2NAT:BUSPROG: AnalyticSTA:DISC: Goals of the firm, role of finance, and analysis of public informationLOC:TBATOP:Partnership form of organizationKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 33.Which of the following statements is CORRECT?a.Most businesses (by number and total dollar sales) are organized as partnerships or proprietorships because it is

easier to set up and operate in one of these forms rather than as a corporation.

However, if the business gets very large, it becomes advantageous to convert to a corporation, mainly because corporations have important tax advantages over proprietorships and partnerships.b.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.c.Most business (measured by dollar sales) is conducted by corporations in spite of large corporations' often less favorable tax treatment, due to legal considerations related to ownership transfers and limited liability.d.Large corporations are taxed more favorably than sole proprietorships.e.Corporate stockholders are exposed to unlimited liability.

ANS:CPTS:1DIF:Difficulty: ModerateOBJ:LO: 1-2NAT:BUSPROG: AnalyticSTA:DISC: Goals of the firm, role of finance, and analysis of public informationLOC:TBATOP:Firm organizationKEY:Bloomâ&#x20AC;&#x2122;s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 34.Jane Doe, who has substantial personal wealth and income, is considering the possibility of starting a new business in the chemical waste management field. She will be the sole owner, and she has enough funds to finance the operation. The business will have a relatively high degree of risk, and it is expected that the firm will incur losses for the first few years. However, the prospects for growth and positive future income look good, and Jane plans to have the firm pay out all of its income as dividends to her once it is well established. Which of the legal forms of business organization would probably best suit her needs?a.Proprietorship, because of ease of entry.b.S corporation, to gain some tax advantages and also to obtain limited liability.c.Partnership, but only if she needs additional capital.d.Regular corporation, because of the limited liability.e.In this situation, the various forms of organization seem equally desirable.

ANS: 35.Which of the following statements is CORRECT?a.The corporate bylaws are a standard set of rules established by the state of incorporation. These rules are identical for all corporations in the state, and their purpose is to ensure that the firm's managers run the firm in accordance with state laws.b.The corporate charter is a standard document prescribed by the state of incorporation, and its purpose is to ensure that the firm's managers run the firm in accordance with state laws. Procedures for electing corporate directors are contained in bylaws, while the declaration of the activities that the firm will pursue and the number of directors are included in the corporate charter.c.Companies must establish a home office, or domicile, in a particular state, and that state must be the one in which most of their business (sales, manufacturing, and so forth) is conducted.d.Attorney fees are generally involved when a company develops its charter and bylaws, but since these documents are voluntary, a new corporation can avoid these costs by deciding not to have either a charter or bylaws.e.The corporate charter is concerned with things like what business the company will engage in, whereas the bylaws are concerned with things like procedures for electing the board of directors.

ANS:EPTS:1DIF:Difficulty: ModerateOBJ:LO: 1-2NAT:BUSPROG: AnalyticSTA:DISC: Goals of the firm, role of finance, and analysis of public informationLOC:TBATOP:Corporate charter and bylawsKEY:Bloomâ&#x20AC;&#x2122;s: AnalysisMSC:TYPE: Multiple Choice: Conceptual

36.With which of the following statements would most people in business agree? a.The short-run profits of a corporation will almost always increase if the firm takes actions the government has determined are in the nation's best interests.b.Government agencies and firms almost always agree with one another regarding the restrictions that should be placed on hiring and firing employees.c.Although people's moral characters are probably developed before they get into a business school, it is still useful for business schools to cover ethics, including giving students an idea about the adverse consequences of unethical behavior to themselves, their firms, and the nation.d.Developing a formal set of rules defining ethical and unethical behavior is not useful for a large corporation. Such rules generally can't be applied in many specific instances, so it is better to deal with ethical issues on a case-by-case basis.e.Because of the courage it takes to blow the whistle, "whistle blowers" are generally promoted more rapidly than other employees.

ANS: 37.The primary operating goal of a publicly-owned firm interested in serving its stockholders should be toa.Maximize the stock price per share over the long run, which is the stock's intrinsic value.b.Maximize the firm's expected EPS.c.Minimize the chances of losses.d.Maximize the firm's expected total income.e.Maximize the stock price on a specific target date.

ANS:APTS:1DIF:Difficulty: ModerateOBJ:LO: 1-3NAT:BUSPROG: AnalyticSTA:DISC: Goals of the firm, role of finance, and analysis of public informationLOC:TBATOP:Goal of firmKEY:Bloomâ&#x20AC;&#x2122;s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 38.Which of the following statements is CORRECT?a.The financial manager's proper goal should be to attempt to maximize the firm's expected cash flows, since that will add the most to the individual shareholders' wealth.b.The financial manager should seek that combination of assets, liabilities, and capital that will generate the largest expected projected after-tax income over the relevant time horizon, generally the coming year.c.The riskiness inherent in a firm's earnings per share (EPS) depends on the characteristics of the projects the firm selects, and thus on the firm's assets.

However, EPS is not affected by the manner in which those assets are financed.d.Potential agency problems can arise between managers and stockholders, because managers hired as agents to act on behalf of the owners may instead make decisions favorable to themselves rather than the stockholders.e.Large, publicly owned firms like IBM and GE are controlled by their management teams. Ownership is generally widely dispersed; hence managers have great freedom in how they run the firm. Managers may operate in stockholders' best interests, but they also may operate in their own personal best interests. As long as they stay within the law, there is no way to either force or motivate managers to act in the stockholders' best interests.

ANS:DPTS:1DIF:Difficulty: ModerateOBJ:LO: 1-3NAT:BUSPROG: AnalyticSTA:DISC: Goals of the firm, role of finance, and analysis of public informationLOC:TBATOP:Corporate goals and controlKEY:Bloomâ&#x20AC;&#x2122;s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 39.Suppose the U.S. Treasury announces plans to issue $50 billion of new bonds.

Assuming the announcement was not expected, what effect, other things held constant, would that have on bond 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.There would be no changes in either prices or interest rates.e.Prices would decline and interest rates would rise.

ANS:EPTS:1DIF:Difficulty: ModerateOBJ:LO: 1-6NAT:BUSPROG: AnalyticSTA:DISC: Financial markets, institutions, and interest ratesLOC:TBATOP:Security prices and interest ratesKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 40.Which of the following would be most likely to lead to higher interest rates on all debt securities in the economy?a.Households start saving a larger percentage of their income.b.The economy moves from a boom to a recession.c.The level of inflation begins to decline.d.Corporations step up their expansion plans and thus increase their demand for capital.e.The Federal Reserve uses monetary policy in an attempt to stimulate the economy.

ANS:DPTS:1DIF:Difficulty: ModerateOBJ:LO: 1-6NAT:BUSPROG: AnalyticSTA:DISC: Financial markets, institutions, and interest ratesLOC:TBATOP:Interest ratesKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 41.Which of the following factors would be most likely to lead to an increase in interest rates in the economy?a.Households reduce their consumption and increase their savings.b.The Federal Reserve decides to try to stimulate the economy.c.There is a decrease in expected inflation.d.The economy falls into a recession.e.Most businesses decide to modernize and expand their manufacturing capacity, and to install new equipment to reduce labor costs.

ANS: 42.Which of the following statements is CORRECT?a.If General Electric were to issue new stock this year it would be considered a secondary market transaction since the company already has stock outstanding.b.Capital market transactions only include preferred stock and common stock transactions.c.The distinguishing feature between spot markets versus futures markets transactions is the maturity of the investments.

That is, 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.d.Both Nasdaq "dealers" and NYSE "specialists" hold inventories of stocks.e.An electronic communications network (ECN) is a physical location exchange.

ANS:DPTS:1DIF:Difficulty: ModerateOBJ:LO: 1-11NAT:BUSPROG: AnalyticSTA:DISC: Financial markets, institutions, and interest ratesLOC:TBATOP:Financial transactionsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 43.Which of the following statements is CORRECT?a.Corporations generally are subject to more favorable tax treatment and fewer regulations than partnerships and sole proprietorships, which is why corporations do most of the business in the United States.b.Managers who face the threat of hostile takeovers are less likely to pursue policies that maximize shareholder value than are managers who do not face the threat of hostile takeovers.c.One advantage of the corporate form of organization is that liability of the owners of the firm is limited to their investment in the firm.d.Because of their simplified organization, it is easier for sole proprietorships and partnerships to

raise large amounts of outside capital than it is for corporations.e.Bond covenants are an effective way to resolve conflicts between shareholders and managers.

ANS:CPTS:1DIF:Difficulty: ModerateOBJ:LO: 1-3NAT:BUSPROG: AnalyticSTA:DISC: Goals of the firm, role of finance, and analysis of public informationLOC:TBATOP:Miscellaneous conceptsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 44.Which of the following statements is CORRECT?a.A good goal for a firm's management is 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.Because most stock ownership is concentrated in the hands of a relatively small segment of society, firms' actions to maximize their stock prices have little benefit to society.d.Corporations and partnerships have an advantage over proprietorships because a sole proprietor is exposed to unlimited liability, but the liability of all investors in the other types of businesses is more limited.e.The potential exists for agency conflicts between stockholders and managers.

ANS:EPTS:1DIF:Difficulty: ModerateOBJ:LO: 1-3NAT:BUSPROG: AnalyticSTA:DISC: Goals of the firm, role of finance, and analysis of public informationLOC:TBATOP:Miscellaneous conceptsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 45.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 partners.b.There is no good reason to expect a firm's bondholders and stockholders to react differently to the types of new asset investments a firm makes.c.Bondholders are generally more willing than stockholders to have managers invest in risky projects with high potential returns as opposed to safer projects with lower expected returns.d.Stockholders are generally more willing than bondholders to have managers invest in risky projects with high potential returns as opposed to safer projects with lower expected returns.e.Relative to sole proprietorships, corporations generally face fewer regulations, which makes raising capital easier for corporations.

ANS:DPTS:1DIF:Difficulty: ModerateOBJ:LO: 1-3NAT:BUSPROG: AnalyticSTA:DISC: Goals of the firm, role of finance, and analysis of public informationLOC:TBATOP:Miscellaneous conceptsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 46.Which of the following statements is NOT CORRECT?a.When a corporation's shares are owned by a few individuals and are not traded on public markets, we say that the firm is "closely, or privately, held."b."Going public" establishes a firm's true intrinsic value, and it also insures that a highly liquid market will always exist for the firm's shares.c.When stock in a closely held corporation is offered to the public for the first time, the transaction is called "going public," and the market for such stock is called the new issue market.d.Publicly owned companies have shares owned by investors who are not associated with management, and public companies must register with and report to a regulatory agency such as the SEC.e.It is possible for a firm to go public and yet not raise any additional new capital at the time.

ANS:BPTS:1DIF:Difficulty: ChallengingOBJ:LO: 1-8NAT:BUSPROG: AnalyticSTA:DISC: Goals of the firm, role of finance, and analysis of public

informationLOC:TBATOP:Ownership and going publicKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual

CHAPTER 2—FINANCIAL STATEMENTS, CASH FLOW, AND TAXES TRUE/FALSE 1.The annual report contains four basic financial statements: the income statement, balance sheet, statement of cash flows, and statement of stockholders' equity.

ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 2-1NAT:BUSPROG: Reflective ThinkingSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Annual reportKEY:Bloom’s: Knowledge 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.

ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 2-1NAT:BUSPROG: Reflective ThinkingSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Annual report and expectationsKEY:Bloom’s: Knowledge 3.Consider the balance sheet of Wilkes Industries as shown below. Because Wilkes has $800,000 of retained earnings, the company would be able to pay cash to buy an asset with a cost of $200,000.

Cash$ 50,000Accounts payable$ 100,000Inventory200,000Accruals 100,000Accounts receivable 250,000Total CL$ 200,000Total CA$ 500,000Debt200,000Net fixed assets$ 900,000Common stock200,000_________Retained earnings 800,000Total assets$1,400,000Total L &amp; E$1,400,000 ANS:FPTS:1DIF:Difficulty: EasyOBJ:LO: 2-2NAT:BUSPROG: AnalyticSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Retained earnings versus cashKEY:Bloom’s: Knowledge 4.On the balance sheet, total assets must always equal total liabilities and equity.

ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 2-2NAT:BUSPROG: Reflective ThinkingSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Balance sheetKEY:Bloom’s: Knowledge 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 values at which these assets are carried on the books.

ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 2-2NAT:BUSPROG: Reflective ThinkingSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Balance sheet: non-cash assetsKEY:Bloom’s: Knowledge 6.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 or cash, and reported costs likewise may not correctly reflect cash outlays. Therefore, there may be a substantial difference between a firm's reported profits and its actual cash flow for the same period.

ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 2-3NAT:BUSPROG: Reflective ThinkingSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Income statementKEY:Bloom’s: Knowledge 7.Net operating working capital is equal to operating current assets minus operating current liabilities.

ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 2-7NAT:BUSPROG: Reflective ThinkingSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Net operating working capitalKEY:Bloom’s: Knowledge 8.Total net operating capital is equal to net fixed assets.

ANS:FPTS:1DIF:Difficulty: EasyOBJ:LO: 2-7NAT:BUSPROG: Reflective ThinkingSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Total net operating capitalKEY:Bloom’s: Knowledge 9.Net operating profit after taxes (NOPAT) is the amount of net income a company would generate from its operations if it had no interest income or interest expense.

ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 2-7NAT:BUSPROG: Reflective ThinkingSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Net operating profit after taxes (NOPAT)KEY:Bloom’s: Knowledge 10.The fact that 70% of the interest income received by a corporation is excluded from its taxable income encourages firms to use more debt financing than they would in the absence of this tax law provision.

ANS:FPTS:1DIF:Difficulty: EasyOBJ:LO: 2-9NAT:BUSPROG: Reflective ThinkingSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Federal income taxes: interest incomeKEY:Bloom’s: Knowledge 11.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 tax-deductible expense, this would probably encourage companies to use more debt financing than they presently do, other things held constant.

ANS:FPTS:1DIF:Difficulty: EasyOBJ:LO: 2-9NAT:BUSPROG: Reflective ThinkingSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Federal income taxes: interest expenseKEY:Bloom’s: Knowledge 12.The interest and dividends paid by a corporation are considered to be deductible operating expenses, hence they decrease the firm's tax liability.

ANS:FPTS:1DIF:Difficulty: EasyOBJ:LO: 2-9NAT:BUSPROG: Reflective ThinkingSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Federal income taxes: interest expense and dividendsKEY:Bloom’s: Knowledge 13.The balance sheet is a financial statement that 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.

ANS:FPTS:1DIF:Difficulty: EasyOBJ:LO: 2-3NAT:BUSPROG: Reflective ThinkingSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Financial statementsKEY:Bloom’s: Knowledge 14.Its retained earnings is the actual cash that the firm has generated through operations less the cash that has been paid out to stockholders as dividends. Retained earnings are kept in cash or near cash accounts and, thus, these cash accounts, when added together, will always be equal to the firm's total retained earnings.

ANS:FPTS:1DIF:Difficulty: ModerateOBJ:LO: 2-4NAT:BUSPROG: Reflective ThinkingSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Retained earningsKEY:Bloom’s: Comprehension 15.The retained earnings account on the balance sheet does not represent cash. Rather, it represents part of stockholders' claims against the firm's existing assets. This implies that retained earnings are in fact stockholders' reinvested earnings.

ANS:TPTS:1DIF:Difficulty: ModerateOBJ:LO: 2-4NAT:BUSPROG: Reflective ThinkingSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Retained earningsKEY:Bloom’s: Comprehension 16.In accounting, emphasis is placed on determining net income in accordance with generally accepted accounting principles. In finance, the primary emphasis is also on net income because that is what investors use to value the firm. However, a secondary financial consideration is cash flow, because cash is needed to operate the business.

ANS:FPTS:1DIF:Difficulty: ModerateOBJ:LO: 2-6NAT:BUSPROG: Reflective ThinkingSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Cash flow and net incomeKEY:Bloom’s: Comprehension 17.To estimate the cash flow from operations, depreciation must be added back to net income because it is a non-cash charge that has been deducted from revenue.

ANS:TPTS:1DIF:Difficulty: ModerateOBJ:LO: 2-5NAT:BUSPROG: Reflective ThinkingSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Statement of cash flowsKEY:Bloom’s: Comprehension 18.The current cash flow from existing assets is highly relevant to the investor.

However, since the value of the firm depends primarily upon its growth opportunities, profit projections from those opportunities are the only relevant future flows with which investors are concerned.

ANS:FPTS:1DIF:Difficulty: ModerateOBJ:LO: 2-7NAT:BUSPROG: Reflective ThinkingSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Future cash flowsKEY:Bloom’s: Comprehension 19.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.

ANS:TPTS:1DIF:Difficulty: ModerateOBJ:LO: 2-9NAT:BUSPROG: Reflective ThinkingSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Federal income taxes: interest expense and dividendsKEY:Bloom’s: Comprehension 20.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 changes in the firm's accounts over that period of time.

ANS:TPTS:1DIF:Difficulty: ModerateOBJ:LO: 2-5NAT:BUSPROG: Reflective ThinkingSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Financial stmts: time dimensionKEY:Bloom’s: Comprehension MULTIPLE CHOICE 21.Which of the following statements is CORRECT?a.The statement of cash needs tells us how much cash the firm will require during some future period, generally a month or a year.b.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.c.The balance sheet gives us a picture of the firm's financial position at a point in time.d.The income statement gives us a picture of the firm's financial position at a point in time.e.The statement of cash flows tells us how much cash the firm has in the form of currency and demand deposits.

ANS:CPTS:1DIF:Difficulty: EasyOBJ:LO: 2-1NAT:BUSPROG: AnalyticSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Financial statementsKEY:Bloom’s: ComprehensionMSC:TYPE: Multiple Choice: Conceptual

22.Which of the following statements is CORRECT?a.A typical industrial company's balance sheet lists the firm's assets that will be converted to cash first, and then goes on down to list the firm's longest lived assets last.b.The balance sheet for a given year, say 2012, is designed to give us an idea of what happened to the firm during that year.c.The balance sheet for a given year, say 2012, tells us how much money the company earned during that year.d.The difference between the total assets reported on the balance sheet and the debts 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).e.For most companies, the market value of the stock equals the book value of the stock as reported on the balance sheet.

ANS:APTS:1DIF:Difficulty: EasyOBJ:LO: 2-2NAT:BUSPROG: AnalyticSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Balance sheetKEY:Bloom’s: ComprehensionMSC:TYPE: Multiple Choice: Conceptual 23.Other things held constant, which of the following actions would increase the amount of cash on a company's balance sheet?a.The company purchases a new piece of equipment.b.The company repurchases common stock.c.The company pays a dividend.d.The company issues new common stock.e.The company gives customers more time to pay their bills.

ANS:DPTS:1DIF:Difficulty: EasyOBJ:LO: 2-2NAT:BUSPROG: AnalyticSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Balance sheetKEY:Bloom’s: ComprehensionMSC:TYPE: Multiple Choice: Conceptual 24.Which of the following items is NOT included in current assets?a.Short-term, highly liquid, marketable securities.b.Accounts receivable.c.Inventory.d.Bonds.e.Cash.

ANS:DPTS:1DIF:Difficulty: EasyOBJ:LO: 2-2NAT:BUSPROG: AnalyticSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Current assetsKEY:Bloom’s: ComprehensionMSC:TYPE: Multiple Choice: Conceptual 25.Which of the following items cannot be found on a firm's balance sheet under current liabilities?a.Accrued payroll taxes.b.Accounts payable.c.Short-term notes payable to the bank.d.Accrued wages.e.Cost of goods sold.

ANS:EPTS:1DIF:Difficulty: EasyOBJ:LO: 2-2NAT:BUSPROG: AnalyticSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Current liabilitiesKEY:Bloom’s: ComprehensionMSC:TYPE: Multiple Choice: Conceptual 26.Which of the following statements is CORRECT?a.The income statement for a given year, say 2012, is designed to give us an idea of how much the firm earned during that year.b.The focal point of the income statement is the cash account, because that account cannot be manipulated by "accounting tricks."c.The reported income of two otherwise identical firms cannot be manipulated by different accounting procedures provided the firms follow Generally Accepted Accounting Principles (GAAP).d.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).e.If a firm follows Generally Accepted Accounting Principles (GAAP), then its reported net income will be identical to its reported net cash flow.

ANS:APTS:1DIF:Difficulty: EasyOBJ:LO: 2-3NAT:BUSPROG: AnalyticSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Income statementKEY:Bloom’s: ComprehensionMSC:TYPE: Multiple Choice: Conceptual 27.Below are the year-end balance sheets for Wolken Enterprises: Assets:20132012Cash$ 200,000$ 170,000Accounts receivable864,000700,000Inventories 2,000,000 1,400,000 Total current assets$3,064,000$2,270,000Net fixed assets 6,000,000 5,600,000Total assets$9,064,000$7,870,000Liabilities and equity:Accounts payable$1,400,000$1,090,000Notes payable 1,600,000 1,800,000 Total current liabilities$3,000,000$2,890,000Long-term debt2,400,0002,400,000Common stock3,000,0002,000,000Retained earnings 664,000 580,000 Total common equity$3,664,000$2,580,000Total liabilities and equity$9,064,000$7,870,000 Wolken has never paid a dividend on its common stock, and it issued $2,400,000 of 10-year non-callable, long-term debt in 2012. As of the end of 2013, none of the principal on this debt had been repaid. Assume that the company's sales in 2012 and 2013 were the same. Which of the following statements must be CORRECT? a.Wolken increased its short-term bank debt in 2013.b.Wolken issued long-term debt in 2013.c.Wolken issued new common stock in 2013.d.Wolken repurchased some common stock in 2013.e.Wolken had negative net income in 2013.

ANS:CPTS:1DIF:Difficulty: ModerateOBJ:LO: 2-2NAT:BUSPROG: AnalyticSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Balance sheetKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 28.On its 2012 balance sheet, Barngrover Books showed $510 million of retained earnings, and exactly that same amount was shown the following year in 2013.

Assuming that no earnings restatements were issued, which of the following statements is CORRECT?a.Dividends could have been paid in 2013, but they would have had to equal the earnings for the year.b.If the company lost money in 2013, they must have paid dividends.c.The company must have had zero net income in 2013.d.The company must have paid out half of its earnings as dividends.e.The company must have paid no dividends in 2013.

ANS:APTS:1DIF:Difficulty: ModerateOBJ:LO: 2-2NAT:BUSPROG: AnalyticSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Balance sheetKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 29.Below is the common equity section (in millions) of Fethe Industries' last two year-end balance sheets: 20122011Common stock$2,000$1,000Retained earnings 2,000 2,340Total common equity$4,000$3,340 The company has never paid a dividend to its common stockholders. Which of the following statements is CORRECT?a.The company's net income in 2011 was higher than in 2012.b.The company issued common stock in 2012.c.The market price of the company's stock doubled in 2012.d.The company had positive net income in both 2011 and 2012, but the company's net income in 2009 was lower than it was in 2011.e.The company has more equity than debt on its balance sheet.

ANS:BPTS:1DIF:Difficulty: ModerateOBJ:LO: 2-2NAT:BUSPROG: AnalyticSTA:DISC: Financial statements, analysis, forecasting, and cash

flowsLOC:TBATOP:Balance sheetKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 30.Which of the following statements is CORRECT?a.The more depreciation a firm has in a given year, the higher its EPS, other things held constant.b.Typically, a firm's DPS should exceed its EPS.c.Typically, a firm's EBIT should exceed its EBITDA.d.If a firm is more profitable than average (e.g., Google), we would normally expect to see its stock price exceed its book value per share.e.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.

ANS:DPTS:1DIF:Difficulty: ModerateOBJ:LO: 2-3NAT:BUSPROG: AnalyticSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:EPS, DPS, BVPS, and stock priceKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 31.Which of the following statements is CORRECT?a.Depreciation and amortization are not cash charges, so neither of them has an effect on a firm's reported profits.b.The more depreciation a firm reports, the higher its tax bill, other things held constant.c.People sometimes talk about the firm's net cash flow, which is shown as the lowest entry on the income statement, hence it is often called "the bottom line."d.Depreciation reduces a firm's cash balance, so an increase in depreciation would normally lead to a reduction in the firm's net cash flow.e.Net cash flow (NCF) is often defined as follows:Net Cash Flow = Net Income + Depreciation and Amortization Charges.

ANS:EPTS:1DIF:Difficulty: ModerateOBJ:LO: 2-6NAT:BUSPROG: AnalyticSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Depreciation, amortization, and net cash flowKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 32.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 are not affected, and assume that the same depreciation method is used for tax and stockholder reporting purposes.a.Companies' reported net incomes would decline.b.Companies' net operating profits after taxes (NOPAT) would decline.c.Companies' physical stocks of fixed assets would increase.d.Companies' net cash flows would increase.e.Companies' cash positions would decline.

ANS:EPTS:1DIF:Difficulty: ModerateOBJ:LO: 2-6NAT:BUSPROG: AnalyticSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Changes in depreciationKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 33.Which of the following factors could explain why Regal Industrial Fixtures had a negative net cash flow last year, even though the cash on its balance sheet increased? a.The company repurchased 20% of its common stock.b.The company sold a new issue of bonds.c.The company made a large investment in new plant and equipment.d.The company paid a large dividend.e.The company had high amortization expenses.

ANS:BPTS:1DIF:Difficulty: ModerateOBJ:LO: 2-5NAT:BUSPROG: AnalyticSTA:DISC: Financial statements, analysis, forecasting, and cash

flowsLOC:TBATOP:Net cash flowKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 34.Analysts following Armstrong Products recently noted that the company's operating net cash flow increased over the prior year, yet cash as reported on the balance sheet decreased. Which of the following factors could explain this situation? a.The company issued new long-term debt.b.The company cut its dividend.c.The company made a large investment in a profitable new plant.d.The company sold a division and received cash in return.e.The company issued new common stock.

ANS:CPTS:1DIF:Difficulty: ModerateOBJ:LO: 2-5NAT:BUSPROG: AnalyticSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Net cash flowKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 35.A security analyst obtained the following information from Prestopino Products' financial statements: �Retained earnings at the end of 2011 were $700,000, but retained earnings at the end of 2012 had declined to $320,000.�The company does not pay dividends.�The company's depreciation expense is its only non-cash expense; it has no amortization charges.�The company has no non-cash revenues.�The company's net cash flow (NCF) for 2012 was $150,000.

On the basis of this information, which of the following statements is CORRECT? a.Prestopino had negative net income in 2012.b.Prestopino's depreciation expense in 2012 was less than $150,000.c.Prestopino had positive net income in 2012, but its income was less than its 2011 income.d.Prestopino's NCF in 2012 must be higher than its NCF in 2011.e.Prestopino's cash on the balance sheet at the end of 2012 must be lower than the cash it had on the balance sheet at the end of 2011.

ANS:APTS:1DIF:Difficulty: ModerateOBJ:LO: 2-5NAT:BUSPROG: AnalyticSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Net cash flow and net incomeKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 36.Aubey Aircraft recently announced that its net income increased sharply from the previous year, yet its net cash flow from operations declined. Which of the following could explain this performance?a.The company's operating income declined.b.The company's expenditures on fixed assets declined.c.The company's cost of goods sold increased.d.The company's depreciation and amortization expenses declined.e.The company's interest expense increased.

ANS:DPTS:1DIF:Difficulty: ModerateOBJ:LO: 2-5NAT:BUSPROG: AnalyticSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Net cash flow and net incomeKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 37.Which of the following statements is CORRECT?a.The statement of cash flows shows how much the firm's cash⎯the total of currency, bank deposits, and short-term liquid securities (or cash equivalents)⎯increased or decreased during a given year.b.The statement of cash flows reflects cash flows from operations, but it does not reflect the effects of buying or selling fixed assets.c.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.d.The statement of cash flows reflects cash flows from continuing operations, but it does not reflect the effects of changes in

working capital.e.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.

ANS:APTS:1DIF:Difficulty: ModerateOBJ:LO: 2-5NAT:BUSPROG: AnalyticSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Statement of cash flowsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 38.Which of the following statements is CORRECT?a.In the statement of cash flows, a decrease in accounts receivable is reported as a use of cash.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 reported as a use of cash.d.In the statement of cash flows, depreciation charges are reported as a use of cash.e.In the statement of cash flows, a decrease in inventories is reported as a use of cash.

ANS:CPTS:1DIF:Difficulty: ModerateOBJ:LO: 2-5NAT:BUSPROG: AnalyticSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Statement of cash flowsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 39.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, for valuation purposes we need to discount cash flows, not accounting income. Moreover, since many firms have a number of separate divisions, and since division managers should be compensated on their divisions' performance, not that of the entire firm, information that focuses on the divisions is needed. These factors have led to the development of information that is focused on cash flows and the operations of individual units.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 are 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.

ANS:BPTS:1DIF:Difficulty: ModerateOBJ:LO: 2-7NAT:BUSPROG: AnalyticSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Modifying acct data for managerial purposesKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 40.Which of the following statements is CORRECT?a.Net cash flow (NCF) is defined as follows: NCF = Net income - Depreciation and Amortization.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 and Amortization − 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)+ Depreciation and Amortization + Capital expenditures.e.Net cash flow is the same as free cash flow (FCF).

ANS:CPTS:1DIF:Difficulty: ModerateOBJ:LO: 2-7NAT:BUSPROG: AnalyticSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Depreciation, amortization, and free cash flowKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 41.Which of the following statements is CORRECT?a.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.b.MVA gives us an idea about how much value a firm's management has added during the last year.c.MVA stands for market value added, and it is defined as follows:MVA = (Shares outstanding)(Stock price) + Book value of common equity.d.EVA stands for economic value added, and it is defined as follows:EVA = EBIT(1 − T) − (Investorsupplied op. capital) ⋅ (A − T cost of capital).e.EVA gives us an idea about how much value a firm's management has added over the firm's life.

ANS:DPTS:1DIF:Difficulty: ModerateOBJ:LO: 2-8NAT:BUSPROG: AnalyticSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:MVA and EVAKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 42.Which of the following statements is CORRECT?a.The maximum federal tax rate on personal income in 2010 was 50%.b.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.c.Interest paid to an individual is counted as income for tax purposes and taxed at the individual's regular tax rate, which in 2010 could go up to 35%, but dividends received were taxed at a maximum rate of 15%.d.The maximum federal tax rate on corporate income in 2010 was 50%.e.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.

ANS:CPTS:1DIF:Difficulty: ModerateOBJ:LO: 2-9NAT:BUSPROG: AnalyticSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Federal income tax systemKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 43.Which of the following statements is CORRECT?a.All corporations other than non-profit corporations are subject to corporate income taxes, which are 15% for the lowest amounts of income and 35% for the highest amounts of income.b.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.c.All businesses, regardless of their legal form of organization, are taxed under the Business Tax Provisions of the Internal Revenue Code.d.Small businesses that qualify under the Tax Code can elect not to pay corporate taxes, but

then their owners must report their pro rata shares of the firm's income as personal income and pay taxes on that income.e.Congress recently changed the tax laws to make dividend income received by individuals exempt from income taxes. Prior to the enactment of that law, corporate income was subject to double taxation, where the firm was first taxed on the income and stockholders were taxed again on the income when it was paid to them as dividends.

ANS:DPTS:1DIF:Difficulty: ModerateOBJ:LO: 2-9NAT:BUSPROG: AnalyticSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Federal income tax systemKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 44.Danielle's Sushi Shop last year had (1) a negative net 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 depreciation and amortization expenses.b.The company had a sharp increase in its inventories.c.The company had a sharp increase in its accrued liabilities.d.The company sold a new issue of common stock.e.The company made a large capital investment early in the year.

ANS:DPTS:1DIF:Difficulty: ModerateOBJ:LO: 2-7NAT:BUSPROG: AnalyticSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:NCF, FCF, and cashKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 45.Assume that Congress recently passed a provision that will enable Barton's Rare Books (BRB) to double its depreciation expense for the upcoming year but will have no effect on its sales revenue or tax rate. Prior to the new provision, BRB's net income after taxes was forecasted to be $4 million. Which of the following best describes the impact of the new provision on BRB'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.Net fixed assets on the balance sheet will decrease.b.The provision will reduce the company's net cash flow.c.The provision will increase the company's tax payments.d.Net fixed assets on the balance sheet will increase.e.The provision will increase the company's net income.

ANS:APTS:1DIF:Difficulty: ModerateOBJ:LO: 2-9NAT:BUSPROG: AnalyticSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Changes in depreciationKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 46.The LeMond Corporation just purchased a new production line. 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.LeMond's tax liability for the year will be lower.b.LeMond's taxable income will be lower.c.LeMond's net fixed assets as shown on the balance sheet will be higher at the end of the year.d.LeMond's cash position will improve (increase).e.LeMond's reported net income after taxes for the year will be lower.

ANS:CPTS:1DIF:Difficulty: ModerateOBJ:LO: 2-9NAT:BUSPROG: AnalyticSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Changes in depreciationKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 47.Lucy's Music Emporium opened its doors on January 1, 2012, and it 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 20 years, but in December 2012 management realized that the assets would last for only 15 years. The firm's accountants plan to report the 2012 financial statements based on this new information. How would the new depreciation assumption affect the company's financial statements?a.The firm's net liabilities would increase.b.The firm's reported net fixed assets would increase.c.The firm's EBIT would increase.d.The firm's reported 2012 earnings per share would increase.e.The firm's cash position in 2012 and 2013 would increase.

ANS:EPTS:1DIF:Difficulty: ModerateOBJ:LO: 2-5NAT:BUSPROG: AnalyticSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Changes in depreciationKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 48.DeYoung Devices Inc., a new high-tech instrumentation firm, is building and equipping a new manufacturing facility. 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 reported net income would increase.b.The firm's operating income (EBIT) would increase.c.The firm's taxable income would increase.d.The firm's net cash flow would increase.e.The firm's tax payments would increase.

ANS:DPTS:1DIF:Difficulty: ModerateOBJ:LO: 2-9NAT:BUSPROG: AnalyticSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Changes in depreciationKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 49.Which of the following statements is CORRECT?a.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.b.Dividends paid reduce the net income that is reported on a company's income statement.c.If a company uses some of its bank deposits to buy short-term, highly liquid marketable securities, this will cause a decline in its current assets as shown on the balance sheet.d.If a company issues new long-term bonds during the current year, this will increase its reported current liabilities at the end of the year.e.Accounts receivable are reported as a current liability on the balance sheet.

ANS:APTS:1DIF:Difficulty: ModerateOBJ:LO: 2-5NAT:BUSPROG: AnalyticSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Financial statementsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 50.Which of the following statements is CORRECT?a.One way to increase EVA is to achieve the same level of operating income but with more investor-supplied capital.b.If a firm reports positive net income, its EVA must also be positive.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 generate the same level of operating income but with less investor-supplied capital.e.Actions that increase reported net income will always increase net cash flow.

ANS:DPTS:1DIF:Difficulty: ModerateOBJ:LO: 2-8NAT:BUSPROG: AnalyticSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:EVA, CF, and net incomeKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 51.Which of the following statements is CORRECT?a.If a firm reports a loss on its income statement, then the retained earnings account as shown on the balance sheet will be negative.b.Since depreciation is a source of funds, the more depreciation a company has, the larger its retained earnings will be, other things held constant.c.A firm can show a large amount of retained earnings on its balance sheet yet need to borrow cash to make required payments.d.Common equity includes common stock and retained earnings, less accumulated depreciation.e.The retained earnings account as shown on the balance sheet shows the amount of cash that is available for paying dividends.

ANS:CPTS:1DIF:Difficulty: ModerateOBJ:LO: 2-5NAT:BUSPROG: AnalyticSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Retained earningsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 52.Olivia Hardison, CFO of Impact United Athletic Designs, plans to have the company issue $500 million of new common stock and use the proceeds to pay off some of its outstanding bonds. Assume that the company, which does not pay any dividends, takes this action, and that total assets, operating income (EBIT), and its tax rate all remain constant. Which of the following would occur?a.The company would have to pay less taxes.b.The company's taxable income would fall.c.The company's interest expense would remain constant.d.The company would have less common equity than before.e.The company's net income would increase.

ANS:EPTS:1DIF:Difficulty: ChallengingOBJ:LO: 2-9NAT:BUSPROG: AnalyticSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Changes in leverageKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 53.Jessie's Bobcat Rentals' operations provided a negative net cash flow last year, 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?a.The company had high depreciation expenses.b.The company repurchased some of its common stock.c.The company dramatically increased its capital expenditures.d.The company retired a large amount of its long-term debt.e.The company sold some of its fixed assets.

ANS: 54.Tucker Electronic System's current balance sheet shows total common equity of $3,125,000. The company has 125,000 shares of stock outstanding, and they sell at a price of $52.50 per share. By how much do the firm's market and book values per share differ?a.$27.50b.$28.88c.$30.32d.$31.83e.$33.43 ANS:

55.Hunter Manufacturing Inc.'s December 31, 2012, balance sheet showed total common equity of $2,050,000 and 100,000 shares of stock outstanding. During 2013, Hunter had $250,000 of net income, and it paid out $100,000 as dividends. What was the book value per share at 12/31/13, assuming that Hunter neither issued nor retired any common stock during 2013?a.$20.90b.$22.00c.$23.10d.$24.26e.$25.47 ANS: 56.Companies generate income from their "regular" operations and from other sources like interest earned on the securities they hold, which is called non-operating income. Lindley Textiles recently reported $12,500 of sales, $7,250 of operating costs other than depreciation, and $1,000 of depreciation. The company had no amortization charges and no non-operating income. It had $8,000 of bonds outstanding that carry a 7.5% interest rate, and its federal-plus-state income tax rate was 40%. How much was Lindley's operating income, or EBIT?a.$3,462b.$3,644c. $3,836d.$4,038e.$4,250 ANS: 57.Frederickson Office Supplies recently reported $12,500 of sales, $7,250 of operating costs other than depreciation, and $1,250 of depreciation. The company had no amortization charges and no non-operating income. It had $8,000 of bonds outstanding that carry a 7.5% interest rate, and its federal-plus-state income tax rate was 40%. How much was the firm's taxable income, or earnings before taxes (EBT)? a.$3,230.00b.$3,400.00c.$3,570.00d.$3,748.50e.$3,935.93 ANS: 58.JBS Inc. recently reported net income of $4,750 and depreciation of $885. How much was its net cash flow, assuming it had no amortization expense and sold none of its fixed assets?a.$4,831.31b.$5,085.59c.$5,353.25d.$5,635.00e.$5,916.75 ANS: 59.Swinnerton Clothing Company's balance sheet showed total current assets of $2,250, all of which were required in operations. Its current liabilities consisted of $575 of accounts payable, $300 of 6% short-term notes payable to the bank, and $145 of accrued wages and taxes. What was its net operating working capital that was financed by investors?a.$1,454b.$1,530c.$1,607d.$1,687e.$1,771 ANS: 60.Over the years, Janjigian Corporation's stockholders have provided $15,250 of capital, part when they purchased new issues of stock and part when they allowed management to retain some of the firm's earnings. The firm now has 1,000 shares of common stock outstanding, and it sells at a price of $42.00 per share. How much value has Janjigian's management added to stockholder wealth over the years, i.e., what is Janjigian's MVA?a.$21,788b.$22,935c.$24,142d.$25,413e.$26,750 ANS: 61.Meric Mining Inc. recently reported $15,000 of sales, $7,500 of operating costs other than depreciation, and $1,200 of depreciation. The company had no amortization charges, it had outstanding $6,500 of bonds that carry a 6.25% interest rate, and its federal-plus-state income tax rate was 35%. How much was the firm's net

income after taxes? Meric uses the same depreciation expense for tax and stockholder reporting purposes.a.$3,284.55b.$3,457.42c.$3,639.39d.$3,830.94e.$4,022.48 ANS: 62.On 12/31/2013, Heaton Industries Inc. reported retained earnings of $675,000 on its balance sheet, and it reported that it had $172,500 of net income during the year.

On its previous balance sheet, at 12/31/2012, the company had reported $555,000 of retained earnings. No shares were repurchased during 2013. How much in dividends did Heaton pay during 2013?a.$47,381b.$49,875c.$52,500d.$55,125e.$57,881 ANS: 63.Ullrich Printing Inc. paid out $21,750 of common dividends during the year. It ended the year with $187,500 of retained earnings versus the prior year's retained earnings of $132,250. How much net income did the firm earn during the year?a. $77,000b.$80,850c.$84,893d.$89,137e.$93,594 ANS: 64.NNR Inc.'s balance sheet showed total current assets of $1,875,000 plus $4,225,000 of net fixed assets. All of these assets were required in operations. The firm's current liabilities consisted of $475,000 of accounts payable, $375,000 of 6% short-term notes payable to the bank, and $150,000 of accrued wages and taxes. Its remaining capital consisted of long-term debt and common equity. What was NNR's total investor-provided operating capital?a.$4,694,128b.$4,941,188c.$5,201,250d. $5,475,000e.$5,748,750 ANS: 65.Last year Tiemann Technologies reported $10,500 of sales, $6,250 of operating costs other than depreciation, and $1,300 of depreciation. The company had no amortization charges, it had $5,000 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 $750.

By how much will net after-tax income change as a result of the change in depreciation? The company uses the same depreciation calculations for tax and stockholder reporting purposes.a.−463.13b.−487.50c.−511.88d.−537.47e.−564.34 ANS: 66.TSW Inc. had the following data for last year: Net income = $800; Net operating profit after taxes (NOPAT) = $700; Total assets = $3,000; and Total operating capital = $2,000. Information for the just-completed year is as follows: Net income = $1,000; Net operating profit after taxes (NOPAT) = $925; Total assets = $2,600; and Total operating capital = $2,500. How much free cash flow did the firm generate during the just-completed year?a.$383b.$425c.$468d.$514e.$566 ANS: 67.Rao Corporation has the following balance sheet. How much net operating working capital does the firm have?

Cash$ 10Accounts payable$ 20Short-term investmentsAccruals20Accounts receivable50Notes payable 50Inventory 40 Current liabilities$ 90 Current assets$130Long-term debt0Net fixed assets 100Common equity30Retained earnings 50Total assets$230Total liab. &amp; equity$230

a.$54.00b.$60.00c.$66.00d.$72.60e.$79.86 ANS: 68.Bae Inc. has the following income statement. How much net operating profit after taxes (NOPAT) does the firm have?

Sales$2,000.00Costs1,200.00Depreciation 100.00EBIT$ 700.00Interest expense 200.00EBT$ 500.00Taxes (35%) 175.00Net income$ 325.00 a.$370.60b.$390.11c.$410.64d.$432.25e.$455.00 ANS: 69.EP Enterprises has the following income statement. How much net operating profit after taxes (NOPAT) does the firm have?

Sales$1,800.00Costs1,400.00Depreciation 250.00EBIT$ 150.00Interest expense 70.00EBT$ 80.00Taxes (40%) 32.00Net income$ 48.00 a.$81.23b.$85.50c.$90.00d.$94.50e.$99.23 ANS: 70.Tibbs Inc. had the following data for the year ending 12/31/12: Net income = $300; Net operating profit after taxes (NOPAT) = $400; Total assets = $2,500; Shortterm investments = $200; Stockholders' equity = $1,800; Total debt = $700; and Total operating capital = $2,300. What was its return on invested capital (ROIC)? a.14.91%b.15.70%c.16.52%d.17.39%e.18.26% ANS: 71.Zumbahlen Inc. has the following balance sheet. How much total operating capital does the firm have?

Cash$ 20.00Accounts payable$ 30.00Short-term investments50.00Accruals50.00Accounts receivable20.00Notes payable 30.00Inventory 60.00 Current liabilities$110.00 Current assets$150.00Long-term debt70.00Gross fixed assets$140.00Common stock30.00Accumulated deprec.

40.00Retained earnings 40.00Net fixed assets$100.00Total common equity$ 70.00Total assets$250.00Total liab. &amp; equity$250.00 a.$114.00b.$120.00c.$126.00d.$132.30e.$138.92 ANS: 72.Barnes' Brothers has the following data for the year ending 12/31/12: Net income = $600; Net operating profit after taxes (NOPAT) = $700; Total assets = $2,500; Short-term investments = $200; Stockholders' equity = $1,800; Total debt = $700; and Total operating capital = $2,100. Barnes' weighted average cost of capital is 10%.

What is its economic value added (EVA)?a.$399.11b.$420.11c.$442.23d.$465.50e. $490.00 ANS: 73.Edwards Electronics recently reported $11,250 of sales, $5,500 of operating costs other than depreciation, and $1,250 of depreciation. The company had no amortization charges, it had $3,500 of bonds that carry a 6.25% interest rate, and its federal-plus-state income tax rate was 35%. How much was its net cash flow?a. $3,284.75b.$3,457.63c.$3,639.61d.$3,831.17e.$4,032.81

74.Wells Water Systems recently reported $8,250 of sales, $4,500 of operating costs other than depreciation, and $950 of depreciation. The company had no amortization charges, it had $3,250 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 sales and cash flows in the future, the firm was required to spend $750 to buy new fixed assets and to invest $250 in net operating working capital. How much free cash flow did Wells generate?a.$1,770.00b.$1,858.50c.$1,951.43d.$2,049.00e. $2,151.45 ANS: 75.HHH Inc. reported $12,500 of sales and $7,025 of operating costs (including depreciation). The company had $18,750 of investor-supplied operating assets (or capital), the weighted average cost of that capital (the WACC) was 9.5%, and the federal-plus-state income tax rate was 40%. What was HHH's Economic Value Added (EVA), i.e., how much value did management add to stockholders' wealth during the year?a.$1,357.13b.$1,428.56c.$1,503.75d.$1,578.94e.$1,657.88 ANS: 76.Last year, Michelson Manufacturing reported $10,250 of sales, $3,500 of operating costs other than depreciation, and $1,250 of depreciation. The company had no amortization charges, it had $3,500 of bonds outstanding 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 $725. By how much will the depreciation change cause the firm's net after-tax income and its net cash flow to change? Note that the company uses the same depreciation calculations for tax and stockholder reporting purposes.a.−$383.84; $206.68b.−$404.04; $217.56c.−$425.30; $229.01d.−$447.69; $241.06e.−$471.25; $253.75 ANS: 77.Bartling Energy Systems recently reported $9,250 of sales, $5,750 of operating costs other than depreciation, and $700 of depreciation. The company had no amortization charges, it had $3,200 of outstanding bonds that carry a 5% interest rate, and its federal-plus-state income tax rate was 35%. In order to sustain its operations and thus generate sales and cash flows in the future, 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?a. $673.27b.$708.70c.$746.00d.$783.30e.$822.47 ANS:

CHAPTER 3—ANALYSIS OF FINANCIAL STATEMENTS TRUE/FALSE 1.Ratio analysis involves analyzing financial statements in order to appraise a firm's financial position and strength.

ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 3-1NAT:BUSPROG: Reflective ThinkingSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Ratio analysisKEY:Bloom’s: Knowledge

2.The current ratio and inventory turnover ratios both help us measure the firm's liquidity. The current ratio measures the relationship of a firm's current assets to its current liabilities, while the inventory turnover ratio gives us an indication of how long it takes the firm to convert its inventory into cash.

ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 3-2NAT:BUSPROG: Reflective ThinkingSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Liquidity ratiosKEY:Bloom’s: Knowledge 3.Although a full liquidity analysis requires the use of a cash budget, the current and quick ratios provide fast and easy-to-use measures of a firm's liquidity position.

ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 3-2NAT:BUSPROG: Reflective ThinkingSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Liquidity ratiosKEY:Bloom’s: Knowledge 4.High current and quick ratios always indicate that a firm is managing its liquidity position well.

ANS:FPTS:1DIF:Difficulty: EasyOBJ:LO: 3-2NAT:BUSPROG: Reflective ThinkingSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Current ratioKEY:Bloom’s: Knowledge 5.The inventory turnover ratio and days sales outstanding (DSO) are two ratios that are used to assess how effectively a firm is managing its assets.

ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 3-3NAT:BUSPROG: Reflective ThinkingSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Asset management ratiosKEY:Bloom’s: Knowledge 6.A decline in a firm's inventory turnover ratio suggests that it is managing its inventory more efficiently and also that its liquidity position is improving, i.e., it is becoming more liquid.

ANS:FPTS:1DIF:Difficulty: EasyOBJ:LO: 3-3NAT:BUSPROG: Reflective ThinkingSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Inventory turnover ratioKEY:Bloom’s: Knowledge 7.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.

ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 3-4NAT:BUSPROG: Reflective ThinkingSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Debt management ratiosKEY:Bloom’s: Knowledge 8.The times-interest-earned ratio is one, but not the only, indication of a firm's ability to meet its long-term and short-term debt obligations.

ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 3-4NAT:BUSPROG: Reflective ThinkingSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:TIE ratioKEY:Bloom’s: Knowledge 9.Profitability ratios show the combined effects of liquidity, asset management, and debt management on operating results.

ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 3-5NAT:BUSPROG: Reflective ThinkingSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Profitability ratiosKEY:Bloom’s: Knowledge 10.Market value ratios provide management with an indication of how investors view the firm's past performance and especially its future prospects.

ANS: 11.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 measuring changes in a firm's performance over time.

ANS:

12.The "apparent," but not the "true," financial position of a company whose sales are seasonal can differ dramatically, depending on the time of year when the financial statements are constructed.

ANS: 13.Significant variations in accounting methods among firms make meaningful ratio comparisons between firms more difficult than if all firms used similar accounting methods.

ANS: 14.The basic earning power ratio (BEP) reflects the earning power of a firm's assets after giving consideration to financial leverage and tax effects.

ANS:F 15.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.

ANS: 16.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.

ANS: 17.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. ANS: 18.Suppose firms follow similar financing policies, face similar risks, have equal access to capital, and operate in competitive product and capital markets. Under these conditions, then firms that have high profit margins will tend to have high asset turnover ratios, and firms with low profit margins will tend to have low turnover ratios.

ANS: 19.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 that of B. ANS: 20.Firms A and B have the same current ratio, 0.75, the same amount of sales and cost of goods sold, 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.

ANS: 21.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.

ANS: 22.Suppose Firms A and B have the same amount of assets, pay the same interest rate on their debt, have the same basic earning power (BEP), and have the same tax rate.

However, Firm A has a higher debt 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.

ANS:

23.If a firm finances with only debt and common equity, and if its equity multiplier is 3.0, then its debt ratio must be 0.667.

ANS:24.One problem with ratio analysis is that relationships can 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.

ANS: 25.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.

ANS: MULTIPLE CHOICE 26.Considered alone, which of the following would increase a company's current ratio?a.An increase in accounts payable.b.An increase in net fixed assets.c.An increase in accrued liabilities.d.An increase in notes payable.e.An increase in accounts receivable.

ANS:EPTS:1DIF:Difficulty: EasyOBJ:LO: 3-2NAT:BUSPROG: AnalyticSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Current ratioKEY:Bloom’s: ComprehensionMSC:TYPE: Multiple Choice: Conceptual 27.Which of the following would, generally, indicate an improvement in a company's financial position, holding other things constant?a.The total assets turnover decreases.b.The TIE declines.c.The DSO increases.d.The EBITDA coverage ratio increases.e.The current and quick ratios both decline.

ANS:DPTS:1DIF:Difficulty: EasyOBJ:LO: 3-2NAT:BUSPROG: AnalyticSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Current ratioKEY:Bloom’s: ComprehensionMSC:TYPE: Multiple Choice: Conceptual 28.A firm wants to strengthen its financial position. Which of the following actions would increase its current ratio?a.Use cash to increase inventory holdings.b.Reduce the company's days' sales outstanding to the industry average and use the resulting cash savings to purchase plant and equipment.c.Use cash to repurchase some of the company's own stock.d.Borrow using short-term debt and use the proceeds to repay debt that has a maturity of more than one year.e.Issue new stock and then use some of the proceeds to purchase additional inventory and hold the remainder as cash.

ANS:EPTS:1DIF:Difficulty: EasyOBJ:LO: 3-2NAT:BUSPROG: AnalyticSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Current ratioKEY:Bloom’s: ComprehensionMSC:TYPE: Multiple Choice: Conceptual 29.Which of the following statements is CORRECT?a.If a firm increases its sales and cost of goods sold while holding its inventories constant, then, other things held constant, its inventory turnover ratio will decrease.b.A reduction in inventories held would have no effect on the current ratio.c.An increase in inventories would have no effect on the current ratio.d.If a firm increases its sales and cost of goods sold while holding its inventories constant, then, other things held constant, its inventory turnover ratio will increase.e.A reduction in the inventory turnover ratio will generally lead to an increase in the ROE.

ANS:DPTS:1DIF:Difficulty: EasyOBJ:LO: 3-3NAT:BUSPROG: AnalyticSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:InventoriesKEY:Bloom’s: ComprehensionMSC:TYPE: Multiple Choice: Conceptual 30.Companies A and C each reported the same earnings per share (EPS), but Company A's stock trades at a higher price. Which of the following statements is CORRECT?a.Company A trades at a higher P/E ratio.b.Company A probably has fewer growth opportunities.c.Company A is probably judged by investors to be riskier.d.Company A must have a higher market-to-book ratio.e.Company A must pay a lower dividend.

ANS:APTS:1DIF:Difficulty: EasyOBJ:LO: 3-6NAT:BUSPROG: AnalyticSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Financial statement analysisKEY:Bloom’s: ComprehensionMSC:TYPE: Multiple Choice: Conceptual 31.Which of the following statements is CORRECT?a.If a firm has the highest price/earnings ratio of any firm in its industry, then, other things held constant, this suggests that the board of directors should fire the president.b.If a firm has the highest market/book ratio of any firm in its industry, then, other things held constant, this suggests that the board of directors should fire the president.c.Other things held constant, the higher a firm's expected future growth rate, the lower its P/E ratio is likely to be.d.The higher the market/book ratio, then, other things held constant, the higher one would expect to find the Market Value Added (MVA).e.If a firm has a history of high Economic Value Added (EVA) numbers each year, and if investors expect this situation to continue, then its market/book ratio and MVA are both likely to be below average.

ANS:DPTS:1DIF:Difficulty: EasyOBJ:LO: 3-6NAT:BUSPROG: AnalyticSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Market value ratiosKEY:Bloom’s: ComprehensionMSC:TYPE: Multiple Choice: Conceptual 32.Which of the following statements is CORRECT?a."Window dressing" is any action that improves a firm's fundamental, long-run position and thus increases its intrinsic value.b.Borrowing by using short-term notes payable and then using the proceeds to retire long-term debt is an example of "window dressing." Offering discounts to customers who pay with cash rather than buy on credit and then using the funds that come in quicker to purchase additional inventories is another example of "window dressing."c.Borrowing on a long-term basis and using the proceeds to retire short-term debt would improve the current ratio and thus could be considered to be an example of "window dressing."d.Offering discounts to customers who pay with cash rather than buy on credit and then using the funds that come in quicker to purchase additional inventories is an example of "window dressing."e.Using some of the firm's cash to reduce long-term debt is an example of "window dressing."

ANS:CPTS:1DIF:Difficulty: EasyOBJ:LO: 3-1NAT:BUSPROG: AnalyticSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Window dressingKEY:Bloom’s: ComprehensionMSC:TYPE: Multiple Choice: Conceptual 33.The Cavendish Company 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 would occur as a result of this action?a.The company's debt ratio increased.b.The company's

current ratio increased.c.The company's times interest earned ratio decreased.d.The company's basic earning power ratio increased.e.The company's equity multiplier increased.

ANS:BPTS:1DIF:Difficulty: EasyOBJ:LO: 3-6NAT:BUSPROG: AnalyticSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Miscellaneous ratiosKEY:Bloom’s: ComprehensionMSC:TYPE: Multiple Choice: Conceptual 34.A firm's new president wants to strengthen the company's financial position.

Which of the following actions would make it financially stronger?a.Increase inventories while holding sales and cost of goods sold constant.b.Increase accounts receivable while holding sales constant.c.Increase EBIT while holding sales constant.d.Increase accounts payable while holding sales constant.e.Increase notes payable while holding sales constant.

ANS:CPTS:1DIF:Difficulty: EasyOBJ:LO: 3-5NAT:BUSPROG: AnalyticSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Miscellaneous ratiosKEY:Bloom’s: ComprehensionMSC:TYPE: Multiple Choice: Conceptual 35.If the CEO of a large, 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 DSO (days' sales outstanding) is 40, whereas the average for its competitors is 30.b.The division's basic earning power ratio is above the average of other firms in its industry.c.The division's total assets turnover ratio is below the average for other firms in its industry.d.The division's debt ratio is above the average for other firms in the industry.e.The division's inventory turnover is 6, whereas the average for its competitors is 8.

ANS:BPTS:1DIF:Difficulty: EasyOBJ:LO: 3-5NAT:BUSPROG: AnalyticSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Miscellaneous ratiosKEY:Bloom’s: ComprehensionMSC:TYPE: Multiple Choice: Conceptual 36.Which of the following would indicate an improvement in a company's financial position, holding other things constant?a.The current and quick ratios both increase.b.The inventory and total assets turnover ratios both decline.c.The debt ratio increases.d.The profit margin declines.e.The EBITDA coverage ratio declines.

ANS:APTS:1DIF:Difficulty: EasyOBJ:LO: 3-5NAT:BUSPROG: AnalyticSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Miscellaneous ratiosKEY:Bloom’s: ComprehensionMSC:TYPE: Multiple Choice: Conceptual 37.If a bank loan officer were considering a company's request for a loan, which of the following statements would you consider to be CORRECT?a.Other things held constant, the lower the current ratio, the lower the interest rate the bank would charge the firm.b.The lower the company's EBITDA coverage ratio, other things held constant, the lower the interest rate the bank would charge the firm.c.Other things held constant, the higher the debt ratio, the lower the interest rate the bank would charge the firm.d.Other things held constant, the lower the debt ratio, the lower the

interest rate the bank would charge the firm.e.The lower the company's TIE ratio, other things held constant, the lower the interest rate the bank would charge the firm.

ANS:DPTS:1DIF:Difficulty: EasyOBJ:LO: 3-4NAT:BUSPROG: AnalyticSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Miscellaneous ratiosKEY:Bloom’s: ComprehensionMSC:TYPE: Multiple Choice: Conceptual 38.Which of the following statements is CORRECT?a.All else equal, increasing the debt ratio will increase the ROA.b.The use of debt financing will tend to lower the basic earning power ratio, other things held constant.c.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.d.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.e.Holding bonds is better than holding stock for investors because income from bonds is taxed on a more favorable basis than income from stock.

ANS:CPTS:1DIF:Difficulty: EasyOBJ:LO: 3-8NAT:BUSPROG: AnalyticSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Effects of leverageKEY:Bloom’s: ComprehensionMSC:TYPE: Multiple Choice: Conceptual 39.A firm wants to strengthen its financial position. Which of the following actions would increase its quick ratio?a.Issue new common stock and use the proceeds to acquire additional fixed assets.b.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.c.Issue new common stock and use the proceeds to increase inventories.d.Speed up the collection of receivables and use the cash generated to increase inventories.e.Use some of its cash to purchase additional inventories.

ANS:BPTS:1DIF:Difficulty: ModerateOBJ:LO: 3-2NAT:BUSPROG: AnalyticSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Quick ratioKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 40.Amram Company's current ratio is 1.9. Considered alone, which of the following actions would reduce the company's current ratio?a.Use cash to reduce accounts payable.b.Borrow using short-term notes payable and use the proceeds to reduce accruals.c.Borrow using short-term notes payable and use the proceeds to reduce long-term debt.d.Use cash to reduce accruals.e.Use cash to reduce short-term notes payable.

ANS: 41.Which of the following statements is CORRECT?a.If a firm increases its sales while holding its accounts receivable constant, then, other things held constant, its days' sales outstanding will decline.b.If a security analyst saw that a firm's days' sales outstanding (DSO) was higher than the industry average and was also increasing and trending still higher, this would be interpreted as a sign of strength.c.If a firm increases its sales while holding its accounts receivable constant, then, other things held constant, its days' sales outstanding (DSO) will increase.d.There is no relationship between the days' sales outstanding (DSO) and the average collection period (ACP). These ratios measure entirely different things.e.A reduction in accounts

receivable would have no effect on the current ratio, but it would lead to an increase in the quick ratio.

ANS: 42.Which of the following statements is CORRECT?a.If two firms differ only in their use of debt⎯i.e., they have identical assets, sales, operating costs, and tax rates⎯but one firm has a higher debt ratio, the firm that uses more debt will have a higher profit margin on sales.b.If one firm has a higher debt ratio than another, we can be certain that the firm with the higher debt ratio will have the lower TIE ratio, as that ratio depends entirely on the amount of debt a firm uses.c.A firm's use of debt will have no effect on its profit margin on sales.d.If two firms differ only in their use of debt⎯i.e., they have identical assets, sales, operating costs, interest rates on their debt, and tax rates⎯but one firm has a higher debt ratio, the firm that uses more debt will have a lower profit margin on sales.e.The debt 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.

ANS: 43.Which of the following statements is CORRECT?a.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.b.If Firms X and Y have the same P/E ratios, then their market-to-book ratios must also be the same.c.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.d.If Firms X and Y have the same earnings per share and market-to-book ratio, they must have the same price earnings ratio.e.If Firm X's P/E ratio exceeds that of Firm Y, then Y is likely to be less risky and also to be expected to grow at a faster rate.

ANS: 44.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%. Under these conditions, the ROE will decrease.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%. Under these conditions, the ROE will increase.c.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%. Without additional information, we cannot tell what will happen to the ROE.d.The modified DuPont equation provides information about how operations affect the ROE, but the equation does not include the effects of debt on the ROE.e.Other things held constant, an increase in the debt ratio will result in an increase in the profit margin on sales.

ANS: 45.You observe that a firm's ROE is above the industry average, but its profit margin and debt ratio are both below the industry average. Which of the following statements is CORRECT?a.Its total assets turnover must equal the industry average.b.Its total assets turnover must be above the industry average.c.Its return on assets must equal the industry average.d.Its TIE ratio must be below the industry average.e.Its total assets turnover must be below the industry average.

ANS: 46.Companies Heidee and Leaudy are virtually identical in that they are both profitable, and they have the same total assets (TA), Sales (S), return on assets (ROA), and profit margin (PM). However, Company Heidee has the higher debt ratio. Which of the following statements is CORRECT?a.Company Heidee has a lower operating income (EBIT) than Company LD.b.Company Heidee has a lower total assets turnover than Company Leaudy.c.Company Heidee has a lower equity multiplier than Company Leaudy.d.Company Heidee has a higher fixed assets turnover than Company Leaudy.e.Company Heidee has a higher ROE than Company Leaudy.

ANS: 47.Cordelion Communications 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 Cordelion 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 times interest earned ratio will decrease.b.The ROA will decline.c.Taxable income will decrease.d.The tax bill will increase.e.Net income will decrease.

ANS: 48.Which of the following statements is CORRECT?a.An increase in a firm's debt ratio, with no changes in its sales or operating costs, could be expected to lower the profit margin.b.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.c.If two firms have the same ROA, the firm with the most debt can be expected to have the lower ROE.d.An increase in the DSO, other things held constant, could be expected to increase the total assets turnover ratio.e.An increase in the DSO, other things held constant, could be expected to increase the ROE. ANS: 49.Heidee Corp. and Leaudy Corp. have identical assets, sales, interest rates paid on their debt, tax rates, and EBIT. However, Heidee uses more debt than Leaudy. Which of the following statements is CORRECT?a.Heidee would have the higher net income as shown on the income statement.b.Without more information, we cannot tell if Heidee or Leaudy would have a higher or lower net income.c.Heidee would have the lower equity multiplier for use in the DuPont equation.d.Heidee would have to pay more in income taxes.e.Heidee would have the lower net income as shown on the income statement.

ANS: 50.Other things held constant, which of the following alternatives would increase a company's cash flow for the current year?a.Increase the number of years over which fixed assets are depreciated for tax purposes.b.Pay down the accounts payables.c.Reduce the days' sales outstanding (DSO) without affecting sales or operating costs.d.Pay workers more frequently to decrease the accrued wages balance.e.Reduce the inventory turnover ratio without affecting sales or operating costs.

ANS:

51.Companies Heidee and Leaudy have the same sales, tax rate, interest rate on their debt, total assets, and basic earning power. Both companies have positive net incomes.

Company Heidee has a higher debt ratio and, therefore, a higher interest expense.

Which of the following statements is CORRECT?a.Company Heidee has more net income.b.Company Heidee pays less in taxes.c.Company Heidee has a lower equity multiplier.d.Company Heidee has a higher ROA.e.Company Heidee has a higher times interest earned (TIE) ratio.

ANS: 52.Companies Heidee and Leaudy have the same tax rate, sales, total assets, and basic earning power. Both companies have positive net incomes. Company Heidee has a higher debt ratio and, therefore, a higher interest expense. Which of the following statements is CORRECT?a.Company Heidee has a lower times interest earned (TIE) ratio.b.Company Heidee has a lower equity multiplier.c.Company Heidee has more net income.d.Company Heidee pays more in taxes.e.Company Heidee has a lower ROE. ANS: 53.Lincoln Industries' current ratio is 0.5. Considered alone, which of the following actions would increase the company's current ratio?a.Use cash to reduce long-term bonds outstanding.b.Borrow using short-term notes payable and use the cash to increase inventories.c.Use cash to reduce accruals.d.Use cash to reduce accounts payable.e.Use cash to reduce short-term notes payable.

ANS: 54.Lofland's has $20 million in current assets and $10 million in current liabilities, while Smaland'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 each plans 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 transaction would improve both firms' financial strength as measured by their current ratios.b.The transactions would raise Lofland's financial strength as measured by its current ratio but lower Smaland's current ratio.c.The transactions would lower Lofland's financial strength as measured by its current ratio but raise Smaland's current ratio.d.The transaction would have no effect on the firm' financial strength as measured by their current ratios.e.The transaction would lower both firm' financial strength as measured by their current ratios.

ANS: 55.Companies Heidee and Leaudy have the same total assets, sales, operating costs, and tax rates, and they pay the same interest rate on their debt. However, company Heidee has a higher debt ratio. Which of the following statements is CORRECT?a.If the interest rate the companies pay on their debt is less than their basic earning power (BEP), then Company Heidee will have the higher ROE.b.Given this information, Leaudy must have the higher ROE.c.Company Leaudy has a higher basic earning power ratio (BEP).d.Company Heidee has a higher basic earning power ratio (BEP).e.If the interest rate the companies pay on their debt is more than their basic earning power (BEP), then Company Heidee will have the higher ROE.

ANS: 56.Arshadi Corp.'s sales last year were $52,000, and its total assets were $22,000.

What was its total assets turnover ratio (TATO)?a.2.03b.2.13c.2.25d.2.36e.2.48 ANS: 57.Hutchinson Corporation has zero debtâ&#x17D;Żit is financed only with common equity. Its total assets are $410,000. The new CFO wants to employ enough debt to bring the debt/assets ratio to 40%, using the proceeds from the borrowing to buy back common stock at its book value. How much must the firm borrow to achieve the target debt ratio?a.$155,800b.$164,000c.$172,200d.$180,810e.$189,851 ANS: 58.Orono Corp.'s sales last year were $435,000, its operating costs were $362,500, and its interest charges were $12,500. What was the firm's times interest earned (TIE) ratio?a.4.72b.4.97c.5.23d.5.51e.5.80 ANS: 59.Rappaport Corp.'s sales last year were $320,000, and its net income after taxes was $23,000. What was its profit margin on sales? a.6.49%b.6.83%c.7.19%d.7.55%e.7.92% ANS: 60.Branch Corp.'s total assets at the end of last year were $315,000 and its net income after taxes was $22,750. What was its return on total assets? a.7.22%b.7.58%c.7.96%d.8.36%e.8.78% ANS: 61.Chambliss Corp.'s total assets at the end of last year were $305,000 and its EBIT was 62,500. What was its basic earning power (BEP)? a.18.49%b.19.47%c.20.49%d.21.52%e.22.59% ANS: 62.Nikko Corp.'s total common equity at the end of last year was $305,000 and its net income after taxes was $60,000. What was its ROE? a.16.87%b.17.75%c.18.69%d.19.67%e.20.66% ANS: 63.An investor is considering starting a new business. The company would require $475,000 of assets, and it would be financed entirely with common stock. The investor 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.$52,230b.$54,979c. $57,873d.$60,919e.$64,125 ANS: 64.Vang Corp.'s stock price at the end of last year was $33.50 and its earnings per share for the year were $2.30. What was its P/E ratio? a.13.84b.14.57c.15.29d.16.06e.16.86 ANS:

65.Lindley Corp.'s stock price at the end of last year was $33.50, and its book value per share was $25.00. What was its market/book ratio?a.1.34b.1.41c.1.48d.1.55e.1.63 ANS: 66.Northwest Lumber had a profit margin of 5.25%, a total assets turnover of 1.5, and an equity multiplier of 1.8. What was the firm's ROE? a.12.79%b.13.47%c.14.18%d.14.88%e.15.63% ANS: 67.Bostian, Inc. has total assets of $625,000. Its total debt outstanding is $185,000.

The Board of Directors has directed the CFO to move towards a debt-to-assets ratio of 55%. How much debt must the company add or subtract to achieve the target debt ratio?a.$158,750b.$166,688c.$175,022d.$183,773e.$192,962 ANS: 68.Emerson Inc.'s would like to undertake a policy of paying out 45% of its income.

Its latest net income was $1,250,000, and it had 225,000 shares outstanding. What dividend per share should it declare?a.$2.14b.$2.26c.$2.38d.$2.50e.$2.63 ANS: 69.Aziz Industries has sales of $100,000 and accounts receivable of $11,500, and it gives its customers 30 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?a.$267.34b.$281.41c.$296.22d.$311.81e.$328.22 ANS: 70.Heaton 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 â&#x2C6;&#x2019; 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.a.6.20b.6.53c.6.86d.7.20e.7.56 ANS: 71.Harper Corp.'s sales last year were $395,000, and its year-end receivables were $42,500. Harper sells on terms that call for customers to pay 30 days after the purchase, but many delay payment beyond Day 30. On average, how many days late do customers pay? Base your answer on this equation: DSO â&#x2C6;&#x2019; Allowed credit period = Average days late, and use a 365-day year when calculating the DSO.a.7.95b.8.37c.8.81d.9.27e.9.74 ANS: 72.Bonner Corp.'s sales last year were $415,000, 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. Bonner'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?a.$164,330b.$172,979c.$182,083d.$191,188e.$200,747 ANS: 73.A new firm is developing its business plan. It will require $565,000 of assets, and it projects $452,800 of sales and $354,300 of operating costs for the first year.

Management is quite 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. What is the maximum debt-to-assets ratio the firm can use?

(Hint: Find the maximum dollars of interest, then the debt that produces that interest, and then the related debt ratio.)a.47.33%b.49.82%c.52.45%d.55.21%e.58.11% ANS: 74.Ziebart Corp.'s EBITDA last year was $390,000 ( = EBIT + depreciation + amortization), its interest charges were $9,500, it had to repay $26,000 of long-term debt, and it had to make a payment of $17,400 under a long-term lease. The firm had no amortization charges. What was the EBITDA coverage ratio? a.7.32b.7.70c.8.09d.8.49e.8.92 ANS: 75.LeCompte Corp. has $312,900 of assets, and it uses only common equity capital (zero debt). Its sales for the last year were $620,000, and its net income after taxes was $24,655. 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 LeCompte need in order to achieve the 15% ROE, holding everything else constant?a.7.57%b.7.95%c.8.35%d.8.76%e.9.20% ANS: 76.Last year Urbana Corp. had $197,500 of assets, $307,500 of sales, $19,575 of net income, and a debt-to-total-assets ratio of 37.5%. The new CFO believes a new computer program will enable it to reduce costs and thus raise net income to $33,000.

Assets, sales, and the debt ratio would not be affected. By how much would the cost reduction improve the ROE?a.9.32%b.9.82%c.10.33%d.10.88%e.11.42% ANS: 77.Stewart Inc.'s latest EPS was $3.50, its book value per share was $22.75, it had 215,000 shares outstanding, and its debt-to-assets ratio was 46%. How much debt was outstanding?a.$3,393,738b.$3,572,356c.$3,760,375d.$3,958,289e.$4,166,620 ANS: 78.Last year Vaughn Corp. had sales of $315,000 and a net income of $17,832, and its year-end assets were $210,000. The firm's total-debt-to-total-assets ratio was 42.5%.

Based on the DuPont equation, what was Vaughn's ROE? a.14.77%b.15.51%c.16.28%d.17.10%e.17.95% ANS: 79.Last year Central Chemicals had sales of $205,000, assets of $127,500, a profit margin of 5.3%, and an equity multiplier of 1.2. The CFO believes that the company could reduce its assets by $21,000 without affecting either sales or costs. Had it

reduced its assets in this amount, and had the debt-to-assets ratio, sales, and costs remained constant, by how much would the ROE have changed? a.1.81%b.2.02%c.2.22%d.2.44%e.2.68% ANS: 80.Last year Mason Inc. had a total assets turnover of 1.33 and an equity multiplier of 1.75. Its sales were $195,000 and its net income was $10,549. The CFO believes that the company could have operated more efficiently, lowered its costs, and increased its net income by $5,250 without changing its sales, assets, or capital structure. Had it cut costs and increased its net income in this amount, by how much would the ROE have changed?a.5.66%b.5.95%c.6.27%d.6.58%e.6.91% ANS: 81.Last year Rosenberg Corp. had $195,000 of assets, $18,775 of net income, and a debt-to-total-assets ratio of 32%. Now suppose the new CFO convinces the president to increase the debt ratio to 48%. Sales and total assets 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?a.4.36%b.4.57%c.4.80%d.5.04%e.5.30% ANS: 82.Last year Altman Corp. had $205,000 of assets, $303,500 of sales, $18,250 of net income, and a debt-to-total-assets ratio of 41%. The new CFO believes the firm has excessive fixed assets and inventory that could be sold, enabling it to reduce its total assets to $152,500. Sales, costs, and net income would not be affected, and the firm would maintain the 41% debt ratio. By how much would the reduction in assets improve the ROE?a.4.69%b.4.93%c.5.19%d.5.45%e.5.73% ANS: 83.Muscarella Inc. has the following balance sheet and income statement data: Cash$ 14,000Accounts payable$ 42,000Receivables70,000Other current liabilities 28,000Inventories 210,000 Total CL$ 70,000 Total CA$294,000Long-term debt70,000Net fixed assets 126,000Common equity 280,000 Total assets$420,000 Total liab. and equity$420,000Sales$280,000Net income$ 21,000 The new CFO thinks that inventories are excessive and could be lowered sufficiently to cause the current ratio to equal the industry average, 2.70, 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? a.4.28%b.4.50%c.4.73%d.4.96%e.5.21% ANS: 84.Last year Swensen Corp. had sales of $303,225, operating costs of $267,500, and year-end assets of $195,000. The debt-to-total-assets ratio was 27%, the interest rate on the debt was 8.2%, and the firm's tax rate was 37%. The new CFO wants to see how the ROE would have been affected if the firm had used a 45% debt ratio. Assume that sales and total assets would not be affected, and that the interest rate and tax rate would both remain constant. By how much would the ROE change in response to the change in the capital structure?a.2.08%b.2.32%c.2.57%d.2.86%e.3.14%

ANS: 85.For the coming year, Crane Inc. is considering two financial plans. Management expects sales to be $301,770, operating costs to be $266,545, assets to be $200,000, and its tax rate to be 35%. Under Plan A it would use 25% debt and 75% common equity. The interest rate on the debt would be 8.8%, but the TIE ratio would have to be kept at 4.00 or more. Under Plan B the maximum debt that met the TIE constraint would be employed. Assuming that sales, operating costs, assets, 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? a.3.83%b.4.02%c.4.22%d.4.43%e.4.65% ANS: 86.Refer to Exhibit 3.1. What is the firm's current ratio? a.0.97b.1.08c.1.20d.1.33e.1.47 ANS: 87.Refer to Exhibit 3.1. What is the firm's quick ratio?a.0.49b.0.61c.0.73d.0.87e.1.05 ANS: 88.Refer to Exhibit 3.1. What is the firm's days sales outstanding? Assume a 360-day year for this calculation.a.48.17b.50.71c.53.38d.56.19e.59.14 ANS: 89.Refer to Exhibit 3.1. What is the firm's total assets turnover? a.0.90b.1.12c.1.40d.1.68e.2.02 ANS: 90.Refer to Exhibit 3.1. What is the firm's inventory turnover ratio? a.4.17b.4.38c.4.59d.5.82e.5.07 ANS: 91.Refer to Exhibit 3.1. What is the firm's TIE?a.1.94b.2.15c.2.39d.2.66e.2.93 ANS: 92.Refer to Exhibit 3.1. What is the firm's EBITDA coverage? a.3.29b.3.46c.3.64d.3.82e.4.01 ANS: 93.Refer to Exhibit 3.1. What is the firm's debt-to-assets ratio? a.45.93%b.51.03%c.56.70%d.63.00%e.70.00% ANS: 94.Refer to Exhibit 3.1. What is the firm's ROA? a.2.70%b.2.97%c.3.26%d.3.59%e.3.95% ANS: 95.Refer to Exhibit 3.1. What is the firm's ROE? a.8.54%b.8.99%c.9.44%d.9.91%e.10.41%

ANS: 96.Refer to Exhibit 3.1. What is the firm's BEP? a.6.00%b.6.32%c.6.65%d.6.98%e.7.33% ANS: 97.Refer to Exhibit 3.1. What is the firm's profit margin? a.1.40%b.1.56%c.1.73%d.1.93%e.2.12% ANS: 98.Refer to Exhibit 3.1. What is the firm's dividends per share?a.$2.62b.$2.91c. $3.20d.$3.53e.$3.88 ANS: 99.Refer to Exhibit 3.1. What is the firm's cash flow per share?a.$10.06b.$10.59c. $11.15d.$11.74e.$12.35 100.Refer to Exhibit 3.1. What is the firm's EPS?a.$5.84b.$6.15c.$6.47d.$6.80e.$7.14 ANS: 101.Refer to Exhibit 3.1. What is the firm's P/E ratio?a.12.0b.12.6c.13.2d.13.9e.14.6 ANS: 102.Refer to Exhibit 3.1. What is the firm's book value per share?a.$61.73b.$64.98c. $68.40d.$72.00e.$75.60 ANS: 103.Refer to Exhibit 3.1. What is the firm's market-to-book ratio? a.0.56b.0.66c.0.78d.0.92e.1.08 ANS: 104.Refer to Exhibit 3.1. What is the firm's equity multiplier? a.3.33b.3.50c.3.68d.3.86e.4.05 ANS:

CHAPTER 4—TIME VALUE OF MONEY TRUE/FALSE 1.Starting to invest early for retirement increases the benefits of compound interest.

ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 4-2NAT:BUSPROG: Reflective ThinkingSTA:DISC: Time value of moneyLOC:TBATOP:CompoundingKEY:Bloom’s: Knowledge 2.Starting to invest early for retirement reduces the benefits of compound interest.

ANS:FPTS:1DIF:Difficulty: EasyOBJ:LO: 4-2NAT:BUSPROG: Reflective ThinkingSTA:DISC: Time value of moneyLOC:TBATOP:CompoundingKEY:Bloom’s: Knowledge 3.A time line is meaningful even if all cash flows do not occur annually.

ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 4-2NAT:BUSPROG: Reflective ThinkingSTA:DISC: Time value of moneyLOC:TBATOP:CompoundingKEY:Bloom’s: Knowledge 4.A time line is not meaningful unless all cash flows occur annually.

ANS:FPTS:1DIF:Difficulty: EasyOBJ:LO: 4-2NAT:BUSPROG: Reflective ThinkingSTA:DISC: Time value of moneyLOC:TBATOP:CompoundingKEY:Bloom’s: Knowledge 5.Time lines can be constructed in situations where some of the cash flows occur annually but others occur quarterly.

ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 4-2NAT:BUSPROG: Reflective ThinkingSTA:DISC: Time value of moneyLOC:TBATOP:CompoundingKEY:Bloom’s: Knowledge 6.Time lines cannot be constructed in situations where some of the cash flows occur annually but others occur quarterly.

ANS:FPTS:1DIF:Difficulty: EasyOBJ:LO: 4-2NAT:BUSPROG: Reflective ThinkingSTA:DISC: Time value of moneyLOC:TBATOP:CompoundingKEY:Bloom’s: Knowledge 7.Time lines can be constructed for annuities where the payments occur at either the beginning or the end of the periods.

ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 4-2NAT:BUSPROG: Reflective ThinkingSTA:DISC: Time value of moneyLOC:TBATOP:CompoundingKEY:Bloom’s: Knowledge 8.Time lines cannot be constructed for annuities unless all the payments occur at the end of the periods.

ANS:FPTS:1DIF:Difficulty: EasyOBJ:LO: 4-2NAT:BUSPROG: Reflective ThinkingSTA:DISC: Time value of moneyLOC:TBATOP:CompoundingKEY:Bloom’s: Knowledge 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.

ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 4-2NAT:BUSPROG: Reflective ThinkingSTA:DISC: Time value of moneyLOC:TBATOP:CompoundingKEY:Bloom’s: Knowledge 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.

ANS:FPTS:1DIF:Difficulty: EasyOBJ:LO: 4-2NAT:BUSPROG: Reflective ThinkingSTA:DISC: Time value of moneyLOC:TBATOP:CompoundingKEY:Bloom’s: Knowledge 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.

ANS:FPTS:1DIF:Difficulty: EasyOBJ:LO: 4-3NAT:BUSPROG: AnalyticSTA:DISC: Time value of moneyLOC:TBATOP:PV versus FVKEY:Bloom’s: Knowledge 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.

ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 4-3NAT:BUSPROG: AnalyticSTA:DISC: Time value of moneyLOC:TBATOP:PV versus FVKEY:Bloom’s: Knowledge 13.Disregarding risk, if money has time value, it is impossible for the present value of a given sum to exceed its future value.

ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 4-3NAT:BUSPROG: AnalyticSTA:DISC: Time value of moneyLOC:TBATOP:PV versus FVKEY:Bloom’s: Knowledge

14.Disregarding risk, if money has time value, it is impossible for the future value of a given sum to exceed its present value.

ANS:FPTS:1DIF:Difficulty: EasyOBJ:LO: 4-3NAT:BUSPROG: AnalyticSTA:DISC: Time value of moneyLOC:TBATOP:PV versus FVKEY:Bloom’s: Knowledge 15.If a bank compounds savings accounts quarterly, the nominal rate will exceed the effective annual rate.

ANS:FPTS:1DIF:Difficulty: EasyOBJ:LO: 4-15NAT:BUSPROG: AnalyticSTA:DISC: Time value of moneyLOC:TBATOP:Effective annual rateKEY:Bloom’s: Knowledge 16.If a bank compounds savings accounts quarterly, the effective annual rate will exceed the nominal rate.

ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 4-15NAT:BUSPROG: AnalyticSTA:DISC: Time value of moneyLOC:TBATOP:Effective annual rateKEY:Bloom’s: Knowledge 17.A "growing annuity" is a cash flow stream that grows at a constant rate for a specified number of periods.

ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 4-18NAT:BUSPROG: AnalyticSTA:DISC: Time value of moneyLOC:TBATOP:Growing annuityKEY:Bloom’s: Knowledge 18.A "growing annuity" is any cash flow stream that grows over time.

ANS:FPTS:1DIF:Difficulty: EasyOBJ:LO: 4-18NAT:BUSPROG: AnalyticSTA:DISC: Time value of moneyLOC:TBATOP:Growing annuityKEY:Bloom’s: Knowledge 19.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.

ANS:FPTS:1DIF:Difficulty: ModerateOBJ:LO: 4-2NAT:BUSPROG: AnalyticSTA:DISC: Time value of moneyLOC:TBATOP:CompoundingKEY:Bloom’s: Comprehension 20.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.

ANS:TPTS:1DIF:Difficulty: ModerateOBJ:LO: 4-2NAT:BUSPROG: AnalyticSTA:DISC: Time value of moneyLOC:TBATOP:CompoundingKEY:Bloom’s: Comprehension 21.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.)

ANS: 22.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.)

ANS:23.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.

ANS:TPTS:1DIF:Difficulty: ModerateOBJ:LO: 4-3NAT:BUSPROG: AnalyticSTA:DISC: Time value of moneyLOC:TBATOP:PV of a dollarKEY:Bloom’s: Comprehension 24.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.

ANS:FPTS:1DIF:Difficulty: ModerateOBJ:LO: 4-3NAT:BUSPROG: AnalyticSTA:DISC: Time value of moneyLOC:TBATOP:PV of a sumKEY:Bloom’s: Comprehension 25.All other things held constant, the present value of a given annual annuity decreases as the number of periods per year increases.

ANS: PTS:1DIF:Difficulty: ModerateOBJ:LO: 4-9NAT:BUSPROG: AnalyticSTA:DISC: Time value of moneyLOC:TBATOP:PV of an annuityKEY:Bloom’s: Comprehension 26.All other things held constant, the present value of a given annual annuity increases as the number of periods per year increases.

ANS:PTS:1DIF:Difficulty: ModerateOBJ:LO: 4-9NAT:BUSPROG: AnalyticSTA:DISC: Time value of moneyLOC:TBATOP:PV of an annuityKEY:Bloom’s: Comprehension 27.If we are given a periodic interest rate, say a monthly rate, we can find the nominal annual rate by multiplying the periodic rate by the number of periods per year.

ANS:TPTS:1DIF:Difficulty: ModerateOBJ:LO: 4-15NAT:BUSPROG: AnalyticSTA:DISC: Time value of moneyLOC:TBATOP:Periodic and nominal ratesKEY:Bloom’s: Comprehension 28.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.

ANS:FPTS:1DIF:Difficulty: ModerateOBJ:LO: 4-15NAT:BUSPROG: AnalyticSTA:DISC: Time value of moneyLOC:TBATOP:Periodic and nominal ratesKEY:Bloom’s: Comprehension 29.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).

ANS:TPTS:1DIF:Difficulty: ModerateOBJ:LO: 4-15NAT:BUSPROG: AnalyticSTA:DISC: Time value of moneyLOC:TBATOP:Effective and nominal ratesKEY:Bloom’s: Comprehension 30.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).

ANS:FPTS:1DIF:Difficulty: ModerateOBJ:LO: 4-15NAT:BUSPROG: AnalyticSTA:DISC: Time value of moneyLOC:TBATOP:Effective and nominal ratesKEY:Bloom’s: Comprehension 31.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.

ANS:FPTS:1DIF:Difficulty: ModerateOBJ:LO: 4-17NAT:BUSPROG: AnalyticSTA:DISC: Time value of moneyLOC:TBATOP:AmortizationKEY:Bloom’s: Comprehension 32.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.

ANS:TPTS:1DIF:Difficulty: ModerateOBJ:LO: 4-17NAT:BUSPROG: AnalyticSTA:DISC: Time value of moneyLOC:TBATOP:AmortizationKEY:Bloom’s: Comprehension

33.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.

ANS:TPTS:1DIF:Difficulty: ModerateOBJ:LO: 4-17NAT:BUSPROG: AnalyticSTA:DISC: Time value of moneyLOC:TBATOP:AmortizationKEY:Bloom’s: Comprehension 34.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.

ANS:FPTS:1DIF:Difficulty: ModerateOBJ:LO: 4-17NAT:BUSPROG: AnalyticSTA:DISC: Time value of moneyLOC:TBATOP:AmortizationKEY:Bloom’s: Comprehension 35.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.

ANS: 36.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.

ANS: MULTIPLE CHOICE 37.Which of the following statements is CORRECT?a.Some of the cash flows shown on a time line can be in the form of annuity payments, but none can be uneven amounts.b.A time line is not meaningful unless all cash flows occur annually.c.Time lines are useful for visualizing complex problems prior to doing actual calculations.d.Time lines cannot be constructed in situations where some of the cash flows occur annually but others occur quarterly.e.Time lines cannot be constructed for annuities where the payments occur at the beginning of the periods.

ANS:CPTS:1DIF:Difficulty: ModerateOBJ:LO: 4-1NAT:BUSPROG: Reflective ThinkingSTA:DISC: Time value of moneyLOC:TBATOP:Time linesKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: ConceptualNOT:Students may be able to correctly determine the answer to this question without [many] calculations. Please see the "Answers &amp; Solutions" section to see calculation requirements for this question.

38.Which of the following statements is CORRECT?a.Some of the cash flows shown on a time line can be in the form of annuity payments, but none can be uneven amounts.b.A time line is not meaningful unless all cash flows occur annually.c.Time lines are not useful for visualizing complex problems prior to doing actual calculations.d.Time lines cannot be constructed in situations where some of the cash flows occur annually but others occur quarterly.e.Time lines can be constructed for annuities where the payments occur at either the beginning or the end of the periods.

ANS:EPTS:1DIF:Difficulty: ModerateOBJ:LO: 4-1NAT:BUSPROG: Reflective ThinkingSTA:DISC: Time value of moneyLOC:TBATOP:Time linesKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: ConceptualNOT:Students may be able to correctly determine the answer to this question without [many] calculations. Please

see the "Answers &amp; Solutions" section to see calculation requirements for this question.

39.Which of the following statements is CORRECT?a.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.b.A time line is not meaningful unless all cash flows occur annually.c.Time lines are not useful for visualizing complex problems prior to doing actual calculations.d.Time lines can be constructed to deal with situations where some of the cash flows occur annually but others occur quarterly.e.Time lines can only be constructed for annuities where the payments occur at the end of the periods, i.e., for ordinary annuities.

ANS:DPTS:1DIF:Difficulty: ModerateOBJ:LO: 4-1NAT:BUSPROG: Reflective ThinkingSTA:DISC: Time value of moneyLOC:TBATOP:Time linesKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: ConceptualNOT:Students may be able to correctly determine the answer to this question without [many] calculations. Please see the "Answers &amp; Solutions" section to see calculation requirements for this question.

40.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.

ANS:EPTS:1DIF:Difficulty: ModerateOBJ:LO: 4-1NAT:BUSPROG: Reflective ThinkingSTA:DISC: Time value of moneyLOC:TBATOP:Time linesKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: ConceptualNOT:Students may be able to correctly determine the answer to this question without [many] calculations. Please see the "Answers &amp; Solutions" section to see calculation requirements for this question.

41.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 discount rate decreases.b.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.c.The discount rate increases.d.The riskiness of the investment's cash flows decreases.e.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.

ANS:CPTS:1DIF:Difficulty: ModerateOBJ:LO: 4-3NAT:BUSPROG: AnalyticSTA:DISC: Time value of moneyLOC:TBATOP:Effects of factors on PVsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: ConceptualNOT:Students may be able to correctly determine the answer to this question without [many] calculations. Please see the "Answers &amp; Solutions" section to see calculation requirements for this question.

42.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 discount rate increases.b.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.c.The discount rate decreases.d.The riskiness of the investment's cash flows increases.e.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.

ANS:CPTS:1DIF:Difficulty: ModerateOBJ:LO: 4-3NAT:BUSPROG: AnalyticSTA:DISC: Time value of moneyLOC:TBATOP:Effects of factors on PVsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: ConceptualNOT:Students may be able to correctly determine the answer to this question without [many] calculations. Please see the "Answers &amp; Solutions" section to see calculation requirements for this question.

43.Which of the following statements is CORRECT?a.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.b.The cash flows for an ordinary (or deferred) annuity all occur at the beginning of the periods.c.If a series of unequal cash flows occurs at regular intervals, such as once a year, then the series is by definition an annuity.d.The cash flows for an annuity due must all occur at the ends of the periods.e.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.

ANS:EPTS:1DIF:Difficulty: ModerateOBJ:LO: 4-6NAT:BUSPROG: Reflective ThinkingSTA:DISC: Time value of moneyLOC:TBATOP:AnnuitiesKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: ConceptualNOT:Students may be able to correctly determine the answer to this question without [many] calculations. Please see the "Answers &amp; Solutions" section to see calculation requirements for this question.

44.Which of the following statements is CORRECT?a.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.b.The cash flows for an ordinary (or deferred) annuity all occur at the beginning of the periods.c.If a series of unequal cash flows occurs at regular intervals, such as once a year, then the series is by definition an annuity.d.The cash flows for an annuity due must all occur at the beginning of the periods.e.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.

ANS:DPTS:1DIF:Difficulty: ModerateOBJ:LO: 4-6NAT:BUSPROG: Reflective ThinkingSTA:DISC: Time value of moneyLOC:TBATOP:AnnuitiesKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: ConceptualNOT:Students may be able to correctly determine the answer to this question without [many] calculations. Please see the "Answers &amp; Solutions" section to see calculation requirements for this question.

45.Your bank account pays a 5% nominal rate of interest. The interest is compounded quarterly. Which of the following statements is CORRECT?a.The periodic rate of interest is 5% and the effective rate of interest is also 5%.b.The periodic rate of interest is 1.25% and the effective rate of interest is 2.5%.c.The periodic rate of interest is 5% and the effective rate of interest is greater than 5%.d.The periodic rate

of interest is 1.25% and the effective rate of interest is greater than 5%.e.The periodic rate of interest is 2.5% and the effective rate of interest is 5%.

ANS:DPTS:1DIF:Difficulty: ModerateOBJ:LO: 4-15NAT:BUSPROG: AnalyticSTA:DISC: Time value of moneyLOC:TBATOP:Quarterly compoundingKEY:Bloomâ&#x20AC;&#x2122;s: AnalysisMSC:TYPE: Multiple Choice: ConceptualNOT:Students may be able to correctly determine the answer to this question without [many] calculations. Please see the "Answers &amp; Solutions" section to see calculation requirements for this question.

46.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 8% and the effective rate of interest is also 8%.b.The periodic rate of interest is 2% and the effective rate of interest is 4%.c.The periodic rate of interest is 8% and the effective rate of interest is greater than 8%.d.The periodic rate of interest is 4% and the effective rate of interest is less than 8%.e.The periodic rate of interest is 2% and the effective rate of interest is greater than 8%.

ANS: 47.A $250,000 loan is to be amortized over 8 years, with annual end-of-year payments. Which of these statements is CORRECT?a.The proportion of interest versus principal repayment would be the same for each of the 8 payments.b.The annual payments would be larger if the interest rate were lower.c.If the loan were amortized over 10 years rather than 8 years, and if the interest rate were the same in either case, the first payment would include more dollars of interest under the 8-year amortization plan.d.The proportion of each payment that represents interest as opposed to repayment of principal would be lower if the interest rate were lower.e.The last payment would have a higher proportion of interest than the first payment.

ANS: 48.A $150,000 loan is to be amortized over 6 years, with annual end-of-year payments. Which of these statements is CORRECT?a.The proportion of interest versus principal repayment would be the same for each of the 7 payments.b.The annual payments would be larger if the interest rate were lower.c.If the loan were amortized over 10 years rather than 6 years, and if the interest rate were the same in either case, the first payment would include more dollars of interest under the 6-year amortization plan.d.The proportion of each payment that represents interest as opposed to repayment of principal would be higher if the interest rate were lower.e.The proportion of each payment that represents interest versus repayment of principal would be higher if the interest rate were higher.

ANS: 49.Which of the following statements regarding a 20-year (240-month) $225,000, fixed-rate mortgage is CORRECT? (Ignore taxes and transactions costs.)a.The outstanding balance declines at a slower rate in the later years of the loan's life.b.The remaining balance after three years will be $225,000 less one third of the interest paid during the first three years.c.Because it is a fixed-rate mortgage, the monthly loan payments (which include both interest and principal payments) are constant.d.Interest payments on the mortgage will increase steadily over time, but the total amount of each payment will remain constant.e.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.

ANS: 50.Which of the following statements regarding a 15-year (180-month) $225,000, fixed-rate mortgage is CORRECT? (Ignore taxes and transactions costs.)a.The outstanding balance declines at a faster rate in the later years of the loan's life.b.The remaining balance after three years will be $125,000 less one third of the interest paid during the first three years.c.Because the outstanding balance declines over time, the monthly payments will also decline over time.d.Interest payments on the mortgage will increase steadily over time, but the total amount of each payment will remain constant.e.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.

ANS:51.Which of the following statements regarding a 30-year monthly payment amortized mortgage with a nominal interest rate of 8% is CORRECT?a.Exactly 8% of the first monthly payment represents interest.b.The monthly payments will decline over time.c.A smaller proportion of the last monthly payment will be interest, and a larger proportion will be principal, than for the first monthly payment.d.The total dollar amount of principal being paid off each month gets smaller as the loan approaches maturity.e.The amount representing interest in the first payment would be higher if the nominal interest rate were 6% rather than 8%.

ANS: 52.Which of the following statements regarding a 20-year monthly payment amortized mortgage with a nominal interest rate of 10% is CORRECT?a.Exactly 10% of the first monthly payment represents interest.b.The monthly payments will increase over time.c.A larger proportion of the first monthly payment will be interest, and a smaller proportion will be principal, than for the last monthly payment.d.The total dollar amount of interest being paid off each month gets larger as the loan approaches maturity.e.The amount representing interest in the first payment would be higher if the nominal interest rate were 7% rather than 10%.

ANS: 53.At the end of 10 years, which of the following investments would have the highest future 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 beginning of every year for the next 10 years (a total of 10 payments).b.Investment B pays $125 at the end of every 6month 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).

ANS: 54.Of the following investments, which 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).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).

ANS:" section to see calculation requirements for this question.

55.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 PV of the $1,000 lump sum has a higher present value than the PV of a 3-year, $333.33 ordinary annuity.b.The periodic interest rate is greater than 3%.c.The periodic rate is less than 3%.d.The present value would be greater if the lump sum were discounted back for more periods.e.The present value of the $1,000 would be smaller if interest were compounded monthly rather than semiannually.

ANS:EPTS:1DIF:Difficulty: ModerateOBJ:LO: 4-15NAT:BUSPROG: AnalyticSTA:DISC: Time value of moneyLOC:TBATOP:Time value conceptsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: ConceptualNOT:Students may be able to correctly determine the answer to this question without [many] calculations. Please see the "Answers &amp; Solutions" section to see calculation requirements for this question.

56.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 PV of the $1,000 lump sum has a smaller present value than the PV of a 3-year, $333.33 ordinary annuity.b.The periodic interest rate is greater than 3%.c.The periodic rate is less than 3%.d.The present value would be greater if the lump sum were discounted back for more periods.e.The present value of the $1,000 would be larger if interest were compounded monthly rather than semiannually.

ANS:APTS:1DIF:Difficulty: ModerateOBJ:LO: 4-15NAT:BUSPROG: AnalyticSTA:DISC: Time value of moneyLOC:TBATOP:Time value conceptsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: ConceptualNOT:Students may be able to correctly determine the answer to this question without [many] calculations. Please see the "Answers &amp; Solutions" section to see calculation requirements for this question.

57.Which of the following statements is CORRECT, assuming positive interest rates and holding other things constant?a.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.b.The present value of a 5-year, $250 annuity due will be lower than the PV of a similar ordinary annuity.c.A 30-year, $150,000 amortized mortgage will have larger monthly payments than an otherwise similar 20-year mortgage.d.A bank loan's nominal interest rate will always be equal to or less than its effective annual rate.e.If an investment pays 10% interest, compounded annually, its effective annual rate will be less than 10%.

ANS:DPTS:1DIF:Difficulty: ModerateOBJ:LO: 4-15NAT:BUSPROG: AnalyticSTA:DISC: Time value of moneyLOC:TBATOP:Time value conceptsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: ConceptualNOT:Students may be able to correctly determine the answer to this

question without [many] calculations. Please see the "Answers &amp; Solutions" section to see calculation requirements for this question.

58.Which of the following statements is CORRECT, assuming positive interest rates and holding other things constant?a.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.b.The present value of a 5-year, $250 annuity due will be lower than the PV of a similar ordinary annuity.c.A 30-year, $150,000 amortized mortgage will have larger monthly payments than an otherwise similar 20-year mortgage.d.A bank loan's nominal interest rate will always be equal to or greater than its effective annual rate.e.If an investment pays 10% interest, compounded quarterly, its effective annual rate will be greater than 10%.

ANS:EPTS:1DIF:Difficulty: ModerateOBJ:LO: 4-15NAT:BUSPROG: AnalyticSTA:DISC: Time value of moneyLOC:TBATOP:Time value conceptsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: ConceptualNOT:Students may be able to correctly determine the answer to this question without [many] calculations. Please see the "Answers &amp; Solutions" section to see calculation requirements for this question.

59.Which of the following statements is CORRECT?a.An investment that has a nominal rate of 6% with semiannual payments will have an effective rate that is smaller than 6%.b.The present value of a 3-year, $150 annuity due will exceed the present value of a 3-year, $150 ordinary annuity.c.If a loan has a nominal annual rate of 8%, then the effective rate can never be greater than 8%.d.If a loan or investment has annual payments, then the effective, periodic, and nominal rates of interest will all be different.e.The proportion of the payment that goes toward interest on a fully amortized loan increases over time.

ANS:BPTS:1DIF:Difficulty: ModerateOBJ:LO: 4-15NAT:BUSPROG: AnalyticSTA:DISC: Time value of moneyLOC:TBATOP:Time value conceptsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: ConceptualNOT:Students may be able to correctly determine the answer to this question without [many] calculations. Please see the "Answers &amp; Solutions" section to see calculation requirements for this question.

60.Which of the following statements is CORRECT?a.An investment that has a nominal rate of 6% with semiannual payments will have an effective rate that is smaller than 6%.b.The present value of a 3-year, $150 ordinary annuity will exceed the present value of a 3-year, $150 annuity due.c.If a loan has a nominal annual rate of 7%, then the effective rate will never be less than 7%.d.If a loan or investment has annual payments, then the effective, periodic, and nominal rates of interest will all be different.e.The proportion of the payment that goes toward interest on a fully amortized loan increases over time.

ANS:CPTS:1DIF:Difficulty: ModerateOBJ:LO: 4-15NAT:BUSPROG: AnalyticSTA:DISC: Time value of moneyLOC:TBATOP:Time value conceptsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: ConceptualNOT:Students may be able to correctly determine the answer to this question without [many] calculations. Please see the "Answers &amp; Solutions" section to see calculation requirements for this question.

61.You are considering two equally risky annuities, each of which pays $15,000 per year for 20 years. Investment ORD is an ordinary (or deferred) annuity, while Investment DUE is an annuity due. Which of the following statements is CORRECT? a.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.b.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.c.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.d.The present value of ORD exceeds the present value of DUE, and the future value of ORD also exceeds the future value of DUE.e.The present value of DUE exceeds the present value of ORD, and the future value of DUE also exceeds the future value of ORD. ANS:EPTS:1DIF:Difficulty: ModerateOBJ:LO: 4-9NAT:BUSPROG: AnalyticSTA:DISC: Time value of moneyLOC:TBATOP:AnnuitiesKEY:Bloomâ&#x20AC;&#x2122;s: AnalysisMSC:TYPE: Multiple Choice: ConceptualNOT:Students may be able to correctly determine the answer to this question without [many] calculations. Please see the "Answers &amp; Solutions" section to see calculation requirements for this question.

62.You are considering two equally risky annuities, each of which pays $25,000 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.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.b.A rational investor would be willing to pay more for DUE than for ORD, so their market prices should differ.c.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.d.The present value of ORD exceeds the present value of DUE, and the future value of ORD also exceeds the future value of DUE.e.The present value of ORD exceeds the present value of DUE, while the future value of DUE exceeds the future value of ORD. ANS:BPTS:1DIF:Difficulty: ModerateOBJ:LO: 4-9NAT:BUSPROG: AnalyticSTA:DISC: Time value of moneyLOC:TBATOP:AnnuitiesKEY:Bloomâ&#x20AC;&#x2122;s: AnalysisMSC:TYPE: Multiple Choice: ConceptualNOT:Students may be able to correctly determine the answer to this question without [many] calculations. Please see the "Answers &amp; Solutions" section to see calculation requirements for this question.

63.Which of the following statements is CORRECT?a.If CF0 is positive and all the other CFs are negative, then you cannot solve for I.b.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 to equal the cash flow at Time 0.c.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.d.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-anderror procedure that is easy with a computer or financial calculator but quite difficult otherwise.e.If you solve for I and get a negative number, then you must have made a mistake.

ANS:DPTS:1DIF:Difficulty: ChallengingOBJ:LO: 4-14NAT:BUSPROG: AnalyticSTA:DISC: Time value of moneyLOC:TBATOP:Solving for I: uneven CFsKEY:Bloomâ&#x20AC;&#x2122;s: AnalysisMSC:TYPE: Multiple Choice: ConceptualNOT:Students may be able to correctly determine the answer to this question without [many] calculations. Please see the "Answers &amp; Solutions" section to see calculation requirements for this question.

64.Which of the following statements is CORRECT?a.If CF0 is positive and all the other CFs are negative, then you can still solve for I.b.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 to equal the cash flow at Time 0.c.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.d.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.e.If you solve for I and get a negative number, then you must have made a mistake.

ANS:APTS:1DIF:Difficulty: ChallengingOBJ:LO: 4-14NAT:BUSPROG: AnalyticSTA:DISC: Time value of moneyLOC:TBATOP:Solving for I: uneven CFsKEY:Bloomâ&#x20AC;&#x2122;s: AnalysisMSC:TYPE: Multiple Choice: ConceptualNOT:Students may be able to correctly determine the answer to this question without [many] calculations. Please see the "Answers &amp; Solutions" section to see calculation requirements for this question.

65.Which of the following bank accounts has the highest effective annual return?a.An account that pays 8% nominal interest with daily (365-day) compounding.b.An account that pays 8% nominal interest with monthly compounding.c.An account that pays 8% nominal interest with annual compounding.d.An account that pays 7% nominal interest with daily (365-day) compounding.e.An account that pays 7% nominal interest with monthly compounding.

ANS: 66.Which of the following bank accounts has the lowest effective annual return?a.An account that pays 8% nominal interest with daily (365-day) compounding.b.An account that pays 8% nominal interest with monthly compounding.c.An account that pays 8% nominal interest with annual compounding.d.An account that pays 7% nominal interest with daily (365-day) compounding.e.An account that pays 7% nominal interest with monthly compounding.

ANS: 67.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.

ANS: 68.Ellen now has $125. How much would she have after 8 years if she leaves it invested at 8.5% with annual compounding?a.$205.83b.$216.67c.$228.07d.$240.08e. $252.08

ANS: 69.How much would Roderick have after 6 years if he has $500 now and leaves it invested at 5.5% with annual compounding?a.$591.09b.$622.20c.$654.95d.$689.42e. $723.89 ANS: 70.JG Asset Services is recommending that you invest $1,500 in a 5-year certificate of deposit (CD) that pays 3.5% interest, compounded annually. How much will you have when the CD matures?a.$1,781.53b.$1,870.61c.$1,964.14d.$2,062.34e.$2,165.46 ANS: 71.Your bank offers a 10-year certificate of deposit (CD) that pays 6.5% interest, compounded annually. If you invest $2,000 in the CD, how much will you have when it matures?a.$3,754.27b.$3,941.99c.$4,139.09d.$4,346.04e.$4,563.34 ANS: 72.Cyberhost Corporation's sales were $225 million last year. If sales grow at 6% per year, how large (in millions) will they be 5 years later?a.$271.74b.$286.05c.$301.10d. $316.16e.$331.96 ANS: 73.Cochrane Associate's net sales last year were $525 million. If sales grow at 7.5% per year, how large (in millions) will they be 8 years later?a.$845.03b.$889.51c. $936.33d.$983.14e.$1,032.30 ANS: 74.How much would $1, growing at 3.5% per year, be worth after 75 years?a. $12.54b.$13.20c.$13.86d.$14.55e.$15.28 ANS: 75.How much would $100, growing at 5% per year, be worth after 75 years?a. $3,689.11b.$3,883.27c.$4,077.43d.$4,281.30e.$4,495.37 ANS: 76.Your bank offers a savings account that pays 3.5% interest, compounded annually.

If you invest $1,000 in the account, then how much will it be worth at the end of 25 years?a.$2,245.08b.$2,363.24c.$2,481.41d.$2,605.48e.$2,735.75 ANS: 77.Your bank offers a savings account that pays 3.5% interest, compounded annually.

How much will $500 invested today be worth at the end of 25 years?a.$1,122.54b. $1,181.62c.$1,240.70d.$1,302.74e.$1,367.88 ANS: 78.Suppose a State of North Carolina bond will pay $1,000 ten years from now. If the going interest rate on these 10-year bonds is 5.5%, how much is the bond worth today?a.$585.43b.$614.70c.$645.44d.$677.71e.$711.59 ANS:

79.Suppose a State of New Mexico bond will pay $1,000 eight years from now. If the going interest rate on these 8-year bonds is 5.5%, how much is the bond worth today? a.$651.60b.$684.18c.$718.39d.$754.31e.$792.02 ANS: 80.How much would $20,000 due in 50 years be worth today if the discount rate were 7.5%?a.$438.03b.$461.08c.$485.35d.$510.89e.$537.78 ANS: 81.You expect to receive $5,000 in 25 years. How much is it worth today if the discount rate is 5.5%?a.$1,067.95b.$1,124.16c.$1,183.33d.$1,245.61e.$1,311.17 ANS: 82.The going rate of interest on a 5-year treasury bond is 4.25%. You have one that will pay $2,500 five years from now. How much is the bond worth today?a. $1,928.78b.$2,030.30c.$2,131.81d.$2,238.40e.$2,350.32 ANS: 83.Suppose a Google.com bond will pay $4,500 ten years from now. If the going interest rate on safe 10-year bonds is 4.25%, how much is the bond worth today?a. $2,819.52b.$2,967.92c.$3,116.31d.$3,272.13e.$3,435.74 ANS: 84.You have just purchased a U.S. Treasury bond for $747.25. 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 will you earn on this bond? a.4.37%b.4.86%c.5.40%d.6.00%e.6.60% ANS: 85.You have purchased a U.S. Treasury 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 $5,000. What interest rate will you earn on this bond? a.3.82%b.4.25%c.4.72%d.5.24%e.5.77% ANS: 86.Ten years ago, Kronan Corporation earned $0.50 per share. Its earnings this year were $2.20. What was the growth rate in earnings per share (EPS) over the 10-year period?a.15.17%b.15.97%c.16.77%d.17.61%e.18.49% ANS: 87.Wildwoods, Inc. earned $1.50 per share five years ago. Its earnings this year were $3.20. What was the growth rate in earnings per share (EPS) over the 5-year period? a.15.54%b.16.36%c.17.18%d.18.04%e.18.94% ANS: 88.You have $5,000 invested in a bank that pays 3.8% annually. How long will it take for your funds to triple?a.23.99b.25.26c.26.58d.27.98e.29.46 ANS:

89.Your bank pays 4% interest annually. You have $2,500 invested in the bank. How long will it take for your funds to double?a.14.39b.15.15c.15.95d.16.79e.17.67 ANS: 90.Brockman Corporation's earnings per share were $3.50 last year, and its growth rate during the prior 5 years was 9.0% per year. If that growth rate were maintained, how many years would it take for Brockman's EPS to triple? a.9.29b.10.33c.11.47d.12.75e.14.02 ANS: 91.Your investment account pays 8.0%, compounded annually. If you invest $5,000 today, how many years will it take for your investment to grow to $9,140.20? a.5.14b.5.71c.6.35d.7.05e.7.84 ANS: 92.Your investment advisor has recommended your 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 $30,000?a.12.37b.13.74c.15.27d.16.97e.18.85 ANS: 93.You are hoping to buy a new boat 3 years from now, and you plan to save $4,200 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.$11,973b.$12,603c.$13,267d.$13,930e.$14,626 ANS: 94.You want to buy new kitchen appliances 2 years from now, and you plan to save $8,200 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.$15,260b.$16,063c.$16,908d.$17,754e.$18,642 ANS: 95.You would like to travel in South America 5 years from now, and you can save $3,100 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. $18,369b.$19,287c.$20,251d.$21,264e.$22,327 ANS: 96.You want to purchase a motorcycle 4 years from now, and you plan to save $3,500 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.$16,112b.$16,918c.$17,763d.$18,652e.$19,584 ANS: 97.You want to open a sushi bar 3 years from now, and you plan to save $7,000 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. $20,993b.$22,098c.$23,261d.$24,424e.$25,645

ANS: 98.What is the PV of an ordinary annuity with 10 payments of $2,700 if the appropriate interest rate is 5.5%?a.$16,576b.$17,449c.$18,367d.$19,334e.$20,352 ANS: 99.What is the PV of an ordinary annuity with 5 payments of $4,700 if the appropriate interest rate is 4.5%?a.$16,806b.$17,690c.$18,621d.$19,601e.$20,633 ANS: 100.Your friend offers to pay you an annuity of $2,500 at the end of each year for 3 years in return for cash today. 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. $5,493.71b.$5,782.85c.$6,087.21d.$6,407.59e.$6,744.83 ANS: 101.After receiving a reward for information leading to the arrest of a notorious criminal, you are considering investing it in an annuity that pays $5,000 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.$50,753b.$53,424c. $56,236d.$59,195e.$62,311 ANS: 102.An uncle of yours who is about to retire wants to sell some of his stock and buy an annuity that will provide him with income of $50,000 per year for 30 years, beginning a year from today. The going rate on such annuities is 7.25%. How much would it cost him to buy such an annuity today?a.$574,924b.$605,183c.$635,442d. $667,214e.$700,575 ANS: 103.What is the PV of an annuity due with 5 payments of $2,500 at an interest rate of 5.5%?a.$11,262.88b.$11,826.02c.$12,417.32d.$13,038.19e.$13,690.10 ANS: 104.What's the present value of a perpetuity that pays $250 per year if the appropriate interest rate is 5%?a.$4,750b.$5,000c.$5,250d.$5,513e.$5,788 ANS: 105.A perpetuity pays $85 per year and costs $950. What is the rate of return? a.8.95%b.9.39%c.9.86%d.10.36%e.10.88% ANS: 106.A new investment opportunity for you is an annuity that pays $550 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. $1,412.84b.$1,487.20c.$1,565.48d.$1,643.75e.$1,725.94 ANS: 107.Your father is considering purchasing an annuity that pays $5,000 at the beginning of each year for 5 years. He could earn 4.5% on his money in other

investments with equal risk. What is the most he should pay for the annuity? a.20,701b.$21,791c.$22,938d.$24,085e.$25,289 ANS: 108.Because your mother is about to retire, she wants to buy an annuity that will provide her with $75,000 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 her to buy the annuity today?a.$825,835b.$869,300c.$915,052d.$963,213e. $1,011,374 ANS: 109.Now that your uncle has decided to retire, he wants to buy an annuity that will provide him with $85,000 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.$1,063,968b.$1,119,966c.$1,178,912d. $1,240,960e.$1,303,008 ANS: 110.A salt mine you inherited will pay you $25,000 per year for 25 years, with the first payment being made today. If you think a fair return on the mine is 7.5%, how much should you ask for it if you decide to sell it?a.$284,595b.$299,574c.$314,553d. $330,281e.$346,795 ANS: 111.Geraldine was injured in a car accident, and the insurance company has offered her the choice of $25,000 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 her as well off financially as with the annuity?a.$225,367b.$237,229c. $249,090d.$261,545e.$274,622 ANS: 112.What's the present value of a 4-year ordinary annuity of $2,250 per year plus an additional $3,000 at the end of Year 4 if the interest rate is 5%?a.$8,509b.$8,957c. $9,428d.$9,924e.$10,446 ANS: 113.Suppose you earned a $275,000 bonus this year and invested it at 8.25% per year.

How much could you withdraw at the end of each of the next 20 years?a.$28,532b. $29,959c.$31,457d.$33,030e.$34,681 ANS: 114.Your aunt wants to retire and has $375,000. She expects to live for another 25 years and to earn 7.5% on her invested funds. How much could she withdraw at the end of each of the next 25 years and end up with zero in the account?a.$28,843.38b. $30,361.46c.$31,959.43d.$33,641.50e.$35,323.58 ANS: 115.Your aunt wants to retire and has $375,000. She expects to live for another 25 years, and she also expects to earn 7.5% on her invested funds. How much could she

withdraw at the beginning of each of the next 25 years and end up with zero in the account?a.$28,243.21b.$29,729.70c.$31,294.42d.$32,859.14e.$34,502.10 ANS: 116.You were left $100,000 in a trust fund set up by your grandfather. The fund 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 could you withdraw today and at the beginning of each of the next 3 years and end up with zero in the account?a.$24,736b.$26,038c.$27,409d.$28,779e.$30,218 ANS: 117.Suppose you inherited $275,000 and invested it at 8.25% per year. How much could you withdraw at the beginning of each of the next 20 years?a.$22,598.63b. $23,788.03c.$25,040.03d.$26,357.92e.$27,675.82 ANS: 118.Your uncle just won the weekly lottery, receiving $375,000, which he invested at a 7.5% annual rate. He now has decided to retire, and he wants to withdraw $35,000 at the end of each year, starting at the end of this year. What is the maximum number of whole payments that can be withdrawn before the account is exhausted, i.e., before the account balance would become negative? (Hint: Round down to the nearest whole number.)a.22b.23c.24d.25e.26 ANS: 119.Your uncle has $300,000 invested at 7.5%, and he now wants to retire. He wants to withdraw $35,000 at the end of each year, beginning 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. What is the maximum number of $35,000 withdrawals that he can make and still have at least $25,000 left in the account? (Hint: If your solution for N is not an integer, round down to the nearest whole number.)a.12b.13c.14d.15e.16 ANS: 120.Your Aunt Elsa has $500,000 invested at 6.5%, and she plans to retire. She wants to withdraw $40,000 at the beginning of each year, starting immediately. What is the maximum number of whole payments that can be withdrawn before the account is exhausted, i.e., before the account balance would become negative? (Hint: Round down to the nearest whole number.)a.18b.19c.20d.21e.22 ANS: 121.Your aunt has $500,000 invested at 5.5%, and she now wants to retire. She wants to withdraw $45,000 at the beginning of each year, beginning immediately. When she makes her last withdrawal (at the beginning of a year), she also wants to have enough left in the account so that you can make a final withdrawal of $50,000 at the end of that year (her last withdrawal is at the beginning of the year, your withdrawal is at the end of that same year). What is the maximum number of $45,000 withdrawals that she can make and still have enough in the account so that you can make a $50,000 withdrawal at the end of the year of her last withdrawal? (Hint: If your solution for N is not an integer, round down to the nearest whole number.)a.13b.14c.15d.16e.17 ANS:

122.Suppose you just won the state lottery, and you have a choice between receiving $2,550,000 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.7.12%b.7.49%c.7.87%d.8.26%e.8.67% ANS: 123.Your girlfriend just won the Florida lottery. She has the choice of $15,000,000 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? a.3.44%b.3.79%c.4.17%d.4.58%e.5.04% ANS: 124.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 open a new restaurant, and your uncle offers to give you $120,000 for the annuity. If you sell it, what rate of return would your uncle earn on his investment? a.6.85%b.7.21%c.7.59%d.7.99%e.8.41% ANS: 125.What annual payment must you receive in order to earn a 6.5% rate of return on a perpetuity that has a cost of $1,250?a.$77.19b.$81.25c.$85.31d.$89.58e.$94.06 ANS: 126.What is the present value of the following cash flow stream at a rate of 6.25%? a.$411.57b.$433.23c.$456.03d.$480.03e.$505.30 ANS: 127.What is the present value of the following cash flow stream at a rate of 12.0%? a.$9,699b.$10,210c.$10,747d.$11,284e.$11,849 ANS: 128.What is the present value of the following cash flow stream at a rate of 8.0%? a.$7,917b.$8,333c.$8,772d.$9,233e.$9,695 ANS: 129.You sold your motorcycle 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 6.0%? a.$5,987b.$6,286c.$6,600d.$6,930e.$7,277 ANS: 130.At a rate of 6.5%, what is the future value of the following cash flow stream? a.$526.01b.$553.69c.$582.83d.$613.51e.$645.80 ANS:

131.Your sister 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 $10,000 at the end of the 5th year. What is the expected rate of return on this investment?a.6.77%b.7.13%c.7.50%d.7.88%e.8.27% ANS: 132.You are offered a chance to buy an asset for $7,250 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.4.93%b.5.19%c.5.46%d.5.75%e.6.05% ANS: 133.What's the future value of $1,500 after 5 years if the appropriate interest rate is 6%, compounded semiannually?a.$1,819b.$1,915c.$2,016d.$2,117e.$2,223 ANS: 134.What's the present value of $4,500 discounted back 5 years if the appropriate interest rate is 4.5%, compounded semiannually?a.$3,089b.$3,251c.$3,422d.$3,602e. $3,782 ANS: 135.What's the future value of $1,200 after 5 years if the appropriate interest rate is 6%, compounded monthly?a.$1,537.69b.$1,618.62c.$1,699.55d.$1,784.53e.$1,873.76 ANS: 136.What's the present value of $1,525 discounted back 5 years if the appropriate interest rate is 6%, compounded monthly?a.$969b.$1,020c.$1,074d.$1,131e.$1,187 ANS: 137.American Express 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 18.00%, with interest paid monthly, what is the card's EFF%? a.18.58%b.19.56%c.20.54%d.21.57%e.22.65% ANS: 138.Southwestern 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. Woodburn Bank also offers to lend you the $50,000, but it will charge an annual rate of 7.0%, with no interest due until the end of the year. How much higher or lower is the effective annual rate charged by Woodburn versus the rate charged by Southwestern?a.0.52%b.0.44%c.0.36%d.0.30%e.0.24% ANS: 139.Suppose United Bank offers to lend you $10,000 for one year at a nominal annual rate of 8.00%, 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. What is the effective annual rate on the loan?a.8.24%b.8.45%c.8.66%d.8.88%e.9.10% ANS:

140.Suppose People's bank offers to lend you $10,000 for 1 year on a loan contract that calls for you to make interest payments of $250.00 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.8.46%b.8.90%c.9.37%d.9.86%e.10.38% ANS: 141.Pacific Bank pays a 4.50% nominal rate on deposits, with monthly compounding.

What effective annual rate (EFF%) does the bank pay? a.3.72%b.4.13%c.4.59%d.5.05%e.5.56% ANS: 142.Suppose your credit card issuer states that it charges a 15.00% nominal annual rate, but you must make monthly payments, which amounts to monthly compounding.

What is the effective annual rate?a.15.27%b.16.08%c.16.88%d.17.72%e.18.61% ANS: 143.Billy Thornton borrowed $20,000 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 Billy have to pay in a 30-day month?a.$120.83b.$126.88c.$133.22d.$139.88e. $146.87 ANS: 144.Suppose you deposited $5,000 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.$5,178.09b.$5,436.99c.$5,708.84d. $5,994.28e.$6,294.00 ANS: 145.Suppose you borrowed $12,000 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.$3,704.02b.$3,889.23c.$4,083.69d.$4,287.87e.$4,502.26 ANS: 146.Suppose you are buying your first home for $145,000, and you have $15,000 for your 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.$741.57b. $780.60c.$821.69d.$862.77e.$905.91 ANS: 147.Your cousin will sell you his coffee shop for $250,000, 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.$4,029.37b.$4,241.44c.$4,464.67d.$4,699.66e.$4,947.01 ANS: 148.Suppose you borrowed $14,000 at a rate of 10.0% 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.$1,200.33b.$1,263.50c.$1,330.00d.$1,400.00e.$1,470.00

ANS: 149.You plan to borrow $35,000 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.$1,994.49b.$2,099.46c.$2,209.96d.$2,326.27e.$2,442.59 ANS: 150.Your bank offers to lend you $100,000 at an 8.5% annual interest rate to start your new business. The terms require you to amortize the loan with 10 equal end-ofyear payments. How much interest would you be paying in Year 2?a.$7,531b.$7,927c. $8,323d.$8,740e.$9,177 ANS: 151.You are considering investing in a European 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 $250,000?

Round fractional months up.a.23b.27c.32d.38e.44 ANS: 152.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 $150,000? a.39.60b.44.00c.48.40d.53.24e.58.57 ANS: 153.The store where you bought new home furnishings offers you two alternative payment plans. The first plan requires a $4,000 immediate up-front 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.12.31%b.12.96%c.13.64%d.14.36%e.15.08% ANS: 154.Your Green Investment Tips subscription 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 $850, 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.7.48b.8.80c.10.35d.12.18e.14.33 ANS: 155.You just deposited $2,500 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. $15,234.08b.$16,035.88c.$16,837.67d.$17,679.55e.$18,563.53 ANS: 156.Partners Bank offers to lend you $50,000 at a nominal rate of 5.0%, simple interest, with interest paid quarterly. An offer to lend you the $50,000 also comes from Community Bank, but it will charge 6.0%, 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.1.56%b.1.30%c.1.09%d.0.91%e.0.72% ANS: 157.Suppose you borrowed $15,000 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.$2,404.91b.$2,531.49c.$2,658.06d.$2,790.96e. $2,930.51 ANS: 158.Suppose you borrowed $15,000 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.$10,155.68b. $10,690.19c.$11,252.83d.$11,845.09e.$12,468.51 ANS: 159.Your older brother turned 35 today, and he is planning to save $7,000 per year for retirement, with the first deposit to be made one year from today. He will invest in a mutual fund that's expected to provide a return of 7.5% per year. He plans to retire 30 years from today, when he turns 65, and he expects to live for 25 years after retirement, to age 90. Under these assumptions, how much can he spend each year after he retires? His first withdrawal will be made at the end of his first retirement year.a.$58,601b.$61,686c.$64,932d.$68,179e.$71,588 ANS: 160.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.7.62%b.8.00%c.8.40%d.8.82%e.9.26% ANS: 161.Your business has just taken out a 1-year installment loan for $72,500 at a nominal rate of 11.0% but with equal end-of-month payments. What percentage of the 2nd monthly payment will go toward the repayment of principal? a.73.67%b.77.55%c.81.63%d.85.93%e.90.45% ANS: 162.On January 1, 2012, your sister's pet supplies business obtained a 30-year amortized mortgage loan for $250,000 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 2012?a.$17,419.55b.$17,593.75c.$17,769.68d. $17,947.38e.$18,126.85 ANS: 163.You borrowed $50,000 which you must repay in 10 years. You plan to make an initial deposit today, then make 9 more deposits at the beginning of each the next 9 years, but with the deposits increasing at the inflation rate. You expect to earn 5% on your funds, and you expect a 3% inflation rate. To the nearest dollar, how large must your initial deposit be to enable you to reach your $50,000 target?a.$3,008b.$3,342c. $3,676d.$4,044e.$4,448

ANS: 164.Your 75-year-old grandmother expects to live for another 15 years. She currently has $1,000,000 of savings, which is invested to earn a guaranteed 5% rate of return. If inflation averages 2% per year, how much can she withdraw (to the nearest dollar) at the beginning of each year and keep the withdrawals constant in real terms, i.e., growing at the same rate as inflation and thus enabling her to maintain a constant standard of living?a.$65,632b.$72,925c.$81,027d.$89,130e.$98,043 ANS: 165.Julian and Jonathan are twin brothers (and so were born on the same day). Today, both turned 25. Their grandfather began putting $2,500 per year into a trust fund for Julian 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 $2,500 payments until a 46th and final payment is made on Julian's 65th birthday. The grandfather set things up this way because he wants Julian to work, not be a "trust fund baby," but he also wants to ensure that Julian is provided for in his old age.

Until now, the grandfather has been disappointed with Jonathan and so has not given him anything. However, they recently reconciled, and the grandfather decided to make an equivalent provision for Jonathan. He will make the first payment to a trust for Jonathan today, and he has instructed his trustee to make 40 additional equal annual payments until Jonathan 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 Jonathan's trust today and each subsequent year to enable him to have the same retirement nest egg as Julian after the last payment is made on their 65th birthday?a. $3,726b.$3,912c.$4,107d.$4,313e.$4,528 ANS: 166.You plan to work for Strickland Corporation for 12 years after graduation and after that want to 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 grandmother just gave you a $25,000 graduation gift that 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.$238,176b. $250,712c.$263,907d.$277,797e.$291,687 ANS: 167.You are in negotiations to make a 7-year loan of $25,000 to DeVille Corporation.

To repay you, DeVille 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. You are confident the payments will be made, since DeVille is essentially riskless. 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. $4,271.67b.$4,496.49c.$4,733.15d.$4,969.81e.$5,218.30 ANS: 168.Scott and Linda have been saving to pay for their daughter Casie's college education. Casie 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, Scott and Linda have accumulated $15,000 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 Casie's anticipated college costs?a.$1,965.21b.$2,068.64c.$2,177.51d.$2,292.12e.$2,412.76 ANS: CHAPTER 5—BONDS, BOND VALUATION, AND INTEREST RATES TRUE/FALSE 1.If a firm raises capital by selling new bonds, it is called the "issuing firm," and the coupon rate is generally set equal to the required rate on bonds of equal risk.

ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 5-2NAT:BUSPROG: Reflective ThinkingSTA:DISC: Stocks and bondsLOC:TBATOP:Issuing bondsKEY:Bloom’s: Knowledge 2.A call provision gives bondholders the right to demand, or "call for," repayment of a bond. Typically, calls are exercised if interest rates rise, because when rates rise the bondholder can get the principal amount back and reinvest it elsewhere at higher rates.

ANS:FPTS:1DIF:Difficulty: EasyOBJ:LO: 5-2NAT:BUSPROG: Reflective ThinkingSTA:DISC: Stocks and bondsLOC:TBATOP:Call provisionKEY:Bloom’s: Knowledge 3.Sinking funds are devices used to force companies to retire bonds on a scheduled basis prior to their maturity. Many bond indentures allow the company to acquire bonds for a sinking fund by either purchasing bonds in the market or selecting the bonds to be acquired by a lottery administered by the trustee through a call at face value.

ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 5-2NAT:BUSPROG: Reflective ThinkingSTA:DISC: Stocks and bondsLOC:TBATOP:Sinking fundsKEY:Bloom’s: Knowledge 4.A zero coupon bond is a bond that pays no interest and is offered (and subsequently sells initially) at par. These bonds provide compensation to investors in the form of capital appreciation.

ANS:FPTS:1DIF:Difficulty: EasyOBJ:LO: 5-2NAT:BUSPROG: Reflective ThinkingSTA:DISC: Stocks and bondsLOC:TBATOP:Zero coupon bondKEY:Bloom’s: Knowledge 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.

ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 5-2NAT:BUSPROG: Reflective ThinkingSTA:DISC: Stocks and bondsLOC:TBATOP:Floating-rate debtKEY:Bloom’s: Knowledge

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.

ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 5-3NAT:BUSPROG: Reflective ThinkingSTA:DISC: Stocks and bondsLOC:TBATOP:Discounted cash flowsKEY:Bloom’s: Knowledge 7.For bonds, price sensitivity to a given change in interest rates is generally greater the longer before the bond matures.

ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 5-3NAT:BUSPROG: Reflective ThinkingSTA:DISC: Stocks and bondsLOC:TBATOP:Bond prices and interest ratesKEY:Bloom’s: Knowledge 8.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.

ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 5-11NAT:BUSPROG: Reflective ThinkingSTA:DISC: Stocks and bondsLOC:TBATOP:Mortgage bondKEY:Bloom’s: Knowledge 9.Other things equal, a firm will have to pay a higher coupon rate on its subordinated debentures than on its second mortgage bonds.

ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 5-11NAT:BUSPROG: Reflective ThinkingSTA:DISC: Stocks and bondsLOC:TBATOP:Debt coupon rateKEY:Bloom’s: Knowledge 10.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.

ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 5-11NAT:BUSPROG: Reflective ThinkingSTA:DISC: Stocks and bondsLOC:TBATOP:Bond ratings and required returnsKEY:Bloom’s: Knowledge 11.A bond that had a 20-year original maturity with 1 year left to maturity has more interest rate 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.)

ANS:FPTS:1DIF:Difficulty: EasyOBJ:LO: 5-13NAT:BUSPROG: Reflective ThinkingSTA:DISC: Stocks and bondsLOC:TBATOP:Interest rate riskKEY:Bloom’s: Knowledge 12.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 interest rate price risk if you purchased a 30-day bond than if you bought a 30-year bond.

ANS:FPTS:1DIF:Difficulty: EasyOBJ:LO: 5-13NAT:BUSPROG: Reflective ThinkingSTA:DISC: Stocks and bondsLOC:TBATOP:Interest rate riskKEY:Bloom’s: Knowledge 13.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.

ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 5-15NAT:BUSPROG: Reflective ThinkingSTA:DISC: Stocks and bondsLOC:TBATOP:Junk bondKEY:Bloom’s: Knowledge 14.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.

ANS:FThe 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.

PTS:1DIF:Difficulty: ModerateOBJ:LO: 5-2NAT:BUSPROG: Reflective ThinkingSTA:DISC: Stocks and bondsLOC:TBATOP:Callable bondsKEY:Bloom’s: Comprehension 15.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.

ANS:FPTS:1DIF:Difficulty: ModerateOBJ:LO: 5-2NAT:BUSPROG: Reflective ThinkingSTA:DISC: Stocks and bondsLOC:TBATOP:Income bondKEY:Bloom’s: Comprehension 16.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 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. ANS:FThe 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.

PTS:1DIF:Difficulty: ModerateOBJ:LO: 5-2NAT:BUSPROG: Reflective ThinkingSTA:DISC: Stocks and bondsLOC:TBATOP:Sinking fundsKEY:Bloom’s: Comprehension 17.Floating-rate debt is advantageous to investors because the interest rate moves up if market rates rise. Since floating-rate debt shifts interest rate risk to companies, it offers no advantages to issuers.

ANS:FFloating rates can benefit issuers if rates decline, so a company that thinks rates are likely to fall would want to issue such bonds.

PTS:1DIF:Difficulty: ModerateOBJ:LO: 5-2NAT:BUSPROG: Reflective ThinkingSTA:DISC: Stocks and bondsLOC:TBATOP:Floating-rate debtKEY:Bloom’s: Comprehension 18.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 interest rates are below 10% and at a discount if interest rates are greater than 10%.

ANS:TPTS:1DIF:Difficulty: ModerateOBJ:LO: 5-3NAT:BUSPROG: Reflective ThinkingSTA:DISC: Stocks and bondsLOC:TBATOP:Bond premiums and discountsKEY:Bloom’s: Comprehension 19.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%.

ANS:TThe bonds expected return (YTM) is 13.81%, which exceeds the 12% required return, so buy the bond.

PTS:1DIF:Difficulty: ModerateOBJ:LO: 5-3NAT:BUSPROG: Reflective ThinkingSTA:DISC: Stocks and bondsLOC:TBATOP:Bond value–annual paymentKEY:Bloom’s: Comprehension 20.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.)

ANS:TPTS:1DIF:Difficulty: ModerateOBJ:LO: 5-4NAT:BUSPROG: Reflective ThinkingSTA:DISC: Stocks and bondsLOC:TBATOP:Bond valueKEY:Bloom’s: Comprehension 21."Restrictive covenants" are designed primarily to protect bondholders by constraining the actions of managers. Such covenants are spelled out in bond indentures.

ANS:TPTS:1DIF:Difficulty: ModerateOBJ:LO: 5-11NAT:BUSPROG: Reflective ThinkingSTA:DISC: Stocks and bondsLOC:TBATOP:Restrictive covenantsKEY:Bloom’s: Comprehension 22.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.

ANS:TThe 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.

PTS:1DIF:Difficulty: ModerateOBJ:LO: 5-13NAT:BUSPROG: Reflective ThinkingSTA:DISC: Stocks and bondsLOC:TBATOP:Prices and interest ratesKEY:Bloom’s: Comprehension MULTIPLE CHOICE 23.Which of the following statements is CORRECT?a.The time to maturity does not affect the change in the value of a bond in response to a given change in interest rates.b.You hold two bonds. One is a 10-year, zero coupon, bond and the other is a 10year 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.c.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.d.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.e.You hold two bonds. One is a 10-year, zero coupon, issue 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 larger percentage decline.

ANS:EPTS:1DIF:Difficulty: EasyOBJ:LO: 5-4NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Interest ratesKEY:Bloom’s: ComprehensionMSC:TYPE: Multiple Choice: Conceptual 24.Which of the following events would make it more likely that a company would choose to call its outstanding callable bonds?a.Market interest rates rise sharply.b.Market interest rates decline sharply.c.The company's financial situation deteriorates significantly.d.Inflation increases significantly.e.The company's bonds are downgraded.

ANS:BPTS:1DIF:Difficulty: EasyOBJ:LO: 5-4NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Callable bondsKEY:Bloom’s: ComprehensionMSC:TYPE: Multiple Choice: Conceptual 25.A 10-year bond with a 9% annual coupon has a yield to maturity of 8%. Which of the following statements is CORRECT?a.The bond is selling below its par value.b.The bond is selling at a discount.c.If the yield to maturity remains constant, the bond's price one year from now will be lower than its current price.d.The bond's current yield is greater than 9%.e.If the yield to maturity remains constant, the bond's price one year from now will be higher than its current price.

ANS:CPTS:1DIF:Difficulty: EasyOBJ:LO: 5-6NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Bond conceptsKEY:Bloom’s: ComprehensionMSC:TYPE: Multiple Choice: Conceptual 26.Which of the following statements is CORRECT?a.An indenture is a bond that is less risky than a mortgage bond.b.The expected return on a corporate bond will generally exceed the bond's yield to maturity.c.If a bond's coupon rate exceeds its yield to maturity, then its expected return to investors exceeds the yield to maturity.d.Under our bankruptcy laws, any firm that is in financial distress will be forced to declare bankruptcy and then be liquidated.e.All else equal, senior debt generally has a lower yield to maturity than subordinated debt.

ANS:EPTS:1DIF:Difficulty: EasyOBJ:LO: 5-16NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Bonds, default riskKEY:Bloom’s: ComprehensionMSC:TYPE: Multiple Choice: Conceptual 27.Ranger Inc. would like to issue new 20-year bonds. Initially, the plan was to make the bonds non-callable. If the bonds were made callable after 5 years at a 5% call premium, how would this affect their required rate of return?a.There is no reason to expect a change in the required rate of return.b.The required rate of return would decline because the bond would then be less risky to a bondholder.c.The required rate of return would increase because the bond would then be more risky to a bondholder.d.It is impossible to say without more information.e.Because of the call premium, the required rate of return would decline.

ANS:CPTS:1DIF:Difficulty: ModerateOBJ:LO: 5-2NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Call provisionKEY:Bloom’s: ComprehensionMSC:TYPE: Multiple Choice: Conceptual 28.Under normal conditions, which of the following would be most likely to increase the coupon rate required to enable a bond to be issued at par?a.Adding a call provision.b.The rating agencies change the bond's rating from Baa to Aaa.c.Making the bond a first mortgage bond rather than a debenture.d.Adding a sinking fund.e.Adding additional restrictive covenants that limit management's actions.

ANS:APTS:1DIF:Difficulty: ModerateOBJ:LO: 5-3NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Bond coupon rateKEY:Bloom’s: ComprehensionMSC:TYPE: Multiple Choice: Conceptual 29.Which of the following bonds would have the greatest percentage increase in value if all interest rates fall by 1%?a.20-year, 10% coupon bond.b.20-year, 5% coupon bond.c.1-year, 10% coupon bond.d.20-year, zero coupon bond.e.10-year, zero coupon bond.

ANS:DPTS:1DIF:Difficulty: ModerateOBJ:LO: 5-13NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Interest rate riskKEY:Bloom’s: ComprehensionMSC:TYPE: Multiple Choice: Conceptual 30.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.A 1-year bond with a 15% coupon.b.A 3-year bond with a 10% coupon.c.A 10-year zero coupon bond.d.A 10-year bond with a 10% coupon.e.An 8-year bond with a 9% coupon.

ANS:CPTS:1DIF:Difficulty: ModerateOBJ:LO: 5-13NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Interest rate riskKEY:Bloom’s: ComprehensionMSC:TYPE: Multiple Choice: Conceptual 31.Which of the following bonds has the greatest interest rate price risk?a.A 10-year, $1,000 face value, zero coupon bond.b.A 10-year, $1,000 face value, 10% coupon bond with annual interest payments.c.All 10-year bonds have the same price risk since they have the same maturity.d.A 10-year, $1,000 face value, 10% coupon bond with semiannual interest payments.

ANS:APTS:1DIF:Difficulty: ModerateOBJ:LO: 5-13NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Interest rate riskKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 32.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 bond with an 8% coupon.b.A 10year bond with an 8% coupon.c.A 10-year bond with a 12% coupon.d.A 10-year zero coupon bond.e.A 1-year zero coupon bond.

ANS:DPTS:1DIF:Difficulty: ModerateOBJ:LO: 5-13NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Interest rate riskKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 33.Which of the following statements is CORRECT?a.Most sinking funds require the issuer to provide funds to a trustee, who saves the money so that it will be available to pay off bondholders when the bonds mature.b.A sinking fund provision makes a bond more risky to investors at the time of issuance.c.Sinking fund provisions never require companies to retire their debt; they only establish "targets" for the company to reduce its debt over time.d.If interest rates have increased since a company issued bonds with a sinking fund, the company is less likely to retire the bonds by buying them back in the open market, as opposed to calling them in at the sinking fund call price.e.Sinking fund provisions sometimes turn out to adversely affect bondholders, and this is most likely to occur if interest rates decline after the bond has been issued.

ANS:EPTS:1DIF:Difficulty: ModerateOBJ:LO: 5-2NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Sinking fundsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 34.Nicholas Industries can issue a 20-year bond with a 6% annual coupon. This bond is not convertible, is not callable, and has no sinking fund. Alternatively, Nicholas 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 Nicholas would have to pay on the convertible, callable bond?a.It could be less than, equal to, or greater than 6%.b.Greater than 6%.c.Exactly equal to 8%.d.Less than 6%.e.Exactly equal to 6%.

ANS:APTS:1DIF:Difficulty: ModerateOBJ:LO: 5-2NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Convertible, callable bondsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 35.The YTMs of three $1,000 face value bonds that mature in 10 years and have the same level of risk are equal. Bond A has an 8% annual coupon, Bond B has a 10% annual coupon, and Bond C has a 12% annual coupon. Bond B sells at par. Assuming interest rates remain constant for the next 10 years, which of the following statements is CORRECT?a.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.b.Bond C sells at a premium (its price is greater than par), and its price is expected to increase over the next year.c.Bond A sells at a discount (its price is less than par), and its price is expected to increase over the next year.d.Over the next year, Bond A's price is expected to decrease, Bond B's price is expected to stay the same, and Bond C's price is expected to increase.e.Bond A's current yield will increase each year.

ANS: 36.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 NOT CORRECT?a.The bond's yield to maturity is 9%.b.The bond's current yield is 9%.c.If the bond's yield to maturity remains constant, the bond will continue to sell at par.d.The bond's current yield exceeds its capital gains yield.e.The bond's expected capital gains yield is positive.

ANS:EPTS:1DIF:Difficulty: ModerateOBJ:LO: 5-6NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Bond yieldsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 37.Which of the following statements is CORRECT?a.If a bond's yield to maturity exceeds its coupon rate, the bond will sell at par.b.All else equal, if a bond's yield to maturity increases, its price will fall.c.If a bond's yield to maturity exceeds its coupon rate, the bond will sell at a premium over par.d.All else equal, if a bond's yield to maturity increases, its current yield will fall.e.A zero coupon bond's current yield is equal to its yield to maturity.

ANS:BPTS:1DIF:Difficulty: ModerateOBJ:LO: 5-6NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Bond yieldsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 38.Stephenson Co.'s 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 current yield exceeds its yield to maturity.b.The bond's yield to maturity is greater than its coupon rate.c.The bond's current yield is equal to its coupon rate.d.If the yield to maturity stays constant until the bond matures, the bond's price will remain at $850.e.The bond's coupon rate exceeds its current yield.

ANS:BPTS:1DIF:Difficulty: ModerateOBJ:LO: 5-6NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Bond yieldsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 39.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.If the yield to maturity

remains at 8%, then the bond's price will decline over the next year.b.The bond's coupon rate is less than 8%.c.If the yield to maturity increases, then the bond's price will increase.d.If the yield to maturity remains at 8%, then the bond's price will remain constant over the next year.e.The bond's current yield is less than 8%.

ANS: 40.Which of the following statements is CORRECT?a.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.b.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.c.If a coupon bond is selling at par, its current yield equals its 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 bond is selling at a discount, the yield to call is a better measure of return than the yield to maturity.

ANS:CPTS:1DIF:Difficulty: ModerateOBJ:LO: 5-6NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Bond yieldsKEY:Bloomâ&#x20AC;&#x2122;s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 41.A 15-year bond has an annual coupon rate of 8%. The coupon rate will remain fixed until the bond matures. The bond has a yield to maturity of 6%. Which of the following statements is CORRECT?a.The bond is currently selling at a price below its par value.b.If market interest rates remain unchanged, the bond's price one year from now will be lower than it is today.c.The bond should currently be selling at its par value.d.If market interest rates remain unchanged, the bond's price one year from now will be higher than it is today.e.If market interest rates decline, the price of the bond will also decline.

ANS:BPTS:1DIF:Difficulty: ModerateOBJ:LO: 5-4NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Interest rates and bond pricesKEY:Bloomâ&#x20AC;&#x2122;s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 42.An 8-year Treasury bond has a 10% coupon, and a 10-year Treasury bond has an 8% coupon. Both bonds 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.Both bonds would decline in price, but the 10-year bond would have the greater percentage decline in price.b.The prices of both bonds would increase by the same amount.c.One bond's price would increase, while the other bond's price would decrease.d.The prices of the two bonds would remain constant.e.The prices of both bonds will decrease by the same amount.

ANS: 43.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 prices of both bonds will remain unchanged.b.The price of Bond A will decrease over time, but the price of Bond B will increase over time.c.The prices of both bonds will increase by 7% per year.d.The prices of both bonds will increase over time, but the price of Bond A will increase by more.e.The price of Bond B will decrease over time, but the price of Bond A will increase over time.

ANS:BPTS:1DIF:Difficulty: ModerateOBJ:LO: 5-4NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Bond yields and pricesKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 44.Assume that interest rates on 15-year noncallable Treasury and corporate bonds with different ratings 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.Tax effects.b.Default risk differences.c.Maturity risk differences.d.Inflation differences.e.Real risk-free rate differences.

ANS:BPTS:1DIF:Difficulty: ModerateOBJ:LO: 5-7NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Interest ratesKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 45.Which of the following statements is CORRECT?a.All else equal, long-term bonds have less interest rate price risk than short-term bonds.b.All else equal, low-coupon bonds have less interest rate price risk than high-coupon bonds.c.All else equal, shortterm bonds have less reinvestment rate risk than long-term bonds.d.All else equal, long-term bonds have less reinvestment rate risk than short-term bonds.e.All else equal, high-coupon bonds have less reinvestment rate risk than low-coupon bonds.

ANS:DPTS:1DIF:Difficulty: ModerateOBJ:LO: 5-13NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Interest vs. reinvestment rate riskKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 46.Which of the following statements is CORRECT?a.Long-term bonds have less interest rate price risk but more reinvestment rate risk than short-term bonds.b.If interest rates increase, all bond prices will increase, but the increase will be greater for bonds that have less interest rate risk.c.Relative to a coupon-bearing bond with the same maturity, a zero coupon bond has more interest rate price risk but less reinvestment rate risk.d.Long-term bonds have less interest rate price risk and also less reinvestment rate risk than short-term bonds.e.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.

ANS:CPTS:1DIF:Difficulty: ModerateOBJ:LO: 5-13NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Interest vs. reinvestment rate riskKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 47.Which of the following statements is CORRECT?a.Liquidity premiums are generally higher on Treasury than corporate bonds.b.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.c.Default risk premiums are generally lower on corporate than on Treasury bonds.d.Reinvestment rate risk is lower, other things held constant, on long-term than on short-term bonds.e.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.

ANS:DPTS:1DIF:Difficulty: ModerateOBJ:LO: 5-14NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Term structure of interest ratesKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual

48.Which of the following statements is CORRECT?a.If a coupon bond is selling at a discount, its price will continue to decline until it reaches its par value at maturity.b.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.c.If a bond's yield to maturity exceeds its annual coupon, then the bond will trade at a premium.d.If a coupon bond is selling at a premium, its current yield equals its yield to maturity.e.If a coupon bond is selling at par, its current yield equals its yield to maturity.

ANS:EPTS:1DIF:Difficulty: ModerateOBJ:LO: 5-6NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Bond conceptsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 49.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 has a current yield greater than 8%.b.The bond sells at a discount.c.The bond's required rate of return is less than 7.5%.d.If the yield to maturity remains constant, the price of the bond will decline over time.e.The bond sells at a price below par.

ANS:DPTS:1DIF:Difficulty: ModerateOBJ:LO: 5-6NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Bond conceptsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 50.Bonds A and B are 15-year, $1,000 face value 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%, which is expected to remain constant for the next 15 years. Which of the following statements is CORRECT?a.One year from now, Bond A's price will be higher than it is today.b.Bond A's current yield is greater than 8%.c.Bond A has a higher price than Bond B today, but one year from now the bonds will have the same price.d.Both bonds have the same price today, and the price of each bond is expected to remain constant until the bonds mature.e.Bond B has a higher price than Bond A today, but one year from now the bonds will have the same price.

ANS:APTS:1DIF:Difficulty: ModerateOBJ:LO: 5-6NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Bond conceptsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 51.Which of the following statements is NOT CORRECT?a.All else equal, bonds with longer maturities have more interest rate (price) risk than bonds with shorter maturities.b.If a bond is selling at its par value, its current yield equals its yield to maturity.c.If a bond is selling at a premium, its current yield will be greater than its yield to maturity.d.All else equal, bonds with larger coupons have greater interest rate (price) risk than bonds with smaller coupons.e.If a bond is selling at a discount to par, its current yield will be less than its yield to maturity.

ANS:DPTS:1DIF:Difficulty: ModerateOBJ:LO: 5-13NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Bond conceptsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 52.Which of the following statements is CORRECT?a.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.b.Other things held constant, a corporation would rather issue noncallable bonds than callable bonds.c.Other things held constant, a callable bond would have a lower required rate of return than a noncallable bond.d.Reinvestment

rate risk is worse from an investor's standpoint than interest rate price risk if the investor has a short investment time horizon.e.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.

ANS:APTS:1DIF:Difficulty: ModerateOBJ:LO: 5-13NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Bond conceptsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 53.Which of the following statements is CORRECT?a.The total yield on a bond is derived from dividends plus changes in the price of the bond.b.Bonds are riskier than common stocks and therefore have higher required returns.c.Bonds issued by larger companies always have lower yields to maturity (less risk) than bonds issued by smaller companies.d.The market value of a bond will always approach its par value as its maturity date approaches, provided the bond's required return remains constant.e.If the Federal Reserve unexpectedly announces that it expects inflation to increase, then we would probably observe an immediate increase in bond prices.

ANS:DPTS:1DIF:Difficulty: ModerateOBJ:LO: 5-6NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Bond conceptsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 54.Which of the following statements is CORRECT?a.If rates fall after its issue, a zero coupon bond could trade at a price above its par value.b.If rates fall rapidly, a zero coupon bond's expected appreciation could become negative.c.If a firm moves from a position of strength toward financial distress, its bonds' yield to maturity would probably decline.d.If a bond is selling at a premium, this implies that its yield to maturity exceeds its coupon rate.e.If a coupon bond is selling at par, its current yield equals its yield to maturity.

ANS:EPTS:1DIF:Difficulty: ModerateOBJ:LO: 5-6NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Bond conceptsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 55.You are considering three different bonds for your portfolio. Each bond has a 10year maturity and a yield to maturity of 10%. Bond X has an 8% annual coupon, Bond Y has a 10% annual coupon, and Bond Z has a 12% annual coupon. Which of the following statements is CORRECT?a.Bond X has the greatest reinvestment rate risk.b.If market interest rates decline, all of the bonds will have an increase in price, and Bond Z will have the largest percentage increase in price.c.If market interest rates remain at 10%, Bond Z's price will be 10% higher one year from today.d.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.e.If the bonds' market interest rates remain at 10%, Bond Z's price will be lower one year from now than it is today.

ANS:EPTS:1DIF:Difficulty: ModerateOBJ:LO: 5-13NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Bond conceptsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 56.Bonds A, B, and C all have a maturity of 15 years and a yield to maturity of 9%.

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. Which of the following statements is CORRECT? a.Bond A has the most interest rate risk.b.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.c.If the yield to maturity on each bond increases to 8%, the prices of all three bonds will decline.d.Bond C sells at a premium over its par value.e.If the yield to maturity on each bond decreases to 6%, Bond A will have the largest percentage increase in its price.

ANS:CPTS:1DIF:Difficulty: ModerateOBJ:LO: 5-13NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Bond conceptsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 57.Which of the following statements is CORRECT?a.A 10-year, 10% coupon bond has less reinvestment rate risk than a 10-year, 5% coupon bond (assuming all else equal).b.The total 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.c.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.d.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%.e.10-year, zero coupon bonds have higher reinvestment rate risk than 10-year, 10% coupon bonds.

ANS:BPTS:1DIF:Difficulty: ModerateOBJ:LO: 5-13NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Bond conceptsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 58.Which of the following statements is CORRECT?a.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.b.Rising inflation makes the actual yield to maturity on a bond greater than a quoted yield to maturity that is based on market prices.c.The yield to maturity on a coupon bond that sells at its par value consists entirely of a current interest yield; it has a zero expected capital gains yield.d.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.e.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.

ANS:CPTS:1DIF:Difficulty: ModerateOBJ:LO: 5-6NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Bond yieldsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 59.Which of the following statements is CORRECT?a.If a coupon bond is selling at a discount, then the bond's expected capital gains yield is negative.b.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.c.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.d.If a coupon bond is selling at par, its current yield equals its yield to maturity.e.If a coupon bond is selling at a premium, then the bond's current yield is zero.

ANS:DPTS:1DIF:Difficulty: ModerateOBJ:LO: 5-6NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Bond yieldsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 60.Which of the following statements is CORRECT?a.If the maturity risk premium (MRP) is greater than zero, then the yield curve must have an upward slope.b.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.c.If the maturity risk premium (MRP) equals zero, the yield curve must be flat.d.The yield curve can never be downward sloping.e.If inflation is expected to increase in the future, and if the maturity risk premium (MRP) is greater than zero, then the yield curve will have an upward slope.

ANS: 61.Assume that the current corporate bond yield curve is upward sloping. Under this condition, then we could be sure thata.The economy is not in a recession.b.Long-term bonds are a better buy than short-term bonds.c.Maturity risk premiums could help to explain the yield curve's upward slope.d.Long-term interest rates are more volatile than short-term rates.e.Inflation is expected to decline in the future.

ANS:CPTS:1DIF:Difficulty: ModerateOBJ:LO: 5-14NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Yield curveKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 62.Which of the following statements is CORRECT?a.The most likely explanation for an inverted yield curve is that investors expect inflation to increase.b.The most likely explanation for an inverted yield curve is that investors expect inflation to decrease.c.If the yield curve is inverted, short-term bonds have lower yields than long-term bonds.d.Inverted yield curves can exist for Treasury bonds, but because of default premiums, the corporate yield curve can never be inverted.e.The higher the maturity risk premium, the higher the probability that the yield curve will be inverted.

ANS:BPTS:1DIF:Difficulty: ModerateOBJ:LO: 5-14NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Yield curveKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 63.Bonds for two companies were just issued: Short Corp.'s bonds will mature in 5 years, and Long Corp.'s bonds will mature in 15 years. Both bonds promise to pay a semiannual coupon, they are not callable or convertible, and they are equally liquid.

Further, assume that the Treasury yield curve is based only on expectations about future inflation, i.e., that the maturity risk premium is zero for T-bonds. Under these conditions, which of the following statements is correct?a.If the Treasury yield curve is downward sloping, Long's bonds must under all conditions have the lower yield.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 the yield curve for Treasury securities is flat, Short's bond must under all conditions have the same yield as Long's bonds.d.If Long's and Short's bonds have the same default risk, their yields must under all conditions be equal.e.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 the lower yield.

ANS:EPTS:1DIF:Difficulty: ModerateOBJ:LO: 5-14NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Corporate yield curveKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 64.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, and an 8% yield to maturity.

Which of the following statements is CORRECT?a.Bond A trades at a discount, whereas Bond B trades at a premium.b.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.c.If the yield to maturity for both bonds immediately decreases to 6%, Bond A's bond will have a larger percentage increase in value.d.Bond A's current yield is greater than that of Bond B.e.Bond A's capital gains yield is greater than Bond B's capital gains yield.

ANS:DPTS:1DIF:Difficulty: ModerateOBJ:LO: 5-6NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Bond rates and pricesKEY:Bloomâ&#x20AC;&#x2122;s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 65.Which of the following statements is CORRECT?a.A callable 10-year, 10% bond should sell at a higher price than an otherwise similar noncallable bond.b.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.c.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.d.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.e.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.

ANS:EPTS:1DIF:Difficulty: ModerateOBJ:LO: 5-6NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Callable bondsKEY:Bloomâ&#x20AC;&#x2122;s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 66.Cornwall Corporation is planning to raise $1,000,000 to finance a new plant.

Which of the following statements is CORRECT?a.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.b.If two tiers of debt are used (with one senior and one subordinated debt class), the subordinated debt will carry a lower interest rate.c.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.d.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.e.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.

ANS: 67.Which of the following statements is CORRECT?a.Subordinated debt has less default risk than senior debt.b.Convertible bonds have lower coupon rates than nonconvertible bonds of similar default risk because they offer the possibility of capital gains.c.Junk bonds typically provide a lower yield to maturity than investment-grade bonds.d.A debenture is a secured bond that is backed by some or all of the firm's fixed assets.e.Junior debt is debt that has been more recently issued, and in bankruptcy it is paid off after senior debt because the senior debt was issued first.

ANS:BPTS:1DIF:Difficulty: ModerateOBJ:LO: 5-15NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Types of debtKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 68.Which of the following statements is CORRECT?a.Other things held constant, a callable bond should have a lower yield to maturity than a noncallable bond.b.Once a firm declares bankruptcy, it must then be liquidated by the trustee, who uses the proceeds to pay bondholders, unpaid wages, taxes, and lawyer fees.c.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.d.A firm with a sinking fund that gave 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.e.One disadvantage of zero coupon bonds is that the issuing firm cannot realize any tax savings from the debt until the bonds mature.

ANS:CPTS:1DIF:Difficulty: ModerateOBJ:LO: 5-16NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Miscellaneous conceptsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 69.Which of the following statements is CORRECT?a.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%.b.The price of a discount bond will increase over time, assuming that the bond's yield to maturity remains constant.c.For a given firm, its debentures are likely to have a lower yield to maturity than its mortgage bonds.d.When large firms are in financial distress, they are almost always liquidated, whereas smaller firms are generally reorganized.e.The total return on a bond during a given year consists only of the coupon interest payments received.

ANS:BPTS:1DIF:Difficulty: ModerateOBJ:LO: 5-16NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Miscellaneous conceptsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 70.Which of the following statements is NOT CORRECT?a.The expected return on a corporate bond must be less than its promised return if the probability of default is greater than zero.b.All else equal, senior debt has less default risk than subordinated debt.c.A company's bond rating is affected by its financial ratios and provisions in its indenture.d.Under Chapter 11 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 its debt according to the seniority of the debt as spelled out in the Act.e.All else equal, secured debt is less risky than unsecured debt.

ANS:DPTS:1DIF:Difficulty: ModerateOBJ:LO: 5-16NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Default and bankruptcyKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 71.Which of the following statements is CORRECT?a.A bond is likely to be called if its market price is below its par value.b.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.c.A bond is likely to be called if its market price is equal to its par value.d.A bond is likely to be called if it sells at a discount below par.e.A bond is likely to be called if its coupon rate is below its YTM. ANS:

72.Which of the following statements is CORRECT?a.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.b.If a bond sells at par, then its current yield will be less than its yield to maturity.c.If a bond sells for less than par, then its yield to maturity is less than its coupon rate.d.A discount bond's price declines each year until it matures, when its value equals its par value.e.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.

ANS: 73.Assume that a 10-year Treasury bond has a 12% annual coupon, while a 15-year Tbond 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 will increase, but the 10-year bond would have a larger percentage increase in price.b.The 10-year bond would sell at a discount, while the 15-year bond would sell at a premium.c.The 10year bond would sell at a premium, while the 15-year bond would sell at par.d.If the yield to maturity on both bonds remains at 10% over the next year, the price of the 10year bond would increase, but the price of the 15-year bond would fall.e.If interest rates decline, the prices of both bonds will increase, but the 15-year bond would have a larger percentage increase in price.

ANS:MSC:TYPE: Multiple Choice: Conceptual 74.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 prevent the use of additional debt. a.1, 4, 6b.1, 2, 3, 4, 6c.1, 2, 3, 4, 5, 6d.1, 3, 4, 5, 6e.1, 3, 4, 6 ANS:EPTS:1DIF:Difficulty: ChallengingOBJ:LO: 5-11NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Bond indentureKEY:Bloomâ&#x20AC;&#x2122;s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 75.Suppose International Digital Technologies decides to raise a total of $200 million, with $100 million as long-term debt and $100 million as common equity. 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 following statements is CORRECT?a.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.b.In this situation, we cannot tell for sure how, or 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 of the two types of bonds would increase as the percentage of mortgage bonds used was increased, but the result might well be such that the firm's total interest charges would not be affected materially by the mix between the two.c.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.d.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.e.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.

ANS: PTS:1DIF:Difficulty: ChallengingOBJ:LO: 5-11NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Types of debt and their relative costsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 76.Which of the following statements is CORRECT?a.If their maturities and other characteristics were the same, a 5% coupon bond would have more interest rate price risk than a 10% coupon bond.b.A 10-year coupon bond would have more reinvestment rate risk than a 5-year coupon bond, but all 10-year coupon bonds have the same amount of reinvestment rate risk.c.A 10-year coupon bond would have more interest rate price risk than a 5-year coupon bond, but all 10-year coupon bonds have the same amount of interest rate price risk.d.If their maturities and other characteristics were the same, a 5% coupon bond would have less interest rate price risk than a 10% coupon bond.e.A zero coupon bond of any maturity will have more interest rate price risk than any coupon bond, even a perpetuity.

ANS:APTS:1DIF:Difficulty: ChallengingOBJ:LO: 5-13NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Interest rate and reinvestment rate riskKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 77.Which of the following statements is CORRECT?a.All else equal, an increase in interest rates will have a greater effect on the prices of short-term than long-term bonds.b.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.c.If a bond's yield to maturity exceeds its coupon rate, the bond's price must be less than its maturity value.d.If a bond's yield to maturity exceeds its coupon rate, the bond's current yield must be less than its coupon rate.e.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 the bond's coupon rates.

ANS:CPTS:1DIF:Difficulty: ChallengingOBJ:LO: 5-6NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Bond yields and pricesKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 78.Assuming all else is constant, which of the following statements is CORRECT? a.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.b.From a corporate borrower's point of view, interest paid on bonds is not tax-deductible.c.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.d.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.e.A 20-year zero coupon bond has more reinvestment rate risk than a 20year coupon bond.

ANS: 79.Kessen Inc.'s bonds mature in 7 years, have a par value of $1,000, and make an annual coupon payment of $70. The market interest rate for the bonds is 8.5%. What is the bond's price?a.$923.22b.$946.30c.$969.96d.$994.21e.$1,019.06 ANS: 80.Noncallable bonds that mature in 10 years were recently issued by Sternglass Inc. They have a par value of $1,000 and an annual coupon of 5.5%. If the current market interest rate is 7.0%, at what price should the bonds sell?a.$829.21b.$850.47c. $872.28d.$894.65e.$917.01 ANS: 81.Curtis Corporation's noncallable bonds currently sell for $1,165. They have a 15year maturity, an annual coupon of $95, and a par value of $1,000. What is their yield to maturity?a.6.20%b.6.53%c.6.87%d.7.24%e.7.62% ANS: 82.Sommers Co.'s bonds currently sell for $1,080 and have a par value of $1,000.

They pay a $100 annual coupon and have a 15-year maturity, but they can be called in 5 years at $1,125. What is their yield to maturity (YTM)? a.8.56%b.9.01%c.9.46%d.9.93%e.10.43% ANS: 83.Sentry Corp. bonds have an annual coupon payment of 7.25%. The bonds have a par value of $1,000, a current price of $1,125, and they will mature in 13 years. What is the yield to maturity on these bonds?a.5.56%b.5.85%c.6.14%d.6.45%e.6.77% ANS: 84.Meacham Enterprises' bonds currently sell for $1,280 and have a par value of $1,000. They pay a $135 annual coupon and have a 15-year maturity, but they can be called in 5 years at $1,050. What is their yield to call (YTC)? a.6.39%b.6.72%c.7.08%d.7.45%e.7.82% ANS: 85.Perry Inc.'s bonds currently sell for $1,150. They have a 6-year maturity, an annual coupon of $85, and a par value of $1,000. What is their current yield? a.7.39%b.7.76%c.8.15%d.8.56%e.8.98% ANS: 86.Rogoff Co.'s 15-year bonds have an annual coupon rate of 9.5%. Each bond has face value of $1,000 and makes semiannual interest payments. If you require an 11.0% nominal yield to maturity on this investment, what is the maximum price you should be willing to pay for the bond?a.$891.00b.$913.27c.$936.10d.$959.51e. $983.49 ANS: 87.If 10-year T-bonds have a yield of 6.2%, 10-year corporate bonds yield 8.5%, the maturity risk premium on all 10-year 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.1.90%b.2.09%c.2.30%d.2.53%e.2.78% ANS: 88.One year ago Lerner and Luckmann Co. issued 15-year, noncallable, 7.5% annual coupon bonds at their par value of $1,000. Today, the market interest rate on these bonds is 5.5%. What is the current price of the bonds, given that they now have 14 years to maturity?a.$1,077.01b.$1,104.62c.$1,132.95d.$1,162.00e.$1,191.79 ANS: 89.Currently, Bruner Inc.'s bonds sell for $1,250. They pay a $120 annual coupon, have a 15-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.)a.2.11%b.2.32%c.2.55%d.2.80%e.3.09% ANS: 90.Gilligan Co.'s bonds currently sell for $1,150. They have a 6.75% annual coupon rate and a 15-year maturity, and are callable in 6 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, the YTC or the YTM? a.3.92%b.4.12%c.4.34%d.4.57%e.4.81% ANS: 91.Haswell Enterprises' bonds have a 10-year maturity, a 6.25% semiannual coupon, and a par value of $1,000. The going interest rate (rd) is 4.75%, based on semiannual compounding. What is the bond's price? a.1,063.09b.1,090.35c.1,118.31d.1,146.27e.1,174.93 ANS: 92.CMS Corporation's balance sheet as of today is as follows: Long-term debt (bonds, at par)$10,000,000Preferred stock2,000,000Common stock ($10 par)10,000,000Retained earnings 4,000,000Total debt and equity$26,000,000 The bonds have a 4.0% coupon rate, payable semiannually, and a par value of $1,000.

They mature exactly 10 years from today. The yield to maturity is 12%, so the bonds now sell below par. What is the current market value of the firm's debt?a.$5,276,731b. $5,412,032c.$5,547,332d.$7,706,000e.$7,898,650 ANS: 93.5-year Treasury bonds yield 5.5%. The inflation premium (IP) is 1.9%, and the maturity risk premium (MRP) on 5-year bonds is 0.4%. What is the real risk-free rate, r*?a.2.59%b.2.88%c.3.20%d.3.52%e.3.87% ANS: 94.The Gergen Group's 5-year bonds yield 6.85%, and 5-year T-bonds yield 4.75%.

The real risk-free rate is r* = 2.80%, the default risk premium for Gergen's bonds is

DRP = 0.85% versus zero for T-bonds, the liquidity premium on Gergen's bonds is LP = 1.25%, 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 5-year bonds?a.1.40%b.1.55%c.1.71%d.1.88%e.2.06% ANS: 95.Chandler Co.'s 5-year bonds yield 7.00%, 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 Chandler's bonds is LP = 0.75% 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 default risk premium (DRP) on Chandler's bonds?a.0.99%b.1.10%c.1.21%d.1.33%e.1.46% ANS: 96.Squire Inc.'s 5-year bonds yield 6.75%, 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 Squire'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 Squire's bonds?a.0.49%b.0.55%c.0.61%d.0.68%e.0.75% ANS: 97.Field Industries' outstanding bonds have a 25-year maturity and $1,000 par value.

Their nominal yield to maturity is 9.25%, they pay interest semiannually, and they sell at a price of $850. What is the bond's nominal (annual) coupon interest rate? a.6.27%b.6.60%c.6.95%d.7.32%e.7.70% ANS: 98.Jerome Corporation's bonds have 15 years to maturity, an 8.75% coupon paid semiannually, 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 $1,050. What is the bond's nominal yield to call?a.5.01%b.5.27%c.5.54%d.5.81%e.6.10% ANS: 99.A 25-year, $1,000 par value bond has an 8.5% annual coupon. The bond currently sells for $875. If the yield to maturity remains at its current rate, what will the price be 5 years from now?a.$839.31b.$860.83c.$882.90d.$904.97e.$927.60 ANS: 100.McCurdy Co.'s Class Q bonds have a 12-year maturity, $1,000 par value, and a 5.75% coupon paid semiannually (2.875% each 6 months), and those bonds sell at their par value. McCurdy's Class P bonds have the same risk, maturity, and par value, but the P bonds pay a 5.75% annual coupon. Neither bond is callable. At what price should the annual payment bond sell?a.$943.98b.$968.18c.$993.01d.$1,017.83e. $1,043.28 ANS: 101.Reinegar Corporation is planning two new issues of 25-year bonds. Bond Par will be sold at its $1,000 par value, and it will have a 10% semiannual coupon. Bond OID will be an Original Issue Discount bond, and it will also have a 25-year maturity and a

$1,000 par value, but its semiannual coupon will be only 6.25%. If both bonds are to provide investors with the same effective yield, how many of the OID bonds must Reinegar issue to raise $3,000,000? Disregard flotation costs, and round your final answer up to a whole number of bonds.a.4,228b.4,337c.4,448d.4,562e.4,676 ANS:

CHAPTER 6—RISK AND RETURN TRUE/FALSE 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.

ANS:FPTS:1DIF:Difficulty: EasyOBJ:LO: 6-2NAT:BUSPROG: Reflective ThinkingSTA:DISC: Risk and returnLOC:TBATOP:Standard deviationKEY:Bloom’s: Knowledge 2.Risk-averse investors require higher rates of return on investments whose returns are highly uncertain, and most investors are risk averse.

ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 6-6NAT:BUSPROG: Reflective ThinkingSTA:DISC: Risk and returnLOC:TBATOP:Risk aversionKEY:Bloom’s: Knowledge 3.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.

ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 6-5NAT:BUSPROG: Reflective ThinkingSTA:DISC: Risk and returnLOC:TBATOP:Portfolio riskKEY:Bloom’s: Knowledge 4.Diversification will normally reduce the riskiness of a portfolio of stocks.

ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 6-5NAT:BUSPROG: Reflective ThinkingSTA:DISC: Risk and returnLOC:TBATOP:Portfolio riskKEY:Bloom’s: Knowledge 5.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.

ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 6-5NAT:BUSPROG: Reflective ThinkingSTA:DISC: Risk and returnLOC:TBATOP:Portfolio riskKEY:Bloom’s: Knowledge 6.The realized return on a stock portfolio is the weighted average of the expected returns on the stocks in the portfolio.

ANS:FPTS:1DIF:Difficulty: EasyOBJ:LO: 6-5NAT:BUSPROG: Reflective ThinkingSTA:DISC: Risk and returnLOC:TBATOP:Portfolio returnKEY:Bloom’s: Knowledge 7.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.

ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 6-6NAT:BUSPROG: Reflective ThinkingSTA:DISC: Risk and returnLOC:TBATOP:Market riskKEY:Bloom’s: Knowledge 8.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.

ANS:FPTS:1DIF:Difficulty: EasyOBJ:LO: 6-6NAT:BUSPROG: Reflective ThinkingSTA:DISC: Risk and returnLOC:TBATOP:Market riskKEY:Bloom’s: Knowledge 9.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.

ANS:FPTS:1DIF:Difficulty: EasyOBJ:LO: 6-7NAT:BUSPROG: Reflective ThinkingSTA:DISC: Risk and returnLOC:TBATOP:Risk and expected returnsKEY:Bloom’s: Knowledge 10.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. ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 6-7NAT:BUSPROG: Reflective ThinkingSTA:DISC: Risk and returnLOC:TBATOP:CAPM and riskKEY:Bloom’s: Knowledge 11.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 well-diversified portfolio.

ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 6-6NAT:BUSPROG: Reflective ThinkingSTA:DISC: Risk and returnLOC:TBATOP:CAPM and riskKEY:Bloom’s: Knowledge 12.If investors become less averse to risk, the slope of the Security Market Line (SML) will increase.

ANS:FPTS:1DIF:Difficulty: EasyOBJ:LO: 6-7NAT:BUSPROG: Reflective ThinkingSTA:DISC: Risk and returnLOC:TBATOP:SML and risk aversionKEY:Bloom’s: Knowledge 13.If a stock's expected return as seen by the marginal investor exceeds this investor's 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.

ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 6-7NAT:BUSPROG: Reflective ThinkingSTA:DISC: Stocks and bondsLOC:TBATOP:Stock market equilibriumKEY:Bloom’s: Knowledge 14.If a stock's market price exceeds its intrinsic value as seen by the marginal investor, then the investor will sell the stock until its price has fallen down to the level of the investor's estimate of the intrinsic value.

ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 6-7NAT:BUSPROG: Reflective ThinkingSTA:DISC: Stocks and bondsLOC:TBATOP:Stock market equilibriumKEY:Bloom’s: Knowledge 15.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 this investor's required return.

ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 6-7NAT:BUSPROG: Reflective ThinkingSTA:DISC: Stocks and bondsLOC:TBATOP:Stock market equilibriumKEY:Bloom’s: Knowledge 16.Two conditions are used to determine whether or not 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

this investor's required return? If either of these conditions, but not necessarily both, holds, then the stock is said to be in equilibrium.

ANS:FIf one condition holds, then the other must also hold.

PTS:1DIF:Difficulty: EasyOBJ:LO: 6-7NAT:BUSPROG: Reflective ThinkingSTA:DISC: Stocks and bondsLOC:TBATOP:Stock market equilibriumKEY:Bloom’s: Knowledge 17.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, its standard deviation.

ANS:TPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-2NAT:BUSPROG: Reflective ThinkingSTA:DISC: Risk and returnLOC:TBATOP:VarianceKEY:Bloom’s: Comprehension 18."Risk aversion" implies that investors require higher expected returns on riskier than on less risky securities.

ANS:TPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-6NAT:BUSPROG: Reflective ThinkingSTA:DISC: Risk and returnLOC:TBATOP:Risk aversionKEY:Bloom’s: Comprehension 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 low standard deviation.

ANS:TPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: Reflective ThinkingSTA:DISC: Risk and returnLOC:TBATOP:Risk aversionKEY:Bloom’s: Comprehension 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.

ANS:TPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-6NAT:BUSPROG: Reflective ThinkingSTA:DISC: Risk and returnLOC:TBATOP:Risk prem. and risk aversionKEY:Bloom’s: Comprehension 21.A stock's beta measures its diversifiable risk relative to the diversifiable risks of other firms.

ANS:FPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-6NAT:BUSPROG: Reflective ThinkingSTA:DISC: Risk and returnLOC:TBATOP:Beta coefficientsKEY:Bloom’s: Comprehension 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.

ANS:FPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-6NAT:BUSPROG: Reflective ThinkingSTA:DISC: Risk and returnLOC:TBATOP:Beta coefficientsKEY:Bloom’s: Comprehension 23.If the returns of two firms are negatively correlated, then one of them must have a negative beta.

ANS:TPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-6NAT:BUSPROG: Reflective ThinkingSTA:DISC: Risk and returnLOC:TBATOP:Beta coefficientsKEY:Bloom’s: Comprehension 24.A stock with a beta equal to −1.0 has zero systematic (or market) risk.

ANS:FPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-6NAT:BUSPROG: Reflective ThinkingSTA:DISC: Risk and returnLOC:TBATOP:Beta coefficientsKEY:Bloom’s: Comprehension 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.

ANS:TPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-6NAT:BUSPROG: Reflective ThinkingSTA:DISC: Risk and returnLOC:TBATOP:Beta coefficientsKEY:Bloom’s: Comprehension 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.

ANS:TPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: Reflective ThinkingSTA:DISC: Risk and returnLOC:TBATOP:Portfolio riskKEY:Bloom’s: Comprehension 27.Portfolio A has but one stock, while Portfolio B consists of all stocks that trade in the market, each held in proportion to its market value. Because of its diversification, Portfolio B will by definition be riskless.

ANS:FPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-6NAT:BUSPROG: Reflective ThinkingSTA:DISC: Risk and returnLOC:TBATOP:Portfolio riskKEY:Bloom’s: Comprehension 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.

ANS:FPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-6NAT:BUSPROG: Reflective ThinkingSTA:DISC: Risk and returnLOC:TBATOP:Portfolio riskKEY:Bloom’s: Comprehension 29.The distributions of rates of return for Companies AA and BB are given below: State of theProbability ofEconomyThis State OccurringAABBBoom0.230% −10%Normal0.610% 5%Recession0.2−5% 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. ANS:FThe stocks have the same expected returns, but BB does badly in booms and well in recessions. Therefore, it would do more to reduce risk.

PTS:1DIF:Difficulty: ModerateOBJ:LO: 6-2NAT:BUSPROG: Reflective ThinkingSTA:DISC: Risk and returnLOC:TBATOP:Portfolio risk and returnKEY:Bloom’s: Comprehension 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.

ANS:FPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-6NAT:BUSPROG: Reflective ThinkingSTA:DISC: Risk and returnLOC:TBATOP:Cor. coefficient and riskKEY:Bloom’s: Comprehension 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.

ANS:TPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-5NAT:BUSPROG: Reflective ThinkingSTA:DISC: Risk and returnLOC:TBATOP:Company-specific riskKEY:Bloom’s: Comprehension

32.We would generally find that the beta of a single security is more stable over time than the beta of a diversified portfolio.

ANS:FPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-6NAT:BUSPROG: Reflective ThinkingSTA:DISC: Risk and returnLOC:TBATOP:Portfolio betaKEY:Bloom’s: Comprehension 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.

ANS:FPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-6NAT:BUSPROG: Reflective ThinkingSTA:DISC: Risk and returnLOC:TBATOP:Portfolio betaKEY:Bloom’s: Comprehension 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.

ANS:FPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-5NAT:BUSPROG: Reflective ThinkingSTA:DISC: Risk and returnLOC:TBATOP:Diversification effectsKEY:Bloom’s: Comprehension 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. ANS:FPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-11NAT:BUSPROG: Reflective ThinkingSTA:DISC: Risk and returnLOC:TBATOP:CAPMKEY:Bloom’s: Comprehension 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.

ANS:FPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: Reflective ThinkingSTA:DISC: Risk and returnLOC:TBATOP:Required returnKEY:Bloom’s: Comprehension 37.A firm can change its beta through managerial decisions, including capital budgeting and capital structure decisions.

ANS:TPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: Reflective ThinkingSTA:DISC: Risk and returnLOC:TBATOP:Changes in betaKEY:Bloom’s: Comprehension 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.

ANS:TPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: Reflective ThinkingSTA:DISC: Risk and returnLOC:TBATOP:Changes in betaKEY:Bloom’s: Comprehension 39.The slope of the SML is determined by the value of beta.

ANS:FPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: Reflective ThinkingSTA:DISC: Risk and returnLOC:TBATOP:SMLKEY:Bloom’s: Comprehension 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. ANS:TPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: Reflective ThinkingSTA:DISC: Risk and returnLOC:TBATOP:SMLKEY:Bloom’s: Comprehension

41.If you plotted the returns of a company against those of the market and found that the slope of your 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 that the observed relationship is expected to continue in the future.

ANS:TPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-6NAT:BUSPROG: Reflective ThinkingSTA:DISC: Risk and returnLOC:TBATOP:SMLKEY:Bloom’s: Comprehension 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 risk-free rate for a well-diversified investor, assuming that the observed relationship is expected to continue into the future.

ANS:FPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-6NAT:BUSPROG: Reflective ThinkingSTA:DISC: Risk and returnLOC:TBATOP:SMLKEY:Bloom’s: Comprehension 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.

ANS:TPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: Reflective ThinkingSTA:DISC: Risk and returnLOC:TBATOP:SMLKEY:Bloom’s: Comprehension 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.

ANS:FThe 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.

PTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: Reflective ThinkingSTA:DISC: Risk and returnLOC:TBATOP:SMLKEY:Bloom’s: Comprehension 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.

ANS:FPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: Reflective ThinkingSTA:DISC: Risk and returnLOC:TBATOP:SMLKEY:Bloom’s: Comprehension 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.

ANS:TPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: Reflective ThinkingSTA:DISC: Risk and returnLOC:TBATOP:CAPM and inflationKEY:Bloom’s: Comprehension 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.

ANS:TPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: Reflective ThinkingSTA:DISC: Risk and returnLOC:TBATOP:Market risk premiumKEY:Bloom’s: Comprehension

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.

ANS:TBoth 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.

PTS:1DIF:Difficulty: ChallengingOBJ:LO: 6-7NAT:BUSPROG: Reflective ThinkingSTA:DISC: Risk and returnLOC:TBATOP:Beta coefficientsKEY:Bloom’s: Comprehension 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.

ANS:FThe CAPM is a single-period model, and it does not take account of securities' maturities.

PTS:1DIF:Difficulty: ChallengingOBJ:LO: 6-7NAT:BUSPROG: Reflective ThinkingSTA:DISC: Risk and returnLOC:TBATOP:CAPMKEY:Bloom’s: Comprehension MULTIPLE CHOICE 50.If markets are in equilibrium, which of the following conditions will exist?a.Each stock's expected return should equal its required return as seen by the marginal investor.b.All stocks should have the same expected return as seen by the marginal investor.c.The expected and required returns on stocks and bonds should be equal.d.All stocks should have the same realized return during the coming year.e.Each stock's expected return should equal its realized return as seen by the marginal investor.

ANS:AStatement a is true, because if the expected return does not equal the required return, then markets are not in equilibrium.

PTS:1DIF:Difficulty: EasyOBJ:LO: 6-7NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Market equilibriumKEY:Bloom’s: ComprehensionMSC:TYPE: Multiple Choice: ConceptualNOT:Question may require calculations to find the correct answer.

51.You are considering investing in one of the these three stocks: StockStandard DeviationBetaA20%0.59B10%0.61C12%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; B.b.B; A.c.C; A.d.C; B.e.A; A. ANS:BPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-6NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:Risk aversionKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 52.Your friend is considering adding one additional stock to a 3-stock portfolio, to form a 4-stock portfolio. She is highly risk averse and has asked for your advice. 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.Stock A.b.Stock B.c.Neither A nor B, as neither has a return sufficient to compensate for risk.d.Add A, since its beta must be lower.e.Either A or B, i.e., the investor should be indifferent between the two.

ANS:BWith only 4 stocks in the portfolio, unsystematic risk matters, and B has less.

PTS:1DIF:Difficulty: ModerateOBJ:LO: 6-6NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:Standard deviationKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 53.Which of the following is NOT a potential problem when estimating and using betas, i.e., which statement is FALSE?a.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.b.The beta of an "average stock," or "the market," can change over time, sometimes drastically.c.Sometimes the past data used to calculate beta do not reflect the likely risk of the firm for the future because conditions have changed.d.All of the statements above are true.e.The fact that a security or project may not have a past history that can be used as the basis for calculating beta.

ANS:BPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-6NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:Beta coefficientsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 54.Stock A's beta is 1.7 and Stock B's beta is 0.7. Which of the following statements must be true about these securities? (Assume market equilibrium.)a.Stock B must be a more desirable addition to a portfolio than A.b.Stock A must be a more desirable addition to a portfolio than B.c.The expected return on Stock A should be greater than that on B.d.The expected return on Stock B should be greater than that on A.e.When held in isolation, Stock A has more risk than Stock B. ANS:CPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-6NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:Beta coefficientsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 55.Which of the following statements is CORRECT?a.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.b.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.c.The beta of a portfolio of stocks is always larger than the betas of any of the individual stocks.d.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.e.The beta of a portfolio of stocks is always smaller than the betas of any of the individual stocks.

ANS:BPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-6NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:Beta coefficientsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 56.Which of the following statements is CORRECT?a.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 5-year period.b.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.c.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.d.If the market risk premium remains constant, but the risk-free rate declines, then the required returns on low-beta stocks will rise while those on high-beta stocks will decline.e.Paid-in-Full Inc. is in the business of collecting past-due accounts for other companies, i.e., it is a collection agency. Paid-in-Full's revenues, profits, and stock price tend to rise during recessions. This suggests that Paid-in-Full 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.

ANS:APTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:Beta coefficientsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 57.Which of the following statements is CORRECT?a.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.b.The beta of an "average stock," which is also "the market beta," can change over time, sometimes drastically.c.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.d.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.e.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.

ANS:DPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:Beta coefficientsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 58.Stock A's beta is 1.7 and Stock B's beta is 0.7. Which of the following statements must be true, assuming the CAPM is correct.a.In equilibrium, the expected return on Stock B will be greater than that on Stock A.b.When held in isolation, Stock A has more risk than Stock B.c.Stock B would be a more desirable addition to a portfolio than A.d.In equilibrium, the expected return on Stock A will be greater than that on B.e.Stock A would be a more desirable addition to a portfolio then Stock B. ANS:DPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-6NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:Beta coefficientsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 59.Stock X has a beta of 0.7 and Stock Y has a beta of 1.7. Which of the following statements must be true, according to the CAPM?a.Stock Y's realized return during the coming year will be higher than Stock X's return.b.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.c.Stock Y's return has a higher standard deviation than Stock X.d.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.e.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.

ANS:BPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:Beta coefficientsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 60.Consider the following average annual returns for Stocks A and B and the Market.

Which of the possible answers best describes the historical betas for A and B? YearsMarketStock AStock B1 0.030.160.052−0.050.200.053 0.010.180.054−0.100.250.055 0.060.140.05 a.bA &gt; +1; bB = 0.b.bA = 0; bB = −1.c.bA &lt; 0; bB = 0.d.bA &lt; −1; bB = 1.e.bA &gt; 0; bB = 1.

ANS: 61.Which of the following statements is CORRECT?a.The higher the correlation between the stocks in a portfolio, the lower the risk inherent in the portfolio.b.An investor can eliminate almost all risk if he or she holds a very large and well diversified portfolio of stocks.c.Once a portfolio has about 40 stocks, adding additional stocks will not reduce its risk by even a small amount.d.An investor can eliminate almost all diversifiable risk if he or she holds a very large, well-diversified portfolio of stocks.e.An investor can eliminate almost all market risk if he or she holds a very large and well diversified portfolio of stocks.

ANS:DPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-5NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:Portfolio riskKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 62.Which of the following statements is CORRECT?a.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.b.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.c.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.d.A portfolio that consists of all stocks in the market would have a required return that is equal to the riskless rate.e.If you add enough randomly selected stocks to a portfolio, you can completely eliminate all of the market risk from the portfolio.

ANS:BPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-5NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:Portfolio risk and betaKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual

63.Recession, inflation, and high interest rates are economic events that are best characterized as beinga.company-specific risk factors that can be diversified away.b.among the factors that are responsible for market risk.c.risks that are beyond the control of investors and thus should not be considered by security analysts or portfolio managers.d.irrelevant except to governmental authorities like the Federal Reserve.e.systematic risk factors that can be diversified away.

ANS:BPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-5NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:Market riskKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 64.Which of the following statements is CORRECT?a.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.b.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.c.Portfolio diversification reduces the variability of returns (as measured by the standard deviation) of each individual stock held in a portfolio.d.A security's beta measures its non-diversifiable, or market, risk relative to that of an average stock.e.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.

ANS:DPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-6NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:Risk and port. divers.KEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 65.Which of the following statements is CORRECT?a.Diversifiable risk can be reduced by forming a large portfolio, but normally even highly-diversified portfolios are subject to market (or systematic) risk.b.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.c.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.d.If you add enough randomly selected stocks to a portfolio, you can completely eliminate all of the market risk from the portfolio.e.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.

ANS:APTS:1DIF:Difficulty: ModerateOBJ:LO: 6-6NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:Risk and port. divers.KEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 66.Which of the following statements is CORRECT?a.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.b.A two-stock portfolio will always have a lower beta than a one-stock portfolio.c.If portfolios are formed by randomly selecting stocks, a 10-stock portfolio will always have a lower beta than a one-stock portfolio.d.A stock with an above-average standard deviation must also have an above-average beta.e.A two-stock portfolio will always have a lower standard deviation than a one-stock portfolio.

ANS:APTS:1DIF:Difficulty: ModerateOBJ:LO: 6-5NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:Port. risk, return, and betaKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 67.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.

ExpectedStandardStockReturnDeviationBetaA10%20%1.0B10%10%1.0C12%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's coefficient of variation is greater than 2.0.b.Portfolio AB's required return is greater than the required return on Stock A.c.Portfolio ABC's expected return is 10.66667%.d.Portfolio ABC has a standard deviation of 20%.e.Portfolio AB has a standard deviation of 20%.

ANS:CPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:Portfolio risk conceptsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 68.Which of the following statements is CORRECT?a.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.b.If a stock has a negative beta, its expected return must be negative.c.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.d.According to the CAPM, stocks with higher standard deviations of returns must also have higher expected returns.e.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.

ANS:APTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:Port. return, CAPM, and betaKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 69.Which of the following is most likely to be true for a portfolio of 40 randomly selected stocks?a.The riskiness of the portfolio is the same as the riskiness of each stock if it was held in isolation.b.The beta of the portfolio is less than the average of the betas of the individual stocks.c.The beta of the portfolio is equal to the average of the betas of the individual stocks.d.The beta of the portfolio is larger than the average of the betas of the individual stocks.e.The riskiness of the portfolio is greater than the riskiness of each of the stocks if each was held in isolation.

ANS:CPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-6NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:Portfolio risk and returnKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 70.If you randomly select stocks and add them to your portfolio, which of the following statements best describes what you should expect?a.Adding more such stocks will increase the portfolio's expected rate of return.b.Adding more such stocks

will reduce the portfolio's beta coefficient and thus its systematic risk.c.Adding more such stocks will have no effect on the portfolio's risk.d.Adding more such stocks will reduce the portfolio's market risk but not its unsystematic risk.e.Adding more such stocks will reduce the portfolio's unsystematic, or diversifiable, risk.

ANS:EPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:Portfolio risk and returnKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 71.Charlie and Lucinda each have $50,000 invested in stock portfolios. Charlie's has a beta of 1.2, an expected return of 10.8%, and a standard deviation of 25%. Lucinda's 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 Charlie's and Lucinda's portfolios is zero.

If Charlie and Lucinda marry and combine their portfolios, which of the following best describes their combined $100,000 portfolio?a.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%.b.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%.c.The combined portfolio's standard deviation will be greater than the simple average of the two portfolios' standard deviations, 25%.d.The combined portfolio's standard deviation will be equal to a simple average of the two portfolios' standard deviations, 25%.e.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%.

ANS:APTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:Portfolio risk and returnKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 72.The two stocks in your portfolio, X and Y, have independent returns, so the correlation between them, rXY is zero. 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%. Which of the following statements best describes the characteristics of your 2-stock portfolio?a.Your portfolio has a standard deviation less than 30%, and its beta is greater than 1.6.b.Your portfolio has a beta equal to 1.6, and its expected return is 15%.c.Your portfolio has a beta greater than 1.6, and its expected return is greater than 15%.d.Your portfolio has a standard deviation greater than 30% and a beta equal to 1.6.e.Your portfolio has a standard deviation of 30%, and its expected return is 15%.

ANS:BPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:Portfolio risk and returnKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 73.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 expected return of your portfolio is likely to decline.b.The diversifiable risk will remain the same, but the market risk will likely decline.c.Both the diversifiable risk and the market risk of your portfolio are likely to decline.d.The total risk of your portfolio should decline, and as a result, the expected rate of return on the portfolio should also decline.e.The

diversifiable risk of your portfolio will likely decline, but the expected market risk should not change.

ANS:EPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:Portfolio risk and returnKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 74.Ann has a portfolio of 20 average stocks, and Tom has a portfolio of 2 average stocks. Assuming the market is in equilibrium, which of the following statements is CORRECT?a.The required return on Ann's portfolio will be lower than that on Tom's portfolio because Ann's portfolio will have less total risk.b.Tom's portfolio will have more diversifiable risk, the same market risk, and thus more total risk than Ann's portfolio, but the required (and expected) returns will be the same on both portfolios.c.If the two portfolios have the same beta, their required returns will be the same, but Ann's portfolio will have less market risk than Tom's.d.The expected return on Jane's portfolio must be lower than the expected return on Dick's portfolio because Jane is more diversified.e.Ann's portfolio will have less diversifiable risk and also less market risk than Tom's portfolio.

ANS:BPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:Portfolio risk and returnKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 75.Stocks A and B are quite similar: Each has 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 standard deviation that is greater than 25%.b.Portfolio P has an expected return that is less than 12%.c.Portfolio P has a standard deviation that is less than 25%.d.Portfolio P has a beta that is less than 1.2.e.Portfolio P has a beta that is greater than 1.2.

ANS:CPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:Portfolio risk and returnKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 76.Stocks A, B, and C are similar in some respects: Each has 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 greater than 25%.b.Portfolio AB has a standard deviation that is greater than 25%.c.Portfolio AB has a standard deviation that is equal to 25%.d.Portfolio AC has a standard deviation that is less than 25%.e.Portfolio AC has an expected return that is less than 10%.

ANS:DPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:Portfolio risk and returnKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 77.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.

Your portfolio consists of 50% A and 50% B. Which of the following statements is

CORRECT?a.The portfolio's expected return is 15%.b.The portfolio's standard deviation is greater than 20%.c.The portfolio's beta is greater than 1.2.d.The portfolio's standard deviation is 20%.e.The portfolio's beta is less than 1.2.

ANS:APTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:Portfolio risk and returnKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 78.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 equal to the expected return on Stock A.b.Portfolio P's expected return is less than the expected return on Stock B.c.Portfolio P's expected return is equal to the expected return on Stock B.d.Portfolio P's expected return is greater than the expected return on Stock C.e.Portfolio P's expected return is greater than the expected return on Stock B. ANS:CPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:Portfolio risk and returnKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 79.In a portfolio of three randomly selected stocks, which of the following could NOT be true; i.e., which statement is false?a.The standard deviation of the portfolio is greater than the standard deviation of one or two of the stocks.b.The beta of the portfolio is lower than the lowest of the three betas.c.The beta of the portfolio is equal to one of the three stock's betas.d.The beta of the portfolio is equal to 1.e.The standard deviation of the portfolio is less than the standard deviation of each of the stocks if they were held in isolation.

ANS:BPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:Portfolio risk and returnKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 80.Stock A has a beta = 0.8, while Stock B has a beta = 1.6. Which of the following statements is CORRECT?a.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.b.An equally weighted portfolio of Stocks A and B will have a beta lower than 1.2.c.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.d.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.e.Stock B's required return is double that of Stock A's.

ANS:APTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:Port. risk &amp; ret. relationshipsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 81.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 $300,000 invested in Stock A and $100,000 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.The stocks are not in

equilibrium based on the CAPM; if A is valued correctly, then B is overvalued.b.The stocks are not in equilibrium based on the CAPM; if A is valued correctly, then B is undervalued.c.Portfolio AB's expected return is 11.0%.d.Portfolio AB's beta is less than 1.2.e.Portfolio AB's standard deviation is 17.5%.

ANS:APTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:Port. risk &amp; ret. relationshipsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 82.You have a portfolio P that consists of 50% Stock X and 50% Stock Y. 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. Given this information, which of the following statements is CORRECT?a.The required return on Portfolio P is equal to the market risk premium (rM − rRF).b.Portfolio P has a beta of 0.7.c.Portfolio P has a beta of 1.0 and a required return that is equal to the riskless rate, rRF.d.Portfolio P has the same required return as the market (rM).e.Portfolio P has a standard deviation of 20%.

ANS:DPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:Port. risk &amp; ret. relationshipsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 83.Which of the following statements is CORRECT? (Assume that the risk-free rate is a constant.)a.The effect of a change in the market risk premium depends on the slope of the yield curve.b.If the market risk premium increases by 1%, then the required return on all stocks will rise by 1%.c.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.d.The effect of a change in the market risk premium depends on the level of the risk-free rate.e.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.

ANS:CPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:Market risk premiumKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 84.In historical data, we see 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.Large-company stocks, small-company stocks, long-term corporate bonds, U.S. Treasury bills, long-term government bonds.b.Small-company stocks, largecompany stocks, long-term corporate bonds, long-term government bonds, U.S. Treasury bills.c.U.S. Treasury bills, long-term government bonds, long-term corporate bonds, small-company stocks, large-company stocks.d.Large-company stocks, smallcompany stocks, long-term corporate bonds, long-term government bonds, U.S. Treasury bills.e.Small-company stocks, long-term corporate bonds, large-company stocks, long-term government bonds, U.S. Treasury bills.

ANS:BPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:Risk &amp; ret. relationshipsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual

85.Suppose that during the coming year, the risk free rate, rRF, is expected to remain the same, while the market risk premium (rM − rRF), is expected to fall. Given this forecast, which of the following statements is CORRECT?a.The required return on all stocks will remain unchanged.b.The required return will fall for all stocks, but it will fall more for stocks with higher betas.c.The required return for all stocks will fall by the same amount.d.The required return will fall for all stocks, but it will fall less for stocks with higher betas.e.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.

ANS:BPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:Required returnKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 86.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.Stock B's required rate of return is twice that of Stock A.b.If Stock A's required return is 11%, then the market risk premium is 5%.c.If Stock B's required return is 11%, then the market risk premium is 5%.d.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.e.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.

ANS:BPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:CAPMKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 87.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 fall has been greater for stocks with higher betas.b.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.c.Required returns have increased for stocks with betas greater than 1.0 but have declined for stocks with betas less than 1.0.d.The required returns on all stocks have fallen by the same amount.e.The required returns on all stocks have fallen, but the decline has been greater for stocks with lower betas.

ANS:APTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:CAPM and required returnKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 88.Assume that the risk-free rate is 5%. Which of the following statements is CORRECT?a.If a stock's beta doubled, its required return under the CAPM would also double.b.If a stock's beta doubled, its required return under the CAPM would more than double.c.If a stock's beta were 1.0, its required return under the CAPM would be 5%.d.If a stock's beta were less than 1.0, its required return under the CAPM would be less than 5%.e.If a stock has a negative beta, its required return under the CAPM would be less than 5%.

ANS:EPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:CAPM and required returnKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual

89.Stock LB has a beta of 0.5 and Stock HB has a beta of 1.5. The market is in equilibrium, with required returns equaling expected returns. Which of the following statements is CORRECT?a.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.b.If both expected inflation and the market risk premium (rM − rRF) increase, the required returns of both stocks will increase by the same amount.c.Since the market is in equilibrium, the required returns of the two stocks should be the same.d.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.e.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.

ANS:APTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:CAPM and required returnKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 90.Portfolio P has equal amounts invested in each of the three stocks, A, B, and C. 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.

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 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.b.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.c.The required returns on all three stocks will increase by the amount of the increase in the market risk premium.d.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.e.The required return of all stocks will remain unchanged since there was no change in their betas.

ANS:APTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:CAPM and required returnKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 91.Which of the following statements is CORRECT?a.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.b.If a company's beta were cut in half, then its required rate of return would also be halved.c.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.d.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.e.If a company's beta doubles, then its required rate of return will also double.

ANS:DPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:CAPM and required returnKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 92.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.If a stock has a negative beta, its required return must also be negative.b.An index fund with beta = 1.0 should have a required return less than 11%.c.If a stock's beta doubles, its required return must also double.d.An index fund with beta = 1.0 should have a required return greater than 11%.e.An index fund with beta = 1.0 should have a required return of 11%.

ANS:EPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:CAPM, beta, and req. returnKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 93.Which of the following statements is CORRECT?a.Lower beta stocks have higher required returns.b.A stock's beta indicates its diversifiable risk.c.Diversifiable risk cannot be completely diversified away.d.Two securities with the same stand-alone risk must have the same betas.e.The slope of the security market line is equal to the market risk premium.

ANS:EPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:SMLKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 94.Which of the following statements is CORRECT?a.If the risk-free rate rises, then the market risk premium must also rise.b.If a company's beta is halved, then its required return will also be halved.c.If a company's beta doubles, then its required return will also double.d.The slope of the security market line is equal to the market risk premium, (rM − rRF).e.Beta is measured by the slope of the security market line.

ANS:DPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:SMLKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 95.Portfolio P has $200,000 consisting of $100,000 invested in Stock A and $100,000 in Stock B. 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%. Which of the following statements is CORRECT? (Assume that the stocks are in equilibrium.)a.Stock B has a higher required rate of return than Stock A.b.Portfolio P has a standard deviation of 22.5%.c.More information is needed to determine the portfolio's beta.d.Portfolio P has a beta of 1.0.e.Stock A's returns are less highly correlated with the returns on most other stocks than are B's returns.

ANS:DPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:SMLKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 96.Dixon Food's stock has a beta of 1.4, while Clark Café's 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 market risk premium increases but the risk-free rate remains unchanged, Dixon's required return will increase because it has a beta greater than 1.0 but Clark's required return will decline because it has a beta less than 1.0.b.Since Dixon's beta is twice that of Clark's,

its required rate of return will also be twice that of Clark's.c.If the risk-free rate increases while the market risk premium remains constant, then the required return on an average stock will increase.d.If the market risk premium decreases but the risk-free rate remains unchanged, Dixon's required return will decrease because it has a beta greater than 1.0 and Clark's will also decrease, but by more than Dixon's because it has a beta less than 1.0.e.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 Dixon since it has a higher beta.

ANS:CPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:SMLKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 97.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.Stock Y must have a higher expected return and a higher standard deviation than Stock X.b.If expected inflation increases but the market risk premium is unchanged, then the required return on both stocks will fall by the same amount.c.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.d.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.e.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.

ANS:CPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:SMLKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 98.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 decrease by the same amount for both Stock A and Stock B.b.The required return would increase for Stock A but decrease for Stock B.c.The required return on Portfolio P would remain unchanged.d.The required return would increase for Stock B but decrease for Stock A.e.The required return would increase for both stocks but the increase would be greater for Stock B than for Stock A. ANS:EPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:SMLKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 99.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 both stocks would increase by 1%.b.The required return on Portfolio P would remain unchanged.c.The required return on Stock A would increase by more than 1%, while the return on Stock B would increase by less than 1%.d.The required return for Stock A would fall, but the required return for Stock B would increase.e.The required return on Portfolio P would increase by 1%.

ANS:EPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:SMLKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 100.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 &gt; 1.0 will increase.b.The return on "the market" will remain constant.c.The return on "the market" will increase.d.The required return on a stock with beta &lt; 1.0 will decline.e.The required return on a stock with beta = 1.0 will not change.

ANS:DPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:SMLKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 101.Which of the following statements is CORRECT?a.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.b.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.c.If investors become less risk averse, the slope of the Security Market Line will increase.d.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.e.The slope of the SML is determined by the value of beta.

ANS:BPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:SMLKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 102.How would the Security Market Line be affected, other things held constant, if the expected inflation rate decreases and investors also become more risk averse? a.The x-axis intercept would decline, and the slope would increase.b.The y-axis intercept would increase, and the slope would decline.c.The SML would be affected only if betas changed.d.Both the y-axis intercept and the slope would increase, leading to higher required returns.e.The y-axis intercept would decline, and the slope would increase.

ANS:EPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:SMLKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 103.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 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.b.Since the overall return on the market stays constant, the required return on each individual stock will also remain constant.c.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.d.The required return of all stocks will fall by the amount of the decline in the market risk premium.e.The

required return of all stocks will increase by the amount of the increase in the risk-free rate.

ANS:CPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:SMLKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 104.Suppose that Federal Reserve actions have caused an increase in the risk-free rate, rRF. Meanwhile, investors are afraid of a recession, so the market risk premium, (rM − rRF), has increased. 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, but the increase would be greatest for stocks with betas of less than 1.0.b.Stocks' required returns would change, but so would expected returns, and the result would be no change in stocks' prices.c.The prices of all stocks would decline, but the decline would be greatest for high-beta stocks.d.The prices of all stocks would increase, but the increase would be greatest for high-beta stocks.e.The required return on all stocks would increase by the same amount.

ANS:CPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:SMLKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 105.Which of the following statements is CORRECT?a.The slope of the Security Market Line is beta.b.Any stock with a negative beta must in theory have a negative required rate of return, provided rRF is positive.c.If a stock's beta doubles, its required rate of return must also double.d.If a stock's returns are negatively correlated with returns on most other stocks, the stock's beta will be negative.e.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.

ANS:DPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:SML, CAPM, and betaKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 106.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 will decline for stocks whose betas are less than 1.0.b.The required rate of return on the market, rM, will not change as a result of these changes.c.The required rate of return for each individual stock in the market will increase by an amount equal to the increase in the market riskd.The required rate of return on a riskless bond will decline.e.The required rate of return for an average stock will increase by an amount equal to the increase in the market risk premium.

ANS:EPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:SML and risk aversionKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 107.Which of the following statements is CORRECT?a.The CAPM has been thoroughly tested, and the theory has been confirmed beyond any reasonable doubt.b.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.c.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.d.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.e.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.

ANS:DPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:SML, CAPM, and port. riskKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 108.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 past realized rate of return must be equal to the expected future rate of return; that is, .b.The required rate of return must equal the past realized rate of return; that is, r = .c.The expected rate of return must be equal to the required rate of return; that is, = r.d.All of the above statements must hold for equilibrium to exist; that is = r = .e.None of the above statements is correct.

ANS:CPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:Market equilibriumKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 109.Which of the following statements is CORRECT?a.Portfolio diversification reduces the variability of returns on an individual stock.b.Risk refers to the chance that some unfavorable event will occur, and a probability distribution is completely described by a listing of the likelihood of unfavorable events.c.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.d.A stock with a beta of −1.0 has zero market risk if held in a 1-stock portfolio.e.When diversifiable risk has been diversified away, the inherent risk that remains is market risk, which is constant for all stocks in the market.

ANS:CPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:Risk conceptsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 110.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 a lower coefficient of variation than Company Y.b.Company X has less market risk than Company Y.c.Company X's returns will be negative when Y's returns are positive.d.Company X's stock is a better buy than Company Y's stock.e.Company X has more diversifiable risk than Company Y. ANS:APTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:Risk measuresKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 111.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.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.b.Portfolio P has more market risk than Stock A but less market risk than B.c.Stock A should have a higher expected return than Stock B as viewed by the marginal investor.d.Portfolio P has a coefficient of variation equal to 2.5.e.Portfolio P has a standard deviation of 25% and a beta of 1.0.

ANS:BPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:Portfolio riskKEY:Bloomâ&#x20AC;&#x2122;s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 112.For a stock to be in equilibrium, that is, for there to be no long-term pressure for its price to depart from its current level, thena.the past realized return must be equal to the expected return during the same period.b.the required return must equal the realized return in all periods.c.the expected return must be equal to both the required future return and the past realized return.d.the expected future returns must be equal to the required return.e.the expected future return must be less than the most recent past realized return.

ANS: 113.Which of the following are the factors for the Fama-French model?a.The excess market return, a debt factor, and a book-to-market factor.b.The excess market return, a size factor, and a debt.c.A debt factor, a size factor, and a book-to-market factor.d.The excess market return, an industrial production factor, and a book-to-market factor.e.The excess market return, a size factor, and a book-to-market factor.

ANS: 114.Gretta's 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. The risk-free rate is 6% and the market risk premium is 5%. Which of the following statements is CORRECT? a.The required return on the market is 10%.b.The portfolio's required return is less than 11%.c.If the risk-free rate remains unchanged but the market risk premium increases by 2%, Gretta's portfolio's required return will increase by more than 2%.d.If the market risk premium remains unchanged but expected inflation increases by 2%, Gretta's portfolio's required return will increase by more than 2%.e.If the stock market is efficient, Gretta's portfolio's expected return should equal the expected return on the market, which is 11%.

ANS: 115.Assume that the market is in equilibrium and that Portfolio AB has 50% invested in Stock A and 50% invested in Stock B. 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 â&#x2C6;&#x2019; rRF, is 6%. 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.Since the two stocks have zero correlation, Portfolio AB is riskless.b.Stock B's beta is 1.0000.c.Portfolio AB's required return is 11%.d.Portfolio AB's standard deviation is 25%.e.Stock A's beta is 0.8333.

ANS: 116.Portfolio AB was created by investing in a combination of Stocks A and B. 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 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 Stock B but less stand-alone risk.b.Portfolio AB has more money invested in Stock A than in Stock B.c.Portfolio AB has the same amount of money invested in each of the two stocks.d.Portfolio AB has more money invested in Stock B than in Stock A.e.Stock A has more market risk than Portfolio AB. ANS: 117.Which of the following statements is CORRECT?a.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 average-risk stock will not change.b.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.c.There is no reason to think that the slope of the yield curve would have any effect on the slope of the SML.d.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.e.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.

ANS: 118.Freedman Flowers' stock has a 50% chance of producing a 25% return, a 30% chance of producing a 10% return, and a 20% chance of producing a â&#x2C6;&#x2019;28% return.

What is the firm's expected rate of return?a.9.41%b.9.65%c.9.90%d.10.15%e.10.40% ANS: 119.Bloome Co.'s stock has a 25% chance of producing a 30% return, a 50% chance of producing a 12% return, and a 25% chance of producing a â&#x2C6;&#x2019;18% return. What is the firm's expected rate of return?a.7.72%b.8.12%c.8.55%d.9.00%e.9.50% ANS: 120.Donald Gilmore has $100,000 invested in a 2-stock portfolio. $35,000 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?a.0.65b.0.72c.0.80d.0.89e.0.98 ANS: 121.Shirley Paul's 2-stock portfolio has a total value of $100,000. $37,500 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 her portfolio's beta?a.1.17b.1.23c.1.29d.1.35e.1.42 ANS:

122.Ivan Knobel holds a well-diversified portfolio that has an expected return of 11.0% and a beta of 1.20. He is in the process of buying 1,000 shares of Syngine Corp at $10 a share and adding it to his portfolio. Syngine has an expected return of 13.0% and a beta of 1.50. The total value of Ivan's current portfolio is $90,000. What will the expected return and beta on the portfolio be after the purchase of the Syngine stock? a.10.64%; 1.17b.11.20%; 1.23c.11.76%; 1.29d.12.35%; 1.36e.12.97%; 1.42 ANS: 123.Calculate the required rate of return for Everest Expeditions 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 1.00, and (5) its realized rate of return has averaged 15.0% over the last 5 years.a.10.29%b.10.83%c.11.40%d.12.00%e.12.60% ANS: 124.Zacher Co.'s stock has a beta of 1.40, the risk-free rate is 4.25%, and the market risk premium is 5.50%. What is the firm's required rate of return? a.11.36%b.11.65%c.11.95%d.12.25%e.12.55% ANS: 125.Nystrand Corporation's stock has an expected return of 12.25%, a beta of 1.25, and is in equilibrium. If the risk-free rate is 5.00%, what is the market risk premium? a.5.80%b.5.95%c.6.09%d.6.25%e.6.40% ANS: 126.Martin Ortner holds a $200,000 portfolio consisting of the following stocks: StockInvestmentBetaA $50,0000.95B 50,0000.80C 50,0001.00D 50,0001.20Total$200,000 What is the portfolio's beta?a.0.938b.0.988c.1.037d.1.089e.1.143 ANS: 127.Sherrie Hymes holds a $200,000 portfolio consisting of the following stocks. The portfolio's beta is 0.875.

StockInvestmentBetaA $50,0000.50B 50,0000.80C 50,0001.00D 50,0001.20Total$200,000 If Sherrie replaces Stock A with another stock, E, which has a beta of 1.50, what will the portfolio's new beta be?a.1.07b.1.13c.1.18d.1.24e.1.30 ANS: 128.Megan Ross holds the following portfolio: StockInvestmentBetaA$150,0001.40B 50,0000.80C 100,0001.00D 75,0001.20Total$375,000 What is the portfolio's beta?a.1.06b.1.17c.1.29d.1.42e.1.56 ANS: 129.Paul McLaren holds the following portfolio: StockInvestmentBetaA$150,0001.40B 50,0000.80C 100,0001.00D 75,0001.20Total$375,000 Paul plans to sell Stock A and replace it with Stock E, which has a beta of 0.75. By how much will the portfolio beta change?a.−0.190b.−0.211c.−0.234d.−0.260e.−0.286

ANS: 130.Jenna holds a diversified $100,000 portfolio consisting of 20 stocks with $5,000 invested in each. The portfolio's beta is 1.12. Jenna plans to sell a stock with b = 0.90 and use the proceeds to buy a new stock with b = 1.80. What will the portfolio's new beta be?a.1.286b.1.255c.1.224d.1.194e.1.165 ANS: 131.Porter Plumbing's stock had a required return of 11.75% last year, when the riskfree rate was 5.50% 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.)a.14.38%b.14.74%c.15.11%d.15.49%e.15.87% ANS: 132.Company A has a beta of 0.70, while Company B's beta is 1.20. The required return on the stock market is 11.00%, and the risk-free rate is 4.25%. 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.)a.2.75%b.2.89%c.3.05%d.3.21%e.3.38% ANS: 133.Stock A's stock has a beta of 1.30, and its required return is 12.00%. Stock B's beta is 0.80. If the risk-free rate is 4.75%, what is the required rate of return on B's stock? (Hint: First find the market risk premium.)a.8.76%b.8.98%c.9.21%d.9.44%e.9.68% ANS: 134.Barker Corp. has a beta of 1.10, 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 Barker's required rate of return?a.9.43%b.9.67%c.9.92%d.10.17%e.10.42% ANS: 135.Brodkey Shoes 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 13.00%. Based on the SML, what is the firm's required return? a.13.51%b.13.86%c.14.21%d.14.58%e.14.95% ANS: 136.Gardner Electric 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 12.50%. Using the SML, what is the firm's required rate of return?a.11.34%b.11.63%c.11.92%d.12.22%e.12.52% ANS:

137.Consider the following information and then calculate the required rate of return for the Universal Investment Fund, which holds 4 stocks. The market's required rate of return is 13.25%, the risk-free rate is 7.00%, and the Fund's assets are as follows: StockInvestmentBetaA$ 200,000 1.50B$ 300,000−0.50C$ 500,000 1.25D$1,000,000 0.75 a.9.58%b.10.09%c.10.62%d.11.18%e.11.77% ANS: 138.Data for Atwill Corporation is shown below. Now Atwill acquires some risky assets that cause its beta to increase by 30%. In addition, expected inflation increases by 2.00%. What is the stock's new required rate of return?

Initial beta1.00Initial required return (rs)10.20%Market risk premium, RPM6.00%Percentage increase in beta30.00%Increase in inflation premium, IP2.00% a.14.00%b.14.70%c.15.44%d.16.21%e.17.02% ANS: 139.Fiske Roofing Supplies' stock has a beta of 1.23, its required return is 11.75%, and the risk-free rate is 4.30%. What is the required rate of return on the market?

(Hint: First find the market risk premium.)a.10.36%b.10.62%c.10.88%d.11.15%e.11.43% ANS: 140.Suppose Stan holds a portfolio consisting of a $10,000 investment in each of 8 different common stocks. The portfolio's beta is 1.25. Now suppose Stan decided to sell one of his stocks that has a beta of 1.00 and to use the proceeds to buy a replacement stock with a beta of 1.35. What would the portfolio's new beta be? a.1.17b.1.23c.1.29d.1.36e.1.43 ANS: 141.Returns for the Alcoff 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.)

YearReturn2010 21.00%2009−12.50%2008 25.00% a.20.08%b.20.59%c.21.11%d.21.64%e.22.18% ANS: 142.Stuart Company'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.)

EconomicConditionsProb.ReturnStrong30% 32.0%Normal40% 10.0%Weak30% −16.0% a.17.69%b.18.62%c.19.55%d.20.52%e.21.55% ANS: 143.Assume that your cousin holds just one stock, Eastman Chemical Bonding (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 Wilder's Creations and Buildings

(WCB). Both companies 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 cousin's risk have been reduced if he had held a portfolio consisting of 60% in ECB and the remainder in WCB? (Hint: Use the sample standard deviation formula.)

YearECBWCB2007 40.00% 40.00%2008−10.00% 15.00%2009 35.00% −5.00%2010 −5.00%−10.00%2011 15.00% 35.00%Average return = 15.00% 15.00%Standard deviation = 22.64% 22.64% a.3.29%b.3.46%c.3.65%d.3.84%e.4.03% ANS: 144.The $10.00 million mutual fund Henry manages has a beta of 1.05 and a 9.50% required return. The risk-free rate is 4.20%. Henry now receives another $5.00 million, which he invests 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.)a.8.83%b.9.05%c.9.27%d.9.51%e.9.74% ANS: 145.Hazel Morrison, a mutual fund manager, has a $40 million portfolio with a beta of 1.00. The risk-free rate is 4.25%, and the market risk premium is 6.00%. Hazel expects to receive an additional $60 million, which she plans to invest in 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?a.1.68b.1.76c.1.85d.1.94e.2.04 ANS: 146.Joel Foster is 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 5.00%. What rate of return should investors expect (and require) on this fund?

StockAmountBetaA$1,075,0001.20B 675,0000.50C 750,0001.40D 500,0000.75$3,000,000 a.10.56%b.10.83%c.11.11%d.11.38%e.11.67% ANS: 147.DHF Company 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 DHF's new required return be?a.14.89%b.15.68%c.16.50%d.17.33%e.18.19% ANS:

CHAPTER 7—VALUATION OF STOCKS AND CORPORATIONS TRUE/FALSE

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.

ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 7-1NAT:BUSPROG: Reflective ThinkingSTA:DISC: Stocks and bondsLOC:TBATOP:ProxyKEY:Bloom’s: Knowledge 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.

ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 7-1NAT:BUSPROG: Reflective ThinkingSTA:DISC: Stocks and bondsLOC:TBATOP:Preemptive rightKEY:Bloom’s: Knowledge 3.If a firm's stockholders are given the preemptive right, this means that stockholders have the right to call for a meeting to vote to replace the management. Without the preemptive right, dissident stockholders would have to seek a change in management through a proxy fight.

ANS:FPTS:1DIF:Difficulty: EasyOBJ:LO: 7-1NAT:BUSPROG: Reflective ThinkingSTA:DISC: Stocks and bondsLOC:TBATOP:Preemptive rightKEY:Bloom’s: Knowledge 4.Classified stock differentiates various classes of common stock, and 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.

ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 7-2NAT:BUSPROG: Reflective ThinkingSTA:DISC: Stocks and bondsLOC:TBATOP:Classified stockKEY:Bloom’s: Knowledge 5.Founders' shares are a type of classified stock where the shares are owned by the firm's founders, and they generally have more votes per share than the other classes of common stock.

ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 7-2NAT:BUSPROG: Reflective ThinkingSTA:DISC: Stocks and bondsLOC:TBATOP:Founders' sharesKEY:Bloom’s: Knowledge 6.The total return on a share of stock refers to the dividend yield less any commissions paid when the stock is purchased and sold.

ANS:FPTS:1DIF:Difficulty: EasyOBJ:LO: 7-4NAT:BUSPROG: Reflective ThinkingSTA:DISC: Stocks and bondsLOC:TBATOP:Total stock returnsKEY:Bloom’s: Knowledge 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.

ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 7-4NAT:BUSPROG: Reflective ThinkingSTA:DISC: Stocks and bondsLOC:TBATOP:Common stock cash flowsKEY:Bloom’s: Knowledge 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.

ANS:FPTS:1DIF:Difficulty: EasyOBJ:LO: 7-4NAT:BUSPROG: Reflective ThinkingSTA:DISC: Stocks and bondsLOC:TBATOP:Value: investment horizonKEY:Bloom’s: Knowledge 9.When a new issue of stock is brought to market, it is the marginal investor who determines the price at which the stock will trade.

ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 7-4NAT:BUSPROG: Reflective ThinkingSTA:DISC: Stocks and bondsLOC:TBATOP:Marginal investor and priceKEY:Bloom’s: Knowledge 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.

ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 7-5NAT:BUSPROG: Reflective ThinkingSTA:DISC: Stocks and bondsLOC:TBATOP:Constant growth modelKEY:Bloom’s: Knowledge 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.

ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 7-6NAT:BUSPROG: Reflective ThinkingSTA:DISC: Stocks and bondsLOC:TBATOP:Nonconstant growth modelKEY:Bloom’s: Knowledge 12.Projected free cash flows should be discounted at the firm's weighted average cost of capital to find the value of its operations.

ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 7-7NAT:BUSPROG: Reflective ThinkingSTA:DISC: Stocks and bondsLOC:TBATOP:Free cash flows and valuationKEY:Bloom’s: Knowledge 13.The corporate valuation model cannot be used unless a company doesn't pay dividends.

ANS:FPTS:1DIF:Difficulty: EasyOBJ:LO: 7-7NAT:BUSPROG: Reflective ThinkingSTA:DISC: Stocks and bondsLOC:TBATOP:Corporate valuation modelKEY:Bloom’s: Knowledge 14.Free cash flows should be discounted at the firm's weighted average cost of capital to find the value of its operations.

ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 7-7NAT:BUSPROG: Reflective ThinkingSTA:DISC: Stocks and bondsLOC:TBATOP:Free cash flows and valuationKEY:Bloom’s: Knowledge 15.Preferred stock is a hybrid⎯a sort of 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.

ANS:FPreferred dividends don't normally grow, and they are not guaranteed.

PTS:1DIF:Difficulty: EasyOBJ:LO: 7-9NAT:BUSPROG: Reflective ThinkingSTA:DISC: Stocks and bondsLOC:TBATOP:Preferred stockKEY:Bloom’s: Knowledge 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.

ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 7-9NAT:BUSPROG: Reflective ThinkingSTA:DISC: Stocks and bondsLOC:TBATOP:Preferred stockKEY:Bloom’s: Knowledge MULTIPLE CHOICE 17.Which of the following statements is CORRECT?a.If a stock has a required rate of return rs = 12% and its dividend is expected to grow at a constant rate of 5%, this implies that the stock's dividend yield is also 5%.b.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.c.The price of a stock is the present value of all expected future dividends, discounted at the dividend growth rate.d.The constant growth model cannot be used for a zero growth stock, where the dividend is expected to remain constant over time.e.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.

ANS:BPTS:1DIF:Difficulty: EasyOBJ:LO: 7-5NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Constant growth modelKEY:Bloom’s: ComprehensionMSC:TYPE: Multiple Choice: ConceptualNOT:Question may require calculations to find the correct answer.

18.If a firm's expected growth rate increased then its required rate of return woulda.decrease.b.fluctuate less than before.c.fluctuate more than before.d.possibly increase, possibly decrease, or possibly remain constant.e.increase.

ANS:DPTS:1DIF:Difficulty: EasyOBJ:LO: 7-5NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Required returnKEY:Bloom’s: ComprehensionMSC:TYPE: Multiple Choice: ConceptualNOT:Question may require calculations to find the correct answer.

19.You, in analyzing a stock, find that its expected return exceeds its required return.

This suggests that you thinka.the stock should be sold.b.the stock is a good buy.c.management is probably not trying to maximize the price per share.d.dividends are not likely to be declared.e.the stock is experiencing supernormal growth.

ANS:BPTS:1DIF:Difficulty: EasyOBJ:LO: 7-5NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Required returnKEY:Bloom’s: ComprehensionMSC:TYPE: Multiple Choice: ConceptualNOT:Question may require calculations to find the correct answer.

20.The preemptive right is important to shareholders because ita.will result in higher dividends per share.b.is included in every corporate charter.c.protects the current shareholders against a dilution of their ownership interests.d.protects bondholders, and thus enables the firm to issue debt with a relatively low interest rate.e.allows managers to buy additional shares below the current market price.

ANS:CPTS:1DIF:Difficulty: ModerateOBJ:LO: 7-1NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Preemptive rightKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: ConceptualNOT:Question may require calculations to find the correct answer.

21.Companies can issue different classes of common stock. Which of the following statements concerning stock classes is CORRECT?a.All common stocks, regardless of class, must have the same voting rights.b.All firms have several classes of common stock.c.All common stock, regardless of class, must pay the same dividend.d.Some class or classes of common stock are entitled to more votes per share than other classes.e.All common stocks fall into one of three classes: A, B, and C. ANS: 22.Which of the following statements is CORRECT?a.Two firms with the same expected dividend and growth rates must also have the same stock price.b.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.c.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%, this implies that the stock's dividend yield is also 5%.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 takes into consideration the capital gains investors expect to earn on a stock.

ANS: 23.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 = â&#x2C6;&#x2019;5%). If the company is in equilibrium and its expected and required rate of return is 15%, which of the following statements is CORRECT?a.The company's dividend yield 5 years from now is expected to be 10%.b.The constant growth model cannot be used because the growth rate is negative.c.The company's expected capital gains yield is 5%.d.The company's expected stock price at the beginning of next year is $9.50.e.The company's current stock price is $20.

ANS: 24.If a stock's dividend is expected to grow at a constant rate of 5% a year, which of the following statements is CORRECT? The stock is in equilibrium.a.The stock's dividend yield is 5%.b.The price of the stock is expected to decline in the future.c.The stock's required return must be equal to or less than 5%.d.The stock's price one year from now is expected to be 5% above the current price.e.The expected return on the stock is 5% a year.

ANS: 25.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? ABRequired return10%12%Market price$25$40Expected growth7%9% a.These two stocks must have the same dividend yield.b.These two stocks should have the same expected return.c.These two stocks must have the same expected capital gains yield.d.These two stocks must have the same expected year-end dividend.e.These two stocks should have the same price.

ANS: 26.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? ABPrice$25$40Expected growth7%9%Expected return10%12% a.The two stocks could not be in equilibrium with the numbers given in the question.b.A's expected dividend is $0.50.c.B's expected dividend is $0.75.d.A's expected dividend is $0.75 and B's expected dividend is $1.20.e.The two stocks should have the same expected dividend.

ANS: 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? ABPrice$25$25Expected growth (constant)10%5%Required return15%15% a.Stock A has a higher dividend yield than Stock B.b.Currently the two stocks have the same price, but over time Stock B's price will pass that of A.c.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.d.The two stocks should not sell at the same price. If their prices

are equal, then a disequilibrium must exist.e.Stock A's expected dividend at t = 1 is only half that of Stock B. ANS: 28.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? XYPrice$30$30Expected growth (constant)6%4%Required return12%10% a.Stock Y has a higher dividend yield than Stock X.b.One year from now, Stock X's price is expected to be higher than Stock Y's price.c.Stock X has the higher expected year-end dividend.d.Stock Y has a higher capital gains yield.e.Stock X has a higher dividend yield than Stock Y. ANS: 29.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$3.00Current Price, P0$50Expected constant growth rate6.0% a.The stock's expected dividend yield and growth rate are equal.b.The stock's expected dividend yield is 5%.c.The stock's expected capital gains yield is 5%.d.The stock's expected price 10 years from now is $100.00.e.The stock's required return is 10%.

ANS: 30.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? XYPrice$25$25Expected dividend yield5%3%Required return12%10% a.Stock X pays a higher dividend per share than Stock Y.b.One year from now, Stock X should have the higher price.c.Stock Y has a lower expected growth rate than Stock X.d.Stock Y has the higher expected capital gains yield.e.Stock Y pays a higher dividend per share than Stock X. ANS:A 31.Merrell Enterprises' stock has an expected return of 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?a.The stock's dividend yield is 8%.b.The current dividend per share is $4.00.c.The stock price is expected to be $54 a share one year from now.d.The stock price is expected to be $57 a share one year from now.e.The stock's dividend yield is 7%.

ANS: 32.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.Stock B must have a higher dividend yield than Stock A.b.Stock A must have a higher dividend yield than Stock B.c.If Stock A has a higher dividend yield than Stock B, its expected capital gains yield must be lower than Stock B's.d.Stock A must have both a higher dividend yield and a higher capital gains yield than Stock B.e.If Stock A has a lower dividend yield than Stock B, its expected capital gains yield must be higher than Stock B's.

ANS:E

PTS:1DIF:Difficulty: ModerateOBJ:LO: 7-5NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Dividend yield and gKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: ConceptualNOT:Question may require calculations to find the correct answer.

33.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.If one stock has a higher dividend yield, it must also have a lower dividend growth rate.b.If one stock has a higher dividend yield, it must also have a higher dividend growth rate.c.The two stocks must have the same dividend growth rate.d.The two stocks must have the same dividend yield.e.The two stocks must have the same dividend per share.

ANS:APTS:1DIF:Difficulty: ModerateOBJ:LO: 7-5NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Dividend yield and gKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: ConceptualNOT:Question may require calculations to find the correct answer.

34.Which of the following statements is CORRECT, assuming stocks are in equilibrium?a.Assume that the required return on a given stock is 13%. If the stock's dividend is growing at a constant rate of 5%, its expected dividend yield is 5% as well.b.A stock's dividend yield can never exceed its expected growth rate.c.A required condition for one to use the constant growth model is that the stock's expected growth rate exceeds its required rate of return.d.Other things held constant, the higher a company's beta coefficient, the lower its required rate of return.e.The dividend yield on a constant growth stock must equal its expected total return minus its expected capital gains yield.

ANS:EPTS:1DIF:Difficulty: ModerateOBJ:LO: 7-5NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Dividend yield and gKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: ConceptualNOT:Question may require calculations to find the correct answer.

35.Which of the following statements is NOT CORRECT?a.The corporate valuation model discounts free cash flows by the required return on equity.b.The corporate valuation model can be used to find the value of a division.c.An important step in applying the corporate valuation model is forecasting the firm's pro forma financial statements.d.Free cash flows are assumed to grow at a constant rate beyond a specified date in order to find the horizon, or terminal, value.e.The corporate valuation model can be used both for companies that pay dividends and those that do not pay dividends.

ANS:APTS:1DIF:Difficulty: ModerateOBJ:LO: 7-7NAT:BUSPROG: AnalyticSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Corporate valuation modelKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual 36.Which of the following statements is CORRECT?a.The preferred stock of a given firm is generally less risky to investors than the same firm's common stock.b.Corporations cannot buy the preferred stocks of other corporations.c.Preferred dividends are not generally cumulative.d.A big advantage of preferred stock is that dividends on preferred stocks are tax deductible by the issuing corporation.e.Preferred stockholders have a priority over bondholders in the event of bankruptcy to the income, but not to the proceeds in a liquidation.

ANS:APTS:1DIF:Difficulty: ModerateOBJ:LO: 7-9NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Preferred stock conceptsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: ConceptualNOT:Question may require calculations to find the correct answer.

37.Which of the following statements is CORRECT?a.Preferred stock is normally expected to provide steadier, more reliable income to investors than the same firm's common stock, and, as a result, the expected after-tax yield on the preferred is lower than the after-tax expected return on the common stock.b.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.c.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 would be tax free.d.One of the advantages to financing with preferred stock is that 70% of the dividends paid out are tax deductible to the issuer.e.A major disadvantage of financing with preferred stock is that preferred stockholders typically have supernormal voting rights.

ANS: 38.Which of the following statements is CORRECT?a.The preemptive right gives stockholders the right to approve or disapprove of a merger between their company and some other company.b.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.c.The stock valuation model, P0 = D1/(rs − g), cannot be used for firms that have negative growth rates.d.The stock valuation model, P0 = D1/ (rs − g), can be used only for firms whose growth rates exceed their required returns.e.If a company has two classes of common stock, Class A and Class B, the stocks may pay different dividends, but under all state charters the two classes must have the same voting rights.

ANS: 39.The required returns of Stocks X and Y are rX = 10% and rY = 12%. Which of the following statements is CORRECT?a.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.b.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.c.The stocks must sell for the same price.d.Stock Y must have a higher dividend yield than Stock X.e.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.

ANS: 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? ABBeta1.100.90Constant growth rate7.00%7.00% a.Stock A must have a higher dividend yield than Stock B.b.Stock B's dividend yield equals its expected dividend growth rate.c.Stock B must have the higher required return.d.Stock B could have the higher expected return.e.Stock A must have a higher stock price than Stock B.

ANS: 41.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 = 6.4%. What is the stock's current price?a.$17.39b.$17.84c.$18.29d.$18.75e.$19.22 ANS: 42.A stock just paid a dividend of D0 = $1.50. The required rate of return is rs = 10.1%, and the constant growth rate is g = 4.0%. What is the current stock price?a. $23.11b.$23.70c.$24.31d.$24.93e.$25.57 ANS: 43.A share of Lash Inc.'s 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 11.4%, what is the stock price?a.$16.28b.$16.70c.$17.13d.$17.57e.$18.01 ANS: 44.Franklin Corporation is expected to pay a dividend of $1.25 per share at the end of the year (D1 = $1.25). The stock sells for $32.50 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.6.17%c.6.33%d.6.49%e.6.65% ANS: 45.$35.50 per share is the current price for Foster Farms' stock. 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. $37.86b.$38.83c.$39.83d.$40.85e.$41.69 ANS: 46.Kelly Enterprises' stock currently sells for $35.25 per share. The dividend is projected to increase at a constant rate of 4.75% 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. $40.17b.$41.20c.$42.26d.$43.34e.$44.46 ANS: 47.If D1 = $1.25, g (which is constant) = 4.7%, and P0 = $26.00, what is the stock's expected dividend yield for the coming year?a.4.12%b.4.34%c.4.57%d.4.81%e.5.05% ANS: 48.If D0 = $2.25, g (which is constant) = 3.5%, and P0 = $50, what is the stock's expected dividend yield for the coming year?a.4.42%b.4.66%c.4.89%d.5.13%e.5.39% ANS: 49.If D1 = $1.50, g (which is constant) = 6.5%, and P0 = $56, what is the stock's expected capital gains yield for the coming year? a.6.50%b.6.83%c.7.17%d.7.52%e.7.90% ANS: 50.If D1 = $1.25, g (which is constant) = 5.5%, and P0 = $44, what is the stock's expected total return for the coming year?a.7.54%b.7.73%c.7.93%d.8.13%e.8.34%

ANS: 51.If D0 = $1.75, g (which is constant) = 3.6%, and P0 = $32.00, what is the stock's expected total return for the coming year?a.8.37%b.8.59%c.8.81%d.9.03%e.9.27% ANS: 52.Barnette Inc.'s free cash flows are expected to be unstable during the next few years while the company undergoes restructuring. However, FCF is expected to be $50 million in Year 5, i.e., FCF at t = 5 equals $50 million, and the FCF growth rate is expected to be constant at 6% beyond that point. If the weighted average cost of capital is 12%, what is the horizon value (in millions) at t = 5?a.$719b.$757c.$797d. $839e.$883 ANS: 53.Gere Furniture forecasts a free cash flow of $40 million in Year 3, i.e., at t = 3, and it expects FCF to grow at a constant rate of 5% thereafter. If the weighted average cost of capital is 10% and the cost of equity is 15%, what is the horizon value, in millions at t = 3?a.$840b.$882c.$926d.$972e.$1,021 ANS: 54.Young &amp; Liu Inc.'s free cash flow during the just-ended year (t = 0) was $100 million, and FCF is expected to grow at a constant rate of 5% in the future. If the weighted average cost of capital is 15%, what is the firm's value of operations, in millions?a.$948b.$998c.$1,050d.$1,103e.$1,158 ANS: 55.The projected cash flow for the next year for Minesuah Inc. is $100,000, and FCF is expected to grow at a constant rate of 6%. If the company's weighted average cost of capital is 11%, what is the value of its operations?a.$1,714,750b.$1,805,000c. $1,900,000d.$2,000,000e.$2,100,000 ANS: 56.Carby Hardware has an outstanding issue of perpetual preferred stock with an annual dividend of $7.50 per share. If the required return on this preferred stock is 6.5%, at what price should the preferred stock sell?a.$104.27b.$106.95c.$109.69d. $112.50e.$115.38 ANS: 57.Dyer Furniture 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 1.15, the market risk premium is 5.50%, and the risk-free rate is 4.00%. What is Dyer's current stock price?a.$28.90b.$29.62c.$30.36d. $31.12e.$31.90 ANS: 58.The Jameson 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 1.15, the market risk premium is 5.00%, and the risk-free rate is 4.00%. What is Jameson's current stock price, P0?a.$18.62b.$19.08c.$19.56d.$20.05e.$20.55

ANS: 59.National Advertising 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 1.25, 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?a.$14.52b.$14.89c.$15.26d. $15.64e.$16.03 ANS: 60.Kellner Motor Co.'s stock has a required rate of return of 11.50%, and it sells for $25.00 per share. Kellner's dividend is expected to grow at a constant rate of 7.00%.

What was the last dividend, D0?a.$0.95b.$1.05c.$1.16d.$1.27e.$1.40 ANS: 61.Hirshfeld Corporation's stock has a required rate of return of 10.25%, and it sells for $57.50 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.$2.20b.$2.44c.$2.69d.$2.96e. $3.25 ANS: 62.Connolly Co.'s expected year-end dividend is D1 = $1.60, 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 Connolly's expected stock price in 7 years, i.e., what is ?a.$37.52b. $39.40c.$41.37d.$43.44e.$45.61 ANS: 63.Alcott's preferred stock pays a dividend of $1.00 per quarter. If the price of the stock is $45.00, what is its nominal (not effective) annual rate of return? a.8.03%b.8.24%c.8.45%d.8.67%e.8.89% ANS: 64.Connor Publishing'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.6.62%b.6.82%c.7.03%d.7.25%e.7.47% ANS: 65.Burke Tires just paid a dividend of D0 = $1.32. 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?a.$41.59b.$42.65c.$43.75d.$44.87e. $45.99 ANS: 66.Kinkead Inc. forecasts that its free cash flow in the coming year, i.e., at t = 1, will be â&#x2C6;&#x2019;$10 million, but its FCF at t = 2 will be $20 million. After Year 2, FCF is expected to grow at a constant rate of 4% forever. If the weighted average cost of capital is 14%, what is the firm's value of operations, in millions?a.$158b.$167c. $175d.$184e.$193 ANS:

67.The free cash flows (in millions) shown below are forecast by Parker &amp; Sons.

If the weighted average cost of capital is 11% and FCF is expected to grow at a rate of 5% after Year 2, what is the Year 0 value of operations, in millions? Assume that the ROIC is expected to remain constant in Year 2 and beyond (and do not make any halfyear adjustments).

Year:12Free cash flow:â&#x2C6;&#x2019;$50$100 a.$1,456b.$1,529c.$1,606d.$1,686e.$1,770 ANS: 68.Heath and Logan Inc. forecasts the free cash flows (in millions) shown below. The weighted average cost of capital is 13%, and the FCFs are expected to continue growing at a 5% rate after Year 3. Assuming that the ROIC is expected to remain constant in Year 3 and beyond, what is the Year 0 value of operations, in millions?

Year:123Free cash flow:â&#x2C6;&#x2019;$15$10$40 a.$315b.$331c.$348d.$367e.$386 ANS: 69.Reynolds Construction's value of operations is $750 million based on the corporate valuation model. Its balance sheet shows $50 million of short-term investments that are unrelated to operations, $100 million of accounts payable, $100 million of notes payable, $200 million of long-term debt, $40 million of common stock (par plus paidin-capital), and $160 million of retained earnings. What is the best estimate for the firm's value of equity, in millions?a.$429b.$451c.$475d.$500e.$525 ANS: 70.Based on the corporate valuation model, the value of Weidner Co.'s operations is $1,200 million. The company's balance sheet shows $80 million in accounts receivable, $60 million in inventory, and $100 million in short-term investments that are unrelated to operations. The balance sheet also shows $90 million in accounts payable, $120 million in notes payable, $300 million in long-term debt, $50 million in preferred stock, $180 million in retained earnings, and $800 million in total common equity. If Weidner has 30 million shares of stock outstanding, what is the best estimate of the stock's price per share?a.$24.90b.$27.67c.$30.43d.$33.48e.$36.82 ANS: 71.The value of Broadway-Brooks Inc.'s operations is $900 million, based on the corporate valuation model. Its balance sheet shows $70 million in accounts receivable, $50 million in inventory, $30 million in short-term investments that are unrelated to operations, $20 million in accounts payable, $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 the stock's price per share?a.$23.00b.$25.56c.$28.40d.$31.24e.$34.36 ANS: 72.Based on the corporate valuation model, Bizzaro Co.'s value of operations is $300 million. The balance sheet shows $20 million of short-term investments that are unrelated to operations, $50 million of accounts payable, $90 million of notes payable, $30 million of long-term debt, $40 million of preferred stock, and $100 million of common equity. Bizzaro has 10 million shares of stock outstanding. What

is the best estimate of the stock's price per share?a.$13.72b.$14.44c.$15.20d.$16.00e. $16.80 ANS: 73.McGaha Enterprises expects earnings and dividends to grow at a rate of 25% for the next 4 years, after the growth rate in earnings and dividends will fall 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?a.$26.77b.$27.89c.$29.05d.$30.21e.$31.42 ANS: 74.Orwell Building Supplies' last dividend was $1.75. Its dividend growth rate is expected to be constant at 25% 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?a.$41.58b.$42.64c.$43.71d.$44.80e.$45.92 ANS: 75.The last dividend paid by Wilden Corporation was $1.55. 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?a.$37.05b.$38.16c.$39.30d.$40.48e.$41.70 ANS: 76.The last dividend paid by Coppard Inc. was $1.25. The dividend growth rate is expected to be constant at 15% 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?a.$30.57b.$31.52c.$32.49d.$33.50e.$34.50 ANS: 77.Sawchuck Consulting has been profitable for the last 5 years, but it 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?

Year0123456Growth rateNANANANA50.00%25.00%8.00%Dividends$0.000$0.000$0.000$0.250$0.375$ 0.469$0.506 a.$9.94b.$10.19c.$10.45d.$10.72e.$10.99 ANS: 78.The free cash flows (in millions) shown below are forecast by Simmons Inc. If the weighted average cost of capital is 13% 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 Year 0 value of operations, in millions?

Year:123Free cash flow:â&#x2C6;&#x2019;$20$42$45 a.$586b.$617c.$648d.$680e.$714 ANS:

79.The required return for Williamson Heating's stock is 12%, and the stock sells for $40 per share. The firm just paid a dividend of $1.00, and the dividend is expected to grow by 30% per year for the next 4 years, so D4 = $1.00(1.30)4 = $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? a.5.17%b.5.44%c.5.72%d.6.02%e.6.34% ANS: 80.Julia Saunders is your boss and the treasurer of Foster Carter Enterprises (FCE).

She 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 $15.00 per share. Julia 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. Julia 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: Julia 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 TV. 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 would be 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.11.84%b.12.21%c.12.58%d.12.97%e.13.36% ANS: