TEST BANK for ESSENTIALS OF CORPORATE FINANCE 5th Edition ISBN 9781760423605 By Stephen A. Ross, Row by StudyGuide

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 01 Testbank

Chapter 01 Testbank 1. The primary market refers to: A. the original sale of securities by the issuer. B. transactions between two institutional shareholders. C. the sale of securities by an individual shareholder. D. the first trade of a firm's securities when the financial markets open in the morning. 2. The most important function of a financial market is: A. to facilitate the flow of funds between lenders and borrowers. B. to provide a market for shares. C. to provide information about an issuing company's financial situation. D. to secure profits for brokers and agents. 3. A primary financial market is one that: A. involves the sale of existing securities. B. offers securities with the highest expected return. C. offers the greatest choice of shares and debentures. D. involves the sale of securities for the first time. 4. Secondary markets: A. allow borrowers to raise long-term funds. B. facilitate capital-raising in the primary market. C. allow borrowers to raise short-term funds. D. all of the answers options are correct. 5. A corporation: A. can neither sue another party nor be sued. B. may not own property. C. may enter into contracts to borrow funds. D. can issue its own shares but cannot purchase shares in another entity. 6. The amount of debt and equity used by a firm to finance its operations is called the firm's: A. debt ratio. B. working capital ratio. C. capital structure. D. financial position.

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 01 Testbank

7. Short-term assets and short-term liabilities are referred to as the firm's: A. cash flow. B. capital budget. C. capital structure. D. working capital. 8. The management of a firm's cash, inventory and payables is referred to as: A. cash-flow forecasting. B. asset management. C. capital management. D. working capital management. 9. A business organisation that is similar to a sole proprietorship but has two or more owners is called a: A. limited liability company. B. corporation. C. dual company. D. partnership. 10. The legal papers which designate a firm's name, nature of business and intended life are called the: A. corporate by-laws. B. charter or constitution. C. partnership agreement. D. joint share company forms. 11. Any situation where a conflict may arise between the firm's owners and its managers is referred to as a(n): A. organisational problem. B. personnel conflict. C. agency problem. D. control issue. 12. A negotiated sale of securities by an issuer to a specific buyer is called a(n): A. public offering. B. secondary placement. C. independent placement. D. private placement. 13. Over-the-counter markets are __________ markets. A. dealer

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 01 Testbank

B. franchise C. private D. auction 14. A securities market with a physical location that is designed to match buyers with sellers is called a(n) ________ market: A. dealer B. private C. auction D. franchise 15. Which one of the following statements is related to capital budgeting? A. A firm should monitor the ratio of debt to equity financing that it uses. B. A firm should monitor the amount of its current assets as compared to its current liabilities. C. A firm should consider the size, risk and timing of an asset's cash flows before deciding to purchase that asset. D. A firm should consider various types of loans offered by various lenders before taking out a loan. 16. Working capital management includes which of the following? I. Controlling the inventory level II. Determining when to pay suppliers III. Deciding how much non-current debt to assume IV. Controlling the amount of cash that is readily available A. I and II only B. I and IV only C. II and III only D. I, II and IV only 17. Who of the following are the actual owners of firms? A. All the shareholders. B. The bondholders. C. The largest shareholders. D. The senior management team. 18. Will and Bill both enjoy sunshine, water and surfboards. Thus, the two friends decided to create a business together in Sydney renting surfboards, paddle boats and inflatable devices. Will and Bill will equally share in the decision making and in the profits or losses. Which type of business did they create if they both have full personal liability for the firm's debts? A. Sole proprietorship B. Limited partnership C. Joint share company

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 01 Testbank

D. General partnership 19. Which one of the following best matches the primary goal of financial management? A. Increasing the dollar amount of each sale B. Increasing traffic flow within the firm's stores C. Transforming fixed costs into variable costs D. Increasing the market value of the firm 20. What is the goal of financial management for a sole proprietorship? A. Maximise profit for the period given the current resources of the firm B. Decrease non-current debt to reduce the risk to the owner C. Minimise the tax impact on the proprietor D. Maximise the market value of the equity 21. Which one of the following is most likely to create a situation where an agency conflict could arise? A. Increasing the size of a firm's operations B. Downsizing a firm C. Separating management from ownership D. Decreasing employee turnover 22. Large Australian company stocks such as BHP and Telstra: A. can only trade on the ASX. B. can trade on the stock exchange of their choosing as long as they qualify for listing. C. trade only in dealer markets. D. are sold to investors as private placement and are held to maturity. 23. Which of the following are effective means of aligning management goals with shareholder interests? I. Employee share options II. Threat of a takeover III. Management bonuses tied to performance goals IV. Threat of a proxy fight A. I and III only B. II and IV only C. I, II and III only D. I, II, III and IV 24. Which of the following is an example of the agency problem? A. Managers always invest in projects that have appropriate returns and that will increase shareholder wealth.

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 01 Testbank

B. Managers resign when they believe they have not always acted in the best interests of shareholders. C. Managers conduct an acquisition program purely to increase the size of an organisation. D. Managers look for new projects as they want to avoid business risk. 25. Which one of the following situations is most likely to create an agency conflict? A. Compensating a manager based on his or her division's profit for the period B. Giving all employees a bonus if a certain level of efficiency is maintained C. Hiring an independent consultant to study the operating efficiency of the firm D. Rejecting a profitable project to protect employee jobs 26. The potential conflict of interest between a firm's owners and its managers is referred to as which type of conflict? A. Organisational B. Structural C. Formation D. Agency 27. The goal of a financial manager should be: A. to maximise next year's profit. B. to minimise next year's cost. C. to maximise the value of the existing equity. D. to take no risks with shareholders' investments. 28. Tim works for a large manufacturing company and is now in charge of all fixed asset purchases. In other words, Tim is in charge of: A. capital structure management. B. asset allocation. C. risk management. D. capital budgeting. 29. The Australian government has a tax claim on the cash flows of a corporation. This claim is defined as a claim by one of the firm's: A. residual owners. B. shareholders. C. financiers. D. stakeholders. 30. Which one of the following correctly defines a common chain of command within a corporation? A. The chief accountant reports directly to the corporate treasurer.

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 01 Testbank

B. The treasurer reports directly to the board of directors. C. The chief financial officer reports directly to the board of directors. D. The accountant reports directly to the chief financial officer. 31. Uptown Markets is financed with 45 per cent debt and 55 per cent equity. This mixture of debt and equity is referred to as the firm's: A. capital structure. B. capital budget. C. asset allocation. D. working capital. E. risk structure. 32. Theo’s BBQ has $48 000 in current assets and $39 000 in current liabilities. Decisions related to these accounts are referred to as: A. capital structure decisions. B. capital budgeting decisions. C. working capital management. D. operating management. E. fixed account structure. 33. Margie opened a used bookstore and is both the 100 per cent owner and the store's manager. Which type of business entity does Margie own if she is personally liable for all the store's debts? A. Sole proprietorship B. Limited partnership C. Corporation D. Joint share company E. General partnership 34. One advantage of the corporate form of organisation is the: A. taxation of the corporate profits. B. unlimited liability for its shareholders. C. double taxation of profits. D. ownership can be transferred more quickly and easily. E. ease of formation compared to other organisational forms. 35. Matt and Alicia created a firm that is a separate legal entity and will share ownership of that firm on a 75/25 basis. Which type of entity did they create if they have no personal liability for the firm's debts? A. Limited partnership B. Corporation C. Sole proprietorship

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 01 Testbank

D. General partnership E. Public company 36. An employee has a claim on the cash flows of Martin’s Machines. This claim is defined as a claim by one of the firm's: A. residual owners. B. shareholders. C. financiers. D. provisional partners. E. stakeholders. 37. The shareholders of Weil’s Markets would benefit if the firm were to be acquired by Better Foods. However, Weil’s board of directors rejects the acquisition offer. This is an example of: A. a corporate takeover. B. a capital structure issue. C. a working capital decision. D. an agency conflict. E. a compensation issue. 38. Jamie is employed as a currency trader in the Japanese yen market. Her job falls into which one of the following areas of finance? A. International finance B. Financial institutions C. Corporate finance D. Capital management E. Personal finance 39. If you accept a job as a domestic security analyst for a brokerage firm, you are most likely working in which one of the following financial areas? A. International finance B. Private placements C. Corporate finance D. Capital management E. Investments 40. Which one of the following occupations best fits into the corporate area of finance? A. Mortgage broker B. Treasury bill analyst C. Chief financial officer D. Insurance risk manager E. Local bank manager

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 01 Testbank

41. Which one of the following functions should be assigned to the corporate treasurer rather than to the controller? A. Data processing B. Cost accounting C. Tax management D. Cash management E. Financial accounting 42. Which one of the following is a working capital decision? A. How should the firm raise additional capital to fund its expansion? B. What debt-equity ratio is best suited to the firm? C. What is the cost of debt financing? D. Should the firm borrow money for five or for 10 years? E. How much cash should the firm keep in reserve? 43. A sole proprietorship: A. provides limited financial liability for its owner. B. involves significant legal costs during the formation process. C. has an unlimited life. D. has its profits taxed as personal income. E. can generally raise significant capital from non-owner sources. 44. Which one of the following forms of business organisation offers liability protection to some of its owners but not to all of its owners? A. Sole proprietorship B. General partnership C. Limited partnership D. Limited liability company E. Corporation 45. Maria is the sole proprietor of an antique store that is located in a rented warehouse. The store has an outstanding loan with the local bank but no other debt obligations. There are no specific assets pledged as security for the loan. Due to a sudden and unexpected downturn in the economy, the store is unable to generate sufficient funds to pay the loan payments due to the bank. Which of the following options does the bank have to collect the money it is owed? I. Sell the inventory and apply the proceeds to the debt II. Sell the lighting fixtures from the building and apply the proceeds to the debt III. Withdraw funds from Maria’s personal account at the bank to pay the store’s debt IV. Sell any assets Maria personally owns and apply the proceeds to the store’s debt A. I only B. III only C. I and II only D. I, II, and III only

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 01 Testbank

E. I, III, and IV only 46. Which one of the following statements correctly applies to a sole proprietorship? A. The business entity has an unlimited life. B. The ownership can easily be transferred to another individual. C. The owner enjoys limited liability for the firm's debts. D. Debt financing is easy to arrange in the firm's name. E. Obtaining additional equity is dependent on the owner's personal finances. 47. Which one of the following statements is correct? A. All secondary markets are dealer markets. B. All secondary markets are broker markets. C. All share trades between existing shareholders are primary market transactions. D. All share transactions are secondary market transactions. E. All over-the-counter sales occur in dealer markets. 48. The issuer of a security must be involved in all _____ transactions involving that security. A. exchange-listed B. secondary market C. over-the-counter D. dealer market E. primary market 49. Which one of the following is most apt to align management's priorities with shareholders' interests? A. Holding corporate and shareholder meetings at high-end resort-type locations preferred by managers B. Compensating managers with company shares that must be held for a minimum of three years C. Paying a special management bonus on every fifth year of employment D. Increasing the number of paid holidays that long-term employees are entitled to receive E. Allowing employees to retire early with full retirement benefits 50. Which one of the following is a capital structure decision? A. Determining the optimal inventory level B. Establishing the preferred debt-equity level C. Selecting new equipment to purchase D. Setting the terms of sale for credit sales E. Determining when suppliers should be paid 51. Which one of the following situations is most apt to create an agency conflict? A. Compensating a manager based on his or her division's profit for the period

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 01 Testbank

B. Giving all employees a bonus if a certain level of efficiency is maintained C. Hiring an independent consultant to study the operating efficiency of the firm D. Basing management bonuses on the length of employment E. Laying off employees during a slack period 52. An agency issue is most likely to develop when: A. a firm encounters a period of stagnant growth. B. a firm downsizes. C. the control of a firm is separated from the firm’s ownership. D. the firm’s owner is also its key manager. E. a firm is structured as a general partnership. 53. Probably the least effective means of aligning management goals with shareholder interests is: A. the potential for a proxy fight by an unhappy segment of shareholders. B. basing all management bonuses on performance goals. C. holding management salaries steady while increasing share option grants. D. the threat of a takeover of the firm. E. automatically increasing management salaries on an annual basis. 54. Levi had an unexpected surprise when he returned home this morning. He found that a chemical spill from a local manufacturer had spilled over onto his property. The potential claim that he has against this manufacturer is that of a(n): A. general creditor. B. debtholder. C. shareholder. D. stakeholder. E. agent. 55. One example of a primary market transaction would be the: A. sale of 100 shares of share by Maria to her best friend. B. purchase by Theo of 5000 shares of share from his father. C. sale of 1000 shares of newly issued share by Alt Company to Miquel. D. sale by Terry of 50 000 shares of share to his brother. E. sale of 5000 shares of share owned by a corporate CEO to his son. 56. You contacted your share broker this morning and placed an order to sell 300 shares of a share that trades on the ASX. This sale will occur in the: A. dealer market. B. over-the-counter market. C. secondary market. D. primary market.

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 01 Testbank

E. tertiary market. 57. Which one of the following applies to a general partnership? A. The firm's operations must be controlled by a single partner. B. Any one of the partners can be held solely liable for all of the partnership's debt. C. The profits of the firm are taxed as a separate entity. D. Each partner's liability for the firm's debts is limited to each partner's investment in the firm. E. The profits of a general partnership are taxed the same as those of a corporation. 58. In a general partnership, each partner is personally liable for: A. only the partnership debts that he or she personally created. B. his or her proportionate share of all partnership debts regardless of which partner incurred that debt. C. the total debts of the partnership, even if he or she was unaware of those debts. D. the debts of the partnership up to the amount he or she invested in the firm. E. all personal and partnership debts incurred by any partner, even if he or she was unaware of those debts. 59. Which one of the following is an advantage of being a limited partner? A. Non-taxable share of any profits B. Control over the daily operations of the firm C. Losses limited to capital invested D. Unlimited profits without risk of incurring a loss E. Active market for ownership interest 60. Which one of the following statements about a limited partnership is correct? A. All partners have their losses limited to their capital investment in the partnership. B. All partners are treated equally. C. There must be at least one general partner. D. Equity financing is easy to obtain and unlimited. E. Any partner can transfer his or her ownership interest without ending the partnership.

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 01 Testbank

Chapter 01 Testbank Key 1. The primary market refers to: A. the original sale of securities by the issuer. B. transactions between two institutional shareholders. C. the sale of securities by an individual shareholder. D. the first trade of a firm's securities when the financial markets open in the morning. Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 1.03 Compare the financial implications of the different forms of business organisation Topic: Financial markets and the corporation

2. The most important function of a financial market is: A. to facilitate the flow of funds between lenders and borrowers. B. to provide a market for shares. C. to provide information about an issuing company's financial situation. D. to secure profits for brokers and agents. Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Hard Learning Objective: 1.03 Compare the financial implications of the different forms of business organisation Topic: Financial markets and the corporation

3. A primary financial market is one that: A. involves the sale of existing securities. B. offers securities with the highest expected return. C. offers the greatest choice of shares and debentures. D. involves the sale of securities for the first time. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 1.03 Compare the financial implications of the different forms of business organisation Topic: Financial markets and the corporation

4. Secondary markets: A. allow borrowers to raise long-term funds. B. facilitate capital-raising in the primary market. C. allow borrowers to raise short-term funds. D. all of the answers options are correct.

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 01 Testbank

Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Hard Learning Objective: 1.03 Compare the financial implications of the different forms of business organisation Topic: Financial markets and the corporation

5. A corporation: A. can neither sue another party nor be sued. B. may not own property. C. may enter into contracts to borrow funds. D. can issue its own shares but cannot purchase shares in another entity. Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 1.03 Compare the financial implications of the different forms of business organisation Topic: Forms of business organisation

6. The amount of debt and equity used by a firm to finance its operations is called the firm's: A. debt ratio. B. working capital ratio. C. capital structure. D. financial position. Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 1.01 Discuss the basic types of financial management decisions and the role of the financial manager Topic: Business finance and the financial manager

7. Short-term assets and short-term liabilities are referred to as the firm's: A. cash flow. B. capital budget. C. capital structure. D. working capital. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 1.01 Discuss the basic types of financial management decisions and the role of the financial manager Topic: Business finance and the financial manager

8. The management of a firm's cash, inventory and payables is referred to as: A. cash-flow forecasting. B. asset management.

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 01 Testbank

C. capital management. D. working capital management. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 1.01 Discuss the basic types of financial management decisions and the role of the financial manager Topic: Business finance and the financial manager

9. A business organisation that is similar to a sole proprietorship but has two or more owners is called a: A. limited liability company. B. corporation. C. dual company. D. partnership. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 1.03 Compare the financial implications of the different forms of business organisation Topic: Forms of business organisation

10. The legal papers which designate a firm's name, nature of business and intended life are called the: A. corporate by-laws. B. charter or constitution. C. partnership agreement. D. joint share company forms. Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 1.03 Compare the financial implications of the different forms of business organisation Topic: Forms of business organisation

11. Any situation where a conflict may arise between the firm's owners and its managers is referred to as a(n): A. organisational problem. B. personnel conflict. C. agency problem. D. control issue. Ans: C AACSB: Ethics Blooms: Comprehension Difficulty: Easy Learning Objective: 1.04 Describe the conflicts of interest that can arise between managers and owners Topic: The agency problem and control of the corporation

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 01 Testbank

12. A negotiated sale of securities by an issuer to a specific buyer is called a(n): A. public offering. B. secondary placement. C. independent placement. D. private placement. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 1.03 Compare the financial implications of the different forms of business organisation Topic: Financial markets and the corporation

13. Over-the-counter markets are __________ markets. A. dealer B. franchise C. private D. auction Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 1.03 Compare the financial implications of the different forms of business organisation Topic: Financial markets and the corporation

14. A securities market with a physical location that is designed to match buyers with sellers is called a(n) ________ market: A. dealer B. private C. auction D. franchise Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 1.03 Compare the financial implications of the different forms of business organisation Topic: Financial markets and the corporation

15. Which one of the following statements is related to capital budgeting? A. A firm should monitor the ratio of debt to equity financing that it uses. B. A firm should monitor the amount of its current assets as compared to its current liabilities. C. A firm should consider the size, risk and timing of an asset's cash flows before deciding to purchase that asset. D. A firm should consider various types of loans offered by various lenders before taking out a loan. Ans: C

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 01 Testbank

AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 1.01 Discuss the basic types of financial management decisions and the role of the financial manager Topic: Business finance and the financial manager

16. Working capital management includes which of the following? I. Controlling the inventory level II. Determining when to pay suppliers III. Deciding how much non-current debt to assume IV. Controlling the amount of cash that is readily available A. I and II only B. I and IV only C. II and III only D. I, II and IV only Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 1.01 Discuss the basic types of financial management decisions and the role of the financial manager Topic: Business finance and the financial manager

17. Who of the following are the actual owners of firms? A. All the shareholders. B. The bondholders. C. The largest shareholders. D. The senior management team. Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 1.04 Describe the conflicts of interest that can arise between managers and owners Topic: The agency problem and control of the corporation

18. Will and Bill both enjoy sunshine, water and surfboards. Thus, the two friends decided to create a business together in Sydney renting surfboards, paddle boats and inflatable devices. Will and Bill will equally share in the decision making and in the profits or losses. Which type of business did they create if they both have full personal liability for the firm's debts? A. Sole proprietorship B. Limited partnership C. Joint share company D. General partnership Ans: D

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 01 Testbank

AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 1.03 Compare the financial implications of the different forms of business organisation Topic: Forms of business organisation

19. Which one of the following best matches the primary goal of financial management? A. Increasing the dollar amount of each sale B. Increasing traffic flow within the firm's stores C. Transforming fixed costs into variable costs D. Increasing the market value of the firm Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 1.02 Identify the goal of financial management Topic: The goal of financial management

20. What is the goal of financial management for a sole proprietorship? A. Maximise profit for the period given the current resources of the firm B. Decrease non-current debt to reduce the risk to the owner C. Minimise the tax impact on the proprietor D. Maximise the market value of the equity Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 1.02 Identify the goal of financial management Topic: The goal of financial management

21. Which one of the following is most likely to create a situation where an agency conflict could arise? A. Increasing the size of a firm's operations B. Downsizing a firm C. Separating management from ownership D. Decreasing employee turnover Ans: C AACSB: Ethics Blooms: Comprehension Difficulty: Easy Learning Objective: 1.04 Describe the conflicts of interest that can arise between managers and owners Topic: The agency problem and control of the corporation

22. Large Australian company stocks such as BHP and Telstra: A. can only trade on the ASX. B. can trade on the stock exchange of their choosing as long as they qualify for listing.

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 01 Testbank

C. trade only in dealer markets. D. are sold to investors as private placement and are held to maturity. Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Hard Learning Objective: 1.03 Compare the financial implications of the different forms of business organisation Topic: Financial markets and the corporation

23. Which of the following are effective means of aligning management goals with shareholder interests? I. Employee share options II. Threat of a takeover III. Management bonuses tied to performance goals IV. Threat of a proxy fight A. I and III only B. II and IV only C. I, II and III only D. I, II, III and IV Ans: D AACSB: Ethics Blooms: Comprehension Difficulty: Medium Learning Objective: 1.04 Describe the conflicts of interest that can arise between managers and owners Topic: The agency problem and control of the corporation

24. Which of the following is an example of the agency problem? A. Managers always invest in projects that have appropriate returns and that will increase shareholder wealth. B. Managers resign when they believe they have not always acted in the best interests of shareholders. C. Managers conduct an acquisition program purely to increase the size of an organisation. D. Managers look for new projects as they want to avoid business risk. Ans: C AACSB: Ethics Blooms: Comprehension Difficulty: Medium Learning Objective: 1.04 Describe the conflicts of interest that can arise between managers and owners Topic: The agency problem and control of the corporation

25. Which one of the following situations is most likely to create an agency conflict? A. Compensating a manager based on his or her division's profit for the period B. Giving all employees a bonus if a certain level of efficiency is maintained C. Hiring an independent consultant to study the operating efficiency of the firm D. Rejecting a profitable project to protect employee jobs Ans: D

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 01 Testbank

AACSB: Ethics Blooms: Comprehension Difficulty: Medium Learning Objective: 1.04 Describe the conflicts of interest that can arise between managers and owners Topic: The agency problem and control of the corporation

26. The potential conflict of interest between a firm's owners and its managers is referred to as which type of conflict? A. Organisational B. Structural C. Formation D. Agency Ans: D AACSB: Ethics Blooms: Comprehension Difficulty: Easy Learning Objective: 1.04 Describe the conflicts of interest that can arise between managers and owners Topic: The agency problem and control of the corporation

27. The goal of a financial manager should be: A. to maximise next year's profit. B. to minimise next year's cost. C. to maximise the value of the existing equity. D. to take no risks with shareholders' investments. Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 1.02 Identify the goal of financial management Topic: The goal of financial management

28. Tim works for a large manufacturing company and is now in charge of all fixed asset purchases. In other words, Tim is in charge of: A. capital structure management. B. asset allocation. C. risk management. D. capital budgeting. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 1.01 Discuss the basic types of financial management decisions and the role of the financial manager Topic: Business finance and the financial manager

29. The Australian government has a tax claim on the cash flows of a corporation. This claim is defined as a claim by one of the firm's:

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 01 Testbank

A. residual owners. B. shareholders. C. financiers. D. stakeholders. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 1.04 Describe the conflicts of interest that can arise between managers and owners Topic: The agency problem and control of the corporation

30. Which one of the following correctly defines a common chain of command within a corporation? A. The chief accountant reports directly to the corporate treasurer. B. The treasurer reports directly to the board of directors. C. The chief financial officer reports directly to the board of directors. D. The accountant reports directly to the chief financial officer. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 1.01 Discuss the basic types of financial management decisions and the role of the financial manager Topic: Business finance and the financial manager

31. Uptown Markets is financed with 45 per cent debt and 55 per cent equity. This mixture of debt and equity is referred to as the firm's: A. capital structure. B. capital budget. C. asset allocation. D. working capital. E. risk structure. Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 1.01 Discuss the basic types of financial management decisions and the role of the financial manager Topic: Business finance and the financial manager

32. Theo’s BBQ has $48 000 in current assets and $39 000 in current liabilities. Decisions related to these accounts are referred to as: A. capital structure decisions. B. capital budgeting decisions. C. working capital management. D. operating management. E. fixed account structure. Ans: C

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 01 Testbank

AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 1.01 Discuss the basic types of financial management decisions and the role of the financial manager Topic: Business finance and the financial manager

33. Margie opened a used bookstore and is both the 100 per cent owner and the store's manager. Which type of business entity does Margie own if she is personally liable for all the store's debts? A. Sole proprietorship B. Limited partnership C. Corporation D. Joint share company E. General partnership Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 1.03 Compare the financial implications of the different forms of business organisation Topic: Forms of business organisation

34. One advantage of the corporate form of organisation is the: A. taxation of the corporate profits. B. unlimited liability for its shareholders. C. double taxation of profits. D. ownership can be transferred more quickly and easily. E. ease of formation compared to other organisational forms. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 1.03 Compare the financial implications of the different forms of business organisation Topic: Forms of business organisation

35. Matt and Alicia created a firm that is a separate legal entity and will share ownership of that firm on a 75/25 basis. Which type of entity did they create if they have no personal liability for the firm's debts? A. Limited partnership B. Corporation C. Sole proprietorship D. General partnership E. Public company Ans: B

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 01 Testbank

AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 1.03 Compare the financial implications of the different forms of business organisation Topic: Forms of business organisation

36. An employee has a claim on the cash flows of Martin’s Machines. This claim is defined as a claim by one of the firm's: A. residual owners. B. shareholders. C. financiers. D. provisional partners. E. stakeholders. Ans: E AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 1.04 Describe the conflicts of interest that can arise between managers and owners Topic: The agency problem and control of the corporation

37. The shareholders of Weil’s Markets would benefit if the firm were to be acquired by Better Foods. However, Weil’s board of directors rejects the acquisition offer. This is an example of: A. a corporate takeover. B. a capital structure issue. C. a working capital decision. D. an agency conflict. E. a compensation issue. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 1.04 Describe the conflicts of interest that can arise between managers and owners Topic: The agency problem and control of the corporation

38. Jamie is employed as a currency trader in the Japanese yen market. Her job falls into which one of the following areas of finance? A. International finance B. Financial institutions C. Corporate finance D. Capital management E. Personal finance Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 1.01 Discuss the basic types of financial management decisions and the role of the financial manager Topic: Finance: A quick look

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39. If you accept a job as a domestic security analyst for a brokerage firm, you are most likely working in which one of the following financial areas? A. International finance B. Private placements C. Corporate finance D. Capital management E. Investments Ans: E AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 1.01 Discuss the basic types of financial management decisions and the role of the financial manager Topic: Finance: A quick look

40. Which one of the following occupations best fits into the corporate area of finance? A. Mortgage broker B. Treasury bill analyst C. Chief financial officer D. Insurance risk manager E. Local bank manager Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 1.01 Discuss the basic types of financial management decisions and the role of the financial manager Topic: Finance: A quick look

41. Which one of the following functions should be assigned to the corporate treasurer rather than to the controller? A. Data processing B. Cost accounting C. Tax management D. Cash management E. Financial accounting Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 1.01 Discuss the basic types of financial management decisions and the role of the financial manager Topic: Business finance and the financial manager

42. Which one of the following is a working capital decision? A. How should the firm raise additional capital to fund its expansion? B. What debt-equity ratio is best suited to the firm? C. What is the cost of debt financing?

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D. Should the firm borrow money for five or for 10 years? E. How much cash should the firm keep in reserve? Ans: E AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 1.01 Discuss the basic types of financial management decisions and the role of the financial manager Topic: Business finance and the financial manager

43. A sole proprietorship: A. provides limited financial liability for its owner. B. involves significant legal costs during the formation process. C. has an unlimited life. D. has its profits taxed as personal income. E. can generally raise significant capital from non-owner sources. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 1.03 Compare the financial implications of the different forms of business organisation Topic: Forms of business organisation

44. Which one of the following forms of business organisation offers liability protection to some of its owners but not to all of its owners? A. Sole proprietorship B. General partnership C. Limited partnership D. Limited liability company E. Corporation Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 1.03 Compare the financial implications of the different forms of business organisation Topic: Forms of business organisation

45. Maria is the sole proprietor of an antique store that is located in a rented warehouse. The store has an outstanding loan with the local bank but no other debt obligations. There are no specific assets pledged as security for the loan. Due to a sudden and unexpected downturn in the economy, the store is unable to generate sufficient funds to pay the loan payments due to the bank. Which of the following options does the bank have to collect the money it is owed? I. Sell the inventory and apply the proceeds to the debt II. Sell the lighting fixtures from the building and apply the proceeds to the debt III. Withdraw funds from Maria’s personal account at the bank to pay the store’s debt IV. Sell any assets Maria personally owns and apply the proceeds to the store’s debt A. I only

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B. III only C. I and II only D. I, II, and III only E. I, III, and IV only Ans: E AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 1.03 Compare the financial implications of the different forms of business organisation Topic: Forms of business organisation

46. Which one of the following statements correctly applies to a sole proprietorship? A. The business entity has an unlimited life. B. The ownership can easily be transferred to another individual. C. The owner enjoys limited liability for the firm's debts. D. Debt financing is easy to arrange in the firm's name. E. Obtaining additional equity is dependent on the owner's personal finances. Ans: E AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 1.03 Compare the financial implications of the different forms of business organisation Topic: Forms of business organisation

47. Which one of the following statements is correct? A. All secondary markets are dealer markets. B. All secondary markets are broker markets. C. All share trades between existing shareholders are primary market transactions. D. All share transactions are secondary market transactions. E. All over-the-counter sales occur in dealer markets. Ans: E AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 1.03 Compare the financial implications of the different forms of business organisation Topic: Financial markets and the corporation

48. The issuer of a security must be involved in all _____ transactions involving that security. A. exchange-listed B. secondary market C. over-the-counter D. dealer market E. primary market Ans: E

Ross, Essentials of Corporate Finance, Fifth Edition

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AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 1.03 Compare the financial implications of the different forms of business organisation Topic: Financial markets and the corporation

49. Which one of the following is most apt to align management's priorities with shareholders' interests? A. Holding corporate and shareholder meetings at high-end resort-type locations preferred by managers B. Compensating managers with company shares that must be held for a minimum of three years C. Paying a special management bonus on every fifth year of employment D. Increasing the number of paid holidays that long-term employees are entitled to receive E. Allowing employees to retire early with full retirement benefits Ans: B AACSB: Ethics Blooms: Understand Difficulty: Medium Learning Objective: 1.04 Describe the conflicts of interest that can arise between managers and owners Topic: The agency problem and control of the corporation

50. Which one of the following is a capital structure decision? A. Determining the optimal inventory level B. Establishing the preferred debt-equity level C. Selecting new equipment to purchase D. Setting the terms of sale for credit sales E. Determining when suppliers should be paid Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 1.01 Discuss the basic types of financial management decisions and the role of the financial manager Topic: Business finance and the financial manager

51. Which one of the following situations is most apt to create an agency conflict? A. Compensating a manager based on his or her division's profit for the period B. Giving all employees a bonus if a certain level of efficiency is maintained C. Hiring an independent consultant to study the operating efficiency of the firm D. Basing management bonuses on the length of employment E. Laying off employees during a slack period Ans: D AACSB: Ethics Blooms: Understand Difficulty: Medium Learning Objective: 1.04 Describe the conflicts of interest that can arise between managers and owners Topic: The agency problem and control of the corporation

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52. An agency issue is most likely to develop when: A. a firm encounters a period of stagnant growth. B. a firm downsizes. C. the control of a firm is separated from the firm’s ownership. D. the firm’s owner is also its key manager. E. a firm is structured as a general partnership. Ans: C AACSB: Ethics Blooms: Remember Difficulty: Easy Learning Objective: 1.04 Describe the conflicts of interest that can arise between managers and owners Topic: The agency problem and control of the corporation

53. Probably the least effective means of aligning management goals with shareholder interests is: A. the potential for a proxy fight by an unhappy segment of shareholders. B. basing all management bonuses on performance goals. C. holding management salaries steady while increasing share option grants. D. the threat of a takeover of the firm. E. automatically increasing management salaries on an annual basis. Ans: E AACSB: Ethics Blooms: Understand Difficulty: Medium Learning Objective: 1.04 Describe the conflicts of interest that can arise between managers and owners Topic: The agency problem and control of the corporation

54. Levi had an unexpected surprise when he returned home this morning. He found that a chemical spill from a local manufacturer had spilled over onto his property. The potential claim that he has against this manufacturer is that of a(n): A. general creditor. B. debtholder. C. shareholder. D. stakeholder. E. agent. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 1.04 Describe the conflicts of interest that can arise between managers and owners Topic: The agency problem and control of the corporation

55. One example of a primary market transaction would be the: A. sale of 100 shares of share by Maria to her best friend. B. purchase by Theo of 5000 shares of share from his father. C. sale of 1000 shares of newly issued share by Alt Company to Miquel.

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D. sale by Terry of 50 000 shares of share to his brother. E. sale of 5000 shares of share owned by a corporate CEO to his son. Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 1.03 Compare the financial implications of the different forms of business organisation Topic: Financial markets and the corporation

56. You contacted your share broker this morning and placed an order to sell 300 shares of a share that trades on the ASX. This sale will occur in the: A. dealer market. B. over-the-counter market. C. secondary market. D. primary market. E. tertiary market. Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 1.03 Compare the financial implications of the different forms of business organisation Topic: Financial markets and the corporation

57. Which one of the following applies to a general partnership? A. The firm's operations must be controlled by a single partner. B. Any one of the partners can be held solely liable for all of the partnership's debt. C. The profits of the firm are taxed as a separate entity. D. Each partner's liability for the firm's debts is limited to each partner's investment in the firm. E. The profits of a general partnership are taxed the same as those of a corporation. Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 1.03 Compare the financial implications of the different forms of business organisation Topic: Forms of business organisation

58. In a general partnership, each partner is personally liable for: A. only the partnership debts that he or she personally created. B. his or her proportionate share of all partnership debts regardless of which partner incurred that debt. C. the total debts of the partnership, even if he or she was unaware of those debts. D. the debts of the partnership up to the amount he or she invested in the firm. E. all personal and partnership debts incurred by any partner, even if he or she was unaware of those debts. Ans: C

Ross, Essentials of Corporate Finance, Fifth Edition

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AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 1.03 Compare the financial implications of the different forms of business organisation Topic: Forms of business organisation

59. Which one of the following is an advantage of being a limited partner? A. Non-taxable share of any profits B. Control over the daily operations of the firm C. Losses limited to capital invested D. Unlimited profits without risk of incurring a loss E. Active market for ownership interest Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 1.03 Compare the financial implications of the different forms of business organisation Topic: Forms of business organisation

60. Which one of the following statements about a limited partnership is correct? A. All partners have their losses limited to their capital investment in the partnership. B. All partners are treated equally. C. There must be at least one general partner. D. Equity financing is easy to obtain and unlimited. E. Any partner can transfer his or her ownership interest without ending the partnership. Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 1.03 Compare the financial implications of the different forms of business organisation Topic: Forms of business organisation

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 01 Testbank

Chapter 01 Testbank Summary Category AACSB: Analytic AACSB: Ethics Blooms: Analysis Blooms: Comprehension Blooms: Remember Blooms: Understand Difficulty: Easy Difficulty: Hard Difficulty: Medium Learning Objective: 1.01 Discuss the basic types of financial management decisions and the role of the financial manager Learning Objective: 1.02 Identify the goal of financial management Learning Objective: 1.03 Compare the financial implications of the different forms of business organisation Learning Objective: 1.04 Describe the conflicts of interest that can arise between managers and owners Topic: Business finance and the financial manager Topic: Finance: A quick look Topic: Financial markets and the corporation Topic: Forms of business organisation Topic: The agency problem and control of the corporation Topic: The goal of financial management

# of Questions 50 10 50 6 1 3 40 3 17 15 3 27 15 12 3 12 15 15 3

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Chapter 02 Testbank 1. The Whitehorse Bookshop Company has non-current assets with a book value of $8000 dollars and an appraised market value of $15 000. Net working capital is $5000 on the books, but if liquidated about $7000 would be realised. The company has recently issued 100 long-term maturity debentures with a face value of $100 each. Current market price of one debenture is equal to $100. What is the book value of the equity? A. $3000 B. $5000 C. $12 000 D. $13 000 2. Pollack Ltd had 10 million shares outstanding at the end of 2015. The company's earnings before interest and tax, at the end of 2015, were $50 million. The company had to pay interest of $15 million and corporate tax of $7 million (20% corporate tax rate). What was EPS (earnings per share) of the company at the end of the year 2015? A. $5 B. $4.50 C. $1.18 D. $2.80 3. Westerman Inc. started the financial year 2015 with $1968 in current assets and $1348 in current liabilities. The corresponding ending figures were $1992 and $1350. What was the change in net working capital during the year 2015? A. $22 B. $24 C. $2 D. $28 4. Cash flow to creditors (debtholders) is defined as: A. dividends paid out less net new equity raised. B. net profit after tax less retained earnings. C. interest paid less net new borrowings. D. interest paid plus net new borrowings. 5. A current asset is defined as an asset that: A. was purchased after the last financial statement date. B. was purchased within the past 12 months. C. normally converts to cash within one year. D. was manufactured within the past year and has yet to be sold.

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6. A fixed asset by definition: A. has a relatively long life. B. has a life of one year or more and is a tangible asset. C. includes both highly liquid assets and intangible assets. D. is equal to total assets minus net working capital. 7. A tangible asset: A. is defined as any asset which adds value to a firm. B. by definition includes both equipment and patents. C. is another term for a fixed asset. D. is a fixed asset with a physical existence. 8. An intangible asset is: A. a valuable fixed asset that has no physical existence. B. a physical fixed asset that loses value over time, such as equipment. C. a fully-depreciated fixed asset which has no remaining market value. D. a current asset with a negligible book value but considerable market value. 9. Liquidity is best defined as: A. the ability to access the cash balances of a firm on a daily basis. B. the option of a firm to sell its inventory at a greatly reduced price. C. the ability of a firm to sell its non-current assets quickly by greatly reducing the price. D. the ease and speed with which an asset can be converted to cash. 10. An statement of profit or loss is a financial statement that: A. reflects a firm's performance over a period of time. B. reports revenues and expenses at the time they affect the cash flows of a firm. C. reveals the current net worth of a firm based on depreciation-adjusted historical cost. D. is based on the cash flows related to the normal daily operations of a firm. 11. Earnings per share represent: A. the gross revenues of a firm divided by the number of outstanding shares. B. the net cash flow available per share. C. the amount of profit for the year (or period) attributable to each share. D. the current book value of a firm on a per share basis. 12. The cash generated from a firm's day-to-day activities is referred to as: A. the cash flow from assets. B. the net working capital. C. the marginal cash flow.

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D. the operating cash flow. 13. Which one of the following terms is defined as the total tax paid divided by the total profit before tax? A. Average tax rate B. Variable tax rate C. Marginal tax rate D. Absolute tax rate 14. Which one of the following is the tax rate that applies to the next dollar of profit before tax that a firm earns? A. Average tax rate B. Variable tax rate C. Marginal tax rate D. Absolute tax rate 15. Cash flow from assets is defined as: A. the cash flow to shareholders minus the cash flow to creditors. B. operating cash flow plus the cash flow to creditors plus the cash flow to shareholders. C. operating cash flow minus the change in net working capital minus net capital spending. D. operating cash flow plus net capital spending plus the change in net working capital. 16. Operating cash flow is defined as: A. a firm's net profit over a specified period of time. B. the cash that a firm generates from its day-to-day activities. C. a firm's operating margin. D. the change in net working capital over a stated period of time. 17. Caldweiler & Co. owes a total of $21 684 in taxes for this year. The profit before tax is $71 509. If the firm earns $100 more in income, it will owe an additional $36 in taxes. What is the average tax rate on income of $71 609? A. 28.00% B. 30.33% C. 33.33% D. 34.00% 18. Paddle Fans & More has a marginal tax rate of 34% and an average tax rate of 23.7%. If the firm earns $138 500 in profit before tax, how much will it owe in taxes? A. $31 366.67 B. $31 500.00 C. $32 824.50

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D. $39 957.25 19. Jones Brothers Farm Equipment owes $48 329 in tax on profit before tax of $549 600. The company has determined that it will owe $56 211 in tax if its profit before tax rises to $575 000. What is the marginal tax rate at this level of income? A. 29.08% B. 30.00% C. 30.67% D. 31.03% 20. Use the following tax table to answer this question: Profit before tax $0 - 50 000 50 001 - 75 000 75 001 - 100 000 100 001 - 335 000 335 001 - 10 000 000

Tax rate 15% 25% 34% 39% 34%

Bait and Tackle has profit before tax of $411 562. How much does it owe in taxes? A. $128 603.33 B. $134 611.27 C. $138 542.79 D. $139 931.08 21. The dividend imputation system in Australia and New Zealand ensures that: A. both company profits and dividends received by shareholders are always taxed at the average rate. B. company profits and dividends received by shareholders are taxed at the same rate. C. if a company pays a dividend out of after-tax profits, domestic shareholders who receive this dividend receive a tax credit. D. Australian resident shareholders do not pay tax on dividends received. 22. Delivery trucks are classified as: A. non-cash expenses. B. current liabilities. C. current assets. D. tangible non-current assets. 23. The statement of financial position of a firm shows beginning Property, plant and equipment non-current assets of $348 200 and ending Property, plant and equipment non-current assets of

Ross, Essentials of Corporate Finance, Fifth Edition

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$371 920. The depreciation expense for the year is $46 080 and the interest expense is $11 460. What is the amount of net capital spending? A. –$22 360 B. –$4780 C. $23 720 D. $69 800 24. Non-cash items refers to: A. the credit sales of a firm. B. prepaid expenses of a firm. C. accounts payable of a firm. D. expenses charged against revenues that do not directly affect the cash flow. 25. Which of the following is not treated as a component of cash flow from assets? A. Operating cash flow B. Interest expense C. Depreciation expense D. Both interest expense and depreciation expense 26. Profit is often expressed on a per share basis and called: A. price to earnings ratio. B. earnings per share. C. retained earnings per share. D. dividends per share. 27. Which of the following would most likely be a short run cost? A. Period cost B. Product cost C. Variable cost D. Historical cost 28. In ________ a system was introduced in Australia whereby shareholders may be allowed a credit for the tax paid by the company. A. 1983 B. 1984 C. 1987 D. 1986 29. Which of the following does not appear in the statement of financial position? A. Good management B. Talented employees

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C. Good reputation D. Profit for the year (or period) 30. Which one of the following is NOT a category of cash flows that is required to be shown on the statement of cash flows? A. Cash flows from operating activities B. Cash flows from financing activities C. Cash flows from taxation D. Cash flows from investing activities 31. The accounting statement that measures the revenues, expenses and profit for the year (or period) of a firm over a period of time is called the: A. statement of cash flows. B. statement of profit or loss. C. GAAP statement. D. statement of financial position. E. net working capital schedule 32. Cash flow to shareholders is defined as: A. cash flow from assets plus cash flow to creditors. B. operating cash flow minus cash flow to creditors. C. dividends paid plus the change in retained earnings. D. dividends paid minus net new equity raised. E. profit for the year (or period) minus the addition to retained earnings. 33. Which one of the following is an intangible fixed asset? A. Inventory B. Machinery C. Copyright D. Account receivable E. Building 34. Over the past year, a firm decreased its current assets and increased its current liabilities. As a result, the firm's net working capital: A. had to increase. B. had to decrease. C. remained constant. D. could have either increased, decreased or remained constant. E. was unaffected as the changes occurred in the firm's current accounts. 35. Net working capital increases when:

Ross, Essentials of Corporate Finance, Fifth Edition

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A. non-current assets are purchased for cash. B. inventory is purchased on credit. C. inventory is sold at cost. D. a credit customer pays for his or her purchase. E. inventory is sold at a profit. 36. Shareholders’ equity is best defined as: A. the residual value of a firm. B. positive net working capital. C. the net liquidity of a firm. D. cash inflows minus cash outflows. E. the cumulative profits of a firm over time. 37. A firm’s liquidity level decreases when: A. inventory is purchased with cash. B. inventory is sold on credit. C. inventory is sold for cash. D. an account receivable is collected. E. proceeds from a non-current loan are received. 38. Profit for the year (or period) increases when: A. fixed costs increase. B. depreciation increases. C. the average tax rate increases. D. revenue increases. E. dividends cease. 39. Based on the recognition principle, revenue is recorded on the financial statements when which of the following is satisfied? I. Payment is collected for the sale of a good or service II. Earnings process is virtually complete III. Value of a sale can be reliably determined IV. Product is physically delivered to the buyer A. I and II only B. I and IV only C. II and III only D. II and IV only E. I and III only 40. Given a profitable firm, depreciation: A. increases profit for the year (or period). B. increases net non-current assets.

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C. decreases net working capital. D. lowers taxes. E. has no effect on profit for the year (or period). 41. The matching principle states that: A. costs should be recorded on the statement of profit or loss whenever those costs can be reliably determined. B. costs should be recorded when paid. C. the costs of producing an item should be recorded when the sale of that item is recorded as revenue. D. sales should be recorded when the payment for that sale is received. E. sales should be recorded when the earnings process is virtually completed and the value of the sale can be determined. 42. The concept of marginal taxation is best exemplified by which of the following? A. Kirby's paid $120 000 in taxes while its primary competitor paid only $80 000 in taxes. B. Johnson's Retreat paid only $45 000 on total revenue of $570 000 last year. C. Mitchell's Grocer increased its sales by $52 000 last year and had to pay an additional $16 000 in taxes. D. Burlington Centre paid no taxes last year due to carryforward losses. E. The Blue Moon paid $2.20 in taxes for every $10 of revenue last year. 43. A negative cash flow to shareholders indicates a firm: A. had a net loss for the year. B. had a positive cash flow to creditors. C. paid dividends that exceeded the amount of the net new equity. D. repurchased more shares than it sold. E. received more from selling shares than it paid out to shareholders. 44. If a firm has a negative cash flow from assets every year for several years, the firm: A. may be continually increasing in size. B. must also have a negative cash flow from operations each year. C. is operating at a high level of efficiency. D. is repaying debt every year. E. has annual net losses. 45. Net capital spending is equal to: A. ending net non-current assets minus beginning net non-current assets plus depreciation. B. beginning net non-current assets minus ending net non-current assets plus depreciation. C. ending net non-current assets minus beginning net non-current assets minus depreciation. D. ending total assets minus beginning total assets plus depreciation. E. ending total assets minus beginning total assets minus depreciation.

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46. What is the maximum average tax rate for corporations? A. 38% B. 25% C. 33% D. 39% E. 35% 47. Kahlan Opinion Surveys had beginning retained earnings of $24 600. During the year, the company reported sales of $105 700, costs of $78 300, depreciation of $9000, dividends of $1200 and interest paid of $635. The tax rate is 30%. What is the retained earnings balance at the end of the year? A. $38 835.50 B. $36 082.15 C. $36 121.44 D. $37 671.44 E. $35 721.45 48. AV Sales has net revenue of $513 000 and costs of $406 800. The depreciation expense is $43 800, interest paid is $11 200 and dividends for the year are $4500. The tax rate is 33%. What is the addition to retained earnings? A. $38 804 B. $34 304 C. $28 120 D. $29 804 E. $30 450 49. Neiger Flours owes $9741 in taxes on profit before tax of $61 509. If the firm earns $100 more in income, it will owe an additional $22 in taxes. What is the average tax rate on income of $61 609? A. 15.00% B. 30.33% C. 33.33% D. 35.00% E. 15.85% 50. Ezmerelda Jewellers has a marginal tax rate of 32% and an average tax rate of 20.9%. If the firm owes $34 330 in taxes, how much profit before tax did it earn? A. $127 584 B. $116 649 C. $164 625 D. $157 500 E. $168 500

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51. Victoria Photography, a sole proprietorship owes $190 874 in taxes on a profit before tax of $608 606. The company has determined that it will owe $195 246 in tax if its profit before tax rises to $620 424. What is the marginal tax rate at this level of income? A. 39% B. 38% C. 37% D. 35% E. 32% 52. Use the following tax table to answer this question: Profit before tax Tax rate $ 0 – 9525 10% 9525 – 38 700 12% 38 700 – 82 500 22% 82 500 – 157 500 24% 157 500 – 200 000 32%

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200 000 – 500 000 35% 500 000 + 37% Andrews Dried Fruit LLC has profit before tax of $630 000. How much does it owe in taxes? A. $141 750 B. $154 800 C. $198 790 D. $$220 500 E. $$233 100 53. Use the following tax table to answer this question: Profit before tax Tax rate $ 0 – 9525 10 % 9525 – 38 700 12 % 38 700 – 82 500 22 %

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82 500 – 157 500 24 % 157 500 – 200 000 32 % 200 000 – 500 000 35 % 500 000 + 37 % Stacey’s Fabrics, a sole proprietorship, earned $260 000 in profit before tax for the year. How much tax does the company owe? A. $96 220 B. $91 000 C. $66 690 D. $62 400 E. $57 200 54. The Pretzel Factory has revenue of $821 300 and costs of $698 500. The depreciation expense is $28 400 and the interest paid is $8400. What is the amount of the firm's operating cash flow if the tax rate is 34%? A. $87 620 B. $89 540 C. $91 220 D. $93 560 E. $95 240

Ross, Essentials of Corporate Finance, Fifth Edition

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55. Outdoor Sports paid $12 500 in dividends and $9310 in interest over the past year. Sales totalled $361 820 with costs of $267 940. The depreciation expense was $16 500 and the tax rate was35%. What was the amount of the operating cash flow? A. $64 232 B. $65 306 C. $57 556 D. $70 056 E. $70 568 56. A firm has earnings before interest and taxes of $27 130, profit for the year (or period) of $16 220 and taxes of $5450 for the year. While the firm paid out $31 600 to pay off existing debt, it then later borrowed $42 000. What is the amount of the cash flow to creditors? A. −$14 040 B. $0 C. −$4940 D. $14 040 E. $4660 57. The Carpentry Shop has sales of $398 600, costs of $254 800, depreciation expense of $26 400, interest expense of $1600 and a tax rate of 34%. What is the profit for the year (or period) for this firm? A. $61 930 B. $66 211 C. $67 516 D. $76 428 E. $83 219 58. Andersen's Nursery has sales of $318 400, costs of $199 400, depreciation expense of $28 600, interest expense of $1100 and a tax rate of 35%. The firm paid out $23 400 in dividends. What is the addition to retained earnings? A. $36 909 B. $34 645 C. $44 141 D. $37 208 E. $40 615 59. Roscoe's non-current assets were purchased three years ago for $1.8 million. These assets can be sold to Stewart's today for $1.2 million. Roscoe's current statement of financial position shows net non-current assets of $960 000, current liabilities of $348 000 and net working capital of $121 000. If all the current assets were liquidated today, the company would receive $518 000 cash. The book value of the firm's assets today is _____ and the market value is ____. A. $1 081 000; $1 308 000

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B. $1 081 000; $1 718 000 C. $1 307 000; $1 429 000 D. $1 429 000; $1 308 000 E. $1 429 000; $1 718 000 60. Kat Outfitting currently has $22 500 in cash. The company owes $49 500 to suppliers for merchandise and $52 500 to the bank for a non-current loan. Customers owe the company $41 000 for their purchases. The inventory has a book value of $76 800 and an estimated market value of $72 000. If the store compiled a statement of financial position as of today, what would be the book value of the current assets? A. $135 500 B. $79 500 C. $86 000 D. $140 300 E. $144 000

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 02 Testbank

Chapter 02 Testbank Key 1. The Whitehorse Bookshop Company has non-current assets with a book value of $8000 dollars and an appraised market value of $15 000. Net working capital is $5000 on the books, but if liquidated about $7000 would be realised. The company has recently issued 100 long-term maturity debentures with a face value of $100 each. Current market price of one debenture is equal to $100. What is the book value of the equity? A. $3000 B. $5000 C. $12 000 D. $13 000 Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 2.01 Differentiate between accounting value (or 'book' value) and market value Topic: The statement of financial position

2. Pollack Ltd had 10 million shares outstanding at the end of 2015. The company's earnings before interest and tax, at the end of 2015, were $50 million. The company had to pay interest of $15 million and corporate tax of $7 million (20% corporate tax rate). What was EPS (earnings per share) of the company at the end of the year 2015? A. $5 B. $4.50 C. $1.18 D. $2.80 Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 2.02 Distinguish between accounting income and cash flow Topic: The statement of profit or loss

3. Westerman Inc. started the financial year 2015 with $1968 in current assets and $1348 in current liabilities. The corresponding ending figures were $1992 and $1350. What was the change in net working capital during the year 2015? A. $22 B. $24 C. $2 D. $28 Ans: A

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 02 Testbank

AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 2.04 Determine a firm's cash flow from its financial statements Topic: Cash flow

4. Cash flow to creditors (debtholders) is defined as: A. dividends paid out less net new equity raised. B. net profit after tax less retained earnings. C. interest paid less net new borrowings. D. interest paid plus net new borrowings. Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 2.04 Determine a firm's cash flow from its financial statements Topic: Cash flow

5. A current asset is defined as an asset that: A. was purchased after the last financial statement date. B. was purchased within the past 12 months. C. normally converts to cash within one year. D. was manufactured within the past year and has yet to be sold. Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 2.01 Differentiate between accounting value (or 'book' value) and market value Topic: The statement of financial position

6. A fixed asset by definition: A. has a relatively long life. B. has a life of one year or more and is a tangible asset. C. includes both highly liquid assets and intangible assets. D. is equal to total assets minus net working capital. Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 2.01 Differentiate between accounting value (or 'book' value) and market value Topic: The statement of financial position

7. A tangible asset: A. is defined as any asset which adds value to a firm. B. by definition includes both equipment and patents. C. is another term for a fixed asset.

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 02 Testbank

D. is a fixed asset with a physical existence. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 2.01 Differentiate between accounting value (or 'book' value) and market value Topic: The statement of financial position

8. An intangible asset is: A. a valuable fixed asset that has no physical existence. B. a physical fixed asset that loses value over time, such as equipment. C. a fully-depreciated fixed asset which has no remaining market value. D. a current asset with a negligible book value but considerable market value. Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 2.01 Differentiate between accounting value (or 'book' value) and market value Topic: The statement of financial position

9. Liquidity is best defined as: A. the ability to access the cash balances of a firm on a daily basis. B. the option of a firm to sell its inventory at a greatly reduced price. C. the ability of a firm to sell its non-current assets quickly by greatly reducing the price. D. the ease and speed with which an asset can be converted to cash. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 2.01 Differentiate between accounting value (or 'book' value) and market value Topic: The statement of financial position

10. An statement of profit or loss is a financial statement that: A. reflects a firm's performance over a period of time. B. reports revenues and expenses at the time they affect the cash flows of a firm. C. reveals the current net worth of a firm based on depreciation-adjusted historical cost. D. is based on the cash flows related to the normal daily operations of a firm. Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 2.02 Distinguish between accounting income and cash flow Topic: The statement of profit or loss

11. Earnings per share represent: A. the gross revenues of a firm divided by the number of outstanding shares.

Ross, Essentials of Corporate Finance, Fifth Edition

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B. the net cash flow available per share. C. the amount of profit for the year (or period) attributable to each share. D. the current book value of a firm on a per share basis. Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 2.02 Distinguish between accounting income and cash flow Topic: The statement of profit or loss

12. The cash generated from a firm's day-to-day activities is referred to as: A. the cash flow from assets. B. the net working capital. C. the marginal cash flow. D. the operating cash flow. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 2.04 Determine a firm's cash flow from its financial statements Topic: Cash flow

13. Which one of the following terms is defined as the total tax paid divided by the total profit before tax? A. Average tax rate B. Variable tax rate C. Marginal tax rate D. Absolute tax rate Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 2.03 Explain the difference between average and marginal tax rates Topic: Taxes

14. Which one of the following is the tax rate that applies to the next dollar of profit before tax that a firm earns? A. Average tax rate B. Variable tax rate C. Marginal tax rate D. Absolute tax rate Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 2.03 Explain the difference between average and marginal tax rates Topic: Taxes

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 02 Testbank

15. Cash flow from assets is defined as: A. the cash flow to shareholders minus the cash flow to creditors. B. operating cash flow plus the cash flow to creditors plus the cash flow to shareholders. C. operating cash flow minus the change in net working capital minus net capital spending. D. operating cash flow plus net capital spending plus the change in net working capital. Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 2.04 Determine a firm's cash flow from its financial statements Topic: Cash flow

16. Operating cash flow is defined as: A. a firm's net profit over a specified period of time. B. the cash that a firm generates from its day-to-day activities. C. a firm's operating margin. D. the change in net working capital over a stated period of time. Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 2.04 Determine a firm's cash flow from its financial statements Topic: Cash flow

17. Caldweiler & Co. owes a total of $21 684 in taxes for this year. The profit before tax is $71 509. If the firm earns $100 more in income, it will owe an additional $36 in taxes. What is the average tax rate on income of $71 609? A. 28.00% B. 30.33% C. 33.33% D. 34.00% Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 2.03 Explain the difference between average and marginal tax rates Topic: Taxes

18. Paddle Fans & More has a marginal tax rate of 34% and an average tax rate of 23.7%. If the firm earns $138 500 in profit before tax, how much will it owe in taxes? A. $31 366.67 B. $31 500.00 C. $32 824.50 D. $39 957.25 Ans: C

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 02 Testbank

AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 2.03 Explain the difference between average and marginal tax rates Topic: Taxes

19. Jones Brothers Farm Equipment owes $48 329 in tax on profit before tax of $549 600. The company has determined that it will owe $56 211 in tax if its profit before tax rises to $575 000. What is the marginal tax rate at this level of income? A. 29.08% B. 30.00% C. 30.67% D. 31.03% Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 2.03 Explain the difference between average and marginal tax rates Topic: Taxes

20. Use the following tax table to answer this question: Profit before tax $0 - 50 000 50 001 - 75 000 75 001 - 100 000 100 001 - 335 000 335 001 - 10 000 000

Tax rate 15% 25% 34% 39% 34%

Bait and Tackle has profit before tax of $411 562. How much does it owe in taxes? A. $128 603.33 B. $134 611.27 C. $138 542.79 D. $139 931.08 Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 2.03 Explain the difference between average and marginal tax rates Topic: Taxes

21. The dividend imputation system in Australia and New Zealand ensures that: A. both company profits and dividends received by shareholders are always taxed at the average rate. B. company profits and dividends received by shareholders are taxed at the same rate.

Ross, Essentials of Corporate Finance, Fifth Edition

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C. if a company pays a dividend out of after-tax profits, domestic shareholders who receive this dividend receive a tax credit. D. Australian resident shareholders do not pay tax on dividends received. Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 2.03 Explain the difference between average and marginal tax rates Topic: Taxes

22. Delivery trucks are classified as: A. non-cash expenses. B. current liabilities. C. current assets. D. tangible non-current assets. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 2.01 Differentiate between accounting value (or 'book' value) and market value Topic: The statement of financial position

23. The statement of financial position of a firm shows beginning Property, plant and equipment non-current assets of $348 200 and ending Property, plant and equipment non-current assets of $371 920. The depreciation expense for the year is $46 080 and the interest expense is $11 460. What is the amount of net capital spending? A. –$22 360 B. –$4780 C. $23 720 D. $69 800 Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 2.04 Determine a firm's cash flow from its financial statements Topic: Cash flow

24. Non-cash items refers to: A. the credit sales of a firm. B. prepaid expenses of a firm. C. accounts payable of a firm. D. expenses charged against revenues that do not directly affect the cash flow. Ans: D

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 02 Testbank

AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 2.02 Distinguish between accounting income and cash flow Topic: The statement of profit or loss

25. Which of the following is not treated as a component of cash flow from assets? A. Operating cash flow B. Interest expense C. Depreciation expense D. Both interest expense and depreciation expense Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 2.04 Determine a firm's cash flow from its financial statements Topic: Cash flow

26. Profit is often expressed on a per share basis and called: A. price to earnings ratio. B. earnings per share. C. retained earnings per share. D. dividends per share. Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 2.02 Distinguish between accounting income and cash flow Topic: The statement of profit or loss

27. Which of the following would most likely be a short run cost? A. Period cost B. Product cost C. Variable cost D. Historical cost Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 2.02 Distinguish between accounting income and cash flow Topic: The statement of profit or loss

28. In ________ a system was introduced in Australia whereby shareholders may be allowed a credit for the tax paid by the company. A. 1983 B. 1984

Ross, Essentials of Corporate Finance, Fifth Edition

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C. 1987 D. 1986 Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 2.03 Explain the difference between average and marginal tax rates Topic: Taxes

29. Which of the following does not appear in the statement of financial position? A. Good management B. Talented employees C. Good reputation D. Profit for the year (or period) Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 2.01 Differentiate between accounting value (or 'book' value) and market value Topic: The statement of financial position

30. Which one of the following is NOT a category of cash flows that is required to be shown on the statement of cash flows? A. Cash flows from operating activities B. Cash flows from financing activities C. Cash flows from taxation D. Cash flows from investing activities Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 2.04 Determine a firm's cash flow from its financial statements Topic: Cash flow

31. The accounting statement that measures the revenues, expenses and profit for the year (or period) of a firm over a period of time is called the: A. statement of cash flows. B. statement of profit or loss. C. GAAP statement. D. statement of financial position. E. net working capital schedule Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 2.02 Distinguish between accounting income and cash flow Topic: The statement of profit or loss

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 02 Testbank

32. Cash flow to shareholders is defined as: A. cash flow from assets plus cash flow to creditors. B. operating cash flow minus cash flow to creditors. C. dividends paid plus the change in retained earnings. D. dividends paid minus net new equity raised. E. profit for the year (or period) minus the addition to retained earnings. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 2.04 Determine a firm's cash flow from its financial statements Topic: Cash flow

33. Which one of the following is an intangible fixed asset? A. Inventory B. Machinery C. Copyright D. Account receivable E. Building Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 2.01 Differentiate between accounting value (or 'book' value) and market value Topic: The statement of financial position

34. Over the past year, a firm decreased its current assets and increased its current liabilities. As a result, the firm's net working capital: A. had to increase. B. had to decrease. C. remained constant. D. could have either increased, decreased or remained constant. E. was unaffected as the changes occurred in the firm's current accounts. Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 2.01 Differentiate between accounting value (or 'book' value) and market value Topic: The statement of financial position

35. Net working capital increases when: A. non-current assets are purchased for cash. B. inventory is purchased on credit. C. inventory is sold at cost. D. a credit customer pays for his or her purchase.

Ross, Essentials of Corporate Finance, Fifth Edition

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E. inventory is sold at a profit. Ans: E AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 2.01 Differentiate between accounting value (or 'book' value) and market value Topic: The statement of financial position

36. Shareholders’ equity is best defined as: A. the residual value of a firm. B. positive net working capital. C. the net liquidity of a firm. D. cash inflows minus cash outflows. E. the cumulative profits of a firm over time. Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 2.01 Differentiate between accounting value (or 'book' value) and market value Topic: The statement of financial position

37. A firm’s liquidity level decreases when: A. inventory is purchased with cash. B. inventory is sold on credit. C. inventory is sold for cash. D. an account receivable is collected. E. proceeds from a non-current loan are received. Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 2.01 Differentiate between accounting value (or 'book' value) and market value Topic: The statement of financial position

38. Profit for the year (or period) increases when: A. fixed costs increase. B. depreciation increases. C. the average tax rate increases. D. revenue increases. E. dividends cease. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 2.02 Distinguish between accounting income and cash flow Topic: The statement of profit or loss

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 02 Testbank

39. Based on the recognition principle, revenue is recorded on the financial statements when which of the following is satisfied? I. Payment is collected for the sale of a good or service II. Earnings process is virtually complete III. Value of a sale can be reliably determined IV. Product is physically delivered to the buyer A. I and II only B. I and IV only C. II and III only D. II and IV only E. I and III only Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 2.02 Distinguish between accounting income and cash flow Topic: The statement of profit or loss

40. Given a profitable firm, depreciation: A. increases profit for the year (or period). B. increases net non-current assets. C. decreases net working capital. D. lowers taxes. E. has no effect on profit for the year (or period). Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 2.02 Distinguish between accounting income and cash flow Topic: The statement of profit or loss

41. The matching principle states that: A. costs should be recorded on the statement of profit or loss whenever those costs can be reliably determined. B. costs should be recorded when paid. C. the costs of producing an item should be recorded when the sale of that item is recorded as revenue. D. sales should be recorded when the payment for that sale is received. E. sales should be recorded when the earnings process is virtually completed and the value of the sale can be determined. Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 2.02 Distinguish between accounting income and cash flow Topic: The statement of profit or loss

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 02 Testbank

42. The concept of marginal taxation is best exemplified by which of the following? A. Kirby's paid $120 000 in taxes while its primary competitor paid only $80 000 in taxes. B. Johnson's Retreat paid only $45 000 on total revenue of $570 000 last year. C. Mitchell's Grocer increased its sales by $52 000 last year and had to pay an additional $16 000 in taxes. D. Burlington Centre paid no taxes last year due to carryforward losses. E. The Blue Moon paid $2.20 in taxes for every $10 of revenue last year. Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 2.03 Explain the difference between average and marginal tax rates Topic: Taxes

43. A negative cash flow to shareholders indicates a firm: A. had a net loss for the year. B. had a positive cash flow to creditors. C. paid dividends that exceeded the amount of the net new equity. D. repurchased more shares than it sold. E. received more from selling shares than it paid out to shareholders. Ans: E AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 2.04 Determine a firm's cash flow from its financial statements Topic: Cash flow

44. If a firm has a negative cash flow from assets every year for several years, the firm: A. may be continually increasing in size. B. must also have a negative cash flow from operations each year. C. is operating at a high level of efficiency. D. is repaying debt every year. E. has annual net losses. Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 2.04 Determine a firm's cash flow from its financial statements Topic: Cash flow

45. Net capital spending is equal to: A. ending net non-current assets minus beginning net non-current assets plus depreciation. B. beginning net non-current assets minus ending net non-current assets plus depreciation. C. ending net non-current assets minus beginning net non-current assets minus depreciation. D. ending total assets minus beginning total assets plus depreciation. E. ending total assets minus beginning total assets minus depreciation.

Ross, Essentials of Corporate Finance, Fifth Edition

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Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 2.04 Determine a firm's cash flow from its financial statements Topic: Cash flow

46. What is the maximum average tax rate for corporations? A. 38% B. 25% C. 33% D. 39% E. 35% Ans: E AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 2.03 Explain the difference between average and marginal tax rates Topic: Taxes

47. Kahlan Opinion Surveys had beginning retained earnings of $24 600. During the year, the company reported sales of $105 700, costs of $78 300, depreciation of $9000, dividends of $1200 and interest paid of $635. The tax rate is 30%. What is the retained earnings balance at the end of the year? A. $38 835.50 B. $36 082.15 C. $36 121.44 D. $37 671.44 E. $35 721.45 Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Hard Learning Objective: 2.02 Distinguish between accounting income and cash flow Topic: The statement of profit or loss

48. AV Sales has net revenue of $513 000 and costs of $406 800. The depreciation expense is $43 800, interest paid is $11 200 and dividends for the year are $4500. The tax rate is 33%. What is the addition to retained earnings? A. $38 804 B. $34 304 C. $28 120 D. $29 804 E. $30 450 Ans: D

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 02 Testbank

AACSB: Analytic Blooms: Analysis Difficulty: Hard Learning Objective: 2.02 Distinguish between accounting income and cash flow Topic: The statement of profit or loss

49. Neiger Flours owes $9741 in taxes on profit before tax of $61 509. If the firm earns $100 more in income, it will owe an additional $22 in taxes. What is the average tax rate on income of $61 609? A. 15.00% B. 30.33% C. 33.33% D. 35.00% E. 15.85% Ans: E AACSB: Analytic Blooms: Analysis Difficulty: Hard Learning Objective: 2.03 Explain the difference between average and marginal tax rates Topic: Taxes

50. Ezmerelda Jewellers has a marginal tax rate of 32% and an average tax rate of 20.9%. If the firm owes $34 330 in taxes, how much profit before tax did it earn? A. $127 584 B. $116 649 C. $164 625 D. $157 500 E. $168 500 Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Hard Learning Objective: 2.03 Explain the difference between average and marginal tax rates Topic: Taxes

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 02 Testbank

AACSB: Analytic Blooms: Analysis Difficulty: Hard Learning Objective: 2.03 Explain the difference between average and marginal tax rates Topic: Taxes

52. Use the following tax table to answer this question: Profit before tax Tax rate $ 0 – 9525 10% 9525 – 38 700 12% 38 700 – 82 500 22% 82 500 – 157 500 24% 157 500 – 200 000 32% 200 000 – 500 000

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 02 Testbank

35% 500 000 + 37% Andrews Dried Fruit LLC has profit before tax of $630 000. How much does it owe in taxes? A. $141 750 B. $154 800 C. $198 790 D. $$220 500 E. $$233 100 Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Hard Learning Objective: 2.03 Explain the difference between average and marginal tax rates Topic: Taxes

53. Use the following tax table to answer this question: Profit before tax Tax rate $ 0 – 9525 10 % 9525 – 38 700 12 % 38 700 – 82 500 22

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 02 Testbank

% 82 500 – 157 500 24 % 157 500 – 200 000 32 % 200 000 – 500 000 35 % 500 000 + 37 % Stacey’s Fabrics, a sole proprietorship, earned $260 000 in profit before tax for the year. How much tax does the company owe? A. $96 220 B. $91 000 C. $66 690 D. $62 400 E. $57 200 Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Hard Learning Objective: 2.03 Explain the difference between average and marginal tax rates Topic: Taxes

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 02 Testbank

54. The Pretzel Factory has revenue of $821 300 and costs of $698 500. The depreciation expense is $28 400 and the interest paid is $8400. What is the amount of the firm's operating cash flow if the tax rate is 34%? A. $87 620 B. $89 540 C. $91 220 D. $93 560 E. $95 240 Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Hard Learning Objective: 2.04 Determine a firm's cash flow from its financial statements Topic: Cash flow

56. A firm has earnings before interest and taxes of $27 130, profit for the year (or period) of $16 220 and taxes of $5450 for the year. While the firm paid out $31 600 to pay off existing debt, it then later borrowed $42 000. What is the amount of the cash flow to creditors? A. −$14 040 B. $0 C. −$4940 D. $14 040 E. $4660 Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Hard Learning Objective: 2.04 Determine a firm's cash flow from its financial statements Topic: Cash flow

Ross, Essentials of Corporate Finance, Fifth Edition

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57. The Carpentry Shop has sales of $398 600, costs of $254 800, depreciation expense of $26 400, interest expense of $1600 and a tax rate of 34%. What is the profit for the year (or period) for this firm? A. $61 930 B. $66 211 C. $67 516 D. $76 428 E. $83 219 Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Hard Learning Objective: 2.02 Distinguish between accounting income and cash flow Topic: The statement of profit or loss

58. Andersen's Nursery has sales of $318 400, costs of $199 400, depreciation expense of $28 600, interest expense of $1100 and a tax rate of 35%. The firm paid out $23 400 in dividends. What is the addition to retained earnings? A. $36 909 B. $34 645 C. $44 141 D. $37 208 E. $40 615 Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Hard Learning Objective: 2.02 Distinguish between accounting income and cash flow Topic: The statement of profit or loss

59. Roscoe's non-current assets were purchased three years ago for $1.8 million. These assets can be sold to Stewart's today for $1.2 million. Roscoe's current statement of financial position shows net non-current assets of $960 000, current liabilities of $348 000 and net working capital of $121 000. If all the current assets were liquidated today, the company would receive $518 000 cash. The book value of the firm's assets today is _____ and the market value is ____. A. $1 081 000; $1 308 000 B. $1 081 000; $1 718 000 C. $1 307 000; $1 429 000 D. $1 429 000; $1 308 000 E. $1 429 000; $1 718 000 Ans: E AACSB: Analytic Blooms: Analysis Difficulty: Hard Learning Objective: 2.01 Differentiate between accounting value (or 'book' value) and market value Topic: The statement of financial position

Ross, Essentials of Corporate Finance, Fifth Edition

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60. Kat Outfitting currently has $22 500 in cash. The company owes $49 500 to suppliers for merchandise and $52 500 to the bank for a non-current loan. Customers owe the company $41 000 for their purchases. The inventory has a book value of $76 800 and an estimated market value of $72 000. If the store compiled a statement of financial position as of today, what would be the book value of the current assets? A. $135 500 B. $79 500 C. $86 000 D. $140 300 E. $144 000 Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Hard Learning Objective: 2.01 Differentiate between accounting value (or 'book' value) and market value Topic: The statement of financial position

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 02 Testbank

Chapter 02 Testbank Summary Category AACSB: Analytic Blooms: Analysis Difficulty: Easy Difficulty: Hard Difficulty: Medium Learning Objective: 2.01 Differentiate between accounting value (or 'book' value) and market value Learning Objective: 2.02 Distinguish between accounting income and cash flow Learning Objective: 2.03 Explain the difference between average and marginal tax rates Learning Objective: 2.04 Determine a firm's cash flow from its financial statements Topic: Cash flow Topic: Taxes Topic: The statement of financial position Topic: The statement of profit or loss

# of Questions 60 60 31 14 15 15 15 15 15 15 15 15 15

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 03 Testbank

Chapter 03 Testbank 1. Ben-Q company has 178 300 shares issued to shareholders and the shares sell for $4.10 per share at the end of the year. As the company's net profit is $450 000, what are its earnings per share (EPS)? A. $0.62 B. $4.38 C. $2.52 D. $2.08 2. The DuPont identity tells us that return on equity (ROE) is affected by the: A. equity multiplier. B. total asset turnover. C. profit margin. D. All of the options given here are correct. 3. Short-term solvency ratios are also referred to as: A. leverage ratios. B. liquidity measures. C. utilisation ratios. D. profitability ratios. 4. The acid-test ratio is also called the: A. current ratio. B. cash ratio. C. times interest earned ratio. D. quick ratio. 5. Ratios that analyse a firm's ability to meet its long-term obligations are called: A. profitability ratios. B. asset utilisation ratios. C. leverage ratios. D. market value ratios. 6. The financial ratio, defined as earnings before interest and taxes divided by interest paid, is called the: A. times interest earned ratio. B. debt-equity ratio. C. profit margin.

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 03 Testbank

D. return on equity. 7. The financial ratio, measured as profit for the year (or period) divided by total assets, is known as a firm's: A. profit margin. B. return on equity. C. total asset turnover. D. return on assets. 8. The internal growth rate is best described as the __________ growth rate achievable __________________. A. minimum; if the firm does not pay out any dividends B. minimum; if the firm maintains a constant equity multiplier C. maximum; without external financing of any kind D. maximum; without using any external equity financing, while maintaining a constant debtequity ratio 9. Common-size financial statements present all statement of financial position account values as a percentage of: A. the forecasted budget. B. sales. C. total equity. D. total assets. 10. The DuPont identity can be totally defined by which one of the following? A. Return on equity, total asset turnover and equity multiplier B. Equity multiplier and return on assets C. Profit margin and return on equity D. Total asset turnover, profit margin and debt-equity ratio 11. A common-size statement of financial position helps financial managers determine: A. which customers are paying on a timely basis. B. if costs are increasing faster or slower than sales. C. if changes are occurring in a firm's mix of assets. D. if a firm is generating more or less sales per dollar of assets than in prior years. 12. High Tower Pharmacy pays a fixed percentage of its profit for the year (or period) out to its shareholders in the form of annual dividends. Given this, the percentage shown on a commonsize statement of profit or loss for the dividend account will: A. remain constant over time. B. be equal to the dividend amount divided by the profit for the year (or period).

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 03 Testbank

C. vary in direct relation to the net profit percentage. D. vary in direct relation to changes in the sales level. 13. Foreign Travel Services has profit for the year (or period) of $48 400, total assets of $219 000, total equity of $154 800 and total sales of $311 700. What is the common-size percentage for the profit for the year (or period)? A. 9.00% B. 13.90% C. 15.53% D. 22.10% 14. Delmont Movers has a profit margin of 6.2% and profit for the year (or period) of $48 900. What is the common-size percentage for the cost of sales if that expense amounted to $379 000 for the year? A. 12.90% B. 23.50% C. 33.25% D. 48.05% 15. A firm has sales of $428 000 for the year. The profit margin is 3.4% and the retention ratio is 60%. What is the common-size percentage for the dividends paid? A. 0.99% B. 1.18% C. 1.21% D. 1.36% 16. The DuPont identity can be used to help a financial manager determine which of the following? I. The degree of financial leverage used by a firm II. The operating efficiency of a firm III. The utilisation rate of a firm's assets IV. The rate of return on a firm's assets A. II and III only B. I and III only C. II, III and IV only D. I, II, III and IV 17. The Inside Door has total debt of $78 600, total equity of $214 000 and a return on equity of 14.5%. What is the return on assets? A. 9.14% B. 10.61% C. 21.45%

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 03 Testbank

D. 34.61% 18. The Noodle Place has total assets of $123 800, a debt-equity ratio of 0.65 and profit for the year (or period) of $7100. What is the return on equity? A. 3.48% B. 3.73% C. 8.01% D. 9.46% 19. Computer Geeks has sales of $521 000, a profit margin of 14.8%, a total asset turnover rate of 2.16 and an equity multiplier of 1.30. What is the return on equity? A. 8.91% B. 12.67% C. 18.28% D. 41.56% 20. Morrison Motors has total equity of $289 100 and profit for the year (or period) of $64 500. The debt-equity ratio is 0.45 and the total asset turnover is 1.6. What is the profit margin? A. 3.10% B. 5.23% C. 5.67% D. 9.62% 21. A firm has profit for the year (or period) of $114 000, a return on assets of 12.6% and a debtequity ratio of 0.60. What is the return on equity? A. 17.11% B. 18.98% C. 20.16% D. 22.20% 22. Donovan Brothers Inc. would like to increase its internal rate of growth. Decreasing which one of the following will help the firm achieve its goal? A. Return on assets B. Profit for the year (or period) C. Retention ratio D. Dividend payout ratio 23. If a firm has a 100% dividend payout ratio, then the internal growth rate of the firm is: A. 0%. B. 100%. C. equal to the ROA.

Ross, Essentials of Corporate Finance, Fifth Edition

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D. negative. 24. Which of the following are determinants of a firm's sustainable rate of growth? I. Amount of sales generated from each dollar invested in assets II. Amount of debt per dollar of equity III. Amount of current assets per dollar of current liabilities IV. Percentage of profit for the year (or period) distributed as dividends A. I and III only B. II and IV only C. I, II and IV only D. II, III and IV only 25. Financial statement analysis: A. will always give a precise analysis of the financial health of a company. B. is based on past results and is therefore not useful. C. provides useful information that can serve as a basis for predicting future performance. D. is limited to internal use by managers. 26. Which of the following statements is correct? A. Peer group analysis is easier when a firm is a conglomerate rather than a single line of business. B. Australian listed companies can only be compared to other companies listed on the ASX. C. Peer group analysis is easier when firms have different fiscal years. D. GICS are useful in identifying companies for comparison purposes but some care must be taken. 27. Which of the following statements identify problems with financial statement analysis? I: It is not always easy to identify a suitable benchmark for comparison purposes. II: As many firms are conglomerates owning more than one line of business, it is sometimes difficult to identify groups of firms that are directly comparable. III: Firms in the same industry operate globally and comparison may be difficult due to different accounting standards used in the preparation of financial statements. IV: Unusual events may affect financial performance that may give misleading signals when comparing firms' results. A. I only B. I, II, III and IV C. I, II and IV D. I and III 28. It takes the Jolly Jumbuck Asian Trading Company 32 days to collect its accounts receivable. Sales for the year are $650 000. What is the accounts receivable turnover ratio? A. 11.23

Ross, Essentials of Corporate Finance, Fifth Edition

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B. 11.41 C. 11.78 D. 12.23 29. Joshua's Antiques has a total asset turnover rate of 1.2, an equity multiplier of 1.4, a profit margin of 5%, a retention ratio of 0.8 and total assets of $120 000. What is the sustainable growth rate? A. 6.98% B. 7.20% C. 7.33% D. 7.54% 30. A fire has destroyed a large percentage of the financial records of the Strongwell Co. You have the task of piecing together information in order to release a financial report. You have found the return on equity to be 13.8%. Sales were $979 000, the total debt ratio was 0.42 and total debt was $548 000. What is the return on assets? A. 6.92% B. 8.00% C. 8.45% D. 9.03% 31. Builder's Outlet just hired a new chief financial officer. To get a feel for the company, she wants to compare the firm's sales and costs over the past three years to determine if any trends are present and also determine where the firm might need to make changes. Which one of the following statements will best suit her purposes? A. Statement of profit or Loss B. Statement of financial position C. Common-size statement of profit or loss D. Common-size statement of financial position E. Statement of cash flows 32. Tower Pharmacy pays out a fixed percentage of its profit for the year (or period) to its shareholders in the form of annual dividends. Given this, the percentage shown on a commonsize statement of profit or loss for the dividend account will: A. remain constant over time. B. be equal to the dividend amount divided by the profit for the year (or period). C. vary in direct relation to the net profit percentage. D. vary in direct relation to changes in the sales level. E. vary but not in direct relation to any other variable. 33. Which one of the following is a measure of long-term solvency? A. Price-earnings ratio

Ross, Essentials of Corporate Finance, Fifth Edition

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B. Profit margin C. Cash coverage ratio D. Receivables turnover E. Quick ratio 34. The cash ratio is used to evaluate the: A. liquidity of a firm. B. speed at which a firm generates cash. C. length of time that a firm can pay its bills if no additional cash becomes available. D. ability of a firm to pay the interest on its debt. E. relationship between the firm's cash balance and its current liabilities. 35. The equity multiplier is equal to: A. one plus the debt-equity ratio. B. one plus the total asset turnover. C. total debt divided by total equity. D. total equity divided by total assets. E. one divided by the total asset turnover. 36. Which one of these statements is true concerning the price-earnings (PE) ratio? A. A high PE ratio may indicate that a firm is expected to grow significantly. B. A PE ratio of 16 indicates that investors are willing to pay $1 for every $16 of current earnings. C. PE ratios are unaffected by the accounting methods employed by a firm. D. The PE ratio is classified as a profitability ratio. E. The PE ratio is a constant value for each firm. 37. Which ratio was primarily designed to monitor firms with negative earnings? A. Price-sales ratio B. Market-to-book ratio C. Profit margin D. ROE E. ROA 38. Sweet Candies reduced its non-current assets this year without affecting the shop's operations, sales or equity. This reduction will increase which of the following ratios? 1. I. Capital intensity ratio 2. II. Return on assets 3. III. Total asset turnover 4. IV. Return on equity A. I and II only

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 03 Testbank

B. II and III only C. II, III and IV only D. I, II and IV only E. I, II, III and IV 39. Donovan’s would like to increase its internal rate of growth. Decreasing which one of the following will help the firm achieve its goal? A. Return on assets B. Profit for the year (or period) C. Retention ratio D. Dividend payout ratio E. Return on equity 40. The sustainable growth rate is based on the premise that: A. an additional dollar of debt will be acquired only if an additional dollar in equity shares is issued. B. no additional equity will be added to the firm. C. the debt-equity ratio will be held constant. D. the dividend payout ratio will be zero. E. the dividend payout ratio will increase at a steady rate. 41. Financial statement analysis: A. is primarily used to identify account values that meet the normal standards. B. is limited to internal use by a firm's managers. C. provides useful information that can serve as a basis for forecasting future performance. D. provides useful information to shareholders but not to debt holders. E. is enhanced by comparing results to those of a firm's peers but not by comparing results to prior periods. 42. Which one of the following statements is correct? A. Peer group analysis is easier when a firm is a conglomerate versus when it has only a single line of business. B. Peer group analysis is easier when seasonal firms have different fiscal years. C. Peer group analysis is simplified when firms use varying methods of depreciation. D. Comparing results across geographic locations is easier since all countries now use a common set of accounting standards. E. Adjustments have to be made when comparing the statement of profit or loss of firms that use different methods of accounting for inventory. 43. Prisqua Rentals has inventory of $147 500, equity of $320 000, total assets of $658 800 and sales of $800 780. What is the common-size percentage for the inventory account? A. 15.07%

Ross, Essentials of Corporate Finance, Fifth Edition

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B. 18.42% C. 20.36% D. 22.39% E. 39.96% 44. A firm has inventory of $46 500, accounts payable of $17 400, cash of $1250, net noncurrent assets of $318 650, non-current debt of $109 500 and accounts receivable of $16 600. What is the common-size percentage of the equity? A. 70.60% B. 70.12% C. 66.87% D. 42.08% E. 68.75% 45. Saki Kale Farms has profit for the year (or period) of $96 320, total assets of $975 200, total equity of $555 280 and total sales of $1 141 275. What is the common-size percentage for the profit for the year (or period)? A. 7.90% B. 8.44% C. 13.88% D. 48.65% E. 74.57% 46. Delmont Movers has a profit margin of 7.1% and profit for the year (or period) of $63 700. What is the common-size percentage for the cost of sales if that expense amounted to $522 600 for the year? A. 12.19% B. 23.50% C. 53.25% D. 61.06% E. 58.25% 47. A firm has sales of $811 000 for the year. The profit margin is 5.1% and the retention ratio is 56%. What is the common-size percentage for the dividends paid? A. 1.99% B. 2.86% C. 1.21% D. 2.24% E. 1.42% 48. Mike's Place has total assets of $152 080, a debt-equity ratio of 0.62 and profit for the year (or period) of $14 342. What is the return on equity?

Ross, Essentials of Corporate Finance, Fifth Edition

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A. 13.48% B. 13.73% C. 15.74% D. 15.28% E. 14.61% 49. Computer Geeks has sales of $618 900, a profit margin of 13.2%, a total asset turnover rate of 1.54 and an equity multiplier of 1.06. What is the return on equity? A. 18.91% B. 12.67% C. 18.28% D. 22.11% E. 21.55% 50. Wiggle Pools has total equity of $358 200 and profit for the year (or period) of $47 500. The debt-equity ratio is .68 and the total asset turnover is 1.2. What is the profit margin? A. 4.82% B. 5.23% C. 5.67% D. 6.58% E. 7.31% 51. A firm has profit for the year (or period) of $197 400, a return on assets of 8.4% and a debtequity ratio of 0.72. What is the return on equity? A. 11.67% B. 18.98% C. 14.45% D. 16.22% E. 15.06% 52. The Blue Lagoon has a return on equity of 23.62%, an equity multiplier of 1.48 and a capital intensity ratio of 1.06. What is the profit margin? A. 15.06% B. 13.57% C. 15.84% D. 16.92% E. 14.60% 53. The Saw Mill has a return on assets of 7.92%, a total asset turnover rate of 1.18 and a debtequity ratio of 1.46. What is the return on equity? A. 14.26% B. 13.64%

Ross, Essentials of Corporate Finance, Fifth Edition

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C. 12.28% D. 19.48% E. 12.03% 54. Rogers Radiators has profit for the year (or period) of $48 200, sales of $947 100, a capital intensity ratio of 0.87 and an equity multiplier of 1.53. What is the return on equity? A. 6.77% B. 5.93% C. 8.95% D. 12.21% E. 14.09% 55. Good Foods has profit for the year (or period) of $82 490, total equity of $518 700 and total assets of $1 089 500. The dividend payout ratio is 0.30. What is the internal growth rate? A. 2.32% B. 3.57% C. 5.60% D. 2.87% E. 4.94% 56. A firm has adopted a policy whereby it will not seek any additional external financing. Given this, what is the maximum growth rate for the firm if it has profit for the year (or period) of $32 600, total equity of $294 000, total assets of $503 000 and a 25% dividend payout ratio? A. 5.11% B. 4.88% C. 6.62% D. 7.67% E. 8.37% 57. A firm has a return on equity of 17.8%, a return on assets of 11.3%, and a 65% dividend payout ratio. What is the sustainable growth rate? A. 5.72% B. 6.84% C. 7.12% D. 11.38% E. 6.64% 58. Last year, a firm earned $67 800 in profit for the year (or period) on sales of $934 600. Total assets increased by $62 000 and total equity increased by $43 500 for the year. No new equity was issued and no shares were repurchased. What is the retention ratio? A. 29.62% B. 35.84%

Ross, Essentials of Corporate Finance, Fifth Edition

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C. 56.25% D. 70.38% E. 64.16% 59. High Road Transport has a current share price of $5.60. For the past year, the company had profit for the year (or period) of $287 400, total equity of $992 300, sales of $1 511 000 and 750 000 shares outstanding. What is the market-to-book ratio? A. 3.54 B. 3.81 C. 3.99 D. 4.47 E. 4.23 60. The Texas Rustler has total assets of $645 563 and an equity multiplier of 1.22. What is the debt-equity ratio? A. .44 B. .32 C. 1.22 D. .22 E. 1.36

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 03 Testbank

Chapter 03 Testbank Key 1. Ben-Q company has 178 300 shares issued to shareholders and the shares sell for $4.10 per share at the end of the year. As the company's net profit is $450 000, what are its earnings per share (EPS)? A. $0.62 B. $4.38 C. $2.52 D. $2.08 Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 3.02 Compute and, more importantly, interpret some common ratios Topic: Ratio analysis

2. The DuPont identity tells us that return on equity (ROE) is affected by the: A. equity multiplier. B. total asset turnover. C. profit margin. D. All of the options given here are correct. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 3.03 Assess the determinants of a firm's profitability and growth Topic: The DuPont identity

3. Short-term solvency ratios are also referred to as: A. leverage ratios. B. liquidity measures. C. utilisation ratios. D. profitability ratios. Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 3.02 Compute and, more importantly, interpret some common ratios Topic: Ratio analysis

4. The acid-test ratio is also called the: A. current ratio. B. cash ratio.

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 03 Testbank

C. times interest earned ratio. D. quick ratio. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 3.02 Compute and, more importantly, interpret some common ratios Topic: Ratio analysis

5. Ratios that analyse a firm's ability to meet its long-term obligations are called: A. profitability ratios. B. asset utilisation ratios. C. leverage ratios. D. market value ratios. Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 3.02 Compute and, more importantly, interpret some common ratios Topic: Ratio analysis

6. The financial ratio, defined as earnings before interest and taxes divided by interest paid, is called the: A. times interest earned ratio. B. debt-equity ratio. C. profit margin. D. return on equity. Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 3.02 Compute and, more importantly, interpret some common ratios Topic: Ratio analysis

7. The financial ratio, measured as profit for the year (or period) divided by total assets, is known as a firm's: A. profit margin. B. return on equity. C. total asset turnover. D. return on assets. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 3.02 Compute and, more importantly, interpret some common ratios Topic: Ratio analysis

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 03 Testbank

8. The internal growth rate is best described as the __________ growth rate achievable __________________. A. minimum; if the firm does not pay out any dividends B. minimum; if the firm maintains a constant equity multiplier C. maximum; without external financing of any kind D. maximum; without using any external equity financing, while maintaining a constant debtequity ratio Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 3.04 Identify and explain some of the problems and pitfalls in financial statement analysis Topic: Internal and sustainable growth

9. Common-size financial statements present all statement of financial position account values as a percentage of: A. the forecasted budget. B. sales. C. total equity. D. total assets. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 3.01 Standardise financial statements for comparison purposes Topic: Standardised financial statements

10. The DuPont identity can be totally defined by which one of the following? A. Return on equity, total asset turnover and equity multiplier B. Equity multiplier and return on assets C. Profit margin and return on equity D. Total asset turnover, profit margin and debt-equity ratio Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 3.03 Assess the determinants of a firm's profitability and growth Topic: The DuPont identity

11. A common-size statement of financial position helps financial managers determine: A. which customers are paying on a timely basis. B. if costs are increasing faster or slower than sales. C. if changes are occurring in a firm's mix of assets. D. if a firm is generating more or less sales per dollar of assets than in prior years. Ans: C

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 03 Testbank

AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 3.01 Standardise financial statements for comparison purposes Topic: Standardised financial statements

12. High Tower Pharmacy pays a fixed percentage of its profit for the year (or period) out to its shareholders in the form of annual dividends. Given this, the percentage shown on a commonsize statement of profit or loss for the dividend account will: A. remain constant over time. B. be equal to the dividend amount divided by the profit for the year (or period). C. vary in direct relation to the net profit percentage. D. vary in direct relation to changes in the sales level. Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 3.01 Standardise financial statements for comparison purposes Topic: Standardised financial statements

13. Foreign Travel Services has profit for the year (or period) of $48 400, total assets of $219 000, total equity of $154 800 and total sales of $311 700. What is the common-size percentage for the profit for the year (or period)? A. 9.00% B. 13.90% C. 15.53% D. 22.10% Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 3.01 Standardise financial statements for comparison purposes Topic: Standardised financial statements

14. Delmont Movers has a profit margin of 6.2% and profit for the year (or period) of $48 900. What is the common-size percentage for the cost of sales if that expense amounted to $379 000 for the year? A. 12.90% B. 23.50% C. 33.25% D. 48.05% Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 3.01 Standardise financial statements for comparison purposes Topic: Standardised financial statements

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 03 Testbank

15. A firm has sales of $428 000 for the year. The profit margin is 3.4% and the retention ratio is 60%. What is the common-size percentage for the dividends paid? A. 0.99% B. 1.18% C. 1.21% D. 1.36% Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 3.01 Standardise financial statements for comparison purposes Topic: Standardised financial statements

16. The DuPont identity can be used to help a financial manager determine which of the following? I. The degree of financial leverage used by a firm II. The operating efficiency of a firm III. The utilisation rate of a firm's assets IV. The rate of return on a firm's assets A. II and III only B. I and III only C. II, III and IV only D. I, II, III and IV Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 3.03 Assess the determinants of a firm's profitability and growth Topic: The DuPont identity

17. The Inside Door has total debt of $78 600, total equity of $214 000 and a return on equity of 14.5%. What is the return on assets? A. 9.14% B. 10.61% C. 21.45% D. 34.61% Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 3.03 Assess the determinants of a firm's profitability and growth Topic: The DuPont identity

18. The Noodle Place has total assets of $123 800, a debt-equity ratio of 0.65 and profit for the year (or period) of $7100. What is the return on equity?

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 03 Testbank

A. 3.48% B. 3.73% C. 8.01% D. 9.46% Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 3.03 Assess the determinants of a firm's profitability and growth Topic: The DuPont identity

19. Computer Geeks has sales of $521 000, a profit margin of 14.8%, a total asset turnover rate of 2.16 and an equity multiplier of 1.30. What is the return on equity? A. 8.91% B. 12.67% C. 18.28% D. 41.56% Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 3.03 Assess the determinants of a firm's profitability and growth Topic: The DuPont identity

20. Morrison Motors has total equity of $289 100 and profit for the year (or period) of $64 500. The debt-equity ratio is 0.45 and the total asset turnover is 1.6. What is the profit margin? A. 3.10% B. 5.23% C. 5.67% D. 9.62% Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 3.03 Assess the determinants of a firm's profitability and growth Topic: The DuPont identity

21. A firm has profit for the year (or period) of $114 000, a return on assets of 12.6% and a debtequity ratio of 0.60. What is the return on equity? A. 17.11% B. 18.98% C. 20.16% D. 22.20% Ans: C

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 03 Testbank

AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 3.03 Assess the determinants of a firm's profitability and growth Topic: The DuPont identity

22. Donovan Brothers Inc. would like to increase its internal rate of growth. Decreasing which one of the following will help the firm achieve its goal? A. Return on assets B. Profit for the year (or period) C. Retention ratio D. Dividend payout ratio Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 3.04 Identify and explain some of the problems and pitfalls in financial statement analysis Topic: Internal and sustainable growth

23. If a firm has a 100% dividend payout ratio, then the internal growth rate of the firm is: A. 0%. B. 100%. C. equal to the ROA. D. negative. Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 3.04 Identify and explain some of the problems and pitfalls in financial statement analysis Topic: Internal and sustainable growth

24. Which of the following are determinants of a firm's sustainable rate of growth? I. Amount of sales generated from each dollar invested in assets II. Amount of debt per dollar of equity III. Amount of current assets per dollar of current liabilities IV. Percentage of profit for the year (or period) distributed as dividends A. I and III only B. II and IV only C. I, II and IV only D. II, III and IV only Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 3.04 Identify and explain some of the problems and pitfalls in financial statement analysis Topic: Internal and sustainable growth

Ross, Essentials of Corporate Finance, Fifth Edition

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25. Financial statement analysis: A. will always give a precise analysis of the financial health of a company. B. is based on past results and is therefore not useful. C. provides useful information that can serve as a basis for predicting future performance. D. is limited to internal use by managers. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 3.04 Identify and explain some of the problems and pitfalls in financial statement analysis Topic: Using financial statement information

26. Which of the following statements is correct? A. Peer group analysis is easier when a firm is a conglomerate rather than a single line of business. B. Australian listed companies can only be compared to other companies listed on the ASX. C. Peer group analysis is easier when firms have different fiscal years. D. GICS are useful in identifying companies for comparison purposes but some care must be taken. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 3.04 Identify and explain some of the problems and pitfalls in financial statement analysis Topic: Using financial statement information

27. Which of the following statements identify problems with financial statement analysis? I: It is not always easy to identify a suitable benchmark for comparison purposes. II: As many firms are conglomerates owning more than one line of business, it is sometimes difficult to identify groups of firms that are directly comparable. III: Firms in the same industry operate globally and comparison may be difficult due to different accounting standards used in the preparation of financial statements. IV: Unusual events may affect financial performance that may give misleading signals when comparing firms' results. A. I only B. I, II, III and IV C. I, II and IV D. I and III Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 3.04 Identify and explain some of the problems and pitfalls in financial statement analysis Topic: Using financial statement information

Ross, Essentials of Corporate Finance, Fifth Edition

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28. It takes the Jolly Jumbuck Asian Trading Company 32 days to collect its accounts receivable. Sales for the year are $650 000. What is the accounts receivable turnover ratio? A. 11.23 B. 11.41 C. 11.78 D. 12.23 Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 3.02 Compute and, more importantly, interpret some common ratios Topic: Ratio analysis

29. Joshua's Antiques has a total asset turnover rate of 1.2, an equity multiplier of 1.4, a profit margin of 5%, a retention ratio of 0.8 and total assets of $120 000. What is the sustainable growth rate? A. 6.98% B. 7.20% C. 7.33% D. 7.54% Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 3.04 Identify and explain some of the problems and pitfalls in financial statement analysis Topic: Internal and sustainable growth

30. A fire has destroyed a large percentage of the financial records of the Strongwell Co. You have the task of piecing together information in order to release a financial report. You have found the return on equity to be 13.8%. Sales were $979 000, the total debt ratio was 0.42 and total debt was $548 000. What is the return on assets? A. 6.92% B. 8.00% C. 8.45% D. 9.03% Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 3.02 Compute and, more importantly, interpret some common ratios Topic: Ratio analysis

31. Builder's Outlet just hired a new chief financial officer. To get a feel for the company, she wants to compare the firm's sales and costs over the past three years to determine if any trends are present and also determine where the firm might need to make changes. Which one of the following statements will best suit her purposes?

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 03 Testbank

A. Statement of profit or Loss B. Statement of financial position C. Common-size statement of profit or loss D. Common-size statement of financial position E. Statement of cash flows Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 3.01 Standardise financial statements for comparison purposes Topic: Standardised financial statements

32. Tower Pharmacy pays out a fixed percentage of its profit for the year (or period) to its shareholders in the form of annual dividends. Given this, the percentage shown on a commonsize statement of profit or loss for the dividend account will: A. remain constant over time. B. be equal to the dividend amount divided by the profit for the year (or period). C. vary in direct relation to the net profit percentage. D. vary in direct relation to changes in the sales level. E. vary but not in direct relation to any other variable. Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 3.01 Standardise financial statements for comparison purposes Topic: Standardised financial statements

33. Which one of the following is a measure of long-term solvency? A. Price-earnings ratio B. Profit margin C. Cash coverage ratio D. Receivables turnover E. Quick ratio Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 3.02 Compute and, more importantly, interpret some common ratios Topic: Ratio analysis

34. The cash ratio is used to evaluate the: A. liquidity of a firm. B. speed at which a firm generates cash. C. length of time that a firm can pay its bills if no additional cash becomes available. D. ability of a firm to pay the interest on its debt. E. relationship between the firm's cash balance and its current liabilities.

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 03 Testbank

Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 3.02 Compute and, more importantly, interpret some common ratios Topic: Ratio analysis

35. The equity multiplier is equal to: A. one plus the debt-equity ratio. B. one plus the total asset turnover. C. total debt divided by total equity. D. total equity divided by total assets. E. one divided by the total asset turnover. Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 3.02 Compute and, more importantly, interpret some common ratios Topic: Ratio analysis

36. Which one of these statements is true concerning the price-earnings (PE) ratio? A. A high PE ratio may indicate that a firm is expected to grow significantly. B. A PE ratio of 16 indicates that investors are willing to pay $1 for every $16 of current earnings. C. PE ratios are unaffected by the accounting methods employed by a firm. D. The PE ratio is classified as a profitability ratio. E. The PE ratio is a constant value for each firm. Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 3.02 Compute and, more importantly, interpret some common ratios Topic: Ratio analysis

37. Which ratio was primarily designed to monitor firms with negative earnings? A. Price-sales ratio B. Market-to-book ratio C. Profit margin D. ROE E. ROA Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 3.02 Compute and, more importantly, interpret some common ratios Topic: Ratio analysis

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 03 Testbank

38. Sweet Candies reduced its non-current assets this year without affecting the shop's operations, sales or equity. This reduction will increase which of the following ratios? 1. I. Capital intensity ratio 2. II. Return on assets 3. III. Total asset turnover 4. IV. Return on equity A. I and II only B. II and III only C. II, III and IV only D. I, II and IV only E. I, II, III and IV Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 3.02 Compute and, more importantly, interpret some common ratios Topic: Ratio analysis

39. Donovan’s would like to increase its internal rate of growth. Decreasing which one of the following will help the firm achieve its goal? A. Return on assets B. Profit for the year (or period) C. Retention ratio D. Dividend payout ratio E. Return on equity Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 3.04 Identify and explain some of the problems and pitfalls in financial statement analysis Topic: Internal and sustainable growth

40. The sustainable growth rate is based on the premise that: A. an additional dollar of debt will be acquired only if an additional dollar in equity shares is issued. B. no additional equity will be added to the firm. C. the debt-equity ratio will be held constant. D. the dividend payout ratio will be zero. E. the dividend payout ratio will increase at a steady rate. Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 3.04 Identify and explain some of the problems and pitfalls in financial statement analysis Topic: Internal and sustainable growth

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 03 Testbank

41. Financial statement analysis: A. is primarily used to identify account values that meet the normal standards. B. is limited to internal use by a firm's managers. C. provides useful information that can serve as a basis for forecasting future performance. D. provides useful information to shareholders but not to debt holders. E. is enhanced by comparing results to those of a firm's peers but not by comparing results to prior periods. Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 3.04 Identify and explain some of the problems and pitfalls in financial statement analysis Topic: Using financial statement information

42. Which one of the following statements is correct? A. Peer group analysis is easier when a firm is a conglomerate versus when it has only a single line of business. B. Peer group analysis is easier when seasonal firms have different fiscal years. C. Peer group analysis is simplified when firms use varying methods of depreciation. D. Comparing results across geographic locations is easier since all countries now use a common set of accounting standards. E. Adjustments have to be made when comparing the statement of profit or loss of firms that use different methods of accounting for inventory. Ans: E AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 3.04 Identify and explain some of the problems and pitfalls in financial statement analysis Topic: Using financial statement information

43. Prisqua Rentals has inventory of $147 500, equity of $320 000, total assets of $658 800 and sales of $800 780. What is the common-size percentage for the inventory account? A. 15.07% B. 18.42% C. 20.36% D. 22.39% E. 39.96% Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 3.01 Standardise financial statements for comparison purposes Topic: Standardised financial statements

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 03 Testbank

44. A firm has inventory of $46 500, accounts payable of $17 400, cash of $1250, net noncurrent assets of $318 650, non-current debt of $109 500 and accounts receivable of $16 600. What is the common-size percentage of the equity? A. 70.60% B. 70.12% C. 66.87% D. 42.08% E. 68.75% Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 3.01 Standardise financial statements for comparison purposes Topic: Standardised financial statements

45. Saki Kale Farms has profit for the year (or period) of $96 320, total assets of $975 200, total equity of $555 280 and total sales of $1 141 275. What is the common-size percentage for the profit for the year (or period)? A. 7.90% B. 8.44% C. 13.88% D. 48.65% E. 74.57% Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 3.01 Standardise financial statements for comparison purposes Topic: Standardised financial statements

46. Delmont Movers has a profit margin of 7.1% and profit for the year (or period) of $63 700. What is the common-size percentage for the cost of sales if that expense amounted to $522 600 for the year? A. 12.19% B. 23.50% C. 53.25% D. 61.06% E. 58.25% Ans: E AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 3.01 Standardise financial statements for comparison purposes Topic: Standardised financial statements

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 03 Testbank

47. A firm has sales of $811 000 for the year. The profit margin is 5.1% and the retention ratio is 56%. What is the common-size percentage for the dividends paid? A. 1.99% B. 2.86% C. 1.21% D. 2.24% E. 1.42% Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 3.01 Standardise financial statements for comparison purposes Topic: Standardised financial statements

48. Mike's Place has total assets of $152 080, a debt-equity ratio of 0.62 and profit for the year (or period) of $14 342. What is the return on equity? A. 13.48% B. 13.73% C. 15.74% D. 15.28% E. 14.61% Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 3.03 Assess the determinants of a firm's profitability and growth Topic: The DuPont identity

49. Computer Geeks has sales of $618 900, a profit margin of 13.2%, a total asset turnover rate of 1.54 and an equity multiplier of 1.06. What is the return on equity? A. 18.91% B. 12.67% C. 18.28% D. 22.11% E. 21.55% Ans: E AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 3.03 Assess the determinants of a firm's profitability and growth Topic: The DuPont identity

50. Wiggle Pools has total equity of $358 200 and profit for the year (or period) of $47 500. The debt-equity ratio is .68 and the total asset turnover is 1.2. What is the profit margin? A. 4.82% B. 5.23%

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 03 Testbank

C. 5.67% D. 6.58% E. 7.31% Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 3.03 Assess the determinants of a firm's profitability and growth Topic: The DuPont identity

51. A firm has profit for the year (or period) of $197 400, a return on assets of 8.4% and a debtequity ratio of 0.72. What is the return on equity? A. 11.67% B. 18.98% C. 14.45% D. 16.22% E. 15.06% Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 3.03 Assess the determinants of a firm's profitability and growth Topic: The DuPont identity

52. The Blue Lagoon has a return on equity of 23.62%, an equity multiplier of 1.48 and a capital intensity ratio of 1.06. What is the profit margin? A. 15.06% B. 13.57% C. 15.84% D. 16.92% E. 14.60% Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 3.03 Assess the determinants of a firm's profitability and growth Topic: The DuPont identity

53. The Saw Mill has a return on assets of 7.92%, a total asset turnover rate of 1.18 and a debtequity ratio of 1.46. What is the return on equity? A. 14.26% B. 13.64% C. 12.28% D. 19.48% E. 12.03% Ans: D

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 03 Testbank

AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 3.03 Assess the determinants of a firm's profitability and growth Topic: The DuPont identity

54. Rogers Radiators has profit for the year (or period) of $48 200, sales of $947 100, a capital intensity ratio of 0.87 and an equity multiplier of 1.53. What is the return on equity? A. 6.77% B. 5.93% C. 8.95% D. 12.21% E. 14.09% Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 3.03 Assess the determinants of a firm's profitability and growth Topic: The DuPont identity

55. Good Foods has profit for the year (or period) of $82 490, total equity of $518 700 and total assets of $1 089 500. The dividend payout ratio is 0.30. What is the internal growth rate? A. 2.32% B. 3.57% C. 5.60% D. 2.87% E. 4.94% Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 3.04 Identify and explain some of the problems and pitfalls in financial statement analysis Topic: Internal and sustainable growth

56. A firm has adopted a policy whereby it will not seek any additional external financing. Given this, what is the maximum growth rate for the firm if it has profit for the year (or period) of $32 600, total equity of $294 000, total assets of $503 000 and a 25% dividend payout ratio? A. 5.11% B. 4.88% C. 6.62% D. 7.67% E. 8.37% Ans: A

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 03 Testbank

AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 3.04 Identify and explain some of the problems and pitfalls in financial statement analysis Topic: Internal and sustainable growth

57. A firm has a return on equity of 17.8%, a return on assets of 11.3%, and a 65% dividend payout ratio. What is the sustainable growth rate? A. 5.72% B. 6.84% C. 7.12% D. 11.38% E. 6.64% Ans: E AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 3.04 Identify and explain some of the problems and pitfalls in financial statement analysis Topic: Internal and sustainable growth

58. Last year, a firm earned $67 800 in profit for the year (or period) on sales of $934 600. Total assets increased by $62 000 and total equity increased by $43 500 for the year. No new equity was issued and no shares were repurchased. What is the retention ratio? A. 29.62% B. 35.84% C. 56.25% D. 70.38% E. 64.16% Ans: E AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 3.04 Identify and explain some of the problems and pitfalls in financial statement analysis Topic: Internal and sustainable growth

59. High Road Transport has a current share price of $5.60. For the past year, the company had profit for the year (or period) of $287 400, total equity of $992 300, sales of $1 511 000 and 750 000 shares outstanding. What is the market-to-book ratio? A. 3.54 B. 3.81 C. 3.99 D. 4.47 E. 4.23 Ans: E

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 03 Testbank

AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 3.02 Compute and, more importantly, interpret some common ratios Topic: Ratio analysis

60. The Texas Rustler has total assets of $645 563 and an equity multiplier of 1.22. What is the debt-equity ratio? A. .44 B. .32 C. 1.22 D. .22 E. 1.36 Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 3.02 Compute and, more importantly, interpret some common ratios Topic: Ratio analysis

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 03 Testbank

Chapter 03 Testbank Summary Category AACSB: Analytic Blooms: Analysis Difficulty: Easy Difficulty: Medium Learning Objective: 3.01 Standardise financial statements for comparison purposes Learning Objective: 3.02 Compute and, more importantly, interpret some common ratios Learning Objective: 3.03 Assess the determinants of a firm's profitability and growth Learning Objective: 3.04 Identify and explain some of the problems and pitfalls in financial statement analysis Topic: Internal and sustainable growth Topic: Ratio analysis Topic: Standardised financial statements Topic: The DuPont identity Topic: Using financial statement information

# of Questions 60 60 38 22 13 16 15 16 11 16 13 15 5

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 04 Testbank

Chapter 04 Testbank 1. The method of calculating interest once during the entire life of the loan, on the original sum borrowed, is known as: A. simple interest. B. interest on interest. C. compounding. D. rule of 72. 2. If you invest $5000 now, and your investment pays 12% per annum, how much will you have in three years if compounded annually (to the nearest dollar)? A. $7025 B. $14 821 C. $6852 D. $8014 3. Suppose you need to pay your air-ticket of $2400 for a European trip next year. If you deposit money now, you can earn 7% per annum. How much do you need to invest today? A. $1759 B. $1968 C. $2000 D. $2243 4. You have been offered an investment that promises to double your money every nine years. Considering the rule of 72, what is your approximate rate of return on the investment? A. 8% B. 9% C. 14% D. 10% 5. You have $50 000 now to invest. If you can earn 10% per annum on your deposit, and can invest for five years, what will be the future value of your deposit (to the nearest dollar) at the end of the investment period? A. $150 493 B. $80 526 C. $99 456 D. $85 025 6. The value of an investment after one or more periods of time is called the:

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 04 Testbank

A. simple value. B. present value. C. discounted value. D. future value. 7. The process of accumulating interest in an investment over time to earn more interest is called: A. discounting. B. compounding. C. complexing. D. indexing. 8. Interest earned on both the initial principal and the reinvested interest from prior periods is called: A. compound interest. B. simple interest. C. complex interest. D. dual interest. 9. The interest rate used to calculate the present value of future cash flows is called the: A. compound interest rate. B. present value factor. C. future value factor. D. discount rate. 10. The valuation calculating the present value of a future cash flow to determine its value today is called __________ valuation. A. complex B. current C. discounted cash flow D. future cash flow 11. A financially wise individual would prefer a loan based on __________ interest and an investment earning __________ interest. A. compound; compound B. compound; simple C. simple; compound D. simple; simple 12. Which one of the following is the correct formula for the future value of a lump sum invested today? A. FV = PV / (1 + r)t

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 04 Testbank

B. FV = PV / (1 + rt) C. FV = PV × rt D. FV = PV × (1 + r)t 13. Which one of the following is the correct formula for computing the present value of a lump sum to be received sometime in the future? A. PV = FV × (1 + t)r B. PV = FV × (1 + r)t C. PV = FV × rt D. PV = FV / (1 + r)t 14. All things being equal, the present value will __________ as the period of time decreases, provided there is an interest rate greater than zero. A. remain constant B. decrease C. increase D. either remain constant or decrease 15. The present value of $10 000 to be received in 10 years will __________ if the discount rate is increased. A. remain constant B. decrease C. increase D. either remain constant or increase 16. The present value of a lump sum future amount _____, assuming that the interest rate is a positive value and all interest is reinvested. A. increases as the interest rate decreases B. decreases as the time period decreases C. is inversely related to the future value D. is directly related to the interest rate 17. Sue needs to invest $3626 today in order for her savings account to be worth $5000 six years from now. Which one of the following terms refers to the $3626? A. Present value B. Compound value C. Future value D. Complex value 18. Lisa has $1000 in cash today. Which one of the following investment options is most likely to double her money?

Ross, Essentials of Corporate Finance, Fifth Edition

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A. 6% interest for 3 years B. 12% interest for 5 years C. 7% interest for 9 years D. 8% interest for 9 years 19. The relationship between the present value and the time period is best described as: A. direct. B. inverse. C. unrelated. D. ambiguous. 20. You want to invest an amount of money today and receive back twice that amount in the future. You expect to earn 8% interest. Approximately how long must you wait for your investment to double in value? A. Six years B. Seven years C. Eight years D. Nine years 21. When you were born, your parents opened an investment account in your name and deposited $500 into the account. The account has earned an average annual rate of return of 4.8%. Today, the account is valued at $36 911.22. How old are you? A. 74.47 years B. 76.67 years C. 81.08 years D. 91.75 years 22. Today, Tony is investing $16 000 at 6.5%, compounded annually, for four years. How much additional income could he earn if he had invested this amount at 7%, compounded annually? A. $323.22 B. $389.28 C. $401.16 D. $442.79 23. How long will it take to double your savings if you earn 3.6% interest, compounded annually? A. 17.78 years B. 18.04 years C. 18.67 years D. 19.60 years

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 04 Testbank

24. You expect to receive $12 000 at graduation one year from now. You plan on investing it at 8% until you have $100 000. How long will you wait from now? A. 27.47 years B. 27.51 years C. 27.55 years D. 28.55 years 25. You and your sister are planning a large anniversary party three years from today for your parents' 50th wedding anniversary. You have estimated that you will need $4500 for this party. You can earn 2.5% compounded annually on your savings. How much would you and your sister have to deposit today in one lump sum to pay for the entire party? A. $4076.55 B. $4178.70 C. $4308.16 D. $4334.90 26. You have $1100 today and want to triple your money in five years. What interest rate must you earn if the interest is compounded annually? A. 18.08% B. 19.90% C. 22.15% D. 24.57% 27. You have been told that you need $25 600 today in order to have $100 000 when you retire 35 years from now. What rate of interest was used in the present value computation? Assume interest is compounded annually. A. 3.97% B. 4.15% C. 4.29% D. 4.53% 28. Your friend claims that he invested $5000 seven years ago and that this investment is worth $38 700 today. For this to be true, what annual rate of return did he have to earn? Assume the interest compounds annually. A. 28.87% B. 31.39% C. 33.96% D. 36.01% 29. Assume the total cost of a university education will be $285 000 when your child enters college in 22 years. You presently have $35 000 to invest. What annual rate of interest must you earn on your investment to cover the cost of your child's university education?

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 04 Testbank

A. 8.65% B. 9.40% C. 10.00% D. 10.60% 30. The present value of a conventional cash flow will ______ if the compounding rate increases. A. increase B. decrease C. remain the same D. either increase or decrease 31. Marcos is investing $5 today at 7% interest so he can have $35 later. This $35 is referred to as the: A. true value. B. future value. C. present value. D. discounted value. E. complex value. 32. Katlyn needs to invest $5318 today in order for her savings account to be worth $8000 six years from now. Which one of the following terms refers to the $5318? A. Present value B. Compound value C. Future value D. Complex value E. Factor value 33. Lucas expects to receive a sales bonus of $7500 one year from now. The process of determining how much that bonus is worth today is called: A. aggregating. B. discounting. C. simplifying. D. compounding. E. extrapolating. 34. Computing the present value of a future cash flow to determine what that cash flow is worth today is called: A. compounding. B. factoring. C. time valuation. D. simple cash flow valuation. E. discounted cash flow valuation.

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 04 Testbank

35. Stacey deposits $5000 into an account that pays 2% interest, compounded annually. At the same time, Kurt deposits $5000 into an account paying 3.5% interest, compounded annually. At the end of three years: A. both Stacey and Kurt will have accounts of equal value. B. Kurt will have twice the money saved that Stacey does. C. Kurt will earn exactly twice the amount of interest that Stacey earns. D. Kurt will have a larger account value than Stacey will. E. Stacey will have more money saved than Kurt. 36. Lisa has $1000 in cash today. Which one of the following investment options is most likely to double her money? A. 6% interest for 3 years B. 12% interest for 5 years C. 7% interest for 9 years D. 8% interest for 9 years E. 6% interest for 10 years 37. The present value of a lump-sum future amount: A. increases as the interest rate decreases. B. decreases as the time period decreases. C. is inversely related to the future value. D. is directly related to the interest rate. E. is directly related to the time period. 38. The relationship between the present value and the investment time period is best described as: A. direct. B. inverse. C. unrelated. D. ambiguous. E. parallel. 39. Which one of the following is a correct statement, all else held constant? A. The present value is inversely related to the future value. B. The future value is inversely related to the period of time. C. The period of time is directly related to the interest rate. D. The present value is directly related to the interest rate. E. The future value is directly related to the interest rate.

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 04 Testbank

40. You want to invest an amount of money today and receive back twice that amount in the future. You expect to earn 9% interest. Approximately how long must you wait for your investment to double in value? A. 6 years B. 7 years C. 8 years D. 12 years E. 14 years 41. What is the future value of $8000 invested today and held for 15 years at 8.5% compounded annually? A. $25 377.35 B. $27 197.94 C. $29 139.86 D. $29 509.77 E. $29 139.86 42. Travis invests $5500 today into a retirement account. He expects to earn 9.2%, compounded annually, on his money for the next 13 years. After that, he wants to be more conservative, so only expects to earn 6%, compounded annually. How much money will he have in his account when he retires 25 years from now, assuming this is the only deposit he makes into the account? A. $29 411.20 B. $34 747.80 C. $34 616.56 D. $41 919.67 E. $42 003.12 43. Ten years ago, you deposited $5500 into an account. Five years ago, you added an additional $2500 to this account. You earned 6.5%, compounded annually, for the first five years and 5.0%, compounded annually, for the last five years. How much money do you have in your account today? A. $8 666.67 B. $11 391.09 C. $12 149.62 D. $12 808.09 E. $13,042.61 44. Your parents spent $7800 to buy 200 shares in a new company 12 years ago. The shares have appreciated 14.6% per year on average. What is the current value of those 200 shares? A. $36 408.70 B. $40 023.03 C. $39 580.92 D. $40 515.08

Ross, Essentials of Corporate Finance, Fifth Edition

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E. $37 449.92 45. You just won $17 500 and deposited your winnings into an account that pays 6.7% interest, compounded annually. How long will you have to wait until your winnings are worth $50 000? A. 15.1 years B. 15.31 years C. 15.52 years D. 15.73 years E. 16.19 years 46. When you were born, your parents opened an investment account in your name and deposited $1500 into the account. The account has earned an average annual rate of return of 5.3%. Today, the account is valued at $42 856. How old are you? A. 71.47 years B. 70.67 years C. 61.08 years D. 67.33 years E. 64.91 years 47. Sixty years ago, your grandparents opened two savings accounts and deposited $250 in each account. The first account was with City Bank at 3.6%, compounded annually. The second account was with Country Bank at 3.65%, compounded annually. Which one of the following statements is true concerning these accounts? (Do not round intermediate calculations.) A. The City Bank account is currently worth $2076.42. B. The City Bank account has paid $48.19 more in interest than the Country Bank account. C. The Country Bank account is currently worth $2170.32. D. The Country Bank account has paid $72.24 more in interest than the City Bank account. E. The Country Bank account has paid $61.30 more in interest than the City Bank account. 48. Starlite Industries will need $2.2 million 4.5 years from now to replace some equipment. Currently, the firm has some extra cash and would like to establish a savings account for this purpose. The account pays 3.6% interest, compounded annually. How much money must the company deposit today to fully fund the equipment purchase? A. $1 679 947.20 B. $1 798 407.21 C. $1 350 868.47 D. $1 876 306.49 E. $1 412 308.18 49. You and your sister are planning a large anniversary party three years from today for your parents' 50th wedding anniversary. You have estimated that you will need $6500 for this party.

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 04 Testbank

You can earn 2.6% compounded annually on your savings. How much would you and your sister have to deposit today in one lump sum to pay for the entire party? A. $6076.55 B. $6018.26 C. $6308.16 D. $5934.90 E. $5868.81 50. Isaac only has $1090 today but needs $1979 to buy a new computer. How long will he have to wait to buy the computer if he earns 5.4% compounded annually on his savings? Assume the price of the computer remains constant. A. 11.83 years B. 11.48 years C. 12.51 years D. 12.77 years E. 11.34 years 51. How long will it take to double your savings if you earn 6.4% interest, compounded annually? A. 11.89 years B. 12.02 years C. 11.39 years D. 11.17 years E. 10.58 years 52. You have $300 today and want to triple your money in five years. What interest rate must you earn if the interest is compounded annually? A. 16.99% B. 23.78% C. 23.28% D. 24.57% E. 31.61% 53. Stephen claims that he invested $6000 six years ago and that this investment is worth $28 700 today. For this to be true, what annual rate of return did he have to earn? Assume the interest compounded annually. A. 28.87% B. 31.39% C. 29.80% D. 26.01% E. 27.87%

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 04 Testbank

54. Western Bank pays 5% simple interest on its savings account balances, whereas Eastern Bank pays 5% compounded annually. If you deposited $6000 in each bank, how much more money would you earn from the Eastern Bank account at the end of three years? A. $55.84 B. $45.75 C. $60.47 D. $40.09 E. $50.14 55. Assume the total cost of a college education will be $325 000 when your child enters college in 16 years. You presently have $40 000 to invest and do not plan to invest anything further. What annual rate of interest must you earn on your investment to cover the entire cost of your child's college education? A. 12.65% B. 10.40% C. 13.99% D. 14.62% E. 11.08% 56. At 10% interest, how long does it take to triple your money? A. 14.33 years B. 11.53 years C. 9.67 years D. 10.36 years E. 10.56 years 57. Suppose that in 2015, a $10 silver certificate from 1898 sold for $11 700. For this to have been true, what would the annual increase in the value of the certificate have been? A. 6.22% B. 6.01% C. 7.23% D. 6.49% E. 7.07% 58. You have just made your first $5000 contribution to your retirement account. Assuming you earn a rate of return of 5% and make no additional contributions, what will your account be worth when you retire in 35 years? What if you wait for 5 years before contributing? A. $26 335.37; $23 011.60 B. $27 311.20; $29 803.04 C. $27 311.20; $22 614.08 D. $27 580.08; $21 609.71 E. $31 241.90; $32 614.08

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 04 Testbank

59. You expect to receive $5000 at graduation one year from now. Your plan is to invest this money at 6.5%, compounded annually, until you have $50 000. At that time, you plan to travel around the world. How long from now will it be until you can begin your travels? A. 36.57 years B. 31.08 years C. 34.55 years D. 32.08 years E. 37.57 years 60. You are due to receive a lump-sum payment of $2350 in seven years. Assuming a discount rate of 2.5% interest, what would be the value of the payment in Year 4? A. $1976.97 B. $2182.21 C. $2128.98 D. $2236.76 E. $2292.68

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 04 Testbank

Chapter 04 Testbank Key 1. The method of calculating interest once during the entire life of the loan, on the original sum borrowed, is known as: A. simple interest. B. interest on interest. C. compounding. D. rule of 72. Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 4.01 Determine the future value of an investment made today Topic: Future value and compounding

2. If you invest $5000 now, and your investment pays 12% per annum, how much will you have in three years if compounded annually (to the nearest dollar)? A. $7025 B. $14 821 C. $6852 D. $8014 Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 4.01 Determine the future value of an investment made today Topic: Future value and compounding

3. Suppose you need to pay your air-ticket of $2400 for a European trip next year. If you deposit money now, you can earn 7% per annum. How much do you need to invest today? A. $1759 B. $1968 C. $2000 D. $2243 Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 4.02 Determine the present value of cash to be received at a future date Topic: Present value and discounting

4. You have been offered an investment that promises to double your money every nine years. Considering the rule of 72, what is your approximate rate of return on the investment?

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 04 Testbank

A. 8% B. 9% C. 14% D. 10% Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 4.03 Calculate the return on an investment Topic: More on present and future values

5. You have $50 000 now to invest. If you can earn 10% per annum on your deposit, and can invest for five years, what will be the future value of your deposit (to the nearest dollar) at the end of the investment period? A. $150 493 B. $80 526 C. $99 456 D. $85 025 Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 4.01 Determine the future value of an investment made today Topic: Future value and compounding

6. The value of an investment after one or more periods of time is called the: A. simple value. B. present value. C. discounted value. D. future value. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 4.01 Determine the future value of an investment made today Topic: Future value and compounding

7. The process of accumulating interest in an investment over time to earn more interest is called: A. discounting. B. compounding. C. complexing. D. indexing. Ans: B

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 04 Testbank

AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 4.01 Determine the future value of an investment made today Topic: Future value and compounding

8. Interest earned on both the initial principal and the reinvested interest from prior periods is called: A. compound interest. B. simple interest. C. complex interest. D. dual interest. Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 4.01 Determine the future value of an investment made today Topic: Future value and compounding

9. The interest rate used to calculate the present value of future cash flows is called the: A. compound interest rate. B. present value factor. C. future value factor. D. discount rate. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 4.04 Predict how long it takes for an investment to reach a desired value Topic: More on present and future values

10. The valuation calculating the present value of a future cash flow to determine its value today is called __________ valuation. A. complex B. current C. discounted cash flow D. future cash flow Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 4.02 Determine the present value of cash to be received at a future date Topic: Present value and discounting

11. A financially wise individual would prefer a loan based on __________ interest and an investment earning __________ interest.

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 04 Testbank

A. compound; compound B. compound; simple C. simple; compound D. simple; simple Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 4.01 Determine the future value of an investment made today Topic: Future value and compounding

12. Which one of the following is the correct formula for the future value of a lump sum invested today? A. FV = PV / (1 + r)t B. FV = PV / (1 + rt) C. FV = PV × rt D. FV = PV × (1 + r)t Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 4.01 Determine the future value of an investment made today Topic: Future value and compounding

13. Which one of the following is the correct formula for computing the present value of a lump sum to be received sometime in the future? A. PV = FV × (1 + t)r B. PV = FV × (1 + r)t C. PV = FV × rt D. PV = FV / (1 + r)t Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 4.02 Determine the present value of cash to be received at a future date Topic: Present value and discounting

14. All things being equal, the present value will __________ as the period of time decreases, provided there is an interest rate greater than zero. A. remain constant B. decrease C. increase D. either remain constant or decrease Ans: C

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 04 Testbank

AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 4.02 Determine the present value of cash to be received at a future date Topic: Present value and discounting

15. The present value of $10 000 to be received in 10 years will __________ if the discount rate is increased. A. remain constant B. decrease C. increase D. either remain constant or increase Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 4.02 Determine the present value of cash to be received at a future date Topic: Present value and discounting

16. The present value of a lump sum future amount _____, assuming that the interest rate is a positive value and all interest is reinvested. A. increases as the interest rate decreases B. decreases as the time period decreases C. is inversely related to the future value D. is directly related to the interest rate Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 4.02 Determine the present value of cash to be received at a future date Topic: Present value and discounting

17. Sue needs to invest $3626 today in order for her savings account to be worth $5000 six years from now. Which one of the following terms refers to the $3626? A. Present value B. Compound value C. Future value D. Complex value Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 4.02 Determine the present value of cash to be received at a future date Topic: Present value and discounting

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 04 Testbank

18. Lisa has $1000 in cash today. Which one of the following investment options is most likely to double her money? A. 6% interest for 3 years B. 12% interest for 5 years C. 7% interest for 9 years D. 8% interest for 9 years Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 4.04 Predict how long it takes for an investment to reach a desired value Topic: More on present and future values

19. The relationship between the present value and the time period is best described as: A. direct. B. inverse. C. unrelated. D. ambiguous. Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 4.03 Calculate the return on an investment Topic: More on present and future values

20. You want to invest an amount of money today and receive back twice that amount in the future. You expect to earn 8% interest. Approximately how long must you wait for your investment to double in value? A. Six years B. Seven years C. Eight years D. Nine years Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 4.04 Predict how long it takes for an investment to reach a desired value Topic: More on present and future values

21. When you were born, your parents opened an investment account in your name and deposited $500 into the account. The account has earned an average annual rate of return of 4.8%. Today, the account is valued at $36 911.22. How old are you? A. 74.47 years B. 76.67 years C. 81.08 years D. 91.75 years

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 04 Testbank

Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 4.04 Predict how long it takes for an investment to reach a desired value Topic: More on present and future values

22. Today, Tony is investing $16 000 at 6.5%, compounded annually, for four years. How much additional income could he earn if he had invested this amount at 7%, compounded annually? A. $323.22 B. $389.28 C. $401.16 D. $442.79 Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 4.03 Calculate the return on an investment Topic: More on present and future values

23. How long will it take to double your savings if you earn 3.6% interest, compounded annually? A. 17.78 years B. 18.04 years C. 18.67 years D. 19.60 years Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 4.04 Predict how long it takes for an investment to reach a desired value Topic: More on present and future values

24. You expect to receive $12 000 at graduation one year from now. You plan on investing it at 8% until you have $100 000. How long will you wait from now? A. 27.47 years B. 27.51 years C. 27.55 years D. 28.55 years Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 4.03 Calculate the return on an investment Topic: More on present and future values

Ross, Essentials of Corporate Finance, Fifth Edition

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25. You and your sister are planning a large anniversary party three years from today for your parents' 50th wedding anniversary. You have estimated that you will need $4500 for this party. You can earn 2.5% compounded annually on your savings. How much would you and your sister have to deposit today in one lump sum to pay for the entire party? A. $4076.55 B. $4178.70 C. $4308.16 D. $4334.90 Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 4.02 Determine the present value of cash to be received at a future date Topic: Present value and discounting

26. You have $1100 today and want to triple your money in five years. What interest rate must you earn if the interest is compounded annually? A. 18.08% B. 19.90% C. 22.15% D. 24.57% Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 4.04 Predict how long it takes for an investment to reach a desired value Topic: More on present and future values

27. You have been told that you need $25 600 today in order to have $100 000 when you retire 35 years from now. What rate of interest was used in the present value computation? Assume interest is compounded annually. A. 3.97% B. 4.15% C. 4.29% D. 4.53% Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 4.03 Calculate the return on an investment Topic: More on present and future values

28. Your friend claims that he invested $5000 seven years ago and that this investment is worth $38 700 today. For this to be true, what annual rate of return did he have to earn? Assume the interest compounds annually. A. 28.87%

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 04 Testbank

B. 31.39% C. 33.96% D. 36.01% Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 4.03 Calculate the return on an investment Topic: More on present and future values

29. Assume the total cost of a university education will be $285 000 when your child enters college in 22 years. You presently have $35 000 to invest. What annual rate of interest must you earn on your investment to cover the cost of your child's university education? A. 8.65% B. 9.40% C. 10.00% D. 10.60% Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 4.04 Predict how long it takes for an investment to reach a desired value Topic: More on present and future values

30. The present value of a conventional cash flow will ______ if the compounding rate increases. A. increase B. decrease C. remain the same D. either increase or decrease Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 4.02 Determine the present value of cash to be received at a future date Topic: Present value and discounting

31. Marcos is investing $5 today at 7% interest so he can have $35 later. This $35 is referred to as the: A. true value. B. future value. C. present value. D. discounted value. E. complex value. Ans: B

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 04 Testbank

AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 4.01 Determine the future value of an investment made today Topic: Future value and compounding

32. Katlyn needs to invest $5318 today in order for her savings account to be worth $8000 six years from now. Which one of the following terms refers to the $5318? A. Present value B. Compound value C. Future value D. Complex value E. Factor value Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 4.02 Determine the present value of cash to be received at a future date Topic: Present value and discounting

33. Lucas expects to receive a sales bonus of $7500 one year from now. The process of determining how much that bonus is worth today is called: A. aggregating. B. discounting. C. simplifying. D. compounding. E. extrapolating. Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 4.02 Determine the present value of cash to be received at a future date Topic: Present value and discounting

34. Computing the present value of a future cash flow to determine what that cash flow is worth today is called: A. compounding. B. factoring. C. time valuation. D. simple cash flow valuation. E. discounted cash flow valuation. Ans: E AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 4.02 Determine the present value of cash to be received at a future date Topic: Present value and discounting

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 04 Testbank

36. Lisa has $1000 in cash today. Which one of the following investment options is most likely to double her money? A. 6% interest for 3 years B. 12% interest for 5 years C. 7% interest for 9 years D. 8% interest for 9 years E. 6% interest for 10 years Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 4.04 Predict how long it takes for an investment to reach a desired value Topic: More on present and future values

37. The present value of a lump-sum future amount: A. increases as the interest rate decreases. B. decreases as the time period decreases. C. is inversely related to the future value. D. is directly related to the interest rate. E. is directly related to the time period. Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 4.02 Determine the present value of cash to be received at a future date Topic: Present value and discounting

38. The relationship between the present value and the investment time period is best described as: A. direct.

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 04 Testbank

B. inverse. C. unrelated. D. ambiguous. E. parallel. Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 4.04 Predict how long it takes for an investment to reach a desired value Topic: More on present and future values

39. Which one of the following is a correct statement, all else held constant? A. The present value is inversely related to the future value. B. The future value is inversely related to the period of time. C. The period of time is directly related to the interest rate. D. The present value is directly related to the interest rate. E. The future value is directly related to the interest rate. Ans: E AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 4.03 Calculate the return on an investment Topic: More on present and future values

40. You want to invest an amount of money today and receive back twice that amount in the future. You expect to earn 9% interest. Approximately how long must you wait for your investment to double in value? A. 6 years B. 7 years C. 8 years D. 12 years E. 14 years Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 4.04 Predict how long it takes for an investment to reach a desired value Topic: More on present and future values

41. What is the future value of $8000 invested today and held for 15 years at 8.5% compounded annually? A. $25 377.35 B. $27 197.94 C. $29 139.86 D. $29 509.77 E. $29 139.86

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 04 Testbank

Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 4.01 Determine the future value of an investment made today Topic: Future value and compounding

42. Travis invests $5500 today into a retirement account. He expects to earn 9.2%, compounded annually, on his money for the next 13 years. After that, he wants to be more conservative, so only expects to earn 6%, compounded annually. How much money will he have in his account when he retires 25 years from now, assuming this is the only deposit he makes into the account? A. $29 411.20 B. $34 747.80 C. $34 616.56 D. $41 919.67 E. $42 003.12 Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 4.01 Determine the future value of an investment made today Topic: Future value and compounding

43. Ten years ago, you deposited $5500 into an account. Five years ago, you added an additional $2500 to this account. You earned 6.5%, compounded annually, for the first five years and 5.0%, compounded annually, for the last five years. How much money do you have in your account today? A. $8 666.67 B. $11 391.09 C. $12 149.62 D. $12 808.09 E. $13,042.61 Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 4.01 Determine the future value of an investment made today Topic: Future value and compounding

44. Your parents spent $7800 to buy 200 shares in a new company 12 years ago. The shares have appreciated 14.6% per year on average. What is the current value of those 200 shares? A. $36 408.70 B. $40 023.03 C. $39 580.92 D. $40 515.08 E. $37 449.92

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 04 Testbank

Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 4.01 Determine the future value of an investment made today Topic: Future value and compounding

45. You just won $17 500 and deposited your winnings into an account that pays 6.7% interest, compounded annually. How long will you have to wait until your winnings are worth $50 000? A. 15.1 years B. 15.31 years C. 15.52 years D. 15.73 years E. 16.19 years Ans: E AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 4.04 Predict how long it takes for an investment to reach a desired value Topic: More on present and future values

46. When you were born, your parents opened an investment account in your name and deposited $1500 into the account. The account has earned an average annual rate of return of 5.3%. Today, the account is valued at $42 856. How old are you? A. 71.47 years B. 70.67 years C. 61.08 years D. 67.33 years E. 64.91 years Ans: E AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 4.04 Predict how long it takes for an investment to reach a desired value Topic: More on present and future values

47. Sixty years ago, your grandparents opened two savings accounts and deposited $250 in each account. The first account was with City Bank at 3.6%, compounded annually. The second account was with Country Bank at 3.65%, compounded annually. Which one of the following statements is true concerning these accounts? (Do not round intermediate calculations.) A. The City Bank account is currently worth $2076.42. B. The City Bank account has paid $48.19 more in interest than the Country Bank account. C. The Country Bank account is currently worth $2170.32. D. The Country Bank account has paid $72.24 more in interest than the City Bank account. E. The Country Bank account has paid $61.30 more in interest than the City Bank account. Ans: E

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 04 Testbank

AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 4.03 Calculate the return on an investment Topic: More on present and future values

48. Starlite Industries will need $2.2 million 4.5 years from now to replace some equipment. Currently, the firm has some extra cash and would like to establish a savings account for this purpose. The account pays 3.6% interest, compounded annually. How much money must the company deposit today to fully fund the equipment purchase? A. $1 679 947.20 B. $1 798 407.21 C. $1 350 868.47 D. $1 876 306.49 E. $1 412 308.18 Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 4.02 Determine the present value of cash to be received at a future date Topic: Present value and discounting

49. You and your sister are planning a large anniversary party three years from today for your parents' 50th wedding anniversary. You have estimated that you will need $6500 for this party. You can earn 2.6% compounded annually on your savings. How much would you and your sister have to deposit today in one lump sum to pay for the entire party? A. $6076.55 B. $6018.26 C. $6308.16 D. $5934.90 E. $5868.81 Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 4.02 Determine the present value of cash to be received at a future date Topic: Present value and discounting

50. Isaac only has $1090 today but needs $1979 to buy a new computer. How long will he have to wait to buy the computer if he earns 5.4% compounded annually on his savings? Assume the price of the computer remains constant. A. 11.83 years B. 11.48 years C. 12.51 years D. 12.77 years E. 11.34 years

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 04 Testbank

Ans: E AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 4.04 Predict how long it takes for an investment to reach a desired value Topic: More on present and future values

51. How long will it take to double your savings if you earn 6.4% interest, compounded annually? A. 11.89 years B. 12.02 years C. 11.39 years D. 11.17 years E. 10.58 years Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 4.04 Predict how long it takes for an investment to reach a desired value Topic: More on present and future values

52. You have $300 today and want to triple your money in five years. What interest rate must you earn if the interest is compounded annually? A. 16.99% B. 23.78% C. 23.28% D. 24.57% E. 31.61% Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 4.03 Calculate the return on an investment Topic: More on present and future values

53. Stephen claims that he invested $6000 six years ago and that this investment is worth $28 700 today. For this to be true, what annual rate of return did he have to earn? Assume the interest compounded annually. A. 28.87% B. 31.39% C. 29.80% D. 26.01% E. 27.87% Ans: C

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 04 Testbank

AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 4.03 Calculate the return on an investment Topic: More on present and future values

55. Assume the total cost of a college education will be $325 000 when your child enters college in 16 years. You presently have $40 000 to invest and do not plan to invest anything further. What annual rate of interest must you earn on your investment to cover the entire cost of your child's college education? A. 12.65% B. 10.40% C. 13.99% D. 14.62% E. 11.08% Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 4.03 Calculate the return on an investment Topic: More on present and future values

56. At 10% interest, how long does it take to triple your money? A. 14.33 years B. 11.53 years C. 9.67 years D. 10.36 years E. 10.56 years Ans: B

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 04 Testbank

AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 4.04 Predict how long it takes for an investment to reach a desired value Topic: More on present and future values

57. Suppose that in 2015, a $10 silver certificate from 1898 sold for $11 700. For this to have been true, what would the annual increase in the value of the certificate have been? A. 6.22% B. 6.01% C. 7.23% D. 6.49% E. 7.07% Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 4.03 Calculate the return on an investment Topic: More on present and future values

58. You have just made your first $5000 contribution to your retirement account. Assuming you earn a rate of return of 5% and make no additional contributions, what will your account be worth when you retire in 35 years? What if you wait for 5 years before contributing? A. $26 335.37; $23 011.60 B. $27 311.20; $29 803.04 C. $27 311.20; $22 614.08 D. $27 580.08; $21 609.71 E. $31 241.90; $32 614.08 Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 4.01 Determine the future value of an investment made today Topic: Future value and compounding

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 04 Testbank

AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 4.03 Calculate the return on an investment Topic: More on present and future values

60. You are due to receive a lump-sum payment of $2350 in seven years. Assuming a discount rate of 2.5% interest, what would be the value of the payment in Year 4? A. $1976.97 B. $2182.21 C. $2128.98 D. $2236.76 E. $2292.68 Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 4.02 Determine the present value of cash to be received at a future date Topic: Present value and discounting

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 04 Testbank

Chapter 04 Testbank Summary Category AACSB: Analytic Blooms: Analysis Difficulty: Easy Difficulty: Medium Learning Objective: 4.01 Determine the future value of an investment made today Learning Objective: 4.02 Determine the present value of cash to be received at a future date Learning Objective: 4.03 Calculate the return on an investment Learning Objective: 4.04 Predict how long it takes for an investment to reach a desired value Topic: Future value and compounding Topic: More on present and future values Topic: Present value and discounting

# of Questions 60 60 48 12 16 16 13 15 16 28 16

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 05 Testbank

Chapter 05 Testbank 1. Budvar-brewery company expects to receive the following cash inflows: $35 000 three years from now, $50 000 five years from now and $80 000 eight years from now. If the interest rate over the whole period is 8% per annum, compounded quarterly, the total present value of these cash flows (to the nearest dollar) is: A. $86 433. B. $103 696. C. $152 777. D. $99 998. 2. An investor wishes to accumulate $950 000 at the end of four-and-a-half years. How much does he need to deposit now, if the interest rate is 12% per annum, compounded monthly (to the nearest dollar)? A. $555 098 B. $496 251 C. $570 843 D. $611 115 3. You have approached Which Bank for a loan to buy a house. The bank offers you a $400 000 loan, repayable in equal monthly instalments at the end of each month for the next 20 years. If the interest rate on the loan is 9% per annum, compounded monthly, your monthly repayment (to the nearest dollar) will be: A. $1831. B. $3599. C. $2821. D. $4667. 4. A series of cash flows of equal amount, equally spaced in time is called a(n): A. perpetuity. B. present value factor. C. annuity. D. consol. 5. An annuity for which the cash flows occur at the beginning of each time period is called a(n): A. ordinary annuity. B. beginning annuity. C. annuity due. D. perpetuity.

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 05 Testbank

6. An annuity where the cash flows continue forever is called a(n): A. ordinary annuity. B. annuity due. C. absolute annuity. D. perpetuity. 7. In Canada and the United Kingdom, a perpetuity is also called a(n): A. consol. B. infinite bond. C. infinity flow. D. dowry. 8. The effective annual rate is defined as the interest rate that is: A. compounded at regular intervals throughout the year. B. equal to a monthly rate multiplied by 12. C. computed by multiplying the rate per period by the number of periods per year. D. expressed as if it were compounded once per year. 9. A pure discount loan can be defined as the: A. present value of a stream of payments to be paid over a period of time in the future. B. present value of a series of interest payments plus one single principal payment in the future. C. present value of a single lump sum to be repaid at some time in the future. D. single lump sum future value of a series of payments over a stated period of time. 10. Which one of the following is the correct formula for the present value of an ordinary annuity? A. C × {{1 - [1 / (1 + r)t]} / r} B. C × {1 - [1 / (1 + r)t]} × r C. C × {1 - [1 / (1 + r)t]} D. C × {{1 - [1 / (1 + r)t]} × r} 11. An increase in the amount of an annuity payment will: A. have no effect on the present value of the annuity. B. decrease the present value of the annuity. C. increase the value of the annuity present value interest factor. D. increase the future value of the annuity. 12. Which one of the following is the correct formula for computing the future value of an annuity? A. C × (Future value factor − 1) / r

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 05 Testbank

B. C × (Future value factor + 1) / r C. C / (Future value factor − 1) + r D. C × (Future value factor + 1) × r 13. A credit card has an APR of 18% and charges interest monthly. The effective annual rate on this account will: A. be less than 18%. B. be less than or equal to 18%. C. equal 18%. D. be greater than 18%. 14. Today you borrowed $1000 from your bank for five years at 8% interest. The loan requires that you make a payment of $80 one year from today. Based on this information, it appears that you have a(n): A. amortised loan. B. blended discounted loan. C. interest-only loan. D. pure discount loan. 15. Peter borrowed $10 000 from his bank and agreed to pay $1000 on the principal plus interest each year. This is an example of a(n): A. interest-only loan. B. amortised loan. C. perpetuity loan. D. pure discount loan. 16. Tom is planning to invest the following amounts at 4% interest. How much money will he have saved at the end of year 3?

A. $2200.00 B. $2238.47 C. $2272.80 D. $2309.16

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 05 Testbank

17. Webster Industrial Products just signed a sales contract with a new customer. What is this contract worth as of the end of year 4 if the following payments will be received and the firm earns 5% on its savings?

A. $397 425.35 B. $402 311.19 C. $460 000.00 D. $483 073.00 18. Jodie's Fashions has just signed a $2.2 million contract. The contract calls for a payment of $0.6 million today, $0.8 million one year from today and $0.8 million two years from today. What is this contract worth today if the firm can earn 7.2% on its money? A. $2 038 616.67 B. $2 042 414.79 C. $2 108 001.32 D. $2 124 339.07 19. Chandler Tire Co. is trying to decide which one of two projects it should accept. Both projects have the same start-up costs. Project 1 will produce annual cash flows of $52 000 a year for six years. Project 2 will produce cash flows of $48 000 a year for eight years. The company requires a 15% return. Which project should the company select and why? A. Project 1; because the annual cash flows are greater than those of Project 2. B. Project 1; because the present value of its cash inflows exceeds those of Project 2 by $14 211.62. C. Project 2; because the total cash inflows are $70 000 greater than those of Project 1. D. Project 2; because the present value of the cash inflows exceeds those of Project 1 by $18 598.33. 20. Kristi is considering an investment that will pay $5000 a year for seven years, starting one year from today. How much should she pay for this investment if she wishes to earn a 12% rate of return? A. $17 899.08 B. $18 023.88 C. $20 186.75 D. $22 818.78

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 05 Testbank

21. Today you are purchasing a 20-year, 6% annuity at a cost of $120 000. The annuity will pay annual payments starting one year from today. What is the amount of each payment? A. $9511.08 B. $10 462.15 C. $10 754.40 D. $11 013.20 22. Lee pays 1% per month interest on his credit card account. When his monthly rate is multiplied by 12, the resulting answer is referred to as the: A. annual percentage rate. B. compounded rate. C. effective annual rate. D. perpetual rate. 23. Witch bank is offering a term deposit that offers 12% per annum interest, compounding monthly. Dragon Bank is offering 12.3% per annum, compounding quarterly. Which of the following statements is true? A. It is better to invest in Dragon bank because the interest rate is higher. B. It is better to invest in Witch bank because the compounding periods are shorter. C. It is better to invest in Dragon bank as the EAR is higher than Witch bank. D. It is better to invest in Witch bank as the EAR is higher than Dragon bank. 24. Bondi Beachwear Pty Ltd has just purchased a new warehouse. To finance the purchase, they arranged for a 25-year mortgage for 80% of the $1 800 000 purchase price. The monthly payment on this loan will be $10 800. What is the APR? What is the EAR? A. 7.67%; 7.94% B. 7.67%; 8.03% C. 7.72%; 7.94% D. 7.72%; 8.03% 25. You have arranged a bank loan with your bank. You will have no monthly payments but have agreed to pay back $100 000 at the end of the year. The bank has stated that the annual interest rate they will charge you is 7.5%. What is the value of the loan? A. $107 500.00 B. $93 023.26 C. $99 378.88 D. $92 796.23 26. Dragon bank is offering student credit cards at a special low interest rate of 16% per annum. If monthly minimum payments are required and interest is charged on monthly balances, what is the effective annual rate (EAR)? A. 13.33%

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 05 Testbank

B. 15.96% C. 16.00% D. 17.23% 27. Which one of the following statements is correct? A. The APR is equal to the EAR for a loan that charges interest monthly. B. The EAR is always greater than the APR. C. The APR on a monthly loan is equal to (1 + monthly interest rate)12 – 1. D. The EAR, rather than the APR, should be used to compare both investment and loan options. 28. Popeye's Fried Chicken just took out an 8% interest-only loan of $50 000 for three years. Payments are to be made at the end of each year. What is the amount of the payment that will be due at the end of year three? A. $19 052.58 B. $20 166.67 C. $50 000.00 D. $54 000.00 29. Bill just financed a used car through his credit union. His loan requires payments of $275 a month for five years. Assuming that all payments are paid on time, his last payment will pay off the loan in full. What type of loan does Bill have? A. Amortised B. Complex C. Pure discount D. Lump sum 30. Krystal plans to save $500 at the end of Year 1, $600 at the end of Year 2 and $800 at the end of Year 3. If she earns 2.8% on her savings, how much money will she have saved at the end of Year 3? A. $1 676.51 B. $1 714.97 C. $1 945.19 D. $1 785.66 E. $1 878.69 31. Retreaded Tires plans to save $23 500, $24 500, $26 500 and $28 000 at the end of each year for Years 1 to 4, respectively. If it earns 2.1% on its savings, how much will the firm have saved at the end of Year 4? A. $100 878.30 B. $102 140.20 C. $105 608.11 D. $104 174.00

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 05 Testbank

E. $111 860.57 32. Moonlight Industries just signed a sales contract with a new customer. JK will receive annual payments in the amount of $50 000, $96 000, $123 000, and $138 000 at the end of Years 1 to 4, respectively. What is this contract worth at the end of Year 4 if the firm earns 3.75% on its savings? A. $443 571.88 B. $348 457.72 C. $431 417.66 D. $412 264.53 E. $424 786.07 33. Oakville Trucking just signed a $5.0 million contract. The contract calls for a payment of $1.25 million today, $1.75 million one year from today and $2.0 million two years from today. What is this contract worth today at a discount rate of 7.25%? A. $4 923 275.74 B. $4 620 444.63 C. $3 247 628.58 D. $4.341 851.15 E. $4 342 468.17 34. Tiger Trucking Company is considering a project that will produce cash inflows of $18 000 at the end of Year 1, $32 000 in Year 2 and $45 000 in Year 3. What is the present value of these cash inflows at a discount rate of 9%? A. $65 615.21 B. $70 181.89 C. $78 195.78 D. $78 485.76 E. $87 112.15 35. The manager of Furniture For Less has approved Mac's application for 36 months of credit with maximum monthly payments of $32. If the APR is 20.2 percent, what is the maximum initial purchase that Mac can buy on credit? A. $627.53 B. $1,047.91 C. $858.70 D. $870.58 E. $617.19 36. Which one of the following has the highest effective annual rate? A. 6% compounded annually B. 6% compounded semiannually

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 05 Testbank

C. 6% compounded quarterly D. 6% compounded daily E. 6% compounded every two years 37. Assume all else is equal. When comparing savings accounts, you should select the account that has the: A. lowest annual percentage rate. B. highest annual percentage rate. C. highest stated rate. D. lowest effective annual rate. E. highest effective annual rate. 38. A credit card has an annual percentage rate of 12.9% and charges interest monthly. The effective annual rate on this account: A. will be less than 12.9%. B. can either be less than or equal to 12.9%. C. is 12.9%. D. can either be greater than or equal to 12.9%. E. will be greater than 12.9%. 39. Which one of the following statements is correct? A. The APR is equal to the EAR for a loan that charges interest monthly. B. The EAR is always greater than the APR. C. The APR on a monthly loan is equal to (1 + monthly interest rate)12 − 1. D. The APR is the best measure of the actual rate you are paying on a loan. E. The EAR, rather than the APR, should be used to compare both investment and loan options. 40. A loan has an APR of 8.5% and an EAR of 8.5%. Given this, the loan must: A. have a one-year term. B. have a 0% interest rate. C. charge interest annually. D. must be partially amortised with each loan payment. E. require the accrued interest be paid in full with each monthly payment. 41. Dixie’s Markets offers credit to its customers and charges interest of 1.2% per month. What is the effective annual rate? A. 15.39% B. 14.61% C. 15.10% D. 15.51% E. 15.73%

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 05 Testbank

42. Sporting Goods charges 0.85% interest per month. What rate of interest are its credit customers actually paying? A. 11.00% B. 11.92% C. 10.26% D. 9.31% E. 10.69% 43. Scott borrowed $2500 today at an APR of 7.4%. The loan agreement requires him to repay $2685 in one lump sum payment one year from now. This type of loan is referred to as a(n): A. interest-only loan. B. pure discount loan. C. quoted rate loan. D. compound interest loan. E. amortised loan. 44. Cindy is taking out a loan today. The cash amount that she is receiving is equal to the present value of the lump sum payment that she will be required to pay two years from today. Which type of loan is this? A. Principal-only B. Amortised C. Interest-only D. Compound E. Pure discount 45. Travis borrowed $10 000 four years ago at an annual interest rate of 7%. The loan term is six years. Since he borrowed the money, Travis has been making annual payments of $700 to the bank. Which type of loan does he have? A. Interest-only B. Pure discount C. Compound D. Amortised E. Complex 46. Letitia borrowed $6000 from her bank two years ago. The loan term is four years. Each year, she must repay the bank $1500 plus the annual interest. Which type of loan does she have? A. Amortised B. Blended discount C. Interest-only D. Pure discount E. Complex

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 05 Testbank

47. Bill just financed a used car through his credit union. His loan requires payments of $275 a month for five years. Assuming that all payments are paid on time, his last payment will pay off the loan in full. What type of loan does Bill have? A. Amortised B. Complex C. Pure discount D. Lump sum E. Interest-only 48. You just borrowed $3000 from your bank and agreed to repay the interest on an annual basis and the principal at the end of three years. What type of loan did you obtain? A. Interest-only B. Amortised C. Perpetual D. Pure discount E. Lump sum 49. The Rent-to-Own Store has a six-year, interest-only loan at 7.6% interest. The firm originally borrowed $115 000. How much will the firm pay in total interest over the life of the loan? A. $32 451.13 B. $53 666.67 C. $47 500.00 D. $69 000.00 E. $52 440.00 50. Jeffries & Sons is borrowing $95 000 for four years at an APR of 7.05%. The principal is to be repaid in equal annual payments over the life of the loan with interest paid annually. Payments will be made at the end of each year. What is the total payment due for Year 3 of this loan? A. $28 224.90 B. $27 098.75 C. $25 424.38 D. $30 447.50 E. $28 773.13 51. Sheet Metals has an outstanding loan that calls for equal annual payments of $12 600.47 over the life of the loan. The original loan amount was $72 000 at an APR of 8.15%. How much of the third loan payment is interest? A. $5868.00 B. $4725.89 C. $4896.48 D. $5009.16 E. $4687.53

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 05 Testbank

52. Travis is buying a car and will finance it with a loan that requires monthly payments of $265 for the next four years. His car payments can be described by which one of the following terms? A. Perpetuity B. Annuity C. Consol D. Lump sum E. Present value 53. Janis just won a scholarship that will pay her $500 a month, starting today, continuing for the next 48 months. Which one of the following terms best describes these scholarship payments? A. Ordinary annuity B. Annuity due C. Consol D. Ordinary perpetuity E. Perpetuity due 54. The Jones Brothers recently established a trust fund that will provide annual scholarships of $12 000 indefinitely. These annual scholarships are: A. an ordinary annuity. B. an annuity due. C. amortised payments. D. a perpetuity. E. a perpetuity due. 55. A perpetuity in Canada is frequently referred to as: A. a consul. B. an infinity. C. forever cash. D. a dowry. E. a forevermore. 56. Which one of the following is the annuity present value formula? A. C × ({1 − [1 / (1 + r)t]} / r) B. C × ({1 − [1 / (1 + r)t]} − r) C. C × ({1 − [r / (1 + r)t]} / r) D. C × ({1 − [1 / (1 × r)t]} × r) E. C × ({1 − [r / (1 × r)t]} × r) 57. Which one of these is a perpetuity? A. Trust income of $1200 a year forever B. Retirement pay of $2200 a month for 20 years

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 05 Testbank

C. Lottery winnings of $1000 a month for life D. Car payment of $260 a month for 60 months E. Rental payment of $800 a month for one year 58. Which one of the following can be classified as an annuity but not as a perpetuity? A. Increasing monthly payments forever B. Increasing quarterly payments for six years C. Unequal payments each year for nine years D. Equal annual payments for life E. Equal weekly payments forever 59. Which one of the following statements concerning annuities is correct? A. The present value of an annuity is equal to the cash flow amount divided by the discount rate. B. An annuity due has payments that occur at the beginning of each time period. C. The future value of an annuity decreases as the interest rate increases. D. If unspecified, you should assume an annuity is an annuity due. E. An annuity is an unending stream of equal payments occurring at equal intervals of time. 60. The stated interest rate is the interest rate expressed: A. as if it were compounded one time per year. B. as the quoted rate compounded by 12 periods per year. C. in terms of the rate charged per day. D. in terms of the interest payment made each period. E. in terms of an effective rate.

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 05 Testbank

Chapter 05 Testbank Key 1. Budvar-brewery company expects to receive the following cash inflows: $35 000 three years from now, $50 000 five years from now and $80 000 eight years from now. If the interest rate over the whole period is 8% per annum, compounded quarterly, the total present value of these cash flows (to the nearest dollar) is: A. $86 433. B. $103 696. C. $152 777. D. $99 998. Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 5.01 Determine the future and present value of investments with multiple cash flows Topic: Future and present values of multiple cash flows

2. An investor wishes to accumulate $950 000 at the end of four-and-a-half years. How much does he need to deposit now, if the interest rate is 12% per annum, compounded monthly (to the nearest dollar)? A. $555 098 B. $496 251 C. $570 843 D. $611 115 Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 5.03 Describe how loans are amortised or paid off Topic: Comparing rates: the effect of compounding periods

3. You have approached Which Bank for a loan to buy a house. The bank offers you a $400 000 loan, repayable in equal monthly instalments at the end of each month for the next 20 years. If the interest rate on the loan is 9% per annum, compounded monthly, your monthly repayment (to the nearest dollar) will be: A. $1831. B. $3599. C. $2821. D. $4667. Ans: B

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 05 Testbank

AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 5.02 Calculate loan payments and find the interest rate on a loan Topic: Valuing level cash flows: annuities and perpetuities

4. A series of cash flows of equal amount, equally spaced in time is called a(n): A. perpetuity. B. present value factor. C. annuity. D. consol. Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 5.02 Calculate loan payments and find the interest rate on a loan Topic: Valuing level cash flows: annuities and perpetuities

5. An annuity for which the cash flows occur at the beginning of each time period is called a(n): A. ordinary annuity. B. beginning annuity. C. annuity due. D. perpetuity. Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 5.02 Calculate loan payments and find the interest rate on a loan Topic: Valuing level cash flows: annuities and perpetuities

6. An annuity where the cash flows continue forever is called a(n): A. ordinary annuity. B. annuity due. C. absolute annuity. D. perpetuity. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 5.02 Calculate loan payments and find the interest rate on a loan Topic: Valuing level cash flows: annuities and perpetuities

7. In Canada and the United Kingdom, a perpetuity is also called a(n): A. consol. B. infinite bond. C. infinity flow.

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 05 Testbank

D. dowry. Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 5.02 Calculate loan payments and find the interest rate on a loan Topic: Valuing level cash flows: annuities and perpetuities

8. The effective annual rate is defined as the interest rate that is: A. compounded at regular intervals throughout the year. B. equal to a monthly rate multiplied by 12. C. computed by multiplying the rate per period by the number of periods per year. D. expressed as if it were compounded once per year. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 5.03 Describe how loans are amortised or paid off Topic: Comparing rates: the effect of compounding periods

9. A pure discount loan can be defined as the: A. present value of a stream of payments to be paid over a period of time in the future. B. present value of a series of interest payments plus one single principal payment in the future. C. present value of a single lump sum to be repaid at some time in the future. D. single lump sum future value of a series of payments over a stated period of time. Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 5.04 Explain how interest rates are quoted (and misquoted) Topic: Loan types and loan amortisation

10. Which one of the following is the correct formula for the present value of an ordinary annuity? A. C × {{1 - [1 / (1 + r)t]} / r} B. C × {1 - [1 / (1 + r)t]} × r C. C × {1 - [1 / (1 + r)t]} D. C × {{1 - [1 / (1 + r)t]} × r} Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 5.02 Calculate loan payments and find the interest rate on a loan Topic: Valuing level cash flows: annuities and perpetuities

11. An increase in the amount of an annuity payment will:

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 05 Testbank

A. have no effect on the present value of the annuity. B. decrease the present value of the annuity. C. increase the value of the annuity present value interest factor. D. increase the future value of the annuity. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 5.01 Determine the future and present value of investments with multiple cash flows Topic: Future and present values of multiple cash flows

12. Which one of the following is the correct formula for computing the future value of an annuity? A. C × (Future value factor − 1) / r B. C × (Future value factor + 1) / r C. C / (Future value factor − 1) + r D. C × (Future value factor + 1) × r Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 5.02 Calculate loan payments and find the interest rate on a loan Topic: Valuing level cash flows: annuities and perpetuities

13. A credit card has an APR of 18% and charges interest monthly. The effective annual rate on this account will: A. be less than 18%. B. be less than or equal to 18%. C. equal 18%. D. be greater than 18%. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 5.03 Describe how loans are amortised or paid off Topic: Comparing rates: the effect of compounding periods

14. Today you borrowed $1000 from your bank for five years at 8% interest. The loan requires that you make a payment of $80 one year from today. Based on this information, it appears that you have a(n): A. amortised loan. B. blended discounted loan. C. interest-only loan. D. pure discount loan. Ans: C

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 05 Testbank

AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 5.04 Explain how interest rates are quoted (and misquoted) Topic: Loan types and loan amortisation

15. Peter borrowed $10 000 from his bank and agreed to pay $1000 on the principal plus interest each year. This is an example of a(n): A. interest-only loan. B. amortised loan. C. perpetuity loan. D. pure discount loan. Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 5.04 Explain how interest rates are quoted (and misquoted) Topic: Loan types and loan amortisation

16. Tom is planning to invest the following amounts at 4% interest. How much money will he have saved at the end of year 3?

A. $2200.00 B. $2238.47 C. $2272.80 D. $2309.16 Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 5.01 Determine the future and present value of investments with multiple cash flows Topic: Future and present values of multiple cash flows

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 05 Testbank

A. $397 425.35 B. $402 311.19 C. $460 000.00 D. $483 073.00 Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 5.01 Determine the future and present value of investments with multiple cash flows Topic: Future and present values of multiple cash flows

18. Jodie's Fashions has just signed a $2.2 million contract. The contract calls for a payment of $0.6 million today, $0.8 million one year from today and $0.8 million two years from today. What is this contract worth today if the firm can earn 7.2% on its money? A. $2 038 616.67 B. $2 042 414.79 C. $2 108 001.32 D. $2 124 339.07 Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 5.01 Determine the future and present value of investments with multiple cash flows Topic: Future and present values of multiple cash flows

19. Chandler Tire Co. is trying to decide which one of two projects it should accept. Both projects have the same start-up costs. Project 1 will produce annual cash flows of $52 000 a year for six years. Project 2 will produce cash flows of $48 000 a year for eight years. The company requires a 15% return. Which project should the company select and why? A. Project 1; because the annual cash flows are greater than those of Project 2. B. Project 1; because the present value of its cash inflows exceeds those of Project 2 by $14 211.62. C. Project 2; because the total cash inflows are $70 000 greater than those of Project 1. D. Project 2; because the present value of the cash inflows exceeds those of Project 1 by $18 598.33. Ans: D

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 05 Testbank

AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 5.01 Determine the future and present value of investments with multiple cash flows Topic: Future and present values of multiple cash flows

20. Kristi is considering an investment that will pay $5000 a year for seven years, starting one year from today. How much should she pay for this investment if she wishes to earn a 12% rate of return? A. $17 899.08 B. $18 023.88 C. $20 186.75 D. $22 818.78 Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 5.01 Determine the future and present value of investments with multiple cash flows Topic: Future and present values of multiple cash flows

21. Today you are purchasing a 20-year, 6% annuity at a cost of $120 000. The annuity will pay annual payments starting one year from today. What is the amount of each payment? A. $9511.08 B. $10 462.15 C. $10 754.40 D. $11 013.20 Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 5.02 Calculate loan payments and find the interest rate on a loan Topic: Valuing level cash flows: annuities and perpetuities

22. Lee pays 1% per month interest on his credit card account. When his monthly rate is multiplied by 12, the resulting answer is referred to as the: A. annual percentage rate. B. compounded rate. C. effective annual rate. D. perpetual rate. Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 5.03 Describe how loans are amortised or paid off Topic: Comparing rates: the effect of compounding periods

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 05 Testbank

23. Witch bank is offering a term deposit that offers 12% per annum interest, compounding monthly. Dragon Bank is offering 12.3% per annum, compounding quarterly. Which of the following statements is true? A. It is better to invest in Dragon bank because the interest rate is higher. B. It is better to invest in Witch bank because the compounding periods are shorter. C. It is better to invest in Dragon bank as the EAR is higher than Witch bank. D. It is better to invest in Witch bank as the EAR is higher than Dragon bank. Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 5.03 Describe how loans are amortised or paid off Topic: Comparing rates: the effect of compounding periods

24. Bondi Beachwear Pty Ltd has just purchased a new warehouse. To finance the purchase, they arranged for a 25-year mortgage for 80% of the $1 800 000 purchase price. The monthly payment on this loan will be $10 800. What is the APR? What is the EAR? A. 7.67%; 7.94% B. 7.67%; 8.03% C. 7.72%; 7.94% D. 7.72%; 8.03% Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 5.03 Describe how loans are amortised or paid off Topic: Comparing rates: the effect of compounding periods

25. You have arranged a bank loan with your bank. You will have no monthly payments but have agreed to pay back $100 000 at the end of the year. The bank has stated that the annual interest rate they will charge you is 7.5%. What is the value of the loan? A. $107 500.00 B. $93 023.26 C. $99 378.88 D. $92 796.23 Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 5.04 Explain how interest rates are quoted (and misquoted) Topic: Loan types and loan amortisation

26. Dragon bank is offering student credit cards at a special low interest rate of 16% per annum. If monthly minimum payments are required and interest is charged on monthly balances, what is the effective annual rate (EAR)? A. 13.33%

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 05 Testbank

B. 15.96% C. 16.00% D. 17.23% Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 5.03 Describe how loans are amortised or paid off Topic: Comparing rates: the effect of compounding periods

27. Which one of the following statements is correct? A. The APR is equal to the EAR for a loan that charges interest monthly. B. The EAR is always greater than the APR. C. The APR on a monthly loan is equal to (1 + monthly interest rate)12 – 1. D. The EAR, rather than the APR, should be used to compare both investment and loan options. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 5.03 Describe how loans are amortised or paid off Topic: Comparing rates: the effect of compounding periods

28. Popeye's Fried Chicken just took out an 8% interest-only loan of $50 000 for three years. Payments are to be made at the end of each year. What is the amount of the payment that will be due at the end of year three? A. $19 052.58 B. $20 166.67 C. $50 000.00 D. $54 000.00 Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 5.04 Explain how interest rates are quoted (and misquoted) Topic: Loan types and loan amortisation

29. Bill just financed a used car through his credit union. His loan requires payments of $275 a month for five years. Assuming that all payments are paid on time, his last payment will pay off the loan in full. What type of loan does Bill have? A. Amortised B. Complex C. Pure discount D. Lump sum Ans: A

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 05 Testbank

AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 5.04 Explain how interest rates are quoted (and misquoted) Topic: Loan types and loan amortisation

30. Krystal plans to save $500 at the end of Year 1, $600 at the end of Year 2 and $800 at the end of Year 3. If she earns 2.8% on her savings, how much money will she have saved at the end of Year 3? A. $1 676.51 B. $1 714.97 C. $1 945.19 D. $1 785.66 E. $1 878.69 Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Hard Learning Objective: 5.01 Determine the future and present value of investments with multiple cash flows Topic: Future and present values of multiple cash flows

31. Retreaded Tires plans to save $23 500, $24 500, $26 500 and $28 000 at the end of each year for Years 1 to 4, respectively. If it earns 2.1% on its savings, how much will the firm have saved at the end of Year 4? A. $100 878.30 B. $102 140.20 C. $105 608.11 D. $104 174.00 E. $111 860.57 Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Hard Learning Objective: 5.01 Determine the future and present value of investments with multiple cash flows Topic: Future and present values of multiple cash flows

32. Moonlight Industries just signed a sales contract with a new customer. JK will receive annual payments in the amount of $50 000, $96 000, $123 000, and $138 000 at the end of Years 1 to 4, respectively. What is this contract worth at the end of Year 4 if the firm earns 3.75% on its savings? A. $443 571.88 B. $348 457.72 C. $431 417.66 D. $412 264.53 E. $424 786.07 Ans: E

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 05 Testbank

AACSB: Analytic Blooms: Analysis Difficulty: Hard Learning Objective: 5.01 Determine the future and present value of investments with multiple cash flows Topic: Future and present values of multiple cash flows

33. Oakville Trucking just signed a $5.0 million contract. The contract calls for a payment of $1.25 million today, $1.75 million one year from today and $2.0 million two years from today. What is this contract worth today at a discount rate of 7.25%? A. $4 923 275.74 B. $4 620 444.63 C. $3 247 628.58 D. $4.341 851.15 E. $4 342 468.17 Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Hard Learning Objective: 5.01 Determine the future and present value of investments with multiple cash flows Topic: Future and present values of multiple cash flows

34. Tiger Trucking Company is considering a project that will produce cash inflows of $18 000 at the end of Year 1, $32 000 in Year 2 and $45 000 in Year 3. What is the present value of these cash inflows at a discount rate of 9%? A. $65 615.21 B. $70 181.89 C. $78 195.78 D. $78 485.76 E. $87 112.15 Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Hard Learning Objective: 5.01 Determine the future and present value of investments with multiple cash flows Topic: Future and present values of multiple cash flows

35. The manager of Furniture For Less has approved Mac's application for 36 months of credit with maximum monthly payments of $32. If the APR is 20.2 percent, what is the maximum initial purchase that Mac can buy on credit? A. $627.53 B. $1,047.91 C. $858.70 D. $870.58 E. $617.19 Ans: C

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 05 Testbank

AACSB: Analytic Blooms: Analysis Difficulty: Hard Learning Objective: 5.01 Determine the future and present value of investments with multiple cash flows Topic: Valuing level cash flows: annuities and perpetuities

36. Which one of the following has the highest effective annual rate? A. 6% compounded annually B. 6% compounded semiannually C. 6% compounded quarterly D. 6% compounded daily E. 6% compounded every two years Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 5.03 Describe how loans are amortised or paid off Topic: Comparing rates: the effect of compounding periods

37. Assume all else is equal. When comparing savings accounts, you should select the account that has the: A. lowest annual percentage rate. B. highest annual percentage rate. C. highest stated rate. D. lowest effective annual rate. E. highest effective annual rate. Ans: E AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 5.03 Describe how loans are amortised or paid off Topic: Comparing rates: the effect of compounding periods

38. A credit card has an annual percentage rate of 12.9% and charges interest monthly. The effective annual rate on this account: A. will be less than 12.9%. B. can either be less than or equal to 12.9%. C. is 12.9%. D. can either be greater than or equal to 12.9%. E. will be greater than 12.9%. Ans: E AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 5.03 Describe how loans are amortised or paid off Topic: Comparing rates: the effect of compounding periods

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 05 Testbank

39. Which one of the following statements is correct? A. The APR is equal to the EAR for a loan that charges interest monthly. B. The EAR is always greater than the APR. C. The APR on a monthly loan is equal to (1 + monthly interest rate)12 − 1. D. The APR is the best measure of the actual rate you are paying on a loan. E. The EAR, rather than the APR, should be used to compare both investment and loan options. Ans: E AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 5.03 Describe how loans are amortised or paid off Topic: Comparing rates: the effect of compounding periods

40. A loan has an APR of 8.5% and an EAR of 8.5%. Given this, the loan must: A. have a one-year term. B. have a 0% interest rate. C. charge interest annually. D. must be partially amortised with each loan payment. E. require the accrued interest be paid in full with each monthly payment. Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 5.03 Describe how loans are amortised or paid off Topic: Comparing rates: the effect of compounding periods

41. Dixie’s Markets offers credit to its customers and charges interest of 1.2% per month. What is the effective annual rate? A. 15.39% B. 14.61% C. 15.10% D. 15.51% E. 15.73% Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Hard Learning Objective: 5.03 Describe how loans are amortised or paid off Topic: Comparing rates: the effect of compounding periods

42. Sporting Goods charges 0.85% interest per month. What rate of interest are its credit customers actually paying? A. 11.00% B. 11.92% C. 10.26% D. 9.31%

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 05 Testbank

E. 10.69% Ans: E AACSB: Analytic Blooms: Analysis Difficulty: Hard Learning Objective: 5.03 Describe how loans are amortised or paid off Topic: Comparing rates: the effect of compounding periods

43. Scott borrowed $2500 today at an APR of 7.4%. The loan agreement requires him to repay $2685 in one lump sum payment one year from now. This type of loan is referred to as a(n): A. interest-only loan. B. pure discount loan. C. quoted rate loan. D. compound interest loan. E. amortised loan. Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 5.04 Explain how interest rates are quoted (and misquoted) Topic: Loan types and loan amortisation

44. Cindy is taking out a loan today. The cash amount that she is receiving is equal to the present value of the lump sum payment that she will be required to pay two years from today. Which type of loan is this? A. Principal-only B. Amortised C. Interest-only D. Compound E. Pure discount Ans: E AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 5.04 Explain how interest rates are quoted (and misquoted) Topic: Loan types and loan amortisation

45. Travis borrowed $10 000 four years ago at an annual interest rate of 7%. The loan term is six years. Since he borrowed the money, Travis has been making annual payments of $700 to the bank. Which type of loan does he have? A. Interest-only B. Pure discount C. Compound D. Amortised E. Complex Ans: A

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 05 Testbank

AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 5.04 Explain how interest rates are quoted (and misquoted) Topic: Loan types and loan amortisation

46. Letitia borrowed $6000 from her bank two years ago. The loan term is four years. Each year, she must repay the bank $1500 plus the annual interest. Which type of loan does she have? A. Amortised B. Blended discount C. Interest-only D. Pure discount E. Complex Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 5.04 Explain how interest rates are quoted (and misquoted) Topic: Loan types and loan amortisation

48. You just borrowed $3000 from your bank and agreed to repay the interest on an annual basis and the principal at the end of three years. What type of loan did you obtain? A. Interest-only B. Amortised C. Perpetual D. Pure discount E. Lump sum Ans: A

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 05 Testbank

AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 5.04 Explain how interest rates are quoted (and misquoted) Topic: Loan types and loan amortisation

49. The Rent-to-Own Store has a six-year, interest-only loan at 7.6% interest. The firm originally borrowed $115 000. How much will the firm pay in total interest over the life of the loan? A. $32 451.13 B. $53 666.67 C. $47 500.00 D. $69 000.00 E. $52 440.00 Ans: E AACSB: Analytic Blooms: Analysis Difficulty: Hard Learning Objective: 5.04 Explain how interest rates are quoted (and misquoted) Topic: Loan types and loan amortisation

50. Jeffries & Sons is borrowing $95 000 for four years at an APR of 7.05%. The principal is to be repaid in equal annual payments over the life of the loan with interest paid annually. Payments will be made at the end of each year. What is the total payment due for Year 3 of this loan? A. $28 224.90 B. $27 098.75 C. $25 424.38 D. $30 447.50 E. $28 773.13 Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Hard Learning Objective: 5.04 Explain how interest rates are quoted (and misquoted) Topic: Loan types and loan amortisation

51. Sheet Metals has an outstanding loan that calls for equal annual payments of $12 600.47 over the life of the loan. The original loan amount was $72 000 at an APR of 8.15%. How much of the third loan payment is interest? A. $5868.00 B. $4725.89 C. $4896.48 D. $5009.16 E. $4687.53 Ans: B

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 05 Testbank

AACSB: Analytic Blooms: Analysis Difficulty: Hard Learning Objective: 5.04 Explain how interest rates are quoted (and misquoted) Topic: Loan types and loan amortisation

52. Travis is buying a car and will finance it with a loan that requires monthly payments of $265 for the next four years. His car payments can be described by which one of the following terms? A. Perpetuity B. Annuity C. Consol D. Lump sum E. Present value Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 5.02 Calculate loan payments and find the interest rate on a loan Topic: Valuing level cash flows: annuities and perpetuities

53. Janis just won a scholarship that will pay her $500 a month, starting today, continuing for the next 48 months. Which one of the following terms best describes these scholarship payments? A. Ordinary annuity B. Annuity due C. Consol D. Ordinary perpetuity E. Perpetuity due Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 5.02 Calculate loan payments and find the interest rate on a loan Topic: Valuing level cash flows: annuities and perpetuities

54. The Jones Brothers recently established a trust fund that will provide annual scholarships of $12 000 indefinitely. These annual scholarships are: A. an ordinary annuity. B. an annuity due. C. amortised payments. D. a perpetuity. E. a perpetuity due. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 5.02 Calculate loan payments and find the interest rate on a loan Topic: Valuing level cash flows: annuities and perpetuities

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 05 Testbank

55. A perpetuity in Canada is frequently referred to as: A. a consul. B. an infinity. C. forever cash. D. a dowry. E. a forevermore. Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 5.02 Calculate loan payments and find the interest rate on a loan Topic: Valuing level cash flows: annuities and perpetuities

56. Which one of the following is the annuity present value formula? A. C × ({1 − [1 / (1 + r)t]} / r) B. C × ({1 − [1 / (1 + r)t]} − r) C. C × ({1 − [r / (1 + r)t]} / r) D. C × ({1 − [1 / (1 × r)t]} × r) E. C × ({1 − [r / (1 × r)t]} × r) Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 5.02 Calculate loan payments and find the interest rate on a loan Topic: Valuing level cash flows: annuities and perpetuities

57. Which one of these is a perpetuity? A. Trust income of $1200 a year forever B. Retirement pay of $2200 a month for 20 years C. Lottery winnings of $1000 a month for life D. Car payment of $260 a month for 60 months E. Rental payment of $800 a month for one year Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 5.02 Calculate loan payments and find the interest rate on a loan Topic: Valuing level cash flows: annuities and perpetuities

58. Which one of the following can be classified as an annuity but not as a perpetuity? A. Increasing monthly payments forever B. Increasing quarterly payments for six years C. Unequal payments each year for nine years D. Equal annual payments for life E. Equal weekly payments forever

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 05 Testbank

Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 5.02 Calculate loan payments and find the interest rate on a loan Topic: Valuing level cash flows: annuities and perpetuities

59. Which one of the following statements concerning annuities is correct? A. The present value of an annuity is equal to the cash flow amount divided by the discount rate. B. An annuity due has payments that occur at the beginning of each time period. C. The future value of an annuity decreases as the interest rate increases. D. If unspecified, you should assume an annuity is an annuity due. E. An annuity is an unending stream of equal payments occurring at equal intervals of time. Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 5.02 Calculate loan payments and find the interest rate on a loan Topic: Valuing level cash flows: annuities and perpetuities

60. The stated interest rate is the interest rate expressed: A. as if it were compounded one time per year. B. as the quoted rate compounded by 12 periods per year. C. in terms of the rate charged per day. D. in terms of the interest payment made each period. E. in terms of an effective rate. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 5.03 Describe how loans are amortised or paid off Topic: Comparing rates: the effect of compounding periods

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 05 Testbank

Chapter 05 Testbank Summary Category AACSB: Analytic Blooms: Analysis Difficulty: Easy Difficulty: Hard Difficulty: Medium Learning Objective: 5.01 Determine the future and present value of investments with multiple cash flows Learning Objective: 5.02 Calculate loan payments and find the interest rate on a loan Learning Objective: 5.03 Describe how loans are amortised or paid off Learning Objective: 5.04 Explain how interest rates are quoted (and misquoted) Topic: Comparing rates: the effect of compounding periods Topic: Future and present values of multiple cash flows Topic: Loan types and loan amortisation Topic: Valuing level cash flows: annuities and perpetuities

# of Questions 60 60 32 11 17 13 16 16 15 16 12 15 17

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 06 Testbank

Chapter 06 Testbank 1. Investors of government bonds require an 8% per annum real return. The inflation rate (CPI) is 5.50%. What is the exact nominal rate? A. 13.50% B. 10.50% C. 2.50% D. 13.94% 2. A 7% Commonwealth government bond has three years to maturity. Given that the bond pays interest semi-annually (i.e. twice a year) and an interest payment has just been made, what is the present value of the bond if the market interest rate is 9% and the face value of the bond is $100 000? A. $88 693.18 B. $94 842.13 C. $101 522.78 D. $105 875.28 3. A corporate bond has a face value of $10 000, a coupon rate of interest of 8.25% per annum, payable semi-annually, and six-and-a-half years remaining to maturity. The market interest rate for bonds of similar risk and maturity is currently 9.5% per annum, what is the present value of the bond? A. $9403.96 B. $10 828.96 C. $10 000 D. $9707.03 4. The interest rate of return that has not been adjusted for inflation is called a: A. real rate. B. nominal rate. C. yield to maturity. D. floating rate. 5. The Fisher effect illustrates the relationship between: A. the coupon rate and yield to maturity. B. nominal returns, real returns and inflation. C. yields on particular securities relative to their maturities. D. present and face value of the bond.

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 06 Testbank

6. The coupon rate is best defined as the: A. annual coupon divided by the current price of a bond. B. periodic payment divided by the premium value of a bond. C. semi-annual interest payment divided by the market price. D. annual coupon divided by the face value of a bond. 7. The rate required in the market on a bond is called the: A. yield to maturity. B. call yield. C. current yield. D. liquidity premium. 8. When interest payments on a bond are made directly to the owner of record, the bond is said to be in _______ form. A. bearer B. coupon C. street D. registered 9. When interest payments are made to whoever holds the bond, the bond is said to be in _____ form. A. bearer B. coupon C. street D. registered 10. A bond that pays no regular interest payments is called a(n) _____ bond. A. exotic B. income C. zero coupon D. convertible 11. The interest rate risk premium is the compensation investors require for their assumption of the risk related to: A. the convertibility of a bond. B. the taxability of a bond. C. inflation rate fluctuations. D. changes in interest rates. 12. The portion of a bond's yield that compensates investors for the possibility that the bond's interest or principal might not be paid is called the:

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 06 Testbank

A. interest rate risk premium. B. missed coupon rate. C. liquidity premium. D. default risk premium. 13. The liquidity premium is the portion of a nominal interest rate that represents compensation for the: A. difference between short-term and long-term tax rates. B. difference in the maturity term of a short-term versus a long-term bond. C. lack of the ability to sell the bond at its fair value in a timely manner. D. changes in interest rates and the resulting changes in bond prices. 14. The general purpose of protective covenants is to help protect the: A. company, in the case of rising interest rates. B. company, in the case of rapid growth. C. lenders, from company actions contrary to the lenders' benefit. D. lenders, from early calls of their bonds. 15. The lowest rating a bond can receive from Moody's and still be classified as investment grade is: A. A. B. BBB. C. B. D. Baa. 16. A convertible bond has features of both debt and equity because the: A. bond pays both interest and dividends. B. bondholders have voting rights. C. bondholder can force the firm to redeem the bond at any time. D. bond can be exchanged for shares. 17. Which party to a bill of exchange is primarily responsible for the payment of the face value to the holder at maturity? A. The drawer B. The endorser C. The acceptor D. The borrower 18. What is the principal amount of a bond that is repaid at the end of the loan term called? A. Coupon B. Market price

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 06 Testbank

C. Accrued price D. Face value 19. Which one of the following is the rate of return an investor earns on a bond before adjusting for inflation? A. Nominal rate B. Real rate C. Dirty rate D. Coupon rate 20. Which one of the following refers to the relationship between nominal returns, real returns and inflation? A. Call premium B. Fisher effect C. Conversion ratio D. Bid-ask spread 21. Which one of the following represents additional compensation provided to bondholders to offset the possibility that the bond issuer might not pay the interest and/or principal payments as expected? A. Interest rate risk premium B. Inflation premium C. Liquidity premium D. Default risk premium 22. The government bond yield curve plots the yields on government bonds relative to the ____ of those securities. A. face value B. market price C. maturity D. coupon rate 23. Which of the following ratings indicate that a bond is low quality? I. Baa II. BB III. B IV. Ba A. II only B. II and III only C. II, III and IV only D. I, II and III only

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 06 Testbank

24. Which one of the following provides compensation to a bondholder when a bond is not readily marketable at its full value? A. Interest rate risk premium B. Inflation premium C. Liquidity premium D. Taxability premium 25. An unexpected decrease in market interest rates will cause a: A. coupon bond's current yield to increase. B. zero coupon bond's price to decrease. C. fixed-rate bond's coupon rate to decrease. D. coupon bond's yield to maturity to decrease. 26. In relation to bonds, which one of the following terms has the same meaning as the term 'crossover'? A. Speculative B. 5B C. Fallen angel D. Junk 27. If inflation is expected to steadily decrease in the future, the term structure of interest rates will most likely be: A. upward sloping. B. flat. C. humped. D. downward sloping. 28. A 12-year, half-yearly coupon bond is priced at $1102.60. The bond has a $1000 face value and a yield to maturity of 5.33%. What is the coupon rate? A. 5.00% B. 5.25% C. 5.50% D. 6.50% 29. Global Trade Inc. has $1000 face value bonds outstanding with a market price of $1013. The bonds pay interest annually, mature in 11 years and have a yield to maturity of 5.34%. What is the current yield? A. 5.39% B. 5.43% C. 5.50% D. 5.61%

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 06 Testbank

30. A bond has an 8% coupon rate, a face value of $1000, half yearly payments and sells at par. The current yield is _____% and the effective annual yield is _____%. A. 6.76; 6.8 B. 6.76; 6.96 C. 7.00; 7.00 D. 8.00; 8.16 31. What condition must exist if a bond’s coupon rate is to equal both the bond’s current yield and its yield to maturity? Assume the market rate of interest for this bond is positive. A. The clean price of the bond must equal the bond’s dirty price. B. The bond must be a zero coupon bond and mature in exactly one year. C. The market price must exceed the par value by the value of one year’s interest. D. The bond must be priced at par. E. There is no condition under which this can occur. 32. On which one of the following dates is the principal amount of a semi-annual coupon bond repaid? A. A portion of the principal is repaid on each coupon date. B. The entire bond is repaid on the issue date. C. Half of the principal is repaid evenly over each coupon period with the remainder paid on the issue date. D. The entire bond is repaid on the maturity date. E. Half of the principal is repaid evenly over each coupon period with the remainder paid on the maturity date. 33. The current yield on a bond is equal to the annual interest divided by the: A. issue price. B. maturity value. C. face amount. D. current market price. E. current par value. 34. The written agreement that contains the specific details related to a bond issue is called the bond: A. indenture. B. debenture. C. document. D. registration statement. E. issue paper. 35. This morning, Jeff found an aged bond certificate lying on the street. He picked it up and noticed that it was a 50-year bond that matured today. He presented the bond to the bank teller at

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 06 Testbank

his local bank and received payment for both the entire principal and the final interest payment. The bond that Jeff found must have been which one of the following? A. Debenture B. Note C. Registered-form bond D. Bearer-form bond E. Callable bond 36. What term is used to describe an account that a bond trustee manages for the sole purpose of redeeming bonds early? A. Registered account B. Bearer account C. Call account D. Sinking fund E. Premium fund 37. Travis recently purchased a callable bond. However, that bond cannot be currently redeemed by the issuer. Thus, the bond must currently be: A. subject to a sinking fund provision. B. a debenture. C. a fallen angel. D. call protected. E. unrated. 38. A company originally issued bonds that were rated investment grade. These bonds have now been downgraded to junk status. These bonds are referred to as: A. called bonds. B. converted bonds. C. unprotected bonds. D. fallen angels. E. floaters. 39. The price at which a dealer will purchase a bond is referred to as the _____ price. A. asking B. face C. call D. put E. bid 40. A real rate of return is defined as a rate that has been adjusted for which one of the following? A. Inflation

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 06 Testbank

B. Interest rate risk C. Taxes D. Liquidity E. Default risk 41. The term structure of interest rates represents the relationship between which of the following? A. Nominal rates on risk-free and risky bonds B. Real rates on risk-free and risky bonds C. Nominal and real rates on default-free, pure discount bonds D. Market and coupon rates on default-free, pure discount bonds E. Nominal rates on default-free, pure discount bonds and time to maturity 42. The inflation premium: A. increases the real return. B. is inversely related to the time to maturity. C. remains constant over time. D. rewards investors for accepting interest rate risk. E. compensates investors for expected price increases. 43. The Treasury yield curve plots the yields on Treasury notes and bonds relative to the ____ of those securities. A. face value B. market price C. maturity D. coupon rate E. issue date 44. Which one of the following premiums is paid on a corporate bond due to its tax status? A. Interest rate risk premium B. Inflation premium C. Liquidity premium D. Taxability premium E. Default risk premium 45. Bond ratings classify bonds based on: A. liquidity, market and default risk. B. liquidity, interest rate and default risk. C. default risk only. D. interest rate, inflation rate and default risk. E. default and liquidity risks.

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 06 Testbank

46. A floating-rate bond frequently has a: A. flexible deferred call period. B. fixed yield to maturity but a flexible coupon payment. C. government guarantee. D. fixed-dollar obligation. E. put provision. 47. The R in the Fisher effect formula represents the: A. current yield. B. real return. C. coupon rate. D. inflation rate. E. nominal return. 48. An upward-sloping term structure of interest rates indicates: A. the real rate of return is lower for short-term bonds than for long-term bonds. B. there is an indirect relationship between real interest rates and time to maturity. C. there is an indirect relationship between nominal interest rates and time to maturity. D. the nominal rate is declining as the real rate rises as the time to maturity increases. E. the nominal rate is increasing even though the real rate is constant as the time to maturity increases. 49. Suppose that a small rural city in the countryside of North Dakota plans to issue $150 000 worth of 10-year bonds. Which one of the following components of the bond's yield will be affected by the fact that no active secondary market is expected for these bonds? A. Real rate B. Liquidity premium C. Interest rate risk premium D. Inflation premium E. Taxability premium 50. Which one of the following bonds is most likely to have the smallest liquidity premium? A. Treasury bill B. Corporate bond issued by a new firm C. Municipal bond issued by the State of New York D. Municipal bond issued by a rural city in Alaska E. Corporate bond issued by General Motors (GM) 51. A corporate bond pays 6.25% interest. How much would a municipal bond have to pay to be equivalent to this on an after-tax basis if you are in the 28% marginal tax bracket? A. 7.82% B. 5.79%

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 06 Testbank

C. 4.50% D. 7.26% E. 8.38% 52. Variance Logistics wants to issue 20-year, zero-coupon bonds that yield 6.2%. What price should it charge for these bonds if the face value is $1000? Assume semi-annual compounding. A. $288.15 B. $294.89 C. $543.03 D. $562.03 E. $326.45 53. Deltona Motors just issued 230 000 zero-coupon bonds. These bonds mature in 18 years, have a par value of $1000 and have a yield to maturity of 5.9%. What is the approximate total amount of money the company raised from issuing these bonds? Assume semi-annual compounding. A. $88.20 million B. $80.76 million C. $75.14 million D. $62.08 million E. $91.84 million 54. Today, you are buying a $1000 face value bond at an invoice price of $987. The bond has a coupon rate of 6% and pays interest semi-annually. There are two months until the next coupon date. What is the clean price of this bond? A. $947 B. $957 C. $967 D. $977 E. $987 55. Last year, you earned a rate of return of 5.89% on your bond investments. During that time, the inflation rate was 1.2%. What was your real rate of return? A. 4.58% B. 4.69% C. 4.72% D. 4.63% E. 4.60% 56. A bond yielded a real rate of return of 3.87% for a time period when the inflation rate was 3.75%. What was the actual nominal rate of return? A. 87.58%

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 06 Testbank

B. 7.62% C. 7.77% D. 8.28% E. .36% 57. If your nominal rate of return is 8.68% and your real rate of return is 2.05%, what is the inflation rate? A. 5.32% B. 6.50% C. 6.29% D. 6.63% E. 16.77% 58. If Treasury bills are currently paying 3.05% and the inflation rate is 1.89%, what is the approximate real rate of interest? The exact real rate? A. 1.16%; 1.14% B. 1.21%; 1.14% C. 1.20%; 1.21% D. 1.19%; 1.16% E. 1.19%; 1.21% 59. The 6.4% bond of Berberich Inc. has a yield to maturity of 6.9%. The bond matures in 11 years, has a face value of $1000 and pays semi-annual interest payments. What is the amount of each coupon payment? A. $30.00 B. $32.00 C. $34.50 D. $69.00 E. $64.00 60. The 5.3% bond of Dominic Cycle Parts has a face value of $1000, a maturity of 12 years, semi-annual interest payments and a yield to maturity of 6.12%. What is the current market price of the bond? A. $945.08 B. $959.33 C. $931.01 D. $1,072.13 E. $912.40

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 06 Testbank

Chapter 06 Testbank Key 1. Investors of government bonds require an 8% per annum real return. The inflation rate (CPI) is 5.50%. What is the exact nominal rate? A. 13.50% B. 10.50% C. 2.50% D. 13.94% Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 6.04 Evaluate the impact of inflation on interest rates Topic: Inflation and interest rates

2. A 7% Commonwealth government bond has three years to maturity. Given that the bond pays interest semi-annually (i.e. twice a year) and an interest payment has just been made, what is the present value of the bond if the market interest rate is 9% and the face value of the bond is $100 000? A. $88 693.18 B. $94 842.13 C. $101 522.78 D. $105 875.28 Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 6.02 Describe how bills and bonds are valued and why they fluctuate in value Topic: Bonds and bond valuation

3. A corporate bond has a face value of $10 000, a coupon rate of interest of 8.25% per annum, payable semi-annually, and six-and-a-half years remaining to maturity. The market interest rate for bonds of similar risk and maturity is currently 9.5% per annum, what is the present value of the bond? A. $9403.96 B. $10 828.96 C. $10 000 D. $9707.03 Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 6.01 Identify important features and different types of bills and bonds Topic: Bonds and bond valuation

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 06 Testbank

4. The interest rate of return that has not been adjusted for inflation is called a: A. real rate. B. nominal rate. C. yield to maturity. D. floating rate. Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 6.04 Evaluate the impact of inflation on interest rates Topic: Inflation and interest rates

5. The Fisher effect illustrates the relationship between: A. the coupon rate and yield to maturity. B. nominal returns, real returns and inflation. C. yields on particular securities relative to their maturities. D. present and face value of the bond. Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 6.04 Evaluate the impact of inflation on interest rates Topic: Inflation and interest rates

7. The rate required in the market on a bond is called the: A. yield to maturity. B. call yield. C. current yield. D. liquidity premium. Ans: A

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 06 Testbank

AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 6.02 Describe how bills and bonds are valued and why they fluctuate in value Topic: Bonds and bond valuation

8. When interest payments on a bond are made directly to the owner of record, the bond is said to be in _______ form. A. bearer B. coupon C. street D. registered Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 6.01 Identify important features and different types of bills and bonds Topic: More on bond features

9. When interest payments are made to whoever holds the bond, the bond is said to be in _____ form. A. bearer B. coupon C. street D. registered Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 6.01 Identify important features and different types of bills and bonds Topic: More on bond features

10. A bond that pays no regular interest payments is called a(n) _____ bond. A. exotic B. income C. zero coupon D. convertible Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 6.03 Discuss bond ratings and what they mean Topic: Some different types of bonds

11. The interest rate risk premium is the compensation investors require for their assumption of the risk related to:

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 06 Testbank

A. the convertibility of a bond. B. the taxability of a bond. C. inflation rate fluctuations. D. changes in interest rates. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 6.05 Explain the term structure of interest rates and the determinants of bond yields Topic: Determinants of bond yields

12. The portion of a bond's yield that compensates investors for the possibility that the bond's interest or principal might not be paid is called the: A. interest rate risk premium. B. missed coupon rate. C. liquidity premium. D. default risk premium. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 6.05 Explain the term structure of interest rates and the determinants of bond yields Topic: Determinants of bond yields

13. The liquidity premium is the portion of a nominal interest rate that represents compensation for the: A. difference between short-term and long-term tax rates. B. difference in the maturity term of a short-term versus a long-term bond. C. lack of the ability to sell the bond at its fair value in a timely manner. D. changes in interest rates and the resulting changes in bond prices. Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 6.05 Explain the term structure of interest rates and the determinants of bond yields Topic: Determinants of bond yields

14. The general purpose of protective covenants is to help protect the: A. company, in the case of rising interest rates. B. company, in the case of rapid growth. C. lenders, from company actions contrary to the lenders' benefit. D. lenders, from early calls of their bonds. Ans: C

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 06 Testbank

AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 6.01 Identify important features and different types of bills and bonds Topic: More on bond features

15. The lowest rating a bond can receive from Moody's and still be classified as investment grade is: A. A. B. BBB. C. B. D. Baa. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 6.03 Discuss bond ratings and what they mean Topic: Bond ratings

16. A convertible bond has features of both debt and equity because the: A. bond pays both interest and dividends. B. bondholders have voting rights. C. bondholder can force the firm to redeem the bond at any time. D. bond can be exchanged for shares. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 6.03 Discuss bond ratings and what they mean Topic: Some different types of bonds

17. Which party to a bill of exchange is primarily responsible for the payment of the face value to the holder at maturity? A. The drawer B. The endorser C. The acceptor D. The borrower Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 6.01 Identify important features and different types of bills and bonds Topic: Bills of exchange and bill valuation

18. What is the principal amount of a bond that is repaid at the end of the loan term called? A. Coupon

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 06 Testbank

B. Market price C. Accrued price D. Face value Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 6.02 Describe how bills and bonds are valued and why they fluctuate in value Topic: Bonds and bond valuation

19. Which one of the following is the rate of return an investor earns on a bond before adjusting for inflation? A. Nominal rate B. Real rate C. Dirty rate D. Coupon rate Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 6.04 Evaluate the impact of inflation on interest rates Topic: Inflation and interest rates

20. Which one of the following refers to the relationship between nominal returns, real returns and inflation? A. Call premium B. Fisher effect C. Conversion ratio D. Bid-ask spread Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 6.04 Evaluate the impact of inflation on interest rates Topic: Inflation and interest rates

21. Which one of the following represents additional compensation provided to bondholders to offset the possibility that the bond issuer might not pay the interest and/or principal payments as expected? A. Interest rate risk premium B. Inflation premium C. Liquidity premium D. Default risk premium Ans: D

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 06 Testbank

AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 6.05 Explain the term structure of interest rates and the determinants of bond yields Topic: Determinants of bond yields

22. The government bond yield curve plots the yields on government bonds relative to the ____ of those securities. A. face value B. market price C. maturity D. coupon rate Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 6.03 Discuss bond ratings and what they mean Topic: Bond markets

23. Which of the following ratings indicate that a bond is low quality? I. Baa II. BB III. B IV. Ba A. II only B. II and III only C. II, III and IV only D. I, II and III only Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 6.03 Discuss bond ratings and what they mean Topic: Bond ratings

24. Which one of the following provides compensation to a bondholder when a bond is not readily marketable at its full value? A. Interest rate risk premium B. Inflation premium C. Liquidity premium D. Taxability premium Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 6.05 Explain the term structure of interest rates and the determinants of bond yields Topic: Determinants of bond yields

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 06 Testbank

25. An unexpected decrease in market interest rates will cause a: A. coupon bond's current yield to increase. B. zero coupon bond's price to decrease. C. fixed-rate bond's coupon rate to decrease. D. coupon bond's yield to maturity to decrease. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 6.01 Identify important features and different types of bills and bonds Topic: Bonds and bond valuation

26. In relation to bonds, which one of the following terms has the same meaning as the term 'crossover'? A. Speculative B. 5B C. Fallen angel D. Junk Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 6.03 Discuss bond ratings and what they mean Topic: Bond ratings

27. If inflation is expected to steadily decrease in the future, the term structure of interest rates will most likely be: A. upward sloping. B. flat. C. humped. D. downward sloping. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 6.05 Explain the term structure of interest rates and the determinants of bond yields Topic: Determinants of bond yields

28. A 12-year, half-yearly coupon bond is priced at $1102.60. The bond has a $1000 face value and a yield to maturity of 5.33%. What is the coupon rate? A. 5.00% B. 5.25% C. 5.50% D. 6.50% Ans: D

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 06 Testbank

AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 6.01 Identify important features and different types of bills and bonds Topic: Bonds and bond valuation

29. Global Trade Inc. has $1000 face value bonds outstanding with a market price of $1013. The bonds pay interest annually, mature in 11 years and have a yield to maturity of 5.34%. What is the current yield? A. 5.39% B. 5.43% C. 5.50% D. 5.61% Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Hard Learning Objective: 6.02 Describe how bills and bonds are valued and why they fluctuate in value Topic: Bonds and bond valuation

30. A bond has an 8% coupon rate, a face value of $1000, half yearly payments and sells at par. The current yield is _____% and the effective annual yield is _____%. A. 6.76; 6.8 B. 6.76; 6.96 C. 7.00; 7.00 D. 8.00; 8.16 Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 6.02 Describe how bills and bonds are valued and why they fluctuate in value Topic: Bonds and bond valuation

31. What condition must exist if a bond’s coupon rate is to equal both the bond’s current yield and its yield to maturity? Assume the market rate of interest for this bond is positive. A. The clean price of the bond must equal the bond’s dirty price. B. The bond must be a zero coupon bond and mature in exactly one year. C. The market price must exceed the par value by the value of one year’s interest. D. The bond must be priced at par. E. There is no condition under which this can occur. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 6.02 Describe how bills and bonds are valued and why they fluctuate in value Topic: Bonds and bond valuation

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 06 Testbank

32. On which one of the following dates is the principal amount of a semi-annual coupon bond repaid? A. A portion of the principal is repaid on each coupon date. B. The entire bond is repaid on the issue date. C. Half of the principal is repaid evenly over each coupon period with the remainder paid on the issue date. D. The entire bond is repaid on the maturity date. E. Half of the principal is repaid evenly over each coupon period with the remainder paid on the maturity date. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 6.02 Describe how bills and bonds are valued and why they fluctuate in value Topic: Bonds and bond valuation

33. The current yield on a bond is equal to the annual interest divided by the: A. issue price. B. maturity value. C. face amount. D. current market price. E. current par value. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 6.02 Describe how bills and bonds are valued and why they fluctuate in value Topic: Bonds and bond valuation

34. The written agreement that contains the specific details related to a bond issue is called the bond: A. indenture. B. debenture. C. document. D. registration statement. E. issue paper. Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 6.01 Identify important features and different types of bills and bonds Topic: More on bond features

35. This morning, Jeff found an aged bond certificate lying on the street. He picked it up and noticed that it was a 50-year bond that matured today. He presented the bond to the bank teller at

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 06 Testbank

his local bank and received payment for both the entire principal and the final interest payment. The bond that Jeff found must have been which one of the following? A. Debenture B. Note C. Registered-form bond D. Bearer-form bond E. Callable bond Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 6.01 Identify important features and different types of bills and bonds Topic: More on bond features

36. What term is used to describe an account that a bond trustee manages for the sole purpose of redeeming bonds early? A. Registered account B. Bearer account C. Call account D. Sinking fund E. Premium fund Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 6.01 Identify important features and different types of bills and bonds Topic: More on bond features

37. Travis recently purchased a callable bond. However, that bond cannot be currently redeemed by the issuer. Thus, the bond must currently be: A. subject to a sinking fund provision. B. a debenture. C. a fallen angel. D. call protected. E. unrated. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 6.01 Identify important features and different types of bills and bonds Topic: More on bond features

38. A company originally issued bonds that were rated investment grade. These bonds have now been downgraded to junk status. These bonds are referred to as: A. called bonds. B. converted bonds.

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 06 Testbank

C. unprotected bonds. D. fallen angels. E. floaters. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 6.03 Discuss bond ratings and what they mean Topic: Bond ratings

39. The price at which a dealer will purchase a bond is referred to as the _____ price. A. asking B. face C. call D. put E. bid Ans: E AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 6.03 Discuss bond ratings and what they mean Topic: Bond markets

40. A real rate of return is defined as a rate that has been adjusted for which one of the following? A. Inflation B. Interest rate risk C. Taxes D. Liquidity E. Default risk Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 6.04 Evaluate the impact of inflation on interest rates Topic: Inflation and interest rates

41. The term structure of interest rates represents the relationship between which of the following? A. Nominal rates on risk-free and risky bonds B. Real rates on risk-free and risky bonds C. Nominal and real rates on default-free, pure discount bonds D. Market and coupon rates on default-free, pure discount bonds E. Nominal rates on default-free, pure discount bonds and time to maturity Ans: E

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 06 Testbank

AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 6.05 Explain the term structure of interest rates and the determinants of bond yields Topic: Determinants of bond yields

42. The inflation premium: A. increases the real return. B. is inversely related to the time to maturity. C. remains constant over time. D. rewards investors for accepting interest rate risk. E. compensates investors for expected price increases. Ans: E AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 6.05 Explain the term structure of interest rates and the determinants of bond yields Topic: Determinants of bond yields

43. The Treasury yield curve plots the yields on Treasury notes and bonds relative to the ____ of those securities. A. face value B. market price C. maturity D. coupon rate E. issue date Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 6.05 Explain the term structure of interest rates and the determinants of bond yields Topic: Determinants of bond yields

44. Which one of the following premiums is paid on a corporate bond due to its tax status? A. Interest rate risk premium B. Inflation premium C. Liquidity premium D. Taxability premium E. Default risk premium Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 6.05 Explain the term structure of interest rates and the determinants of bond yields Topic: Determinants of bond yields

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 06 Testbank

45. Bond ratings classify bonds based on: A. liquidity, market and default risk. B. liquidity, interest rate and default risk. C. default risk only. D. interest rate, inflation rate and default risk. E. default and liquidity risks. Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 6.03 Discuss bond ratings and what they mean Topic: Bond ratings

46. A floating-rate bond frequently has a: A. flexible deferred call period. B. fixed yield to maturity but a flexible coupon payment. C. government guarantee. D. fixed-dollar obligation. E. put provision. Ans: E AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 6.03 Discuss bond ratings and what they mean Topic: Some different types of bonds

47. The R in the Fisher effect formula represents the: A. current yield. B. real return. C. coupon rate. D. inflation rate. E. nominal return. Ans: E AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 6.04 Evaluate the impact of inflation on interest rates Topic: Inflation and interest rates

48. An upward-sloping term structure of interest rates indicates: A. the real rate of return is lower for short-term bonds than for long-term bonds. B. there is an indirect relationship between real interest rates and time to maturity. C. there is an indirect relationship between nominal interest rates and time to maturity. D. the nominal rate is declining as the real rate rises as the time to maturity increases. E. the nominal rate is increasing even though the real rate is constant as the time to maturity increases.

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 06 Testbank

Ans: E AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 6.05 Explain the term structure of interest rates and the determinants of bond yields Topic: Determinants of bond yields

49. Suppose that a small rural city in the countryside of North Dakota plans to issue $150 000 worth of 10-year bonds. Which one of the following components of the bond's yield will be affected by the fact that no active secondary market is expected for these bonds? A. Real rate B. Liquidity premium C. Interest rate risk premium D. Inflation premium E. Taxability premium Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 6.05 Explain the term structure of interest rates and the determinants of bond yields Topic: Determinants of bond yields

50. Which one of the following bonds is most likely to have the smallest liquidity premium? A. Treasury bill B. Corporate bond issued by a new firm C. Municipal bond issued by the State of New York D. Municipal bond issued by a rural city in Alaska E. Corporate bond issued by General Motors (GM) Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 6.05 Explain the term structure of interest rates and the determinants of bond yields Topic: Determinants of bond yields

51. A corporate bond pays 6.25% interest. How much would a municipal bond have to pay to be equivalent to this on an after-tax basis if you are in the 28% marginal tax bracket? A. 7.82% B. 5.79% C. 4.50% D. 7.26% E. 8.38% Ans: C

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 06 Testbank

AACSB: Analytic Blooms: Analysis Difficulty: Hard Learning Objective: 6.01 Identify important features and different types of bills and bonds Topic: More on bond features

52. Variance Logistics wants to issue 20-year, zero-coupon bonds that yield 6.2%. What price should it charge for these bonds if the face value is $1000? Assume semi-annual compounding. A. $288.15 B. $294.89 C. $543.03 D. $562.03 E. $326.45 Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Hard Learning Objective: 6.03 Discuss bond ratings and what they mean Topic: Some different types of bonds

53. Deltona Motors just issued 230 000 zero-coupon bonds. These bonds mature in 18 years, have a par value of $1000 and have a yield to maturity of 5.9%. What is the approximate total amount of money the company raised from issuing these bonds? Assume semi-annual compounding. A. $88.20 million B. $80.76 million C. $75.14 million D. $62.08 million E. $91.84 million Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Hard Learning Objective: 6.03 Discuss bond ratings and what they mean Topic: Some different types of bonds

54. Today, you are buying a $1000 face value bond at an invoice price of $987. The bond has a coupon rate of 6% and pays interest semi-annually. There are two months until the next coupon date. What is the clean price of this bond? A. $947 B. $957 C. $967 D. $977 E. $987 Ans: C

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 06 Testbank

AACSB: Analytic Blooms: Analysis Difficulty: Hard Learning Objective: 6.02 Describe how bills and bonds are valued and why they fluctuate in value Topic: Bonds and bond valuation

55. Last year, you earned a rate of return of 5.89% on your bond investments. During that time, the inflation rate was 1.2%. What was your real rate of return? A. 4.58% B. 4.69% C. 4.72% D. 4.63% E. 4.60% Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Hard Learning Objective: 6.04 Evaluate the impact of inflation on interest rates Topic: Inflation and interest rates

56. A bond yielded a real rate of return of 3.87% for a time period when the inflation rate was 3.75%. What was the actual nominal rate of return? A. 87.58% B. 7.62% C. 7.77% D. 8.28% E. .36% Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Hard Learning Objective: 6.04 Evaluate the impact of inflation on interest rates Topic: Inflation and interest rates

57. If your nominal rate of return is 8.68% and your real rate of return is 2.05%, what is the inflation rate? A. 5.32% B. 6.50% C. 6.29% D. 6.63% E. 16.77% Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Hard Learning Objective: 6.04 Evaluate the impact of inflation on interest rates Topic: Inflation and interest rates

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 06 Testbank

58. If Treasury bills are currently paying 3.05% and the inflation rate is 1.89%, what is the approximate real rate of interest? The exact real rate? A. 1.16%; 1.14% B. 1.21%; 1.14% C. 1.20%; 1.21% D. 1.19%; 1.16% E. 1.19%; 1.21% Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Hard Learning Objective: 6.04 Evaluate the impact of inflation on interest rates Topic: Inflation and interest rates

59. The 6.4% bond of Berberich Inc. has a yield to maturity of 6.9%. The bond matures in 11 years, has a face value of $1000 and pays semi-annual interest payments. What is the amount of each coupon payment? A. $30.00 B. $32.00 C. $34.50 D. $69.00 E. $64.00 Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Hard Learning Objective: 6.02 Describe how bills and bonds are valued and why they fluctuate in value Topic: Bonds and bond valuation

60. The 5.3% bond of Dominic Cycle Parts has a face value of $1000, a maturity of 12 years, semi-annual interest payments and a yield to maturity of 6.12%. What is the current market price of the bond? A. $945.08 B. $959.33 C. $931.01 D. $1,072.13 E. $912.40 Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Hard Learning Objective: 6.02 Describe how bills and bonds are valued and why they fluctuate in value Topic: Bonds and bond valuation

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 06 Testbank

Chapter 06 Testbank Summary Category AACSB: Analytic Blooms: Analysis Difficulty: Easy Difficulty: Hard Difficulty: Medium Learning Objective: 6.01 Identify important features and different types of bills and bonds Learning Objective: 6.02 Describe how bills and bonds are valued and why they fluctuate in value Learning Objective: 6.03 Discuss bond ratings and what they mean Learning Objective: 6.04 Evaluate the impact of inflation on interest rates Learning Objective: 6.05 Explain the term structure of interest rates and the determinants of bond yields Topic: Bills of exchange and bill valuation Topic: Bond markets Topic: Bond ratings Topic: Bonds and bond valuation Topic: Determinants of bond yields Topic: Inflation and interest rates Topic: More on bond features Topic: Some different types of bonds

# of Questions 60 60 40 11 9 12 12 12 11 13 1 2 5 15 13 11 8 5

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 07 Testbank

Chapter 07 Testbank 1. Tellite Ltd, a telecommunication company, did not pay a dividend in the last financial year. However, the company has indicated that it expects to earn $1 per share in this financial year and to pay out 20% of these earnings in dividends. Financial analysts expect that Tellite's earnings per share and dividend per share will grow at a rate of 10% a year. The rate of return required by investors has been estimated at 12% per annum. Estimate the present value of the share. A. $10 B. $50 C. $11 D. $5.50 2. The company share market price is $25, its next-period expected dividend is $1 and investors in that market require a rate of return at 14% per annum. What is the implied rate of growth in dividends at this time? A. 14% B. 10% C. 8% D. 9% 3. Fujian Tea company shares have a current price of $20 per share and paid a dividend of $1.40 per share during the year. Compute the dividend yield. A. 6.25% B. -6.25% C. 14% D. 7% 4. The Australian Securities Exchange (ASX) is: A. one of the world's top 10 listed exchange groups, measured by its market capitalization. B. a market solely for small and medium enterprises. C. a dealer market with a trading floor. D. made up of a primary market only. 5. What is true about a preference share? A. The preference share is a form of equity from a legal standpoint. B. The preference share has preference over ordinary shares in the payment of dividends. C. Holders of the preference shares usually have no voting rights. D. All of the options given here are correct.

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 07 Testbank

6. The share valuation process, which determines the price of a share by dividing the next period's dividend by the discount rate less the dividend growth rate, is called the: A. share price model. B. pricing formula. C. capital gain model. D. dividend growth model. 7. Next year's expected annual dividend divided by today's share price is called the share's: A. required return. B. dividend yield. C. maturity yield. D. capital gains yield. 8. The rate at which the value of an investment grows is called the: A. required return. B. dividend yield. C. capital return. D. capital gains yield. 9. The authority granted by a shareholder that permits another individual to vote that shareholder's shares is called a: A. straight vote. B. cumulative vote. C. statement. D. proxy. 10. The market in which new securities are originally sold to investors is called the _____ market. A. primary B. open C. secondary D. free 11. The market where one shareholder sells shares to another shareholder is called the _____ market. A. primary B. open C. secondary D. free 12. A dealer is an agent who:

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 07 Testbank

A. transacts buy and sell orders on a commission basis. B. buys and sells securities from inventory. C. arranges transactions on a fee basis. D. trades solely on behalf of a floor broker. 13. An agent who arranges security transactions among investors is a called a: A. dealer. B. specialist. C. broker. D. member. 14. The current price of a share is based: A. primarily on the future value of the cash flows derived from the share. B. solely on the anticipated future dividends. C. on the present value of all the future cash flows from that share. D. strictly on the anticipated future share price. 15. The required return: A. provides an estimate of the return an investor might expect if he or she purchases a share at today's market price. B. is based on the assumption that a share will maintain a constant dividend. C. tends to be low for the share of a firm which is experiencing rapid growth. D. places more emphasis on the capital gains yield than on the dividend yield. 16. Which one of the following will increase the current value of a share? A. Decrease in the dividend growth rate B. Increase in the required return C. Increase in the market rate of return D. Increase in the capital gains yield 17. Marble Books Inc. is expected to pay an annual dividend of $1.80 per share next year. The required return is 16% and the growth rate is 4%. What is the expected value of this share five years from now? A. $15.00 B. $15.60 C. $16.80 D. $18.25 18. The ordinary share of Wetmore Industries is valued at $10.08 per share. The company increases its dividend by 3.5% annually and expects its next dividend to be $1.24. What is the required rate of return on this share?

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 07 Testbank

A. 15.80% B. 16.23% C. 16.35% D. 16.49% 19. What is the name given to the model that computes the present value of a share by dividing next year's annual dividend amount by the difference between the discount rate and the rate of change in the annual dividend amount? A. Share pricing model B. Equity pricing model C. Capital gain model D. Dividend growth model 20. The price of a share at Year 4 can be expressed as: A. D0 / (R + g4) B. D0 × (1 + R)5 C. D1 × (1 + R)5 D. D5 / (R - g) 21. Which one of the following types of securities has no priority in a bankruptcy proceeding? A. Convertible bond B. Senior debt C. Ordinary shares D. Preference share 22. Kate could not attend the last shareholders' meeting and thus she granted the authority to vote on her behalf to the managers of the firm. Which one of the following terms is used to describe the method by which Kate's shares were voted? A. Straight B. Cumulative C. Consent-form D. Proxy 23. Which of the following statements is TRUE, according to the constant growth model? A. The higher the discount rate, the lower the stock price. B. The higher the holding period, the higher the stock price. C. The growth rate should be larger than the discount factor. D. The value of a stock depends on the holding period of an investor. 24. What is the market called that allows shareholders to resell their shares to other investors? A. Primary

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 07 Testbank

B. Proxy C. Secondary D. Inside 25. Ordinary shareholders have all the following rights except the: A. right to elect directors. B. right to priority in the event of company liquidation. C. right to share proportionally in dividends paid. D. right to share proportionally in assets remaining after liabilities have been paid in a company liquidation. 26. Which one of the following generally pays a fixed dividend, receives first priority in dividend payment and maintains the right to a dividend payment, even if that payment is deferred? A. Ordinary shares B. Promissory notes C. Non-cumulative preference shares D. Cumulative preference shares 27. The stream of customer instructions to buy and sell securities is called the: A. order flow. B. market maker. C. execution stream. D. operations flow. 28. Dividends are which one of the following? A. Payable at the discretion of a firm's president B. Treated as a tax-deductible expense to the paying firm C. Paid out of after tax profits D. Paid to holders of record as of the declaration date 29. Which of the following is NOT a participant in the share market? A. The primary market B. The secondary market C. Brokers D. Government 30. When valuing a share using the constant-growth model, D1 represents the: A. expected difference in the share price over the next year. B. expected share price in one year. C. last annual dividend paid.

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 07 Testbank

D. the next expected annual dividend. E. discount rate. 31. The dividend yield is defined as: A. the last annual dividend divided by the current market price per share. B. the last annual dividend divided by the current book value per share. C. next year's expected dividend divided by the current market price per share. D. next year's expected dividend divided by the current book value per share. E. next year's expected dividend divided by the par value per share. 32. The capital gains yield equals which one of the following? A. Total yield B. Required rate of return C. Market rate of return D. Dividend yield E. Dividend growth rate 33. Which one of the following types of securities has the lowest priority in a bankruptcy proceeding? A. Convertible bond B. Senior debt C. Common share D. Preferred share E. Straight bond 34. Mary owns 100 shares. Each share entitles her to one vote per open seat on the board of directors. Assume there are three open seats in the current election and Mary casts all 300 of her votes for a single candidate. What is the term used to describe this type of voting? A. Proxy B. Aggregate C. Cumulative D. Straight E. Condensed 35. There are two open seats on the board of directors. If two separate votes occur to elect the new directors, the firm is using a type of voting that is best described as _____ voting. A. simultaneous B. straight C. proxy D. cumulative E. sequential

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 07 Testbank

36. Jensen Shipping has four open seats on its board of directors. How many shares will a shareholder need to control to ensure that his or her candidate is elected to the board given the fact that the firm uses straight voting? Assume each share receives one vote. A. Twenty percent of the shares plus one share B. Twenty-five percent of the shares plus one share C. One-third of the shares plus one share D. Fifty percent of the shares plus one share E. Fifty-one percent of the shares plus one share 37. Dividends are best defined as: A. cash payments to shareholders. B. cash payments to either bondholders or shareholders. C. cash or share payments to shareholders. D. cash or share payments to either bondholders or shareholders. E. distributions of share to current shareholders. 38. Which type of share pays a fixed dividend, receives first priority in dividend payment and maintains the right to a dividend payment, even if that payment is deferred? A. Non-cumulative preferred B. Cumulative preferred C. Senior common D. Cumulative common E. Non-cumulative common 39. Inside quotes are defined as the: A. bid and asked prices presented by NYSE DMMs. B. last bid and asked price offered prior to the market close. C. lowest asked and highest bid offers. D. daily opening bid and asked quotes. E. last traded bid and asked prices. 40. What is the market called that facilitates the sale of shares between individual investors? A. Primary B. Proxy C. Secondary D. Inside E. Initial 41. Which one of the following is an electronic network that enables Katie to sell her shares of ABC stock directly to Marti? A. SuperDOT B. POST

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 07 Testbank

C. ECN D. SEAT E. eNET 42. NASDAQ is best described as: A. a modern-day trading floor with locations in Chicago and London. B. an electronic communication network. C. an electronic network of securities dealers. D. an internet broker’s market. E. a primary market. 43. Which of the following statements is correct? A. On the ASX, no trading can be done through brokers. B. The ASX has trading floor. C. The ASX and NZX are not computer networks. D. On the ASX, all trading can be done through brokers. 44. The Australian Financial Review gives information on all the shares and other securities traded on the: A. NYSE and NZX. B. NYSE and ASX. C. ASX and NZX. D. ASX. 45. ______________ are the only people with direct access to SEATS. A. Employees of ASX B. Employees of NZX C. Members of the former mutual association D. Financial advisors of investors 46. Supplemental liquidity providers (SLPs) trade securities on behalf of: A. their own accounts. B. the customers of a specific brokerage firm. C. designated market makers. D. any share exchange member. E. any share exchange customer. 47. Most trades on the NYSE are executed: A. by floor brokers on the exchange floor. B. independent brokers on the exchange floor. C. electronically.

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 07 Testbank

D. by designated market makers of the floor of the exchange. E. by dealers. 48. To be a member of the NYSE, you must: A. be a primary dealer. B. buy a seat. C. own a trading license. D. be registered as a floor trader. E. be a DMM. 49. The specific location on the floor of an exchange where a particular security is traded is called a: A. box office. B. Figure 6. C. post. D. trading booth. E. seat. 50. Spiral Staircase is offering preferred stock which is referred to as 10-10 stock. This stock will pay an annual dividend of $10 a share starting 10 years from now. What is this stock worth to you today if you require a rate of return of 9.5 percent? A. $66.70 B. $46.51 C. $49.63 D. $120.52 E. $105.26 51. There are three open positions on the board of directors of XYZ Enterprises. The company has 264 000 shares outstanding. Each share is entitled to one vote. How many shares must you own to guarantee your personal election to the board of directors if the firm uses cumulative voting? A. 82 001 shares B. 75 001 shares C. 88 001 shares D. 72 000 shares E. 66 001 shares 52. A firm has four open positions on its board of directors. How many shares do you need to own to guarantee your own election to the board if the firm has 387 500 shares outstanding and uses cumulative voting? Each share is granted one vote. A. 33 334 shares B. 77 501 shares

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 07 Testbank

C. 75 251 shares D. 70 501 shares E. 96 876 shares 53. Miller's Hardware has 415 000 shares outstanding with a current market value of $42 a share. You own 84 500 of those shares. Next month, the election will be held to select four new members to the board of directors. The firm uses a cumulative voting system. How much additional money do you need to spend to guarantee that you will be elected to the board, assuming that everyone else votes for one of the other candidates? A. $0 B. $28 518 C. $34 062 D. $62 958 E. $98 910 54. Laura owns 6700 shares of GP Global, worth $92 460. The firm has 15 000 shares outstanding. Each share is entitled to one vote under the straight voting policy of the firm. The next election is in four months, at which time four directors are up for election. How much more must Laura invest in this firm to guarantee her election to the board? A. $0 B. $6 554.00 C. $11 053.80 D. $8 406.15 E. $14 478.80 55. A preferred share sells for $54.20 per share and has a market return of 9.68%. What is the dividend amount? A. $5.09 B. $5.14 C. $4.75 D. $5.42 E. $5.25 56. Hi-Lo has 160 000 shares outstanding priced at $33 per share. There will be three open positions on its board in the next election. Currently, you are not a shareholder but would like to become one and also gain a seat on the board. How much will it cost you to buy a seat if the company uses straight voting? What if the firm uses cumulative voting? A. $1 760 033; $2 640 033 B. $2 710 033; $1 760 033 C. $2 710 033; $1 430 033 D. $2 640 033; $1 320 033 E. $2 640 033; $1 760 033

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 07 Testbank

57. Ground Chuck Processing just paid its annual dividend of $1.25 per share. The firm recently announced that all future dividends will be increased by 3% annually. What is one share worth to you if you require a rate of return of 11.5%? A. $14.89 B. $15.92 C. $15.15 D. $13.52 E. $15.05 58. Business Calculators Inc. will pay an annual dividend of $2.25 per share next year. The company just announced that future dividends will be increasing by 0.75% annually. How much are you willing to pay for one share of this share if you require a rate of return of 12.25%? A. $18.30 B. $19.57 C. $22.94 D. $19.28 E. $22.48 59. The common share of Big Marvin Treats has a total return of 10.25%, a share price of $28.75 and recently paid an annual dividend of $1.65. What is the capital gains rate if the company maintains a constant dividend? A. 7.54% B. 15.76% C. 10.37% D. 4.51% E. 3.79% 60. Ferris Athletic Equipment plans to pay an annual dividend of $1.90 per share next year, $1.25 per share a year for the following two years and then a final liquidating dividend of $11.50 per share four years from now. How much is one share worth to you today if you require a rate of return of 19.65% of this risky investment? A. $8.80 B. $7.54 C. $6.74 D. $11.77 E. $9.47

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 07 Testbank

Chapter 07 Testbank Key 1. Tellite Ltd, a telecommunication company, did not pay a dividend in the last financial year. However, the company has indicated that it expects to earn $1 per share in this financial year and to pay out 20% of these earnings in dividends. Financial analysts expect that Tellite's earnings per share and dividend per share will grow at a rate of 10% a year. The rate of return required by investors has been estimated at 12% per annum. Estimate the present value of the share. A. $10 B. $50 C. $11 D. $5.50 Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 7.01 Assess how share prices depend on future dividends and dividend growth Topic: Ordinary share valuation

2. The company share market price is $25, its next-period expected dividend is $1 and investors in that market require a rate of return at 14% per annum. What is the implied rate of growth in dividends at this time? A. 14% B. 10% C. 8% D. 9% Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 7.01 Assess how share prices depend on future dividends and dividend growth Topic: Ordinary share valuation

3. Fujian Tea company shares have a current price of $20 per share and paid a dividend of $1.40 per share during the year. Compute the dividend yield. A. 6.25% B. -6.25% C. 14% D. 7% Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 7.01 Assess how share prices depend on future dividends and dividend growth Topic: Ordinary share valuation

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 07 Testbank

4. The Australian Securities Exchange (ASX) is: A. one of the world's top 10 listed exchange groups, measured by its market capitalization. B. a market solely for small and medium enterprises. C. a dealer market with a trading floor. D. made up of a primary market only. Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 7.03 Explain how the share markets work Topic: The share markets

5. What is true about a preference share? A. The preference share is a form of equity from a legal standpoint. B. The preference share has preference over ordinary shares in the payment of dividends. C. Holders of the preference shares usually have no voting rights. D. All of the options given here are correct. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 7.02 Identify the different ways corporate directors are elected to office Topic: Some features of ordinary compounding periods

7. Next year's expected annual dividend divided by today's share price is called the share's: A. required return. B. dividend yield. C. maturity yield. D. capital gains yield. Ans: B

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 07 Testbank

AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 7.01 Assess how share prices depend on future dividends and dividend growth Topic: Ordinary share valuation

8. The rate at which the value of an investment grows is called the: A. required return. B. dividend yield. C. capital return. D. capital gains yield. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 7.01 Assess how share prices depend on future dividends and dividend growth Topic: Ordinary share valuation

9. The authority granted by a shareholder that permits another individual to vote that shareholder's shares is called a: A. straight vote. B. cumulative vote. C. statement. D. proxy. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 7.02 Identify the different ways corporate directors are elected to office Topic: Some features of ordinary compounding periods

10. The market in which new securities are originally sold to investors is called the _____ market. A. primary B. open C. secondary D. free Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 7.03 Explain how the share markets work Topic: The share markets

11. The market where one shareholder sells shares to another shareholder is called the _____ market.

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 07 Testbank

A. primary B. open C. secondary D. free Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 7.03 Explain how the share markets work Topic: The share markets

12. A dealer is an agent who: A. transacts buy and sell orders on a commission basis. B. buys and sells securities from inventory. C. arranges transactions on a fee basis. D. trades solely on behalf of a floor broker. Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 7.03 Explain how the share markets work Topic: The share markets

13. An agent who arranges security transactions among investors is a called a: A. dealer. B. specialist. C. broker. D. member. Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 7.03 Explain how the share markets work Topic: The share markets

14. The current price of a share is based: A. primarily on the future value of the cash flows derived from the share. B. solely on the anticipated future dividends. C. on the present value of all the future cash flows from that share. D. strictly on the anticipated future share price. Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 7.01 Assess how share prices depend on future dividends and dividend growth Topic: Ordinary share valuation

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 07 Testbank

15. The required return: A. provides an estimate of the return an investor might expect if he or she purchases a share at today's market price. B. is based on the assumption that a share will maintain a constant dividend. C. tends to be low for the share of a firm which is experiencing rapid growth. D. places more emphasis on the capital gains yield than on the dividend yield. Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 7.01 Assess how share prices depend on future dividends and dividend growth Topic: Ordinary share valuation

16. Which one of the following will increase the current value of a share? A. Decrease in the dividend growth rate B. Increase in the required return C. Increase in the market rate of return D. Increase in the capital gains yield Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 7.01 Assess how share prices depend on future dividends and dividend growth Topic: Ordinary share valuation

17. Marble Books Inc. is expected to pay an annual dividend of $1.80 per share next year. The required return is 16% and the growth rate is 4%. What is the expected value of this share five years from now? A. $15.00 B. $15.60 C. $16.80 D. $18.25 Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 7.01 Assess how share prices depend on future dividends and dividend growth Topic: Ordinary share valuation

18. The ordinary share of Wetmore Industries is valued at $10.08 per share. The company increases its dividend by 3.5% annually and expects its next dividend to be $1.24. What is the required rate of return on this share? A. 15.80% B. 16.23% C. 16.35% D. 16.49%

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 07 Testbank

Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 7.01 Assess how share prices depend on future dividends and dividend growth Topic: Ordinary share valuation

19. What is the name given to the model that computes the present value of a share by dividing next year's annual dividend amount by the difference between the discount rate and the rate of change in the annual dividend amount? A. Share pricing model B. Equity pricing model C. Capital gain model D. Dividend growth model Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 7.01 Assess how share prices depend on future dividends and dividend growth Topic: Ordinary share valuation

20. The price of a share at Year 4 can be expressed as: A. D0 / (R + g4) B. D0 × (1 + R)5 C. D1 × (1 + R)5 D. D5 / (R - g) Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 7.01 Assess how share prices depend on future dividends and dividend growth Topic: Ordinary share valuation

21. Which one of the following types of securities has no priority in a bankruptcy proceeding? A. Convertible bond B. Senior debt C. Ordinary shares D. Preference share Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 7.02 Identify the different ways corporate directors are elected to office Topic: Some features of ordinary compounding periods

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 07 Testbank

22. Kate could not attend the last shareholders' meeting and thus she granted the authority to vote on her behalf to the managers of the firm. Which one of the following terms is used to describe the method by which Kate's shares were voted? A. Straight B. Cumulative C. Consent-form D. Proxy Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 7.02 Identify the different ways corporate directors are elected to office Topic: Some features of ordinary compounding periods

23. Which of the following statements is TRUE, according to the constant growth model? A. The higher the discount rate, the lower the stock price. B. The higher the holding period, the higher the stock price. C. The growth rate should be larger than the discount factor. D. The value of a stock depends on the holding period of an investor. Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 7.03 Explain how the share markets work Topic: The share markets

24. What is the market called that allows shareholders to resell their shares to other investors? A. Primary B. Proxy C. Secondary D. Inside Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 7.03 Explain how the share markets work Topic: The share markets

25. Ordinary shareholders have all the following rights except the: A. right to elect directors. B. right to priority in the event of company liquidation. C. right to share proportionally in dividends paid. D. right to share proportionally in assets remaining after liabilities have been paid in a company liquidation. Ans: B

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 07 Testbank

AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 7.02 Identify the different ways corporate directors are elected to office Topic: Some features of ordinary compounding periods

26. Which one of the following generally pays a fixed dividend, receives first priority in dividend payment and maintains the right to a dividend payment, even if that payment is deferred? A. Ordinary shares B. Promissory notes C. Non-cumulative preference shares D. Cumulative preference shares Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 7.02 Identify the different ways corporate directors are elected to office Topic: Some features of ordinary compounding periods

27. The stream of customer instructions to buy and sell securities is called the: A. order flow. B. market maker. C. execution stream. D. operations flow. Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 7.03 Explain how the share markets work Topic: The share markets

28. Dividends are which one of the following? A. Payable at the discretion of a firm's president B. Treated as a tax-deductible expense to the paying firm C. Paid out of after tax profits D. Paid to holders of record as of the declaration date Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 7.02 Identify the different ways corporate directors are elected to office Topic: Some features of ordinary compounding periods

29. Which of the following is NOT a participant in the share market? A. The primary market

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 07 Testbank

B. The secondary market C. Brokers D. Government Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 7.03 Explain how the share markets work Topic: The share markets

30. When valuing a share using the constant-growth model, D1 represents the: A. expected difference in the share price over the next year. B. expected share price in one year. C. last annual dividend paid. D. the next expected annual dividend. E. discount rate. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 7.01 Assess how share prices depend on future dividends and dividend growth Topic: Ordinary share valuation

31. The dividend yield is defined as: A. the last annual dividend divided by the current market price per share. B. the last annual dividend divided by the current book value per share. C. next year's expected dividend divided by the current market price per share. D. next year's expected dividend divided by the current book value per share. E. next year's expected dividend divided by the par value per share. Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 7.01 Assess how share prices depend on future dividends and dividend growth Topic: Ordinary share valuation

32. The capital gains yield equals which one of the following? A. Total yield B. Required rate of return C. Market rate of return D. Dividend yield E. Dividend growth rate Ans: E

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 07 Testbank

AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 7.01 Assess how share prices depend on future dividends and dividend growth Topic: Ordinary share valuation

33. Which one of the following types of securities has the lowest priority in a bankruptcy proceeding? A. Convertible bond B. Senior debt C. Common share D. Preferred share E. Straight bond Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 7.02 Identify the different ways corporate directors are elected to office Topic: Some features of ordinary compounding periods

34. Mary owns 100 shares. Each share entitles her to one vote per open seat on the board of directors. Assume there are three open seats in the current election and Mary casts all 300 of her votes for a single candidate. What is the term used to describe this type of voting? A. Proxy B. Aggregate C. Cumulative D. Straight E. Condensed Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 7.02 Identify the different ways corporate directors are elected to office Topic: Some features of ordinary compounding periods

35. There are two open seats on the board of directors. If two separate votes occur to elect the new directors, the firm is using a type of voting that is best described as _____ voting. A. simultaneous B. straight C. proxy D. cumulative E. sequential Ans: B

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 07 Testbank

AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 7.02 Identify the different ways corporate directors are elected to office Topic: Some features of ordinary compounding periods

37. Dividends are best defined as: A. cash payments to shareholders. B. cash payments to either bondholders or shareholders. C. cash or share payments to shareholders. D. cash or share payments to either bondholders or shareholders. E. distributions of share to current shareholders. Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 7.02 Identify the different ways corporate directors are elected to office Topic: Some features of ordinary compounding periods

38. Which type of share pays a fixed dividend, receives first priority in dividend payment and maintains the right to a dividend payment, even if that payment is deferred? A. Non-cumulative preferred B. Cumulative preferred C. Senior common D. Cumulative common E. Non-cumulative common Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 7.02 Identify the different ways corporate directors are elected to office Topic: Some features of ordinary compounding periods

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 07 Testbank

39. Inside quotes are defined as the: A. bid and asked prices presented by NYSE DMMs. B. last bid and asked price offered prior to the market close. C. lowest asked and highest bid offers. D. daily opening bid and asked quotes. E. last traded bid and asked prices. Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 7.03 Explain how the share markets work Topic: The share markets

40. What is the market called that facilitates the sale of shares between individual investors? A. Primary B. Proxy C. Secondary D. Inside E. Initial Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 7.03 Explain how the share markets work Topic: The share markets

41. Which one of the following is an electronic network that enables Katie to sell her shares of ABC stock directly to Marti? A. SuperDOT B. POST C. ECN D. SEAT E. eNET Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 7.03 Explain how the share markets work Topic: The share markets

42. NASDAQ is best described as: A. a modern-day trading floor with locations in Chicago and London. B. an electronic communication network. C. an electronic network of securities dealers. D. an internet broker’s market.

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 07 Testbank

E. a primary market. Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 7.03 Explain how the share markets work Topic: The share markets

43. Which of the following statements is correct? A. On the ASX, no trading can be done through brokers. B. The ASX has trading floor. C. The ASX and NZX are not computer networks. D. On the ASX, all trading can be done through brokers. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 7.03 Explain how the share markets work Topic: The share markets

44. The Australian Financial Review gives information on all the shares and other securities traded on the: A. NYSE and NZX. B. NYSE and ASX. C. ASX and NZX. D. ASX. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 7.03 Explain how the share markets work Topic: The share markets

45. ______________ are the only people with direct access to SEATS. A. Employees of ASX B. Employees of NZX C. Members of the former mutual association D. Financial advisors of investors Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 7.03 Explain how the share markets work Topic: The share markets

46. Supplemental liquidity providers (SLPs) trade securities on behalf of:

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A. their own accounts. B. the customers of a specific brokerage firm. C. designated market makers. D. any share exchange member. E. any share exchange customer. Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 7.03 Explain how the share markets work Topic: The share markets

47. Most trades on the NYSE are executed: A. by floor brokers on the exchange floor. B. independent brokers on the exchange floor. C. electronically. D. by designated market makers of the floor of the exchange. E. by dealers. Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 7.03 Explain how the share markets work Topic: The share markets

48. To be a member of the NYSE, you must: A. be a primary dealer. B. buy a seat. C. own a trading license. D. be registered as a floor trader. E. be a DMM. Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 7.03 Explain how the share markets work Topic: The share markets

49. The specific location on the floor of an exchange where a particular security is traded is called a: A. box office. B. Figure 6. C. post. D. trading booth. E. seat. Ans: C

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AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 7.03 Explain how the share markets work Topic: The share markets

50. Spiral Staircase is offering preferred stock which is referred to as 10-10 stock. This stock will pay an annual dividend of $10 a share starting 10 years from now. What is this stock worth to you today if you require a rate of return of 9.5 percent? A. $66.70 B. $46.51 C. $49.63 D. $120.52 E. $105.26 Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 7.02 Identify the different ways corporate directors are elected to office Topic: Some features of ordinary compounding periods

51. There are three open positions on the board of directors of XYZ Enterprises. The company has 264 000 shares outstanding. Each share is entitled to one vote. How many shares must you own to guarantee your personal election to the board of directors if the firm uses cumulative voting? A. 82 001 shares B. 75 001 shares C. 88 001 shares D. 72 000 shares E. 66 001 shares Ans: E Feedback: Shares needed = {[1 / (3 + 1)] × 264 000} + 1 = 66 001 AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 7.02 Identify the different ways corporate directors are elected to office Topic: Some features of ordinary compounding periods

52. A firm has four open positions on its board of directors. How many shares do you need to own to guarantee your own election to the board if the firm has 387 500 shares outstanding and uses cumulative voting? Each share is granted one vote. A. 33 334 shares B. 77 501 shares C. 75 251 shares D. 70 501 shares E. 96 876 shares

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Ans: B Feedback: Shares needed = {[1 / (4 + 1)] × 387 500} + 1 = 77 501 shares AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 7.02 Identify the different ways corporate directors are elected to office Topic: Some features of ordinary compounding periods

53. Miller's Hardware has 415 000 shares outstanding with a current market value of $42 a share. You own 84 500 of those shares. Next month, the election will be held to select four new members to the board of directors. The firm uses a cumulative voting system. How much additional money do you need to spend to guarantee that you will be elected to the board, assuming that everyone else votes for one of the other candidates? A. $0 B. $28 518 C. $34 062 D. $62 958 E. $98 910 Ans: A Feedback: Shares needed = {[1 / (4 + 1)] × 415 000} + 1 = 83 001 You already own sufficient shares to guarantee your election. AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 7.02 Identify the different ways corporate directors are elected to office Topic: Some features of ordinary compounding periods

54. Laura owns 6700 shares of GP Global, worth $92 460. The firm has 15 000 shares outstanding. Each share is entitled to one vote under the straight voting policy of the firm. The next election is in four months, at which time four directors are up for election. How much more must Laura invest in this firm to guarantee her election to the board? A. $0 B. $6 554.00 C. $11 053.80 D. $8 406.15 E. $14 478.80 Ans: C Feedback: Investment needed =[(15 000 / 2) + 1 − 6700] × ($92 460 / 6700) = $11 053.80 AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 7.02 Identify the different ways corporate directors are elected to office Topic: Some features of ordinary compounding periods

55. A preferred share sells for $54.20 per share and has a market return of 9.68%. What is the dividend amount?

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A. $5.09 B. $5.14 C. $4.75 D. $5.42 E. $5.25 Ans: E Feedback: Dividend = 0.0968 × $54.20 = $5.25 AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 7.02 Identify the different ways corporate directors are elected to office Topic: Some features of ordinary compounding periods

56. Hi-Lo has 160 000 shares outstanding priced at $33 per share. There will be three open positions on its board in the next election. Currently, you are not a shareholder but would like to become one and also gain a seat on the board. How much will it cost you to buy a seat if the company uses straight voting? What if the firm uses cumulative voting? A. $1 760 033; $2 640 033 B. $2 710 033; $1 760 033 C. $2 710 033; $1 430 033 D. $2 640 033; $1 320 033 E. $2 640 033; $1 760 033 Ans: D Feedback: CostStraight = $33 ×[(160 000 / 2) + 1] = $2 640 033 CostCumulative = $33 × {[160 000 / (3 + 1)] + 1} = $1 320,033 AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 7.02 Identify the different ways corporate directors are elected to office Topic: Some features of ordinary compounding periods

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58. Business Calculators Inc. will pay an annual dividend of $2.25 per share next year. The company just announced that future dividends will be increasing by 0.75% annually. How much are you willing to pay for one share of this share if you require a rate of return of 12.25%? A. $18.30 B. $19.57 C. $22.94 D. $19.28 E. $22.48 Ans: B Feedback: P0 = $2.25 / (0.1225 − 0.0075) = $19.57 AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 7.01 Assess how share prices depend on future dividends and dividend growth Topic: Ordinary share valuation

59. The common share of Big Marvin Treats has a total return of 10.25%, a share price of $28.75 and recently paid an annual dividend of $1.65. What is the capital gains rate if the company maintains a constant dividend? A. 7.54% B. 15.76% C. 10.37% D. 4.51% E. 3.79% Ans: D Feedback: 0.1025 = $1.65 / $28.75 + g g = 0.0451, or 4.51% AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 7.01 Assess how share prices depend on future dividends and dividend growth Topic: Ordinary share valuation

60. Ferris Athletic Equipment plans to pay an annual dividend of $1.90 per share next year, $1.25 per share a year for the following two years and then a final liquidating dividend of $11.50 per share four years from now. How much is one share worth to you today if you require a rate of return of 19.65% of this risky investment? A. $8.80 B. $7.54 C. $6.74 D. $11.77 E. $9.47 Ans: A Feedback: P0 = ($1.90 / 1.19651) + ($1.25 / 1.19652) + ($1.25 / 1.19653) + ($11.50 / 1.19654) = $8.80

Ross, Essentials of Corporate Finance, Fifth Edition

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AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 7.01 Assess how share prices depend on future dividends and dividend growth Topic: Ordinary share valuation

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 07 Testbank

Chapter 07 Testbank Summary Category AACSB: Analytic Blooms: Analysis Difficulty: Easy Difficulty: Medium Learning Objective: 7.01 Assess how share prices depend on future dividends and dividend growth Learning Objective: 7.02 Identify the different ways corporate directors are elected to office Learning Objective: 7.03 Explain how the share markets work Topic: Ordinary share valuation Topic: Some features of ordinary compounding periods Topic: The share markets

# of Questions 60 60 53 7 20 20 20 20 20 20

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Chapter 08 Testbank 1. The internal rate of return identifies: A. the minimum acceptable discount rate. B. the cost-benefit ratio. C. the average profit from a project. D. none of the given answers. 2. The net present value rule states that you should accept a project if the NPV: A. is equal to zero or negative. B. exceeds the required rate. C. is less than 1.0. D. is positive. 3. A net present value of zero implies that an investment: A. has an initial cost of zero. B. has cash inflows which have a zero present value. C. has no expected impact on shareholders. D. does not pay back its initial cash outlay. 4. Which one of the following statements is correct concerning the payback rule? A. The payback period is computed using the present value of each of the cash flows. B. The rule says that you should accept a project if the payback period is greater than 1.0. C. The rule works best when comparing mutually exclusive projects. D. The rule is flawed because it ignores all cash flows after some arbitrary point in time. 5. The payback rule works best in evaluating which one of the following? A. A low-cost project that pays back slowly B. A low-cost project that pays back rapidly C. A high-cost project with equal cash inflows over a long period of time D. A high-cost project with increasing cash inflows over time 6. You are considering a project that has an internal rate of return that is equal to the required return. This means that the: A. net present value is negative in an amount equal to the initial investment. B. project is returning the minimal amount that is acceptable to you. C. profitability index is greater than one. D. average accounting return exceeds the project's required return.

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7. Which one of the following best expresses two mutually exclusive investments? A. Constructing a theatre and a restaurant side by side B. Locating a restaurant inside a theatre building C. Building either a gas station or a restaurant on a corner lot D. Building both a restaurant and a parking lot on a vacant lot 8. If managers only invest in projects that have a profitability index greater than 1.0, the: A. firm will increase in value. B. manager will be forced to explain to shareholders why the net worth of the firm is declining. C. value of the firm's share should remain constant. D. cash flows of the firm should decrease. 9. The payback method of analysis is the most beneficial in which one of the following situations? A. A firm is considering a project that can easily be extended if it is profitable. B. A firm can either build a bowling alley or a miniature golf course on a piece of land, but not both. C. A ski resort is considering adding a golf course to increase revenues. D. A firm has free cash that can be invested but must be returned in time to meet a bond obligation two years from now. 10. Your firm requires an average accounting return (AAR) of at least 15% on all fixed asset purchases. Currently, you are considering some new equipment costing $96 000. This equipment will have a three-year life over which time it will be depreciated on a straight-line basis to a zero book value. The annual profit for the year (or period) from this project is estimated at $5500, $12 400 and $17 600 for the three years. Should you accept this project based on the accounting rate of return? Why or why not? A. Yes; because the AAR is less than 15%. B. Yes; because the AAR is equal to 15%. C. Yes; because the AAR is greater than 15%. D. No; because the AAR is less than 15%. 11. Ben Lake Enterprises is currently considering a project that will produce cash inflows of $3500 a year for three years followed by $1200 a year for two more years. The cost of the project is $10 000. What is the profitability index if the discount rate is 7%? A. 0.96 B. 0.98 C. 1.00 D. 1.10

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12. If an investment is producing a return that is equal to the required return, the investment's net present value will be: A. positive B. greater than the project's initial investment C. zero D. equal to the project's net profit 13. Both Projects A and B are acceptable as independent projects. However, the selection of either one of these projects eliminates the option of selecting the other project. Which one of the following terms best describes the relationship between Project A and Project B? A. Mutually exclusive B. Conventional C. Multiple choice D. Dual return 14. The modified internal rate of return is specifically designed to address the problems associated with which one of the following? A. Mutually exclusive projects B. Unconventional cash flows C. Long-term projects D. Negative net present values 15. The reinvestment approach to the modified internal rate of return: A. individually discounts each separate cash flow back to the present B. reinvests all the cash flows, including the initial cash flow, to the end of the project C. discounts all negative cash flows to the present and compounds all positive cash flows to the end of the project D. compounds all of the cash flows, except for the initial cash flow, to the end of the project 16. Which one of the following is specifically designed to compute the rate of return on a project that has unconventional cash flows? A. Average accounting return B. Profitability index C. Internal rate of return D. Modified internal rate of return 17. Which one of the following methods of analysis is most appropriate to use when two investments are mutually exclusive? A. Internal rate of return B. Profitability index C. Net present value D. Modified internal rate of return

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18. The net present value of an investment represents the difference between the investment's: A. cash inflows and outflows. B. cost and net profit. C. cost and market value. D. cash flows and profits. 19. Discounted cash flow valuation is the process of discounting an investment's: A. assets. B. future profits. C. liabilities. D. future cash flows. 20. Which one of the following indicates that a project is expected to create value for its owners? A. A profitability index less than 1.0 B. A payback period greater than the requirement C. A positive net present value D. A positive average accounting rate of return 21. The average profit for the year (or period) of a project divided by the project's average book value is referred to as the project's: A. required return. B. market rate of return. C. internal rate of return. D. average accounting return. 22. Manly Manufacturing Ltd is evaluating an expansion of its business by purchasing new manufacturing equipment. The equipment has an installation cost of $26 million, which will be depreciated straight-line to zero over its three-year life. If the plant has projected profit for the year (or period) of $2 348 000, $2 680 000 and $1 920 000 over these three years, what is the project's average accounting return (AAR)? A. 11.69% B. 14.14% C. 15.088% D. 17.82% 23. The Bondi Pizza Palace is considering opening a new store at a start-up cost of $700 000. The initial investment will be depreciated straight-line to zero over the 15-year life of the project. Based on the income projections shown below, what is the average accounting rate of return? Years Profit for the year (or period)

1–5 6–10 11–15 A. 13.05% B. 13.68% C. 14.01% D. 14.76%

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$62 000 54 000 39 000

24. Which one of the following can be defined as a benefit–cost ratio? A. Internal rate of return B. Average accounting return C. Profitability index D. Net present value 25. Which one of the following indicates that a project should be rejected? A. Average accounting return that exceeds the requirement B. Payback period that is shorter than the requirement period C. Positive net present value D. Profitability index less than 1.0 26. Payback is best used to evaluate which type of projects? A. Low-cost, short-term B. High-cost, short-term C. Low-cost, long-term D. High-cost, long-term 27. In which one of the following situations would the payback method be the preferred method of analysis? A. A project that can easily be expanded B. Two mutually exclusive projects C. A proposed expansion of a firm's current operations D. Investment funds available only for a limited period of time 28. An investment has an initial cost of $3.3 million. This investment will be depreciated by $900 000 a year over the three-year life of the project. Should this project be accepted based on the average accounting rate of return if the required rate is 10.0%? Why or why not? Year Profit for the year (or period) 1 $211 700 2 186 400 3 165 500

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A. Yes, because the AAR is 10.0%. B. Yes, because the AAR is less than 10.0%. C. No, because the AAR is greater than 10.0%. D. No, because the AAR is less than 10.0%. 29. A project has expected cash inflows, starting with year 1, of $2200, $2900, $3500 and finally in Year 4: $4000. The profitability index is 1.14 and the discount rate is 12%. What is the initial cost of the project? A. $7899.16 B. $8098.24 C. $8166.19 D. $9211.06 30. Which one of the following analysis methods is most similar to the analysis of net present value? A. Payback period B. Internal rate of return C. Profitability index D. Average accounting return 31. The payback period is the length of time it takes an investment to generate sufficient cash flows to enable the project to: A. produce a positive annual cash flow. B. produce a positive cash flow from assets. C. offset its fixed expenses. D. offset its total expenses. E. recoup its initial cost. 32. The internal rate of return is the: A. discount rate that causes a project’s after-tax income to equal zero. B. discount rate that results in a zero net present value for the project. C. discount rate that results in a net present value equal to the project's initial cost. D. rate of return required by the project's investors. E. project's current market rate of return. 33. The net present value profile illustrates how the net present value of an investment is affected by which one of the following? A. Project's initial cost B. Discount rate C. Timing of the project's cash inflows D. Inflation rate

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E. Real rate of return 34. The possibility that more than one discount rate can cause the net present value of an investment to equal zero is referred to as: A. duplication. B. the net present value profile. C. multiple rates of return. D. the AAR problem. E. the dual dilemma. 35. Which one of the following is true if the managers of a firm accept only projects that have a profitability index greater than 1.5? A. The firm should increase in value each time it accepts a new project B. The firm is most likely steadily losing value C. The price of the firm's share should remain constant D. The net present value of each new project is zero E. The internal rate of return on each new project is zero 36. What is the net present value of a project with the following cash flows if the discount rate is 12 per cent? Year 0 1 2 3

Cash Flow −$ 27 500 14 800 19 400 5 200

A. $4881.10 B. $11 900.00 C. $4358.13 D. $11 035.24 E. $8129.06 37. Which one of the following statements is correct? A. A longer payback period is preferred over a shorter payback period. B. The payback rule states that you should accept a project if the payback period is less than one year. C. The payback period ignores the time value of money. D. The payback rule is biased in favour of long-term projects. E. The payback period considers the timing and amount of all of a project's cash flows.

Ross, Essentials of Corporate Finance, Fifth Edition

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38. Which one of the following is the primary advantage of payback analysis? A. Incorporation of the time value of money concept B. Ease of use C. Research and development bias D. Arbitrary cut-off point E. Long-term bias 39. Which one of the following methods of analysis ignores cash flows? A. Profitability index B. Payback C. Average accounting return D. Modified internal rate of return E. Internal rate of return 40. Which one of the following analytical methods is based on profit for the year (or period)? A. Profitability index B. Internal rate of return C. Average accounting return D. Modified internal rate of return E. Payback 41. Which one of the following is most closely related to the net present value profile? A. Internal rate of return B. Average accounting return C. Profitability index D. Payback E. Discounted payback 42. An investment has conventional cash flows and a profitability index of 1.0. Given this, which one of the following must be true? A. The internal rate of return exceeds the required rate of return. B. The investment never pays back. C. The net present value is equal to zero. D. The average accounting return is 1.0. E. The net present value is greater than 1.0. 43. The profitability index reflects the value created per dollar: A. invested. B. of sales. C. of profit for the year (or period). D. of profit before tax. E. of shareholders' equity.

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44. Based on the most recent survey information presented in your textbook, CFOs tend to use which two methods of investment analysis the most frequently? A. Payback and net present value B. Payback and internal rate of return C. Internal rate of return and net present value D. Net present value and profitability index E. Profitability index and internal rate of return 45. Daniel’s Market is considering a project with an initial cost of $176 500. The project will not produce any cash flows for the first three years. Starting in Year 4, the project will produce cash inflows of $127 500 a year for three years. This project is risky, so the firm has assigned it a discount rate of 17%. What is the project's net present value? A. $105 222 B. −$6500 C. $29 301.80 D. $621.30 E. −$601.03 46. John is considering a project with cash inflows of $1100, $1000, $1050 and $1200 over the next four years, respectively. The relevant discount rate is 12.5%. What is the net present value of this project if it the start-up cost is $3200? A. $54.50 B. $48.04 C. −$35.45 D. $89.33 E. $122.00 47. What is the payback period for a project with the following cash flows? Year Cash Flow 0 −$ 75 000 1 15 000 2 23 000 3 35 000 4 25 000 A. 2.56 years B. 2.89 years C. 3.08 years D. 3.24 years E. Never

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48. EKG Inc. is considering a new project that will require an initial cash investment of $419 000. The project will produce no cash flows for the first two years. The projected cash flows for Years 3 through 7 are $69 000, $98 000, $109 000, $145 000 and $165 000, respectively. How long will it take the firm to recover its initial investment in this project? A. 3.81 years B. 3.98 years C. 5.57 years D. 5.99 years E. The project never pays back. 49. Auto Detailers is buying some new equipment at a cost of $188 900. This equipment will be depreciated on a straight-line basis to a zero book value over its eight-year life. The equipment is expected to generate profit for the year (or period) of $11 000 a year for the first four years and $24 000 a year for the last four years. What is the average accounting rate of return? A. 15.48% B. 17.76% C. 18.09% D. 22.68% E. 18.53% 50. An investment has an initial cost of $2.7 million and profit for the year (or period) of $189 400, $178 600 and $172 500 for Years 1 to 3. This investment will be depreciated by $900 000 a year over the three-year life of the project. Should this project be accepted based on the average accounting rate of return if the required rate is 12.5%? Why or why not? A. Yes, because the AAR is 12.5%. B. Yes, because the AAR is less than 12.5%. C. Yes, because the AAR is greater than 12.5%. D. No, because the AAR is greater than 12.5%. E. No, because the AAR is less than 12.5%. 51. A project has the following cash flows. What is the internal rate of return? Year 0 1 2 3

Cash Flow −$ 111 000 49 650 52 300 36 450

A. 15.17% B. 13.41% C. 13.68%

Ross, Essentials of Corporate Finance, Fifth Edition

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D. 12.53% E. 13.15% 52. A project has the following cash flows. What is the internal rate of return? Year Cash Flow 0 −$ 12 500 1 2 750 2 3 100 3 3 333 4 5 260 A. 5.43% B. 5.50% C. 5.92% D. 5.57% E. 5.53% 53. You are considering an investment for which you require a rate of return of 8.5%. The investment costs $53 500 and will produce cash inflows of $20 000 for three years. Should you accept this project based on its internal rate of return? Why or why not? A. Yes; because the IRR is 5.96%. B. Yes; because the IRR is 9.56%. C. Yes; because the IRR is 8.50%. D. No; because the IRR is 9.56%. E. No; because the IRR is 5.96%. 54. The Steel Factory is considering a project that will produce annual cash flows of $43 800, $40 200, $46 200 and $41 800 over the next four years, respectively. What is the internal rate of return if the initial cost of the project is $127 900? A. 13.00% B. 10.19% C. 11.28% D. 12.24% E. 12.83% 55. Miller Brothers is considering a project that will produce cash inflows of $32 500, $38 470, $40 805 and $41 268 a year for the next four years, respectively. What is the internal rate of return if the initial cost of the project is $184 600? A. 7.39% B. 6.86% C. 6.47% D. 7.62%

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E. 6.24% 56. The net present value of a project's cash inflows is $2716 at a discount rate of 12%. The profitability index is 1.09 and the firm's tax rate is 34%. What is the initial cost of the project? A. $2314.07 B. $2018.50 C. $2428.32 D. $2491.74 E. $2066.67 57. You are trying to determine whether or not to expand your business by building a new manufacturing plant. The plant has an installation cost of $29 million, which will be depreciated straight-line to zero over its three-year life. If the plant has projected profit for the year (or period) of $1 848 000, $2 080 000 and $2,720 000 over these three years, what is the project's average accounting return (AAR)? A. 14.69% B. 14.14% C. 15.03% D. 15.28% E. 14.21% 58. Miller and Sons is evaluating a project with the following cash flows: Year Cash Flow 0 −$ 72 000 1 29 100 2 20 600 3 42 500 4 24 300 5 − 9 800 The company uses a 10% interest rate on all of its projects. What is the MIRR of the project using the reinvestment approach? The discounting approach? The combination approach? A. 18.54%; 17.29%; 14.61% B. 13.96%; 14.38%; 14.61% C. 18.54%; 17.29%; 13.67% D. 13.96%; 17.85%; 13.67% E. 18.54%; 18.23%; 18.61% 59. What is the net present value of a project with the following cash flows if the discount rate is 9%? Year Cash Flow 0 −$ 15 000.00 1 4 800.00

2 3 A. −$972.61 B. $972.61 C. −$892.30 D. $892.30 E. $812.90

Ross, Essentials of Corporate Finance, Fifth Edition

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5 700.00 6 250.00

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 08 Testbank

Chapter 08 Testbank Key 1. The internal rate of return identifies: A. the minimum acceptable discount rate. B. the cost-benefit ratio. C. the average profit from a project. D. none of the given answers. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 8.03 Describe the internal rate of return criterion and its strengths and weaknesses Topic: The internal rate of return

2. The net present value rule states that you should accept a project if the NPV: A. is equal to zero or negative. B. exceeds the required rate. C. is less than 1.0. D. is positive. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 8.04 Explain why the net present value criterion is the best way to evaluate proposed investments Topic: Net present value

3. A net present value of zero implies that an investment: A. has an initial cost of zero. B. has cash inflows which have a zero present value. C. has no expected impact on shareholders. D. does not pay back its initial cash outlay. Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 8.04 Explain why the net present value criterion is the best way to evaluate proposed investments Topic: Net present value

4. Which one of the following statements is correct concerning the payback rule? A. The payback period is computed using the present value of each of the cash flows. B. The rule says that you should accept a project if the payback period is greater than 1.0. C. The rule works best when comparing mutually exclusive projects. D. The rule is flawed because it ignores all cash flows after some arbitrary point in time.

Ross, Essentials of Corporate Finance, Fifth Edition

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Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 8.01 Summarise the payback rule and some of its shortcomings Topic: The payback rule

5. The payback rule works best in evaluating which one of the following? A. A low-cost project that pays back slowly B. A low-cost project that pays back rapidly C. A high-cost project with equal cash inflows over a long period of time D. A high-cost project with increasing cash inflows over time Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 8.01 Summarise the payback rule and some of its shortcomings Topic: The payback rule

6. You are considering a project that has an internal rate of return that is equal to the required return. This means that the: A. net present value is negative in an amount equal to the initial investment. B. project is returning the minimal amount that is acceptable to you. C. profitability index is greater than one. D. average accounting return exceeds the project's required return. Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 8.03 Describe the internal rate of return criterion and its strengths and weaknesses Topic: The internal rate of return

8. If managers only invest in projects that have a profitability index greater than 1.0, the: A. firm will increase in value.

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B. manager will be forced to explain to shareholders why the net worth of the firm is declining. C. value of the firm's share should remain constant. D. cash flows of the firm should decrease. Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 8.06 Calculate the profitability index and understand its relation to net present value Topic: The profitability index

9. The payback method of analysis is the most beneficial in which one of the following situations? A. A firm is considering a project that can easily be extended if it is profitable. B. A firm can either build a bowling alley or a miniature golf course on a piece of land, but not both. C. A ski resort is considering adding a golf course to increase revenues. D. A firm has free cash that can be invested but must be returned in time to meet a bond obligation two years from now. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 8.01 Summarise the payback rule and some of its shortcomings Topic: The payback rule

10. Your firm requires an average accounting return (AAR) of at least 15% on all fixed asset purchases. Currently, you are considering some new equipment costing $96 000. This equipment will have a three-year life over which time it will be depreciated on a straight-line basis to a zero book value. The annual profit for the year (or period) from this project is estimated at $5500, $12 400 and $17 600 for the three years. Should you accept this project based on the accounting rate of return? Why or why not? A. Yes; because the AAR is less than 15%. B. Yes; because the AAR is equal to 15%. C. Yes; because the AAR is greater than 15%. D. No; because the AAR is less than 15%. Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 8.02 Describe accounting rates of return and some of the problems with them Topic: The average accounting return

11. Ben Lake Enterprises is currently considering a project that will produce cash inflows of $3500 a year for three years followed by $1200 a year for two more years. The cost of the project is $10 000. What is the profitability index if the discount rate is 7%? A. 0.96

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B. 0.98 C. 1.00 D. 1.10 Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 8.06 Calculate the profitability index and understand its relation to net present value Topic: The profitability index

12. If an investment is producing a return that is equal to the required return, the investment's net present value will be: A. positive B. greater than the project's initial investment C. zero D. equal to the project's net profit Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 8.03 Describe the internal rate of return criterion and its strengths and weaknesses Topic: The internal rate of return

13. Both Projects A and B are acceptable as independent projects. However, the selection of either one of these projects eliminates the option of selecting the other project. Which one of the following terms best describes the relationship between Project A and Project B? A. Mutually exclusive B. Conventional C. Multiple choice D. Dual return Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 8.03 Describe the internal rate of return criterion and its strengths and weaknesses Topic: The internal rate of return

14. The modified internal rate of return is specifically designed to address the problems associated with which one of the following? A. Mutually exclusive projects B. Unconventional cash flows C. Long-term projects D. Negative net present values Ans: B

Ross, Essentials of Corporate Finance, Fifth Edition

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AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 8.05 Apply the modified internal rate of return Topic: The internal rate of return

15. The reinvestment approach to the modified internal rate of return: A. individually discounts each separate cash flow back to the present B. reinvests all the cash flows, including the initial cash flow, to the end of the project C. discounts all negative cash flows to the present and compounds all positive cash flows to the end of the project D. compounds all of the cash flows, except for the initial cash flow, to the end of the project Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 8.05 Apply the modified internal rate of return Topic: The internal rate of return

16. Which one of the following is specifically designed to compute the rate of return on a project that has unconventional cash flows? A. Average accounting return B. Profitability index C. Internal rate of return D. Modified internal rate of return Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 8.05 Apply the modified internal rate of return Topic: The internal rate of return

17. Which one of the following methods of analysis is most appropriate to use when two investments are mutually exclusive? A. Internal rate of return B. Profitability index C. Net present value D. Modified internal rate of return Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 8.05 Apply the modified internal rate of return Topic: The internal rate of return

18. The net present value of an investment represents the difference between the investment's:

Ross, Essentials of Corporate Finance, Fifth Edition

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A. cash inflows and outflows. B. cost and net profit. C. cost and market value. D. cash flows and profits. Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 8.04 Explain why the net present value criterion is the best way to evaluate proposed investments Topic: Net present value

19. Discounted cash flow valuation is the process of discounting an investment's: A. assets. B. future profits. C. liabilities. D. future cash flows. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 8.04 Explain why the net present value criterion is the best way to evaluate proposed investments Topic: Net present value

20. Which one of the following indicates that a project is expected to create value for its owners? A. A profitability index less than 1.0 B. A payback period greater than the requirement C. A positive net present value D. A positive average accounting rate of return Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 8.04 Explain why the net present value criterion is the best way to evaluate proposed investments Topic: Net present value

21. The average profit for the year (or period) of a project divided by the project's average book value is referred to as the project's: A. required return. B. market rate of return. C. internal rate of return. D. average accounting return. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 8.02 Describe accounting rates of return and some of the problems with them Topic: The average accounting return

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22. Manly Manufacturing Ltd is evaluating an expansion of its business by purchasing new manufacturing equipment. The equipment has an installation cost of $26 million, which will be depreciated straight-line to zero over its three-year life. If the plant has projected profit for the year (or period) of $2 348 000, $2 680 000 and $1 920 000 over these three years, what is the project's average accounting return (AAR)? A. 11.69% B. 14.14% C. 15.088% D. 17.82% Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 8.02 Describe accounting rates of return and some of the problems with them Topic: The average accounting return

23. The Bondi Pizza Palace is considering opening a new store at a start-up cost of $700 000. The initial investment will be depreciated straight-line to zero over the 15-year life of the project. Based on the income projections shown below, what is the average accounting rate of return? Years Profit for the year (or period) 1–5 $62 000 6–10 54 000 11–15 39 000 A. 13.05% B. 13.68% C. 14.01% D. 14.76% Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 8.02 Describe accounting rates of return and some of the problems with them Topic: The average accounting return

24. Which one of the following can be defined as a benefit–cost ratio? A. Internal rate of return B. Average accounting return C. Profitability index D. Net present value Ans: C

Ross, Essentials of Corporate Finance, Fifth Edition

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AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 8.06 Calculate the profitability index and understand its relation to net present value Topic: The profitability index

25. Which one of the following indicates that a project should be rejected? A. Average accounting return that exceeds the requirement B. Payback period that is shorter than the requirement period C. Positive net present value D. Profitability index less than 1.0 Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 8.06 Calculate the profitability index and understand its relation to net present value Topic: The profitability index

26. Payback is best used to evaluate which type of projects? A. Low-cost, short-term B. High-cost, short-term C. Low-cost, long-term D. High-cost, long-term Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 8.01 Summarise the payback rule and some of its shortcomings Topic: The payback rule

27. In which one of the following situations would the payback method be the preferred method of analysis? A. A project that can easily be expanded B. Two mutually exclusive projects C. A proposed expansion of a firm's current operations D. Investment funds available only for a limited period of time Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 8.01 Summarise the payback rule and some of its shortcomings Topic: The payback rule

28. An investment has an initial cost of $3.3 million. This investment will be depreciated by $900 000 a year over the three-year life of the project. Should this project be accepted based on the average accounting rate of return if the required rate is 10.0%? Why or why not?

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Year Profit for the year (or period) 1 $211 700 2 186 400 3 165 500 A. Yes, because the AAR is 10.0%. B. Yes, because the AAR is less than 10.0%. C. No, because the AAR is greater than 10.0%. D. No, because the AAR is less than 10.0%. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 8.02 Describe accounting rates of return and some of the problems with them Topic: The average accounting return

29. A project has expected cash inflows, starting with year 1, of $2200, $2900, $3500 and finally in Year 4: $4000. The profitability index is 1.14 and the discount rate is 12%. What is the initial cost of the project? A. $7899.16 B. $8098.24 C. $8166.19 D. $9211.06 Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 8.06 Calculate the profitability index and understand its relation to net present value Topic: The profitability index

30. Which one of the following analysis methods is most similar to the analysis of net present value? A. Payback period B. Internal rate of return C. Profitability index D. Average accounting return Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 8.05 Apply the modified internal rate of return Topic: The internal rate of return

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31. The payback period is the length of time it takes an investment to generate sufficient cash flows to enable the project to: A. produce a positive annual cash flow. B. produce a positive cash flow from assets. C. offset its fixed expenses. D. offset its total expenses. E. recoup its initial cost. Ans: E AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 8.01 Summarise the payback rule and some of its shortcomings Topic: The payback rule

32. The internal rate of return is the: A. discount rate that causes a project’s after-tax income to equal zero. B. discount rate that results in a zero net present value for the project. C. discount rate that results in a net present value equal to the project's initial cost. D. rate of return required by the project's investors. E. project's current market rate of return. Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 8.05 Apply the modified internal rate of return Topic: The internal rate of return

33. The net present value profile illustrates how the net present value of an investment is affected by which one of the following? A. Project's initial cost B. Discount rate C. Timing of the project's cash inflows D. Inflation rate E. Real rate of return Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 8.05 Apply the modified internal rate of return Topic: The internal rate of return

34. The possibility that more than one discount rate can cause the net present value of an investment to equal zero is referred to as: A. duplication. B. the net present value profile. C. multiple rates of return.

Ross, Essentials of Corporate Finance, Fifth Edition

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D. the AAR problem. E. the dual dilemma. Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 8.05 Apply the modified internal rate of return Topic: The internal rate of return

35. Which one of the following is true if the managers of a firm accept only projects that have a profitability index greater than 1.5? A. The firm should increase in value each time it accepts a new project B. The firm is most likely steadily losing value C. The price of the firm's share should remain constant D. The net present value of each new project is zero E. The internal rate of return on each new project is zero Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 8.06 Calculate the profitability index and understand its relation to net present value Topic: The profitability index

36. What is the net present value of a project with the following cash flows if the discount rate is 12 per cent? Year 0 1 2 3

Cash Flow −$ 27 500 14 800 19 400 5 200

A. $4881.10 B. $11 900.00 C. $4358.13 D. $11 035.24 E. $8129.06 Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 8.04 Explain why the net present value criterion is the best way to evaluate proposed investments Topic: Net present value

37. Which one of the following statements is correct?

Ross, Essentials of Corporate Finance, Fifth Edition

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A. A longer payback period is preferred over a shorter payback period. B. The payback rule states that you should accept a project if the payback period is less than one year. C. The payback period ignores the time value of money. D. The payback rule is biased in favour of long-term projects. E. The payback period considers the timing and amount of all of a project's cash flows. Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 8.01 Summarise the payback rule and some of its shortcomings Topic: The payback rule

38. Which one of the following is the primary advantage of payback analysis? A. Incorporation of the time value of money concept B. Ease of use C. Research and development bias D. Arbitrary cut-off point E. Long-term bias Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 8.01 Summarise the payback rule and some of its shortcomings Topic: The payback rule

39. Which one of the following methods of analysis ignores cash flows? A. Profitability index B. Payback C. Average accounting return D. Modified internal rate of return E. Internal rate of return Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 8.02 Describe accounting rates of return and some of the problems with them Topic: The average accounting return

40. Which one of the following analytical methods is based on profit for the year (or period)? A. Profitability index B. Internal rate of return C. Average accounting return D. Modified internal rate of return E. Payback Ans: C

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 08 Testbank

AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 8.02 Describe accounting rates of return and some of the problems with them Topic: The average accounting return

41. Which one of the following is most closely related to the net present value profile? A. Internal rate of return B. Average accounting return C. Profitability index D. Payback E. Discounted payback Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 8.05 Apply the modified internal rate of return Topic: The internal rate of return

42. An investment has conventional cash flows and a profitability index of 1.0. Given this, which one of the following must be true? A. The internal rate of return exceeds the required rate of return. B. The investment never pays back. C. The net present value is equal to zero. D. The average accounting return is 1.0. E. The net present value is greater than 1.0. Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 8.06 Calculate the profitability index and understand its relation to net present value Topic: The profitability index

43. The profitability index reflects the value created per dollar: A. invested. B. of sales. C. of profit for the year (or period). D. of profit before tax. E. of shareholders' equity. Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 8.06 Calculate the profitability index and understand its relation to net present value Topic: The profitability index

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45. Daniel’s Market is considering a project with an initial cost of $176 500. The project will not produce any cash flows for the first three years. Starting in Year 4, the project will produce cash inflows of $127 500 a year for three years. This project is risky, so the firm has assigned it a discount rate of 17%. What is the project's net present value? A. $105 222 B. −$6500 C. $29 301.80 D. $621.30 E. −$601.03 Ans: E AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 8.04 Explain why the net present value criterion is the best way to evaluate proposed investments Topic: Net present value

46. John is considering a project with cash inflows of $1100, $1000, $1050 and $1200 over the next four years, respectively. The relevant discount rate is 12.5%. What is the net present value of this project if it the start-up cost is $3200? A. $54.50 B. $48.04 C. −$35.45 D. $89.33 E. $122.00 Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 8.04 Explain why the net present value criterion is the best way to evaluate proposed investments Topic: Net present value

47. What is the payback period for a project with the following cash flows?

Ross, Essentials of Corporate Finance, Fifth Edition

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Year Cash Flow 0 −$ 75 000 1 15 000 2 23 000 3 35 000 4 25 000 A. 2.56 years B. 2.89 years C. 3.08 years D. 3.24 years E. Never Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 8.01 Summarise the payback rule and some of its shortcomings Topic: The payback rule

49. Auto Detailers is buying some new equipment at a cost of $188 900. This equipment will be depreciated on a straight-line basis to a zero book value over its eight-year life. The equipment is expected to generate profit for the year (or period) of $11 000 a year for the first four years and $24 000 a year for the last four years. What is the average accounting rate of return? A. 15.48% B. 17.76% C. 18.09% D. 22.68% E. 18.53%

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Ans: E AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 8.02 Describe accounting rates of return and some of the problems with them Topic: The average accounting return

50. An investment has an initial cost of $2.7 million and profit for the year (or period) of $189 400, $178 600 and $172 500 for Years 1 to 3. This investment will be depreciated by $900 000 a year over the three-year life of the project. Should this project be accepted based on the average accounting rate of return if the required rate is 12.5%? Why or why not? A. Yes, because the AAR is 12.5%. B. Yes, because the AAR is less than 12.5%. C. Yes, because the AAR is greater than 12.5%. D. No, because the AAR is greater than 12.5%. E. No, because the AAR is less than 12.5%. Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 8.02 Describe accounting rates of return and some of the problems with them Topic: The average accounting return

51. A project has the following cash flows. What is the internal rate of return? Year 0 1 2 3

Cash Flow −$ 111 000 49 650 52 300 36 450

A. 15.17% B. 13.41% C. 13.68% D. 12.53% E. 13.15% Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 8.03 Describe the internal rate of return criterion and its strengths and weaknesses Topic: The internal rate of return

52. A project has the following cash flows. What is the internal rate of return?

Year Cash Flow 0 −$ 1 2 3 4

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12 500 2 750 3 100 3 333 5 260

A. 5.43% B. 5.50% C. 5.92% D. 5.57% E. 5.53% Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 8.03 Describe the internal rate of return criterion and its strengths and weaknesses Topic: The internal rate of return

53. You are considering an investment for which you require a rate of return of 8.5%. The investment costs $53 500 and will produce cash inflows of $20 000 for three years. Should you accept this project based on its internal rate of return? Why or why not? A. Yes; because the IRR is 5.96%. B. Yes; because the IRR is 9.56%. C. Yes; because the IRR is 8.50%. D. No; because the IRR is 9.56%. E. No; because the IRR is 5.96%. Ans: E AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 8.03 Describe the internal rate of return criterion and its strengths and weaknesses Topic: The internal rate of return

54. The Steel Factory is considering a project that will produce annual cash flows of $43 800, $40 200, $46 200 and $41 800 over the next four years, respectively. What is the internal rate of return if the initial cost of the project is $127 900? A. 13.00% B. 10.19% C. 11.28% D. 12.24% E. 12.83% Ans: A

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 08 Testbank

AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 8.03 Describe the internal rate of return criterion and its strengths and weaknesses Topic: The internal rate of return

55. Miller Brothers is considering a project that will produce cash inflows of $32 500, $38 470, $40 805 and $41 268 a year for the next four years, respectively. What is the internal rate of return if the initial cost of the project is $184 600? A. 7.39% B. 6.86% C. 6.47% D. 7.62% E. 6.24% Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 8.03 Describe the internal rate of return criterion and its strengths and weaknesses Topic: The internal rate of return

56. The net present value of a project's cash inflows is $2716 at a discount rate of 12%. The profitability index is 1.09 and the firm's tax rate is 34%. What is the initial cost of the project? A. $2314.07 B. $2018.50 C. $2428.32 D. $2491.74 E. $2066.67 Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 8.06 Calculate the profitability index and understand its relation to net present value Topic: The profitability index

57. You are trying to determine whether or not to expand your business by building a new manufacturing plant. The plant has an installation cost of $29 million, which will be depreciated straight-line to zero over its three-year life. If the plant has projected profit for the year (or period) of $1 848 000, $2 080 000 and $2,720 000 over these three years, what is the project's average accounting return (AAR)? A. 14.69% B. 14.14% C. 15.03% D. 15.28% E. 14.21% Ans: D

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 08 Testbank

AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 8.02 Describe accounting rates of return and some of the problems with them Topic: The average accounting return

58. Miller and Sons is evaluating a project with the following cash flows: Year Cash Flow 0 −$ 72 000 1 29 100 2 20 600 3 42 500 4 24 300 5 − 9 800 The company uses a 10% interest rate on all of its projects. What is the MIRR of the project using the reinvestment approach? The discounting approach? The combination approach? A. 18.54%; 17.29%; 14.61% B. 13.96%; 14.38%; 14.61% C. 18.54%; 17.29%; 13.67% D. 13.96%; 17.85%; 13.67% E. 18.54%; 18.23%; 18.61% Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 8.05 Apply the modified internal rate of return Topic: The internal rate of return

59. What is the net present value of a project with the following cash flows if the discount rate is 9%? Year Cash Flow 0 −$ 15 000.00 1 4 800.00 2 5 700.00 3 6 250.00 A. −$972.61 B. $972.61 C. −$892.30 D. $892.30 E. $812.90 Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 8.04 Explain why the net present value criterion is the best way to evaluate proposed investments Topic: Net present value

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60. John is considering a project with cash inflows of $1750, $1850, $2000 and $2550 over the next four years, respectively. The relevant discount rate is 14%. What is the net present value of this project if it the start-up cost is $5000? A. $818.35 B. $947.56 C. −$600.00 D. $693.61 E. $379.75 Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 8.04 Explain why the net present value criterion is the best way to evaluate proposed investments Topic: Net present value

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 08 Testbank

Chapter 08 Testbank Summary Category AACSB: Analytic Blooms: Analysis Difficulty: Easy Difficulty: Medium Learning Objective: 8.01 Summarise the payback rule and some of its shortcomings Learning Objective: 8.02 Describe accounting rates of return and some of the problems with them Learning Objective: 8.03 Describe the internal rate of return criterion and its strengths and weaknesses Learning Objective: 8.04 Explain why the net present value criterion is the best way to evaluate proposed investments Learning Objective: 8.05 Apply the modified internal rate of return Learning Objective: 8.06 Calculate the profitability index and understand its relation to net present value Topic: Net present value Topic: The average accounting return Topic: The internal rate of return Topic: The payback rule Topic: The practice of capital budgeting Topic: The profitability index

# of Questions 60 60 57 3 10 10 10 10 10 10 10 10 20 10 1 9

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 09 Testbank

Chapter 09 Testbank 1. Shere Khan Corporation is currently evaluating a new project. Relatively inexpensive equipment with an estimated cost of $300 000 would be purchased, but shipping costs to move the equipment would total $25 000 and installation charges would add another $15 000 to the total equipment costs. Further, the company's inventories would have to be increased by $20 000 at the time of initial investment. The straight-line depreciation rate is 20% and corporate tax rate is 25%. What is the cash outflow in Year 0? A. $20 000 B. $360 000 C. $325 000 D. $340 000 2. Shere Khan Corporation is currently evaluating a new project. Relatively inexpensive equipment with an estimated cost of $300 000 would be purchased, but shipping costs to move the equipment would total $25 000 and installation charges would add another $15 000 to the total equipment costs. Further, the company's inventories would have to be increased by $20 000 at the time of initial investment. The straight-line depreciation rate is 20% and corporate tax rate is 25%. Calculate the annual depreciation. A. $60 000 B. $45 000 C. $72 000 D. $68 000 3. Shere Khan Corporation is currently evaluating a new project. Relatively inexpensive equipment with an estimated cost of $300 000 would be purchased, but shipping costs to move the equipment would total $25 000 and installation charges would add another $15 000 to the total equipment costs. Furthermore, the company's inventories would have to be increased by $20 000 at the time of initial investment. The straight-line depreciation rate is 20% and corporate tax rate is 25%. Calculate the tax effect of depreciation on annual cash flows. A. $15 000 B. $11 250 C. $18 000 D. $17 000 4. Byrne Corporation generated sales of 1500 bicycles at a selling price of $1000 each. The fixed costs are $800 000 and variable costs per unit are $30. The annual depreciation of the machinery is $150 000. Calculate the annual operating cash flow if the corporate tax rate is 30%. A. $503 500 B. $655 000 C. $506 500

Ross, Essentials of Corporate Finance, Fifth Edition

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D. $656 500 5. The incremental cash flows of a project can best be defined as the difference between a firm's _____ with and without the project. A. net worth B. profit for the year C. present cash flows D. future cash flows 6. An opportunity cost is defined as: A. the increased cost incurred when a new project is accepted. B. the increased sales of an existing product if a new product is added to a firm's offerings. C. a cost that has been incurred and cannot be recouped. D. the most valuable alternative that is given up if a particular investment is undertaken. 7. The analysis of the effect that a single variable has on the net present value of a project is called ________ analysis. A. sensitivity B. erosion C. cost reduction D. scenario 8. Alfonso & Sons purchased a new grinding machine two years ago at a cost of $390 000. Last year some revolutionary developments occurred, making their machine virtually worthless as it cannot produce products that meet the higher quality standards of the newer machines. If Alfonso & Sons continue using their current machine, they will lose all their customers. They have not found anyone willing to purchase the machine even at a deeply discounted price. The best description of this machine today is that it is a(n) _____ cost. A. erosion B. rationed C. sunk D. market 9. The net working capital invested in a project is generally: A. a sunk cost. B. an opportunity cost. C. recouped in the first year of the project. D. recouped at the end of the project. 10. Which one of the following can be completely ignored when analysing a project? A. Depreciation

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 09 Testbank

B. Taxes C. Net working capital D. Sunk cost 11. Ignoring the option to expand: A. overestimates the internal rate of return on a project. B. underestimates the net present value of a project. C. ignores the possibility that a negative net present value project might be positive given changes over time. D. ignores the possibility that one variable is the primary source of the forecasting risk associated with a project. 12. A debt-free firm has profit for the year of $128 400, taxes of $46 200 and depreciation of $21 300. What is the operating cash flow? A. $82 200 B. $103 500 C. $107 100 D. $149 700 13. A cost-cutting project will decrease costs by $25 000 a year. The annual depreciation on the project's non-current assets will be $6800 and the tax rate is 34%. What is the amount of the change in the firm's operating cash flow created by this project? A. –$14 188 B. –$6212 C. $10 812 D. $18 812 14. Jeans 'n' More currently sells blue jeans and T-shirts. Management is considering adding fleece tops to their range to provide a cooler weather option. The tops would sell for $39 each and they expect to sell 6000 units per year. By adding the fleece tops, management feels that they will sell an additional 1200 pairs of jeans at $45 a pair and 500 fewer T-shirts at $10 each. The variable cost per unit is $20 on the jeans, $4.50 on the T-shirts and $22 on the fleece tops. The incremental annual depreciation expense related to the fleece top is $32 000 and the incremental annual fixed costs related to the fleece top are $60 000. The tax rate is 35%. What is the project's operating cash flow? A. $45 012.50 B. $54 612.50 C. $56 212.50 D. $62 212.50 15. Any changes to a firm's projected future cash flows that are caused by adding a new project are referred to as which one of the following?

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 09 Testbank

A. Eroded cash flows B. Deviated projections C. Incremental cash flows D. Directly impacted flows 16. Which one of the following terms refers to the best option that was foregone when a particular investment is selected? A. Side effect B. Erosion C. Sunk cost D. Opportunity cost 17. A pro forma financial statement is a financial statement that: A. expresses all values as a percentage of either total assets or total sales. B. compares actual results to the budgeted amounts. C. compares the performance of a firm to its industry. D. projects future years' operations. 18. The amount by which a firm's tax bill is reduced as a result of the depreciation expense is referred to as the depreciation: A. tax shield. B. credit. C. erosion. D. opportunity cost. 19. Which of the following should be included when compiling pro forma statements for a proposed investment? I. Forecasted sales II. Start-up costs III. After-tax salvage value of any assets sold IV. Anticipated changes in net working capital A. I only B. II and IV only C. I, II and III only D. I, II, III and IV 20. The tax shield approach to computing the operating cash flow, given a tax-paying firm: A. ignores both interest expense and taxes. B. separates cash inflows from cash outflows. C. is based on the fact that depreciation does not affect the operating cash flows. D. recognises that depreciation creates a cash inflow.

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 09 Testbank

21. Which one of the following statements is correct when a firm faces hard rationing? A. All positive net present value projects will be accepted. B. Each division within a firm will be allocated an amount for capital expenditures that will be less than the total value of its positive net present value projects. C. The firm does not have funds to finance any new projects. D. The firm will fund only those projects that create value for its shareholders. 22. Which of the following should be included in the analysis of a proposed investment? I. Erosion effects II. Opportunity costs III. Sunk costs IV. Side effects A. I only B. II only C. I and IV only D. I, II and IV only 23. A project has annual depreciation of $16 200, costs of $87 100 and sales of $123 000. The applicable tax rate is 40%. What is the operating cash flow according to the tax shield approach? A. $21 540 B. $27 667 C. $27 458 D. $28 020 24. Scenario analysis is best described as the determination of the: A. most likely outcome for a project. B. reasonable range of project outcomes. C. variable that has the greatest effect on a project's outcome. D. effect that a project's initial cost has on the project's net present value. 25. You are analysing a project and have developed the following estimates. The depreciation is $14 800 a year and the tax rate is 35%. What is the base case operating cash flow? A. $18 770 B. $18 972 C. $21 433 D. $21 690 26. You are analysing a project and have developed the following estimates. The depreciation is $3200 a year and the tax rate is 34%. What is the best-case operating cash flow? A. $13 473 B. $14 196 C. $15 280

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 09 Testbank

D. $17 423 27. You are analysing a project and have developed the following estimates. The depreciation is $52 000 a year and the tax rate is 34%. What is the worst-case operating cash flow? A. –$32 509 B. –$19 288 C. –$4225 D. $48 106 28. We are evaluating a project that costs $1.68 million, has a five-year life and no salvage value. Assume depreciation is straight-line to zero over the life of the project. Sales are projected at 82 000 units per year. Price per unit is $43.29, variable cost per unit is $22.18 and fixed costs are $623 000 per year. The tax rate is 34% and we require a 10% return on this project. What is the sensitivity of NPV to a 100-unit change in the sales figure? A. $3998.40 B. $4609.18 C. $4897.20 D. $5281.55 29. Which one of the following should NOT be considered in capital budgeting? A. Opportunity costs B. Side effects C. Financing costs D. Sunk costs 30. Which one of the following is NOT a common method for capital budgeting? A. Sensitivity analysis B. Scenario analysis C. Break-even analysis D. Tax shield approach 31. Which one of the following terms is most commonly used to describe the cash flows of a new project that are simply an offset of reduced cash flows for a current project? A. Opportunity cost B. Sunk cost C. Erosion D. Replicated flows E. Pirated flows 32. Which one of the following refers to a method of increasing the rate at which an asset is depreciated?

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 09 Testbank

A. Non-cash expense B. Straight-line depreciation C. Depreciation tax shield D. Accelerated cost recovery system E. Market-based depreciation 33. Kate is analysing a proposed project to determine how changes in the sales quantity would affect the project's net present value. What type of analysis is being conducted? A. Sensitivity analysis B. Erosion planning C. Scenario analysis D. Benefit-cost analysis E. Opportunity cost analysis 34. The opportunities that a manager has to modify a project once the project has started are called: A. sensitivity choices. B. managerial options. C. scenario adjustments. D. restructuring options. E. erosion control measures. 35. Contingency planning focuses on the: A. opportunity costs involved with a project. B. sunk costs related to a project. C. economic effects on a project's profitability. D. managerial options implicit in a project. E. optional capital requirements of a project. 36. Which one of the following refers to the option to expand into related businesses in the future? A. Strategic option B. Contingency option C. Soft rationing D. Hard rationing E. Capital rationing option 37. Kyle Electric has three positive net present value opportunities. Unfortunately, the firm has not been able to find financing for any of these projects. Which one of the following terms best fits the situation facing the firm? A. Sensitivity analysis B. Capital rationing

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 09 Testbank

C. Soft rationing D. Contingency planning E. Sunk cost 38. Northern Companies has three separate divisions. Each year, the company determines the amount it can afford to spend in total for capital expenditures and then allocates one-third of that amount to each division. This allocation process is called: A. soft rationing. B. hard rationing. C. opportunity cost allocation. D. divisional separation. E. strategic planning. 39. Dismal Outlook is unable to obtain financing for any new projects under any circumstances. This company is faced with: A. contingency planning. B. soft rationing. C. hard rationing. D. real options. E. sunk costs. 40. Weston Steel purchased a new coal furnace six years ago at a cost of $2.2 million. Last year, the government changed the emission requirements and this furnace cannot meet those standards. Thus, the company can no longer use the furnace, nor has it been able to locate anyone willing to purchase the furnace. Given the current situation, the furnace is best described as which type of cost? A. Erosion B. Book C. Sunk D. Market E. Opportunity 41. Valley Forge and Metal purchased a truck five years ago for local deliveries. Which one of the following costs related to this truck is the best example of a sunk cost? Assume the truck has a usable life of five years. A. New tires that will be purchased this winter B. Costs of repairs needed so the truck can pass inspection next month C. Money spent last month repairing a damaged front fender D. Engine tune-up that is scheduled for this afternoon E. Cost for a truck driver for the remainder of the truck's useful life

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 09 Testbank

42. CrossTown Builders is considering remodelling an old building it currently owns. The building was purchased 10 years ago for $1.2 million. Over the past 10 years, the firm rented out the building and used the rent to pay off the mortgage. The building is now owned free and clear and has a current market value of $1.9 million. The company is considering remodelling the building into industrial-type apartments at an estimated cost of $1.6 million. The estimated present value of the future income from these apartments is $4.1 million. Which one of the following defines the opportunity cost of the remodelling project? A. Present value of the future income B. Cost of the remodelling C. Current market value of the building D. Initial cost of the building plus the remodelling costs E. Current market value of the building plus the remodelling costs 43. Assume an all-equity firm has positive net earnings. The operating cash flow of this firm: A. ignores both depreciation and taxes. B. is unaffected by the depreciation expense. C. must be negative. D. increases when the tax rate decreases. E. is equal to Profit for the year minus depreciation. 44. The operating cash flows of a project: A. are unaffected by the depreciation method selected. B. are equal to the project's total projected profit for the year. C. decrease when net working capital increases. D. include any after tax salvage values. E. include erosion effects. 45. Which one of the following will increase the operating cash flow as computed using the tax shield approach? A. Decrease in depreciation B. Decrease in sales C. Increase in variable costs D. Decrease in fixed costs E. Increase in the tax rate 46. Which one of the following is a correct value to use if you are conducting a best-case scenario analysis? A. Sales price that is most likely to occur B. Lowest expected level of sales quantity C. Lowest expected salvage value D. Highest expected need for net working capital E. Lowest expected value for fixed costs

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 09 Testbank

47. Ignoring the option to wait: A. may overestimate the internal rate of return on a project. B. may underestimate the net present value of a project. C. ignores the ability of a manager to increase output after a project has been implemented. D. is the same as ignoring all strategic options. E. ignores the value of discontinuing a project early. 48. Nu Tek is comprised of four separate operating divisions. For this year, the firm has decided to allocate capital funds using a soft rationing approach. Which one of the following applies to this situation? A. Division managers will be limited to accepting a single new project each. B. Division managers are being given blanket approval to accept all positive net present value projects. C. Division managers should expect to be treated equally, at least initially, in the capital distribution process. D. Division managers will not receive any funding for new projects but will be allowed to expand current operations. E. Division managers will not receive capital funding for any project. 49. A project has annual depreciation of $15 028, costs of $82 592 and sales of $138 765. The applicable tax rate is 34%. What is the operating cash flow according to the tax shield approach? A. $21 540.09 B. $27 666.67 C. $27 157.02 D. $42 183.70 E. $39 878.84 50. You are analysing a project and have developed the following estimates: unit sales = 2150, price per unit = $84, variable cost per unit = $57, fixed costs per year = $13 900. The depreciation is $8300 a year and the tax rate is 35%. What effect would an increase of $1 in the selling price have on the operating cash flow? A. $1397.50 B. $1249.65 C. $1320.65 D. $3773.25 E. $1430.35 51. Lakeside Winery is considering expanding its winemaking operations. The expansion will require new equipment costing $708 000 that would be depreciated on a straight-line basis to a zero balance over the four-year life of the project. The equipment can be sold for $220 000 after the four years. The project requires $46 000 initially for net working capital, all of which will be recouped at the end of the project. The projected operating cash flow is $211 500 a year. What is the net present value of this project if the relevant discount rate is 13% and the tax rate is 34%?

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 09 Testbank

A. −$7632.77 B. −$8309.18 C. −$10747.11 D. $7008.14 E. $1309.54 52. Outdoor Sports is considering adding a miniature golf course to its facility. The course would cost $138 000, would be depreciated on a straight-line basis over its five-year life and would have a zero salvage value. The estimated income from the golfing fees would be $72 000 a year with $24 000 of that amount being variable cost. The fixed cost would be $11 600. In addition, the firm anticipates an additional $14 000 in revenue from its existing facilities if the golf course is added. The project will require $3000 of net working capital, which is recoverable at the end of the project. What is the net present value of this project at a discount rate of 12% and a tax rate of 34%? A. $11 309.11 B. $11 628.04 C. $12 737.26 D. $14 438.78 E. $14 900.41 53. Sensitivity analysis: A. looks at the most reasonably optimistic and pessimistic results for a project. B. helps identify the variable within a project that presents the greatest forecasting risk. C. is used for projects that cannot be analysed by scenario analysis because the cash flows are unconventional. D. is generally conducted prior to scenario analysis just to determine if the range of potential outcomes is acceptable. E. illustrates how an increase in operating cash flow caused by changing both the revenue and the costs simultaneously will change the net present value for a project. 54. Consider an asset that costs $311 000 and is depreciated straight-line to zero over its six-year tax life. The asset is to be used in a four-year project; at the end of the project, the asset can be sold for $58 000. If the relevant tax rate is 34%, what is the after tax cash flow from the sale of this asset? A. $73 526.67 B. $68 411.19 C. $70 103.33 D. $40 466.67 E. $42 473.33 55. An asset used in a three-year project falls in the three-year PRRT class for tax purposes. The PRRT percentage rates starting with Year 1 are: 33.33, 44.45, 14.81 and 7.41. The asset has an

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 09 Testbank

acquisition cost of $2.6 million and will be sold for $1.1 million at the end of the project. If the tax rate is 34%, what is the after tax salvage value of the asset? A. $742 519.10 B. $726 000.00 C. $832 056.60 D. $791 504.40 E. $887 560.15 56. A debt-free firm has profit for the year of $210 000, taxes of $55 822.78 and depreciation of $42 000. What is the operating cash flow? A. $213 300 B. $248 800 C. $202 400 D. $252 000 E. $244 200 57. Turner Industries started a new project three months ago. Sales arising from this project are significantly less than anticipated. Given this, which one of the following is management most likely to implement? A. Option to wait B. Soft rationing C. Option to delay D. Option to expand E. Option to abandon 58. Scenario analysis asks which of the following questions? A. How will changing the number of units sold affect the outcome of this project? B. What is the best outcome that should reasonably be expected? C. How much will a $1 increase in the variable cost per unit change the net present value? D. Will the net present value increase or decrease if the quantity sold increases by 100 units? E. How will the operating cash flow change if the depreciation method is changed? 59. An all-equity firm has profit for the year of $112 780, depreciation of $8750 and taxes of $29 980. What is the firm's operating cash flow? A. $150 965 B. $142 760 C. $91 550 D. $121 530 E. $151 510

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 09 Testbank

60. A new project is expected to generate an operating cash flow of $85 560 and will initially free up $10 475 in net working capital. Purchases of non-current assets costing $85 000 will be required to start up the project. What is the total cash flow for this project at Time zero? A. −$75 085 B. −$74 525 C. −$85 000 D. −$87 250 E. $62 250

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 09 Testbank

Chapter 09 Testbank Key 1. Shere Khan Corporation is currently evaluating a new project. Relatively inexpensive equipment with an estimated cost of $300 000 would be purchased, but shipping costs to move the equipment would total $25 000 and installation charges would add another $15 000 to the total equipment costs. Further, the company's inventories would have to be increased by $20 000 at the time of initial investment. The straight-line depreciation rate is 20% and corporate tax rate is 25%. What is the cash outflow in Year 0? A. $20 000 B. $360 000 C. $325 000 D. $340 000 Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 9.01 Determine the relevant cash flows for a proposed investment Topic: More on project cash flow

2. Shere Khan Corporation is currently evaluating a new project. Relatively inexpensive equipment with an estimated cost of $300 000 would be purchased, but shipping costs to move the equipment would total $25 000 and installation charges would add another $15 000 to the total equipment costs. Further, the company's inventories would have to be increased by $20 000 at the time of initial investment. The straight-line depreciation rate is 20% and corporate tax rate is 25%. Calculate the annual depreciation. A. $60 000 B. $45 000 C. $72 000 D. $68 000 Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 9.01 Determine the relevant cash flows for a proposed investment Topic: More on project cash flow

3. Shere Khan Corporation is currently evaluating a new project. Relatively inexpensive equipment with an estimated cost of $300 000 would be purchased, but shipping costs to move the equipment would total $25 000 and installation charges would add another $15 000 to the total equipment costs. Furthermore, the company's inventories would have to be increased by $20 000 at the time of initial investment. The straight-line depreciation rate is 20% and corporate tax rate is 25%. Calculate the tax effect of depreciation on annual cash flows. A. $15 000

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 09 Testbank

B. $11 250 C. $18 000 D. $17 000 Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 9.01 Determine the relevant cash flows for a proposed investment Topic: More on project cash flow

4. Byrne Corporation generated sales of 1500 bicycles at a selling price of $1000 each. The fixed costs are $800 000 and variable costs per unit are $30. The annual depreciation of the machinery is $150 000. Calculate the annual operating cash flow if the corporate tax rate is 30%. A. $503 500 B. $655 000 C. $506 500 D. $656 500 Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 9.02 Analyse a project’s projected cash flows Topic: Pro forma financial statements and project cash flows

5. The incremental cash flows of a project can best be defined as the difference between a firm's _____ with and without the project. A. net worth B. profit for the year C. present cash flows D. future cash flows Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 9.01 Determine the relevant cash flows for a proposed investment Topic: Project cash flows: a first look

6. An opportunity cost is defined as: A. the increased cost incurred when a new project is accepted. B. the increased sales of an existing product if a new product is added to a firm's offerings. C. a cost that has been incurred and cannot be recouped. D. the most valuable alternative that is given up if a particular investment is undertaken. Ans: D

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 09 Testbank

AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 9.01 Determine the relevant cash flows for a proposed investment Topic: Incremental cash flows

7. The analysis of the effect that a single variable has on the net present value of a project is called ________ analysis. A. sensitivity B. erosion C. cost reduction D. scenario Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 9.03 Evaluate an estimated NPV Topic: Scenario and other what-if analyses

8. Alfonso & Sons purchased a new grinding machine two years ago at a cost of $390 000. Last year some revolutionary developments occurred, making their machine virtually worthless as it cannot produce products that meet the higher quality standards of the newer machines. If Alfonso & Sons continue using their current machine, they will lose all their customers. They have not found anyone willing to purchase the machine even at a deeply discounted price. The best description of this machine today is that it is a(n) _____ cost. A. erosion B. rationed C. sunk D. market Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 9.01 Determine the relevant cash flows for a proposed investment Topic: Incremental cash flows

9. The net working capital invested in a project is generally: A. a sunk cost. B. an opportunity cost. C. recouped in the first year of the project. D. recouped at the end of the project. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 9.02 Analyse a project’s projected cash flows Topic: Pro forma financial statements and project cash flows

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 09 Testbank

10. Which one of the following can be completely ignored when analysing a project? A. Depreciation B. Taxes C. Net working capital D. Sunk cost Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 9.01 Determine the relevant cash flows for a proposed investment Topic: Incremental cash flows

11. Ignoring the option to expand: A. overestimates the internal rate of return on a project. B. underestimates the net present value of a project. C. ignores the possibility that a negative net present value project might be positive given changes over time. D. ignores the possibility that one variable is the primary source of the forecasting risk associated with a project. Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 9.03 Evaluate an estimated NPV Topic: Additional considerations in capital budgeting

12. A debt-free firm has profit for the year of $128 400, taxes of $46 200 and depreciation of $21 300. What is the operating cash flow? A. $82 200 B. $103 500 C. $107 100 D. $149 700 Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 9.02 Analyse a project’s projected cash flows Topic: Pro forma financial statements and project cash flows

13. A cost-cutting project will decrease costs by $25 000 a year. The annual depreciation on the project's non-current assets will be $6800 and the tax rate is 34%. What is the amount of the change in the firm's operating cash flow created by this project? A. –$14 188 B. –$6212 C. $10 812

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 09 Testbank

D. $18 812 Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 9.02 Analyse a project’s projected cash flows Topic: Pro forma financial statements and project cash flows

14. Jeans 'n' More currently sells blue jeans and T-shirts. Management is considering adding fleece tops to their range to provide a cooler weather option. The tops would sell for $39 each and they expect to sell 6000 units per year. By adding the fleece tops, management feels that they will sell an additional 1200 pairs of jeans at $45 a pair and 500 fewer T-shirts at $10 each. The variable cost per unit is $20 on the jeans, $4.50 on the T-shirts and $22 on the fleece tops. The incremental annual depreciation expense related to the fleece top is $32 000 and the incremental annual fixed costs related to the fleece top are $60 000. The tax rate is 35%. What is the project's operating cash flow? A. $45 012.50 B. $54 612.50 C. $56 212.50 D. $62 212.50 Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 9.02 Analyse a project’s projected cash flows Topic: Pro forma financial statements and project cash flows

15. Any changes to a firm's projected future cash flows that are caused by adding a new project are referred to as which one of the following? A. Eroded cash flows B. Deviated projections C. Incremental cash flows D. Directly impacted flows Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 9.01 Determine the relevant cash flows for a proposed investment Topic: Project cash flows: a first look

16. Which one of the following terms refers to the best option that was foregone when a particular investment is selected? A. Side effect B. Erosion C. Sunk cost D. Opportunity cost

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 09 Testbank

Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 9.01 Determine the relevant cash flows for a proposed investment Topic: Incremental cash flows

17. A pro forma financial statement is a financial statement that: A. expresses all values as a percentage of either total assets or total sales. B. compares actual results to the budgeted amounts. C. compares the performance of a firm to its industry. D. projects future years' operations. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 9.02 Analyse a project’s projected cash flows Topic: Pro forma financial statements and project cash flows

18. The amount by which a firm's tax bill is reduced as a result of the depreciation expense is referred to as the depreciation: A. tax shield. B. credit. C. erosion. D. opportunity cost. Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 9.02 Analyse a project’s projected cash flows Topic: Pro forma financial statements and project cash flows

19. Which of the following should be included when compiling pro forma statements for a proposed investment? I. Forecasted sales II. Start-up costs III. After-tax salvage value of any assets sold IV. Anticipated changes in net working capital A. I only B. II and IV only C. I, II and III only D. I, II, III and IV Ans: D

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 09 Testbank

AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 9.02 Analyse a project’s projected cash flows Topic: Pro forma financial statements and project cash flows

20. The tax shield approach to computing the operating cash flow, given a tax-paying firm: A. ignores both interest expense and taxes. B. separates cash inflows from cash outflows. C. is based on the fact that depreciation does not affect the operating cash flows. D. recognises that depreciation creates a cash inflow. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 9.02 Analyse a project’s projected cash flows Topic: Pro forma financial statements and project cash flows

22. Which of the following should be included in the analysis of a proposed investment? I. Erosion effects II. Opportunity costs III. Sunk costs IV. Side effects A. I only B. II only C. I and IV only D. I, II and IV only Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 9.01 Determine the relevant cash flows for a proposed investment Topic: Incremental cash flows

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 09 Testbank

23. A project has annual depreciation of $16 200, costs of $87 100 and sales of $123 000. The applicable tax rate is 40%. What is the operating cash flow according to the tax shield approach? A. $21 540 B. $27 667 C. $27 458 D. $28 020 Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 9.02 Analyse a project’s projected cash flows Topic: Pro forma financial statements and project cash flows

24. Scenario analysis is best described as the determination of the: A. most likely outcome for a project. B. reasonable range of project outcomes. C. variable that has the greatest effect on a project's outcome. D. effect that a project's initial cost has on the project's net present value. Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 9.03 Evaluate an estimated NPV Topic: Scenario and other what-if analyses

25. You are analysing a project and have developed the following estimates. The depreciation is $14 800 a year and the tax rate is 35%. What is the base case operating cash flow? A. $18 770 B. $18 972 C. $21 433 D. $21 690 Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 9.03 Evaluate an estimated NPV Topic: Scenario and other what-if analyses

26. You are analysing a project and have developed the following estimates. The depreciation is $3200 a year and the tax rate is 34%. What is the best-case operating cash flow? A. $13 473 B. $14 196 C. $15 280 D. $17 423 Ans: D

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 09 Testbank

AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 9.03 Evaluate an estimated NPV Topic: Scenario and other what-if analyses

27. You are analysing a project and have developed the following estimates. The depreciation is $52 000 a year and the tax rate is 34%. What is the worst-case operating cash flow? A. –$32 509 B. –$19 288 C. –$4225 D. $48 106 Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 9.03 Evaluate an estimated NPV Topic: Scenario and other what-if analyses

28. We are evaluating a project that costs $1.68 million, has a five-year life and no salvage value. Assume depreciation is straight-line to zero over the life of the project. Sales are projected at 82 000 units per year. Price per unit is $43.29, variable cost per unit is $22.18 and fixed costs are $623 000 per year. The tax rate is 34% and we require a 10% return on this project. What is the sensitivity of NPV to a 100-unit change in the sales figure? A. $3998.40 B. $4609.18 C. $4897.20 D. $5281.55 Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 9.03 Evaluate an estimated NPV Topic: Scenario and other what-if analyses

29. Which one of the following should NOT be considered in capital budgeting? A. Opportunity costs B. Side effects C. Financing costs D. Sunk costs Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 9.03 Evaluate an estimated NPV Topic: Additional considerations in capital budgeting

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 09 Testbank

30. Which one of the following is NOT a common method for capital budgeting? A. Sensitivity analysis B. Scenario analysis C. Break-even analysis D. Tax shield approach Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 9.03 Evaluate an estimated NPV Topic: Additional considerations in capital budgeting

31. Which one of the following terms is most commonly used to describe the cash flows of a new project that are simply an offset of reduced cash flows for a current project? A. Opportunity cost B. Sunk cost C. Erosion D. Replicated flows E. Pirated flows Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 9.01 Determine the relevant cash flows for a proposed investment Topic: Incremental cash flows

32. Which one of the following refers to a method of increasing the rate at which an asset is depreciated? A. Non-cash expense B. Straight-line depreciation C. Depreciation tax shield D. Accelerated cost recovery system E. Market-based depreciation Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 9.01 Determine the relevant cash flows for a proposed investment Topic: More on project cash flow

33. Kate is analysing a proposed project to determine how changes in the sales quantity would affect the project's net present value. What type of analysis is being conducted? A. Sensitivity analysis B. Erosion planning C. Scenario analysis D. Benefit-cost analysis

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E. Opportunity cost analysis Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 9.03 Evaluate an estimated NPV Topic: Scenario and other what-if analyses

34. The opportunities that a manager has to modify a project once the project has started are called: A. sensitivity choices. B. managerial options. C. scenario adjustments. D. restructuring options. E. erosion control measures. Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 9.03 Evaluate an estimated NPV Topic: Additional considerations in capital budgeting

35. Contingency planning focuses on the: A. opportunity costs involved with a project. B. sunk costs related to a project. C. economic effects on a project's profitability. D. managerial options implicit in a project. E. optional capital requirements of a project. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 9.03 Evaluate an estimated NPV Topic: Additional considerations in capital budgeting

36. Which one of the following refers to the option to expand into related businesses in the future? A. Strategic option B. Contingency option C. Soft rationing D. Hard rationing E. Capital rationing option Ans: A

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AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 9.03 Evaluate an estimated NPV Topic: Additional considerations in capital budgeting

37. Kyle Electric has three positive net present value opportunities. Unfortunately, the firm has not been able to find financing for any of these projects. Which one of the following terms best fits the situation facing the firm? A. Sensitivity analysis B. Capital rationing C. Soft rationing D. Contingency planning E. Sunk cost Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 9.03 Evaluate an estimated NPV Topic: Additional considerations in capital budgeting

38. Northern Companies has three separate divisions. Each year, the company determines the amount it can afford to spend in total for capital expenditures and then allocates one-third of that amount to each division. This allocation process is called: A. soft rationing. B. hard rationing. C. opportunity cost allocation. D. divisional separation. E. strategic planning. Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 9.03 Evaluate an estimated NPV Topic: Additional considerations in capital budgeting

39. Dismal Outlook is unable to obtain financing for any new projects under any circumstances. This company is faced with: A. contingency planning. B. soft rationing. C. hard rationing. D. real options. E. sunk costs. Ans: C

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AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 9.03 Evaluate an estimated NPV Topic: Additional considerations in capital budgeting

40. Weston Steel purchased a new coal furnace six years ago at a cost of $2.2 million. Last year, the government changed the emission requirements and this furnace cannot meet those standards. Thus, the company can no longer use the furnace, nor has it been able to locate anyone willing to purchase the furnace. Given the current situation, the furnace is best described as which type of cost? A. Erosion B. Book C. Sunk D. Market E. Opportunity Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 9.01 Determine the relevant cash flows for a proposed investment Topic: Incremental cash flows

41. Valley Forge and Metal purchased a truck five years ago for local deliveries. Which one of the following costs related to this truck is the best example of a sunk cost? Assume the truck has a usable life of five years. A. New tires that will be purchased this winter B. Costs of repairs needed so the truck can pass inspection next month C. Money spent last month repairing a damaged front fender D. Engine tune-up that is scheduled for this afternoon E. Cost for a truck driver for the remainder of the truck's useful life Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 9.01 Determine the relevant cash flows for a proposed investment Topic: Incremental cash flows

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B. Cost of the remodelling C. Current market value of the building D. Initial cost of the building plus the remodelling costs E. Current market value of the building plus the remodelling costs Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 9.01 Determine the relevant cash flows for a proposed investment Topic: Incremental cash flows

43. Assume an all-equity firm has positive net earnings. The operating cash flow of this firm: A. ignores both depreciation and taxes. B. is unaffected by the depreciation expense. C. must be negative. D. increases when the tax rate decreases. E. is equal to Profit for the year minus depreciation. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 9.01 Determine the relevant cash flows for a proposed investment Topic: More on project cash flow

44. The operating cash flows of a project: A. are unaffected by the depreciation method selected. B. are equal to the project's total projected profit for the year. C. decrease when net working capital increases. D. include any after tax salvage values. E. include erosion effects. Ans: E AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 9.01 Determine the relevant cash flows for a proposed investment Topic: Incremental cash flows

45. Which one of the following will increase the operating cash flow as computed using the tax shield approach? A. Decrease in depreciation B. Decrease in sales C. Increase in variable costs D. Decrease in fixed costs E. Increase in the tax rate Ans: D

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AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 9.02 Analyse a project’s projected cash flows Topic: Pro forma financial statements and project cash flows

46. Which one of the following is a correct value to use if you are conducting a best-case scenario analysis? A. Sales price that is most likely to occur B. Lowest expected level of sales quantity C. Lowest expected salvage value D. Highest expected need for net working capital E. Lowest expected value for fixed costs Ans: E AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 9.03 Evaluate an estimated NPV Topic: Scenario and other what-if analyses

48. Nu Tek is comprised of four separate operating divisions. For this year, the firm has decided to allocate capital funds using a soft rationing approach. Which one of the following applies to this situation? A. Division managers will be limited to accepting a single new project each. B. Division managers are being given blanket approval to accept all positive net present value projects. C. Division managers should expect to be treated equally, at least initially, in the capital distribution process. D. Division managers will not receive any funding for new projects but will be allowed to expand current operations. E. Division managers will not receive capital funding for any project. Ans: C

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AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 9.03 Evaluate an estimated NPV Topic: Additional considerations in capital budgeting

49. A project has annual depreciation of $15 028, costs of $82 592 and sales of $138 765. The applicable tax rate is 34%. What is the operating cash flow according to the tax shield approach? A. $21 540.09 B. $27 666.67 C. $27 157.02 D. $42 183.70 E. $39 878.84 Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 9.02 Analyse a project’s projected cash flows Topic: Pro forma financial statements and project cash flows

50. You are analysing a project and have developed the following estimates: unit sales = 2150, price per unit = $84, variable cost per unit = $57, fixed costs per year = $13 900. The depreciation is $8300 a year and the tax rate is 35%. What effect would an increase of $1 in the selling price have on the operating cash flow? A. $1397.50 B. $1249.65 C. $1320.65 D. $3773.25 E. $1430.35 Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 9.02 Analyse a project’s projected cash flows Topic: Pro forma financial statements and project cash flows

51. Lakeside Winery is considering expanding its winemaking operations. The expansion will require new equipment costing $708 000 that would be depreciated on a straight-line basis to a zero balance over the four-year life of the project. The equipment can be sold for $220 000 after the four years. The project requires $46 000 initially for net working capital, all of which will be recouped at the end of the project. The projected operating cash flow is $211 500 a year. What is the net present value of this project if the relevant discount rate is 13% and the tax rate is 34%? A. −$7632.77 B. −$8309.18 C. −$10747.11 D. $7008.14

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E. $1309.54 Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 9.01 Determine the relevant cash flows for a proposed investment Topic: More on project cash flow

52. Outdoor Sports is considering adding a miniature golf course to its facility. The course would cost $138 000, would be depreciated on a straight-line basis over its five-year life and would have a zero salvage value. The estimated income from the golfing fees would be $72 000 a year with $24 000 of that amount being variable cost. The fixed cost would be $11 600. In addition, the firm anticipates an additional $14 000 in revenue from its existing facilities if the golf course is added. The project will require $3000 of net working capital, which is recoverable at the end of the project. What is the net present value of this project at a discount rate of 12% and a tax rate of 34%? A. $11 309.11 B. $11 628.04 C. $12 737.26 D. $14 438.78 E. $14 900.41 Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 9.02 Analyse a project’s projected cash flows Topic: Pro forma financial statements and project cash flows

53. Sensitivity analysis: A. looks at the most reasonably optimistic and pessimistic results for a project. B. helps identify the variable within a project that presents the greatest forecasting risk. C. is used for projects that cannot be analysed by scenario analysis because the cash flows are unconventional. D. is generally conducted prior to scenario analysis just to determine if the range of potential outcomes is acceptable. E. illustrates how an increase in operating cash flow caused by changing both the revenue and the costs simultaneously will change the net present value for a project. Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 9.03 Evaluate an estimated NPV Topic: Scenario and other what-if analyses

54. Consider an asset that costs $311 000 and is depreciated straight-line to zero over its six-year tax life. The asset is to be used in a four-year project; at the end of the project, the asset can be

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sold for $58 000. If the relevant tax rate is 34%, what is the after tax cash flow from the sale of this asset? A. $73 526.67 B. $68 411.19 C. $70 103.33 D. $40 466.67 E. $42 473.33 Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 9.01 Determine the relevant cash flows for a proposed investment Topic: More on project cash flow

55. An asset used in a three-year project falls in the three-year PRRT class for tax purposes. The PRRT percentage rates starting with Year 1 are: 33.33, 44.45, 14.81 and 7.41. The asset has an acquisition cost of $2.6 million and will be sold for $1.1 million at the end of the project. If the tax rate is 34%, what is the after tax salvage value of the asset? A. $742 519.10 B. $726 000.00 C. $832 056.60 D. $791 504.40 E. $887 560.15 Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 9.01 Determine the relevant cash flows for a proposed investment Topic: More on project cash flow

56. A debt-free firm has profit for the year of $210 000, taxes of $55 822.78 and depreciation of $42 000. What is the operating cash flow? A. $213 300 B. $248 800 C. $202 400 D. $252 000 E. $244 200 Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 9.02 Analyse a project’s projected cash flows Topic: Pro forma financial statements and project cash flows

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57. Turner Industries started a new project three months ago. Sales arising from this project are significantly less than anticipated. Given this, which one of the following is management most likely to implement? A. Option to wait B. Soft rationing C. Option to delay D. Option to expand E. Option to abandon Ans: E AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 9.03 Evaluate an estimated NPV Topic: Additional considerations in capital budgeting

58. Scenario analysis asks which of the following questions? A. How will changing the number of units sold affect the outcome of this project? B. What is the best outcome that should reasonably be expected? C. How much will a $1 increase in the variable cost per unit change the net present value? D. Will the net present value increase or decrease if the quantity sold increases by 100 units? E. How will the operating cash flow change if the depreciation method is changed? Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 9.03 Evaluate an estimated NPV Topic: Scenario and other what-if analyses

59. An all-equity firm has profit for the year of $112 780, depreciation of $8750 and taxes of $29 980. What is the firm's operating cash flow? A. $150 965 B. $142 760 C. $91 550 D. $121 530 E. $151 510 Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 9.02 Analyse a project’s projected cash flows Topic: Pro forma financial statements and project cash flows

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B. −$74 525 C. −$85 000 D. −$87 250 E. $62 250 Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 9.02 Analyse a project’s projected cash flows Topic: Pro forma financial statements and project cash flows

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Chapter 09 Testbank Summary Category AACSB: Analytic Blooms: Analysis Difficulty: Easy Difficulty: Medium Learning Objective: 9.01 Determine the relevant cash flows for a proposed investment Learning Objective: 9.02 Analyse a project’s projected cash flows Learning Objective: 9.03 Evaluate an estimated NPV Topic: Additional considerations in capital budgeting Topic: Incremental cash flows Topic: More on project cash flow Topic: Pro forma financial statements and project cash flows Topic: Project cash flows: a first look Topic: Scenario and other what-if analyses

# of Questions 60 60 56 4 20 17 23 13 10 8 17 2 10

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Chapter 10 Testbank 1. Based on the following share price data (in $) for Pi-Omega Corporation, calculate the standard deviation of returns on Pi-Omega.

A. 0.0294 B. 0.4436 C. 0.7893 D. 0.0462 2. The Reserve Bank of Australia expects the inflation rate in Australia to be 4.50% and financial analysts evaluate the risk-premium on small company shares to be 3.70% for the year. The Commonwealth Government's T-notes yield is expected to be 8% for the next year. What rate of return is expected to be earned on small-company shares over the next year? A. 8.20% B. 4.50% C. 11.20% D. 11.70% 3. One of the biggest Australian companies' shares returned 9.37%, –3.55% and 11.55% over the past three years, respectively. What is the arithmetic average return for this period? A. 8.16% B. 5.79% C. 8.68% D. 9.37% 4. The average squared difference between the actual return and the average return is called the: A. mean. B. alpha. C. beta. D. variance. 5. When a financial market reflects all the available information in the prices of the securities, the market is referred to as a(n): A. normal distribution.

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B. primary market. C. efficient capital market. D. delayed reaction market. 6. Which of the following statements are correct? I. The risk-free rate of return generally earns a risk premium of about 1% II. The reward for bearing risk is called the standard deviation III. Based on historical returns, there are rewards for bearing risk IV. In general, the higher the risk, the higher the expected return A. I and II only B. III and IV only C. I, II and IV only D. II, III and IV only 7. The higher the standard deviation of a security, the _____ the expected rate of return and the _____ the risk. A. lower; lower B. lower; higher C. higher; lower D. higher; higher 8. The arithmetic average return of 8, 12, 2 and 16% is computed as: A. the square root of (8 + 12 + 2 + 16). B. the ¼ root of (8 + 12 + 2 + 16). C. (8 + 12 + 2 + 16) × 4. D. (8 + 12 + 2 + 16) ÷ 4. 9. The efficient markets hypothesis (EMH): A. acknowledges that some fairly sizeable inefficiencies will exist even in efficient markets, but only over the long-term. B. argues that markets which fluctuate noticeably from one day to the next cannot be efficient. C. suggests that an efficient market incorporates only about 90% of all public information into the market prices. D. advocates that all investments in an efficient market have a net present value of zero. 10. If the securities markets are only weak-form efficient, then the price of a share will: A. react to new information over a couple of weeks. B. react slowly to new information concerning the future outlook of the firm. C. tend to overreact to new information concerning the future plans of the firm. D. be based solely on historical information.

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11. Which one of the following supports the argument that financial markets are semistrong-form efficient? A. Financial analysts gain a marketplace advantage by studying financial statements. B. Only company insiders have a marketplace advantage. C. Only historical information is reflected in the market prices of securities. D. All information, public and private, is included in current market prices. 12. If the financial markets are strong-form efficient, then: A. only the most talented analysts can determine the true value of a security. B. only company insiders have a marketplace advantage. C. technical analysis provides the best tool to use to gain a marketplace advantage. D. no one person has an advantage in the marketplace. 13. A year ago, Fred purchased 300 shares of RPJ for $14 400. The shares are currently selling for $36 per share and Fred has decided to sell all of his shares. What is the total return that Fred has earned on this investment if he received a special dividend of $5 per share? A. –25.00% B. –19.44% C. –14.58% D. –8.89% 14. Over the past 10 years, large-company shares have returned 11.2%. The risk premium on these shares was 4.8% and the inflation rate was 3.7%. What was the risk-free rate of return? A. 2.7% B. 6.4% C. 7.5% D. 8.5% 15. A bond has an average return of 6.8% and a standard deviation of 4.6%. What range of returns would you expect to see 68% of the time? A. 2.2% to 11.4% B. 4.6% to 11.4% C. 4.6% to 22.8% D. 11.4% to 22.8% 16. Which one of the following combinations will always result in an increased dividend yield? A. Increase in the share price combined with a lower dividend amount B. Increase in the share price combined with a higher dividend amount C. Decrease in the share price combined with a lower dividend amount D. Decrease in the share price combined with a higher dividend amount

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17. Which one of the following statements is correct concerning both the dollar return and the percentage return on a share investment? A. The dollar return is dependent on the size of the investment while the percentage return is not. B. The dollar return is more accurate than the percentage return because the dollar return includes dividend income while the percentage return does not. C. The dollar return considers the time value of money while the percentage return does not. D. Dollar returns are based on capital gains while percentage returns are based on the total rate of return. 18. One year ago, you purchased 400 shares for $12 a share. The share pays $0.22 per share in dividends each year. Today, you sold your shares for $28.30 per share. What is your total dollar return on this investment? A. $6222 B. $6432 C. $6520 D. $6608 19. One year ago, you bought a share for $36.48 a share. You received a dividend of $1.62 per share last month and sold the share today for $40.18 a share. What is the capital gains yield on this investment? A. 2.86% B. 3.70% C. 10.14% D. 12.29% 20. Over the period of 1900–2010, which one of the following investment classes had the highest returns? A. Government bonds B. Cash on hand C. Equities D. Inflation 21. Investors require a 4% return on risk-free investments. On a particular risky investment, investors require an excess return of 7% in addition to the risk-free rate of 4%. What is this excess return called? A. Inflation premium B. Required return C. Real return D. Risk premium 22. Which one of the following has a rate of return that is used as a proxy for the risk-free rate? A. Long-term government bonds

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B. Long-term corporate bonds C. Inflation, as measured by the consumer price index D. Treasury notes 23. The variance is the average squared difference between which of the following? A. Actual return and average return B. Actual return and (average return / N – 1) C. Actual return and the real return D. Average return and the standard deviation 24. Which one of the following statements is correct? A. The risk-free rate of return has a risk premium of 1.0. B. The reward for bearing risk is called the standard deviation. C. Risks and expected return are inversely related. D. The higher the expected rate of return, the wider the distribution of returns. 25. The historical returns on equities as reported in your textbook in Section 10.2 are based on: A. 10-year government bonds. B. a portfolio of 30-day bank bills. C. the All Ordinaries Index. D. the ASX 200. 26. Percentage returns: I. are easy to understand II. relay information about a security more easily than dollar returns do III. are not affected by the amount of the investment IV. can be easily separated into dividend yield and capital gain yield A. II and III only B. I and III only C. I, II and III only D. I, II, III and IV 27. Dan is a chemist for ABC, a major drug manufacturer. Dan cannot earn excess profits on ABC shares based on the knowledge he has related to his experiments if the financial markets are: A. weak-form efficient. B. strong-form efficient. C. semistrong-form efficient. D. efficient at any level.

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28. Over the past five years, a share returned 8.3%, –32.5%, –2.2%, 46.9% and 11.8%, respectively. What is the variance of these returns? A. 0.071188 B. 0.076290 C. 0.081504 D. 0.082547 29. Over the last four years, a share has had an arithmetic average return of 8.8%. Three of those four years produced returns of 16.3%, 10.2% and –14.1%, respectively. What is the geometric average return for this four-year period? A. 7.83% B. 8.39% C. 8.67% D. 9.40% 30. An efficient market is defined as one in which: A. all participants have the same opportunity to make the same returns. B. all participants have the same legal rights and transactions costs. C. securities’ prices quickly and fully reflect all available information. D. securities’ prices are completely in line with their intrinsic value. 31. Which one of the following statements is correct concerning both the dollar return and the percentage return on a share investment? A. Without the size of an investment, the dollar return has less value than the percentage return. B. The dollar return is more accurate than the percentage return because the dollar return includes dividend income while the percentage return does not. C. The dollar return considers the time value of money while the percentage return does not. D. Dollar returns are based on capital gains while percentage returns are based on the total rate of return. E. Dollar returns must either be zero or a positive value while percentage returns can be negative, zero or positive. 32. One year ago, you purchased 600 shares. This morning you sold those shares and realised a total return of 3.1%. Given this information, you know for sure the: A. share price increased by 3.1% over the last year. B. share increased in value over the past year. C. share paid a dividend. D. dividend yield is greater than zero. E. sum of the dividend yield and the capital gains yield is 3.1%. 33. The historical returns on large-company shares, as reported by Ibbotson and Sinquefield and reported in your textbook, are based on the:

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A. largest 20% of the shares traded on the NYSE. B. share returns for the largest 10% of the publicly traded firms in the US. C. returns of the 100 largest firms in the US. D. returns of all the shares listed on the NYSE. E. shares of the 500 companies included in the S&P 500 index. 34. Over the period of 1926–2014, which one of the following investment classes had the highest volatility of returns? A. Large-company shares B. US Treasury bills C. Small-company shares D. Long-term corporate bonds E. Long-term government bonds 35. Over the period of 1926–2014: A. long-term government bonds underperformed long-term corporate bonds. B. small-company shares underperformed large-company shares. C. inflation exceeded the rate of return on US Treasury bills. D. U.S. Treasury bills outperformed long-term government bonds. E. large-company shares outperformed all other investment categories. 36. The rate of return on which one of the following has a risk premium of 0%? A. Long-term government bonds B. Long-term corporate bonds C. Intermediate-term government bonds D. US Treasury bills E. Large-company shares 37. What was the maximum loss faced by the investors during the year 2008? A. 14% B. 18% C. 15% D. 12% 38. The historical record for the period 1993–2018 shows that the average real return on cash was: A. 7.74% per year. B. 2.52% per year. C. 2.32% per year. D. 7.52% per year.

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39. What was the average annual risk premium on government bonds for the period 1993–2018? A. 5.42% B. 4.42% C. 2.48% D. 1.48% E. 3.48% 40. One year ago, you purchased a 7% coupon bond with a face value of $1000 when it was selling for 102.5% of par. Today, you sold this bond for 104% of par. What is your total dollar return on this investment? A. $85 B. $55 C. $70 D. $15 E. $100 41. One year ago, you purchased 500 shares for $22 a share. The share pays $0.32 a share in dividends each year. Today, you sold your shares for $24.50 a share. What is your total dollar return on this investment? A. $1250 B. $1090 C. $1199 D. $1164 E. $1410 42. The lower the standard deviation of returns on a security, the _____ the expected rate of return and the _____ the risk. A. lower; lower B. lower; higher C. higher; lower D. higher; higher 43. When, if ever, will the geometric average return exceed the arithmetic average return for a given set of returns? A. When the set of returns includes only risk-free rates B. When the set of returns has a wide frequency distribution C. When the set of returns has a very narrow frequency distribution D. When all of the rates of return in the set of returns are equal to each other E. Never 44. The average risk premium on long-term government bonds for the period 1926–2014 was equal to:

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A. zero. B. 1%. C. the rate of return on the bonds plus the corporate bond rate. D. the rate of return on the bonds minus the T-bill rate. E. the rate of return on the bonds minus the inflation rate. 45. If the financial markets are efficient. then: A. share prices should remain constant. B. share prices should increase or decrease slowly as new events are analysed and the information is absorbed by the markets. C. an increase in the value of one security should be offset by a decrease in the value of another security. D. share prices will change only when an event actually occurs, not at the time the event is anticipated. E. share prices should respond only to unexpected news and events. 46. According to the efficient markets hypothesis, in an efficient market, investors will earn: A. excess profits over the long-term. B. excess profits, but only on current investments. C. exactly what they pay for when they buy securities. D. a return that cannot be accurately predicted because investments are subject to the random movements of the markets. E. a return that ‘beats the market’. 47. Semistrong-form market efficiency states that the value of a security is based on: A. all public and private information. B. historical information only. C. all publicly available information. D. all publicly available information plus any data that can be gathered from insider trading. E. random information with no clear distinction as to the source of that information. 48. If the financial markets are semistrong-form efficient, then: A. only the most talented analysts can determine the true value of a security. B. only individuals with private information have a marketplace advantage. C. technical analysis provides the best tool to use to gain a marketplace advantage. D. no one individual has an advantage in the marketplace. E. every security offers the same rate of return. 49. The share of Arbitrage Training is priced at $37 per share and has a dividend yield of 2.8%. The firm pays constant annual dividends. What is the amount of the next dividend per share? A. $1.15 B. $1.77

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C. $1.04 D. $0.96 E. $1.20 50. Paneer Asphalt Materials pays a constant annual dividend of $1.26 per share on its share. Last year at this time, the market rate of return on this share was 14.9%. Today, the market rate has fallen to 12.5%. What would your capital gains yield have been if you had purchased this share one year ago and then sold the share today? A. −16.11% B. −23.16% C. 9.35% D. 17.66% E. 19.2% 51. One year ago, Marcus purchased 400 shares of Maverick Data for $21 052. Today, he sold those shares for $56.00 per share. What is the total return on this investment if the dividend yield is 1.9%? A. 9.10% B. 8.30% C. 6.56% D. 5.39% E. 7.61% 52. Assume that last year, Catrin earned 9.8% on his investments while US Treasury bills yielded 2.3% and the inflation rate was 1.4%. What real rate of return did he earn on his investments last year? A. 8.76% B. 8.28% C. 10.69% D. 9.37% E. 7.52% 53. Assume you earned 12.3% on your investments for a time period when the risk-free rate was 4.25% and the inflation rate was 1.2%. What was your real rate of return for the period? A. −9.71% B. 8.21% C. 10.97% D. −10.35% E. 10.23% 54. Sarah earned a 3.3% real rate of return on her investments for the past year. During that time, the risk-free rate was 3.6% and the inflation rate was 3.1%. What was her nominal rate of return?

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 10 Testbank

A. 5.30% B. 6.06% C. 6.50% D. 6.67% E. 6.91% 55. Assume that over the past 88 years, US Treasury bills had an average return of 3.5% as compared to 6.1% on long-term government bonds. During this same time period, assume inflation averaged 3.0%. What was the average nominal risk premium on the long-term government bonds? A. 3.1% B. .1% C. 2.9% D. 1.8% E. 2.6% 56. Over the past four years, the annual percentage returns on large-company shares were 15, 7, 4 and 18%. For the same time period, US Treasury bills produced the returns of 6, 3, 2 and 4%. Inflation averaged 2.8% over the four-year period. The average real rate of return on largecompany shares was ___% as compared to _____% for Treasury bills. A. 6.47; 0.92 B. 6.47; 1.08 C. 7.98; 0.92 D. 7.98; 1.08 E. 7.98; 1.22 57. Suppose a share had an initial price of $47 per share, paid a dividend of $0.63 per share during the year and had an ending share price of $ 38. What was the capital gains yield? A. 20.31% B. −23.68% C. 17.39% D. −19.15% E. −18.53% 58. You bought a share of 7.5% preferred share for $91.60 last year. The market price for your share is now $89.10. What is your total return to date on this investment? A. 5.51% B. 4.73% C. 5.86% D. 6.10% E. 5.46%

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 10 Testbank

59. One year ago, you bought a share for $62.35 per share. You received a dividend of $1.40 per share last month and sold the share today for $63.75 per share. What is the capital gains yield on this investment? A. 1.91% B. −2.30% C. 2.25% D. 2.40% E. −2.40% 60. One year ago, Brookes purchased 200 shares of Surfer Bay share for $22 250. Today, he sold those shares for $114.00 per share. What is the total return on this investment if the dividend yield is 1.2%? A. 4.47% B. 3.67% C. 1.93% D. 0.76% E. 2.98%

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 10 Testbank

Chapter 10 Testbank Key 1. Based on the following share price data (in $) for Pi-Omega Corporation, calculate the standard deviation of returns on Pi-Omega.

A. 0.0294 B. 0.4436 C. 0.7893 D. 0.0462 Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 10.03 Explain the historical risks on various important types of investments Topic: The variability of returns: the second lesson

2. The Reserve Bank of Australia expects the inflation rate in Australia to be 4.50% and financial analysts evaluate the risk-premium on small company shares to be 3.70% for the year. The Commonwealth Government's T-notes yield is expected to be 8% for the next year. What rate of return is expected to be earned on small-company shares over the next year? A. 8.20% B. 4.50% C. 11.20% D. 11.70% Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 10.02 Discuss the historical returns on various important types of investments Topic: Average returns: the first lesson

3. One of the biggest Australian companies' shares returned 9.37%, –3.55% and 11.55% over the past three years, respectively. What is the arithmetic average return for this period? A. 8.16% B. 5.79% C. 8.68% D. 9.37% Ans: B

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 10 Testbank

AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 10.03 Explain the historical risks on various important types of investments Topic: More on average returns

4. The average squared difference between the actual return and the average return is called the: A. mean. B. alpha. C. beta. D. variance. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 10.03 Explain the historical risks on various important types of investments Topic: The variability of returns: the second lesson

5. When a financial market reflects all the available information in the prices of the securities, the market is referred to as a(n): A. normal distribution. B. primary market. C. efficient capital market. D. delayed reaction market. Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 10.04 Assess the implications of market efficiency Topic: Capital market efficiency

6. Which of the following statements are correct? I. The risk-free rate of return generally earns a risk premium of about 1% II. The reward for bearing risk is called the standard deviation III. Based on historical returns, there are rewards for bearing risk IV. In general, the higher the risk, the higher the expected return A. I and II only B. III and IV only C. I, II and IV only D. II, III and IV only Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 10.02 Discuss the historical returns on various important types of investments Topic: Average returns: the first lesson

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 10 Testbank

7. The higher the standard deviation of a security, the _____ the expected rate of return and the _____ the risk. A. lower; lower B. lower; higher C. higher; lower D. higher; higher Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 10.03 Explain the historical risks on various important types of investments Topic: The variability of returns: the second lesson

8. The arithmetic average return of 8, 12, 2 and 16% is computed as: A. the square root of (8 + 12 + 2 + 16). B. the ¼ root of (8 + 12 + 2 + 16). C. (8 + 12 + 2 + 16) × 4. D. (8 + 12 + 2 + 16) ÷ 4. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 10.04 Assess the implications of market efficiency Topic: More on average returns

9. The efficient markets hypothesis (EMH): A. acknowledges that some fairly sizeable inefficiencies will exist even in efficient markets, but only over the long-term. B. argues that markets which fluctuate noticeably from one day to the next cannot be efficient. C. suggests that an efficient market incorporates only about 90% of all public information into the market prices. D. advocates that all investments in an efficient market have a net present value of zero. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 10.04 Assess the implications of market efficiency Topic: Capital market efficiency

10. If the securities markets are only weak-form efficient, then the price of a share will: A. react to new information over a couple of weeks. B. react slowly to new information concerning the future outlook of the firm. C. tend to overreact to new information concerning the future plans of the firm. D. be based solely on historical information. Ans: D

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 10 Testbank

AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 10.04 Assess the implications of market efficiency Topic: Capital market efficiency

12. If the financial markets are strong-form efficient, then: A. only the most talented analysts can determine the true value of a security. B. only company insiders have a marketplace advantage. C. technical analysis provides the best tool to use to gain a marketplace advantage. D. no one person has an advantage in the marketplace. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 10.04 Assess the implications of market efficiency Topic: Capital market efficiency

13. A year ago, Fred purchased 300 shares of RPJ for $14 400. The shares are currently selling for $36 per share and Fred has decided to sell all of his shares. What is the total return that Fred has earned on this investment if he received a special dividend of $5 per share? A. –25.00% B. –19.44% C. –14.58% D. –8.89% Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 10.01 Calculate the return on an investment Topic: Returns

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 10 Testbank

14. Over the past 10 years, large-company shares have returned 11.2%. The risk premium on these shares was 4.8% and the inflation rate was 3.7%. What was the risk-free rate of return? A. 2.7% B. 6.4% C. 7.5% D. 8.5% Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 10.02 Discuss the historical returns on various important types of investments Topic: Average returns: the first lesson

15. A bond has an average return of 6.8% and a standard deviation of 4.6%. What range of returns would you expect to see 68% of the time? A. 2.2% to 11.4% B. 4.6% to 11.4% C. 4.6% to 22.8% D. 11.4% to 22.8% Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 10.03 Explain the historical risks on various important types of investments Topic: The variability of returns: the second lesson

16. Which one of the following combinations will always result in an increased dividend yield? A. Increase in the share price combined with a lower dividend amount B. Increase in the share price combined with a higher dividend amount C. Decrease in the share price combined with a lower dividend amount D. Decrease in the share price combined with a higher dividend amount Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 10.01 Calculate the return on an investment Topic: Returns

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 10 Testbank

Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 10.01 Calculate the return on an investment Topic: Returns

18. One year ago, you purchased 400 shares for $12 a share. The share pays $0.22 per share in dividends each year. Today, you sold your shares for $28.30 per share. What is your total dollar return on this investment? A. $6222 B. $6432 C. $6520 D. $6608 Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 10.01 Calculate the return on an investment Topic: Returns

19. One year ago, you bought a share for $36.48 a share. You received a dividend of $1.62 per share last month and sold the share today for $40.18 a share. What is the capital gains yield on this investment? A. 2.86% B. 3.70% C. 10.14% D. 12.29% Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 10.01 Calculate the return on an investment Topic: Returns

20. Over the period of 1900–2010, which one of the following investment classes had the highest returns? A. Government bonds B. Cash on hand C. Equities D. Inflation Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 10.02 Discuss the historical returns on various important types of investments Topic: The historical record

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 10 Testbank

21. Investors require a 4% return on risk-free investments. On a particular risky investment, investors require an excess return of 7% in addition to the risk-free rate of 4%. What is this excess return called? A. Inflation premium B. Required return C. Real return D. Risk premium Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 10.02 Discuss the historical returns on various important types of investments Topic: Average returns: the first lesson

22. Which one of the following has a rate of return that is used as a proxy for the risk-free rate? A. Long-term government bonds B. Long-term corporate bonds C. Inflation, as measured by the consumer price index D. Treasury notes Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 10.02 Discuss the historical returns on various important types of investments Topic: Average returns: the first lesson

23. The variance is the average squared difference between which of the following? A. Actual return and average return B. Actual return and (average return / N – 1) C. Actual return and the real return D. Average return and the standard deviation Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 10.03 Explain the historical risks on various important types of investments Topic: The variability of returns: the second lesson

24. Which one of the following statements is correct? A. The risk-free rate of return has a risk premium of 1.0. B. The reward for bearing risk is called the standard deviation. C. Risks and expected return are inversely related. D. The higher the expected rate of return, the wider the distribution of returns. Ans: D

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 10 Testbank

AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 10.03 Explain the historical risks on various important types of investments Topic: The variability of returns: the second lesson

25. The historical returns on equities as reported in your textbook in Section 10.2 are based on: A. 10-year government bonds. B. a portfolio of 30-day bank bills. C. the All Ordinaries Index. D. the ASX 200. Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 10.02 Discuss the historical returns on various important types of investments Topic: The historical record

26. Percentage returns: I. are easy to understand II. relay information about a security more easily than dollar returns do III. are not affected by the amount of the investment IV. can be easily separated into dividend yield and capital gain yield A. II and III only B. I and III only C. I, II and III only D. I, II, III and IV Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 10.01 Calculate the return on an investment Topic: Returns

27. Dan is a chemist for ABC, a major drug manufacturer. Dan cannot earn excess profits on ABC shares based on the knowledge he has related to his experiments if the financial markets are: A. weak-form efficient. B. strong-form efficient. C. semistrong-form efficient. D. efficient at any level. Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 10.04 Assess the implications of market efficiency Topic: Capital market efficiency

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 10 Testbank

28. Over the past five years, a share returned 8.3%, –32.5%, –2.2%, 46.9% and 11.8%, respectively. What is the variance of these returns? A. 0.071188 B. 0.076290 C. 0.081504 D. 0.082547 Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 10.03 Explain the historical risks on various important types of investments Topic: More on average returns

29. Over the last four years, a share has had an arithmetic average return of 8.8%. Three of those four years produced returns of 16.3%, 10.2% and –14.1%, respectively. What is the geometric average return for this four-year period? A. 7.83% B. 8.39% C. 8.67% D. 9.40% Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Hard Learning Objective: 10.03 Explain the historical risks on various important types of investments Topic: More on average returns

30. An efficient market is defined as one in which: A. all participants have the same opportunity to make the same returns. B. all participants have the same legal rights and transactions costs. C. securities’ prices quickly and fully reflect all available information. D. securities’ prices are completely in line with their intrinsic value. Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 10.04 Assess the implications of market efficiency Topic: Capital market efficiency

31. Which one of the following statements is correct concerning both the dollar return and the percentage return on a share investment? A. Without the size of an investment, the dollar return has less value than the percentage return. B. The dollar return is more accurate than the percentage return because the dollar return includes dividend income while the percentage return does not. C. The dollar return considers the time value of money while the percentage return does not.

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 10 Testbank

D. Dollar returns are based on capital gains while percentage returns are based on the total rate of return. E. Dollar returns must either be zero or a positive value while percentage returns can be negative, zero or positive. Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 10.01 Calculate the return on an investment Topic: Returns

32. One year ago, you purchased 600 shares. This morning you sold those shares and realised a total return of 3.1%. Given this information, you know for sure the: A. share price increased by 3.1% over the last year. B. share increased in value over the past year. C. share paid a dividend. D. dividend yield is greater than zero. E. sum of the dividend yield and the capital gains yield is 3.1%. Ans: E AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 10.01 Calculate the return on an investment Topic: Returns

33. The historical returns on large-company shares, as reported by Ibbotson and Sinquefield and reported in your textbook, are based on the: A. largest 20% of the shares traded on the NYSE. B. share returns for the largest 10% of the publicly traded firms in the US. C. returns of the 100 largest firms in the US. D. returns of all the shares listed on the NYSE. E. shares of the 500 companies included in the S&P 500 index. Ans: E AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 10.02 Discuss the historical returns on various important types of investments Topic: The historical record

34. Over the period of 1926–2014, which one of the following investment classes had the highest volatility of returns? A. Large-company shares B. US Treasury bills C. Small-company shares D. Long-term corporate bonds E. Long-term government bonds

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 10 Testbank

Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 10.03 Explain the historical risks on various important types of investments Topic: The variability of returns: the second lesson

35. Over the period of 1926–2014: A. long-term government bonds underperformed long-term corporate bonds. B. small-company shares underperformed large-company shares. C. inflation exceeded the rate of return on US Treasury bills. D. U.S. Treasury bills outperformed long-term government bonds. E. large-company shares outperformed all other investment categories. Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 10.03 Explain the historical risks on various important types of investments Topic: The variability of returns: the second lesson

36. The rate of return on which one of the following has a risk premium of 0%? A. Long-term government bonds B. Long-term corporate bonds C. Intermediate-term government bonds D. US Treasury bills E. Large-company shares Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 10.02 Discuss the historical returns on various important types of investments Topic: Average returns: the first lesson

37. What was the maximum loss faced by the investors during the year 2008? A. 14% B. 18% C. 15% D. 12% Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 10.03 Explain the historical risks on various important types of investments Topic: The variability of returns: the second lesson

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 10 Testbank

38. The historical record for the period 1993–2018 shows that the average real return on cash was: A. 7.74% per year. B. 2.52% per year. C. 2.32% per year. D. 7.52% per year. Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 10.03 Explain the historical risks on various important types of investments Topic: The variability of returns: the second lesson

39. What was the average annual risk premium on government bonds for the period 1993–2018? A. 5.42% B. 4.42% C. 2.48% D. 1.48% E. 3.48% Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 10.02 Discuss the historical returns on various important types of investments Topic: Average returns: the first lesson

40. One year ago, you purchased a 7% coupon bond with a face value of $1000 when it was selling for 102.5% of par. Today, you sold this bond for 104% of par. What is your total dollar return on this investment? A. $85 B. $55 C. $70 D. $15 E. $100 Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 10.01 Calculate the return on an investment Topic: Returns

41. One year ago, you purchased 500 shares for $22 a share. The share pays $0.32 a share in dividends each year. Today, you sold your shares for $24.50 a share. What is your total dollar return on this investment? A. $1250 B. $1090

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 10 Testbank

C. $1199 D. $1164 E. $1410 Ans: E AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 10.01 Calculate the return on an investment Topic: Returns

42. The lower the standard deviation of returns on a security, the _____ the expected rate of return and the _____ the risk. A. lower; lower B. lower; higher C. higher; lower D. higher; higher Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 10.03 Explain the historical risks on various important types of investments Topic: The variability of returns: the second lesson

43. When, if ever, will the geometric average return exceed the arithmetic average return for a given set of returns? A. When the set of returns includes only risk-free rates B. When the set of returns has a wide frequency distribution C. When the set of returns has a very narrow frequency distribution D. When all of the rates of return in the set of returns are equal to each other E. Never Ans: E AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 10.04 Assess the implications of market efficiency Topic: More on average returns

44. The average risk premium on long-term government bonds for the period 1926–2014 was equal to: A. zero. B. 1%. C. the rate of return on the bonds plus the corporate bond rate. D. the rate of return on the bonds minus the T-bill rate. E. the rate of return on the bonds minus the inflation rate. Ans: D

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 10 Testbank

AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 10.04 Assess the implications of market efficiency Topic: The variability of returns: the second lesson

45. If the financial markets are efficient. then: A. share prices should remain constant. B. share prices should increase or decrease slowly as new events are analysed and the information is absorbed by the markets. C. an increase in the value of one security should be offset by a decrease in the value of another security. D. share prices will change only when an event actually occurs, not at the time the event is anticipated. E. share prices should respond only to unexpected news and events. Ans: E AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 10.04 Assess the implications of market efficiency Topic: Capital market efficiency

46. According to the efficient markets hypothesis, in an efficient market, investors will earn: A. excess profits over the long-term. B. excess profits, but only on current investments. C. exactly what they pay for when they buy securities. D. a return that cannot be accurately predicted because investments are subject to the random movements of the markets. E. a return that ‘beats the market’. Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 10.04 Assess the implications of market efficiency Topic: Capital market efficiency

47. Semistrong-form market efficiency states that the value of a security is based on: A. all public and private information. B. historical information only. C. all publicly available information. D. all publicly available information plus any data that can be gathered from insider trading. E. random information with no clear distinction as to the source of that information. Ans: C

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 10 Testbank

AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 10.04 Assess the implications of market efficiency Topic: Capital market efficiency

48. If the financial markets are semistrong-form efficient, then: A. only the most talented analysts can determine the true value of a security. B. only individuals with private information have a marketplace advantage. C. technical analysis provides the best tool to use to gain a marketplace advantage. D. no one individual has an advantage in the marketplace. E. every security offers the same rate of return. Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 10.04 Assess the implications of market efficiency Topic: Capital market efficiency

49. The share of Arbitrage Training is priced at $37 per share and has a dividend yield of 2.8%. The firm pays constant annual dividends. What is the amount of the next dividend per share? A. $1.15 B. $1.77 C. $1.04 D. $0.96 E. $1.20 Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 10.01 Calculate the return on an investment Topic: Returns

50. Paneer Asphalt Materials pays a constant annual dividend of $1.26 per share on its share. Last year at this time, the market rate of return on this share was 14.9%. Today, the market rate has fallen to 12.5%. What would your capital gains yield have been if you had purchased this share one year ago and then sold the share today? A. −16.11% B. −23.16% C. 9.35% D. 17.66% E. 19.2% Ans: E

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 10 Testbank

AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 10.01 Calculate the return on an investment Topic: Returns

51. One year ago, Marcus purchased 400 shares of Maverick Data for $21 052. Today, he sold those shares for $56.00 per share. What is the total return on this investment if the dividend yield is 1.9%? A. 9.10% B. 8.30% C. 6.56% D. 5.39% E. 7.61% Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 10.01 Calculate the return on an investment Topic: Returns

52. Assume that last year, Catrin earned 9.8% on his investments while US Treasury bills yielded 2.3% and the inflation rate was 1.4%. What real rate of return did he earn on his investments last year? A. 8.76% B. 8.28% C. 10.69% D. 9.37% E. 7.52% Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 10.02 Discuss the historical returns on various important types of investments Topic: Average returns: the first lesson

53. Assume you earned 12.3% on your investments for a time period when the risk-free rate was 4.25% and the inflation rate was 1.2%. What was your real rate of return for the period? A. −9.71% B. 8.21% C. 10.97% D. −10.35% E. 10.23% Ans: C

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 10 Testbank

AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 10.02 Discuss the historical returns on various important types of investments Topic: Average returns: the first lesson

54. Sarah earned a 3.3% real rate of return on her investments for the past year. During that time, the risk-free rate was 3.6% and the inflation rate was 3.1%. What was her nominal rate of return? A. 5.30% B. 6.06% C. 6.50% D. 6.67% E. 6.91% Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 10.02 Discuss the historical returns on various important types of investments Topic: Average returns: the first lesson

55. Assume that over the past 88 years, US Treasury bills had an average return of 3.5% as compared to 6.1% on long-term government bonds. During this same time period, assume inflation averaged 3.0%. What was the average nominal risk premium on the long-term government bonds? A. 3.1% B. .1% C. 2.9% D. 1.8% E. 2.6% Ans: E AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 10.02 Discuss the historical returns on various important types of investments Topic: Average returns: the first lesson

56. Over the past four years, the annual percentage returns on large-company shares were 15, 7, 4 and 18%. For the same time period, US Treasury bills produced the returns of 6, 3, 2 and 4%. Inflation averaged 2.8% over the four-year period. The average real rate of return on largecompany shares was ___% as compared to _____% for Treasury bills. A. 6.47; 0.92 B. 6.47; 1.08 C. 7.98; 0.92 D. 7.98; 1.08 E. 7.98; 1.22 Ans: C

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 10 Testbank

AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 10.02 Discuss the historical returns on various important types of investments Topic: Average returns: the first lesson

57. Suppose a share had an initial price of $47 per share, paid a dividend of $0.63 per share during the year and had an ending share price of $ 38. What was the capital gains yield? A. 20.31% B. −23.68% C. 17.39% D. −19.15% E. −18.53% Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 10.01 Calculate the return on an investment Topic: Returns

58. You bought a share of 7.5% preferred share for $91.60 last year. The market price for your share is now $89.10. What is your total return to date on this investment? A. 5.51% B. 4.73% C. 5.86% D. 6.10% E. 5.46% Ans: E AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 10.01 Calculate the return on an investment Topic: Returns

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 10 Testbank

AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 10.01 Calculate the return on an investment Topic: Returns

60. One year ago, Brookes purchased 200 shares of Surfer Bay share for $22 250. Today, he sold those shares for $114.00 per share. What is the total return on this investment if the dividend yield is 1.2%? A. 4.47% B. 3.67% C. 1.93% D. 0.76% E. 2.98% Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 10.01 Calculate the return on an investment Topic: Returns

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 10 Testbank

Chapter 10 Testbank Summary Category AACSB: Analytic Blooms: Analysis Difficulty: Easy Difficulty: Hard Difficulty: Medium Learning Objective: 10.01 Calculate the return on an investment Learning Objective: 10.02 Discuss the historical returns on various important types of investments Learning Objective: 10.03 Explain the historical risks on various important types of investments Learning Objective: 10.04 Assess the implications of market efficiency Topic: Average returns: the first lesson Topic: Capital market efficiency Topic: More on average returns Topic: Returns Topic: The historical record Topic: The variability of returns: the second lesson

# of Questions 60 60 52 1 7 17 15 14 14 12 11 5 17 3 12

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 11 Testbank

Chapter 11 Testbank 1. The following table details an analyst's prediction of the probabilities of different states of the market over the next year, along with the forecast returns on security Alpha—a share of a company in a cyclical industry in each different market state. What is the expected return and standard deviation of returns on security Alpha? A. 8.20% and 4.26% B. 7.80% and 9.09% C. 8.50% and 0.83% D. 6.52% and 8.26% 2. Suppose an investor created the following portfolio:

What is the expected return on this portfolio? A. 12.5% B. 9.7% C. 15% D. 8.5% 3. The Capital Assets Pricing Model (CAPM) shows that the expected return for a particular asset depends mostly on the: A. expected dividend growth. B. reward for bearing non-systematic risk. C. amount of non-systematic risk. D. the pure time value of money. 4. Consider the following information on two securities:

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 11 Testbank

What is the risk-free rate if these securities both plot on the security market line? A. 8% B. 9% C. 10% D. 6% 5. Which one of the following is the best definition of the term 'expected return' as it applies to the concept of risk and return? A. The certain return on a risk-free asset that is going to be earned in the future B. The guaranteed return on a short-term treasury security that will be earned in the future C. The difference between the expected return on a risky asset and the certain return on a riskfree asset D. The return on a risky asset which is expected in the future 6. A portfolio weight is defined as the: A. total market value of a portfolio divided by the total book value of that portfolio. B. percentage of a portfolio's total value that is invested in a particular asset. C. current value of a portfolio minus the value one year ago, divided by the value one year ago. D. total number of shares in a particular asset divided by the total number of shares held in a portfolio. 7. The risk associated with the overall market is referred to as _____ risk. A. unsystematic B. total C. diversified D. systematic 8. Unsystematic risk is defined as the risk: A. derived solely from expected events. B. that affects the entire market. C. that affects a small number of securities. D. that applies to an individual's portfolio. 9. The market risk premium is the: A. net present value of the additional return an investor receives for bearing risk. B. difference between the expected return on an individual security and that of the overall market. C. difference in returns on a risky asset for the current year as compared to the prior year. D. difference between the expected return on a market portfolio and the risk-free rate of return. 10. Which one of the following is the best example of an event related to an expected return?

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 11 Testbank

A. An announcement that a firm will meet its sales projections B. A market decline due to increased tensions in the world C. A news release that a firm is going to be acquired at a premium D. A sudden increase in the inflation rate 11. Which one of the following is considered an example of systematic risk? A. Resignation of a firm's chief financial officer B. An increase in overseas sales for a conglomerate, such as General Electric C. Higher company profits than those forecasted D. A higher inflation rate than predicted 12. Total risk is: A. measured by beta. B. measured by standard deviation. C. another term for the market risk premium. D. another term for systematic risk. 13. You own a $222 000 000 portfolio that is invested in Shares A and B. The portfolio beta is equal to the market beta. Share A has an expected return of 18.7% and has a beta of 1.42. Share B has a beta of 0.88. What is the value of your investment What is the value of your investment in Share A? A. $38 600 B. $42 333 C. $44 500 D. $49 333 14. Based on the capital asset pricing model, a security that: A. has a beta of 1.0 should produce the risk-free rate of return. B. is over-priced will plot as a point below the security market line. C. is under-priced will plot as a point to the left of the overall market point. D. has a beta of 1.2 will plot as a point to the left of the overall market point. 15. A share is expected to return 13% in an economic boom, 10% in a normal economy and 3% in a recessionary economy. Which one of the following will lower the overall expected rate of return on this share? A. A decrease in the probability of an economic boom B. An increase in the probability of an economic boom C. A decrease in the probability of a recession occurring D. An increase in the rate of return for a normal economy 16. Which of the following types of risk is avoidable through diversification?

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 11 Testbank

A. Portfolio risk B. Systematic risk C. Unsystematic risk D. Total risk 17. Which one of the following is the best example of an announcement that is most likely to result in an unexpected return? A. The verification by senior management that the firm is being acquired as had been rumoured B. An announcement that a firm will continue its practice of paying a $3 a share annual dividend C. A news bulletin that the anticipated lay-offs in a firm will occur as expected on 1 December D. A statement by a firm that it has just discovered a manufacturing defect and is recalling its product 18. Which one of the following is the best example of unsystematic risk? A. A warehouse fire B. A decrease in the value of the dollar C. Inflation exceeding market expectations D. An increase in consumer spending 19. Portfolio diversification eliminates which one of the following? A. Portfolio risk premium B. Reward for bearing risk C. Total investment risk D. Unsystematic risk 20. Manly Manufacturing Pty Ltd share has an expected return of 14.47%. The risk-free rate is 3.8% and the market risk premium is 8.6%. What is the share's beta? A. 1.32 B. 1.24 C. 1.19 D. 1.28 21. Diversifiable risk is interchangeable with which term? A. Market risk premium B. Market risk C. Systematic risk D. Unsystematic risk 22. Which of the following terms can be used to describe unsystematic risk? I. Asset-specific risk II. Diversifiable risk

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 11 Testbank

III. Market risk IV. Unique risk A. I and IV only B. II and III only C. I, II and IV only D. I, II, III and IV 23. The amount of systematic risk present in a particular risky asset relative to that in an average risky asset is called the: A. security's alpha B. standard deviation C. asset mean D. beta coefficient 24. Which one of the following is the minimum required rate of return on a new investment that makes that investment attractive? A. Risk-free rate B. Market risk premium C. Expected return minus the risk-free rate D. Cost of capital 25. The expected rate of return on Delaware Shores Inc. shares is based on three possible states of the economy. These states are boom, normal and recession, which have probabilities of occurrence of 20%, 75% and 5% respectively. Which one of the following statements is correct concerning the variance of the returns on this share? A. The variance must decrease if the probability of occurrence for a boom increases. B. The variance will remain constant as long as the sum of the economic probabilities is 100%. C. The variance can be positive, zero or negative, depending on the expected rate of return assigned to each economic state. D. The variance must be positive provided that each state of the economy produces a different expected rate of return. 26. Given the following information, what is the variance of the returns on a portfolio that is invested 40% in both Shares A and B, and 20% in Share C?

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 11 Testbank

A. 0.002102 B. 0.002490 C. 0.002513 D. 0.005746 27. Given the following information, what is the variance of the returns on this share? State of economy Probability of state of economy Rate of return Boom 0.18 0.29 Normal 0.77 0.14 Recession 0.05 –0.45 A. 0.021387 B. 0.021449 C. 0.021506 D. 0.021538 28. The beta of a risky portfolio cannot be less than _____, nor greater than ____. A. 0; 1 B. 1; the market beta C. the lowest individual beta in the portfolio; market beta D. the lowest individual beta in the portfolio; the highest individual beta in the portfolio 29. You want to create a $65 000 portfolio comprised of two shares plus a risk-free security. Share A has an expected return of 14.2% and Share B has an expected return of 17.8%. You want to own $20 000 of Share B. The risk-free rate is 4.8% and the expected return on the market is 13.1%. If you want the portfolio to have an expected return equal to that of the market, how much should you invest in the risk-free security? A. $11 921 B. $13 509 C. $15 266 D. $17 315 30. Risk premium is defined as: A. the difference between expected return on a risky investment and return on a risk-free investment. B. the beta coefficient. C. a portfolio’s expected return. D. the difference between expected return on a market portfolio and return on a risk-free investment.

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 11 Testbank

31. Systematic risk is defined as: A. any risk that affects a large number of assets. B. the total risk of an individual security. C. diversifiable risk. D. asset-specific risk. E. the risk unique to a firm's management. 32. Unsystematic risk can be defined by all of the following except: A. unrewarded risk. B. diversifiable risk. C. market risk. D. unique risk. E. asset-specific risk. 33. Mary owns a risky share and anticipates earning 16.5% on her investment in that share. Which one of the following best describes the 16.5% rate? A. Expected return B. Real return C. Market rate D. Systematic return E. Risk premium 34. The security market line is a linear function that is graphed by plotting data points based on the relationship between the: A. risk-free rate and beta. B. market rate of return and beta. C. market rate of return and the risk-free rate. D. risk-free rate and the market rate of return. E. expected return and beta. 35. Which statement is true? A. The expected rate of return on any portfolio must be positive. B. The arithmetic average of the betas for each security held in a portfolio must equal 1.0. C. The beta of any portfolio must be 1.0. D. The weights of the securities held in any portfolio must equal 1.0. E. The standard deviation of any portfolio must equal 1.0. 36. Which one of these represents systematic risk? A. Major layoff by a regional manufacturer of power boats B. Increase in consumption created by a reduction in personal tax rates C. Surprise firing of a firm's chief financial officer D. Closure of a major retail chain of stores

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 11 Testbank

E. Product recall by one manufacturer 37. Which one of these is the best example of systematic risk? A. Discovery of a major gas field B. Decrease in textile imports C. Increase in agricultural exports D. Decrease in gross domestic product E. Decrease in management bonuses for banking executives 38. Standard deviation measures _____ risk while beta measures _____ risk. A. systematic; unsystematic B. unsystematic; systematic C. total; unsystematic D. total; systematic E. asset-specific; market 39. Systematic risk is: A. totally eliminated when a portfolio is fully diversified. B. defined as the total risk associated with surprise events. C. risk that affects a limited number of securities. D. measured by beta. E. measured by standard deviation. 40. Which one of the following is the vertical intercept of the security market line? A. Market rate of return B. Individual security rate of return C. Market risk premium D. Individual security beta multiplied by the market risk premium E. Risk-free rate 41. According to the capital asset pricing model, the expected return on a security will be affected by all of the following except the: A. market risk premium. B. risk-free rate. C. market rate of return. D. security’s standard deviation. E. security’s beta. 42. The World United share currently plots on the security market line and has a beta of 1.04. Which one of the following will increase that share's rate of return without affecting the risk level of the share, all else constant?

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 11 Testbank

A. An increase in the risk-free rate B. Decrease in the security's beta C. Overpricing of the share in the marketplace D. Increase in the market risk-to-reward ratio E. Decrease in the market rate of return 43. The capital asset pricing model: A. assumes the market has a beta of zero and the risk-free rate is positive. B. rewards investors based on total risk assumed. C. considers the relationship between the fluctuations in a security’s returns versus the market’s returns. D. applies to portfolios but not to individual securities. E. assumes the market risk premium is constant over time. 44. The Midwest Fastener Supply share is expected to return 16% in a booming economy, 12% in a normal economy and −3% in a recession. The probabilities of an economic boom, normal state or recession are 12%, 80% and 8%, respectively. What is the expected rate of return on this share? A. 11.28% B. 10.67% C. 10.95% D. 11.91% E. 11.70% 45. A Crabby Shores share is expected to return 15.7% in a booming economy, 9.8% in a normal economy and 2.3% in a recession. The probabilities of an economic boom, normal state or recession are 15%, 73% and 12%, respectively. What is the expected rate of return on this share? A. 10.07% B. 10.74% C. 10.61% D. 9.79% E. 8.68% 46. A Bernard Companies share has an expected return of 9.5%. The share is expected to return 11% in a normal economy and 13.4% in a boom. The probabilities of a recession, normal economy and a boom are 10%, 84% and 6%, respectively. What is the expected return if the economy is in a recession? A. −5.44% B. −2.97% C. −2.46% D. −10.98% E. −6.98%

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 11 Testbank

47. Bass Clef Music Stores' share has a risk premium of 7%, while the inflation rate is 1.9% and the risk-free rate is 2.2%. What is the expected return on this share? A. 10.9% B. 7.3% C. 9.2% D. 10.8% E. 12.3% 48. A Malone Imports share should return 12% in a boom, 10% in a normal economy and 2% in a recession. The probabilities of a boom, normal economy and recession are 5%, 85% and 10%, respectively. What is the variance of the returns on this share? A. 0.000522 B. 0.000611 C. 0.024718 D. 0.006107 E. 0.015254 49. The common share of The Dominic Companies should return 29% in a boom, 12% in a normal economy and −15% in a recession. The probabilities of a boom, normal economy and recession are 12%, 86% and 2%, respectively. What is the variance of the returns on this share? A. 0.005809 B. 0.005019 C. 0.006047 D. 0.004701 E. 0.006270 50. You own a portfolio of two shares, A and B. Share A is valued at $84 650 and has an expected return of 10.6%. Share B has an expected return of 6.4%. What is the expected return on the portfolio if the portfolio value is $97 500? A. 9.99% B. 9.62% C. 9.74% D. 10.09% E. 10.05% 51. You own a portfolio that is invested 32% in share A, 43% in share B and the remainder in share C. The expected returns on shares A, B and C are 11.5%, 15.2% and 8.8%, respectively. What is the expected return on the portfolio? A. 11.71% B. 12.18% C. 12.83% D. 12.42% E. 12.49%

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 11 Testbank

52. You own a portfolio consisting of the securities listed below. The expected return for each security is as shown. What is the expected return on the portfolio? Share Number of shares Price per share Expected return A 175 $ 9 11.2% B 250 18 16.4% C 400 56 8.7% D 225 39 24.5% A. 13.81% B. 12.91% C. 13.28% D. 14.14% E. 13.46% 53. You have compiled the following information on your investments. What rate of return should you expect to earn on this portfolio? Share Number of shares Price per share Expected return A 500 $ 51 13.6% B 200 66 14.8% C 300 42 7.5% D 250 29 2.1% A. 11.57% B. 11.13% C. 11.87% D. 11.30% E. 11.61% 54. A $36 000 portfolio is invested in a risk-free security and two shares. The beta of share A is 1.29 while the beta of share B is 0.90. One-half of the portfolio is invested in the risk-free security. How much is invested in share A if the beta of the portfolio is 0.58? A. $6000 B. $9000 C. $12 000 D. $15 000 E. $18 000

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 11 Testbank

55. You own a portfolio that has $2200 invested in share A and $1300 invested in share B. If the expected returns on these shares are 11% and 17%, respectively, what is the expected return on the portfolio? A. 12.57% B. 11.14% C. 14.96% D. 13.23% E. 13.07% 56. Share J has a beta of 1.06 and an expected return of 12.3%, while share K has a beta of 0.74 and an expected return of 6.7%. If you create a portfolio with the same risk as the market, what rate of return should you expect to earn? A. 10.67% B. 11.18% C. 11.62% D. 11.25% E. 11.13% 57. A Bernard Companies share has an expected return of 10.75%. The share is expected to return 13.5% in a normal economy and 19.6% in a boom. The probabilities of a recession, normal economy and a boom are 5%, 80% and 15%, respectively. What is the expected return if the economy is in a recession? A. −59.80% B. −42.77% C. −68.20% D. −36.72% E. −63.76% 58. A Sarina Stable Supply share has a risk premium of 6.2%, while the inflation rate is 1.7% and the risk-free rate is 3.1%. What is the expected return on this share? A. 10.2% B. 7.63% C. 9.3% D. 10.9% E. 12.4% 59. A share has a beta of 0.95, the expected return on the market is 13.25 and the risk-free rate is 3.66. What must the expected return on this share be? A. 10.59% B. 39.02% C. 14.26% D. 19.86% E. 12.77%

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 11 Testbank

60. Given the following information, what is the variance of the returns on a portfolio that is invested 40% in both Shares A and B, and 20% in Share C? Rate of Return if State Occurs: State of Economy Probability of State Occurring Share A (%) Share B (%) Share C (%) Boom 0.08 15.8 9.4 21.2 Normal 0.92 10.6 6.8 10.4 A. 0.000602 B. 0.001490 C. 0.000513 D. 0.000205 E. 0.001143

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 11 Testbank

Chapter 11 Testbank Key 1. The following table details an analyst's prediction of the probabilities of different states of the market over the next year, along with the forecast returns on security Alpha—a share of a company in a cyclical industry in each different market state. What is the expected return and standard deviation of returns on security Alpha? A. 8.20% and 4.26% B. 7.80% and 9.09% C. 8.50% and 0.83% D. 6.52% and 8.26% Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 11.01 Calculate expected returns Topic: Expected returns and variances

2. Suppose an investor created the following portfolio:

What is the expected return on this portfolio? A. 12.5% B. 9.7% C. 15% D. 8.5% Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 11.01 Calculate expected returns Topic: Expected returns and variances

3. The Capital Assets Pricing Model (CAPM) shows that the expected return for a particular asset depends mostly on the: A. expected dividend growth. B. reward for bearing non-systematic risk. C. amount of non-systematic risk.

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 11 Testbank

D. the pure time value of money. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 11.04 Discuss the security market line and the risk-return trade-off Topic: The security market line

4. Consider the following information on two securities:

What is the risk-free rate if these securities both plot on the security market line? A. 8% B. 9% C. 10% D. 6% Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 11.04 Discuss the security market line and the risk-return trade-off Topic: The security market line

5. Which one of the following is the best definition of the term 'expected return' as it applies to the concept of risk and return? A. The certain return on a risk-free asset that is going to be earned in the future B. The guaranteed return on a short-term treasury security that will be earned in the future C. The difference between the expected return on a risky asset and the certain return on a riskfree asset D. The return on a risky asset which is expected in the future Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 11.01 Calculate expected returns Topic: Expected returns and variances

6. A portfolio weight is defined as the: A. total market value of a portfolio divided by the total book value of that portfolio. B. percentage of a portfolio's total value that is invested in a particular asset. C. current value of a portfolio minus the value one year ago, divided by the value one year ago.

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 11 Testbank

D. total number of shares in a particular asset divided by the total number of shares held in a portfolio. Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 11.02 Explain the impact of diversification Topic: Portfolios

7. The risk associated with the overall market is referred to as _____ risk. A. unsystematic B. total C. diversified D. systematic Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 11.03 Define the systematic risk principle Topic: Risk: systematic and unsystematic

8. Unsystematic risk is defined as the risk: A. derived solely from expected events. B. that affects the entire market. C. that affects a small number of securities. D. that applies to an individual's portfolio. Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 11.03 Define the systematic risk principle Topic: Risk: systematic and unsystematic

9. The market risk premium is the: A. net present value of the additional return an investor receives for bearing risk. B. difference between the expected return on an individual security and that of the overall market. C. difference in returns on a risky asset for the current year as compared to the prior year. D. difference between the expected return on a market portfolio and the risk-free rate of return. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 11.04 Discuss the security market line and the risk-return trade-off Topic: The security market line

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 11 Testbank

10. Which one of the following is the best example of an event related to an expected return? A. An announcement that a firm will meet its sales projections B. A market decline due to increased tensions in the world C. A news release that a firm is going to be acquired at a premium D. A sudden increase in the inflation rate Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 11.02 Explain the impact of diversification Topic: Announcements, surprises and expected returns

11. Which one of the following is considered an example of systematic risk? A. Resignation of a firm's chief financial officer B. An increase in overseas sales for a conglomerate, such as General Electric C. Higher company profits than those forecasted D. A higher inflation rate than predicted Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 11.03 Define the systematic risk principle Topic: Risk: systematic and unsystematic

12. Total risk is: A. measured by beta. B. measured by standard deviation. C. another term for the market risk premium. D. another term for systematic risk. Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 11.02 Explain the impact of diversification Topic: Diversification and portfolio risk

13. You own a $222 000 000 portfolio that is invested in Shares A and B. The portfolio beta is equal to the market beta. Share A has an expected return of 18.7% and has a beta of 1.42. Share B has a beta of 0.88. What is the value of your investment What is the value of your investment in Share A? A. $38 600 B. $42 333 C. $44 500 D. $49 333 Ans: D

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 11 Testbank

AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 11.03 Define the systematic risk principle Topic: Systematic risk and beta

14. Based on the capital asset pricing model, a security that: A. has a beta of 1.0 should produce the risk-free rate of return. B. is over-priced will plot as a point below the security market line. C. is under-priced will plot as a point to the left of the overall market point. D. has a beta of 1.2 will plot as a point to the left of the overall market point. Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 11.04 Discuss the security market line and the risk-return trade-off Topic: The security market line

15. A share is expected to return 13% in an economic boom, 10% in a normal economy and 3% in a recessionary economy. Which one of the following will lower the overall expected rate of return on this share? A. A decrease in the probability of an economic boom B. An increase in the probability of an economic boom C. A decrease in the probability of a recession occurring D. An increase in the rate of return for a normal economy Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 11.01 Calculate expected returns Topic: Expected returns and variances

16. Which of the following types of risk is avoidable through diversification? A. Portfolio risk B. Systematic risk C. Unsystematic risk D. Total risk Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 11.02 Explain the impact of diversification Topic: Diversification and portfolio risk

17. Which one of the following is the best example of an announcement that is most likely to result in an unexpected return?

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 11 Testbank

A. The verification by senior management that the firm is being acquired as had been rumoured B. An announcement that a firm will continue its practice of paying a $3 a share annual dividend C. A news bulletin that the anticipated lay-offs in a firm will occur as expected on 1 December D. A statement by a firm that it has just discovered a manufacturing defect and is recalling its product Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 11.02 Explain the impact of diversification Topic: Announcements, surprises and expected returns

18. Which one of the following is the best example of unsystematic risk? A. A warehouse fire B. A decrease in the value of the dollar C. Inflation exceeding market expectations D. An increase in consumer spending Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 11.03 Define the systematic risk principle Topic: Risk: systematic and unsystematic

19. Portfolio diversification eliminates which one of the following? A. Portfolio risk premium B. Reward for bearing risk C. Total investment risk D. Unsystematic risk Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 11.02 Explain the impact of diversification Topic: Diversification and portfolio risk

20. Manly Manufacturing Pty Ltd share has an expected return of 14.47%. The risk-free rate is 3.8% and the market risk premium is 8.6%. What is the share's beta? A. 1.32 B. 1.24 C. 1.19 D. 1.28 Ans: B

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 11 Testbank

AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 11.04 Discuss the security market line and the risk-return trade-off Topic: The security market line

21. Diversifiable risk is interchangeable with which term? A. Market risk premium B. Market risk C. Systematic risk D. Unsystematic risk Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 11.02 Explain the impact of diversification Topic: Diversification and portfolio risk

22. Which of the following terms can be used to describe unsystematic risk? I. Asset-specific risk II. Diversifiable risk III. Market risk IV. Unique risk A. I and IV only B. II and III only C. I, II and IV only D. I, II, III and IV Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 11.03 Define the systematic risk principle Topic: Risk: systematic and unsystematic

23. The amount of systematic risk present in a particular risky asset relative to that in an average risky asset is called the: A. security's alpha B. standard deviation C. asset mean D. beta coefficient Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 11.03 Define the systematic risk principle Topic: Systematic risk and beta

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 11 Testbank

24. Which one of the following is the minimum required rate of return on a new investment that makes that investment attractive? A. Risk-free rate B. Market risk premium C. Expected return minus the risk-free rate D. Cost of capital Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 11.04 Discuss the security market line and the risk-return trade-off Topic: The SML and the cost of capital: a preview

25. The expected rate of return on Delaware Shores Inc. shares is based on three possible states of the economy. These states are boom, normal and recession, which have probabilities of occurrence of 20%, 75% and 5% respectively. Which one of the following statements is correct concerning the variance of the returns on this share? A. The variance must decrease if the probability of occurrence for a boom increases. B. The variance will remain constant as long as the sum of the economic probabilities is 100%. C. The variance can be positive, zero or negative, depending on the expected rate of return assigned to each economic state. D. The variance must be positive provided that each state of the economy produces a different expected rate of return. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Hard Learning Objective: 11.01 Calculate expected returns Topic: Expected returns and variances

26. Given the following information, what is the variance of the returns on a portfolio that is invested 40% in both Shares A and B, and 20% in Share C?

A. 0.002102 B. 0.002490 C. 0.002513 D. 0.005746 Ans: D

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 11 Testbank

AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 11.02 Explain the impact of diversification Topic: Portfolios

27. Given the following information, what is the variance of the returns on this share? State of economy Probability of state of economy Rate of return Boom 0.18 0.29 Normal 0.77 0.14 Recession 0.05 –0.45 A. 0.021387 B. 0.021449 C. 0.021506 D. 0.021538 Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 11.01 Calculate expected returns Topic: Expected returns and variances

28. The beta of a risky portfolio cannot be less than _____, nor greater than ____. A. 0; 1 B. 1; the market beta C. the lowest individual beta in the portfolio; market beta D. the lowest individual beta in the portfolio; the highest individual beta in the portfolio Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 11.03 Define the systematic risk principle Topic: Systematic risk and beta

29. You want to create a $65 000 portfolio comprised of two shares plus a risk-free security. Share A has an expected return of 14.2% and Share B has an expected return of 17.8%. You want to own $20 000 of Share B. The risk-free rate is 4.8% and the expected return on the market is 13.1%. If you want the portfolio to have an expected return equal to that of the market, how much should you invest in the risk-free security? A. $11 921 B. $13 509 C. $15 266 D. $17 315

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 11 Testbank

Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 11.02 Explain the impact of diversification Topic: Portfolios

30. Risk premium is defined as: A. the difference between expected return on a risky investment and return on a risk-free investment. B. the beta coefficient. C. a portfolio’s expected return. D. the difference between expected return on a market portfolio and return on a risk-free investment. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 11.01 Calculate expected returns Topic: Expected returns and variances

31. Systematic risk is defined as: A. any risk that affects a large number of assets. B. the total risk of an individual security. C. diversifiable risk. D. asset-specific risk. E. the risk unique to a firm's management. Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 11.03 Define the systematic risk principle Topic: Risk: systematic and unsystematic

32. Unsystematic risk can be defined by all of the following except: A. unrewarded risk. B. diversifiable risk. C. market risk. D. unique risk. E. asset-specific risk. Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 11.03 Define the systematic risk principle Topic: Risk: systematic and unsystematic

Ross, Essentials of Corporate Finance, Fifth Edition

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33. Mary owns a risky share and anticipates earning 16.5% on her investment in that share. Which one of the following best describes the 16.5% rate? A. Expected return B. Real return C. Market rate D. Systematic return E. Risk premium Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 11.01 Calculate expected returns Topic: Expected returns and variances

34. The security market line is a linear function that is graphed by plotting data points based on the relationship between the: A. risk-free rate and beta. B. market rate of return and beta. C. market rate of return and the risk-free rate. D. risk-free rate and the market rate of return. E. expected return and beta. Ans: E AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 11.04 Discuss the security market line and the risk-return trade-off Topic: The security market line

35. Which statement is true? A. The expected rate of return on any portfolio must be positive. B. The arithmetic average of the betas for each security held in a portfolio must equal 1.0. C. The beta of any portfolio must be 1.0. D. The weights of the securities held in any portfolio must equal 1.0. E. The standard deviation of any portfolio must equal 1.0. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 11.02 Explain the impact of diversification Topic: Portfolios

36. Which one of these represents systematic risk? A. Major layoff by a regional manufacturer of power boats B. Increase in consumption created by a reduction in personal tax rates C. Surprise firing of a firm's chief financial officer D. Closure of a major retail chain of stores

Ross, Essentials of Corporate Finance, Fifth Edition

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E. Product recall by one manufacturer Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 11.03 Define the systematic risk principle Topic: Risk: systematic and unsystematic

37. Which one of these is the best example of systematic risk? A. Discovery of a major gas field B. Decrease in textile imports C. Increase in agricultural exports D. Decrease in gross domestic product E. Decrease in management bonuses for banking executives Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 11.03 Define the systematic risk principle Topic: Risk: systematic and unsystematic

38. Standard deviation measures _____ risk while beta measures _____ risk. A. systematic; unsystematic B. unsystematic; systematic C. total; unsystematic D. total; systematic E. asset-specific; market Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 11.03 Define the systematic risk principle Topic: Systematic risk and beta

39. Systematic risk is: A. totally eliminated when a portfolio is fully diversified. B. defined as the total risk associated with surprise events. C. risk that affects a limited number of securities. D. measured by beta. E. measured by standard deviation. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 11.03 Define the systematic risk principle Topic: Systematic risk and beta

Ross, Essentials of Corporate Finance, Fifth Edition

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40. Which one of the following is the vertical intercept of the security market line? A. Market rate of return B. Individual security rate of return C. Market risk premium D. Individual security beta multiplied by the market risk premium E. Risk-free rate Ans: E AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 11.04 Discuss the security market line and the risk-return trade-off Topic: The security market line

41. According to the capital asset pricing model, the expected return on a security will be affected by all of the following except the: A. market risk premium. B. risk-free rate. C. market rate of return. D. security’s standard deviation. E. security’s beta. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 11.04 Discuss the security market line and the risk-return trade-off Topic: The security market line

42. The World United share currently plots on the security market line and has a beta of 1.04. Which one of the following will increase that share's rate of return without affecting the risk level of the share, all else constant? A. An increase in the risk-free rate B. Decrease in the security's beta C. Overpricing of the share in the marketplace D. Increase in the market risk-to-reward ratio E. Decrease in the market rate of return Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 11.04 Discuss the security market line and the risk-return trade-off Topic: The security market line

43. The capital asset pricing model: A. assumes the market has a beta of zero and the risk-free rate is positive. B. rewards investors based on total risk assumed.

Ross, Essentials of Corporate Finance, Fifth Edition

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C. considers the relationship between the fluctuations in a security’s returns versus the market’s returns. D. applies to portfolios but not to individual securities. E. assumes the market risk premium is constant over time. Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 11.04 Discuss the security market line and the risk-return trade-off Topic: The security market line

44. The Midwest Fastener Supply share is expected to return 16% in a booming economy, 12% in a normal economy and −3% in a recession. The probabilities of an economic boom, normal state or recession are 12%, 80% and 8%, respectively. What is the expected rate of return on this share? A. 11.28% B. 10.67% C. 10.95% D. 11.91% E. 11.70% Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 11.04 Discuss the security market line and the risk-return trade-off Topic: The SML and the cost of capital: a preview

45. A Crabby Shores share is expected to return 15.7% in a booming economy, 9.8% in a normal economy and 2.3% in a recession. The probabilities of an economic boom, normal state or recession are 15%, 73% and 12%, respectively. What is the expected rate of return on this share? A. 10.07% B. 10.74% C. 10.61% D. 9.79% E. 8.68% Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 11.04 Discuss the security market line and the risk-return trade-off Topic: The SML and the cost of capital: a preview

46. A Bernard Companies share has an expected return of 9.5%. The share is expected to return 11% in a normal economy and 13.4% in a boom. The probabilities of a recession, normal economy and a boom are 10%, 84% and 6%, respectively. What is the expected return if the economy is in a recession?

Ross, Essentials of Corporate Finance, Fifth Edition

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A. −5.44% B. −2.97% C. −2.46% D. −10.98% E. −6.98% Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 11.01 Calculate expected returns Topic: Expected returns and variances

47. Bass Clef Music Stores' share has a risk premium of 7%, while the inflation rate is 1.9% and the risk-free rate is 2.2%. What is the expected return on this share? A. 10.9% B. 7.3% C. 9.2% D. 10.8% E. 12.3% Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 11.01 Calculate expected returns Topic: Expected returns and variances

48. A Malone Imports share should return 12% in a boom, 10% in a normal economy and 2% in a recession. The probabilities of a boom, normal economy and recession are 5%, 85% and 10%, respectively. What is the variance of the returns on this share? A. 0.000522 B. 0.000611 C. 0.024718 D. 0.006107 E. 0.015254 Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 11.01 Calculate expected returns Topic: Expected returns and variances

49. The common share of The Dominic Companies should return 29% in a boom, 12% in a normal economy and −15% in a recession. The probabilities of a boom, normal economy and recession are 12%, 86% and 2%, respectively. What is the variance of the returns on this share? A. 0.005809 B. 0.005019

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 11 Testbank

C. 0.006047 D. 0.004701 E. 0.006270 Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 11.01 Calculate expected returns Topic: Expected returns and variances

50. You own a portfolio of two shares, A and B. Share A is valued at $84 650 and has an expected return of 10.6%. Share B has an expected return of 6.4%. What is the expected return on the portfolio if the portfolio value is $97 500? A. 9.99% B. 9.62% C. 9.74% D. 10.09% E. 10.05% Ans: E AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 11.01 Calculate expected returns Topic: Portfolios

51. You own a portfolio that is invested 32% in share A, 43% in share B and the remainder in share C. The expected returns on shares A, B and C are 11.5%, 15.2% and 8.8%, respectively. What is the expected return on the portfolio? A. 11.71% B. 12.18% C. 12.83% D. 12.42% E. 12.49% Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 11.02 Explain the impact of diversification Topic: Portfolios

C D

400 225

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8.7% 24.5%

A. 13.81% B. 12.91% C. 13.28% D. 14.14% E. 13.46% Ans: E AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 11.02 Explain the impact of diversification Topic: Portfolios

53. You have compiled the following information on your investments. What rate of return should you expect to earn on this portfolio? Share Number of shares Price per share Expected return A 500 $ 51 13.6% B 200 66 14.8% C 300 42 7.5% D 250 29 2.1% A. 11.57% B. 11.13% C. 11.87% D. 11.30% E. 11.61% Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 11.02 Explain the impact of diversification Topic: Portfolios

54. A $36 000 portfolio is invested in a risk-free security and two shares. The beta of share A is 1.29 while the beta of share B is 0.90. One-half of the portfolio is invested in the risk-free security. How much is invested in share A if the beta of the portfolio is 0.58? A. $6000 B. $9000 C. $12 000 D. $15 000 E. $18 000

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 11 Testbank

Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 11.03 Define the systematic risk principle Topic: Systematic risk and beta

55. You own a portfolio that has $2200 invested in share A and $1300 invested in share B. If the expected returns on these shares are 11% and 17%, respectively, what is the expected return on the portfolio? A. 12.57% B. 11.14% C. 14.96% D. 13.23% E. 13.07% Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 11.02 Explain the impact of diversification Topic: Portfolios

56. Share J has a beta of 1.06 and an expected return of 12.3%, while share K has a beta of 0.74 and an expected return of 6.7%. If you create a portfolio with the same risk as the market, what rate of return should you expect to earn? A. 10.67% B. 11.18% C. 11.62% D. 11.25% E. 11.13% Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 11.04 Discuss the security market line and the risk-return trade-off Topic: The SML and the cost of capital: a preview

57. A Bernard Companies share has an expected return of 10.75%. The share is expected to return 13.5% in a normal economy and 19.6% in a boom. The probabilities of a recession, normal economy and a boom are 5%, 80% and 15%, respectively. What is the expected return if the economy is in a recession? A. −59.80% B. −42.77% C. −68.20% D. −36.72% E. −63.76%

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 11 Testbank

Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 11.01 Calculate expected returns Topic: Expected returns and variances

58. A Sarina Stable Supply share has a risk premium of 6.2%, while the inflation rate is 1.7% and the risk-free rate is 3.1%. What is the expected return on this share? A. 10.2% B. 7.63% C. 9.3% D. 10.9% E. 12.4% Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 11.01 Calculate expected returns Topic: Expected returns and variances

59. A share has a beta of 0.95, the expected return on the market is 13.25 and the risk-free rate is 3.66. What must the expected return on this share be? A. 10.59% B. 39.02% C. 14.26% D. 19.86% E. 12.77% Ans: E AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 11.04 Discuss the security market line and the risk-return trade-off Topic: The SML and the cost of capital: a preview

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 11 Testbank

0.08 15.8 9.4 21.2 Normal 0.92 10.6 6.8 10.4 A. 0.000602 B. 0.001490 C. 0.000513 D. 0.000205 E. 0.001143 Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 11.02 Explain the impact of diversification Topic: Portfolios

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 11 Testbank

Chapter 11 Testbank Summary Category AACSB: Analytic Blooms: Analysis Difficulty: Easy Difficulty: Hard Difficulty: Medium Learning Objective: 11.01 Calculate expected returns Learning Objective: 11.02 Explain the impact of diversification Learning Objective: 11.03 Define the systematic risk principle Learning Objective: 11.04 Discuss the security market line and the risk-return trade-off Topic: Announcements, surprises and expected returns Topic: Diversification and portfolio risk Topic: Expected returns and variances Topic: Portfolios Topic: Risk: systematic and unsystematic Topic: Systematic risk and beta Topic: The SML and the cost of capital: a preview Topic: The security market line

# of Questions 60 60 53 1 6 15 15 15 15 2 4 14 10 9 6 5 10

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 12 Testbank

Chapter 12 Testbank 1. The Whitehorse Book Company has 140 million shares outstanding. The market price of one share is currently $2. The company's debentures are publicly traded and their market price is equal to 93% of its face value. The debentures have a total book value of $50 000 000 and the current yield to maturity of corporate debenture is 12% per annum. The risk-free rate is 8.50% and the market risk premium is 5.20%. Market analysts estimated that the Whitehorse Book Company has a beta of 0.90. The corporate tax rate is 30%. What is the company's weighted average cost of capital (WACC) under the classical tax system? A. 14.24% B. 11.10% C. 12.50% D. 13.18% 2. The Whitehorse Book Company has 140 million shares outstanding. The market price of one share is currently $2. The company's debentures are publicly traded and their market price is equal to 93% of its face value. The debentures have a total book value of $50 000 000 and the current yield to maturity of corporate debenture is 12% per annum. The risk-free rate is 8.50% and the market risk premium is 5.20%. Market analysts estimated that the Whitehorse Book Company has a beta of 0.90. The corporate tax rate is 30%. What is the company's weighted average cost of capital (WACC) considering the imputation tax system? A. 13.18% B. 7.70% C. 12.15% D. 9.11% 3. Calculate the after-tax return to a shareholder assuming a dividend imputation system is used in Australia (if the dividend is fully franked). The shareholder is currently subject to a marginal tax rate of 40% and receives a dividend of $700 per annum. The corporate tax rate is equal to 30%. A. $420 B. $700 C. $350 D. $600 4. The PMP Insurance Company preference shares are trading on the ASX at $9 each and a dividend of $0.63 has just been paid. The face value of the issue is $10. What is the cost of preference shares for PMP? A. 14.29% B. 6.30% C. 1.11%

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D. 7.00% 5. Rainbow Mining Pty Ltd is concerned that opening a new credit line will affect its share price. Now the company has a risk return on its shares of 17.50%, determined by using a beta factor of 1.50. The risk free rate is 7%. What is the risk premium for Rainbow Mining? A. 7.00% B. 5.50% C. 10.00% D. 10.50% 6. Rainbow Mining Pty Ltd is concerned that opening a new credit line will affect its share price. Now the company has a risk return on its shares of 17.50%, determined by using a beta factor of 1.50. The risk free rate is 7%. What is the market risk premium based on the information given for Rainbow Mining? A. 17.50% B. 5.50% C. 11.86% D. 7.00% 7. The proportional cost of equity plus the proportional after tax cost of debt is called the: A. pure play weight. B. capital structure weight. C. portfolio weight. D. weighted average cost of capital. 8. Using the weighted average cost of capital (WACC) of another firm, one which is focused on the type of project you are considering, rather than using your own firm's WACC is called the: A. competitor's game. B. project divisor. C. insider's look. D. pure play approach. 9. When the management of a firm evaluates the risk of a proposed project and adjusts the firm's WACC based on that evaluation to ascertain the required return for the project, they are using the _____ approach. A. subjective B. normative C. insider D. pure play 10. In an efficient market, a security with a beta of 0.98 will have a rate of return which lies:

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 12 Testbank

A. on the SML just to the right of the market return. B. on the SML just to the left of the market return. C. just below the SML and to the right of the market return. D. just below the security market line (SML) and to the left of the market return. 11. Which one of the following represents the best estimate for a firm's pre-tax cost of debt? A. The current coupon on the firm's existing debt B. The current yield on the firm's existing debt C. Twice the rate of return currently offered on risk-free securities D. The current yield-to-maturity on the firm's existing debt 12. An increase in the market value of a preferred preference share will _____ the cost of the preferred preference share. A. increase B. either increase or decrease C. decrease D. not affect 13. Which one of the following is a correct statement regarding a firm's weighted average cost of capital (WACC)? A. A 5% increase in a firm's debt–equity ratio will tend to increase the firm's WACC. B. The WACC will decrease when the tax rate decreases for all firms that utilise debt financing. C. The WACC can be used as the required return for all new projects with similar risk to that of the existing firm. D. A reduction in the risk level of a firm will tend to increase the firm's WACC. 14. A firm has a cost of equity of 10%, a cost of preferred preference shares of 9% and an aftertax cost of debt of 5%. Given this, which one of the following will decrease the firm's cost of capital? A. Decreasing the debt–equity ratio B. Increasing the systematic risk of the firm C. Decreasing the firm–specific risk associated with the firm D. Issuing new debt to offset an increase in the dividend payout ratio 15. The cost of capital for a project should: A. never exceed the cost of capital for the overall firm. B. meet or exceed the internal rate of return of the project. C. be adjusted based on the size of the project. D. be adjusted based on the risk of the project. 16. When using the pure play approach, a firm is seeking a rate of return which:

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 12 Testbank

A. is applicable to the risk level of the investment under consideration. B. is lower than its own cost of capital. C. matches the expected internal rate of return of the investment being considered. D. will cause a project to have a positive net present value. 17. Nelson Enterprises just paid an annual dividend of $1.56 per share. This dividend is expected to increase by 3% annually. Currently, the firm has a beta of 1.13 and a share price of $28 a share. The risk-free rate is 3% and the market rate of return is 10.5%. What is your best estimate of Nelson's cost of equity? A. 8.74% B. 10.11% C. 11.48% D. 9.72% 18. Horseless Carriages issued 20-year, 7% semi-annual bonds 11 years ago. The bonds currently sell at 101.3% of face value. What is the firm's after tax cost of debt if the tax rate is 34%? A. 4.87% B. 6.83% C. 6.71% D. 4.49% 19. The 7% preferred share preference share of Winslow & Winslow is selling for $54 a share. What is the firm's cost of preferred preference shares (face value $100)? A. 3.78% B. 17.56% C. 7.71% D. 12.96% 20. Which of the following are weaknesses of the dividend growth model? I. Market risk premium fluctuations II. Lack of dividends for some firms III. Reliance on historical beta IV. Sensitivity of model to dividend growth rate A. I and II only B. I and III only C. II and IV only D. I, II, III and IV 21. In an efficient market, the cost of equity for a risky firm does which one of the following, according to the security market line? A. Produces a return that will be less than the market rate but higher than the risk-free rate B. Equals the market rate of return for all shares

Ross, Essentials of Corporate Finance, Fifth Edition

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C. Has a maximum cost equal to the market rate of return D. Increases in direct relation to the share's systematic risk 22. Which of the following will increase the cost of equity for a firm with a beta of 1.1? I. Decrease in the security's beta II. Decrease in the market risk premium III. Decrease in the risk-free rate IV. Increase in the risk-free rate A. II only B. III only C. I and II only D. I and III only 23. Which one of the following will increase the cost of equity, all things being equal? A. Increase in the dividend growth rate B. Decrease in beta C. Decrease in future dividends D. Increase in share price 24. All things being equal, which of the following will increase the after-tax cost of debt for a firm? I. Increase in the yield to maturity of the firm's outstanding debt II. Decrease in the yield to maturity of the firm's outstanding debt III. Increase in the firm's tax rate IV. Decrease in the firm's tax rate A. I only B. I and III only C. I and IV only D. II and III only 25. Which one of the following statements is correct? A. An increase in the market value of preference shares will increase a firm's weighted average cost of capital. B. The cost of preference shares is unaffected by the issuer's tax rate. C. Preference shares are generally the cheapest source of capital for a firm. D. The cost of preference shares remains constant from year to year. 26. Alpha Industries is considering a project with an initial cost of $7.4 million. The project will produce cash inflows of $1.54 million a year for seven years. The firm uses the subjective approach to assign discount rates to projects. For this project, the subjective adjustment is +1.5%. The firm has a pre–tax cost of debt of 8.6% and a cost of equity of 13.7%. The debtequity ratio is 0.0.65 and the tax rate is 35%. What is the net present value of the project?

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A. –$372 951 B. –$187 016 C. $48 209 D. $269 480 27. The computation of which one of the following requires assigning every proposed investment to a particular risk class? A. Pure play cost of capital B. Cost of equity C. WACC D. Subjective cost of capital 28. Which of the following is NOT an operating cost? A. Interest payments B. Advertising costs C. Legal fees D. Depreciation of non-current assets 29. Which of the following statements is correct with regard to debt financing? A. The firm’s cost of equity is reduced. B. The shareholders’ wealth is increased. C. The firm’s tax bill is increased. D. The firm’s risk level is reduced. 30. Consider the following information for the Golf Corporation: the market price per share is $12; the book value per share is $10; the number of shares outstanding is 100 million; the market price per bond is $800; the face value per bond is $1000; the number of bonds outstanding is 1 million. Calculate the proportion of debt and equity for the corporation that you would use for estimating the weighted average cost of capital. A. 40% debt and 60% equity B. 50% debt and 50% equity C. 45.5% debt and 54.5% equity D. 70% debt and 30% equity 31. Katie owns 100 shares of ABC. Which one of the following terms is used to refer to the return that Katie and the other shareholders require on their investment in ABC? A. Weighted average cost of capital B. Pure play cost C. Cost of equity D. Subjective cost E. Cost of debt

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32. Lester lent money to The Corner Store by purchasing bonds issued by the store. The rate of return that he and the other lenders require is referred to as the: A. pure play cost. B. cost of debt. C. weighted average cost of capital. D. subjective cost. E. cost of equity. 33. The weighted average cost of capital is defined as the weighted average of a firm's: A. return on all of its investments. B. cost of equity, cost of preferred and its after-tax cost of debt. C. pre-tax cost of debt and its preferred and common equity securities. D. bond coupon rates. E. common and preferred share. 34. Farmer's Supply is considering opening a clothing store, which would be a new line of business for the firm. Management has decided to use the cost of capital of a similar clothing store as the discount rate to evaluate this proposed expansion. Which one of the following terms describes this evaluation approach? A. Equity approach B. After-tax approach C. Subjective approach D. Market play E. Pure play approach 35. Kate is the CFO of a major firm and has the job of assigning discount rates to each project under consideration. Kate's method of doing this is to assign an incrementally higher rate as the risk level of the project increases and a lower rate as the risk level declines. Kate is applying the ___ approach. A. pure play B. divisional rating C. subjective D. straight WACC E. equity rating 36. Ted is trying to decide what cost of capital he should assign to a project. Which one of the following should be his primary consideration in this decision? A. Amount of debt used to finance the project B. Use, or lack, of preferred share as a financing option C. Mix of funds used to finance the project D. Risk level of the project E. Length of the project's life

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37. Black Stone Furnaces wants to build a new facility. The cost of capital for this investment is primarily dependent on which one of the following? A. The firm's overall source of funds B. Source of the funds used to build the facility C. Current tax rate D. The nature of the investment E. Firm's historical average rate of return 38. Which one of the following statements is correct relating to the dividend growth model approach to computing the cost of equity? A. The rate of growth must exceed the required rate of return. B. The rate of return must be adjusted for taxes. C. The annual dividend used in the computation must be for Year 1 if you are Time 0’s share price to compute the return. D. The cost of equity is equal to the return on the share plus the risk-free rate. E. The cost of equity is equal to the return on the share multiplied by the share's beta. 39. A firm has a return on equity of 12.4% according to the dividend growth model and a return of 18.7% according to the capital asset pricing model. The market rate of return is 13.5%. What rate should the firm use as the cost of equity when computing the firm's weighted average cost of capital (WACC)? A. 12.4% because it is lower than 18.7% B. 18.7% because it is higher than 12.4% C. The arithmetic average of 12.4% and 18.7% D. The arithmetic average of 12.4%, 13.5% and 18.7% E. 13.5% 40. When evaluating a project, the dividend growth model: A. can only be used by firms that pay increasing dividends. B. must be used by all dividend-paying firms. C. is only applicable when the growth rate of the project exceeds the dividend growth rate. D. is relatively simple to use. E. must use the growth rate of the project as the rate of growth in the formula. 41. The results of the dividend growth model: A. vary directly with the market rate of return. B. can only be applied to projects that have a growth rate equal to that of the current firm. C. are highly dependent upon the beta used in the model. D. are sensitive to the rate of dividend growth. E. are most reliable when the growth rate exceeds 10%. 42. In an efficient market, the cost of equity for a high-risk firm:

Ross, Essentials of Corporate Finance, Fifth Edition

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A. will be less than the market rate but higher than the risk-free rate. B. must equal the market rate of return. C. changes by 1% for every 1% change in the risk-free rate. D. decreases as the beta of the firm's share increases. E. increases in direct relation to the share's systematic risk. 43. Assume a firm has a beta of 1.2. All else held constant, the cost of equity for this firm will increase if the: A. market risk premium decreases. B. risk-free rate decreases. C. market rate of return decreases. D. beta decreases. E. either the risk-free rate or the market rate of return decreases. 44. An increase in a levered firm’s tax rate will: A. decrease the cost of preferred share. B. increase both the cost of preferred share and debt. C. decrease the firm’s cost of capital. D. decrease the cost of equity capital. E. increase the firm’s WACC. 45. Which one of the following is used as the pre-tax cost of debt? A. Average coupon rate on the firm's outstanding bonds B. Coupon rate on the firm's latest bond issue C. Weighted average yield to maturity on the firm's outstanding debt D. Average current yield on the firm's outstanding debt E. Annual interest divided by the market price per bond for the latest bond issue 46. Which one of the following will decrease the after-tax cost of debt for a firm? A. Decrease in the firm's beta B. Increase in tax rates C. Increase in the risk-free rate of return D. Decrease in the market price of the debt E. Increase in a bond's yield to maturity 47. All else constant, an increase in a firm's cost of debt: A. could be caused by an increase in the firm's tax rate. B. will result in an increase in the firm's cost of capital. C. will lower the firm's weighted average cost of capital. D. will lower the firm's cost of equity. E. will increase the firm's capital structure weight of debt.

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48. The cost of preferred share: A. increases when a firm's tax rate decreases. B. is constant over time. C. is unaffected by changes in the market price of the share. D. is equal to the share's dividend yield. E. increases as the price of the share increases. 49. Which one of the following will affect the capital structure weights used to compute a firm's weighted average cost of capital? A. Decrease in the book value of a firm's equity B. Decrease in a firm's tax rate C. Increase in the market value of the firm's common share D. Increase in the market risk premium E. Increase in the firm's beta 50. Which one of the following represents the minimum rate of return a firm must earn on its assets if it is to maintain the current value of its securities? A. Cost of equity B. Pre-tax cost of debt C. After-tax cost of debt D. Weighted average cost of capital E. Weighted average cost of preferred and common share 51. A firm has a cost of equity of 13%, a cost of preferred of 11%, an after tax cost of debt of 5.2% and a tax rate of 35%. Given this, which one of the following will increase the firm's weighted average cost of capital? A. Increasing the firm's tax rate B. Issuing new bonds at par C. Redeeming shares of common share D. Increasing the firm's beta E. Increasing the debt-equity ratio 52. All else constant, the weighted average cost of capital for a risky, levered firm will decrease if: A. the firm's bonds start selling at a premium rather than at a discount. B. the market risk premium increases. C. the firm replaces some of its debt with preferred shares. D. corporate taxes are eliminated. E. the dividend yield on the common share increases. 53. Old Town Industries has three divisions. Division X has been in existence the longest and has the most stable sales. Division Y has been in existence for five years and is slightly less risky

Ross, Essentials of Corporate Finance, Fifth Edition

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than the overall firm. Division Z is the research and development side of the business. Given this, the firm should probably: A. require the highest rate of return from Division X since it has been in existence the longest. B. assign the highest cost of capital to Division Z because it is most likely the riskiest of the three divisions. C. use the firm's WACC as the cost of capital for Division Z as it provides analysis for the entire firm. D. use the firm's WACC as the cost of capital for Divisions A and B because they are part of the revenue-producing operations of the firm. E. allocate capital funds evenly among the divisions to maintain the current capital structure of the firm. 54. Kurt, who is a divisional manager, continually brags that his division's required return for its projects is 1% lower than the return required for any other division of the firm. Which one of the following most likely contributes the most to the lower rate requirement for Kurt's division? A. Kurt tends to overestimate the projected cash inflows on his projects. B. Kurt tends to underestimate the variable costs of his projects. C. Kurt has the most efficiently managed division. D. Kurt's division is less risky than the other divisions. E. Kurt's projects are generally financed with debt while the other divisions' projects are financed with equity. 55. Which one of the following is the primary determinant of an investment's cost of capital? A. Life of the investment B. Amount of the initial cash outlay C. The investment’s level of risk D. The source of funds used for the investment E. The investment's net present value 56. Spartans has 6.5% bonds outstanding that mature in 18 years. The bonds pay interest semiannually and have a face value of $1000. Currently, the bonds are selling for $985 each. What is the firm's pre-tax cost of debt? A. 6.77% B. 6.64% C. 6.94% D. 7.11% E. 6.20% 57. Three years ago, the Fairchildress Co. issued 20-year, 7.75% semi-annual coupon bonds at par. Today, the bonds are quoted at 102.6%. What is this firm's pre-tax cost of debt? A. 57.32% B. 7.13% C. 7.48%

Ross, Essentials of Corporate Finance, Fifth Edition

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D. 7.88% E. 7.34% 58. Pride of Lions has bonds outstanding that carry an annual coupon of 5.75%. The bonds mature in 9 years and are currently priced at 98% of face value. What is the firm's pre-tax cost of debt? A. 6.04% B. 9.850% C. 8.60% D. 11.28% E. 12.02% 59. Madison Square Stores has a $20 million bond issue outstanding that currently has a market value of $19.4 million. The bonds mature in 6.5 years and pay semi-annual interest payments of $35 each. What is the firm's pre-tax cost of debt? A. 8.21% B. 7.59% C. 7.08% D. 7.74% E. 7.80% 60. The preferred share of Dolphin Pools pays an annual dividend of $5.25 a share and sells for $48 a share. The tax rate is 35%. What is the firm's cost of preferred share? A. 9.67% B. 10.94% C. 15.07% D. 15.59% E. 16.47%

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 12 Testbank

Chapter 12 Testbank Key 1. The Whitehorse Book Company has 140 million shares outstanding. The market price of one share is currently $2. The company's debentures are publicly traded and their market price is equal to 93% of its face value. The debentures have a total book value of $50 000 000 and the current yield to maturity of corporate debenture is 12% per annum. The risk-free rate is 8.50% and the market risk premium is 5.20%. Market analysts estimated that the Whitehorse Book Company has a beta of 0.90. The corporate tax rate is 30%. What is the company's weighted average cost of capital (WACC) under the classical tax system? A. 14.24% B. 11.10% C. 12.50% D. 13.18% Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 12.03 Determine a firm's overall cost of capital Topic: The weighted average cost of capital

2. The Whitehorse Book Company has 140 million shares outstanding. The market price of one share is currently $2. The company's debentures are publicly traded and their market price is equal to 93% of its face value. The debentures have a total book value of $50 000 000 and the current yield to maturity of corporate debenture is 12% per annum. The risk-free rate is 8.50% and the market risk premium is 5.20%. Market analysts estimated that the Whitehorse Book Company has a beta of 0.90. The corporate tax rate is 30%. What is the company's weighted average cost of capital (WACC) considering the imputation tax system? A. 13.18% B. 7.70% C. 12.15% D. 9.11% Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 12.03 Determine a firm's overall cost of capital Topic: The weighted average cost of capital

3. Calculate the after-tax return to a shareholder assuming a dividend imputation system is used in Australia (if the dividend is fully franked). The shareholder is currently subject to a marginal tax rate of 40% and receives a dividend of $700 per annum. The corporate tax rate is equal to 30%. A. $420

Ross, Essentials of Corporate Finance, Fifth Edition

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B. $700 C. $350 D. $600 Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 12.03 Determine a firm's overall cost of capital Topic: The weighted average cost of capital

4. The PMP Insurance Company preference shares are trading on the ASX at $9 each and a dividend of $0.63 has just been paid. The face value of the issue is $10. What is the cost of preference shares for PMP? A. 14.29% B. 6.30% C. 1.11% D. 7.00% Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 12.02 Determine a firm's cost of debt Topic: The costs of debt and preference shares

5. Rainbow Mining Pty Ltd is concerned that opening a new credit line will affect its share price. Now the company has a risk return on its shares of 17.50%, determined by using a beta factor of 1.50. The risk free rate is 7%. What is the risk premium for Rainbow Mining? A. 7.00% B. 5.50% C. 10.00% D. 10.50% Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 12.01 Determine a firm's cost of equity capital Topic: The cost of equity

6. Rainbow Mining Pty Ltd is concerned that opening a new credit line will affect its share price. Now the company has a risk return on its shares of 17.50%, determined by using a beta factor of 1.50. The risk free rate is 7%. What is the market risk premium based on the information given for Rainbow Mining? A. 17.50% B. 5.50% C. 11.86% D. 7.00%

Ross, Essentials of Corporate Finance, Fifth Edition

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Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 12.01 Determine a firm's cost of equity capital Topic: The cost of equity

7. The proportional cost of equity plus the proportional after tax cost of debt is called the: A. pure play weight. B. capital structure weight. C. portfolio weight. D. weighted average cost of capital. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 12.03 Determine a firm's overall cost of capital Topic: The weighted average cost of capital

8. Using the weighted average cost of capital (WACC) of another firm, one which is focused on the type of project you are considering, rather than using your own firm's WACC is called the: A. competitor's game. B. project divisor. C. insider's look. D. pure play approach. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 12.04 Identify some of the pitfalls associated with a firm's overall cost of capital and what to do about them Topic: Divisional and project costs of capital

9. When the management of a firm evaluates the risk of a proposed project and adjusts the firm's WACC based on that evaluation to ascertain the required return for the project, they are using the _____ approach. A. subjective B. normative C. insider D. pure play Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 12.04 Identify some of the pitfalls associated with a firm's overall cost of capital and what to do about them Topic: Divisional and project costs of capital

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 12 Testbank

10. In an efficient market, a security with a beta of 0.98 will have a rate of return which lies: A. on the SML just to the right of the market return. B. on the SML just to the left of the market return. C. just below the SML and to the right of the market return. D. just below the security market line (SML) and to the left of the market return. Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 12.01 Determine a firm's cost of equity capital Topic: The cost of equity

11. Which one of the following represents the best estimate for a firm's pre-tax cost of debt? A. The current coupon on the firm's existing debt B. The current yield on the firm's existing debt C. Twice the rate of return currently offered on risk-free securities D. The current yield-to-maturity on the firm's existing debt Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 12.03 Determine a firm's overall cost of capital Topic: The weighted average cost of capital

12. An increase in the market value of a preferred preference share will _____ the cost of the preferred preference share. A. increase B. either increase or decrease C. decrease D. not affect Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 12.02 Determine a firm's cost of debt Topic: The costs of debt and preference shares

13. Which one of the following is a correct statement regarding a firm's weighted average cost of capital (WACC)? A. A 5% increase in a firm's debt–equity ratio will tend to increase the firm's WACC. B. The WACC will decrease when the tax rate decreases for all firms that utilise debt financing. C. The WACC can be used as the required return for all new projects with similar risk to that of the existing firm. D. A reduction in the risk level of a firm will tend to increase the firm's WACC. Ans: C

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 12 Testbank

AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 12.03 Determine a firm's overall cost of capital Topic: The weighted average cost of capital

14. A firm has a cost of equity of 10%, a cost of preferred preference shares of 9% and an aftertax cost of debt of 5%. Given this, which one of the following will decrease the firm's cost of capital? A. Decreasing the debt–equity ratio B. Increasing the systematic risk of the firm C. Decreasing the firm–specific risk associated with the firm D. Issuing new debt to offset an increase in the dividend payout ratio Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 12.03 Determine a firm's overall cost of capital Topic: The weighted average cost of capital

15. The cost of capital for a project should: A. never exceed the cost of capital for the overall firm. B. meet or exceed the internal rate of return of the project. C. be adjusted based on the size of the project. D. be adjusted based on the risk of the project. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 12.03 Determine a firm's overall cost of capital Topic: The weighted average cost of capital

16. When using the pure play approach, a firm is seeking a rate of return which: A. is applicable to the risk level of the investment under consideration. B. is lower than its own cost of capital. C. matches the expected internal rate of return of the investment being considered. D. will cause a project to have a positive net present value. Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 12.04 Identify some of the pitfalls associated with a firm's overall cost of capital and what to do about them Topic: Divisional and project costs of capital

17. Nelson Enterprises just paid an annual dividend of $1.56 per share. This dividend is expected to increase by 3% annually. Currently, the firm has a beta of 1.13 and a share price of $28 a

Ross, Essentials of Corporate Finance, Fifth Edition

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share. The risk-free rate is 3% and the market rate of return is 10.5%. What is your best estimate of Nelson's cost of equity? A. 8.74% B. 10.11% C. 11.48% D. 9.72% Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 12.01 Determine a firm's cost of equity capital Topic: The cost of equity

18. Horseless Carriages issued 20-year, 7% semi-annual bonds 11 years ago. The bonds currently sell at 101.3% of face value. What is the firm's after tax cost of debt if the tax rate is 34%? A. 4.87% B. 6.83% C. 6.71% D. 4.49% Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 12.02 Determine a firm's cost of debt Topic: The costs of debt and preference shares

19. The 7% preferred share preference share of Winslow & Winslow is selling for $54 a share. What is the firm's cost of preferred preference shares (face value $100)? A. 3.78% B. 17.56% C. 7.71% D. 12.96% Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 12.01 Determine a firm's cost of equity capital Topic: The cost of equity

20. Which of the following are weaknesses of the dividend growth model? I. Market risk premium fluctuations II. Lack of dividends for some firms III. Reliance on historical beta IV. Sensitivity of model to dividend growth rate A. I and II only B. I and III only

Ross, Essentials of Corporate Finance, Fifth Edition

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C. II and IV only D. I, II, III and IV Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 12.01 Determine a firm's cost of equity capital Topic: The cost of equity

21. In an efficient market, the cost of equity for a risky firm does which one of the following, according to the security market line? A. Produces a return that will be less than the market rate but higher than the risk-free rate B. Equals the market rate of return for all shares C. Has a maximum cost equal to the market rate of return D. Increases in direct relation to the share's systematic risk Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 12.01 Determine a firm's cost of equity capital Topic: The cost of equity

22. Which of the following will increase the cost of equity for a firm with a beta of 1.1? I. Decrease in the security's beta II. Decrease in the market risk premium III. Decrease in the risk-free rate IV. Increase in the risk-free rate A. II only B. III only C. I and II only D. I and III only Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 12.01 Determine a firm's cost of equity capital Topic: The cost of equity

23. Which one of the following will increase the cost of equity, all things being equal? A. Increase in the dividend growth rate B. Decrease in beta C. Decrease in future dividends D. Increase in share price Ans: A

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 12 Testbank

AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 12.01 Determine a firm's cost of equity capital Topic: The cost of equity

24. All things being equal, which of the following will increase the after-tax cost of debt for a firm? I. Increase in the yield to maturity of the firm's outstanding debt II. Decrease in the yield to maturity of the firm's outstanding debt III. Increase in the firm's tax rate IV. Decrease in the firm's tax rate A. I only B. I and III only C. I and IV only D. II and III only Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 12.02 Determine a firm's cost of debt Topic: The costs of debt and preference shares

25. Which one of the following statements is correct? A. An increase in the market value of preference shares will increase a firm's weighted average cost of capital. B. The cost of preference shares is unaffected by the issuer's tax rate. C. Preference shares are generally the cheapest source of capital for a firm. D. The cost of preference shares remains constant from year to year. Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 12.02 Determine a firm's cost of debt Topic: The costs of debt and preference shares

26. Alpha Industries is considering a project with an initial cost of $7.4 million. The project will produce cash inflows of $1.54 million a year for seven years. The firm uses the subjective approach to assign discount rates to projects. For this project, the subjective adjustment is +1.5%. The firm has a pre–tax cost of debt of 8.6% and a cost of equity of 13.7%. The debtequity ratio is 0.0.65 and the tax rate is 35%. What is the net present value of the project? A. –$372 951 B. –$187 016 C. $48 209 D. $269 480 Ans: A

Ross, Essentials of Corporate Finance, Fifth Edition

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AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 12.04 Identify some of the pitfalls associated with a firm's overall cost of capital and what to do about them Topic: Divisional and project costs of capital

27. The computation of which one of the following requires assigning every proposed investment to a particular risk class? A. Pure play cost of capital B. Cost of equity C. WACC D. Subjective cost of capital Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 12.04 Identify some of the pitfalls associated with a firm's overall cost of capital and what to do about them Topic: Divisional and project costs of capital

28. Which of the following is NOT an operating cost? A. Interest payments B. Advertising costs C. Legal fees D. Depreciation of non-current assets Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 12.04 Identify some of the pitfalls associated with a firm's overall cost of capital and what to do about them Topic: Company valuation with the WACC

29. Which of the following statements is correct with regard to debt financing? A. The firm’s cost of equity is reduced. B. The shareholders’ wealth is increased. C. The firm’s tax bill is increased. D. The firm’s risk level is reduced. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 12.04 Identify some of the pitfalls associated with a firm's overall cost of capital and what to do about them Topic: Company valuation with the WACC

30. Consider the following information for the Golf Corporation: the market price per share is $12; the book value per share is $10; the number of shares outstanding is 100 million; the market price per bond is $800; the face value per bond is $1000; the number of bonds outstanding is 1

Ross, Essentials of Corporate Finance, Fifth Edition

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million. Calculate the proportion of debt and equity for the corporation that you would use for estimating the weighted average cost of capital. A. 40% debt and 60% equity B. 50% debt and 50% equity C. 45.5% debt and 54.5% equity D. 70% debt and 30% equity Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 12.04 Identify some of the pitfalls associated with a firm's overall cost of capital and what to do about them Topic: Company valuation with the WACC

31. Katie owns 100 shares of ABC. Which one of the following terms is used to refer to the return that Katie and the other shareholders require on their investment in ABC? A. Weighted average cost of capital B. Pure play cost C. Cost of equity D. Subjective cost E. Cost of debt Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 12.01 Determine a firm's cost of equity capital Topic: The cost of equity

33. The weighted average cost of capital is defined as the weighted average of a firm's: A. return on all of its investments. B. cost of equity, cost of preferred and its after-tax cost of debt. C. pre-tax cost of debt and its preferred and common equity securities. D. bond coupon rates.

Ross, Essentials of Corporate Finance, Fifth Edition

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E. common and preferred share. Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 12.03 Determine a firm's overall cost of capital Topic: The weighted average cost of capital

34. Farmer's Supply is considering opening a clothing store, which would be a new line of business for the firm. Management has decided to use the cost of capital of a similar clothing store as the discount rate to evaluate this proposed expansion. Which one of the following terms describes this evaluation approach? A. Equity approach B. After-tax approach C. Subjective approach D. Market play E. Pure play approach Ans: E AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 12.04 Identify some of the pitfalls associated with a firm's overall cost of capital and what to do about them Topic: Divisional and project costs of capital

35. Kate is the CFO of a major firm and has the job of assigning discount rates to each project under consideration. Kate's method of doing this is to assign an incrementally higher rate as the risk level of the project increases and a lower rate as the risk level declines. Kate is applying the ___ approach. A. pure play B. divisional rating C. subjective D. straight WACC E. equity rating Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 12.04 Identify some of the pitfalls associated with a firm's overall cost of capital and what to do about them Topic: Divisional and project costs of capital

36. Ted is trying to decide what cost of capital he should assign to a project. Which one of the following should be his primary consideration in this decision? A. Amount of debt used to finance the project B. Use, or lack, of preferred share as a financing option C. Mix of funds used to finance the project D. Risk level of the project

Ross, Essentials of Corporate Finance, Fifth Edition

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E. Length of the project's life Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 12.04 Identify some of the pitfalls associated with a firm's overall cost of capital and what to do about them Topic: Divisional and project costs of capital

38. Which one of the following statements is correct relating to the dividend growth model approach to computing the cost of equity? A. The rate of growth must exceed the required rate of return. B. The rate of return must be adjusted for taxes. C. The annual dividend used in the computation must be for Year 1 if you are Time 0’s share price to compute the return. D. The cost of equity is equal to the return on the share plus the risk-free rate. E. The cost of equity is equal to the return on the share multiplied by the share's beta. Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 12.01 Determine a firm's cost of equity capital Topic: The cost of equity

39. A firm has a return on equity of 12.4% according to the dividend growth model and a return of 18.7% according to the capital asset pricing model. The market rate of return is 13.5%. What rate should the firm use as the cost of equity when computing the firm's weighted average cost of capital (WACC)? A. 12.4% because it is lower than 18.7% B. 18.7% because it is higher than 12.4% C. The arithmetic average of 12.4% and 18.7% D. The arithmetic average of 12.4%, 13.5% and 18.7% E. 13.5%

Ross, Essentials of Corporate Finance, Fifth Edition

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Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 12.03 Determine a firm's overall cost of capital Topic: The weighted average cost of capital

40. When evaluating a project, the dividend growth model: A. can only be used by firms that pay increasing dividends. B. must be used by all dividend-paying firms. C. is only applicable when the growth rate of the project exceeds the dividend growth rate. D. is relatively simple to use. E. must use the growth rate of the project as the rate of growth in the formula. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 12.01 Determine a firm's cost of equity capital Topic: The cost of equity

41. The results of the dividend growth model: A. vary directly with the market rate of return. B. can only be applied to projects that have a growth rate equal to that of the current firm. C. are highly dependent upon the beta used in the model. D. are sensitive to the rate of dividend growth. E. are most reliable when the growth rate exceeds 10%. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 12.01 Determine a firm's cost of equity capital Topic: The cost of equity

42. In an efficient market, the cost of equity for a high-risk firm: A. will be less than the market rate but higher than the risk-free rate. B. must equal the market rate of return. C. changes by 1% for every 1% change in the risk-free rate. D. decreases as the beta of the firm's share increases. E. increases in direct relation to the share's systematic risk. Ans: E AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 12.01 Determine a firm's cost of equity capital Topic: The cost of equity

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 12 Testbank

43. Assume a firm has a beta of 1.2. All else held constant, the cost of equity for this firm will increase if the: A. market risk premium decreases. B. risk-free rate decreases. C. market rate of return decreases. D. beta decreases. E. either the risk-free rate or the market rate of return decreases. Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 12.01 Determine a firm's cost of equity capital Topic: The cost of equity

44. An increase in a levered firm’s tax rate will: A. decrease the cost of preferred share. B. increase both the cost of preferred share and debt. C. decrease the firm’s cost of capital. D. decrease the cost of equity capital. E. increase the firm’s WACC. Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 12.02 Determine a firm's cost of debt Topic: The costs of debt and preference shares

45. Which one of the following is used as the pre-tax cost of debt? A. Average coupon rate on the firm's outstanding bonds B. Coupon rate on the firm's latest bond issue C. Weighted average yield to maturity on the firm's outstanding debt D. Average current yield on the firm's outstanding debt E. Annual interest divided by the market price per bond for the latest bond issue Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 12.02 Determine a firm's cost of debt Topic: The costs of debt and preference shares

46. Which one of the following will decrease the after-tax cost of debt for a firm? A. Decrease in the firm's beta B. Increase in tax rates C. Increase in the risk-free rate of return D. Decrease in the market price of the debt E. Increase in a bond's yield to maturity

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Chapter 12 Testbank

Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 12.03 Determine a firm's overall cost of capital Topic: The weighted average cost of capital

47. All else constant, an increase in a firm's cost of debt: A. could be caused by an increase in the firm's tax rate. B. will result in an increase in the firm's cost of capital. C. will lower the firm's weighted average cost of capital. D. will lower the firm's cost of equity. E. will increase the firm's capital structure weight of debt. Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 12.02 Determine a firm's cost of debt Topic: The costs of debt and preference shares

49. Which one of the following will affect the capital structure weights used to compute a firm's weighted average cost of capital? A. Decrease in the book value of a firm's equity B. Decrease in a firm's tax rate C. Increase in the market value of the firm's common share D. Increase in the market risk premium E. Increase in the firm's beta Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 12.03 Determine a firm's overall cost of capital Topic: The weighted average cost of capital

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Chapter 12 Testbank

50. Which one of the following represents the minimum rate of return a firm must earn on its assets if it is to maintain the current value of its securities? A. Cost of equity B. Pre-tax cost of debt C. After-tax cost of debt D. Weighted average cost of capital E. Weighted average cost of preferred and common share Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 12.03 Determine a firm's overall cost of capital Topic: The weighted average cost of capital

51. A firm has a cost of equity of 13%, a cost of preferred of 11%, an after tax cost of debt of 5.2% and a tax rate of 35%. Given this, which one of the following will increase the firm's weighted average cost of capital? A. Increasing the firm's tax rate B. Issuing new bonds at par C. Redeeming shares of common share D. Increasing the firm's beta E. Increasing the debt-equity ratio Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 12.03 Determine a firm's overall cost of capital Topic: The weighted average cost of capital

52. All else constant, the weighted average cost of capital for a risky, levered firm will decrease if: A. the firm's bonds start selling at a premium rather than at a discount. B. the market risk premium increases. C. the firm replaces some of its debt with preferred shares. D. corporate taxes are eliminated. E. the dividend yield on the common share increases. Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 12.03 Determine a firm's overall cost of capital Topic: The weighted average cost of capital

53. Old Town Industries has three divisions. Division X has been in existence the longest and has the most stable sales. Division Y has been in existence for five years and is slightly less risky

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Chapter 12 Testbank

54. Kurt, who is a divisional manager, continually brags that his division's required return for its projects is 1% lower than the return required for any other division of the firm. Which one of the following most likely contributes the most to the lower rate requirement for Kurt's division? A. Kurt tends to overestimate the projected cash inflows on his projects. B. Kurt tends to underestimate the variable costs of his projects. C. Kurt has the most efficiently managed division. D. Kurt's division is less risky than the other divisions. E. Kurt's projects are generally financed with debt while the other divisions' projects are financed with equity. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 12.04 Identify some of the pitfalls associated with a firm's overall cost of capital and what to do about them Topic: Divisional and project costs of capital

55. Which one of the following is the primary determinant of an investment's cost of capital? A. Life of the investment B. Amount of the initial cash outlay C. The investment’s level of risk D. The source of funds used for the investment E. The investment's net present value Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 12.04 Identify some of the pitfalls associated with a firm's overall cost of capital and what to do about them Topic: Divisional and project costs of capital

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 12 Testbank

56. Spartans has 6.5% bonds outstanding that mature in 18 years. The bonds pay interest semiannually and have a face value of $1000. Currently, the bonds are selling for $985 each. What is the firm's pre-tax cost of debt? A. 6.77% B. 6.64% C. 6.94% D. 7.11% E. 6.20% Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 12.02 Determine a firm's cost of debt Topic: The costs of debt and preference shares

57. Three years ago, the Fairchildress Co. issued 20-year, 7.75% semi-annual coupon bonds at par. Today, the bonds are quoted at 102.6%. What is this firm's pre-tax cost of debt? A. 57.32% B. 7.13% C. 7.48% D. 7.88% E. 7.34% Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 12.02 Determine a firm's cost of debt Topic: The costs of debt and preference shares

58. Pride of Lions has bonds outstanding that carry an annual coupon of 5.75%. The bonds mature in 9 years and are currently priced at 98% of face value. What is the firm's pre-tax cost of debt? A. 6.04% B. 9.850% C. 8.60% D. 11.28% E. 12.02% Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 12.02 Determine a firm's cost of debt Topic: The costs of debt and preference shares

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Chapter 12 Testbank

59. Madison Square Stores has a $20 million bond issue outstanding that currently has a market value of $19.4 million. The bonds mature in 6.5 years and pay semi-annual interest payments of $35 each. What is the firm's pre-tax cost of debt? A. 8.21% B. 7.59% C. 7.08% D. 7.74% E. 7.80% Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 12.02 Determine a firm's cost of debt Topic: The costs of debt and preference shares

60. The preferred share of Dolphin Pools pays an annual dividend of $5.25 a share and sells for $48 a share. The tax rate is 35%. What is the firm's cost of preferred share? A. 9.67% B. 10.94% C. 15.07% D. 15.59% E. 16.47% Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 12.02 Determine a firm's cost of debt Topic: The costs of debt and preference shares

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 12 Testbank

Chapter 12 Testbank Summary Category AACSB: Analytic Blooms: Analysis Difficulty: Easy Difficulty: Medium Learning Objective: 12.01 Determine a firm's cost of equity capital Learning Objective: 12.02 Determine a firm's cost of debt Learning Objective: 12.03 Determine a firm's overall cost of capital Learning Objective: 12.04 Identify some of the pitfalls associated with a firm's overall cost of capital and what to do about them Topic: Company valuation with the WACC Topic: Divisional and project costs of capital Topic: The cost of equity Topic: The costs of debt and preference shares Topic: The weighted average cost of capital

# of Questions 60 60 48 12 15 15 15 15 3 12 15 15 15

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 13 Testbank

Chapter 13 Testbank 1. A new board of directors of the BMP Corporation is considering a capital restructuring as currently BMP uses no-debt financing. The board is considering issuing $3 400 000 of debt and using the funds to retire one quarter of 160 000 shares that the company currently has outstanding. The interest rate on debt is 8.30% per annum. Calculate the break-even level of earnings before interest and taxes (EBIT) between both capital structure options. A. $282 200 B. $375 326 C. $1 128 800 D. $2 550 000 2. The corporate tax rate is 37%. The MaPol Company has a $100 million debenture issue outstanding with a coupon rate of 6.84% per annum. Face value of one debenture is $10 000 and investors require a 7% return on debentures with similar credit rating. What is the present value of the tax shield? A. $7 000 000 B. $30 160 000 C. $25 300 800 D. $37 000 000 3. The BaPol Company has a cost of equity of 14% and a weighted average cost of capital of 13.02%. What is the company's cost of debt, if BaPol Company maintains the debt−equity ratio of 0.44? Consider that there are no taxes. A. 17.59% B. 13.48% C. 16.68% D. 10.80% 4. Janus International is an all-equity company. You are given the following information for Janus International: EBIT = $880 000 forever; Corporate tax rate = 25%; Cost of equity = 12%. The company is in the process of issuing $1 000 000 of bonds at par that carry a 11.50% annual coupon. What is the levered value of the firm? A. $5 750 000 B. $6 655 250 C. $8 000 000 D. $5 528 750 5. If we observe capital structures across the industries in Australia, what industry typically has the highest debt–equity ratios, excluding banks?

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 13 Testbank

A. Gold mining B. Property trusts C. Capital goods D. Utilities 6. Financial risk is defined as the: A. equity risk that comes from the capital structure of a firm. B. risk associated with a firm's level of surplus cash. C. probability that a firm's weighted average cost of capital (WACC) will increase. D. credit risk associated with the firm's borrowing. 7. The legal and administrative costs of liquidation are called _____ bankruptcy costs. A. static B. sunk C. direct D. indirect 8. A firm's optimal capital structure: A. is generally a mix of 40% debt and 60% equity. B. exists when the debt–equity ratio is 0.50. C. is found by locating the mix of debt and equity which causes the earnings per share to equal exactly $1. D. is the debt–equity ratio that results in the lowest possible weighted average cost of capital. 9. Assume that you are comparing two firms that are identical, with one exception. Firm A is an all–equity firm and firm B has a debt–equity ratio of 0.60. All things being equal, firm A will: A. have lower EPS than firm B when the level of EBIT is relatively low. B. have lower EPS than firm B when the level of earnings before interest and taxes (EBIT) is relatively high. C. always have higher EPS than firm B, since it has no interest expense. D. generate a higher EBIT, but lower profit for the year than firm B. 10. You are comparing two financial policies. The first is all equity. The second involves the use of $2 million of debt. The break-even point between these two policies occurs when the earnings before interest and taxes (EBIT) is $450 000. Given this, it is accurate to say that leverage _____ beneficial to the firm when EBIT is $325 000 and _____ beneficial when EBIT is $625 000. A. is; is not B. The answer cannot be determined based on the information provided C. is not; is D. is; is

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 13 Testbank

11. Less Debt Inc. just revised its capital structure such that the firm's debt–equity ratio decreased from 0.80 to 0.40. Those individual investors who prefer the old capital structure: A. should loan out funds equivalent to the amount invested in Less Debt. B. should sell half of their equity holdings and invest in cash. C. can replicate that structure by reducing their debt and doubling their investment in the firm. D. can replicate that structure by increasing their use of homemade leverage. 12. Taylor & Taylor has positive earnings before interest and taxes (EBIT). Given this, which one of the following statements related to the interest tax shield is correct? A. The value of the interest tax shield is inversely related to the amount of financial leverage employed. B. The present value of the tax shield is equal to TC x D. C. The present value of the tax shield is equal to (TC − RD) D. D. As EBIT increases, the value of the interest tax shield decreases. 13. M&M Proposition I, with taxes, states that the value of a levered (VL) firm is equal to: A. VU − (TC − RD) × D. B. VU − (TC × D). C. VU + (TC × D). D. VU + (TC − RD) × D. 14. The maximum firm value, according to the static theory of capital structure, occurs at a point where the: A. value of the firm, as defined by M&M Proposition I, with tax, is exactly equal to the value of the firm, as defined by M&M Proposition I, without tax. B. financial distress costs are equal to zero. C. value of the firm equalises the costs of financial distress with the present value of the tax shield on debt. D. value of the firm is equal to the value defined by M&M Proposition I, with tax. 15. The use of borrowing by an individual to adjust his or her overall exposure to financial leverage is referred to as: A. homemade leverage. B. financial risk management. C. M&M Proposition I. D. M&M Proposition II. 16. Which one of the following is the equity risk arising from the daily operations of a firm? A. Industry risk B. Business risk C. Financial risk D. Strategic risk

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Chapter 13 Testbank

17. Paying interest reduces the taxes owed by a firm. Which one of the following terms applies to this relationship? A. Static theory of interest rates B. Interest tax shield C. Homemade leverage D. Financial risk 18. Which one of the following represents the present value of the interest tax shield? A. Tc × D B. D/(1 − Tc) C. D / Tc D. D × (1 − Tc) 19. Which of the following will increase the value of a levered firm according to M&M Proposition I with taxes? I. Decrease in the amount of the debt II. Increase in the value of the unlevered firm III. Decrease in the tax rate IV. Increase in the interest rate on the debt A. II and III only B. II only C. I and IV only D. II and IV only 20. Which of the following statements correctly relate to M&M Proposition I with taxes? I. Debt decreases the value of a firm II. The levered value of a firm exceeds the firm's unlevered value III. The weighted average cost of capital (WACC) is constant IV. The optimal capital structure is zero debt A. II only B. I, III and IV only C. I and IV only D. II and III only 21. Stone House Cafe has a 30% tax rate and total taxes of $35 280. What is the value of the interest tax shield if the interest expense is $16 700? A. $5010 B. $6023 C. $5395 D. $5708

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Chapter 13 Testbank

22. Kelner's Nursery has 8000 bonds outstanding with a face value of $1000 each. The coupon rate is 6.5% and the tax rate is 34%. What is the present value of the interest tax shield? A. $3.09 million B. $3.26 million C. $2.83 million D. $2.72 million 23. Which one of the following statements related to the static theory of capital structure is correct? A. The linear function of a firm's value has a constant positive slope. B. The actual value of a firm continually rises in direct proportion to the increased use of debt. C. A firm's value is maximised when a firm operates at its optimal debt level. D. The value of a firm will automatically decrease whenever the debt-equity ratio is decreased. 24. Which one of the following is correct, based on the static theory of capital structure? A. A firm receives the greatest benefit from debt financing when its tax rate is relatively low. B. A debt-equity ratio of one is considered to be the optimal capital structure. C. The costs of financial distress decrease the value of a firm. D. At the optimal level of debt a firm also optimises its tax shield on debt. 25. Assume both corporate taxes and financial distress costs apply to a firm. Given this, the static theory of capital structure illustrates that: A. the maximum value of a firm is obtained when a firm is financed solely with debt. B. a firm's value and its weighted average cost of capital are inversely related. C. the value of a firm rises as both the interest rate on debt and the tax rate rise. D. the value of a firm rises as the interest rate on debt rises. 26. Which one of the following best defines legal liquidation? A. A temporary technical insolvency B. Negotiating new payment terms with a firm's creditors C. A legal proceeding for liquidating or reorganising a business D. The internal process of revising the capital structure of a firm 27. Which one of the following terms refers to the termination of a firm as a going concern? A. Technical insolvency B. Liquidation C. Reorganisation D. Legal bankruptcy 28. When is a firm insolvent from an accounting perspective? A. When the firm's revenues cease

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 13 Testbank

B. When the firm's debt exceeds the value of the firm's equity C. When the market value of the firm's equity equals zero D. When the firm has a negative net worth 29. Which one of the following will generally receive the highest priority in a bankruptcy liquidation, assuming the absolute priority rule is followed? A. Government tax claims B. Claims by unsecured creditors C. Bankruptcy administrative expenses D. Employee wages 30. Which one of the following is a direct liquidation cost? A. Loss of customer goodwill resulting from a liquidation filing B. Legal and accounting fees related to a liquidation proceeding C. Management time spent on a liquidation proceeding D. Any financial distress cost 31. The use of borrowing by an individual to adjust his or her overall exposure to financial leverage is referred to as: A. M&M Proposition I. B. capital restructuring. C. homemade leverage. D. M&M Proposition II. E. financial risk management. 32. Which one of the following statements matches M&M Proposition I without taxes? A. The cost of equity capital has a positive linear relationship with a firm's capital structure. B. The dividends paid by a firm determine the firm's value. C. The cost of equity capital varies in response to changes in a firm's capital structure. D. The value of a firm is independent of the firm's capital structure. E. The value of a firm is dependent on the firm's capital structure. 33. Which one of the following states that a firm’s cost of equity capital is a positive linear function of the firm’s capital structure? A. Static theory of capital structure B. M&M Proposition I without taxes C. M&M Proposition II without taxes D. Homemade leverage theory E. M&M Proposition I with taxes 34. Which one of the following is the equity risk arising from the daily operations of a firm?

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 13 Testbank

A. Strategic risk B. Financial risk C. Liquidity risk D. Industry risk E. Business risk 35. Which one of the following is the equity risk arising from the capital structure selected by a firm? A. Strategic risk B. Financial risk C. Liquidity risk D. Industry risk E. Business risk 36. Paying interest reduces the taxes owed by a firm. Which one of the following terms applies to this relationship? A. Static theory of interest rates B. M&M Proposition I C. Financial risk D. Interest tax shield E. Homemade leverage 37. Which one of the following is a direct bankruptcy cost? A. Loss of customer goodwill resulting from a bankruptcy filing B. Legal and accounting fees related to a bankruptcy proceeding C. Management time spent on a bankruptcy proceeding D. Any financial distress cost E. Costs a firm spends trying to avoid bankruptcy 38. Which one of the following terms applies to the costs incurred by a firm that is trying to avoid filing for bankruptcy? A. Indirect bankruptcy costs B. Direct bankruptcy costs C. Static theory cost D. Optimal capital structure cost E. Reorganisation costs 39. Which one of the following is the theory that a firm should borrow up to the point where the additional tax benefit from an extra dollar of debt equals the additional costs associated with financial distress from that additional debt? A. M&M Proposition I, with taxes B. M&M Proposition II, with taxes

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Chapter 13 Testbank

C. M&M Proposition I, without taxes D. Homemade leverage proposition E. Static theory of capital structure 40. Which one of the following best defines legal bankruptcy? A. Negotiating new payment terms with a firm's creditors B. A temporary technical insolvency C. A legal proceeding for liquidating or reorganising a business D. The internal process of revising the capital structure of a firm E. The failure of a firm to meet its financial obligations in a timely manner 41. Which one of the following terms refers to the termination of a firm as a going concern? A. Insolvency B. Reorganisation C. Prepack D. Liquidation 42. Greenwood Motels has filed a petition for bankruptcy but hopes to continue its operations both during and after the bankruptcy process. Which one of the following terms best applies to this situation? A. Liquidation B. Technical insolvency C. Accounting insolvency D. Reorganisation 43. Which one of the following statements concerning financial leverage is correct? A. Financial leverage increases profits and decreases losses. B. Financial leverage has no effect on a firm's return on equity. C. Financial leverage refers to the use of common shares. D. Financial leverage magnifies both profits and losses. E. Increasing financial leverage will always decrease the earnings per share. 44. Which one of the following is minimised when the value of a firm is maximised? A. Return on equity B. WACC C. Debt D. Taxes E. Bankruptcy costs

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Chapter 13 Testbank

45. Assume you are comparing two firms that are identical in every aspect, except one is levered and one is unlevered. Which one of the following statements is correct regarding these two firms? A. The levered firm has higher EPS (earnings per share) than the unlevered firm at the breakeven point. B. The levered firm will have higher EPS than the unlevered firm at all levels of EBIT. C. The unlevered firm will have higher EPS than the levered firm at relatively high levels of EBIT. D. The EPS for the unlevered firm will always exceed those of the levered firm. E. The unlevered firm will have higher EPS at relatively low levels of EBIT. 46. Which one of the following represents the present value of the interest tax shield? A. D × (1 − Tc) B. D/(1 − Tc) C. D/Tc D. D − D(Tc) E. Tc × D 47. According to M&M Proposition I with taxes, the value of a levered firm will increase when the: A. value of the unlevered firm increases. B. tax rate is decreased. C. debt-equity ratio is lowered. D. interest rate on the debt is lowered. E. interest rate on the debt is increased. 48. Which one of the following is an example of a direct bankruptcy cost? A. Operating at a debt-equity ratio that is less than the optimal ratio B. Reducing the dividend payout ratio as a means of increasing a firm's equity C. Forgoing a positive net present value project to conserve current cash D. Incurring legal fees for the preparation of bankruptcy filings E. Losing a key customer due to concerns over a firm's financial viability 49. The static theory of capital structure assumes a firm: A. maintains a constant debt-equity ratio. B. has an all-equity structure. C. is fixed in terms of its assets and operations. D. pays no taxes. E. is operating at the point where financial distress costs are eliminated. 50. Which one of the following conditions exists at the point where a firm maximises its value? A. The tax benefit from an additional dollar of debt is zero.

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Chapter 13 Testbank

B. Financial distress costs are equal to zero. C. The debt-equity ratio is 1.0. D. WACC is minimised. E. The cost of equity is minimised. 51. Which one of the following statements related to the static theory of capital structure is correct? A. A firm begins to lose value as soon as the first dollar of debt is incurred. B. The actual value of a firm continually rises in direct proportion to the increased use of debt. C. The linear function of a firm's value has a constant positive slope. D. A firm's value is maximised when a firm operates at its optimal debt level. E. The value of a firm will automatically decrease whenever the debt-equity ratio is decreased. 52. Which one of the following is correct based on the static theory of capital structure? A. A firm receives the greatest benefit from debt financing when its tax rate is relatively low. B. A debt-equity ratio of 1 is considered to be the optimal capital structure. C. The costs of financial distress decrease the value of a firm. D. The more debt a firm assumes, the greater the incentive to acquire even more debt until such time as the firm is financed with 100% debt. E. At the optimal level of debt, a firm also optimises its tax shield on debt. 53. Assume both corporate taxes and financial distress costs apply to a firm. Given this, the static theory of capital structure illustrates that: A. a firm's value and its weighted average cost of capital are inversely related. B. a firm's value and its tax rate are inversely related. C. the maximum value of a firm is obtained when a firm is financed solely with debt. D. the value of a firm rises as the interest rate on debt rises. E. the value of a firm rises as both the interest rate on debt and the tax rate rise. 54. When is a firm insolvent from an accounting perspective? A. When the firm is unable to meet its financial obligations in a timely manner B. When the firm's debt exceeds the value of the firm's equity C. When the firm has a negative net worth D. When the firm's revenues cease E. When the market value of the firm's equity equals zero 55. Peter’s Tools recently defaulted on a bank loan. To avoid a bankruptcy proceeding, the bank agreed to a composition. This composition would do which one of the following? A. Forgive the loan payment in its entirety B. Extend the due date on the missed loan payment C. Reduce the amount of the loan payments so Peter’s can pay on time D. Transfer some of Peter's assets to the bank in lieu of the loan payment

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Chapter 13 Testbank

E. Transfer all the equity shares in Peter’s to the lending bank 56. Which one of the following will generally receive the highest priority in a bankruptcy liquidation, assuming the absolute priority rule is followed? A. Claims by unsecured creditors B. Employee wages C. Government tax claims D. Contributions to employee retirement plans E. Bankruptcy administrative expenses 57. Which one of the following statements concerning financial leverage is correct? A. The benefits of leverage are unaffected by the amount of a firm's earnings. B. The use of leverage will always increase a firm's earnings per share. C. The shareholders of a firm are exposed to less risk any time a firm uses financial leverage. D. Changes in the capital structure of a firm will generally change the firm's earnings per share. E. Financial leverage is beneficial to a firm only when the firm has negative earnings. 58. Which statement is true? A. A prepack is a plan of liquidation used to distribute a firm's assets. B. Bankruptcy courts have ‘cram-down’ powers. C. The absolute priority rule must be strictly followed in all bankruptcy proceedings. D. Creditors cannot force a firm into bankruptcy even though they might like to do so. E. A reorganisation plan can be approved only if the firm's creditors all agree with the plan. 59. Brick House Markets has a tax rate of 34% and taxable income of $308 211. What is the value of the interest tax shield if the interest expense is $39 700? A. $14 887 B. $15 010 C. $15 595 D. $13 498 E. $16 023 60. The Fruit Mart is an all-equity firm with a current cost of equity of 17.4%. The estimated earnings before interest and taxes are $169 500 annually forever. Currently, the firm has no debt but is in the process of borrowing $400 000 at 9.5% interest. The tax rate is 35%. What is the value of the unlevered firm? A. $649 207 B. $753 571 C. $656 411 D. $719 307 E. $633 190

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 13 Testbank

Chapter 13 Testbank Key 1. A new board of directors of the BMP Corporation is considering a capital restructuring as currently BMP uses no-debt financing. The board is considering issuing $3 400 000 of debt and using the funds to retire one quarter of 160 000 shares that the company currently has outstanding. The interest rate on debt is 8.30% per annum. Calculate the break-even level of earnings before interest and taxes (EBIT) between both capital structure options. A. $282 200 B. $375 326 C. $1 128 800 D. $2 550 000 Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 13.01 Discuss the effect of financial leverage Topic: The effect of financial leverage

2. The corporate tax rate is 37%. The MaPol Company has a $100 million debenture issue outstanding with a coupon rate of 6.84% per annum. Face value of one debenture is $10 000 and investors require a 7% return on debentures with similar credit rating. What is the present value of the tax shield? A. $7 000 000 B. $30 160 000 C. $25 300 800 D. $37 000 000 Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 13.02 Analyse the impact of taxes and bankruptcy on capital structure choice Topic: Corporate taxes and capital structure

3. The BaPol Company has a cost of equity of 14% and a weighted average cost of capital of 13.02%. What is the company's cost of debt, if BaPol Company maintains the debt−equity ratio of 0.44? Consider that there are no taxes. A. 17.59% B. 13.48% C. 16.68% D. 10.80% Ans: D

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 13 Testbank

AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 13.01 Discuss the effect of financial leverage Topic: The effect of financial leverage

4. Janus International is an all-equity company. You are given the following information for Janus International: EBIT = $880 000 forever; Corporate tax rate = 25%; Cost of equity = 12%. The company is in the process of issuing $1 000 000 of bonds at par that carry a 11.50% annual coupon. What is the levered value of the firm? A. $5 750 000 B. $6 655 250 C. $8 000 000 D. $5 528 750 Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Hard Learning Objective: 13.02 Analyse the impact of taxes and bankruptcy on capital structure choice Topic: Corporate taxes and capital structure

5. If we observe capital structures across the industries in Australia, what industry typically has the highest debt–equity ratios, excluding banks? A. Gold mining B. Property trusts C. Capital goods D. Utilities Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 13.01 Discuss the effect of financial leverage Topic: Capital structure and the cost of equity capital

6. Financial risk is defined as the: A. equity risk that comes from the capital structure of a firm. B. risk associated with a firm's level of surplus cash. C. probability that a firm's weighted average cost of capital (WACC) will increase. D. credit risk associated with the firm's borrowing. Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 13.01 Discuss the effect of financial leverage Topic: Capital structure and the cost of equity capital

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 13 Testbank

7. The legal and administrative costs of liquidation are called _____ bankruptcy costs. A. static B. sunk C. direct D. indirect Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 13.02 Analyse the impact of taxes and bankruptcy on capital structure choice Topic: Bankruptcy/Liquidation costs

8. A firm's optimal capital structure: A. is generally a mix of 40% debt and 60% equity. B. exists when the debt–equity ratio is 0.50. C. is found by locating the mix of debt and equity which causes the earnings per share to equal exactly $1. D. is the debt–equity ratio that results in the lowest possible weighted average cost of capital. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 13.01 Discuss the effect of financial leverage Topic: Capital structure and the cost of equity capital

9. Assume that you are comparing two firms that are identical, with one exception. Firm A is an all–equity firm and firm B has a debt–equity ratio of 0.60. All things being equal, firm A will: A. have lower EPS than firm B when the level of EBIT is relatively low. B. have lower EPS than firm B when the level of earnings before interest and taxes (EBIT) is relatively high. C. always have higher EPS than firm B, since it has no interest expense. D. generate a higher EBIT, but lower profit for the year than firm B. Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 13.01 Discuss the effect of financial leverage Topic: The effect of financial leverage

10. You are comparing two financial policies. The first is all equity. The second involves the use of $2 million of debt. The break-even point between these two policies occurs when the earnings before interest and taxes (EBIT) is $450 000. Given this, it is accurate to say that leverage _____ beneficial to the firm when EBIT is $325 000 and _____ beneficial when EBIT is $625 000. A. is; is not B. The answer cannot be determined based on the information provided C. is not; is

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D. is; is Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 13.01 Discuss the effect of financial leverage Topic: The effect of financial leverage

12. Taylor & Taylor has positive earnings before interest and taxes (EBIT). Given this, which one of the following statements related to the interest tax shield is correct? A. The value of the interest tax shield is inversely related to the amount of financial leverage employed. B. The present value of the tax shield is equal to TC x D. C. The present value of the tax shield is equal to (TC − RD) D. D. As EBIT increases, the value of the interest tax shield decreases. Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 13.02 Analyse the impact of taxes and bankruptcy on capital structure choice Topic: Corporate taxes and capital structure

13. M&M Proposition I, with taxes, states that the value of a levered (VL) firm is equal to: A. VU − (TC − RD) × D. B. VU − (TC × D). C. VU + (TC × D). D. VU + (TC − RD) × D. Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 13.02 Analyse the impact of taxes and bankruptcy on capital structure choice Topic: Corporate taxes and capital structure

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Chapter 13 Testbank

14. The maximum firm value, according to the static theory of capital structure, occurs at a point where the: A. value of the firm, as defined by M&M Proposition I, with tax, is exactly equal to the value of the firm, as defined by M&M Proposition I, without tax. B. financial distress costs are equal to zero. C. value of the firm equalises the costs of financial distress with the present value of the tax shield on debt. D. value of the firm is equal to the value defined by M&M Proposition I, with tax. Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 13.04 Explain the theory of optimal capital structure Topic: Optimal capital structure

15. The use of borrowing by an individual to adjust his or her overall exposure to financial leverage is referred to as: A. homemade leverage. B. financial risk management. C. M&M Proposition I. D. M&M Proposition II. Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 13.01 Discuss the effect of financial leverage Topic: The effect of financial leverage

16. Which one of the following is the equity risk arising from the daily operations of a firm? A. Industry risk B. Business risk C. Financial risk D. Strategic risk Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 13.01 Discuss the effect of financial leverage Topic: Capital structure and the cost of equity capital

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Chapter 13 Testbank

Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 13.02 Analyse the impact of taxes and bankruptcy on capital structure choice Topic: Corporate taxes and capital structure

18. Which one of the following represents the present value of the interest tax shield? A. Tc × D B. D/(1 − Tc) C. D / Tc D. D × (1 − Tc) Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 13.02 Analyse the impact of taxes and bankruptcy on capital structure choice Topic: Corporate taxes and capital structure

19. Which of the following will increase the value of a levered firm according to M&M Proposition I with taxes? I. Decrease in the amount of the debt II. Increase in the value of the unlevered firm III. Decrease in the tax rate IV. Increase in the interest rate on the debt A. II and III only B. II only C. I and IV only D. II and IV only Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 13.02 Analyse the impact of taxes and bankruptcy on capital structure choice Topic: Corporate taxes and capital structure

20. Which of the following statements correctly relate to M&M Proposition I with taxes? I. Debt decreases the value of a firm II. The levered value of a firm exceeds the firm's unlevered value III. The weighted average cost of capital (WACC) is constant IV. The optimal capital structure is zero debt A. II only B. I, III and IV only C. I and IV only D. II and III only Ans: A

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Chapter 13 Testbank

AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 13.02 Analyse the impact of taxes and bankruptcy on capital structure choice Topic: Corporate taxes and capital structure

21. Stone House Cafe has a 30% tax rate and total taxes of $35 280. What is the value of the interest tax shield if the interest expense is $16 700? A. $5010 B. $6023 C. $5395 D. $5708 Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 13.02 Analyse the impact of taxes and bankruptcy on capital structure choice Topic: Corporate taxes and capital structure

22. Kelner's Nursery has 8000 bonds outstanding with a face value of $1000 each. The coupon rate is 6.5% and the tax rate is 34%. What is the present value of the interest tax shield? A. $3.09 million B. $3.26 million C. $2.83 million D. $2.72 million Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 13.02 Analyse the impact of taxes and bankruptcy on capital structure choice Topic: Corporate taxes and capital structure

23. Which one of the following statements related to the static theory of capital structure is correct? A. The linear function of a firm's value has a constant positive slope. B. The actual value of a firm continually rises in direct proportion to the increased use of debt. C. A firm's value is maximised when a firm operates at its optimal debt level. D. The value of a firm will automatically decrease whenever the debt-equity ratio is decreased. Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 13.04 Explain the theory of optimal capital structure Topic: Optimal capital structure

24. Which one of the following is correct, based on the static theory of capital structure?

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Chapter 13 Testbank

A. A firm receives the greatest benefit from debt financing when its tax rate is relatively low. B. A debt-equity ratio of one is considered to be the optimal capital structure. C. The costs of financial distress decrease the value of a firm. D. At the optimal level of debt a firm also optimises its tax shield on debt. Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 13.04 Explain the theory of optimal capital structure Topic: Optimal capital structure

25. Assume both corporate taxes and financial distress costs apply to a firm. Given this, the static theory of capital structure illustrates that: A. the maximum value of a firm is obtained when a firm is financed solely with debt. B. a firm's value and its weighted average cost of capital are inversely related. C. the value of a firm rises as both the interest rate on debt and the tax rate rise. D. the value of a firm rises as the interest rate on debt rises. Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 13.04 Explain the theory of optimal capital structure Topic: Optimal capital structure

26. Which one of the following best defines legal liquidation? A. A temporary technical insolvency B. Negotiating new payment terms with a firm's creditors C. A legal proceeding for liquidating or reorganising a business D. The internal process of revising the capital structure of a firm Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 13.03 Identify the essentials of the bankruptcy process Topic: A quick look at the bankruptcy/liquidation process

27. Which one of the following terms refers to the termination of a firm as a going concern? A. Technical insolvency B. Liquidation C. Reorganisation D. Legal bankruptcy Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 13.03 Identify the essentials of the bankruptcy process Topic: A quick look at the bankruptcy/liquidation process

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Chapter 13 Testbank

28. When is a firm insolvent from an accounting perspective? A. When the firm's revenues cease B. When the firm's debt exceeds the value of the firm's equity C. When the market value of the firm's equity equals zero D. When the firm has a negative net worth Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 13.03 Identify the essentials of the bankruptcy process Topic: A quick look at the bankruptcy/liquidation process

29. Which one of the following will generally receive the highest priority in a bankruptcy liquidation, assuming the absolute priority rule is followed? A. Government tax claims B. Claims by unsecured creditors C. Bankruptcy administrative expenses D. Employee wages Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 13.03 Identify the essentials of the bankruptcy process Topic: A quick look at the bankruptcy/liquidation process

30. Which one of the following is a direct liquidation cost? A. Loss of customer goodwill resulting from a liquidation filing B. Legal and accounting fees related to a liquidation proceeding C. Management time spent on a liquidation proceeding D. Any financial distress cost Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 13.02 Analyse the impact of taxes and bankruptcy on capital structure choice Topic: Bankruptcy/Liquidation costs

31. The use of borrowing by an individual to adjust his or her overall exposure to financial leverage is referred to as: A. M&M Proposition I. B. capital restructuring. C. homemade leverage. D. M&M Proposition II. E. financial risk management. Ans: C

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Chapter 13 Testbank

AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 13.01 Discuss the effect of financial leverage Topic: The effect of financial leverage

32. Which one of the following statements matches M&M Proposition I without taxes? A. The cost of equity capital has a positive linear relationship with a firm's capital structure. B. The dividends paid by a firm determine the firm's value. C. The cost of equity capital varies in response to changes in a firm's capital structure. D. The value of a firm is independent of the firm's capital structure. E. The value of a firm is dependent on the firm's capital structure. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 13.01 Discuss the effect of financial leverage Topic: Capital structure and the cost of equity capital

33. Which one of the following states that a firm’s cost of equity capital is a positive linear function of the firm’s capital structure? A. Static theory of capital structure B. M&M Proposition I without taxes C. M&M Proposition II without taxes D. Homemade leverage theory E. M&M Proposition I with taxes Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 13.01 Discuss the effect of financial leverage Topic: Capital structure and the cost of equity capital

34. Which one of the following is the equity risk arising from the daily operations of a firm? A. Strategic risk B. Financial risk C. Liquidity risk D. Industry risk E. Business risk Ans: E AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 13.01 Discuss the effect of financial leverage Topic: Capital structure and the cost of equity capital

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Chapter 13 Testbank

35. Which one of the following is the equity risk arising from the capital structure selected by a firm? A. Strategic risk B. Financial risk C. Liquidity risk D. Industry risk E. Business risk Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 13.01 Discuss the effect of financial leverage Topic: Capital structure and the cost of equity capital

36. Paying interest reduces the taxes owed by a firm. Which one of the following terms applies to this relationship? A. Static theory of interest rates B. M&M Proposition I C. Financial risk D. Interest tax shield E. Homemade leverage Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 13.02 Analyse the impact of taxes and bankruptcy on capital structure choice Topic: Corporate taxes and capital structure

37. Which one of the following is a direct bankruptcy cost? A. Loss of customer goodwill resulting from a bankruptcy filing B. Legal and accounting fees related to a bankruptcy proceeding C. Management time spent on a bankruptcy proceeding D. Any financial distress cost E. Costs a firm spends trying to avoid bankruptcy Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 13.03 Identify the essentials of the bankruptcy process Topic: A quick look at the bankruptcy/liquidation process

38. Which one of the following terms applies to the costs incurred by a firm that is trying to avoid filing for bankruptcy? A. Indirect bankruptcy costs B. Direct bankruptcy costs C. Static theory cost

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 13 Testbank

D. Optimal capital structure cost E. Reorganisation costs Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 13.02 Analyse the impact of taxes and bankruptcy on capital structure choice Topic: Bankruptcy/Liquidation costs

39. Which one of the following is the theory that a firm should borrow up to the point where the additional tax benefit from an extra dollar of debt equals the additional costs associated with financial distress from that additional debt? A. M&M Proposition I, with taxes B. M&M Proposition II, with taxes C. M&M Proposition I, without taxes D. Homemade leverage proposition E. Static theory of capital structure Ans: E AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 13.04 Explain the theory of optimal capital structure Topic: Optimal capital structure

40. Which one of the following best defines legal bankruptcy? A. Negotiating new payment terms with a firm's creditors B. A temporary technical insolvency C. A legal proceeding for liquidating or reorganising a business D. The internal process of revising the capital structure of a firm E. The failure of a firm to meet its financial obligations in a timely manner Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 13.03 Identify the essentials of the bankruptcy process Topic: A quick look at the bankruptcy/liquidation process

41. Which one of the following terms refers to the termination of a firm as a going concern? A. Insolvency B. Reorganisation C. Prepack D. Liquidation Ans: D

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Chapter 13 Testbank

AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 13.03 Identify the essentials of the bankruptcy process Topic: A quick look at the bankruptcy/liquidation process

42. Greenwood Motels has filed a petition for bankruptcy but hopes to continue its operations both during and after the bankruptcy process. Which one of the following terms best applies to this situation? A. Liquidation B. Technical insolvency C. Accounting insolvency D. Reorganisation Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 13.03 Identify the essentials of the bankruptcy process Topic: A quick look at the bankruptcy/liquidation process

43. Which one of the following statements concerning financial leverage is correct? A. Financial leverage increases profits and decreases losses. B. Financial leverage has no effect on a firm's return on equity. C. Financial leverage refers to the use of common shares. D. Financial leverage magnifies both profits and losses. E. Increasing financial leverage will always decrease the earnings per share. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 13.01 Discuss the effect of financial leverage Topic: The effect of financial leverage

44. Which one of the following is minimised when the value of a firm is maximised? A. Return on equity B. WACC C. Debt D. Taxes E. Bankruptcy costs Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 13.04 Explain the theory of optimal capital structure Topic: Optimal capital structure

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Chapter 13 Testbank

46. Which one of the following represents the present value of the interest tax shield? A. D × (1 − Tc) B. D/(1 − Tc) C. D/Tc D. D − D(Tc) E. Tc × D Ans: E AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 13.02 Analyse the impact of taxes and bankruptcy on capital structure choice Topic: Corporate taxes and capital structure

47. According to M&M Proposition I with taxes, the value of a levered firm will increase when the: A. value of the unlevered firm increases. B. tax rate is decreased. C. debt-equity ratio is lowered. D. interest rate on the debt is lowered. E. interest rate on the debt is increased. Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 13.02 Analyse the impact of taxes and bankruptcy on capital structure choice Topic: Corporate taxes and capital structure

48. Which one of the following is an example of a direct bankruptcy cost? A. Operating at a debt-equity ratio that is less than the optimal ratio

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 13 Testbank

B. Reducing the dividend payout ratio as a means of increasing a firm's equity C. Forgoing a positive net present value project to conserve current cash D. Incurring legal fees for the preparation of bankruptcy filings E. Losing a key customer due to concerns over a firm's financial viability Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 13.03 Identify the essentials of the bankruptcy process Topic: A quick look at the bankruptcy/liquidation process

49. The static theory of capital structure assumes a firm: A. maintains a constant debt-equity ratio. B. has an all-equity structure. C. is fixed in terms of its assets and operations. D. pays no taxes. E. is operating at the point where financial distress costs are eliminated. Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 13.04 Explain the theory of optimal capital structure Topic: Optimal capital structure

50. Which one of the following conditions exists at the point where a firm maximises its value? A. The tax benefit from an additional dollar of debt is zero. B. Financial distress costs are equal to zero. C. The debt-equity ratio is 1.0. D. WACC is minimised. E. The cost of equity is minimised. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 13.04 Explain the theory of optimal capital structure Topic: Optimal capital structure

51. Which one of the following statements related to the static theory of capital structure is correct? A. A firm begins to lose value as soon as the first dollar of debt is incurred. B. The actual value of a firm continually rises in direct proportion to the increased use of debt. C. The linear function of a firm's value has a constant positive slope. D. A firm's value is maximised when a firm operates at its optimal debt level. E. The value of a firm will automatically decrease whenever the debt-equity ratio is decreased. Ans: D

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Chapter 13 Testbank

AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 13.04 Explain the theory of optimal capital structure Topic: Optimal capital structure

52. Which one of the following is correct based on the static theory of capital structure? A. A firm receives the greatest benefit from debt financing when its tax rate is relatively low. B. A debt-equity ratio of 1 is considered to be the optimal capital structure. C. The costs of financial distress decrease the value of a firm. D. The more debt a firm assumes, the greater the incentive to acquire even more debt until such time as the firm is financed with 100% debt. E. At the optimal level of debt, a firm also optimises its tax shield on debt. Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 13.04 Explain the theory of optimal capital structure Topic: Optimal capital structure

53. Assume both corporate taxes and financial distress costs apply to a firm. Given this, the static theory of capital structure illustrates that: A. a firm's value and its weighted average cost of capital are inversely related. B. a firm's value and its tax rate are inversely related. C. the maximum value of a firm is obtained when a firm is financed solely with debt. D. the value of a firm rises as the interest rate on debt rises. E. the value of a firm rises as both the interest rate on debt and the tax rate rise. Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 13.04 Explain the theory of optimal capital structure Topic: Optimal capital structure

54. When is a firm insolvent from an accounting perspective? A. When the firm is unable to meet its financial obligations in a timely manner B. When the firm's debt exceeds the value of the firm's equity C. When the firm has a negative net worth D. When the firm's revenues cease E. When the market value of the firm's equity equals zero Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 13.03 Identify the essentials of the bankruptcy process Topic: A quick look at the bankruptcy/liquidation process

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Chapter 13 Testbank

55. Peter’s Tools recently defaulted on a bank loan. To avoid a bankruptcy proceeding, the bank agreed to a composition. This composition would do which one of the following? A. Forgive the loan payment in its entirety B. Extend the due date on the missed loan payment C. Reduce the amount of the loan payments so Peter’s can pay on time D. Transfer some of Peter's assets to the bank in lieu of the loan payment E. Transfer all the equity shares in Peter’s to the lending bank Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 13.03 Identify the essentials of the bankruptcy process Topic: A quick look at the bankruptcy/liquidation process

56. Which one of the following will generally receive the highest priority in a bankruptcy liquidation, assuming the absolute priority rule is followed? A. Claims by unsecured creditors B. Employee wages C. Government tax claims D. Contributions to employee retirement plans E. Bankruptcy administrative expenses Ans: E AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 13.03 Identify the essentials of the bankruptcy process Topic: A quick look at the bankruptcy/liquidation process

57. Which one of the following statements concerning financial leverage is correct? A. The benefits of leverage are unaffected by the amount of a firm's earnings. B. The use of leverage will always increase a firm's earnings per share. C. The shareholders of a firm are exposed to less risk any time a firm uses financial leverage. D. Changes in the capital structure of a firm will generally change the firm's earnings per share. E. Financial leverage is beneficial to a firm only when the firm has negative earnings. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 13.01 Discuss the effect of financial leverage Topic: The effect of financial leverage

58. Which statement is true? A. A prepack is a plan of liquidation used to distribute a firm's assets. B. Bankruptcy courts have ‘cram-down’ powers. C. The absolute priority rule must be strictly followed in all bankruptcy proceedings. D. Creditors cannot force a firm into bankruptcy even though they might like to do so.

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Chapter 13 Testbank

E. A reorganisation plan can be approved only if the firm's creditors all agree with the plan. Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 13.03 Identify the essentials of the bankruptcy process Topic: A quick look at the bankruptcy/liquidation process

59. Brick House Markets has a tax rate of 34% and taxable income of $308 211. What is the value of the interest tax shield if the interest expense is $39 700? A. $14 887 B. $15 010 C. $15 595 D. $13 498 E. $16 023 Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 13.02 Analyse the impact of taxes and bankruptcy on capital structure choice Topic: Corporate taxes and capital structure

60. The Fruit Mart is an all-equity firm with a current cost of equity of 17.4%. The estimated earnings before interest and taxes are $169 500 annually forever. Currently, the firm has no debt but is in the process of borrowing $400 000 at 9.5% interest. The tax rate is 35%. What is the value of the unlevered firm? A. $649 207 B. $753 571 C. $656 411 D. $719 307 E. $633 190 Ans: E AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 13.02 Analyse the impact of taxes and bankruptcy on capital structure choice Topic: Corporate taxes and capital structure

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 13 Testbank

Chapter 13 Testbank Summary Category AACSB: Analytic Blooms: Analysis Difficulty: Easy Difficulty: Hard Difficulty: Medium Learning Objective: 13.01 Discuss the effect of financial leverage Learning Objective: 13.02 Analyse the impact of taxes and bankruptcy on capital structure choice Learning Objective: 13.03 Identify the essentials of the bankruptcy process Learning Objective: 13.04 Explain the theory of optimal capital structure Topic: A quick look at the bankruptcy/liquidation process Topic: Bankruptcy/Liquidation costs Topic: Capital structure and the cost of equity capital Topic: Corporate taxes and capital structure Topic: Optimal capital structure Topic: The effect of financial leverage

# of Questions 60 60 44 1 15 18 18 13 11 13 3 8 15 11 10

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 14 Testbank

Chapter 14 Testbank 1. Centropen Inc. has 460 000 shares outstanding and the total market value of the equity is $1 610 000. The firm has just announced a repurchase of $420 000 worth of shares. After the repurchase, Centropen will have ____ shares outstanding at a market price of ____ per share. A. 250 000; $2.59 B. 301 000; $3.10 C. 320 000; $3.40 D. 340 000; $3.50 2. The ex-dividend date is defined as _____ business days before the date of_____. A. two; payment B. three; record C. three; payment D. one; record 3. Which one of the following is the date on which the board of directors agrees to pay a dividend and passes a resolution to do so? Which one of the following dates is the date on which the board of directors voted to pay a dividend? A. record date B. ex-dividend date C. settle date D. declaration date 4. Doris' Boutique has 4000 shares outstanding at a price per share of $15. What will the price per share be if the firm pays a $1.30 per share cash dividend? Ignore taxes and market imperfections. A. $13.70 B. $15.40 C. $15.80 D. $16.00 5. LaDoris' Boutique has 4500 shares outstanding at a price per share of $20. The firm has decided to repurchase 600 of those shares in the open market. What will the price per share be after the share repurchase is completed? Ignore taxes and market imperfections. A. $17.80 B. $18.40 C. $18.80 D. $20.00

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 14 Testbank

6. Heidi owns 400 shares of Boyd Enterprises, which is valued at $17 a share. Boyd Enterprises just declared a 10% bonus issue. How many shares will Heidi own and what will the price per share be after the dividend? A. 360; $15.45 B. 360; $18.70 C. 440; $15.45 D. 440; $17.00 7. Which of the following would generally coincide with the overall priorities of a compromise dividend policy? I. allowing the debt-equity ratio to increase temporarily to avoid a dividend cut II. forgoing a major positive investment to avoid the issuance of new shares III. maintaining a constant debt-equity ratio by selling additional shares as needed IV. limiting positive net present value projects in order to reach a target dividend payout ratio A. II only B. I and III only C. I only D. II and IV only 8. Macro Computers just paid their annual regular cash dividend of $1.20 per share, along with a special dividend of $0.30 per share. The company follows a policy of increasing their dividend by 2% annually. Which one of the following is the best estimate of Macro's next annual dividend amount? A. $1.53 B. $1.50 C. $1.22 D. $1.20 9. Bloomington Homes needs $168 000 for new investments next year. The company has a debtequity ratio of 0.55 and has a residual dividend policy. The after-tax earnings for the year that just ended were $247 500. How much of their annual earnings will the firm pay out in dividends? A. $71 900.00 B. $147 500.00 C. $102 348.16 D. $139 112.90 10. Which one of the following is a payment of either cash or shares that is paid out of earnings to a firm's shareholders? A. distribution B. share repurchase C. dividend D. interest

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 14 Testbank

11. Which one of the following best defines a regular cash dividend? A. one-time payment of cash by a firm to its shareholders B. distribution of the proceeds from the sale of a portion of a firm's operations C. distribution by a firm to its shareholders D. cash payment by a firm to its owners as part of a firm's normal operations 12. On which one of the following dates are dividends direct deposited to shareholders bank accounts? A. ex-dividend date B. date of record C. public announcement date D. payment date 13. Which two of the following tend to limit the amount of dividends that can be paid by a leveraged corporation? I. current tax laws II. corporate tax rates III. bond trust deed covenant IV. laws pertaining to retained earnings A. I and II only B. I and III only C. II and III only D. III and IV only 14. Assume that clienteles exist. Given this assumption, which one of the following statements is correct? A. All firms will adopt a high dividend payout policy. B. Dividend policy is irrelevant as long as each clientele group is currently satisfied. C. A firm can increase its share price by increasing its dividend payout. D. All firms should adopt a low dividend payout policy. 15. The clientele effect states that investors fall into various groups because of differences in their preferences for which one of the following? A. share price levels B. dividends C. current investments D. risk level 16. Which one of the following reduces the number of shares outstanding but does not change a firm's total equity? A. share split

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 14 Testbank

B. reverse split C. redemption D. liquidation 17. Which one of the following will result from a share repurchase? A. decrease in the market price per share B. decrease in the earnings per share C. decrease in the PE ratio D. increase in the market value of equity per share 18. Rural Feed Lots Ltd is an all-equity firm with positive profit for the year (or period). Which one of the following will result if the firm pays a cash dividend? A. number of shares outstanding will increase B. total assets will remain constant C. price-earnings ratio will decrease D. earnings per share will decrease 19. Kelso's is considering spending $80 000 on either a share repurchase or an extra cash dividend. Which one of the following values will be the same whether the firm pays a dividend or repurchases shares? Assume there are no taxes or market imperfections. A. number of shares outstanding B. price per share C. price-earnings ratio D. earnings per share 20. As compared to a cash dividend, a share repurchase will do which of the following? A. not affect the earnings per share but will decrease the PE ratio B. increase both earnings per share and the PE ratio C. increase the earnings per share but not affect the PE ratio D. increase the earnings per share and decrease the PE ratio 21. Research conducted on firms' dividend policies over time support which one of the following conclusions? A. Managers tend to smooth dividends. B. Share prices tend to increase whenever anticipated changes in dividends occur. C. Firms commence paying dividends prior to doing any share repurchases. D. Aggregate dividends and share repurchases have steadily declined in real terms. 22. Which one of the following is a drawback of cash dividends? A. Cash dividends support share prices. B. Firms may have to forgo positive net present value projects.

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 14 Testbank

C. Dividend-paying firms tend to attract a wider field of investors than do non-dividend-paying firms. D. Share prices tend to increase as annual dividend amounts increase. 23. Which one of the following tends to be the primary attitude of firms' towards their dividend policy? A. Dividends should be increased annually no matter what. B. Dividend smoothing is talked about but it is not really a factor that affects dividend decisions. C. The costs associated with cutting dividends are perceived to be less than the costs of obtaining external financing. D. Once a dividend is increased, it should not be decreased. 24. This morning, Lambert Materials bought 10 000 of its outstanding shares in the open market. What type of transaction was this? A. share payout B. share split C. bonus issue D. share repurchase 25. Which one of the following is a non-cash payment made by a firm to its shareholders and is a payment that lessens the value of each outstanding share? A. reverse share split B. cash dividends C. bonus issue D. regular cash dividend 26. Martin & Martin Inc. shares are currently selling for $19 per share. The firm just made an offer to one of its major shareholders to repurchase all the shares owned by that shareholder for $25 per share. What type of offer is being made? A. rights offer B. secondary issue C. targeted repurchase D. tender offer 27. Joseph Turner and Sons has 125 000 shares outstanding. The firm has extra cash so it announced this morning that it is willing to repurchase 25 000 of its shares. What type of offer is the firm making? A. rights offer B. secondary issue C. targeted repurchase D. tender offer

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 14 Testbank

28. Through which of the following can a firm reduce its number of outstanding shares? I. open market purchase II. rights offer III. tender offer IV. targeted repurchase A. IV only B. I and IV only C. II, III and IV only D. I, III and IV only 29. On which one of the following dates is the determination made as to which shareholders will receive a dividend payment? A. payment date B. ex-dividend date C. public announcement date D. date of record 30. Which of the following is NOT an argument for the relevance of dividends? A. Informational content B. Reduction of uncertainty C. Some investors’ preference for current income D. Consideration of paying taxes 31. Which one of the following is a payment by a firm to its shareholders from any source other than current or accumulated retained earnings? A. Interest B. Distribution C. Retained earnings D. Dividend E. Share repurchase 32. On which one of the following dates are dividend cheques deposited? A. Date of record B. Ex-dividend date C. Payment date D. Declaration date E. Public announcement date 33. This morning, Structural Steel purchased 3500 of its outstanding shares in the open market. What type of transaction was this? A. Share payout B. Share distribution

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 14 Testbank

C. Share dividend D. Share repurchase E. Share reversal 34. Which one of the following reduces the number of shares outstanding but does not decrease the value of equity or shareholders’ equity? A. Share repurchase B. Share split C. Reverse share split D. Cash distribution E. Liquidating dividend 35. During the past year, ABC shares have sold for as little as $19 a share and as much as $33 a share. Which one of the following terms applies to these prices? A. Benchmark values B. Price splits C. Price dividers D. Split range E. Trading range 36. Tuesday 1 December is the ex-dividend date for Alpha share. Which one of the following dates is the record date? Assume there are no banking holidays to consider. A. Friday 27 November B. Monday 30 November C. Wednesday 2 December D. Thursday 3 December E. Friday 4 December 37. Which one of the following statements is correct? A. Dividends are irrelevant. B. Flotation costs are a good reason to support a high-dividend payout. C. Current tax laws favour high current dividends for individual investors. D. Dividend policy is the time pattern of dividend payout. E. Corporate investors tend to prefer low-dividend payouts on securities they own. 38. The argument that dividend policy is irrelevant tends to be supported by which one of these factors? A. Flotation costs associated with equity issues B. Current tax laws C. An unsatisfied demand for high-dividend-paying shares D. Current equilibrium in the clientele dividend market E. The current tax exclusion available to corporate investors

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 14 Testbank

39. Which one of the following statements is correct concerning the taxation of dividends and capital gains? A. Seventy per cent of capital gains derived from share investments are tax exempt for corporate investors. B. Dividends are a form of tax-exempt income for individual investors. C. All investors are subject to the same tax rate on dividend income. D. Individual investors can defer taxation on both dividends and capital gains. E. As of 2015, individual investors pay a tax rate that varies from 0% to 15% on dividend income. 40. Which one of the following would tend to favour a low-dividend payout? A. Higher tax rates on capital gains than on dividend income B. High flotation cost for equity issues C. Endowment fund investors who cannot spend principal D. Investors' desire for a high-dividend yield E. Elimination of the tax deferral on capital gains 41. Which one of the following is least likely to limit the amount of cash dividends a firm can pay? A. Lack of retained earnings B. A bankruptcy proceeding C. A bond indenture covenant D. State laws E. Increasing share price 42. Which one of these favours a high-dividend payout? A. Low transaction costs on share trades B. Lower taxes on capital gains than on dividends C. Tax deferment on capital gains, but not on dividend income D. Flotation costs E. Corporate shareholders 43. What percentage of capital gains are excluded from taxation for corporate shareholders? A. 0% B. 10% C. 25% D. 70% E. 75% 44. Bob’s Standard Station has 15 000 shares of share outstanding at a market price of $15 a share. The current earnings per share are $1.26. The firm has total assets of $312 000 and total

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 14 Testbank

liabilities of $97 500. Next week, the firm will be repurchasing $37 500 worth of share. Ignore taxes. What will be the earnings per share after the share repurchase? A. $1.598 B. $1.547 C. $1.335 D. $1.512 E. $1.563 45. Which statement is correct? A. Tax rates are the key determinant to a company’s dividend policy. B. Firms are equally likely to increase or decrease their normal dividends per share. C. Dividends tend to be more erratic than earnings. D. Mature firms are less likely to pay dividends than young firms. E. Dividend growth tends to lag earnings growth. 46. Which statement is correct regarding US companies? A. The personal taxes of investors is the key factor managers consider when establishing a dividend policy. B. Firms tend to increase their regular dividend as soon as they expect increased earnings in the future. C. Firms tend to react quickly to lower dividends any time the economy begins to slow. D. Firms tend to quickly adjust their dividends to changes in the firm's PE ratio. E. Procter & Gamble is one example of a firm with a long history of increasing dividends. 47. Normal cash dividends that are increased regularly tend to send which message? A. The firm is attempting to reduce its tax bill. B. The dividends are expected to increase the firm’s agency costs. C. The firm is planning on downsizing. D. The firm is discontinuing all share repurchases. E. The firm expects to be profitable. 48. Which one of the following is a drawback of cash dividends? A. Firms may have to obtain additional external financing which would not be required in the absence of the dividends. B. Share prices tend to increase as annual dividend amounts increase. C. Cash dividends support share prices. D. Dividends tend to lower agency costs. E. Dividend-paying firms tend to attract a wider field of investors than do non-dividend-paying firms.

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 14 Testbank

49. Water Front Rentals has 20 000 shares of share outstanding at a market price of $24 each and earnings per share of $1.84. The firm has decided to repurchase $75 000 worth of share. What will the PE ratio be after the repurchase, all else held constant? A. 11.55 B. 13.24 C. 9.50 D. 10.69 E. 11.01 50. Which one of the following is basically equivalent to a two-for-one share split? A. 20% share dividend B. 25% share dividend C. 50% share dividend D. 100% share dividend E. 200% share dividend 51. Modern Homes just declared a four-for-three share split. Which of the following occurred as a result of this split? I. Number of shares outstanding increased by one-third II. Number of shares outstanding decreased by one-fourth III. Price per share increased by one-third IV. Price per share decreased by one-fourth A. I only B. I and III only C. I and IV only D. II and III only E. II and IV only 52. Of the following, which two are the best reasons for doing a reverse share split? I. Return a share to its normal trading range II. Eliminate small shareholders III. Reduce shareholder costs IV. Avoid delisting A. I and II B. I and III C. II and III D. II and IV E. III and IV 53. Assume there are no taxes or imperfections. Given this assumption, which one of the following statements is correct? A. A cash dividend has no effect on the market price of the payer's share. B. A cash dividend decreases shareholder wealth.

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 14 Testbank

C. Share repurchases decrease the market value per share. D. Both a cash dividend and a share repurchase increase a firm's PE ratio. E. A share repurchase has the same effect on a firm's market value statement of financial position as does a cash dividend. 54. Dixie’s has a market value statement of financial position as shown below. The firm currently has 2200 shares of share outstanding and profit for the year (or period) of $10 500. Market Value Statement of Financial Position Excess cash $ 14 300 Debt $ 84 600 Other assets 215 460 Equity 145 160 Total $ 229 760 Total $ 229 760 The firm has decided to spend $6500 on new equipment and use the remaining excess cash to pay an extra cash dividend. What will the firm's PE ratio be after this dividend is paid, all else held constant? Ignore taxes. A. 14.20 B. 16.67 C. 13.08 D. 11.22 E. 14.57 55. Botanical Gardens Nursery has 7500 shares outstanding at a market price of $18 a share. The earnings per share are $1.23. The firm has total assets of $384 000 and total liabilities of $146 000. Today, the firm is paying a quarterly cash dividend of $0.22 a share. What will be the earnings per share after the dividend is paid if the tax rate on dividends is 15%? A. $1.01 B. $1.04 C. $1.23 D. $1.17 E. $1.20 56. Davidson International has 13 700 shares outstanding at a price per share of $28. The firm has decided to repurchase 500 of those shares in the open market. What will the price per share be after the share repurchase is completed? Ignore taxes and market imperfections.

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 14 Testbank

A. $29.14 B. $28.84 C. $28.89 D. $28.00 E. $29.06 57. Cookies and Cream has 5000 shares outstanding at a market price of $8.29 per share. What will be the price per share after a share dividend of 8%? Ignore taxes and market imperfections. A. $7.24 B. $7.68 C. $7.45 D. $7.96 E. $8.03 58. Fresh Baked Goods has 36 800 shares outstanding at a market price of $24.91per share. What will be the price per share after a share dividend of 6%? Ignore taxes and market imperfections. A. $24.90 B. $23.50 C. $25.00 D. $25.31 E. $25.40 59. Heidi owns 400 shares of Boyd Enterprises, which is valued at $13 a share. Boyd Enterprises just declared a share dividend of 4%. How many shares will Heidi own and what will be the price per share after the dividend? A. 385; $12.50 B. 385; $13.00 C. 416; $12.50 D. 416; $13.00 E. 416; $13.50 60. The Press has total assets of $848 000 and total debt of $402 000 on a market value basis. There are 25 000 shares outstanding. The company has announced it is going to repurchase $40 000 worth of shares in the open market. What will be the price per share after the repurchase? A. $36.29 B. $17.84 C. $38.67 D. $39.42 E. $39.89

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 14 Testbank

Chapter 14 Testbank Key 1. Centropen Inc. has 460 000 shares outstanding and the total market value of the equity is $1 610 000. The firm has just announced a repurchase of $420 000 worth of shares. After the repurchase, Centropen will have ____ shares outstanding at a market price of ____ per share. A. 250 000; $2.59 B. 301 000; $3.10 C. 320 000; $3.40 D. 340 000; $3.50 Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 14.03 Differentiate between cash and shares dividends Topic: Share repurchases: an alternative to cash dividends

2. The ex-dividend date is defined as _____ business days before the date of_____. A. two; payment B. three; record C. three; payment D. one; record Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 14.01 Discuss dividend types and how dividends are paid Topic: Cash dividends and dividend payment

3. Which one of the following is the date on which the board of directors agrees to pay a dividend and passes a resolution to do so? Which one of the following dates is the date on which the board of directors voted to pay a dividend? A. record date B. ex-dividend date C. settle date D. declaration date Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 14.01 Discuss dividend types and how dividends are paid Topic: Cash dividends and dividend payment

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 14 Testbank

4. Doris' Boutique has 4000 shares outstanding at a price per share of $15. What will the price per share be if the firm pays a $1.30 per share cash dividend? Ignore taxes and market imperfections. A. $13.70 B. $15.40 C. $15.80 D. $16.00 Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 14.03 Differentiate between cash and shares dividends Topic: Share repurchases: an alternative to cash dividends

5. LaDoris' Boutique has 4500 shares outstanding at a price per share of $20. The firm has decided to repurchase 600 of those shares in the open market. What will the price per share be after the share repurchase is completed? Ignore taxes and market imperfections. A. $17.80 B. $18.40 C. $18.80 D. $20.00 Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 14.04 Explain why share repurchases are an alternative to dividends Topic: Share repurchases: an alternative to cash dividends

7. Which of the following would generally coincide with the overall priorities of a compromise dividend policy? I. allowing the debt-equity ratio to increase temporarily to avoid a dividend cut II. forgoing a major positive investment to avoid the issuance of new shares

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 14 Testbank

III. maintaining a constant debt-equity ratio by selling additional shares as needed IV. limiting positive net present value projects in order to reach a target dividend payout ratio A. II only B. I and III only C. I only D. II and IV only Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 14.02 Explain the issues surrounding dividend policy decisions Topic: Does dividend policy matter?

8. Macro Computers just paid their annual regular cash dividend of $1.20 per share, along with a special dividend of $0.30 per share. The company follows a policy of increasing their dividend by 2% annually. Which one of the following is the best estimate of Macro's next annual dividend amount? A. $1.53 B. $1.50 C. $1.22 D. $1.20 Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 14.02 Explain the issues surrounding dividend policy decisions Topic: Does dividend policy matter?

9. Bloomington Homes needs $168 000 for new investments next year. The company has a debtequity ratio of 0.55 and has a residual dividend policy. The after-tax earnings for the year that just ended were $247 500. How much of their annual earnings will the firm pay out in dividends? A. $71 900.00 B. $147 500.00 C. $102 348.16 D. $139 112.90 Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Hard Learning Objective: 14.02 Explain the issues surrounding dividend policy decisions Topic: Does dividend policy matter?

10. Which one of the following is a payment of either cash or shares that is paid out of earnings to a firm's shareholders? A. distribution B. share repurchase

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 14 Testbank

C. dividend D. interest Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 14.01 Discuss dividend types and how dividends are paid Topic: Cash dividends and dividend payment

12. On which one of the following dates are dividends direct deposited to shareholders bank accounts? A. ex-dividend date B. date of record C. public announcement date D. payment date Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 14.01 Discuss dividend types and how dividends are paid Topic: Cash dividends and dividend payment

13. Which two of the following tend to limit the amount of dividends that can be paid by a leveraged corporation? I. current tax laws II. corporate tax rates III. bond trust deed covenant IV. laws pertaining to retained earnings A. I and II only B. I and III only C. II and III only D. III and IV only Ans: D

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 14 Testbank

AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 14.02 Explain the issues surrounding dividend policy decisions Topic: Does dividend policy matter?

14. Assume that clienteles exist. Given this assumption, which one of the following statements is correct? A. All firms will adopt a high dividend payout policy. B. Dividend policy is irrelevant as long as each clientele group is currently satisfied. C. A firm can increase its share price by increasing its dividend payout. D. All firms should adopt a low dividend payout policy. Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 14.02 Explain the issues surrounding dividend policy decisions Topic: Does dividend policy matter?

15. The clientele effect states that investors fall into various groups because of differences in their preferences for which one of the following? A. share price levels B. dividends C. current investments D. risk level Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 14.02 Explain the issues surrounding dividend policy decisions Topic: Does dividend policy matter?

16. Which one of the following reduces the number of shares outstanding but does not change a firm's total equity? A. share split B. reverse split C. redemption D. liquidation Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 14.01 Discuss dividend types and how dividends are paid Topic: Bonus issues and share splits

17. Which one of the following will result from a share repurchase?

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 14 Testbank

A. decrease in the market price per share B. decrease in the earnings per share C. decrease in the PE ratio D. increase in the market value of equity per share Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 14.04 Explain why share repurchases are an alternative to dividends Topic: Share repurchases: an alternative to cash dividends

18. Rural Feed Lots Ltd is an all-equity firm with positive profit for the year (or period). Which one of the following will result if the firm pays a cash dividend? A. number of shares outstanding will increase B. total assets will remain constant C. price-earnings ratio will decrease D. earnings per share will decrease Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 14.04 Explain why share repurchases are an alternative to dividends Topic: Share repurchases: an alternative to cash dividends

19. Kelso's is considering spending $80 000 on either a share repurchase or an extra cash dividend. Which one of the following values will be the same whether the firm pays a dividend or repurchases shares? Assume there are no taxes or market imperfections. A. number of shares outstanding B. price per share C. price-earnings ratio D. earnings per share Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 14.03 Differentiate between cash and shares dividends Topic: Share repurchases: an alternative to cash dividends

20. As compared to a cash dividend, a share repurchase will do which of the following? A. not affect the earnings per share but will decrease the PE ratio B. increase both earnings per share and the PE ratio C. increase the earnings per share but not affect the PE ratio D. increase the earnings per share and decrease the PE ratio Ans: A

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 14 Testbank

AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 14.04 Explain why share repurchases are an alternative to dividends Topic: Share repurchases: an alternative to cash dividends

21. Research conducted on firms' dividend policies over time support which one of the following conclusions? A. Managers tend to smooth dividends. B. Share prices tend to increase whenever anticipated changes in dividends occur. C. Firms commence paying dividends prior to doing any share repurchases. D. Aggregate dividends and share repurchases have steadily declined in real terms. Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 14.04 Explain why share repurchases are an alternative to dividends Topic: What we know and do not know about dividend and payout policies

22. Which one of the following is a drawback of cash dividends? A. Cash dividends support share prices. B. Firms may have to forgo positive net present value projects. C. Dividend-paying firms tend to attract a wider field of investors than do non-dividend-paying firms. D. Share prices tend to increase as annual dividend amounts increase. Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 14.04 Explain why share repurchases are an alternative to dividends Topic: What we know and do not know about dividend and payout policies

23. Which one of the following tends to be the primary attitude of firms' towards their dividend policy? A. Dividends should be increased annually no matter what. B. Dividend smoothing is talked about but it is not really a factor that affects dividend decisions. C. The costs associated with cutting dividends are perceived to be less than the costs of obtaining external financing. D. Once a dividend is increased, it should not be decreased. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 14.04 Explain why share repurchases are an alternative to dividends Topic: What we know and do not know about dividend and payout policies

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 14 Testbank

24. This morning, Lambert Materials bought 10 000 of its outstanding shares in the open market. What type of transaction was this? A. share payout B. share split C. bonus issue D. share repurchase Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 14.04 Explain why share repurchases are an alternative to dividends Topic: Share repurchases: an alternative to cash dividends

25. Which one of the following is a non-cash payment made by a firm to its shareholders and is a payment that lessens the value of each outstanding share? A. reverse share split B. cash dividends C. bonus issue D. regular cash dividend Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 14.01 Discuss dividend types and how dividends are paid Topic: Bonus issues and share splits

26. Martin & Martin Inc. shares are currently selling for $19 per share. The firm just made an offer to one of its major shareholders to repurchase all the shares owned by that shareholder for $25 per share. What type of offer is being made? A. rights offer B. secondary issue C. targeted repurchase D. tender offer Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 14.03 Differentiate between cash and shares dividends Topic: Share repurchases: an alternative to cash dividends

27. Joseph Turner and Sons has 125 000 shares outstanding. The firm has extra cash so it announced this morning that it is willing to repurchase 25 000 of its shares. What type of offer is the firm making? A. rights offer B. secondary issue C. targeted repurchase

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 14 Testbank

D. tender offer Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 14.03 Differentiate between cash and shares dividends Topic: Share repurchases: an alternative to cash dividends

28. Through which of the following can a firm reduce its number of outstanding shares? I. open market purchase II. rights offer III. tender offer IV. targeted repurchase A. IV only B. I and IV only C. II, III and IV only D. I, III and IV only Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 14.03 Differentiate between cash and shares dividends Topic: Share repurchases: an alternative to cash dividends

29. On which one of the following dates is the determination made as to which shareholders will receive a dividend payment? A. payment date B. ex-dividend date C. public announcement date D. date of record Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 14.01 Discuss dividend types and how dividends are paid Topic: Bonus issues and share splits

30. Which of the following is NOT an argument for the relevance of dividends? A. Informational content B. Reduction of uncertainty C. Some investors’ preference for current income D. Consideration of paying taxes Ans: D

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 14 Testbank

AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 14.02 Explain the issues surrounding dividend policy decisions Topic: Does dividend policy matter?

31. Which one of the following is a payment by a firm to its shareholders from any source other than current or accumulated retained earnings? A. Interest B. Distribution C. Retained earnings D. Dividend E. Share repurchase Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 14.01 Discuss dividend types and how dividends are paid Topic: Cash dividends and dividend payment

32. On which one of the following dates are dividend cheques deposited? A. Date of record B. Ex-dividend date C. Payment date D. Declaration date E. Public announcement date Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 14.01 Discuss dividend types and how dividends are paid Topic: Cash dividends and dividend payment

33. This morning, Structural Steel purchased 3500 of its outstanding shares in the open market. What type of transaction was this? A. Share payout B. Share distribution C. Share dividend D. Share repurchase E. Share reversal Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 14.03 Differentiate between cash and shares dividends Topic: Share repurchases: an alternative to cash dividends

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 14 Testbank

34. Which one of the following reduces the number of shares outstanding but does not decrease the value of equity or shareholders’ equity? A. Share repurchase B. Share split C. Reverse share split D. Cash distribution E. Liquidating dividend Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 14.01 Discuss dividend types and how dividends are paid Topic: Bonus issues and share splits

35. During the past year, ABC shares have sold for as little as $19 a share and as much as $33 a share. Which one of the following terms applies to these prices? A. Benchmark values B. Price splits C. Price dividers D. Split range E. Trading range Ans: E AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 14.01 Discuss dividend types and how dividends are paid Topic: Bonus issues and share splits

36. Tuesday 1 December is the ex-dividend date for Alpha share. Which one of the following dates is the record date? Assume there are no banking holidays to consider. A. Friday 27 November B. Monday 30 November C. Wednesday 2 December D. Thursday 3 December E. Friday 4 December Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 14.01 Discuss dividend types and how dividends are paid Topic: Cash dividends and dividend payment

37. Which one of the following statements is correct? A. Dividends are irrelevant. B. Flotation costs are a good reason to support a high-dividend payout. C. Current tax laws favour high current dividends for individual investors.

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 14 Testbank

D. Dividend policy is the time pattern of dividend payout. E. Corporate investors tend to prefer low-dividend payouts on securities they own. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 14.02 Explain the issues surrounding dividend policy decisions Topic: Does dividend policy matter?

38. The argument that dividend policy is irrelevant tends to be supported by which one of these factors? A. Flotation costs associated with equity issues B. Current tax laws C. An unsatisfied demand for high-dividend-paying shares D. Current equilibrium in the clientele dividend market E. The current tax exclusion available to corporate investors Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 14.02 Explain the issues surrounding dividend policy decisions Topic: Does dividend policy matter?

40. Which one of the following would tend to favour a low-dividend payout? A. Higher tax rates on capital gains than on dividend income B. High flotation cost for equity issues C. Endowment fund investors who cannot spend principal D. Investors' desire for a high-dividend yield E. Elimination of the tax deferral on capital gains Ans: B

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 14 Testbank

AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 14.02 Explain the issues surrounding dividend policy decisions Topic: Does dividend policy matter?

41. Which one of the following is least likely to limit the amount of cash dividends a firm can pay? A. Lack of retained earnings B. A bankruptcy proceeding C. A bond indenture covenant D. State laws E. Increasing share price Ans: E AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 14.02 Explain the issues surrounding dividend policy decisions Topic: Does dividend policy matter?

42. Which one of these favours a high-dividend payout? A. Low transaction costs on share trades B. Lower taxes on capital gains than on dividends C. Tax deferment on capital gains, but not on dividend income D. Flotation costs E. Corporate shareholders Ans: E AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 14.02 Explain the issues surrounding dividend policy decisions Topic: Does dividend policy matter?

43. What percentage of capital gains are excluded from taxation for corporate shareholders? A. 0% B. 10% C. 25% D. 70% E. 75% Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 14.02 Explain the issues surrounding dividend policy decisions Topic: Does dividend policy matter?

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 14 Testbank

44. Bob’s Standard Station has 15 000 shares of share outstanding at a market price of $15 a share. The current earnings per share are $1.26. The firm has total assets of $312 000 and total liabilities of $97 500. Next week, the firm will be repurchasing $37 500 worth of share. Ignore taxes. What will be the earnings per share after the share repurchase? A. $1.598 B. $1.547 C. $1.335 D. $1.512 E. $1.563 Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 14.04 Explain why share repurchases are an alternative to dividends Topic: Share repurchases: an alternative to cash dividends

45. Which statement is correct? A. Tax rates are the key determinant to a company’s dividend policy. B. Firms are equally likely to increase or decrease their normal dividends per share. C. Dividends tend to be more erratic than earnings. D. Mature firms are less likely to pay dividends than young firms. E. Dividend growth tends to lag earnings growth. Ans: E AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 14.04 Explain why share repurchases are an alternative to dividends Topic: What we know and do not know about dividend and payout policies

46. Which statement is correct regarding US companies? A. The personal taxes of investors is the key factor managers consider when establishing a dividend policy. B. Firms tend to increase their regular dividend as soon as they expect increased earnings in the future. C. Firms tend to react quickly to lower dividends any time the economy begins to slow. D. Firms tend to quickly adjust their dividends to changes in the firm's PE ratio. E. Procter & Gamble is one example of a firm with a long history of increasing dividends. Ans: E AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 14.04 Explain why share repurchases are an alternative to dividends Topic: What we know and do not know about dividend and payout policies

47. Normal cash dividends that are increased regularly tend to send which message? A. The firm is attempting to reduce its tax bill.

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 14 Testbank

B. The dividends are expected to increase the firm’s agency costs. C. The firm is planning on downsizing. D. The firm is discontinuing all share repurchases. E. The firm expects to be profitable. Ans: E AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 14.04 Explain why share repurchases are an alternative to dividends Topic: What we know and do not know about dividend and payout policies

48. Which one of the following is a drawback of cash dividends? A. Firms may have to obtain additional external financing which would not be required in the absence of the dividends. B. Share prices tend to increase as annual dividend amounts increase. C. Cash dividends support share prices. D. Dividends tend to lower agency costs. E. Dividend-paying firms tend to attract a wider field of investors than do non-dividend-paying firms. Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 14.04 Explain why share repurchases are an alternative to dividends Topic: What we know and do not know about dividend and payout policies

50. Which one of the following is basically equivalent to a two-for-one share split? A. 20% share dividend B. 25% share dividend C. 50% share dividend D. 100% share dividend

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 14 Testbank

E. 200% share dividend Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 14.01 Discuss dividend types and how dividends are paid Topic: Bonus issues and share splits

51. Modern Homes just declared a four-for-three share split. Which of the following occurred as a result of this split? I. Number of shares outstanding increased by one-third II. Number of shares outstanding decreased by one-fourth III. Price per share increased by one-third IV. Price per share decreased by one-fourth A. I only B. I and III only C. I and IV only D. II and III only E. II and IV only Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 14.01 Discuss dividend types and how dividends are paid Topic: Bonus issues and share splits

52. Of the following, which two are the best reasons for doing a reverse share split? I. Return a share to its normal trading range II. Eliminate small shareholders III. Reduce shareholder costs IV. Avoid delisting A. I and II B. I and III C. II and III D. II and IV E. III and IV Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 14.01 Discuss dividend types and how dividends are paid Topic: Bonus issues and share splits

53. Assume there are no taxes or imperfections. Given this assumption, which one of the following statements is correct? A. A cash dividend has no effect on the market price of the payer's share.

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 14 Testbank

B. A cash dividend decreases shareholder wealth. C. Share repurchases decrease the market value per share. D. Both a cash dividend and a share repurchase increase a firm's PE ratio. E. A share repurchase has the same effect on a firm's market value statement of financial position as does a cash dividend. Ans: E AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 14.04 Explain why share repurchases are an alternative to dividends Topic: Share repurchases: an alternative to cash dividends

54. Dixie’s has a market value statement of financial position as shown below. The firm currently has 2200 shares of share outstanding and profit for the year (or period) of $10 500. Market Value Statement of Financial Position Excess cash $ 14 300 Debt $ 84 600 Other assets 215 460 Equity 145 160 Total $ 229 760 Total $ 229 760 The firm has decided to spend $6500 on new equipment and use the remaining excess cash to pay an extra cash dividend. What will the firm's PE ratio be after this dividend is paid, all else held constant? Ignore taxes. A. 14.20 B. 16.67 C. 13.08 D. 11.22 E. 14.57 Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 14.03 Differentiate between cash and shares dividends Topic: Share repurchases: an alternative to cash dividends

55. Botanical Gardens Nursery has 7500 shares outstanding at a market price of $18 a share. The earnings per share are $1.23. The firm has total assets of $384 000 and total liabilities of

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 14 Testbank

$146 000. Today, the firm is paying a quarterly cash dividend of $0.22 a share. What will be the earnings per share after the dividend is paid if the tax rate on dividends is 15%? A. $1.01 B. $1.04 C. $1.23 D. $1.17 E. $1.20 Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 14.03 Differentiate between cash and shares dividends Topic: Share repurchases: an alternative to cash dividends

56. Davidson International has 13 700 shares outstanding at a price per share of $28. The firm has decided to repurchase 500 of those shares in the open market. What will the price per share be after the share repurchase is completed? Ignore taxes and market imperfections. A. $29.14 B. $28.84 C. $28.89 D. $28.00 E. $29.06 Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 14.03 Differentiate between cash and shares dividends Topic: Share repurchases: an alternative to cash dividends

57. Cookies and Cream has 5000 shares outstanding at a market price of $8.29 per share. What will be the price per share after a share dividend of 8%? Ignore taxes and market imperfections. A. $7.24 B. $7.68 C. $7.45 D. $7.96 E. $8.03 Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 14.03 Differentiate between cash and shares dividends Topic: Share repurchases: an alternative to cash dividends

58. Fresh Baked Goods has 36 800 shares outstanding at a market price of $24.91per share. What will be the price per share after a share dividend of 6%? Ignore taxes and market imperfections. A. $24.90

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 14 Testbank

B. $23.50 C. $25.00 D. $25.31 E. $25.40 Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 14.03 Differentiate between cash and shares dividends Topic: Share repurchases: an alternative to cash dividends

59. Heidi owns 400 shares of Boyd Enterprises, which is valued at $13 a share. Boyd Enterprises just declared a share dividend of 4%. How many shares will Heidi own and what will be the price per share after the dividend? A. 385; $12.50 B. 385; $13.00 C. 416; $12.50 D. 416; $13.00 E. 416; $13.50 Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 14.03 Differentiate between cash and shares dividends Topic: Share repurchases: an alternative to cash dividends

60. The Press has total assets of $848 000 and total debt of $402 000 on a market value basis. There are 25 000 shares outstanding. The company has announced it is going to repurchase $40 000 worth of shares in the open market. What will be the price per share after the repurchase? A. $36.29 B. $17.84 C. $38.67 D. $39.42 E. $39.89 Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 14.03 Differentiate between cash and shares dividends Topic: Share repurchases: an alternative to cash dividends

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 14 Testbank

Chapter 14 Testbank Summary Category AACSB: Analytic Blooms: Analysis Difficulty: Easy Difficulty: Hard Difficulty: Medium Learning Objective: 14.01 Discuss dividend types and how dividends are paid Learning Objective: 14.02 Explain the issues surrounding dividend policy decisions Learning Objective: 14.03 Differentiate between cash and shares dividends Learning Objective: 14.04 Explain why share repurchases are an alternative to dividends Topic: Bonus issues and share splits Topic: Cash dividends and dividend payment Topic: Does dividend policy matter? Topic: Share repurchases: an alternative to cash dividends Topic: What we know and do not know about dividend and payout policies

# of Questions 60 60 45 1 14 16 14 15 15 8 8 14 23 7

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 15 Testbank

Chapter 15 Testbank 1. If an offer of issued securities is made only to institutional investors, such as life insurance offices and superannuation funds, the method is called: A. subordinated debt. B. family issue. C. private placement. D. matching principle. 2. The legal document provided to prospective investors which describes details of the issuer and the proposed securities offering is called a: A. registration statement. B. prospectus. C. formal filing. D. public statement. 3. A public issue of securities which are first offered to existing shareholders is best defined as a(n): A. IPO. B. general offer. C. private placement. D. rights offer. 4. The investment firms that act as intermediaries between the issuer of securities and the general public are called: A. brokers. B. investment advisors. C. red herrings. D. underwriters. 5. Which one of the following is the most likely to be financed with venture capital? A. Expanding a firm's existing production line B. Building a prototype of a new invention C. Building a new factory overseas to move production closer to existing foreign customers D. Raising equity to reduce the debt load of a firm 6. The founders of a new firm generally receive: A. a fixed percentage of all venture capital raised.

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 15 Testbank

B. sufficient funding in the early stages of venture capital financing to pay off any personal obligations incurred for the sake of the business entity. C. compensation, which is referred to as 'seed money'. D. minimal salaries during the early stages of venture capital financing. 7. Which of the following functions are performed by underwriters? I. Selling and distributing new securities II. Determining the method used to issue the securities III. Guaranteeing the payment of the offering price to the issuer if the underwriting is done on a best efforts basis IV. Setting the offering price A. I, II, III and IV B. I, II and IV only C. II, III and IV only D. II and III only 8. Venture capital is most likely to be the source of funding for which one of the following? A. Seasonal production B. New, high-risk venture C. Daily operations for an established, profitable firm D. Global expansion for an established firm 9. Which of the following are true statements? I. Venture capitalists tend to be long-term investors in a firm. II. Venture capital is relatively easy to obtain for most new firms. III. Venture capitalists generally have an exit strategy. IV. Venture capitalists tend to specialise in one type of financing for a select type of firm. A. I and II only B. I and III only C. I and IV only D. III and IV only 10. Which of the following are important factors to consider when seeking a venture capitalist? I. Exit strategy II. Management style III. Personal contacts IV. Financial strength A. I, II, III and IV B. III and IV only C. I and III only D. II and IV only

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 15 Testbank

11. Which one of the following best describes an initial public offering? A. Shares held by a firm's founder B. Any newly issued shares offered to the general public C. Any shares initially offered to a firm's existing shareholders D. The first sale of equity shares to the general public 12. What is the group of underwriters called who share both the risks and the marketing responsibilities for a securities offering? A. Underwriting cartel B. Syndicate C. Venture capitalists D. Firm commitment group 13. Which of the following have been offered as justification for IPO underpricing? I. Young firms tend to be very risky. II. The best IPOs are oversubscribed. III. Underwriters like to avoid lawsuits. IV. It benefits the existing shareholders. A. I, II and III only B. I, II, III and IV C. II, III and IV only D. II and IV only 14. Which one of the following statements related to IPO underpricing is correct? A. The only period in Australia when underpricing produced first-day returns of 50% or more was during the tech bubble of 1999–2000. B. IPO underpricing is limited to the Australian market. C. Some of the greatest IPO underpricing has occurred in China. D. The IPOs of larger-sized firms tend to be more underpriced than the IPOs of smaller-sized firms. 15. Which one of the following tends to be true for the average investor? A. They often encounter the 'winner's curse'. B. They frequently earn initially high returns on IPOs when shares are undersubscribed. C. Average investors are not allowed to purchase IPOs at the offer price. D. They generally receive their full allocation of shares even when an IPO is oversubscribed. 16. Which one of the following statements concerning IPOs and underpricing is correct? A. The more an issue is underpriced, the more it tends to be oversubscribed. B. Underpricing tends to discourage investors from participating in the IPO market. C. IPO underpricing is a function of the underwriting fee. D. IPO underpricing primarily benefits a firm's pre-issue owners.

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 15 Testbank

17. Share prices tend to _____ following the announcement of a new equity issue and tend to _____ following the announcement of a new debt issue. A. decrease; increase B. increase; decrease C. increase; remain relatively constant D. decrease; remain relatively constant 18. Which one of the following statements is correct? A. Issuing new equity shares is always viewed by the market as a positive event. B. A decline in the price of existing shares when a new issue is released is a direct cost of selling securities. C. A firm's existing shareholders would prefer that new securities be issued when those securities are overpriced rather than underpriced. D. The financial market generally reacts in the same way to a new issue of equity as it does to a new issue of debt as long as the issuer is the same. 19. If the market price of existing publicly traded shares declines due to the announcement of a new share issue, the decline is referred to as which one of the following? A. Direct issue cost B. Underpricing C. Abnormal return D. Other direct underwriting costs 20. Which one of the following terms is defined as an underwriting for which the underwriters assume full responsibility for any unsold shares? A. Initial public offering B. Best-efforts underwriting C. Rights offer D. Standby underwriting 21. Lewis Materials recently offered 15 000 shares but only received payment for 12 500 shares since that was all the shares the underwriters could sell. What type of underwriting was this? A. Best-efforts B. Rights issue C. Syndicated D. Firm commitment 22. Sly's just arranged a three-year direct business loan with his bank. Which one of the following terms matches this loan arrangement? A. Bond issue B. Term loan

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 15 Testbank

C. Rights offer D. New equity issue 23. Which of the following are valid comments regarding venture capitalists? I. Venture capitalists provide funding for high-risk ventures. II. Venture capitalists often take part in the running of the firm. III. Venture capitalists only provide secured debt. IV. Venture capitalists often provide money in stages. A. I, II, III and IV B. II, III and IV only C. II and IV only D. I, II and IV only 24. Which one of the following projects is most likely to be financed with venture capital? A. Additional warehouse space for a profitable trucking firm B. New product for an international plastics manufacturing company C. Prototype for a newly patented hand tool by an individual inventor D. Seasonal merchandise for a major retailer 25. Which one of the following statements concerning issue costs is correct? A. The underwriters pay the spread. B. Taxes are an indirect underwriting cost. C. The total direct cost as a percentage of gross proceeds for an IPO tends to increase as the size of the offer decreases. D. Cost of management time spent working on a new issue is a type of a direct cost. 26. Which one of the following statements concerning the issuance of non-current debt is correct? A. Banks dominate the private placement segment of the debt market. B. The costs of distributing bonds or debentures are higher in the private market. C. Private placements generally have shorter maturities than term loans. D. A direct placement of debt generally has more restrictive covenants than a public issue. 27. Franklin Oil issued 150 000 shares last week. The underwriters charged a 7.5% spread in exchange for agreeing to a firm commitment. The legal and accounting fees amounted to $310 000 and the company incurred $65 000 in indirect costs. The offer price was $31 a share. Within the first hour of trading, the share price increased to $34 a share. What was the flotation cost as a percentage of the funds raised? A. 20.89% B. 24.03% C. 24.47% D. 29.89%

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 15 Testbank

28. High Mountain Gear issued 240 000 shares last week. The underwriters charged a 7.85% spread in exchange for agreeing to a firm commitment. The legal and accounting fees were $385 000. The company incurred $98 000 in indirect costs related to management time and other internal expenses. The offer price was $21 per share. Within the first hour of trading, the share was selling for $23.20 a share. What was the flotation cost as a percentage of the funds raised? A. 21.53% B. 25.29% C. 27.46% D. 33.80% 29. Hilltop Market is offering 60 000 shares of shares to the public in a general cash offer. The offer price is $30 a share and the underwriter's fee is 8%. The administrative costs are estimated at $310 000. How much will Hilltop Market receive from this share offering assuming the issue is completely sold? A. $1 370 800 B. $1 800 000 C. $1 610 000 D. $1 346 000 30. Venture capital is: A. another term for an initial public offering of equity securities. B. financing for new firms that are frequently considered to be highly risky. C. money used to repurchase shares of a firm’s outstanding shares. D. money raised through a public offering that allows a firm to expand its operations into a new product line. 31. AJ’s Glass Works just arranged a three-year direct business loan. Which one of the following terms matches this loan arrangement? A. Term loan B. Private placement C. Rights offer D. Seasoned offer E. Shelf offer 32. Deep Water Marina has 12 000 shares outstanding that were sold to the general public last year. The firm has just decided to issue an additional 4000 shares and will make these shares available to the firm's current shareholders before making any offer to the general public. Which type of offer is this? A. General cash offer B. Rights offer C. In-house offering D. Private placement

Ross, Essentials of Corporate Finance, Fifth Edition

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E. Initial public offering 33. A new issue of common shares offered to the general public by a firm that is currently publicly held is called a(n): A. initial public offering. B. private placement. C. rights offer. D. venture capital offer. E. seasoned equity offering. 34. AB Securities assists issuers by pricing and selling new securities to the general public. Which one of the following terms best fits the role that AB Securities is playing? A. Underwriter B. Investment advisor C. Specialist D. Securities dealer E. Venture capitalist 35. GW Underwriters retains the difference between its buying price and its offering price on new securities. What is this amount called? A. Markup B. Commission C. Rights price D. Spread E. Offer 36. Florida Farms recently offered 12 000 shares for sale but received payment for only 10 500 shares since that was all the shares the underwriters could sell. What type of underwriting was this? A. Syndicated B. Firm commitment C. Private placement D. Best efforts E. Dutch auction 37. Which one of the following is an underwriting of securities where the offer price is determined by investor bids? A. Private placement B. Best efforts underwriting C. Initial public offering D. Green Shoe option E. Dutch auction

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 15 Testbank

38. Which statement is true? A. Venture capitalists tend to be long-term investors in a firm. B. Venture capitalists generally have an exit strategy. C. Venture capitalists generally provide all of their funding in one lump sum. D. Venture capital is relatively easy to obtain given today’s markets. E. Venture capitalists tend to invest in a vast array of enterprises rather than specialise in a few areas. 39. You own 400 of the 21 000 outstanding shares of DLK share. The firm just announced that it will be issuing an additional 3000 shares to the general public in a cash offer at $16 per share. What type of event are you participating in if you decide to purchase 100 of these additional shares? A. Dutch auction B. Seasoned equity offering C. Private placement D. IPO E. Rights offer 40. Currently, you own 1.2% of the outstanding shares of Home Security. The firm has decided to issue additional shares of share and has given you the first option to purchase 1.2% of those additional shares. What type of offer is this? A. Rights offer B. Red herring offer C. Private placement D. IPO E. General cash offer 41. Which of the following duties belong to the underwriters of a firm commitment securities offer? I. Duty to offer the Green Shoe provision to all investors who buy at the offer price II. Duty to set the offer price III. Duty to distribute the offered shares IV. Duty to purchase any unsold shares A. I and III only B. II and IV only C. II, III and IV only D. I, II and III only E. I, II, III and IV 42. Who determines the offer price in a Dutch auction? A. Lead underwriter B. Chief financial officer of the issuing firm

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 15 Testbank

C. ASIC D. Bidders E. Board of directors of the issuing firm 43. Which one of the following is probably the most effective means of increasing investors' interest in an IPO? A. Extending the lockup period B. Issuing the IPO through a rights offering C. Underpricing the IPO D. Eliminating the quiet period E. Eliminating the Green Shoe option 44. Which statement is correct? A. IPO underpricing is minimal in China. B. IPO underpricing is limited to the Australian markets. C. The percentage of underpricing remains stable over time in the Australia. D. The only period in Australia when underpricing produced first day returns of 50% or more was during the tech bubble of 1999–2000. E. Some of the greatest IPO underpricing has occurred in Saudi Arabia. 45. Which statement is correct? A. The underwriters pay the spread. B. Taxes are an indirect underwriting cost. C. Seasoned equity offerings (SEOs) tend to be less costly than IPOs. D. Straight bonds are more costly to issue than convertible bonds. E. The total direct cost as a percentage of gross proceeds for an IPO tends to decrease as the size of the offer decreases. 46. Which statement is correct? A. Rarely is debt issued privately in the Australia. B. All Australian debt issues, private and public, must be registered with ASIC. C. Private placements generally have shorter maturities than term loans. D. It is easier to renegotiate a public issue than it is a private issue of debt. E. A direct placement of debt generally has more restrictive covenants than a public issue. 47. Which statement is true? A. Firms often pay higher interest rates on term loans than on public issues of debt. B. The only difference between a term loan and a private placement is the size of the issue. C. A prospectus is required for equity issues but not for debt issues. D. The flotation costs of issuing debt tend to be more expensive than for issuing equity. E. Direct non-current loans must be registered with the ASIC.

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 15 Testbank

48. The maximum amount of securities a company can issue in a 12-month period through crowdfunding is: A. $50 000. B. $50 000 the first year and up to $100 000 per year after that. C. $100 000 per year during the first two years and up to $500 000 any year thereafter. D. $1 million. E. $100 000 per year up to a cumulative total of $1 million in all years. 49. What is the maximum amount an investor can invest in crowdfunding issues in a 12-month period? A. $10 000 B. $10 000 per security with a maximum of 10 separate securities C. $100 000 per security with a maximum of five separate securities D. $100 000 E. $1 million spread over a maximum of 10 separate securities 50. Salem Pet Supply would like to sell 1400 shares of share using the Dutch auction method. The bids received are as follows: Bidder A B C D

Quantity 700 1200 1300 800

Price 32 31 30 29

Bidder C will receive _____ shares and pay a price per share of _____. A. 0; $0 B. 1400; $27.00 C. 455; $28.00 D. 455; $29.00 E. 700; $38.75 51. Future Technology wants to raise $15 million to purchase equipment by issuing new securities. Management estimates the issue will cost the firm $926 250 for accounting, legal and other costs. The underwriting spread is 6% and the issue price is $25 per share. How many shares must be sold if the firm is to have sufficient funds remaining after costs to purchase all of the desired equipment? A. 608 010 shares B. 521 121 shares C. 677 713 shares D. 647 666 shares E. 582 139 shares

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 15 Testbank

52. Free Trade Partners needs to raise $24.2 million to expand its operations into South America. The company will sell new common shares using a general cash offering. The underwriters will charge a spread of 7.6%, the administrative costs will be $631 000 and the offer price will be $32 per share. How many shares must be sold if the firm is to raise the funds it desires? A. 748 315 shares B. 839 793 shares C. 911 502 shares D. 989 415 shares E. 1 051 515 shares 53. The Art Works needs to raise $6.2 million for a new facility. Assuming it issues new equity shares via a general cash offering, the firm expects to incur administrative costs of $412 000 in addition to the underwriting spread of 7.8%. If the offer price turns out to be $16 a share, how many shares need to be sold to finance the new facility? A. 448 210 shares B. 454 743 shares C. 406 211 shares D. 405 141 shares E. 487 923 shares 54. Cross Country Movers has just gone public. Under a firm commitment agreement, the firm received $19.84 for each of the 2.12 million shares sold. The initial offering price was $24.40 per share, and the share rose to $25 per share in the first few minutes of trading. The company paid $626 000 in legal and other direct costs and $105 000 in indirect costs. What was the flotation cost as a percentage of the funds raised? A. 29.91% B. 27.85% C. 30.49% D. 28.24% E. 28.60% 55. Which one of the following best describes a private placement? A. Interim financing for a new, high-risk entity B. Non-current loan by a limited number of investors C. Two-year direct business loan D. Three-year loan to a firm by its original founder E. New equity issue offered to current shareholders 56. Space Tours wants to do an IPO but is not comfortable that underwriters will set the most optimal offer price for the securities. Which one of the following might the firm consider to address this uncertainty? A. Extended quiet period

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 15 Testbank

B. Extended lockup period C. Best efforts underwriting D. Dutch auction underwriting E. Standby underwriting 57. Mushroom Veggie Meats would like to sell 3000 shares of share using a Dutch auction. The bids received are as follows: Bidder A B C D

Quantity 500 700 1000 1500

Price 45 44 43 42

What is the total amount the issuer will receive from this auction? Ignore costs. A. $128 600 B. $126 000 C. $127 400 D. $125 000 E. $129 600 58. Wendy placed an order with her broker to purchase 500 shares of each of three IPOs that are being released this month. Each IPO has an offer price of $23 a share. The number of shares allocated to Wendy, along with the closing share price at the end of the first day of trading for each share, are as follows: Share Shares Allocated End of Day 1 Price A 220 $23.60 B 450 $18.00 C 175 $29.10 What is her total profit or loss on these three shares as of the end of the first day of trading for each share? A. $639.50 B. −$369.50 C. −$1050.00 D. $572.00 E. $1,370 59. Present Tense Tonic wants to raise $13 million to purchase equipment by issuing new securities. Management estimates the issue will cost the firm $875 500 for accounting, legal and other costs. The underwriting spread is 6.5% and the issue price is $24 per share. How many

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 15 Testbank

shares of share must be sold if the firm is to have sufficient funds remaining after costs to purchase all of the desired equipment? A. 608 010 shares B. 521 121 shares C. 618 338 shares D. 647 666 shares E. 582 139 shares 60. Dingo Farms wants to raise $10 million to purchase equipment by issuing new securities. Management estimates the issue will cost the firm $625 500 for accounting, legal and other costs. The underwriting spread is 8% and the issue price is $20 per share. How many shares of share must be sold if the firm is to have sufficient funds remaining after costs to purchase all of the desired equipment? A. 679 891 shares B. 655 500 shares C. 577 446 shares D. 500 000 shares E. 82 139 shares

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 15 Testbank

Chapter 15 Testbank Key 1. If an offer of issued securities is made only to institutional investors, such as life insurance offices and superannuation funds, the method is called: A. subordinated debt. B. family issue. C. private placement. D. matching principle. Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 15.02 Describe how securities are sold to the public and the role of investment banks in the process Topic: Alternative issue methods

2. The legal document provided to prospective investors which describes details of the issuer and the proposed securities offering is called a: A. registration statement. B. prospectus. C. formal filing. D. public statement. Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 15.02 Describe how securities are sold to the public and the role of investment banks in the process Topic: Selling securities to the public: the basic procedure

3. A public issue of securities which are first offered to existing shareholders is best defined as a(n): A. IPO. B. general offer. C. private placement. D. rights offer. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 15.02 Describe how securities are sold to the public and the role of investment banks in the process Topic: Alternative issue methods

4. The investment firms that act as intermediaries between the issuer of securities and the general public are called:

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 15 Testbank

A. brokers. B. investment advisors. C. red herrings. D. underwriters. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 15.02 Describe how securities are sold to the public and the role of investment banks in the process Topic: Underwriters

5. Which one of the following is the most likely to be financed with venture capital? A. Expanding a firm's existing production line B. Building a prototype of a new invention C. Building a new factory overseas to move production closer to existing foreign customers D. Raising equity to reduce the debt load of a firm Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 15.01 Explain the venture capital market and its role in the financing of new, high-risk ventures Topic: The financing life cycle of a firm: early-stage financing and venture capital

6. The founders of a new firm generally receive: A. a fixed percentage of all venture capital raised. B. sufficient funding in the early stages of venture capital financing to pay off any personal obligations incurred for the sake of the business entity. C. compensation, which is referred to as 'seed money'. D. minimal salaries during the early stages of venture capital financing. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 15.01 Explain the venture capital market and its role in the financing of new, high-risk ventures Topic: The financing life cycle of a firm: early-stage financing and venture capital

7. Which of the following functions are performed by underwriters? I. Selling and distributing new securities II. Determining the method used to issue the securities III. Guaranteeing the payment of the offering price to the issuer if the underwriting is done on a best efforts basis IV. Setting the offering price A. I, II, III and IV B. I, II and IV only C. II, III and IV only D. II and III only

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 15 Testbank

Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 15.02 Describe how securities are sold to the public and the role of investment banks in the process Topic: Underwriters

8. Venture capital is most likely to be the source of funding for which one of the following? A. Seasonal production B. New, high-risk venture C. Daily operations for an established, profitable firm D. Global expansion for an established firm Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 15.01 Explain the venture capital market and its role in the financing of new, high-risk ventures Topic: The financing life cycle of a firm: early-stage financing and venture capital

9. Which of the following are true statements? I. Venture capitalists tend to be long-term investors in a firm. II. Venture capital is relatively easy to obtain for most new firms. III. Venture capitalists generally have an exit strategy. IV. Venture capitalists tend to specialise in one type of financing for a select type of firm. A. I and II only B. I and III only C. I and IV only D. III and IV only Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 15.01 Explain the venture capital market and its role in the financing of new, high-risk ventures Topic: The financing life cycle of a firm: early-stage financing and venture capital

10. Which of the following are important factors to consider when seeking a venture capitalist? I. Exit strategy II. Management style III. Personal contacts IV. Financial strength A. I, II, III and IV B. III and IV only C. I and III only D. II and IV only Ans: A

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 15 Testbank

AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 15.01 Explain the venture capital market and its role in the financing of new, high-risk ventures Topic: The financing life cycle of a firm: early-stage financing and venture capital

12. What is the group of underwriters called who share both the risks and the marketing responsibilities for a securities offering? A. Underwriting cartel B. Syndicate C. Venture capitalists D. Firm commitment group Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 15.02 Describe how securities are sold to the public and the role of investment banks in the process Topic: Underwriters

13. Which of the following have been offered as justification for IPO underpricing? I. Young firms tend to be very risky. II. The best IPOs are oversubscribed. III. Underwriters like to avoid lawsuits. IV. It benefits the existing shareholders. A. I, II and III only B. I, II, III and IV C. II, III and IV only D. II and IV only Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 15.03 Explain initial public offerings and some of the costs of going public Topic: IPOs and underpricing

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 15 Testbank

14. Which one of the following statements related to IPO underpricing is correct? A. The only period in Australia when underpricing produced first-day returns of 50% or more was during the tech bubble of 1999–2000. B. IPO underpricing is limited to the Australian market. C. Some of the greatest IPO underpricing has occurred in China. D. The IPOs of larger-sized firms tend to be more underpriced than the IPOs of smaller-sized firms. Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 15.03 Explain initial public offerings and some of the costs of going public Topic: IPOs and underpricing

15. Which one of the following tends to be true for the average investor? A. They often encounter the 'winner's curse'. B. They frequently earn initially high returns on IPOs when shares are undersubscribed. C. Average investors are not allowed to purchase IPOs at the offer price. D. They generally receive their full allocation of shares even when an IPO is oversubscribed. Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 15.03 Explain initial public offerings and some of the costs of going public Topic: IPOs and underpricing

16. Which one of the following statements concerning IPOs and underpricing is correct? A. The more an issue is underpriced, the more it tends to be oversubscribed. B. Underpricing tends to discourage investors from participating in the IPO market. C. IPO underpricing is a function of the underwriting fee. D. IPO underpricing primarily benefits a firm's pre-issue owners. Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 15.03 Explain initial public offerings and some of the costs of going public Topic: IPOs and underpricing

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 15 Testbank

AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 15.03 Explain initial public offerings and some of the costs of going public Topic: New equity sales and the value of the firm

18. Which one of the following statements is correct? A. Issuing new equity shares is always viewed by the market as a positive event. B. A decline in the price of existing shares when a new issue is released is a direct cost of selling securities. C. A firm's existing shareholders would prefer that new securities be issued when those securities are overpriced rather than underpriced. D. The financial market generally reacts in the same way to a new issue of equity as it does to a new issue of debt as long as the issuer is the same. Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 15.03 Explain initial public offerings and some of the costs of going public Topic: New equity sales and the value of the firm

19. If the market price of existing publicly traded shares declines due to the announcement of a new share issue, the decline is referred to as which one of the following? A. Direct issue cost B. Underpricing C. Abnormal return D. Other direct underwriting costs Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 15.03 Explain initial public offerings and some of the costs of going public Topic: The cost of issuing securities

20. Which one of the following terms is defined as an underwriting for which the underwriters assume full responsibility for any unsold shares? A. Initial public offering B. Best-efforts underwriting C. Rights offer D. Standby underwriting Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 15.02 Describe how securities are sold to the public and the role of investment banks in the process Topic: Underwriters

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 15 Testbank

21. Lewis Materials recently offered 15 000 shares but only received payment for 12 500 shares since that was all the shares the underwriters could sell. What type of underwriting was this? A. Best-efforts B. Rights issue C. Syndicated D. Firm commitment Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 15.02 Describe how securities are sold to the public and the role of investment banks in the process Topic: Underwriters

22. Sly's just arranged a three-year direct business loan with his bank. Which one of the following terms matches this loan arrangement? A. Bond issue B. Term loan C. Rights offer D. New equity issue Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 15.02 Describe how securities are sold to the public and the role of investment banks in the process Topic: Issuing long-term debt

23. Which of the following are valid comments regarding venture capitalists? I. Venture capitalists provide funding for high-risk ventures. II. Venture capitalists often take part in the running of the firm. III. Venture capitalists only provide secured debt. IV. Venture capitalists often provide money in stages. A. I, II, III and IV B. II, III and IV only C. II and IV only D. I, II and IV only Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 15.01 Explain the venture capital market and its role in the financing of new, high-risk ventures Topic: The financing life cycle of a firm: early-stage financing and venture capital

24. Which one of the following projects is most likely to be financed with venture capital? A. Additional warehouse space for a profitable trucking firm B. New product for an international plastics manufacturing company C. Prototype for a newly patented hand tool by an individual inventor

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 15 Testbank

D. Seasonal merchandise for a major retailer Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 15.01 Explain the venture capital market and its role in the financing of new, high-risk ventures Topic: The financing life cycle of a firm: early-stage financing and venture capital

25. Which one of the following statements concerning issue costs is correct? A. The underwriters pay the spread. B. Taxes are an indirect underwriting cost. C. The total direct cost as a percentage of gross proceeds for an IPO tends to increase as the size of the offer decreases. D. Cost of management time spent working on a new issue is a type of a direct cost. Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 15.03 Explain initial public offerings and some of the costs of going public Topic: The cost of issuing securities

26. Which one of the following statements concerning the issuance of non-current debt is correct? A. Banks dominate the private placement segment of the debt market. B. The costs of distributing bonds or debentures are higher in the private market. C. Private placements generally have shorter maturities than term loans. D. A direct placement of debt generally has more restrictive covenants than a public issue. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 15.02 Describe how securities are sold to the public and the role of investment banks in the process Topic: Issuing long-term debt

27. Franklin Oil issued 150 000 shares last week. The underwriters charged a 7.5% spread in exchange for agreeing to a firm commitment. The legal and accounting fees amounted to $310 000 and the company incurred $65 000 in indirect costs. The offer price was $31 a share. Within the first hour of trading, the share price increased to $34 a share. What was the flotation cost as a percentage of the funds raised? A. 20.89% B. 24.03% C. 24.47% D. 29.89% Ans: D

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 15 Testbank

AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 15.03 Explain initial public offerings and some of the costs of going public Topic: The cost of issuing securities

29. Hilltop Market is offering 60 000 shares of shares to the public in a general cash offer. The offer price is $30 a share and the underwriter's fee is 8%. The administrative costs are estimated at $310 000. How much will Hilltop Market receive from this share offering assuming the issue is completely sold? A. $1 370 800 B. $1 800 000 C. $1 610 000 D. $1 346 000 Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 15.03 Explain initial public offerings and some of the costs of going public Topic: The cost of issuing securities

30. Venture capital is: A. another term for an initial public offering of equity securities. B. financing for new firms that are frequently considered to be highly risky. C. money used to repurchase shares of a firm’s outstanding shares. D. money raised through a public offering that allows a firm to expand its operations into a new product line. Ans: B

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 15 Testbank

31. AJ’s Glass Works just arranged a three-year direct business loan. Which one of the following terms matches this loan arrangement? A. Term loan B. Private placement C. Rights offer D. Seasoned offer E. Shelf offer Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 15.02 Describe how securities are sold to the public and the role of investment banks in the process Topic: Issuing long-term debt

32. Deep Water Marina has 12 000 shares outstanding that were sold to the general public last year. The firm has just decided to issue an additional 4000 shares and will make these shares available to the firm's current shareholders before making any offer to the general public. Which type of offer is this? A. General cash offer B. Rights offer C. In-house offering D. Private placement E. Initial public offering Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 15.02 Describe how securities are sold to the public and the role of investment banks in the process Topic: Alternative issue methods

33. A new issue of common shares offered to the general public by a firm that is currently publicly held is called a(n): A. initial public offering. B. private placement. C. rights offer. D. venture capital offer. E. seasoned equity offering. Ans: E

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 15 Testbank

AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 15.02 Describe how securities are sold to the public and the role of investment banks in the process Topic: Alternative issue methods

34. AB Securities assists issuers by pricing and selling new securities to the general public. Which one of the following terms best fits the role that AB Securities is playing? A. Underwriter B. Investment advisor C. Specialist D. Securities dealer E. Venture capitalist Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 15.02 Describe how securities are sold to the public and the role of investment banks in the process Topic: Underwriters

35. GW Underwriters retains the difference between its buying price and its offering price on new securities. What is this amount called? A. Markup B. Commission C. Rights price D. Spread E. Offer Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 15.03 Explain initial public offerings and some of the costs of going public Topic: The cost of issuing securities

36. Florida Farms recently offered 12 000 shares for sale but received payment for only 10 500 shares since that was all the shares the underwriters could sell. What type of underwriting was this? A. Syndicated B. Firm commitment C. Private placement D. Best efforts E. Dutch auction Ans: D

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 15 Testbank

AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 15.02 Describe how securities are sold to the public and the role of investment banks in the process Topic: Underwriters

37. Which one of the following is an underwriting of securities where the offer price is determined by investor bids? A. Private placement B. Best efforts underwriting C. Initial public offering D. Green Shoe option E. Dutch auction Ans: E AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 15.02 Describe how securities are sold to the public and the role of investment banks in the process Topic: Underwriters

39. You own 400 of the 21 000 outstanding shares of DLK share. The firm just announced that it will be issuing an additional 3000 shares to the general public in a cash offer at $16 per share. What type of event are you participating in if you decide to purchase 100 of these additional shares? A. Dutch auction B. Seasoned equity offering C. Private placement D. IPO E. Rights offer Ans: B

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 15 Testbank

40. Currently, you own 1.2% of the outstanding shares of Home Security. The firm has decided to issue additional shares of share and has given you the first option to purchase 1.2% of those additional shares. What type of offer is this? A. Rights offer B. Red herring offer C. Private placement D. IPO E. General cash offer Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 15.02 Describe how securities are sold to the public and the role of investment banks in the process Topic: Alternative issue methods

41. Which of the following duties belong to the underwriters of a firm commitment securities offer? I. Duty to offer the Green Shoe provision to all investors who buy at the offer price II. Duty to set the offer price III. Duty to distribute the offered shares IV. Duty to purchase any unsold shares A. I and III only B. II and IV only C. II, III and IV only D. I, II and III only E. I, II, III and IV Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 15.02 Describe how securities are sold to the public and the role of investment banks in the process Topic: Underwriters

42. Who determines the offer price in a Dutch auction? A. Lead underwriter B. Chief financial officer of the issuing firm C. ASIC D. Bidders E. Board of directors of the issuing firm Ans: D

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 15 Testbank

AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 15.02 Describe how securities are sold to the public and the role of investment banks in the process Topic: Underwriters

43. Which one of the following is probably the most effective means of increasing investors' interest in an IPO? A. Extending the lockup period B. Issuing the IPO through a rights offering C. Underpricing the IPO D. Eliminating the quiet period E. Eliminating the Green Shoe option Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 15.03 Explain initial public offerings and some of the costs of going public Topic: IPOs and underpricing

44. Which statement is correct? A. IPO underpricing is minimal in China. B. IPO underpricing is limited to the Australian markets. C. The percentage of underpricing remains stable over time in the Australia. D. The only period in Australia when underpricing produced first day returns of 50% or more was during the tech bubble of 1999–2000. E. Some of the greatest IPO underpricing has occurred in Saudi Arabia. Ans: E AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 15.03 Explain initial public offerings and some of the costs of going public Topic: IPOs and underpricing

45. Which statement is correct? A. The underwriters pay the spread. B. Taxes are an indirect underwriting cost. C. Seasoned equity offerings (SEOs) tend to be less costly than IPOs. D. Straight bonds are more costly to issue than convertible bonds. E. The total direct cost as a percentage of gross proceeds for an IPO tends to decrease as the size of the offer decreases. Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 15.03 Explain initial public offerings and some of the costs of going public Topic: The cost of issuing securities

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 15 Testbank

46. Which statement is correct? A. Rarely is debt issued privately in the Australia. B. All Australian debt issues, private and public, must be registered with ASIC. C. Private placements generally have shorter maturities than term loans. D. It is easier to renegotiate a public issue than it is a private issue of debt. E. A direct placement of debt generally has more restrictive covenants than a public issue. Ans: E AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 15.03 Explain initial public offerings and some of the costs of going public Topic: Issuing long-term debt

47. Which statement is true? A. Firms often pay higher interest rates on term loans than on public issues of debt. B. The only difference between a term loan and a private placement is the size of the issue. C. A prospectus is required for equity issues but not for debt issues. D. The flotation costs of issuing debt tend to be more expensive than for issuing equity. E. Direct non-current loans must be registered with the ASIC. Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 15.03 Explain initial public offerings and some of the costs of going public Topic: Issuing long-term debt

49. What is the maximum amount an investor can invest in crowdfunding issues in a 12-month period? A. $10 000 B. $10 000 per security with a maximum of 10 separate securities C. $100 000 per security with a maximum of five separate securities

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 15 Testbank

D. $100 000 E. $1 million spread over a maximum of 10 separate securities Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 15.03 Explain initial public offerings and some of the costs of going public Topic: Alternative issue methods

50. Salem Pet Supply would like to sell 1400 shares of share using the Dutch auction method. The bids received are as follows: Bidder A B C D

Quantity 700 1200 1300 800

Price 32 31 30 29

Bidder C will receive _____ shares and pay a price per share of _____. A. 0; $0 B. 1400; $27.00 C. 455; $28.00 D. 455; $29.00 E. 700; $38.75 Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 15.02 Describe how securities are sold to the public and the role of investment banks in the process Topic: Underwriters

51. Future Technology wants to raise $15 million to purchase equipment by issuing new securities. Management estimates the issue will cost the firm $926 250 for accounting, legal and other costs. The underwriting spread is 6% and the issue price is $25 per share. How many shares must be sold if the firm is to have sufficient funds remaining after costs to purchase all of the desired equipment? A. 608 010 shares B. 521 121 shares C. 677 713 shares D. 647 666 shares E. 582 139 shares Ans: C

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 15 Testbank

AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 15.03 Explain initial public offerings and some of the costs of going public Topic: The cost of issuing securities

53. The Art Works needs to raise $6.2 million for a new facility. Assuming it issues new equity shares via a general cash offering, the firm expects to incur administrative costs of $412 000 in addition to the underwriting spread of 7.8%. If the offer price turns out to be $16 a share, how many shares need to be sold to finance the new facility? A. 448 210 shares B. 454 743 shares C. 406 211 shares D. 405 141 shares E. 487 923 shares Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 15.03 Explain initial public offerings and some of the costs of going public Topic: The cost of issuing securities

54. Cross Country Movers has just gone public. Under a firm commitment agreement, the firm received $19.84 for each of the 2.12 million shares sold. The initial offering price was $24.40 per share, and the share rose to $25 per share in the first few minutes of trading. The company paid $626 000 in legal and other direct costs and $105 000 in indirect costs. What was the flotation cost as a percentage of the funds raised? A. 29.91% B. 27.85% C. 30.49%

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 15 Testbank

D. 28.24% E. 28.60% Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 15.03 Explain initial public offerings and some of the costs of going public Topic: The cost of issuing securities

55. Which one of the following best describes a private placement? A. Interim financing for a new, high-risk entity B. Non-current loan by a limited number of investors C. Two-year direct business loan D. Three-year loan to a firm by its original founder E. New equity issue offered to current shareholders Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 15.03 Explain initial public offerings and some of the costs of going public Topic: New equity sales and the value of the firm

56. Space Tours wants to do an IPO but is not comfortable that underwriters will set the most optimal offer price for the securities. Which one of the following might the firm consider to address this uncertainty? A. Extended quiet period B. Extended lockup period C. Best efforts underwriting D. Dutch auction underwriting E. Standby underwriting Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 15.02 Describe how securities are sold to the public and the role of investment banks in the process Topic: Underwriters

57. Mushroom Veggie Meats would like to sell 3000 shares of share using a Dutch auction. The bids received are as follows: Bidder A B C D

Quantity 500 700 1000 1500

Price 45 44 43 42

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 15 Testbank

What is the total amount the issuer will receive from this auction? Ignore costs. A. $128 600 B. $126 000 C. $127 400 D. $125 000 E. $129 600 Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 15.02 Describe how securities are sold to the public and the role of investment banks in the process Topic: Underwriters

58. Wendy placed an order with her broker to purchase 500 shares of each of three IPOs that are being released this month. Each IPO has an offer price of $23 a share. The number of shares allocated to Wendy, along with the closing share price at the end of the first day of trading for each share, are as follows: Share Shares Allocated End of Day 1 Price A 220 $23.60 B 450 $18.00 C 175 $29.10 What is her total profit or loss on these three shares as of the end of the first day of trading for each share? A. $639.50 B. −$369.50 C. −$1050.00 D. $572.00 E. $1,370 Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 15.03 Explain initial public offerings and some of the costs of going public Topic: IPOs and underpricing

59. Present Tense Tonic wants to raise $13 million to purchase equipment by issuing new securities. Management estimates the issue will cost the firm $875 500 for accounting, legal and other costs. The underwriting spread is 6.5% and the issue price is $24 per share. How many shares of share must be sold if the firm is to have sufficient funds remaining after costs to purchase all of the desired equipment? A. 608 010 shares B. 521 121 shares

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 15 Testbank

C. 618 338 shares D. 647 666 shares E. 582 139 shares Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 15.03 Explain initial public offerings and some of the costs of going public Topic: The cost of issuing securities

60. Dingo Farms wants to raise $10 million to purchase equipment by issuing new securities. Management estimates the issue will cost the firm $625 500 for accounting, legal and other costs. The underwriting spread is 8% and the issue price is $20 per share. How many shares of share must be sold if the firm is to have sufficient funds remaining after costs to purchase all of the desired equipment? A. 679 891 shares B. 655 500 shares C. 577 446 shares D. 500 000 shares E. 82 139 shares Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 15.03 Explain initial public offerings and some of the costs of going public Topic: The cost of issuing securities

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 15 Testbank

Chapter 15 Testbank Summary Category AACSB: Analytic Blooms: Analysis Difficulty: Easy Difficulty: Medium Learning Objective: 15.01 Explain the venture capital market and its role in the financing of new, high-risk ventures Learning Objective: 15.02 Describe how securities are sold to the public and the role of investment banks in the process Learning Objective: 15.03 Explain initial public offerings and some of the costs of going public Topic: Alternative issue methods Topic: IPOs and underpricing Topic: Issuing long-term debt Topic: New equity sales and the value of the firm Topic: Selling securities to the public: the basic procedure Topic: The cost of issuing securities Topic: The financing life cycle of a firm: early-stage financing and venture capital Topic: Underwriters

# of Questions 60 60 53 7 9 24 27 8 7 5 3 1 13 9 14

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 16 Testbank

Chapter 16 Testbank 1. The __________ facility is a major source of short-term finance for a corporation. It allows the company, without any previous notice, to put its bank account into ______, up to an agreed limit. A. commercial bills rollover; surplus B. overdraft; deficit C. promissory notes rollover; deficit D. revolving; deficit 2. Factoring involves the lender buying the accounts receivable assets of the borrowing company at a discount to their face value. If the factoring company can recover future bad debt from the borrowing company, this is called: A. factoring on a notification basis. B. unconventional factoring. C. a disintermediated type of factoring. D. conventional factoring. 3. The time between the payment for inventory and the receipt of cash from the sale of that inventory is called the: A. inventory period. B. accounts receivable period. C. cash cycle. D. accounts payable period. 4. The operating cycle commences when: A. a sale is made. B. inventory is purchased. C. a receivable is created. D. an accounts payable is paid. 5. The cash cycle is equal to: A. the inventory period minus the accounts receivable period minus the accounts payable period. B. the inventory period minus the accounts payable period. C. the accounts receivable period minus the accounts payable period plus the inventory period. D. the operating cycle plus the accounts payable period 6. The inventory period is equal to: A. 365 multiplied by the average inventory divided by the cost of sales.

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 16 Testbank

B. the inventory turnover rate divided by 365. C. sales divided by the average inventory multiplied by 365. D. the cost of sales divided by the inventory turnover rate. 7. Which one of the following statements is correct concerning the accounts payable period? A. An increase in the accounts payable period will increase the operating cycle, all things being equal. B. Extending the accounts payable period effectively decreases the cash needs of a firm. C. The accounts payable period is equal to the cost of sales divided by the average accounts payable. D. Managers generally prefer a shorter accounts payable period than a longer one. 8. Which of the following are considered to be shortage costs? I. The cost of placing an order II. Production disruptions caused by the inventory III. Lost sales due to limited selection IV. Opportunity cost associated with highly liquid assets A. II, III and IV only B. I and II only C. II and IV only D. I, II and III only 9. Gilbert & Sons has sales for the year of $24 800 and cost of sales of $14 200. The firm carries an average inventory of $3100 and an average accounts payable balance of $2400. What is the inventory period? A. 78 days B. 85 days C. 83 days D. 80 days 10. The Moose Co. currently has 81 days in its cash cycle and 136 days in its operating cycle. The firm purchases all of its inventory from one supplier. This supplier has offered a 5% discount to The Moose Co. if it will pay for its purchases within 10 days. If The Moose Co. changes it payables policy and pays in 10 days, the firm's cash cycle will be _____ days. A. 114 B. 103 C. 91 D. 126 11. Allison Adventures has the following estimated sales:

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 16 Testbank

Purchases are equal to 65% of the following quarter's sales. The accounts receivable period is 30 days and the accounts payable period is 45 days. Assume that there are 30 days in each month. Allison Adventures will purchase _____ of goods in the third quarter and pay their suppliers _____ during the third quarter. A. $1885; $1983 B. $2275; $2178 C. $2080; $1983 D. $2080; $2178 12. Which one of the following commences on the day inventory is purchased and ends on the day the payment for that inventory is collected? Assume all sales and purchases are on credit. A. Inventory period B. Operating cycle C. Accounts receivable period D. Cash cycle 13. The amount of time that a firm holds inventory in stock is referred to as which one of the following? A. Accounts payable period B. Inventory period C. Accounts receivable period D. Operating cycle 14. The accounts receivable period is the time that elapses between the _____ and the _____. A. sale of inventory; billing to customer B. sale of inventory; collection of the receivable C. purchase of inventory; payment to the supplier D. sale of inventory; payment to supplier 15. Which one of the following is the length of time that a retailer owes its supplier for an inventory purchase? A. Operating cycle B. Cash cycle C. Accounts receivable period D. Accounts payable period 16. Which one of the following is directly related to increases in a firm's current assets? A. Out-of-stock events B. Re-order costs

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 16 Testbank

C. Shortage costs D. Carrying costs 17. Which of the following are inversely related to increases in a firm's current assets? I. Re-order costs II. Shortage costs III. Restocking costs IV. Carrying costs A. I, III and IV only B. II, III and IV only C. II and IV only D. I, II and III only 18. Which one of the following is most indicative of a flexible short-term financial policy? A. Relatively small investment in current assets B. High ratio of short-term debt to non-current debt C. High ratio of current assets to sales D. Relatively low level of liquidity 19. Which of the following costs tend to rise when a firm switches from a restrictive financial policy to a flexible financial policy? I. Restocking costs II. Lower prices to offset limited selection III. Storage costs IV. Current-asset opportunity costs A. I and II only B. III and IV only C. I, II and III only D. I, III and IV only 20. Black Water Mills is operating at its optimal point. Which one of the following conditions exists given this firm's operating status? A. Carrying costs exceed shortage costs B. Both carrying costs and shortage costs are at their minimum levels C. Shortage costs are equal to zero D. Shortage costs equal carrying costs 21. Which one of the following statements is correct? A. Firms that follow restrictive financial policies can generally avoid short-term debt financing. B. Long-term interest rates tend to be more volatile than short-term interest rates. C. Firms should generally finance all of their assets with non-current debt.

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 16 Testbank

D. A firm is less likely to face financial distress if it adopts a flexible financial policy rather than a restrictive policy. 22. Moore & Moore has just finished projecting its expected cash receipts and expenditures for next year. What is this projection called? A. Statement of financial position B. Cash budget C. Operating projection D. Receivables schedule 23. Which one of the following best describes a line of credit? A. Long-term prearranged, committed bank loan B. Short-term loan secured by accounts receivable C. Long-term, prearranged, non-committed bank loan D. Short-term prearranged bank loan that can be either committed or non-committed 24. Accounts receivable financing is the term used to describe which of the following types of loans that involve either the assignment or the factoring of a firm's accounts receivables? A. Bailment financing B. Secured non-current loan C. Unsecured short-term loan D. Secured short-term loan 25. By definition, an inventory loan is which one of the following types of loan? A. Trust receipt loan B. Secured non-current loan C. Unsecured non-current loan D. Secured short-term loan 26. Which one of the following statements related to a cash budget is correct? A. The cumulative surplus is computed prior to adjusting for the minimum cash balance. B. Financially healthy firms can have a negative quarterly net cash inflow. C. Firms generally set the minimum cash balance at zero for planning purposes. D. Capital expenditures are treated as a cash inflow on a cash budget. 27. A committed line of credit: A. guarantees that any funds borrowed during a stated period of time will be charged the lowest rate of interest the lending bank offers to any of its customers. B. provides greater assurance than a non-committed credit line that funds will be available when needed by a firm.

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 16 Testbank

C. guarantees that a set amount of funds will be available to a firm for a stated period of time regardless of events that might occur during that time period. D. is a loan arrangement for a stated period of time which is free of all costs and fees other than the actual interest paid on the funds borrowed. 28. Which type of financing is generally used by new car dealers to finance their inventories? A. Field warehousing financing B. Bailment financing C. Committed line of credit D. Blanket inventory lien arrangement 29. A firm with a flexible short-term financial policy will have: A. a relatively low ratio of current assets to sales. B. relatively few marketable securities. C. a relatively high amount of account receivable. D. a relatively low level of inventory. 30. Which of the following would be found in a cash budget? A. Provision for doubtful debts B. Accrued expenditure C. Capital expenditure D. Depreciation 31. The cash cycle equals the: A. inventory period plus the accounts receivable period. B. inventory period plus the accounts payable period. C. operating cycle minus the inventory period. D. operating cycle minus the accounts payable period. E. operating cycle minus the accounts receivable period. 32. Which of these activities is a source of cash? A. Decreasing non-current debt B. Increasing inventory C. Repurchasing shares of share D. Increasing non-current assets E. Decreasing accounts receivable 33. Which one of these will increase the operating cycle? A. Decreasing the days' sales in inventory B. Decreasing the accounts payable period C. Increasing the accounts receivable turnover rate

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 16 Testbank

D. Decreasing the inventory turnover rate E. Decreasing the accounts payable turnover rate 34. Which one of the following will increase the operating cycle? A. Decreasing the accounts payable period B. Increasing the accounts payable turnover rate C. Increasing the cash cycle D. Decreasing the accounts receivable turnover rate E. Decreasing the inventory period 35. Which one of the following actions will decrease the operating cycle? A. Increasing inventory B. Paying suppliers faster C. Paying for more inventory with cash rather than credit D. Granting customers more time to pay for their credit purchases E. Lessening the production time needed to manufacture a good for sale 36. The operating cycle is equal to the: A. inventory period plus the accounts payable period. B. accounts receivable period plus the cash cycle. C. inventory period minus the accounts payable period plus the accounts receivable period. D. accounts receivable period plus the inventory period. E. inventory period plus the cash cycle. 37. Which one of the following can occur if the operating cycle decreases while both the accounts receivable and the accounts payable periods remain constant? A. Inventory period remains constant B. Cash cycle increases C. Inventory turnover rate increases D. Accounts receivable turnover rate increases E. Cash cycle remains constant 38. Which statement is true? A. A decrease in the accounts receivable turnover rate decreases the cash cycle. B. Paying a supplier within the discount period rather than waiting until the end of the normal credit period will decrease the cash cycle. C. The number of days in the cash cycle can be positive, negative or equal to zero. D. An increase in the inventory turnover rate must increase the cash cycle. E. The payables period must be shorter than the receivables period. 39. Which industry is most likely to have the shortest operating cycle?

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 16 Testbank

A. Toy store B. Car manufacturer C. Local restaurant D. Furniture store E. Plastics manufacturer 40. Which firm is most likely to have the shortest inventory period? A. General merchandise retail store B. Hardware store C. Furniture store D. Locomotive manufacturer E. Delicatessen 41. An increase in the accounts receivable period is most likely to: A. lengthen the accounts payable period. B. shorten the inventory period. C. shorten the operating cycle. D. lengthen the cash cycle. E. shorten the accounts payable period. 42. Suppose MMP changes its policy and starts requiring all of its customers to pay within 20 days rather than the 30 days that it currently allows. Which one of the following will result from this change? A. Increase in receivables period B. Increase in inventory period C. Decrease in cash cycle D. Increase in operating cycle E. Increase in accounts payable period 43. Tri-City Grocers is a chain of grocery stores that just hired a new CFO. Which of the following actions would you expect this CFO to adopt given her statement that she wants to implement a more flexible financing policy for the firm? I. Easing the credit terms given to customers II. Increasing the amount of inventory carried by each grocery store III. Borrowing funds to keep more cash available for store operations IV. Decreasing the firms' investments in marketable securities A. I and III only B. II and IV only

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 16 Testbank

C. I, II and III only D. II, III and IV only E. I, II, III and IV 44. A flexible short-term financial policy will tend to have more of which of the following than a restrictive short-term financial policy will? I. Uncollectable accounts receivable II. Work stoppages for lack of raw materials III. Carrying costs IV. Obsolete or out-of-date inventory A. I and II only B. III and IV only C. II and III only D. I, II and III only E. I, III and IV only 45. Which of the following costs will tend to increase if a firm switches to a restrictive shortterm financial policy from a flexible short-term policy? I. Lost sales due to out-of-stock items II. Inventory warehousing costs III. Cash-outs IV. Total annual order costs A. I and III only B. II and IV only C. I, III and IV only D. I, II and IV only E. I, II, III and IV 46. Which of the following tend to rise when a firm switches to a flexible financial policy from a restrictive financial policy? I. Restocking costs II. Price reductions to offset limited selection

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 16 Testbank

III. Storage costs IV. Current asset opportunity costs A. I and II only B. III and IV only C. I, III and IV only D. I, II and III only E. II, III and IV only 47. Generally speaking, which of the following situations will occur if a seasonal company adopts a compromise financial policy? I. Periods where short-term financing is required II. Less non-current debt than if the firm followed a restrictive financial policy III. Periods of excess funds which can be invested in short-term marketable securities IV. Lower investment in non-current assets than if the firm adopted a flexible financial policy A. I only B. II only C. I and III only D. II and IV only E. I, III and IV only 48. A committed line of credit: A. guarantees that a set amount of funds will be available to a firm for a stated period of time regardless of events that might occur during that time period. B. is a guarantee that a bank will purchase a firm's accounts receivable at full value. C. provides greater assurance than a non-committed credit line that funds will be available when needed by a firm. D. guarantees that any funds borrowed during a stated period of time will be charged the lowest rate of interest the lending bank offers to any of its customers. E. is a loan arrangement for a stated period of time which is free of all costs and fees other than the actual interest paid on the funds borrowed. 49. The Corner Store is a small-sized general store that stocks a minimal level of basic supplies and offers gasoline to a rural community. Which type of credit is probably best-suited for financing this store's inventory? A. Trust receipt financing

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 16 Testbank

B. Receivables factoring C. Field warehousing D. Blanket inventory lien E. Receivables assignment 50. Which characteristic applies to commercial paper? A. Maturities of 270 days or more B. Interest rates higher than comparable bank loans C. Issued directly by large-sized firms D. Issued primarily by low-rated firms 51. Dexter Companies has a conventional factoring arrangement with its local bank. Which of these would be a common characteristic of that type of financing arrangement? A. Dexter Companies will receive the full amount of the accounts receivable included in this arrangement on an agreed upon date sometime in the future. B. The responsibility for collecting the covered receivables lies with Dexter Companies. C. Any bad debt that results from an account receivable included in this arrangement will be a cost to the bank. D. Dexter Companies will pay a monthly fee to the bank and in turn will receive payment for the full amount of its accounts receivable. E. The arrangement keeps the receivables as an asset of Dexter Companies but places a lien on those accounts in favor of the lending bank. 52. Dover Wholesalers sells products exclusively to Benn Retailer. Benn Retailer buys exclusively from Dover Wholesalers. Dover Wholesalers has a receivables period of 44 days, an inventory period of 8 days and a payables period of 63 days. Benn Retailer has an inventory period of 15 days, a receivables period of 22 days and a payables period of 44 days. Which statement is correct given this information? A. Dover Wholesalers has a shorter operating cycle than does Benn Retailer. B. Benn Retailer has an operating cycle of 81 days. C. It takes Benn Retailer less time to collect payment on a sale than it does for the firm to sell its inventory. D. Dover Wholesalers is financing 100% of Benn Retailer's operating cycle. E. Dover Wholesalers has a cash cycle of 11 days. 53. Gaming Station has to restock a popular electronic game every five days as it completely sells out in that period of time. What is the inventory turnover rate for this game? A. 115 times B. 105 times C. 99 times D. 118 times E. 73 times

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 16 Testbank

54. Holiday Tree Farm has a cash balance of $34 and a short-term loan balance of $180 at the beginning of Q1. The net cash inflow for the first quarter is $36 and for the second quarter there is a net cash outflow of $48. All cash shortfalls are funded with short-term debt. The firm pays 2% of its prior quarter's ending loan balance as interest each quarter. The minimum cash balance is $20. What is the short-term loan balance at the end of Q2? A. $184.30 B. $179.20 C. $138.60 D. $128.40 E. $193.10 55. Steep Mountain Oil has a cash balance of $15 and a short-term loan balance of $53 at the beginning of Q1. The net cash outflow for Q1of $39 and for Q2 there is a net cash inflow of $23. All cash shortfalls are funded with short-term debt. The firm pays 1.1% of its prior quarter's ending loan balance as interest each quarter. The minimum cash balance is $15. What is the short-term loan balance at the end of the Q2? A. $70.60 B. $81.30 C. $65.90 D. $67.70 E. $76.80 56. Kacie’s has an average collection period of 23 days and factors all receivables immediately at a discount of 0.95%. What is the effective cost of borrowing? Assume that default is extremely unlikely. A. 16.32% B. 16.28% C. 16.36% D. 16.52% E. 16.49% 57. Which one of the following is a graphical representation of the operating and cash cycles? A. Operations line B. Production period C. Cash flow time line D. Inventory flow chart E. Customer service line 58. Big Red’s purchases from suppliers in a quarter are equal to 71% of the next quarter's forecast sales. The payables period is 60 days; other expenses are paid when incurred. Wages, taxes and other expenses are 24% of sales, and interest and dividends are $40 per quarter. No capital expenditures are planned. Projected quarterly sales, starting with Q1, are $1520, $1580,

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 16 Testbank

$1630 and $1590, respectively. Sales for the first quarter of the following year are projected at $1540. What is the amount of the total disbursements for Q2? A. $1564 B. $1520 C. $1601 D. $1538 E. $1553 59. Here are some important figures from the budget of Global Enterprises for the second quarter: Credit sales Credit purchases Cash disbursements: Wages, taxes, and other Interest Non-current asset purchases

April $ 524 600 359 100

May $ 546 800 366 700

June $ 568 100 384 200

98 400 7 500 11 300

99 100 7 500 0

124 600 7 500 48 900

The company predicts that 2% of its credit sales will never be collected, 45% of its sales will be collected in the month of sale and the remaining 53% will be collected in the following month. Credit purchases will be paid in the month following the purchase. March credit sales were $487 900 and credit purchases were $349 500. What is the ending cash balance for April if the beginning cash balance was $39 500? A. $67 410 B. $67 457 C. $68 800 D. $64 440 E. $69 230 60. Which of these actions is indicative of a restrictive short-term financial policy? A. Granting increasing amounts of credit to customers B. Expanding the number of inventory items carried C. Increasing the firm's investment in the current accounts D. Minimising the cash balances held by the firm E. Investing relatively large amounts in marketable securities

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 16 Testbank

Chapter 16 Testbank Key 1. The __________ facility is a major source of short-term finance for a corporation. It allows the company, without any previous notice, to put its bank account into ______, up to an agreed limit. A. commercial bills rollover; surplus B. overdraft; deficit C. promissory notes rollover; deficit D. revolving; deficit Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 16.03 Identify the essentials of short-term financial planning Topic: Short-term financing

2. Factoring involves the lender buying the accounts receivable assets of the borrowing company at a discount to their face value. If the factoring company can recover future bad debt from the borrowing company, this is called: A. factoring on a notification basis. B. unconventional factoring. C. a disintermediated type of factoring. D. conventional factoring. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 16.03 Identify the essentials of short-term financial planning Topic: Short-term financing

3. The time between the payment for inventory and the receipt of cash from the sale of that inventory is called the: A. inventory period. B. accounts receivable period. C. cash cycle. D. accounts payable period. Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 16.01 Discuss operating and cash cycles and why they are important Topic: The operating cycle and the cash cycle

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 16 Testbank

4. The operating cycle commences when: A. a sale is made. B. inventory is purchased. C. a receivable is created. D. an accounts payable is paid. Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 16.01 Discuss operating and cash cycles and why they are important Topic: The operating cycle and the cash cycle

5. The cash cycle is equal to: A. the inventory period minus the accounts receivable period minus the accounts payable period. B. the inventory period minus the accounts payable period. C. the accounts receivable period minus the accounts payable period plus the inventory period. D. the operating cycle plus the accounts payable period Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 16.01 Discuss operating and cash cycles and why they are important Topic: The operating cycle and the cash cycle

6. The inventory period is equal to: A. 365 multiplied by the average inventory divided by the cost of sales. B. the inventory turnover rate divided by 365. C. sales divided by the average inventory multiplied by 365. D. the cost of sales divided by the inventory turnover rate. Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 16.01 Discuss operating and cash cycles and why they are important Topic: The operating cycle and the cash cycle

7. Which one of the following statements is correct concerning the accounts payable period? A. An increase in the accounts payable period will increase the operating cycle, all things being equal. B. Extending the accounts payable period effectively decreases the cash needs of a firm. C. The accounts payable period is equal to the cost of sales divided by the average accounts payable. D. Managers generally prefer a shorter accounts payable period than a longer one. Ans: B

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 16 Testbank

AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 16.01 Discuss operating and cash cycles and why they are important Topic: The operating cycle and the cash cycle

8. Which of the following are considered to be shortage costs? I. The cost of placing an order II. Production disruptions caused by the inventory III. Lost sales due to limited selection IV. Opportunity cost associated with highly liquid assets A. II, III and IV only B. I and II only C. II and IV only D. I, II and III only Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 16.02 Differentiate between the types of short-term financial policy Topic: Some aspects of short-term financial policy

9. Gilbert & Sons has sales for the year of $24 800 and cost of sales of $14 200. The firm carries an average inventory of $3100 and an average accounts payable balance of $2400. What is the inventory period? A. 78 days B. 85 days C. 83 days D. 80 days Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 16.01 Discuss operating and cash cycles and why they are important Topic: The operating cycle and the cash cycle

10. The Moose Co. currently has 81 days in its cash cycle and 136 days in its operating cycle. The firm purchases all of its inventory from one supplier. This supplier has offered a 5% discount to The Moose Co. if it will pay for its purchases within 10 days. If The Moose Co. changes it payables policy and pays in 10 days, the firm's cash cycle will be _____ days. A. 114 B. 103 C. 91 D. 126 Ans: D

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 16 Testbank

AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 16.01 Discuss operating and cash cycles and why they are important Topic: The operating cycle and the cash cycle

11. Allison Adventures has the following estimated sales:

12. Which one of the following commences on the day inventory is purchased and ends on the day the payment for that inventory is collected? Assume all sales and purchases are on credit. A. Inventory period B. Operating cycle C. Accounts receivable period D. Cash cycle Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 16.01 Discuss operating and cash cycles and why they are important Topic: The operating cycle and the cash cycle

13. The amount of time that a firm holds inventory in stock is referred to as which one of the following? A. Accounts payable period B. Inventory period C. Accounts receivable period D. Operating cycle Ans: B

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 16 Testbank

AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 16.01 Discuss operating and cash cycles and why they are important Topic: The operating cycle and the cash cycle

14. The accounts receivable period is the time that elapses between the _____ and the _____. A. sale of inventory; billing to customer B. sale of inventory; collection of the receivable C. purchase of inventory; payment to the supplier D. sale of inventory; payment to supplier Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 16.01 Discuss operating and cash cycles and why they are important Topic: The operating cycle and the cash cycle

15. Which one of the following is the length of time that a retailer owes its supplier for an inventory purchase? A. Operating cycle B. Cash cycle C. Accounts receivable period D. Accounts payable period Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 16.01 Discuss operating and cash cycles and why they are important Topic: The operating cycle and the cash cycle

16. Which one of the following is directly related to increases in a firm's current assets? A. Out-of-stock events B. Re-order costs C. Shortage costs D. Carrying costs Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 16.02 Differentiate between the types of short-term financial policy Topic: Some aspects of short-term financial policy

17. Which of the following are inversely related to increases in a firm's current assets? I. Re-order costs II. Shortage costs

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 16 Testbank

III. Restocking costs IV. Carrying costs A. I, III and IV only B. II, III and IV only C. II and IV only D. I, II and III only Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 16.02 Differentiate between the types of short-term financial policy Topic: Some aspects of short-term financial policy

18. Which one of the following is most indicative of a flexible short-term financial policy? A. Relatively small investment in current assets B. High ratio of short-term debt to non-current debt C. High ratio of current assets to sales D. Relatively low level of liquidity Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 16.02 Differentiate between the types of short-term financial policy Topic: Some aspects of short-term financial policy

19. Which of the following costs tend to rise when a firm switches from a restrictive financial policy to a flexible financial policy? I. Restocking costs II. Lower prices to offset limited selection III. Storage costs IV. Current-asset opportunity costs A. I and II only B. III and IV only C. I, II and III only D. I, III and IV only Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 16.02 Differentiate between the types of short-term financial policy Topic: Some aspects of short-term financial policy

20. Black Water Mills is operating at its optimal point. Which one of the following conditions exists given this firm's operating status? A. Carrying costs exceed shortage costs B. Both carrying costs and shortage costs are at their minimum levels

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 16 Testbank

C. Shortage costs are equal to zero D. Shortage costs equal carrying costs Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 16.02 Differentiate between the types of short-term financial policy Topic: Some aspects of short-term financial policy

21. Which one of the following statements is correct? A. Firms that follow restrictive financial policies can generally avoid short-term debt financing. B. Long-term interest rates tend to be more volatile than short-term interest rates. C. Firms should generally finance all of their assets with non-current debt. D. A firm is less likely to face financial distress if it adopts a flexible financial policy rather than a restrictive policy. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 16.02 Differentiate between the types of short-term financial policy Topic: Some aspects of short-term financial policy

22. Moore & Moore has just finished projecting its expected cash receipts and expenditures for next year. What is this projection called? A. Statement of financial position B. Cash budget C. Operating projection D. Receivables schedule Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 16.03 Identify the essentials of short-term financial planning Topic: The cash budget

23. Which one of the following best describes a line of credit? A. Long-term prearranged, committed bank loan B. Short-term loan secured by accounts receivable C. Long-term, prearranged, non-committed bank loan D. Short-term prearranged bank loan that can be either committed or non-committed Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 16.03 Identify the essentials of short-term financial planning Topic: Short-term financing

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 16 Testbank

24. Accounts receivable financing is the term used to describe which of the following types of loans that involve either the assignment or the factoring of a firm's accounts receivables? A. Bailment financing B. Secured non-current loan C. Unsecured short-term loan D. Secured short-term loan Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 16.03 Identify the essentials of short-term financial planning Topic: Short-term financing

25. By definition, an inventory loan is which one of the following types of loan? A. Trust receipt loan B. Secured non-current loan C. Unsecured non-current loan D. Secured short-term loan Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 16.03 Identify the essentials of short-term financial planning Topic: The cash budget

26. Which one of the following statements related to a cash budget is correct? A. The cumulative surplus is computed prior to adjusting for the minimum cash balance. B. Financially healthy firms can have a negative quarterly net cash inflow. C. Firms generally set the minimum cash balance at zero for planning purposes. D. Capital expenditures are treated as a cash inflow on a cash budget. Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 16.03 Identify the essentials of short-term financial planning Topic: The cash budget

27. A committed line of credit: A. guarantees that any funds borrowed during a stated period of time will be charged the lowest rate of interest the lending bank offers to any of its customers. B. provides greater assurance than a non-committed credit line that funds will be available when needed by a firm. C. guarantees that a set amount of funds will be available to a firm for a stated period of time regardless of events that might occur during that time period. D. is a loan arrangement for a stated period of time which is free of all costs and fees other than the actual interest paid on the funds borrowed.

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 16 Testbank

Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 16.03 Identify the essentials of short-term financial planning Topic: Short-term financing

28. Which type of financing is generally used by new car dealers to finance their inventories? A. Field warehousing financing B. Bailment financing C. Committed line of credit D. Blanket inventory lien arrangement Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 16.03 Identify the essentials of short-term financial planning Topic: Short-term financing

29. A firm with a flexible short-term financial policy will have: A. a relatively low ratio of current assets to sales. B. relatively few marketable securities. C. a relatively high amount of account receivable. D. a relatively low level of inventory. Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 16.02 Differentiate between the types of short-term financial policy Topic: Some aspects of short-term financial policy

30. Which of the following would be found in a cash budget? A. Provision for doubtful debts B. Accrued expenditure C. Capital expenditure D. Depreciation Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 16.03 Identify the essentials of short-term financial planning Topic: Short-term financing

31. The cash cycle equals the: A. inventory period plus the accounts receivable period. B. inventory period plus the accounts payable period.

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 16 Testbank

C. operating cycle minus the inventory period. D. operating cycle minus the accounts payable period. E. operating cycle minus the accounts receivable period. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 16.01 Discuss operating and cash cycles and why they are important Topic: The operating cycle and the cash cycle

32. Which of these activities is a source of cash? A. Decreasing non-current debt B. Increasing inventory C. Repurchasing shares of share D. Increasing non-current assets E. Decreasing accounts receivable Ans: E AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 16.03 Identify the essentials of short-term financial planning Topic: Short-term financing

33. Which one of these will increase the operating cycle? A. Decreasing the days' sales in inventory B. Decreasing the accounts payable period C. Increasing the accounts receivable turnover rate D. Decreasing the inventory turnover rate E. Decreasing the accounts payable turnover rate Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 16.01 Discuss operating and cash cycles and why they are important Topic: The operating cycle and the cash cycle

34. Which one of the following will increase the operating cycle? A. Decreasing the accounts payable period B. Increasing the accounts payable turnover rate C. Increasing the cash cycle D. Decreasing the accounts receivable turnover rate E. Decreasing the inventory period Ans: D

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 16 Testbank

AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 16.01 Discuss operating and cash cycles and why they are important Topic: The operating cycle and the cash cycle

35. Which one of the following actions will decrease the operating cycle? A. Increasing inventory B. Paying suppliers faster C. Paying for more inventory with cash rather than credit D. Granting customers more time to pay for their credit purchases E. Lessening the production time needed to manufacture a good for sale Ans: E AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 16.01 Discuss operating and cash cycles and why they are important Topic: The operating cycle and the cash cycle

36. The operating cycle is equal to the: A. inventory period plus the accounts payable period. B. accounts receivable period plus the cash cycle. C. inventory period minus the accounts payable period plus the accounts receivable period. D. accounts receivable period plus the inventory period. E. inventory period plus the cash cycle. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 16.01 Discuss operating and cash cycles and why they are important Topic: The operating cycle and the cash cycle

37. Which one of the following can occur if the operating cycle decreases while both the accounts receivable and the accounts payable periods remain constant? A. Inventory period remains constant B. Cash cycle increases C. Inventory turnover rate increases D. Accounts receivable turnover rate increases E. Cash cycle remains constant Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 16.01 Discuss operating and cash cycles and why they are important Topic: The operating cycle and the cash cycle

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 16 Testbank

38. Which statement is true? A. A decrease in the accounts receivable turnover rate decreases the cash cycle. B. Paying a supplier within the discount period rather than waiting until the end of the normal credit period will decrease the cash cycle. C. The number of days in the cash cycle can be positive, negative or equal to zero. D. An increase in the inventory turnover rate must increase the cash cycle. E. The payables period must be shorter than the receivables period. Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 16.01 Discuss operating and cash cycles and why they are important Topic: The operating cycle and the cash cycle

39. Which industry is most likely to have the shortest operating cycle? A. Toy store B. Car manufacturer C. Local restaurant D. Furniture store E. Plastics manufacturer Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 16.01 Discuss operating and cash cycles and why they are important Topic: The operating cycle and the cash cycle

40. Which firm is most likely to have the shortest inventory period? A. General merchandise retail store B. Hardware store C. Furniture store D. Locomotive manufacturer E. Delicatessen Ans: E AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 16.01 Discuss operating and cash cycles and why they are important Topic: The operating cycle and the cash cycle

41. An increase in the accounts receivable period is most likely to: A. lengthen the accounts payable period. B. shorten the inventory period. C. shorten the operating cycle. D. lengthen the cash cycle. E. shorten the accounts payable period.

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 16 Testbank

Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 16.02 Differentiate between the types of short-term financial policy Topic: Some aspects of short-term financial policy

42. Suppose MMP changes its policy and starts requiring all of its customers to pay within 20 days rather than the 30 days that it currently allows. Which one of the following will result from this change? A. Increase in receivables period B. Increase in inventory period C. Decrease in cash cycle D. Increase in operating cycle E. Increase in accounts payable period Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 16.02 Differentiate between the types of short-term financial policy Topic: Some aspects of short-term financial policy

43. Tri-City Grocers is a chain of grocery stores that just hired a new CFO. Which of the following actions would you expect this CFO to adopt given her statement that she wants to implement a more flexible financing policy for the firm? I. Easing the credit terms given to customers II. Increasing the amount of inventory carried by each grocery store III. Borrowing funds to keep more cash available for store operations IV. Decreasing the firms' investments in marketable securities A. I and III only B. II and IV only C. I, II and III only D. II, III and IV only E. I, II, III and IV Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 16.02 Differentiate between the types of short-term financial policy Topic: Some aspects of short-term financial policy

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 16 Testbank

44. A flexible short-term financial policy will tend to have more of which of the following than a restrictive short-term financial policy will? I. Uncollectable accounts receivable II. Work stoppages for lack of raw materials III. Carrying costs IV. Obsolete or out-of-date inventory A. I and II only B. III and IV only C. II and III only D. I, II and III only E. I, III and IV only Ans: E AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 16.02 Differentiate between the types of short-term financial policy Topic: Some aspects of short-term financial policy

45. Which of the following costs will tend to increase if a firm switches to a restrictive shortterm financial policy from a flexible short-term policy? I. Lost sales due to out-of-stock items II. Inventory warehousing costs III. Cash-outs IV. Total annual order costs A. I and III only B. II and IV only C. I, III and IV only D. I, II and IV only E. I, II, III and IV Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 16.02 Differentiate between the types of short-term financial policy Topic: Some aspects of short-term financial policy

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 16 Testbank

46. Which of the following tend to rise when a firm switches to a flexible financial policy from a restrictive financial policy? I. Restocking costs II. Price reductions to offset limited selection III. Storage costs IV. Current asset opportunity costs A. I and II only B. III and IV only C. I, III and IV only D. I, II and III only E. II, III and IV only Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 16.02 Differentiate between the types of short-term financial policy Topic: Some aspects of short-term financial policy

47. Generally speaking, which of the following situations will occur if a seasonal company adopts a compromise financial policy? I. Periods where short-term financing is required II. Less non-current debt than if the firm followed a restrictive financial policy III. Periods of excess funds which can be invested in short-term marketable securities IV. Lower investment in non-current assets than if the firm adopted a flexible financial policy A. I only B. II only C. I and III only D. II and IV only E. I, III and IV only Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 16.02 Differentiate between the types of short-term financial policy Topic: Some aspects of short-term financial policy

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 16 Testbank

48. A committed line of credit: A. guarantees that a set amount of funds will be available to a firm for a stated period of time regardless of events that might occur during that time period. B. is a guarantee that a bank will purchase a firm's accounts receivable at full value. C. provides greater assurance than a non-committed credit line that funds will be available when needed by a firm. D. guarantees that any funds borrowed during a stated period of time will be charged the lowest rate of interest the lending bank offers to any of its customers. E. is a loan arrangement for a stated period of time which is free of all costs and fees other than the actual interest paid on the funds borrowed. Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 16.03 Identify the essentials of short-term financial planning Topic: Short-term financing

49. The Corner Store is a small-sized general store that stocks a minimal level of basic supplies and offers gasoline to a rural community. Which type of credit is probably best-suited for financing this store's inventory? A. Trust receipt financing B. Receivables factoring C. Field warehousing D. Blanket inventory lien E. Receivables assignment Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 16.03 Identify the essentials of short-term financial planning Topic: Short-term financing

50. Which characteristic applies to commercial paper? A. Maturities of 270 days or more B. Interest rates higher than comparable bank loans C. Issued directly by large-sized firms D. Issued primarily by low-rated firms Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 16.03 Identify the essentials of short-term financial planning Topic: Short-term financing

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 16 Testbank

51. Dexter Companies has a conventional factoring arrangement with its local bank. Which of these would be a common characteristic of that type of financing arrangement? A. Dexter Companies will receive the full amount of the accounts receivable included in this arrangement on an agreed upon date sometime in the future. B. The responsibility for collecting the covered receivables lies with Dexter Companies. C. Any bad debt that results from an account receivable included in this arrangement will be a cost to the bank. D. Dexter Companies will pay a monthly fee to the bank and in turn will receive payment for the full amount of its accounts receivable. E. The arrangement keeps the receivables as an asset of Dexter Companies but places a lien on those accounts in favor of the lending bank. Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 16.03 Identify the essentials of short-term financial planning Topic: Short-term financing

52. Dover Wholesalers sells products exclusively to Benn Retailer. Benn Retailer buys exclusively from Dover Wholesalers. Dover Wholesalers has a receivables period of 44 days, an inventory period of 8 days and a payables period of 63 days. Benn Retailer has an inventory period of 15 days, a receivables period of 22 days and a payables period of 44 days. Which statement is correct given this information? A. Dover Wholesalers has a shorter operating cycle than does Benn Retailer. B. Benn Retailer has an operating cycle of 81 days. C. It takes Benn Retailer less time to collect payment on a sale than it does for the firm to sell its inventory. D. Dover Wholesalers is financing 100% of Benn Retailer's operating cycle. E. Dover Wholesalers has a cash cycle of 11 days. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 16.01 Discuss operating and cash cycles and why they are important Topic: The operating cycle and the cash cycle

53. Gaming Station has to restock a popular electronic game every five days as it completely sells out in that period of time. What is the inventory turnover rate for this game? A. 115 times B. 105 times C. 99 times D. 118 times E. 73 times Ans: E

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 16 Testbank

AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 16.01 Discuss operating and cash cycles and why they are important Topic: The operating cycle and the cash cycle

55. Steep Mountain Oil has a cash balance of $15 and a short-term loan balance of $53 at the beginning of Q1. The net cash outflow for Q1of $39 and for Q2 there is a net cash inflow of $23. All cash shortfalls are funded with short-term debt. The firm pays 1.1% of its prior quarter's ending loan balance as interest each quarter. The minimum cash balance is $15. What is the short-term loan balance at the end of the Q2? A. $70.60 B. $81.30 C. $65.90 D. $67.70 E. $76.80 Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 16.03 Identify the essentials of short-term financial planning Topic: A short-term financial plan

56. Kacie’s has an average collection period of 23 days and factors all receivables immediately at a discount of 0.95%. What is the effective cost of borrowing? Assume that default is extremely unlikely. A. 16.32% B. 16.28% C. 16.36%

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 16 Testbank

D. 16.52% E. 16.49% Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 16.03 Identify the essentials of short-term financial planning Topic: A short-term financial plan

57. Which one of the following is a graphical representation of the operating and cash cycles? A. Operations line B. Production period C. Cash flow time line D. Inventory flow chart E. Customer service line Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 16.01 Discuss operating and cash cycles and why they are important Topic: The operating cycle and the cash cycle

58. Big Red’s purchases from suppliers in a quarter are equal to 71% of the next quarter's forecast sales. The payables period is 60 days; other expenses are paid when incurred. Wages, taxes and other expenses are 24% of sales, and interest and dividends are $40 per quarter. No capital expenditures are planned. Projected quarterly sales, starting with Q1, are $1520, $1580, $1630 and $1590, respectively. Sales for the first quarter of the following year are projected at $1540. What is the amount of the total disbursements for Q2? A. $1564 B. $1520 C. $1601 D. $1538 E. $1553 Ans: E AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 16.03 Identify the essentials of short-term financial planning Topic: The cash budget

59. Here are some important figures from the budget of Global Enterprises for the second quarter: Credit sales Credit purchases

April $ 524 600 359 100

May $ 546 800 366 700

June $ 568 100 384 200

Cash disbursements: Wages, taxes, and other Interest Non-current asset purchases

Ross, Essentials of Corporate Finance, Fifth Edition

98 400 7 500 11 300

99 100 7 500 0

Chapter 16 Testbank

124 600 7 500 48 900

The company predicts that 2% of its credit sales will never be collected, 45% of its sales will be collected in the month of sale and the remaining 53% will be collected in the following month. Credit purchases will be paid in the month following the purchase. March credit sales were $487 900 and credit purchases were $349 500. What is the ending cash balance for April if the beginning cash balance was $39 500? A. $67 410 B. $67 457 C. $68 800 D. $64 440 E. $69 230 Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 16.03 Identify the essentials of short-term financial planning Topic: A short-term financial plan

60. Which of these actions is indicative of a restrictive short-term financial policy? A. Granting increasing amounts of credit to customers B. Expanding the number of inventory items carried C. Increasing the firm's investment in the current accounts D. Minimising the cash balances held by the firm E. Investing relatively large amounts in marketable securities Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 16.02 Differentiate between the types of short-term financial policy Topic: Some aspects of short-term financial policy

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 16 Testbank

Chapter 16 Testbank Summary Category AACSB: Analytic Blooms: Analysis Difficulty: Easy Difficulty: Medium Learning Objective: 16.01 Discuss operating and cash cycles and why they are important Learning Objective: 16.02 Differentiate between the types of short-term financial policy Learning Objective: 16.03 Identify the essentials of short-term financial planning Topic: A short-term financial plan Topic: Short-term financing Topic: Some aspects of short-term financial policy Topic: The cash budget Topic: The operating cycle and the cash cycle

# of Questions 60 60 49 11 24 16 20 4 12 16 4 24

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 17 Testbank

Chapter 17 Testbank 1. A firm grants trade credit with terms of 3/20, n/60 (i.e. net 60). It signifies that if payment has not been made within ____ days, then the full invoice price is payable within _____ days. A. 3; 60 B. 20; 40 C. 20; 23 D. 20; 60 2. A firm grants trade credit with terms of 3/20, net 60. What effective annual rate (EAR) does a buyer pay by not taking the discount? If the buyer can borrow funds from a bank at an interest of 21% per annum, should the account be settled within 20 days? A. 32.04%; yes B. 22.04%; yes C. 28.51%; yes D. 16.83%; yes 3. Which of the following are considered as money market securities in Australia? I. Bank-accepted bills II. Commercial bills III. 10-year government bonds IV. Treasury notes V. A bank term loan A. I, II and IV only B. IV, V and VI only C. I, II and V only D. IV and V only 4. A disbursement account into which funds are transferred from a master account only as they are needed to cover cheques presented for payment is called a _____ account. A. zero-balance B. lockbox C. cash clearing D. ledger 5. The economic order quantity (EOQ) is best defined as the: A. least amount of inventory which a firm can purchase at any one time. B. amount of inventory that is sold during the time period that it takes a vendor to restock an item. C. minimal amount of inventory which must be purchased in order to qualify for a cash discount.

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 17 Testbank

D. restocking quantity that minimises the total cost of inventory. 6. Don, a local building contractor, keeps an extra $5000 in his cheque account simply for any emergency which might arise. This is an example of the _____ motive for holding cash. A. transaction B. daily C. availability D. precautionary 7. An increase in which of the following will tend to increase the length of the credit period? I. Product cost II. Consumer demand III. Product perishability IV. Credit risk A. I and IV only B. I only C. I and II only D. II and III only 8. The optimal credit policy: A. minimises the carrying costs associated with granting credit. B. minimises the total cost of granting credit. C. is the policy that produces the largest amount of sales for a firm. D. is the policy that eliminates all potential bad debts. 9. An increase in a firm's average collection period generally indicates that: A. customers are paying more promptly. B. an increased number of customers are taking advantage of the cash discount offered. C. the cash flows of the firm have increased. D. at least some customers are taking longer to pay. 10. A firm has determined that 66% of its accounts receivable are less than one month old, 32% are more than one month but less than two months old, and the remainder are more than two months old. The firm probably compiled a(n) _____ to determine this information. A. settlement statement B. aging schedule C. credit scoring report D. collateral trust schedule 11. Abco International offers credit terms of 2/7, net 20. What is the effective annual rate on a $13 000 purchase if you forgo the discount?

Ross, Essentials of Corporate Finance, Fifth Edition

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A. 21.18% B. 36.50% C. 76.34% D. 28.88% 12. Baxter's, Inc. generally holds $125 000 in cash in case an unexpected investment opportunity arises. Which one of the following refers to holding cash for this type of purpose? A. Precautionary motive B. Opportunistic motive C. Speculative motive D. Transaction motive 13. Which one of the following is the need to hold cash simply as a financial reserve? A. Opportunistic motive B. Speculative motive C. Activity motive D. Precautionary motive 14. The transaction motive for holding cash refers to the need to have cash for which one of the following purposes? A. Investment opportunities B. Financial reserve C. Daily operations D. Bargain opportunities 15. Which one of the following is a speculative motive for holding cash? A. Paying the annual insurance premium on the firm's assets B. Buying extra inventory because a key supplier offered a special one-time discount C. Paying incentives to the employees at the end of every month D. Paying a $100 bonus to all employees at year end 16. Which one of the following defines the terms of sale? A. Conditions under which a firm sells its goods or services for either cash or credit B. Period of time during which a discount can be taken on an invoice C. Legal documents related to the credit sale of either goods or services D. Period of time granted to a customer to pay for the goods or services received 17. Which one of the following is the process of determining the creditworthiness of customers? A. Credit analysis B. Customer invoicing C. Account aging

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 17 Testbank

D. Credit terms 18. Which one of the following is a shortage cost associated with a firm's inventory? A. Restocking cost B. Inventory obsolescence C. Insurance cost D. Opportunity cost of capital 19. Which one of the following best states the primary goal of inventory management? A. Minimise the level of inventory for the most expensive items B. Minimise the average inventory level C. Minimise opportunity costs D. Minimise total inventory costs 20. Which one of the following best defines the term 'credit scoring'? A. the process of quantifying the probability of default when granting credit to customers B. categorising customers into groups depending upon the length of time it takes each customer to pay for purchases C. evaluating the opportunity costs of a credit policy D. compiling a list of accounts receivables segregated by the length of time that each receivable has been outstanding 21. Which one of the following is the set of procedures used to determine the inventory levels for demand-dependent inventory? A. Just-in-time inventory system B. Kanban C. Material requirement planning D. Inventory flow log 22. Which one of the following is a system for managing demand-dependent inventories that minimises the amount of inventory on hand? A. Inventory flow log B. Keiretsu C. Just-in-time inventory system D. Kanban 23. Kate's Korner Market monitors 3% of its inventory on a daily basis, another 20% on a weekly basis and the remaining inventory on a quarterly basis. What inventory management approach is being used? A. Economic order quantity B. Q*

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 17 Testbank

C. Just-in-time D. ABC approach 24. Laurie's Ice Rink keeps an extra $1500 in its cheque account simply in case an emergency arises. Which type of motive for holding cash does this represent? A. Float requirement cash disbursement B. Precautionary C. Transaction D. Speculative 25. When are funds generally transferred into zero-balance accounts? A. Monthly B. Weekly C. Never D. As needed 26. Which one of the following best illustrates the concept of derived demand? A. A minimum wage worker tends to buy more home-brand products than do more highly-paid professionals. B. Retail stores have higher sales around the holiday season than in other seasons of the year. C. Restaurant sales are rising because unemployment is falling. D. A windscreen company has to step up production because motor vehicle sales are increasing. 27. Sydney Surfboards sells 12 000 surfboards a year at an average price per carpet board of $499. The carrying cost per unit is $25 and the fixed order costs are $75. What is the economic order quantity assuming there is no safety stock. A. 848 B. 8 C. 28 D. 268 28. The speculative motive is the need to hold cash: A. to pay outstanding cheques. B. to maintain a firm’s daily operations. C. to invest in opportunities that may arise. D. to compensate a bank for services rendered. 29. Which of the following is NOT a component of credit policy? A. Terms of sale B. Credit analysis C. Collection policy

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 17 Testbank

D. Long-term bonds issue 30. The following classes of costs are usually involved in inventory decisions EXCEPT: A. the cost of ordering. B. the carrying cost. C. the cost of shortages. D. the machining cost. 31. AJ’s Market generally holds $50 000 in cash in case an unexpected investment opportunity arises. This is an example of the ____ motive for holding cash. A. precautionary B. opportunistic C. speculative D. reserve E. transaction 32. Cash concentration is best defined as: A. combining an entire firm's daily receipts into one bank deposit. B. combining a week's worth of cash receipts into one bank deposit. C. combining cash from multiple bank accounts into a firm's main bank accounts. D. using multiple lockboxes for collecting cash payments. E. combining a firm's bills so that disbursement cheques are sent only monthly. 33. The process of determining the probability that potential customers will not pay is called: A. credit analysis. B. collection policy. C. account aging. D. credit terms. E. customer invoicing. 34. Collection policy refers to the: A. process of determining which customers will be granted credit. B. process of determining the probability that customers will not pay. C. set of guidelines used by a firm to determine the cost of offering credit to its customers. D. daily process of handling cash inflows and outflows of cash. E. set of procedures a firm follows in collecting accounts receivable. 35. The length of time a firm grants its customers to pay for their purchases is called the: A. lockbox period. B. discount period. C. credit period.

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 17 Testbank

D. cash cycle. E. receivables turnover period. 36. A bill given to a customer for goods he or she purchased is called a(n): A. account reconciliation. B. invoice. C. docket. D. remittance advice. E. shipping receipt. 37. The primary purpose of a cash discount is to: A. compensate customers for an out-of-stock item. B. compensate customers for faulty goods or services. C. offset the interest charges on an account receivable. D. induce customers to pay promptly. E. induce customers to purchase specialty items. 38. The graphical representation of the sum of the carrying costs and the opportunity costs of a credit policy is called the: A. aging report. B. economic credit function. C. optimal credit curve. D. credit analysis graph. E. credit cost curve. 39. A (n) _____ is a subsidiary of a firm that exists solely to handle the credit functions of the parent company. A. internal credit organisation B. bank C. credit association D. captive finance company E. credit union 40. The set of procedures used to determine the inventory levels for demand-dependent inventories is called: A. the inventory flow log. B. materials requirements planning. C. a just-in-time inventory system. D. the kanban. E. the keiretsu.

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 17 Testbank

41. Which of these is most likely the fastest method of collecting cash? A. Requiring customers to submit all payments to a lockbox B. Requiring customers to submit all payments to the home office C. Initiating a financial electronic data interchange at the time of sale D. Offering customers credit terms of 1/5, net 15 E. Eliminating all disbursement float 42. How quickly can a bank receive payment once it transmits a copy of a cheque to the bank on which the cheque was drawn? A. Immediately B. In one day C. Between one and two days D. In two days E. Between two and three days 43. Cash concentration accounts: A. are no longer needed since the Check Clearing Act for the 21st Century has been passed. B. eliminate the need for lockboxes. C. decrease a firm's disbursement float by reducing mail and processing delays. D. allow firms to more efficiently handle cash. E. tend to decrease a firm's investment income. 44. Which of these is the most ethical practice related to cash disbursement management? A. Intentionally delaying payments by creating a complex accounts payable system B. Taking the cash discount but paying after the discount period C. Paying a supplier from a zero-balance account D. Purposely losing a supplier's invoice and requiring the supplier to submit another copy E. Mailing a cheque from the most remote location possible 45. Which one of the following is a primary benefit of implementing zero-balance accounts into a cash management system? A. Increased disbursements float B. Total elimination of all safety shares C. Additional cash availability D. Decreased collection float E. Elimination of all float 46. Which statement is true concerning a controlled disbursement account? A. The number of cheques that can be disbursed on any one day is limited. B. The bank will inform the firm of the amount that needs to be transferred on a daily basis. C. The amount that can be disbursed on any given day is limited to the balance in the account when the bank opens in the morning.

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 17 Testbank

D. The total number of cheques that can be written in any one month is limited. E. The amount of the disbursements is limited to the amount the firm has available on its bank line of credit. 47. Which characteristic generally applies to commercial paper? A. Issued only by financial institutions B. Issued only by corporations C. Maturities limited to 90 days or less D. Unsecured E. Secured by accounts receivable 48. A firm offers credit terms of 1/5, net 25. How long is the net credit period? A. 1 day B. 5 days C. 20 days D. 25 days E. 30 days 49. A firm grants credit with terms of 2/10, net 30. The firm's customers have ___ days to pay in order to receive a _____% discount. A. 2; 10 B. 10; 2 C. 15; 2 D. 20; 2 E. 30; 20 50. Which of these is the best example of a raw material? A. Set of tires for an automaker B. Partially assembled airplane C. Cabinets ready to be shipped D. Can of paint waiting to be sold E. Completed product awaiting customer delivery 51. The primary goal of inventory management is to minimise the: A. number of orders per year. B. average inventory level. C. total costs of holding inventory. D. level of inventory for the most expensive items. E. total opportunity costs.

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 17 Testbank

52. The economic order quantity approach states that inventory order sizes should be determined by: A. dividing annual item sales by the carrying cost per item and multiplying by 2. B. computing the average number of items sold each month. C. equating restocking costs with carrying costs. D. dividing the inventory into various groups based on the value per item. E. computing the amount of the derived demand. 53. A firm uses the extended economic order quantity approach to inventory management. Which one of the following inventory levels is considered to be the minimum inventory level given this approach? A. Zero inventory B. Reorder point level C. Safety stock level D. 50% of the reorder quantity E. Safety stock plus the reorder quantity 54. Which one of the following inventory management approaches determines the finished goods inventory level and then works backward until the raw material needs are determined? A. Extended EOQ B. Just-in-time C. ABC approach D. Materials requirements planning E. Economic order quantity 55. Rock Bottom Carpets sells 3100 carpets a year at an average price per carpet of $1640. The carrying cost per unit is $218.40. The company orders 500 carpets at a time and has a fixed order cost of $78 per order. The carpets are sold out before they are restocked. What is the economic order quantity? A. 38 carpets B. 66 carpets C. 47 carpets D. 51 carpets E. 72 carpets 56. Used Furniture sells 1330 sofas a year at an average price per sofa of $549. The carrying cost per unit is $31.60. The company orders 75 sofas at a time and has a fixed order cost of $69 per order. The sofas are sold out before they are restocked. What is the economic order quantity? A. 76 sofas B. 72 sofas C. 81 sofas D. 98 sofas E. 101 sofas

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 17 Testbank

57. The Flowering Vine buys hanging plants for $4 each and resells them for $10.95 each. The firm sells 6200 plants per year. Generally, the firm orders 250 plants at a time and has a fixed cost per order of $49. The carrying cost per unit is $22.32. To avoid newer plants mixing with older plants, the inventory is totally sold out before it is restocked. Given the current ordering system, the total annual carrying cost is ____ and the total annual restocking cost is ____. A. $2811; $1215 B. $2811; $1269 C. $2790; $1215 D. $2790; $1225 E. $3212; $1269 58. Stinkey sells 2250 units of its perfume collection each year at a price per unit of $199. All sales are on credit with terms of 2/7, net 30. The discount is taken by 91% of the customers. What is the average amount of the company's accounts receivable? A. $11 126 B. $11 246 C. $11 003 D. $14 815 E. $14 778 59. PP&M sells earnings forecasts for international securities. Its credit terms are 1/5, net 20. Based on experience, 66% of all customers take the discount. What is the average collection period? A. 10.4 days B. 10.1 days C. 11.1 days D. 10.6 days E. 10.9 days 60. Kelly just finished compiling a listing of her firm's accounts receivables with each invoice segregated according to the length of time the invoice has been outstanding. What is the name given to this listing? A. Aging schedule B. Collection report C. Credit evaluation report D. Invoice schedule E. Terms of credit

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 17 Testbank

Chapter 17 Testbank Key 1. A firm grants trade credit with terms of 3/20, n/60 (i.e. net 60). It signifies that if payment has not been made within ____ days, then the full invoice price is payable within _____ days. A. 3; 60 B. 20; 40 C. 20; 23 D. 20; 60 Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 17.02 Analyse how firms manage their receivables and the basic components of a firm’s credit policies Topic: Credit and receivables

2. A firm grants trade credit with terms of 3/20, net 60. What effective annual rate (EAR) does a buyer pay by not taking the discount? If the buyer can borrow funds from a bank at an interest of 21% per annum, should the account be settled within 20 days? A. 32.04%; yes B. 22.04%; yes C. 28.51%; yes D. 16.83%; yes Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 17.02 Analyse how firms manage their receivables and the basic components of a firm’s credit policies Topic: Credit and receivables

3. Which of the following are considered as money market securities in Australia? I. Bank-accepted bills II. Commercial bills III. 10-year government bonds IV. Treasury notes V. A bank term loan A. I, II and IV only B. IV, V and VI only C. I, II and V only D. IV and V only Ans: A

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 17 Testbank

AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 17.01 Explain how firms manage their cash and liquidity Topic: Cash and liquidity management

4. A disbursement account into which funds are transferred from a master account only as they are needed to cover cheques presented for payment is called a _____ account. A. zero-balance B. lockbox C. cash clearing D. ledger Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 17.01 Explain how firms manage their cash and liquidity Topic: Cash management: collection, disbursement and investment

5. The economic order quantity (EOQ) is best defined as the: A. least amount of inventory which a firm can purchase at any one time. B. amount of inventory that is sold during the time period that it takes a vendor to restock an item. C. minimal amount of inventory which must be purchased in order to qualify for a cash discount. D. restocking quantity that minimises the total cost of inventory. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 17.03 Differentiate between the types of inventory and inventory management systems used by firms and explain what determines the optimal inventory level Topic: Inventory management techniques

6. Don, a local building contractor, keeps an extra $5000 in his cheque account simply for any emergency which might arise. This is an example of the _____ motive for holding cash. A. transaction B. daily C. availability D. precautionary Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 17.01 Explain how firms manage their cash and liquidity Topic: Cash and liquidity management

7. An increase in which of the following will tend to increase the length of the credit period?

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 17 Testbank

I. Product cost II. Consumer demand III. Product perishability IV. Credit risk A. I and IV only B. I only C. I and II only D. II and III only Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 17.02 Analyse how firms manage their receivables and the basic components of a firm’s credit policies Topic: Credit and receivables

8. The optimal credit policy: A. minimises the carrying costs associated with granting credit. B. minimises the total cost of granting credit. C. is the policy that produces the largest amount of sales for a firm. D. is the policy that eliminates all potential bad debts. Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 17.02 Analyse how firms manage their receivables and the basic components of a firm’s credit policies Topic: Credit and receivables

9. An increase in a firm's average collection period generally indicates that: A. customers are paying more promptly. B. an increased number of customers are taking advantage of the cash discount offered. C. the cash flows of the firm have increased. D. at least some customers are taking longer to pay. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 17.02 Analyse how firms manage their receivables and the basic components of a firm’s credit policies Topic: Credit and receivables

10. A firm has determined that 66% of its accounts receivable are less than one month old, 32% are more than one month but less than two months old, and the remainder are more than two months old. The firm probably compiled a(n) _____ to determine this information. A. settlement statement B. aging schedule C. credit scoring report D. collateral trust schedule

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 17 Testbank

Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 17.02 Analyse how firms manage their receivables and the basic components of a firm’s credit policies Topic: Credit and receivables

11. Abco International offers credit terms of 2/7, net 20. What is the effective annual rate on a $13 000 purchase if you forgo the discount? A. 21.18% B. 36.50% C. 76.34% D. 28.88% Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 17.02 Analyse how firms manage their receivables and the basic components of a firm’s credit policies Topic: Credit and receivables

12. Baxter's, Inc. generally holds $125 000 in cash in case an unexpected investment opportunity arises. Which one of the following refers to holding cash for this type of purpose? A. Precautionary motive B. Opportunistic motive C. Speculative motive D. Transaction motive Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 17.01 Explain how firms manage their cash and liquidity Topic: Cash and liquidity management

13. Which one of the following is the need to hold cash simply as a financial reserve? A. Opportunistic motive B. Speculative motive C. Activity motive D. Precautionary motive Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 17.01 Explain how firms manage their cash and liquidity Topic: Cash and liquidity management

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 17 Testbank

14. The transaction motive for holding cash refers to the need to have cash for which one of the following purposes? A. Investment opportunities B. Financial reserve C. Daily operations D. Bargain opportunities Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 17.01 Explain how firms manage their cash and liquidity Topic: Cash and liquidity management

15. Which one of the following is a speculative motive for holding cash? A. Paying the annual insurance premium on the firm's assets B. Buying extra inventory because a key supplier offered a special one-time discount C. Paying incentives to the employees at the end of every month D. Paying a $100 bonus to all employees at year end Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 17.01 Explain how firms manage their cash and liquidity Topic: Cash and liquidity management

16. Which one of the following defines the terms of sale? A. Conditions under which a firm sells its goods or services for either cash or credit B. Period of time during which a discount can be taken on an invoice C. Legal documents related to the credit sale of either goods or services D. Period of time granted to a customer to pay for the goods or services received Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 17.02 Analyse how firms manage their receivables and the basic components of a firm’s credit policies Topic: Credit and receivables

17. Which one of the following is the process of determining the creditworthiness of customers? A. Credit analysis B. Customer invoicing C. Account aging D. Credit terms Ans: A

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 17 Testbank

AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 17.02 Analyse how firms manage their receivables and the basic components of a firm’s credit policies Topic: Credit and receivables

18. Which one of the following is a shortage cost associated with a firm's inventory? A. Restocking cost B. Inventory obsolescence C. Insurance cost D. Opportunity cost of capital Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 17.03 Differentiate between the types of inventory and inventory management systems used by firms and explain what determines the optimal inventory level Topic: Inventory management

19. Which one of the following best states the primary goal of inventory management? A. Minimise the level of inventory for the most expensive items B. Minimise the average inventory level C. Minimise opportunity costs D. Minimise total inventory costs Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 17.03 Differentiate between the types of inventory and inventory management systems used by firms and explain what determines the optimal inventory level Topic: Inventory management techniques

20. Which one of the following best defines the term 'credit scoring'? A. the process of quantifying the probability of default when granting credit to customers B. categorising customers into groups depending upon the length of time it takes each customer to pay for purchases C. evaluating the opportunity costs of a credit policy D. compiling a list of accounts receivables segregated by the length of time that each receivable has been outstanding Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 17.02 Analyse how firms manage their receivables and the basic components of a firm’s credit policies Topic: Credit and receivables

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 17 Testbank

21. Which one of the following is the set of procedures used to determine the inventory levels for demand-dependent inventory? A. Just-in-time inventory system B. Kanban C. Material requirement planning D. Inventory flow log Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 17.03 Differentiate between the types of inventory and inventory management systems used by firms and explain what determines the optimal inventory level Topic: Inventory management techniques

22. Which one of the following is a system for managing demand-dependent inventories that minimises the amount of inventory on hand? A. Inventory flow log B. Keiretsu C. Just-in-time inventory system D. Kanban Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 17.03 Differentiate between the types of inventory and inventory management systems used by firms and explain what determines the optimal inventory level Topic: Inventory management techniques

23. Kate's Korner Market monitors 3% of its inventory on a daily basis, another 20% on a weekly basis and the remaining inventory on a quarterly basis. What inventory management approach is being used? A. Economic order quantity B. Q* C. Just-in-time D. ABC approach Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 17.03 Differentiate between the types of inventory and inventory management systems used by firms and explain what determines the optimal inventory level Topic: Inventory management techniques

24. Laurie's Ice Rink keeps an extra $1500 in its cheque account simply in case an emergency arises. Which type of motive for holding cash does this represent? A. Float requirement cash disbursement B. Precautionary

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 17 Testbank

C. Transaction D. Speculative Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 17.01 Explain how firms manage their cash and liquidity Topic: Cash and liquidity management

25. When are funds generally transferred into zero-balance accounts? A. Monthly B. Weekly C. Never D. As needed Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 17.01 Explain how firms manage their cash and liquidity Topic: Cash management: collection, disbursement and investment

26. Which one of the following best illustrates the concept of derived demand? A. A minimum wage worker tends to buy more home-brand products than do more highly-paid professionals. B. Retail stores have higher sales around the holiday season than in other seasons of the year. C. Restaurant sales are rising because unemployment is falling. D. A windscreen company has to step up production because motor vehicle sales are increasing. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 17.03 Differentiate between the types of inventory and inventory management systems used by firms and explain what determines the optimal inventory level Topic: Inventory management

27. Sydney Surfboards sells 12 000 surfboards a year at an average price per carpet board of $499. The carrying cost per unit is $25 and the fixed order costs are $75. What is the economic order quantity assuming there is no safety stock. A. 848 B. 8 C. 28 D. 268 Ans: D

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 17 Testbank

AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 17.03 Differentiate between the types of inventory and inventory management systems used by firms and explain what determines the optimal inventory level Topic: Inventory management techniques

28. The speculative motive is the need to hold cash: A. to pay outstanding cheques. B. to maintain a firm’s daily operations. C. to invest in opportunities that may arise. D. to compensate a bank for services rendered. Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 17.01 Explain how firms manage their cash and liquidity Topic: Cash and liquidity management

29. Which of the following is NOT a component of credit policy? A. Terms of sale B. Credit analysis C. Collection policy D. Long-term bonds issue Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 17.02 Analyse how firms manage their receivables and the basic components of a firm’s credit policies Topic: Credit and receivables

30. The following classes of costs are usually involved in inventory decisions EXCEPT: A. the cost of ordering. B. the carrying cost. C. the cost of shortages. D. the machining cost. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 17.03 Differentiate between the types of inventory and inventory management systems used by firms and explain what determines the optimal inventory level Topic: Inventory management techniques

31. AJ’s Market generally holds $50 000 in cash in case an unexpected investment opportunity arises. This is an example of the ____ motive for holding cash. A. precautionary

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 17 Testbank

B. opportunistic C. speculative D. reserve E. transaction Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 17.01 Explain how firms manage their cash and liquidity Topic: Cash and liquidity management

32. Cash concentration is best defined as: A. combining an entire firm's daily receipts into one bank deposit. B. combining a week's worth of cash receipts into one bank deposit. C. combining cash from multiple bank accounts into a firm's main bank accounts. D. using multiple lockboxes for collecting cash payments. E. combining a firm's bills so that disbursement cheques are sent only monthly. Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 17.01 Explain how firms manage their cash and liquidity Topic: Cash management: collection, disbursement and investment

33. The process of determining the probability that potential customers will not pay is called: A. credit analysis. B. collection policy. C. account aging. D. credit terms. E. customer invoicing. Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 17.02 Analyse how firms manage their receivables and the basic components of a firm’s credit policies Topic: Credit and receivables

34. Collection policy refers to the: A. process of determining which customers will be granted credit. B. process of determining the probability that customers will not pay. C. set of guidelines used by a firm to determine the cost of offering credit to its customers. D. daily process of handling cash inflows and outflows of cash. E. set of procedures a firm follows in collecting accounts receivable. Ans: E

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 17 Testbank

35. The length of time a firm grants its customers to pay for their purchases is called the: A. lockbox period. B. discount period. C. credit period. D. cash cycle. E. receivables turnover period. Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 17.02 Analyse how firms manage their receivables and the basic components of a firm’s credit policies Topic: Credit and receivables

36. A bill given to a customer for goods he or she purchased is called a(n): A. account reconciliation. B. invoice. C. docket. D. remittance advice. E. shipping receipt. Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 17.02 Analyse how firms manage their receivables and the basic components of a firm’s credit policies Topic: Credit and receivables

37. The primary purpose of a cash discount is to: A. compensate customers for an out-of-stock item. B. compensate customers for faulty goods or services. C. offset the interest charges on an account receivable. D. induce customers to pay promptly. E. induce customers to purchase specialty items. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 17.02 Analyse how firms manage their receivables and the basic components of a firm’s credit policies Topic: Credit and receivables

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 17 Testbank

38. The graphical representation of the sum of the carrying costs and the opportunity costs of a credit policy is called the: A. aging report. B. economic credit function. C. optimal credit curve. D. credit analysis graph. E. credit cost curve. Ans: E AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 17.02 Analyse how firms manage their receivables and the basic components of a firm’s credit policies Topic: Credit and receivables

39. A (n) _____ is a subsidiary of a firm that exists solely to handle the credit functions of the parent company. A. internal credit organisation B. bank C. credit association D. captive finance company E. credit union Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 17.02 Analyse how firms manage their receivables and the basic components of a firm’s credit policies Topic: Credit and receivables

40. The set of procedures used to determine the inventory levels for demand-dependent inventories is called: A. the inventory flow log. B. materials requirements planning. C. a just-in-time inventory system. D. the kanban. E. the keiretsu. Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 17.03 Differentiate between the types of inventory and inventory management systems used by firms and explain what determines the optimal inventory level Topic: Inventory management techniques

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 17 Testbank

D. Offering customers credit terms of 1/5, net 15 E. Eliminating all disbursement float Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 17.01 Explain how firms manage their cash and liquidity Topic: Cash and liquidity management

42. How quickly can a bank receive payment once it transmits a copy of a cheque to the bank on which the cheque was drawn? A. Immediately B. In one day C. Between one and two days D. In two days E. Between two and three days Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 17.02 Analyse how firms manage their receivables and the basic components of a firm’s credit policies Topic: Credit and receivables

43. Cash concentration accounts: A. are no longer needed since the Check Clearing Act for the 21st Century has been passed. B. eliminate the need for lockboxes. C. decrease a firm's disbursement float by reducing mail and processing delays. D. allow firms to more efficiently handle cash. E. tend to decrease a firm's investment income. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 17.01 Explain how firms manage their cash and liquidity Topic: Cash and liquidity management

44. Which of these is the most ethical practice related to cash disbursement management? A. Intentionally delaying payments by creating a complex accounts payable system B. Taking the cash discount but paying after the discount period C. Paying a supplier from a zero-balance account D. Purposely losing a supplier's invoice and requiring the supplier to submit another copy E. Mailing a cheque from the most remote location possible Ans: C

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 17 Testbank

AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 17.01 Explain how firms manage their cash and liquidity Topic: Cash management: collection, disbursement and investment

45. Which one of the following is a primary benefit of implementing zero-balance accounts into a cash management system? A. Increased disbursements float B. Total elimination of all safety shares C. Additional cash availability D. Decreased collection float E. Elimination of all float Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 17.01 Explain how firms manage their cash and liquidity Topic: Cash management: collection, disbursement and investment

46. Which statement is true concerning a controlled disbursement account? A. The number of cheques that can be disbursed on any one day is limited. B. The bank will inform the firm of the amount that needs to be transferred on a daily basis. C. The amount that can be disbursed on any given day is limited to the balance in the account when the bank opens in the morning. D. The total number of cheques that can be written in any one month is limited. E. The amount of the disbursements is limited to the amount the firm has available on its bank line of credit. Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 17.01 Explain how firms manage their cash and liquidity Topic: Cash management: collection, disbursement and investment

47. Which characteristic generally applies to commercial paper? A. Issued only by financial institutions B. Issued only by corporations C. Maturities limited to 90 days or less D. Unsecured E. Secured by accounts receivable Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 17.01 Explain how firms manage their cash and liquidity Topic: Cash management: collection, disbursement and investment

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 17 Testbank

48. A firm offers credit terms of 1/5, net 25. How long is the net credit period? A. 1 day B. 5 days C. 20 days D. 25 days E. 30 days Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 17.02 Analyse how firms manage their receivables and the basic components of a firm’s credit policies Topic: Credit and receivables

49. A firm grants credit with terms of 2/10, net 30. The firm's customers have ___ days to pay in order to receive a _____% discount. A. 2; 10 B. 10; 2 C. 15; 2 D. 20; 2 E. 30; 20 Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 17.02 Analyse how firms manage their receivables and the basic components of a firm’s credit policies Topic: Credit and receivables

50. Which of these is the best example of a raw material? A. Set of tires for an automaker B. Partially assembled airplane C. Cabinets ready to be shipped D. Can of paint waiting to be sold E. Completed product awaiting customer delivery Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 17.03 Differentiate between the types of inventory and inventory management systems used by firms and explain what determines the optimal inventory level Topic: Inventory management

51. The primary goal of inventory management is to minimise the: A. number of orders per year. B. average inventory level. C. total costs of holding inventory.

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 17 Testbank

D. level of inventory for the most expensive items. E. total opportunity costs. Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 17.03 Differentiate between the types of inventory and inventory management systems used by firms and explain what determines the optimal inventory level Topic: Inventory management

53. A firm uses the extended economic order quantity approach to inventory management. Which one of the following inventory levels is considered to be the minimum inventory level given this approach? A. Zero inventory B. Reorder point level C. Safety stock level D. 50% of the reorder quantity E. Safety stock plus the reorder quantity Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 17.03 Differentiate between the types of inventory and inventory management systems used by firms and explain what determines the optimal inventory level Topic: Inventory management techniques

54. Which one of the following inventory management approaches determines the finished goods inventory level and then works backward until the raw material needs are determined? A. Extended EOQ B. Just-in-time C. ABC approach D. Materials requirements planning

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 17 Testbank

E. Economic order quantity Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 17.03 Differentiate between the types of inventory and inventory management systems used by firms and explain what determines the optimal inventory level Topic: Inventory management techniques

55. Rock Bottom Carpets sells 3100 carpets a year at an average price per carpet of $1640. The carrying cost per unit is $218.40. The company orders 500 carpets at a time and has a fixed order cost of $78 per order. The carpets are sold out before they are restocked. What is the economic order quantity? A. 38 carpets B. 66 carpets C. 47 carpets D. 51 carpets E. 72 carpets Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 17.03 Differentiate between the types of inventory and inventory management systems used by firms and explain what determines the optimal inventory level Topic: Inventory management techniques

56. Used Furniture sells 1330 sofas a year at an average price per sofa of $549. The carrying cost per unit is $31.60. The company orders 75 sofas at a time and has a fixed order cost of $69 per order. The sofas are sold out before they are restocked. What is the economic order quantity? A. 76 sofas B. 72 sofas C. 81 sofas D. 98 sofas E. 101 sofas Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 17.03 Differentiate between the types of inventory and inventory management systems used by firms and explain what determines the optimal inventory level Topic: Inventory management techniques

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 17 Testbank

A. $2811; $1215 B. $2811; $1269 C. $2790; $1215 D. $2790; $1225 E. $3212; $1269 Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 17.03 Differentiate between the types of inventory and inventory management systems used by firms and explain what determines the optimal inventory level Topic: Inventory management techniques

58. Stinkey sells 2250 units of its perfume collection each year at a price per unit of $199. All sales are on credit with terms of 2/7, net 30. The discount is taken by 91% of the customers. What is the average amount of the company's accounts receivable? A. $11 126 B. $11 246 C. $11 003 D. $14 815 E. $14 778 Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 17.02 Analyse how firms manage their receivables and the basic components of a firm’s credit policies Topic: Credit and receivables

59. PP&M sells earnings forecasts for international securities. Its credit terms are 1/5, net 20. Based on experience, 66% of all customers take the discount. What is the average collection period? A. 10.4 days B. 10.1 days C. 11.1 days D. 10.6 days E. 10.9 days Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 17.02 Analyse how firms manage their receivables and the basic components of a firm’s credit policies Topic: Credit and receivables

60. Kelly just finished compiling a listing of her firm's accounts receivables with each invoice segregated according to the length of time the invoice has been outstanding. What is the name given to this listing? A. Aging schedule

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 17 Testbank

B. Collection report C. Credit evaluation report D. Invoice schedule E. Terms of credit Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 17.02 Analyse how firms manage their receivables and the basic components of a firm’s credit policies Topic: Credit and receivables

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 17 Testbank

Chapter 17 Testbank Summary Category AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 17.01 Explain how firms manage their cash and liquidity Learning Objective: 17.02 Analyse how firms manage their receivables and the basic components of a firm’s credit policies Learning Objective: 17.03 Differentiate between the types of inventory and inventory management systems used by firms and explain what determines the optimal inventory level Topic: Cash and liquidity management Topic: Cash management: collection, disbursement and investment Topic: Credit and receivables Topic: Inventory management Topic: Inventory management techniques

# of Questions 60 60 60 18 24 18 11 7 24 4 14

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 18 Testbank

Chapter 18 Testbank 1. The following rates are given: 1 euro = 1.90 Australian dollars (AUD) 1 euro = 1.90 Swiss francs (CHF) 1 AUD = 0.97 CHF If you have 100 000 Australian dollars available, how much profit can you earn using the triangle arbitrage? A. A$ nil B. A$3800 C. A$1900 D. A$3093 2. The spot rate for euro is 0.5849 euros for one Australian dollar, and the one year forward rate is €0.5720 = A$1. The risk-free rate in the Eurozone is 4.10%. If interest rate parity exists, a oneyear risk-free security is yielding ___ % per annum. A. 5.12% B. 6.80% C. 7.15% D. 6.36% 3. A vintage Parker, type 65, fountain pen from 1968, popular among collectors, costs 105 British pounds in the United Kingdom, while you can buy the identical pen for 229 Australian dollars in a shop in Melbourne. According to purchasing-power parity, the AUD/GBP exchange rate is: A. A$1.05/£1 B. A$2.29/£1 C. A$2.40/£1 D. A$2.18/£1 4. The London Interbank Offer Rate (LIBOR) is the rate that most _____ banks charge one another for overnight _____ loans. A. domestic; US dollar B. foreign; gold bullion C. international; gold bullion D. international; Eurodollar 5. Which one of the following is the best universal definition of an exchange rate? A. The number of units of a currency that were originally required to obtain one euro when the country adopted the euro as their official currency

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 18 Testbank

B. The price, which includes the government fee, to purchase a country's currency C. The price of a country's currency expressed in terms of that country's currency unit D. The price of one country's currency expressed in terms of another country's currency 6. A spot trade is defined as an agreement to exchange currencies based on the exchange rate _____ for settlement within _____ business day(s). A. today; two B. today; three C. one year from today; three D. one year from today; two 7. The concept that exchange rates vary to keep purchasing power constant among currencies is referred to as: A. exchange rate equilibrium. B. universal parity. C. exchange rate parity. D. purchasing-power parity. 8. The concept that the difference in interest rates between two countries is equal to the percentage difference between the forward exchange rate and the spot exchange rate is called: A. exchange rate parity. B. interest rate parity. C. exchange rate equilibrium. D. foreign equalisation. 9. Exchange-rate risk is defined by your textbook as the risk related to: A. trading in the foreign exchange markets with the sole purpose of arbitrage. B. investing in a foreign currency for the sole purpose of profiting on rate fluctuations. C. holding a foreign currency as an investment over a period of time. D. having international operations in a world where relative currency values fluctuate. 10. Rembrandt, Samurai, Yankee, Matilda and Bulldog are all names given to: A. domestic bonds. B. foreign bonds. C. foreign interest rates. D. Eurobonds. 11. Which one of the following statements is accurate concerning the foreign exchange market? A. The Foreign Exchange Market has physical trading floors in London, Tokyo and New York City.

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 18 Testbank

B. As a financial market, the foreign exchange market is second in size only to the New York Share Exchange. C. Parties are only permitted to participate in the foreign exchange market if they are holding 40% above. D. The foreign exchange market is an over-the-counter market. 12. Translation exposure to exchange-rate risk is primarily associated with the: A. accounting for a firm's overseas ventures. B. daily exchange of a firm's cash receipts. C. cash investments of a firm. D. actual operations of a firm. 13. The spot rate for the British pound is £0.53 = A$1 and for the euro is €0.78 = A$1. What is the £/€ cross rate? A. £0.6775/€1 B. £0.6795/€1 C. £0.6787/€1 D. £1.4717/€1 14. Eurobonds are best defined as international bonds issued in _____ and denominated in _____. A. multiple countries; a single currency B. a single country; a single currency C. a single country; multiple currencies D. Euroland; euros 15. The market where euros, pesos, dollars and pounds are traded is referred to as which one of the following? A. LIBOR market B. ADR market C. Foreign exchange market D. Gilt market 16. An agreement to exchange currencies at some time in the future is referred to as which one of the following? A. Spot trade B. Forward trade C. Forward exchange rate D. Gilt

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 18 Testbank

17. Assume that PE is the euro price of a product, PAU is the Australian price of the identical product and S0 is the spot exchange rate, quoted as the amount of Euro per Australian dollar. Given this, which one of the following correctly expresses absolute purchasing-power parity? A. PAU = S0 + PE B. PE = S0 / PAU C. PAU = S0 × PE D. PE = S0 × PAU 18. Assume a canned soft drink costs $1 in the Australia and $1.30 in Canada. At the same time, the currency per Australian dollar is C$1.30. Which one of the following conditions exists in this situation? A. absolute purchasing-power parity B. translation exposure C. equal spot and forward rates D. interest rate parity 19. Which one of the following must be significantly eliminated if interest rate parity is to exist? A. Relative purchasing-power parity B. Short-run exposure to exchange-rate risk C. Absolute purchasing-power parity D. Covered interest arbitrage opportunities 20. Interest rate parity defines the relationships among which of the following? A. Spot exchange rates, forward exchange rates, nominal interest rates and real interest rates B. Real and nominal interest rates across countries C. Forward-exchange rates, relative interest rates and spot exchange rates D. Real interest and inflation rates 21. Which one of the following occurs when interest rate parity exists between countries A and B? A. Forward exchange rates for countries A and B must be equal for all time periods. B. Risk-free interest rates in countries A and B must be equal. C. Country A investors are indifferent between risk-free investments in countries A and B. D. Significant covered interest arbitrage opportunities between currencies A and B must exist. 22. Which one of the following is the risk arising from changes in value caused by political actions? A. Exchange-rate risk B. Cross-rate risk C. LIBOR risk D. Political risk

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 18 Testbank

23. Which one of the following terms is defined as having international operations in a world where relative currency values change? A. Interest rate parity B. Exchange-rate risk C. Absolute purchasing-power parity D. Relative purchasing-power parity 24. Short-run exposure to exchange-rate risk is best illustrated by which one of the following? A. Daily fluctuations in the spot rate B. Unrealised foreign exchange gains C. Change in book value when the market value of an asset remains constant D. Changes in relative economic conditions between two countries 25. Which one of the following is an example of the political risks associated with foreign operations? A. Translation exposure to exchange-rate risk B. Technological changes C. Exchange rate fluctuations D. Changes in foreign tax laws 26. Ozzie Nuts Pty Ltd imports walnuts from Canada at a landed cost of US$25.00 per case and sell 10 000 cases per year at A$30.00. Currently the exchange rate is A$1 = US$0.9000 and the company's gross profit would be A$22 222 for a year at this exchange rate. Experts are predicting that the exchange rate will fall to US$0.8300. If the experts are correct, what will happen to Ozzie Nuts' full year gross profit if the selling price remains unchanged? A. Gross profit will not change. B. Gross profit will increase by A$23 428. C. The company will continue to make a profit. D. The company will make a loss on the transactions. 27. The foreign subsidiary of a US firm is profitable when profits are measured in the foreign currency but those profits become losses when measured in US dollars. This is an example of which one of the following? A. Interest rate disparities B. Short-run exposure to exchange-rate risk C. Long-run exposure to exchange-rate risk D. Translation exposure to exchange-rate risk 28. Which one of the following is an example of long-run exposure to exchange-rate risk? Ignore all fees and transaction costs.

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 18 Testbank

A. An Australian firm owns land in Mexico valued at three million pesos. That value has remained constant in Mexican pesos for the past year. However, the firm's financial statement reflects a 3% decrease in the value of that land for last year. B. An Australian firm sells A$250 000 worth of goods to Peru. However, when the payment for those goods arrives and the Australian firm exchanges the foreign currency, it receives only A$248 700. C. An Australian firm purchases A$120 000 worth of goods from Canada. However, by the time the goods arrive and the invoice is payable, the cost of those goods has increased to A$120 400. D. A few years ago an Australian firm built a factory in Asia to take advantage of the lower labour costs. Today, the Asian labour costs have increased such that the Asian factory no longer provides a cost advantage over an Australian factory. 29. Suppose an Australian firm builds a factory in China, staffs it with Chinese workers, uses materials supplied by Chinese companies and finances the entire operation with a loan from a Chinese bank located in the same town as the factory. This firm is most likely trying to greatly reduce, or eliminate, which one of the following? A. Interest rate disparities B. Short-run exposure to exchange-rate risk C. Long-run exposure to exchange-rate risk D. Political risk associated with the foreign operations 30. Which one of the following is a suggested method of handling exchange-rate risk for a large, multinational firm? Assume the operations in each country represent a different division of the firm. A. At the division level B. At a level that combines all divisions representing a separate geographic continent C. At a level that combines divisions based on the currency used by each division D. On a centralised basis for all divisions 31. Assume $1 = €.8036 = A$1.1757. What is the cross-rate for Australian dollars in terms of euros? A. A$1.1066/€1 B. A$1.2908/€1 C. A$1.3929/€1 D. A$1.4630/€1 E. A$1.5042/€1 32. Which one of the following is the best definition of Eurocurrency? A. Any paper money used by a country that has adopted the euro as its common currency B. Money deposited in a financial institution outside the country whose currency is involved C. Both paper and coins officially adopted under the euro system of coinage D. Australian dollars owned by any country that has adopted the euro as its currency

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 18 Testbank

E. Any exchange of funds between two countries that have adopted the euro as their official currency 33. Which one of the following terms is used to describe international bonds issued in a single country and generally denominated in that country's currency? A. Eurobonds B. American Depositary Receipts C. Foreign bonds D. Swaps E. Gilts 34. Which one of the following is the rate that most international banks charge when they loan Eurodollars to other banks? A. ADR B. LIBOR C. Cross-rate D. Gilt rate E. Swap rate 35. Which of these is defined as an agreement to exchange two securities or two currencies? A. Hedge B. Swap C. SWIFT D. Gilt E. Arbitrage 36. Suppose the Swiss franc exchange rate is SF.9703 = $1, and the euro exchange rate is €.8024 = $1. What is the cross-rate in terms of Swiss francs per euro? A. SF.7692/€1 B. SF.7786/€1 C. SF1.1054/€1 D. SF1.1832/€1 E. SF1.2092/€1 37. Assume the USD equivalent of the Norwegian krone is .1425. If you have NKr5, 500, how much do you have in US dollars? A. $861.42 B. $42 608.14 C. $38 596.49 D. $783.75 E. $16 216.50

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 18 Testbank

38. A trader in Switzerland just agreed to trade Swiss francs for British pounds based on today's exchange rate. The trade is expected to settle tomorrow. What term best describes this exchange? A. Arbitrage transaction B. Forward trade C. Spot trade D. Purchasing-power parity E. Interest rate parity 39. The spot exchange rate is the exchange rate that applies to a(n): A. LIBOR transaction. B. ADR transaction. C. spot trade. D. forward trade. E. future transaction. 40. You are going to London and plan on spending £4,200. How many dollars will this trip cost you if the currency per $1 is £.82? A. $5,875.95 B. $5,892.16 C. $5,121.95 D. $5,890.01 E. $6,044.04 41. Assume your favourite running shoes cost $119 in the Australia while the identical shoes cost C$139.50 in Canada. According to purchasing-power parity, what is the C$/$ exchange rate? A. C$0.8530/$1 B. C$0.8426/$1 C. C$1.0918/$1 D. C$1.1723/$1 E. C$1.2305/$1 42. Which of these states that the difference in interest rates between two countries is equal to the percentage difference between the forward exchange rate and the spot exchange rate? A. Arbitrage equilibrium B. Relative purchasing-power parity C. Absolute purchasing-power parity D. Interest rate parity E. Cross-rate parity 43. Assume the one-year forward rate between the Australia and Japan is ¥120.38 = $1. A oneyear risk-free security in Japan is yielding 4.3% while it is 3.8% in the Australia. Assume interest rate parity exists. What is the spot rate between the Australia and Japan?

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 18 Testbank

A. ¥120.41 B. ¥121.08 C. ¥119.80 D. ¥120.94 E. ¥119.03 44. Assume you can exchange $1 for ¥110.23 or €0.86 in Australia. In Tokyo, the exchange rate is ¥1 = €0.009. If you have $900, how much profit can you earn using triangle arbitrage? A. $130.58 B. $127.56 C. $138.21 D. $129.87 E. $135.88 45. The spot rate on the Norwegian kroner is 8.49. The exchange rate one year from now is expected to be 8.53 assuming that relative interest rate parity exists. Interest rates in Norway are 2%. What is the interest rate in Australia? A. 1.53% B. 2.0% C. 1.77% D. 1.04% E. 1.24% 46. Relative purchasing-power parity is based on the principle that the expected percentage change in the exchange rate between two countries is equal to which one of the following? A. Difference in the risk-free interest rates in the two countries B. Average interest rate in the two countries C. Average inflation rate of the two countries D. Difference in the inflation rates of the two countries E. Difference between the two countries' average inflation and interest rates 47. The spot rate on the Canadian dollar is 1.34. Interest rates in Canada are expected to average 3.4% while they are anticipated to be 3.9% in the Australia. What is the expected exchange rate three years from now? A. C$1.37 B. C$1.32 C. C$1.36 D. C$1.29 E. C$1.28

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 18 Testbank

48. Currently, you can exchange €100 for $124.15. The inflation rate in Europe is expected to be 3.3 percent as compared to 3.1 percent in the Australia. Assuming that relative purchasing-power parity exists, what should the exchange rate be five years from now? A. €.8098/$1 B. €.8136/$1 C. €.8071/$1 D. €.8039/$1 E. €.7975/$1 49. Currently, you can exchange €100 for $112.55. The inflation rate in Europe is expected to be 1.4 percent. In one year, it is expected that €100 can be exchanged for $113.50. Assume relative purchasing-power parity exists. What is the expected inflation rate in the U.S.? A. 2.69% B. 2.98% C. 2.24% D. 3.65% E. 3.98% 50. Assume the current spot rate between the UK and the Australia is £.6402 per $1. The expected inflation rate in the Australia is 1.9 percent. The expected inflation rate in the UK is 2.1%. If relative purchasing-power parity exists, what will the exchange rate be two years from now? A. £.6549/$1 B. £.6404/$1 C. £.6417/$1 D. £.6382/$1 E. £.6453/$1 51. Which one of the following is an example of long-run exposure to exchange-rate risk? Ignore all fees and transaction costs. A. An Australian firm owns land in Mexico valued at three million pesos. That value has remained constant in Mexican pesos for the past year. However, the firm's financial statement reflects a 3% decrease in the value of that land for last year. B. An Australian firm sells $250 000 worth of goods to Peru. However, when the payment for those goods arrives and the Australian firm exchanges the foreign currency, it receives only $248 700. C. An Australian firm purchases $120 000 worth of goods from Canada. However, by the time the goods arrive and the invoice is payable, the cost of those goods has increased to $120 400. D. A few years ago, an Australian firm built a factory in Asia to take advantage of the lower labour costs. Today, the Asian labour costs have increased such that the Asian factory no longer provides a cost advantage over an Australian factory. 52. Short-run exposure to exchange-rate risk is best illustrated by which one of the following?

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 18 Testbank

A. Change in book value when the market value of an asset remains constant B. Daily fluctuations in the spot rate C. Increases in the forward rate as the time to settlement increases D. Changes in relative economic conditions between two countries E. Unrealised foreign exchange gains 53. A particular set of golf clubs in the Australia costs $879. According to absolute purchasingpower parity, what should the identical set of clubs cost in the UK if the spot rate is £.6421 = $1? A. £1,368.95 B. £1,428.08 C. £533.80 D. £547.50 E. £564.41 54. Assume you can exchange $1 for either £1 or €0.50 in the Australia. In the London market, you can exchange £1 for €.52. This situation creates an opportunity to profit immediately from which one of the following? A. Futures arbitrage B. Currency hedge C. Interest rate swap D. Absolute purchasing-power parity E. Triangle arbitrage 55. Which one of these provides the greatest political risk for an international firm? A. A product assembly plant located in a foreign country B. A foreign sales office C. Accounting office that handles all payroll functions and is located in a foreign country D. Copper mining in a foreign country 56. You just returned from a trip to Germany and have 523 euros in your pocket. How many dollars will you receive when you exchange this money if .95 Australian dollars equal one euro? A. $502.56 B. $496.85 C. $504.35 D. $497.18 E. $562.56 57. Assume the one-year forward rate for the British pound is £0.6381 = $1. The spot rate is £0.6392 = $1. The interest rate on a risk-free asset in the UK is 4.4%. If interest rate parity exists, what is the one-year risk-free rate in the Australia? A. 4.68% B. 4.58%

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 18 Testbank

C. 4.77% D. 4.63% E. 4.67% 58. The spot rate on the Hong Kong dollar is 7.84. Interest rates in Hong Kong are expected to be 2.75% while they are anticipated to be 2.5% in the Australia. What is the expected exchange rate two years from now? A. HK$7.9825 B. HK$7.1808 C. HK$7.8792 D. HK$8.3778 E. HK$8.4141 59. An Australian firm has total assets valued at €918 000 located in Germany. This valuation did not change from last year. Last year, the exchange rate was €0.92 = $1. Today, the exchange rate is €0.80 = $1. By what amount did these assets change in value for the year on the firm's Australian financial statements? A. −$149 673.91 B. −$162 311.19 C. $162 311.19 D. $149 673.91 E. $0 60. An Australian firm has total assets valued at £318 000 located in London. This valuation did not change from last year. Last year, the exchange rate was £0.61 = $1. Today, the exchange rate is £0.63 = $1. By what amount did these assets change in value on the firm's Australian financial statements? A. −$16 549.57 B. −$13 511.03 C. −$12 248.91 D. $13 511.03 E. $0

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 18 Testbank

Chapter 18 Testbank Key 1. The following rates are given: 1 euro = 1.90 Australian dollars (AUD) 1 euro = 1.90 Swiss francs (CHF) 1 AUD = 0.97 CHF If you have 100 000 Australian dollars available, how much profit can you earn using the triangle arbitrage? A. A$ nil B. A$3800 C. A$1900 D. A$3093 Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 18.01 Explain how exchange rates are quoted, assess what they mean, and differentiate between spot and forward exchange rates Topic: Foreign exchange markets and exchange rates

2. The spot rate for euro is 0.5849 euros for one Australian dollar, and the one year forward rate is €0.5720 = A$1. The risk-free rate in the Eurozone is 4.10%. If interest rate parity exists, a oneyear risk-free security is yielding ___ % per annum. A. 5.12% B. 6.80% C. 7.15% D. 6.36% Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 18.02 Discuss purchasing-power parity and interest rate parity and analyse their implications for exchange-rate changes Topic: Exchange rates and interest rates

3. A vintage Parker, type 65, fountain pen from 1968, popular among collectors, costs 105 British pounds in the United Kingdom, while you can buy the identical pen for 229 Australian dollars in a shop in Melbourne. According to purchasing-power parity, the AUD/GBP exchange rate is: A. A$1.05/£1 B. A$2.29/£1 C. A$2.40/£1 D. A$2.18/£1 Ans: D

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 18 Testbank

AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 18.02 Discuss purchasing-power parity and interest rate parity and analyse their implications for exchange-rate changes Topic: Purchasing-power parity

4. The London Interbank Offer Rate (LIBOR) is the rate that most _____ banks charge one another for overnight _____ loans. A. domestic; US dollar B. foreign; gold bullion C. international; gold bullion D. international; Eurodollar Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 18.01 Explain how exchange rates are quoted, assess what they mean, and differentiate between spot and forward exchange rates Topic: Terminology

5. Which one of the following is the best universal definition of an exchange rate? A. The number of units of a currency that were originally required to obtain one euro when the country adopted the euro as their official currency B. The price, which includes the government fee, to purchase a country's currency C. The price of a country's currency expressed in terms of that country's currency unit D. The price of one country's currency expressed in terms of another country's currency Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 18.01 Explain how exchange rates are quoted, assess what they mean, and differentiate between spot and forward exchange rates Topic: Foreign exchange markets and exchange rates

6. A spot trade is defined as an agreement to exchange currencies based on the exchange rate _____ for settlement within _____ business day(s). A. today; two B. today; three C. one year from today; three D. one year from today; two Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 18.01 Explain how exchange rates are quoted, assess what they mean, and differentiate between spot and forward exchange rates Topic: Foreign exchange markets and exchange rates

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 18 Testbank

7. The concept that exchange rates vary to keep purchasing power constant among currencies is referred to as: A. exchange rate equilibrium. B. universal parity. C. exchange rate parity. D. purchasing-power parity. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 18.02 Discuss purchasing-power parity and interest rate parity and analyse their implications for exchange-rate changes Topic: Purchasing-power parity

8. The concept that the difference in interest rates between two countries is equal to the percentage difference between the forward exchange rate and the spot exchange rate is called: A. exchange rate parity. B. interest rate parity. C. exchange rate equilibrium. D. foreign equalisation. Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 18.02 Discuss purchasing-power parity and interest rate parity and analyse their implications for exchange-rate changes Topic: Exchange rates and interest rates

9. Exchange-rate risk is defined by your textbook as the risk related to: A. trading in the foreign exchange markets with the sole purpose of arbitrage. B. investing in a foreign currency for the sole purpose of profiting on rate fluctuations. C. holding a foreign currency as an investment over a period of time. D. having international operations in a world where relative currency values fluctuate. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 18.03 Identify the different types of exchange-rate risk and ways firms manage exchange-rate risk Topic: Exchange-rate risk

10. Rembrandt, Samurai, Yankee, Matilda and Bulldog are all names given to: A. domestic bonds. B. foreign bonds. C. foreign interest rates. D. Eurobonds.

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 18 Testbank

Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 18.01 Explain how exchange rates are quoted, assess what they mean, and differentiate between spot and forward exchange rates Topic: Terminology

11. Which one of the following statements is accurate concerning the foreign exchange market? A. The Foreign Exchange Market has physical trading floors in London, Tokyo and New York City. B. As a financial market, the foreign exchange market is second in size only to the New York Share Exchange. C. Parties are only permitted to participate in the foreign exchange market if they are holding 40% above. D. The foreign exchange market is an over-the-counter market. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 18.01 Explain how exchange rates are quoted, assess what they mean, and differentiate between spot and forward exchange rates Topic: Foreign exchange markets and exchange rates

12. Translation exposure to exchange-rate risk is primarily associated with the: A. accounting for a firm's overseas ventures. B. daily exchange of a firm's cash receipts. C. cash investments of a firm. D. actual operations of a firm. Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 18.03 Identify the different types of exchange-rate risk and ways firms manage exchange-rate risk Topic: Exchange-rate risk

13. The spot rate for the British pound is £0.53 = A$1 and for the euro is €0.78 = A$1. What is the £/€ cross rate? A. £0.6775/€1 B. £0.6795/€1 C. £0.6787/€1 D. £1.4717/€1 Ans: B

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 18 Testbank

AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 18.01 Explain how exchange rates are quoted, assess what they mean, and differentiate between spot and forward exchange rates Topic: Foreign exchange markets and exchange rates

14. Eurobonds are best defined as international bonds issued in _____ and denominated in _____. A. multiple countries; a single currency B. a single country; a single currency C. a single country; multiple currencies D. Euroland; euros Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 18.01 Explain how exchange rates are quoted, assess what they mean, and differentiate between spot and forward exchange rates Topic: Terminology

15. The market where euros, pesos, dollars and pounds are traded is referred to as which one of the following? A. LIBOR market B. ADR market C. Foreign exchange market D. Gilt market Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 18.01 Explain how exchange rates are quoted, assess what they mean, and differentiate between spot and forward exchange rates Topic: Foreign exchange markets and exchange rates

16. An agreement to exchange currencies at some time in the future is referred to as which one of the following? A. Spot trade B. Forward trade C. Forward exchange rate D. Gilt Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 18.01 Explain how exchange rates are quoted, assess what they mean, and differentiate between spot and forward exchange rates Topic: Foreign exchange markets and exchange rates

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 18 Testbank

18. Assume a canned soft drink costs $1 in the Australia and $1.30 in Canada. At the same time, the currency per Australian dollar is C$1.30. Which one of the following conditions exists in this situation? A. absolute purchasing-power parity B. translation exposure C. equal spot and forward rates D. interest rate parity Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 18.02 Discuss purchasing-power parity and interest rate parity and analyse their implications for exchange-rate changes Topic: Purchasing-power parity

19. Which one of the following must be significantly eliminated if interest rate parity is to exist? A. Relative purchasing-power parity B. Short-run exposure to exchange-rate risk C. Absolute purchasing-power parity D. Covered interest arbitrage opportunities Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 18.02 Discuss purchasing-power parity and interest rate parity and analyse their implications for exchange-rate changes Topic: Exchange rates and interest rates

20. Interest rate parity defines the relationships among which of the following? A. Spot exchange rates, forward exchange rates, nominal interest rates and real interest rates B. Real and nominal interest rates across countries

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 18 Testbank

C. Forward-exchange rates, relative interest rates and spot exchange rates D. Real interest and inflation rates Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 18.02 Discuss purchasing-power parity and interest rate parity and analyse their implications for exchange-rate changes Topic: Exchange rates and interest rates

21. Which one of the following occurs when interest rate parity exists between countries A and B? A. Forward exchange rates for countries A and B must be equal for all time periods. B. Risk-free interest rates in countries A and B must be equal. C. Country A investors are indifferent between risk-free investments in countries A and B. D. Significant covered interest arbitrage opportunities between currencies A and B must exist. Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 18.02 Discuss purchasing-power parity and interest rate parity and analyse their implications for exchange-rate changes Topic: Exchange rates and interest rates

22. Which one of the following is the risk arising from changes in value caused by political actions? A. Exchange-rate risk B. Cross-rate risk C. LIBOR risk D. Political risk Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 18.04 Discuss the impact of political risk on international business investing Topic: Political risk

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 18 Testbank

AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 18.03 Identify the different types of exchange-rate risk and ways firms manage exchange-rate risk Topic: Exchange-rate risk

24. Short-run exposure to exchange-rate risk is best illustrated by which one of the following? A. Daily fluctuations in the spot rate B. Unrealised foreign exchange gains C. Change in book value when the market value of an asset remains constant D. Changes in relative economic conditions between two countries Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 18.03 Identify the different types of exchange-rate risk and ways firms manage exchange-rate risk Topic: Exchange-rate risk

25. Which one of the following is an example of the political risks associated with foreign operations? A. Translation exposure to exchange-rate risk B. Technological changes C. Exchange rate fluctuations D. Changes in foreign tax laws Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 18.04 Discuss the impact of political risk on international business investing Topic: Political risk

26. Ozzie Nuts Pty Ltd imports walnuts from Canada at a landed cost of US$25.00 per case and sell 10 000 cases per year at A$30.00. Currently the exchange rate is A$1 = US$0.9000 and the company's gross profit would be A$22 222 for a year at this exchange rate. Experts are predicting that the exchange rate will fall to US$0.8300. If the experts are correct, what will happen to Ozzie Nuts' full year gross profit if the selling price remains unchanged? A. Gross profit will not change. B. Gross profit will increase by A$23 428. C. The company will continue to make a profit. D. The company will make a loss on the transactions. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 18.03 Identify the different types of exchange-rate risk and ways firms manage exchange-rate risk Topic: Exchange-rate risk

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 18 Testbank

27. The foreign subsidiary of a US firm is profitable when profits are measured in the foreign currency but those profits become losses when measured in US dollars. This is an example of which one of the following? A. Interest rate disparities B. Short-run exposure to exchange-rate risk C. Long-run exposure to exchange-rate risk D. Translation exposure to exchange-rate risk Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 18.03 Identify the different types of exchange-rate risk and ways firms manage exchange-rate risk Topic: Exchange-rate risk

28. Which one of the following is an example of long-run exposure to exchange-rate risk? Ignore all fees and transaction costs. A. An Australian firm owns land in Mexico valued at three million pesos. That value has remained constant in Mexican pesos for the past year. However, the firm's financial statement reflects a 3% decrease in the value of that land for last year. B. An Australian firm sells A$250 000 worth of goods to Peru. However, when the payment for those goods arrives and the Australian firm exchanges the foreign currency, it receives only A$248 700. C. An Australian firm purchases A$120 000 worth of goods from Canada. However, by the time the goods arrive and the invoice is payable, the cost of those goods has increased to A$120 400. D. A few years ago an Australian firm built a factory in Asia to take advantage of the lower labour costs. Today, the Asian labour costs have increased such that the Asian factory no longer provides a cost advantage over an Australian factory. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 18.03 Identify the different types of exchange-rate risk and ways firms manage exchange-rate risk Topic: Exchange-rate risk

29. Suppose an Australian firm builds a factory in China, staffs it with Chinese workers, uses materials supplied by Chinese companies and finances the entire operation with a loan from a Chinese bank located in the same town as the factory. This firm is most likely trying to greatly reduce, or eliminate, which one of the following? A. Interest rate disparities B. Short-run exposure to exchange-rate risk C. Long-run exposure to exchange-rate risk D. Political risk associated with the foreign operations Ans: C

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 18 Testbank

AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 18.03 Identify the different types of exchange-rate risk and ways firms manage exchange-rate risk Topic: Exchange-rate risk

30. Which one of the following is a suggested method of handling exchange-rate risk for a large, multinational firm? Assume the operations in each country represent a different division of the firm. A. At the division level B. At a level that combines all divisions representing a separate geographic continent C. At a level that combines divisions based on the currency used by each division D. On a centralised basis for all divisions Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 18.03 Identify the different types of exchange-rate risk and ways firms manage exchange-rate risk Topic: Exchange-rate risk

31. Assume $1 = €.8036 = A$1.1757. What is the cross-rate for Australian dollars in terms of euros? A. A$1.1066/€1 B. A$1.2908/€1 C. A$1.3929/€1 D. A$1.4630/€1 E. A$1.5042/€1 Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 18.01 Explain how exchange rates are quoted, assess what they mean, and differentiate between spot and forward exchange rates Topic: Foreign exchange markets and exchange rates

32. Which one of the following is the best definition of Eurocurrency? A. Any paper money used by a country that has adopted the euro as its common currency B. Money deposited in a financial institution outside the country whose currency is involved C. Both paper and coins officially adopted under the euro system of coinage D. Australian dollars owned by any country that has adopted the euro as its currency E. Any exchange of funds between two countries that have adopted the euro as their official currency Ans: B

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 18 Testbank

33. Which one of the following terms is used to describe international bonds issued in a single country and generally denominated in that country's currency? A. Eurobonds B. American Depositary Receipts C. Foreign bonds D. Swaps E. Gilts Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 18.01 Explain how exchange rates are quoted, assess what they mean, and differentiate between spot and forward exchange rates Topic: Terminology

34. Which one of the following is the rate that most international banks charge when they loan Eurodollars to other banks? A. ADR B. LIBOR C. Cross-rate D. Gilt rate E. Swap rate Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 18.01 Explain how exchange rates are quoted, assess what they mean, and differentiate between spot and forward exchange rates Topic: Terminology

35. Which of these is defined as an agreement to exchange two securities or two currencies? A. Hedge B. Swap C. SWIFT D. Gilt E. Arbitrage Ans: B

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 18 Testbank

36. Suppose the Swiss franc exchange rate is SF.9703 = $1, and the euro exchange rate is €.8024 = $1. What is the cross-rate in terms of Swiss francs per euro? A. SF.7692/€1 B. SF.7786/€1 C. SF1.1054/€1 D. SF1.1832/€1 E. SF1.2092/€1 Ans: E AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 18.01 Explain how exchange rates are quoted, assess what they mean, and differentiate between spot and forward exchange rates Topic: Foreign exchange markets and exchange rates

37. Assume the USD equivalent of the Norwegian krone is .1425. If you have NKr5, 500, how much do you have in US dollars? A. $861.42 B. $42 608.14 C. $38 596.49 D. $783.75 E. $16 216.50 Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 18.01 Explain how exchange rates are quoted, assess what they mean, and differentiate between spot and forward exchange rates Topic: Foreign exchange markets and exchange rates

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 18 Testbank

39. The spot exchange rate is the exchange rate that applies to a(n): A. LIBOR transaction. B. ADR transaction. C. spot trade. D. forward trade. E. future transaction. Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 18.01 Explain how exchange rates are quoted, assess what they mean, and differentiate between spot and forward exchange rates Topic: Foreign exchange markets and exchange rates

40. You are going to London and plan on spending £4,200. How many dollars will this trip cost you if the currency per $1 is £.82? A. $5,875.95 B. $5,892.16 C. $5,121.95 D. $5,890.01 E. $6,044.04 Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 18.01 Explain how exchange rates are quoted, assess what they mean, and differentiate between spot and forward exchange rates Topic: Foreign exchange markets and exchange rates

41. Assume your favourite running shoes cost $119 in the Australia while the identical shoes cost C$139.50 in Canada. According to purchasing-power parity, what is the C$/$ exchange rate? A. C$0.8530/$1 B. C$0.8426/$1 C. C$1.0918/$1 D. C$1.1723/$1 E. C$1.2305/$1 Ans: D

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 18 Testbank

42. Which of these states that the difference in interest rates between two countries is equal to the percentage difference between the forward exchange rate and the spot exchange rate? A. Arbitrage equilibrium B. Relative purchasing-power parity C. Absolute purchasing-power parity D. Interest rate parity E. Cross-rate parity Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 18.02 Discuss purchasing-power parity and interest rate parity and analyse their implications for exchange-rate changes Topic: Exchange rates and interest rates

43. Assume the one-year forward rate between the Australia and Japan is ¥120.38 = $1. A oneyear risk-free security in Japan is yielding 4.3% while it is 3.8% in the Australia. Assume interest rate parity exists. What is the spot rate between the Australia and Japan? A. ¥120.41 B. ¥121.08 C. ¥119.80 D. ¥120.94 E. ¥119.03 Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 18.02 Discuss purchasing-power parity and interest rate parity and analyse their implications for exchange-rate changes Topic: Exchange rates and interest rates

44. Assume you can exchange $1 for ¥110.23 or €0.86 in Australia. In Tokyo, the exchange rate is ¥1 = €0.009. If you have $900, how much profit can you earn using triangle arbitrage? A. $130.58 B. $127.56 C. $138.21 D. $129.87 E. $135.88 Ans: C

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 18 Testbank

AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 18.02 Discuss purchasing-power parity and interest rate parity and analyse their implications for exchange-rate changes Topic: Foreign exchange markets and exchange rates

45. The spot rate on the Norwegian kroner is 8.49. The exchange rate one year from now is expected to be 8.53 assuming that relative interest rate parity exists. Interest rates in Norway are 2%. What is the interest rate in Australia? A. 1.53% B. 2.0% C. 1.77% D. 1.04% E. 1.24% Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 18.02 Discuss purchasing-power parity and interest rate parity and analyse their implications for exchange-rate changes Topic: Exchange rates and interest rates

46. Relative purchasing-power parity is based on the principle that the expected percentage change in the exchange rate between two countries is equal to which one of the following? A. Difference in the risk-free interest rates in the two countries B. Average interest rate in the two countries C. Average inflation rate of the two countries D. Difference in the inflation rates of the two countries E. Difference between the two countries' average inflation and interest rates Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 18.02 Discuss purchasing-power parity and interest rate parity and analyse their implications for exchange-rate changes Topic: Purchasing-power parity

47. The spot rate on the Canadian dollar is 1.34. Interest rates in Canada are expected to average 3.4% while they are anticipated to be 3.9% in the Australia. What is the expected exchange rate three years from now? A. C$1.37 B. C$1.32 C. C$1.36 D. C$1.29 E. C$1.28 Ans: B

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 18 Testbank

49. Currently, you can exchange €100 for $112.55. The inflation rate in Europe is expected to be 1.4 percent. In one year, it is expected that €100 can be exchanged for $113.50. Assume relative purchasing-power parity exists. What is the expected inflation rate in the U.S.? A. 2.69% B. 2.98% C. 2.24% D. 3.65% E. 3.98% Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 18.02 Discuss purchasing-power parity and interest rate parity and analyse their implications for exchange-rate changes Topic: Purchasing-power parity

50. Assume the current spot rate between the UK and the Australia is £.6402 per $1. The expected inflation rate in the Australia is 1.9 percent. The expected inflation rate in the UK is 2.1%. If relative purchasing-power parity exists, what will the exchange rate be two years from now? A. £.6549/$1 B. £.6404/$1 C. £.6417/$1 D. £.6382/$1

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 18 Testbank

E. £.6453/$1 Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 18.02 Discuss purchasing-power parity and interest rate parity and analyse their implications for exchange-rate changes Topic: Purchasing-power parity

51. Which one of the following is an example of long-run exposure to exchange-rate risk? Ignore all fees and transaction costs. A. An Australian firm owns land in Mexico valued at three million pesos. That value has remained constant in Mexican pesos for the past year. However, the firm's financial statement reflects a 3% decrease in the value of that land for last year. B. An Australian firm sells $250 000 worth of goods to Peru. However, when the payment for those goods arrives and the Australian firm exchanges the foreign currency, it receives only $248 700. C. An Australian firm purchases $120 000 worth of goods from Canada. However, by the time the goods arrive and the invoice is payable, the cost of those goods has increased to $120 400. D. A few years ago, an Australian firm built a factory in Asia to take advantage of the lower labour costs. Today, the Asian labour costs have increased such that the Asian factory no longer provides a cost advantage over an Australian factory. Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 18.03 Identify the different types of exchange-rate risk and ways firms manage exchange-rate risk Topic: Exchange-rate risk

52. Short-run exposure to exchange-rate risk is best illustrated by which one of the following? A. Change in book value when the market value of an asset remains constant B. Daily fluctuations in the spot rate C. Increases in the forward rate as the time to settlement increases D. Changes in relative economic conditions between two countries E. Unrealised foreign exchange gains Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 18.03 Identify the different types of exchange-rate risk and ways firms manage exchange-rate risk Topic: Exchange-rate risk

53. A particular set of golf clubs in the Australia costs $879. According to absolute purchasingpower parity, what should the identical set of clubs cost in the UK if the spot rate is £.6421 = $1? A. £1,368.95 B. £1,428.08 C. £533.80

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 18 Testbank

D. £547.50 E. £564.41 Ans: E AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 18.02 Discuss purchasing-power parity and interest rate parity and analyse their implications for exchange-rate changes Topic: Purchasing-power parity

54. Assume you can exchange $1 for either £1 or €0.50 in the Australia. In the London market, you can exchange £1 for €.52. This situation creates an opportunity to profit immediately from which one of the following? A. Futures arbitrage B. Currency hedge C. Interest rate swap D. Absolute purchasing-power parity E. Triangle arbitrage Ans: E AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 18.01 Explain how exchange rates are quoted, assess what they mean, and differentiate between spot and forward exchange rates Topic: Foreign exchange markets and exchange rates

55. Which one of these provides the greatest political risk for an international firm? A. A product assembly plant located in a foreign country B. A foreign sales office C. Accounting office that handles all payroll functions and is located in a foreign country D. Copper mining in a foreign country Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Easy Learning Objective: 18.04 Discuss the impact of political risk on international business investing Topic: Political risk

56. You just returned from a trip to Germany and have 523 euros in your pocket. How many dollars will you receive when you exchange this money if .95 Australian dollars equal one euro? A. $502.56 B. $496.85 C. $504.35 D. $497.18 E. $562.56 Ans: B

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 18 Testbank

57. Assume the one-year forward rate for the British pound is £0.6381 = $1. The spot rate is £0.6392 = $1. The interest rate on a risk-free asset in the UK is 4.4%. If interest rate parity exists, what is the one-year risk-free rate in the Australia? A. 4.68% B. 4.58% C. 4.77% D. 4.63% E. 4.67% Ans: B AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 18.02 Discuss purchasing-power parity and interest rate parity and analyse their implications for exchange-rate changes Topic: Exchange rates and interest rates

58. The spot rate on the Hong Kong dollar is 7.84. Interest rates in Hong Kong are expected to be 2.75% while they are anticipated to be 2.5% in the Australia. What is the expected exchange rate two years from now? A. HK$7.9825 B. HK$7.1808 C. HK$7.8792 D. HK$8.3778 E. HK$8.4141 Ans: C AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 18.02 Discuss purchasing-power parity and interest rate parity and analyse their implications for exchange-rate changes Topic: Exchange rates and interest rates

59. An Australian firm has total assets valued at €918 000 located in Germany. This valuation did not change from last year. Last year, the exchange rate was €0.92 = $1. Today, the exchange rate is €0.80 = $1. By what amount did these assets change in value for the year on the firm's Australian financial statements? A. −$149 673.91 B. −$162 311.19 C. $162 311.19 D. $149 673.91

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 18 Testbank

E. $0 Ans: D AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 18.03 Identify the different types of exchange-rate risk and ways firms manage exchange-rate risk Topic: Exchange-rate risk

60. An Australian firm has total assets valued at £318 000 located in London. This valuation did not change from last year. Last year, the exchange rate was £0.61 = $1. Today, the exchange rate is £0.63 = $1. By what amount did these assets change in value on the firm's Australian financial statements? A. −$16 549.57 B. −$13 511.03 C. −$12 248.91 D. $13 511.03 E. $0 Ans: A AACSB: Analytic Blooms: Analysis Difficulty: Medium Learning Objective: 18.03 Identify the different types of exchange-rate risk and ways firms manage exchange-rate risk Topic: Exchange-rate risk

Ross, Essentials of Corporate Finance, Fifth Edition

Chapter 18 Testbank

Chapter 18 Testbank Summary Category AACSB: Analytic Blooms: Analysis Difficulty: Easy Difficulty: Medium Learning Objective: 18.01 Explain how exchange rates are quoted, assess what they mean, and differentiate between spot and forward exchange rates Learning Objective: 18.02 Discuss purchasing-power parity and interest rate parity and analyse their implications for exchange-rate changes Learning Objective: 18.03 Identify the different types of exchange-rate risk and ways firms manage exchange-rate risk Learning Objective: 18.04 Discuss the impact of political risk on international business investing Topic: Exchange rates and interest rates Topic: Exchange-rate risk Topic: Foreign exchange markets and exchange rates Topic: Political risk Topic: Purchasing-power parity Topic: Terminology

# of Questions 60 60 44 16 22 22 13 3 11 13 16 3 10 7