TEST BANK for Finance: Applications and Theory 5th Edition by Marcia Cornett, Troy Adair & John Nofs by StudyGuide

Finance, 5e (Cornett) Chapter 1 Introduction to Financial Management 1) Which statements(s) is/are true for successful application of financial theories? A) The economy will be more productive. B) Individual's wealth will grow. C) A and B are true. D) None of the above. Answer: C Difficulty: 1 Easy Topic: Financial theories Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 01-01 Define the major areas of finance as they apply to corporate financial management. 2) Not all cash a company generates will be returned to the investors. Which of the following will NOT reduce the amount of capital returned to the investors? A) retained earnings B) taxes C) dividends Answer: C Difficulty: 1 Easy Topic: Dividends and pay out policy Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 01-01 Define the major areas of finance as they apply to corporate financial management.

3) This subarea of finance involves methods and techniques to make appropriate decisions about what kinds of securities to own, which firms' securities to buy, and how to be paid back in the form that the investor wishes. A) real markets B) investments C) financial management Answer: B Difficulty: 1 Easy Topic: Introduction to corporate finance Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 01-01 Define the major areas of finance as they apply to corporate financial management. 4) This subarea of finance looks at firm decisions in acquiring and utilizing cash received from investors or from retained earnings. A) investments B) financial management C) financial institutions and markets Answer: B Difficulty: 1 Easy Topic: Introduction to corporate finance Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 01-01 Define the major areas of finance as they apply to corporate financial management. 5) Financial management involves decisions about which of the following? A) which projects to fund B) how to minimize taxation C) what type of capital should be raised D) all of these choices are correct. Answer: D Difficulty: 1 Easy Topic: Financial management decisions Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 01-01 Define the major areas of finance as they apply to corporate financial management.

6) This subarea of finance helps facilitate the capital flows between investors and companies. A) investments B) financial management C) treasury management D) financial institutions and markets Answer: D Difficulty: 1 Easy Topic: Introduction to corporate finance Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 01-01 Define the major areas of finance as they apply to corporate financial management. 7) This subarea of finance is important for adapting to the global economy. A) investments B) financial management C) international finance D) financial institutions and markets Answer: C Difficulty: 1 Easy Topic: Introduction to corporate finance Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 01-01 Define the major areas of finance as they apply to corporate financial management. 8) A potential future negative impact to value and/or cash flows is often discussed in terms of probability of loss and the expected magnitude of the loss. This is called A) options. B) standard deviation. C) coefficient of variation. D) risk. Answer: D Difficulty: 1 Easy Topic: Risks and returns Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 01-01 Define the major areas of finance as they apply to corporate financial management.

9) This is a term to describe non-physical assets like stocks and bonds that get their value from future cash flows. A) investment B) financial asset C) real asset D) financial markets Answer: B Difficulty: 1 Easy Topic: Introduction to corporate finance Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 01-01 Define the major areas of finance as they apply to corporate financial management. 10) Which of the following is defined as a group of securities that exhibit similar characteristics, behave similarly in the marketplace, and are subject to the same laws and regulations? A) investments B) asset classes C) market instruments D) financial markets Answer: B Difficulty: 1 Easy Topic: Introduction to corporate finance Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 01-01 Define the major areas of finance as they apply to corporate financial management. 11) The most commonly accepted groups of asset classes include all of the following except A) stocks. B) bonds. C) machinery and equipment. D) real estate. Answer: C Difficulty: 1 Easy Topic: Introduction to corporate finance Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 01-01 Define the major areas of finance as they apply to corporate financial management. 4

12) Which of the following is the firm's highest-level financial manager? A) chief executive officer B) chief financial officer C) board of directors D) corporate governance Answer: B Difficulty: 1 Easy Topic: Management organization and roles Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 01-02 Show how finance is at the heart of sound business decisions. 13) Which of the following managers would NOT use finance? A) operational managers B) marketing managers C) human resource managers D) all of these choices are correct. Answer: D Difficulty: 1 Easy Topic: Management organization and roles Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 01-02 Show how finance is at the heart of sound business decisions. 14) Which of the following personal decisions is NOT impacted by finance? A) borrowing money to purchase cars or homes B) making credit card payments C) making retirement decisions D) all of these choices are correct. Answer: D Difficulty: 1 Easy Topic: Introduction to corporate finance Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 01-03 Learn the financial principles that govern your personal decisions.

15) When determining a form of business organization, all of the following are considered EXCEPT A) who owns the firm. B) the owners' risks. C) the tax ramifications. D) the physical location of the business. Answer: D Difficulty: 1 Easy Topic: Forms of business organization Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 01-04 Examine the three most common business organizational forms in the United States today. 16) This type of business organization is relatively easy to start, and it is subject to much lighter regulatory and paperwork burden than other business forms. A) sole proprietorship B) partnership C) corporation D) hybrid organization Answer: A Difficulty: 1 Easy Topic: Forms of business organization Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 01-04 Examine the three most common business organizational forms in the United States today. 17) This type of business organization is entirely legally independent from its owners. A) sole proprietorship B) partnership C) public corporations D) hybrid organizations Answer: C Difficulty: 1 Easy Topic: Forms of business organization Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 01-04 Examine the three most common business organizational forms in the United States today. 6

18) Which of the following is NOT considered a hybrid organization? A) S corporation B) limited liability partnership C) limited liability company D) limited partnership E) all of these choices are correct. Answer: E Difficulty: 1 Easy Topic: Forms of business organization Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 01-04 Examine the three most common business organizational forms in the United States today. 19) The practice generally known as double taxation is due to A) shareholders' dividends being taxed at both the federal and state levels. B) corporate income being taxed at both the federal and state levels. C) interest on shareholders' dividends being taxed as income. D) corporate incomes being taxed at the corporate level, then again at the shareholder level when corporate profits are paid out as dividends. Answer: D Difficulty: 2 Medium Topic: Forms of business organization Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 01-04 Examine the three most common business organizational forms in the United States today.

20) As individual legal entities, corporations assume liability for their own debts, so the shareholders hold A) only limited liability. B) unlimited liability. C) shared liability. D) joint liability. Answer: A Difficulty: 1 Easy Topic: Forms of business organization Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 01-04 Examine the three most common business organizational forms in the United States today. 21) In order for an angel investor or venture capitalist to exchange capital for ownership in a business that is a sole proprietorship, which of these must happen? A) The business must be re-formed as a partnership. B) The owner must give up some control. C) The owner must co sign on all loans. D) The business must be re-formed as a partnership and the owner must give up some control. Answer: D Difficulty: 1 Easy Topic: Forms of business organization Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 01-04 Examine the three most common business organizational forms in the United States today. 22) Which statement(s) should be considered to maximize owner's equity value? A) How best to bring additional funds into the firm. B) Which projects to invest in. C) How best to return the profits from those projects to the owners over time. D) All of the above. Answer: D Difficulty: 1 Easy Topic: Goal of financial management Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 01-05 Distinguish among appropriate and inappropriate goals for financial managers. 8

23) For corporations, maximizing the value of owner's equity can also be stated as A) maximizing retained earnings. B) maximizing earnings per share. C) maximizing net income. D) maximizing the stock price. Answer: D Difficulty: 1 Easy Topic: Goal of financial management Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 01-05 Distinguish among appropriate and inappropriate goals for financial managers. 24) A metaphor used to illustrate how an individual pursuing his own interests also tends to promote the good of the community. A) agency theory B) angel investor C) invisible hand D) perks or perquisites Answer: C Difficulty: 2 Medium Topic: Goal of financial management Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 01-05 Distinguish among appropriate and inappropriate goals for financial managers.

25) This should be the primary objective of a firm as it may actually be the most beneficial for society in the long run. A) minimizing layoffs B) maximizing market share C) minimizing costs D) maximizing shareholder value Answer: D Difficulty: 2 Medium Topic: Goal of financial management Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 01-05 Distinguish among appropriate and inappropriate goals for financial managers. 26) Nonwage compensation that might actually enhance owner value, in that such items may boost managers' productivity. A) agency theory B) angel investor C) invisible hand D) perks or perquisites Answer: D Difficulty: 1 Easy Topic: Agency costs and problems Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 01-06 Identify a firm's primary agency relationship and discuss the possible conflicts that may arise. 27) Which of these are NOT basic approaches to minimizing the agency problem? A) ignore the conflict of interest B) monitor managers' actions C) align managers' personal interest with those of the owners by making the managers owners D) all of these choices are correct. Answer: D Difficulty: 2 Medium Topic: Agency costs and problems Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 01-06 Identify a firm's primary agency relationship and discuss the possible conflicts that may arise. 10

28) Which of the following is an example of aligning managers' personal interests with those of the owners? A) allow the managers to have as many perks as they request B) pay the managers high salaries C) offer the managers an equity stake in the firm D) trust the managers' actions as they will always act in the owners' best interest Answer: C Difficulty: 2 Medium Topic: Agency costs and problems Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 01-06 Identify a firm's primary agency relationship and discuss the possible conflicts that may arise. 29) This is the set of laws, policies, incentives, and monitors designed to handle the issues arising from the separation of ownership and control. A) agency theory B) corporate governance C) defined benefit plan D) invisible hand Answer: B Difficulty: 1 Easy Topic: Ethics, governance, and regulation Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 01-06 Identify a firm's primary agency relationship and discuss the possible conflicts that may arise.

30) This group is elected by stockholders to oversee management in a corporation. A) chief counselors B) chief executives C) board of directors D) auditors Answer: C Difficulty: 1 Easy Topic: Management organization and roles Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 01-06 Identify a firm's primary agency relationship and discuss the possible conflicts that may arise. 31) These individuals examine the firm's accounting systems and comment on whether financial statements fairly represent the firm's financial position. A) accounting departments B) chief financial officers C) board of directors D) auditors Answer: D Difficulty: 1 Easy Topic: Introduction to corporate finance Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 01-06 Identify a firm's primary agency relationship and discuss the possible conflicts that may arise. 32) These individuals follow a firm, conduct their own evaluations of the company's business activities, and report to the investment community. A) auditors B) investment analysts C) investment bankers D) credit analysts Answer: B Difficulty: 2 Medium Topic: Introduction to corporate finance Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 01-06 Identify a firm's primary agency relationship and discuss the possible conflicts that may arise. 12

33) These individuals help firms access capital markets and advise managers about how to interact with those capital markets. A) auditors B) investment analysts C) investment bankers D) credit analysts Answer: C Difficulty: 2 Medium Topic: Introduction to corporate finance Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 01-06 Identify a firm's primary agency relationship and discuss the possible conflicts that may arise. 34) These individuals examine a firm's financial strength for its debt holders. A) auditors B) investment analysts C) investment bankers D) credit analysts Answer: D Difficulty: 2 Medium Topic: Introduction to corporate finance Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 01-06 Identify a firm's primary agency relationship and discuss the possible conflicts that may arise.

35) Which of the following is a legal duty between two parties where one party must act in the interest of the other party? A) agency theory B) angel investor C) fiduciary D) investment banker Answer: C Difficulty: 2 Medium Topic: Agency costs and problems Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 01-07 Discuss how ethical decision making is part of the study of financial management. 36) Which of the following can create ethical dilemmas between corporate managers and stockholders? A) agency relationship B) auditors C) boards of directors D) venture capitalist Answer: A Difficulty: 2 Medium Topic: Agency costs and problems Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 01-07 Discuss how ethical decision making is part of the study of financial management.

37) Individuals who provide small amounts of capital and expert business advice to small firms in exchange for an ownership stake in the firm are referred to as A) institutional investors. B) corporate investors. C) angel investors. D) capital investors. Answer: C Difficulty: 1 Easy Topic: Introduction to corporate finance Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 01-04 Examine the three most common business organizational forms in the United States today. 38) The opportunity to buy stock at a fixed price over a specific period of time is referred to as A) stock opportunities. B) stock options. C) real assets. D) restricted stock. Answer: B Difficulty: 1 Easy Topic: Options Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 01-06 Identify a firm's primary agency relationship and discuss the possible conflicts that may arise. 39) The portion of a company's profits that are kept by the company rather than distributed to the stockholders as cash dividends is referred to as A) restricted earnings. B) venture capital. C) retained earnings. D) institutional investment. Answer: C Difficulty: 1 Easy Topic: Statement of retained earnings Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 01-01 Define the major areas of finance as they apply to corporate financial management. 15

40) An employee stock option plan is A) a perk usually only given to the board of directors as compensation. B) a plan that only partnerships can use to defer compensation to partners. C) a way to align the interests of employees with those of the owners. Answer: C Difficulty: 1 Easy Topic: Employee stock options Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 01-06 Identify a firm's primary agency relationship and discuss the possible conflicts that may arise. 41) Outside parties that monitor the firm include all of the following EXCEPT A) credit agencies. B) the New York Stock Exchange. C) analysts. D) bankers. Answer: B Difficulty: 1 Easy Topic: Agency costs and problems Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 01-06 Identify a firm's primary agency relationship and discuss the possible conflicts that may arise. 42) Which of the following is NOT a function of the board of directors? A) hire the CEO B) evaluate the CEO C) design compensation contracts for the CEO D) provide reports to the auditors Answer: D Difficulty: 1 Easy Topic: Management organization and roles Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 01-06 Identify a firm's primary agency relationship and discuss the possible conflicts that may arise.

43) The overall goal of the financial manager is to A) minimize total costs. B) maximize net income. C) maximize earnings per share. D) maximize shareholder wealth. Answer: D Difficulty: 1 Easy Topic: Goal of financial management Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 01-01 Define the major areas of finance as they apply to corporate financial management. 44) Maximizing owners' equity value means carefully considering all of the following EXCEPT A) how to best bring additional funds into the firm. B) which projects to invest in. C) how best to increase the firm's risk. D) how best to return the profits from those projects to the owners over time. Answer: C Difficulty: 1 Easy Topic: Goal of financial management Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 01-01 Define the major areas of finance as they apply to corporate financial management. 45) The agency relationship in corporate finance occurs A) when the shareholders hire a manager to run their company. B) when the corporation hires an advertising agency to market their new product or service. C) when the board of directors are elected to staggered terms. D) when the board of directors oversee the CEO. Answer: A Difficulty: 1 Easy Topic: Agency costs and problems Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 01-06 Identify a firm's primary agency relationship and discuss the possible conflicts that may arise.

46) The most common type of business in the United States is the A) corporation. B) partnership. C) sole proprietorship. D) hybrid organization such as a limited liability company. Answer: C Difficulty: 1 Easy Topic: Forms of business organization Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 01-04 Examine the three most common business organizational forms in the United States today. 47) The biggest disadvantage of the sole proprietorship is A) unlimited liability. B) double taxation. C) limited access to capital. D) total control. Answer: A Difficulty: 1 Easy Topic: Forms of business organization Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 01-04 Examine the three most common business organizational forms in the United States today. 48) Which of the following statements is incorrect? A) Sole proprietorships are subject to less regulation. B) Both angel investors and venture capitalists exchange capital for ownership. C) Shareholders are responsible for paying off the corporate bonds in the event of a bankruptcy. D) All of these choices are correct. Answer: C Difficulty: 1 Easy Topic: Forms of business organization Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 01-04 Examine the three most common business organizational forms in the United States today.

49) All of the following are advantages to organizing as a corporation EXCEPT A) limited liability. B) double taxation. C) easy access to capital. D) easy to transfer ownership. Answer: B Difficulty: 1 Easy Topic: Forms of business organization Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 01-04 Examine the three most common business organizational forms in the United States today. 50) Which of the following statements is correct? A) Sole proprietorships are easy to start. B) If the sole proprietorship gets sued, the owner is not liable. C) It is relatively easy for sole proprietorships to raise money. D) Profits from the sole proprietorship are subject to double taxation. Answer: A Difficulty: 1 Easy Topic: Forms of business organization Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 01-04 Examine the three most common business organizational forms in the United States today. 51) From a taxation perspective, the form of business organization with the highest business level taxes is the A) sole proprietorship. B) corporation. C) partnership. D) S corporation. Answer: B Difficulty: 1 Easy Topic: Forms of business organization Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 01-04 Examine the three most common business organizational forms in the United States today.

52) From the perspective of access to capital, the best form of business organization is the A) sole proprietorship. B) corporation. C) partnership. D) S corporation. Answer: B Difficulty: 1 Easy Topic: Forms of business organization Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 01-04 Examine the three most common business organizational forms in the United States today. 53) From the perspective of ownership risk, the best form of business organization is the A) sole proprietorship. B) corporation. C) partnership. D) S corporation. Answer: B Difficulty: 1 Easy Topic: Forms of business organization Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 01-04 Examine the three most common business organizational forms in the United States today. 54) From the perspective of control, the best form of business organization is the A) sole proprietorship. B) corporation. C) partnership. D) S corporation. Answer: A Difficulty: 1 Easy Topic: Forms of business organization Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 01-04 Examine the three most common business organizational forms in the United States today.

55) Which of the following statements is incorrect? A) Partnerships have unlimited liability. B) Most sole proprietors raise money by borrowing from banks. C) An advantage of sole proprietorships is that the owner has complete control. D) S corporations are considered a hybrid organization. Answer: B Difficulty: 1 Easy Topic: Forms of business organization Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 01-04 Examine the three most common business organizational forms in the United States today. 56) Which organization(s) is/are characterized by single taxation and limited liability to all owners? A) S corporations. B) Limited liability partnerships (LLPs). C) Limited liability companies (LLCs). D) All of the above. Answer: D Difficulty: 1 Easy Topic: Forms of business organization Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 01-04 Examine the three most common business organizational forms in the United States today. 57) Which statement is incorrect regarding hybrid organizations? A) They offer single taxation. B) They offer limited risk to the owners. C) They offer the same type of control as a sole proprietorship. D) All of these choices are correct. Answer: C Difficulty: 1 Easy Topic: Forms of business organization Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 01-04 Examine the three most common business organizational forms in the United States today.

58) Agency problems exist in which forms of business ownership? A) sole proprietorship B) S corporation C) partnership D) corporation Answer: D Difficulty: 1 Easy Topic: Agency costs and problems Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 01-06 Identify a firm's primary agency relationship and discuss the possible conflicts that may arise. 59) Methods to minimize agency problem include all EXCEPT A) offer the managers an equity stake in the firm. B) award the CEO stock options. C) allow the CEO to purchase stock via an employee stock option plan. D) allow the CEO to purchase bonds via an employee bond option plan. Answer: D Difficulty: 1 Easy Topic: Agency costs and problems Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 01-06 Identify a firm's primary agency relationship and discuss the possible conflicts that may arise. 60) All of the following are an example of a fiduciary relationship EXCEPT A) a bank employee manages deposits. B) a financial advisor advises her clients. C) a CEO manages the firm. D) the shareholder elects a board member. Answer: D Difficulty: 1 Easy Topic: Agency costs and problems Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 01-07 Discuss how ethical decision making is part of the study of financial management.

61) Restricted stock is A) a special type of stock that is not transferable from the current holder to others until specific conditions are satisfied. B) a special type of stock that can be converted into corporate bonds after a specific amount of time has elapsed. C) a special type of stock that is a result of offering an employee stock ownership plan. Answer: A Difficulty: 1 Easy Topic: Introduction to corporate finance Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 01-07 Discuss how ethical decision making is part of the study of financial management. 62) The board of directors A) are hired by the CEO. B) are elected by shareholders. C) have unlimited liability since they oversee the day-to-day operations of the firm. D) are employed by the Securities Exchange Commission to ensure its rules and regulations have been met. Answer: B Difficulty: 1 Easy Topic: Management organization and roles Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 01-06 Identify a firm's primary agency relationship and discuss the possible conflicts that may arise. 63) Which of these does NOT act as a monitor of how the firm is being run outside the firm? A) auditors B) analysts C) credit rating agencies D) members of the board of directors Answer: D Difficulty: 1 Easy Topic: Ethics, governance, and regulation Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 01-06 Identify a firm's primary agency relationship and discuss the possible conflicts that may arise. 23

64) An angel investor differs from a venture capitalist because of the A) type of investment. B) investment time frame. C) size of investment. D) voting rights. Answer: C Difficulty: 1 Easy Topic: Introduction to corporate finance Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 01-04 Examine the three most common business organizational forms in the United States today. 65) Corporate stakeholders include all of the following EXCEPT A) employees. B) shareholders. C) suppliers. D) auditors. Answer: D Difficulty: 1 Easy Topic: Introduction to corporate finance Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 01-05 Distinguish among appropriate and inappropriate goals for financial managers. 66) What is the difference in perspective between finance and accounting? A) timing B) risk C) liability D) ownership Answer: A Difficulty: 1 Easy Topic: Introduction to corporate finance Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 01-02 Show how finance is at the heart of sound business decisions.

67) Which of the following statements is correct? A) Accountants are focused on what happened in the past. B) Financial managers are focused on what happened in the past. C) Both accountants and financial managers use total quality management systems to standardize data. D) Financial managers double-check the accountant's statements. Answer: A Difficulty: 1 Easy Topic: Introduction to corporate finance Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 01-02 Show how finance is at the heart of sound business decisions. 68) Which of these is the system of incentives and monitors that tries to overcome the agency problem? A) Security Exchange Commission B) Checks and Balances C) Board of Directors D) Corporate Governance Answer: D Difficulty: 1 Easy Topic: Agency costs and problems Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 01-06 Identify a firm's primary agency relationship and discuss the possible conflicts that may arise. 69) The treasurer is typically responsible for: A) Managing cash and credit. B) Issuing and repurchasing financial securities such as stocks and bonds. C) Hedging against charges in foreign exchange and interest rates. D) All of the above. Answer: D Difficulty: 1 Easy Topic: Role of Treasurer Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 01-08 Describe the complex, necessary relationships among firms, financial institutions, and financial markets.

70) Which of the following do not ensure firm viability over the long run? A) maximizing employment B) market share C) profits D) all of these choices are correct. Answer: D Difficulty: 1 Easy Topic: Goal of financial management Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 01-05 Distinguish among appropriate and inappropriate goals for financial managers. 71) Which of these must effectively distribute capital between investors and companies? A) individuals B) international investors C) companies D) financial institutions Answer: D Difficulty: 1 Easy Topic: Capital market performance Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 01-01 Define the major areas of finance as they apply to corporate financial management. 72) Which of the following can use financial concepts to improve their decisions? A) financial professionals only B) financial and nonfinance professionals C) day-to-day operations managers only D) long-term operations managers only Answer: B Difficulty: 1 Easy Topic: Goal of financial management Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 01-02 Show how finance is at the heart of sound business decisions.

73) Which of the following will help you make better personal financial decisions? A) knowing finance theory B) applying financial tools C) auditors D) knowing finance theory and applying financial tools. Answer: D Difficulty: 2 Medium Topic: Introduction to corporate finance Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 01-03 Learn the financial principles that govern your personal decisions. 74) According to an updated rule by the U.S. Securities Exchange Commission in 2017: A) Publicly traded companies are to release a ratio of CEO earnings compared to median pay for workers. B) The median ratio of CEO-to-median-worker-salary for the 100 largest companies is to be 235to-one. C) A and B are true. D) None of the above are true. Answer: D Difficulty: 1 Easy Topic: Tax Cuts & Jobs Act of 2017 Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 01-09 Understand how the new tax law impacts financial decision making. 75) According to the new Tax Cuts and Jobs Act (TCJA) of 2017, which of the following statements are true? A) Changes in tax law can lead to making different financial decisions. B) The new law reduces the amount of debt interest that can be deducted. C) Companies may wish to use more equity financing and less debt financing. D) All of the above. Answer: D Difficulty: 1 Easy Topic: Tax Cuts & Jobs Act of 2017 Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 01-09 Understand how the new tax law impacts financial decision making.

Finance, 5e (Cornett) Chapter 2 Reviewing Financial Statements 1) Which financial statement reports a firm's assets, liabilities, and equity at a particular point in time? A) balance sheet B) income statement C) statement of retained earnings D) statement of cash flows Answer: A Difficulty: 1 Easy Topic: Balance sheet Bloom's: Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 02-01 Recall the major financial statements that firms must prepare and provide. 2) Which financial statement shows the total revenues that a firm earns and the total expenses the firm incurs to generate those revenues over a specific period of time–generally one year? A) balance sheet B) income statement C) statement of retained earnings D) statement of cash flows Answer: B Difficulty: 1 Easy Topic: Income statement Bloom's: Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 02-01 Recall the major financial statements that firms must prepare and provide.

3) Which financial statement reports the amounts of cash that the firm generated and distributed during a particular time period? A) balance sheet B) income statement C) statement of retained earnings D) statement of cash flows Answer: D Difficulty: 1 Easy Topic: Statement of cash flows Bloom's: Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 02-01 Recall the major financial statements that firms must prepare and provide. 4) Which financial statement reconciles net income earned during a given period and any cash dividends paid within that period using the change in retained earnings between the beginning and end of the period? A) balance sheet B) income statement C) statement of retained earnings D) statement of cash flows Answer: C Difficulty: 1 Easy Topic: Statement of retained earnings Bloom's: Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 02-01 Recall the major financial statements that firms must prepare and provide.

5) On which of the four major financial statements would you find the common stock and paid-in surplus? A) balance sheet B) income statement C) statement of cash flows D) statement of retained earnings Answer: A Difficulty: 1 Easy Topic: Balance sheet Bloom's: Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 02-01 Recall the major financial statements that firms must prepare and provide. 6) On which of the four major financial statements would you find the increase in inventory? A) balance sheet B) income statement C) statement of cash flows D) statement of retained earnings Answer: C Difficulty: 1 Easy Topic: Statement of cash flows Bloom's: Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 02-01 Recall the major financial statements that firms must prepare and provide. 7) On which of the four major financial statements would you find net plant and equipment? A) balance sheet B) income statement C) statement of cash flows D) statement of retained earnings Answer: A Difficulty: 1 Easy Topic: Balance sheet Bloom's: Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 02-01 Recall the major financial statements that firms must prepare and provide.

8) Financial statements of publicly traded firms can be found in a number of places. Which of the following is NOT an option for finding publicly traded firms' financial statements? A) Facebook B) a firm's website C) Securities and Exchange Commission's (SEC) website D) websites such as finance.yahoo.com Answer: A Difficulty: 1 Easy Topic: Financial statements Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 02-01 Recall the major financial statements that firms must prepare and provide. 9) Which of the following changes are true of the Tax Cut and Jobs Act (TCJA) of 2017? A) Businesses are allowed to immediately deduct 100% of the cost of eligible property in the year it is placed into service through 2022. B) Allowable bonus depreciations will phase down over four years. C) Both A and B are true. D) None of the above are true. Answer: C Difficulty: 1 Easy Topic: Financial statements Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 02-01 Recall the major financial statements that firms must prepare and provide.

10) Which of the following statements is NOT true of the Tax Cut and Jobs Act (TCJA) of 2017? A) The act permanently lowers corporate taxes from a progressive schedule to a flat 21% starting in 2018. B) The act limits the deductibility of net interest expense that exceeds 21% of a firm's adjusted taxable income starting in 2018. C) Neither A or B is false. D) Both A and B are false. Answer: B Difficulty: 1 Easy Topic: Financial statements Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 02-01 Recall the major financial statements that firms must prepare and provide. 11) For which of the following would one expect the book value of the asset to differ widely from its market value? A) cash B) accounts receivable C) inventory D) fixed assets Answer: D Difficulty: 1 Easy Topic: Market and book values Bloom's: Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 02-02 Differentiate between book (or accounting) value and market value.

12) Common stockholders' equity divided by number of shares of common stock outstanding is the formula for A) earnings per share (EPS). B) dividends per share (DPS). C) book value per share (BVPS). D) market value per share (MVPS). Answer: C Difficulty: 1 Easy Topic: Per-share valuations Bloom's: Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 02-02 Differentiate between book (or accounting) value and market value. 13) When a firm alters its capital structure to include more or less debt (and, in turn, less or more equity), it impacts which of the following? A) the residual cash flows available for stockholders B) the number of shares of stock outstanding C) the earnings per share (EPS) D) all of these choices are correct. Answer: D Difficulty: 2 Medium Topic: Capital structure basics Bloom's: Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 02-03 Explain how taxes influence corporate managers' and investors' decisions. 14) This is the amount of additional taxes a firm must pay out for every additional dollar of taxable income it earns. A) average tax rate B) marginal tax rate C) progressive tax system D) earnings before tax Answer: B Difficulty: 1 Easy Topic: Taxes Bloom's: Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 02-03 Explain how taxes influence corporate managers' and investors' decisions. 6

15) An equity-financed firm will A) pay more in income taxes than a debt-financed firm. B) pay less in income taxes than a debt-financed firm. C) pay the same in income taxes as a debt-financed firm. D) not pay any income taxes. Answer: A Difficulty: 2 Medium Topic: Taxes Bloom's: Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 02-03 Explain how taxes influence corporate managers' and investors' decisions. 16) Deferred taxes occur when a company postpones taxes on profits pertaining to A) tax years they are under an audit by the Internal Revenue Service. B) funds they have not collected because they use the accrual method of accounting. C) a loss they intend to carry back or carry forward on their income tax returns. D) a particular period as they end up postponing part of their tax liability on this year's profits to future years. Answer: D Difficulty: 2 Medium Topic: Taxes Bloom's: Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 02-03 Explain how taxes influence corporate managers' and investors' decisions. 17) When evaluating the statement of cash flows, which of the following statement(s) is/are true? A) Negative cash flow could be a result of investments in new fixed assets or inventory. B) Cash expenditures used to expand the firm could drain cash during expansion periods. C) Can assist financial professionals in identifying where cash is generated and dispersed. D) All of the above. Answer: D Difficulty: 2 Medium Topic: Taxes Bloom's: Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 02-03 Explain how taxes influence corporate managers' and investors' decisions. 7

18) Net operating profit after taxes (NOPAT) is defined as which of the following? A) net profit a firm earns before taxes, but after any financing costs B) net profit a firm earns after taxes, and after any financing cost C) net profit a firm earns after taxes, but before any financing costs D) net profit a firm earns before taxes, and before any financing cost Answer: C Difficulty: 2 Medium Topic: Free cash flow Bloom's: Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 02-04 Differentiate between accounting income and cash flows. 19) This is cash flow available for payments to stockholders and debt holders of a firm after the firm has made investments in assets necessary to sustain the ongoing operations of the firm. A) net income available to common stockholders B) cash flow from operations C) net cash flow D) free cash flow Answer: D Difficulty: 1 Easy Topic: Free cash flow Bloom's: Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 02-05 Demonstrate how to use a firm's financial statements to calculate its cash flows. 20) Which of the following activities result in an increase in a firm's cash? A) decrease fixed assets B) decrease accounts payable C) pay dividends D) repurchase of common stock Answer: A Difficulty: 2 Medium Topic: Sources and uses of cash Bloom's: Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 02-05 Demonstrate how to use a firm's financial statements to calculate its cash flows.

21) These are cash inflows and outflows associated with buying and selling of fixed or other long-term assets. A) cash flows from operations B) cash flows from investing activities C) cash flows from financing activities D) net change in cash and cash equivalents Answer: B Difficulty: 1 Easy Topic: Investing activities Bloom's: Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 02-05 Demonstrate how to use a firm's financial statements to calculate its cash flows. 22) Which statement regarding retained earnings is false? A) Reinvesting earnings is more expensive than raising capital from outside sources. B) Increases in retained earnings can occur because a firm has net income. C) Increases in retained earnings can occur when the firm's common stockholders let management reinvest net income back into the firm rather than payout dividends. D) None of the above. Answer: A Difficulty: 1 Easy Topic: Investing activities Bloom's: Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 02-05 Demonstrate how to use a firm's financial statements to calculate its cash flows.

23) If a company reports a large amount of net income on its income statement during a year, the firm could have A) positive cash flow. B) negative cash flow. C) zero cash flow. D) all of these choices are correct. Answer: D Difficulty: 2 Medium Topic: Cash flows Bloom's: Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 02-05 Demonstrate how to use a firm's financial statements to calculate its cash flows. 24) Free cash flow is defined as A) cash flows available for payments to stockholders of a firm after the firm has made payments to all others with claims against it. B) cash flows available for payments to stockholders and debt holders of a firm after the firm has made payments necessary to vendors. C) cash flows available for payments to stockholders and debt holders of a firm after the firm has made investments in assets necessary to sustain the ongoing operations of the firm. D) cash flows available for payments to stockholders and debt holders of a firm that would be tax-free to the recipients. Answer: C Difficulty: 2 Medium Topic: Free cash flow Bloom's: Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 02-05 Demonstrate how to use a firm's financial statements to calculate its cash flows.

25) The Sarbanes-Oxley Act requires public companies to ensure which of the following individuals have considerable experience applying generally accepted accounting principles (GAAP) for financial statements? A) external auditors B) internal auditors C) chief financial officers D) corporate boards' audit committees Answer: D Difficulty: 2 Medium Topic: Ethics, governance, and regulation Bloom's: Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 02-06 Observe cautions that should be taken when examining financial statements. 26) Within the GAAP framework: A) Managers may smooth earnings to show investors that firm assets are growing. B) Managers may take steps to over or understate earnings. C) Both A and B are possible D) None of the above. Answer: C Difficulty: 2 Medium Topic: Ethics, governance, and regulation Bloom's: Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 02-06 Observe cautions that should be taken when examining financial statements.

27) You are evaluating the balance sheet for Campus Corporation. From the balance sheet you find the following balances: cash and marketable securities = $400,000, accounts receivable = $200,000, inventory = $100,000, accrued wages and taxes = $10,000, accounts payable = $300,000, and notes payable = $600,000. What is Campus's net working capital? A) –$210,000 B) $700,000 C) $910,000 D) $1,610,000 Answer: A Explanation: net working capital = current assets – current liabilities.

Cypress's current assets Cash and marketable securities Accounts receivable Inventory Total current assets

= = = = =

Accrued wages and taxes Accounts payable Notes payable Total current liabilities

= = =

$ 400,000 $ 200,000 $ 100,000 $ 700,000 $ 10,000 $ 300,000 $ 600,000 $ 910,000

So the firm's net working capital is −$210,000 ($700,000 − $910,000). Difficulty: 1 Easy Topic: Net working capital Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 02-01 Recall the major financial statements that firms must prepare and provide.

28) Jack and Jill Corporation's year-end 2018 balance sheet lists current assets of $250,000, fixed assets of $800,000, current liabilities of $195,000, and long-term debt of $300,000. What is Jack and Jill's total stockholders' equity? A) $495,000 B) $555,000 C) $1,050,000 D) There is not enough information to calculate total stockholders' equity. Answer: B Explanation: Recall the balance sheet identity in Equation 2-1: Assets = Liabilities + Equity. Rearranging this equation: Equity = Assets − Liabilities. Thus, the balance sheets would appear as follows:

Book value Book value Assets Liabilities and Equity Current assets $ 250,000 Current liabilities $ 195,000 Fixed assets 800,000 Long—term debt 300,000 Stockholder's equity 555,000 Total $ 1,050,000 Total $ 1,050,000

Difficulty: 1 Easy Topic: Balance sheet Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 02-01 Recall the major financial statements that firms must prepare and provide.

29) Bullseye, Inc.'s 2018 income statement lists the following income and expenses: EBIT = $900,000, interest expense = $85,000, and net income = $570,000. What are the 2018 taxes reported on the income statement? A) $245,000 B) $330,000 C) $815,000 D) There is not enough information to calculate 2018 taxes. Answer: A Explanation: Using the setup of an Income Statement in Table 2.2: EBIT Interest expense EBT Taxes Net income

$ 900,000 − 85,000 815,000 − 245,000 $ 570,000

Difficulty: 1 Easy Topic: Income statement Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 02-01 Recall the major financial statements that firms must prepare and provide.

30) Consider a firm with an EBIT of $500,000. The firm finances its assets with $2,000,000 debt (costing 6 percent) and 50,000 shares of stock selling at $20.00 per share. To reduce the firm's risk associated with this financial leverage, the firm is considering reducing its debt by $1,000,000 by selling an additional 50,000 shares of stock. The firm is in the 40 percent tax bracket. The change in capital structure will have no effect on the operations of the firm. Thus, EBIT will remain $500,000. What is the change in the firm's EPS from this change in capital structure? A) decrease EPS by $1.68 B) decrease EPS by $1.92 C) decrease EPS by $3.20 D) increase EPS by $0.72 Answer: B Explanation: Using the setup of an Income Statement in Example 2.2:

Before Capital Structure Change Change EBIT −Interest ($2,000,000 × 0.06) −Interest ($1,000,000 × 0.06) EBT −Taxes (40%) Net Income Divide # of Shares EPS

$ 500,000 120,000 $ 380,000 152,000 $ 228,000 50,000 $ 4.56

After Capital Structure Change $ 500,000 60,000 $ 440,000 176,000 $ 264,000 100,000 $ 2.64

The change in capital structure would dilute the stockholders' EPS by $1.92. Difficulty: 1 Easy Topic: Per-share valuations Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 02-01 Recall the major financial statements that firms must prepare and provide.

31) Consider a firm with an EBIT of $5,000,000. The firm finances its assets with $20,000,000 debt (costing 5 percent) and 70,000 shares of stock selling at $50.00 per share. To reduce the firm's risk associated with this financial leverage, the firm is considering reducing its debt by $5,000,000 by selling an additional 100,000 shares of stock. The firm is in the 40 percent tax bracket. The change in capital structure will have no effect on the operations of the firm. Thus, EBIT will remain $5,000,000. What is the change in the firm's EPS from this change in capital structure? A) decrease EPS by $9.29 B) decrease EPS by $18.70 C) decrease EPS by $19.29 D) increase EPS by $2.14 Answer: C Explanation: Using the setup of an Income Statement in Example 2.2:

Change EBIT −Interest ($20,000,000 × 0.05) −Interest ($15,000,000 × 0.05) EBT −Taxes (40%) Net Income Divide # of Shares EPS

Before Capital Structure Change

After Capital Structure Change

$ 5,000,000

1,000,000 750,000 $ 4,000,000 1,600,000 $ 2,400,000 70,000 $ 34.29

$ 4,250,000 1,700,000 $ 2,550,000 170,000 $ 15.00

The change in capital structure would dilute the stockholders' EPS by $19.29. Difficulty: 1 Easy Topic: Per-share valuations Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 02-01 Recall the major financial statements that firms must prepare and provide.

32) Barnyard, Inc.'s 2018 income statement lists the following income and expenses: EBIT = $500,000, interest expense = $45,000, and taxes = $152,000. Barnyard's has no preferred stock outstanding and 200,000 shares of common stock outstanding. What are its 2018 earnings per share? A) $2.50 B) $2.275 C) $1.74 D) $1.515 Answer: D Explanation: Using the setup of an Income Statement in Table 2.2:

EBIT Interest expense EBT Taxes Net income

$ 500,000 –45,000 455,000 – 152,000 $ 303,000

Thus, Earnings per share (EPS)

= 303,000 = $1.515 per share 200,000

Difficulty: 1 Easy Topic: Per-share valuations Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 02-01 Recall the major financial statements that firms must prepare and provide.

33) Eccentricity, Inc. had $300,000 in 2018 taxable income. Using the tax schedule from Table 2.3, what are the company's 2018 income taxes, average tax rate, and marginal tax rate, respectively?

Taxable income $0 – $50,000 $50,001 – $75,000 $75,001 – $100,000 $100,001 – $335,000 $335,000 – $10,000,000

Pay this amount on Base income $ 0 $ 7,500 $ 13,750 $ 22,250 $ 113,900

Plus this percentage on anything over the base 15% 25% 34% 39% 34%

A) $22,250, 7.42%, 39% B) $78,000, 26.00%, 39% C) $100,250, 33.42%, 39% D) $139,250, 46.42%, 39% Answer: C Explanation: From Table 2.3, the $300,000 of taxable income puts Eccentricity in the 39 percent marginal tax bracket. Thus, Tax liability = Tax on base amount + Tax rate (amount over base): = $22,250 + .39 ($300,000 − $100,000) = $100,250 Note that the base amount is the maximum dollar value listed in the previous tax bracket. The average tax rate for Eccentricity Inc. comes to:

Average tax rate

= $100,250 $300,000 = 33.4167%

If Eccentricity earned $1 more of taxable income, it would pay 39 cents (its tax rate of 39 percent) more in taxes. Thus, the firm's marginal tax rate is 39 percent. Difficulty: 1 Easy Topic: Taxes Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 02-03 Explain how taxes influence corporate managers' and investors' decisions.

34) Swimmy, Inc. had $400,000 in 2018 taxable income. Using the tax schedule from Table 2.3, what are the company's 2018 income taxes, average tax rate, and marginal tax rate, respectively?

Taxable income $0 – $50,000 $50,001 – $75,000 $75,001 – $100,000 $100,001 – $335,000 $335,000 – $10,000,000

Pay this amount on Base income $ 0 $ 7,500 $ 13,750 $ 22,250 $ 113,900

Plus this percentage on anything over the base 15% 25% 34% 39% 34%

A) $22,100, 5.53%, 34% B) $113,900, 28.48%, 34% C) $136,000, 34.00%, 34% D) $136,000, 39.00%, 34% Answer: C Explanation: From Table 2.3, the $400,000 of taxable income puts Swimmy in the 34 percent marginal tax bracket. Thus, Tax liability = Tax on base amount + Tax rate (amount over base): = $113,900 + 0.34 ($400,000 − $335,000) = $136,000 Note that the base amount is the maximum dollar value listed in the previous tax bracket. The average tax rate for Swimmy Inc. comes to: Average tax rate

= $136,000 $400,000 = 34%

If Swimmy earned $1 more of taxable income, it would pay 34 cents (its tax rate of 34 percent) more in taxes. Thus, the firm's marginal tax rate is 34 percent. Difficulty: 1 Easy Topic: Taxes Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 02-03 Explain how taxes influence corporate managers' and investors' decisions.

35) Scuba, Inc. is concerned about the taxes paid by the company in 2018. In addition to $5 million of taxable income, the firm received $80,000 of interest on state-issued bonds and $500,000 of dividends on common stock it owns in Boating Adventures, Inc. What are Scuba's tax liability, average tax rate, and marginal tax rate, respectively?

Taxable income $0 – $50,000 $50,001 – $75,000 $75,001 – $100,000 $100,001 – $335,000 $335,000 – $10,000,000

Pay this amount on Base income $ 0 $ 7,500 $ 13,750 $ 22,250 $ 113,900

Plus this percentage on anything over the base 15% 25% 34% 39% 34%

A) $1,637,100, 31.79%, 34% B) $1,751,000, 34.00%, 34% C) $1,870,000, 34.00%, 34% D) $1,983,900, 36.07%, 34% Answer: B Explanation: In this case, interest on the state-issued bonds is not taxable and should not be included in taxable income. Further, the first 70 percent of the dividends received from Boating Adventures is not taxable. Thus, only 30 percent of the dividends received are taxed, so: Taxable income = $5,000,000 + (0.3) $500,000 = $5,150,000. Now Scuba's tax liability will be: Tax liability = $113,900 + 0.34 ($5,150,000 – $335,000) = $1,751,000. The $500,000 of dividend income increased Scuba's tax liability by $51,000 (= (0.3) × $500,000 × (0.34)). Scuba's resulting average tax rate is now: Average tax rate = $1,751,000/$5,150,000 = 34.00%. Finally, if Scuba earned $1 more of taxable income, it would still pay 34 cents (based upon its marginal tax rate of 34 percent) more in taxes. Difficulty: 1 Easy Topic: Taxes Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 02-03 Explain how taxes influence corporate managers' and investors' decisions.

36) Paige's Properties Inc. reported 2018 net income of $5 million and depreciation of $1,500,000. Paige's Properties, Inc.'s 2017 and 2018 balance sheets are listed as follows (in millions of dollars).

Current assets Cash and marketable securities Accounts receivable Inventory Total

2017 $ 10 20 10 $ 40

2018 Current liabilities Accrued wages and $ 20 taxes 34 Accounts payable 11 Notes payable $ 65 Total

2017 $

2018 5

$ 11

25 10 $ 40

29 25 $ 65

What is the 2018 net cash flow from operating activities for Paige's Properties, Inc.? A) –$13,500,000 B) $1,500,000 C) $5,000,000 D) $6,500,000 Answer: B Explanation: Cash Flows from Operating Activities Net income Additions (sources of cash): Depreciation Increase accrued wages and taxes Increase in accounts payable Subtraction (uses of cash): Increase in accounts receivable Increase in inventory Net cash flow from operating activities:

5,000,000 1,500,000 6,000,000 4,000,000

− 14,000,000 − 1,000,000 $ 1,500,000

Difficulty: 1 Easy Topic: Operating activities Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 02-04 Differentiate between accounting income and cash flows.

37) In 2018, Upper Crust had cash flows from investing activities of ($250,000) and cash flows from financing activities of ($150,000). The balance in the firm's cash account was $90,000 at the beginning of 2018 and $105,000 at the end of the year. What was Upper Crust's cash flow from operations for 2018? A) $15,000 B) $105,000 C) $400,000 D) $415,000 Answer: D Explanation: Net change in cash and marketable securities = $105,000 − $90,000 = $15,000.

Cash flows from operating activities Cash flows from investing activities Cash flows from financing activities Net change in cash and marketable securities

= = = =

$ 415,000 − 250,000 − 150,000 $ 15,000

38) In 2018, Lower Case Productions had cash flows from investing activities of +$50,000 and cash flows from financing activities of +$100,000. The balance in the firm's cash account was $80,000 at the beginning of 2018 and $65,000 at the end of the year. What was Lower Case's cash flow from operations for 2018? A) –$15,000 B) –$150,000 C) –$165,000 D) –$65,000 Answer: C Explanation: Net change in cash and marketable securities = $65,000 − $80,000 = −$15,000. −$ 165,000

Cash Flows from Operating Activities

Cash Flows from Investing Activities Cash Flows from Financing Activities Net Change in Cash and Marketable Securities

= + 50,000 = + 100,000 = −$ 15,000

39) You are considering an investment in Crew Cut, Inc. and want to evaluate the firm's free cash flow. From the income statement, you see that Crew Cut earned an EBIT of $23 million, paid taxes of $4 million, and its depreciation expense was $8 million. Crew Cut's gross fixed assets increased by $10 million from 2017 to 2018. The firm's current assets increased by $6 million and spontaneous current liabilities increased by $4 million. What is Crew Cut's operating cash flow, investment in operating capital and free cash flow for 2018, respectively in millions? A) $23, $10, $13 B) $23, $12, $11 C) $27, $10, $17 D) $27, $12, $15 Answer: D Explanation: Crew Cut's operating cash flow was: OCF = EBIT − Taxes + Depreciation = ($23m. − $4m. + $8m.) = $27m. Investment in operating capital for 2008 was: IOC = Δ Gross fixed assets + Δ Net operating working capital = $10m. + ($6m. − $4m.) = $12m. Accordingly, Crew Cut's free cash flow for 2008 was: FCF = Operating cash flow − Investment in operating capital = $27m. − $12m. = $15m.

In other words, in 2018 Crew Cut had cash flows of $15 million available to pay its stockholders and debt holders. Difficulty: 1 Easy Topic: Free cash flow Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 02-05 Demonstrate how to use a firm's financial statements to calculate its cash flows.

40) You are considering an investment in Cruise, Inc. and want to evaluate the firm's free cash flow. From the income statement, you see that Cruise earned an EBIT of $202 million, paid taxes of $51 million, and its depreciation expense was $75 million. Cruise's gross fixed assets increased by $70 million from 2017 to 2018. The firm's current assets decreased by $10 million and spontaneous current liabilities increased by $6 million. What is Cruise's operating cash flow, investment in operating capital, and free cash flow for 2018, respectively, in millions? A) $202, $70, $130 B) $226, $70, $156 C) $226, $54, $172 D) $226, $74, $152 Answer: C Explanation: Cruise's operating cash flow was: OCF = EBIT − Taxes + Depreciation = ($202m. − $51m. + $75m.) = $226m. Investment in operating capital for 2018 was: IOC = Δ Gross fixed assets + Δ Net operating working capital = $70m. + (–$10m. − $6m.) = $54m. Accordingly, Cruise's free cash flow for 2018 was: FCF = Operating cash flow − Investment in operating capital = $226m. − $54m. = $172m.

In other words, in 2018 Cruise had cash flows of $172 million available to pay its stockholders and debt holders. Difficulty: 1 Easy Topic: Free cash flow Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 02-05 Demonstrate how to use a firm's financial statements to calculate its cash flows.

41) Catering Corp. reported free cash flows for 2018 of $8 million and investment in operating capital of $2 million. Catering listed $1 million in depreciation expense and $2 million in taxes on its 2018 income statement. What was Catering's 2018 EBIT? A) $7 million B) $10 million C) $11 million D) $13 million Answer: C Explanation: Catering's free cash flow for 2018 was: FCF = Operating cash flow − Investment in operating capital $8m. = Operating cash flow − $2m. So, operating cash flow = $8m. + $2m. = $10m. Catering's operating cash flow was: OCF = EBIT − Taxes + Depreciation $10m. = (EBIT − $2m. + $1m.) So, EBIT = $10m. + $2m. − $1m. = $11m. Difficulty: 1 Easy Topic: Free cash flow Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 02-05 Demonstrate how to use a firm's financial statements to calculate its cash flows.

42) TriCycle, Corp. began the year 2018 with $25 million in retained earnings. The firm earned net income of $7 million in 2018 and paid $1 million to its preferred stockholders and $3 million to its common stockholders. What is the year-end 2018 balance in retained earnings for TriCycle? A) $25 million B) $28 million C) $32 million D) $36 million Answer: B Explanation: The statement of retained earnings for 2018 is as follows:

Balance of Retained Earnings, December 31, 2017 Plus: Net Income for 2018 Less: Cash Dividends Paid Preferred Stock Common Stock Total Cash Dividends Paid

$ 25m 7m $ 1m 3m 4m

Balance of Retained Earnings, December 31, 2018

$ 28m

Difficulty: 1 Easy Topic: Statement of retained earnings Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 02-01 Recall the major financial statements that firms must prepare and provide.

43) Night Scapes, Corp. began the year 2018 with $10 million in retained earnings. The firm suffered a net loss of $2 million in 2018 and yet paid $2 million to its preferred stockholders and $1 million to its common stockholders. What is the year-end 2018 balance in retained earnings for Night Scapes? A) $5 million B) $8 million C) $9 million D) $15 million Answer: A Explanation: The statement of retained earnings for 2018 is as follows:

Balance of Retained Earnings, December 31, 2017 Less: Net Income for 2018 Less: Cash Dividends Paid Preferred Stock Common Stock

$ 10m 2m $ 2m 1m

Total Cash Dividends Paid

Balance of Retained Earnings, December 31, 2018

44) Use the following information to find dividends paid to common stockholders during 2018.

Balance of Retained Earnings, December 31, 2017 Plus: Net Income for 2018 Less: Cash Dividends Paid Preferred Stock Common Stock Total Cash Dividends Paid

$ 52m 21m $ 7m ?m ?m

Balance of Retained Earnings, December 31, 2018

$ 56m

A) $3 million B) $4 million C) $10 million D) $17 million Answer: C Explanation: Total Cash Dividends Paid = $56m − $21m − $52m = −$17m. Thus, common stock dividends paid = $17m − $7m = $10m. Difficulty: 1 Easy Topic: Statement of retained earnings Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 02-01 Recall the major financial statements that firms must prepare and provide.

45) Harvey's Hamburger Stand has total assets of $3 million of which $1 million are current assets. Cash makes up 20 percent of the current assets and accounts receivable makes up another 5 percent of current assets. Harvey's gross plant and equipment has a book value of $1.5 million and other long-term assets have a book value of $1 million. Using this information, what is the balance of inventory and the balance of depreciation on Harvey's Hamburger Stand's balance sheet? A) $250,000, $500,000 B) $250,000, $1 million C) $750,000, $500,000 D) $750,000, $1 million Answer: C Explanation: Current assets: Cash and marketable Securities (.2 × $1) Accounts receivable (.05 × $1) Inventory Total Fixed assets: Gross plant and equipment Less: Depreciation Net plant and equipment Other long-term assets Total Total assets

$ 0.20 0.05 .75 $ 1.0 $

1.5 0.5 $ 1.0 1.0 $ 2.0 $ 3.0

Step 1: Inventory = $1 – $0.20 – $0.05 = $.75. Step 2: Total fixed assets = $3.0 – $1.0 = $2.0. Step 3: Net plant equipment = $2.0 – $1.0 = $1.0. Step 4: Depreciation = $1.5 – $1.0 = $0.5. Difficulty: 2 Medium Topic: Balance sheet Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 02-01 Recall the major financial statements that firms must prepare and provide.

46) School Books, Inc. has total assets of $18 million of which $6 million are current assets. Cash makes up 10 percent of the current assets and accounts receivable makes up another 40 percent of current assets. School Books' gross plant and equipment has an original cost of $13 million and other long-term assets have a cost value of $2 million. Using this information, what are the balance of inventory and the balance of depreciation on School Books' balance sheet? A) $3 million, $2 million B) $3 million, $3 million C) $2.4 million, $2 million D) $2.4 million, $3 million Answer: B Explanation: Current assets: Cash and marketable Securities (.10 × $6) Accounts receivable (.40 × $6) Inventory Total Fixed assets: Gross plant and equipment Less: Depreciation Net plant and equipment Other long-term assets Total Total assets

0.6 2.4 3.0 6.0

$ 13.0 3.0 $ 10.0 2.0 $ 12.0 $ 18.0

Step 1: Inventory = $6 – $0.6 – $2.4 = $3.0. Step 2: Total fixed assets = $18 – $6 = $12.0. Step 3: Net plant equipment = $12 – $2 = $10.0. Step 4: Depreciation = $13 – $10 = $3.0. Difficulty: 2 Medium Topic: Balance sheet Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 02-01 Recall the major financial statements that firms must prepare and provide.

47) Ted's Taco Shop has total assets of $5 million. Forty percent of these assets are financed with debt of which $400,000 is current liabilities. The firm has no preferred stock but the balance in common stock and paid-in surplus is $1 million. Using this information what is the balance for long-term debt and retained earnings on Ted's Taco Shop's balance sheet? A) $400,000, $1 million B) $1.6 million, $2 million C) $1.6 million, $3 million D) $2 million, $3 million Answer: B Explanation: Total current liabilities Long–term debt: Total debt: Stockholder's equity: Preferred stock Common stock and paid–in surplus (2 million shares) Retained earnings Total Total liabilities and equity

$ .4 $ 1.6 $ 2 $

$ $

0 1 2 3 5

Step 1: Total liabilities and equity = Total Assets = $5. Step 2: Total debt = .4 × $5 = $2. Step 3: Long–term debt = $2 – $.4 = $1.6. Step 4: Total Stockholder's Equity = $5 – $2 = $3. Step 5: Retained earnings = $3 – $1 = $2. Difficulty: 2 Medium Topic: Balance sheet Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 02-01 Recall the major financial statements that firms must prepare and provide.

48) Hair Etc. has total assets of $15 million. Twenty percent of these assets are financed with debt of which $1 million is current liabilities. The firm has no preferred stock but the balance in common stock and paid-in surplus is $8 million. Using this information what is the balance for long-term debt and retained earnings on Hair Etc.'s balance sheet? A) $1 million, $8 million B) $2 million, $4 million C) $2 million, $8 million D) $3 million, $4 million Answer: B Explanation: Total current liabilities Long–term debt: Total debt: Stockholder's equity: Preferred stock Common stock and paid–in surplus (2 million shares) Retained earnings Total Total liabilities and equity

$ $ $

1 2 3

0 8 4 $ 12 $ 15

Step 1: Total liabilities and equity = Total Assets = $15. Step 2: Total debt = .2 × $15m = $3. Step 3: Long–term debt = $3 – $1 = $2. Step 4: Total Stockholder's Equity = $15 – $3 = $12. Step 5: Retained earnings = $12 – $8 = $4. Difficulty: 2 Medium Topic: Balance sheet Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 02-01 Recall the major financial statements that firms must prepare and provide.

49) Acme Bricks balance sheet lists net fixed assets as $40 million. The fixed assets could currently be sold for $50 million. Acme's current balance sheet shows current liabilities of $15 million and net working capital of $12 million. If all the current accounts were liquidated today, the company would receive $77 million cash after paying $15 million in liabilities. What is the book value of Acme's assets today? What is the market value of these assets? A) $12 million, $77 million B) $27 million, $92 million C) $40 million, $50 million D) $67 million, $142 million Answer: D Explanation: Book value Assets Current assets Fixed assets Total

$ 27m. 40m. $ 67m.

Market value $

92m. 50m. $ 142m.

Step 1: Net working capital (book value) = Current assets (book value) − Current liabilities (book value) = $12m = Current assets (book value) − $15m => Current assets (book value) = $12m + $15m = $27m. Step 2: Total assets (book value) = $27m + $40m = $67m. Step 3: Net working capital (market value) = Current assets (market value) − Current liabilities (market value) = $77m = Current assets (market value) − $15m => Current assets (market value) = $77m + $15m = $92m. Step 4: Total assets (market value) = $92m + $50m = $142m. Difficulty: 2 Medium Topic: Market and book values Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 02-02 Differentiate between book (or accounting) value and market value.

50) Glo's Glasses balance sheet lists net fixed assets as $20 million. The fixed assets could currently be sold for $25 million. Glo's current balance sheet shows current liabilities of $7 million and net working capital of $3 million. If all the current accounts were liquidated today, the company would receive $9 million cash after paying $7 million in liabilities. What is the book value of Glo's assets today? What is the market value of these assets? A) $10 million, $16 million B) $10 million, $35 million C) $30 million, $35 million D) $30 million, $41 million Answer: D Explanation: Assets Current assets Fixed assets Total

Book value

Market value

$ 10m. 20m. $ 30m.

$ 16m. 25m. $ 41m.

Step 1: Net working capital (book value) = Current assets (book value) − Current liabilities (book value) = $3m = Current assets (book value) − $7m => Current assets (book value) = $3m + $7m = $10m. Step 2: Total assets (book value) = $10m + $20m = $30m. Step 3: Net working capital (market value) = Current assets (market value) − Current liabilities (market value) = $9m = Current assets (market value) − $7m => Current assets (market value) = $9m + $7m = $16m. Step 4: Total assets (market value) = $16m + $25m = $41m. Difficulty: 2 Medium Topic: Market and book values Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 02-02 Differentiate between book (or accounting) value and market value.

51) Rupert's Rims balance sheet lists net fixed assets as $15 million. The fixed assets could currently be sold for $17 million. Rupert's current balance sheet shows current liabilities of $5 million and net working capital of $3 million. If all the current accounts were liquidated today, the company would receive $6 million cash after paying $5 million in liabilities. What is the book value of Rupert's assets today? What is the market value of these assets? A) $8 million, $23 million B) $23 million, $25 million C) $23 million, $28 million D) $31 million, $28 million Answer: C Explanation: Book value Assets Current assets Fixed assets Total

8m. 15m. $ 23m.

Market value $ 11m. 17m. $ 28m.

Step 1: Net working capital (book value) = Current assets (book value) − Current liabilities (book value) = $3m = Current assets (book value) − $5m => Current assets (book value) = $3m + $5m = $8m. Step 2: Total assets (book value) = $8m + $15m = $23m. Step 3: Net working capital (market value) = Current assets (market value) − Current liabilities (market value) = $6m = Current assets (market value) − $5m => Current assets (market value) = $6m + $5m = $11m. Step 4: Total assets (market value) = $11m + $17m = $28m. Difficulty: 2 Medium Topic: Market and book values Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 02-02 Differentiate between book (or accounting) value and market value.

37) You are considering a stock investment in one of two firms (AllDebt, Inc. and AllEquity, Inc.), both of which operate in the same industry and have identical operating income of $600,000. AllDebt, Inc. finances its $1.2 million in assets with $1 million in debt (on which it pays 10 percent interest annually) and $0.2 million in equity. AllEquity, Inc. finances its $1.2 million in assets with no debt and $1.2 million in equity. Both firms pay a tax rate of 30 percent on their taxable income. What are the asset funders' (the debt holders and stockholders) resulting return on assets for the two firms? A) 29.17%, and 35%, respectively B) 37.5%, and 35%, respectively C) 37.5%, and 37.5%, respectively D) 50%, and 50%, respectively Answer: B Explanation: Operating income Less: Interest Taxable income Less: Taxes (30%) Net income Income available for asset funders (= operating income − taxes)

AllDebt $ 0.6m. 0.1m. 0.5m. 0.15m. $ 0.35m. $ 0.45m.

AllEquity $ 0.6m. 0m. 0.6m. 0.18m. $ 0.42m. $ 0.42m.

Return on assets funders' investment: Interest = $1m. × .1 = $.1 m. AllDebt = $0.45m/$1.2m = 37.50%. AllEquity = $0.42m/$1.2m = 35.00%. Difficulty: 2 Medium Topic: Profitability ratios Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 02-01 Recall the major financial statements that firms must prepare and provide.

38) You are considering a stock investment in one of two firms (AllDebt, Inc. and AllEquity, Inc.), both of which operate in the same industry and have identical operating income of $3 million. AllDebt, Inc. finances its $6 million in assets with $5 million in debt (on which it pays 5 percent interest annually) and $1 million in equity. AllEquity, Inc. finances its $6 million in assets with no debt and $6 million in equity. Both firms pay a tax rate of 40 percent on their taxable income. What are the asset funders' (the debt holders and stockholders) resulting return on assets for the two firms? A) 27.5%, and 30%, respectively B) 31.67%, and 30%, respectively C) 33%, and 30%, respectively D) 50%, and 50%, respectively Answer: B Explanation: Operating income Less: Interest Taxable income Less: Taxes (40%) Net income Income available for asset funders (= operating income − taxes)

AllDebt $ 3m. 0.25m. 2.75m. 1.1m. $ 1.65m. $ 1.9m.

AllEquity $ 3m. 0m. 3m. 1.2m. $ 1.8m. $ 1.8m.

Return on assets funders' investment: Interest = $5m. × .05 = $0.25m. AllDebt = $1.9m/$6m = 31.67%. AllEquity = $1.8m/$6m = 30.00%. Difficulty: 2 Medium Topic: Profitability ratios Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 02-01 Recall the major financial statements that firms must prepare and provide.

39) You are considering a stock investment in one of two firms (AllDebt, Inc. and AllEquity, Inc.), both of which operate in the same industry and have identical operating income of $400,000. AllDebt, Inc. finances its $800,000 in assets with $600,000 in debt (on which it pays 5 percent interest annually) and $200,000 in equity. AllEquity, Inc. finances its $800,000 in assets with no debt and $800,000 in equity. Both firms pay a tax rate of 30 percent on their taxable income. What are the asset funders' (the debt holders and stockholders) resulting return on assets for the two firms? A) 32.375%, and 35.00%, respectively B) 36.125%, and 35.00%, respectively C) 46.25%, and 50%, respectively D) 50%, and 50%, respectively Answer: B Explanation: Operating income Less: Interest Taxable income Less: Taxes (30%) Net income Income available for asset funders (= operating income − taxes)

AllDebt $ 0.4m. 0.03m. 0.37m. 0.111m. $ 0.259m.

AllEquity $ 0.4m. 0m. 0.4m. 0.12m. $ 0.28m.

$ 0.289m.

$ 0.28m.

Return on assets funders' investment: Interest = $0.6m. × .05 = $0.03m. AllDebt = $0.289m/$0.8m = 36.125%. AllEquity = $0.28m/$0.8m = 35.00%. Difficulty: 2 Medium Topic: Profitability ratios Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 02-01 Recall the major financial statements that firms must prepare and provide.

55) You have been given the following information for Fina's Furniture Corp.: Net sales = $25,500,000; Cost of goods sold = $10,250,000; Addition to retained earnings = $305,000; Dividends paid to preferred and common stockholders = $500,000; Interest expense = $2,000,000. The firm's tax rate is 30 percent. What is the depreciation expense for Fina's Furniture Corp.? A) $12,100,000 B) $12,400,000 C) $14,100,000 D) $14,400,000 Answer: A Explanation: Net sales (all credit) Less: Cost of goods sold Gross profits Less: Depreciation Earnings before interest and taxes (EBIT) Less: Interest Earnings before taxes (EBT) Less: Taxes Net income Less: Common and preferred stock dividends Addition to retained earnings

$ 25,500,000 10,250,000 $ 15,250,000 $ 12,100,000 $ 3,150,000 2,000,000 $ 1,150,000 $ $ $

805,000 500,000 305,000

Step 1: Net income = Common and preferred stock dividends + Addition to retained earnings = $500,000 + $305,000 = $805,000. Step 2: EBT (1 − tax rate) = Net income => EBT = Net income/(1 − tax rate) = $805,000/(1 − 0.3) = $1,150,000. Step 3: EBIT − Interest = EBT => EBIT = EBT + Interest = $1,150,000 + $2,000,000 = $3,150,000. Step 4: Gross profits = Net sales − Cost of goods sold = $25,500,000 − 10,250,000 = $15,250,000. Step 5: Gross profits − Depreciation = EBIT => Depreciation = Gross profits − EBIT = $15,250,000 − $3,150,000 = $12,100,000. Difficulty: 2 Medium Topic: Income statement Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 02-01 Recall the major financial statements that firms must prepare and provide.

56) You have been given the following information for Romeo's Rockers Corp.: Net sales = $5,200,000; Cost of goods sold = $2,100,000; Addition to retained earnings = $1,000,000; Dividends paid to preferred and common stockholders = $400,000; Interest expense = $200,000. The firm's tax rate is 30 percent. What is the depreciation expense for Romeo's Rockers Corp.? A) $900,000 B) $1,100,000 C) $1,500,000 D) $1,600,000 Answer: A Explanation: Net sales (all credit) Less: Cost of goods sold Gross profits Less: Depreciation Earnings before interest and taxes (EBIT) Less: Interest Earnings before taxes (EBT) Less: Taxes Net income Less: Common and preferred stock dividends Addition to retained earnings

$ 5,200,000 2,100,000 $ 3,100,000 $ 900,000 $ 2,200,000 200,000 $ 2,000,000 $ 1,400,000 $ 400,000 $ 1,000,000

Step 1: Net income = Common and preferred stock dividends + Addition to retained earnings = $400,000 + $1,000,000 = $1,400,000. Step 2: EBT (1 − tax rate) = Net income => EBT = Net income/(1 − tax rate) = $1,400,000/(1 − 0.3) = $2,000,000. Step 3: EBIT − Interest = EBT => EBIT = EBT + Interest = $2,000,000 + $200,000 = $2,200,000. Step 4: Gross profits = Net sales − Cost of goods sold = $5,200,000 − 2,100,000 = $3,100,000. Step 5: Gross profits − Depreciation = EBIT => Depreciation = Gross profits − EBIT = $3,100,000 − $2,200,000 = $900,000. Difficulty: 2 Medium Topic: Income statement Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 02-01 Recall the major financial statements that firms must prepare and provide.

57) You have been given the following information for Nicole's Neckties Corp.: Net sales = $2,500,000; Cost of goods sold = $1,300,000; Addition to retained earnings = $30,000; Dividends paid to preferred and common stockholders = $300,000; Interest expense = $50,000. The firm's tax rate is 40 percent. What is the depreciation expense for Nicole's Neckties Corp.? A) $550,000 B) $600,000 C) $650,000 D) $820,000 Answer: B Explanation: Net sales (all credit) Less: Cost of goods sold Gross profits Less: Depreciation Earnings before interest and taxes (EBIT) Less: Interest Earnings before taxes (EBT) Less: Taxes Net income Less: Common and preferred stock dividends Addition to retained earnings

$ 2,500,000 1,300,000 $ 1,200,000 $ 600,000 $ 600,000 50,000 $ 550,000 $ $ $

330,000 300,000 30,000

Step 1: Net income = Common and preferred stock dividends + Addition to retained earnings = $300,000 + $30,000 = $330,000. Step 2: EBT (1 − tax rate) = Net income => EBT = Net income/(1 − tax rate) = $330,000/(1 − 0.4) = $550,000. Step 3: EBIT − Interest = EBT => EBIT = EBT + Interest = $550,000 + $50,000 = $600,000. Step 4: Gross profits = Net sales − Cost of goods sold = $2,500,000 − 1,300,000 = $1,200,000. Step 5: Gross profits − Depreciation = EBIT => Depreciation = Gross profits − EBIT = $1,200,000 − $600,000 = $600,000. Difficulty: 2 Medium Topic: Income statement Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 02-01 Recall the major financial statements that firms must prepare and provide.

58) You have been given the following information for Sherry's Sandwich Corp.: Net sales = $300,000; Gross profit = $100,000; Addition to retained earnings = $30,000; Dividends paid to preferred and common stockholders = $8,500; Depreciation expense = $25,000. The firm's tax rate is 30 percent. What are the cost of goods sold and the interest expense for Sherry's Sandwich Corp.? A) $20,000, and $200,000, respectively B) $100,000, and $20,000, respectively C) $200,000, and $20,000, respectively D) $200,000, and $36,500, respectively Answer: C Explanation: $ 300,000 200,000 $ 100,000 $ 25,000 $ 75,000 20,000 $ 55,000

Net sales (all credit) Less: Cost of goods sold Gross profits Less: Depreciation Earnings before interest and taxes (EBIT) Less: Interest Earnings before taxes (EBT) Less: Taxes Net income Less: Common and preferred stock dividends Addition to retained earnings

$ $ $

38,500 8,500 30,000

Step 1: Net income = Common and preferred stock dividends + Addition to retained earnings = $8,500 + $30,000 = $38,500. Step 2: EBT (1 − tax rate) = Net income => EBT = Net income/(1 − tax rate) = $38,500/(1 − 0.3) = $55,000. Step 3: Gross profits = Net sales − Cost of goods sold => Net Sales − Gross Profit = Cost of Goods Sold = $300,000 − 100,000 = $200,000. Step 4: Gross profits − Depreciation = EBIT = $100,000 − $25,000 = $75,000. Step 5: EBIT − Interest = EBT => Interest = EBIT − EBT = $75,000 − $55,000 = $20,000. Difficulty: 2 Medium Topic: Income statement Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 02-01 Recall the major financial statements that firms must prepare and provide.

59) You have been given the following information for Kaye's Krumpet Corp.: Net sales = $150,000; Gross profit = $100,000; Addition to retained earnings = $20,000; Dividends paid to preferred and common stockholders = $8,000; Depreciation expense = $50,000. The firm's tax rate is 30 percent. What are the cost of goods sold and the interest expense for Kaye's Krumpet Corp.? A) $10,000, and $50,000, respectively B) $50,000, and $10,000, respectively C) $50,000, and $22,000, respectively D) $62,000, and $10,000, respectively Answer: B Explanation: $ 150,000 50,000 $ 100,000 $ 50,000 $ 50,000 10,000 $ 40,000

$ $ $

28,000 8,000 20,000

Step 1: Net income = Common and preferred stock dividends + Addition to retained earnings = $8,000 + $20,000 = $28,000. Step 2: EBT (1 − tax rate) = Net income => EBT = Net income/(1 − tax rate) = $28,000/(1 − 0.3) = $40,000. Step 3: Gross profits = Net sales − Cost of goods sold => Net Sales − Gross Profit = Cost of Goods Sold = $150,000 − 100,000 = $50,000. Step 4: Gross profits − Depreciation = EBIT = $100,000 − $50,000 = $50,000. Step 5: EBIT − Interest = EBT => Interest = EBIT − EBT = $50,000 − $40,000 = $10,000. Difficulty: 2 Medium Topic: Income statement Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 02-01 Recall the major financial statements that firms must prepare and provide.

60) You have been given the following information for Ross's Rocket Corp.: Net sales = $1,000,000; Gross profit = $400,000; Addition to retained earnings = $60,000; Dividends paid to preferred and common stockholders = $90,000; Depreciation expense = $50,000. The firm's tax rate is 40 percent. What are the cost of goods sold and the interest expense for Ross's Rocket Corp.? A) $100,000, and $600,000, respectively B) $600,000, and $100,000, respectively C) $600,000, and $200,000, respectively D) $700,000, and $100,000, respectively Answer: B Explanation: Net sales (all credit) Less: Cost of goods sold Gross profits Less: Depreciation Earnings before interest and taxes (EBIT) Less: Interest Earnings before taxes (EBT) Less: Taxes Net income Less: Common and preferred stock dividends Addition to retained earnings

$ 1,000,000 600,000 $ 400,000 $ 50,000 $ 350,000 100,000 $ 250,000 $ $ $

150,000 90,000 60,000

Step 1: Net income = Common and preferred stock dividends + Addition to retained earnings = $90,000 + $60,000 = $150,000. Step 2: EBT (1 − tax rate) = Net income => EBT = Net income/(1 − tax rate) = $150,000/(1 − 0.4) = $250,000. Step 3: Gross profits = Net sales − Cost of goods sold => Net Sales − Gross Profit = Cost of Goods Sold = $1,000,000 − 400,000 = $600,000. Step 4: Gross profits − Depreciation = EBIT = $400,000 − $50,000 = $350,000. Step 5: EBIT − Interest = EBT => Interest = EBIT − EBT = $350,000 − $250,000 = $100,000. Difficulty: 2 Medium Topic: Income statement Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 02-01 Recall the major financial statements that firms must prepare and provide.

61) The Carolina Corporation had a 2018 taxable income of $3,000,000 from operations after all operating costs but before (1) interest charges of $500,000, (2) dividends received of $75,000, (3) dividends paid of $1,000,000, and (4) income taxes.

Using the tax schedule in Table 2.3, what is Carolina's income tax liability? What are Carolina's average and marginal tax rates on taxable income from operations? A) $857,650, 28.59%, 34%, respectively B) $875,500, 29.18%, 34%, respectively C) $875,500, 34.00%, 34%, respectively D) $1,020,000, 34.00%, 34%, respectively Answer: A Explanation: The first 70 percent of the dividends received by Carolina Corp. is not taxable. Thus, only 30 percent of the dividends received are taxed, so: Taxable income = $3,000,000 − $500,000 + (0.3)$75,000 = $2,522,500. Now Carolina's Corp.'s tax liability will be: Tax liability = $113,900 + 0.34 ($2,522,500 − $335,000) = $857,650. Carolina Corp.'s resulting average tax rate is now: Average tax rate = $857650/$3,000,000 = 28.59%. Finally, if Carolina Corp. earned $1 more of taxable income, it would still pay 34 cents (based upon its marginal tax rate of 34 percent) more in taxes. Difficulty: 2 Medium Topic: Taxes Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 02-03 Explain how taxes influence corporate managers' and investors' decisions.

62) The Ohio Corporation had a 2018 taxable income of $50,000,000 from operations after all operating costs but before (1) interest charges of $500,000, (2) dividends received of $45,000, (3) dividends paid of $10,000,000, and (4) income taxes.

Using the tax schedule in Table 2.3, what is Ohio's income tax liability? What are Ohio's average and marginal tax rates on taxable income from operations? A) $6,416,667, 12.83%, 35%, respectively B) $13,829,725, 27.66%, 35%, respectively C) $17,329,725, 34.66%, 35%, respectively D) $17,340,750, 34.68%, 35%, respectively Answer: C Explanation: The first 70 percent of the dividends received by Ohio Corp. is not taxable. Thus, only 30 percent of the dividends received are taxed, so: Taxable income = $50,000,000 − $500,000 + (0.3)$45,000 = $49,513,500. Now Ohio's Corp.'s tax liability will be: Tax liability = $6,416,667 + 0.35 ($49,513,500 − $18,333,333) = $17,329,725.45. Ohio Corp.'s resulting average tax rate is now: Average tax rate = $17,329,725.45/$50,000,000 = 34.66%. Finally, if Ohio Corp. earned $1 more of taxable income, it would still pay 35 cents (based upon its marginal tax rate of 35 percent) more in taxes. Difficulty: 2 Medium Topic: Taxes Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 02-03 Explain how taxes influence corporate managers' and investors' decisions.

63) The Sasnak Corporation had a 2018 taxable income of $4,450,000 from operations after all operating costs but before (1) interest charges of $750,000, (2) dividends received of $900,000, (3) dividends paid of $500,000, and (4) income taxes.

Using the tax schedule in Table 2.3, what is Sasnak's income tax liability? What are Sasnak's average and marginal tax rates on taxable income from operations? A) $1,349,800, 30.33%, 34%, respectively B) $1,349,800, 34.00%, 34%, respectively C) $1,564,000, 34.00%, 34%, respectively D) $1,564,000, 35.15%, 34%, respectively Answer: A Explanation: The first 70 percent of the dividends received by Sasnak Corp. is not taxable. Thus, only 30 percent of the dividends received are taxed, so: Taxable income = $4,450,000 − $750,000 + (0.3)$900,000 = $3,970,000. Now Sasnak's Corp.'s tax liability will be: Tax liability = $113,900 + 0.34 ($3,970,000 − $335,000) = $1,349,800. Sasnak Corp.'s resulting average tax rate is now: Average tax rate = $1,349,800/$4,450,000 = 30.33%. Finally, if Sasnak Corp. earned $1 more of taxable income, it would still pay 34 cents (based upon its marginal tax rate of 34 percent) more in taxes. Difficulty: 2 Medium Topic: Taxes Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 02-03 Explain how taxes influence corporate managers' and investors' decisions.

64) The AOK Corporation had a 2018 taxable income of $2,200,000 from operations after all operating costs but before (1) interest charges of $90,000, (2) dividends received of $750,000, (3) dividends paid of $80,000, and (4) income taxes.

Using the tax schedule in Table 2.3, what is AOK's income tax liability? What are AOK's average and marginal tax rates on taxable income from operations? A) $793,900, 34%, 34%, respectively B) $793,900, 36.0864%, 34%, respectively C) $972,400, 34%, 34%, respectively D) $972,400, 44.2%, 34%, respectively Answer: B Explanation: The first 70 percent of the dividends received by AOK Corp. is not taxable. Thus, only 30 percent of the dividends received are taxed, so: Taxable income = $2,200,000 − $90,000 + (0.3)$750,000 = $2,335,000. Now AOK's Corp.'s tax liability will be: Tax liability = $113,900 + 0.34 ($2,335,000 − $335,000) = $793,900. AOK Corp.'s resulting average tax rate is now: Average tax rate = $793,900/$2,200,000 = 36.0864%. Finally, if AOK Corp. earned $1 more of taxable income, it would still pay 34 cents (based upon its marginal tax rate of 34 percent) more in taxes. Difficulty: 2 Medium Topic: Taxes Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 02-03 Explain how taxes influence corporate managers' and investors' decisions.

65) Suppose that in addition to the $5.5 million of taxable income from operations, Emily's Flowers, Inc. received $500,000 of interest on state-issued bonds and $300,000 of dividends on common stock it owns in Amy's Iris Bulbs, Inc. Using the tax schedule in Table 2.3 what is Emily's Flowers' income tax liability? What are Emily's Flowers' average and marginal tax rates on total taxable income? A) $1,900,600, 34%, 34%, respectively B) $1,972,000, 34%, 34%, respectively C) $2,070,600, 34%, 34%, respectively D) $2,142,000, 34%, 34%, respectively Answer: A Explanation: Interest on the state-issued bonds is not taxable and should not be included in taxable income. Further, the first 70 percent of the dividends received from Amy's is not taxable. Thus, only 30 percent of the dividends received are taxed, so: Taxable income = $5,500,000 + (0.3) $300,000 = $5,590,000. Now Emily's tax liability will be: Tax liability = $113,900 + 0.34 ($5,590,000 – $335,000) = $1,900,600. Emily's resulting average tax rate is now: Average tax rate = $1,900,600/$5,590,000 = 34%. Finally, if Emily earned $1 more of taxable income, it would still pay 34 cents (based upon its marginal tax rate of 34 percent) more in taxes. Difficulty: 2 Medium Topic: Taxes Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 02-03 Explain how taxes influence corporate managers' and investors' decisions.

66) Suppose that in addition to the $300,000 of taxable income from operations, Liam's Burgers, Inc. received $25,000 of interest on state-issued bonds and $50,000 of dividends on common stock it owns in Sodas, Inc. Using the tax schedule in Table 2.3 what is Liam's income tax liability? What are Liam's average and marginal tax rates on total taxable income? A) $106,100, 33.68%, 39%, respectively B) $122,850, 39.00%, 39%, respectively C) $129,500, 34.53%, 39%, respectively D) $139,250, 37.13%, 39%, respectively Answer: A Explanation: Interest on the state-issued bonds is not taxable and should not be included in taxable income. Further, the first 70 percent of the dividends received from Sodas is not taxable. Thus, only 30 percent of the dividends received are taxed, so: Taxable income = $300,000 + (0.3) $50,000 = $315,000. Now Liam's tax liability will be: Tax liability = $22,250 + 0.39 ($315,000 − $100,000) = $106,100. Liam's resulting average tax rate is now: Average tax rate = $106,100/$315,000 = 33.68%. Finally, if Liam earned $1 more of taxable income, it would still pay 39 cents (based upon its marginal tax rate of 39 percent) more in taxes. Difficulty: 2 Medium Topic: Taxes Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 02-03 Explain how taxes influence corporate managers' and investors' decisions.

67) Fina's Faucets, Inc. has net cash flows from operating activities for the last year of $17 million. The income statement shows that net income is $15 million and depreciation expense is $6 million. During the year, the change in inventory on the balance sheet was an increase of $4 million, change in accrued wages and taxes was an increase of $1 million and change in accounts payable was an increase of $1 million. At the beginning of the year the balance of accounts receivable was $5 million. What was the end of year balance for accounts receivable? A) $2 million B) $3 million C) $7 million D) $9 million Answer: C Explanation: Cash Flows from Operating Activities Net income Additions (sources of cash): Depreciation Increase in accrued wages and taxes Increase in accounts payable Subtractions (uses of cash): Increase in accounts receivable Increase in inventory Net cash flow from operating activities:

$ 15m. 6m. 1m. 1m. −2m. −4m. $ 17m.

Increase in accounts receivable = $17m. − $15m. − $6m. − $1m. − $1m. + $4m. = $−2m. Thus, end of year balance of accounts receivable = $5m + $2m = $7m. Difficulty: 2 Medium Topic: Operating activities Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 02-05 Demonstrate how to use a firm's financial statements to calculate its cash flows.

68) Zoe's Dog Biscuits, Inc. has net cash flows from operating activities for the last year of $226 million. The income statement shows that net income is $150 million and depreciation expense is $85 million. During the year, the change in inventory on the balance sheet was an increase of $14 million, change in accrued wages and taxes was an increase of $15 million and change in accounts payable was an increase of $10 million. At the beginning of the year the balance of accounts receivable was $45 million. What was the end of year balance for accounts receivable? A) $20 million B) $25 million C) $45 million D) $65 million Answer: D Explanation: Cash Flows from Operating Activities Net income Additions (sources of cash): Depreciation Increase in accrued wages and taxes Increase in accounts payable Subtractions (uses of cash): Increase in accounts receivable Increase in inventory Net cash flow from operating activities:

$ 150m. 85m. 15m. 10m. −20m. −14m. $ 226m.

Increase in accounts receivable = $226m. − $150m. − $85m. − $15m. − $10m. + $14m. = $−20m. Thus, end of year balance of accounts receivable = $45m + $20m = $65m. Difficulty: 2 Medium Topic: Operating activities Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 02-05 Demonstrate how to use a firm's financial statements to calculate its cash flows.

69) Nickolas's Nut Farms, Inc. has net cash flows from operating activities for the last year of $25 million. The income statement shows that net income is $15 million and depreciation expense is $6 million. During the year, the change in inventory on the balance sheet was a decrease of $4 million, change in accrued wages and taxes was a decrease of $1 million and change in accounts payable was a decrease of $1 million. At the beginning of the year the balance of accounts receivable was $5 million. What was the end of year balance for accounts receivable? A) $2 million B) $3 million C) $7 million D) $9 million Answer: B Explanation: Cash Flows from Operating Activities Net income Additions (sources of cash): Depreciation Decrease in accounts receivable Decrease in inventory Subtractions (uses of cash): Decrease in accrued wages and taxes Decrease in accounts payable Net cash flow from operating activities:

$ 15m. 6m. 2m. 4m. −1m. −1m. $ 25m.

Decrease in accounts receivable = $25m. − $15m. − $6m. − $4m. + $1m. + $1m. = $2m. Thus, end of year balance of accounts receivable = $5m − $2m = $3m. Difficulty: 2 Medium Topic: Operating activities Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 02-05 Demonstrate how to use a firm's financial statements to calculate its cash flows.

70) Crispy Corporation has net cash flow from financing activities for the last year of $20 million. The company paid $5 million in dividends last year. During the year, the change in notes payable on the balance sheet was an increase of $2 million, and change in common and preferred stock was an increase of $3 million. The end of year balance for long-term debt was $45 million. What was their beginning of year balance for long-term debt? A) $15 million B) $20 million C) $25 million D) $35 million Answer: C Explanation: Cash Flows from Financing Activities Additions: Increase in notes payable Increase in long-term debt Increase in common and preferred stock Subtractions: Pay stock dividends Net cash flow from financing activities:

2m. 20m. 3m.

−5m. $ 20m.

Increase in long–term debt = $20m. + $5m. − $2m. − $3m. = $20m. Thus, beginning of year balance for long–term debt = $45m − $20m = $25m. Difficulty: 2 Medium Topic: Financing activities Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 02-05 Demonstrate how to use a firm's financial statements to calculate its cash flows.

71) Full Moon Productions Inc. has net cash flow from financing activities for the last year of $105 million. The company paid $15 million in dividends last year. During the year, the change in notes payable on the balance sheet was an increase of $40 million, and change in common and preferred stock was an increase of $50 million. The end of year balance for long-term debt was $50 million. What was their beginning of year balance for long-term debt? A) $5 million B) $20 million C) $30 million D) $35 million Answer: B Explanation: Cash Flows from Financing Activities Additions: Increase in notes payable Increase in long-term debt Increase in common and preferred stock Subtractions: Pay stock dividends Net cash flow from financing activities:

40m. 30m. 50m.

−15m. $ 105m.

Increase in long-term debt = $105m. + $15m. − $40m. − $50m. = $30m. Thus, beginning of year balance for long-term debt = $50m − $30m = $20m. Difficulty: 2 Medium Topic: Financing activities Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 02-05 Demonstrate how to use a firm's financial statements to calculate its cash flows.

72) Café Creations Inc. has net cash flow from financing activities for the last year of $25 million. The company paid $15 million in dividends last year. During the year, the change in notes payable on the balance sheet was a decrease of $40 million, and change in common and preferred stock was an increase of $50 million. The end of year balance for long-term debt was $40 million. What was their beginning of year balance for long-term debt? A) $10 million B) $20 million C) $30 million D) $40 million Answer: A Explanation: Cash Flows from Financing Activities Additions: Increase in long-term debt Increase in common and preferred stock Subtractions: Decrease in notes payable Pay stock dividends Net cash flow from financing activities:

30m. 50m.

–40m. –15m. 25m.

Increase in long-term debt = $25m. + $15m. + $40m. − $50m. = $30m. Thus, beginning of year balance for long-term debt = $40m − $30m = $10m. Difficulty: 2 Medium Topic: Financing activities Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 02-05 Demonstrate how to use a firm's financial statements to calculate its cash flows.

73) The 2010 income statement for Pete's Pumpkins shows that depreciation expense is $250 million, EBIT is $500 million, EBT is $320 million, and the tax rate is 30 percent. At the beginning of the year, the balance of gross fixed assets was $1,600 million and net operating working capital was $640 million. At the end of the year gross fixed assets was $2,000 million. Pete's free cash flow for the year was $630 million. What is their end of year balance for net operating working capital? A) $24 million B) $264 million C) $654 million D) $1,064 million Answer: B Explanation: Taxes = $320m × (0.3) = $96m => Pete's operating cash flow was: OCF = EBIT – Taxes + Depreciation = ($500m − $96m + $250m) = $654m. Pete's free cash flow for 2010 was: FCF = Operating cash flow − Investment in operating capital. $630m = $654m − Investment in operating capital => Investment in operating capital = $654m − $630m = $24m. Accordingly, investment in operating capital for 2010 was: IOC = ΔGross fixed assets + ΔNet operating working capital => $24m = ($2,000m − $1,600m) + (Ending net operating working capital − $640m) => Ending net operating working capital = $24m − ($2,000m − $1,600m) + $640m = $264m. Difficulty: 2 Medium Topic: Free cash flow Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 02-05 Demonstrate how to use a firm's financial statements to calculate its cash flows.

74) The 2018 income statement for Lou's Shoes shows that depreciation expense is $2 million, EBIT is $5 million, EBT is $3 million, and the tax rate is 40 percent. At the beginning of the year, the balance of gross fixed assets was $16 million and net operating working capital was $6 million. At the end of the year gross fixed assets was $20 million. Lou's free cash flow for the year was $4 million. What is their end of year balance for net operating working capital? A) $1.8 million B) $3.8 million C) $5.8 million D) $12.2 million Answer: B Explanation: Taxes = $3m × (0.4) = $1.2m => Lou's operating cash flow was: OCF = EBIT − Taxes + Depreciation. = ($5m − $1.2m + $2m) = $5.8m. Lou's free cash flow for 2018 was: FCF = Operating cash flow − Investment in operating capital. $4m = $5.8m − Investment in operating capital. => Investment in operating capital = $5.8m − $4m = $1.8m. Accordingly, investment in operating capital for 2018 was: IOC = ΔGross fixed assets + ΔNet operating working capital. $1.8m = ($20m − $16m) + (Ending net operating working capital − $6m). => Ending net operating working capital = $1.8m − ($20m − $16m) + $6m = $3.8m. Difficulty: 2 Medium Topic: Free cash flow Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 02-05 Demonstrate how to use a firm's financial statements to calculate its cash flows.

75) The 2018 income statement for Paige's Purses shows that depreciation expense is $10 million, EBIT is $25 million, EBT is $15 million, and the tax rate is 30 percent. At the beginning of the year, the balance of gross fixed assets was $80 million and net operating working capital was $30 million. At the end of the year gross fixed assets was $100 million. Paige's free cash flow for the year was $20 million. What is their end of year balance for net operating working capital? A) $10.5 million B) $14 million C) $20.5 million D) $30.5 million Answer: C Explanation: Taxes = $15m × (0.3) = $4.5m => Paige's operating cash flow was: OCF = EBIT − Taxes + Depreciation. = ($25m − $4.5m + $10m) = $30.5m. Paige's free cash flow for 2018 was: FCF = Operating cash flow − Investment in operating capital. $20m = $30.5m − Investment in operating capital. => Investment in operating capital = $30.5m − $20m = $10.5m. Accordingly, investment in operating capital for 2018 was: IOC = ΔGross fixed assets + ΔNet operating working capital. $10.5m = ($100m − $80m) + (Ending net operating working capital − $30m). => Ending net operating working capital = $10.5m − ($100m − $80m) + 30m = $20.5m. Difficulty: 2 Medium Topic: Free cash flow Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 02-05 Demonstrate how to use a firm's financial statements to calculate its cash flows.

76) The 2018 income statement for Betty's Barstools shows that depreciation expense is $100 million, EBIT is $400 million, and taxes are $120 million. At the end of the year, the balance of gross fixed assets was $510 million. The increase in net operating working capital during the year was $94 million. Betty's free cash flow for the year was $625 million. What was the beginning of year balance for gross fixed assets? A) $359 million B) $380 million C) $849 million D) $1,094 million Answer: C Explanation: Betty's operating cash flow was: OCF = EBIT − Taxes + Depreciation. = ($400m − $120m + $100m) = $380m. Betty's free cash flow for 2018 was: FCF = Operating cash flow − Investment in operating capital. $625m = $380m − Investment in operating capital. => Investment in operating capital = $380m − $625m = −$245m. Accordingly, investment in operating capital for 2018 was: IOC = ΔGross fixed assets + ΔNet operating working capital. −$245m = ($510m − Beginning of year gross fixed assets) + $94m. => Beginning of year gross fixed assets = 510m − (−$245m) + $94m = $849m. Difficulty: 2 Medium Topic: Free cash flow Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 02-05 Demonstrate how to use a firm's financial statements to calculate its cash flows.

77) The 2018 income statement for John's Gym shows that depreciation expense is $20 million, EBIT is $80 million, and taxes are $24 million. At the end of the year, the balance of gross fixed assets was $102 million. The increase in net operating working capital during the year was $18 million. John's free cash flow for the year was $41 million. What was the beginning of year balance for gross fixed assets? A) $43 million B) $85 million C) $84 million D) $163 million Answer: B Explanation: John's operating cash flow was: OCF = EBIT − Taxes + Depreciation = ($80m − $24m + $20m) = $76m John's free cash flow for 2018 was: FCF = Operating cash flow − Investment in operating capital $41m = $76m − Investment in operating capital => Investment in operating capital = $76m − $41m = $35m Accordingly, investment in operating capital for 2018 was: IOC = ΔGross fixed assets + ΔNet operating working capital $35m = ($102m − Beginning of year gross fixed assets) + $18m => Beginning of year gross fixed assets = 102m − $35m + $18m = $85m Difficulty: 2 Medium Topic: Free cash flow Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 02-05 Demonstrate how to use a firm's financial statements to calculate its cash flows.

78) Bike and Hike, Inc. started the year with a balance of retained earnings of $100 million and ended the year with retained earnings of $128 million. The company paid dividends of $9 million to the preferred stock holders and $22 million to common stock holders. What was Bike and Hike's net income for the year? A) $28 million B) $31 million C) $59 million D) $128 million Answer: C Explanation: Statement of Retained Earnings as of December 31, 2018 (in millions of dollars)

Balance of retained earnings, December 31, 2017 Plus: Net income for 2018 (= $128m + 31m − 100m) Less: Cash dividends paid Preferred stock Common stock

$ 100m 59m $

Total cash dividends paid

9m 22m 31m

Balance of retained earnings, December 31, 2018

$ 128m

Net income for 2018 = $128m + 31m − 100m = 59m. Difficulty: 2 Medium Topic: Statement of retained earnings Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 02-01 Recall the major financial statements that firms must prepare and provide.

79) Soccer Starz, Inc. started the year with a balance of retained earnings of $25 million and ended the year with retained earnings of $32 million. The company paid dividends of $2 million to the preferred stock holders and $6 million to common stock holders. What was Soccer Starz's net income for the year? A) $7 million B) $15 million C) $40 million D) $49 million Answer: B Explanation: Statement of Retained Earnings as of December 31, 2018 (in millions of dollars)

Balance of retained earnings, December 31, 2017 Plus: Net income for 2018 (= $32m + 8m − 25m) Less: Cash dividends paid Preferred stock Common stock Total cash dividends paid

$ 25m 15m $ 2m 6m 8m

Balance of retained earnings, December 31, 2018

$ 32m

Net income for 2018 = $32m + 8m − 25m = 15m. Difficulty: 2 Medium Topic: Statement of retained earnings Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 02-01 Recall the major financial statements that firms must prepare and provide.

80) Jamaican Ice Cream Corp. started the year with a balance of retained earnings of $100 million. The company reported net income for the year of $45 million, paid dividends of $2 million to the preferred stockholders and $15 million to common stockholders. What is Jamaican Ice Cream's end of year balance in retained earnings? A) $38 million B) $55 million C) $128 million D) $162 million Answer: C Explanation: Statement of Retained Earnings as of December 31, 2018 (in millions of dollars)

Balance of retained earnings, December 31, 2017 Plus: Net income for 2018 Less: Cash dividends paid Preferred stock Common stock

$ 100m 45m $

Total cash dividends paid

2m 15m 17m

Balance of retained earnings, December 31, 2018

$ 128m

Difficulty: 2 Medium Topic: Statement of retained earnings Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 02-01 Recall the major financial statements that firms must prepare and provide.

81) The following is the 2017 income statement for Lamps, Inc.

Lamps, Inc. Income Statement for Year Ending December 31, 2017 (in millions of dollars) Net sales Less: Cost of goods sold Gross profits Less: Depreciation Earnings before interest and taxes (EBIT) Less: Interest Earnings before taxes (EBT) Less: Taxes Net income

$ 100 80 20 5 15 2 13 5 $ 8

The CEO of Lamps wants the company to earn a net income of $12 million in 2018. Cost of goods sold is expected to be 75 percent of net sales, depreciation expense is not expected to change, interest expense is expected to increase to $4 million, and the firm's tax rate will be 40 percent. What is the net sales needed to produce net income of $12 million? A) $29 million B) $112 million C) $116 million D) $124 million

Answer: C Explanation: Lamps, INC. Income Statement for Year Ending December 31, 2018 (in millions of dollars) Net sales $ 116 Less: Cost of goods sold 87 Gross profits 29 Less: Depreciation 5 Earnings before interest and taxes (EBIT) 24 Less: Interest 4 Earnings before taxes (EBT) 20 Less: Taxes Net income $ 12 Step 1: EBT (1 − t) = Net income = $12m = EBT (1 − 0.4) => EBT = $12m/(1 − 0.4) = $20m. Step 2: EBIT = EBT + Interest = $20m + $4m = $24m. Step 3: Gross profits = EBIT + Depreciation = $24m + $5m = $29m. Step 4: Net sales = Gross profits/(1 − Cost of goods sold percent) = $29m/(1 − 0.75) = $116m. Step 5: Cost of goods sold = Sales − Gross profits = $116m − $29 = $87m. Difficulty: 3 Hard Topic: Income statement Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 02-01 Recall the major financial statements that firms must prepare and provide.

82) You have been given the following information for Halle's Holiday Store Corp. for the year 2017: Net sales = $50,000,000; Cost of goods sold = $35,000,000; Addition to retained earnings = $2,000,000; Dividends paid to preferred and common stockholders = $3,000,000; Interest expense = $3,000,000. The firm's tax rate is 30 percent. In 2018, net sales are expected to increase by $5 million, cost of goods sold is expected to be 65 percent of net sales, expensed depreciation is expected to be the same as in 2017, interest expense is expected to be $2,500,000, the tax rate is expected to be 30 percent of EBT, and dividends paid to preferred and common stockholders will not change. What is the addition to retained earnings expected in 2018? A) $2,000,000 B) $5,325,000 C) $8,447,500 D) $10,304,643 Answer: B Explanation: Income Statement for Year Ending December 31, 2017 (in millions of dollars) Net sales (all credits) $ 50,000,000 Less: Cost of goods sold 35,000,000 Gross profits 15,000,000 Less: Depreciation ($15m. − $10,142,857) 4,857,143 Earnings before interest and taxes (EBIT) ($7,142,857 10,142,857 + $3m) Less: Interest 3,000,000 Earnings before taxes (EBT) 7,142,857 Less: Taxes Net income $ 5,000,000 Less: Preferred and common stock dividends $ 3,000,000 Addition to retained earnings $ 2,000,000 Depreciation = $15,000,000 − $10,142,857 = $4,857,143. Earnings before interest and taxes (EBIT) = $7,142,857 + $3,000,000 = $10,142,857. Earnings before taxes (EBT) = $5,000,000/ (1 − 0.30) = $7,142,857. Difficulty: 3 Hard Topic: Income statement Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 02-01 Recall the major financial statements that firms must prepare and provide.

83) Martha's Moving Van 4U, Inc. had free cash flow during 2018 of $1 million, EBIT of $30 million, tax expense of $8 million, and depreciation of $4 million. • • • •

Beginning of the year gross fixed assets were $30m and end of the year gross fixed assets were $40m. Beginning of the year current assets were $110m and end of the year current assets were $130m. Beginning of the year current liabilities were $85m. Accrued wages and taxes at the end of the year were $20m and Notes Payable at the end of the year were $35m.

Using the above information, what was Martha's Accounts Payable ending balance in 2018? A) $5 million B) $15 million C) $35 million D) $45 million

Answer: C Explanation: Martha's operating cash flow for 2018 was: OCF = EBIT − Taxes + Depreciation = ($30m − $8m + $4m) = $26m Martha's free cash flow was: FCF = Operating cash flow − Investment in operating capital $1m = $26m − Investment in operating capital So, Investment in operating capital = $26m − $1m = $25m IOC = ΔGross fixed assets + ΔNet operating working capital $25m = ($40m − $30m) + ΔNet operating working capital => ΔNet operating working capital = $25m − ($40m − $30m) = $15m ΔNet operating working capital = $15m = ∆Current assets − ∆Current liabilities $15m = ($130m − $110m) − ∆Current liabilities => ∆Current liabilities = ($130m − $110m) − $15m = $5m => 2018 Current liabilities = $85m + $5m = $90m and 2018 Current liabilities = Accrued wages and taxes + Accounts payable + Notes payable $90m = $20m + Accounts payable + $35m => Accounts payable = $90m − $20m − $35m = $35m Martha's Moving Van 4U, Inc. Balance Sheet as of December 31, 2017 and 2018 (in millions of dollars) Liabilities and 2017 2018 2017 Equity Current liabilities

Assets Current assets Cash and marketable securities Accounts receivable Inventory Total Fixed assets: Gross plant and equipment Less: Depreciation Net plant and equipment Other long-term assets Total Total assets

Accrued wages and taxes

Accounts payable Notes payable Total Long-term debt: Stockholders' equity: Preferred stock (5m shares) Common stock and paid-insurplus (20m shares)

80 110

90 130

10 $

12 $

Retained earnings Total Total liabilities

160

188

2018

20 35

$ $

30 85 20

$ $

35 90 25

160

$ 188

and equity

Difficulty: 3 Hard Topic: Free cash flow Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 02-05 Demonstrate how to use a firm's financial statements to calculate its cash flows. 70

84) You are evaluating the balance sheet for Goodman's Bees Corporation. From the balance sheet you find the following balances: cash and marketable securities = $200,000, accounts receivable = $1,100,000, inventory = $2,000,000, accrued wages and taxes = $500,000, accounts payable = $600,000, and notes payable = $100,000. Calculate Goodman's Bees' net working capital. A) $2,000,000 B) $2,100,000 C) $1,400,000 D) $1,900,000 Answer: B Explanation: (0.2m + 1.1m + 2.0m) − (0.5m + 0.6m + 0.1m) = 2.1m. Difficulty: 1 Easy Topic: Net working capital Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 02-01 Recall the major financial statements that firms must prepare and provide. 85) Zoeckler Mowing & Landscaping's year-end 2018 balance sheet lists current assets of $350,000, fixed assets of $325,000, current liabilities of $145,000, and long-term debt of $185,000. Calculate Zoeckler's total stockholders' equity. A) $115,000 B) $490,000 C) $345,000 D) $500,000 Answer: C Explanation: (0.350 + 0.325) − (0.145 + 0.185) = 0.345m. Difficulty: 1 Easy Topic: Balance sheet Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 02-01 Recall the major financial statements that firms must prepare and provide.

86) Reed's Birdie Shot, Inc.'s 2018 income statement lists the following income and expenses: EBIT = $550,000, interest expense = $43,000, and net income = $300,000. Calculate the 2018 taxes reported on the income statement. A) $85,000 B) $107,000 C) $309,000 D) $207,000 Answer: D Explanation: (0.550m − 0.043m) − 0.3m = 0.207m. Difficulty: 1 Easy Topic: Income statement Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 02-01 Recall the major financial statements that firms must prepare and provide. 87) Reed's Birdie Shot, Inc.'s 2018 income statement lists the following income and expenses: EBIT = $555,000, interest expense = $178,000, and taxes = $148,000. Reed's has no preferred stock outstanding and 100,000 shares of common stock outstanding. Calculate the 2018 earnings per share. A) $3.49 B) $2.29 C) $3.14 D) $2.79 Answer: B Explanation: (0.555m − 0.178m − 0.148m)/0.1m = $2.29. Difficulty: 1 Easy Topic: Per-share valuations Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 02-01 Recall the major financial statements that firms must prepare and provide.

88) Oakdale Fashions Inc. had $255,000 in 2018 taxable income. If the firm paid $82,100 in taxes, what is the firm's average tax rate? A) 34.70% B) 32.20% C) 29.90% D) 28.20% Answer: B Explanation: 82,100/255,000 = 32.20%. Difficulty: 1 Easy Topic: Taxes Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 02-03 Explain how taxes influence corporate managers' and investors' decisions. 89) Hunt Taxidermy, Inc. is concerned about the taxes paid by the company in 2018. In addition to $36.5 million of taxable income, the firm received $1,250,000 of interest on state-issued bonds and $400,000 of dividends on common stock it owns in Hunt Taxidermy, Inc. Calculate Hunt Taxidermy's taxable income. A) $40,250,000 B) $38,150,000 C) $36,900,000 D) $36,620,000 Answer: D Explanation: $36.5m + (0.3)0.4m = 36.620m. Difficulty: 1 Easy Topic: Taxes Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 02-03 Explain how taxes influence corporate managers' and investors' decisions.

90) Ramakrishnan Inc. reported 2018 net income of $20 million and depreciation of $1,500,000. The top part of Ramakrishnan, Inc.'s 2017 and 2018 balance sheets is listed as follows (in millions of dollars).

Assets

2017

2018

Current assets Cash and marketable securities Accounts receivable Inventory Total

110 $ 200

121 $ 225

Liabilities & Equity Current liabilities Accrued wages and taxes Accounts payable Notes payable Total

2017

2018

18 45

40 $ 103

45 $ 115

Calculate the 2018 net cash flow from operating activities for Ramakrishnan, Inc. A) $12,500,000 B) $10,500,000 C) $8,500,000 D) $7,100,000 Answer: C Explanation: 20 + (1.5 + 2 + 5) − (9 + 11) = $8.5m. Difficulty: 1 Easy Topic: Operating activities Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 02-04 Differentiate between accounting income and cash flows.

91) In 2018, Usher Sports Shop had cash flows from investing activities of ($2,150,000) and cash flows from financing activities of ($3,219,000). The balance in the firm's cash account was $980,000 at the beginning of 2018 and $1,025,000 at the end of the year. Calculate Usher Sports Shop's cash flow from operations for 2018. A) $6,219,000 B) $5,414,000 C) $4,970,000 D) $5,980,000 Answer: B Explanation: (1,025,000 − 980,000) = X − 2,150,000 − 3,219,000; => X = Cash flow from operations = $5,414,000. Difficulty: 1 Easy Topic: Operating activities Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 02-04 Differentiate between accounting income and cash flows. 92) You are considering an investment in Fields and Struthers, Inc. and want to evaluate the firm's free cash flow. From the income statement, you see that Fields and Struthers earned an EBIT of $52 million, paid taxes of $10 million, and its depreciation expense was $5 million. Fields and Struthers' gross fixed assets increased by $38 million from 2017 to 2018. The firm's current assets increased by $20 million and spontaneous current liabilities increased by $12 million. Calculate Fields and Struthers' operating cash flow (OCF), investment in operating capital (IOC), and free cash flow (FCF) for 2018. A) OCF = $42,000,000; IOC = $37,000,000; FCF = $5,000,000 B) OCF = $47,000,000; IOC = $37,000,000; FCF = $10,000,000 C) OCF = $42,000,000; IOC = $46,000,000; FCF = −$4,000,000 D) OCF = $47,000,000; IOC = $46,000,000; FCF = $1,000,000 Answer: D Explanation: OCF = EBIT − Taxes + Depreciation = ($52m − $10m + $5m) = $47m. Investment in operating capital: ΔGross fixed assets + ΔNet operating working capital = $38m + ($20m − $12m) = $46m. Accordingly, Fields and Struthers' free cash flow for 2018 was: FCF = Operating cash flow − Investment in operating capital = $47m − $46m = $1m. Difficulty: 1 Easy Topic: Free cash flow Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 02-05 Demonstrate how to use a firm's financial statements to calculate its cash flows.

93) Tater and Pepper Corp. reported free cash flows for 2018 of $20 million and investment in operating capital of $15 million. Tater and Pepper listed $8 million in depreciation expense and $12 million in taxes on its 2018 income statement. Calculate Tater and Pepper's 2018 EBIT. A) $49,000,000 B) $42,000,000 C) $39,000,000 D) $47,000,000 Answer: C Explanation: FCF = Operating cash flow − Investment in operating capital; $20m = X − $15m; X = $35m; OCF = EBIT − Taxes + Depreciation; $35m = (EBIT − $12m + $8m); EBIT = $39m. Difficulty: 1 Easy Topic: Free cash flow Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 02-05 Demonstrate how to use a firm's financial statements to calculate its cash flows. 94) Mr. Husker's Tuxedos, Corp. began the year 2018 with $205 million in retained earnings. The firm earned net income of $30 million in 2018 and paid $5 million to its preferred stockholders and $12 million to its common stockholders. What is the year-end 2018 balance in retained earnings for Mr. Husker's Tuxedos? A) $193,000,000 B) $200,000,000 C) $213,000,000 D) $218,000,000 Answer: D Explanation: $205m + $30m − $5m − $12m = $218m. Difficulty: 1 Easy Topic: Statement of retained earnings Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 02-01 Recall the major financial statements that firms must prepare and provide.

95) Brenda's Bar and Grill has total assets of $17 million of which $5 million are current assets. Cash makes up 12 percent of the current assets and accounts receivable makes up another 40 percent of current assets. Brenda's gross plant and equipment has a cost value of $12 million and other long-term assets have a cost value of $1,000,000. Using this information, what are the balance of inventory and the balance of depreciation on Brenda's Bar and Grill's balance sheet? A) $2.4 million; $1 million B) $3.4 million; $2 million C) $1.4 million; $1 million D) $0.4 million; $3 million Answer: A Explanation: Step 1: Find Inventory: CA = 5 = Cash + A/R + Inv = 0.12 × 5 + 0.40 × 5 + Inv; => Inv = $2.4m; Step 2: Find Depreciation Expense: TA = CA + FA − Accumulated Depreciation.; 17 = 5 + (12 + 1) − Accumulated Depreciation; => Accumulated Depreciation = $1m. Difficulty: 2 Medium Topic: Balance sheet Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 02-01 Recall the major financial statements that firms must prepare and provide. 96) Ed's Tobacco Shop has total assets of $100 million. Fifty percent of these assets are financed with debt of which $37 million is current liabilities. The firm has no preferred stock but the balance in common stock and paid-in surplus is $32 million. Using this information what is the balance for long-term debt and retained earnings on Ed's Tobacco Shop's balance sheet? A) $18 million; $27 million B) $12 million; $12 million C) $14 million; $29 million D) $13 million; $18 million Answer: D Explanation: Step 1: Find long-term debt: TL = CL + long-term debt = 0.5 × 100 = 37 + longterm debt; long-term debt = $13 million; Step 2: Find RE: Total equity = 0.5 × 100 = 50 = CS + P + RE = 32 + RE; RE = $18 million. Difficulty: 2 Medium Topic: Balance sheet Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 02-01 Recall the major financial statements that firms must prepare and provide.

97) Muffin's Masonry, Inc.'s balance sheet lists net fixed assets as $16 million. The fixed assets could currently be sold for $17 million. Muffin's current balance sheet shows current liabilities of $5.5 million and net working capital of $6.5 million. If all the current accounts were liquidated today, the company would receive $10.25 million cash after paying $5.5 million in liabilities. What is the book value of Muffin's Masonry's assets today? What is the market value of these assets? A) Book Value: $28m; Market Value: $32.75m B) Book Value: $32m; Market Value: $42.25m C) Book Value: $32m; Market Value: $32.75m D) Book Value: $28m; Market Value: $42.25m Answer: A Explanation: Step 1: Find CA (book value): = CA − CL = NWC; => CA (book value) = 6.5m + 5.5m = $12m. Step 2: Find TA (book value): TA = Net FA + CA = $16m + $12m = $28m. Step 3: Find CA (market value): NWC (market) + CL = $10.25 + $5.5m = $15.75m. Step 4: Find TA (market value): Net FA + CA = $17m + $15.75m = $32.75m. Difficulty: 2 Medium Topic: Market and book values Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 02-02 Differentiate between book (or accounting) value and market value.

98) Ed's Tobacco Shop has total assets of $100 million. Fifty percent of these assets are financed with debt of which $37 million is current liabilities. The firm has no preferred stock but the balance in common stock and paid-in surplus is $32 million. Using this information what is the balance for long-term debt and retained earnings on Ed's Tobacco Shop's balance sheet? A) $1,970,842.88 B) $1,214,285.71 C) $1,521,989.23 D) $2,364,285.71 Answer: B Explanation: Step 1: NI = Dividends + Addition to RE = 4,000,000.00 + 995,000 = $4,995,000. Step 2: NI = EBT (1 − tax rate) => EBT = NI/(1 − tax rate) = $4,995,000/(1 − 0.30) = $7,135,714.29. Step 3: EBIT − Interest = EBT => EBIT = $7,135,714.29 + $1,150,000 = $8,285,714.29. Step 4: Gross profits = Net sales − COGS = $15,250,000 − $5,750,000 = $9,500,000. Step 5: Gross profits − Depreciation = EBIT => Depreciation = $9,500,000 − $8,285,714.29 = $1,214,285.71. Difficulty: 2 Medium Topic: Income statement Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 02-01 Recall the major financial statements that firms must prepare and provide. 99) Dogs 4 U Corporation has net cash flow from financing activities for the last year of $10 million. The company paid $8 million in dividends last year. During the year, the change in notes payable on the balance sheet was $9 million, and change in common and preferred stock was $0 million. The end of year balance for long-term debt was $44 million. Calculate the beginning of year balance for long-term debt. A) $37 million B) $34 million C) $33 million D) $35 million Answer: D Explanation: $10 = $9 − $8 – $0 + Change in long-term debt; => change in long-term debt = $9 = Ending Bal − Change in long-term debt; => Beg balance of long-term debt = $35. Difficulty: 2 Medium Topic: Financing activities Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 02-05 Demonstrate how to use a firm's financial statements to calculate its cash flows.

100) The 2011 income statement for Duffy's Pest Control shows that depreciation expense is $180 million, EBIT is $420 million, EBT is $240 million, and the tax rate is 30 percent. At the beginning of the year, the balance of gross fixed assets was $1,500 million and net operating working capital was $500 million. At the end of the year gross fixed assets was $1,803 million. Duffy's free cash flow for the year was $425 million. Calculate the end of year balance for net operating working capital. A) $403 million B) $300 million C) $203 million D) $103 million Answer: B Explanation: Step 1: Find OCF: OCF = $420 − ($240 × 0.3) + $180 = $528; Step 2: Find investment in operating capital: FCF = $425 = $528 − Investment in Op Cap; Investment in operating capital = $103 Step 3: Find ending level of net op. working cap: $103 = ($1,803 − $1,500) + (Ending net op. working capital − $500); Ending net op. working capital = $300 Difficulty: 2 Medium Topic: Free cash flow Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 02-05 Demonstrate how to use a firm's financial statements to calculate its cash flows. 101) The CEO of Tom and Sue's wants the company to earn a net income of $3.25 million in 2018. Cost of goods sold is expected to be 60 percent of net sales, depreciation expense is $2.9 million, interest expense is expected to increase to $1.050 million, and the firm's tax rate will be 30 percent. Calculate the net sales needed to produce net income of $3.25 million. A) $26.02 million B) $29.36 million C) $21.48 million D) $28.25 million Answer: C Explanation: Work backwards (up) the income statement: EBT = 3.25/1 − 0.3 = $4.64m; EBIT = $4.64m + $1.05m = $5.69m; Gross Profits = $5.69m + $2.9 = $8.59m; Net sales = $8.59/(1 − 0.6) = $21.475m Difficulty: 3 Hard Topic: Income statement Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 02-01 Recall the major financial statements that firms must prepare and provide. 80

102) All of the following would be a result of changing to the MACRS method of depreciation EXCEPT A) higher depreciation expense. B) lower taxes in the early years of a project's life. C) lower taxable income in the early years of a project's life. D) All of these choices are correct. Answer: D Difficulty: 1 Easy Topic: Depreciation methods Bloom's: Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 02-01 Recall the major financial statements that firms must prepare and provide. 103) Which of the following is NOT a source of cash? A) The firm reduces its inventory. B) The firm pays off some of its long-term debt. C) The firm has positive net income. D) The firm sells more common stock. Answer: B Difficulty: 2 Medium Topic: Sources and uses of cash Bloom's: Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 02-05 Demonstrate how to use a firm's financial statements to calculate its cash flows. 104) Which of the following is a use of cash? A) The firm takes its depreciation expense. B) The firm sells some of its fixed assets. C) The firm issues more long-term debt. D) The firm decreases its accrued wages and taxes. Answer: D Difficulty: 2 Medium Topic: Sources and uses of cash Bloom's: Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 02-05 Demonstrate how to use a firm's financial statements to calculate its cash flows. 81

105) Is it possible for a firm to have positive net income and yet to have cash flow problems? A) No, this is impossible since net income increases the firm's cash. B) Yes, this can occur when a firm is growing very rapidly. C) Yes, this is possible if the firm window-dressed its financial statements. D) No, this is impossible since net income and cash are highly correlated. Answer: B Difficulty: 1 Easy Topic: Statement of cash flows Bloom's: Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 02-04 Differentiate between accounting income and cash flows. 106) All of the following are cash flows from operations EXCEPT A) increases or decreases in cash. B) net income. C) depreciation. D) increases or decreases in accounts payable. Answer: A Difficulty: 2 Medium Topic: Operating activities Bloom's: Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 02-05 Demonstrate how to use a firm's financial statements to calculate its cash flows. 107) All of the following are cash flows from financing EXCEPT a(n) A) increase in accounts payable. B) issuing stock. C) stock repurchases. D) paying dividends. Answer: A Difficulty: 2 Medium Topic: Financing activities Bloom's: Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 02-05 Demonstrate how to use a firm's financial statements to calculate its cash flows.

108) Cash flows available to pay the firm's stockholders and debt holders after the firm has made the necessary working capital investments, fixed asset investments, and developed the necessary new products to sustain the firm's ongoing operations is referred to as: A) operating cash flow. B) net operating working capital. C) free cash flow. Answer: C Difficulty: 2 Medium Topic: Free cash flow Bloom's: Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 02-05 Demonstrate how to use a firm's financial statements to calculate its cash flows. 109) Investment in operating capital is: A) the change in assets plus the change in current liabilities. B) the change in gross fixed assets plus depreciation. C) the change in gross fixed assets plus the change in free cash flow. D) None of the options. Answer: D Difficulty: 2 Medium Topic: Free cash flow Bloom's: Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 02-05 Demonstrate how to use a firm's financial statements to calculate its cash flows.

110) A firm had EBIT of $1,000, paid taxes of $225, expensed depreciation at $13, and its gross fixed assets increased by $25. What was the firm's operating cash flow? A) $763 B) $737 C) $813 D) $788 Answer: D Explanation: $1,000 − $225 + $13 = $788. Difficulty: 2 Medium Topic: Operating cash flow Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 02-05 Demonstrate how to use a firm's financial statements to calculate its cash flows. 111) Which of the following is an example of a capital structure? A) 15 percent current assets and 85 percent fixed assets B) 10 percent current liabilities and 90 percent long-term debt C) 20 percent debt and 80 percent equity Answer: C Difficulty: 2 Medium Topic: Capital structure Bloom's: Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 02-01 Recall the major financial statements that firms must prepare and provide.

112) Lemmon Inc. lists fixed assets of $100 on its balance sheet. The firm's fixed assets have recently been appraised at $140. The firm's balance sheet also lists current assets at $15. Current assets were appraised at $16.50. Current liabilities book and market values stand at $12 and the firm's long-term debt is $40. Calculate the market value of the firm's stockholders' equity. A) $156.50 B) $112.50 C) $104.50 D) $144.50 Answer: C Explanation: ($140 + $16.50) − $12 − $40 = $104.50 Difficulty: 2 Medium Topic: Market and book values Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 02-01 Recall the major financial statements that firms must prepare and provide. 113) A firm has operating income of $1,000, depreciation expense of $185, and its investment in operating capital is $400. The firm is 100 percent equity financed and has a 35 percent tax rate. What is the firm's operating cash flow? A) $725 B) $795 C) $835 D) $965 Answer: C Explanation: ($1,000 − $350 + $185) = $835. Difficulty: 2 Medium Topic: Operating cash flow Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 02-02 Differentiate between book (or accounting) value and market value.

114) All of the following are reasons that one should be cautious in interpreting financial statements EXCEPT A) firms can take steps to over- or understate earnings at various times. B) it is difficult to compare two firms that use different depreciation methods. C) financial managers have quite a bit of latitude in using accounting rules to manage their reported earnings. D) All of these choices are correct. Answer: D Difficulty: 2 Medium Topic: Financial statements Bloom's: Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 02-06 Observe cautions that should be taken when examining financial statements. 115) Which of the following statements is correct? A) The bottom line on the statement of cash flows equals the change in the retained earnings on the balance sheet. B) The reason the statement of cash flows is important is because cash is what pays the firm's obligations, not accounting profit. C) If a firm has accounting profit, its cash account will always increase. D) All of these choices are correct. Answer: B Difficulty: 2 Medium Topic: Statement of cash flows Bloom's: Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 02-04 Differentiate between accounting income and cash flows.

116) ABC Inc. has $100 in cash on its balance sheet at the end of 2017. During 2018, the firm issued $450 in common stock, reduced its notes payable by $40, purchased fixed assets in the amount of $750, and had cash flows from operating activities of $315. How much cash did ABC Inc. have on its balance sheet at the end of 2018? A) $75 B) $140 C) $225 D) −$25 Answer: A Explanation: 100 + 315 − 40 − 750 + 450 = $75. Difficulty: 2 Medium Topic: Statement of cash flows Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 02-03 Explain how taxes influence corporate managers' and investors' decisions. 117) LLV Inc. originally forecasted the following financial data for next year: sales = $1,000, cost of goods sold = $675, and interest expense = $90. The firm believes that COGS will always be 67.5 percent of sales. Due to increased global demand, the firm is now projecting that sales will be 20 percent higher than the original forecast. What is the additional net income (as compared to the original forecast) the firm can expect assuming a 35 percent tax rate? A) $59.45 B) $195.00 C) $42.25 D) $74.00 Answer: C Explanation: Step 1: Original forecasted NI = [(1,000 − 675) − 90](1 − 0.35) = 152.75; Step 2: NI under increase in sales = [1,200 − (0.675 × 1,200) − 90](1 − 0.35) = 195; Additional NI = 195 − 152.75 = 42.25. Difficulty: 3 Hard Topic: Income statement Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 02-02 Differentiate between book (or accounting) value and market value.

118) LLV Inc. originally forecasted the following financial data for next year: sales = $1,000, cost of goods sold = $710, and interest expense = $95. The firm believes that COGS will always be 71 percent of sales. Due to pressure from shareholders, the firm wants to achieve a net income of $150. Assuming the interest expense will remain the same, how large must sales be to achieve this goal? Assume a 35 percent tax rate. A) $1,403.82 B) $1,3009.18 C) $1,123.34 D) $1,296.51 Answer: C Explanation: 150/(1 − 0.35) = EBT = 230.77; EBT + Int Exp = EBIT = 325.77; EBIT/(1 − 0.71) = Sales = 1,123.34. Difficulty: 3 Hard Topic: Income statement Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 02-01 Recall the major financial statements that firms must prepare and provide. 119) A firm has sales of $690, EBIT of $300, depreciation of $40, and fixed assets increased by $265. If the firm's tax rate is 40 percent and there were no increases in net operating working capital, what is the firm's free cash flow? A) $15 B) $75 C) –$45 D) –$55 Answer: C Explanation: [300 − (300 × 0.4) + 40] − 265 = FCF = −$45. Difficulty: 2 Medium Topic: Free cash flow Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 02-05 Demonstrate how to use a firm's financial statements to calculate its cash flows.

120) GW Inc. had $800 million in retained earnings at the beginning of the year. During the year, the firm paid $0.75 per share dividend and generated $1.92 earnings per share. The firm has 100 million shares outstanding. At the end of year, what was the level of retained earnings for GW? A) $725 million B) $917 million C) $882 million D) $807 million Answer: B Explanation: 800m + {1.92 × 100m} − {0.75 × 100m} = $917m. Difficulty: 3 Hard Topic: Statement of retained earnings Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 02-05 Demonstrate how to use a firm's financial statements to calculate its cash flows. 121) For which of the following would one expect the book value of the asset to differ widely from its market value? A) accounts receivable B) accounts payable C) notes payable D) equity Answer: D Difficulty: 1 Easy Topic: Market and book values Bloom's: Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 02-02 Differentiate between book (or accounting) value and market value.

122) Which of these is the term for the ease of conversion of an asset into cash at a fair value? A) Liquidity B) Fair Market Value (FMV) C) Book Value D) Current Asset Answer: A Difficulty: 1 Easy Topic: Financial statements Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 02-01 Recall the major financial statements that firms must prepare and provide. 123) Epic, Inc.'s 2018 income statement lists the following income and expenses: EBIT = $1,000,000, interest expense = $75,000, and taxes = $277,500. Epic has no preferred stock outstanding and 100,000 shares of common stock outstanding. What are its 2018 earnings per share? A) $10.00 B) $9.25 C) $7.225 D) $6.475 Answer: D Explanation: Using the setup of an Income Statement in Table 2.2:

EBIT Interest expense

$ 1,000,000 − 75,000

EBT Taxes Net income

−

925,000 277,500 647,500

Thus, Earnings per share (EFS) = $647,500/100,000 = $6.475 per share. Difficulty: 1 Easy Topic: Per-share valuations Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 02-01 Recall the major financial statements that firms must prepare and provide.

124) Downtown Development, Inc.'s 2018 income statement lists the following income and expenses: EBIT = $700,000, interest expense = $100,000, and taxes = $168,000. Downtown has no preferred stock outstanding and 50,000 shares of common stock outstanding. What are its 2018 earnings per share? A) $14.00 B) $12.00 C) $10.64 D) $8.64 Answer: D Explanation: Using the setup of an Income Statement in Table 2.2: EBIT Interest expense EBT Taxes Net income

$ 700,000 − 100,000 600,000 − 168,000 432,000

Thus, Earnings per share (EPS) = $432,000/50,000 = $8.64 EPS. Difficulty: 1 Easy Topic: Per-share valuations Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 02-01 Recall the major financial statements that firms must prepare and provide.

125) You are evaluating the balance sheet for Epic Corporation. From the balance sheet you find the following balances: cash and marketable securities = $500,000, accounts receivable = $200,000, inventory = $100,000, accrued wages and taxes = $50,000, accounts payable = $60,000, and notes payable = $200,000. Calculate Epic's net working capital. A) $490,000 B) $540,000 C) $690,000 D) $800,000 Answer: A Explanation: (500,000 + 200,000 + 100,000) − (50,000 + 60,000 + 200,000) = 490,000. Difficulty: 1 Easy Topic: Net working capital Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 02-01 Recall the major financial statements that firms must prepare and provide. 126) You are evaluating the balance sheet for Ultra Corporation. From the balance sheet you find the following balances: cash and marketable securities = $10,000, accounts receivable = $2,000, inventory = $20,000, accrued wages and taxes = $1,000, accounts payable = $3,000, and notes payable = $10,000. Calculate Ultra's net working capital. A) $ 8,000 B) $18,000 C) $28,000 D) $32,000 Answer: B Explanation: (10,000 + 2,000 + 20,000) − (1,000 + 3,000 + 10,000) = 18,000. Difficulty: 1 Easy Topic: Net working capital Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 02-01 Recall the major financial statements that firms must prepare and provide.

127) Which of the following is the term within the GAAP framework whereby firms can engage in a process of controlling their earnings, otherwise known as "smoothing" their earnings, as long as it's not taken to an extreme. A) commingling B) delisting C) window dressing D) earnings management Answer: D Difficulty: 2 Medium Topic: Ethics, governance, and regulation Bloom's: Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 02-06 Observe cautions that should be taken when examining financial statements. 128) A firm has sales of $10,000, EBIT of $3,000, depreciation of $400, and fixed assets increased by $2,000. If the firm's tax rate is 30 percent and there were no increases in net operating working capital, what is the firm's free cash flow? A) $7400 B) $600 C) $500 D) –$1,220 Answer: C Explanation: [3,000 − (3,000 × 0.3) + 400] − 2,000 = FCF = $500. Difficulty: 2 Medium Topic: Free cash flow Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 02-05 Demonstrate how to use a firm's financial statements to calculate its cash flows.

129) A firm has sales of $50,000, EBIT of $10,000, depreciation of $4,000, and fixed assets increased by $2,000. If the firm's tax rate is 30 percent and there was a $1,000 increase in net operating working capital, what is the firm's free cash flow? A) $10,000 B) $9,000 C) $8,000 D) $1,200 Answer: C Explanation: [10,000 − (10,000 × 0.3) + 4,000] − (2000 + 1,000) = FCF = $8,000. Difficulty: 2 Medium Topic: Free cash flow Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 02-05 Demonstrate how to use a firm's financial statements to calculate its cash flows. 130) Ultra Inc. had $100 million in retained earnings at the beginning of the year. During the year, the firm paid $0.25 per share dividend and generated $2.00 earnings per share. The firm has 10 million shares outstanding. At the end of year, what was the level of retained earnings for GW? A) $100 million B) $117.5 million C) $120 million D) $145 million Answer: B Explanation: 100m + (2.00 × 10m) − (0.25 × 10m) = $117.5m. Difficulty: 3 Hard Topic: Statement of retained earnings Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 02-05 Demonstrate how to use a firm's financial statements to calculate its cash flows.

Finance, 5e (Cornett) Chapter 3 Analyzing Financial Statements 1) Which of the following refer to ratios that measure the relationship between a firm's liquid (or current) assets and its current liabilities? A) cross-section B) internal-growth C) liquidity D) market value Answer: C Difficulty: 1 Easy Topic: Short-term solvency ratios Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 03-01 Calculate and interpret major liquidity ratios. 2) Which type of ratio measures the dollars of current assets available to pay each dollar of current liabilities A) cross-section B) current C) internal-growth D) quick or acid-test Answer: B Difficulty: 1 Easy Topic: Short-term solvency ratios Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 03-01 Calculate and interpret major liquidity ratios.

3) Which type of ratio measures a firm's ability to pay off short-term obligations without relying on inventory sales? A) cash B) current C) internal-growth D) quick or acid-test Answer: D Difficulty: 1 Easy Topic: Short-term solvency ratios Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 03-01 Calculate and interpret major liquidity ratios. 4) Which ratio measures a firm's ability to pay short-term obligations with its available cash and market securities? A) cash B) current C) internal-growth D) quick or acid-test Answer: A Difficulty: 1 Easy Topic: Short-term solvency ratios Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 03-01 Calculate and interpret major liquidity ratios. 5) Which statement is true? A) The less liquid assets a firm holds, the less likely it is that the firm will experience financial distress. B) The lower the liquidity ratios, the less liquidity risk a firm has. C) Liquid assets generate profits for the firm. D) Extremely high levels of liquidity guard against liquidity crises, but at the cost of lower returns on assets. Answer: D Difficulty: 2 Medium Topic: Short-term solvency ratios Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 03-01 Calculate and interpret major liquidity ratios.

6) Select the most commonly used liquidity ratios A) Current ratio B) Quick ratio C) Cash ratio D) All of the above are considered commonly used liquidity ratios. Answer: D Difficulty: 2 Medium Topic: Short-term solvency ratios Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 03-01 Calculate and interpret major liquidity ratios. 7) Which of the following ratios measure how efficiently a firm uses its assets, as well as how efficiently the firm manages its accounts payable? A) asset management B) cash C) internal-growth D) quick or acid-test Answer: A Difficulty: 1 Easy Topic: Asset management ratios Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 03-02 Calculate and interpret major asset management ratios. 8) Which ratio measures the number of dollars of sales produced per dollar of inventory? A) asset management B) cash C) internal-growth D) inventory turnover Answer: D Difficulty: 1 Easy Topic: Asset management ratios Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 03-02 Calculate and interpret major asset management ratios.

9) Which of these statements is true? A) A low inventory turnover ratio or a low days' sales in inventory is a sign of good inventory management. B) A high inventory turnover ratio or a low days' sales in inventory is a sign of good inventory management. C) A low inventory turnover ratio or a high days' sales in inventory is a sign of good inventory management. D) A high inventory turnover ratio or a high days' sales in inventory is a sign of good inventory management. Answer: B Difficulty: 2 Medium Topic: Asset management ratios Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 03-02 Calculate and interpret major asset management ratios. 10) Which of the following measures the number of days accounts receivable are held before the firm collects cash from the sale? A) accounts receivable turnover B) average collection period C) average payment period D) accounts payable turnover Answer: B Difficulty: 1 Easy Topic: Asset management ratios Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 03-02 Calculate and interpret major asset management ratios.

11) Which of the following measures the number of days that the firm holds accounts payable before it has to extend cash to buy raw materials? A) accounts receivable turnover B) average collection period C) average payment period D) accounts payable turnover Answer: C Difficulty: 1 Easy Topic: Asset management ratios Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 03-02 Calculate and interpret major asset management ratios. 12) Which of the following measures the number of dollars of sales produced per dollar of fixed assets? A) fixed asset to working capital ratio B) fixed asset turnover ratio C) fixed asset management ratio D) sales to working capital ratio Answer: B Difficulty: 1 Easy Topic: Asset management ratios Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 03-02 Calculate and interpret major asset management ratios. 13) Which of these statements is true? A) The age of a firm's cash will affect the current ratio level. B) The age of a firm's accounts receivable will affect the current ratio level. C) The age of a firm's fixed assets will affect the fixed asset turnover ratio level. D) The age of a firm's fixed assets will affect the current ratio level. Answer: C Difficulty: 2 Medium Topic: Asset management ratios Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 03-02 Calculate and interpret major asset management ratios.

14) Which of these statements is true? A) In general, the lower the total asset turnover and the lower the capital intensity ratio, the more efficient the overall asset management of the firm will be. B) In general, the lower the total asset turnover and the higher the capital intensity ratio, the more efficient the overall asset management of the firm will be. C) In general, the higher the total asset turnover and the lower the capital intensity ratio, the more efficient the overall asset management of the firm will be. D) In general, the higher the total asset turnover and the higher the capital intensity ratio, the more efficient the overall asset management of the firm will be. Answer: C Difficulty: 2 Medium Topic: Asset management ratios Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 03-02 Calculate and interpret major asset management ratios. 15) Which of these ratios measure the extent to which the firm uses debt (or financial leverage) versus equity to finance its assets? A) debt management ratios B) equity ratios C) financial ratios D) liquidity ratios Answer: A Difficulty: 1 Easy Topic: Long-term solvency ratios Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 03-03 Calculate and interpret major debt ratios. 16) Which ratio measures the percentage of total assets financed by debt? A) debt B) debt-to-equity C) equity multiplier D) liquidity Answer: A Difficulty: 1 Easy Topic: Long-term solvency ratios Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 03-03 Calculate and interpret major debt ratios. 6

17) Select the major debt management ratios. A) Debt ratio and debt-to-equity. B) The equity multiplier and the times interest earned. C) The fixed-charge coverage and the cash coverage. D) All of the above. Answer: D Difficulty: 1 Easy Topic: Long-term solvency ratios Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 03-03 Calculate and interpret major debt ratios. 18) Which of the following refers to the amount of debt versus equity a firm has on its balance sheet? A) capital coverage B) capital structure C) debt structure D) financial structure Answer: B Difficulty: 1 Easy Topic: Capital structure Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 03-03 Calculate and interpret major debt ratios. 19) Which of these is NOT considered a coverage ratio? A) cash coverage ratio B) current ratio C) fixed-charge coverage ratio D) times interest earned Answer: B Difficulty: 1 Easy Topic: Long-term solvency ratios Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 03-03 Calculate and interpret major debt ratios.

20) According to the Tax Cuts and Jobs Act (TCJA) of 2017, which of the following statements are true? A) The act contains a new limitation on the deductibility of net interest expense that exceeds 30% of a firm's adjusted taxable income starting in 2018. B) For tax years beginning before January 1, 2022, adjusted taxable income is measured as a businesses' EBITDA. C) Both A and B are true. D) Neither A or B are true. Answer: C Difficulty: 1 Easy Topic: Long-term solvency ratios Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 03-03 Calculate and interpret major debt ratios. 21) Which of these ratios show the combined effects of liquidity, asset management, and debt management on the overall operation results of the firm? A) liquidity B) coverage C) financial D) profitability Answer: D Difficulty: 1 Easy Topic: Profitability ratios Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 03-04 Calculate and interpret major profitability ratios. 22) Which of the following measures the operating return on the firm's assets, irrespective of financial leverage and taxes? A) basic earnings power ratio B) profit margin C) return on assets D) return on equity Answer: A Difficulty: 1 Easy Topic: Profitability ratios Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 03-04 Calculate and interpret major profitability ratios. 8

23) Return on Equity…. A) Measures the return on the common stockholder's investment in the assets of the firm. B) Measures the overall return on the firm's assets, including financial leverage and taxes. C) Measures the operating return on the firm's assets regardless of financial leverage and taxes. D) Is the percent of sales left after all operating expenses are deducted. Answer: A Difficulty: 1 Easy Topic: Profitability ratios Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 03-04 Calculate and interpret major profitability ratios. 24) For publicly traded firms, which of these ratios measure what investors think of the company's future performance and risk? A) liquidity ratios B) market value ratios C) price value ratios D) profitability ratios Answer: B Difficulty: 1 Easy Topic: Market value ratios Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 03-05 Calculate and interpret major market value ratios. 25) Which statement(s) is/are true of PE ratios? A) Managers, analysts, and investors expect companies with high PE ratios to experience future growth. B) Measures the amount that investors will pay for the firm's stock per dollar of equity used to finance the firm's assets. C) Measures how much investors are willing to pay for each dollar the firm earns per share of its stock. D) Both A and C are true. Answer: D Difficulty: 1 Easy Topic: Market value ratios Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 03-05 Calculate and interpret major market value ratios. 9

26) Which of these can be used by interested parties to identify changes in corporate performance? A) common-size financial statements B) industrialized financial statements C) sanitized financial statements Answer: A Difficulty: 1 Easy Topic: Standardized financial statements Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 03-07 Understand the differences between time series and cross-sectional ratio analysis. 27) Which of the following is the maximum growth rate that can be achieved by financing asset growth with new debt and retained earnings? A) internal growth rate B) retained earnings growth rate C) sustainable growth rate D) weighted growth rate Answer: C Difficulty: 1 Easy Topic: Internal and sustainable growth rates Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 03-07 Understand the differences between time series and cross-sectional ratio analysis. 28) To interpret financial ratios, managers, analysts, and investors use which of the following type of benchmarks? A) competitive analysis B) cross-industry analysis C) time-industry analysis D) time series analysis Answer: D Difficulty: 1 Easy Topic: Financial statement analysis Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 03-08 Explain cautions that should be taken when examining financial ratios. 10

29) Which statement is true of ratio analysis: A) can provide useful information on a firm's current position but should never be used to forecast future performance. B) can provide useful information on a firm's current position and hint at future performance. C) can provide useful information on a firm's past but not current position. D) can provide useful information on a firm's past and current position, but should never be used to forecast future performance. Answer: B Difficulty: 1 Easy Topic: Short-term solvency ratios Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 03-08 Explain cautions that should be taken when examining financial ratios. 30) The key to cross-sectional analysis comparison of firm ratios include: A) Identifying similar firms that compete in the same markets. B) Identifying similar firms that have similar asset sizes. C) Identifying firms that operate in a similar manner. D) All of the above. Answer: D Difficulty: 1 Easy Topic: Short-term solvency ratios Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 03-08 Explain cautions that should be taken when examining financial ratios.

31) You are evaluating the balance sheet for Blue Jays Corporation. From the balance sheet you find the following balances: cash and marketable securities = $200,000, accounts receivable = $800,000, inventory = $1,000,000, accrued wages and taxes = $250,000, accounts payable = $400,000, and notes payable = $300,000. What are Blue Jays' current ratio, quick ratio, and cash ratio, respectively? A) 1.05263, 1.05263, 0.21053 B) 2.10526, 1.05263, 0.21053 C) 3.07692, 1.53846, 0.30769 D) 3.07692, 1.05263, 0.30769 Answer: B Explanation: Current ratio =

$200,000 + $800,000 + $1,000,000

= 2.10526 times

$250,000 + $400,000 + $300,000 Quick ratio (acid-test ratio) =

$200,000 + $800,000 + $1,000,000 – $1,000,000 $250,000 + $400,000 + $300,000

Cash ratio =

$200,000 $250,000 + $400,000 + $300,000

Difficulty: 1 Easy Topic: Short-term solvency ratios Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 03-01 Calculate and interpret major liquidity ratios.

= 1.05263 times

= 0.21053 times

32) The top part of Mars, Inc.'s 2018 balance sheet is listed as follows (in millions of dollars).

Current assets: Cash and marketable securities Accounts receivable Inventory Total

Current liabilities: Accrued wages and taxes Accounts payable Notes payable Total

10 40 160 $ 210

What are Mars, Inc.'s current ratio, quick ratio, and cash ratio for 2018? A) 0.1111, 0.5556, 0.2 B) 2.3333, 0.5556, 0.1111 C) 4.2, 1.0, 0.2 D) 10.5, 6.0, 1.0 Answer: B Explanation: Current ratio =

Quick ratio (acid-test ratio) =

Cash ratio =

$210m. $90m.

= 2.3333 times

$210m. − $160m. $90m.

$10m. $90m.

= 0.5556 times

= 0.1111 times

Difficulty: 1 Easy Topic: Short-term solvency ratios Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 03-01 Calculate and interpret major liquidity ratios.

$ 20 30 40 $ 90

33) The top part of Rammy's Inc.'s 2018 balance sheet is listed as follows (in millions of dollars).

Current assets: Cash and marketable securities Accounts receivable Inventory Total

Current liabilities: Accrued wages and taxes Accounts payable Notes payable Total

5 15 95 $ 115

What are Mars, Inc.'s current ratio, quick ratio, and cash ratio for 2018? A) 1.74242, 0.30303, 0.07576 B) 7.1875, 1.25, 0.3125 C) 1.43939, 0.30303, 0.07576 D) 19.16667, 3.33333, 0.83333 Answer: A Explanation: Current ratio = $115m. = 1.74242 times $66m.

Quick ratio (acid-test ratio) =

Cash ratio =

$115m. − $95m. $66m.

= 0.30303 times

$5m. = 0.07576 times $66m.

Difficulty: 1 Easy Topic: Asset management ratios Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 03-01 Calculate and interpret major liquidity ratios.

6 10 50 $ 66

34) Tops N Bottoms Corp. reported sales for 2018 of $50 million. Tops N Bottoms listed $4 million of inventory on its balance sheet. Using a 365-day year, how many days did Tops N Bottoms' inventory stay on the premises? How many times per year did Tops N Bottoms' inventory turnover? A) 29.2 days, 12.5 times, respectively B) 12.5 days, 29.2 times, respectively C) 0.08 days, 12.5 times, respectively D) 29.2 days, 0.0345 times, respectively Answer: A Explanation: Days′ sales in inventory =

$4m. × 365 $50m.

Inventory turnover ratio =

$50m. $4m.

= 29.2 days

= 12.5 times

35) Rachets R Us Corp. reported sales for 2013 of $200,000. Rachets R Us listed $25,000 of inventory on its balance sheet. Using a 365-day year, how many days did Rachets R Us's inventory stay on the premises? How many times per year did Rachets R Us's inventory turnover? A) 0.125 days, 8 times, respectively B) 0.125 days, 5 times, respectively C) 45.625 days, 8 times, respectively D) 45.625 days, 5 times respectively Answer: C Explanation: Days′ sales in inventory =

$25,000 × 365 = 45.625 days $200,000

Inventory turnover ratio =

$200,000 = 8 times $25,000

Difficulty: 1 Easy Topic: Asset management ratios Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 03-02 Calculate and interpret major asset management ratios. 36) CornProducts Corp. ended the year 2018 with an average collection period of 40 days. The firm's credit sales for 2018 were $9 million. What is the approximate year-end 2018 balance in accounts receivable for Corn Products? A) $225,000 B) $986,300 C) $4,444,400 D) $360,000,000 Answer: B Explanation: Average collection period (ACP)

Accounts receivable × 365 = 40 days $9m.

=> Accounts receivable = 40 days × $9m./365 = $0.9863m.

Difficulty: 1 Easy Topic: Long-term solvency ratios Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 03-02 Calculate and interpret major asset management ratios.

37) Trina'sTrikes, Inc. reported a debt-to-equity ratio of 2 times at the end of 2018. If the firm's total debt at year-end was $10 million, how much equity does Trina's Trikes have? A) $2 million B) $5 million C) $10 million D) $20 million Answer: B Explanation: Debt-to-equity ratio

= Total debt = 2 =

$10m.

=> Total equity = $10m./2 = 5m.

Total equity

Difficulty: 1 Easy Topic: Long-term solvency ratios Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 03-03 Calculate and interpret major debt ratios. 38) Will's Wheels, Inc. reported a debt-to-equity ratio of 0.65 times at the end of 2018. If the firm's total debt at year-end was $5 million, how much equity does Will's Wheels have? A) $0.65 million B) $3.25 million C) $5 million D) $7.69 million Answer: D Explanation: Debt-to-equity ratio

=> Total equity = Total = .65 = $5m. debt $5m./.65 = 7.6923m. Total Total equity equity

Difficulty: 1 Easy Topic: Long-term solvency ratios Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 03-03 Calculate and interpret major debt ratios.

39) You are considering a stock investment in one of two firms (LotsofDebt, Inc. and LotsofEquity, Inc.), both of which operate in the same industry. LotsofDebt, Inc. finances its $100 million in assets with $90 million in debt and $10 million in equity. LotsofEquity, Inc. finances its $100 million in assets with $10 million in debt and $90 million in equity. What are the debt ratio, equity multiplier, and debt-to-equity ratio for the two firms? A) LotsofDebt: 90 percent, 10 times, 9 times, respectively; and LotsofEquity: 10 percent, 1.11 times, 0.1111 times, respectively B) LotsofDebt: 10 percent, 1.11 times, 0.1111 times, respectively; and LotsofEquity: 90 percent, 10 times, 9 times, respectively C) LotsofDebt: 90 percent, 1.11 times, 0.1111 times, respectively; and LotsofEquity: 10 percent, 10 times, 9 times, respectively D) LotsofDebt: 10 percent, 10 times, 9 times, respectively; and LotsofEquity: 90 percent, 1.11 times, 0.1111 times, respectively

Answer: A Explanation: Lots of Debt

Debt ratio

$90m. $100m.

= 90.00%

Equity multiplier ratio

= $100m. = 10 times $10m.

Debt-to-equity ratio

= $90m. = 9 times $10m.

Lots of Equity

Debt ratio

$10m. $100m.

Equity multiplier ratio

Debt-to-equity ratio

= 10.00%

= $100m. = 1.11 times $90m.

$10m. = .1111 times $90m.

Difficulty: 1 Easy Topic: Market value ratios Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 03-03 Calculate and interpret major debt ratios.

40) Bree's Tennis Supply's market-to-book ratio is currently 9.4 times and PE ratio is 20 times. If Bree's Tennis Supply's common stock is currently selling at $20.50 per share, what is the book value per share and earnings per share? A) $1.025, $2.1809, respectively B) $2.1809, $1.025, respectively C) $410.00, $192.70, respectively D) $192.70, $410.00, respectively Answer: B Explanation: Market-to-book ratio = 9.4 =

$20.50

=> Book value per share = $20.50/9.40 = $2.1809

Book value per share

Price-earnings (PE) ratio = 20 times =

$20.50

=> Earnings per share = $20.50/20 = $1.025

Earnings per share Difficulty: 1 Easy Topic: Market value ratios Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 03-05 Calculate and interpret major market value ratios.

41) Tina's Track Supply's market-to-book ratio is currently 4.5 times and PE ratio is 10.5 times. If Tina's Track Supply's common stock is currently selling at $100 per share, what is the book value per share and earnings per share? A) $450, $1,050, respectively B) $1,050, $450, respectively C) $22.2222, $9.5238, respectively D) $9.5238, $22.2222, respectively Answer: C Explanation: Market-to-book ratio = 4.5 =

$100

=> Book value per share = $100/4.5 = $22.2222

Book value per share

Price-earnings (PE) ratio = 10.5 times =

$100

=> Earnings per share = $100/10.5 = $9.5238

Earnings per share Difficulty: 1 Easy Topic: DuPont identity Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 03-05 Calculate and interpret major market value ratios. 42) If Epic, Inc. has an ROE = 25 percent, equity multiplier = 4, a profit margin of 12 percent, what is the total asset turnover ratio? A) 0.0833 B) 0.192 C) 0.5208 D) 0.75 Answer: C Explanation: ROE = 0.25 = 0.12 × Total asset turnover × 4 => Total asset turnover = 0.25/(0.12 × 4) = 0.520833. Difficulty: 1 Easy Topic: DuPont identity Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 03-06 Appreciate how various ratios relate to one another.

43) If Apex, Inc. has an ROE = 10 percent, equity multiplier = 3, and profit margin of 5 percent, what is the total asset turnover ratio? A) 0.0600 B) 0.0667 C) 0.1667 D) 0.6667 Answer: D Explanation: ROE = 0.10 = 0.05 × Total asset turnover × 3 => Total asset turnover = 0.10/(0.05 × 3) = 0.6667. Difficulty: 1 Easy Topic: DuPont identity Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 03-06 Appreciate how various ratios relate to one another. 44) Last year Café Creations, Inc. had an ROA of 25 percent, a profit margin of 12 percent, and sales of $4 million. What is Café Creations' total assets? A) $0.12m. B) $0.48m. C) $1.00m. D) $1.92m. Answer: D Explanation: ROA = 0.25 = 0.12 × ($4m/Total assets) => Total assets = 0.12 × $4m/0.25m = $1.92m. Difficulty: 1 Easy Topic: DuPont identity Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 03-06 Appreciate how various ratios relate to one another.

45) Last year Mocha Java, Inc. had an ROA of 10 percent, a profit margin of 5 percent, and sales of $25 million. What is Mocha Java's total assets? A) $0.125m. B) $1.25m. C) $12.5m. D) $12m. Answer: C Explanation: ROA = 0.10 = 0.05 × ($25m/Total assets) => Total assets = 0.05 × $25m/0.10m = $12.5m. Difficulty: 1 Easy Topic: Internal and sustainable growth rates Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 03-06 Appreciate how various ratios relate to one another. 46) Last year Umbrellas Unlimited Corporation had an ROA of 10 percent and a dividend payout ratio of 50 percent. What is the internal growth rate? A) 1.00 percent B) 2.25 percent C) 5.26 percent D) 100.00 percent Answer: C Explanation: Internal growth rate =

0.10 × 0.50 1 − (0.10 × 0.50)

= 0.0526 = 5.26%

47) Last year Rain Repel Corporation had an ROA of 5 percent and a dividend payout ratio of 90 percent. What is the internal growth rate? A) 4.75 percent B) 0.50 percent C) 50.00 percent D) 52.63 percent Answer: B Explanation: RR = 1 − .9 = 0.10.

Internal growth rate =

0.05 × 0.10 = 0.0050 = 0.50% 1 − (0.05 × 0.10)

Difficulty: 1 Easy Topic: Internal and sustainable growth rates Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 03-06 Appreciate how various ratios relate to one another. 48) Last year Poncho Villa Corporation had an ROA of 16 percent and a dividend payout ratio of 25 percent. What is the internal growth rate? A) 1.19 percent B) 13.64 percent C) 25.40 percent D) 33.33 percent Answer: B Explanation: RR = 1 − .25 = .75.

Internal growth rate =

0.16 × 0.75 = 0.1364 = 13.64% 1 − (0.16 × 0.75)

49) Last year Umbrellas Unlimited Corporation had an ROE of 16.5 percent and a dividend payout ratio of 40 percent. What is the sustainable growth rate? A) 13.17 percent B) 10.99 percent C) 27.50 percent D) 32.93 percent Answer: B Explanation: RR = 1 − .40 = .60.

Sustainable growth rate =

0.165 × 0.60 = 0.1099 = 10.99% 1 − (0.165 × 0.60)

Difficulty: 1 Easy Topic: Internal and sustainable growth rates Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 03-06 Appreciate how various ratios relate to one another. 50) Last year Rain Repel Corporation had an ROE of 10 percent and a dividend payout ratio of 80 percent. What is the sustainable growth rate? A) 1.11 percent B) 2.04 percent C) 44.44 percent D) 50.00 percent Answer: B Explanation: RR = 1 − .80 = .20.

Sustainable growth rate =

0.10 × 0.20 = 0.0204 = 2.04% 1 − (0.10 × 0.20)

Difficulty: 1 Easy Topic: Short-term solvency ratios Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 03-06 Appreciate how various ratios relate to one another.

51) Burt's TVs has current liabilities of $25 million. Cash makes up 40 percent of the current assets and accounts receivable makes up another 20 percent of current assets. Burt's current ratio = 0.85 times. What is the value of inventory listed on the firm's balance sheet? A) $4.25m. B) $8.5m. C) $10m. D) $40m. Answer: B Explanation: Current ratio = 0.85 = Current assets/$25m => Current assets = 0.85 × $25m = $21.25m. Cash = 0.40 × $21.25m = $8.5m. Accounts receivable = 0.20 × $21.25m = $4.25m. => Inventory = $21.25m − $8.5m − $4.25m = $8.5m. Difficulty: 2 Medium Topic: Short-term solvency ratios Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 03-01 Calculate and interpret major liquidity ratios. 52) Ernie's Mufflers has current liabilities of $45 million. Cash makes up 5 percent of the current assets and accounts receivable makes up another 50 percent of current assets. Ernie's current ratio = 1.5 times. What is the value of inventory listed on the firm's balance sheet? A) $13.75m. B) $20.25m. C) $30.375m. D) $33.75m. Answer: C Explanation: Current ratio = 1.5 = Current assets/$45m => Current assets = 1.5 × $45m = $67.5m. Cash = 0.05 × $67.5m = $3.375m. Accounts receivable = 0.50 × $67.5m = $33.75m. => Inventory = $67.5m − $3.375m − $33.75m = $30.375m. Difficulty: 2 Medium Topic: Short-term solvency ratios Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 03-01 Calculate and interpret major liquidity ratios.

53) You have the following information on Marco's Polo Shop: total liabilities and equity = $205 million, current liabilities = $45 million, inventory = $60 million, and quick ratio = 2.4 times. Using this information, what is the balance for fixed assets on Marco's Polo balance sheet? A) $37m. B) $97m. C) $145m. D) $157m. Answer: A Explanation: Quick ratio (acid-test ratio) = 2.4 times =

Current assets − $60m. $45m.

=> Current assets = (2.4 × $45m) + $60m = $168m. => Total assets = $205m = $168m + Fixed assets => Fixed assets = $205m − $168m = $37m. Difficulty: 2 Medium Topic: Short-term solvency ratios Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 03-01 Calculate and interpret major liquidity ratios. 54) You have the following information on Olivia's Bridle Shop: total liabilities and equity = $65 million, current liabilities = $10 million, inventory = $15 million, and quick ratio = 3 times. Using this information, what is the balance for fixed assets on Olivia's balance sheet? A) $20m. B) $40m. C) $45m. D) $135m. Answer: A Explanation: Quick ratio (acid-test ratio) = 3 times =

Current assets − $15m. $10m.

=> Current assets = (3 × $10m) + $15m = $45m. => Total assets = $65m = $45m + Fixed assets => Fixed assets = $65m − $45m = $20m. Difficulty: 2 Medium Topic: Asset management ratios Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 03-01 Calculate and interpret major liquidity ratios.

55) Oasis Products, Inc. has current liabilities = $10 million, current ratio = 1.5 times, inventory turnover ratio = 12 times, average collection period = 20 days, and sales = $100 million. What is the value of their cash and marketable securities? A) $1,187,215 B) $8,333,333 C) $15,000,000 D) $17,146,188 Answer: A Explanation: Current ratio = 1.5 times =

Current assets $10m

Inventory turnover ratio = 12 times =

=> Current assets = 1.5 × $10m = $15m.

$100m

=> Inventory = $100m/12 = $8,333,333

Inventory

Average collection period (ACP) = 20 days =

Accounts receivable × 365 days $100m

=> Accounts receivable = 20 × $100m/365 = $5,479,452. => Cash and marketable securities = $15m − $8,333,333 − $5,479,452 = $1,187,215. Difficulty: 2 Medium Topic: Asset management ratios Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 03-01 Calculate and interpret major liquidity ratios.; 03-02 Calculate and interpret major asset management ratios.

56) Green Products, Inc. has current liabilities = $40 million, current ratio = 2.4 times, inventory turnover ratio = 8 times, average collection period = 40 days, and sales = $320 million. What is the value of their cash and marketable securities? A) $20.93m. B) $56.00m. C) $75.07m. D) $96.00m. Answer: A Explanation: Current ratio = 2.4 times = Current assets => Current assets = 2.4 × $40m = $96m. $40m

Inventory turnover ratio = 8 times =

$320m

=> Inventory = $320m/8 = $40m.

Inventory Average collection period (ACP) = 40 days =

Accounts receivable × 365 days $320m

=> Accounts receivable = 40 × $320m/365 = $35.0685m. => Cash and marketable securities = $96m − $40m − $35.0685 = $20.9315m. Difficulty: 2 Medium Topic: Profitability ratios Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 03-01 Calculate and interpret major liquidity ratios.; 03-02 Calculate and interpret major asset management ratios.

57) You have the following information on Universe It Ts, Inc.: sales to working capital = 10 times, profit margin = 25 percent, net income available to common stockholders = $3 million, and current liabilities = $1 million. What is the firm's balance of current assets? A) $1.075m B) $1.2m C) $2.2m D) $5m Answer: C Explanation: Profit margin = 0.25 = $3m/Sales => Sales = $3m/0.25 = $12m. Sales/(Current assets − Current liabilities) = 10 = $12m/(Current assets − $1m). => Current assets = ($12m/10) + 1m = $2.2m. Difficulty: 2 Medium Topic: Profitability ratios Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 03-02 Calculate and interpret major asset management ratios.; 03-04 Calculate and interpret major profitability ratios. 58) You have the following information on Zip's Diner, Inc.: sales to working capital = 8 times, profit margin = 5 percent, net income available to common stockholders = $20 million, and current liabilities = $4 million. What is the firm's balance of current assets? A) $4.125m B) $6.5m C) $46m D) $54m Answer: D Explanation: Profit margin = 0.05 = $20m/Sales => Sales = $20m/0.05 = $400m. Sales/(Current assets − Current liabilities) = 8 = $400m/(Current assets − $4m). => Current assets = ($400m/8) + 4m = $54m. Difficulty: 2 Medium Topic: Asset management ratios Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 03-02 Calculate and interpret major asset management ratios.; 03-04 Calculate and interpret major profitability ratios.

31) Use the following information to calculate current assets: sales = $12 million, capital intensity ratio = 4 times, debt ratio = 45 percent, and fixed asset turnover ratio = 2.5 times. A) $4.8m B) $21.6m C) $43.2m D) $48m Answer: C Explanation: Assets Current assets $ 43.2m. Fixed assets $ 4.8m. Total assets $ 48.0m.

Liabilities and Equity Total liabilities Total equity Total liabilities and equity

$ 21.6m. $ 26.4m. $ 48.0m.

Step 1: Capital intensity ratio = 4 = Total assets/$12m => Total assets = 4 × $12m = $48m and Total liabilities and equity = $48m. Step 2: Debt ratio = 0.45 = Total debt/$48m => Total debt = 0.45 × $48m = $21.6m. Step 3: Total equity = $48m − $21.6m = $26.4m. Step 4: Fixed asset turnover = 2.5 = $12m/Fixed assets => Fixed assets = $12m/2.5 = $4.8m. Step 5: Current assets = $48m − $4.8m = $43.2m. Difficulty: 2 Medium Topic: Asset management ratios Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 03-02 Calculate and interpret major asset management ratios.; 03-03 Calculate and interpret major debt ratios.

32) Use the following information to calculate current assets: sales = $100 million, capital intensity ratio = 0.5 times, debt ratio = 30 percent, and fixed asset turnover ratio = 5 times. A) $10m B) $15m C) $30m D) $50m Answer: C Explanation: Assets Current assets Fixed assets Total assets

$ 30m. $ 20m. $ 50m.

Liabilities and Equity Total liabilities Total equity Total liabilities and equity

$ 15m. $ 35m. $ 50m.

Step 1: Capital intensity ratio = 0.5 = Total assets/$100m => Total assets = 0.5 × $100m = $50m and Total liabilities and equity = $50m. Step 2: Debt ratio = 0.30 = Total debt/$50m => Total debt = 0.3 × $50m = $15m. Step 3: Total equity = $50m − $15m = $35m. Step 4: Fixed asset turnover = 5 = $100m/Fixed assets => Fixed assets = $100m/5 = $20m. Step 5: Current assets = $50m − $20m = $30m. Difficulty: 2 Medium Topic: Long-term solvency ratios Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 03-02 Calculate and interpret major asset management ratios.; 03-03 Calculate and interpret major debt ratios.

61) Zoe's Dog Toys, Inc. reported a debt to equity ratio of 0.5 times at the end of 2018. If the firm's total assets at year-end are $50 million, how much of their assets is financed with equity? A) $16.67m B) $25m C) $33.33m D) $50m Answer: C Explanation: Debt to equity = 0.5 = Total debt/Total equity = Total debt/(Total assets − Total debt) = 0.5 = Total debt/($50m − Total debt) => 0.5 × ($50m − Total debt) = Total debt. => (0.5 × $50m) − (0.5 × Total debt) = Total debt => $25m = (0.5 × Total debt) + Total Debt. => Total debt = $25m/1.5 = $16.67m. => Total equity = $50m − $16.67m = $33.33m. Difficulty: 2 Medium Topic: Long-term solvency ratios Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 03-03 Calculate and interpret major debt ratios. 62) Nicole's Neon Signs, Inc. reported a debt to equity ratio of 1.9 times at the end of 2018. If the firm's total assets at year-end are $100 million, how much of their assets is financed with equity?A) $34.48m B) $65.52m C) $52.63m D) $100m Answer: A Explanation: Debt to equity = 1.9 = Total debt/Total equity = Total debt/(Total assets − Total debt). 1.9 = Total debt/($100m − Total debt) => 1.9 × ($100m − Total debt) = Total debt. => (1.9 × $100m) − (1.9 × Total debt) = Total debt => $190m = (1.9 × Total debt) + Total Debt. => Total debt = $190m/2.9 = $65.52m. => Total equity = $100m − $65.52m = $34.48m. Difficulty: 2 Medium Topic: Long-term solvency ratios Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 03-03 Calculate and interpret major debt ratios.

63) Tierre's Ts, Inc. reported a debt to equity ratio of 3 times at the end of 2018. If the firm's total assets at year-end are $15 million, how much of their assets is financed with equity? A) $3.75m B) $5m C) $11.25m D) $45m Answer: A Explanation: Debt to equity = 3 = Total debt/Total equity = Total debt/(Total assets − Total debt). 3 = Total debt/($15m − Total debt) => 3 × ($15m − Total debt) = Total debt. => (3 × $15m) − (3 × Total debt) = Total debt => $45m = (3 × Total debt) + Total Debt. => Total debt = $45m/4 = $11.25m. => Total equity = $15m − $11.25m = $3.75m. Difficulty: 2 Medium Topic: Long-term solvency ratios Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 03-03 Calculate and interpret major debt ratios. 64) Paige's Purses, Inc. reported a debt to equity ratio of 2.4 times at the end of 2018. If the firm's total assets at year-end are $27 million, how much of their assets is financed with equity? A) $7.94m B) $11.25m C) $19.06m D) $64.8m Answer: A Explanation: Debt to equity = 2.4 = Total debt/Total equity = Total debt/(Total assets − Total debt). 2.4 = Total debt/($27m − Total debt) => 2.4 × ($27m − Total debt) = Total debt. => (2.4 × $27m) − (2.4 × Total debt) = Total debt => $64.8m = (2.4 × Total debt) + Total Debt. => Total debt = $64.8m/3.4 = $19.06m. => Total equity = $27m − $19.06m = $7.94m. Difficulty: 2 Medium Topic: Long-term solvency ratios Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 03-03 Calculate and interpret major debt ratios.

65) Calculate the times interest earned ratio for Tierre's Ts, Inc. using the following information. Sales = $200,000, cost of goods sold = $50,000, depreciation expense = $13,000, addition to retained earnings = $70,000, dividends per share = $0.50, tax rate = 30 percent, and number of shares of common stock outstanding = 1,000. Tierre's Ts has no preferred stock outstanding. A) 0.1814 B) 0.4854 C) 0.685 D) 3.7756 Answer: D Explanation: $ 200,000 50,000 $ 150,000 13,000 $ 137,000 36,286 $ 100,714

$ $ $

70,500 500 70,000

Step 1: Common stock dividends = $0.50 × 1,000 = $500. Step 2: Net income = Common stock dividends + Addition to retained earnings = $500 + $70,000 = $70,500. Step 3: EBT (1 − tax rate) = Net income => EBT = Net income/(1 − tax rate) = $70,500/(1 − 0.3) = $100,714. Step 4: Gross profits = Net sales − Cost of goods sold = $200,000 − $50,000 = $150,000. Step 5: Gross profits − Depreciation = EBIT = $150,000 − $13,000 = $137,000. Step 6: EBIT − Interest = EBT => Interest = EBIT − EBT = $137,000 − $100,714 = $36,286. => Times interest earned = $137,000/$36,286 = 3.7756 times. Difficulty: 2 Medium Topic: Long-term solvency ratios Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 03-03 Calculate and interpret major debt ratios. 35

66) Calculate the times interest earned ratio for Paige's Purses, Inc. using the following information: sales = $50,000,000, cost of goods sold = $15,000,000, depreciation expense = $2,000,000, addition to retained earnings = $10,000,000, dividends per share = $1.10, tax rate = 30 percent, and number of shares of common stock outstanding = 10,000,000. Paige's Purses has no preferred stock outstanding. A) 0.27 B) 3.30 C) 11.00 D) 16.67 Answer: C Explanation: Net sales (all credit) Less: Cost of goods sold Gross profits Less: Depreciation Earnings before interest and taxes (EBIT) Less: Interest Earnings before taxes (EBT) Less: Taxes Net income Less: Common stock dividends Addition to retained earnings

$ 50,000,000 15,000,000 $ 35,000,000 2,000,000 $ 33,000,000 3,000,000 $ 30,000,000 $ 21,000,000 $ 11,000,000 $ 10,000,000

Step 1: Common stock dividends = $1.10 × 10,000,000 = $11,000,000. Step 2: Net income = Common stock dividends + Addition to retained earnings = $11,000,000 + $10,000,000 = $21,000,000. Step 3: EBT (1 − tax rate) = Net income => EBT = Net income/(1 − tax rate) = $21,000,000/(1 − 0.3) = $30,000,000. Step 4: Gross profits = Net sales − Cost of goods sold = $50,000,000 − $15,000,000 = $35,000,000. Step 5: Gross profits − Depreciation = EBIT = $35,000,000 − $2,000,000 = $33,000,000. Step 6: EBIT − Interest = EBT => Interest = EBIT − EBT = $33,000,000 − $30,000,000 = $3,000,000. => Times interest earned = $33,000,000/$3,000,000 = 11 times. Difficulty: 2 Medium Topic: Profitability ratios Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 03-03 Calculate and interpret major debt ratios. 36

67) You are thinking of investing in Tikki's Torches, Inc. You have only the following information on the firm at year-end 2018: net income = $500,000, total debt = $12 million, and debt ratio = 40 percent. What is Tikki's ROE for 2018? A) 1.67 percent B) 2.78 percent C) 4.17 percent D) 10.42 percent Answer: B Explanation: Debt ratio = 0.4 = $12m/Total assets => Total assets = $12m/0.4 = $30m => Total equity = $30m − $12m = $18m => ROE = $500,000/$18m = 2.78 percent Difficulty: 2 Medium Topic: Profitability ratios Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 03-02 Calculate and interpret major asset management ratios.; 03-04 Calculate and interpret major profitability ratios. 68) You are thinking of investing in Ski Sports, Inc. You have only the following information on the firm at year-end 2018: net income = $50,000, total debt = $1 million, and debt ratio = 70 percent. What is Ski's ROE for 2018? A) 2.94 percent B) 3.49 percent C) 7.14 percent D) 11.67 percent Answer: D Explanation: Debt ratio = 0.7 = $1m/Total assets => Total assets = $1m/0.7 = $1.4286m => Total equity = $1.4286m − $1m = $0.4286m => ROE = $50,000/$428,600 = 11.67 percent Difficulty: 2 Medium Topic: Profitability ratios Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 03-02 Calculate and interpret major asset management ratios.; 03-04 Calculate and interpret major profitability ratios.

69) You are thinking of investing in Wave Runnerz, Inc. You have only the following information on the firm at year-end 2013: net income = $10 million, total debt = $65 million, and debt ratio = 35 percent. What is Wave Runnerz's ROE for 2018? A) 8.28 percent B) 15.38 percent C) 28.57 percent D) 43.96 percent Answer: A Explanation: Debt ratio = 0.35 = $65m/Total assets => Total assets = $65m/0.35 = $185.71m. => Total equity = $185.71m − $65m = $120.71m. => ROE = $10m/$120.71m = 8.2843 percent. Difficulty: 2 Medium Topic: Profitability ratios Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 03-02 Calculate and interpret major asset management ratios.; 03-04 Calculate and interpret major profitability ratios. 70) PJ's Ice Cream Parlour has asked you to help piece together financial information on the firm for the most current year. Managers give you the following information: sales = $50 million, total debt = $20 million, debt ratio = 50 percent, and ROE = 12 percent. Using this information, what is PJ's ROA? A) 4 percent B) 6 percent C) 10 percent D) 12 percent Answer: B Explanation: Debt ratio = 0.50 = $20m/Total assets => Total assets = $20m/0.5 = $40m. => Total equity = $40m − $20m = $20m. => ROE = 0.12 = Net income/$20m => Net income = 0.12 × $20m = $2.4. => ROA = $2.4m/$40m = 6 percent. Difficulty: 2 Medium Topic: Profitability ratios Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 03-04 Calculate and interpret major profitability ratios.

71) DJ's Soda Fountain has asked you to help piece together financial information on the firm for the most current year. Managers give you the following information: sales = $20 million, total debt = $3 million, debt ratio = 75 percent, ROE = 27 percent. Using this information, what is DJ's ROA? A) .0675 percent B) 6.75 percent C) 25.00 percent D) 27.00 percent Answer: B Explanation: Debt ratio = 0.75 = $3m/Total assets => Total assets = $3m/0.75 = $4m => Total equity = $4m − $3m = $1m => ROE = 0.27 = Net income/$1m => Net income = 0.27 × $1m = $270,000 => ROA = $270,000/$4m = 6.75 percent Difficulty: 2 Medium Topic: Market value ratios Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 03-04 Calculate and interpret major profitability ratios. 72) Lab R Doors' year-end price on its common stock is $40. The firm has total assets of $75 million, the debt ratio is 60 percent, there is no preferred stock, and there are 4 million shares of common stock outstanding. Calculate the market-to-book ratio for Lab R Doors. A) 2.13 B) 3.20 C) 5.33 D) 10.00 Answer: C Explanation: Debt ratio = 0.6 = Total debt/$75m => Total debt = 0.6 × $75m = $45m. => Total equity = $75m − $45m = $30m. => Book value of equity = $30m/4m = $7.50 per share. => Market to book ratio = $40/$7.50 = 5.3333 times. Difficulty: 2 Medium Topic: Market value ratios Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 03-05 Calculate and interpret major market value ratios.

73) Fancy Paws' year-end price on its common stock is $20. The firm has total assets of $40 million, the debt ratio is 40 percent, there is no preferred stock, and there are 2 million shares of common stock outstanding. Calculate the market-to-book ratio for Fancy Paws. A) 0.47 B) 1.67 C) 8.00 D) 10.00 Answer: B Explanation: Debt ratio = 0.4 = Total debt/$40m => Total debt = 0.4 × $40m = $16m. => Total equity = $40m − $16m = $24m. => Book value of equity = $24m/2m = $12.00 per share. => Market-to-book ratio = $20/$12.00 = 1.67 times. Difficulty: 2 Medium Topic: Market value ratios Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 03-05 Calculate and interpret major market value ratios. 74) Lab R Doors' year-end price on its common stock is $40. The firm has a profit margin of 10 percent, total assets of $30 million, a total asset turnover ratio of 2, no preferred stock, and there are 4 million shares of common stock outstanding. What is the PE ratio for Lab R Doors? A) 0.375 B) 0.750 C) 6.667 D) 26.667 Answer: D Explanation: Total asset turnover = 2 = Sales/$30m => Sales = $30m × 2 = $60m. => Profit margin = 0.1 = Net income/$60m => Net income = 0.1 × $60m = $6m. => EPS = $6m/4m = $1.50 per share. => PE ratio = $40/$1.50 = 26.67 times. Difficulty: 2 Medium Topic: Market value ratios Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 03-06 Appreciate how various ratios relate to one another.

75) Fancy Paws' year-end price on its common stock is $20. The firm has a profit margin of 12 percent, total assets of $20 million, a total asset turnover ratio of 0.5, no preferred stock, and there are 2 million shares of common stock outstanding. What is the PE ratio for Fancy Paws? A) 3.33 B) 8.33 C) 10.00 D) 33.33 Answer: D Explanation: Total asset turnover = 0.5 = Sales/$20m => Sales = $20m × 0.5 = $10m. => Profit margin = 0.12 = Net income/$10m => Net income = 0.12 × $10m = $1.2m. => EPS = $1.2m/2m = $0.60 per share. => PE ratio = $20/$0.60 = 33.33 times. Difficulty: 2 Medium Topic: DuPont identity Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 03-06 Appreciate how various ratios relate to one another. 76) Last year, PJ's Ice Cream Parlours, Inc. reported an ROE = 12 percent. The firm's debt ratio was 40 percent, sales were $25 million, and the capital intensity ratio was 0.75 times. What is the net income for PJ's last year? A) $1.35m B) $2.40m C) $3.00m D) $18.75m Answer: A Explanation: Capital intensity ratio = 0.75 = Total assets/$25 => Total assets = 0.75 × $25m = $18.75m. => Debt ratio = 0.4 = Total debt/$18.75m => Total debt = 0.4 × $18.75m = $7.5m. => Total equity = $18.75m − $7.5m = $11.25m. => ROE = 0.12 = Net income/$11.25m => Net income = 0.12 × $11.25m = $1.35m. Difficulty: 2 Medium Topic: DuPont identity Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 03-05 Calculate and interpret major market value ratios.

77) Last year, DJ's Soda Fountains, Inc. reported an ROE = 27 percent. The firm's debt ratio was 50 percent, sales were $9 million, and the capital intensity ratio was 1.5 times. What is the net income for DJ's last year? A) $1.22m B) $1.82m C) $2.43m D) $2.84m Answer: B Explanation: Capital intensity ratio = 1.5 = Total assets/$9m => Total assets = 1.5 × $9m = $13.5m. => Debt ratio = 0.5 = Total debt/$13.5m => Total debt = 0.5 × $13.5m = $6.75m. => Total equity = $13.5m − $6.75m = $6.75m. => ROE = 0.27 = Net income/$6.75m => Net income = 0.27 × $6.75m = $1.8225m. Difficulty: 2 Medium Topic: Long-term solvency ratios Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 03-05 Calculate and interpret major market value ratios. 78) You are considering investing in Totally Tire Services. You have been able to locate the following information on the firm: total assets = $50 million, accounts receivable = $10 million, ACP = 15 days, net income = $4.5 million, and debt-to-equity ratio = 0.75 times. What is the ROE for the firm? A) 1.58 percent B) 9.00 percent C) 15.75 percent D) 28.81 percent Answer: C Explanation: Debt-to-equity = 0.75 = Total debt/Total equity = Total debt/(Total assets − Total debt). 0.75 = Total debt/(50m − Total debt) => (0.75 × 50m) − 0.75 × Total debt = Total debt. => 37.5m = 1.75 × Total debt => Total debt = 37.5m/1.75m = $21.4286m. => Total equity = $50m − $21.4286 = $28.5714m. => ROE = $4.5m/$28.5714m = 15.75 percent. Difficulty: 2 Medium Topic: Long-term solvency ratios Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 03-06 Appreciate how various ratios relate to one another.

79) You are considering investing in Lenny's Lube, Inc. You have been able to locate the following information on the firm: total assets = $20 million, accounts receivable = $6 million, ACP = 20 days, net income = $5 million, and debt-to-equity ratio = 2.5 times. What is the ROE for the firm? A) 2.5000 percent B) 13.9882 percent C) 35.0000 percent D) 87.50 percent Answer: D Explanation: Debt-to-equity = 2.5 = Total debt/Total equity = Total debt/(Total assets − Total debt). 2.5 = Total debt/(20m − Total debt) => (2.5 × 20m) − 2.5 × Total debt = Total debt. => 50m = 3.5 × Total debt => Total debt = 50m/3.5 = $14.2857m. => Total equity = $20m − $14.2857m = $5.7143m. => ROE = $5m/$5.7143m = 87.50 percent. Difficulty: 2 Medium Topic: Internal and sustainable growth rates Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 03-06 Appreciate how various ratios relate to one another.

80) Leash N Collar reported a profit margin of 8 percent, total asset turnover ratio of 1.5 times, debt-to-equity ratio of 0.75 times, net income of $400,000, and dividends paid to common stockholders of $200,000. The firm has no preferred stock outstanding. What is Leash N Collar's internal growth rate? A) 5.2632 percent B) 7.3333 percent C) 8.6956 percent D) 6.383 percent Answer: D Explanation: ROA = Profit Margin × Total asset turnover = 8 percent × 1.5 = 12 percent. RR = ($400,000 − $200,000) / $400,000 = 0.50.

Internal growth rate =

ROA × RR = 0.12 × 0.50 = 0.06383 = 6.383% 1 − (ROA × RR) 1 − (0.12 × 0.50)

Difficulty: 2 Medium Topic: Internal and sustainable growth rates Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 03-06 Appreciate how various ratios relate to one another.

81) Saddle and Bridle reported a profit margin of 12 percent, total asset turnover ratio of 2 times, debt-to-equity ratio of 1.9 times, net income of $1 million, and dividends paid to common stockholders of $250,000. The firm has no preferred stock outstanding. What is Saddle and Bridle's internal growth rate? A) 13.64 percent B) 18.00 percent C) 24.00 percent D) 21.95 percent Answer: D Explanation: ROA = Profit Margin × Total asset turnover = 12 percent × 2 = 24 percent. RR = ($1,000,000 − $250,000)/$1,000,000 = 0.75.

Internal growth rate =

ROA × RR = 0.24 × 0.75 = 0.2195 = 21.95% 1 − (ROA × RR) 1 − (0.24 × 0.75)

82) You have located the following information on Rock Company: debt ratio = 40 percent, capital intensity ratio = 2.25 times, profit margin = 8 percent, and dividend payout ratio = 25 percent. What is the sustainable growth rate for Rock? A) 3.56 percent B) 6.00 percent C) 4.65 percent D) 8.00 percent Answer: C Explanation: Equity multiplier = Total assets/Total equity => 1/Equity multiplier = Total equity/Total assets. Debt ratio = Total debt/Total assets = (Total assets − Total equity)/Total assets = 1 − (Total equity/Total assets). 0.4 = 1 − (Total equity/Total assets) => Total equity/Total assets = 1 − 0.4 = 0.6 = 1/Equity multiplier => Equity multiplier = 1/0.6 = 1.6667. ROE = Profit Margin × Total asset turnover × Equity multiplier = 0.08 × 1/2.25 × 1.6667 = 5.926 percent. Retention ratio (RR) = 1 − dividend payout ratio = 1 − 0.25 = 0.75.

Sustainable growth rate =

ROE × RR = 0.0593 × 0.75 = 0.0465 = 4.65% 1 − (ROE × RR) 1 − (0.0593 × 0.75)

83) You have located the following information on Greenwich Company: debt ratio = 60 percent, capital intensity ratio = 0.75 times, profit margin = 13.5 percent, and dividend payout ratio = 80 percent. What is the sustainable growth rate for Greenwich? A) 2.70 percent B) 10.80 percent C) 25.00 percent D) 9.89 percent Answer: D Explanation: Equity multiplier = Total assets/Total equity => 1/Equity multiplier = Total equity/Total assets. Debt ratio = Total debt/Total assets = (Total assets − Total equity)/Total assets = 1 − (Total equity/Total assets). 0.6 = 1 − (Total equity/Total assets) => Total equity/Total assets = 1 − 0.6 = 0.4 = 1/Equity multiplier. => Equity multiplier = 1/0.4 = 2.5. ROE = Profit Margin × Total asset turnover × Equity multiplier. = 0.135 × 1/0.75 × 2.5 = 45 percent. Retention ratio (RR) = 1 − dividend payout ratio = 1 − 0.8 = 0.2.

Sustainable growth rate =

ROE × RR = 0.45 × 0.20 = 0.0989 = 9.89% 1 − (ROE × RR) 1 − (0.45 × 0.20)

84) You have located the following information on Maize Company: debt ratio = 20 percent, capital intensity ratio = 1.25 times, profit margin = 12 percent, and dividend payout ratio = 10 percent. What is the sustainable growth rate for Maize? A) 1.20 percent B) 10.10 percent C) 12.11 percent D) 73.26 percent Answer: C Explanation: Equity multiplier = Total assets/Total equity => 1/Equity multiplier = Total equity/Total assets. Debt ratio = Total debt/Total assets = (Total assets − Total equity)/Total assets = 1 − (Total equity/Total assets). 0.2 = 1 − (Total equity/Total assets) => Total equity/Total assets = 1 − 0.2 = 0.8 = 1/Equity multiplier. => Equity multiplier = 1/0.8 = 1.25. ROE = Profit Margin × Total asset turnover × Equity multiplier. = 0.12 × 1/1.25 × 1.25 = 12 percent. Retention ratio (RR) = 1 − dividend payout ratio = 1 − 0.1 = 0.9.

Sustainable growth rate =

ROE × RR = 0.12 × 0.90 = 0.1211 = 12.11% 1 − (ROE × RR) 1 − (0.12 × 0.90)

85) You have located the following information on Tyler Company: debt ratio = 50 percent, capital intensity ratio = 1.5 times, profit margin = 9 percent, and dividend payout ratio = 40 percent. What is the sustainable growth rate for Tyler? A) 12.00 percent B) 7.76 percent C) 20.00 percent D) 30.00 percent Answer: B Explanation: Equity multiplier = Total assets/Total equity => 1/Equity multiplier = Total equity/Total assets. Debt ratio = Total debt/Total assets = (Total assets − Total equity)/Total assets = 1 − (Total equity/Total assets). 0.5 = 1 − (Total equity/Total assets) => Total equity/Total assets = 1 − 0.5 = 0.5 = 1/Equity multiplier. => Equity multiplier = 1/0.5 = 2. ROE = Profit Margin × Total asset turnover × Equity multiplier. = 0.09 × 1/1.5 × 2 = 12 percent. Retention ratio (RR) = 1 − dividend payout ratio = 1 − 0.4 = 0.6.

Sustainable growth rate =

ROE × RR = 0.12 × 0.60 = 0.0776 = 7.76% 1 − (ROE × RR) 1 − (0.12 × 0.60)

Difficulty: 2 Medium Topic: Short-term solvency ratios Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 03-06 Appreciate how various ratios relate to one another. 86) Which of the following activities will increase a firm's current ratio? A) purchase inventory using cash B) buy equipment with a short-term bank loan C) accrued wages and taxes increase D) none of these statements will increase a firm's current ratio Answer: D Difficulty: 2 Medium Topic: Short-term solvency ratios Bloom's: Evaluate; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 03-01 Calculate and interpret major liquidity ratios.

87) Which of the following will increase a firm's quick ratio assuming no other accounts change? A) a reduction in accounts payable B) an increase in accounts receivable C) an increase in marketable securities D) all of these choices are correct. Answer: D Difficulty: 2 Medium Topic: Short-term solvency ratios Bloom's: Evaluate; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 03-01 Calculate and interpret major liquidity ratios. 88) Which of the following statements is correct? A) The cash ratio measures a firm's ability to pay long-term debt with its available cash and marketable securities. B) Holding high levels of liquidity to guard against liquidity crises is an inappropriate goal for the firm. C) The quick (or acid-test) ratio measures a firm's ability to pay off short-term obligations with long-term debt. D) The current ratio is a more stringent measure of liquidity than the quick (or acid-test) ratio. Answer: B Difficulty: 2 Medium Topic: DuPont identity Bloom's: Evaluate AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 03-01 Calculate and interpret major liquidity ratios.

89) A firm has a profit margin of 12 percent; total asset turnover of 0.55 and an equity multiplier of 2.2. What is the firm's ROA and ROE? A) ROA = 6.6 percent; ROE = 14.52 percent B) ROA = 7.2 percent; ROE = 15.84 percent C) ROA = 9.5 percent; ROE = 20.9 percent D) ROA = 8.1 percent; ROE = 17.82 percent Answer: A Explanation: ROA = PM × TA TO = 0.12 × 0.55 = 6.6 percent; ROE = PM × TA TO × EM = 6.6 percent × 2.2 = 14.52 percent. Difficulty: 2 Medium Topic: Asset management ratios Bloom's: Apply; Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 03-06 Appreciate how various ratios relate to one another. 90) Which of the following statements is correct? A) If a firm has a very high fixed asset turnover, it means that the firm may be nearing its maximum production capacity. B) An extremely low average collection period will maximize net income. C) In general, a firm should strive for a high average payment period because it wants to pay for its purchases as quickly as possible. D) All of these choices are correct. Answer: A Difficulty: 2 Medium Topic: Asset management ratios Bloom's: Evaluate AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 03-02 Calculate and interpret major asset management ratios. 91) Which ratio assesses how efficiently a firm uses its fixed assets? A) capital intensity ratio B) current ratio C) average collection period D) fixed asset turnover Answer: D Difficulty: 1 Easy Topic: Asset management ratios Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 03-02 Calculate and interpret major asset management ratios. 51

92) Which ratio measures how many days inventory is held before the final product is sold? A) inventory turnover B) days' sales in inventory C) total asset turnover D) inventory intensity ratio Answer: B Difficulty: 1 Easy Topic: Asset management ratios Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 03-02 Calculate and interpret major asset management ratios. 93) A firm reported year-end sales of $20 million. It listed $7 million of inventory on its balance sheet. Using a 365-day year, how many days did the firm's inventory stay on the premises? A) 127.75 days B) 157.75 days C) 97.75 days D) 87.75 days Answer: A Explanation: Inv × 365/Sales = 7 × 365/20 = 127.75. Difficulty: 1 Easy Topic: Asset management ratios Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 03-02 Calculate and interpret major asset management ratios. 94) A firm ended the year with an average collection period of 50 days. The firm's credit sales were $11 million. What is the firm's year-end balance in accounts receivable? A) $1.27 million B) $0.85 million C) $1.51 million D) $2.05 million Answer: C Explanation: 50 = (AR × 365)/11; AR × 365 = 50 × 11; AR = 1.51m. Difficulty: 1 Easy Topic: Asset management ratios Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 03-02 Calculate and interpret major asset management ratios. 52

95) A firm reported sales of $10 million. It had a debt ratio of 40 percent and total debt amounted to $3 million. What was the firm's capital intensity ratio? A) 1.25 times B) 2.02 times C) 0.40 times D) 0.75 times Answer: D Explanation: TA = 3/0.4 = 7.5; TA/Sales = 7.5/10 = 0.75. Difficulty: 2 Medium Topic: Profitability ratios Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 03-02 Calculate and interpret major asset management ratios.; 03-03 Calculate and interpret major debt ratios. 96) A firm reported working capital of $5.5 million and fixed assets of $20 million. Its fixed asset turnover was 1.2 times. What was the firm's sales to working capital ratio? A) 2.21 times B) 4.36 times C) 5.19 times D) 6.03 times Answer: B Explanation: Sales = 1.2 × 20 = 24; sales/working capital = 24/5.5 = 4.36. Difficulty: 1 Easy Topic: Long-term solvency ratios Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 03-01 Calculate and interpret major liquidity ratios.

97) Which of the following statements is correct? A) The use of debt in the capital structure results in tax benefits to the firm. B) Debt is referred to as "financial leverage" because it magnifies returns to shareholders. C) Debt management ratios evaluate whether a firm is financing its assets with a reasonable amount of debt versus equity financing. D) All of these choices are correct. Answer: D Difficulty: 2 Medium Topic: Long-term solvency ratios Bloom's: Analyze AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 03-03 Calculate and interpret major debt ratios. 98) Calculate the times interest earned ratio using the following information. Sales = $1.5 million, cost of goods sold = $800,000, depreciation expense = $100,000, addition to retained earnings = $85,000, dividends per share = $1.2, tax rate = 30 percent, and number of shares of common stock outstanding = 100,000. Assume the firm has no preferred stock. A) 2.25 times B) 1.25 times C) 1.95 times D) 2.75 times Answer: C Explanation: NI = 85,000 + 120,000 = 205,000; EBIT = 1.5 − 0.8 − 0.1 = 0.6m; EBT = NI/1 − T = 292,857; Interest = EBIT − EBT = 307,143; TIE = 600,000/307,143 = 1.95 times. Difficulty: 3 Hard Topic: Long-term solvency ratios Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 03-03 Calculate and interpret major debt ratios.

99) You are considering a stock investment in one of two firms (A and B), both of which operate in the same industry. A finances its $20 million in assets with $18 million in debt and $2 million in equity. B finances its $20 million in assets with $2 million in debt and $18 million in equity. Calculate the equity multiplier for the two firms. A) Firm A: 15 times; Firm B: 1.00 times B) Firm A: 10 times; Firm B: 1.11 times C) Firm A: 10 times; Firm B: 9.99 times D) Firm A: 20 times; Firm B: 1.11 times Answer: B Explanation: A: 20/2 = 10 times; B: 20/18 = 1.11 times. Difficulty: 1 Easy Topic: Long-term solvency ratios Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 03-06 Appreciate how various ratios relate to one another. 100) You are considering a stock investment in one of two firms (A and B), both of which operate in the same industry. A finances its $20 million in assets with $18 million in debt and $2 million in equity. B finances its $20 million in assets with $2 million in debt and $18 million in equity. Calculate the debt-to-equity ratio for the two firms. A) Firm A: 9 times; Firm B: 1.11 times B) Firm A: 19 times; Firm B: 0.11 times C) Firm A: 9 times; Firm B: 0.11 times D) Firm A: 19 times; Firm B: 1.11 times Answer: C Explanation: A: 18/2 = 9; B: 2/18 = .11. Difficulty: 1 Easy Topic: Financial statement analysis Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 03-03 Calculate and interpret major debt ratios.

101) Which of the following statements is correct? A) Performing cross-sectional ratio analysis refers to assessing how a firm performed over a certain section of time. B) Performing cross-sectional analysis is easy since industries are usually clustered with firms that are identical. C) Time-series analysis is useless in assessing improvement or deterioration of ratios since the data is historical. D) To interpret financial ratios, users should analyze the performance of the firm over time and the performance of the firm against one or more companies in the same industry. Answer: D Difficulty: 1 Easy Topic: Standardized financial statements Bloom's: Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 03-07 Understand the differences between time series and cross-sectional ratio analysis. 102) Common-size financial statements A) allow for an easy comparison of balance sheets and income statements across firms in the industry. B) provide quantitative clues about the direction that the firm is moving. C) are obtained by dividing all income statement accounts by net sales and all balance sheet accounts by total assets. D) All of these choices are correct Answer: D Difficulty: 2 Medium Topic: Internal and sustainable growth rates Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 03-06 Appreciate how various ratios relate to one another.

103) A firm reported a profit margin of 8.5 percent, total asset turnover of 0.85 times, debt-toequity ratio of 0.90 times, net income of $550,000, and dividends paid to common stockholders of $100,000. The firm has no preferred stock outstanding. What is the firm's internal growth rate? A) 3.61 percent B) 6.29 percent C) 5.91 percent D) 11.04 percent Answer: B Explanation: ROA = PM × TA TO = 0.085 × 0.85 = 7.23 percent; RR = 450/550 = 0.8182; IGR = (0.0723 × 0.8182)/(1 − 0.0723 × 0.8182) = 6.29 percent. Difficulty: 2 Medium Topic: Internal and sustainable growth rates Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 03-06 Appreciate how various ratios relate to one another. 104) A firm has a debt ratio of 45 percent, capital intensity ratio is 1.3 times, profit margin is 10 percent, and dividend payout ratio is 30 percent. Calculate the sustainable growth rate for the firm. A) 1.56 percent B) 2.96 percent C) 3.05 percent D) 4.79 percent Answer: C Explanation: ROE = 0.1/1.3 × 0.55 = 4.23 percent; SGR = (0.7 × 0.0423)/(1 − 0.0423 × 0.7) = 3.05 percent. Difficulty: 2 Medium Topic: DuPont identity Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 03-03 Calculate and interpret major debt ratios.; 03-04 Calculate and interpret major profitability ratios.; 03-06 Appreciate how various ratios relate to one another.

105) A corporation has a total asset turnover of 2 times, ROA of 12 percent and EM of 1.17. What is this firm's profit margin and debt ratio? A) profit margin: 2 percent; debt ratio: 19.45 percent B) profit margin: 3 percent; debt ratio: 31.81 percent C) profit margin: 4 percent; debt ratio: 12.94 percent D) profit margin: 6 percent; debt ratio: 14.53 percent Answer: D Explanation: PM = ROA/TA TO = 0.12/2 = 6 percent; Debt ratio = (1 − 1/EM) = (1 − 1/1.17) = 14.53 percent. Difficulty: 2 Medium Topic: Market value ratios Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 03-03 Calculate and interpret major debt ratios.; 03-04 Calculate and interpret major profitability ratios. 106) A firm's year-end price on its common stock is $55. The firm has a profit margin of 6 percent, total assets of $75 million, a total asset turnover ratio of 0.9, no preferred stock, and 2.5 million shares of common stock outstanding. Calculate the PE ratio for the firm. A) 16.94 times B) 17.98 times C) 24.16 times D) 33.95 times Answer: D Explanation: Sales = 0.9 × 75 = 67.5; NI = 0.06 × 67.5 = 4.05; EPS = 4.05/2.5 = 1.62; PE = 55/1.62 = 33.95. Difficulty: 2 Medium Topic: DuPont identity Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 03-02 Calculate and interpret major asset management ratios.; 03-04 Calculate and interpret major profitability ratios.; 03-05 Calculate and interpret major market value ratios.

107) A firm reported an ROE of 19 percent. The firm's debt ratio was 45 percent, sales were $12 million, and the capital intensity ratio was 1.1 times. Calculate the net income for the firm. A) 0.34 million B) 1.38 million C) 1.93 million D) 2.06 million Answer: B Explanation: TA = Sales × capital intensity = 1.1 × 12 = 13.2; Equity = TA(1 − debt ratio) = 13.2(0.55) = 7.26; NI = ROE × equity = 0.19 × 7.26 = 1.38. Difficulty: 3 Hard Topic: Profitability ratios Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 03-06 Appreciate how various ratios relate to one another. 108) Firm A and Firm B have the same total assets, ROA and profit margin (greater than 0). However, Firm B has a higher debt ratio and interest expense than Firm A. Which of the following statements is correct? A) Firm B must have a higher ROE than Firm A. B) Firm B must have a higher capital intensity ratio than Firm A. C) Firm B must have a higher fixed asset turnover than Firm A. D) Firm B must have a lower ACP than Firm A. Answer: A Difficulty: 3 Hard Topic: Long-term solvency ratios Bloom's: Analyze AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 03-02 Calculate and interpret major asset management ratios.; 03-04 Calculate and interpret major profitability ratios.; 03-06 Appreciate how various ratios relate to one another.

109) Which ratio measures the number of dollars of operating cash available to meet each dollar of interest and other fixed charges that the firm owes? A) times interest earned B) fixed-charge coverage ratio C) cash coverage ratio D) operating coverage ratio Answer: C Difficulty: 1 Easy Topic: DuPont identity Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 03-03 Calculate and interpret major debt ratios. 110) A firm has a ROE of 14 percent and a debt-to-equity ratio of 40 percent. If the total asset turnover is 3.4, what is the firm's profit margin? A) 2.94 percent B) 3.86 percent C) 4.29 percent D) 5.67 percent Answer: A Explanation: Equity multiplier = 1 + Debt-to-equity = 1 + .40 = 1.40 ROE = Profit margin × Total asset turnover × Equity multiplier 14% = Profit margin × 3.4 × 1.40 Profit margin = 2.94% Difficulty: 3 Hard Topic: Capital structure Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 03-06 Appreciate how various ratios relate to one another.

111) The term "capital structure" refers to A) the amount of current versus long-term debt on the balance sheet. B) the amount of current versus fixed assets on the balance sheet. C) the amount of long-term debt versus equity on the balance sheet. Answer: C Difficulty: 1 Easy Topic: Long-term solvency ratios Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 03-03 Calculate and interpret major debt ratios. 112) What is the debt ratio for a firm with an equity multiplier of 3.5? A) 44.09 percent B) 58.51 percent C) 66.25 percent D) 71.43 percent Answer: D Explanation: (1 − 1/EM) = (1 − 1/3.5) = 71.43 percent. Difficulty: 1 Easy Topic: Long-term solvency ratios Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 03-03 Calculate and interpret major debt ratios.; 03-06 Appreciate how various ratios relate to one another. 113) A firm has EBIT of $300,000 and depreciation expense of $12,000. Fixed charges total $44,000. Interest expense totals $7,000. What is the firm's cash coverage ratio? A) 3.76 times B) 4.91 times C) 7.25 times D) 7.09 times Answer: D Explanation: (300,000 + 12,000)/44,000 = 7.09. Difficulty: 1 Easy Topic: Profitability ratios Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 03-01 Calculate and interpret major liquidity ratios.

114) Which ratio measures the operating return on the firm's assets irrespective of financial leverage and taxes? A) basic earning power ratio B) profit margin C) return on assets D) operating leverage return Answer: A Difficulty: 1 Easy Topic: DuPont identity Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 03-03 Calculate and interpret major debt ratios.; 03-04 Calculate and interpret major profitability ratios. 115) A firm has an ROA of 12 percent and an ROE of 52 percent. What is the firm's equity multiplier? A) 0.23 B) 4.33 C) 1.63 D) 2.90 Answer: B Explanation: ROE/ROA = TA/Equity = 52/12 = 4.33. Difficulty: 1 Easy Topic: Market value ratios Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 03-04 Calculate and interpret major profitability ratios.; 03-06 Appreciate how various ratios relate to one another.

116) Which company has the most risk from an investor's standpoint? Firm A has a PE of 92 times and Firm B has a PE of 16 times. Assume both firms operate in the same industry. Firm A has fewer shares outstanding than Firm B. A) Firm A because it has the higher PE ratio. B) Firm B because it has a lower PE ratio. C) Firm A because it has fewer shares outstanding. D) Firm B because it has more shares outstanding. Answer: A Difficulty: 2 Medium Topic: Internal and sustainable growth rates Bloom's: Analyze AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 03-05 Calculate and interpret major market value ratios. 117) The maximum growth rate that can be achieved by financing asset growth with new debt and retained earnings is called the A) internal growth rate. B) retention rate. C) sustainable growth rate. D) operating expansion rate. Answer: C Difficulty: 1 Easy Topic: Internal and sustainable growth rates Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 03-06 Appreciate how various ratios relate to one another. 118) The maximum growth rate that can be achieved by financing asset growth with internal financing or retained earnings is called the A) internal growth rate. B) retention rate. C) sustainable growth rate. D) operating expansion rate. Answer: A Difficulty: 1 Easy Topic: Financial statement analysis Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 03-06 Appreciate how various ratios relate to one another.

119) According to the list provided in the textbook, which of the following is NOT one of the cautions in using ratios to evaluate firm performance? A) The firm has seasonal cash flow differences. B) The firm has different accounting procedures. C) The firm has a different capital structure. D) The firm had a one-time event. Answer: C Difficulty: 1 Easy Topic: Asset management ratios Bloom's: Analyze AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 03-08 Explain cautions that should be taken when examining financial ratios. 120) A firm that is efficient in inventory management will have A) a high inventory turnover ratio and a low days sales in inventory ratio. B) a low inventory turnover ratio and a low days sales in inventory ratio. C) a high inventory turnover ratio and a high days sales in inventory ratio. D) a low inventory turnover ratio and a high days sales in inventory ratio. Answer: A Difficulty: 2 Medium Topic: Asset management ratios Bloom's: Evaluate AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 03-02 Calculate and interpret major asset management ratios. 121) Which of the following statements is correct? A) A low average payment period and a high accounts payable turnover are a sign of good management. B) A high average payment period and a low accounts payable turnover are a sign of good management. C) A high average payment period and a high accounts payable turnover are a sign of good management. D) A low average payment period and a low accounts payable turnover are a sign of good management. Answer: B Difficulty: 2 Medium Topic: Profitability ratios Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 03-02 Calculate and interpret major asset management ratios. 64

122) Which ratio measures the overall return on the firm's assets including financial leverage and taxes? A) ROA B) ROE C) basic earning power D) profit margin Answer: A Difficulty: 1 Easy Topic: Asset management ratios Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 03-04 Calculate and interpret major profitability ratios. 123) A firm has an ACP of 38 days and its annual sales are $5.3 million. What is its account receivable balance? A) $551,781 B) $619,304 C) $692,098 D) $759,021 Answer: A Explanation: A/R = ACP × Sales/365 = 38 × 5.3/365 = 0.551781. Difficulty: 1 Easy Topic: Standardized financial statements Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 03-01 Calculate and interpret major liquidity ratios. 124) The term "spreading the financial statements" refers to A) creating common-size financial statements. B) comparing the statements to the industry average. C) calculating the internal and sustainable growth rate. D) evaluating the debt levels. Answer: A Difficulty: 1 Easy Topic: Long-term solvency ratios Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 03-06 Appreciate how various ratios relate to one another.

125) Which ratio measures the number of dollars of operating earnings available to meet each dollar of interest obligations on the firm's debt? A) fixed-charge coverage ratio B) times interest earned C) cash coverage ratio D) ROA Answer: B Difficulty: 1 Easy Topic: Long-term solvency ratios Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 03-03 Calculate and interpret major debt ratios. 126) Which ratio measures the number of dollars of operating earnings available to meet the firm's interest dollars and other fixed charges? A) times interest earned B) basic earning power C) fixed-charge coverage ratio D) ROA Answer: C Difficulty: 1 Easy Topic: Asset management ratios Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 03-03 Calculate and interpret major debt ratios. 127) Which of the following is unlikely to have a high capital intensity ratio? A) railroad B) automobile manufacturer C) law firm D) shipbuilder Answer: C Difficulty: 1 Easy Topic: Financial statement analysis Bloom's: Evaluate AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 03-02 Calculate and interpret major asset management ratios.

128) All of the following are users of financial ratios EXCEPT A) managers. B) investors. C) analysts. D) auditors. Answer: D Difficulty: 1 Easy Topic: Liquidity Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 03-07 Understand the differences between time series and cross-sectional ratio analysis. 129) A strong liquidity position means that A) the firm is able to meet its short-term obligations. B) the firm uses little debt in its capital structure. C) the firm pays out a large portion of its net income in the form of dividends. D) the firm pays its creditors on time. Answer: A Difficulty: 1 Easy Topic: Financial statement analysis Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 03-01 Calculate and interpret major liquidity ratios. 130) An investor wanting large returns will be interested in companies that have A) high ROAs. B) high ROEs. C) high current ratios. D) high times interest earned. Answer: B Difficulty: 1 Easy Topic: Financial statement analysis Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 03-04 Calculate and interpret major profitability ratios.

131) Which of the following statements is true about return on equity (ROE)? A) It measures the return on common stockholders' investment in the assets of the firm. B) The value of the firm's ROE is affected by net income. C) The value of the firm's ROE is affected by the amount of financial leverage or debt that the firm uses. D) All of these choices are correct. Answer: D Difficulty: 2 Medium Topic: Financial statement analysis Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 03-04 Calculate and interpret major profitability ratios. 132) Which of the following statements is not correct regarding accounts payable management and average payment period (APP)? A) A firm wants to pay for its purchases as slowly as possible. B) The faster the firm pays for its supply purchases, the longer it can avoid financing such as notes payable or long-term debt. C) A high APP is generally a sign of good management. D) An extremely high APP could be a sign of bad firm management. Answer: B Difficulty: 2 Medium Topic: Profitability ratios Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 03-02 Calculate and interpret major asset management ratios.

133) A firm has EBIT of $400,000 and depreciation expense of $20,000. Fixed charges total $50,000. Interest expense totals $7,000. What is the firm's cash coverage ratio? A) 7.60 times B) 8.00 times C) 8.40 times D) 8.54 times Answer: C Explanation: (400,000 + 20,000)/50,000 = 8.40. Difficulty: 1 Easy Topic: Profitability ratios Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 03-01 Calculate and interpret major liquidity ratios.; 03-03 Calculate and interpret major debt ratios. 134) A firm has EBIT of $1,000,000 and depreciation expense of $400,000. Fixed charges total $600,000. Interest expense totals $70,000. What is the firm's cash coverage ratio? A) 1.00 times B) 1.67 times C) 2.33 times D) 2.45 times Answer: C Explanation: (1,000,000 + 400,000)/600,000 = 2.33. Difficulty: 1 Easy Topic: Profitability ratios Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 03-01 Calculate and interpret major liquidity ratios.; 03-03 Calculate and interpret major debt ratios.

135) A firm has EBIT of $400,000 and depreciation expense of $20,000. Fixed charges total $50,000. Interest expense totals $7,000. What is the firm's fixed-charge coverage ratio? A) 7.60 times B) 8.00 times C) 8.40 times D) 8.54 times Answer: B Explanation: 400,000/50,000 = 8.00. Difficulty: 1 Easy Topic: Asset management ratios Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 03-01 Calculate and interpret major liquidity ratios.; 03-03 Calculate and interpret major debt ratios. 136) A firm has EBIT of $1,000,000 and depreciation expense of $400,000. Fixed charges total $600,000. Interest expense totals $70,000. What is the firm's fixed-charge coverage ratio? A) 1.00 times B) 1.67 times C) 2.33 times D) 2.45 times Answer: B Explanation: 1,000,000/600,000 = 1.67. Difficulty: 1 Easy Topic: Asset management ratios Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 03-01 Calculate and interpret major liquidity ratios.; 03-03 Calculate and interpret major debt ratios. 137) Which of the following activities will increase a firm's current ratio? A) sale of inventory for a profit B) buy equipment with a long-term bank loan C) pay the current month's rent Answer: A Difficulty: 2 Medium Topic: Short-term solvency ratios Bloom's: Evaluate; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 03-01 Calculate and interpret major liquidity ratios. 70

138) A firm reported year-end cost of goods sold of $10 million. It listed $2 million of inventory on its balance sheet. Using a 365-day year, how many days did the firm's inventory stay on the premises? A) 73 days B) 20 days C) 18.25 days D) 2 days Answer: A Explanation: Inv × 365/cost of goods sold = 2 × 365/10 = 73. Difficulty: 1 Easy Topic: Asset management ratios Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 03-02 Calculate and interpret major asset management ratios. 139) A firm ended the year with an average collection period of 20 days. The firm's credit sales were $50 million. What is the firm's year-end balance in accounts receivable? A) $1.46 million B) $2.50 million C) $2.74 million D) $4.00 million Answer: C Explanation: 20 = (AR × 365)/50; AR × 365 = 20 × 50; AR = 2.74m. Difficulty: 1 Easy Topic: Asset management ratios Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 03-02 Calculate and interpret major asset management ratios.

140) Which of the following statements is false regarding inventory management? A) In general, a firm wants to produce a low level of sales per dollar of inventory. B) In general, a firm wants to produce a high level of sales per dollar of inventory. C) A high inventory turnover ratio or a low days' sales in inventory is generally a sign of good management. D) Extremely high levels for inventory turnover ratio and low levels for days' sales in inventory ratio may actually be a sign of bad firm or production management. Answer: A Difficulty: 1 Easy Topic: Asset management ratios Bloom's: Evaluate AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 03-02 Calculate and interpret major asset management ratios.

Finance, 5e (Cornett) Chapter 4 Time Value of Money 1: Analyzing Single Cash Flows 1) Which of the following is NOT true when developing a time line? A) Cash inflows are designated with a positive number. B) Cash outflows are designated with a positive number. C) The cost is known as the interest rate. D) The time line shows the magnitude of cash flows at different points in time. Answer: B Difficulty: 1 Easy Topic: Time value of money Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 04-01 Create a cash flow time line. 2) People borrow money because they expect A) their purchases to give them the satisfaction in the future that compensates them for the interest payments charged on the loan. B) the time value of money to apply only if they are saving money. C) interest rates to rise. D) that consumers don't need to calculate the impact of interest on their purchases. Answer: A Difficulty: 1 Easy Topic: Time value of money Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 04-01 Create a cash flow time line. 3) How are future values affected by changes in interest rates? A) The lower the interest rate, the larger the future value will be. B) The higher the interest rate, the larger the future value will be. C) Future values are not affected by changes in interest rates. D) One would need to know the present value in order to determine the impact. Answer: B Difficulty: 1 Easy Topic: Time value of money Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 04-02 Compute the future value of money.

4) How do you calculate the future value of a single period? A) Add the interest earned to today's cash flow. B) Add the interest earned to next year's cash flow. C) Multiply the interest eared with today's cash flow. D) Multiply the interest eared with next year's cash flow. Answer: A Difficulty: 1 Easy Topic: Time value of money Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 04-02 Compute the future value of money. 5) How are present values affected by changes in interest rates? A) The lower the interest rate, the larger the present value will be. B) The higher the interest rate, the larger the present value will be. C) Present values are not affected by changes in interest rates. D) One would need to know the future value in order to determine the impact. Answer: A Difficulty: 1 Easy Topic: Time value of money Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 04-04 Calculate the present value of a payment made in the future. 6) We call the process of earning interest on both the original deposit and on the earlier interest payments A) discounting. B) multiplying. C) compounding. D) computing. Answer: C Difficulty: 1 Easy Topic: Simple and compound interest Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 04-03 Show how the power of compound interest increases wealth.

7) Which of these statements is true of discounting? A) It is the reverse of compounding. B) It significantly decreases the value of a future amount to the present. C) It is the process of figuring out how much an amount that you expect to receive in the future is worth today. D) All of the above. Answer: D Difficulty: 1 Easy Topic: Simple and compound interest Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 04-04 Calculate the present value of a payment made in the future. 8) The process of figuring out how much an amount that you expect to receive in the future is worth today is called A) discounting. B) multiplying. C) compounding. D) computing. Answer: A Difficulty: 1 Easy Topic: Time value of money Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 04-04 Calculate the present value of a payment made in the future. 9) The interest rate, i, which we use to calculate present value, is often referred to as the A) discount rate. B) multiplier. C) compound rate. D) dividend. Answer: A Difficulty: 1 Easy Topic: Interest rates Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 04-04 Calculate the present value of a payment made in the future.

10) The Rule of 72 is a simple mathematical approximation for A) the present value required to double an investment. B) the future value required to double an investment. C) the payments required to double an investment. D) the number of years required to double an investment. Answer: D Difficulty: 1 Easy Topic: Rule of 72 Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 04-06 Apply the Rule of 72. 11) With regard to money deposited in a bank, future values are A) smaller than present values. B) larger than present values. C) equal to present values. D) are completely independent of present values. Answer: B Difficulty: 1 Easy Topic: Time value of money Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 04-02 Compute the future value of money. 12) Which of the following statements about the Rule of 72 is not true? A) It is a mathematical approximation for the number of years required to double an investment. B) It illustrates the power of a discounted rate. C) It can be used to approximate the interest rate needed to double an investment for a specified amount of time. D) None of the above. Answer: B Difficulty: 1 Easy Topic: Rule of 72 Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 04-06 Apply the Rule of 72.

13) A dollar paid (or received) in the future is A) worth more than a dollar paid (or received) today. B) worth as much as a dollar paid (or received) today. C) not worth as much as a dollar paid (or received) today. D) not comparable to a dollar paid (or received) today. Answer: C Difficulty: 1 Easy Topic: Time value of money Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 04-04 Calculate the present value of a payment made in the future. 14) When computing the rate of return from selling an investment, the number of years between the present and future cash flows is an important factor in determining A) the annual rate earned. B) the annual payments required. C) whether the present value or the future value is a cash inflow. D) whether the present value or the future value is a cash outflow. Answer: A Difficulty: 1 Easy Topic: Number of time periods Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 04-07 Compute the rate of return realized on selling an investment. 15) When calculating the number of years needed to grow an investment to a specific amount of money A) the lower the interest rate, the shorter the time period needed to achieve the growth. B) the higher the interest rate, the shorter the time period needed to achieve the growth. C) the interest rate has nothing to do with the length of the time period needed to achieve the growth. D) the Rule of 72 is the only way to calculate the time period needed to achieve the growth. Answer: B Difficulty: 1 Easy Topic: Number of time periods Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 04-08 Calculate the number of years needed to grow an investment.

16) Moving cash flows from one point in time to another requires us to use A) only present value equations. B) only future value equations. C) both present value and future value equations. D) the Rule of 72. Answer: C Difficulty: 2 Medium Topic: Time value of money Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 04-05 Move cash flows from one year to another. 17) The longer money can earn interest, A) the greater the interest earned on the original deposit exceeds the interest-on-interest. B) the greater the compounding effect. C) the greater the present value must be to reach a financial goal. D) the greater the risk to the investor of not reaching a financial goal. Answer: B Difficulty: 1 Easy Topic: Simple and compound interest Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 04-03 Show how the power of compound interest increases wealth. 18) To solve for time-value equations, you need to know: A) the starting cash flow. B) the interest rate. C) the future cash flow. D) all of the above. Answer: D Difficulty: 1 Easy Topic: Rate of return Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 04-05 Move cash flows from one year to another.

19) What information would you need to know to solve a rate of return problem? A) the present value cash flow. B) the number of years of the investment. C) the future value cash flow. D) all of the above. Answer: D Difficulty: 1 Easy Topic: Rate of return Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 04-05 Move cash flows from one year to another. 20) What is the future value of $700 deposited for one year earning 4 percent interest rate annually? A) $28 B) $700 C) $728 D) $1,428 Answer: C Explanation: PV = 700, PMT = 0, I = 4, N = 1, FV = 728 Difficulty: 1 Easy Topic: Future value - single cash flow Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-02 Compute the future value of money. 21) What is the future value of $1,000 deposited for one year earning 5 percent interest rate annually? A) $1,000 B) $1,005 C) $1,050 D) $2,050 Answer: C Explanation: PV = 1000, PMT = 0, I = 5, N = 1, FV = 1050 Difficulty: 1 Easy Topic: Future value - single cash flow Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-02 Compute the future value of money.

22) What is the future value of $2,000 deposited for one year earning 6 percent interest rate annually? A) $120 B) $2.000 C) $2,120 D) $4,120 Answer: C Explanation: PV = 2000, PMT = 0, I = 6, N = 1, FV = 2120 Difficulty: 1 Easy Topic: Future value - single cash flow Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-02 Compute the future value of money. 23) How much would be in your savings account in 7 years after depositing $100 today if the bank pays 5 percent interest per year? A) $135.00 B) $140.71 C) $735.00 D) $814.20 Answer: B Explanation: PV = 100, PMT = 0, I = 5, N = 7, FV = 140.71 Difficulty: 1 Easy Topic: Future value - single cash flow Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-03 Show how the power of compound interest increases wealth.

24) How much would be in your savings account in 10 years after depositing $50 today if the bank pays 7 percent interest per year? A) $35.00 B) $98.36 C) $535.00 D) $690.82 Answer: B Explanation: PV = 50, PMT = 0, I = 7, N = 10, FV = 98.36 Difficulty: 1 Easy Topic: Future value - single cash flow Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-03 Show how the power of compound interest increases wealth. 25) A deposit of $500 earns the following interest rates? 5 percent in the first year, 6 percent in the second year, and 8 percent in the third year. What would be the third year future value? A) $527.14 B) $595.00 C) $601.02 D) $1595.00 Answer: C Explanation: $500 × (1 + 0.05) × (1 + 0.06) × (1 + 0.08) = 601.02. Difficulty: 1 Easy Topic: Simple and compound interest Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-03 Show how the power of compound interest increases wealth.

26) A deposit of $1,000 earns the following interest rates? 8 percent in the first year, 7 percent in the second year, and 8 percent in the third year. What would be the third year future value? A) $1,082.15 B) $1,230.00 C) $1,248.05 D) $3,030.00 Answer: C Explanation: $1,000 × (1 + 0.08) × (1 + 0.07) × (1 + 0.08) = $1,248.05. Difficulty: 1 Easy Topic: Simple and compound interest Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-03 Show how the power of compound interest increases wealth. 27) A deposit of $300 earns interest rates of 7 percent in the first year and 10 percent in the second year. What would be the second year future value? A) $351.00 B) $353.10 C) $602.17 D) $651.00 Answer: B Explanation: $300 × (1 + 0.07) × (1 + 0.10) = $353.10. Difficulty: 1 Easy Topic: Simple and compound interest Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-03 Show how the power of compound interest increases wealth.

28) A deposit of $700 earns interest rates of 10 percent in the first year and 7 percent in the second year. What would be the second year future value? A) $771.07 B) $819.00 C) $823.90 D) $1519.00 Answer: C Explanation: $700 × (1 + 0.10) × (1 + 0.07) = $823.90. Difficulty: 1 Easy Topic: Simple and compound interest Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-03 Show how the power of compound interest increases wealth. 29) What is the present value of a $500 payment in one year when the discount rate is 5 percent? A) $475.00 B) $476.19 C) $500.00 D) $525.00 Answer: B Explanation: FV = 500, PMT = 0, I = 5, N = 1, PV = 476.19. Difficulty: 1 Easy Topic: Present value - single cash flow Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-04 Calculate the present value of a payment made in the future. 30) What is the present value of a $250 payment in one year when the discount rate is 6 percent? A) $245.00 B) $235.85 C) $250.00 D) $265.00 Answer: B Explanation: FV = 250, PMT = 0, I = 6, N = 1, PV = 235.85. Difficulty: 1 Easy Topic: Present value - single cash flow Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-04 Calculate the present value of a payment made in the future.

31) What is the present value of a $500 payment made in four years when the discount rate is 8 percent? A) $365.35 B) $367.51 C) $460.00 D) $680.24 Answer: B Explanation: FV = 500, PMT = 0, I = 8, N = 4, PV = 367.51 Difficulty: 1 Easy Topic: Present value - single cash flow Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-04 Calculate the present value of a payment made in the future. 32) What is the present value of a $750 payment made in three years when the discount rate is 5 percent? A) $646.96 B) $647.88 C) $712.50 D) $868.22 Answer: B Explanation: FV = 750, PMT = 0, I = 5, N = 3, PV = 647.88 Difficulty: 1 Easy Topic: Present value - single cash flow Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-04 Calculate the present value of a payment made in the future.

33) What is the present value of a $200 payment made in three years when the discount rate is 8 percent? A) $150.00 B) $158.77 C) $251.94 D) $515.42 Answer: B Explanation: FV = 200, PMT = 0, I = 8, N = 3, PV = 158.77 Difficulty: 1 Easy Topic: Present value - single cash flow Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-04 Calculate the present value of a payment made in the future. 34) Approximately how many years does it take to double a $300 investment when interest rates are 8 percent per year? A) 0.11 years B) 4.17 years C) 9 years D) 11 years Answer: C Explanation: 72/8 = 9 Difficulty: 1 Easy Topic: Rule of 72 Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-06 Apply the Rule of 72.

35) Approximately how many years does it take to double a $500 investment when interest rates are 4 percent per year? A) 0.06 year B) 6 years C) 6.94 years D) 18 years Answer: D Explanation: 72/4 = 18 Difficulty: 1 Easy Topic: Rule of 72 Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-06 Apply the Rule of 72. 36) Approximately how many years does it take to double a $600 investment when interest rates are 6 percent per year? A) 0.08 year B) 8 years C) 8.33 years D) 12 years Answer: D Explanation: 72/6 = 12 Difficulty: 1 Easy Topic: Rule of 72 Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-06 Apply the Rule of 72. 37) Approximately what interest rate is needed to double an investment over six years? A) 6 percent B) 12 percent C) 17 percent D) 100 percent Answer: B Explanation: 72/6 = 12 Difficulty: 1 Easy Topic: Rule of 72 Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-06 Apply the Rule of 72. 14

38) Approximately what interest rate is needed to double an investment over four years? A) 4 percent B) 18 percent C) 25 percent D) 100 percent Answer: B Explanation: 72/4 = 18 Difficulty: 1 Easy Topic: Rule of 72 Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-06 Apply the Rule of 72. 39) Approximately what interest rate is needed to double an investment over eight years? A) 8 percent B) 9 percent C) 12 percent D) 100 percent Answer: B Explanation: 72/8 = 9 Difficulty: 1 Easy Topic: Rule of 72 Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-06 Apply the Rule of 72. 40) Determine the interest rate earned on a $1,500 deposit when $1,680 is paid back in one year. A) 0.89 percent B) 1.12 percent C) 12.00 percent D) 89.00 percent Answer: C Explanation: PV = 1500, PMT = 0, N = 1, FV = 1680, CPT I = 12 Difficulty: 1 Easy Topic: Interest rates Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-07 Compute the rate of return realized on selling an investment.

41) Determine the interest rate earned on a $500 deposit when $650 is paid back in one year. A) 0.77 percent B) 1.30 percent C) 30.0 percent D) 77.0 percent Answer: C Explanation: PV = 500, PMT = 0, N = 1, FV = 650, CPT I = 30 Difficulty: 1 Easy Topic: Interest rates Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-07 Compute the rate of return realized on selling an investment. 42) Determine the interest rate earned on a $450 deposit when $475 is paid back in one year. A) 0.89 percent B) 1.13 percent C) 5.56 percent D) 13.0 percent Answer: C Explanation: PV = 450, PMT = 0, N = 1, FV = 475, CPT I = 5.56 Difficulty: 1 Easy Topic: Interest rates Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-07 Compute the rate of return realized on selling an investment. 43) Consider a $1,000 deposit earning 7 percent interest per year for four years. How much total interest is earned on the original deposit (excluding interest earned on interest)? A) $28.00 B) $30.00 C) $280.00 D) $310.00 Answer: C Explanation: $1,000 × 7 percent × 4 = $280. Difficulty: 2 Medium Topic: Simple and compound interest Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-03 Show how the power of compound interest increases wealth.

44) Consider a $2,000 deposit earning 6 percent interest per year for five years. How much total interest is earned on the original deposit (excluding interest earned on interest)? A) $60.00 B) $76.45 C) $600.00 D) $676.45 Answer: C Explanation: $2,000 × 6 percent × 5 = $600. Difficulty: 2 Medium Topic: Simple and compound interest Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-03 Show how the power of compound interest increases wealth. 45) Consider a $500 deposit earning 5 percent interest per year for five years. How much total interest is earned on the original deposit (excluding interest earned on interest)? A) $13.14 B) $25.00 C) $125.00 D) $138.14 Answer: C Explanation: $500 × 5 percent × 5 = $125. Difficulty: 2 Medium Topic: Simple and compound interest Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-03 Show how the power of compound interest increases wealth.

46) Consider a $200 deposit earning 8 percent interest per year for three years. How much total interest is earned on interest (excluding interest earned on the original deposit)? A) $3.94 B) $24.00 C) $48.00 D) $51.94 Answer: A Explanation: PV = 200, N = 3, I = 8, PMT = 0, FV = 251.94. $200 × 8 percent × 3 = $48. $251.94 − $200 − $48 = $3.94. Difficulty: 2 Medium Topic: Simple and compound interest Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-03 Show how the power of compound interest increases wealth. 47) What is the value in year 3 of a $500 cash flow made in year 5 when interest rates are 6 percent? A) $374 B) $420 C) $440 D) $445 Answer: D Explanation: FV = 500, N = (5 − 3) = 2, I = 6, PMT = 0, CPT PV = 445 Difficulty: 2 Medium Topic: Present value - single cash flow Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-05 Move cash flows from one year to another.

48) What is the value in year 5 of a $600 cash flow made in year 10 when interest rates are 5 percent? A) $368.35 B) $450.00 C) $470.12 D) $570.00 Answer: C Explanation: FV = 600, N = (10 − 5) = 5, I = 5, PMT = 0, CPT PV = 470.12 Difficulty: 2 Medium Topic: Present value - single cash flow Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-05 Move cash flows from one year to another. 49) What is the value in year 3 of a $250 cash flow made in year 15 when interest rates are 12 percent? A) $45.67 B) $64.17 C) $177.95 D) $220.00 Answer: B Explanation: FV = 250, N = (15 − 3) = 12, I = 12, PMT = 0, CPT PV = 64.17 Difficulty: 2 Medium Topic: Present value - single cash flow Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-05 Move cash flows from one year to another.

50) What is the value in year 7 of a $700 cash flow made in year 3 when the interest rates are 10 percent? A) $478.11 B) $980.00 C) $1,024.87 D) $1,364.10 Answer: C Explanation: PV = 700, N = (7 − 3) = 4, I = 10, PMT = 0, CPT FV = 1024.87 Difficulty: 2 Medium Topic: Future value - single cash flow Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-05 Move cash flows from one year to another. 51) What is the value in year 6 of a $900 cash flow made in year 4 when the interest rates are 8 percent? A) $1,044.00 B) $1,049.76 C) $1,332.00 D) $1,428.19 Answer: B Explanation: PV = 900, N = (6 − 4) = 2, I = 8, PMT = 0, CPT FV = 1049.76 Difficulty: 2 Medium Topic: Future value - single cash flow Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-05 Move cash flows from one year to another.

52) What is the value in year 15 of a $600 cash flow made in year 3 when the interest rates are 4 percent? A) $374.76 B) $888.00 C) $960.62 D) $1,080.57 Answer: C Explanation: PV = 600, N = (15 − 3) = 12, I = 4, PMT = 0, CPT FV = 960.62 Difficulty: 2 Medium Topic: Future value - single cash flow Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-05 Move cash flows from one year to another. 53) What annual rate of return is earned on a $200 investment when it grows to $850 in 10 years? A) 3.25 percent B) 4.25 percent C) 13.47 percent D) 15.57 percent Answer: D Explanation: PV = −200, N = 10, PMT = 0, FV = 850, CPT I = 15.57 Difficulty: 2 Medium Topic: Interest rates Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-07 Compute the rate of return realized on selling an investment.

54) What annual rate of return is earned on a $5,000 investment when it grows to $7,000 in six years? A) 1.40 percent B) 5.45 percent C) 5.77 percent D) 40.00 percent Answer: C Explanation: PV = −5000, N = 6, PMT = 0, FV = 7000, CPT I = 5.77 Difficulty: 2 Medium Topic: Interest rates Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-07 Compute the rate of return realized on selling an investment. 55) What annual rate of return is earned on a $900 investment when it grows to $2,500 in 15 years? A) 1.78 percent B) 2.78 percent C) 6.58 percent D) 7.05 percent Answer: D Explanation: PV = −900, N = 15, PMT = 0, FV = 2500, CPT I = 7.05 Difficulty: 2 Medium Topic: Interest rates Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-07 Compute the rate of return realized on selling an investment.

56) What annual rate of return is earned on a $10,000 investment when it grows to $15,000 in 10 years? A) 1.50 percent B) 3.97 percent C) 4.14 percent D) 5.00 percent Answer: C Explanation: PV = −10000, N = 10, PMT = 0, FV = 15000, CPT I = 4.14 Difficulty: 2 Medium Topic: Interest rates Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-07 Compute the rate of return realized on selling an investment. 57) How many years will it take $1 million to grow to $3 million with an annual interest rate of 7 percent? A) 10.29 years B) 14.52 years C) 16.24 years D) 33.33 years Answer: C Explanation: PV = −1, I = 7, PMT = 0, FV = 3, CPT N = 16.24 Difficulty: 2 Medium Topic: Number of time periods Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-08 Calculate the number of years needed to grow an investment.

58) How many years will it take $100 to grow to $1,000 with an annual interest rate of 8 percent? A) 9.00 years B) 10.00 years C) 29.92 years D) 33.35 years Answer: C Explanation: PV = −100, I = 8, PMT = 0, FV = 1000, CPT N = 29.92 Difficulty: 2 Medium Topic: Number of time periods Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-08 Calculate the number of years needed to grow an investment. 59) How many years will it take $200 to grow to $250 with an annual interest rate of 4 percent? A) 1.24 years B) 5.69 years C) 6.25 years D) 18.00 years Answer: B Explanation: PV = −200, I = 4, PMT = 0, FV = 250, CPT N = 5.69 Difficulty: 2 Medium Topic: Number of time periods Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-08 Calculate the number of years needed to grow an investment. 60) How long will it take $3,000 to reach $5,000 when it grows at 7 percent per year? A) 7.00 years B) 7.55 years C) 9.52 years D) 10.29 years Answer: B Explanation: PV = −3000, I = 7, PMT = 0, FV = 5000, CPT N = 7.55 Difficulty: 2 Medium Topic: Number of time periods Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-08 Calculate the number of years needed to grow an investment.

61) How long will it take $100 to reach $500 when it grows at 10 percent per year? A) 7.20 years B) 16.89 years C) 17.46 years D) 40.00 years Answer: B Explanation: PV = −100, I = 10, PMT = 0, FV = 500, CPT N = 16.89 Difficulty: 2 Medium Topic: Number of time periods Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-08 Calculate the number of years needed to grow an investment. 62) How long will it take $4,000 to reach $4,500 when it grows at 8 percent per year? A) 1.12 years B) 1.48 years C) 1.53 years D) 9.00 years Answer: C Explanation: PV = −4000, I = 8, PMT = 0, FV = 4500, CPT N = 1.53 Difficulty: 2 Medium Topic: Number of time periods Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-08 Calculate the number of years needed to grow an investment. 63) At age 20 you invest $1,000 that earns 7 percent each year. At age 30 you invest $1,000 that earns 10 percent per year. In which case would you have more money at age 60? A) At age 20 invest $1,000 at 7 percent. B) At age 30 invest $1,000 at 10 percent. C) Both yield the same amount at age 60. D) There is not enough information to determine which case earns the most money at age 60. Answer: B Explanation: At 20: N = 60 − 20 = 40, PV = 1000, I = 7, PMT = 0, CPT FV = 14974.46. At 30: N = 60 − 30 = 30, PV = 1000, I = 10, PMT = 0, CPT FV = 17449.40. Difficulty: 3 Hard Topic: Future value - single cash flow Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-02 Compute the future value of money. 25

64) At age 25 you invest $2,000 that earns 6 percent each year. At age 35 you invest $2,000 that earns 9 percent per year. In which case would you have more money at age 60? A) At age 25 invest $2,000 at 6 percent. B) At age 35 invest $2,000 at 9 percent. C) Both yield the same amount at age 60. D) There is not enough information to determine which case earns the most money at age 60. Answer: B Explanation: At 25: N = 60 − 25 = 35, PV = 2000, I = 6, PMT = 0, CPT FV = 15372.17. At 35: N = 60 − 35 = 25, PV = 2000, I = 9, PMT = 0, CPT FV = 17246.16. Difficulty: 3 Hard Topic: Future value - single cash flow Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-02 Compute the future value of money. 65) You invested $1,000 in the stock market one year ago. Today, the investment is valued at $750. What return did you earn? What return would you need to get next year to break even overall? A) −112.5 percent, +75 percent, respectively B) −75 percent, +112.5 percent, respectively C) −33.33 percent, +25 percent, respectively D) −25 percent, +33.33 percent, respectively Answer: D Explanation: PV = 1000, N = 1, FV = −750, PMT = 0, CPT I = −25 percent. $250/$750 = 0.3333 = 33.33 percent. Difficulty: 3 Hard Topic: Interest rates Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-07 Compute the rate of return realized on selling an investment.

66) You invested $5,000 in the stock market one year ago. Today, the investment is valued at $4,500. What return did you earn? What return would you need to get next year to break even overall? A) −111.11 percent, +90 percent, respectively B) −90 percent, +111.11 percent, respectively C) −10 percent, +11.11 percent, respectively D) −11.11 percent, +10 percent, respectively Answer: C Explanation: PV = 5000, N = 1, FV = −4500, PMT = 0, CPT I = −10 percent. $500/$4500 = 0.1111 = 11.11 percent. Difficulty: 3 Hard Topic: Interest rates Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-07 Compute the rate of return realized on selling an investment. 67) You invested $1,000 in the stock market one year ago. Today, the investment is valued at $1,250. What return did you earn? What return would you suffer next year for your investment to be valued at the original $1,000? A) +25 percent, −20 percent, respectively B) −25 percent, +20 percent, respectively C) 125 percent, −25 percent, respectively D) 125 percent, −20 percent, respectively Answer: A Explanation: PV = 1000, N = 1, FV = −1250, PMT = 0, CPT I = 25 percent. −$250/$1,250 = −0.2000 = −20.00 percent. Difficulty: 3 Hard Topic: Interest rates Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-07 Compute the rate of return realized on selling an investment.

68) You invested $5,000 in the stock market one year ago. Today, the investment is valued at $5,500. What return did you earn? What return would you suffer next year for your investment to be valued at the original $5,000? A) 10 percent, −9.09 percent, respectively B) −10 percent, +9.09 percent, respectively C) 110 percent, −10 percent, respectively D) 110 percent, −9.09 percent, respectively Answer: A Explanation: PV = 5000, N = 1, FV = −5500, PMT = 0, CPT I = 10 percent. −$500/$5,500 = −0.0909 = −9.09 percent. Difficulty: 3 Hard Topic: Interest rates Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-07 Compute the rate of return realized on selling an investment. 69) What annual rate of return is earned on a $4,000 investment made in year 2 when it grows to $8,000 by the end of year 8? A) 9.00 percent B) 12.00 percent C) 12.25 percent D) 50.00 percent Answer: C Explanation: PV = 4000, N = (8 − 2) = 6, FV = −8000, PMT = 0, CPT I = 12.25 percent. Difficulty: 3 Hard Topic: Interest rates Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-07 Compute the rate of return realized on selling an investment.

70) What annual rate of return is earned on a $2,000 investment made in year 3 when it grows to $3,000 by the end of year 6? A) 6.99 percent B) 14.47 percent C) 24.00 percent D) 50.00 percent Answer: B Explanation: PV = 2000, N = (6 − 3) = 3, FV = −3000, PMT = 0, CPT I = 14.47 percent. Difficulty: 3 Hard Topic: Interest rates Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-07 Compute the rate of return realized on selling an investment. 71) What annual rate of return is implied on a $1,000 loan taken next year when $1,500 must be repaid in year 5? A) 8.45 percent B) 10.00 percent C) 10.67 percent D) 12.50 percent Answer: C Explanation: PV = 1000, N = (5 − 1) = 4, FV = −1500, PMT = 0, CPT I = 10.67 percent. Difficulty: 3 Hard Topic: Interest rates Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-07 Compute the rate of return realized on selling an investment.

72) What annual rate of return is implied on a $700 loan taken next year when $800 must be repaid in year 3? A) 4.55 percent B) 4.76 percent C) 6.90 percent D) 7.14 percent Answer: C Explanation: PV = 700, N = (3 − 1) = 2, FV = −800, PMT = 0, CPT I = 6.90 percent. Difficulty: 3 Hard Topic: Interest rates Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-07 Compute the rate of return realized on selling an investment. 73) Five years ago, Jane invested $5,000 and locked in an 8 percent annual interest rate for 25 years (end 20 years from now). James can make a 20-year investment today and lock in a 10 percent interest rate. How much money should he invest now in order to have the same amount of money in 20 years as Jane? A) $3,160.43 B) $3,464.11 C) $5,089.91 D) $7,346.64 Answer: C Explanation: Jane: PV = 5000, N = 25, I = 8, PMT = 0, CPT FV = 34,242.38 James: FV = 34,242.38, N = (25 − 5) = 20, I = 10, PMT = 0, CPT PV = 5,089.91 Difficulty: 3 Hard Topic: Time value of money Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-02 Compute the future value of money.; 04-04 Calculate the present value of a payment made in the future.

74) Ten years ago, Jane invested $1,000 and locked in a 7 percent annual interest rate for 30 years (end 20 years from now). James can made a 20-year investment today and lock in a 6 percent interest rate. How much money should he invest now in order to have the same amount of money in 20 years as Jane? A) $673.75 B) $1,206.59 C) $1,967.15 D) $2,373.54 Answer: D Explanation: Jane: PV = 1000, N = 30, I = 7, PMT = 0, CPT FV = 7612.26. James: FV = 7612.26, N = (30 − 10) = 20, I = 6, PMT = 0, CPT PV = 2373.54. Difficulty: 3 Hard Topic: Time value of money Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-02 Compute the future value of money.; 04-04 Calculate the present value of a payment made in the future. 75) What is the future value of $600 invested for four years earning an 11 percent interest rate annually? A) $792.90 B) $803.61 C) $899.23 D) $910.84 Answer: D Explanation: PV = 600, N = 4, I = 11 percent, FV = 910.84. Difficulty: 1 Easy Topic: Future value - single cash flow Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-02 Compute the future value of money.

76) A deposit of $500 earns 5 percent the first year, 6 percent the second year, and 7 percent the third year. What would be the third year future value? A) $595.46 B) $615.62 C) $634.91 D) $671.02 Answer: A Explanation: Step 1:PV0= 500, N = 1, I = 5 percent =>FV1= 525, Step 2:PV1= 525, N = 1, I = 6 percent =>FV2= 556.50, Step 3:PV3= 556.5, N = 1, I = 7 percent =>FV3= 595.46. Difficulty: 1 Easy Topic: Simple and compound interest Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-03 Show how the power of compound interest increases wealth. 77) What is the future value of $2,500 deposited for one year earning a 14 percent interest rate annually? A) $2,550 B) $2,850 C) $2,950 D) $3,150 Answer: B Explanation: PV = 2500, N = 1, I = 14 => FV = 2850. Difficulty: 1 Easy Topic: Future value - single cash flow Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-02 Compute the future value of money.

78) What is the present value of a $600 payment in one year when the discount rate is 8 percent? A) $498.61 B) $525.87 C) $555.56 D) $575.09 Answer: C Explanation: FV = 600, N = 1, I = 8 percent, => PV = 555.56. Difficulty: 1 Easy Topic: Present value - single cash flow Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-04 Calculate the present value of a payment made in the future. 79) What is the present value of a $7,000 payment made in six years when the discount rate is 4 percent? A) $5,290.42 B) $5,532.20 C) $5,802.82 D) $6,103.73 Answer: B Explanation: FV = 7000, N = 6, I = 4, => PV = 5532.20. Difficulty: 1 Easy Topic: Present value - single cash flow Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-04 Calculate the present value of a payment made in the future.

80) Compute the present value of $3,000 paid in four years using the following discount rates: 3 percent in year 1, 4 percent in year 2, 5 percent in year 3, and 6 percent in year 4. A) $1,998.73 B) $2,109.14 C) $2,491.28 D) $2,516.26 Answer: D Explanation: FV4 = 3000, N = 1, I = 6 => PV3 = 2830.19, FV3 = 2830.19, N = 1, I = 5, => PV2 = 2695.42, FV2= 2695.42, N = 1, I = 4, => PV1 = 2591.75, FV1 = 2591.75, N = 1, I = 3, => PV0 = 2516.26. Difficulty: 1 Easy Topic: Time value of money Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-04 Calculate the present value of a payment made in the future. 81) Compute the present value of $4,000 paid in five years using the following discount rates: 10 percent in year 1, 2 percent in year 2, 12 percent in year 3, and 9 percent in years 4 and 5. A) $2,679.15 B) $2,206.81 C) $2,317.03 D) $2,362.19 Answer: A Explanation: FV5= 4000, N = 2, I = 9, =>PV3= 3366.72, FV3= 3366.72, N = 1, I = 12, =>PV2= 3006.00, FV2= 3006.00, N = 1, I = 2, =>PV1 = 2947.06, FV1= 2947.06, N = 1, I = 10,PV0= 2679.15. Difficulty: 1 Easy Topic: Time value of money Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-04 Calculate the present value of a payment made in the future.

82) Approximately how many years does it take to double a $475 investment when interest rates are 8 percent per year? A) 18 years B) 12 years C) 9 years D) 4.75 years Answer: C Explanation: 72/I = 72/8 = 9 Difficulty: 1 Easy Topic: Number of time periods Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-06 Apply the Rule of 72. 83) Approximately what rate is needed to double an investment over five years? A) 8 percent B) 12.2 percent C) 14.4 percent D) 15.8 percent Answer: C Explanation: N = 72/I, 72/N = I = 72/5 = 14.4 Difficulty: 1 Easy Topic: Rule of 72 Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-06 Apply the Rule of 72. 84) Determine the interest rate earned on an $800 deposit when $808 is paid back in one year. A) 100 percent B) 10 percent C) 1 percent D) 15 percent Answer: C Explanation: PV = 800, N = 1, FV = 808, => I = 1 Difficulty: 1 Easy Topic: Interest rates Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-07 Compute the rate of return realized on selling an investment.

85) Which is more valuable, receiving $775 today or receiving $885 in 2.5 years if interest rates are 7.25 percent? A) receiving $775 today B) receiving $885 in 2.5 years C) They are worth the same amount D) Need more information to make a determination. Answer: A Explanation: FV = 885, N = 2.5, I = 7.25, => PV = 742.48 Difficulty: 2 Medium Topic: Present value - single cash flow Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-05 Move cash flows from one year to another. 86) What would be more valuable, receiving $1,895 today or receiving $3,450 in six years if interest rates are 8 percent? A) receiving $1,895 today B) receiving $3,450 in six years C) They are worth the same amount D) Need more information to make a determination. Answer: B Explanation: FV = 3450, N = 6, I = 8, => PV = 2174.09 Difficulty: 2 Medium Topic: Present value - single cash flow Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-05 Move cash flows from one year to another. 87) What is the value in year 2 of a $200 cash flow made in year 8 if interest rates are 3 percent? A) $132.89 B) $147.23 C) $152.91 D) $167.50 Answer: D Explanation: FV = 200, N = 6, I = 3, => PV = 167.50 Difficulty: 2 Medium Topic: Present value - single cash flow Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-05 Move cash flows from one year to another. 36

88) What is the value in year 3 of a $10,000 cash flow made in year 20 if interest rates are 5 percent? A) $4,362.97 B) $4,491.27 C) $5,374.11 D) $5,572.19 Answer: A Explanation: FV = 10000, N = 17, I = 5, => PV = 4362.97 Difficulty: 2 Medium Topic: Present value - single cash flow Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-05 Move cash flows from one year to another. 89) What annual rate of return is earned on an $895 investment that grows to $1,976 in eight years? A) 9.14 percent B) 9.97 percent C) 10.41 percent D) 11.73 percent Answer: C Explanation: PV = 895, n = 8, FV = 1976, => i = 10.41 Difficulty: 2 Medium Topic: Interest rates Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-07 Compute the rate of return realized on selling an investment.

90) A stock investor deposited $3,450 six years ago. Today the account is valued at $2,180. What annual rate of return has this investor earned? A) −7.95 percent B) −7.37 percent C) −10.26 percent D) −9.74 percent Answer: B Explanation: PV = 3450, N = 6, FV = 2180, => I = −7.37 Difficulty: 2 Medium Topic: Interest rates Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-07 Compute the rate of return realized on selling an investment. 91) How many years (and months) will it take $4 million to grow to $7 million with an annual interest rate of 12 percent? A) 4 years and 1.92 months B) 4 years and 11.28 months C) 5 years and 6.54 months D) 5 years and 10.86 months Answer: B Explanation: PV = 4, FV = 7, I = 12, => N = 4.94 = 4 years and 11.28 months Difficulty: 2 Medium Topic: Number of time periods Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-08 Calculate the number of years needed to grow an investment.

92) How many years (and months) will it take $1 million to grow to $3 million with an annual interest rate of 7.5 percent? A) 15 years and 2.29 months B) 17 years and 5.6 months C) 18 years and 3.8 months D) 19 years and 2.4 months Answer: A Explanation: PV = 1, FV = 3, I = 7.5, => N = 15.1908 = 15 years and 2.29 months Difficulty: 2 Medium Topic: Number of time periods Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-08 Calculate the number of years needed to grow an investment. 93) Scenario A: At age 27, you invest $1,500 that earns 9 percent each year. Scenario B: At age 40, you invest $2,500 that earns 11 percent per year. Under which scenario do you accumulate more money by age 60? A) Scenario A B) Scenario B C) Both scenarios have the same value by age 60. D) Need more data to answer. Answer: A Explanation: Scenario A: PV = 1500, N = 33, I = 9, => FV = 25773.04. Scenario B: PV = 2500, N = 20, I = 11, => FV = 20155.78. Difficulty: 3 Hard Topic: Future value - single cash flow Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-02 Compute the future value of money.

94) Scenario A: At age 19 you invest $1,500 that earns 8 percent per year. Scenario B: At age 30 you invest $1,500 that earns 13 percent per year. Under which scenario would you have more money at age 55 and what is the dollar difference at age 55 between the two scenarios? A) Scenario A, $1,085.49 B) Scenario A, $2,104.73 C) Scenario B, $4,179.36 D) Scenario B, $7,893.55 Answer: D Explanation: Scenario A: PV = 1500, N = 36, I = 8, => FV = 23952.26. Scenario B: PV = 1500, N = 25, I = 13, => FV = 31845.81 Difference = 31845.81 − 23952.26 = 7893.55. Difficulty: 3 Hard Topic: Future value - single cash flow Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-02 Compute the future value of money. 95) You invested $2,000 in the stock market one year ago. Today, the investment is valued at $9,500. What return did you earn? What return would you need to suffer next year for your investment to be valued at the original $2,000? A) −78.95 percent, 0 percent B) 375 percent, −78.95 percent C) 250 percent, −51.8 percent D) −78.95 percent, 100 percent Answer: B Explanation: Step 1: PV = 2000, FV = 9500, N = 1, => I = 375.00. Step 2: PV = 9500, FV = 2000, N = 1, => I = −78.95. Difficulty: 3 Hard Topic: Interest rates Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-07 Compute the rate of return realized on selling an investment.

96) You invested $1,400 in the stock market one year ago. Today the investment is valued at $1,100. What return did you earn? What return would you need to get back next year to break even overall? A) −14.62 percent, 31.19 percent B) −9.43 percent, 31.67 percent C) −21.43 percent, 27.27 percent D) −29.17 percent, 32.18 percent Answer: C Explanation: Step 1: PV = 1400, FV = 1100, N = 1, => I = −21.43. Step 2: PV = 1100, FV = 1400, N = 1, => I = 27.27. Difficulty: 3 Hard Topic: Interest rates Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-07 Compute the rate of return realized on selling an investment. 97) What annual rate of return is earned on a $13,000 investment made in year 2 when it grows to $17,000 by the end of year 7? A) 10.64 percent B) 4.28 percent C) 8.04 percent D) 5.51 percent Answer: D Explanation: PV = 13000, FV = 17000, N = 5 => I = 5.51 Difficulty: 3 Hard Topic: Interest rates Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-07 Compute the rate of return realized on selling an investment.

98) What annual rate of return is implied on a $5,000 loan taken next year when $7,700 must be repaid in year 8? A) 6.36 percent B) 7.12 percent C) 8.54 percent D) 11.62 percent Answer: A Explanation: PV = 5000, N = 7, FV = 7700, => I = 6.36 Difficulty: 3 Hard Topic: Interest rates Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-07 Compute the rate of return realized on selling an investment. 99) You just won the lottery and after taxes you have $32,000. You want to have $1,000,000 by the time you are 65, which is 45 years from now. Assuming that you can earn 9 percent each year on your money, how much (in dollars) of the $32,000 must you invest today? A) $17,891.62 B) $18,524.91 C) $20,692.24 D) $22,943.28 Answer: C Explanation: FV = 1000000, N = 45, I = 9, => PV = 20692.24 Difficulty: 3 Hard Topic: Present value - single cash flow Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-04 Calculate the present value of a payment made in the future.

100) Ten years ago, Hailey invested $1,000 and locked in a 9 percent annual rate for 30 years (end 20 years from now). Aidan can make a 20-year investment today and lock in an 8 percent rate. How much money should he invest now in order to have the same amount of money in 20 years as Hailey? A) $1,589.03 B) $2,846.56 C) $3,109.48 D) $2,109.73 Answer: B Explanation: Hailey: PV = 1000, N = 30, I = 9, => FV = 13267.67. Aidan: FV = 13267.67, N = 20, I = 8, => PV = 2846.56. Difficulty: 3 Hard Topic: Present value - single cash flow Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-02 Compute the future value of money.; 04-04 Calculate the present value of a payment made in the future. 101) You are scheduled to receive a $750 cash flow in one year, a $1,000 cash flow in two years, and pay a $300 payment in four years. If interest rates are 6 percent per year, what is the combined present value of these cash flows? A) $1,359.92 B) $1,413.92 C) $1,592.63 D) $1,613.02 Answer: A Explanation: Step 1: FV = 750, N = 1, I = 6, => PV = 707.55 Step 2: FV = 1000, N = 2, I = 6, => PV = 890.00 Step 3: FV = −300, N = 4, I = 6, => PV = −237.63 Step 4: Sum of 3 PV = 1359.92 Difficulty: 3 Hard Topic: Present value - multiple cash flows Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-05 Move cash flows from one year to another.

102) You are scheduled to pay a $350 cash flow in one year, and receive a $1,000 cash flow in years 3 and 4. If interest rates are 10 percent per year, what is the combined present value of these cash flows? A) $991.38 B) $1,097.14 C) $1,116.14 D) $1,213.92 Answer: C Explanation: Step 1: FV = −350, N = 1, I = 10, => PV = −318.18. Step 2: FV = 1000, N = 3, I = 10, => PV = 751.31. Step 3: FV = 1000, N = 4, I = 10, => PV = 683.01. Step 4: Sum of 3 PV = 1116.14. Difficulty: 3 Hard Topic: Present value - multiple cash flows Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-05 Move cash flows from one year to another. 103) As the production manager of HPG, Inc., you have received an offer from the supplier who provides the wires used in headsets. Due to poor planning, the supplier has an excess amount of wire and is willing to sell $750,000 worth for only $600,000. You already have one year's supply of wire on hand. This new wire would be used one year from today. What implied interest rate would your firm be earning if you purchased the wire? A) −20 percent B) 13.5 percent C) 21 percent D) 25 percent Answer: D Explanation: N = 1, PV = 600000, FV = 750000, => I = 25. Difficulty: 3 Hard Topic: Interest rates Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-07 Compute the rate of return realized on selling an investment.

104) An appliance store sells a TV for $1,200 and gives their customers a full three years to pay for the TV. If interest rates are 5 percent, what is the equivalent sales price of the TV when the customer takes the full 3 years to pay for it? A) $991.72 B) $1,036.61 C) $1,104.14 D) $1,389.15 Answer: B Explanation: FV = 1200, N = 3, I = 5, => PV = 1036.61 Difficulty: 3 Hard Topic: Present value - multiple cash flows Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-01 Create a cash flow time line. 105) Assume you borrow $5,000 today and pay back the loan in one lump sum four years from today. You are charged 8 percent interest per year. What amount will you pay back and how much interest will you pay? A) $6,399.56, $1,399.56 B) $6,508.21, $1,508.21 C) $6,802.44, $1,802.44 D) $7,902.11, $2,902.11 Answer: C Explanation: PV = 5000, N = 4, I = 8, FV = 6802.44 Int = 6802.44 − 5000 = 1802.44 Difficulty: 3 Hard Topic: Future value - single cash flow Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-03 Show how the power of compound interest increases wealth.

106) Assume that you borrow $2,000 from your sister and that you will pay her back in one lump sum. She charges you 9 percent interest in year 1 and increases the rate by 1 percent per year until the loan is paid off. How much will you owe if you wait until year 3 to pay off the loan? A) $2,467.91 B) $2,661.78 C) $2,775.23 D) $2,809.53 Answer: B Explanation: FV3 = 2000(1.09)(1.1)(1.11) = 2661.78. Difficulty: 3 Hard Topic: Simple and compound interest Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-03 Show how the power of compound interest increases wealth. 107) Assume you borrow $500 from a payday lender. The terms are that you must pay a fee of $75 in advance (today) and one year from now you need to repay $750. What implied interest rate are you paying? A) 43.09 percent B) 55.78 percent C) 76.47 percent D) 81.03 percent Answer: C Explanation: PV = 425, FV = 750, N = 1, => I = 76.47 Difficulty: 3 Hard Topic: Interest rates Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-07 Compute the rate of return realized on selling an investment.

108) Assume you borrow $100 from a payday lender. The terms are that you must pay a fee of $25 in advance (today) and one year from now you need to repay $112. What implied interest rate are you paying? A) 12.00 percent B) 25.00 percent C) 49.33 percent D) 86.99 percent Answer: C Explanation: PV = 75, FV = 112, N = 1, => I = 49.33 Difficulty: 3 Hard Topic: Interest rates Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-07 Compute the rate of return realized on selling an investment. 109) Five years ago, sales were $4 million. Today your company's sales are $10 million. What annual rate have sales been growing? A) 1.5 percent B) 12.65 percent C) 16.65 percent D) 20.11 percent Answer: D Explanation: PV = 4, FV = 10, N = 5, => I = 20.11 Difficulty: 3 Hard Topic: Interest rates Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-07 Compute the rate of return realized on selling an investment.

110) How long will it take for the purchasing power of $1 to be cut in half if inflation is 4 percent? A) 4.97 years B) 7.42 years C) 10.72 years D) 17.67 years Answer: D Explanation: PV = 1; FV = 0.5; I = −4; => N = 17.67 Difficulty: 2 Medium Topic: Interest rates Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-08 Calculate the number of years needed to grow an investment. 111) You have $100,000 in your account. Assuming no additional deposits are made and your account earns 15 percent per year, how long will it take for the account to have a balance of $500,000? A) 10.28 years B) 11.09 years C) 11.52 years D) 12.64 years Answer: C Explanation: PV = 100000, FV = 500000, I = 15, => N = 11.52 Difficulty: 2 Medium Topic: Number of time periods Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-08 Calculate the number of years needed to grow an investment.

112) You have $50,000 in your account. Assuming no additional deposits are made and your account earns 8 percent per year, how long will it take for the account to have a balance of $500,000? A) 28.83 years B) 29.92 years C) 50.00 years D) 90.00 years Answer: B Explanation: PV = 50000, FV = 500000, I = 8, => N = 29.9188 Difficulty: 2 Medium Topic: Number of time periods Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-08 Calculate the number of years needed to grow an investment. 113) Which of the following statements is correct? A) $100 to be received in the future is worth more than that today since it could be invested and earn interest. B) $100 to be received in the future is worth less than that today since it could be invested and earn interest. C) The Rule of 72 calculates the compounded return on investments. D) Discounting is finding the future value of an original investment. Answer: B Difficulty: 1 Easy Topic: Time value of money; Rule of 72 Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-02 Compute the future value of money.; 04-06 Apply the Rule of 72.

114) You double your money in five years. The reason your return is not 20 percent per year is because: A) it is probably a "fad" investment. B) it does not reflect the effect of discounting. C) it does not reflect the effect of the Rule of 72. D) it does not reflect the effect of compounding. Answer: D Difficulty: 1 Easy Topic: Simple and compound interest Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-07 Compute the rate of return realized on selling an investment. 115) You borrow $3,500 and will pay back the entire amount in five years. You are charged 9 percent interest per year. How much interest do you pay on this loan? A) $1,885.18 B) $1,907.35 C) $1,959.02 D) $2,106.81 Answer: A Explanation: PV = 3500,N = 5,I = 9,=> FV = 5385.18, 5385.18 − 3500 = 1885.18 Difficulty: 2 Medium Topic: Future value - single cash flow Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-03 Show how the power of compound interest increases wealth. 116) You borrow $10,000 and will pay back the entire amount in 10 years. You are charged 6 percent interest per year. How much interest do you pay on this loan? A) $6,000.00 B) $7,715.61 C) $7,908.48 D) $11,193.97 Answer: C Explanation: PV = 10000, N = 10, I = 6, => FV = 17908.48, 17908.48 − 10000 = 7908.48 Difficulty: 2 Medium Topic: Future value - single cash flow Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-03 Show how the power of compound interest increases wealth. 50

117) Your firm receives an offer from the supplier who provides computer chips used to manufacture cell phones. Due to poor planning, the supplier has an excess amount of chips and is willing to sell $600,000 worth of chips for only $500,000. You already have two years' supply on hand. It would cost you $7,500 today to store the chips until your firm needs them in two years. What implied interest rate would you be earning if you purchased and store the chips? A) 6.57 percent B) 8.73 percent C) 9.54 percent D) 18.23 percent Answer: B Explanation: N = 2, PV = 507500, FV = 600000, => I = 8.73 Difficulty: 3 Hard Topic: Interest rates Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-07 Compute the rate of return realized on selling an investment. 118) You are considering an investment that is expected to pay 5 percent in year 1, 7 percent in years 2 and 3 and 9 percent in year 4. If you invest $2,000 today, what will this investment be worth at the end of the fourth year? A) $2,501.42 B) $2,693.71 C) $2,713.04 D) $2,620.68 Answer: D Explanation: Step 1: PV = 2000, N = 1, I = 5, => FV = 2100, Step 2: PV = 2100, N = 2, I = 7, => 2404.29, Step 3: PV = 2404.29, N = 1, I = 9, => FV = 2620.68. Difficulty: 2 Medium Topic: Future value - single cash flow Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-02 Compute the future value of money.

119) You are considering an investment that is expected to pay 3 percent in year 1, 5 percent in years 2 and 3 and 7 percent in year 4. If you invest $1,000 today, what will this investment be worth at the end of the fourth year? A) $1215.07 B) $1215.51 C) $1275.81 D) $1285.75 Answer: A Explanation: Step 1: PV = 1000, N = 1, I = 3, => FV = 1030, Step 2: PV = 1030, N = 2, I = 5, => 1135.575, Step 3: PV = 1135.575, N = 1, I = 7, => FV = 1215.0653. Difficulty: 2 Medium Topic: Future value - single cash flow Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-02 Compute the future value of money. 120) We call the process of earning interest on both the original deposit and on the earlier interest payments A) simple interest. B) compounding. C) future value. D) discounting. Answer: B Difficulty: 1 Easy Topic: Future value - single cash flow Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-01 Create a cash flow time line.

121) When your investment compounds, your money will grow in a(n) A) linear B) exponential C) static D) implied

fashion.

Answer: B Difficulty: 1 Easy Topic: Future value - single cash flow Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-03 Show how the power of compound interest increases wealth. 122) You invested $1,000 for five years in an account that earns 5 percent. However, today you learn that you are able to move the account into an investment that earns 10 percent. Which of the following statements is correct? A) If you select the investment earning 10 percent, you will double your profit. B) If you select the investment earning 10 percent, you will more than double your profit. C) If you select the investment earning 10 percent, your profit will be less than double. D) None of the statements is correct. Answer: B Difficulty: 2 Medium Topic: Time value of money Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-03 Show how the power of compound interest increases wealth. 123) Which of the following statements is incorrect with respect to time lines? A) A helpful tool for organizing our analysis is the time line. B) Cash flows we receive are called inflows and denoted with a positive number. C) Cash flows we pay out are called outflows and designated with a negative number. D) Interest rates are not included on our time lines. Answer: D Difficulty: 1 Easy Topic: Time value of money Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-01 Create a cash flow time line.

124) Which of the following will not increase a present value? A) increase the interest rate B) decrease the number of periods C) increase the future value Answer: A Difficulty: 2 Medium Topic: Time value of money Bloom's: Evaluate AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-04 Calculate the present value of a payment made in the future. 125) Suppose a U.S. Treasury bond promises to pay $9,780.13 in three years. If bonds of this type are generating a 4 percent annual return, how much would you pay for this bond today? A) $8,429.71 B) $11,001.32 C) $8,694.50 D) $9,112.78 Answer: C Explanation: FV = 9780.13, N = 3, I = 4, => PV = 8694.5 Difficulty: 2 Medium Topic: Present value - single cash flow Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-04 Calculate the present value of a payment made in the future. 126) A firm's net income last year was $2.65 million. Its net income grew 8 percent during the last "5" years. If that growth rate continues, how long will it take for the firm's net income to double? A) 6.6 years B) 7.1 years C) 8.2 years D) 9 years Answer: D Explanation: PV = 2.65, FV = 5.3, I = 8, => N = 9 Difficulty: 2 Medium Topic: Rule of 72 Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-08 Calculate the number of years needed to grow an investment.

127) A firm's net income last year was $1.5 million. Its net income grew 5 percent during the last "5" years. If that growth rate continues, how long will it take for the firm's net income to double? A) 7.6 years B) 10.47 years C) 14.21 years D) 14.55 years Answer: C Explanation: PV = 1.5, FV = 3, I = 5, => N = 14.21 Difficulty: 2 Medium Topic: Rule of 72 Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-08 Calculate the number of years needed to grow an investment. 128) You want to retire in 25 years and you have just inherited $300,000. You believe you will need $1,450,000 upon retirement. What rate will you need to earn on the account to achieve this goal? A) 4.5 percent B) 5.5 percent C) 6.5 percent D) 8.5 percent Answer: C Explanation: PV = 300000, FV = 1450000, N = 25, => I = 6.5 Difficulty: 2 Medium Topic: Interest rates Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-07 Compute the rate of return realized on selling an investment.

129) You want to retire in 40 years and you have $40,000 saved in your retirement account. You believe you will need $1,500,000 upon retirement. What rate will you need to earn on the account to achieve this goal? A) 6.75 percent B) 7.48 percent C) 9.13 percent D) 9.48 percent Answer: D Explanation: PV = 40000, FV = 1500000, N = 40, => I = 9.4840 Difficulty: 2 Medium Topic: Interest rates Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-07 Compute the rate of return realized on selling an investment. 130) Which of the following investments would you prefer? A) an investment earning 10 percent for 20 years B) an investment earning 8.5 percent for 20 years C) an investment earning 5 percent for 40 years D) an investment earning 3 percent for 40 years Answer: C Difficulty: 2 Medium Topic: Time value of money Bloom's: Understand; Evaluate AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 04-02 Compute the future value of money.; 04-05 Move cash flows from one year to another.

131) Which of the following is the equivalent of $300 received today? A) Seven hundred ninety-five dollars ninety-nine cents to be received 20 years in the future assuming a 5 percent annual interest rate. B) Hundred dollars to be received two years from now and $200 three years from now. C) Three hundred dollars compounded at 10 percent for one year. D) All of these choices are correct. Answer: A Explanation: FV = 795.99, N = 20, I = 5 => PV = 300 Difficulty: 1 Easy Topic: Time value of money Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-04 Calculate the present value of a payment made in the future. 132) A $400 investment has doubled to $800 in six years because of a 12.25 percent return. How much longer will it take for the investment to reach $1100 if it continues to earn 12.25 percent? A) 2.56 years B) 2.76 years C) 3.46 years D) 5 years Answer: B Explanation: PV = 800, FV = 1100, I = 12.25 => N = 2.76 Difficulty: 2 Medium Topic: Number of time periods Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-08 Calculate the number of years needed to grow an investment.

133) A $1,000 investment has doubled to $2,000 in seven years. How much longer will it take for the investment to reach $5,000 if it continues to earn the same rate? A) 6.16 years B) 6.86 years C) 7.15 years D) 9.25 years Answer: D Explanation: Step 1: PV = 1000, FV = 2000, N = 7 => I = 10.41. Step 2: FV = 5000, PV = 2000, I = 10.41, => N = 9.25. Difficulty: 3 Hard Topic: Number of time periods Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-08 Calculate the number of years needed to grow an investment. 134) A $5,000 investment has doubled to $10,000 in ten years. How much longer will it take for the investment to reach $15,000 if it continues to earn the same rate? A) 5.00 years B) 5.85 years C) 6.86 years D) 7.20 years Answer: B Explanation: Step 1: PV = 5000, FV = 10000, N = 10 => I = 7.1773. Step 2: FV = 15000, PV = 10000, I = 7.1773, => N = 5.85. Difficulty: 3 Hard Topic: Number of time periods Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-08 Calculate the number of years needed to grow an investment.

135) Which of the following would you prefer? A) four hundred dollars to be received in nine years when rates are 8 percent B) two hundred ten dollars today C) five hundred dollars to be received in 12 years when rates are 8 percent D) five hundred dollars to be received in 12 years when rates are 9 percent Answer: B Explanation: PV of $400 to be received in nine years when rates are 8 percent = 200.10 PV of $500 to be received in 12 years when rates are 8 percent = 198.56 PV of $500 to be received in 12 years when rates are 9 percent < PV of $500 to be received in 12 years when rates are 8 percent. Difficulty: 2 Medium Topic: Present value - single cash flow Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-04 Calculate the present value of a payment made in the future. 136) Which of the following would you prefer? A) five hundred dollars to be received in 10 years when rates are 8 percent B) three hundred dollars today C) six hundred dollars to be received in 12 years when rates are 8 percent D) seven hundred dollars to be received in 12 years when rates are 7 percent Answer: D Explanation: PV of $500 to be received in 10 years when rates are 8 percent = 231.60 PV of $600 to be received in 12 years when rates are 8 percent = 238.27 PV of $700 to be received in 12 years when rates are 7 percent = 310.81. Difficulty: 2 Medium Topic: Present value - single cash flow Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-04 Calculate the present value of a payment made in the future.

137) What is the value in year 10 of a $1,000 cash flow made in year 5 if interest rates are 9 percent in years 6 and 7, and increase to 13 percent in the remaining years? A) $1,538.62 B) $1,691.47 C) $1,714.31 D) $1,799.42 Answer: C Explanation: Step 1: PV = 1000, N = 2, I = 9, => FV = 1188.10. Step 2: PV = 1188.10, N = 3, I = 13, => FV = 1714.31. Difficulty: 3 Hard Topic: Future value - single cash flow Bloom's: Apply; Create AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-03 Show how the power of compound interest increases wealth.; 04-05 Move cash flows from one year to another. 138) What is the value in year 4 of a $9,000 cash flow made in year 13 if interest rates are 7 percent in years "4 through 9" and increase to 11 percent after that? A) $4,226.99 B) $4,472.06 C) $4,698.17 D) $4,716.52 Answer: A Explanation: Step 1: FV = 9000, N = 4, I = 11, => PV = 5928.58. Step 2: FV = 5928.58, N = 5, I = 7, => PV = 4226.99. Difficulty: 3 Hard Topic: Future value - single cash flow Bloom's: Apply; Create AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-03 Show how the power of compound interest increases wealth.; 04-05 Move cash flows from one year to another.

139) What is the value in year 6 of a $9,000 cash flow made in year 14 if interest rates are 7 percent in years "4 through 9" and increase to 10 percent after that? A) $4,252.19 B) $4,417.46 C) $4,561.71 D) $45,798.53 Answer: C Explanation: Step 1: FV = 9000, N = 5, I = 10, => PV = 5588.29. Step 2: FV = 5588.29, N = 3, I = 7, => PV = 4561.71. Difficulty: 3 Hard Topic: Future value - single cash flow Bloom's: Apply; Create AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-03 Show how the power of compound interest increases wealth.; 04-05 Move cash flows from one year to another. 140) What is the value in year 20 of a $1,000 cash flow made in year 8 if interest rates are 15 percent in years "6 through 13" and increase to 18 percent in the remaining years? A) $5,779.57 B) $5,912.42 C) $6,005.71 D) $6,407.13 Answer: D Explanation: Step 1: PV = 1000, N = 5, I = 15, => FV = 2011.36. Step 2: PV = 2011.36, N = 7, I = 18, => FV = 6407.13. Difficulty: 3 Hard Topic: Future value - single cash flow Bloom's: Apply; Create AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-03 Show how the power of compound interest increases wealth.; 04-05 Move cash flows from one year to another.

141) A $2 million deposit earns 7 percent for 13 years. If the account earns 9 percent per year forever after that, how long will it take to grow to $5 million? A) zero; the account exceeds $5 million after 13 years B) 0.26 year C) 0.43 year D) 1.18 years Answer: C Explanation: Step 1: PV = 2, N = 13, I = 7, => FV = 4.82. Step 2: PV = 4.82, I = 9, FV = 5, => N = 0.43. Difficulty: 3 Hard Topic: Number of time periods Bloom's: Apply; Create AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-03 Show how the power of compound interest increases wealth.; 04-08 Calculate the number of years needed to grow an investment. 142) A $7 million deposit earns 5 percent for nine years. If the account loses 2 percent per year after that, how long will it take to be reduced back to $7 million? A) 6.78 years B) 10.29 years C) 11.29 years D) 21.74 years Answer: D Explanation: Step 1: PV = 7, N = 9, I = 5, => FV = 10.86. Step 2: PV = 10.86, I = −2, FV = 7, => N = 21.74. Difficulty: 3 Hard Topic: Number of time periods Bloom's: Apply; Create AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-03 Show how the power of compound interest increases wealth.; 04-08 Calculate the number of years needed to grow an investment.

143) You deposit $20,000 in an account that doubles in seven years. How many years will it take the account to be reduced to its original value if it loses 12 percent per year? A) 4.92 years B) 5.42 years C) 6.62 years D) 8.22 years Answer: B Explanation: Step 1: PV = 20000, N = 7, FV = 40000, => I = 10.41. Step 2: PV = 40,000, I = −12, FV= 20000, => N = 5.42. Difficulty: 3 Hard Topic: Number of time periods Bloom's: Apply; Create AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-07 Compute the rate of return realized on selling an investment.; 04-08 Calculate the number of years needed to grow an investment. 144) You deposit $20,000 in an account that doubles in seven years. How many years will it take the account to double again if it earns 14 percent per year? A) 4.92 years B) 5.29 years C) 6.62 years D) 8.22 years Answer: B Explanation: PV = 40,000, FV = 80,000, I = 14, => N = 5.29 Difficulty: 3 Hard Topic: Number of time periods Bloom's: Apply; Create AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-08 Calculate the number of years needed to grow an investment.

145) Time value of money concepts can be used by A) individuals doing personal financial planning. B) CFOs and CEOs to make business decisions. C) investors calculating a return on an investment. D) All of these choices are correct. Answer: D Difficulty: 1 Easy Topic: Time value of money Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-01 Create a cash flow time line. 146) How much would be in your savings account in 12 years if you deposited $1,500 today? Assume the bank pays 5 percent per year. A) $2,387.12 B) $2,491.03 C) $2,693.78 D) $2,771.09 Answer: C Explanation: PV = 1500, N = 12, I = 5, => FV = 2693.78 Difficulty: 1 Easy Topic: Future value - single cash flow Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-03 Show how the power of compound interest increases wealth. 147) An average home in Chicago costs $295,000. If house prices are expected to grow at an average rate of 3 percent per year, what will a house cost in five years? A) $328,995.61 B) $338,941.27 C) $341,985.85 D) $347,028.19 Answer: C Explanation: PV = 295000, I = 3, N = 5, => FV = 341985.85 Difficulty: 1 Easy Topic: Future value - single cash flow Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-03 Show how the power of compound interest increases wealth.

148) If an average home in your town currently costs $250,000, and house prices are expected to grow at an average rate of 3 percent per year, what will a house cost in eight years? A) $255,033.41 B) $255,043.97 C) $314,928.01 D) $316,692.52 Answer: D Explanation: PV = 250000, I = 3, N = 8, => FV = 316,692.52 Difficulty: 1 Easy Topic: Future value - single cash flow Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-03 Show how the power of compound interest increases wealth. 149) You are offered a choice between $770 today and $815 one year from today. Assume that interest rates are 4 percent. Which do you prefer? A) $770 today B) $815 one year from today C) They are equivalent to each other. D) $770 today at 3 percent interest rates Answer: B Explanation: PV = 770, N = 1, I = 4, FV = 800.8 Difficulty: 1 Easy Topic: Future value - single cash flow Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-02 Compute the future value of money.

150) You deposit $10,000 in an account that doubles in "6" years. How many years will it take the account to be reduced to its original value if it loses 10 percent per year? A) 6.00 years B) 6.58 years C) 7.27 years D) 10.00 years Answer: B Explanation: Step 1: PV = 10000, N = 6, FV = 20000, => I = 12.2462. Step 2: PV = 20,000, I = −10, FV, 10000, => N = −6.5788. Difficulty: 3 Hard Topic: Time value of money Bloom's: Apply; Create AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-07 Compute the rate of return realized on selling an investment.; 04-08 Calculate the number of years needed to grow an investment. 151) You deposit $200 in an account that doubles in 10 years. How many years will it take the account to be reduced to its original value if it loses 25 percent per year? A) 2.00 years B) 2.41 years C) 3.11 years D) 4.00 years Answer: B Explanation: Step 1: PV = 200, N = 10, FV = 400, => I = 7.1773. Step 2: PV = 400, I = −25, FV= 200, => N = 2.4094. Difficulty: 3 Hard Topic: Time value of money Bloom's: Apply; Create AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-07 Compute the rate of return realized on selling an investment.; 04-08 Calculate the number of years needed to grow an investment.

152) Which of the following investments would you prefer? A) an investment earning 6 percent for 10 years B) an investment earning 5 percent for 20 years C) an investment earning 4 percent for 30 years D) an investment earning 3 percent for 40 years Answer: D Difficulty: 2 Medium Topic: Future value - single cash flow Bloom's: Understand; Evaluate AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 04-02 Compute the future value of money.; 04-05 Move cash flows from one year to another. 153) If an average home in your town currently costs $350,000, and house prices are expected to grow at an average rate of 3 percent per year, what will an average house cost in "5" years? A) $402,500.00 B) $405,168.75 C) $405,745.93 D) $507,500.00 Answer: C Explanation: PV = 350000, I = 3, N = 5, => FV = 405,745.9260 Difficulty: 1 Easy Topic: Future value - single cash flow Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-03 Show how the power of compound interest increases wealth. 154) If an average home in your town currently costs $300,000, and house prices are expected to grow at an average rate of 5 percent per year, what will an average house cost in 10 years? A) $450,000.00 B) $483,153.01 C) $488,668.39 D) $507,593.74 Answer: C Explanation: PV = 300000, I = 5, N = 10, => FV = 488,668.39 Difficulty: 1 Easy Topic: Future value - single cash flow Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-03 Show how the power of compound interest increases wealth. 67

155) Compute the present value of $9,000 paid in four years using the following discount rates: 4 percent in year 1, 5 percent in year 2, 4 percent in year 3, and 3 percent in year 4. A) $7,693.95 B) $8,543.26 C) $9,000.00 D) $10,823.01 Answer: A Explanation: FV4= 9000, N = 1, I = 3 =>PV3 = 8737.8641, FV3= 8737.8641, N = 1, I = 4, =>PV2 = 8401.7924, FV2= 8401.7924, N = 1, I = 5, =>PV1 = 8001.7070, FV1= 8001.71, N = 1, I = 4, =>PV0 = 7693.9491 Difficulty: 1 Easy Topic: Present value - single cash flow Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-04 Calculate the present value of a payment made in the future. 156) What is the value in year 6 of a $1,000 cash flow made in year 2 if interest rates are 5 percent in years 3 and 4, and increase to 6 percent in the remaining years? A) $1,215.51 B) $1,238.77 C) $2,970.03 D) $2,982.74 Answer: B Explanation: Step 1: PV = 1000, N = 2, I = 5, => FV = 1102.50. Step 2: PV = 1105.5000, N = 2, I = 6, => FV = 1238.7690. Difficulty: 3 Hard Topic: Future value - single cash flow Bloom's: Apply; Create AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-03 Show how the power of compound interest increases wealth.; 04-05 Move cash flows from one year to another.

157) Which is more valuable, receiving $1,000 today or receiving $1,200 in 3 years if interest rates are 7 percent? A) receiving $1,000 today B) receiving $1,200 in 3 years C) They are worth the same amount. D) need more information to make a determination Answer: A Explanation: FV = 1200, N = 3, I = 7, => PV = 979.56 or PV = 1000, N = 3, I = 7, => FV = 1225.04. Difficulty: 2 Medium Topic: Interest rates Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-05 Move cash flows from one year to another. 158) Determine the interest rate earned on a $200 deposit when $208 is paid back in one year. A) 104 percent B) 8 percent C) 4 percent D) 2 percent Answer: C Explanation: PV = 200, N = 1, FV = 208, => I = 4 Difficulty: 1 Easy Topic: Interest rates Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 04-07 Compute the rate of return realized on selling an investment.

Finance, 5e (Cornett) Chapter 5 Time Value of Money 2: Analyzing Annuity Cash Flows 1) When saving for future expenditures, we can add the see what the total will be worth at some point in time. A) present value B) future value C) time value to money D) payment

of contributions over time to

Answer: B Difficulty: 1 Easy Topic: Future value - multiple cash flows Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 05-01 Compound multiple cash flows to the future. 2) When moving from the left to the right of a time line, we are using A) compound interest to calculate future values. B) discounted cash flows to calculate present values. C) only payments to calculate future values. D) simple interest to calculate future values. Answer: A Difficulty: 1 Easy Topic: Time value of money Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 05-01 Compound multiple cash flows to the future. 3) Level sets of frequent, consistent cash flows are called A) loans. B) budgets. C) annuities. D) bills. Answer: C Difficulty: 1 Easy Topic: Annuities Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 05-02 Compute the future value of frequent, level cash flows.

4) The length of time of the annuity is very important in accumulating wealth within an annuity. What other factor also has this effect? A) the time line B) interest rate for compounding C) the present value D) the future value Answer: B Difficulty: 1 Easy Topic: Annuities Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 05-02 Compute the future value of frequent, level cash flows. 5) In order to discount multiple cash flows to the present, one would use A) the appropriate compound rate. B) the appropriate discount rate. C) the appropriate simple rate. D) the appropriate tax rate. Answer: B Difficulty: 1 Easy Topic: Time value of money Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 05-03 Discount multiple cash flows to the present. 6) An annuity due: A) is an annuity in which the cash flows occur at the beginning of each period. B) makes the cash flow in the beginning of year 1 look like it's a cash flow of today. C) moves the cash flow from the end of the year to the beginning, which looks like the end of the previous year. D) the appropriate tax rate. Answer: A Difficulty: 1 Easy Topic: Time value of money Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 05-03 Discount multiple cash flows to the present.

7) Your credit rating and current economic conditions will determine A) whether you get simple or compound interest. B) how long compounding will affect you. C) how long discounting will affect you. D) the interest rate that a lender will offer. Answer: D Difficulty: 1 Easy Topic: Loan interest and rates Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 05-04 Compute the present value of an annuity. 8) When interest rates are lower, borrowers can A) get loans more easily. B) cannot get loans as easily. C) borrow more money. D) afford higher payments. Answer: C Difficulty: 2 Medium Topic: Loan interest and rates Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 05-04 Compute the present value of an annuity. 9) The present value of annuity payments made far into the future is A) worth very little today. B) worth much more today. C) valued as having no time value of money. D) valued as worthless as their value is not determinable. Answer: A Difficulty: 2 Medium Topic: Present value - annuity Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 05-04 Compute the present value of an annuity.

10) Which of the following statements about compound frequency is not true? A) Compounding frequency can only be annual, semi-annual or quarterly. B) The higher the compound frequency, the higher the future value will be. C) The relative increase in value from increasing compounding frequency seems to diminish with increasing frequencies. D) None of the above are untrue statements. Answer: A Difficulty: 2 Medium Topic: Compound frequency Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 05-04 Compute the present value of an annuity. 11) Which of the following statements about annual percentage rate (APR) and effective annual rate (EAR) are not true? A) The annual percentage rate (APR) is considered a more accurate measurement of what you will actually pay. B) Lenders are legally required to show potential borrowers the effective annual rate (EAR) on any loan offered. C) The difference between APR and EAR is not that large. D) None of the above are untrue statements. Answer: A Difficulty: 2 Medium Topic: APR and EAR Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 05-04 Compute the present value of an annuity. 12) A perpetuity, a special form of annuity, pays cash flows A) and is not effected by interest rate changes. B) that do not have time value of money implications. C) continuously for one year. D) periodically forever. Answer: D Difficulty: 1 Easy Topic: Perpetuities Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 05-05 Figure cash flows and present value of a perpetuity.

13) Many people who want to start investing for their future want to start today, which implies an annuity stream that is paid at the beginning of the period. Beginning-of-period cash flows are referred to as A) ordinary annuities. B) annuities due. C) perpetuities. D) present values. Answer: B Difficulty: 1 Easy Topic: Annuities Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 05-06 Adjust values for beginning-of-period annuity payments. 14) To compute the present or future value of an annuity due, one computes the value of an ordinary annuity and then A) multiplies it by (1 + i). B) divides it by (1 + i). C) multiplies it by (1 − i). D) divides it by (1 − i). Answer: A Difficulty: 2 Medium Topic: Annuities Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 05-06 Adjust values for beginning-of-period annuity payments. 15) When computing the future value of an annuity, the higher the compound frequency A) the lower the future value will be. B) the higher the future value will be. C) the less likely the future value can be calculated. D) the more likely the future value can be calculated. Answer: B Difficulty: 2 Medium Topic: Future value - annuity Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 05-07 Explain the impact of compound frequency and the difference between the annual percentage rate and the effective annual rate.

16) Compounding monthly versus annually causes the interest rate to be effectively higher, and thus the future value A) grows. B) decreases. C) is independent of the monthly compounding. D) is affected only if the calculation involves an annuity due. Answer: A Difficulty: 1 Easy Topic: Simple and compound interest Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 05-07 Explain the impact of compound frequency and the difference between the annual percentage rate and the effective annual rate. 17) The simple form of an annualized interest rate is called the annual percentage rate (APR). The effective annual rate (EAR) is a A) less accurate measure of the interest rate paid for monthly compounding. B) more accurate measure of the interest rate paid for monthly compounding. C) concept that is only used because the law requires it, and is of no use to a borrower. D) measure that only applies to mortgages. Answer: B Difficulty: 1 Easy Topic: Simple and compound interest Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 05-07 Explain the impact of compound frequency and the difference between the annual percentage rate and the effective annual rate. 18) People refinance their home mortgages A) when rates fall. B) when rates rise. C) when rates fall and rise. D) whenever they need to, independent of rates. Answer: A Difficulty: 1 Easy Topic: Loan interest and rates Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 05-09 Compute payments and amortization schedules for car and mortgage loans. 6

19) Loan amortization schedules show A) the principal balance paid per period only. B) the interest paid per period only. C) both the principal balance and interest paid per period. D) the present value of the payments due. Answer: C Difficulty: 1 Easy Topic: Amortization Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 05-09 Compute payments and amortization schedules for car and mortgage loans. 20) When you get your credit card bill, it will offer a minimum payment, which A) usually only pays the accrued interest and a small amount of principal. B) usually only pays the principal and a small amount of accrued interest. C) usually only pays the principal and no accrued interest. D) usually only pays the accrued interest and no principal. Answer: A Difficulty: 1 Easy Topic: Amortization Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 05-10 Calculate the number of payments on a loan. 21) When you get your credit card bill, if you make a payment larger than the minimum payment A) you are wasting your current consumption and making TVM not work for you. B) you will reduce the payoff time. C) you will increase the payoff time. D) you will not affect the payoff time. Answer: B Difficulty: 1 Easy Topic: Amortization Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 05-10 Calculate the number of payments on a loan.

22) Compute the future value in year 10 of a $1,000 deposit in year 1, and another $1,500 deposit at the end of year 4 using an 8 percent interest rate. A) $3,120.73 B) $4,379.31 C) $4,500.00 D) $5,397.31 Answer: B Explanation: N = 10 − 1 = 9 I=8 PV = 1000 PMT = 0 CPT FV = 1999.00 1999.00 + 2380.31 = 4379.31

N = 10 − 4 = 6 I=8 PV = 1500 PMT = 0 CPT FV = 2380.31

Difficulty: 1 Easy Topic: Future value - multiple cash flows Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-01 Compound multiple cash flows to the future. 23) Compute the future value in year 4 of a $500 deposit in year 1, and another $1,000 deposit at the end of year 3 using a 5 percent interest rate. A) $1,625.00 B) $1,628.81 C) $1,800.00 D) $1,823.26 Answer: B Explanation: N = 4−1=3 I=5 PV = 500 PMT = 0 CPT FV = 578.81 578.81 + 1050.00 = 1628.81

N = 4−3=1 I=5 PV = 1000 PMT = 0 CPT FV = 1050.00

24) What is the future value of an $800 annuity payment over 15 years if the interest rates are 6 percent? A) $1,917.25 B) $7,002.99 C) $12,720.00 D) $18,620.78 Answer: D Explanation: N = 15 I=6 PV = 0 PMT = 800 CPT FV = 18620.78 Difficulty: 1 Easy Topic: Future value - annuity Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-02 Compute the future value of frequent, level cash flows. 25) What is the future value of a $1,000 annuity payment over 4 years if the interest rates are 8 percent? A) $3,312.10 B) $4,320.00 C) $4,506.11 D) $9,214.20 Answer: C Explanation: N = 4 I=8 PV = 0 PMT = 1000 CPT FV = 4506.11 Difficulty: 1 Easy Topic: Future value - annuity Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-02 Compute the future value of frequent, level cash flows.

26) What is the present value of a $500 deposit in year 1, and another $100 deposit at the end of year 4 if interest rates are 5 percent? A) $480.00 B) $493.62 C) $558.46 D) $582.27 Answer: C Explanation: 0 = CFO 500 = C01, 1 F01 0 = C02, 2 F02 400 = C03, 1 F03 I=5 NPV = 558.46 Difficulty: 1 Easy Topic: Present value - multiple cash flows Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-03 Discount multiple cash flows to the present. 27) What is the present value of a $250 deposit in year 1, and another $50 deposit at the end of year 6 if interest rates are 10 percent? A) $120.00 B) $169.34 C) $255.50 D) $278.22 Answer: C Explanation: 0 = CFO 250 = C01, 1 F01 0 = C02, 4 F02 50 = C03, 1 F03 I = 10 NPV = 255.50 Difficulty: 1 Easy Topic: Present value - multiple cash flows Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-03 Discount multiple cash flows to the present.

28) What is the present value of a $300 annuity payment over 5 years if interest rates are 8 percent? A) $204.17 B) $440.80 C) $1,197.81 D) $1,938.96 Answer: C Explanation: FV = 0 PMT = 300 I=8 N=5 CPT PV = 1197.81 Difficulty: 1 Easy Topic: Present value - annuity Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-04 Compute the present value of an annuity. 29) What is the present value of a $600 annuity payment over 4 years if interest rates are 6 percent? A) $475.26 B) $757.49 C) $2,079.06 D) $3,145.28 Answer: C Explanation: FV = 0 PMT = 600 I=6 N=4 CPT PV = 2079.06 Difficulty: 1 Easy Topic: Present value - annuity Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-04 Compute the present value of an annuity.

30) What is the present value, when interest rates are 6.5 percent, of a $100 payment made every year forever? A) $6.50 B) $650.00 C) $1,000.00 D) $1,538.46 Answer: D Explanation: $100/0.065 = $1538.46. Difficulty: 1 Easy Topic: Perpetuities Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-05 Figure cash flows and present value of a perpetuity. 31) What is the present value, when interest rates are 10 percent, of a $75 payment made every year forever? A) $6.75 B) $675.00 C) $750.00 D) $1,000.00 Answer: C Explanation: $75/0.10 = $750. Difficulty: 1 Easy Topic: Perpetuities Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-05 Figure cash flows and present value of a perpetuity.

32) If the present value of an ordinary, 4-year annuity is $1,000 and interest rates are 6 percent, what is the present value of the same annuity due? A) $943.40 B) $1,000.00 C) $1,040.00 D) $1,060.00 Answer: D Explanation: END MODE PV = 1000 FV = 0 I=6 N=4 CPT PMT = 288.59149 BGN MODE FV = 0 PMT = 288.59149 I=6 N=4 CPT PV = 1060.00 Difficulty: 1 Easy Topic: Present value - annuity Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-06 Adjust values for beginning-of-period annuity payments.

33) If the future value of an ordinary, 7-year annuity is $10,000 and interest rates are 4 percent, what is the future value of the same annuity due? A) $9,615.38 B) $10,000.00 C) $10,400.00 D) $10,700.00 Answer: C Explanation: END MODE FV = 10000 PV = 0 I=4 N=7 CPT PMT = 1266.09612 BGN MODE PV = 0 PMT = 1266.09612 I=4 N=7 CPT FV = 10400.00 Difficulty: 1 Easy Topic: Future value - annuity Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-06 Adjust values for beginning-of-period annuity payments.

34) If the future value of an ordinary, 4-year annuity is $1,000 and interest rates are 6 percent, what is the future value of the same annuity due? A) $943.40 B) $1,000.00 C) $1,040.00 D) $1,060.00 Answer: D Explanation: END MODE FV = 1000 PV = 0 I=6 N=4 CPT PMT = 228.59149 BGN MODE PV = 0 PMT = 228.59149 I=6 N=4 CPT FV = 1060.00 Difficulty: 1 Easy Topic: Future value - annuity Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-06 Adjust values for beginning-of-period annuity payments. 35) A loan is offered with monthly payments and a 10 percent APR. What is the loan's effective annual rate (EAR)? A) 10.00 percent B) 10.47 percent C) 11.20 percent D) 12.67 percent Answer: B Explanation: (1 + 0.10/12)^12 − 1 = 0.1047 = 10.47 percent. Difficulty: 1 Easy Topic: Simple and compound interest Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-07 Explain the impact of compound frequency and the difference between the annual percentage rate and the effective annual rate.

36) A loan is offered with monthly payments and a 6.5 percent APR. What is the loan's effective annual rate (EAR)? A) 5.69 percent B) 6.697 percent C) 7.28 percent D) 12.63 percent Answer: B Explanation: (1 + 0.065/12)^12 − 1 = 0.06697 = 6.697 percent. Difficulty: 1 Easy Topic: Simple and compound interest Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-07 Explain the impact of compound frequency and the difference between the annual percentage rate and the effective annual rate. 37) Given a 4 percent interest rate, compute the year 6 future value of deposits made in years 1, 2, 3, and 4 of $1,000, $1,200, $1,200, and $1,400. A) $4,334.53 B) $5,070.78 C) $5,191.68 D) $5,484.56 Answer: D Explanation: N = 5, I = 4, PV = 1000, PMT = 0, CPT FV = 1216.65 N = 4, I = 4, PV = 1200, PMT = 0, CPT FV = 1403.83 N = 3, I = 4, PV = 1200, PMT = 0, CPT FV = 1349.8368 N = 2, I = 4, PV = 1400, PMT = 0, CPT FV = 1514.24 sum of FV = 5484.56. Difficulty: 2 Medium Topic: Future value - multiple cash flows Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-01 Compound multiple cash flows to the future.

38) Given a 6 percent interest rate, compute the year 6 future value of deposits made in years 1, 2, 3, and 4 of $1,200, $1,400, $1,400, and $1,500. A) $4,741.68 B) $5,986.26 C) $6,179.80 D) $6,726.16 Answer: D Explanation: N = 5, I = 6, PV = 1200, PMT = 0, CPT FV = 1605.8707 N = 4, I = 6, PV = 1400, PMT = 0, CPT FV = 1767.4677 N = 3, I = 6, PV = 1400, PMT = 0, CPT FV = 1667.4224 N = 2, I = 6, PV = 1500, PMT = 0, CPT FV = 1685.40 sum of FV = 6726.16. Difficulty: 2 Medium Topic: Future value - multiple cash flows Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-01 Compound multiple cash flows to the future. 39) Assume that you contribute $100 per month to a retirement plan for 20 years. Then you are able to increase the contribution to $200 per month for another 20 years. Given a 6 percent interest rate, what is the value of your retirement plan after 40 years? A) $225,353 B) $19,155 C) $245,353 D) $199,359 Answer: C Explanation: N = 40 × 12 = 480, I = 6/12 = 0.5, PV = 0, PMT = 100, CPT FV = 199149 N = 20 × 12 = 240, I = 6/12 = 0.5, PV = 0, PMT = 100 (200 − 100), CPT FV = 46204 sum of FV = 245353. Difficulty: 2 Medium Topic: Future value - annuity Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-02 Compute the future value of frequent, level cash flows.

40) Assume that you contribute $200 per month to a retirement plan for 15 years. Then you are able to increase the contribution to $400 per month for another 25 years. Given a 5 percent interest rate, what is the value of your retirement plan after 40 years? A) $424,305.97 B) $24,159.95 C) $28,475.66 D) $72,479.86 Answer: A Explanation: N = 40 × 12 = 480, I = 5/12 = 0.4167, PV = 0, PMT = 200, CPT FV = 305,204.03 N = 25 × 12 = 300, I = 5/12 = 0.4167, PV = 0, PMT = 200 (400 − 200), CPT FV = 119,101.94 sum of FV = 424305.97. Difficulty: 2 Medium Topic: Future value - annuity Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-02 Compute the future value of frequent, level cash flows. 41) Given a 5 percent interest rate, compute the present value of deposits made in years 1, 2, 3, and 4 of $1,000, $1,400, $1,400, and $1,500. A) $4,360.32 B) $4,665.65 C) $5,047.62 D) $5,305.00 Answer: B Explanation: 0 = CF0 1000 = C01, 1 F01 1400 = C02, 2 F02 1500 = C03, 1 F03 I=5 NPV = 4665.65 Difficulty: 2 Medium Topic: Present value - multiple cash flows Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-03 Discount multiple cash flows to the present.

42) Given a 7 percent interest rate, compute the present value of deposits made in years 1, 2, 3, and 4 of $1,000, $1,200, $1,500, and $1,500. A) $3,967.06 B) $4,351.50 C) $4,859.81 D) $5,207.00 Answer: B Explanation: 0 = CF0 1000 = CO1, 1 F01 1200 = C02, 1 F02 1500 = C03, 2 F03 I=7 NPV = 4351.50 Difficulty: 2 Medium Topic: Present value - multiple cash flows Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-03 Discount multiple cash flows to the present. 43) Given a 4 percent interest rate, compute the present value of deposits made in years 1, 2, 3, and 4 of $1,000, $1,200, $1,200, and $1,400. A) $4,103.06 B) $4,334.53 C) $4,615.38 D) $4,804.00 Answer: B Explanation: 0 = CF0 1000 = CO1, 1 F01 1200 = C02, 2 F02 1400 = C03, 1 F03 I=4 NPV = 4334.53 Difficulty: 2 Medium Topic: Present value - multiple cash flows Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-03 Discount multiple cash flows to the present.

44) Given a 6 percent interest rate, compute the present value of deposits made in years 1, 2, 3, and 4 of $1,200, $1,400, $1,400, and $1,500. A) $4,356.52 B) $4,741.68 C) $5,188.68 D) $5,506.00 Answer: B Explanation: 0 = CF0 1200 = CO1, 1 F01 1400 = C02, 2 F02 1500 = C03, 1 F03 I=6 NPV = 4741.68 Difficulty: 2 Medium Topic: Present value - multiple cash flows Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-03 Discount multiple cash flows to the present. 45) A small business owner visits his bank to ask for a loan. The owner states that he can repay a loan at $1,500 per month for the next three years and then $500 per month for the two years after that. If the bank is charging customers 5.5 percent APR, how much would it be willing to lend the business owner? A) $4,046.90 B) $59,293.50 C) $24,261.00 D) $66,000.00 Answer: B Explanation: N = 5 × 12 = 60, I = 5.5/12 = 0.4583, FV = 0, PMT = 500, CPT PV = 26176.42 N = 3 × 12 = 36, I = 5.5/12 = 0.4583, FV = 0, PMT = 1000 (1500 − 500), CPT PV = 33117.08 sum of PV = 59293.50. Difficulty: 2 Medium Topic: Present value - multiple cash flows Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-02 Compute the future value of frequent, level cash flows.

46) A small business owner visits his bank to ask for a loan. The owner states that he can repay a loan at $2,000 per month for the next three years and then $1,000 per month for the two years after that. If the bank is charging customers 8.5 percent APR, how much would it be willing to lend the business owner? A) $80,419.29 B) $6,494.66 C) $21,780.74 D) $96,000.00 Answer: A Explanation: N = 5 × 12 = 60, I = 8.5/12 = 0.7083, FV = 0, PMT = 1000, CPT PV = 48741.18 N = 3 × 12 = 36, I = 8.5/12 = 0.7083, FV = 0, PMT = 1000 (2000 − 1000), CPT PV = 31678.11 sum of PV = 80419.29. Difficulty: 2 Medium Topic: Present value - multiple cash flows Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-02 Compute the future value of frequent, level cash flows. 47) A perpetuity pays $100 per year and interest rates are 6.5 percent. How much would its value change if interest rates increased to 9 percent? A) $250.00 increase B) $250.00 decrease C) $427.35 increase D) $427.35 decrease Answer: D Explanation: $100/0.065 = $1538.46, $100/0.09 = $1111.11. change = 1538.46 − 1111.11 = 427.35 decrease. Difficulty: 2 Medium Topic: Perpetuities Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-05 Figure cash flows and present value of a perpetuity.

48) A perpetuity pays $50 per year and interest rates are 9 percent. How much would its value change if interest rates decreased to 6 percent? A) $150.00 increase B) $150.00 decrease C) $277.78 increase D) $277.78 decrease Answer: C Explanation: $50/0.09 = $555.55, $50/0.06 = $833.33. change = 555.55 − 833.33 = 277.78 increase. Difficulty: 2 Medium Topic: Perpetuities Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-05 Figure cash flows and present value of a perpetuity. 49) If you start making $100 monthly contributions today and continue them for five years, what is their future value if the compounding rate is 10 percent APR? What is the present value of this annuity? A) $508.14, $487.74 B) $512.64, $491.80 C) $7,743.71, $4,706.53 D) $7,808.24, $4,745.76 Answer: D Explanation: N = 5 × 12 = 60, I = 10/12 = 0.83, PV = 0, PMT = 100, CPT FV = 7808.24 N = 5 × 12 = 60, I = 10/12 = 0.83, FV = 0, PMT = 100, CPT PV = 4745.76 Difficulty: 2 Medium Topic: Future value - annuity Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-06 Adjust values for beginning-of-period annuity payments.

50) If you start making $25 monthly contributions today and continue them for four years, what is their future value if the compounding rate is 6 percent APR? What is the present value of this annuity? A) $101.26, $99.26 B) $1,352.45, $1,064.51 C) $1,359.21, $1,069.83 D) $2,171.02, $1,516.03 Answer: C Explanation: N = 4 × 12 = 48, I = 6/12 = 0.5, PV = 0, PMT = 25, CPT FV = 1359.21 N = 4 × 12 = 48, I = 6/12 = 0.5, FV = 0, PMT = 25, CPT PV = 1069.83 Difficulty: 2 Medium Topic: Future value - annuity Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-06 Adjust values for beginning-of-period annuity payments. 51) Payday loans are very short-term loans that charge very high interest rates. You can borrow $500 today and repay $550 in two weeks. What is the compound annual rate implied by this 10 percent rate charged for only two weeks? A) 10.50 percent B) 12.00 percent C) 1091.82 percent D) 110.50 percent Answer: C Explanation: (1 + 0.10)^26 − 1 = 1091.82 percent. Difficulty: 2 Medium Topic: Simple and compound interest Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-07 Explain the impact of compound frequency and the difference between the annual percentage rate and the effective annual rate.

52) Payday loans are very short-term loans that charge very high interest rates. You can borrow $600 today and repay $675 in two weeks. What is the compound annual rate implied by this 12.5 percent rate charged for only two weeks? A) 12.89 percent B) 13.28 percent C) 2037.79 percent D) 113.28 percent Answer: C Explanation: ((1 + 0.125)^26) − 1 = 2037.79 percent. Difficulty: 2 Medium Topic: Simple and compound interest Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-07 Explain the impact of compound frequency and the difference between the annual percentage rate and the effective annual rate. 53) Payday loans are very short-term loans that charge very high interest rates. You can borrow $200 today and repay $250 in two weeks. What is the compound annual rate implied by this 25 percent rate charged for only two weeks? A) 26.60 percent B) 32,987.22 percent C) 30.00 percent D) 128.25 percent Answer: B Explanation: ((1 + 0.25)^26) − 1 = 32,987.22 percent. Difficulty: 2 Medium Topic: Simple and compound interest Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-07 Explain the impact of compound frequency and the difference between the annual percentage rate and the effective annual rate.

54) What is the interest rate of a 4-year, annual $1,000 annuity with present value of $3,500? A) 3.85 percent B) 5.56 percent C) 8.84 percent D) 9.70 percent Answer: B Explanation: N = 4, PV = −3500, PMT = 1000, FV = 0, CPT I = 5.56 Difficulty: 2 Medium Topic: Interest rates Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-08 Compute the interest rate of annuity payments. 55) What is the interest rate of a 6-year, annual $3,000 annuity with present value of $14,000? A) 5.64 percent B) 7.69 percent C) 10.17 percent D) 11.32 percent Answer: B Explanation: N = 6, PV = −14000, PMT = 3000, FV = 0, CPT I = 7.69 Difficulty: 2 Medium Topic: Interest rates Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-08 Compute the interest rate of annuity payments. 56) What annual interest rate would you need to earn if you wanted a $200 per month contribution to grow to $14,700 in five years? A) 6.47 percent B) 7.76 percent C) 8.01 percent D) 14.70 percent Answer: C Explanation: N = 5 × 12 = 60, PV = 0, PMT = −200, FV = 14700, CPT I = .6676 × 12 = 8.01 Difficulty: 2 Medium Topic: Interest rates Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-08 Compute the interest rate of annuity payments.

57) What annual interest rate would you need to earn if you wanted a $500 per month contribution to grow to $27,050 in four years? A) 2.37 percent B) 5.77 percent C) 6.00 percent D) 13.53 percent Answer: C Explanation: N = 4 × 12 = 48, PV = 0, PMT = −500, FV = 27050, CPT I = .5002 × 12 = 6.00 Difficulty: 2 Medium Topic: Interest rates Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-08 Compute the interest rate of annuity payments. 58) You wish to buy a $20,000 car. The dealer offers you a 5-year loan with an 8 percent APR. What are the monthly payments? A) $272.19 B) $333.33 C) $405.53 D) $4,080.35 Answer: C Explanation: N = 5 × 12 = 60, PV = 20000, I = 8/12 = 0.6667, FV = 0, CPT PMT = −405.53 Difficulty: 2 Medium Topic: Loan payments Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-09 Compute payments and amortization schedules for car and mortgage loans.

59) You wish to buy a $15,000 car. The dealer offers you a 4-year loan with a 9 percent APR. What are the monthly payments? A) $260.78 B) $312.50 C) $373.28 D) $3,820.56 Answer: C Explanation: N = 4 × 12 = 48, PV = 15000, I = 9/12 = 0.75, FV = 0, CPT PMT = −373.28 Difficulty: 2 Medium Topic: Loan payments Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-09 Compute payments and amortization schedules for car and mortgage loans. 60) Joey realizes that he has charged too much on his credit card and has racked up $3,000 in debt. If he can pay $150 each month and the card charges 18 percent APR (compounded monthly), how long will it take him to pay off the debt? A) 13.03 months B) 14.68 months C) 20.00 months D) 23.96 months Answer: D Explanation: PV = 3000, I = 18/12 = 1.5, FV = 0, PMT = −150, CPT N = 23.96 Difficulty: 2 Medium Topic: Number of time periods Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-10 Calculate the number of payments on a loan.

61) Joey realizes that he has charged too much on his credit card and has racked up $4,000 in debt. If he can pay $200 each month and the card charges 20 percent APR (compounded monthly), how long will it take him to pay off the debt? A) 17.40 months B) 20.00 months C) 24.04 months D) 24.53 months Answer: D Explanation: PV = 4000, I = 20/12 = 1.6667, FV = 0, PMT = −200, CPT N = 24.53 Difficulty: 2 Medium Topic: Number of time periods Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-10 Calculate the number of payments on a loan. 62) Phoebe realizes that she has charged too much on her credit card and has racked up $7,000 in debt. If she can pay $200 each month and the card charges 17 percent APR (compounded monthly), how long will it take her to pay off the debt? A) 28.63 months B) 35.00 months C) 47.71 months D) 48.68 months Answer: D Explanation: PV = 7000, I = 17/12 = 1.416667, FV = 0, PMT = −200, CPT N = 48.68 Difficulty: 2 Medium Topic: Number of time periods Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-10 Calculate the number of payments on a loan.

63) Phoebe realizes that she has charged too much on her credit card and has racked up $10,000 in debt. If she can pay $300 each month and the card charges 18 percent APR (compounded monthly), how long will it take her to pay off the debt? A) 27.23 months B) 33.33 months C) 46.56 months D) 69.70 months Answer: C Explanation: PV = 10000, I = 18/12 = 1.5, FV = 0, PMT = −300, CPT N = 46.56 Difficulty: 2 Medium Topic: Number of time periods Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-10 Calculate the number of payments on a loan. 64) Given a 7 percent interest rate, compute the year 6 future value if deposits of $2,500 and $1,500 are made in years 2 and 3, respectively, and a withdrawal of $900 is made in year 4. A) $2,721.44 B) $4,084.15 C) $4,491.60 D) $7,059.04 Answer: B Explanation: Step 1: 0 = CFO 0 = C01, 1 F01 2500 = C02, 1 F02 1500 = C03, 1 F03 −900 = C04, 1 F04 7=I NPV = 2721.44 Step 2: PV = 2721.44 N=6 I=7 PMT = 0 CPT FV = 4084.15 Difficulty: 3 Hard Topic: Future value - multiple cash flows Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-01 Compound multiple cash flows to the future. 29

65) Given an 8 percent interest rate, compute the year 7 future value if deposits of $1,500 and $2,500 are made in years 2 and 3, respectively, and a withdrawal of $2,000 is made in year 5. A) $1,909.42 B) $3,272.41 C) $3,433.60 D) $5,656.34 Answer: B Explanation: Step 1: 0 = CFO 0 = C01, 1 F01 1500 = C02, 1 F02 2500 = C03, 1 F03 0 = C04, 1 F04 −2000 = C05, 1 F05 8=I NPV = 1909.42 Step 2: PV = 1909.42 N=7 I=8 PMT = 0 CPT FV = 3272.41 Difficulty: 3 Hard Topic: Future value - multiple cash flows Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-01 Compound multiple cash flows to the future.

66) If you are saving for a plane ticket for a future vacation and you deposit $200 today, followed by $250 at the end of the first year, and a $300 deposit at the end of the second year, what will the future value of your deposits be in 3 years if the interest rates are 5%? A) $750 B) $822.15 C) $787.5 D) None of the above Answer: B Explanation: $200 × (1 × 0.05)3 = $231.525 $250 × (1 × 0.05)2 = $275.625 $300 × (1 × 0.05)1 = $315 FV3 = $200 × (1 × 0.05)3 + $250 × (1 × 0.05)2 + $300 × (1 × 0.05)1 = $822.15 Difficulty: 3 Hard Topic: Future value - multiple cash flows Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-01 Compound multiple cash flows to the future. 67) A car company is offering a choice of deals. You can receive $2,000 cash back on the purchase, or a 2 percent APR, 3-year loan. The price of the car is $17,000 and you could obtain a 3-year loan from your credit union, at 7 percent APR. Which deal is cheaper? A) the car company's 2 percent 3-year loan B) the rebate with the credit union's 7 percent 3-year loan Answer: B Explanation: Car Company: PV = 17000, I = 2/12 = 0.1667, FV = 0, N = 3 × 12 = 36, PMT = −486.92 Credit Union: PV = (17000 − 2000) = 15,000, N = 3 × 12 = 36, I = 7/12 = 0.5833, FV = 0, CPT PMT = −463.15 Difficulty: 3 Hard Topic: Loan payments Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-04 Compute the present value of an annuity.; 05-09 Compute payments and amortization schedules for car and mortgage loans.

68) Monica has decided that she wants to build enough retirement wealth that, if invested at 7 percent per year, will provide her with $3,000 monthly income for 30 years. To date, she has saved nothing, but she still has 20 years until she retires. How much money does she need to contribute per month to reach her goal? A) $671.78 B) $865.62 C) $3,000.00 D) $7,025.77 Answer: B Explanation: Step 1: FV = 0, I = 7/12 = 0.5833, PMT = 3000, N = 30 × 12 = 360, CPT PV = 450922.70. Step 2: FV = 450922.70, I = 7/12 = 0.5833, N = 20 × 12 = 240, PV = 0, CPT PMT = −865.62. Difficulty: 3 Hard Topic: Present value - annuity Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-04 Compute the present value of an annuity.; 05-09 Compute payments and amortization schedules for car and mortgage loans. 69) Ross has decided that he wants to build enough retirement wealth that, if invested at 6 percent per year, will provide him with $2,500 monthly income for 30 years. To date, he has saved nothing, but he still has 20 years until he retires. How much money does he need to contribute per month to reach his goal? A) $895.95 B) $902.47 C) $1,947.88 D) $2,500.00 Answer: B Explanation: Step 1: FV = 0, I = 6/12 = 0.5, PMT = 2500, N = 30 × 12 = 360, CPT PV = 416979.036. Step 2: FV = 416979.036, I = 6/12 = 0.5, N = 20 × 12 = 240, PV = 0, CPT PMT = −902.47. Difficulty: 3 Hard Topic: Present value - annuity Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-04 Compute the present value of an annuity.; 05-09 Compute payments and amortization schedules for car and mortgage loans.

70) Hank purchased a $20,000 car two years ago using an 8 percent, 5-year loan. He has decided that he would sell the car now, if he could get a price that would pay off the balance of his loan. What is the minimum price Hank would need to receive for his car? A) $8,000.00 B) $12,079.65 C) $12,941.12 D) $15,133.64 Answer: C Explanation: FV = 0, I = 8/12 = 0.6667, N = 5 × 12 = 60, PV = 20000, CPT PMT = −405.53 2nd, Amort, P1 = 1, P2 = (2 × 12) = 24, Bal = 12941.12 Difficulty: 3 Hard Topic: Amortization Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-09 Compute payments and amortization schedules for car and mortgage loans. 71) A mortgage broker is offering a 30-year mortgage with a teaser rate. In the first two years of the mortgage, the borrower makes monthly payments on only a 5 percent APR interest rate. After the second year, the mortgage interest charged increases to 8 percent APR. What is the effective interest rate in the first two years? What is the effective interest rate after the second year? A) 4.89 percent, 7.72 percent respectively B) 5.00 percent, 8.00 percent respectively C) 5.12 percent, 8.30 percent respectively D) 12.59 percent, 12.65 percent respectively Answer: C Explanation: (1 + 0.05/12)^12 − 1 = 0.05116 = 5.12 percent. (1 + 0.08/12)^12 − 1 = 0.0830 = 8.30 percent. Difficulty: 3 Hard Topic: Loan interest and rates Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-07 Explain the impact of compound frequency and the difference between the annual percentage rate and the effective annual rate.

72) A mortgage broker is offering a 30-year mortgage with a teaser rate. In the first two years of the mortgage, the borrower makes monthly payments on only a 5.5 percent APR interest rate. After the second year, the mortgage interest charged increases to 8.5 percent APR. What is the effective interest rate in the first two years? What is the effective interest rate after the second year? A) 5.37 percent, 8.19 percent respectively B) 5.50 percent, 8.50 percent respectively C) 5.64 percent, 8.84 percent respectively D) 12.60 percent, 12.66 percent respectively Answer: C Explanation: (1 + 0.055/12)^12 − 1 = 0.0564 = 5.64 percent. (1 + 0.085/12)^12 − 1 = 0.0884 = 8.84 percent. Difficulty: 3 Hard Topic: Loan interest and rates Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-07 Explain the impact of compound frequency and the difference between the annual percentage rate and the effective annual rate. 73) Compute the future value in year 12 of a $2,000 deposit in year 3 and another $4,000 deposit at the end of year 5 using a 10 percent interest rate. A) $12,510.77 B) $12,909.81 C) $13,406.73 D) $15,007.52 Answer: A Explanation: Step 1: PV = 2000, N = 9, I = 10, => FV = 4715.90. Step 2: PV = 4000, N = 7, I = 10, => FV = 7794.87. sum of FV = 12510.77. Difficulty: 1 Easy Topic: Future value - multiple cash flows Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-01 Compound multiple cash flows to the future.

74) What is the future value of a $500 annuity payment over eight years if interest rates are 14 percent? A) $6,241.09 B) $6,616.38 C) $6,750.14 D) $6,809.72 Answer: B Explanation: PV = 0, PMT= 500, N = 8, I = 14, => FV = 6616.38 Difficulty: 1 Easy Topic: Future value - annuity Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-02 Compute the future value of frequent, level cash flows. 75) Bill makes $100 payments at the end of each year for 5 years. If interest rates are 8%, what is the present value of this annuity stream? A) $500 B) $399.27 C) $475 D) $455.63 Answer: B

Explanation: PVA5 = $100 ×

= $100 × 3.9927 = $399.27

Difficulty: 1 Easy Topic: Future value - annuity Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-02 Compute the future value of frequent, level cash flows.

76) Compute the present value of a $2,500 deposit in year 4 and another $10,000 deposit at the end of year 8 if interest rates are 15 percent. A) $4,211.26 B) $4,572.19 C) $4,698.40 D) $4,901.57 Answer: C Explanation: Step 1: FV = 2500, N = 4, I = 15, => PV = 1429.38. Step 2: FV = 10000, N = 8, I = 15, => PV = 3269.02. sum of the PVs = 4698.40. Difficulty: 1 Easy Topic: Present value - multiple cash flows Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-03 Discount multiple cash flows to the present. 77) What is the present value of a $775 annuity payment over six years if interest rates are 11 percent? A) $3,017.84 B) $3,119.67 C) $3,202.92 D) $3,278.67 Answer: D Explanation: PMT= 775, FV = 0, N = 6, I = 11, => PV = 3278.67 Difficulty: 1 Easy Topic: Present value - annuity Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-04 Compute the present value of an annuity.

78) What is the present value of a $1,100 payment made every year forever when interest rates are 4.5 percent? A) $11,100 B) $21,089.37 C) $22,963.14 D) $24,444.44 Answer: D Explanation: 1100/0.045 = 24444.44. Difficulty: 1 Easy Topic: Perpetuities Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-05 Figure cash flows and present value of a perpetuity. 79) If the present value of an ordinary, 8-year annuity is $12,500 and interest rates are 9.1 percent, what is the present value of the same annuity due? A) $13,637.50 B) $13,941.90 C) $14,114.80 D) $14,211.90 Answer: A Explanation: 12500(1.091) = 13637.50. Difficulty: 1 Easy Topic: Present value - annuity Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-06 Adjust values for beginning-of-period annuity payments.

80) If the future value of an ordinary, 11-year annuity is $5,575 and interest rates are 5.5 percent, what is the future value of the same annuity due? A) $5,619.52 B) $5,769.06 C) $5,881.63 D) $5,947.88 Answer: C Explanation: 5575(1.055) = 5881.63. Difficulty: 1 Easy Topic: Future value - annuity Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-06 Adjust values for beginning-of-period annuity payments. 81) A loan is offered with monthly payments and a 14.5 percent APR. What is the loan's effective annual rate (EAR)? A) 14.97 percent B) 15.50 percent C) 15.13 percent D) 15.63 percent Answer: B Explanation: [(1 + 0.145/12)^12] − 1 = 0.1550. Difficulty: 1 Easy Topic: Loan interest and rates Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-07 Explain the impact of compound frequency and the difference between the annual percentage rate and the effective annual rate.

82) Given a 7 percent interest rate, compute the year 8 future value of deposits made in years 1, 2, 3, and 4 of $750, $1,200, $500, and $250. A) $3,801.62 B) $3,899.17 C) $4,034.20 D) $4,167.29 Answer: C Explanation: Step 1: PV= 750, I = 7, N = 7, => FV= 1204.34. Step 2: PV= 1200, I = 7, N = 6, => FV = 1800.88. Step 3: PV = 500, I = 7, N = 5, => FV = 701.28. Step 4: PV = 250, I = 7, N = 4, => FV = 327.70. sum of FVs = 4034.20. Difficulty: 2 Medium Topic: Future value - multiple cash flows Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-01 Compound multiple cash flows to the future. 83) Assume that you contribute $300 per month to a retirement plan for 25 years. Then you are able to increase the contribution to $500 per month for 20 years. Given a 9 percent interest rate, what is the value of your retirement plan after 45 years? A) $1,743,956.03 B) $1,989,703.51 C) $2,189,194.36 D) $2,355,040.91 Answer: D Explanation: Step 1: PV = 0, PMT = 300, I = 9/12, N = 300, => FV = 336336.58. Step 2: PV = 336336.58, PMT = 500, N = 240, I = 9/12; => FV = 2355040.91. Difficulty: 2 Medium Topic: Future value - annuity Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-02 Compute the future value of frequent, level cash flows.

84) Given an 8 percent interest rate, compute the present value of payments made in years 1, 2, 3, and 4 of $900, $800, $700, and $600. A) $2,409.33 B) $2,515.90 C) $2,591.72 D) $2,611.38 Answer: B Explanation: 0 = CF0 900 = C01, 1 F01 800 = C02, 2 F02 700 = C03, 1 F03 600 = C04, 1 F04 I = 8 NPV = 2,515.90 Difficulty: 2 Medium Topic: Present value - multiple cash flows Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-03 Discount multiple cash flows to the present. 85) A small business owner visits his bank to ask for a loan. The owner states that she can repay a loan at $2,500 per month for the next two years and then $3,000 per month for another two years after that. If the bank is charging customers 6.5 percent APR, how much would it be willing to lend the business owner? A) $111,712.39 B) $114,009.21 C) $115,278.17 D) $117,809.63 Answer: C Explanation: Step 1: PMT = 3000, N = 48, I = 6.5/12, FV = 0 => PV = 126502.46. Step 2: PMT = 500, N = 24, I = 6.5/12, FV = 0; => PV = 11,224.29. Step 3: 126502.46 − 11,224.29 = 115278.17. Difficulty: 2 Medium Topic: Present value - multiple cash flows Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-02 Compute the future value of frequent, level cash flows.

86) A perpetuity pays $250 per year and interest rates are 8.5 percent. How much would its value change if interest decreased to 5.5 percent? Did the value increase or decrease? A) $1,604.27; increase B) $1,604.27; decrease C) $1,714.20; increase D) $1,714.20; decrease Answer: A Explanation: Step 1: 250/0.085 = 2941.18. Step 2: 250/0.055 = 4545.45. Step 3: Difference = 1604.27. Difficulty: 2 Medium Topic: Perpetuities Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-05 Figure cash flows and present value of a perpetuity. 87) A perpetuity pays $250 per year and interest rates are 5.5 percent. How much would its value change if interest increased to 8.5 percent? Did the value increase or decrease? A) $1,604.27; increase B) $1,604.27; decrease C) $1,508.29; increase D) $1,508.29; decrease Answer: B Explanation: Step 1: 250/0.055 = 4545.45. Step 2: 250/0.085 = 2941.18. Step 3: Difference = −1604.27. Difficulty: 2 Medium Topic: Perpetuities Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-05 Figure cash flows and present value of a perpetuity.

88) If you start making $115 monthly contributions today and continue them for six years, what is their present value if the compounding rate is 12 percent APR? What is the present value of this annuity? A) $5,512.90 B) $5,633.10 C) $5,882.30 D) $5,941.12 Answer: D Explanation: Set BEG mode. PMT = 115, N = 72, I = 1, FV = 0, => PV = 5941.12 Difficulty: 2 Medium Topic: Present value - annuity Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-06 Adjust values for beginning-of-period annuity payments. 89) Payday loans are very short-term loans that charge very high interest rates. You can borrow $550 today and repay $675 in two weeks. What is the compounded annual rate implied by this 22.73 percent rate charged for only two weeks? A) 25.40 percent B) 204.45 percent C) 2,044.56 percent D) 20,445.61 percent Answer: D Explanation: [(1 + 0.2273)^26] − 1 = 204.4561 = 20445.61 percent. Difficulty: 2 Medium Topic: Simple and compound interest Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-07 Explain the impact of compound frequency and the difference between the annual percentage rate and the effective annual rate.

90) What is the interest rate of a 6-year, annual $10,000 annuity with a present value of $40,000? A) 11.94 percent B) 12.24 percent C) 12.98 percent D) 13.12 percent Answer: C Explanation: PV = 40,000, PMT = 10,000, FV = 0, N = 6, => I = 12.98 Difficulty: 2 Medium Topic: Interest rates Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-08 Compute the interest rate of annuity payments. 91) What annual interest rate would you need to earn if you wanted a $1,250 per month contribution to grow to $65,000 in three years? A) 18.59 percent B) 21.26 percent C) 24.00 percent D) 25.19 percent Answer: C Explanation: PV = 0; N = 36, PMT = 1250, FV = 65000, => I = 2.00 annual rate = 2 × 12 = 24 Difficulty: 2 Medium Topic: Interest rates Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-08 Compute the interest rate of annuity payments.

92) You wish to buy a $30,000 car. The dealer offers you a 5-year loan with a 9 percent APR. What are the monthly payments? What is the monthly payment if you paid interest only? A) $622.75, $225.00 B) $659.41, $291.23 C) $701.23, $291.23 D) $712.03, $271.19 Answer: A Explanation: Step 1: PV = 30,000, N = 60, I = 9/12, FV = 0, => PMT = 622.75. Step 2: PV = 30000, N = 60, I = 9/12, FV = −30000, => PMT = 225.00. Difficulty: 2 Medium Topic: Loan payments Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-09 Compute payments and amortization schedules for car and mortgage loans. 93) Isaac realizes that he charged too much on his credit card and has racked up $5,000 in debt. If he can pay $225 each month and the card charges 17.55 percent APR (compounded monthly), how long will it take him to pay off the credit card? A) 19.14 months B) 21.77 months C) 22.62 months D) 27.07 months Answer: D Explanation: PV = 5000, PMT = 225, FV = 0, I = 17.55/12, => N = 27.07 Difficulty: 2 Medium Topic: Number of time periods Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-10 Calculate the number of payments on a loan.

94) Isaac realizes that he charged too much on his credit card and has racked up $7,000 in debt. If he can pay $275 each month and the card charges 17.55 percent APR (compounded monthly), how long will it take him to pay off the credit card? How much interest expense will Isaac pay during this time? A) 32.07 months; $8,819.25 B) 32.07 months; $1,819.25 C) 22.07 months; $8,819.25 D) 22.07 months; $1,819.25 Answer: B Explanation: Step 1: PV = 7000, PMT = 275, FV = 0, I = 17.55/12, => N = 32.07. Step 2: (32.07 × 275) − 7000 = $1,819.25. Difficulty: 3 Hard Topic: Number of time periods Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-09 Compute payments and amortization schedules for car and mortgage loans. 95) Given a 10 percent interest rate, compute the year 9 future value if deposits of $10,000 and $20,000 are made in years 1 and 5 respectively, and a withdrawal of $5,000 is made in year 7. A) $44,667.89 B) $45,103.47 C) $46,585.66 D) $47,002.89 Answer: A Explanation: Step 1: PV= 10,000, N = 8, I = 10, PMT= 0, => FV = 21435.89. Step 2: PV = 20000, N = 4, I = 10, PMT = 0, => FV = 29282.00. Step 3: PV = −5000, PMT = 0, N = 2, I = 10, => FV = −6050.00. sum of FVs = 44,667.89 Difficulty: 3 Hard Topic: Future value - multiple cash flows Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-02 Compute the future value of frequent, level cash flows.

96) A car company is offering a choice of deals. You can receive $600 cash back on the purchase, or a 2 percent APR, 4-year loan. The price of the car is $18,900 and you could obtain a 4-year loan from your credit union at 6 percent APR. What is the monthly payment of each deal? A) cash back: PMT = $429.78, 2 percent APR: PMT = $410.04 B) cash back: PMT = $438.24, 2 percent APR: PMT = $424.09 C) cash back: PMT = $458.12, 2 percent APR: PMT = $414.09 D) cash back: PMT = $408.33, 2 percent APR: PMT = $410.04 Answer: A Explanation: Step 1: PV= 18300, FV = 0, I = 6/12, N = 48, => PMT = 429.78. Step 2: PV = 18900, FV = 0, I = 2/12, N = 48, => PMT = 410.04. Difficulty: 3 Hard Topic: Loan payments Bloom's: Apply; Evaluate AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-04 Compute the present value of an annuity.; 05-09 Compute payments and amortization schedules for car and mortgage loans. 97) A furniture company is offering a choice of deals. You can receive $100 cash back on the purchase, or a 2 percent APR, 2-year loan. The price of the dining room set is $3,750 and you could obtain a 2-year loan from your credit union at 6 percent APR. What is the cost per month of each deal? A) Cash back: $161.77, 2 percent APR: $159.53 B) Cash back: $171.29, 2 percent APR: $179.02 C) Cash back: $153.96, 2 percent APR: $181.09 D) Cash back: $180.03, 2 percent APR: $166.17 Answer: A Explanation: Step 1: Cash back: PV = 3650, N = 24, I = 6/12; FV = 0, => PMT = 161.77. Step 2: 2 percent APR: PV = 3750, N = 24, I = 2/12, FV = 0, PMT = 159.53. Difficulty: 3 Hard Topic: Loan payments Bloom's: Apply; Evaluate AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-04 Compute the present value of an annuity.; 05-09 Compute payments and amortization schedules for car and mortgage loans.

98) What is the amount of interest and repayment of principal balance in month 2 for a loan of $10,000, paid monthly over five years at a 7 percent APR? A) Interest = $101.32, Principal repayment = $57.51 B) Interest = $57.52, Principal repayment = $140.49 C) Interest = $157.52, Principal repayment = $40.49 D) Interest = $107.52, Principal repayment = $40.49 Answer: B Explanation: Step 1: PV = 10000, N = 60, I = 7/12, FV = 0, => PMT = 198.01. Step 2: N = 1, PV = 10000, PMT = −198.01, I = 7/12, => FV = 9860.32. Step 3: Int = 9860.32 × 0.07/12 = 57.52. Step 4: 198.01 − 57.52 = Repayment = 140.49. Difficulty: 3 Hard Topic: Amortization Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-09 Compute payments and amortization schedules for car and mortgage loans. 99) Jasmine has decided that she wants to build enough retirement wealth that, if invested at 6 percent per year, will provide her with $3,000 of monthly income for 30 years. To date, she has saved nothing but she still has 25 years until she retires. Jasmine believes that she can earn 6 percent on her investments until she retires. How much money does she need to contribute per month to reach her goal? A) $512.93 B) $616.27 C) $722.05 D) $863.49 Answer: C Explanation: Step 1: FV = 0, PMT = 3000, N = 360, I = 6/12, PV = 500374.84. Step 2: PV = 0, FV = 500374.84, N = 300, I = 6/12, => PMT = 722.05. Difficulty: 3 Hard Topic: Present value - annuity Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-04 Compute the present value of an annuity.; 05-09 Compute payments and amortization schedules for car and mortgage loans.

100) Jasmine has decided that she wants to build enough retirement wealth that, if invested at 6 percent per year, will provide her with $3,000 of monthly income for 30 years. To date, she has saved nothing but she still has 25 years until she retires. Jasmine believes that she can earn 9 percent on her investments until she retires. How much money does she need to contribute per month to reach her goal? A) $446.32 B) $521.84 C) $667.13 D) $722.05 Answer: A Explanation: Step 1: FV = 0, PMT = 3000, N = 360, I = 6/12, PV = 500374.84. Step 2: PV = 0, FV = 500374.84, N = 300, I = 9/12, => PMT = 446.32. Difficulty: 3 Hard Topic: Present value - annuity Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-04 Compute the present value of an annuity.; 05-09 Compute payments and amortization schedules for car and mortgage loans. 101) Chase purchased a $23,000 car three years ago using a 14 percent, 6-year car loan. He has decided that he would sell the car now if he could get a price that would pay off the balance of his loan. What is the minimum price Chase would need to receive for his car? (Assume monthly payments.) A) $12,592.41 B) $13,866.82 C) $14,136.72 D) $14,809.48 Answer: B Explanation: Step 1: PV = 23000, FV = 0, N = 72, I = 14/12, => PMT = 473.93. Step 2: PV = 23000, N = 36, I = 14/12, PMT = −473.93, => FV = 13866.82. Difficulty: 3 Hard Topic: Amortization Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-09 Compute payments and amortization schedules for car and mortgage loans.

102) Chase purchased a $30,000 car three years ago using a 10 percent, 5-year car loan. He has decided that he would sell the car now if he could get a price that would pay off the balance of his loan. What is the minimum price Chase would need to receive for his car? (Assume monthly payments.) A) $12,000.00 B) $13,813.25 C) $21,500.75 D) $23,739.05 Answer: B Explanation: Step 1: PV = 30000, FV = 0, N = 60, I = 10/12, => PMT = 637.4113. Step 2: PV = 30000, N = 36, I = 10/12, PMT = −637.4113, => FV = 13813.2487. Difficulty: 3 Hard Topic: Amortization Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-09 Compute payments and amortization schedules for car and mortgage loans. 103) A mortgage broker is offering a $225,000 30-year mortgage with a teaser rate. In the first two years of the mortgage, the borrower makes monthly payments on only a 2.5 percent APR interest rate. After the second year, the mortgage interest rate charged increases to 8.5 percent APR. What are the mortgage payments in the first two years? What are the mortgage payments after the second year? A) $790.25; $1,512.93 B) $790.25; $1,309.13 C) $889.02; $1,650.61 D) $889.02; $1,677.09 Answer: D Explanation: Step 1: N = 360, I = 2.5/12, PV = 225000, FV = 0, PMT = 889.02. Step 2: N = 24, I = 2.5/12, PMT = 889.02, PV = 225000, => FV = 214668.13. Step 3: PV = 214668.13, N = 336, I = 8.5/12, FV = 0, => PMT = 1677.09. Difficulty: 3 Hard Topic: Loan payments Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-09 Compute payments and amortization schedules for car and mortgage loans.

104) Consider that you are 30 years old and have just changed to a new job. You have $91,000 in the retirement plan from your former employer. You can roll that money into the retirement plan of the new employer. You will also contribute $4,800 each year into your new employer's plan. If the rolled-over money and the new contributions both earn a 7 percent return, how much should you expect to have when you retire in 38 years? A) $2,012,560.60 B) $2,018,506.60 C) $2,106,718.60 D) $2,216,781.60 Answer: B Explanation: PV = 91000, I = 7, PMT = 4800, N = 38, => FV = 2018506.60 Difficulty: 3 Hard Topic: Future value - annuity Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-02 Compute the future value of frequent, level cash flows. 105) Consider that you are 30 years old and have just changed to a new job. You have $91,000 in the retirement plan from your former employer. You can roll that money into the retirement plan of the new employer. You will also contribute $400 each month into your new employer's plan. If the rolled-over money and the new contributions both earn a 7 percent annual return, how much should you expect to have when you retire in 38 years? A) $2,019,095.26 B) $2,195,145.40 C) $2,298,025.12 D) $2,301,116.92 Answer: B Explanation: PV = 91000, N = 456, I = 7/12, PMT = 400, => FV = 2195145.40 Difficulty: 3 Hard Topic: Future value - annuity Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-02 Compute the future value of frequent, level cash flows.

106) Your client has been given a trust fund valued at $1 million. She cannot access the money until she turns 68 years old, which is in 12 years. At that time, she can withdraw $30,000 per month. If the trust fund is invested at a 7 percent interest rate, how many months will it last your client once she starts to withdraw the money? A) 77.05 months B) 81.05 months C) 99.05 months D) 119.05 months Answer: C Explanation: Step 1: PV = 1000000, N = 12, I = 7, FV = 2252191.59. Step 2: PV = 2252161.59, PMT = −30000, FV = 0, I = 7/12, => N = 99.05 months. Difficulty: 3 Hard Topic: Number of time periods Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-02 Compute the future value of frequent, level cash flows.; 05-10 Calculate the number of payments on a loan. 107) A local furniture store is advertising a deal in which you buy a $3,500 living room set with three years before you need to make payments (no interest is incurred). How much would you have to deposit each month in a savings account earning 3.5 percent APR, compounded monthly, to be able to pay the $3,500 bill in three years? A) $92.35 B) $108.13 C) $112.86 D) $121.97 Answer: A Explanation: PV = 0, N = 36, I = 3.5/12, FV = 3500, => PMT = 92.35 Difficulty: 3 Hard Topic: Time value payments Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-04 Compute the present value of an annuity.

108) A local furniture store is advertising a deal in which you buy a $3,500 living room set with three years before you need to make payments (no interest is incurred). How much money would you have to deposit now in a savings account earning 3.5 percent APR, compounded monthly, to pay the $3,500 bill in three years? A) $2,981.17 B) $3,151.62 C) $3,200.61 D) $3,886.89 Answer: B Explanation: FV = 3500, I = 3.5/12, N = 36, PMT = 0, => PV = 3151.62 Difficulty: 3 Hard Topic: Present value - single cash flow Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-02 Compute the future value of frequent, level cash flows. 109) You have secured a loan from your bank for two years to build your home. The terms of the loan are that you will borrow $120,000 now and an additional $52,000 in one year. Interest of 9 percent APR will be charged on the balance monthly. Since no payments will be made during the 2-year loan, the balance will grow. At the end of the two years, the balance will be converted to a traditional 30-year mortgage at a 6.5 percent interest rate. What will you pay as monthly mortgage payments (principal and interest only)? A) $998.49 B) $1,063.27 C) $1,190.14 D) $1,266.97 Answer: D Explanation: Step 1: PV = 120000, PMT = 0, N = 12, I = 9/12, => FV = 131256.83. Step 2: PV = 183256.83, PMT = 0, I = 9/12, N = 12, FV = 200447.58. Step 3: PV = 200447.58, N = 360, I = 6.5/12, FV = 0, => PMT = 1266.97. Difficulty: 3 Hard Topic: Loan payments Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-09 Compute payments and amortization schedules for car and mortgage loans.

110) Say that you purchase a house for $150,000 by getting a mortgage for $135,000 and paying a $15,000 down payment. If you get a 15-year mortgage with a 6 percent interest rate, what are the monthly payments? A) $997.28 B) $1,072.51 C) $1,139.21 D) $1,238.93 Answer: C Explanation: PV = 135000, N = 180, I = 6/12, FV = 0, => PMT = 1139.21 Difficulty: 2 Medium Topic: Loan payments Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-09 Compute payments and amortization schedules for car and mortgage loans. 111) Say that you purchase a house for $150,000 by getting a mortgage for $135,000 and paying a $15,000 down payment. If you get a 15-year mortgage with a 6 percent interest rate, what would the loan balance be in seven years? A) $74,778.16 B) $79,091.72 C) $84,223.16 D) $86,687.84 Answer: D Explanation: Step 1: PV = 135000, N = 180, I = 6/12, FV = 0, => PMT = 1139.21. Step 2: PV = −135000, PMT = 1139.21, N = 84, I = 6/12, FV = 86687.84. Difficulty: 3 Hard Topic: Amortization Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-09 Compute payments and amortization schedules for car and mortgage loans.

112) Say that you purchase a house for $150,000 by getting a mortgage for $135,000 and paying a $15,000 down payment. Assume you get a 15-year mortgage with a 6 percent interest rate. If the house appreciates at a 2 percent rate per year, what will be the value of the house in seven years? How much of this value is equity? A) $172,302.85; $65,101.91 B) $172,302.85; $85,615.01 C) $185,612.09; $79,662.83 D) $185,612.09; $81,038.72 Answer: B Explanation: Step 1: PV = 150000, N = 7, I = 2, PMT = 0, => FV = 172302.85. Step 2: PV = 135000, N = 180, I = 6/12, FV = 0, => PMT = 1139.21. Step 3: PV = −135000, PMT = 1139.21, N = 84, I = 6/12, FV = 86687.84. Step 4: 172302.85 − 86687.84 = 85615.01. Difficulty: 3 Hard Topic: Amortization Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-09 Compute payments and amortization schedules for car and mortgage loans. 113) A small business owner visits his bank to ask for a loan. The owner states that she can repay a loan at $1,250 per month for the next three years and then $500 per month for two years after that. If the bank is charging customers 12 percent APR, how much would it be willing to lend the business owner? A) $45,058.15 B) $45,911.64 C) $46,055.21 D) $46,813.94 Answer: A Explanation: Step 1: PMT = 500, N = 60, I = 1, => PV = 22477.52. Step 2: PMT = 750, N = 36, I = 1, => PV = 22580.63. Step 3: 22477.52 + 22580.63 = 45058.15. Difficulty: 3 Hard Topic: Present value - annuity Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-02 Compute the future value of frequent, level cash flows.

114) A small business owner visits his bank to ask for a loan. The owner states that she can repay a loan at $1,500 per month for the next 3 years and then $500 per month for three years after that. If the bank is charging customers 10 percent APR, how much would it be willing to lend the business owner? A) $32,019.95 B) $57,980.57 C) $61,982.47 D) $192,119.70 Answer: B Explanation: Step 1: PMT = 500, N = 72, I = 10/12, => PV = 26989.33. Step 2: PMT = 1000, N = 36, I = 10/12, => PV = 30991.24. Step 3: 26989.33 + 30991.24 = 57980.57. Difficulty: 3 Hard Topic: Present value - annuity Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-02 Compute the future value of frequent, level cash flows. 115) You win $1,000 today, which happens to be your 20th birthday. You decide to deposit this money in an account and plan to add $1,000 to it each year on your birthday beginning one year from today. If you earn 10 percent per year in the account, how long will it take to grow to $750,000? A) 23.17 years B) 32.87 years C) 44.44 years D) 51.38 years Answer: C Explanation: PV = 1000, PMT = 1000, I = 10, FV = −750000, => N = 44.44 Difficulty: 3 Hard Topic: Number of time periods Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-02 Compute the future value of frequent, level cash flows.

116) Your 30-year $95,000 mortgage calls for payments to be made at the end of each month. The loan has a 5.85 percent annual interest rate. What is the remaining balance after five years? A) $68,194.73 B) $76,903.26 C) $81,072.85 D) $88,236.44 Answer: D Explanation: Step 1: PV = 95000, N = 360, I = 5.85/12, FV = 0, => PMT = 560.44. Step 2: PV = 95000, N = 60, I = 5.85/12, PMT = −560.44, => FV = 88236.44. Difficulty: 3 Hard Topic: Amortization Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-09 Compute payments and amortization schedules for car and mortgage loans. 117) Due to poor spending habits, Ricky has accumulated $10,000 in credit card debt. He has missed several payments and now the annual interest rate on the card is 18.95 percent! If he pays $175 per month on the card, how long will it take Ricky to pay off the card? A) 121.5 months B) 148.50 months C) 162.5 months D) Ricky never pays off the card. Answer: B Explanation: PV = 10000, PMT = −175, I = 18.95/12, FV = 0, => N = 148.50 Difficulty: 2 Medium Topic: Number of time periods Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-10 Calculate the number of payments on a loan.

118) Due to poor spending habits, Ricky has accumulated $10,000 in credit card debt. He has missed several payments and now the annual interest rate on the card is 18.95 percent! If he pays $175 per month on the card, in total, how much interest expense does Ricky pay to the credit card company? A) $15,987.50 B) $17,008.52 C) $12,905.13 D) $8,714.62 Answer: A Explanation: Step 1: PV = 10000, PMT = −175, I = 18.95/12, FV = 0, => N = 148.50. Step 2: 148.5 × 175 = 25987.5 − 10000 = 15987.5. Difficulty: 3 Hard Topic: Number of time periods Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-09 Compute payments and amortization schedules for car and mortgage loans.; 05-10 Calculate the number of payments on a loan. 119) Due to poor spending habits, Ricky has accumulated $5,000 in credit card debt. He has missed several payments and now the annual interest rate on the card is 16.75 percent! If he pays $200 per month on the card, in total, how much interest expense does Ricky pay to the credit card company? A) $847.50 B) $1,192.00 C) $2,118.75 D) $6,192.00 Answer: B Explanation: Step 1: PV = 5000, PMT = −200, I = 16.75/12, FV = 0, => N = 30.96. Step 2: 30.96 × 200 = 6192 − 5000 = 1192. Difficulty: 3 Hard Topic: Number of time periods Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-09 Compute payments and amortization schedules for car and mortgage loans.; 05-10 Calculate the number of payments on a loan.

120) You deposit $1,000 today and want to save $100 each month beginning one month from today. Your account earns a 5 percent annual interest rate. How long will it take you to accumulate $5,000? A) 29.3 months B) 35.7 months C) 42.6 months D) 52.1 months Answer: B Explanation: PV = 1000, PMT = 100, FV = −5000, I = 5/12, => N = 35.7 months Difficulty: 2 Medium Topic: Number of time periods Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-02 Compute the future value of frequent, level cash flows. 121) You are deciding among several different bank accounts. Which of the following will generate the highest effective annual rate (EAR)? A) a 6 percent rate with monthly compounding B) a 6 percent rate with annual compounding C) a 6.08 percent rate with annual compounding D) a 6 percent rate with quarterly compounding Answer: A Explanation: [(1 + 0.06/12)^12] − 1 = 6.17 percent. Difficulty: 2 Medium Topic: Simple and compound interest Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-07 Explain the impact of compound frequency and the difference between the annual percentage rate and the effective annual rate.

122) You are deciding among several different bank accounts. Which of the following will generate the highest effective annual rate (EAR)? A) a 10 percent rate with monthly compounding B) a 10 percent rate with annual compounding C) a 10.5 percent rate with annual compounding D) a 10 percent rate with quarterly compounding Answer: C Explanation: [(1 + 0.1/12)^12] − 1 = 10.47 percent. Difficulty: 2 Medium Topic: Simple and compound interest Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-07 Explain the impact of compound frequency and the difference between the annual percentage rate and the effective annual rate. 123) Which of the following will increase the present value of an annuity? A) The discount rate increases. B) The discount rate decreases. C) The number of periods the annuity is received decreases. D) The final payment diminishes. Answer: B Difficulty: 2 Medium Topic: Present value - annuity Bloom's: Apply; Evaluate AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 05-04 Compute the present value of an annuity. 124) Which of the following will decrease the present value of an annuity? A) The discount rate increases. B) The discount rate decreases. C) The number of periods the annuity is received increases. D) The final payment increases. Answer: A Difficulty: 2 Medium Topic: Present value - annuity Bloom's: Analyze AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 05-04 Compute the present value of an annuity.

125) Which of the following statements is correct? A) A 15-year mortgage will have larger monthly payments than a 30-year mortgage. B) If an account earns 3 percent per year compounded annually, then it also has an effective annual rate (EAR) of 3 percent. C) The present value of a $500 perpetuity is greater if the interest rate is higher. D) The first, second, and third statements above are correct. E) Only the first and second, statements above are correct. Answer: E Difficulty: 3 Hard Topic: Simple and compound interest Bloom's: Apply; Evaluate AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 05-07 Explain the impact of compound frequency and the difference between the annual percentage rate and the effective annual rate.; 05-09 Compute payments and amortization schedules for car and mortgage loans. 126) You just bought a new home and have a 30-year mortgage with monthly payments. Which statement regarding your mortgage is correct? A) Your monthly payments will decrease over time. B) The dollar amount of interest expense you pay each year will remain the same each year. C) The dollar amount of principal paid increases each month. D) All of these choices are correct. Answer: C Difficulty: 2 Medium Topic: Amortization Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-09 Compute payments and amortization schedules for car and mortgage loans.

127) Bank A charges a 7.75 percent annual percentage rate and interest is due at the end of the year. Bank B charges a 7 percent annual percentage rate and interest must be paid monthly. What is the effective annual rate charged by each bank? A) Bank A: 7.75 percent, Bank B: 7.23 percent B) Bank A: 7.85 percent, Bank B: 7.23 percent C) Bank A: 7.25 percent, Bank B: 7.5 percent D) Bank A: 7.85 percent, Bank B: 8.15 percent Answer: A Explanation: EAR for Bank B: [(1 + 0.07/12)^12] − 1 = 7.23; EAR for Bank A = 7.75 percent. Difficulty: 2 Medium Topic: Simple and compound interest Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-07 Explain the impact of compound frequency and the difference between the annual percentage rate and the effective annual rate. 128) Bank A charges a 7.50 percent annual percentage rate and interest is due at the end of the year. Bank B charges a 6.95 percent annual percentage rate and interest must be paid monthly.What is the effective annual rate charged by each bank? A) Bank A: 7.5 percent, Bank B: 6.95 percent B) Bank A: 7.76 percent, Bank B: 6.95 percent C) Bank A: 7.5 percent, Bank B: 7.18 percent D) Bank A: 7.76 percent, Bank B: 7.18 percent Answer: C Explanation: EAR for Bank B: [(1 + 0.0695/12)^12] − 1 = 7.1757 percent; EAR for Bank A = 7.5 percent. Difficulty: 2 Medium Topic: Simple and compound interest Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-07 Explain the impact of compound frequency and the difference between the annual percentage rate and the effective annual rate.

129) Your company borrows $55,000 today to fund its growth initiatives. It must repay the bank in four annual payments of $17,100 at the end of each year. What annual interest rate is your firm paying? A) 7.76 percent B) 8.26 percent C) 9.33 percent D) 10.26 percent Answer: C Explanation: PV = 55000, PMT = −17100, N = 4, FV = 0, => I = 9.33 Difficulty: 2 Medium Topic: Interest rates Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-08 Compute the interest rate of annuity payments. 130) Your company borrows $75,000 today to fund its growth initiatives. It must repay the bank in four annual payments of $26,600 at the end of each year. What annual interest rate is your firm paying? A) 15.62 percent B) 17.18 percent C) 14.74 percent D) 16.97 percent Answer: A Explanation: PV = 75000, N = 4, PMT = −26600, FV = 0, => I = 15.62 Difficulty: 2 Medium Topic: Interest rates Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-08 Compute the interest rate of annuity payments.

131) Your company borrows $275,000 today to fund its growth initiatives. It must repay the bank in five annual payments of $76,300 at the end of each year. What annual interest rate is your firm paying? A) 10.85 percent B) 12.01 percent C) 17.75 percent D) 18.02 percent Answer: B Explanation: PV = 275000, N = 5, PMT = −76,300, FV = 0, => I = 12.0065 Difficulty: 2 Medium Topic: Interest rates Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-08 Compute the interest rate of annuity payments. 132) As a college student, you probably receive many credit card offers in the mail. Consider these two offers. The first card charges a 17 percent APR. An examination of the footnotes reveals that this card compounds monthly. The second credit card charges 16.25 percent APR and compounds weekly. What is the effective annual rate of the cheaper card? A) 17.00 percent B) 17.62 percent C) 16.25 percent D) 18.39 percent Answer: B Explanation: Step 1: EAR of card 1: [(1 + 0.17/12)^12] − 1 = 18.39 percent. Step 2: EAR of card 2: [(1 + 0.1625/52)^52] − 1 = 17.62 percent. Difficulty: 2 Medium Topic: Simple and compound interest Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-07 Explain the impact of compound frequency and the difference between the annual percentage rate and the effective annual rate.

133) As a college student, you probably receive many credit card offers in the mail. Consider these two offers. The first card charges a 17 percent APR. An examination of the footnotes reveals that this card compounds daily (365 day year). The second credit card charges 18 percent APR and compounds semiannually. What is the effective annual rate of the cheaper card? A) 18.00 percent B) 17.00 percent C) 18.81 percent D) 18.53 percent Answer: D Explanation: Step 1: EAR of card 1: [(1 + 0.17/365)^365] − 1 = 18.53 percent. Step 2: EAR of card 2: [(1 + 0.18/2)^2] − 1 = 18.81 percent. Difficulty: 2 Medium Topic: Simple and compound interest Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-07 Explain the impact of compound frequency and the difference between the annual percentage rate and the effective annual rate. 134) You have reviewed your budget and determine that the most you can afford on a car loan is $375 per month. What is the most you can borrow if interest rates are 8 percent and you can pay the loan over five years? A) $20,591.86 B) $16,779.02 C) $18,494.41 D) $21,147.83 Answer: C Explanation: FV = 0, PMT = −375, N = 60, I = 8/12, => PV = 18494.41 Difficulty: 2 Medium Topic: Present value - annuity Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-04 Compute the present value of an annuity.

135) You have reviewed your budget and determine that the most you can afford on a car loan is $455 per month. What is the most you can borrow if interest rates are 7 percent and you can pay the loan over four years? A) $19,000.89 B) $19,741.29 C) $20,074.82 D) $21,671.53 Answer: A Explanation: FV = 0, N = 48, I = 7/12, PMT = −455, => PV = 19000.89 Difficulty: 2 Medium Topic: Present value - annuity Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-04 Compute the present value of an annuity. 136) You have reviewed your budget and determine that the most you can afford on a car loan is $550 per month. What is the most you can borrow if interest rates are 6 percent and you can pay the loan over three years? A) $1,470.16 B) $15,639.28 C) $17,641.92 D) $18,079.06 Answer: D Explanation: FV = 0, N = 36, I = 6/12, PMT = −550, => PV = 18079.0589 Difficulty: 2 Medium Topic: Present value - annuity Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-04 Compute the present value of an annuity.

137) Your firm needs to buy additional physical therapy equipment that costs $27,000. The equipment manufacturer will give you the equipment now if you will pay $7,000 per year for the next five years. Assume your firm can borrow at a 13 percent interest rate. You need to analyze if your firm should pay the manufacturer the $27,000 now or accept the five-year annuity offer of $7,000. Which of the following statements is correct? A) You decide to pay $27,000 today because paying in cash is always cheaper. B) You decide to pay for the equipment over time because it only costs $24,620.62. C) You decide to pay for the equipment over time because it only costs $29,112.86. D) You decide to pay $27,000 today because it is cheaper than paying for the equipment over time. Answer: B Explanation: Cost of Annuity: PMT = 7000, I = 13, N = 5, FV = 0, => PV = 24620.62 Difficulty: 3 Hard Topic: Present value - annuity Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-04 Compute the present value of an annuity. 138) Your firm needs to buy additional physical therapy equipment that costs $35,000. The equipment manufacturer will give you the equipment now if you will pay $8,000 per year for the next five years. Assume your firm can borrow at a 3 percent interest rate. You need to analyze if your firm should pay the manufacturer the $35,000 now or accept the five-year annuity offer of $8,000. Which of the following statements is correct? A) You decide to pay $35,000 today because paying in cash is always cheaper. B) You decide to pay $35,000 today because paying for the equipment over time costs $36,637.66. C) You decide to pay for the equipment over time because it only costs $39,112.86. D) Paying for the equipment over time costs $36,637.66, which is less than paying $35,000 today. Answer: B Explanation: Cost of Annuity: FV = 0, PMT = 8000, N = 5, I = 3, => PV = 36637.66 Difficulty: 2 Medium Topic: Present value - annuity Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-04 Compute the present value of an annuity.

139) You started your first job after graduating from college. Your company offers a retirement plan for which the company contributes 50 percent of what you contribute each year. You expect to contribute $4,000 per year from your salary. You decide to invest the contributions in assets that you expect to earn 8 percent per year. If you plan to retire in 35 years, how big will you expect that retirement account to be? A) $689,267.21 B) $823,147.29 C) $1,033,900.82 D) $1,308,427.41 Answer: C Explanation: PMT = 6000, FV = 0, N = 35, I = 8, => FV = 1,033,900.82 Difficulty: 2 Medium Topic: Future value - annuity Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-02 Compute the future value of frequent, level cash flows. 140) You started your first job after graduating from college. Your company offers a retirement plan for which the company contributes 25 percent of what you contribute each year. You expect to contribute $5,000 per year from your salary. You decide to invest the contributions in assets that you expect to earn 8 percent per year. If you plan to retire in 35 years, how big will you expect that retirement account to be? A) $861,584.02 B) $921,597.31 C) $972,110.74 D) $1,076,980.02 Answer: D Explanation: PV = 0, PMT= 6250, I = 8, N = 35, => FV = 1076980.02 Difficulty: 2 Medium Topic: Future value - annuity Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-02 Compute the future value of frequent, level cash flows.

141) You started your first job after graduating from college. Your company offers a retirement plan for which the company contributes 50 percent of what you contribute each year. You expect to contribute $2,000 per year from your salary. You decide to invest the contributions in assets that you expect to earn 10 percent per year. If you plan to retire in 40 years, how big will you expect that retirement account to be? A) $442,592.56 B) $885,185.11 C) $1,327,777.67 D) $1,527,787.70 Answer: C Explanation: PV = 0, PMT = 3000, I = 10, N = 40, => FV = 1327777.667 Difficulty: 2 Medium Topic: Future value - annuity Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-02 Compute the future value of frequent, level cash flows. 142) Sally saves $500 per month in her retirement plan. She plans on making monthly contributions for 35 years. If her account earns a 12 percent annual interest rate, how much will she have at the end of 35 years and what percent of the total are her out-of-pocket contributions? A) $1,113,879.14; 43.72 percent B) $2,452,905.33; 12.07 percent C) $3,215,479.74; 6.53 percent D) $3,691,003.27; 8.28 percent Answer: C Explanation: Step 1: PV = 0, PMT = 500, N = 35 × 12, I = 12/12, => FV = 3215479.74. Step 2: 35 × 12 × 500/3215479.74 = 6.53 percent. Difficulty: 3 Hard Topic: Future value - annuity Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-02 Compute the future value of frequent, level cash flows.

143) Jane has been saving $500 in her retirement account each month for the last 20 years and plans to continue contributing $500 each month for the next 20 years. Her account has been earning an 8 percent annual interest rate and she expects to earn the same rate for the next 20 years. Her twin brother, Hal, has not saved anything for the last 20 years. Due to sibling rivalry, he wants to have as much as Jane is expected to have at the end of 20 years. If Hal expects to earn the same annual interest rate as Jane, how much must Hal save each month to achieve his goal? A) $1,043.71 B) $1,517.92 C) $2,007.53 D) $2,963.40 Answer: D Explanation: Step 1: PV = 0, PMT = 500, N = 40 × 12, I = 8/12, => FV = 1745503.92. Step 2: PV = 0, N = 20 × 12, I = 8/12, FV = 1745503.92, => PMT = 2963.40. Difficulty: 3 Hard Topic: Future value - annuity Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-02 Compute the future value of frequent, level cash flows. 144) Jane has been saving $450 in her retirement account each month for the last 20 years and plans to continue contributing $450 each month for the next 20 years. Her account has been earning a 9 percent annual interest rate and she expects to earn the same rate for the next 20 years. Her twin brother, Hal, has not saved anything for the last 20 years. Due to sibling rivalry, he wants to have as much as Jane is expected to have at the end of 20 years. If Hal expects to earn the same annual interest rate as Jane, how much must Hal save each month to achieve his goal? A) $1,791.34 B) $2,109.28 C) $2,872.91 D) $3,154.12 Answer: D Explanation: Step 1: PV = 0, PMT = 450, I = 9/12; N = 40 × 12, => FV = 2106594.12 Step 2: PV = 0, FV = 2106594.12, I = 9/12, N = 20 × 12, => PMT = 3154.12 Difficulty: 3 Hard Topic: Future value - annuity Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-02 Compute the future value of frequent, level cash flows.

145) Jane has been saving $200 in her retirement account each month for the last 20 years and plans to continue contributing $200 each month for the next 20 years. Her account has been earning an 8 percent annual interest rate and she expects to earn the same rate for the next 20 years. Her twin brother, Hal, has not saved anything for the last 20 years. Due to sibling rivalry, he wants to have as much as Jane is expected to have at the end of 20 years. If Hal expects to earn the same annual interest rate as Jane, how much must Hal save each month to achieve his goal? A) $400.00 B) $1,185.36 C) $1,569.85 D) $2,909.17 Answer: B Explanation: Step 1: PV = 0, PMT = 200, I = 8/12, N = 40 × 12, => FV = 698,201.5663. Step 2: PV = 0, FV = 698,201.5663, I = 8/12, N = 20 × 12, => PMT = 1185.3606. Difficulty: 3 Hard Topic: Future value - annuity Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-02 Compute the future value of frequent, level cash flows. 146) Your current $95,000 mortgage calls for monthly payments over 30 years at an annual interest rate of 6 percent. If you pay an additional $50 each month beginning with the first payment, how soon do you pay off your mortgage? A) 329.67 months B) 311.56 months C) 291.78 months D) 288.45 months Answer: C Explanation: Step 1: PV = 95000, FV = 0, N = 360, I = 6/12, => PMT = 569.57. Step 2: PMT = −619.57, FV = 0, I = 6/12, PV = 95000, => N = 291.78. Difficulty: 3 Hard Topic: Number of time periods Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-09 Compute payments and amortization schedules for car and mortgage loans.; 05-10 Calculate the number of payments on a loan.

147) Your current $115,000 mortgage calls for monthly payments over 30 years at an annual interest rate of 7 percent. If you pay an additional $50 each month beginning with the first payment, how much interest expense do you save by prepaying? A) $32,764.43 B) $30,718.29 C) $29,503.14 D) $22,008.73 Answer: A Explanation: Step 1: PV = 115000, FV = 0, N = 360, I = 7/12, => PMT = 765.10. Step 2: PV = 115000, PMT = −815.10, I = 7/12, FV = 0, => N = 297.72. Step 3: 360 × 765.10 − 297.72 × 815.10 = 32,764.43. Difficulty: 3 Hard Topic: Number of time periods Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-09 Compute payments and amortization schedules for car and mortgage loans.; 05-10 Calculate the number of payments on a loan. 148) Your current $155,000 mortgage calls for monthly payments over 25 years at an annual interest rate of 6 percent. If you pay an additional $50 each month beginning with the first payment, how much interest expense do you save by pre-paying? A) $15,981.28 B) $16,009.62 C) $17,152.22 D) $19,001.69 Answer: C Explanation: Step 1: PV = 155000, FV = 0, N = 25 × 12, I = 6/12, => PMT = 998.67. Step 2: PV = 155000, PMT = −1048.67, I = 6/12, FV = 0, => N = 269.34. Step 3: 300 × 998.67 − 269.34 × 1048.67 = 17,152.22. Difficulty: 3 Hard Topic: Number of time periods Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-09 Compute payments and amortization schedules for car and mortgage loans.; 05-10 Calculate the number of payments on a loan.

149) After saving diligently your entire career, you and your spouse are ready to retire with a nest egg of $600,000. You need to invest this money in a mix of stocks and bonds that will allow you to earn $5,000 per month for 30 years. What annual interest rate (APR) do you need to earn? A) 9.40 percent B) 10.13 percent C) 8.37 percent D) 9.61 percent Answer: A Explanation: PV = 600,000, N = 360, FV = 0, PMT = −5000, => I = 0.7831, APR = 0.7831 × 12 = 9.40 Difficulty: 2 Medium Topic: Interest rates Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-08 Compute the interest rate of annuity payments. 150) After saving diligently your entire career, you and your spouse are ready to retire with a nest egg of $500,000. You need to invest this money in a mix of stocks and bonds that will allow you to earn $4,000 per month for 30 years. What annual interest rate (APR) do you need to earn? A) 6.92 percent B) 7.45 percent C) 8.94 percent D) 9.17 percent Answer: C Explanation: PV = 500000, N = 360, FV = 0, PMT = −4000, => I = 0.7446, APR = 0.74 × 12 = 8.94 percent Difficulty: 2 Medium Topic: Interest rates Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-08 Compute the interest rate of annuity payments.

151) Which of the following will increase the future value of an annuity? A) The number of periods increases. B) The amount of the annuity increases. C) The interest rate increases. D) All of these choices are correct. Answer: D Difficulty: 1 Easy Topic: Future value - annuity Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-02 Compute the future value of frequent, level cash flows. 152) Which of the following will increase the present value of an annuity? A) The number of periods decreases. B) The interest rate decreases. C) The amortization schedule decreases. D) The effective rate is calculated over fewer years. Answer: B Difficulty: 1 Easy Topic: Present value - annuity Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-04 Compute the present value of an annuity.

153) If the present value of an ordinary, 10-year annuity is $25,000 and interest rates are 7 percent, what is the present value of the same annuity due? A) $23,644.49 B) $24,997.51 C) $25,000.00 D) $26,750.00 Answer: D Explanation: END MODE PV = 25000 FV = 0 I=7 N = 10 CPT PMT = 3559.4376 BGN MODE FV = 0 PMT = 3559.4376 I=7 N = 10 CPT PV = 26750.00 Difficulty: 1 Easy Topic: Present value - annuity Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-06 Adjust values for beginning-of-period annuity payments.

154) If the future value of an ordinary, 5-year annuity is $100,000 and interest rates are 5 percent, what is the future value of the same annuity due? A) $95,238.10 B) $100,000.00 C) $105,000.00 D) $107,000.00 Answer: C Explanation: END MODE FV = 100000 PV = 0 I=5 N=5 CPT PMT = 18097.4798 BGN MODE PV = 0 PMT = 18097.4798 I=5 N=5 CPT FV = 105000.00 Difficulty: 1 Easy Topic: Future value - annuity Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-06 Adjust values for beginning-of-period annuity payments. 155) If you start making $90 monthly contributions today and continue them for ten years, what is their future value if the compounding rate is 6 percent APR? What is the present value of this annuity? A) $14,794.14; $8,106.61 B) $14,794.14; $8,147.14 C) $14,822.89; $8,106.61 D) $14,822.89; $8,147.14 Answer: A Explanation: N = 10 × 12 = 120, I = 6/12 = 0.50, PV = 0, PMT = 90, CPT FV = 14794.14 N = 10 × 12 = 120, I = 6/12 = 0.50, FV = 0, PMT = 90, CPT PV = 8106.61 Difficulty: 2 Medium Topic: Future value - annuity Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-06 Adjust values for beginning-of-period annuity payments.

156) Payday loans are very short-term loans that charge very high interest rates. You can borrow $500 today and repay $550 in ten weeks. What is the compound annual rate implied by this 10 percent rate charged for only ten weeks? A) 5.20 percent B) 10.41 percent C) 59.94 percent D) 64.15 percent Answer: D Explanation: [(1 + 0.10)^5.2] − 1 = 64.15 percent. Difficulty: 2 Medium Topic: Compound frequency Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-07 Explain the impact of compound frequency and the difference between the annual percentage rate and the effective annual rate. 157) A car company is offering a choice of deals. You can receive $4,000 cash back on the purchase, or a 0 percent APR, 4-year loan. The price of the car is $40,000 and you could obtain a 4-year loan from your credit union, at 6 percent APR. Which deal is cheaper? A) The car company's 0 percent 4-year loan. B) The rebate with the credit union's 6 percent 4-year loan. C) There is not enough information given to determine which deal is cheaper. Answer: A Explanation: Car Company: PV = 40000, I = 0, FV = 0, N = 4 × 12 = 48, PMT = −833.33 Credit Union: PV = (40000 − 4000) = 36,000, N = 4 × 12 = 48, I = 6/12 = 0.50, FV = 0, CPT PMT = −845.46 Difficulty: 3 Hard Topic: Loan payments Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-04 Compute the present value of an annuity.; 05-09 Compute payments and amortization schedules for car and mortgage loans.

158) Paige has decided that she wants to build enough retirement wealth that, if invested at 5 percent per year, will provide her with $2,500 monthly income for 20 years. To date, she has saved nothing, but she still has 40 years until she retires. How much money does she need to contribute per month to reach her goal? A) $180.02 B) $248.24 C) $460.81 D) $921.61 Answer: B Explanation: Step 1: FV = 0, I = 5/12 = 0.4167, PMT = 2500, N = 20 × 12 = 240, CPT PV = −378,813.2827. Step 2: FV = 378,813.2827, I = 5/12 = 0.4167, N = 40 × 12 = 480, PV = 0, CPT PMT = −248.2361. Difficulty: 3 Hard Topic: Present value - annuity Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-04 Compute the present value of an annuity.; 05-09 Compute payments and amortization schedules for car and mortgage loans. 159) Bethany purchased a $35,000 car three years ago using a 6 percent, 5-year loan. She has decided that she would sell the car now, if she could get a price that would pay off the balance of her loan. What is the minimum price Bethany would need to receive for her car? A) $9,680,67 B) $15,267.12 C) $22,242.11 D) $23,429.19 Answer: B Explanation: FV = 0, I = 6/12 = 0.50, N = 5 × 12 = 60, PV = 35000, CPT PMT = −676.6481 2nd, Amort, P1 = 1, P2 = (3 × 12) = 36, Bal = 15267.12 Difficulty: 3 Hard Topic: Amortization Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-09 Compute payments and amortization schedules for car and mortgage loans.

160) A mortgage broker is offering a 30-year mortgage with a teaser rate. In the first two years of the mortgage, the borrower makes monthly payments on only a 2.5 percent APR interest rate. After the second year, the mortgage interest charged increases to 4.25 percent APR. What is the effective interest rate in the first two years? What is the effective interest rate after the second year? A) 2.08 percent, 3.54 percent respectively B) 2.50 percent, 4.25 percent respectively C) 2.53 percent, 4.33 percent respectively D) 5.00 percent, 8.50 percent respectively Answer: C Explanation: (1 + 0.025/12)^12 − 1 = 0.0253 = 2.53 percent. (1 + 0.0425/12)^12 − 1 = 0.0433 = 4.33 percent. Difficulty: 3 Hard Topic: Loan interest and rates Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-07 Explain the impact of compound frequency and the difference between the annual percentage rate and the effective annual rate. 161) A furniture company is offering a choice of deals. You can receive $500 cash back on the purchase, or a 4 percent APR, 2-year loan. The price of the dining room set is $5,000 and you could obtain a 2-year loan from your credit union at 3 percent APR. What is the cost per month of each deal? A) cash back: $193.42, 4 percent APR: $217.12 B) cash back: $193.42, 2 percent APR: $214.91 C) cash back: $195.41, 2 percent APR: $217.12 D) cash back: $195.41, 2 percent APR: $214.91 Answer: A Explanation: Step 1: Cash back: PV = 4500, N = 2 × 12=24, I = 3/12 = 0.25, FV = 0, => PMT = 193.4155. Step 2: 4 percent APR: PV = 5000, N = 2 × 12=24, I = 4/12 = 0.3333, FV = 0, PMT = 217.1246. Difficulty: 3 Hard Topic: Loan payments Bloom's: Apply; Evaluate AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 05-04 Compute the present value of an annuity.; 05-09 Compute payments and amortization schedules for car and mortgage loans.

Finance, 5e (Cornett) Chapter 6 Understanding Financial Markets and Institutions 1) Which of these provide a forum in which demanders of funds raise funds by issuing new financial instruments, such as stocks and bonds? A) investment banks B) money markets C) primary markets D) secondary markets Answer: C Difficulty: 1 Easy Topic: Primary and secondary markets Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 06-01 Differentiate between primary and secondary markets and between money and capital markets. 2) In the United States, which of these financial institutions arrange most primary market transactions for businesses? A) investment banks B) asset transformer C) direct transfer agents D) over-the-counter agents Answer: A Difficulty: 1 Easy Topic: Primary and secondary markets Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 06-01 Differentiate between primary and secondary markets and between money and capital markets.

3) Primary market financial instruments include stock issues from firms allowing their equity shares to be publicly traded on the stock market for the first time. We usually refer to these firsttime issues as which of the following? A) initial public offerings B) direct transfers C) money market transfers D) over-the-counter stocks Answer: A Difficulty: 1 Easy Topic: Initial public offerings Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 06-01 Differentiate between primary and secondary markets and between money and capital markets. 4) Once firms issue financial instruments in primary markets, these same stocks and bonds are then traded in which of these? A) initial public offerings B) direct transfers C) secondary markets D) over-the-counter stocks Answer: C Difficulty: 1 Easy Topic: Primary and secondary markets Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 06-01 Differentiate between primary and secondary markets and between money and capital markets.

5) Which of these feature debt securities or instruments with maturities of one year or less? A) money markets B) primary markets C) secondary markets D) over-the-counter stocks Answer: A Difficulty: 1 Easy Topic: Money and capital markets Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 06-01 Differentiate between primary and secondary markets and between money and capital markets. 6) Which of the following is NOT a money market instrument? A) treasury bills B) commercial paper C) corporate bonds D) bankers' acceptances Answer: C Difficulty: 1 Easy Topic: Money market securities Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 06-02 List the types of securities traded in money and capital markets. 7) Which of these money market instruments are short-term funds transferred between financial institutions, usually for no more than one day? A) treasury bills B) federal funds C) commercial paper D) banker acceptances Answer: B Difficulty: 1 Easy Topic: Money market securities Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 06-02 List the types of securities traded in money and capital markets.

8) Which of the following is NOT a capital market instrument? A) U.S. Treasury notes and bonds B) U.S. Treasury bills C) U.S. government agency bonds D) corporate stocks and bonds Answer: B Difficulty: 1 Easy Topic: Money market securities Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 06-02 List the types of securities traded in money and capital markets. 9) Which of the following are money market securities to obtain short-term funds? A) U.S. Treasury notes and bonds B) U.S. Treasury bills C) Commercial paper D) Both b and c Answer: D Difficulty: 1 Easy Topic: Money market securities Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 06-02 List the types of securities traded in money and capital markets. 10) Which of the following is/are NOT a capital market security A) Corporate bonds B) Banker's acceptances C) Corporate stocks D) State and local government bonds Answer: B Difficulty: 1 Easy Topic: Capital market securities Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 06-02 List the types of securities traded in money and capital markets.

11) Which of these capital market instruments are long-term loans to individuals or businesses to purchase homes, pieces of land, or other real property? A) treasury notes and bonds B) mortgages C) mortgage-backed securities D) corporate bonds Answer: B Difficulty: 1 Easy Topic: Types of loans Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 06-02 List the types of securities traded in money and capital markets. 12) Which of these markets trade currencies for immediate or for some future stated delivery? A) money markets B) primary markets C) foreign exchange markets D) over-the-counter stocks Answer: C Difficulty: 1 Easy Topic: Foreign exchange markets Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 06-02 List the types of securities traded in money and capital markets. 13) Which of these formalizes an agreement between two parties to exchange a standard quantity of an asset at a predetermined price on a specified date in the future? A) derivative security B) initial public offering C) liquidity asset D) trading volume Answer: A Difficulty: 1 Easy Topic: Derivatives and other securities Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 06-02 List the types of securities traded in money and capital markets.

14) Which of these does NOT perform vital functions to securities markets of all sorts by channelling funds from those with surplus funds to those with shortages of funds? A) commercial banks B) secondary markets C) insurance companies D) mutual funds Answer: B Difficulty: 1 Easy Topic: Primary and secondary markets Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 06-02 List the types of securities traded in money and capital markets. 15) Which of these refer to the ease with which an asset can be converted into cash? A) direct transfer B) liquidity C) primary market D) secondary market Answer: B Difficulty: 1 Easy Topic: Money and capital markets Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 06-02 List the types of securities traded in money and capital markets. 16) Which of the following is the risk that an asset's sale price will be lower than its purchase price? A) default risk B) liquidity risk C) price risk D) trading risk Answer: C Difficulty: 1 Easy Topic: Nominal interest rate factors Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 06-02 List the types of securities traded in money and capital markets.

17) Financial intermediaries provide which of the following? A) Purchase the financial claims that fund users issue. B) Finance purchases by selling financial claims to household investors and other fund suppliers. C) Both a and b D) None of the above Answer: C Difficulty: 1 Easy Topic: Financial intermediaries Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 06-03 Identify different types of financial institutions and the services that each provides. 18) Which of these is the interest rate that is actually observed in financial markets? A) nominal interest rates B) real interest rates C) real risk-free rate D) market premium Answer: A Difficulty: 2 Medium Topic: Nominal and real rates Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 06-06 Analyze specific factors that influence interest rates. 19) Which of these is the interest rate that would exist on a default-free security if no inflation were expected? A) nominal interest rate B) real interest rate C) default premium D) market premium Answer: B Difficulty: 2 Medium Topic: Nominal and real rates Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 06-06 Analyze specific factors that influence interest rates.

20) Which of the following is the risk that a security issuer will miss an interest or principal payment or continue to miss such payments? A) default risk B) liquidity risk C) maturity risk D) price risk Answer: A Difficulty: 1 Easy Topic: Nominal interest rate factors Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 06-06 Analyze specific factors that influence interest rates. 21) Which of these is NOT a participant in the shadow banking system? A) structured investment vehicles (SIVs) B) special purpose vehicles (SPVs) C) limited-purpose finance companies D) credit unions Answer: D Difficulty: 2 Medium Topic: Types of financial institutions Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 06-03 Identify different types of financial institutions and the services that each provides. 22) How is the shadow banking system the same as the traditional banking system? A) It intermediates the flow of funds between net savers and net borrowers. B) It serves as a middle man. C) The complete credit intermediation is performed through a series of steps involving many nonbank financial service firms. D) The complete credit intermediation is performed by a single bank. Answer: A Difficulty: 2 Medium Topic: Financial institution functions Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 06-03 Identify different types of financial institutions and the services that each provides.

23) Which statement is NOT true of the loanable funds theory? A) Views the level of interest rates as resulting from factors that affect the supply and demand for loanable funds. B) Categorizes financial market participants as net suppliers or demanders of funds. C) Is a model that is rarely used to explain interest rates and interest rate movement. D) Is a theory of interest rate determination that views equilibrium interest rates in financial markets as a result of the supply and demand for loanable funds. Answer: C Difficulty: 2 Medium Topic: Loanable funds theory Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 06-04 Know the main suppliers and demanders of loanable funds. 24) Which of the following is the continual increase in the price level of a basket of goods and services? A) deflation B) inflation C) recession D) stagflation Answer: B Difficulty: 1 Easy Topic: Nominal interest rate factors Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 06-06 Analyze specific factors that influence interest rates. 25) Which of these statements is true? A) The higher the default risk, the higher the interest rate that securities buyers will demand. B) The lower the default risk, the higher the interest rate that securities buyers will demand. C) The higher the default risk, the lower the interest rate that securities buyers will demand. D) The default risk does not impact the interest rate that securities buyers will demand. Answer: A Difficulty: 1 Easy Topic: Nominal interest rate factors Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 06-06 Analyze specific factors that influence interest rates.

26) Which of these is a comparison of market yields on securities, assuming all characteristics except maturity are the same? A) liquidity risk B) market risk C) maturity risk D) term structure of interest rates Answer: D Difficulty: 1 Easy Topic: Nominal interest rate factors Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 06-06 Analyze specific factors that influence interest rates. 27) According to this theory of term structure of interest rates, at any given point in time, the yield curve reflects the market's current expectations of future short-term rates. A) expectations theory B) future short-term rates theory C) term structure of interest rates theory D) unbiased expectations theory Answer: D Difficulty: 2 Medium Topic: Interest rate theories Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 06-07 Offer different theories that explain the shape of the term structure of interest rates.

28) Which of the following theories argues that individual investors and financial institutions have specific maturity preferences, and to encourage buyers to hold securities with maturities other than their most preferred requires a higher interest rate? A) liquidity premium hypothesis B) market segmentation theory C) supply and demand theory D) unbiased expectations theory Answer: B Difficulty: 2 Medium Topic: Interest rate theories Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 06-07 Offer different theories that explain the shape of the term structure of interest rates. 29) Which of these is the expected or "implied" rate on a short-term security that will originate at some point in the future? A) current yield B) forward rate C) spot rate D) yield to maturity Answer: B Difficulty: 2 Medium Topic: Term structure of interest rates Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 06-08 Demonstrate how forward interest rates derive from the term structure of interest rates.

30) Which of these is NOT a theory that explains the shape of the term structure of interest rates? A) liquidity theory B) market segmentation theory C) short-term structure of interest rates theory D) unbiased expectations theory Answer: C Difficulty: 1 Easy Topic: Interest rate theories Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 06-07 Offer different theories that explain the shape of the term structure of interest rates. 31) A particular security's default risk premium is 3 percent. For all securities, the inflation risk premium is 2 percent and the real interest rate is 2.25 percent. The security's liquidity risk premium is 0.75 percent and maturity risk premium is 0.90 percent. The security has no special covenants. What is the security's equilibrium rate of return? A) 1.78 percent B) 3.95 percent C) 8.90 percent D) 17.8 percent Answer: C Explanation: ij* = 2.00% + 2.25% + 3.00% + 0.75% + 0.90% = 8.90%. Difficulty: 1 Easy Topic: Nominal interest rate factors Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 06-06 Analyze specific factors that influence interest rates.

32) You are considering an investment in 30-year bonds issued by a corporation. The bonds have no special covenants. The Wall Street Journal reports that one-year T-bills are currently earning 3.50 percent. Your broker has determined the following information about economic activity and the corporation's bonds: Real interest rate = 2.50 percent Default risk premium = 1.75 percent Liquidity risk premium = 0.70 percent Maturity risk premium = 1.50 percent What is the inflation premium? What is the fair interest rate on the corporation's 30-year bonds? A) 1 percent and 1.49 percent, respectively B) 1 percent and 6.45 percent, respectively C) 1 percent and 7.45 percent, respectively D) 3.50 percent and 9.95 percent, respectively Answer: C Explanation: Expected (IP) = i − RIR = 3.50% − 2.50% = 1.00%. ij* = 1.00% + 2.50% + 1.75% + 0.70% + 1.50% = 7.45%. Difficulty: 1 Easy Topic: Nominal interest rate factors Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 06-06 Analyze specific factors that influence interest rates. 33) A corporation's 10-year bonds have an equilibrium rate of return of 7 percent. For all securities, the inflation risk premium is 1.50 percent and the real interest rate is 3.0 percent. The security's liquidity risk premium is 0.15 percent and maturity risk premium is 0.70 percent. The security has no special covenants. What is the bond's default risk premium? A) 1.40 percent B) 1.65 percent C) 5.35 percent D) 9.35 percent Answer: B Explanation: 7.00% = 1.5% + 3% + DRP + 0.15% + 0.70% => DRP = 7.00% − (1.5% + 3% + 0.15% + 0.70%) = 1.65%. Difficulty: 1 Easy Topic: Nominal interest rate factors Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 06-06 Analyze specific factors that influence interest rates.

34) A two-year Treasury security currently earns 5.25 percent. Over the next two years, the real interest rate is expected to be 3.00 percent per year and the inflation premium is expected to be 2.00 percent per year. What is the maturity risk premium on the two-year Treasury security? A) 0.25 percent B) 1.00 percent C) 1.05 percent D) 5.00 percent Answer: A Explanation: 5.25% = 2.00% + 3.00% + 0.00% + 0.00% + MP => MP = 5.25% − (2.00% + 3.00% + 0.00% + 0.00%) = 0.25%. Difficulty: 1 Easy Topic: Nominal interest rate factors Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 06-06 Analyze specific factors that influence interest rates. 35) Suppose that the current one-year rate (one-year spot rate) and expected one-year T-bill rates over the following three years (i.e., years 2, 3, and 4, respectively) are as follows: 1R1 = 5%,

E(2r1) = 5.5%, E(3r1) = 6.5%, E(4r1) = 7.0% Using the unbiased expectations theory, what is the current (long-term) rate for four-yearmaturity Treasury securities? A) 6.00 percent B) 6.33 percent C) 6.75 percent D) 7.00 percent Answer: A Explanation: 1R4 = [(1 + 0.05)(1 + 0.055)(1 + 0.065)(1 + 0.07)]1/4 − 1 = 6%. Difficulty: 1 Easy Topic: Interest rate theories Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 06-07 Offer different theories that explain the shape of the term structure of interest rates.

36) One-year Treasury bills currently earn 5.50 percent. You expect that one year from now, one-year Treasury bill rates will increase to 5.75 percent. If the unbiased expectations theory is correct, what should the current rate be on two-year Treasury securities? A) 5.50 percent B) 5.625 percent C) 5.75 percent D) 11.25 percent Answer: B Explanation: 1R2 = [(1 + 0.055)(1 + 0.0575)]1/2 − 1 = 5.62492604%. Difficulty: 1 Easy Topic: Interest rate theories Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 06-07 Offer different theories that explain the shape of the term structure of interest rates. 37) Which statement(s) are true regarding the liquidity premium theory: A) States that long-term rates are equal to geometric averages of current and expected short-term rates. B) Liquidity premiums that increase with maturity result in upward sloping yield curves. C) An upward sloping yield curve may reflect investor's expectations that future short-term rates will be flat. D) All of the above. Answer: D Difficulty: 1 Easy Topic: Interest rate theories Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 06-07 Offer different theories that explain the shape of the term structure of interest rates.

38) One-year Treasury bills currently earn 5.50 percent. You expect that one year from now, one-year Treasury bill rates will increase to 5.75 percent. The liquidity premium on two-year securities is 0.075 percent. If the liquidity theory is correct, what should the current rate be on two-year Treasury securities? A) 3.775 percent B) 5.625 percent C) 5.662 percent D) 11.325 percent Answer: C Explanation: 1R2 = [(1 + 0.055)(1 + 0.0575 + 0.00075)]1/2 − 1 = 5.66237504%. Difficulty: 1 Easy Topic: Interest rate theories Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 06-07 Offer different theories that explain the shape of the term structure of interest rates. 39) Based on economists' forecasts and analysis, one-year Treasury bill rates and liquidity premiums for the next four years are expected to be as follows: Using the liquidity premium theory, what is the current rate on a four-year Treasury security? R1

6.65 %

E(r2)

7.75 % L2

0.10 %

E(r3)

7.85 % L3

0.20 %

E(r4)

8.15 % L4

0.25 %

A) 7.736 percent B) 7.600 percent C) 7.738 percent D) 8.400 percent Answer: A Explanation: 1R4 = [(1 + 0.0665)(1 + 0.0775 + 0.0010)(1 + 0.0785 + 0.0020)(1 + 0.0815 + 0.0025)]1/4 − 1 = 7.73548. Difficulty: 1 Easy Topic: Interest rate theories Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 06-07 Offer different theories that explain the shape of the term structure of interest rates. 16

40) One-year Treasury bills currently earn 3.15 percent. You expect that one year from now, 1year Treasury bill rates will increase to 3.65 percent and that two years from now, one-year Treasury bill rates will increase to 4.05 percent. If the unbiased expectations theory is correct, what should the current rate be on three-year Treasury securities? A) 3.40 percent B) 3.62 percent C) 3.75 percent D) 3.85 percent Answer: B Explanation: 1R3 = [(1 + 0.0315)(1 + 0.0365)(1 + 0.0405)]1/3 − 1 = 3.62%. Difficulty: 1 Easy Topic: Interest rate theories Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 06-07 Offer different theories that explain the shape of the term structure of interest rates. 41) One-year Treasury bills currently earn 2.55 percent. You expect that one year from now, one-year Treasury bill rates will increase to 2.85 percent and that two years from now, one-year Treasury bill rates will increase to 3.15 percent. If the unbiased expectations theory is correct, what should the current rate be on 3-year Treasury securities? A) 2.55 percent B) 2.85 percent C) 2.93 percent D) 3.15 percent Answer: B Explanation: 1R3 = [(1 + 0.0255)(1 + 0.0285)(1 + 0.0315)]1/3 − 1 = 2.85%. Difficulty: 1 Easy Topic: Interest rate theories Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 06-07 Offer different theories that explain the shape of the term structure of interest rates.

42) The Wall Street Journal reports that the rate on three-year Treasury securities is 7.00 percent, and the six-year Treasury rate is 7.25 percent. From discussions with your broker, you have determined that the expected inflation premium will be 1.75 percent next year, 2.25 percent in year 2, and 2.40 percent in year 3 and beyond. Further, you expect that real interest rates will be 3.75 percent annually for the foreseeable future. What is the maturity risk premium on the sixyear Treasury security? A) 0.83 percent B) 0.983 percent C) 1.10 percent D) 1.233 percent Answer: C Explanation: 7.25% = 2.40% + 3.75% + MP => MP = 7.25% − (2.40% + 3.75%) = 1.10% Difficulty: 2 Medium Topic: Nominal interest rate factors Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 06-06 Analyze specific factors that influence interest rates. 43) A corporation's 10-year bonds are currently yielding a return of 7.75 percent. The expected inflation premium is 3.0 percent annually and the real interest rate is expected to be 3.00 percent annually over the next 10 years. The liquidity risk premium on the corporation's bonds is 0.50 percent. The maturity risk premium is 0.25 percent on two-year securities and increases by 0.10 percent for each additional year to maturity. What is the default risk premium on the corporation's 10-year bonds? A) 0.18 percent B) 0.20 percent C) 0.22 percent D) 0.27 percent Answer: B Explanation: 7.75% = 3.00% + 3.00% + DRP + 0.50% + (0.25% + (0.10% × 8)) => DRP = 7.75% − (3.00% + 3.00% + 0.50% + (0.25% + (0.10% × 8))) = 0.20. Difficulty: 2 Medium Topic: Nominal interest rate factors Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 06-06 Analyze specific factors that influence interest rates.

44) Suppose we observe the following rates: 1R1 = 6 percent, 1R2 = 7.5 percent. If the unbiased expectations theory of the term structure of interest rates holds, what is the one-year interest rate expected one year from now, E(2r1)? A) 6.75 percent B) 7.50 percent C) 9.02 percent D) 13.5 percent Answer: C Explanation: 1 + 1R2 = {(1 + 1R1)(1 + E(2r1))}1/2 1.075 = {1.06(1 + E(2r1))}1/2 1.155625 = 1.06(1 + E(2r1)) 1.155625/1.06 = 1 + E(2r1) 1 + E(2r1) = 1.090212264 E(2r1) = 0.0902 = 9.02. Difficulty: 2 Medium Topic: Interest rate theories Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 06-06 Analyze specific factors that influence interest rates.

45) The Wall Street Journal reports that the rate on four-year Treasury securities is 4.75 percent and the rate on five-year Treasury securities is 5.95 percent. According to the unbiased expectations hypotheses, what does the market expect the one-year Treasury rate to be four years from today, E(5r1)? A) 1.11 percent B) 5.95 percent C) 10.70 percent D) 10.89 percent Answer: D Explanation: 1 + 1R5 = {(1 + 1R4)4(1 + E(5r1))}1/5 1.0595 = {(1.0475)4(1 + E(5r1))}1/5 (1.0595)5 = (1.0475)4 (1 + E(5r1)) (1.0595)5/(1.0475)4 = 1 + E(5r1) 1 + E(5r1) = 1.108890541 E(5r1) = 10.89%. Difficulty: 2 Medium Topic: Interest rate theories Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 06-07 Offer different theories that explain the shape of the term structure of interest rates.

46) The Wall Street Journal reports that the rate on three-year Treasury securities is 4.75 percent and the rate on four-year Treasury securities is 5.00 percent. The one-year interest rate expected in three years is E(4r1), 5.25 percent. According to the liquidity premium theory, what is the liquidity premium on the four-year Treasury security, L4? A) 0.0375 percent B) 0.504 percent C) 5.01 percent D) 5.04 percent Answer: B Explanation: 1 + 1R4 = {(1 + 1R3)(1 + E(4r1) + L4)}1/4 1.0500 = {(1.0475)3(1 + 0.0525 + L4)}1/4 (1.0500)4 = (1.0475)3(1 + 0.0525 + L4) (1.0500)4/(1.0475)3 = 1 + 0.0525 + L4 (1.0500)4/(1.0475)3 − 1.0525 = L4 = 0.0050358564 = 0.504%. Difficulty: 2 Medium Topic: Interest rate theories Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 06-07 Offer different theories that explain the shape of the term structure of interest rates.

47) Suppose we observe the following rates: 1R1 = 8 percent, 1R2 = 10 percent, and E(2r1) = 8 percent. If the liquidity premium theory of the term structure of interest rates holds, what is the liquidity premium for year 2, L2? A) 1.02 percent B) 4.04 percent C) 6.15 percent D) 12.03 percent Answer: B Explanation: 1 + 1R2 = {(1 + 1R1)(1 + E(2r1) + L2)}1/2 1.10 = {(1.08)(1 + 0.08 + L2)}1/2 (1.10)2 = (1.08)(1 + 0.08 + L2) (1.10)2/(1.08) = 1 + 0.08 + L2 (1.10)2/(1.08) − 1.08 = L2 = 0.04037 = 4.04%. Difficulty: 2 Medium Topic: Interest rate theories Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 06-07 Offer different theories that explain the shape of the term structure of interest rates.

48) You note the following yield curve in The Wall Street Journal. According to the unbiased expectations hypothesis, what is the one-year forward rate for the period beginning one year from today, 2f1? Maturity One day One year Two years Three years

Yield 3.00% 5.00 6.25 8.00

A) 1.01 percent B) 1.19 percent C) 5.625 percent D) 7.51 percent Answer: D Explanation: 1R2 = 0.0625 = [(1 + 0.050)(1 + 2f1)]1/2 − 1 ψ [(1.0625)2/(1.050)] − 1 = 2f1 = 7.51%. Difficulty: 2 Medium Topic: Interest rate theories Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 06-08 Demonstrate how forward interest rates derive from the term structure of interest rates.

49) On May 23, 20XX, the existing or current (spot) one-year, two-year, three-year, and fouryear zero-coupon Treasury security rates were as follows: 1R1 = 5.25%, 1R2 = 5.75%, 1R3 = 6.25%, 1R4 = 6.45%

Using the unbiased expectations theory, what is the one-year forward rate on zero-coupon Treasury bonds for year 4 as of May 23, 20XX? A) 5.925 percent B) 6.45 percent C) 7.05 percent D) 10.32 percent Answer: C Explanation: 4f1 = [(1 + 1R4)4/(1 + 1R3)3] − 1 = [(1 + 0.0645)4/(1 + 0.0625)3] − 1 = 7.05%. Difficulty: 2 Medium Topic: Interest rate theories Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 06-08 Demonstrate how forward interest rates derive from the term structure of interest rates. 50) The Wall Street Journal reports that the current rate on 10-year Treasury bonds is 6.75 percent, on 20-year Treasury bonds is 7.25 percent, and on a 20-year corporate bond is 8.50 percent. Assume that the maturity risk premium is zero. If the default risk premium and liquidity risk premium on a 10-year corporate bond is the same as that on the 20-year corporate bond, what is the current rate on a 10-year corporate bond. A) 7.50 percent B) 8.00 percent C) 8.50 percent D) 8.75 percent Answer: B Explanation: 20-year corporate bond: 8.5% = 7.25% + DRP + LRP + 0.00% => DRP + LRP = 8.5% − 7.25% = 1.25%. 10-year corporate bond: ij* = 6.75% + 1.25% = 8.00%. Difficulty: 3 Hard Topic: Nominal interest rate factors Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 06-06 Analyze specific factors that influence interest rates. 24

51) The Wall Street Journal reports that the current rate on 5-year Treasury bonds is 6.50 percent and on 10-year Treasury bonds is 6.75 percent. Assume that the maturity risk premium is zero. Calculate the expected rate on a 5-year Treasury bond purchased five years from today, E(5r1). A) 6.625 percent B) 6.75 percent C) 7.00 percent D) 7.58 percent Answer: C Explanation: 1 + 1R10 = {(1 + 1R5)5(1 + E(5r1))5}1/10 = 1.0675 = {(1 + 0.065)5(1 + E(5r1))5}1/10 => E(5r1) = {(1.0675)10/(1 + 0.065)5}1/5 − 1 = 7.00%. Difficulty: 3 Hard Topic: Nominal interest rate factors Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 06-06 Analyze specific factors that influence interest rates. 52) Suppose we observe the three-year Treasury security rate (1R3) to be 6 percent, the expected one-year rate next year E(2r1) to be 3 percent, and the expected one-year rate the following year E(3r1) to be 5 percent. If the unbiased expectations theory of the term structure of interest rates holds, what is the one-year Treasury security rate, 1R1? A) 3.00 percent B) 10.13 percent C) 14.00 percent D) 19.88 percent Answer: B Explanation: 1.06 = {(1 + 1R1)(1 + E(2r1))(1 + E(3r1))}1/3 1.06 = {(1 + 1R1) × 1.03 × 1.05}1/3 (1.06)3 = (1 + 1R1) × 1.03 × 1.05 1 + 1R1 = 1.191016/(1.03 × 1.05) 1R1 = 0.10126 = 10.13%. Difficulty: 3 Hard Topic: Interest rate theories Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 06-07 Offer different theories that explain the shape of the term structure of interest rates.

53) The Wall Street Journal reports that the rate on three-year Treasury securities is 6.25 percent and the rate on five-year Treasury securities is 6.45 percent. According to the unbiased expectations hypothesis, what does the market expect the two-year Treasury rate to be three years from today, E(4r2)? A) 6.35 percent B) 6.75 percent C) 7.25 percent D) 7.45 percent Answer: B Explanation: 1 + 1R5 = {(1 + 1R3)3(1 + E(3r2))2}1/5 = 1.0645 = {(1 + 0.0625)3(1 + E(3r2))2}1/5 => E(3r2) = {(1.0645)5/(1 + 0.0625)3}1/2 − 1 = 6.75. Difficulty: 3 Hard Topic: Interest rate theories Bloom's: Apply; Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 06-07 Offer different theories that explain the shape of the term structure of interest rates. 54) One-year Treasury bills currently earn 3.25 percent. You expect that one year from now, one-year Treasury bill rates will increase to 3.45 percent and that two years from now, one-year Treasury bill rates will increase to 3.95 percent. The liquidity premium on two-year securities is 0.05 percent and on three-year securities is 0.15 percent. If the liquidity theory is correct, what should the current rate be on three-year Treasury securities? A) 3.25 percent B) 3.55 percent C) 3.62 percent D) 4.10 percent Answer: C Explanation: 1R2 = [(1 + 0.0325)(1 + 0.0345 + 0.0005)(1 + 0.0395 + 0.0015)]1/3 − 1 = 3.62%. Difficulty: 2 Medium Topic: Interest rate theories Bloom's: Apply; Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 06-07 Offer different theories that explain the shape of the term structure of interest rates.

55) One-year Treasury bills currently earn 2.95 percent. You expect that one year from now, one-year Treasury bill rates will increase to 3.15 percent and that two years from now, one-year Treasury bill rates will increase to 3.35 percent. The liquidity premium on two-year securities is 0.05 percent and on three-year securities is 0.15 percent. If the liquidity theory is correct, what should the current rate be on three-year Treasury securities? A) 2.95 percent B) 3.15 percent C) 3.22 percent D) 3.35 percent Answer: C Explanation: 1R2 = [(1 + 0.0295)(1 + 0.0315 + 0.0005)(1 + 0.0335 + 0.0015)]1/3 − 1 = 3.22%. Difficulty: 2 Medium Topic: Interest rate theories Bloom's: Apply; Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 06-07 Offer different theories that explain the shape of the term structure of interest rates. 56) Assume the current interest rate on a one-year Treasury bond (1R1) is 5.00 percent, the current rate on a two-year Treasury bond (1R2) is 5.75 percent, and the current rate on a threeyear Treasury bond (1R3) is 6.25 percent. If the unbiased expectations theory of the term structure of interest rates is correct, what is the one-year interest rate expected on Treasury bills during year 3, 3f1? A) 5.00 percent B) 5.67 percent C) 7.26 percent D) 8.00 percent Answer: C Explanation: 1R1 = 5.0% 1/2 − 1 = f = 6.51%. 1R2 = 1.0575 = [(1 + 0.05)(1 + 2f1)] 21 1/3 − 1 = f = 7.26%. 1R3 = 1.0625 = [(1 + 0.05)(1 + 0.0651)(1 + 3f1)] 31

Difficulty: 3 Hard Topic: Interest rate theories Bloom's: Apply; Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 06-08 Demonstrate how forward interest rates derive from the term structure of interest rates.

57) A recent edition of The Wall Street Journal reported interest rates of 3.10 percent, 3.50 percent, 3.75 percent, and 3.95 percent for three-year, four-year, five-year, and six-year Treasury security yields, respectively, According to the unbiased expectation theory of the term structure of interest rates, what are the expected one-year rates for year 6? A) 3.575 percent B) 3.95 percent C) 4.96 percent D) 5.33 percent Answer: C Explanation: 1 + 1R6 = {(1 + 1R5)5(1 + E(6r1))}1/6 1.0395 = {(1.0375)5(1 + E(6r1))}1/6 (1.0395)6 = (1.0375)5(1 + E(6r1)) (1.0395)6/(1.0375)5 = 1 + E(6r1) 1 + E(6r1) = 1.04955798 E(6r1) = 4.96%. Difficulty: 3 Hard Topic: Interest rate theories Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 06-08 Demonstrate how forward interest rates derive from the term structure of interest rates. 58) A particular security's default risk premium is 3 percent. For all securities, the inflation risk premium is 1.75 percent and the real interest rate is 4.2 percent. The security's liquidity risk premium is 0.35 percent and maturity risk premium is 0.95 percent. The security has no special covenants. Calculate the security's equilibrium rate of return. A) 8.50 percent B) 6.05 percent C) 10.25 percent D) 9.90 percent Answer: C Explanation: 3 + 1.75 + 4.2 + 0.35 + 0.95 = 10.25. Difficulty: 1 Easy Topic: Nominal interest rate factors Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 06-06 Analyze specific factors that influence interest rates.

59) You are considering an investment in 30-year bonds issued by Moore Corporation. The bonds have no special covenants. The Wall Street Journal reports that one-year T-bills are currently earning 3.55 percent. Your broker has determined the following information about economic activity and Moore Corporation bonds: Real interest rate = 2.75 percent Default risk premium = 1.05 percent Liquidity risk premium = 0.50 percent Maturity risk premium = 1.85 percent What is the inflation premium? A) 0.80 percent B) 1.25 percent C) 6.25 percent D) 8.00 percent Answer: A Explanation: 3.55 − 2.75 = 0.80. Difficulty: 1 Easy Topic: Nominal interest rate factors Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 06-06 Analyze specific factors that influence interest rates.

60) You are considering an investment in 30-year bonds issued by Moore Corporation. The bonds have no special covenants. The Wall Street Journal reports that one-year T-bills are currently earning 3.55 percent. Your broker has determined the following information about economic activity and Moore Corporation bonds: Real interest rate = 2.75 percent Default risk premium = 1.05 percent Liquidity risk premium = 0.50 percent Maturity risk premium = 1.85 percent What is the fair interest rate on Moore Corporation 30-year bonds? A) 3.80 percent B) 6.45 percent C) 6.95 percent D) 9.70 percent Answer: C Explanation: 1.05 + 0.5 + 1.85 + 3.55 = 6.95. Difficulty: 1 Easy Topic: Nominal interest rate factors Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 06-06 Analyze specific factors that influence interest rates. 61) Dakota Corporation 15-year bonds have an equilibrium rate of return of 9 percent. For all securities, the inflation risk premium is 1.95 percent and the real interest rate is 3.65 percent. The security's liquidity risk premium is 0.35 percent and maturity risk premium is 0.95 percent. The security has no special covenants. Calculate the bond's default risk premium. A) 2.10 percent B) 3.05 percent C) 3.40 percent D) 2.45 percent Answer: A Explanation: 9 − 1.95 − 3.65 − 0.35 − 0.95 = 2.1. Difficulty: 1 Easy Topic: Nominal interest rate factors Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 06-06 Analyze specific factors that influence interest rates.

62) A two-year Treasury security currently earns 5.13 percent. Over the next two years, the real interest rate is expected to be 2.15 percent per year and the inflation premium is expected to be 1.75 percent per year. Calculate the maturity risk premium on the two-year Treasury security. A) 5.13 percent B) 3.38 percent C) 2.98 percent D) 1.23 percent Answer: D Explanation: 5.13 − 1.75 − 2.15 = 1.23. Difficulty: 1 Easy Topic: Nominal interest rate factors Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 06-06 Analyze specific factors that influence interest rates. 63) Suppose that the current one-year rate (one-year spot rate) and expected one-year T-bill rates over the following three years (i.e., years 2, 3, and 4, respectively) are as follows: 1R1 = 5 percent,

E(2r1) = 7 percent, E(3r1) = 7.5 percent E(4r1) = 7.85 percent Using the unbiased expectations theory, calculate the current (long-term) rates for one-year and two-year-maturity Treasury securities. A) one-year: 5.00 percent,two-year: 5.50 percent B) one-year: 5.00 percent, two-year: 6.00 percent C) one-year: 5.50 percent, two-year: 6.15 percent D) one-year: 5.50 percent, two-year: 5.75 percent Answer: B Explanation: 1R1 = 5% and 1R2 = [(1 + 0.05)(1 + 0.07)]1/2 − 1 = 6.0%. Difficulty: 1 Easy Topic: Interest rate theories Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 06-07 Offer different theories that explain the shape of the term structure of interest rates.

64) Suppose that the current one-year rate (one-year spot rate) and expected one-year T-bill rates over the following three years (i.e., years 2, 3, and 4 respectively) are as follows: 1R1 = 5 percent,

E(2r1) = 6 percent, E(3r1) = 7.5 percent E(4r1) = 7.85 percent Using the unbiased expectations theory, calculate the current (long-term) rates for three-yearand four-year-maturity Treasury securities. A) one-year: 6.16 percent, two-year: 6.58 percent B) one-year: 6.16 percent, two-year: 6.78 percent C) one-year: 6.25 percent, two-year: 6.45 percent D) one-year: 5.95 percent, two-year: 6.45 percent Answer: A Explanation: 1R3 = [(1 + 0.05)(1 + 0.06)(1 + 0.075)]1/3 − 1 = 6.16% and 1/4 − 1 = 6.58%. 1R4 = [(1 + 0.05)(1 + 0.06)(1 + 0.075)(1 + 0.0785)]

Difficulty: 1 Easy Topic: Interest rate theories Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 06-07 Offer different theories that explain the shape of the term structure of interest rates.

65) Suppose that the current one-year rate (one-year spot rate) and expected one-year T-bill rates over the following three years (i.e., years 2, 3, and 4, respectively) are as follows: 1R1 = 5 percent,

E(2r1) = 6 percent, E(3r1) = 7.5 percent E(4r1) = 6.85 percent Using the unbiased expectations theory, calculate the current (long-term) rates for one-, two-, three-, and four-year-maturity Treasury securities. A) 5.00 percent, 5.50 percent, 6.16 percent, 6.33 percent B) 5.00 percent, 5.25 percent, 6.10 percent, 6.27 percent C) 5.00 percent, 5.50 percent, 6.10 percent, 6.23 percent D) 5.00 percent, 5.25 percent, 6.16 percent, 6.49 percent Answer: A Explanation: 1R1 = 5% 1/2 − 1 = 5.5%. 1R2 = [(1 + 0.05)(1 + 0.06)] 1/3 − 1 = 6.16%. 1R3 = [(1 + 0.05)(1 + 0.06)(1 + 0.075)] 1/4 − 1 = 6.33%. 1R4 = [(1 + 0.05)(1 + 0.06)(1 + 0.075)(1 + 0.0685)]

Difficulty: 2 Medium Topic: Interest rate theories Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 06-07 Offer different theories that explain the shape of the term structure of interest rates.

66) One-year Treasury bills currently earn 3.75 percent. You expect that one year from now, one-year Treasury bill rates will increase to 4.15 percent. If the unbiased expectations theory is correct, what should the current rate be on two-year Treasury securities? A) 4.25 percent B) 3.85 percent C) 3.95 percent D) 4.35 percent Answer: C Explanation: 1R2 = [(1 + 0.0375)(1 + 0.0415)]0.5 − 1 = 3.95%. Difficulty: 1 Easy Topic: Interest rate theories Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 06-07 Offer different theories that explain the shape of the term structure of interest rates. 67) One-year Treasury bills currently earn 4.5 percent. You expect that one year from now, oneyear Treasury bill rates will increase to 6.65 percent. The liquidity premium on two-year securities is 0.05 percent. If the liquidity theory is correct, what should the current rate be on two-year Treasury securities? A) 5.24 percent B) 5.59 percent C) 5.65 percent D) 5.95 percent Answer: B Explanation: 1R2 = [(1 + 0.045)(1 + 0.0665 + 0.0005)]0.5 − 1 = 5.59%. Difficulty: 1 Easy Topic: Interest rate theories Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 06-07 Offer different theories that explain the shape of the term structure of interest rates.

68) Based on economists' forecasts and analysis, one-year Treasury bill rates and liquidity premiums for the next four years are expected to be as follows:

R1 E(r2) E(r3) E(r4)

= = = =

5.95percent 6.25percent 6.75percent 7.15percent

= = =

L2 L3 L4

0.05percent 0.10percent 0.12percent

Using the liquidity premium theory, what should be the current rate on four-year Treasury securities? A) 6.59 percent B) 6.75 percent C) 6.82 percent D) 7.13 percent Answer: A Explanation: 1R4 = [(1 + 0.0595)(1 + 0.0625 + 0.0005)(1 + 0.0675 + 0.0010)(1 + 0.0715 + 0.0012)]1/4 − 1 = 6.59%. Difficulty: 1 Easy Topic: Interest rate theories Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 06-07 Offer different theories that explain the shape of the term structure of interest rates.

69) The Wall Street Journal reports that the rate on three-year Treasury securities is 7.00 percent, and the six-year Treasury rate is 6.20 percent. From discussions with your broker, you have determined that the expected inflation premium will be 2.25 percent next year, 2.50 percent in year 2, and 2.50 percent in year 3 and beyond. Further, you expect that real interest rates will be 4.4 percent annually for the foreseeable future. Calculate the maturity risk premium on the 3-year Treasury security. A) 0.00 percent B) 0.10 percent C) 4.50 percent D) 2.60 percent Answer: B Explanation: 7.00% = 2.50% + 4.40% + MP => MP = 7.00% − (2.50% + 4.40%) = 0.10%. Difficulty: 2 Medium Topic: Nominal interest rate factors Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 06-06 Analyze specific factors that influence interest rates. 70) The Wall Street Journal reports that the rate on three-year Treasury securities is 6.50 percent, and the six-year Treasury rate is 6.80 percent. From discussions with your broker, you have determined that the expected inflation premium will 2.25 percent next year, 2.50 percent in year 2, and 2.60 percent in year 3 and beyond. Further, you expect that real interest rates will be 3.4 percent annually for the foreseeable future. Calculate the maturity risk premium on the three-year and the six-year Treasury security. A) 3-year: 0.6 percent, 6-year: 0.80 percent B) 3-year: 0.5 percent, 6-year: 0.90 percent C) 3-year: 0.6 percent, 6-year: 1.20 percent D) 3-year: 0.5 percent, 6-year: 0.80 percent Answer: D Explanation: Step 1: 6.50% = 2.60% + 3.40% + MP => MP = 6.50% − (2.60% + 3.40%) = 0.50%. Step 2: 6.80% = 2.60% + 3.40% + MP => MP = 6.80% − (2.60% + 3.40%) = 0.80%. Difficulty: 2 Medium Topic: Nominal interest rate factors Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 06-06 Analyze specific factors that influence interest rates.

71) Nikki G's Corporation's 10-year bonds are currently yielding a return of 9.25 percent. The expected inflation premium is 2.0 percent annually and the real interest rate is expected to be 3.10 percent annually over the next 10 years. The liquidity risk premium on Nikki G's bonds is 0.1 percent. The maturity risk premium is 0.10 percent on two-year securities and increases by 0.05 percent for each additional year to maturity. Calculate the default risk premium on Nikki G's 10-year bonds. A) 2.55 percent B) 5.65 percent C) 3.55 percent D) 1.85 percent Answer: C Explanation: 9.25% = 2.0% + 3.10% + DRP + 0.1% + (0.10% + (0.05% × 8)) DRP = 9.25% − (2.0% + 3.10% + 0.1% + 0.5%) = 3.55%. Difficulty: 2 Medium Topic: Nominal interest rate factors Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 06-06 Analyze specific factors that influence interest rates. 72) Suppose we observe the following rates: 1R1 = 12 percent, 1R2 = 15 percent. If the unbiased expectations theory of the term structure of interest rates holds, what is the one-year interest rate expected one year from now, E(2r1)? A) 13.5 percent B) 14.2 percent C) 15.6 percent D) 18.0 percent Answer: D Explanation: 1 + 1R2 = {(1 + 1R1)(1 + E(2r1))}1/2 1.15 = {1.12(1 + E(2r1))}1/2 1.32 = 1.12(1 + E(2r1)) 1.32/1.12 = 1 + E(2r1) 1 + E(2r1) = 1.18 E(2r1) = 0.18. Difficulty: 2 Medium Topic: Interest rate theories Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 06-06 Analyze specific factors that influence interest rates.

73) The Wall Street Journal reports that the rate on four-year Treasury securities is 7.50 percent and the rate on five-year Treasury securities is 9.15 percent. According to the unbiased expectations hypothesis, what does the market expect the one-year Treasury rate to be four years from today, E(5r1)? A) 16.0 percent B) 18.4 percent C) 15.9 percent D) 13.7 percent Answer: A Explanation: 1 + 1R5 = {(1 + 1R4)4(1 + E(5r1))}1/5 1.0915 = {(1.075)4(1 + E(5r1))}1/5 (1.0915)5 = (1.075)4(1 + E(5r1)) (1.0915)5/(1.075)4 = 1 + E(5r1) 1 + E(5r1) = 1.1601 E(5r1) = 16.01%. Difficulty: 2 Medium Topic: Interest rate theories Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 06-07 Offer different theories that explain the shape of the term structure of interest rates.

74) The Wall Street Journal reports that the rate on three-year Treasury securities is 7.25 percent and the rate on four-year Treasury securities is 8.50 percent. The one-year interest rate expected in three years is E(4r1), 4.10 percent. According to the liquidity premium theory, what is the liquidity premium on the four-year Treasury security, L4? A) 6.7 percent B) 7.1 percent C) 8.2 percent D) 9.6 percent Answer: C Explanation: 1 + 1R4 = {(1 + 1R3)(1 + E(4r1) + L4)}1/4 1.0850 = {(1.0725)3(1 + 0.0410 + L4)}1/4 (1.0850)4 = (1.0725)3(1 + 0.0410 + L4) (1.0850)4/(1.0725)3 = 1 + 0.0410 + L4 (1.0850)4/(1.0725)3 − 1.0410 = L4 = 0.0824 = 8.24%. Difficulty: 2 Medium Topic: Interest rate theories Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 06-07 Offer different theories that explain the shape of the term structure of interest rates.

75) Suppose we observe the following rates: 1R1 = 13 percent, 1R2 = 16 percent, and E(2r1) = 10 percent. If the liquidity premium theory of the term structure of interest rates holds, what is the liquidity premium for year 2, L2? A) 8.7 percent B) 9.1 percent C) 9.7 percent D) 10.0 percent Answer: B Explanation: 1 + 1R2 = {(1 + 1R1)(1 + E(2r1) + L2)}1/2 1.16 = {(1.13)(1 + 0.10 + L2)}1/2 (1.16)2 = (1.13)(1 + 0.10 + L2) (1.16)2/(1.13) = 1 + 0.10 + L2 (1.16)2/(1.13) − 1.10 = L2 = 0.0908. Difficulty: 2 Medium Topic: Interest rate theories Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 06-07 Offer different theories that explain the shape of the term structure of interest rates.

76) You note the following yield curve in The Wall Street Journal. According to the unbiased expectations hypothesis, what is the one-year forward rate for the period beginning one year from today, 2f1? Maturity One day One year Two years Three years

Yield 2.00% 6.00 7.50 9.00

A) 7.6 percent B) 8.6 percent C) 9.0 percent D) 10.2 percent Answer: C Explanation: 1R2 = 0.075 = [(1 + 0.06)(1 + 2f1)]1/2 − 1; [(1.075)2/(1.06)] − 1 = 2f1 = 9.02%. Difficulty: 2 Medium Topic: Interest rate forecasting Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 06-08 Demonstrate how forward interest rates derive from the term structure of interest rates.

77) On May 23, 20XX, the existing or current (spot) one-year, two-year, three-year, and fouryear zero-coupon Treasury security rates were as follows: 1R1 = 4.55 percent, 1R2 = 4.75 percent, 1R3 = 5.25 percent, 1R4 = 5.95 percent

Using the unbiased expectations theory, calculate the one-year forward rates on zero-coupon Treasury bonds for years two, three, and four as of May 23, 20XX. A) year 1: 4.95 percent, Year 2: 6.26 percent, Year 3: 8.08 percent B) year 1: 3.75 percent, Year 2: 6.02 percent, Year 3: 9.00 percent C) year 1: 4.95 percent, Year 2: 7.26 percent, Year 3: 8.08 percent D) year 1: 3.65 percent, Year 2: 6.32 percent, Year 3: 11.08 percent Answer: A Explanation: 2f1 = [(1 + 1R2)2/(1 + 1R1)] − 1 = [(1 + 0.0475)2/(1 + 0.0455)] − 1 = 4.95% 3 2 3 2 3f1 = [(1 + 1R3) /(1 + 1R2) ] − 1 = [(1 + 0.0525) /(1 + 0.0475) ] − 1 = 6.26% 4 3 4 3 4f1 = [(1 + 1R4) /(1 + 1R3) ] − 1 = [(1 + 0.0595) /(1 + 0.0525) ] − 1 = 8.08%.

Difficulty: 2 Medium Topic: Interest rate forecasting Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 06-06 Analyze specific factors that influence interest rates. 78) The Wall Street Journal reports that the current rate on 10-year Treasury bonds is 6.25 percent, on 20-year Treasury bonds is 7.95 percent, and on a 20-year corporate bond is 10.75 percent. Assume that the maturity risk premium is zero. If the default risk premium and liquidity risk premium on a 10-year corporate bond is the same as that on the 20-year corporate bond, calculate the current rate on a 10-year corporate bond. A) 9.05 percent B) 6.15 percent C) 7.60 percent D) 8.70 percent Answer: A Explanation: 20-year bond: 10.75% = 7.95% + DRP + LRP + 0.00% => DRP + LRP = 2.8%. 10-year bond: ij* = 6.25% + 2.8% = 9.05%. Difficulty: 3 Hard Topic: Nominal interest rate factors Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 06-06 Analyze specific factors that influence interest rates. 42

79) The Wall Street Journal reports that the current rate on five-year Treasury bonds is 6.45 percent and on 10-year Treasury bonds is 7.75 percent. Assume that the maturity risk premium is zero. Calculate the expected rate on a five-year Treasury bond purchased five years from today, E(5r5). A) 7.25 percent B) 8.12 percent C) 9.07 percent D) 10.16 percent Answer: C Explanation: 1 + 1R10 = {(1 + 1R5)5(1 + E(5r5))5}1/10 = 1.0775 = {(1 + 0.0645)5(1 + E(5r5))5}1/10 E(5r5) = {(1.0775)10/(1 + 0.0645)5}1/5 − 1 = 9.07%. Difficulty: 3 Hard Topic: Nominal interest rate factors Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 06-06 Analyze specific factors that influence interest rates. 80) Suppose we observe the three-year Treasury security rate (1R3) to be 11 percent, the expected one-year rate next year E(2r1) to be 4 percent, and the expected one-year rate the following year E(3r1) to be 5 percent. If the unbiased expectations theory of the term structure of interest rates holds, what is the one-year Treasury security rate, 1R1? A) 18.57 percent B) 10.19 percent C) 23.19 percent D) 25.24 percent Answer: D Explanation: 1.11 = {(1 + 1R1)(1 + E(2r1))(1 + E(3r1))}1/3 1.11 = {(1 + 1R1) × 1.04 × 1.05}1/3 (1.11)3 = (1 + 1R1) × 1.04 × 1.05 1 + 1R1 = 1.3676/(1.04 × 1.05) 1R1 = 0.2524 = 25.24%. Difficulty: 3 Hard Topic: Interest rate theories Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 06-07 Offer different theories that explain the shape of the term structure of interest rates. 43

81) Assume the current interest rate on a one-year Treasury bond (1R1) is 5.50 percent, the current rate on a two-year Treasury bond (1R2) is 5.95 percent, and the current rate on a threeyear Treasury bond (1R3) is 8.50 percent. If the unbiased expectations theory of the term structure of interest rates is correct, what is the one-year interest rate expected on Treasury bills during year 3, 3f1? A) 13.79 percent B) 12.29 percent C) 11.69 percent D) 10.29 percent Answer: A Explanation: 1R1 = 5.5% 1/2 − 1; f = 6.40%. 1R2 = 1.0595 = [(1 + 0.055)(1 + 2f1)] 21 1/3 − 1; f = 13.79%. 1R3 = 1.085 = [(1 + 0.055)(1 + 0.064)(1 + 3f1)] 31

Difficulty: 3 Hard Topic: Interest rate theories Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 06-08 Demonstrate how forward interest rates derive from the term structure of interest rates. 82) If the yield curve is downward sloping, what is the yield to maturity on a 30-year Treasury bond relative to a 10-year Treasury bond? A) The yield on the 10-year bond must be greater than the yield on the 30-year bond. B) The yield on the 10-year bond must be less than the yield on the 30-year bond. C) The yields on the two bonds are equal. D) We need to know the other risk premiums to answer this question. Answer: A Difficulty: 2 Medium Topic: Treasury yield curve Bloom's: Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 06-06 Analyze specific factors that influence interest rates.

83) One-year Treasury bill rates in 20XX averaged 5.15 percent and inflation for the year was 7.3 percent. If investors had expected the same inflation rate as that realized, calculate the real interest rate for 20XX according to the Fisher effect. A) 0.00 percent B) −2.15 percent C) 2.15 percent D) 3.95 percent Answer: B Explanation: 5.15 − 7.3 = −2.15%. Difficulty: 2 Medium Topic: Fisher effect Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 06-06 Analyze specific factors that influence interest rates. 84) Assume that you observe the following rates on long-term bonds: U.S. Treasury bonds = 4.15 percent AAA Corporate bonds = 6.2 percent BBB The main reason for the differences in the interest rates is: A) maturity risk premium B) inflation premium C) default risk premium D) convertibility premium Answer: C Difficulty: 2 Medium Topic: Nominal interest rate factors Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 06-06 Analyze specific factors that influence interest rates.

85) Which of the following statements is correct? A) According to the unbiased expectations theory, the return for holding a two-year bond to maturity is equal to the nominal rate divided by the real interest rate. B) The rate on a 10-year Corporate bond can never be less than the rate on a 10-year Treasury. C) We usually observe the inverted yield curve. D) The rate on a three-year Treasury can never be less than the rate on a 15-year Treasury. Answer: B Difficulty: 3 Hard Topic: Treasury yield curve Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 06-06 Analyze specific factors that influence interest rates.; 06-07 Offer different theories that explain the shape of the term structure of interest rates. 86) One-year interest rates are 3 percent. The market expects one-year rates to be 5 percent one year from now. The market also expects one-year rates to be 7 percent two years from now. Assume that the unbiased expectations theory holds. Which of the following is correct? A) The yield curve is downward sloping. B) The yield curve is flat. C) The yield curve is upward sloping. D) We need the maturity risk premiums to be able to answer this question. Answer: C Difficulty: 1 Easy Topic: Interest rate theories Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 06-07 Offer different theories that explain the shape of the term structure of interest rates.

87) Which of the following statements is correct? A) If the unbiased expectations theory is correct, we could see an inverted yield curve. B) If a yield curve is inverted, long-term bonds have higher yields than short-term bonds. C) If the maturity risk premium is zero, the yield curve would be flat. D) If the unbiased expectations theory is correct, the maturity risk premium is zero. Answer: D Difficulty: 2 Medium Topic: Interest rate theories Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 06-07 Offer different theories that explain the shape of the term structure of interest rates. 88) The Wall Street Journal states that the yield curve for Treasuries is downward sloping and there is no liquidity premium or maturity risk premium. Given this information, which of the following statements is correct? A) A 30-year corporate bond must have a higher yield than a five-year corporate bond. B) A five-year corporate bond must have a higher yield than a 30-year Treasury bond. C) A five-year Treasury bond must have a higher yield than a five-year corporate bond. D) All of these choices are correct. Answer: B Difficulty: 2 Medium Topic: Treasury yield curve Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 06-07 Offer different theories that explain the shape of the term structure of interest rates.

89) Which of the following statements is correct? A) An IPO is an example of a primary market transaction. B) Money markets are subject to wider price fluctuations and are therefore more risky than capital market instruments. C) A direct transfer of funds is more efficient than utilizing financial institutions. D) The market segmentation theory argues that the different investors have different risk preferences which determine the shape of the yield curve. Answer: A Difficulty: 1 Easy Topic: Primary and secondary markets Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 06-01 Differentiate between primary and secondary markets and between money and capital markets.; 06-02 List the types of securities traded in money and capital markets.; 06-05 Understand how equilibrium interest rates are determined. 90) In 20XX, the 10-year Treasury rate was 4.5 percent while the average 10-year Aaa corporate bond debt carried an interest rate of 6.0 percent. What is the average default risk premium on Aaa corporate bonds? A) 0.75 percent B) 1.5 percent C) 1.95 percent D) 2.25 percent Answer: B Explanation: 6.0 − 4.5 = 1.5. Difficulty: 1 Easy Topic: Nominal interest rate factors Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 06-06 Analyze specific factors that influence interest rates.

91) Which of the following statements is correct? A) The default risk premium of Baa 20-year corporate bonds over Aaa 20-year corporate bonds does not vary. B) The market segmentation theory assumes that borrowers and investors do not want to shift from one maturity sector to another without an interest rate premium. C) Real interest rates are the rates that are quoted in the news. D) All of these choices are correct. Answer: B Difficulty: 2 Medium Topic: Interest rate theories Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 06-06 Analyze specific factors that influence interest rates.; 06-05 Understand how equilibrium interest rates are determined. 92) All of the following are types of financial institutions EXCEPT A) insurance companies. B) pension funds. C) thrifts. D) Federal reserve. Answer: D Difficulty: 1 Easy Topic: Types of financial institutions Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 06-03 Identify different types of financial institutions and the services that each provides. 93) All of the following are benefits that financial institutions provide to our economy EXCEPT A) increased liquidity. B) increased monitoring. C) increased dollar amount of funds flowing from suppliers to fund users. D) increased price risk. Answer: D Difficulty: 1 Easy Topic: Financial institution functions Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 06-03 Identify different types of financial institutions and the services that each provides. 49

94) All of the following are factors that affect nominal interest rates EXCEPT A) time to maturity. B) real interest rate. C) convertibility features. D) foreign exchange. Answer: D Difficulty: 1 Easy Topic: Nominal interest rate factors Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 06-06 Analyze specific factors that influence interest rates. 95) Which of the following statements is correct? A) A flat yield curve occurs when the yield-to-maturity is virtually unaffected by the term-tomaturity. B) Real interest rates are generally lower than nominal interest rates. C) Liquidity risk is the risk that a security may be difficult to sell on short notice for its true value. D) All of these choices are correct. Answer: D Difficulty: 2 Medium Topic: Nominal and real rates Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 06-06 Analyze specific factors that influence interest rates.

96) Which of the following statements is incorrect? A) Governments affect foreign exchange rates indirectly by altering prevailing interest rates within their own countries. B) Foreign currency exchange rates vary with the day-to-day demand and supply of the two foreign currencies. C) Central governments can intervene in foreign exchange markets directly and value their currency at high rates relative to another currency. D) All of these choices are correct. Answer: D Difficulty: 1 Easy Topic: Exchange rates Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 06-02 List the types of securities traded in money and capital markets. 97) The theory that argues that individual investors and financial institutions have specific maturity preferences is called the A) market segmentation theory. B) unbiased expectations theory. C) liquidity preference theory. D) inverted forward theory. Answer: A Difficulty: 1 Easy Topic: Interest rate theories Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 06-07 Offer different theories that explain the shape of the term structure of interest rates.

98) The theory that states that the yield curve reflects the market's current expectations of future short-term rates is called the A) market segmentation theory. B) liquidity premium theory. C) unbiased expectations theory. D) inverted forward theory. Answer: C Difficulty: 1 Easy Topic: Interest rate theories Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 06-07 Offer different theories that explain the shape of the term structure of interest rates. 99) Which of the following statements is incorrect? A) The over-the-counter market operates in a fixed location to conduct trades for local stocks. B) Liquidity is the ease with which an asset can be converted into cash. C) An initial public offering is an example of a primary market transaction. D) Money market instruments have maturities of less than one year. Answer: A Difficulty: 1 Easy Topic: Money and capital markets Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 06-01 Differentiate between primary and secondary markets and between money and capital markets.; 06-02 List the types of securities traded in money and capital markets.; 06-06 Analyze specific factors that influence interest rates. 100) All of the following are secondary market transactions EXCEPT A) GE sells $30 million of new preferred stock. B) Microsoft sells $2 million of IBM preferred stock out of its marketable securities portfolio. C) The Magellan Fund buys $100 million of Apple previously issued bonds. D) Allstate Insurance Co. sells $5 million in IBM bonds. Answer: A Difficulty: 1 Easy Topic: Primary and secondary markets Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 06-01 Differentiate between primary and secondary markets and between money and capital markets. 52

101) Which of the following is NOT correct with respect to derivative securities? A) They are among the riskiest of securities in the financial securities markets. B) They can be used for hedging purposes. C) Examples of derivatives include futures, options, and swaps. D) All of these choices are correct. Answer: D Difficulty: 1 Easy Topic: Derivatives and other securities Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 06-02 List the types of securities traded in money and capital markets. 102) Which of the following is NOT correct with respect to financial institutions? A) Financial institutions channel funds from those with shortages to those with surplus funds. B) Commercial banks, insurance companies, and mutual funds are examples of financial institutions. C) Financial institutions reduce monitoring costs and liquidity costs. D) Financial institutions reduce price risk. Answer: A Difficulty: 1 Easy Topic: Financial institution functions Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 06-03 Identify different types of financial institutions and the services that each provides. 103) All of the following are factors that influence interest rates for individual securities EXCEPT A) the security's term to maturity. B) inflation. C) special provisions regarding the use of funds raised by a particular security issuer. D) the home mortgage rate. Answer: D Difficulty: 1 Easy Topic: Nominal interest rate factors Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 06-06 Analyze specific factors that influence interest rates.

104) The real interest rate is A) the rate charged to the corporations with the best credit rating or least amount of default risk. B) the rate that a security would pay if no inflation were expected over its holding period. C) the rate that a security would pay if the security had no maturity risk. Answer: B Difficulty: 1 Easy Topic: Nominal and real rates Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 06-06 Analyze specific factors that influence interest rates. 105) All of the following special provisions benefit security holders EXCEPT A) tax-free status. B) convertibility. C) callability. D) All of these choices are correct. Answer: C Difficulty: 2 Medium Topic: Nominal interest rate factors Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 06-06 Analyze specific factors that influence interest rates. 106) Which of the following assets has the lowest liquidity? A) U.S. Treasury bill. B) bonds issued by GM. C) common stock issued by Apple Inc. D) common stock issued by a small but financially strong firm. Answer: D Difficulty: 1 Easy Topic: Nominal interest rate factors Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 06-06 Analyze specific factors that influence interest rates.

107) All of the following are common shapes for the yield curve EXCEPT A) elliptical. B) upward-sloping. C) flat. D) inverted. Answer: A Difficulty: 1 Easy Topic: Term structure of interest rates Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 06-06 Analyze specific factors that influence interest rates. 108) The Wall Street Journal reports that the current rate on five-year Treasury bonds is 2.85 percent and on 10-year Treasury bonds is 4.35 percent. Assume that the maturity risk premium is zero. Calculate the expected rate on a five-year Treasury bond purchased five years from today, E(5r5). A) 3.60 percent B) 5.87 percent C) 7.20 percent D) 8.28 percent Answer: B Explanation: 1 + 1R10 = {(1 + 1R5)5(1 + E(5r5))5}1/10 = 1 .0435 = {(1 + 0.0285)5(1 + E(5r5))5}1/10 => E(5r5) = {(1.0435)10/(1 + 0.0285)5}1/5 − 1 = 5.87%. Difficulty: 3 Hard Topic: Interest rate forecasting Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 06-06 Analyze specific factors that influence interest rates.

109) The Wall Street Journal reports that the current rate on 10-year Treasury bonds is 3.25 percent and on 20-year Treasury bonds is 5.50 percent. Assume that the maturity risk premium is zero. Calculate the expected rate on a 10-year Treasury bond purchased 10 years from today, E(10r10). A) 2.25 percent B) 4.38 percent C) 7.80 percent D) 8.75 percent Answer: C Explanation: 1 + 1R20 = {(1 + 1R10)10(1 + E(10r10))10}1/20 = 1.0550 = {(1 + 0.0325)10(1 + E(10r10))10}1/20 => E(10r10) = {(1.0550)20/(1 + 0.0325)10}1/10 − 1 = 7.80%. Difficulty: 3 Hard Topic: Interest rate forecasting Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 06-06 Analyze specific factors that influence interest rates. 110) Which of the following are suppliers of loanable funds? A) households B) government units C) foreign investors D) All of these choices are correct. Answer: D Difficulty: 1 Easy Topic: Money and capital markets Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 06-04 Know the main suppliers and demanders of loanable funds.

111) Which of the following do foreign suppliers of funds in the U.S. financial market assess? A) interest rates offered on financial securities B) their total wealth C) risk of the securities D) All of these choices are correct. Answer: D Difficulty: 1 Easy Topic: Money and capital markets Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 06-04 Know the main suppliers and demanders of loanable funds. 112) Which of the following are demanders of loanable funds? A) households B) businesses C) governments D) All of these choices are correct. Answer: D Difficulty: 1 Easy Topic: Money and capital markets Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 06-04 Know the main suppliers and demanders of loanable funds. 113) Why would foreign participants borrow from U.S. financial markets? A) They look for the cheapest source of funds. B) They look at the economic conditions of their home country. C) All of these choices are correct. Answer: C Difficulty: 1 Easy Topic: Money and capital markets Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 06-04 Know the main suppliers and demanders of loanable funds.

114) Which of the following factors cause the supply of funds curve to shift? A) total wealth B) risk of the financial security C) future spending needs D) All of these choices are correct. Answer: D Difficulty: 1 Easy Topic: Term structure of interest rates Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 06-05 Understand how equilibrium interest rates are determined. 115) When monetary policy objectives are to contract the economic growth, which of the following occurs? A) The Federal Reserve decreases the supply of funds available in the financial markets. B) At every interest rate the supply of loanable funds increases. C) The supply curve shifts down and to the right. D) The equilibrium interest rate decreases. Answer: A Difficulty: 2 Medium Topic: Money and capital markets Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 06-05 Understand how equilibrium interest rates are determined. 116) Which of the following factors cause the demand for funds curve to shift? A) utility derived from assets purchased with borrowed funds B) restrictiveness of non-price conditions of borrowing C) domestic and foreign economic conditions D) All of these choices are correct. Answer: D Difficulty: 1 Easy Topic: Interest rate theories Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 06-05 Understand how equilibrium interest rates are determined.

117) Which of the following occurs as the utility derived from an asset purchased with borrowed funds increases? A) The willingness of market participants to borrow decreases. B) The absolute dollar value borrowed increases. C) At every interest rate the demand for loanable funds decrease. Answer: B Difficulty: 2 Medium Topic: Interest rate theories Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 06-05 Understand how equilibrium interest rates are determined. 118) Which of the following occurs as the nonprice restrictions put on borrowers as a condition of borrowing increase? A) The willingness of market participants to borrow decreases. B) The absolute dollar value borrowed increases. C) At every interest rate the demand for loanable funds increases. Answer: A Difficulty: 2 Medium Topic: Interest rate theories Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 06-05 Understand how equilibrium interest rates are determined. 119) Which of the following occurs as domestic economic conditions experience a period of growth especially relative to other countries? A) Market participants are willing to borrow more heavily. B) At every interest rate the supply of loanable funds increases. C) At every interest rate the demand for loanable funds increases. D) All of these choices are correct. Answer: D Difficulty: 2 Medium Topic: Interest rate theories Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 06-05 Understand how equilibrium interest rates are determined.; 06-04 Know the main suppliers and demanders of loanable funds.

Finance, 5e (Cornett) Chapter 7 Valuing Bonds 1) Which of these statements is false? A) Bonds are a more important capital sources than stocks for companies and governments. B) Some bonds offer high potential for rewards and, consequently, higher risk. C) The bond market is larger than the stock market. D) Bonds are always less risky than stocks. Answer: D Difficulty: 1 Easy Topic: Bond features Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 07-01 Describe bond characteristics. 2) A bond's main characteristics include? A) The date the principal will be paid B) The par value of each bond C) The coupon rate D) All of the above Answer: D Difficulty: 1 Easy Topic: Bond features Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 07-01 Describe bond characteristics. 3) Bonds are issued by which of the following? A) corporations B) federal government or its agencies C) state and local governments D) All of these choices are correct. Answer: D Difficulty: 1 Easy Topic: Bond types Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 07-01 Describe bond characteristics.

4) Which of these statements answers why bonds are known as fixed income securities? A) Many investors on fixed incomes buy them. B) Investors know how much they will receive in interest payments. C) Investors will not receive their principal when the bond's term is up. D) All of the options. Answer: B Difficulty: 1 Easy Topic: Bond features Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 07-01 Describe bond characteristics. 5) The interest rate used to compute the bond's interest payment each year refers to: A) Coupon rate B) Par value C) Bond price D) None of the above Answer: A Difficulty: 1 Easy Topic: Indenture provisions Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 07-01 Describe bond characteristics. 6) Regarding a bond's characteristics, which of the following is the principal loan amount that the borrower must repay? A) call premium B) maturity date C) par or face value D) time to maturity value Answer: C Difficulty: 1 Easy Topic: Bond features Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 07-01 Describe bond characteristics.

7) To compensate the bondholders for getting the bond called, the issuer pays which of the following? A) call feature B) call premium C) coupon rate D) original issue premium Answer: B Difficulty: 1 Easy Topic: Bond features Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 07-01 Describe bond characteristics. 8) Which of the following determines the dollar amount of interest paid to bondholders? A) original issue discount B) call premium C) coupon rate D) market rate Answer: C Difficulty: 1 Easy Topic: Bond coupons Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 07-01 Describe bond characteristics. 9) Bond prices are quoted in terms of which of the following? A) original issue discount B) percent of par value C) coupon rate in dollars D) market rate in dollars Answer: B Difficulty: 1 Easy Topic: Bond quotes and trading Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 07-01 Describe bond characteristics.

10) Which of the following are main issues of bonds? A) U.S. Treasury bonds B) corporate bonds C) municipal bonds D) All of these choices are correct. Answer: D Difficulty: 1 Easy Topic: Bond types Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 07-02 Identify various bond issuers and their motivation for issuing debt. 11) Which of the following statements is true? A) Interest payments paid to U.S. Treasury bondholders are not taxed at the federal level. B) Interest payments paid to corporate bondholders are not taxed at the federal level. C) Interest payments paid to corporate bondholders are not taxed at the state level. D) Interest payments paid to municipal bondholders are not taxed at the federal level, or by the state for which the bond is issued. Answer: D Difficulty: 2 Medium Topic: Bond types Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 07-02 Identify various bond issuers and their motivation for issuing debt. 12) Which of the following issues Treasury Inflation Protected Securities (TIPS)? A) U.S. Treasury B) corporations C) municipalities D) nonprofits Answer: A Difficulty: 1 Easy Topic: Bond types Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 07-02 Identify various bond issuers and their motivation for issuing debt.

13) Which of the following is true regarding U.S. Government Agency Securities? A) They carry the federal government's full faith and credit guarantee. B) They do not carry the federal government's full faith and credit guarantee. C) They are insured by the FDIC. D) They are treated the same as U.S. Treasury bonds with regard to the federal government's full faith and credit guarantee. Answer: B Difficulty: 2 Medium Topic: Bond types Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 07-02 Identify various bond issuers and their motivation for issuing debt. 14) Which of the following is a debt security whose payments originate from other loans, such as credit card debt, auto loans, and home equity loans? A) asset-backed securities B) credit quality securities C) debentures D) junk bonds Answer: A Difficulty: 1 Easy Topic: Bond types Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 07-02 Identify various bond issuers and their motivation for issuing debt. 15) Which of the following statement(s) below is true regarding asset-backed securities? A) Investors receive interest and principle as borrowers pay off their consumer loans. B) Give the investors a choice between the par value or a specified number of shares of stock. C) Is one of the fastest growing areas in the financial services sector. D) Both a and c are true. Answer: D Difficulty: 1 Easy Topic: Bond types Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 07-02 Identify various bond issuers and their motivation for issuing debt.

16) Which of the following is NOT a factor that determines the coupon rate of a company's bonds? A) the amount of uncertainty about whether the company will be able to make all the payments. B) the term of the loan. C) the level of interest rates in the overall economy at the time. D) All of these choices are correct. Answer: D Difficulty: 1 Easy Topic: Bond coupons Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 07-03 Read and interpret bond quotes. 17) Which of the following bonds makes no interest payments? A) a bond whose coupon rate is equal to the market interest rates B) a bond whose coupon rates are greater than market interest rates C) a bond whose coupon rates are less than the market interest rates D) zero-coupon bond Answer: D Difficulty: 1 Easy Topic: Bond types Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 07-04 Compute bond prices using present value concepts. 18) Which of the following is a true statement? A) If interest rates fall, U.S. Treasury bonds will have decreasing values. B) If interest rates fall, corporate bonds will have decreasing values. C) If interest rates fall, no bonds will enjoy rising values. D) If interest rates fall, all bonds will enjoy rising values. Answer: D Difficulty: 1 Easy Topic: Interest rate risk Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 07-05 Explain the relationship between bond prices and interest rates.

19) Which of the following statements about interest rate risk is NOT true? A) Long-term bondholders do not experience much interest rate risk. B) Interest rate risk does not affect all bonds the same. C) Bondholders can experience distinct gains and losses during periods when interest rates change quickly. D) None of the above. Answer: A Difficulty: 1 Easy Topic: Interest rate risk Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 07-05 Explain the relationship between bond prices and interest rates. 20) Which of the following terms means that during periods when interest rates change substantially, bondholders experience distinct gains and losses in their bond investments? A) credit quality risk B) interest rate risk C) liquidity rate risk D) reinvestment rate risk Answer: B Difficulty: 1 Easy Topic: Interest rate risk Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 07-05 Explain the relationship between bond prices and interest rates. 21) Which of the following terms means the chance that future interest payments will have to be reinvested at a lower interest rate? A) credit quality risk B) interest rate risk C) liquidity rate risk D) reinvestment rate risk Answer: D Difficulty: 1 Easy Topic: Bond yields and returns Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 07-05 Explain the relationship between bond prices and interest rates.

22) Which of the following terms is a comparison of market yields on securities, assuming all characteristics except maturity are the same? A) credit quality risk B) interest rate risk C) liquidity of interest rate risk D) term structure of interest rates Answer: D Difficulty: 1 Easy Topic: Bond yields and returns Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 07-05 Explain the relationship between bond prices and interest rates. 23) A bond's current yield is defined as A) the bond's annual coupon rate divided by the bond's par value. B) the bond's annual coupon rate divided by the market interest rate. C) the bond's annual coupon rate divided by the bond's current market price. D) the bond's annual coupon rate divided by the bond's original issue price. Answer: C Difficulty: 1 Easy Topic: Bond yields and returns Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 07-06 Compute bond yields. 24) Which of the following is an important advantage to the issuer of a bond with a call provision? A) They are able to avoid interest rate risk. B) They are able to avoid reinvestment rate risk. C) They are able to reduce their credit risk. D) They allow for refinancing opportunities. Answer: D Difficulty: 1 Easy Topic: Bond features Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 07-06 Compute bond yields.

25) Which of the following is a reason municipal bonds offer lower rates of interest income for their investors? A) They are able to avoid interest rate risk. B) They are able to avoid reinvestment rate risk. C) They are able to offer reduced credit risk as they are backed by the federal government. D) They are tax exempt—at least at the federal level. Answer: D Difficulty: 1 Easy Topic: Bond features Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 07-06 Compute bond yields. 26) Which Standard & Poor's Bond credit rating does the following description belong to? "Currently highly vulnerable to non-payment." A) Highly speculative CCC B) Most speculative CC C) Imminent default C D) Default D Answer: B Difficulty: 1 Easy Topic: Bond ratings and credit risk Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 07-07 Find bond ratings and assess credit risk's effects on bond yields. 27) Which of the following terms is the chance that the bond issuer will not be able to make timely payments? A) credit quality risk B) interest rate risk C) liquidity of interest rate risk D) term structure of interest rates Answer: A Difficulty: 1 Easy Topic: Bond ratings and credit risk Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 07-07 Find bond ratings and assess credit risk's effects on bond yields.

28) Which of the following bonds carry significant risk that the issuer will not make current or future payments? A) credit quality risk bonds B) interest rate risk bonds C) liquidity rate risk bonds D) junk bonds Answer: D Difficulty: 1 Easy Topic: Bond ratings and credit risk Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 07-07 Find bond ratings and assess credit risk's effects on bond yields. 29) Determine the semi-annual interest payment for the following three bonds: 5.5 percent coupon corporate bond, 6.45 percent coupon Treasury note, and a corporate zero-coupon bond maturing in 10 years. (Assume a $1,000 par value.) A) $5.50, $6.45, $0, respectively B) $27.50, $32.25, $0, respectively C) $27.50, $32.25, $100, respectively D) $55.00, $64.50, $0, respectively Answer: B Explanation: 5.5 percent coupon corporate bond (paid semiannually): 0.5 × 5.5% × $1,000 = $27.50. 6.45 percent coupon Treasury note: 0.5 × 6.45% × $1,000 = $32.25. Corporate zero-coupon bond maturing in 10 years: 0% × $1,000 = $0. Difficulty: 1 Easy Topic: Bond coupons Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 07-01 Describe bond characteristics.

30) Determine the semi-annual interest payment for the following three bonds: 2.5 percent coupon corporate bond, 3.15 percent coupon Treasury note, and a corporate zero-coupon bond maturing in 10 years. (Assume a $1,000 par value.) A) $2.50, $3.15, $0, respectively B) $12.50, $15.75, $0, respectively C) $12.50, $15.75, $100, respectively D) $25.00, $31.50, $0, respectively Answer: B Explanation: 2.5 percent coupon corporate bond (paid semiannually): 0.5 × 2.5% × $1,000 = $12.50. 3.15 percent coupon Treasury note: 0.5 × 3.15% × $1,000 = $15.75. Corporate zero-coupon bond maturing in 10 years: 0% × $1,000 = $0. Difficulty: 1 Easy Topic: Bond coupons Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 07-01 Describe bond characteristics. 31) Determine the semi-annual interest payment for the following three bonds: 4 percent coupon corporate bond, 4.75 percent coupon Treasury note, and a corporate zero-coupon bond maturing in 15 years. (Assume a $1,000 par value.) A) $4.00, $4.75, $0, respectively B) $20.00, $23.75, $0, respectively C) $20.00, $23.75, $150, respectively D) $40.00, $47.50, $0, respectively Answer: B Explanation: 4 percent coupon corporate bond (paid semiannually): 0.5 × 4% × $1,000 = $20.00. 4.75 percent coupon Treasury note: 0.5 × 4.75% × $1,000 = $23.75. Corporate zero-coupon bond maturing in 10 years: 0% × $1,000 = $0. Difficulty: 1 Easy Topic: Bond coupons Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 07-01 Describe bond characteristics.

32) A bond issued by a corporation on June 15, 2007, is scheduled to mature on June 15, 2017. If today is December 16, 2008, what is this bond's time to maturity? (Assume annual interest payments.) A) 1 year, 6 months B) 8 years C) 8 years, 6 months D) 10 years Answer: C Explanation: June 15, 2017 minus December 16, 2008 = 8 years and 6 months. Difficulty: 1 Easy Topic: Time to maturity Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 07-01 Describe bond characteristics. 33) A bond issued by a corporation on May 1, 1999, is scheduled to mature on May 1, 2019. If today is May 2, 2009, what is this bond's time to maturity? (Assume annual interest payments.) A) 9 years B) 10 years C) 19 years D) 20 years Answer: B Explanation: May 1, 2019 minus May 2, 2009 = 10 years and 0 months. Difficulty: 1 Easy Topic: Time to maturity Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 07-01 Describe bond characteristics.

34) A bond issued by a corporation on October 1, 2007, is scheduled to mature on October 1, 3007. If today is October 2, 2009, what is this bond's time to maturity? (Assume annual interest payments.) A) 2 years B) 50 years C) 998 years D) 100 years Answer: C Explanation: October 1, 3007 minus October 2, 2009 = 998 years. Difficulty: 1 Easy Topic: Time to maturity Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 07-01 Describe bond characteristics. 35) A 5.5 percent corporate coupon bond is callable in four years for a call premium of one year of coupon payments. Assuming a par value of $1,000, what is the price paid to the bondholder if the issuer calls the bond? (Assume annual interest payments.) A) $55 B) $220 C) $1,000 D) $1,055 Answer: D Explanation: Principal + Call premium = $1,000 + 5.5% × $1,000 = $1,055. Difficulty: 1 Easy Topic: Bond features Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 07-01 Describe bond characteristics.

36) A 6 percent corporate coupon bond is callable in 10 years for a call premium of one year of coupon payments. Assuming a par value of $1,000, what is the price paid to the bondholder if the issuer calls the bond? A) $60 B) $600 C) $1,000 D) $1,060 Answer: D Explanation: Principal + Call premium = $1,000 + 6% × $1,000 = $1,060. Difficulty: 1 Easy Topic: Bond features Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 07-01 Describe bond characteristics. 37) A 4.5 percent corporate coupon bond is callable in five years for a call premium of one year of coupon payments. Assuming a par value of $1,000, what is the price paid to the bondholder if the issuer calls the bond? A) $45 B) $225 C) $1,000 D) $1,045 Answer: D Explanation: Principal + Call premium = $1,000 + 4.5% × $1,000 = $1,045. Difficulty: 1 Easy Topic: Bond features Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 07-01 Describe bond characteristics.

38) A 2.5 percent TIPS has an original reference CPI of 170.4. If the current CPI is 205.7, what is the current interest payment and par value of the TIPS? (Assume semiannual interest payments and $1,000 par value.) A) $7.16, $1,000, respectively B) $15.09, $1,000, respectively C) $7.16, $1,207.16, respectively D) $15.09, $1,207.16, respectively Answer: D Explanation: Interest payment = 0.5 × 2.5% × $1,207.16 = $15.09. Par value = 205.7/170.4 × $1,000 = $1,207.16. Difficulty: 1 Easy Topic: Bond coupons Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 07-02 Identify various bond issuers and their motivation for issuing debt. 39) A 3.75 percent TIPS has an original reference CPI of 175.8. If the current CPI is 207.7, what is the current interest payment and par value of the TIPS? (Assume semiannual interest payments and $1,000 par value.) A) $18.75, $1,000, respectively B) $37.50, $1,000, respectively C) $22.15, $1,181.46, respectively D) $37.50, $1,181.46, respectively Answer: C Explanation: Interest payment = 0.5 × 3.75% × $1,181.46 = $22.15. Par value = 207.7/175.8 × $1,000 = $1,181.4562. Difficulty: 1 Easy Topic: Bond coupons Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 07-02 Identify various bond issuers and their motivation for issuing debt.

40) Consider the following three bond quotes; a Treasury note quoted at 87.25, and a corporate bond quoted at 102.42, and a municipal bond quoted at 101.45. If the Treasury and corporate bonds have a par value of $1,000 and the municipal bond has a par value of $5,000, what is the price of these three bonds in dollars? A) $872.50, $1,000, $1,000, respectively B) $1,000, $1,000, $1,000, respectively C) $872.50, $1,024.20, $5,072.50, respectively D) $1,000, $1,024.20, $1,001.45, respectively Answer: C Explanation: Treasury note at 87.25: 87.25% × $1,000 = $872.50. Corporate bond at 102.42: 102.42% × $1,000 = $1,024.20. Municipal bond at 101.45: 101.45% × $5,000 = $5,072.50. Difficulty: 1 Easy Topic: Bond quotes and trading Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 07-03 Read and interpret bond quotes. 41) Consider the following three bond quotes; a Treasury note quoted at 102.30, and a corporate bond quoted at 99.45, and a municipal bond quoted at 102.45. If the Treasury and corporate bonds have a par value of $1,000 and the municipal bond has a par value of $5,000, what is the price of these three bonds in dollars? A) $1,002.30, $1,000, $1,000, respectively B) $1,000, $1,000, $5,000, respectively C) $1,002.30, $994.50, $5,012.25 respectively D) $1,023.00, $994.50, $5,122.50, respectively Answer: D Explanation: Treasury note at 102.30: 102.30% × $1,000 = $1,023.00. Corporate bond at 99.45: 99.45% × $1,000 = $994.50. Municipal bond at 102.45: 102.45% × $5,000 = $5,122.50. Difficulty: 1 Easy Topic: Bond quotes and trading Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 07-03 Read and interpret bond quotes.

42) Calculate the price of a zero-coupon bond that matures in 10 years if the market interest rate is 6 percent. (Assume semiannual compounding and $1,000 par value.) A) $553.68 B) $558.66 C) $940.00 D) $1,000.00 Answer: A Explanation: Use semiannual compounding: PV =

= $553.6792

Difficulty: 1 Easy Topic: Bond valuation Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 07-04 Compute bond prices using present value concepts. 43) Calculate the price of a zero-coupon bond that matures in five years if the market interest rate is 7.50 percent. (Assume semiannual compounding and $1,000 par value.) A) $692.04 B) $696.57 C) $962.50 D) $1,000.00 Answer: A Explanation: Use semi-annual compounding: PV =

= $692.04

Difficulty: 1 Easy Topic: Bond valuation Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 07-04 Compute bond prices using present value concepts.

44) What's the current yield of a 6 percent coupon corporate bond quoted at a price of 101.70? A) 5.9 percent B) 6.0 percent C) 6.1 percent D) 10.2 percent Answer: A Explanation: 6% ÷ 101.7% = 0.058997 = 5.9%. Difficulty: 1 Easy Topic: Bond yields and returns Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 07-06 Compute bond yields. 45) What's the current yield of a 5.75 percent coupon corporate bond quoted at a price of 103.05? A) 5.58 percent B) 5.75 percent C) 5.93 percent D) 17.54 percent Answer: A Explanation: 5.75% ÷ 103.05% = 0.055798 = 5.58%. Difficulty: 1 Easy Topic: Bond yields and returns Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 07-06 Compute bond yields. 46) What's the current yield of an 8.15 percent coupon corporate bond quoted at a price of 94.30? A) 4.30 percent B) 8.01 percent C) 8.15 percent D) 8.64 percent Answer: D Explanation: 8.15% ÷ 94.30% = 0.08643 = 8.6%. Difficulty: 1 Easy Topic: Bond yields and returns Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 07-06 Compute bond yields.

47) What's the taxable equivalent yield on a municipal bond with a yield to maturity of 3.9 percent for an investor in the 35 percent marginal tax bracket? A) 1.09% B) 3.90% C) 6.00% D) 11.14% Answer: C Explanation: Use Equation 6.4: Equivalent taxable yield =

= 6%

Difficulty: 1 Easy Topic: Bond yields and returns Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 07-06 Compute bond yields. 48) What is the taxable equivalent yield on a municipal bond with a yield to maturity of 4.5 percent for an investor in the 39 percent marginal tax bracket? A) 1.76 percent B) 4.50 percent C) 7.38 percent D) 11.54 percent Answer: C Explanation: Use Equation 6.4: Equivalent taxable yield =

= 7.38%

Difficulty: 1 Easy Topic: Bond yields and returns Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 07-06 Compute bond yields.

49) Rank the following bonds in order from lowest credit risk to highest risk all with the same time to maturity, by their yield to maturity: JM Corporate bond with yield of 12.25 percent, IB Corporate bond with yield of 4.49 percent, TC Corporate bond with yield of 8.76 percent, and B&O Corporate bond with a yield of 5.99 percent. A) JM bond, TC bond, B&O bond, IB bond B) IB bond, B&O bond, TC bond, JM bond C) TC bond, B&O bond, IB bond, JM bond D) JM bond, IB bond, B&O bond, TC bond Answer: B Explanation: IB bond with a yield of 4.49 percent B&O bond with yield of 5.99 percent TC bond with yield of 8.76 percent JM bond with yield of 12.25 percent Difficulty: 1 Easy Topic: Bond ratings and credit risk Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 07-07 Find bond ratings and assess credit risk's effects on bond yields. 50) Consider a 2.75 percent TIPS with an issue CPI reference of 184.2. At the beginning of this year, the CPI was 195.4 and was at 200.5 at the end of the year. What was the capital gain of the TIPS in dollars this year? A) $5.10 B) $11.20 C) $16.30 D) $27.69 Answer: D Explanation: Gain = End of year value − Beginning of year value = 200.5/184.2 × $1,000 − 195.4/184.2 × $1,000 = $1,088.49 − $1,060.80 = $27.69. Difficulty: 2 Medium Topic: Bond valuation Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 07-02 Identify various bond issuers and their motivation for issuing debt.

51) Consider a 3.25 percent TIPS with an issue CPI reference of 186.7. At the beginning of this year, the CPI was 197.5 and was at 202.4 at the end of the year. What was the capital gain of the TIPS in dollars? (Assume semi-annual interest payments and $1,000 par value.) A) $4.90 B) $10.80 C) $15.70 D) $26.25 Answer: D Explanation: Gain = End of year value − Beginning of year value = 202.4/186.7 × $1,000 − 197.5/186.7 × $1,000 = $1,084.09 − $1,057.85 = $26.25. Difficulty: 2 Medium Topic: Bond valuation Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 07-02 Identify various bond issuers and their motivation for issuing debt. 52) Consider a 3.75 percent TIPS with an issue CPI reference of 183.5. At the beginning of this year, the CPI was 190.6 and was at 199.4 at the end of the year. What was the capital gain of the TIPS in percentage terms? (Assume semiannual interest payments and $1,000 par value.) A) 3.75 percent B) 4.62 percent C) 7.10 percent D) 8.80 percent Answer: B Explanation: Gain = End of year value − Beginning of year value = 199.4/183.5 × $1,000 − 190.6/183.5 × $1,000 = $1,086.65 − $1,038.69 = $47.96 As a percentage, the gain was = $47.96 ÷ $1,038.69 = 4.62%. Difficulty: 2 Medium Topic: Bond valuation Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 07-02 Identify various bond issuers and their motivation for issuing debt.

53) Compute the price of a 4.75 percent coupon bond with 15 years left to maturity and a market interest rate of 6.25 percent. (Assume interest payments are semiannual and par value is $1,000.) Is this a discount or premium bond? A) discount B) premium Answer: A Explanation: N = 30, I = 3.125, PMT = 23.75, FV = 1000, CPT PV = −855.34 Since this is less than $1,000, it is a discount bond. Difficulty: 2 Medium Topic: Bond valuation Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 07-04 Compute bond prices using present value concepts. 54) Compute the price of a 6 percent coupon bond with 10 years left to maturity and a market interest rate of 8.75 percent. (Assume interest payments are semiannual and par value is $1,000.) Is this a discount or premium bond? A) discount B) premium Answer: A Explanation: N = 20, I = 4.375, PMT = 30, FV = 1000, CPT PV = −819.19 Since this is less than $1,000, it is a discount bond. Difficulty: 2 Medium Topic: Bond valuation Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 07-04 Compute bond prices using present value concepts.

55) A 6 percent coupon bond with 12 years left to maturity is priced to offer a 6.5 percent yield to maturity. You believe that in one year, the yield to maturity will be 6.25 percent. What is the change in price the bond will experience in dollars? (Assume semiannual interest payments and $1,000 par value.) A) $25.00 B) $21.55 C) $53.48 D) $80.37 Answer: B Explanation: Compute the current bond price: N = 24, I = 3.25, PMT = 30, FV = 1000, CPT PV = −958.78 Now compute the price in one year: N = 22, I = 3.125, PMT = 30, FV = 1000, CPT PV = −980.33 So the dollar change in price is: $980.33 − $958.78 = $21.55. Difficulty: 2 Medium Topic: Interest rate risk Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 07-05 Explain the relationship between bond prices and interest rates. 56) A 5.5 percent coupon bond with 18 years left to maturity is priced to offer a 6.25 percent yield to maturity. You believe that in one year, the yield to maturity will be 5.75 percent. What is the change in price the bond will experience in dollars? (Assume semiannual interest payments and $1,000 par value.) A) $25.00 B) $26.89 C) $53.48 D) $80.37 Answer: C Explanation: Compute the current bond price: N = 36, I = 3.125, PMT = 27.50, FV = 1000, CPT PV = −919.63 Now compute the price in one year: N = 34, I = 2.875, PMT = 27.50, FV = 1000, CPT PV = −973.11 So the dollar change in price is: $973.11 − $919.63 = $53.48. Difficulty: 2 Medium Topic: Interest rate risk Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 07-05 Explain the relationship between bond prices and interest rates.

57) A 5.75 percent coupon bond with 12 years left to maturity is offered for sale at $978.83. What yield to maturity is the bond offering? (Assume interest payments are paid semiannually and par value is $1,000.) A) 3.00 percent B) 3.09 percent C) 5.75 percent D) 6.00 percent Answer: D Explanation: N = 24, PV = −978.83, PMT = 28.75, FV = 1000, CPT I = 3%, YTM = 3% × 2 = 6% Difficulty: 2 Medium Topic: Bond yields and returns Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 07-06 Compute bond yields. 58) A 4.25 percent coupon bond with eight years left to maturity is offered for sale at $983.36. What yield to maturity is the bond offering? (Assume interest payments are paid semiannually and par value is $1,000.) A) 2.25 percent B) 2.36 percent C) 4.25 percent D) 4.50 percent Answer: D Explanation: N = 16, PV = −983.36, PMT = 21.25, FV = 1000, CPT I = 2.25%, YTM = 2.25% × 2 = 4.50% Difficulty: 2 Medium Topic: Bond yields and returns Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 07-06 Compute bond yields.

59) A 7.25 percent coupon bond with 25 years left to maturity can be called in five years. The call premium is one year of coupon payments. It is offered for sale at $1,066.24. What is the yield to call of the bond? (Assume that interest payments are paid semiannually and par value is $1,000.) A) 3.41 percent B) 3.45 percent C) 3.51 percent D) 6.90 percent Answer: D Explanation: N = 10, PV = −1066.24, PMT = 36.25, FV = 1072.50, CPT I = 3.45%, YTC = 3.45% × 2 = 6.90% Difficulty: 2 Medium Topic: Bond yields and returns Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 07-06 Compute bond yields. 60) A 4.75 percent coupon bond with 12 years left to maturity can be called in two years. The call premium is one year of coupon payments. It is offered for sale at $1037.35. What is the yield to call of the bond? (Assume that interest payments are paid semiannually and par value is $1,000.) A) 4.60 percent B) 4.68 percent C) 4.75 percent D) 5.05 percent Answer: D Explanation: N = 4, PV = −1037.35, PMT = 23.75, FV = 1047.50, CPT I = 2.525%, YTC = 2.525% × 2 = 5.05% Difficulty: 2 Medium Topic: Bond yields and returns Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 07-06 Compute bond yields.

61) A client in the 33 percent marginal tax bracket is comparing a municipal bond that offers a 5 percent yield to maturity and a similar-risk corporate bond that offers a 6.25 percent yield. Which bond will give the client more profit after taxes? A) the municipal bond. B) the corporate bond. C) Both give the client equal profits after taxes. D) There is not enough information given to determine the answer. Answer: A Explanation: First determine the ETY: Equivalent taxable yield =

= 7.46%

Since 7.46% > 6.25%, the client should take the municipal bond. Difficulty: 2 Medium Topic: Bond yields and returns Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 07-06 Compute bond yields. 62) A client in the 28 percent marginal tax bracket is comparing a municipal bond that offers a 3.25 percent yield to maturity and a similar-risk corporate bond that offers a 4.10 percent yield. Which bond will give the client more profit after taxes? A) the municipal bond. B) the corporate bond. C) Both give the client equal profits after taxes. D) There is not enough information given to determine the answer. Answer: A Explanation: First determine the ETY: Equivalent taxable yield =

= 4.51%

Since 4.51% > 4.1%, the client should take the municipal bond. Difficulty: 2 Medium Topic: Bond yields and returns Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 07-06 Compute bond yields.

63) A client in the 35 percent marginal tax bracket is comparing a municipal bond that offers a 4.25 percent yield to maturity and a similar-risk corporate bond that offers a 5.10 percent yield. Which bond will give the client more profit after taxes? A) the municipal bond. B) the corporate bond. C) Both give the client equal profits after taxes. D) There is not enough information given to determine answer. Answer: A Explanation: First determine the ETY: Equivalent taxable yield =

= 6.54%

Since 6.54% > 5.1%, the client should take the municipal bond. Difficulty: 2 Medium Topic: Bond yields and returns Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 07-06 Compute bond yields. 64) Reconsider a 3.25 percent TIPS that was issued with CPI reference of 186.7. The bond is purchased at the beginning of the year (after the interest payment), when the CPI was 197.5. For the interest in the middle of the year, the CPI was 201.1. Now, at the end of the year, the CPI is 202.4 and the interest payment has been made. What is the total return of the TIPS in percentage terms for the year? (Assume semiannual interest payments and $1,000 par value.) A) 1.6 percent B) 2.4 percent C) 5.8 percent D) 9.1 percent Answer: C Explanation: Capital gain = End of year value − Beginning of year value = 202.4/186.7 × $1,000 − 197.5/186.7 × $1,000 = $1,084.09 − $1,057.85 = $26.24. The mid-year interest payment was: 0.5 × 3.25% × 201.1/186.7 × $1,000 = $17.50. The end-of-year interest payment was: 0.5 × 3.25% × 202.4/186.7 × $1,000 = $17.62. Total dollar return = $26.24 + $17.50 + $17.62 = $61.36. As a percentage, the return was = $61.36 ÷ $1,057.85 = 5.8%. Difficulty: 3 Hard Topic: Bond yields and returns Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 07-02 Identify various bond issuers and their motivation for issuing debt. 27

65) A 6.75 percent coupon bond with 10 years left to maturity is priced to offer a 6.5 percent yield to maturity. You believe that in one year, the yield to maturity will be 6.65 percent. If this occurs, what would be the total return of the bond in percent? (Assume semiannual interest payments and $1,000 par value.) A) 5.5 percent B) 5.6 percent C) 6.6 percent D) 6.7 percent Answer: A Explanation: Compute the current bond price: N = 20, I = 3.25, PMT = 33.75, FV = 1000, CPT PV = −1018.17 Now compute the price in one year: N = 18, I = 3.325, PMT = 33.75, FV = 1000, CPT PV = −1006.69 So the dollar change in price + interest payments are: $1,006.69 − $1,018.17 + $67.50 = $56.02. The percentage return is: $56.02 ÷ $1,018.17 = 5.5%. Difficulty: 3 Hard Topic: Bond yields and returns Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 07-05 Explain the relationship between bond prices and interest rates.

66) A 7.25 percent coupon bond with 25 years left to maturity is priced to offer a 7 percent yield to maturity. You believe that in one year, the yield to maturity will be 7.15 percent. If this occurs, what would be the total return of the bond in percent? (Assume semiannual interest payments and $1,000 par value.) A) 3.5 percent B) 5.3 percent C) 7.0 percent D) 7.15 percent Answer: B Explanation: Compute the current bond price: N = 50, I = 3.5, PMT = 36.25, FV = 1000, CPT PV = −1029.32 Now compute the price in one year: N = 48, I = 3.575, PMT = 36.25, FV = 1000, CPT PV = −1011.40 So the dollar change in price + interest payments are: $1011.40 − $1029.32 + $72.50 = $54.58 The percentage return is: $54.58 ÷ $1,029.32 = 5.3% Difficulty: 3 Hard Topic: Bond yields and returns Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 07-05 Explain the relationship between bond prices and interest rates. 67) A 3.25 percent coupon municipal bond has 12 years left to maturity and has a price quote of 98.75. The bond can be called in five years. The call premium is one year of coupon payments. What is the bond's taxable equivalent yield for an investor in the 35 percent marginal tax bracket? (Assume interest payments are paid semiannually and a par value of $5,000.) A) 3.38 percent B) 5.00 percent C) 5.20 percent D) 10.12 percent Answer: C Explanation: YTM: N = 24, PV = −4937.50, PMT = 81.25, FV = 5000, CPT I = 1.69%, YTM = 1.69% × 2 = 3.38%. Equivalent taxable yield =

= 5.2%

Difficulty: 3 Hard Topic: Bond yields and returns Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 07-06 Compute bond yields. 29

68) A 4.5 percent coupon municipal bond has 10 years left to maturity and has a price quote of 97.75. The bond can be called in four years. The call premium is one year of coupon payments. What is the bond's taxable equivalent yield for an investor in the 33 percent marginal tax bracket? (Assume interest payments are paid semiannually and a par value of $5,000.) A) 4.5 percent B) 4.78 percent C) 7.13 percent D) 14.48 percent Answer: C Explanation: YTM: N = 20, PV = −4887.50, PMT = 112.50, FV = 5000, CPT I = 2.39%, YTM = 2.39% × 2 = 4.78%. Equivalent taxable yield =

= 7.13%

Difficulty: 3 Hard Topic: Bond yields and returns Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 07-06 Compute bond yields. 69) A corporate bond with a 5.75 percent coupon has 15 years left to maturity. It has had a credit rating of BB and a yield to maturity of 6.25 percent. The firm has recently gotten more financially stable and the rating agency is upgrading the bonds to BBB. The new appropriate discount rate will be 6.00 percent. What will be the change in the bond's price in dollars? (Assume interest payments are paid semiannually and a par value of $1,000.) A) decrease $22.25 B) increase $22.25 C) decrease $23.72 D) increase $23.72 Answer: D Explanation: Compute the current bond price: N = 30, I = 3.125, PMT = 28.75, FV = 1000, CPT PV = −951.78 Now compute the price after the rating change: N = 30, I = 3.00, PMT = 28.75, FV = 1000, CPT PV = −975.50 So the dollar change in price is: $975.50 − $951.78 = $23.72. Difficulty: 3 Hard Topic: Bond ratings and credit risk Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 07-07 Find bond ratings and assess credit risk's effects on bond yields. 30

70) Which of the following was the catalyst for the recent financial crisis? A) corruption in the investment banking industry B) widespread layoffs due to illegal alien hiring C) defaults on subprime mortgages D) All of these choices are correct. Answer: C Difficulty: 1 Easy Topic: Debt market performance and considerations Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 07-02 Identify various bond issuers and their motivation for issuing debt. 71) Which of the following is NOT true about EE savings bonds? A) Interest payments are received annually but are tax deductible. B) About one in six Americans owns a savings bond. C) These are tax deferred investments. D) Paper bonds sell for one-half of their face value. Answer: A Difficulty: 1 Easy Topic: Bond types Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 07-02 Identify various bond issuers and their motivation for issuing debt. 72) If Zeus Energy bonds are upgraded from BBB− to BBB+, which of the following statements is true? A) The current bond price will decrease and interest rates on new bonds issued will increase. B) Interest rates required on new bonds issued will increase. C) The current bond price will decrease. D) The current bond price will increase and interest rates on new bonds issued will decrease. Answer: D Difficulty: 1 Easy Topic: Bond ratings and credit risk Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 07-07 Find bond ratings and assess credit risk's effects on bond yields.

73) A 6.5 percent coupon bond with 12 years left to maturity can be called in four years. The call premium is one year of coupon payments. It is offered for sale at $1,190.25. What is the yield to call of the bond? (Assume interest payments are paid semiannually and par value is $1,000.) A) 1.48 percent B) 2.96 percent C) 6.5 percent D) 7.23 percent Answer: B Explanation: PV = 1190.25; PMT = 32.50; N = 8; FV = 1065; => I = 1.48 YTC = 1.48 × 2 = 2.96 Difficulty: 2 Medium Topic: Bond yields and returns Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 07-06 Compute bond yields. 74) A 7.5 percent coupon bond with 16 years left to maturity is offered for sale at $834.92. What yield to maturity is the bond offering? (Assume interest payments are paid semiannually and par value is $1,000.) A) 4.77 percent B) 7.5 percent C) 9.54 percent D) 10.34 percent Answer: C Explanation: PV = 834.92; PMT = 37.5; FV = 1000; N = 32; => I = 4.77; 4.77 × 2 = 9.54 Difficulty: 2 Medium Topic: Bond yields and returns Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 07-06 Compute bond yields.

75) An 8 percent coupon bond with 15 years to maturity is priced to offer a 9 percent yield to maturity. You believe that in one year, the yield to maturity will be 6.5 percent. What is the change in price the bond will experience in dollars? (Assume annual interest payments and par value is $1,000.) A) $163.92 B) $176.15 C) $198.45 D) $215.82 Answer: D Explanation: Step 1: PMT = 80; FV = 1000; N = 15; I = 9; => PV = 919.39. Step 2: I = 6.5; PMT = 80; N = 14; FV = 1000; => PV = 1135.21. Step 3: 1135.21 − 919.39 = 215.82. Difficulty: 2 Medium Topic: Interest rate risk Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 07-05 Explain the relationship between bond prices and interest rates. 76) Calculate the price of a 6.5 percent coupon bond with 27 years left to maturity and a market interest rate of 5 percent. (Assume interest payments are semiannual and par value is $1,000.) Is this a discount or premium bond? A) $982.03; discount B) $1,010.59; discount C) $1,220.93; premium D) $1,315.62; premium Answer: C Explanation: PMT = 32.5; N = 54; FV = 1000; I = 2.5; => PV = 1220.93; premium Difficulty: 2 Medium Topic: Bond valuation Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 07-04 Compute bond prices using present value concepts.

77) Calculate the price of a 6.5 percent coupon bond with 17 years left to maturity and a market interest rate of 10.5%. (Assume interest rates are semiannual and par value is $1,000.) Is this a discount or premium bond? A) $685.93; discount B) $791.03; discount C) $1,051.83; premium D) $1,176.31; premium Answer: A Explanation: PMT = 32.5; FV = 1000; I = 5.25; N = 34; => PV = 685.93; discount Difficulty: 2 Medium Topic: Bond valuation Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 07-04 Compute bond prices using present value concepts. 78) Calculate the price of a zero-coupon bond that matures in 20 years if the market interest rate is 8.5 percent. (Assume annual compounding and a par value of $1,000.) A) $90.29 B) $195.62 C) $1,195.62 D) $995.62 Answer: B Explanation: PMT = 0; FV = 1000; N = 20; I = 8.5; => PV = 195.62 Difficulty: 1 Easy Topic: Bond valuation Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 07-04 Compute bond prices using present value concepts.

79) What is the taxable equivalent yield on a municipal bond with a yield to maturity of 4 percent for an investor in the 28 percent tax bracket? A) 2.88 percent B) 3.87 percent C) 4.51 percent D) 5.56 percent Answer: D Explanation: 4/(1 − 0.28) = 5.56. Difficulty: 1 Easy Topic: Bond yields and returns Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 07-06 Compute bond yields. 80) Rank from lowest credit risk to highest credit risk the following bonds, with the same time to maturity, by their yield to maturity: Treasury bond with yield of 5.55 percent, IBM bond with yield of 7.95 percent, Trump Casino bond with a yield of 9.15 percent and Banc Ono bond with a yield of 6.12 percent. A) Treasury, Trump Casino, Banc Ono, IBM B) Trump Casino, IBM, Banc Ono, Treasury C) Treasury, Banc Ono, IBM, Trump Casino D) Trump Casino, Banc Ono, IBM, Treasury Answer: C Explanation: Rank from lowest YTM to highest YTM. Difficulty: 1 Easy Topic: Bond ratings and credit risk Bloom's: Evaluate AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 07-07 Find bond ratings and assess credit risk's effects on bond yields.

81) Consider a 4.5 percent TIPS with an issue CPI reference of 187.2. At the beginning of this year, the CPI was 199.5 and was 213.7 at the end of the year. What was the capital gain of the TIPS in dollars? A) $32.73 B) $46.92 C) $62.49 D) $75.85 Answer: D Explanation: (213.7/187.2) × 1,000 − (199.5/187.2) × 1,000 = 75.85. Difficulty: 2 Medium Topic: Bond yields and returns Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 07-02 Identify various bond issuers and their motivation for issuing debt. 82) Rank from highest credit risk to lowest credit risk the following bonds, with the same time to maturity, by their yield to maturity: Treasury bond with yield of 6.55 percent, IBM bond with yield of 10.95 percent, Trump Casino bond with a yield of 9.15 percent, and Banc Ono bond with a yield of 9.46 percent. A) Treasury, Trump Casino, Banc Ono, IBM B) Banc Ono, Trump Casino, IBM, Treasury C) Trump Casino, Treasury, Banc Ono, IBM D) IBM, Banc Ono, Trump Casino, Treasury Answer: D Explanation: Rank from highest YTM to lowest YTM. Difficulty: 1 Easy Topic: Bond ratings and credit risk Bloom's: Evaluate AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 07-07 Find bond ratings and assess credit risk's effects on bond yields.

83) Consider the following bond quote: a municipal bond quoted at 101.25. If the municipal bond has a par value of $5,000, what is the price of the bond in dollars? A) $5,089.06 B) $5,050.19 C) $5,062.50 D) $5,109.75 Answer: C Explanation: 101.25% × 5,000 = 5,062.50. Difficulty: 1 Easy Topic: Bond quotes and trading Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 07-03 Read and interpret bond quotes. 84) A 3.75 percent TIPS has an original reference CPI of 183.9. If the current CPI is 214.7, what is the current interest payment? (Assume semiannual interest payments and a par value of $1,000.) A) $43.78 B) $37.50 C) $21.89 D) $18.75 Answer: C Explanation: 3.75% × (214.7/183.9) × 1,000/2 = 21.89. Difficulty: 1 Easy Topic: Bond coupons Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 07-02 Identify various bond issuers and their motivation for issuing debt.

85) A 5.125 percent TIPS has an original reference CPI of 191.8. If the current CPI is 188.3, what is the par value of the TIPS? A) $981.75 B) $1,018.60 C) $992.75 D) $1,042.95 Answer: A Explanation: 1,000 × (188.3/191.8) = 981.75. Difficulty: 1 Easy Topic: Bond valuation Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 07-02 Identify various bond issuers and their motivation for issuing debt. 86) A 7.5 percent coupon bond with nine years left to maturity is priced to offer a 10.4 percent yield to maturity. You believe that in one year, the yield to maturity will be 8 percent. What is the change in price the bond will experience in dollars? (Assume interest payments are semiannual and par value is $1,000.) A) $97.75 B) $101.50 C) $129.25 D) $137.75 Answer: D Explanation: Step 1: PMT = 37.50; FV = 1000; N = 18; I = 5.2; => PV = 833.12. Step 2: I = 4; PMT = 37.50; N = 16; FV = 1000; => PV = 970.87. Step 3: 970.87 − 833.12 = 137.75. Difficulty: 2 Medium Topic: Interest rate risk Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 07-05 Explain the relationship between bond prices and interest rates.

87) A 6.75 percent coupon bond with 13 years left to maturity can be called in two years. The call premium is one year of coupon payments. It is offered for sale at $919.75. What is the yield to call of the bond? Assume interest payments are paid semiannually and par value is $1,000. A) 12.14 percent B) 7.27 percent C) 14.54 percent D) 8.29 percent Answer: C Explanation: N = 4; PMT = 33.75; PV = 919.75; FV = 1067.50; => I = 7.27 YTC = 7.27 × 2 = 14.54 Difficulty: 2 Medium Topic: Bond yields and returns Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 07-06 Compute bond yields. 88) A 5.5 percent coupon municipal bond has 16 years left to maturity and has a price quote of 92.55. The bond can be called in nine years. The call premium is one year of coupon payments. Compute the bond's current yield. Assume interest payments are paid semiannually and a par value of $5,000. A) 5.94 percent B) 11.89 percent C) 12.19 percent D) 13.14 percent Answer: A Explanation: 5.5/92.55 = 0.0594. Difficulty: 2 Medium Topic: Bond yields and returns Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 07-06 Compute bond yields.

89) A 5.5 percent coupon municipal bond has 16 years left to maturity and has a price quote of 92.55. The bond can be called in nine years. The call premium is one year of coupon payments. Compute the bond's yield to maturity and yield to call. Assume interest payments are paid semiannually and a par value of $5,000. A) YTM = 6.91 percent; YTC = 7.52 percent B) YTM = 6.24 percent; YTC = 7.08 percent C) YTM = 5.78 percent; YTC = 6.61 percent D) YTM = 5.92 percent; YTC = 6.85 percent Answer: B Explanation: Step 1: N = 32; PV = 0.9255 × 5000; FV = 5000; PMT = 137.5; => I = 3.12; 2 × 3.12 = 6.24 = YTM. Step 2: PMT = 137.5; N = 18; PV = 0.9255 × 5000; FV = 5275; => I = 3.54; YTC = 2 × 3.54 = 7.08. Difficulty: 3 Hard Topic: Bond yields and returns; Yield to call Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 07-06 Compute bond yields. 90) An 8 percent coupon municipal bond has 15 years left to maturity and has a price quote of 98.5. The bond can be called in six years. The call premium is one year of coupon payments. Compute the bond's yield to call and determine if the bond will be called. Assume interest payments are paid semiannually and a par value of $5,000. A) 4.68 percent; Yes, the bond will be called. B) 9.36 percent; Yes, the bond will be called. C) 9.36 percent; No, the bond will not be called. D) 10.71 percent; No, the bond will not be called. Answer: C Explanation: Step 1: N = 12; PMT = 200; PV = 4925; FV = 5400; => I = 4.68; YTC = 2 × 4.68 = 9.36. Step 2: Bond sells at discount; unlikely it will be called. Difficulty: 3 Hard Topic: Bond yields and returns Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 07-06 Compute bond yields.

91) An 8% coupon municipal bond has 15 years left to maturity and has a price quote of 102.0. The bond can be called in 6 years. The call premium is one year of coupon payments. Compute the bond's yield to call and determine if the bond will be called. Assume interest payments are paid semiannually and a par value of $5,000. A) 4.31%; Yes, the bond will be called. B) 8.62%; Yes, the bond will be called. C) 8.62%; No, the bond will not be called. D) 11.21%; No the bond will not be called. Answer: B Explanation: Step 1: N = 12; PMT = 200; PV = 5100; FV = 5400; => I = 4.31; YTC = 2 × 4.31 = 8.62. Step 2: Bond sells at premium; likely it will be called. Difficulty: 3 Hard Topic: Bond yields and returns Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 07-06 Compute bond yields. 92) A corporate bond with a 5 percent coupon has 10 years left to maturity. It has had a credit rating of BBB and a yield to maturity of 8.0 percent. The firm has recently gotten into some trouble and the rating agency is downgrading the bonds to BB. The new appropriate discount rate will be 9 percent. What will be the change in the bond's price in dollars? Assume interest payments are paid semiannually and par value is $1,000. A) −$43.61 B) −$51.07 C) −$62.43 D) −$56.31 Answer: D Explanation: Step 1: PMT = 25; N = 20; I = 4; FV = 1000; => PV = 796.15. Step 2: PMT = 25; N = 20; I = 4.5; FV = 1000; => PV = 739.84 diff = −56.31. Difficulty: 3 Hard Topic: Bond ratings and credit risk Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 07-07 Find bond ratings and assess credit risk's effects on bond yields.

93) A corporate bond with an 8.5 percent coupon has 10 years left to maturity. It has had a credit rating of A and a yield to maturity of 10 percent. The firm has recently gotten into some trouble and the rating agency is downgrading the bonds to BBB. The new appropriate discount rate will be 11.5 percent. What will be the change in the bond's price in dollars? Assume interest payments are paid semiannually and par value is $1,000. A) −$82.13 B) −$95.19 C) −$101.37 D) −$69.85 Answer: A Explanation: Step 1: PMT = 42.50; N = 20; I = 5; FV = 1000; => PV = 906.53. Step 2: PMT = 42.50; N = 20; I = 5.75; FV = 1000; => PV = 824.40; diff = −82.13. Difficulty: 3 Hard Topic: Bond ratings and credit risk Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 07-07 Find bond ratings and assess credit risk's effects on bond yields. 94) Junk bonds are those bonds with a credit rating of A) BB and lower. B) B and lower. C) BBB and lower. D) None of these choices are correct. Answer: A Difficulty: 2 Medium Topic: Bond ratings and credit risk Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 07-07 Find bond ratings and assess credit risk's effects on bond yields.

95) Which of the following are backed only by the reputation and financial stability of the corporation? A) debentures B) unsecured bonds C) Both debentures and unsecured bonds D) None of these choices are correct. Answer: C Difficulty: 1 Easy Topic: Bond ratings and credit risk Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 07-07 Find bond ratings and assess credit risk's effects on bond yields. 96) Investment grade bonds include those bonds with ratings A) from AAA to BB. B) from AAA to BBB. C) from AAA to B. D) from AAA to A. Answer: B Difficulty: 2 Medium Topic: Bond ratings and credit risk Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 07-07 Find bond ratings and assess credit risk's effects on bond yields. 97) Which of the following statements is correct? A) Yield spreads between bonds of different quality remain static over time. B) Yield spreads are set by the Securities Exchange Commission. C) Yield spreads between bonds of different quality change over time. D) None of these choices are correct. Answer: C Difficulty: 2 Medium Topic: Bond ratings and credit risk; Credit risk Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 07-07 Find bond ratings and assess credit risk's effects on bond yields.

98) Sally is choosing between two bonds both of which mature in 15 years and have the same level of risk. Bond A is a municipal bond that yields 5.25 percent. Bond B is a corporate bond that yields 7.75 percent. If Sally is in the 30 percent tax bracket, which bond should she select and why? A) Sally should select Bond A because its interest income is not taxable. B) Sally should select Bond B because it has lower risk. C) Sally should select Bond A because its taxable equivalent yield is greater than the yield of Bond B. D) Sally should select Bond B because the taxable equivalent yield of Bond A is less than the yield of Bond B. Answer: D Explanation: TEY = 5.25% (1 − 0.3) = 7.5% vs. 7.75%; select the corporate bond. Difficulty: 3 Hard Topic: Bond yields and returns Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 07-06 Compute bond yields. 99) Sally is choosing between two bonds both of which mature in 15 years and have the same level of risk. Bond A is a municipal bond that yields 5.75 percent. Bond B is a corporate bond that yields 7.75 percent. If Sally is in the 28 percent tax bracket, which bond should she select and why? A) Sally should select Bond A because its interest income is not taxable. B) Sally will be indifferent between Bond A and B since the taxable equivalent yield of Bond A equals the yield of Bond B. C) Sally should select Bond A because its TEY is greater than the yield of Bond B. D) Sally should select Bond B because the TEY of Bond A is less than the yield of Bond B. Answer: C Explanation: TEY = 5.75% (1 − 0.28) = 7.99% vs. 7.75%; select the municipal bond. Difficulty: 3 Hard Topic: Bond yields and returns Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 07-06 Compute bond yields.

100) Sally is choosing between two bonds both of which mature in 15 years and have the same level of risk. Bond A is a municipal bond that yields 7.20 percent. Bond B is a corporate bond that yields 10.00 percent. If Sally is in the 28 percent tax bracket, which bond should she select and why? A) Sally should select Bond A because its interest income is not taxable. B) Sally will be indifferent between Bond A and B since the taxable equivalent yield of Bond A equals the yield of Bond B. C) Sally should select Bond A because its taxable equivalent yield is greater than the yield of Bond B. D) Sally should select Bond B because the taxable equivalent yield of Bond A is less than the yield of Bond B. Answer: B Explanation: TEY = 10.00% (1 − 0.28) = 7.20% vs. 7.20%; indifferent between the two. Difficulty: 3 Hard Topic: Bond yields and returns Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 07-06 Compute bond yields. 101) A bond with 14 years to maturity is selling for $1,070 and has a yield to maturity of 10.06 percent. If this bond pays its coupon payments semiannually and par value is $1,000, what is the bond's annual coupon rate? A) 5.50 percent B) 8.19 percent C) 9.57 percent D) 11.00 percent Answer: D Explanation: PV = −1070; FV = 1,000; N = 28; I = 5.03; => PMT = 55.01; annual coupon payment = 55.01 × 2 = 110.02; annual coupon rate = 110.02/1,000 × 100 = 11.00%. Difficulty: 3 Hard Topic: Bond coupons Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 07-01 Describe bond characteristics.

102) A bond with 23 years to maturity is selling for $991 and has a yield to maturity of 8.12 percent. If this bond pays its coupon payments semiannually and par value is $1,000, what is the bond's annual coupon rate? A) 7.45 percent B) 8.03 percent C) 9.39 percent D) 10.82 percent Answer: B Explanation: PV = −991; FV = 1000; N = 46; I = 4.06; => PMT = 40.16; annual coupon payment = 40.16 × 2 = 80.32; annual coupon rate = 80.32/1,000 × 100 = 8.03%. Difficulty: 3 Hard Topic: Bond coupons Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 07-01 Describe bond characteristics. 103) All of the following items would need to be included in the bond's indenture agreement EXCEPT A) the coupon rate. B) the call feature. C) the credit rating. D) steps that the bondholder can take in the event that the issuer fails to pay the interest or principal. Answer: C Difficulty: 1 Easy Topic: Indenture provisions Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 07-01 Describe bond characteristics.

104) Which of the following is not a correct statement? A) Treasury inflation-protected securities have fixed coupon rates. B) The federal government adjusts the par value of Treasury inflation-protected securities at the rate of inflation. C) At maturity, an investor in Treasury inflation-protected securities receives an inflationadjusted principal amount. D) All of these choices are correct. Answer: D Difficulty: 2 Medium Topic: Bond features Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 07-02 Identify various bond issuers and their motivation for issuing debt. 105) Which of the following would NOT be an example of an agency bond? A) Federal Home Loan Bank bond B) Student Loan Marketing Association bond C) Fannie Mae bond D) Treasury bills Answer: D Difficulty: 1 Easy Topic: Types of bonds Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 07-02 Identify various bond issuers and their motivation for issuing debt. 106) Which of the following statements is correct? A) Bonds with short-term maturities will have very little interest rate risk. B) Bonds with lower coupon payments will have very little interest rate risk. C) Bonds with higher credit ratings will have very little interest rate risk. D) All of these choices are correct. Answer: A Difficulty: 2 Medium Topic: Interest rate risk Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 07-05 Explain the relationship between bond prices and interest rates.

107) Which of the following statements is correct? A) Bonds with lower coupons have lower interest rate risk. B) Long-term bonds have more interest rate risk than short-term bonds. C) Short-term bonds with high coupons have high interest rate risk. D) Zero-coupon bonds do not have interest rate risk. Answer: B Difficulty: 2 Medium Topic: Interest rate risk Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 07-05 Explain the relationship between bond prices and interest rates. 108) Which of the following bonds will have the largest percentage increase in value if interest rates decrease by 1 percent? A) 2-year, 5 percent coupon bond B) 30-year, 10 percent coupon bond C) 10-year, zero-coupon D) 30-year, zero-coupon Answer: D Difficulty: 3 Hard Topic: Interest rate risk Bloom's: Evaluate AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 07-05 Explain the relationship between bond prices and interest rates.

109) Rank the following bonds, from highest to lowest interest rate risk: 2-year 6 percent coupon bond, 2-year 8 percent coupon bond, 30-year 5 percent coupon bond, 30-year, zero-coupon bond. A) 30-year, zero-coupon bond, 30-year 5 percent coupon bond, 2-year 8 percent coupon bond, 2year 6 percent coupon bond B) 2-year 8 percent coupon bond, 2-year 6 percent coupon bond, 30-year 5 percent coupon bond, 30-year zero-coupon bond C) 30-year, zero-coupon bond, 30-year 5 percent coupon bond, 2-year 6 percent coupon bond, 2year 8 percent coupon bond D) 30-year, 5 percent coupon bond, 30-year zero-coupon bond, 2-year 8 percent coupon bond, 2year 6 percent coupon bond Answer: C Difficulty: 2 Medium Topic: Interest rate risk Bloom's: Evaluate AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 07-05 Explain the relationship between bond prices and interest rates. 110) Which of the following statements is correct? A) All else the same, an investor will require less return to invest in a callable bond than one that is not callable. B) All else the same, an investor will require more return to invest in a callable bond than one that is not callable. C) The call feature does not impact the return that investors demand. D) We would need to know the current level of interest rates to answer this question. Answer: B Difficulty: 2 Medium Topic: Bond yields and returns Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 07-06 Compute bond yields.

111) Under which conditions will an investor demand a larger return (yield) on a bond? A) The bond issue is upgraded from A to AA. B) The bond issue is downgraded from A to BBB. C) Interest rates decrease due to decline in inflation. D) None of the conditions will cause an increase in the bond's yield. Answer: B Difficulty: 1 Easy Topic: Bond ratings and credit risk Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 07-07 Find bond ratings and assess credit risk's effects on bond yields. 112) Which of the following statements is correct? A) There is an inverse relationship between bond prices and bond yields. B) There is a positive relationship between bond prices and bond yields. C) There is no relationship between bond prices and bond yields. D) The relationship between bond prices and bond yields is dependent on the market interest rate. Answer: A Difficulty: 2 Medium Topic: Bond yields and returns Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 07-04 Compute bond prices using present value concepts. 113) If a bond is selling at a premium, then A) its coupon rate must be greater than its yield. B) its coupon rate must be less than its yield. C) its coupon rate must be equal to its yield. D) its coupon rate must be equal to one-half the yield to maturity for a 5-year bond. Answer: A Difficulty: 2 Medium Topic: Bond yields and returns Bloom's: Create AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 07-03 Read and interpret bond quotes.; 07-04 Compute bond prices using present value concepts.

114) The bond's annual coupon rate divided by its market price is referred to as the A) yield to call. B) yield to maturity. C) current yield. D) term structure of interest rates. Answer: C Difficulty: 1 Easy Topic: Bond yields and returns Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 07-06 Compute bond yields. 115) Possible shapes for the yield curve include all of the following EXCEPT A) humped. B) downward-sloping. C) flat. D) All of these choices are correct. Answer: D Difficulty: 2 Medium Topic: Term structure of interest rates Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 07-05 Explain the relationship between bond prices and interest rates. 116) Possible shapes for the yield curve include all of the following EXCEPT A) upward-sloping. B) humped. C) horizontal line. D) vertical line. Answer: D Difficulty: 2 Medium Topic: Term structure of interest rates Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 07-05 Explain the relationship between bond prices and interest rates.

117) If a bond is selling at a discount, which of the following statements is correct? A) The yield to maturity must be greater than the coupon rate. B) The coupon rate must be greater than the yield to maturity. C) The bond must have a low bond rating. D) All of these choices are correct. Answer: A Difficulty: 3 Hard Topic: Bond yields and returns Bloom's: Create AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 07-06 Compute bond yields. 118) If a bond is selling at par value, which of the following statements is correct? A) The current yield must equal the coupon rate. B) The current yield must equal the yield to maturity. C) Both of these statements are correct. D) None of these choices are correct. Answer: C Difficulty: 3 Hard Topic: Bond yields and returns Bloom's: Create AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 07-06 Compute bond yields. 119) To increase the liquidity for the home mortgage market, Fannie Mae and Freddie Mac purchased home mortgages from banks and other lenders. They combined the mortgages into diversified portfolios of loans and issued A) trust securities. B) mortgage-backed securities. C) current yield securities. D) treasury inflation-protected securities. Answer: B Difficulty: 1 Easy Topic: Bond types Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 07-02 Identify various bond issuers and their motivation for issuing debt.

120) Under what conditions is a bond likely to be called? A) The firm is in financial duress. B) The firm is planning a massive expansion and needs to raise a lot of capital. C) Interest rates have significantly declined. D) The firm wants to increase its debt ratio. Answer: C Difficulty: 2 Medium Topic: Bond features Bloom's: Evaluate AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 07-06 Compute bond yields. 121) A 30-year bond with an 8 percent coupon has a yield to maturity of 6 percent. The bond could be called in seven years and if called would generate a yield to call of 5.75 percent. What is this bond's call premium? Assume the coupon payments are made annually and par value is $1,000. A) $219.73 B) $152.64 C) $106.29 D) $301.76 Answer: A Explanation: Step 1: Find the selling price of the bond: FV = 1000; I = 6; N = 30; PMT = 80; => PV = 1275.30. Step 2: Find the call price: PV = −1275.30; N = 7; I = 5.75; PMT = 80; => FV = 1219.73. Step 3: Call premium = 1000 − 1219.73 = 219.73. Difficulty: 3 Hard Topic: Bond valuation Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 07-01 Describe bond characteristics.

122) A 15-year bond with a 10 percent coupon has a yield to maturity of 8 percent. The bond could be called in four years and if called would generate a yield to call of 6 percent. What is this bond's call premium? Assume the coupon payments are made semiannually and par value is $1,000. A) $19.73 B) $81.87 C) $41.20 D) $66.03 Answer: C Explanation: Step 1: Find the selling price of the bond: FV = 1000; I = 4; N = 30; PMT = 50; => PV = 1172.92. Step 2: Find the call price: PV = −1172.92; N = 8; I = 3; PMT = 50; => FV = 1041.20. Step 3: Call premium = 1000 − 1041.20 = 41.20. Difficulty: 3 Hard Topic: Bond valuation Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 07-01 Describe bond characteristics. 123) A 5 percent coupon bond has 10 years to maturity and could be called in two years. If the bond is called, investors will earn 6.2 percent. The call premium is one year of coupon payments. If coupon payments are made semiannually and par value is $1,000, what is the bond's yield to maturity? A) 2.36 percent B) 4.72 percent C) 5.18 percent D) 6.49 percent Answer: B Explanation: Step 1: Find the bond's price: FV = 1050; PMT = 25; I = 3.1; N = 4; => PV = 1022.00. Step 2: Find YTM: PV = −1022.00; FV = 1000; PMT = 25; N = 20; => I = 2.36; YTM = 2.36 × 2 = 4.72%. Difficulty: 3 Hard Topic: Bond yields and returns; Yield to call Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 07-06 Compute bond yields.

124) A 7 percent coupon bond has 10 years to maturity and could be called in three years. If the bond is called, investors will earn 5.5 percent. The call premium is one year of coupon payments. If coupon payments are made semiannually and par value is $1,000, what is the bond's yield to maturity? A) 2.84 percent B) 3.17 percent C) 5.38 percent D) 5.67 percent Answer: D Explanation: Step 1: Find the bond's price: FV = 1070; PMT = 35; I = 2.75; N = 6; => PV = 1100.45. Step 2: Find YTM: PV = −1100.45; FV = 1000; PMT = 35; N = 20; => I = 2.84; YTM = 2.84 × 2 = 5.67%. Difficulty: 3 Hard Topic: Bond yields and returns; Yield to call Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 07-06 Compute bond yields. 125) A 10 percent coupon bond has 15 years to maturity and could be called in two years. If the bond is called, investors will earn 4 percent. The call premium is one year of coupon payments. If coupon payments are made annually and par value is $1,000, what is the bond's yield to maturity? A) 6.19 percent B) 6.82 percent C) 7.65 percent D) 7.98 percent Answer: C Explanation: Step 1: Find the bond's price: FV = 1100; PMT = 100; I = 4; N = 2; => PV = 1205.62. Step 2: Find YTM: PV = −1205.62; FV = 1000; PMT = 100; N = 15; => I = 7.65% = YTM. Difficulty: 3 Hard Topic: Bond yields and returns; Yield to call Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 07-06 Compute bond yields.

126) Which of the following countries became the first to miss an International Monetary Fund loan repayment? A) Argentina B) Greece C) Japan D) Mexico Answer: B Difficulty: 2 Medium Topic: Debt market performance and considerations Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 07-07 Find bond ratings and assess credit risk's effects on bond yields. 127) A 3.25 percent TIPS has an original reference CPI of 194.1. If the current CPI is 210.3, what is the current interest payment? (Assume semiannual interest payments and a par value of $1,000.) A) $15.00 B) $16.25 C) $17.61 D) $31.54 Answer: C Explanation: 3.25% × (210.3/194.1) × 1,000/2 = 17.61. Difficulty: 1 Easy Topic: Bond coupons Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 07-02 Identify various bond issuers and their motivation for issuing debt.

128) A 2.95 percent TIPS has an original reference CPI of 180.2. If the current CPI is 205.1, what is the current interest payment and par value of the TIPS? (Assume semiannual interest payments and $1,000 par value.) A) $16.79, $878.60, respectively B) $29.50, $1,000.00, respectively C) $16.79, $1,138.18, respectively D) $29.50, $1,138.18, respectively Answer: C Explanation: Interest payment = 0.5 × 2.95% × $1,138.18 = $16.79. Par value = 205.1/180.2 × $1,000 = $1,138.1798. Difficulty: 1 Easy Topic: Bond coupons Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 07-02 Identify various bond issuers and their motivation for issuing debt. 129) A 4.15 percent TIPS has an original reference CPI of 182.1. If the current CPI is 188.3, what is the par value of the TIPS? A) $1,034.05 B) $1,004.75 C) $1,000.00 D) $967.07 Answer: A Explanation: 1,000 × (188.3/182.1) = 1034.0472. Difficulty: 1 Easy Topic: Bond valuation Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 07-02 Identify various bond issuers and their motivation for issuing debt.

130) Reconsider a 2.75 percent TIPS that was issued with CPI reference of 191.7. The bond is purchased at the beginning of the year (after the interest payment), when the CPI was 197.5. For the interest in the middle of the year, the CPI was 205.2. Now, at the end of the year, the CPI is 204.4 and the interest payment has been made. What is the total return of the TIPS in percentage terms for the year? (Assume semiannual interest payments and $1,000 par value.) A) 2.75 percent B) 5.60 percent C) 6.35 percent D) 6.80 percent Answer: C Explanation: Capital gain = end of year value − beginning of year value = 204.4/191.7 × $1,000 − 197.5/191.7 × $1,000 = $1,066.25 − $1,030.26 = $35.99. The mid-year interest payment was: 0.5 × 2.75% × 205.2/191.7 × $1,000 = $14.72. The end-of-year interest payment was: 0.5 × 2.75% × 204.4/191.7 × $1,000 = $14.66. Total dollar return = $35.99 + $14.72 + $14.66 = $65.37. As a percentage, the return was = $65.37 ÷ $1,030.26 = 6.35%. Difficulty: 3 Hard Topic: Bond yields and returns Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 07-02 Identify various bond issuers and their motivation for issuing debt. 131) Which of the following is another name for junk bonds? A) high-risk bonds B) high-price bonds C) high-yield bonds D) None of these choices are correct. Answer: C Difficulty: 2 Medium Topic: Credit risk; Bond yields Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 07-07 Find bond ratings and assess credit risk's effects on bond yields.

132) A 4.25 percent coupon municipal bond has 10 years left to maturity and has a price quote of 108.75. The bond can be called in five years. The call premium is one year of coupon payments. What is the bond's taxable equivalent yield for an investor in the 28 percent marginal tax bracket? (Assume interest payments are paid semiannually and a par value of $1,000.) A) 2.24 percent B) 4.47 percent C) 5.75 percent D) 5.90 percent Answer: B Explanation: YTM: N = 20, PV = −1087.50, PMT = 21.25, FV = 1000, CPT I = 1.6098%, YTM = 1.6098% × 2 = 3.2196%. Equivalent taxable yield = Muni yield/(1 − tax rate) = 3.22%/(1 − 0.28) = 4.4722%. Difficulty: 3 Hard Topic: Bond yields and returns Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 07-06 Compute bond yields. 133) A 3.5 percent coupon municipal bond has 8 years left to maturity and has a price quote of 102.75. The bond can be called in four years. The call premium is one year of coupon payments. What is the bond's taxable equivalent yield for an investor in the 33 percent marginal tax bracket? (Assume interest payments are paid semiannually and a par value of $1,000.) A) 2.35 percent B) 3.50 percent C) 4.64 percent D) 9.75 percent Answer: C Explanation: YTM: N = 16, PV = −1027.50, PMT = 17.50, FV = 1000, CPT I = 1.5545%, YTM = 1.5545% × 2 = 3.1091%. Equivalent taxable yield = Muni yield/(1 − tax rate) = 3.11%/(1 − .33) = 4.6418%. Difficulty: 3 Hard Topic: Bond yields and returns Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 07-06 Compute bond yields.

134) Which of the following is used to compute bond cash interest payments? A) current yield B) yield to maturity C) coupon rate D) None of these choices are correct. Answer: C Difficulty: 1 Easy Topic: Bond coupons Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 07-06 Compute bond yields. 135) Many bonds are not callable, but for those that are, which of following is a common feature? A) called any time after 2 years of issuance B) called any time after 2 years from the time an investor buys the bond C) called any time after 10 years of issuance D) called any time after 10 years from the time an investor buys the bond Answer: C Difficulty: 1 Easy Topic: Bond features Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 07-01 Describe bond characteristics.

Finance, 5e (Cornett) Chapter 8 Valuing Stocks 1) Which of these investors earn returns from receiving dividends and from stock price appreciation? A) bondholders B) stockholders C) investment bankers D) managers Answer: B Difficulty: 1 Easy Topic: Shareholder rights Bloom's: Apply; Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 08-01 Understand the rights and returns that come with common stock ownership. 2) As residual claimants, which of these investors claim any cash flows to the firm that remain after the firm pays all other claims? A) creditors B) bondholders C) preferred stockholders D) common stockholders Answer: D Difficulty: 1 Easy Topic: Shareholder rights Bloom's: Apply; Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 08-01 Understand the rights and returns that come with common stock ownership.

3) When residual cash flows are high, stock values will be A) unchanged. B) low. C) high. D) unpredictable. Answer: C Difficulty: 2 Medium Topic: Common stock features Bloom's: Apply; Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 08-01 Understand the rights and returns that come with common stock ownership. 4) Trading at physical exchanges like the New York Stock Exchange and the American Stock Exchange takes place A) at dealers' trading posts. B) at brokers' trading posts. C) at dealers' computers. D) at market markers. Answer: B Difficulty: 1 Easy Topic: Stock exchanges Bloom's: Apply; Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 08-02 Know how stock exchanges function. 5) At any given time, the market value of a firm's common stock depends upon: A) The company's profitability and the growth prospects for the future. B) The current market interest rates and the conditions in the overall stock market. C) Both a and b D) Neither a or b Answer: C Difficulty: 1 Easy Topic: Stock exchanges Bloom's: Apply; Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 08-02 Know how stock exchanges function.

6) Which of the following characteristics describe the NASDAQ stock market? A) is an electronic stock market without a physical trading floor. B) ranks second behind the NYSE in terms of total dollar value. C) lists approximately 3,900 domestic and foreign companies. D) All of the above. Answer: D Difficulty: 1 Easy Topic: Stock exchanges Bloom's: Apply; Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 08-02 Know how stock exchanges function. 7) Why is the ask price higher than the bid price? A) It represents the gain a market maker achieves. B) It represents the gain the stock seller achieves. C) It represents the gain the stock buyer achieves. D) It represents the gain all participants will achieve. Answer: A Difficulty: 1 Easy Topic: Stock market prices and reporting Bloom's: Apply; Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 08-04 Know the terminology of stock trading. 8) The Dow Jones Industrial Average (DJIA) includes A) all of the stock listed on the New York Stock Exchange. B) 30 of the largest (market capitalization) and most active companies in the U.S. economy. C) 500 firms that are the largest in their respective economic sectors. D) 500 firms that are the largest as ranked by Fortune Magazine. Answer: B Difficulty: 1 Easy Topic: Stock market prices and reporting Bloom's: Apply; Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 08-03 Track the wider stock market with stock indexes and differentiate among the kinds of information each index provides.

9) The Standard & Poor's 500 Index includes A) all of the stock listed on the New York Stock Exchange. B) 30 of the largest (market capitalization) and most active companies in the U.S. economy. C) 500 firms that are the largest in their respective economic sectors. D) 500 firms that are the largest as ranked by Fortune Magazine. Answer: C Difficulty: 1 Easy Topic: Stock market prices and reporting Bloom's: Apply; Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 08-03 Track the wider stock market with stock indexes and differentiate among the kinds of information each index provides. 10) The NASDAQ Composite includes A) all of the stocks listed on the NASDAQ Stock Exchange. B) 30 of the largest (market capitalization) and most active companies in the U.S. economy. C) 500 firms that are the largest in their respective economic sectors. D) 500 firms that are the largest as ranked by Fortune Magazine. Answer: A Difficulty: 1 Easy Topic: Stock market prices and reporting Bloom's: Apply; Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 08-03 Track the wider stock market with stock indexes and differentiate among the kinds of information each index provides. 11) Which of the following will only be executed if the order's price conditions are met? A) a trade B) a limit order C) an unlimited order D) a spread Answer: B Difficulty: 1 Easy Topic: Stock trading Bloom's: Apply; Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 08-04 Know the terminology of stock trading.

12) Investors buy stock at the A) dealer price. B) bid price. C) quoted ask price. D) broker price. Answer: C Difficulty: 1 Easy Topic: Stock trading Bloom's: Apply; Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 08-04 Know the terminology of stock trading. 13) Investors sell stock at the A) dealer price. B) bid price. C) quoted ask price. D) broker price. Answer: B Difficulty: 1 Easy Topic: Stock trading Bloom's: Apply; Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 08-04 Know the terminology of stock trading. 14) Which of these are valued as a special zero-growth case of the constant growth rate model? A) common stock B) preferred stock C) future dividends D) future stock prices Answer: B Difficulty: 1 Easy Topic: Zero-growth stock Bloom's: Apply; Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 08-05 Compute stock values using dividend discount and constant-growth models.

15) The dividend discount model: A) is a valuation approach based on future dividend income. B) is a hybrid security that has characteristics of both long-term debt and common stock. C) expects to have above average rates of growth in revenue, earnings, and/or dividends. D) none of the above. Answer: A Difficulty: 1 Easy Topic: Dividend discount model Bloom's: Apply; Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 08-05 Compute stock values using dividend discount and constant-growth models. 16) Stock valuation model dynamics make clear that lower discount rates lead to A) lower valuations. B) higher valuations. C) lower growth rates. D) higher growth rates. Answer: B Difficulty: 1 Easy Topic: Dividend discount model Bloom's: Apply; Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 08-05 Compute stock values using dividend discount and constant-growth models. 17) Stock valuation model dynamics make clear that higher growth rates lead to A) lower valuations. B) higher valuations. C) lower growth rates continuing. D) higher growth rates continuing. Answer: B Difficulty: 1 Easy Topic: Dividend discount model Bloom's: Apply; Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 08-05 Compute stock values using dividend discount and constant-growth models.

18) We can estimate a stock's value by A) using the book value of the total stockholder equity section. B) discounting the future dividends and future stock price appreciation. C) compounding the past dividends and past stock price appreciation. D) using the book value of the total assets divided by the number of shares outstanding. Answer: B Difficulty: 1 Easy Topic: Dividend discount model Bloom's: Apply; Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 08-05 Compute stock values using dividend discount and constant-growth models. 19) Many companies grow very fast at first, but slower future growth can be expected. Such companies are called A) Fortune 500 companies. B) blue chip companies. C) variable growth rate firms. D) constant growth rate firms. Answer: C Difficulty: 1 Easy Topic: Supernormal growth stock Bloom's: Apply; Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 08-06 Calculate the stock value of a variable-growth-rate company. 20) A variable growth rate: A) is a valuation technique used when a firm's current growth rate is expected to change sometime in the future. B) combines the present-value cash flow equation and the constant-growth-rate model equation. C) both a and b D) neither a or b Answer: C Difficulty: 1 Easy Topic: Variable growth rate Bloom's: Apply; Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 08-06 Calculate the stock value of a variable-growth-rate company.

21) We often use the P/E ratio model with the firm's growth rate to estimate A) required rates of return. B) inflation. C) a stock's current price. D) a stock's future price. Answer: D Difficulty: 2 Medium Topic: Stock valuation using multiples Bloom's: Apply; Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 08-07 Assess relative stock values using the P/E ratio model. 22) When reviewing a stock's price measured to other stocks, you are assessing a stock's: A) price/earnings (P/E) ratio B) relative value C) value stocks D) none of the above. Answer: B Difficulty: 2 Medium Topic: Relative value Bloom's: Apply; Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 08-07 Assess relative stock values using the P/E ratio model. 23) Value stocks usually have A) low P/E ratios and high growth rates. B) high P/E ratios and low growth rates. C) low P/E ratios and low growth rates. D) high P/E ratios and high growth rates. Answer: A Difficulty: 2 Medium Topic: Stock valuation using multiples Bloom's: Apply; Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 08-07 Assess relative stock values using the P/E ratio model.

24) Dividend yield is defined as A) the last four quarters of dividend income expressed as a percentage of the par value of the stock. B) the last four quarters of dividend income expressed as a percentage of the current stock price. C) the last dividend paid expressed as a percentage of the current stock price. D) the next dividend to be paid expressed as a percentage of the current stock price. Answer: B Difficulty: 1 Easy Topic: Stock returns and yields Bloom's: Apply; Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 08-05 Compute stock values using dividend discount and constant-growth models. 25) The size of the firm measured as the current stock price multiplied by the number of shares outstanding is referred to as the firm's A) market capitalization. B) book value. C) market makers. D) constant growth model. Answer: A Difficulty: 1 Easy Topic: Market and book values Bloom's: Apply; Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 08-04 Know the terminology of stock trading.

26) If on November 26, 2017, The Dow Jones Industrial Average closed at 12,743.40, which was down 237.44 that day. What was the return (in percent) of the stock market that day? A) −0.02 percent B) +0.02 percent C) −1.83 percent D) +1.83 percent Answer: C Explanation: −237.44/[12,743.40 − (−237.44)] Difficulty: 1 Easy Topic: Stock returns and yields Bloom's: Apply; Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-03 Track the wider stock market with stock indexes and differentiate among the kinds of information each index provides. 27) If on November 27, 2017, The Dow Jones Industrial Average closed at 12,958.44, which was up 215.04 that day. What was the return (in percent) of the stock market that day? A) −0.017 percent B) +0.017 percent C) −1.69 percent D) +1.69 percent Answer: D Explanation: 215.04/(12,958.44 − 215.04) Difficulty: 1 Easy Topic: Stock returns and yields Bloom's: Apply; Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-03 Track the wider stock market with stock indexes and differentiate among the kinds of information each index provides.

28) At your discount brokerage firm, it costs $9.95 per stock trade. How much money do you need to buy 100 shares of Ralph Lauren (RL), which trades at $85.13? A) $8,503.05 B) $8,503.00 C) $8,522.95 D) $9,508.00 Answer: C Explanation: ($85.13 per share × 100 shares) + $9.95 = $8,522.95. Difficulty: 1 Easy Topic: Stock trading Bloom's: Apply; Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-04 Know the terminology of stock trading. 29) At your discount brokerage firm, it costs $8.50 per stock trade. How much money do you need to buy 200 shares of Apple (AAPL), which trades at $171.54? A) $32,608.00 B) $34,299.50 C) $34,316.50 D) $36,008.00 Answer: C Explanation: ($171.54 per share × 200 shares) + $8.50 = $34,316.50. Difficulty: 1 Easy Topic: Stock trading Bloom's: Apply; Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-04 Know the terminology of stock trading.

30) At your full-service brokerage firm, it costs $110 per stock trade. How much money do you receive after selling 100 shares of Time Warner, Inc. (TMX), which trades at $22.62? A) $2,152.00 B) $2,262.00 C) $2,372.00 D) $2,388.20 Answer: A Explanation: ($22.62 per share × 100 shares) − $110 = $2,152.00. Difficulty: 1 Easy Topic: Stock trading Bloom's: Apply; Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-04 Know the terminology of stock trading. 31) At your full-service brokerage firm, it costs $120 per stock trade. How much money do you receive after selling 200 shares of Ralph Lauren (RL), which trades at $85.13? A) $16,546.00 B) $16,906.00 C) $17,026.00 D) $17,146.00 Answer: B Explanation: ($85.13 per share × 200 shares) − $120 = $16,906.00. Difficulty: 1 Easy Topic: Stock trading Bloom's: Apply; Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-04 Know the terminology of stock trading.

32) You would like to buy shares of International Business Machines (IBM). The current bid and ask quotes are $96.17 and $96.24, respectively. You place a market buy-order for 100 shares that executes at these quoted prices. How much money did it cost to buy these shares? A) $7.00 B) $9,617.00 C) $9,624.00 D) $19,241.00 Answer: C Explanation: $96.24 per share × 100 shares = $9,624.00. Difficulty: 1 Easy Topic: Stock trading Bloom's: Apply; Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-04 Know the terminology of stock trading. 33) You would like to buy shares of Nokia (NOK). The current bid and ask quotes are $20.13 and $20.15, respectively. You place a market buy-order for 300 shares that executes at these quoted prices. How much money did it cost to buy these shares? A) $6.00 B) $6,039.00 C) $6,045.00 D) $12,084.00 Answer: C Explanation: $20.15 per share × 300 shares = $6,045. Difficulty: 1 Easy Topic: Stock trading Bloom's: Apply; Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-04 Know the terminology of stock trading.

34) You would like to sell 100 shares of Pfizer, Inc. (PFE). The current bid and ask quotes are $27.22 and $27.25, respectively. You place a limit sell-order at $27.24. If the trade executes, how much money do you receive from the buyer? A) $2,722.00 B) $2,724.00 C) $2,725.00 D) $5,446.00 Answer: B Explanation: $27.24 per share × 100 shares = $2,724.00. Difficulty: 1 Easy Topic: Stock trading Bloom's: Apply; Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-04 Know the terminology of stock trading. 35) You would like to sell 400 shares of International Business Machines (IBM). The current bid and ask quotes are $96.24 and $96.17, respectively. You place a limit sell-order at $96.20. If the trade executes, how much money do you receive from the buyer? A) $38,464.00 B) $38,468.00 C) $38,480.00 D) $38,496.00 Answer: C Explanation: $96.20 per share × 400 shares = $38,480.00. Difficulty: 1 Easy Topic: Stock trading Bloom's: Apply; Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-04 Know the terminology of stock trading.

36) If a preferred stock from Pfizer Inc. (PFE) pays $3.00 in annual dividends, and the required return on the preferred stock is 7 percent, what's the value of the stock? A) $0.21 B) $0.43 C) $21.00 D) $42.86 Answer: D Explanation: $3.00/7% = $42.86. Difficulty: 1 Easy Topic: Zero-growth stock Bloom's: Apply; Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-05 Compute stock values using dividend discount and constant-growth models. 37) If a preferred stock from Ecology and Environment, Inc. (EEI) pays $2.50 in annual dividends, and the required return on the preferred stock is 5.8 percent, what's the value of the stock? A) $0.15 B) $0.43 C) $14.50 D) $43.10 Answer: D Explanation: $2.50/5.8% = $43.10. Difficulty: 1 Easy Topic: Zero-growth stock Bloom's: Apply; Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-05 Compute stock values using dividend discount and constant-growth models.

38) International Business Machines (IBM) has earnings per share of $6.85 and a P/E ratio of 15.19. What is the stock price? A) $0.45 B) $2.22 C) $45.09 D) $104.05 Answer: D Explanation: $6.85 × 15.19 = $104.05. Difficulty: 1 Easy Topic: Stock valuation using multiples Bloom's: Apply; Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-07 Assess relative stock values using the P/E ratio model. 39) Pfizer, Inc. (PFE) has earnings per share of $2.09 and a P/E ratio of 11.02. What is the stock price? A) $0.19 B) $5.27 C) $18.97 D) $23.03 Answer: D Explanation: $2.09 × 11.02 = $23.03. Difficulty: 1 Easy Topic: Stock valuation using multiples Bloom's: Apply; Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-07 Assess relative stock values using the P/E ratio model.

40) Ralph Lauren (RL) has earnings per share of $3.85 and a P/E ratio of 17.37. What is the stock price? A) $0.22 B) $4.51 C) $22.16 D) $66.87 Answer: D Explanation: $3.85 × 17.37 = $66.87. Difficulty: 1 Easy Topic: Stock valuation using multiples Bloom's: Apply; Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-07 Assess relative stock values using the P/E ratio model. 41) A firm is expected to pay a dividend of $2.00 next year and $2.14 the following year. Financial analysts believe the stock will be at their target price of $75.00 in two years. Compute the value of this stock with a required return of 10 percent. A) $65.40 B) $66.67 C) $65.57 D) $79.14 Answer: C Explanation: 0 CF0 2.00 C01, 1 F01 77.14 C02, 1 F02 10 I NPV = 65.57 Difficulty: 2 Medium Topic: Dividend discount model Bloom's: Apply; Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-05 Compute stock values using dividend discount and constant-growth models.

42) A firm is expected to pay a dividend of $3.00 next year and $3.21 the following year. Financial analysts believe the stock will be at their target price of $80.00 in two years. Compute the value of this stock with a required return of 13 percent. A) $50.00 B) $67.52 C) $67.82 D) $86.21 Answer: C Explanation: 0 CF0 3.00 C01, 1 F01 83.21 C02, 1 F02 13 I NPV = 67.82 Difficulty: 2 Medium Topic: Dividend discount model Bloom's: Apply; Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-05 Compute stock values using dividend discount and constant-growth models. 43) Annual dividends of Walmart Stores (WMT) grew from $0.23 in 2000 to $0.83 in 2007. What was the annual growth rate? A) 2.61 percent B) 20.12 percent C) 37.29 percent D) 260.87 percent Answer: B Explanation: N = 7, PV = −0.23, FV = 0.83, PMT = 0, CPT I = 20.12% Difficulty: 2 Medium Topic: Constant-growth stock Bloom's: Apply; Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-05 Compute stock values using dividend discount and constant-growth models.

44) Annual dividends of Pfizer, Inc. (PFE) grew from $0.38 in 2000 to $1.15 in 2007. What was the annual growth rate? A) 2.02 percent B) 17.14 percent C) 28.95 percent D) 202.63 percent Answer: B Explanation: N = 7, PV = −0.38, FV = 1.15, PMT = 0, CPT I = 17.14% Difficulty: 2 Medium Topic: Constant-growth stock Bloom's: Apply; Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-05 Compute stock values using dividend discount and constant-growth models. 45) Financial analysts forecast Best Buy Company (BBY) growth for the future to be 13 percent. Their recent dividend was $0.49. What is the value of their stock when the required rate of return is 14.13 percent? A) $3.92 B) $4.90 C) $43.36 D) $49.00 Answer: D Explanation: (0.49 × 1.13)/(0.1413 − 0.13) = $49.00. Difficulty: 2 Medium Topic: Constant-growth stock Bloom's: Apply; Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-05 Compute stock values using dividend discount and constant-growth models.

46) Financial analysts forecast Target Corp. (TGT) growth for the future to be 11 percent. Their recent dividend was $0.52. What is the value of their stock when the required rate of return is 11.89 percent? A) $5.25 B) $6.48 C) $58.43 D) $64.85 Answer: D Explanation: (0.52 × 1.11)/(0.1189 − 0.11) = $64.85. Difficulty: 2 Medium Topic: Constant-growth stock Bloom's: Apply; Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-05 Compute stock values using dividend discount and constant-growth models. 47) American Eagle Outfitters (AEO) recently paid a $0.38 dividend. The dividend is expected to grow at a 15.5 percent rate. At the current stock price of $24.07, what is the return shareholders are expecting? A) 15.50 percent B) 15.52 percent C) 17.08 percent D) 17.32 percent Answer: D Explanation: [(0.38 × 1.155)/24.07] + 0.155 = 0.1732 = 17.32%. Difficulty: 2 Medium Topic: Stock returns and yields Bloom's: Apply; Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-05 Compute stock values using dividend discount and constant-growth models.

48) The Buckle (BKE) recently paid a $0.90 dividend. The dividend is expected to grow at a 19 percent rate. At the current stock price of $43.17, what is the return shareholders are expecting? A) 19.00 percent B) 19.02 percent C) 21.48 percent D) 22.74 percent Answer: C Explanation: [(0.90 × 1.19)/43.17] + 0.19 = 0.2148 = 21.48%. Difficulty: 2 Medium Topic: Stock returns and yields Bloom's: Apply; Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-05 Compute stock values using dividend discount and constant-growth models. 49) Home Depot (HD) recently paid a $0.90 dividend. The dividend is expected to grow at a 17 percent rate. At the current stock price of $33.08, what is the return shareholders are expecting? A) 2.70 percent B) 17.03 percent C) 17.18 percent D) 20.18 percent Answer: D Explanation: [(0.90 × 1.17)/33.08] + 0.17 = 0.2018 = 20.18%. Difficulty: 2 Medium Topic: Stock returns and yields Bloom's: Apply; Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-05 Compute stock values using dividend discount and constant-growth models.

50) A firm does not pay a dividend. It is expected to pay its first dividend of $0.10 per share in two years. This dividend will grow at 11 percent indefinitely. Using a 13 percent discount rate, compute the value of this stock. A) $4.42 B) $4.59 C) $5.43 D) $7.21 Answer: A Explanation: Step 1: P2 = (0.10 × 1.11)/(0.13 − 0.11) = $5.55. Step 2: FV = 5.55 + 0.10 = $5.65. N = 2, I = 13, PMT = 0, CPT PV = $4.42 Difficulty: 2 Medium Topic: Constant-growth stock Bloom's: Apply; Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-06 Calculate the stock value of a variable-growth-rate company. 51) A firm does not pay a dividend. It is expected to pay its first dividend of $0.15 per share in three years. This dividend will grow at 9 percent indefinitely. Using a 10 percent discount rate, compute the value of this stock. A) $12.28 B) $12.40 C) $16.35 D) $16.50 Answer: B Explanation: Step 1: P2 = (0.15 × 1.09)/(0.10 − 0.09) = $16.35. Step 2: FV = 16.35 + 0.15 = $16.50. N = 3, I = 10, PMT = 0, CPT PV = $12.40 Difficulty: 2 Medium Topic: Constant-growth stock Bloom's: Apply; Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-06 Calculate the stock value of a variable-growth-rate company.

52) Walmart (WMT) recently earned a profit of $3.13 per share and has a P/E ratio of 14.22. The dividend has been growing at a 12.5 percent rate over the past few years. If this growth continues, what would be the stock price in five years if the P/E ratio remained unchanged? What would the price be if the P/E ratio declined to 10 in five years? A) $6.08, $5.04 respectively B) $72.22, $50.40 respectively C) $80.20, $56.40 respectively D) $86.46, $60.80 respectively Answer: C Explanation: PV = $3.13 , I = 12.5, PMT = 0, N = 5, CPT FV = $5.64 $5.64 × 14.22 = $80.20. $5.64 × 10 = $56.40. Difficulty: 2 Medium Topic: Stock valuation using multiples Bloom's: Apply; Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-07 Assess relative stock values using the P/E ratio model. 53) Target Corp. (TGT) recently earned a profit of $3.57 earnings per share and has a P/E ratio of 17.3. The dividend has been growing at a 14 percent rate over the past few years. If this growth continues, what would be the stock price in five years if the P/E ratio remained unchanged? What would the price be if the P/E ratio increased to 23 in five years? A) $118.85, $158.01 respectively B) $137.19, $182.39 respectively C) $173.87, $231.15 respectively D) $308.81, $410.55 respectively Answer: A Explanation: PV = $3.57 , I = 14 , PMT = 0, N = 5, CPT FV = $6.87 $6.87 × 17.3 = $118.85. $6.87 × 23 = $158.01. Difficulty: 2 Medium Topic: Stock valuation using multiples Bloom's: Apply; Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-07 Assess relative stock values using the P/E ratio model.

24) A firm recently paid a $1.00 annual dividend. The dividend is expected to increase by 10 percent in each of the next four years. In the fourth year, the stock price is expected to be $100. If the required rate for this stock is 14 percent, what is its value? A) $25.00 B) $36.60 C) $62.87 D) $72.30 Answer: C Explanation: D1 = $1.00 × 1.10 = $1.10 = C01, 1 F01. D2 = $1.10 × 1.10 = $1.21 = C02, 1 F02. D3 = $1.21 × 1.10 = $1.331 = C03, 1 F03. D4 = $1.331 × 1.10 = $1.4641. D4 + P4 = $101.4641 = C04, 1 F04. I = 14 NPV = 62.87 Difficulty: 3 Hard Topic: Dividend discount model Bloom's: Apply; Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-05 Compute stock values using dividend discount and constant-growth models.

25) A firm recently paid a $0.30 annual dividend. The dividend is expected to increase by 8 percent in each of the next four years. In the fourth year, the stock price is expected to be $60. If the required rate for this stock is 10 percent, what is its value? A) $15.00 B) $20.41 C) $42.13 D) $45.30 Answer: C Explanation: D1 = $0.30 × 1.08 = $0.324 = C01, 1 F01. D2 = $0.324 × 1.08 = $0.3499 = C02, 1 F02. D3 = $0.3499 × 1.08 = $0.3779 = C03, 1 F03. D4 = $0.3779 × 1.08 = $0.4081. D4 + P4 = $60.4081 = C04, 1 F04. I = 10 NPV = 42.13 Difficulty: 3 Hard Topic: Dividend discount model Bloom's: Apply; Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-05 Compute stock values using dividend discount and constant-growth models. 56) Best Buy Co. (BBY) paid a $0.27 dividend per share in 2013, which grew to $0.49 in 2017. This growth is expected to continue. What is the value of this stock at the beginning of 2017 when the required rate of return is 17.23 percent? A) $2.84 B) $42.24 C) $49.03 D) $50.78 Answer: C Explanation: N = 4, PV = −0.27, FV = 0.49, PMT = 0, CPT I = 16.07% = g P2017 = (0.49 × 1.1607)/(0.1723 − 0.1607) = $49.03. Difficulty: 3 Hard Topic: Constant-growth stock Bloom's: Apply; Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-05 Compute stock values using dividend discount and constant-growth models.

57) Target Corp. (TGT) paid a $0.21 dividend per share in 2010, which grew to $0.52 in 2017. This growth is expected to continue. What is the value of this stock at the beginning of 2017 when the required rate of return is 14.77 percent? A) $3.52 B) $55.32 C) $62.97 D) $63.49 Answer: C Explanation: N = 7, PV = −0.21, FV = 0.52, PMT = 0, CPT I = 13.83% = g P2017 = (0.52 × 1.1383)/(0.1477 − 0.1383) = $62.97. Difficulty: 3 Hard Topic: Constant-growth stock Bloom's: Apply; Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-05 Compute stock values using dividend discount and constant-growth models. 58) Consider a firm that had been priced using a 10 percent growth rate and a 14 percent required rate. The firm recently paid a $1.00 dividend. The firm has just announced that because of a new joint venture, it will likely grow at a 12 percent rate. How much should the stock price change (in dollars and percentage)? A) $25, 1 percent B) $25, 100 percent C) $28.50, 1.04 percent D) $28.50, 104 percent Answer: D Explanation: Price before change: ($1.00 × 1.10)/(0.14 − 0.10) = $27.50. Price after change: ($1.00 × 1.12)/(0.14 − 0.12) = $56.00. Change: $56.00 − $27.50 = $28.50. $28.50/$27.50 = 103.64%. Difficulty: 3 Hard Topic: Constant-growth stock Bloom's: Apply; Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-05 Compute stock values using dividend discount and constant-growth models.

59) Consider a firm that had been priced using a 6 percent growth rate and a 9 percent required rate. The firm recently paid a $0.50 dividend. The firm has just announced that because of a new joint venture, it will likely grow at an 8 percent rate. How much should the stock price change (in dollars and percentage)? A) $33.33, 67 percent B) $33.33, 198 percent C) $36.33, 67 percent D) $36.33, 206 percent Answer: D Explanation: Price before change: ($0.50 × 1.06)/(0.09 − 0.06) = $17.67. Price after change: ($0.50 × 1.08)/(0.09 − 0.08) = $54.00. Change: $54.00 − $17.67 = $36.33. $36.33/$17.67 = 206%. Difficulty: 3 Hard Topic: Constant-growth stock Bloom's: Apply; Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-05 Compute stock values using dividend discount and constant-growth models. 60) A fast growing firm recently paid a dividend of $0.50 per share. The dividend is expected to increase at a 25 percent rate for the next 3 years. Afterwards, a more stable 12 percent growth rate can be assumed. If a 15 percent discount rate is appropriate for this stock, what is its value? A) $5.00 B) $22.62 C) $25.75 D) $36.46 Answer: C Explanation: D1 = $0.50 × 1.25 = $0.625 = C01, 1 F01. D2 = $0.625 × 1.25 = $0.78125 = C02, 1 F02. D3 = $0.78125 × 1.25 = $0.9766. D4 = $0.9766 × 1.12 = 1.09. P3 = $1.09/(0.15 − 0.12) = 36.46. D3 + P3 = $37.43 = C03, 1 F03. I = 15 NPV = $25.745 Difficulty: 3 Hard Topic: Two-stage growth stock Bloom's: Apply; Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-06 Calculate the stock value of a variable-growth-rate company.

61) A fast growing firm recently paid a dividend of $1.00 per share. The dividend is expected to increase at a 25 percent rate for the next three years. Afterwards, a more stable 8 percent growth rate can be assumed. If a 10 percent discount rate is appropriate for this stock, what is its value? A) $12.50 B) $75.93 C) $83.13 D) $120.24 Answer: C Explanation: D1 = $1.00 × 1.25 = $1.25 = C01, 1 F01. D2 = $1.25 × 1.25 = $1.5625 = C02, 1 F02. D3 = $1.5625 × 1.25 = $1.9531. D4 = $1.9531 × 1.08 = $2.10935. P3 = $2.10935/(0.10 − 0.08) = $105.47. D3 + P3 = $107.42 = C03, 1 F03. I = 10 NPV = $83.13 Difficulty: 3 Hard Topic: Two-stage growth stock Bloom's: Apply; Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-06 Calculate the stock value of a variable-growth-rate company.

29) Suppose that a firm's recent earnings per share and dividends per share are $3.00 and $1.50, respectively. Both are expected to grow at 10 percent. However, the firm's current P/E ratio of 20 seems high for this growth rate. The P/E ratio is expected to fall to 16 within five years. Compute a value for this stock by first estimating the dividends over the next five years and the stock price in five years. Then discount these cash flows using a 14 percent required rate. A) $31.68 B) $40.15 C) $46.89 D) $60.00 Answer: C Explanation: D1 = $1.50 × 1.10 = $1.65 = C01, 1 F01. D2 = $1.65 × 1.10 = $1.815 = C02, 1 F02. D3 = $1.815 × 1.10 = $1.9965 = C03, 1 F03. D4 = $1.9965 × 1.10 = $2.1916 = C04, 1 F04. D5 = $2.1916 × 1.10 = $2.4157. P5 = 16 × $3.00 × (1.10)^5 = 77.30. D5 + P5 = 79.72 = C05, 1 F05. I = 14 NPV = $46.89 Difficulty: 3 Hard Topic: Stock valuation using multiples Bloom's: Apply; Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-05 Compute stock values using dividend discount and constant-growth models.; 08-06 Calculate the stock value of a variable-growth-rate company.; 08-07 Assess relative stock values using the P/E ratio model.

30) Suppose that a firm's recent earnings per share and dividends per share are $2.50 and $1.00, respectively. Both are expected to grow at 10 percent. However, the firm's current P/E ratio of 22 seems high for this growth rate. The P/E ratio is expected to fall to 18 within five years. Compute a value for this stock by first estimating the dividends over the next five years and the stock price in five years. Then discount these cash flows using a 14 percent required rate. A) $37.51 B) $37.64 C) $42.14 D) $72.47 Answer: C Explanation: D1 = $1.00 × 1.10 = $1.10 = C01, 1 F01. D2 = $1.10 × 1.10 = $1.21 = C02, 1 F02. D3 = $1.21 × 1.10 = $1.331 = C03, 1 F03. D4 = $1.331 × 1.10 = $1.4641 = C04, 1 F04. D5 = $1.4641 × 1.10 = $1.6105. P5 = 18 × $2.50 × (1.10)^5 = $72.47. D5 + P5 = $74.08 = C05, 1 F05. I = 14 NPV = $42.14 Difficulty: 3 Hard Topic: Stock valuation using multiples Bloom's: Apply; Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-05 Compute stock values using dividend discount and constant-growth models.; 08-06 Calculate the stock value of a variable-growth-rate company.; 08-07 Assess relative stock values using the P/E ratio model. 64) At your discount brokerage firm, it costs $9.95 per stock trade. How much money do you need to buy 200 shares of General Electric (GE), which trades at $45.19? A) $9,038.00 B) $4,528.95 C) $9,047.95 D) $4,595.95 Answer: C Explanation: (200 × 45.19) + 9.95 = 9047.95. Difficulty: 1 Easy Topic: Stock trading Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-04 Know the terminology of stock trading.

65) At your discount brokerage firm, it costs $7.95 per stock trade. How much money do you receive after selling 250 shares of General Electric (GE), which trades at $55.19? A) $14,037.95 B) $11,958.55 C) $12,174.95 D) $13,789.55 Answer: D Explanation: 250 × 55.19 − 7.95 = 13,789.55. Difficulty: 1 Easy Topic: Stock trading Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-04 Know the terminology of stock trading. 66) A preferred stock from DLC pays $3.00 in annual dividends. If the required return on the preferred stock is 9.3 percent, what is the value of the stock? A) $34.89 B) $32.26 C) $38.49 D) $31.13 Answer: B Explanation: 3/0.093 = 32.26. Difficulty: 1 Easy Topic: Zero-growth stock Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-05 Compute stock values using dividend discount and constant-growth models.

67) Ultra Petroleum (UPL) has earnings per share of $1.75 and P/E of 42.56. What is the stock price? A) $74.48 B) $76.68 C) $85.68 D) $112.98 Answer: A Explanation: 42.56 × 1.75 = 74.48. Difficulty: 1 Easy Topic: Stock valuation using multiples Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-07 Assess relative stock values using the P/E ratio model. 68) JPM has earnings per share of $3.75 and P/E of 47. What is the stock price? A) $174.08 B) $176.25 C) $185.95 D) $112.98 Answer: B Explanation: 47 × 3.75 = 176.25. Difficulty: 1 Easy Topic: Stock valuation using multiples Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-07 Assess relative stock values using the P/E ratio model.

69) A firm is expected to pay a dividend of $2.00 next year and $3.75 the following year. Financial analysts believe the stock will be at their price target of $125.00 in two years. Compute the value of this stock with a required rate of return of 15 percent. A) $78.34 B) $81.05 C) $87.13 D) $99.09 Answer: D Explanation: 2/1.15 + (3.75 + 125)/1.15^2 = 99.09. Difficulty: 2 Medium Topic: Dividend discount model Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-05 Compute stock values using dividend discount and constant-growth models. 70) Financial analysts forecast ABC Inc. growth for the future to be 12 percent. ABC's recent dividend was $1.60. What is the value of ABC stock when the required return is 15 percent? A) $59.73 B) $63.72 C) $79.81 D) $91.02 Answer: A Explanation: 1.6(1.12)/(0.15 − 0.12) = 59.73. Difficulty: 2 Medium Topic: Constant-growth stock Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-05 Compute stock values using dividend discount and constant-growth models.

71) A fast growing firm recently paid a dividend of $0.80 per share. The dividend is expected to increase at a rate of 30 percent for the next four years. Afterwards, a more stable 7 percent growth rate can be assumed. If a 10 percent discount rate is appropriate for this stock, what is its value? A) $60.48 B) $60.18 C) $61.34 D) $73.86 Answer: A Explanation: PV (1.04) + PV (1.35) + PV (1.76) + PV (2.28 + (2.44)/0.03) = 60.48. Difficulty: 3 Hard Topic: Two-stage growth stock Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-06 Calculate the stock value of a variable-growth-rate company. 72) A fast growing firm recently paid a dividend of $1.00 per share. The dividend is expected to increase at a rate of 15 percent for the next 3 years. Afterwards, a more stable 6 percent growth rate can be assumed. If a 10 percent discount rate is appropriate for this stock, what is its value? A) $33.54 B) $37.99 C) $39.37 D) $42.03 Answer: A Explanation: PV (1.15) + PV (1.32) + PV (1.52 + (1.61)/0.04) = 33.54. Difficulty: 3 Hard Topic: Two-stage growth stock Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-06 Calculate the stock value of a variable-growth-rate company.

73) A firm recently paid a $0.50 annual dividend. The dividend is expected to increase by 10 percent in each of the next three years. In the third year, the stock price is expected to be $110. If the required return is 15 percent, what is its value? A) $62.53 B) $68.95 C) $73.71 D) $78.67 Answer: C Explanation: Using a financial calculator: PV (0.55) + PV (0.61) + PV [0.67 + 110] = 73.71. Difficulty: 3 Hard Topic: Dividend discount model Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-05 Compute stock values using dividend discount and constant-growth models. 74) Campbell Soup Co. paid a $1.55 dividend per share in 2012, which grew to $1.95 in 2017. This growth is expected to continue. What is the value of this stock at the beginning of 2017 when the required return is 10.5 percent? A) $35.20 B) $34.16 C) $33.48 D) $32.17 Answer: A Explanation: Step 1: Calculate the growth rate: PV = −1.55; FV = 1.95; N = 5; => I = growth rate = 4.70%; Step 2: 1.95 (1 + 0.0470)/[0.105 − 0.047] = $35.20. Difficulty: 3 Hard Topic: Constant-growth stock Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-05 Compute stock values using dividend discount and constant-growth models.

75) Consider a firm that had been priced using a 12 percent growth rate and a 16 percent required return. The firm recently paid a $5.00 dividend. The firm has just announced that because of a new joint venture, it will likely grow at a 12.5 percent rate. How much should the stock price change (in dollars and percentage)? A) $21.50; 13.72 percent B) $21.50; 16.14 percent C) $20.71; 14.79 percent D) $20.71; 19.93 percent Answer: C Explanation: Step 1: Price under 12 percent growth rate: 5 (1.12)/[0.16 − 0.12] = 140.00; Step 2: Price under 12.5 percent growth rate: 5 (1.125)/[0.16 − 0.125] = 160.71; Stock price change = $20.71; percentage change = 14.79%. Difficulty: 3 Hard Topic: Constant-growth stock Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-05 Compute stock values using dividend discount and constant-growth models. 76) Suppose that a firm's recent earnings per share and dividend per share are $2.50 and $1.00, respectively. Both are expected to grow at 5 percent. However, the firm's current P/E ratio of 23 seems high for this growth rate. The P/E ratio is expected to fall to 19 within five years. Compute a value for this stock. Assume a 10 percent required rate. A) $36.19 B) $38.86 C) $40.31 D) $42.00 Answer: D Explanation: Step 1: Find the dividends in the next five years: D1 = $1.00 × (1 + 0.05) = $1.05 D2 = $1.05 × (1 + 0.05) = $1.10 D3 = $1.10 × (1 + 0.05) = $1.16 D4 = $1.16 × (1 + 0.05) = $1.22 D5 = $1.22 × (1 + 0.05) = $1.28. Step 2: Find the stock price in year 5: 19 × 2.5 × 1.05^5 = 60.62. Step 3: Using financial calculator, discount all cash flows at 10 percent: $42.00. Difficulty: 3 Hard Topic: Stock valuation using multiples Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-05 Compute stock values using dividend discount and constant-growth models.; 08-07 Assess relative stock values using the P/E ratio model.

77) A firm has been losing sales due to technological obsolescence. It projects growth for the future to be −2 percent. Its recent dividend was $2.00. What is the value of this stock when the required return is 9 percent? A) $28.00 B) $29.14 C) $17.82 D) $15.52 Answer: C Explanation: 2 (1 − 0.02)/[0.09 − (−0.02)] = $17.82. Difficulty: 3 Hard Topic: Constant-growth stock Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-05 Compute stock values using dividend discount and constant-growth models. 78) A firm has been losing sales due to technological obsolescence. It projects growth for the future to be −3 percent. Its recent dividend was $2.50. What is the value of this stock when the required return is 7 percent? A) $28.17 B) $24.25 C) $17.42 D) $15.53 Answer: B Explanation: 2.5 (1 − 0.03)/[0.07 − (−0.03)] = $24.25. Difficulty: 3 Hard Topic: Constant-growth stock Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-05 Compute stock values using dividend discount and constant-growth models.

79) To list a stock on the NYSE, a company must meet minimum requirements that include all of the following EXCEPT A) firm size. B) total number of stockholders. C) level of trading volume. D) P/E ratio. Answer: D Difficulty: 2 Medium Topic: Stock exchanges Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-02 Know how stock exchanges function. 80) Which of the following is an electronic stock market without a physical trading floor? A) American Stock Exchange B) Mercantile Exchange C) New York Stock Exchange D) Nasdaq Stock Market Answer: D Difficulty: 1 Easy Topic: Stock exchanges Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-02 Know how stock exchanges function. 81) Individuals who use their own stock inventory and capital to buy and sell the stocks they represent are called A) market makers. B) brokers. C) investors. D) none of the options. Answer: A Difficulty: 1 Easy Topic: Stock exchanges Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-02 Know how stock exchanges function.

82) All of the following are stock market indices EXCEPT A) Standard & Poor's 500 Index. B) Dow Jones Industrial Average. C) Nasdaq Composite Index. D) Mercantile 1000. Answer: D Difficulty: 1 Easy Topic: Stock market prices and reporting Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-03 Track the wider stock market with stock indexes and differentiate among the kinds of information each index provides. 83) GEN has 10 million shares outstanding and a stock price of $89.25. What is GEN's market capitalization? A) $89,250,000,000 B) $89,250,000 C) $892,500,000 D) $892,500 Answer: C Explanation: 10,000,000 × 89.25 = $892,500,000. Difficulty: 1 Easy Topic: Market and book values Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-03 Track the wider stock market with stock indexes and differentiate among the kinds of information each index provides.

84) GEN has 1 million shares outstanding and a P/E ratio of 12. Its earnings per share is $2.00. What is GEN's market capitalization? A) $24,000,000 B) $12,000,000 C) $2,000,000 D) $96,000,000 Answer: A Explanation: Step 1: P/E × EPS = Price = 12 × 2 = $24; Step 2: 24 × 1,000,000 = $24,000,000. Difficulty: 2 Medium Topic: Market and book values Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-03 Track the wider stock market with stock indexes and differentiate among the kinds of information each index provides. 85) GEN has 3 million shares outstanding and a P/E ratio of 15. Its earnings per share is $3.00. What is GEN's market capitalization? A) $45,000,000 B) $135,000,000 C) $112,000,000 D) $9,000,000 Answer: B Explanation: Step 1: P/E × EPS = Price = 15 × 3 = $45; Step 2: 45 × 3,000,000 = $135,000,000. Difficulty: 2 Medium Topic: Market and book values Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-03 Track the wider stock market with stock indexes and differentiate among the kinds of information each index provides.

86) ABC has a net profit margin of 3.3 percent on sales of $10,000,000. The firm has 50,000 shares outstanding. If the firm's P/E is 19 times, how much is the stock selling for? A) $41.72 B) $34.96 C) $125.40 D) $99.16 Answer: C Explanation: Step 1: Find EPS. 0.033 × 10,000,000/50,000 = 6.6; Step 2: P/E × EPS = Price = 19 × 6.6 = 125.40. Difficulty: 3 Hard Topic: Stock valuation using multiples Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-07 Assess relative stock values using the P/E ratio model. 87) ABC has a net profit margin of 4.3 percent on sales of $12,000,000. The firm has 250,000 shares outstanding. If the firm's P/E is 16 times, how much is the stock selling for? A) $41.72 B) $35.96 C) $25.40 D) $33.02 Answer: D Explanation: Step 1: Find EPS. 0.043 × 12,000,000/250,000 = 2.06; Step 2: P/E × EPS = Price = 16 × 2.06 = 33.02. Difficulty: 3 Hard Topic: Stock valuation using multiples Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-07 Assess relative stock values using the P/E ratio model.

88) Which of the following indices best reflects the ten sectors of the economy? A) Nasdaq Composite B) Dow Jones Industrial Average C) Standard & Poor's 500 D) None of the options Answer: C Difficulty: 2 Medium Topic: Stock market prices and reporting Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-03 Track the wider stock market with stock indexes and differentiate among the kinds of information each index provides. 89) Studies of investor psychology have discovered that A) investors tend to trade too much. B) investors tend to sell their winners too soon. C) investors tend to become overconfident. D) All of these choices are correct. Answer: D Difficulty: 2 Medium Topic: Behavioral finance Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-03 Track the wider stock market with stock indexes and differentiate among the kinds of information each index provides. 90) Sally has researched GLE and wants to pay no more than $50 for the stock. Currently, GLE is trading in the market for $54. Sally would be best served to A) buy using a limit order. B) buy using a market order. C) use the bid-ask spread to her advantage. D) None of the options. Answer: A Difficulty: 1 Easy Topic: Stock trading Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-03 Track the wider stock market with stock indexes and differentiate among the kinds of information each index provides.

91) Which of the following is incorrect with respect to limit orders? A) They can be used only to buy stock. B) If the current quote does not meet the price cited in the limit order, the trade is not executed. C) The advantage of the limit order is that the investor makes the trade at the desired price. D) The disadvantage of the limit order is that the trade might not be executed at all. Answer: A Difficulty: 2 Medium Topic: Stock trading Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-03 Track the wider stock market with stock indexes and differentiate among the kinds of information each index provides. 92) Which of the following is incorrect with respect to preferred stock? A) Preferred stock is largely owned by other companies rather than individual investors. B) Preferred stock takes preference over common stock in bankruptcy proceedings. C) Preferred stock dividends do not grow. D) All of these choices are correct. Answer: D Difficulty: 2 Medium Topic: Preferred stock features Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-05 Compute stock values using dividend discount and constant-growth models. 93) JUJU's dividend next year is expected to be $1.50. It is trading at $45 and is expected to grow at 9 percent per year. What is JUJU's dividend yield and capital gain? A) 1.5 percent; 6 percent B) 9 percent; 3.33 percent C) 3.33 percent; 9 percent D) 6 percent; 1.5 percent Answer: C Explanation: Step 1: Dividend yield = 1.5/45 = 3.33%; Step 2: Capital gain = g = 9%. Difficulty: 1 Easy Topic: Expected (required) return Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-05 Compute stock values using dividend discount and constant-growth models. 43

94) JUJU's dividend next year is expected to be $5.50. It is trading at $45 and is expected to grow at 4 percent per year. What is JUJU's dividend yield and capital gain? A) 2.5 percent; 6 percent B) 12.22 percent; 4 percent C) 4 percent; 12.22 percent D) 6 percent; 2.5 percent Answer: B Explanation: Step 1: Dividend yield = 5.5/45 = 12.22%; Step 2: Capital gain = g = 4%. Difficulty: 1 Easy Topic: Expected (required) return Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-05 Compute stock values using dividend discount and constant-growth models. 95) Value stocks are A) stocks that are expected to exhibit high growth. B) stocks that have low P/E ratios and are selling at a bargain price. C) stocks that have high valuation ratios, such as P/E. D) none of the options. Answer: B Difficulty: 2 Medium Topic: Classes of stock Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-07 Assess relative stock values using the P/E ratio model. 96) A firm does not pay any dividends at this point in time. Which valuation method should be used on this stock? A) Residual Claimant Model B) Variable Growth Model C) P/E Ratio Model D) Capital Gain Model Answer: C Difficulty: 1 Easy Topic: Stock valuation using multiples Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-07 Assess relative stock values using the P/E ratio model. 44

97) Which of the following statements is incorrect? A) Trading at the New York Stock Exchange and the American Stock Exchange are done by open outcry. B) Dealers create market liquidity in the Nasdaq's electronic market. C) The Dow Jones Industrial Average includes 35 of the largest companies in the United States. D) The Nasdaq contains many very large technology firms. Answer: C Difficulty: 2 Medium Topic: Stock exchanges; Indices Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-02 Know how stock exchanges function.; 08-03 Track the wider stock market with stock indexes and differentiate among the kinds of information each index provides. 98) A firm is expected to pay a $4.00 dividend per share. The stock is selling in the market place for $55.00 per share. If investors are demanding 12 percent on this stock, what is this stock's growth rate? A) 4.73 percent B) 7.25 percent C) 5.91 percent D) 6.14 percent Answer: A Explanation: $55 = 4/[0.12 − g]; g = 4.73%. Difficulty: 3 Hard Topic: Constant-growth stock Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-05 Compute stock values using dividend discount and constant-growth models.

99) A firm is expected to pay a $2.00 dividend per share. The stock is selling in the market place for $50.00 per share. If investors are demanding 10 percent on this stock, what is this stock's growth rate? A) 4.73 percent B) 5.92 percent C) 6.00 percent D) 7.29 percent Answer: C Explanation: $50 = 2/[0.10 − g]; g = 6.0%. Difficulty: 3 Hard Topic: Value a constant growth stock Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-05 Compute stock values using dividend discount and constant-growth models. 100) A firm's recent dividend was $2.00 per share. The stock is selling in the market place for $50.00 per share. If investors are demanding 10 percent on this stock, what is this stock's growth rate? A) 4.73 percent B) 5.92 percent C) 6.00 percent D) 5.77 percent Answer: D Explanation: $50 = 2 (1 + g)/[0.10 − g]; g = 5.77%. Difficulty: 3 Hard Topic: Constant-growth stock Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-05 Compute stock values using dividend discount and constant-growth models.

101) A firm's recent dividend was $4.00 per share. The stock is selling in the market place for $55.00 per share. If investors are demanding 12 percent on this stock, what is this stock's growth rate? A) 4.73 percent B) 4.41 percent C) 5.91 percent D) 6.14 percent Answer: B Explanation: $55 = 4 (1 + g)/[0.12 − g]; g = 4.41%. Difficulty: 3 Hard Topic: Constant-growth stock Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-05 Compute stock values using dividend discount and constant-growth models. 102) A stock is expected to pay a $1.00 dividend per share. The growth rate is expected to be 4 percent. If investors demand 10 percent on this stock, what is the expected price of the stock 10 years from now? A) $24.68 B) $22.17 C) $25.00 D) $26.93 Answer: A Explanation: Step 1: Price = 1/[0.10 − 0.04] = $16.67; Step 2: Find the FV of $16.67 growing at 4 percent = $24.68. Difficulty: 3 Hard Topic: Constant-growth stock Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-05 Compute stock values using dividend discount and constant-growth models.

103) A stock is expected to pay a $4.00 dividend per share. The growth rate is expected to be 5 percent. If investors demand 10 percent on this stock, what is the expected price of the stock 10 years from now? A) $94.68 B) $92.17 C) $130.31 D) $126.93 Answer: C Explanation: Step 1: Price = 4/[0.10 − 0.05] = $80.00; Step 2: Find the FV of $80.00 growing at 5 percent = $130.31. Difficulty: 3 Hard Topic: Constant-growth stock Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-05 Compute stock values using dividend discount and constant-growth models. 104) A stock is expected to pay a $4.00 dividend per share. The growth rate is expected to be −1 percent. If investors demand 8 percent on this stock, what is the expected price of the stock three years from now? A) $54.68 B) $52.17 C) $41.06 D) $43.12 Answer: D Explanation: Step 1: Price = 4/[0.08 + 0.01] = $44.44; Step 2: Find the FV of $44.44 growing at −1% = $43.12. Difficulty: 3 Hard Topic: Constant-growth stock Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-05 Compute stock values using dividend discount and constant-growth models.

105) A stock is expected to pay a $5.00 dividend per share. The growth rate is expected to be −2 percent. If investors demand 8 percent on this stock, what is the expected price of the stock five years from now? A) $54.68 B) $45.20 C) $41.06 D) $53.12 Answer: B Explanation: Step 1: Price = 5/[0.08 + 0.02] = $50.00; Step 2: Find the FV of $50.00 growing at −2% = $45.20. Difficulty: 3 Hard Topic: Constant-growth stock Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-05 Compute stock values using dividend discount and constant-growth models. 106) A firm's stock is selling at $95.00 per share. Its growth rate is 10 percent and investors demand 15 percent on this stock. What is the firm's expected dividend? A) $4.75 B) $5.95 C) $6.25 D) $5.50 Answer: A Explanation: 95 = DIV/0.15 − 0.10; DIV = 4.75. Difficulty: 3 Hard Topic: Constant-growth stock Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-05 Compute stock values using dividend discount and constant-growth models.

107) A firm's stock is selling at $75.00 per share. Its growth rate is 10 percent and investors demand 17 percent on this stock. What is the firm's expected dividend? A) $4.75 B) $5.95 C) $6.25 D) $5.25 Answer: D Explanation: 75 = DIV/0.17 − 0.10; DIV = 5.25. Difficulty: 3 Hard Topic: Constant-growth stock Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-05 Compute stock values using dividend discount and constant-growth models. 108) Which of the following statements is incorrect? A) Preferred stock prices fluctuate with market interest rates and behave like corporate bond prices. B) Common stock prices changes with the value of the company's underlying business. C) Preferred stockholders have higher precedence for repayment than common stock in the event of firm liquidation from bankruptcy. D) All of these choices are correct. Answer: D Difficulty: 3 Hard Topic: Preferred stock features Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-05 Compute stock values using dividend discount and constant-growth models.

109) A stock recently paid a dividend of $3 per share. Its growth rate is expected to be 8 percent. Investors require a 10 percent return. The stock is selling in the market for $140. What is this stock worth and is the stock undervalued or overvalued? A) $162; undervalued B) $162; overvalued C) $150; undervalued D) $150; overvalued Answer: A Explanation: 3(1.08)/[0.1 − 0.08] = $162; undervalued. Difficulty: 3 Hard Topic: Constant-growth stock Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-05 Compute stock values using dividend discount and constant-growth models. 110) A stock recently paid a dividend of $2.5 per share. Its growth rate is expected to be 8 percent. Investors require a 10 percent return. The stock is selling in the market for $150. What is this stock worth and is the stock undervalued or overvalued? A) $125; undervalued B) $125; overvalued C) $135; undervalued D) $135; overvalued Answer: D Explanation: 2.5(1.08)/[0.1 − 0.08] = $135; overvalued. Difficulty: 3 Hard Topic: Constant-growth stock Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-05 Compute stock values using dividend discount and constant-growth models.

111) Laura is considering two investments: Stock A and B. Both stocks have a P/E ratio of 19. Stock A has an expected growth rate of 5 percent and stock B has an expected growth rate of 13 percent. Which is the better stock and why? A) Stock B is better because it is considered to be cheaper than Stock A. B) Stock A is better because it is expected to grow at a slower rate and therefore will be less risky than Stock B. C) Since the P/E ratios are the same, Laura would be indifferent between the two stocks. D) None of these choices are correct. Answer: A Difficulty: 3 Hard Topic: Stock valuation using multiples Bloom's: Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-07 Assess relative stock values using the P/E ratio model. 112) Coca-Cola recently paid a $3.00 dividend. Investors expect a 12 percent return on this stock. What is the difference in price if Coca-Cola is expected to grow at 6 percent versus 8 percent? A) $18 B) $48 C) $28 D) $38 Answer: C Explanation: Step 1: Price at 6 percent growth: 3(1.06)/[0.12 − 0.06] = $53; Step 2: Price at 8 percent growth: 3(1.08)/[0.12 − 0.08] = $81; Difference in price = $28. Difficulty: 3 Hard Topic: Constant-growth stock Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-05 Compute stock values using dividend discount and constant-growth models.

113) Coca-Cola recently paid a $3.00 dividend. Investors expect a 12 percent return on this stock. What is the difference in price if Coca-Cola is expected to grow at 7 percent versus 8 percent? A) $11.40 B) $16.80 C) $21.60 D) $19.40 Answer: B Explanation: Step 1: Price at 7 percent growth: 3(1.07)/[0.12 − 0.07] = $64.20; Step 2: Price at 8 percent growth: 3(1.08)/[0.12 − 0.08] = $81; Difference in price = $16.8. Difficulty: 3 Hard Topic: Constant-growth stock Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-05 Compute stock values using dividend discount and constant-growth models. 114) Coca-Cola recently paid a $3.00 dividend. Investors expect a 12 percent return on this stock. What is the percentage change in price if Coca-Cola is expected to grow at 7 percentversus 8 percent? A) 31.29 percent B) 19.82 percent C) 21.60 percent D) 26.17 percent Answer: D Explanation: Step 1: Price at 7 percent growth: 3(1.07)/[0.12 − 0.07] = $64.20; Step 2: Price at 8 percent growth: 3(1.08)/[0.12 − 0.08] = $81; Difference in price = $16.8; Percentage change in price = 16.8/64.20. Difficulty: 3 Hard Topic: Constant-growth stock Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-05 Compute stock values using dividend discount and constant-growth models.

115) A firm does not pay a dividend. It is expected to pay its first dividend of $1.00 per share in two years. This dividend will grow at 5 percent indefinitely. Using a 12 percent discount rate, compute the value of this stock. A) $12.76 B) $12.19 C) $11.96 D) $11.39 Answer: A Explanation: Step 1: P2 = (1.00 × 1.05)/(0.12 − 0.05) = $15.00. Step 2: FV = 15.00 + 1.00 = $16.00 N = 2, I = 12, PMT = 0, CPT PV = $12.7551. Difficulty: 2 Medium Topic: Constant-growth stock Bloom's: Apply; Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-06 Calculate the stock value of a variable-growth-rate company. 116) A firm does not pay a dividend. It is expected to pay its first dividend of $1.50 per share in three years. This dividend will grow at 6 percent indefinitely. Using a 10 percent discount rate, compute the value of this stock. A) $29.86 B) $30.99 C) $41.25 D) $42.79 Answer: B Explanation: Step 1: P2 = (1.50 × 1.06)/(0.10 − 0.06) = $39.75. Step 2: FV = 39.75 + 1.50 = $41.25 N = 3, I = 10, PMT = 0, CPT PV = $30.9917. Difficulty: 2 Medium Topic: Constant-growth stock Bloom's: Apply; Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-06 Calculate the stock value of a variable-growth-rate company.

117) Suppose that a firm's recent earnings per share and dividends per share are $5.00 and $1.00, respectively. Both are expected to grow at 5 percent. However, the firm's current P/E ratio of 18 seems high for this growth rate. The P/E ratio is expected to fall to 10 within five years. Compute a value for this stock by first estimating the dividends over the next five years and the stock price in five years. Then discount these cash flows using a 12 percent required rate. A) $32.51 B) $40.35 C) $50.00 D) $63.81 Answer: B Explanation: D1 = $1.00 × 1.05 = $1.05 = C01, 1 F01. D2 = $1.05 × 1.05 = $1.1025 = C02, 1 F02. D3 = $1.1025 × 1.05 = $1.1576 = C03, 1 F03. D4 = $1.1576 × 1.05 = $1.2155 = C04, 1 F04. D5 = $1.2155 × 1.05 = $1.2763. P5 = 10 × $5.00 × (1.05)^5 = 63.8141. D5 + P5 = 65.0904 = C05, 1 F05. I = 12 NPV = $40.3469 Difficulty: 3 Hard Topic: Stock valuation using multiples Bloom's: Apply; Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-05 Compute stock values using dividend discount and constant-growth models.; 08-06 Calculate the stock value of a variable-growth-rate company.; 08-07 Assess relative stock values using the P/E ratio model. 118) You would like to buy shares of International Business Machines (IBM). The current bid and ask quotes are $103.25 and $103.30, respectively. You place a market buy-order for 200 shares that executes at these quoted prices. How much money did it cost to buy these shares? A) $10,330.00 B) $20,650.00 C) $20,660.00 D) None of these choices are correct. Answer: C Explanation: $103.30 per share × 200 shares = $20,660.00 Difficulty: 1 Easy Topic: Stock trading Bloom's: Apply; Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-04 Know the terminology of stock trading.

119) You would like to buy shares of Nokia (NOK). The current bid and ask quotes are $25.43 and $25.45, respectively. You place a market buy-order for 150 shares that executes at these quoted prices. How much money did it cost to buy these shares? A) $1,908.75 B) $3,815.50 C) $3,817.50 D) None of these choices are correct. Answer: C Explanation: $25.45 per share × 150 shares = $3,817.50 Difficulty: 1 Easy Topic: Stock trading Bloom's: Apply; Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-04 Know the terminology of stock trading. 120) If Walmart (WMT) recently earned a profit of $5.10 per share and has a P/E ratio of 16.25. The dividend has been growing at a 6 percent rate over the past few years. If this growth continues, what would be the stock price in five years if the P/E ratio remained unchanged? What would the price be if the P/E ratio declined to 12 in five years? A) $41.44, $30.60 respectively B) $82.88, $61.20 respectively C) $110.91, $81.90 respectively D) $414.38, $306.00 respectively Answer: C Explanation: PV = $5.10 , I = 6, PMT = 0, N = 5, CPT FV = $6.8250 $6.8250 × 16.25 = $110.9054. $6.8250 × 12 = $81.90. Difficulty: 2 Medium Topic: Stock valuation using multiples Bloom's: Apply; Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-07 Assess relative stock values using the P/E ratio model.

121) If Target Corp. (TGT) recently earned a profit of $6.07 earnings per share and has a P/E ratio of 16.5. The dividend has been growing at a 10 percent rate over the past few years. If this growth continues, what would be the stock price in five years if the P/E ratio remained unchanged? What would the price be if the P/E ratio increased to 18 in five years? A) $100.16, $109.26 respectively B) $161.30, $175.96 respectively C) $259.78, $283.39 respectively D) $261.30, $275.96 respectively Answer: B Explanation: PV = $6.07, I = 10, PMT = 0, N = 5, CPT FV = $9.7758 $9.7758 × 16.5 = $161.3006. $9.7758 × 18 = $175.9644. Difficulty: 2 Medium Topic: Stock valuation using multiples Bloom's: Apply; Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-07 Assess relative stock values using the P/E ratio model. 122) At your discount brokerage firm, it costs $10.50 per stock trade. How much money do you need to buy 100 shares of Apple (AAPL), which trades at $202.64? A) $20,253.50 B) $20,264.00 C) $20,274.50 D) $21,314.00 Answer: C Explanation: ($202.64 per share × 100 shares) + $10.50 = $20,274.50 Difficulty: 1 Easy Topic: Stock trading Bloom's: Apply; Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-04 Know the terminology of stock trading.

123) At your full-service brokerage firm, it costs $125 per stock trade. How much money do you receive after selling 200 shares of Time Warner, Inc. (TMX), which trades at $29.54? A) $5,783.00 B) $5,908.00 C) $6,033.00 D) $19,092.00 Answer: A Explanation: ($29.54 per share × 200 shares) − $125 = $5,783.00. Difficulty: 1 Easy Topic: Stock trading; Selling stock with commissions Bloom's: Apply; Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-04 Know the terminology of stock trading. 124) A preferred stock from DLC pays $5.10 in annual dividends. If the required return on the preferred stock is 12.1 percent, what is the value of the stock? A) $6.31 B) $42.15 C) $47.25 D) $240.97 Answer: B Explanation: 5.10/0.121 = $42.1488. Difficulty: 1 Easy Topic: Zero-growth stock Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 08-05 Compute stock values using dividend discount and constant-growth models.

Finance, 5e (Cornett) Chapter 9 Characterizing Risk and Return 1) Which of these includes any capital gain (or loss) that occurred as well as any income that you received from a specific investment? A) average return B) dollar return C) market return D) portfolio Answer: B Difficulty: 1 Easy Topic: Dollar and percentage returns Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 09-01 Compute an investment's dollar and percentage return. 2) Which of these is the dollar return characterized as a percentage of money invested? A) average return B) dollar return C) market return D) percentage return Answer: D Difficulty: 1 Easy Topic: Dollar and percentage returns Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 09-01 Compute an investment's dollar and percentage return. 3) Which of these is a measure summarizing the overall past performance of an investment? A) average return B) dollar return C) market return D) percentage return Answer: A Difficulty: 1 Easy Topic: Dollar and percentage returns Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 09-01 Compute an investment's dollar and percentage return.

4) Which of these statements is true? A) When people purchase a stock, they know exactly what their dollar and percent return are going to be. B) Many people purchase stocks as they find comfort in the certainty for this safe form of investing. C) When people purchase a stock, they know the short-term return, but not the long-term return. D) When people purchase a stock, they do not know what their return is going to be—either short term or in the long run. Answer: D Difficulty: 1 Easy Topic: Risks and returns Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 09-02 Find information about the historical returns and volatility for the stock, bond, and cash markets. 5) Which of the following is defined as the volatility of an investment, which includes firm specific risk as well as market risk? A) diversifiable risk B) market risk C) standard deviation D) total risk Answer: D Difficulty: 1 Easy Topic: Risks and returns Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 09-01 Compute an investment's dollar and percentage return.

6) Which of these is a measure of risk to reward earned by an investment over a specific period of time? A) coefficient of variation B) market deviation C) standard deviation D) total variation Answer: A Difficulty: 1 Easy Topic: Risk and return relationship Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 09-04 Recognize the risk-return relationship and its implications. 7) Which of the following is an index that tracks 500 companies, which allows for a great deal of diversification? A) Nasdaq B) Fortune 500 C) S&P 500 D) Wall Street Journal Answer: C Difficulty: 1 Easy Topic: Stock market prices and reporting Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 09-04 Recognize the risk-return relationship and its implications. 8) Which of these is defined as a combination of investment assets held by an investor? A) bundle B) market basket C) portfolio D) All of these choices are correct. Answer: C Difficulty: 1 Easy Topic: Risk and return relationship Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 09-04 Recognize the risk-return relationship and its implications.

9) Which of the following is defined as the portion of total risk that is attributable to firm or industry factors and can be reduced through diversification? A) firm specific risk B) market risk C) modern portfolio risk D) total risk Answer: A Difficulty: 1 Easy Topic: Systematic and unsystematic risk Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 09-05 Plan investments that take advantage of diversification and its impact on total risk. 10) Which of these is the portion of total risk that is attributable to overall economic factors? A) firm specific risk B) market risk C) modern portfolio risk D) total risk Answer: B Difficulty: 1 Easy Topic: Systematic and unsystematic risk Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 09-05 Plan investments that take advantage of diversification and its impact on total risk. 11) Which of the following is another term for market risk? A) firm specific risk B) modern portfolio risk C) nondiversifiable risk D) total risk Answer: C Difficulty: 1 Easy Topic: Systematic and unsystematic risk Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 09-05 Plan investments that take advantage of diversification and its impact on total risk.

12) Which of the following is the concept and procedure for combining securities into a portfolio to minimize risk? A) firm specific theory B) modern portfolio theory C) optimal portfolio theory D) total portfolio theory Answer: B Difficulty: 1 Easy Topic: Diversification concepts and measures Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 09-06 Find efficient and optimal portfolios. 13) Which of these is the investor's combination of securities that achieves the highest expected return for a given risk level? A) efficient portfolio B) modern portfolio C) optimal portfolio D) total portfolio Answer: C Difficulty: 1 Easy Topic: Modern portfolio theory Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 09-06 Find efficient and optimal portfolios. 14) Which of these is the term for portfolios with the highest return possible for each risk level? A) efficient portfolios B) modern portfolios C) optimal portfolios D) total portfolios Answer: A Difficulty: 1 Easy Topic: Modern portfolio theory Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 09-06 Find efficient and optimal portfolios.

15) Which of the following makes this a true statement: The shape of the efficient frontier implies that A) diminishing returns apply to risk-taking in the investment world. B) increasing returns apply to risk-taking in the investment world. C) returns are not impacted by risk-taking in the investment world. D) None of these choices complete the sentence to make it true. Answer: A Difficulty: 2 Medium Topic: Modern portfolio theory Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 09-06 Find efficient and optimal portfolios. 16) Which of the following is a measurement of the co-movement between two variables that ranges between −1 and +1? A) coefficient of variation B) correlation C) standard deviation D) total risk Answer: B Difficulty: 2 Medium Topic: Diversification concepts and measures Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 09-05 Plan investments that take advantage of diversification and its impact on total risk. 17) To find the percentage return of an investment A) multiply the dollar return by the investment's value at the beginning of the period. B) divide the dollar return by the investment's value at the beginning of the period. C) multiply the dollar return by the investment's value at the end of the period. D) divide the dollar return by the investment's value at the end of the period. Answer: B Difficulty: 1 Easy Topic: Total return Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 09-01 Compute an investment's dollar and percentage return.

18) Which statement is true? A) The larger the standard deviation, the lower the total risk. B) The larger the standard deviation, the higher the total risk. C) The larger the standard deviation, the more portfolio risk. D) The standard deviation is not an indication of total risk. Answer: B Difficulty: 1 Easy Topic: Standard deviation and variance Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 09-01 Compute an investment's dollar and percentage return. 19) We commonly measure the risk-return relationship using which of the following? A) coefficient of variation B) correlation coefficient C) standard deviation D) expected returns Answer: A Difficulty: 1 Easy Topic: Risk and return relationship Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 09-04 Recognize the risk-return relationship and its implications. 20) MedTech Corp. stock was $50.95 per share at the end of last year. Since then, it paid a $0.45 per share dividend. The stock price is currently $62.50. If you owned 500 shares of MedTech, what was your percent return? A) 7.20 percent B) 8.83 percent C) 22.67 percent D) 23.55 percent Answer: D Explanation: Dollar Return = (Ending Value − Beginning Value) + Income = ($62.50 × 500 − $50.95 × 500) + ($0.45 × 500) = $6,000. Percentage Return = $6,000 ÷ ($50.95 × 500) = 0.2355 = 23.55 percent. Difficulty: 1 Easy Topic: Total return Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 09-01 Compute an investment's dollar and percentage return. 7

21) Rx Corp. stock was $60.00 per share at the end of last year. Since then, it paid a $1.00 per share dividend last year. The stock price is currently $62.50. If you owned 400 shares of Rx, what was your percent return? A) 1.67 percent B) 4.17 percent C) 5.60 percent D) 5.83 percent Answer: D Explanation: Dollar Return = (Ending Value − Beginning Value) + Income = ($62.50 × 400 − $60.00 × 400) + ($1.00 × 400) = $1,400. Percentage Return = $1,400 ÷ ($60 × 400) = 0.0583 = 5.83 percent. Difficulty: 1 Easy Topic: Total return Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 09-01 Compute an investment's dollar and percentage return. 22) TechNo stock was $25 per share at the end of last year. Since then, it paid a $1.50 per share dividend last year. The stock price is currently $23. If you owned 300 shares of TechNo, what was your percent return? A) −2 percent B) −8 percent C) 6 percent D) 6.5 percent Answer: A Explanation: Dollar Return = (Ending Value − Beginning Value) + Income = $23 × 300 − $25 × 300 + $1.50 × 300 = −$150. Percentage Return = −$150 ÷ ($25 × 300) = −0.02 = −2 percent. Difficulty: 1 Easy Topic: Total return Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 09-01 Compute an investment's dollar and percentage return.

23) Noble stock was $60.00 per share at the end of last year. Since then, it paid a $2.00 per share dividend last year. The stock price is currently $58. If you owned 400 shares of Noble, what was your percent return? A) −3.33 percent B) 0 percent C) 3.33 percent D) 3.45 percent Answer: B Explanation: Dollar Return = (Ending Value − Beginning Value) + Income = $58 × 400 − $60 × 400 + $2.00 × 400 = $0. Percentage Return = $0 ÷ ($60 × 400) = 0.0 = 0 percent. Difficulty: 1 Easy Topic: Total return Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 09-01 Compute an investment's dollar and percentage return. 24) WayCo stock was $75 per share at the end of last year. Since then, it paid a $3 per share dividend last year. The stock price is currently $70. If you owned 200 shares of WayCo, what was your percent return? A) −6.67 percent B) −2.67 percent C) 4.00 percent D) 4.29 percent Answer: B Explanation: Dollar Return = (Ending Value − Beginning Value) + Income = $70 × 200 − $75 × 200 + $3 × 200 = −$400. Percentage Return = −$400 ÷ ($75 × 200) = −0.0267 = −2.67 percent. Difficulty: 1 Easy Topic: Total return Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 09-01 Compute an investment's dollar and percentage return.

25) Rank the following three stocks by their level of total risk, highest to lowest. Rail Haul has an average return of 10 percent and standard deviation of 15 percent. The average return and standard deviation of Idol Staff are 15 percent and 25 percent; and of Poker-R-Us are 12 percent and 35 percent. A) Rail Haul, Poker-R-Us, Idol Staff B) Idol Staff, Poker-R-Us, Rail Haul C) Poker-R-Us, Idol Staff, Rail Haul D) Idol Staff, Rail Haul, Poker-R-Us Answer: C Explanation: Rank by standard deviation. Difficulty: 1 Easy Topic: Risks and returns Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 09-03 Measure and evaluate the total risk of an investment using several methods. 26) Rank the following three stocks by their level of total risk, highest to lowest. Rail Haul has an average return of 8 percent and standard deviation of 10 percent. The average return and standard deviation of Idol Staff are 10 percent and 20 percent; and of Poker-R-Us are 6 percent and 15 percent. A) Rail Haul, Poker-R-Us, Idol Staff B) Idol Staff, Rail Haul, Poker-R-Us C) Poker-R-Us, Idol Staff, Rail Haul D) Idol Staff, Poker-R-Us, Rail Haul Answer: D Explanation: Rank by standard deviation. Difficulty: 1 Easy Topic: Risks and returns Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 09-03 Measure and evaluate the total risk of an investment using several methods.

27) Rank the following three stocks by their risk-return relationship, best to worst. Rail Haul has an average return of 10 percent and standard deviation of 15 percent. The average return and standard deviation of Idol Staff are 15 percent and 25 percent; and of Poker-R-Us are 12 percent and 35 percent. A) Rail Haul, Idol Staff, Poker-R-Us B) Idol Staff, Poker-R-Us, Rail Haul C) Poker-R-Us, Idol Staff, Rail Haul D) Idol Staff, Rail Haul, Poker-R-Us Answer: A Explanation: Rank by coefficient of variation: Rail Haul CoV = 15/10 = 1.5, Idol Staff CoV = 25/15 = 1.67, Poker-R-Us CoV = 35/12 = 2.92. Difficulty: 1 Easy Topic: Risk and return relationship Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 09-04 Recognize the risk-return relationship and its implications. 28) Rank the following three stocks by their risk-return relationship, best to worst. Rail Haul has an average return of 8 percent and standard deviation of 10 percent. The average return and standard deviation of Idol Staff are 10 percent and 20 percent; and of Poker-R-Us are 6 percent and 15 percent. A) Rail Haul, Idol Staff, Poker-R-Us B) Idol Staff, Rail Haul, Poker-R-Us C) Poker-R-Us, Idol Staff, Rail Haul D) Idol Staff, Poker-R-Us, Rail Haul Answer: A Explanation: Rank by coefficient of variation: Rail Haul CoV = 10/8 = 1.25, Idol Staff CoV = 20/10 = 2, Poker-R-Us CoV = 15/6 = 2.5. Difficulty: 1 Easy Topic: Risk and return relationship Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 09-04 Recognize the risk-return relationship and its implications.

29) Determine which one of these three portfolios dominates another. Name the dominated portfolio and the portfolio that dominates it. Portfolio Blue has an expected return of 14 percent and risk of 19 percent. The expected return and risk of portfolio Yellow are 15 percent and 18 percent; and for the Purple portfolio are 16 percent and 21 percent. A) Portfolio Blue dominates portfolio Yellow. B) Portfolio Yellow dominates portfolio Blue. C) Portfolio Blue dominates Portfolio Purple. D) Portfolio Purple dominates portfolio Yellow. Answer: B Explanation: Portfolio Yellow dominates portfolio Blue because it has both a higher expected return and a lower risk level. Difficulty: 1 Easy Topic: Modern portfolio theory Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 09-06 Find efficient and optimal portfolios. 30) Determine which one of these three portfolios dominates another. Name the dominated portfolio and the portfolio that dominates it. Portfolio Blue has an expected return of 7 percent and risk of 10 percent. The expected return and risk of portfolio Yellow are 13 percent and 10 percent; and for the Purple portfolio are 9 percent and 14 percent. A) Portfolio Blue dominates portfolio Yellow. B) Portfolio Yellow dominates portfolio Blue. C) Portfolio Purple dominates portfolio Blue. D) Portfolio Purple dominates portfolio Yellow. Answer: B Explanation: Portfolio Yellow dominates portfolio Blue because it has both a higher expected return and the same risk level. Difficulty: 1 Easy Topic: Modern portfolio theory Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 09-06 Find efficient and optimal portfolios.

31) Determine which one of these three portfolios dominates another. Name the dominated portfolio and the portfolio that dominates it. Portfolio Blue has an expected return of 13 percent and risk of 17 percent. The expected return and risk of portfolio Yellow are 15 percent and 19 percent; and for the Purple portfolio are 12 percent and 18 percent. A) Portfolio Blue dominates portfolio Yellow. B) Portfolio Blue dominates portfolio Purple. C) Portfolio Purple dominates portfolio Blue. D) Portfolio Purple dominates portfolio Yellow. Answer: B Explanation: Portfolio Blue dominates portfolio Purple because it has both a higher expected return and a lower risk level. Difficulty: 1 Easy Topic: Modern portfolio theory Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 09-06 Find efficient and optimal portfolios. 32) An investor owns $10,000 of Adobe Systems stock, $15,000 of Dow Chemical, and $25,000 of Office Depot. What are the portfolio weights of each stock? A) Adobe System = 0.3333, Dow Chemical = 0.3333, Office Depot = 0.3333 B) Adobe System = 0.2, Dow Chemical = 0.3, Office Depot = 0.5 C) Adobe System = 0.3, Dow Chemical = 0.2, Office Depot = 0.5 D) Adobe System = 0.2667, Dow Chemical = 0.3333, Office Depot = 0.4 Answer: B Explanation: Total portfolio is $10,000 + $15,000 + $25,000 = $50,000. Adobe System weight = $10,000/$50,000 = 0.2. Dow Chemical weight = $15,000/50,000 = 0.3. Office Depot weight = $25,000/$50,000 = 0.5. Difficulty: 1 Easy Topic: Portfolio weights Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 09-07 Compute a portfolio's return.

33) An investor owns $2,000 of Adobe Systems stock, $4,000 of Dow Chemical, and $6,000 of Office Depot. What are the portfolio weights of each stock? A) Adobe System = 0.3333, Dow Chemical = 0.3333, Office Depot = 0.3333 B) Adobe System = 0.1667, Dow Chemical = 0.3333, Office Depot = 0.5 C) Adobe System = 0.3333, Dow Chemical = 0.1667, Office Depot = 0.5 D) Adobe System = 0.2, Dow Chemical = 0.4, Office Depot = 0.6 Answer: B Explanation: Total portfolio is $2,000 + $4,000 + $6,000 = $12,000. Adobe System weight = $2,000/$12,000 = 0.1667. Dow Chemical weight = $4,000/12,000 = 0.3333. Office Depot weight = $6,000/$12,000 = 0.5. Difficulty: 1 Easy Topic: Portfolio weights Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 09-07 Compute a portfolio's return. 34) Year-to-date, Company O had earned a −2.10 percent return. During the same time period, Company V earned 8.00 percent and Company M earned 6.25 percent. If you have a portfolio made up of 40 percent Company O, 30 percent Company V, and 30 percent Company M, what is your portfolio return? A) 3.435 percent B) 5.115 percent C) 12.15 percent D) 16.35 percent Answer: A Explanation: Portfolio Return is 0.4 × −2.10% + 0.3 × 8% + 0.3 × 6.25% = 3.435%. Difficulty: 1 Easy Topic: Portfolio return Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 09-07 Compute a portfolio's return.

35) Year-to-date, Company Y had earned a 7 percent return. During the same time period, Company R earned 9.25 percent and Company C earned −2.25 percent. If you have a portfolio made up of 35 percent Y, 40 percent R, and 25 percent C, what is your portfolio return? A) 4.6667 percent B) 6.1667 percent C) 5.5875 percent D) 12.6625 percent Answer: C Explanation: Portfolio Return is 0.35 × 7% + 0.4 × 9.25% + 0.25 × −2.25% = 5.5875%. Difficulty: 1 Easy Topic: Portfolio return Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 09-07 Compute a portfolio's return. 36) Year-to-date, Company Y had earned a 10.8 percent return. During the same time period, Company R earned 12.20 percent and Company C earned −1.56 percent. If you have a portfolio made up of 45 percent Y, 35 percent R, and 20 percent C, what is your portfolio return? A) 7.15 percent B) 8.19 percent C) 8.82 percent D) 9.44 percent Answer: C Explanation: Portfolio Return is 0.45 × 10.8% + 0.35 × 12.20% + 0.20 × −1.56% = 8.818%. Difficulty: 1 Easy Topic: Portfolio return Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 09-07 Compute a portfolio's return.

37) The past five monthly returns for K and Company are 4.25 percent, 4.13 percent, −2.05 percent, 3.25 percent, and 7.25 percent. What is the average monthly return? A) 1.403 percent B) 1.744 percent C) 3.366 percent D) 4.186 percent Answer: C Explanation: Average Return = (4.25% + 4.13% − 2.05% + 3.25% + 7.25%)/5 = 3.366%. Difficulty: 2 Medium Topic: Arithmetic and geometric returns Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 09-01 Compute an investment's dollar and percentage return. 38) The past five monthly returns for K and Company are 2.28 percent, 2.64 percent, −1.05 percent, 4.25 percent, and 9.25 percent. What is the average monthly return? A) 1.45 percent B) 1.62 percent C) 3.47 percent D) 3.89 percent Answer: C Explanation: Average Return = (2.28% + 2.64% − 1.05% + 4.25% + 9.25%)/5 = 3.47%. Difficulty: 2 Medium Topic: Arithmetic and geometric returns Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 09-01 Compute an investment's dollar and percentage return.

39) The past five monthly returns for PG Company are 3.25 percent, −1.45 percent, 4.35 percent, 6.49 percent, and 3.75 percent. What is the average monthly return? A) 1.366 percent B) 1.608 percent C) 3.278 percent D) 3.858 percent Answer: C Explanation: Average Return = (3.25% − 1.45% + 4.35% + 6.49% + 3.75%)/5 = 3.278%. Difficulty: 2 Medium Topic: Arithmetic and geometric returns Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 09-01 Compute an investment's dollar and percentage return. 40) The standard deviation of the past five monthly returns for K and Company are 4.25 percent, 4.13 percent, −2.05 percent, 3.25 percent, and 7.25 percent. What is the standard deviation? A) 1.40 percent B) 3.89 percent C) 3.38 percent D) 16.83 percent Answer: C Explanation: =3.53%

41) The standard deviation of the past five monthly returns for K and Company are 2.28 percent, 2.64 percent, −1.05 percent, 4.25 percent, and 9.25 percent. What is the standard deviation? A) 1.45 percent B) 1.62 percent C) 3.47 percent D) 3.76 percent Answer: D Explanation: =3.76%

Difficulty: 2 Medium Topic: Standard deviation and variance Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 09-03 Measure and evaluate the total risk of an investment using several methods. 42) The standard deviation of the past five monthly returns for PG Company are 2.75 percent, −0.75 percent, 4.15 percent, 6.29 percent, and 3.84 percent. What is the standard deviation? A) 2.309 percent B) 2.581 percent C) 3.256 percent D) 3.406 percent Answer: B Explanation: =2.581

43) If you own 400 shares of Air Line Inc. at $44.50, 500 shares of BuyRite at $52.90, and 100 shares of MotorCity at $9.25, what are the portfolio weights of each stock? A) Air Line = 0.3333, BuyRite = 0.3333, MotorCity = 0.3333 B) Air Line = 0.40, BuyRite = 0.50, MotorCity = 0.10 C) Air Line = 0.3940, BuyRite = 0.5855, MotorCity = 0.0205 D) Air Line = 0.4173, BuyRite = 0.4960, MotorCity = 0.0867 Answer: C Explanation: Total portfolio is 400 × $44.50 + 500 × $52.90 + 100 × $9.25 = $45,175. Air Line weight = 400 × $44.50/$45,175 = 0.3940. BuyRite weight = 500 × $52.90/$45,175 = 0.5855. MotorCity weight = 100 × $9.25/$45,175 = 0.0205. Difficulty: 2 Medium Topic: Portfolio weights Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 09-03 Measure and evaluate the total risk of an investment using several methods. 44) If you own 100 shares of Air Line Inc. at $42.50, 250 shares of BuyRite at $53.25, and 350 shares of MotorCity at $7.75, what are the portfolio weights of each stock? A) Air Line = 0.3333, BuyRite = 0.3333, MotorCity = 0.3333 B) Air Line = 0.10, BuyRite = 0.25, MotorCity = 0.35 C) Air Line = 0.2096, BuyRite = 0.6566, MotorCity = 0.1338 D) Air Line = 0.1429, BuyRite = 0.3571, MotorCity = 0.5000 Answer: C Explanation: Total portfolio is 100 × $42.50 + 250 × $53.25 + 350 × $7.75 = $20,275. Air Line weight = 100 × $42.50/$20,275 = 0.2096. BuyRite weight = 250 × $53.25/$20,275 = 0.6566. MotorCity weight = 350 × $7.75/$20,275 = 0.1338. Difficulty: 2 Medium Topic: Portfolio weights Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 09-03 Measure and evaluate the total risk of an investment using several methods.

45) At the beginning of the month, you owned $6,000 of Company G, $8,000 of Company S, and $1,000 of Company N. The monthly returns for Company G, Company S, and Company N were 7.25 percent, −1.50 percent, and −0.23 percent. What is your portfolio return? A) 1.84 percent B) 2.08 percent C) 3.71 percent D) 5.52 percent Answer: B Explanation: Total portfolio is $6,000 + $8,000 + $1,000 = $15,000. Company G weight = $6,000/$15,000 = 0.40. Company S weight = $8,000/$15,000 = 0.53. Company N weight = $1,000/$15,000 = 0.07. So Portfolio Return is 0.40 × 7.25% + 0.53 × −1.50% + 0.07 × −0.23% = 2.08%. Difficulty: 2 Medium Topic: Portfolio weights Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 09-07 Compute a portfolio's return. 46) At the beginning of the month, you owned $8,000 of Company G, $8,000 of Company S, and $3,000 of Company N. The monthly returns for Company G, Company S, and Company N were 7.80 percent, 1.50 percent, and −0.75 percent. What is your portfolio return? A) 2.85 percent B) 3.80 percent C) 4.03 percent D) 8.55 percent Answer: B Explanation: Total portfolio is $8,000 + $8,000 + $3,000 = $19,000. Company G weight = $8,000 / $19,000 = 0.42. Company S weight = $8,000 / $19,000 = 0.42. Company N weight = $3,000 / $19,000 = 0.16. So Portfolio Return is 0.42 × 7.80% + 0.42 × 1.50% + 0.16 × −0.75% = 3.80%. Difficulty: 2 Medium Topic: Portfolio return Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 09-07 Compute a portfolio's return.

47) You have $15,040 to invest. You want to purchase shares of Company A at $42.50, Company B at $51.50, and Company F at $9.75. How many shares of each company should you purchase so that your portfolio consists of 20 percent Company A, 40 percent Company B, and 40 percent Company F? Report only whole stock shares. A) Company A = 20 shares, Company B = 40 shares, Company F = 40 shares B) Company A = 85 shares, Company B = 21 shares, Company F = 39 shares C) Company A = 70 shares, Company B = 116 shares, Company F = 617 shares D) Company A = 353 shares, Company B = 291 shares, Company F = 1538 shares Answer: C Explanation: Company A: 0.20 × $15,040 ÷ $42.50 = 70.776 → 70 shares. Company B: 0.40 × $15,040 ÷ $51.50 = 116.8155 → 116. Company F: 0.40 × $15,040 ÷ $9.75 = 617.02 → 617. Because of rounding. Difficulty: 2 Medium Topic: Portfolio weights Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 09-07 Compute a portfolio's return. 48) You have $45,050 to invest. You want to purchase shares of Company A at $10.25, Company B at $15.10, and Company F at $9.05. How many shares of each company should you purchase so that your portfolio consists of 30 percent Company A, 50 percent Company B, and 20 percent Company F? Report only whole stock shares. A) Company A = 30 shares, Company B = 50 shares, Company F = 20 shares B) Company A = 44 shares, Company B = 30 shares, Company F = 50 shares C) Company A = 308 shares, Company B = 755 shares, Company F = 181 shares D) Company A = 1,318 shares, Company B = 1,491 shares, Company F = 995 shares Answer: D Explanation: Company A: 0.30 × $45,050 ÷ $10.25 = 1318.537 → 1318. Company B: 0.50 × $45,050 ÷ $15.10 = 1491.722 → 1491. Company F: 0.20 × $45,050 ÷ $9.05 = 995.58 → 995. Because of rounding. Difficulty: 2 Medium Topic: Portfolio weights Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 09-07 Compute a portfolio's return.

22) The following table shows your stock positions at the beginning of the year, the dividends that each stock paid during the year, and the stock prices at the end of the year. What is your portfolio percentage return?

Company W P J D

Shares 200 200 400 200

Beginning of Year Price $ 45.00 $ 5.00 $ 20.00 $ 27.00

Dividend per Share $ 2.50 $ 1.00 $ 1.25

End of Year Price $ 44.00 $ 5.25 $ 22.00 $ 27.50

A) 3.21 percent B) 4.06 percent C) 7.26 percent D) 8.97 percent Answer: C Explanation: Company W P J D Total =

Beginning Percentage Value Portfolio Weight Capital Gain Income Total Return Return $ 9,000.00 0.3846 $ (200.00 ) $ 500.00 $ 300.00 $ 1,000.00 0.0427 $ 50.00 $ 200.00 $ 250.00 $ 8,000.00 0.3419 $ 800.00 $ 0.00 $ 800.00 $ 5,400.00 0.2308 $ 100.00 $ 250.00 $ 350.00 $ 23,400.00 $ 1700.00 Portfolio Return = 7.26 %

Difficulty: 2 Medium Topic: Portfolio return Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 09-07 Compute a portfolio's return.

23) The following table shows your stock positions at the beginning of the year, the dividends that each stock paid during the year, and the stock prices at the end of the year. What is your portfolio percentage return?

Company W P J D

Shares 500 100 200 200

Beginning of Year Price $ 5.00 $ 15.00 $ 25.00 $ 30.00

Dividend per Share $ 0.50 $ 1.00 $ 2.00

End of Year Price $ 4.00 $ 15.25 $ 22.00 $ 33.50

A) 2.50 percent B) 5.83 percent C) 10.50 percent D) 13.83 percent Answer: A Explanation: Company W P J D Total =

Beginning Portfolio Value Weight Capital Gain Income Total Return $ 2,500.00 0.1667 $ (500.00 ) $ 250.00 $ (250.00 ) $ 1,500.00 0.1000 $ 25.00 $ 100.00 $ 125.00 $ 5,000.00 0.3333 $ (600.00 ) $ 0.00 $ (600.00 ) $ 6,000.00 0.4000 $ 700.00 $ 400.00 $ 1,100.00 $ 15,000.00 $ 375.00 Portfolio Return =

Difficulty: 2 Medium Topic: Portfolio return Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 09-07 Compute a portfolio's return.

Percentage Return

2.5

24) The following table shows your stock positions at the beginning of the year, the dividends that each stock paid during the year, and the stock prices at the end of the year. What is your portfolio percentage return?

Company W P J D

Shares 100 200 400 200

Beginning of Year Price $ 25.00 $ 14.00 $ 8.00 $ 3.00

Dividend per Share $ 1.00 $ 0.75 $ 0.50

End of Year Price $ 24.00 $ 15.25 $ 10.00 $ 3.50

A) 3.85 percent B) 11.54 percent C) 15.38 percent D) 17.58 percent Answer: C Explanation: Company W P J D Total =

Beginning Portfolio Value Weight $ 2,500.00 0.2747 $ 2,800.00 0.3077 $ 3,200.00 0.3516 $ 600.00 0.0660 $ 9,100.00

Capital Gain Income $ (100.00 ) $ 100.00 $ 250.00 $ 150.00 $ 800.00 $ 0.00 $ 100.00 $ 100.00

Total Return $ 0.00 $ 400.00 $ 800.00 $ 200.00 $ 1,400.00 Portfolio Return =

Difficulty: 2 Medium Topic: Portfolio return Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 09-07 Compute a portfolio's return.

Percentage Return

15.38

52) The past five monthly returns for PG Company are 1.25 percent, −1.50 percent, 4.25 percent, 3.75 percent, and 1.98 percent. What is the average monthly return? A) 1.946 percent B) 2.546 percent C) 9.73 percent D) 12.73 percent Answer: A Explanation: Average Return = (1.25% − 1.5% + 4.25% + 3.75% + 1.98%)/5 = 1.946%. Difficulty: 2 Medium Topic: Arithmetic and geometric returns Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 09-01 Compute an investment's dollar and percentage return. 53) Compute the standard deviation of the five monthly returns for PG&E: 1.25 percent, −1.50 percent, 4.25 percent, 3.75 percent, and 1.98 percent. A) 1.876 percent B) 1.946 percent C) 2.046 percent D) 2.287 percent Answer: D Explanation: =2.287

54) If you own 600 shares of Alaska Corporation at $23.25, 450 shares of Best Company at $34.50, and 150 shares of Motor Company at $6.95, what are the portfolio weights of each stock? A) Alaska = 0.6000, Best = 0.4500, Motor = 0.1500 B) Alaska = 0.3594, Best = 0.5332, Motor = 0.1074 C) Alaska = 0.4571, Best = 0.5087, Motor = 0.0342 D) Alaska = 0.2325, Best = 0.3450, Motor = 0.0695 Answer: C Explanation: Total portfolio is 600 × $23.25 + 450 × $34.50 + 150 × $6.95 = $30,517.50. Alaska weight = 600 × $23.25/$30,517.50 = 0.4571. Best weight = 450 × $34.50/$30,517.50 = 0.5087. Motor weight = 150 × $6.95/$30,517.50 = 0.0342. Difficulty: 2 Medium Topic: Portfolio weights Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 09-07 Compute a portfolio's return. 55) If you own 1,000 shares of Alaska Corporation at $19.95, 250 shares of Best Company at $17.50, and 250 shares of Motor Company at $2.50, what are the portfolio weights of each stock? A) Alaska = 0.1000, Best = 0.2500, Motor = 0.2500 B) Alaska = 0.4994, Best = 0.4380, Motor = 0.0626 C) Alaska = 0.7996, Best = 0.1754, Motor = 0.0250 D) Alaska = 0.1995, Best = 0.1750, Motor = 0.0250 Answer: C Explanation: Total portfolio is 1,000 × $19.95 + 250 × $17.50 + 250 × $2.50 = $24,950. Alaska weight = 1,000 × $19.95/$24,950 = 0.7996. Best weight = 250 × $17.50/$24,950 = 0.1754. Motor weight = 250 × $2.50/$24,950 = 0.0250. Difficulty: 2 Medium Topic: Portfolio weights Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 09-07 Compute a portfolio's return.

56) FedEx Corp. stock ended the previous year at $113.39 per share. It paid a $0.40 per share dividend last year. It ended last year at $126.69. If you owned 300 shares of FedEx, what was your dollar return and percent return? A) $3,990, 11.73 percent B) $4,110, 12.08 percent C) $4,250, 12.29 percent D) $2,009, 9.13 percent Answer: B Explanation: Dollar Return = (Ending value − Beginning Value) + Income = $126.69 × 300 − $113.39 × 300 + $0.40 × 300 = $4,110. Percentage Return = $4,110 ÷ ($113.39 × 300) = 0.1208 = 12.08%. Difficulty: 1 Easy Topic: Total return Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 09-01 Compute an investment's dollar and percentage return. 57) Sprint Nextel Corp. stock ended the previous year at $25.00 per share. It paid a $2.57 per share dividend last year. It ended last year at $18.89. If you owned 650 shares of Sprint, what was your dollar return and percent return? A) $2,960, 11.13 percent B) −$4,960, −16.13 percent C) −$3,960, −15.13 percent D) −$2,301, −14.16 percent Answer: D Explanation: Dollar Return = (Ending value − Beginning Value) + Income = $18.89 × 650 − $25.00 × 650 + $2.57 × 650 = −$2,301. Percentage Return = −$2,301 ÷ ($25.00 × 650) = −0.1416 = −14.16%. Difficulty: 1 Easy Topic: Total return Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 09-01 Compute an investment's dollar and percentage return.

58) Rank the following three stocks by their total risk level, highest to lowest. Night Ryder has an average return of 14 percent and standard deviation of 30 percent. The average return and standard deviation of WholeMart are 12 percent and 25 percent; and of Fruit Fly are 25 percent and 40 percent. A) Fruit Fly, Night Ryder, WholeMart B) Night Ryder, WholeMart, Fruit Fly C) WholeMart, Fruit Fly, Night Ryder D) WholeMart, Night Ryder, Fruit Fly Answer: A Explanation: Rank by standard deviation: Fruit Fly, Night Ryder, and then WholeMart. Difficulty: 1 Easy Topic: Risks and returns Bloom's: Evaluate AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 09-03 Measure and evaluate the total risk of an investment using several methods. 59) Rank the following three stocks by their risk-return relationship, best to worst. Rail Haul has an average return of 10 percent and standard deviation of 19 percent. The average return and standard deviation of Idol Staff are 12 percent and 22 percent; and of Poker-R-Us are 11 percent and 25 percent. A) Idol Staff, Rail Haul, Poker-R-Us B) Rail Haul, Idol Staff, Poker-R-Us C) Idol Staff, Poker-R-Us, Rail Haul D) Poker-R-Us, Rail Haul, Idol Staff Answer: A Explanation: Rank by coefficient of variation: Idol Staff CoV = 22/12 = 1.83, Rail Haul CoV = 19/10 = 1.9, and Poker-R-Us CoV = 25/11 = 2.27. Difficulty: 1 Easy Topic: Risk and return relationship Bloom's: Evaluate AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 09-04 Recognize the risk-return relationship and its implications.

60) Rank the following three stocks by their risk-return relationship, best to worst. Night Ryder has an average return of 33 percent and standard deviation of 40 percent. The average return and standard deviation of WholeMart are 10 percent and 20 percent; and of Fruit Fly are 19 percent and 33 percent. A) Night Ryder, WholeMart, Fruit Fly B) WholeMart, Fruit Fly, Night Ryder C) Night Ryder, Fruit Fly, WholeMart D) Fruit Fly, Whole Mart, Night Ryder Answer: C Explanation: Rank by coefficient of variation: Night Ryder CoV = 40/33 = 1.21, Fruit Fly CoV = 33/19 = 1.74, and Whole Mart CoV = 20/10 = 2.00. Difficulty: 1 Easy Topic: Risk and return relationship Bloom's: Evaluate AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 09-04 Recognize the risk-return relationship and its implications. 61) An investor owns $8,000 of Adobe Systems stock, $5,000 of Dow Chemical, and $3,000 of Office Depot. What are the portfolio weights of each stock? A) Adobe: 0.5, Dow Chemical: 0.31, Office Depot: 0.19 B) Adobe: 0.5, Dow Chemical: 0.32, Office Depot: 0.18 C) Adobe: 0.5, Dow Chemical: 0.13, Office Depot: 0.27 D) Adobe: 0.5, Dow Chemical: 0.19, Office Depot: 0.31 Answer: A Explanation: Total portfolio is $8,000 + $5,000 + $3,000 = $16,000. Adobe System weight = $8,000/$16,000 = 0.5. Dow Chemical weight = $5,000/$16,000 = 0.3125. Office Depot weight = $3,000/$16,000 = 0.1875. Difficulty: 1 Easy Topic: Portfolio weights Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 09-07 Compute a portfolio's return.

62) Consider the risk-return relationship in T-bills during each decade since 1950. Given this data, which of the following statements is correct? Decade 1950s 1960s 1970s 1980s 1990s 2000s

CoV 0.40 0.33 0.29 0.29 0.24 0.55

A) The best risk-return relationship was during the 1950s. B) The best risk-return relationship was during the 1990s. C) Since T-bills are backed by the full faith of the U.S. government, computing the risk-return relationship for them is invalid. D) None of these choices are correct. Answer: B Explanation: The lower the coefficient of variation, the better the risk-return relationship. All these CoVs are very low. While they appear to have great risk-return relationships, it is because the risk is very low. T-bills are very safe instruments. However, they offer very low returns. Difficulty: 2 Medium Topic: Risk and return relationship Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 09-04 Recognize the risk-return relationship and its implications.; 09-02 Find information about the historical returns and volatility for the stock, bond, and cash markets.

63) Year-to-date, Oracle had earned a 15.0 percent return. During the same time period, Valero Energy earned −12.96 percent and McDonald's earned 1.80 percent. If you have a portfolio made up of 50 percent Oracle, 10 percent Valero Energy, and 40 percent McDonald's, what is your portfolio return? A) 6.14 percent B) 4.86 percent C) 5.86 percent D) 6.92 percent Answer: D Explanation: Portfolio Return is 0.5 × 15.0% + 0.1 × −12.96% + 0.4 × 1.8% = 6.92%. Difficulty: 1 Easy Topic: Portfolio return Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 09-07 Compute a portfolio's return. 64) The past five monthly returns for Kohl's are 2.55 percent, −8.62 percent, −14.44 percent, −1.52 percent, and 4.75 percent. What is the average monthly return? A) 2.21 percent B) 1.21 percent C) −3.46 percent D) −6.17 percent Answer: C Explanation: Average Return = (2.55% − 8.62% − 14.44% − 1.52% + 4.75%)/5 = −3.46%. Difficulty: 2 Medium Topic: Arithmetic and geometric returns Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 09-01 Compute an investment's dollar and percentage return.

65) The past five monthly returns for PG&E are 12.14 percent, −11.37 percent, 3.77 percent, 6.47 percent, and 3.58 percent. What is the average monthly return? A) 2.92 percent B) 1.21 percent C) −3.46 percent D) 3.17 percent Answer: A Explanation: Average Return = (12.14% − 11.37% + 3.77% + 6.47% + 3.58%)/5 = 2.92%. Difficulty: 2 Medium Topic: Arithmetic and geometric returns Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 09-01 Compute an investment's dollar and percentage return. 66) Compute the standard deviation of Kohl's monthly returns. The past five monthly returns for Kohl's are 5.55 percent, 8.62 percent, −4.44 percent, −1.52 percent, and 9.75 percent. A) 4.92 percent B) 5.07 percent C) 6.28 percent D) 6.12 percent Answer: C Explanation: =6.28

67) Consider the characteristics of the following three stocks:

Thumb Devices Air Comfort Sport Garb

Expected Return 13% 10 10

Standard Deviation 23% 19 17

The correlation between Thumb Devices and Air Comfort is −0.12. The correlation between Thumb Devices and Sport Garb is 0.89. The correlation between Air Comfort and Sport Garb is −0.85. If you can pick only two stocks for your portfolio, which two stocks should be included in your portfolio to eliminate the most risk? Why? A) Combine Thumb Devices and Sport Garb because they have a high correlation. B) Combine Thumb Devices and Air Comfort because of high standard deviations. C) Combine Air Comfort and Sport Garb due to negative correlation. D) Combine Thumb Devices and Sport Garb because Thumb Devices has the highest return and Sport Garb has the lowest standard deviation. Answer: C Explanation: Combine the Air Comfort and Sport Garb because this combination has the most negative correlation which offers the lowest risk. Difficulty: 2 Medium Topic: Diversification concepts and measures Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 09-04 Recognize the risk-return relationship and its implications.; 09-05 Plan investments that take advantage of diversification and its impact on total risk.

68) If you own 300 shares of Alaska Air at $15.88, 250 shares of Best Buy at $151.00, and 1,150 shares of Ford Motor at $3.51, what are the portfolio weights of each stock? A) weight of Alaska Air: 10.23 percent, weight of Best Buy: 81.09 percent, weight of Ford Motor: 8.67 percent B) weight of Alaska Air: 6.23 percent, weight of Best Buy: 71.09 percent, weight of Ford Motor: 22.67 percent C) weight of Alaska Air: 15.23 percent, weight of Best Buy: 81.09 percent, weight of Ford Motor: 3.67 percent D) weight of Alaska Air: 20.23 percent, weight of Best Buy: 76.09 percent, weight of Ford Motor: 3.67 percent Answer: A Explanation: Total portfolio is 300 × $15.88 + 250 × $151.00 + 1150 × $3.51 = $46,550.50. Alaska Air weight = 300 × $15.88/$46,550.50 = 0.1023. Best Buy weight = 250 × $151.00/$46,550.50 = 0.8109. Ford Motor weight = 1,150 × 3.51/$46,550.50 = 0.0867. Difficulty: 2 Medium Topic: Portfolio weights Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 09-07 Compute a portfolio's return. 69) If you own 400 shares of Xerox at $15.00, 500 shares of Qwest at $10.00, and 350 shares of Liz Claiborne at $45.00, what are the portfolio weights of each stock? A) weight of Xerox: 22.43 percent, weight of Qwest: 11.09 percent, weight of Liz Claiborne: 58.88 percent B) weight of Xerox: 34.67 percent, weight of Qwest: 16.69 percent, weight of Liz Claiborne: 48.64 percent C) weight of Xerox: 22.43 percent, weight of Qwest: 18.69 percent, weight of Liz Claiborne: 58.88 percent D) weight of Xerox: 36.98 percent, weight of Qwest: 61.07 percent, weight of Liz Claiborne: 1.95 percent Answer: C Explanation: Total portfolio is 400 × $15.00 + 500 × $10.00 + 350 × $45.00 = $26,750.00. Xerox weight = 400 × $15/$26,750 = 0.2243. Qwest weight = 500 × $10/$26,750 = 0.1869. Liz Claiborne weight = 350 × $45/$26,750 = 0.5888. Difficulty: 2 Medium Topic: Portfolio weights Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 09-07 Compute a portfolio's return.

70) At the beginning of the month, you owned $15,500 of General Motors, $4,500 of Starbucks, and $9,000 of Nike. The monthly returns for General Motors, Starbucks, and Nike were 7.10 percent, −1.36 percent, and −0.54 percent. What is your portfolio return? A) −1.12 percent B) 1.17 percent C) 2.54 percent D) 3.42 percent Answer: D Explanation: Total portfolio is $15,500 + $4,500 + $9,000 = $29,000 General Motors weight = $15,500 / $29,000 = 0.5345 Starbucks weight = $4,500 / $29,000 = 0.1552 Nike weight = $9,000 / $29,000 = 0.3103 So Portfolio Return is 0.5345 × 7.10% + 0.1552 × −1.36% + 0.3103 × −0.54% = 3.42% Difficulty: 2 Medium Topic: Portfolio return Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 09-07 Compute a portfolio's return. 71) You have $10,000 to invest. You want to purchase shares of Alaska Air at $50.00, Best Buy at $50.00, and Ford Motor at $10.00. How many shares of each company should you purchase so that your portfolio consists of 25 percent Alaska Air, 40 percent Best Buy, and 35 percent Ford Motor? Report only whole stock shares. A) 50 shares of Alaska Air, 80 shares of Best Buy, and 300 shares of Ford Motor B) 50 shares of Alaska Air, 80 shares of Best Buy, and 350 shares of Ford Motor C) 40 shares of Alaska Air, 90 shares of Best Buy, and 300 shares of Ford Motor D) 75 shares of Alaska Air, 40 shares of Best Buy, and 350 shares of Ford Motor Answer: B Explanation: Alaska Air: 0.25 × $10,000 ÷ $50 = 50 shares. Best Buy: 0.40 × $10,000 ÷ $50 = 80 shares. Ford Motor: 0.35 × $10,000 ÷ $10.00 = 350 shares. Difficulty: 3 Hard Topic: Portfolio weights Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 09-07 Compute a portfolio's return.

72) Consider the following annual returns of Estee Lauder and Lowe's Companies:

Estee Lauder 20.4% −26.0% 17.6% 49.9% −16.8%

2006 2005 2004 2003 2002

Lowe's Companies −6.0% 16.1% 14.2% 48.0% −19.0%

Compute each stock's average return, standard deviation, and coefficient of variation. A) Estee Lauder: 9.02 percent, 17.99 percent, 2.00; and Lowe's Companies: 10.66 percent, 18.99 percent, 1.78 B) Estee Lauder: 9.02 percent, 30.69 percent, 3.4; and Lowe's Companies: 10.66 percent, 18.99 percent, 1.78 C) Estee Lauder: 9.02 percent, 30.69 percent, 3.4; and Lowe's Companies: 10.66 percent, 25.46 percent, 2.39 D) Estee Lauder: 10.7 percent, 17.79 percent, 1.66; and Lowe's Companies: 12.64 percent, 18.99 percent, 1.50 Answer: C Explanation: Solution by spreadsheet:

Ave StDev Cov

= = =

Estee Lauder Lowe's Companies 9.02% 10.66% 30.69% 25.46% 3.40 2.39

Lowe's has experienced a higher average return than Estee Lauder's with a lower risk (standard deviation). Thus, it is not a surprise that Lowe's has a better (lower) coefficient of variation. Lowe's was better. Difficulty: 3 Hard Topic: Risk and return relationship Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 09-04 Recognize the risk-return relationship and its implications.; 09-03 Measure and evaluate the total risk of an investment using several methods.

73) Which of the following statements is correct? A) A single stock has a lot of diversifiable risk. B) A single stock has more market risk than a diversified portfolio of stocks. C) Bonds and stocks have a high correlation because they are both financial assets. D) None of these choices are correct. Answer: A Difficulty: 1 Easy Topic: Diversification concepts and measures Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 09-04 Recognize the risk-return relationship and its implications. 74) Which of the following statements is correct? A) A dominant portfolio has the best risk-return relationship as compared to other portfolios. B) When an investment achieves a high return it always has a high level of risk. C) A low standard deviation means that the investment is less likely to achieve high returns, which means that it is more risky. D) None of these choices are correct. Answer: A Difficulty: 2 Medium Topic: Risk and return relationship Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 09-04 Recognize the risk-return relationship and its implications.; 09-06 Find efficient and optimal portfolios.

75) Which of the following statements is correct? A) The dollar return is a more useful measure to compare performance because it more accurately reflects the change in wealth of the investor. B) A dominant portfolio is one that has the highest risk and highest return within a set of portfolios. C) By adding stocks to your portfolio, it is possible to effectively eliminate nearly all of the market risk. D) None of these choices are correct. Answer: D Difficulty: 2 Medium Topic: Diversification concepts and measures Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 09-01 Compute an investment's dollar and percentage return.; 09-05 Plan investments that take advantage of diversification and its impact on total risk.; 09-06 Find efficient and optimal portfolios. 76) Jane Adams invests all her money in the stock of one firm. Which of the following must be true? A) Her return will have more volatility than the return in the overall stock market. B) Her return will have less volatility than the return in the overall stock market. C) Her return will have the same volatility as the return in the overall stock market. D) There is no relationship between her return and the return in the overall stock market. Answer: A Difficulty: 2 Medium Topic: Diversification concepts and measures Bloom's: Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 09-04 Recognize the risk-return relationship and its implications.

77) Which of the following statements is correct with regards to diversification? A) Diversifying reduces the return of the portfolio. B) Diversifying reduces the market risk of the portfolio. C) Diversifying reduces the dollar return of the portfolio. D) None of these choices are correct. Answer: D Difficulty: 2 Medium Topic: Diversification concepts and measures Bloom's: Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 09-04 Recognize the risk-return relationship and its implications. 78) Jenna receives an investment newsletter that recommends that she invest in a stock that has doubled the return of the S&P 500 in the last two months. It also claims that this stock is a "safe bet" for the future. Which of the following statements is correct regarding this information? A) This investment newsletter is most likely correct because they most likely have some special knowledge about the stock. B) The investment newsletter contains contrary information since the stock must be a high risk and therefore cannot also be a "safe bet." C) It is common for individual stocks to double the return of the S&P 500 and still be a "safe bet." D) None of these choices are correct. Answer: B Difficulty: 2 Medium Topic: Risk and return relationship Bloom's: Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 09-04 Recognize the risk-return relationship and its implications. 79) Which of the following is correct regarding the coefficient of variation? A) It measures the amount of standard deviation for each one percent of covariance. B) It measures the amount of return achieved for each one percent of risk taken. C) It measures the amount of risk taken for each one percent of return achieved. D) None of these choices are correct. Answer: C Difficulty: 1 Easy Topic: Risk and return relationship Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 09-04 Recognize the risk-return relationship and its implications. 39

80) Which of the following is correct regarding the total risk of a company? A) A company can change its risk level over time. B) Some firms are riskier because they offer many different products and/or services. C) Companies can increase their risk by reducing the amount of money they have borrowed. D) None of these choices are correct. Answer: A Difficulty: 2 Medium Topic: Diversification concepts and measures Bloom's: Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 09-03 Measure and evaluate the total risk of an investment using several methods. 81) Which of the following statements is correct regarding total risk? A) A conglomerate will have more total risk than a firm that has one line of business. B) All firms have about the same total risk because they are all exposed to the same market risk. C) Total risk can be quantified by measuring the covariance between the firm and the overall market. D) None of these choices are correct. Answer: D Difficulty: 2 Medium Topic: Diversification concepts and measures Bloom's: Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 09-03 Measure and evaluate the total risk of an investment using several methods.

82) Which of the following statements is correct regarding total risk? A) The coefficient of variation is a measure of the firm's total risk. B) All firms have the same amount of total risk because they are all exposed to the same market risk. C) Conglomerates will have less total risk than a firm that has one line of business. D) None of these choices are correct. Answer: C Difficulty: 2 Medium Topic: Diversification concepts and measures Bloom's: Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 09-03 Measure and evaluate the total risk of an investment using several methods. 83) Interest rates, inflation, and economic growth are economic factors that are examples of A) firm-specific risks that can be diversified away. B) market risk. C) external factors that are neither firm specific risk nor market risk. D) None of these choices are correct. Answer: B Difficulty: 2 Medium Topic: Systematic and unsystematic risk Bloom's: Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 09-04 Recognize the risk-return relationship and its implications. 84) Which of the following statements is correct? A) For a few firms in completely different industries, it is possible to have a correlation that approaches −2.0. B) A correlation of −1.0 means that the two firms are uncorrelated or that they have no relationship. C) Most common stocks have low correlation with each other since they operate in different industries. D) None of these choices are correct. Answer: D Difficulty: 2 Medium Topic: Diversification concepts and measures Bloom's: Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 09-04 Recognize the risk-return relationship and its implications. 41

85) Which of the following statements is correct? A) Uncorrelated assets have a correlation of −1.0. B) Most common stocks are positively correlated with each other because they are impacted by the same economic factors. C) We can typically add many stocks together to fully eliminate the market risk in a portfolio. D) None of these choices are correct. Answer: B Difficulty: 2 Medium Topic: Diversification concepts and measures Bloom's: Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 09-04 Recognize the risk-return relationship and its implications. 86) Which of the following statements is correct? A) Stocks and long-term Treasury bonds are highly positively correlated. B) Stocks and Treasury bills are highly positively correlated. C) Stocks, long-term Treasury bonds, and Treasury bills are all highly correlated. D) None of these choices are correct. Answer: D Difficulty: 2 Medium Topic: Diversification concepts and measures Bloom's: Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 09-04 Recognize the risk-return relationship and its implications. 87) Which of the following is incorrect? A) It is possible to combine assets that all move in the exact same fashion over time and gain the benefits of diversification. B) Adding long-term Treasury bonds to a stock portfolio will reduce the risk of the portfolio. C) The optimal portfolio provides the highest return for the investor's desired risk. D) All of these choices are correct. Answer: A Difficulty: 2 Medium Topic: Diversification concepts and measures Bloom's: Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 09-04 Recognize the risk-return relationship and its implications.

88) The efficient frontier portfolios are A) portfolios that risk adverse investors will select. B) portfolios where all the market risk is diversified away. C) portfolios where the correlation among assets is 0.0. D) portfolios that dominate all others. Answer: D Difficulty: 2 Medium Topic: Modern portfolio theory Bloom's: Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 09-04 Recognize the risk-return relationship and its implications. 89) The optimal portfolio for you will be A) the one that offers the lowest correlation. B) the one that offers the highest returns. C) the one that reflects the amount of risk that you are willing to take. D) the one that offers the most diversification. Answer: C Difficulty: 1 Easy Topic: Modern portfolio theory Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 09-04 Recognize the risk-return relationship and its implications. 90) Sally wants to invest in only two stocks. Which pair of stocks should Sally select? A) Stocks A and B move downward at the same time. B) Stocks C and D move in opposite directions at the same time. C) Stocks E and F move upward at the same time. D) Stocks G and H move randomly at the same time. Answer: B Difficulty: 3 Hard Topic: Diversification concepts and measures Bloom's: Evaluate AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 09-04 Recognize the risk-return relationship and its implications.

91) Which of the following are investor diversification problems? A) Many employees hold mostly their employer's stocks as investments. B) Many households hold relatively few individual stocks—the median is three. C) Investors seem to prefer local firms thereby limiting diversification opportunities. D) All of these choices are correct. Answer: D Difficulty: 2 Medium Topic: Diversification concepts and measures Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 09-04 Recognize the risk-return relationship and its implications. 92) Which of the following describes what will occur as you randomly add stocks to your portfolio? A) The nondiversifiable risk will decrease. B) Both the diversifiable and nondiversifiable risk will decrease. C) The portfolio return will increase. D) The diversifiable risk will decrease. Answer: D Difficulty: 2 Medium Topic: Diversification concepts and measures Bloom's: Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 09-04 Recognize the risk-return relationship and its implications. 93) Which of the following is the correct ranking from least risky to most risky? A) Long-term Treasury bonds, stocks, Treasury bills B) Treasury bills, long-term Treasury bonds, stocks C) stocks, long-term Treasury bond, Treasury bills D) stocks, Treasury bills, long-term Treasury bonds Answer: B Difficulty: 1 Easy Topic: Asset classes Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 09-02 Find information about the historical returns and volatility for the stock, bond, and cash markets.

94) Which of the following is correct? A) Investors can reduce the risk in their portfolio by investing in international stocks since they tend to have low correlation with our own stock market. B) Combining both stocks and bonds will likely reduce risk in a portfolio because the two assets have low correlation. C) Your optimal portfolio is an efficient portfolio with your desired risk level. D) All of these choices are correct. Answer: D Difficulty: 2 Medium Topic: Modern portfolio theory Bloom's: Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 09-05 Plan investments that take advantage of diversification and its impact on total risk.; 09-06 Find efficient and optimal portfolios.; 09-02 Find information about the historical returns and volatility for the stock, bond, and cash markets. 95) Modern portfolio theory is A) a concept and procedure for combining securities into a portfolio to minimize risk. B) a concept and procedure for combining securities into a portfolio to maximize return. C) a concept and procedure for combining securities into a portfolio to maximize volatility. D) a concept and procedure for combining securities into a portfolio to maximize dollar return. Answer: A Difficulty: 1 Easy Topic: Modern portfolio theory Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 09-06 Find efficient and optimal portfolios. 96) The total risk of the S&P 500 Index is equal to A) diversifiable risk. B) nondiversifiable risk. C) modern portfolio risk. D) efficient frontier risk. Answer: B Difficulty: 1 Easy Topic: Systematic and unsystematic risk Bloom's: Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 09-04 Recognize the risk-return relationship and its implications.

97) Consider the following correlations: IBM IBM Apple Disney

Apple 1.0 −0.2 0.3

1 −0.7

Disney 1

Given this data, which of the following is most preferable if an investor can only select one pair of companies? A) Apple and IBM B) Disney and IBM C) Disney and Apple D) It does not matter which two are selected—there is no preference. Answer: C Difficulty: 1 Easy Topic: Diversification concepts and measures Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 09-04 Recognize the risk-return relationship and its implications. 98) If you invested $1,000 in Disney and $5,000 in Oracle and the two companies returned 15 percent and 18 percent respectively, what was your portfolio's return? A) 15.5 percent B) 17.1 percent C) 16.2 percent D) 17.5 percent Answer: D Explanation: Total invested: $6,000, 1/6 × 15% + 5/6 × 18% = 17.5. Difficulty: 1 Easy Topic: Portfolio return Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 09-07 Compute a portfolio's return.

99) JoJo's portfolio's return is 12 percent. She is invested in Cisco and IBM which had returns of 15 percent and 9 percent respectively. What percentage of JoJo's assets are invested in each firm? A) 40 percent in Cisco and 60 percent in IBM B) 50 percent in Cisco and 50 percent in IBM C) 30 percent in Cisco and 70 percent in IBM D) unable to determine with the data provided Answer: B Explanation: 12 = 15x + (1 − x) 9, x = 0.5. Difficulty: 3 Hard Topic: Portfolio weights Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 09-07 Compute a portfolio's return. 100) Sharif's portfolio generated returns of 12 percent, 15 percent, −15 percent, 19 percent, and −12 percent over five years. What was his average return over this period? A) 19 percent B) 3.8 percent C) 17 percent D) 2.1 percent Answer: B Explanation: (12 + 15 − 15 − 12 + 19)/5 = 3.8. Difficulty: 1 Easy Topic: Arithmetic and geometric returns Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 09-01 Compute an investment's dollar and percentage return. 101) The mean return computed by finding the equivalent return that is compounded for N periods is . A) dollar return B) geometric returns C) average return D) percentage return Answer: B Difficulty: 1 Easy Topic: Returns Bloom's: Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 09-01 Compute an investment's dollar and percentage return. 47

102) Which of the following is correct? A) Over a long time frame, stocks have performed better than long-term Treasury bonds. B) Average stock returns are not an indication of what an investor may earn in any one year. C) In some years, long-term Treasury bonds performed better than stocks. D) All of these choices are correct. Answer: D Difficulty: 1 Easy Topic: Asset classes Bloom's: Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 09-02 Find information about the historical returns and volatility for the stock, bond, and cash markets. 103) Which of the following statements regarding risk of assets is correct? A) Every decade since 1950 has seen a lot of stock market volatility. B) The bond market has experienced the most volatility in the 1980s as interest rates varied dramatically. C) High risk means that an investor may receive poor returns in the short run. D) All of the statements are correct. Answer: D Difficulty: 1 Easy Topic: Risk of Assets Bloom's: Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 09-02 Find information about the historical returns and volatility for the stock, bond, and cash markets. 104) Which of the following is correct? A) Total risk is measured by the standard deviation. B) There is a positive relationship between risk and return. C) If you observe a high variability in a stock's returns you can infer that the stock is very risky. D) All of these choices are correct. Answer: D Difficulty: 1 Easy Topic: Risk and return relationship Bloom's: Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 09-03 Measure and evaluate the total risk of an investment using several methods. 48

105) A stock has an expected return of 12 percent and a standard deviation of 20 percent. Longterm Treasury bonds have an expected return of 9 percent and a standard deviation of 15 percent. Given this data, which of the following statements is correct? A) The two assets have the same coefficient of variation. B) The stock investment has a better risk-return trade-off. C) The bond investment has a better risk-return trade-off. D) The stock investment and the bond investment have the same diversifiable risk. Answer: A Explanation: CoV for the stock investment: 20/12 = 1.67; CoV for the bond: 15/9 = 1.67 Difficulty: 1 Easy Topic: Risk and return relationship Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 09-04 Recognize the risk-return relationship and its implications. 106) Which statement regarding coefficient of variation is NOT true? A) is known as the trade-off between market risk and return. B) is a common relative measure of risk vs. reward. C) is the standard deviation divided by the average return. D) A smaller coefficient of variation indicates a better risk-reward relationship. Answer: A Difficulty: 1 Easy Topic: Coefficient of Variation Bloom's: Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 09-04 Recognize the risk-return relationship and its implications.

107) A stock has an expected return of 15 percent and a standard deviation of 20 percent. Longterm Treasury bonds have an expected return of 9 percent and a standard deviation of 11 percent. Given this data, which of the following statements is correct? A) The two assets have the same coefficient of variation. B) The stock investment has a better risk-return trade-off. C) The bond investment has a better risk-return trade-off. D) The stock investment and the bond investment have the same diversifiable risk. Answer: C Explanation: CoV for the stock investment: 20/15 = 1.33; CoV for the bond: 11/9 = 1.22 Difficulty: 1 Easy Topic: Risk and return relationship Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 09-04 Recognize the risk-return relationship and its implications. 108) From 1950 to 2007, the average return in the stock market, as measured by the S&P 500, was 13.2 percent and a standard deviation of 17 percent. Given this information, which of the following statements is correct? A) With an average return this high, it is unlikely that an investor will lose money in the stock market in the next year or two. B) With a standard deviation this high, it is likely that an investor will lose money in some years over a 25-year investment period. C) This investment is not very good since the standard deviation is greater than the average return. D) All of these choices are correct. Answer: B Difficulty: 2 Medium Topic: Normal probability distribution Bloom's: Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 09-02 Find information about the historical returns and volatility for the stock, bond, and cash markets.

109) Sharif's portfolio generated returns of 10 percent, 9 percent, −2 percent, and 6 percent over four years. What was his average return over this period? A) 5.75 percent B) 6.75 percent C) 23 percent D) 27 percent Answer: A Explanation: (10 + 9 − 2 + 6)/4 = 5.75. Difficulty: 1 Easy Topic: Arithmetic and geometric returns Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 09-01 Compute an investment's dollar and percentage return. 110) Year-to-date, Oracle had earned a 12.57 percent return. During the same time period, Valero Energy earned −9.32 percent and McDonald's earned 3.45 percent. If you have a portfolio made up of 60 percent Oracle, 20 percent Valero Energy, and 20 percent McDonald's, what is your portfolio return? A) 10.10 percent B) 8.45 percent C) 6.70 percent D) 6.37 percent Answer: D Explanation: Portfolio Return is 0.6 × 12.57% + 0.2 × −9.32% + 0.2 × 3.45% = 6.3680%. Difficulty: 1 Easy Topic: Portfolio return Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 09-07 Compute a portfolio's return.

111) The past three monthly returns for Kohl's are 2.25 percent, −1.54 percent, and 1.35 percent. What is the average monthly return? A) 0.69 percent B) 1.71 percent C) 2.06 percent D) 5.14 percent Answer: A Explanation: Average Return = (2.25% − 1.54% + 1.35%)/3 = 0.6867%. Difficulty: 2 Medium Topic: Arithmetic and geometric returns Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 09-01 Compute an investment's dollar and percentage return. 112) A stock has an expected return of 12 percent and a standard deviation of 25 percent. Longterm Treasury bonds have an expected return of 5 percent and a standard deviation of 9 percent. Given this data, which of the following statements is correct? A) The two assets have the same coefficient of variation. B) The stock investment has a better risk-return trade-off. C) The bond investment has a better risk-return trade-off. D) The stock investment and the bond investment have the same diversifiable risk. Answer: C Explanation: CoV for the stock investment: 25/12 = 2.08; CoV for the bond: 9/5 = 1.8 Difficulty: 1 Easy Topic: Risk and return relationship Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 09-04 Recognize the risk-return relationship and its implications.

113) If you invested $30,000 in Disney and $10,000 in Oracle and the two companies returned 6 percent and 12 percent respectively, what was your portfolio's return? A) 18.0 percent B) 10.5 percent C) 9.0 percent D) 7.5 percent Answer: D Explanation: Total invested: $40,000, 3/4 × 6% + 1/4 × 12% = 7.5%. Difficulty: 1 Easy Topic: Portfolio return Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 09-07 Compute a portfolio's return. 114) The process of putting money in different types of investments for the purpose of reducing the overall risk of the portfolio is . A) diversification B) the S&P 500 Index C) market risk D) the stock market Answer: A Difficulty: 1 Easy Topic: Systematic and unsystematic risk Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 09-05 Plan investments that take advantage of diversification and its impact on total risk. 115) Which statement is NOT true regarding efficient portfolios? A) Combining stocks that move together over time does not offer much risk reduction. B) Combining stocks that do not move together provides a lot of risk reduction. C) both a and b are NOT true D) none of the above are NOT true Answer: D Difficulty: 1 Easy Topic: Efficient Portfolios Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 09-05 Plan investments that take advantage of diversification and its impact on total risk. 53

Finance, 5e (Cornett) Chapter 10 Estimating Risk and Return 1) Which of the following is a true statement? A) The risk and return that a firm experienced in the past is also the risk level for its future. B) Firms can quite possibly change their stocks' risk level by substantially changing their business. C) If a firm takes on riskier new projects over time, the firm itself will become less risky. D) If a firm takes on less risky new projects over time, the firm itself will become more risky. Answer: B Difficulty: 1 Easy Topic: Risks and returns Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 10-01 Compute forward-looking expected return and risk. 2) Which of the following is the average of the possible returns weighted by the likelihood of those returns occurring? A) efficient return B) expected return C) market return D) required return Answer: B Difficulty: 1 Easy Topic: Expected return Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 10-01 Compute forward-looking expected return and risk. 3) Which of these is the set of probabilities for all possible occurrences? A) probability B) probability distribution C) stock market bubble D) market probabilities Answer: B Difficulty: 1 Easy Topic: Normal probability distribution Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 10-01 Compute forward-looking expected return and risk. 1

4) Which of the following is typically considered the return on U.S. government bonds and bills and equals the real interest plus the expected inflation premium? A) required return B) risk-free rate C) risk premium D) market risk premium Answer: B Difficulty: 1 Easy Topic: Risks and returns Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 10-02 Understand risk premiums. 5) Which of the following is the reward investors require for taking risk? A) required return B) risk-free rate C) risk premium D) market risk premium Answer: C Difficulty: 1 Easy Topic: Risks and returns Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 10-02 Understand risk premiums. 6) Which of these is the reward for taking systematic stock market risk? A) required return B) risk-free rate C) risk premium D) market risk premium Answer: D Difficulty: 1 Easy Topic: Risks and returns Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 10-02 Understand risk premiums.

7) Which of the following is a model that includes an equation that relates a stock's required return to an appropriate risk premium? A) asset pricing B) behavioral finance C) beta D) efficient markets Answer: A Difficulty: 1 Easy Topic: Capital asset pricing model Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 10-02 Understand risk premiums. 8) Which of the following is the asset pricing theory based on a beta, a measure of market risk? A) behavioral asset pricing model B) capital asset pricing model C) efficient markets asset pricing model D) efficient market hypothesis Answer: B Difficulty: 1 Easy Topic: Capital asset pricing model Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 10-03 Know and apply the Capital Asset Pricing Model (CAPM). 9) In theory, which of these is a combination of securities that places the portfolio on the efficient frontier and on a line tangent from the risk-free rate? A) efficient market B) market portfolio C) probability distribution D) stock market bubble Answer: B Difficulty: 1 Easy Topic: Capital asset pricing model Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 10-03 Know and apply the Capital Asset Pricing Model (CAPM).

10) Which of the following is the use of debt to increase an investment position? A) behavioral finance B) financial leverage C) probability D) stock market bubble Answer: B Difficulty: 1 Easy Topic: Financial and operating leverage Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 10-03 Know and apply the Capital Asset Pricing Model (CAPM). 11) Which of these is the line on a graph of return and risk (standard deviation) from the risk-free rate through the market portfolio? A) capital asset pricing line B) capital market line C) efficient market line D) efficient market hypothesis Answer: B Difficulty: 1 Easy Topic: Capital asset pricing model Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 10-03 Know and apply the Capital Asset Pricing Model (CAPM). 12) Which of these is a measure of the sensitivity of a stock or portfolio to market risk? A) behavioral finance B) beta C) efficient market D) hedge Answer: B Difficulty: 1 Easy Topic: Beta Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 10-04 Calculate and apply beta, a measure of market risk.

13) Which of these is similar to the Capital Market Line, except that risk is characterized by beta instead of standard deviation? A) market risk line B) probability market line C) security market line D) stock market line Answer: C Difficulty: 1 Easy Topic: Capital asset pricing model Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 10-03 Know and apply the Capital Asset Pricing Model (CAPM). 14) Which of these is the measurement of risk for a collection of stocks for an investor? A) beta B) efficient market C) expected return D) portfolio beta Answer: D Difficulty: 1 Easy Topic: Beta Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 10-03 Know and apply the Capital Asset Pricing Model (CAPM). 15) Which of the following is NOT a necessary condition for an efficient market? A) many buyers and sellers B) no prohibitively high barriers to entry C) free and readily available information available to all participants D) no trading or transaction costs Answer: D Difficulty: 2 Medium Topic: Market efficiency - foundations and types Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 10-05 Differentiate the levels of market efficiency and their implications.

16) Which of the following are the stocks of small companies that are priced below $1 per share? A) bargain stocks B) hedge fund stocks C) penny stocks D) stock market bubble stocks Answer: C Difficulty: 1 Easy Topic: Classes of stock Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 10-05 Differentiate the levels of market efficiency and their implications. 17) Which of these is a theory that describes the types of information that are reflected in current stock prices? A) asset pricing B) behavioral finance C) efficient market hypothesis D) public information Answer: C Difficulty: 1 Easy Topic: Market efficiency - foundations and types Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 10-05 Differentiate the levels of market efficiency and their implications. 18) Which of the following is data that includes past stock prices and volume, financial statements, corporate news, analyst opinions, etc.? A) audited financial statements B) generally accepted accounting principles C) privately held information D) public information Answer: D Difficulty: 1 Easy Topic: Market efficiency - foundations and types Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 10-05 Differentiate the levels of market efficiency and their implications.

19) Which of these refers to something that has not been released to the public, but is known by few individuals, likely company insiders? A) audited financial statements B) restricted stock C) privately held information D) insider trading Answer: C Difficulty: 1 Easy Topic: Market efficiency - foundations and types Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 10-05 Differentiate the levels of market efficiency and their implications. 20) Investor enthusiasm causes an inflated bull market that drives prices too high, ending in a dramatic collapse in prices is known as A) behavior finance. B) efficient market. C) privately held information. D) stock market bubble. Answer: D Difficulty: 1 Easy Topic: Market efficiency - foundations and types Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 10-05 Differentiate the levels of market efficiency and their implications. 21) The study of the cognitive processes and biases associated with making financial and economic decisions is known as A) asset pricing model. B) behavioral finance. C) efficient market hypothesis. D) stock market bubble. Answer: B Difficulty: 1 Easy Topic: Behavioral finance Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 10-05 Differentiate the levels of market efficiency and their implications.

22) Shares of stock issued to employees that have limitations on when they can be sold are known as A) executive stock options. B) privately held information. C) restricted stock. D) stock market bubble. Answer: C Difficulty: 1 Easy Topic: Classes of stock Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 10-06 Calculate and explain investors' required return and risk. 23) Special rights given to some employees to buy a specific number of shares of the company stock at a fixed price during a specific period of time are known as A) executive stock options. B) privately held information. C) restricted stock. D) stock market bubble. Answer: A Difficulty: 1 Easy Topic: Employee stock options Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 10-06 Calculate and explain investors' required return and risk. 24) The constant growth model assumes which of the following? A) that there is privately held information B) that the stock is efficiently priced C) that there are executive stock options available to managers D) that there is no restricted stock Answer: B Difficulty: 2 Medium Topic: Constant-growth stock Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 10-07 Use the constant-growth model to compute required return.

9) Compute the expected return given these three economic states, their likelihoods, and the potential returns: Economic State Fast Growth Slow Growth Recession

Probability 0.1 0.6 0.3

Return 50% 8% − 10%

A) 6.8 percent B) 12.8 percent C) 16.0 percent D) 22.7 percent Answer: A Explanation: Expected return = 0.1 × 50% + 0.6 × 8% + 0.3 × −10% = 6.8%. Difficulty: 1 Easy Topic: Expected return Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 10-01 Compute forward-looking expected return and risk.

10) Compute the expected return given these three economic states, their likelihoods, and the potential returns: Economic State Fast Growth Slow Growth Recession

Probability 0.3 0.4 0.3

Return 40% 15% − 15%

A) 13.5 percent B) 22.5 percent C) 18.3 percent D) 40.0 percent Answer: A Explanation: Expected return = 0.3 × 40% + 0.4 × 15% + 0.3 × −15% = 13.5%. Difficulty: 1 Easy Topic: Expected return Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 10-01 Compute forward-looking expected return and risk. 27) If the risk-free rate is 8 percent and the market risk premium is 2 percent, what is the required return for the market? A) 2 percent B) 6 percent C) 8 percent D) 10 percent Answer: D Explanation: Required return = 8% + 2% = 10%. Difficulty: 1 Easy Topic: Capital asset pricing model Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 10-02 Understand risk premiums.

28) If the risk-free rate is 10 percent and the market risk premium is 4 percent, what is the required return for the market? A) 4 percent B) 7 percent C) 10 percent D) 14 percent Answer: D Explanation: Required return = 10% + 4% = 14%. Difficulty: 1 Easy Topic: Capital asset pricing model Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 10-02 Understand risk premiums. 29) The annual return on the S&P 500 Index was 12.4 percent. The annual T-bill yield during the same period was 5.7 percent. What was the market risk premium during that year? A) 5.7 percent B) 6.7 percent C) 12.4 percent D) 18.1 percent Answer: B Explanation: Average market risk premium = 12.4% − 5.7% = 6.7%. Difficulty: 1 Easy Topic: Capital asset pricing model Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 10-02 Understand risk premiums.

30) The annual return on the S&P 500 Index was 18.1 percent. The annual T-bill yield during the same period was 6.2 percent. What was the market risk premium during that year? A) 6.2 percent B) 11.9 percent C) 18.1 percent D) 24.3 percent Answer: B Explanation: Average market risk premium = 18.1% − 6.2% = 11.9%. Difficulty: 1 Easy Topic: Capital asset pricing model Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 10-02 Understand risk premiums. 31) A company has a beta of 0.50. If the market return is expected to be 12 percent and the riskfree rate is 5 percent, what is the company's required return? A) 6.0 percent B) 8.5 percent C) 11.0 percent D) 13.5 percent Answer: B Explanation: Required return = 5% + 0.50 × (12% − 5%) = 8.5%. Difficulty: 1 Easy Topic: Capital asset pricing model Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 10-03 Know and apply the Capital Asset Pricing Model (CAPM).

32) A company has a beta of 13.25. If the market return is expected to be 14 percent and the free risk-rate is 5.5 percent, what is the company's required return? A) 22.750 percent B) 33.125 percent C) 45.500 percent D) 51.000 percent Answer: B Explanation: Required return = 5.5% + 3.25 × (14% − 5.5%) = 33.125%. Difficulty: 1 Easy Topic: Capital asset pricing model Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 10-03 Know and apply the Capital Asset Pricing Model (CAPM). 33) A company has a beta of 3.75. If the market return is expected to be 20 percent and the riskfree rate is 9.5 percent, what is the company's required return? A) 33.250 percent B) 39.375 percent C) 48.875 percent D) 55.625 percent Answer: C Explanation: Required return = 9.5% + 3.75 × (20% − 9.5%) = 48.875%. Difficulty: 1 Easy Topic: Capital asset pricing model Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 10-03 Know and apply the Capital Asset Pricing Model (CAPM).

34) A company has a beta of 14.5. If the market return is expected to be 14 percent and the free risk-rate is 7 percent, what is the company's risk premium? A) 7.0 percent B) 25.5 percent C) 31.5 percent D) 38.5 percent Answer: C Explanation: Risk premium = 4.5 × (14% − 7%) = 31.5%. Difficulty: 1 Easy Topic: Capital asset pricing model Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 10-03 Know and apply the Capital Asset Pricing Model (CAPM). 35) A company has a beta of 2.91. If the market return is expected to be 16 percent and the riskfree rate is 4 percent, what is the company's risk premium? A) 11.64 percent B) 12.00 percent C) 22.91 percent D) 34.92 percent Answer: D Explanation: Risk premium = 2.91 × (16% − 4%) = 34.92%. Difficulty: 1 Easy Topic: Capital asset pricing model Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 10-03 Know and apply the Capital Asset Pricing Model (CAPM).

36) You have a portfolio with a beta of 0.9. What will be the new portfolio beta if you keep 40 percent of your money in the old portfolio and 60 percent in a stock with a beta of 1.5? A) 1.00 B) 1.20 C) 1.26 D) 2.40 Answer: C Explanation: New portfolio beta = 0.40 × 0.9 + 0.60 × 1.5 = 1.26. Difficulty: 1 Easy Topic: Beta Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 10-03 Know and apply the Capital Asset Pricing Model (CAPM). 37) You have a portfolio with a beta of 1.25. What will be the new portfolio beta if you keep 80 percent of your money in the old portfolio and 20 percent in a stock with a beta of 1.75? A) 1.00 B) 1.35 C) 1.50 D) 3.00 Answer: B Explanation: New portfolio beta = 0.80 × 1.25 + 0.20 × 1.75 = 1.35. Difficulty: 1 Easy Topic: Beta Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 10-03 Know and apply the Capital Asset Pricing Model (CAPM).

38) If the NASDAQ stock market bubble peaked at 3,750, and two and a half years later it had fallen to 2,200, what would be the percentage decline? A) −15.87 percent B) −17.05 percent C) −41.33 percent D) −58.67 percent Answer: C Explanation: Market decline = (2,200 − 3,750) ÷ 3,750 = −0.4133 = −41.33%. Difficulty: 1 Easy Topic: Dollar and percentage returns Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 10-05 Differentiate the levels of market efficiency and their implications. 39) If the Japanese stock market bubble peaked at 37,500, and two and a half years later it had fallen to 25,900, what was the percentage decline? A) −10.31 percent B) −27.63 percent C) −30.93 percent D) −69.07 percent Answer: C Explanation: Market decline = (25,900 − 37,500) ÷ 37,500 = −0.3093 = −30.93%. Difficulty: 1 Easy Topic: Dollar and percentage returns Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 10-05 Differentiate the levels of market efficiency and their implications.

40) A company's current stock price is $84.50 and it is likely to pay a $3.50 dividend next year. Since analysts estimate the company will have a 10 percent growth rate, what is its expected return? A) 4.14 percent B) 4.26 percent C) 10.00 percent D) 14.14 percent Answer: D Explanation: Use Equation 10.6: i

+ g =

$3.50

+ 0.10 = 0.1414

= 14.14%

$84.50

Difficulty: 1 Easy Topic: Expected return Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 10-07 Use the constant-growth model to compute required return. 41) A company's current stock price is $65.40 and it is likely to pay a $2.25 dividend next year. Since analysts estimate the company will have an 11.25 percent growth rate, what is its expected return? A) 3.44 percent B) 3.61 percent C) 11.25 percent D) 14.69 percent Answer: D Explanation: Use Equation 10.6: i

D1 P0

+ g =

$2.25

+ 0.1125 = 0.1469

= 14.69%

$65.40

Difficulty: 1 Easy Topic: Expected return Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 10-07 Use the constant-growth model to compute required return.

18) Compute the standard deviation of the expected return given these three economic states, their likelihoods, and the potential returns: Economic State Fast Growth Slow Growth Recession

Probability 0.1 0.6 0.3

Return 50% 8% − 10%

A) 6.8 percent B) 16.5 percent C) 21.5 percent D) 46.4 percent Answer: B Explanation: Expected return = 0.1 × 50% + 0.6 × 8% + 0.3 × − 10% = 6.8%.

Standard Deviation =

= = 16.4973% Difficulty: 2 Medium Topic: Standard deviation and variance Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 10-01 Compute forward-looking expected return and risk.

19) Compute the standard deviation of the expected return given these three economic states, their likelihoods, and the potential returns: Economic State Fast Growth Slow Growth Recession

Probability 0.2 0.5 0.3

Return 30% 6% − 2%

A) 8.4 percent B) 10.87 percent C) 11.34 percent D) 24.09 percent Answer: C Explanation: Expected return = 0.2 × 30% + 0.5 × 6% + 0.3 × − 2% = 8.4%.

Standard Deviation =

= = 11.34% Difficulty: 2 Medium Topic: Standard deviation and variance Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 10-01 Compute forward-looking expected return and risk.

44) A manager believes his firm will earn a 16 percent return next year. His firm has a beta of 1.5, the expected return on the market is 14 percent, and the risk-free rate is 4 percent. Compute the return the firm should earn given its level of risk and determine whether the manager is saying the firm is undervalued or overvalued. A) 19 percent, undervalued B) 19 percent, overvalued C) 22 percent, undervalued D) 22 percent, overvalued Answer: B Explanation: Use CAPM to determine the firm's required return = 4% + 1.5 × (14% − 4%) = 19%. Since the return required for the level of risk is 19 percent and the manager believes a 16 percent return will be achieved, the manager is saying the firm is overvalued. Difficulty: 2 Medium Topic: Capital asset pricing model Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 10-03 Know and apply the Capital Asset Pricing Model (CAPM). 45) A manager believes his firm will earn a 12 percent return next year. His firm has a beta of 1.2, the expected return on the market is 8 percent, and the risk-free rate is 3 percent. Compute the return the firm should earn given its level of risk and determine whether the manager is saying the firm is undervalued or overvalued. A) 9 percent, undervalued B) 9 percent, overvalued C) 13.8 percent, undervalued D) 13.8 percent, overvalued Answer: A Explanation: Use CAPM to determine the firm's required return = 3% + 1.2 × (8% − 3%) = 9%. Since the return required for the level of risk is 9 percent and the manager believes a 12 percent return will be achieved, the manager is saying the firm is undervalued. Difficulty: 2 Medium Topic: Capital asset pricing model Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 10-03 Know and apply the Capital Asset Pricing Model (CAPM).

46) A manager believes his firm will earn a 7.5 percent return next year. His firm has a beta of 2, the expected return on the market is 5 percent, and the risk-free rate is 2 percent. Compute the return the firm should earn given its level of risk and determine whether the manager is saying the firm is undervalued or overvalued. A) 8 percent, undervalued B) 8 percent, overvalued C) 12 percent, undervalued D) 12 percent, overvalued Answer: B Explanation: Use CAPM to determine the firm's required return = 2% + 2 × (5% − 2%) = 8%. Since the return required for the level of risk is 8 percent and the manager believes a 7.5 percent return will be achieved, the manager is saying the firm is overvalued. Difficulty: 2 Medium Topic: Capital asset pricing model Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 10-03 Know and apply the Capital Asset Pricing Model (CAPM). 47) You own $2,000 of City Steel stock that has a beta of 2.5. You also own $8,000 of Rent-NCo (beta = 1.9) and $4,000 of Lincoln Corporation (beta = 0.25). What is the beta of your portfolio? A) 1.51 B) 1.55 C) 4.65 D) 14.00 Answer: A Explanation: First determine the total value of the portfolio and the weights of each stock in the portfolio: Total value = $2,000 + $8,000 + $4,000 = $14,000. City Steel weight = $2,000/$14,000 = 14.29%. Rent-N-Co weight = $8,000/$14,000 = 57.14%. Lincoln Corporation weight = $4,000/$14,000 = 28.57%. Now compute the portfolio beta = 0.1429 × 2.5 + 0.5714 × 1.9 + 0.2857 × 0.25 = 1.51. Difficulty: 2 Medium Topic: Beta Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 10-03 Know and apply the Capital Asset Pricing Model (CAPM).

48) You own $1,000 of City Steel stock that has a beta of 1.5. You also own $5,000 of Rent-NCo (beta = 1.8) and $4,000 of Lincoln Corporation (beta = 0.9). What is the beta of your portfolio? A) 1.4 B) 1.5 C) 4.2 D) 4.65 Answer: A Explanation: First determine the total value of the portfolio and the weights of each stock in the portfolio: Total value = $1,000 + $5,000 + $4,000 = $10,000. City Steel weight = $1,000/$10,000 = 10%. Rent-N-Co weight = $5,000/$10,000 = 50%. Lincoln Corporation weight = $4,000/$10,000 = 40%. Now compute the portfolio beta = 0.10 × 1.5 + 0.50 × 1.8 + 0.40 × 0.9 = 1.41. Difficulty: 2 Medium Topic: Beta Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 10-03 Know and apply the Capital Asset Pricing Model (CAPM).

23) Compute the standard deviation given these four economic states, their likelihoods, and the potential returns: Economic State Fast Growth Slow Growth Recession Depression

Probability 0.40 0.40 0.10 0.10

Return 50% 10% − 10% − 5%

A) 6.71 percent B) 22.5 percent C) 23.37 percent D) 52.20 percent Answer: C Explanation: Expected return = 0.4 × 50% + 0.4 × 10% + 0.10 × −10% + 0.10 × −5% = 22.5%.

Standard Deviation =

= = 23.37% Difficulty: 3 Hard Topic: Standard deviation and variance Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 10-01 Compute forward-looking expected return and risk.

24) Compute the standard deviation given these four economic states, their likelihoods, and the potential returns: Economic State Fast Growth Slow Growth Recession Depression

Probability 0.20 0.50 0.20 0.10

Return 100% 10% − 1% − 10%

A) 12.19 percent B) 23.8 percent C) 38.65 percent D) 88.06 percent Answer: C Explanation: Expected return = 0.2 × 100% + 0.5 × 10% + 0.20 × − 1% + 0.10 × − 10% = 23.8%.

Standard Deviation =

= = 38.65% Difficulty: 3 Hard Topic: Standard deviation and variance Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 10-01 Compute forward-looking expected return and risk.

25) Compute the standard deviation given these four economic states, their likelihoods, and the potential returns: Economic State Fast Growth Slow Growth Recession Depression

Probability 0.35 0.45 0.10 0.10

Return 40% 10% − 10% − 100%

A) 7.5 percent B) 12.65 percent C) 39.48 percent D) 113.69 percent Answer: C Explanation: Expected return = 0.35 × 40% + 0.45 × 10% + 0.10 × − 10% + 0.10 × − 100% = 7.5%.

Standard Deviation =

= = 39.48% Difficulty: 3 Hard Topic: Standard deviation and variance Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 10-01 Compute forward-looking expected return and risk.

52) You own $14,000 of Diner's Corp. stock that has a beta of 2.1. You also own $14,000 of Comm Corp. (beta = 1.3) and $12,000 of Airlines Corp. (beta = 0.6). Assume that the market return will be 15 percent and the risk-free rate is 6.5 percent. What is the total risk premium of the portfolio? A) 11.645 percent B) 20.55 percent C) 23.905 percent D) 38.00 percent Answer: A Explanation: For the portfolio, determine the total value of the portfolio and the weights of each stock in the portfolio: Total value = $14,000 + $14,000 + $12,000 = $40,000. Diner's weight = $14,000/$40,000 = 35%. Comm's weight = $14,000/$40,000 = 35%. Airlines' weight = $12,000/$40,000 = 30%. Now compute the portfolio beta = 0.35 × 2.1 + 0.35 × 1.3 + 0.30 × 0.6 = 1.37. So the portfolio's risk premium = 1.37 × (15% − 6.5%) = 11.645%. Difficulty: 3 Hard Topic: Capital asset pricing model Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 10-03 Know and apply the Capital Asset Pricing Model (CAPM).

53) You own $5,000 of Software Corp's stock that has a beta of 3.75. You also own $10,000 of Home Improvement Corp. (beta = 1.5) and $15,000 of Publishing Corp. (beta = 0.35). Assume that the market return will be 13 percent and the risk-free rate is 4.5 percent. What is the risk premium of the portfolio? A) 11.05 percent B) 16.50 percent C) 17.00 percent D) 24.70 percent Answer: A Explanation: For the portfolio, determine the total value of the portfolio and the weights of each stock in the portfolio: Total value = $5,000 + $10,000 + $15,000 = $30,000. Software's weight = $5,000/$30,000 = 16.7%. Home Improvement's weight = $10,000/$30,000 = 33.3%. Publishing's weight = $15,000/$30,000 = 50%. Now compute the portfolio beta = 0.17 × 3.75 + 0.33 × 1.5 + 0.50 × 0.35 = 1.3. So the portfolio's risk premium = 1.3 × (13% − 4.5%) = 11.05%. Difficulty: 3 Hard Topic: Capital asset pricing model Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 10-03 Know and apply the Capital Asset Pricing Model (CAPM).

54) You hold the positions in the following table. If you expect the market to earn 14 percent and the risk-free rate is 5 percent, what is the required return of the portfolio?

Website.com Budget Stores Manufacturing Corp. Pharmacy Corp.

Price $ 20.50 $ 36.20 $ 60.70 $ 28.40

Shares 100 150 75 200

Beta 3.2 1.5 2.4 0.75

A) 20.21 percent B) 22.66 percent C) 28.66 percent D) 32.48 percent Answer: A Explanation: For the portfolio, determine the total value of the portfolio and the weights of each stock in the portfolio: Total value = $20.50 × 100 + $36.20 × 150 + $60.70 × 75 + $28.40 × 200 = $17,712.50. Website.com weight = $20.50 × 100/$17,712.50 = 11.57%. Budget weight = $36.20 × 150/$17,712.50 = 30.66%. Manufacturing weight = $60.70 × 75/$17,712.50 = 25.70%. Pharmacy weight = $28.40 × 200/$17,712.50 = 32.07%. Now compute the portfolio beta = 0.1157 × 3.2 + 0.3066 × 1.5 + 0.2570 × 2.4 + 0.3207 × 0.75 = 1.6875. So the portfolio's required return = 5% + 1.69 × (14% − 5%) = 20.21%. Difficulty: 3 Hard Topic: Capital asset pricing model Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 10-03 Know and apply the Capital Asset Pricing Model (CAPM).

55) You hold the positions in the following table. What is the beta of your portfolio?

TechNo Comp. Delivery Corp. Computer Corp. Food Corp.

Price $ 15.25 $ 105.00 $ 35.40 $ 18.75

Shares 2000 500 300 200

Beta 4.0 1.4 0.9 − 0.7

A) 1.4 B) 2.08 C) 2.13 D) 5.6 Answer: B Explanation: For the portfolio, determine the total value of the portfolio and the weights of each stock in the portfolio: Total value = $15.25 × 2,000 + $105.00 × 500 + $35.40 × 300 + $18.75 × 200 = $97,370. TechNo weight = $15.25 × 2,000/$97,370 = 31.32%. Delivery weight = $105 × 500/$97,370 = 53.92%. Computer weight = $35.40 × 300/$97,370 = 10.91%. Food weight = $18.75 × 200/$97,370 = 3.85%. Now compute the portfolio beta = 0.3132 × 4.0 + 0.5392 × 1.4 + 0.1091 × 0.9 + 0.0385 × − 0.7 = 2.07892. Difficulty: 3 Hard Topic: Beta Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 10-03 Know and apply the Capital Asset Pricing Model (CAPM).

56) Compute the expected return given these three economic states, their likelihoods, and the potential returns: Economic State Fast Growth Slow Growth Recession

Probability 0.2 0.6 0.2

Return 23% 14% − 30%

A) 3.5 percent B) 7.0 percent C) 7.5 percent D) 12.5 percent Answer: B Explanation: Expected return = 0.2 × 23% + 0.6 × 14% + 0.2 × − 30% = 7.0%. Difficulty: 1 Easy Topic: Expected return Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 10-01 Compute forward-looking expected return and risk. 57) The average annual return on the S&P 500 Index from 1986 to 1995 was 17.6 percent. The average annual T-bill yield during the same period was 9.8 percent. What was the market risk premium during these 10 years? A) 8.2 percent B) 7.8 percent C) 8.8 percent D) 9.8 percent Answer: B Explanation: Average market risk premium = 17.6% − 9.8% = 7.8%. Difficulty: 1 Easy Topic: Capital asset pricing model Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 10-02 Understand risk premiums.

58) Hastings Entertainment has a beta of 1.24. If the market return is expected to be 10 percent and the risk-free rate is 4 percent, what is Hastings' required return? A) 11.44 percent B) 12.44 percent C) 14.96 percent D) 16.40 percent Answer: A Explanation: Hastings' required return = 4% + 1.24 × (10% − 4%) = 11.44%. Difficulty: 1 Easy Topic: Capital asset pricing model Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 10-03 Know and apply the Capital Asset Pricing Model (CAPM). 59) Netflix, Inc. has a beta of 3.61. If the market return is expected to be 13.2 percent and the risk-free rate is 7 percent, what is Netflix's risk premium? A) 20.91 percent B) 22.38 percent C) 25.72 percent D) 29.38 percent Answer: B Explanation: Netflix's risk premium = 3.61 × (13.2% − 7%) = 22.38%. Difficulty: 1 Easy Topic: Capital asset pricing model Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 10-03 Know and apply the Capital Asset Pricing Model (CAPM).

60) You have a portfolio with a beta of 3.1. What will be the new portfolio beta if you keep 85 percent of your money in the old portfolio and 15 percent in a stock with a beta of 4.5? A) 3.31 B) 3.51 C) 3.61 D) 3.71 Answer: A Explanation: New portfolio beta = 0.85 × 3.1 + 0.15 × 4.5 = 3.31. Difficulty: 1 Easy Topic: Beta Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 10-03 Know and apply the Capital Asset Pricing Model (CAPM). 61) The Nasdaq stock market bubble peaked at 10,816 in 2000. Two and a half years later it had fallen to 4,000. What was the percentage decline? A) −63.02% B) −69.47% C) −57.13% D) −49.18% Answer: A Explanation: Market decline = (4,000 −10,816) ÷ 10,816 = −0.6302 = −63.02%. Difficulty: 1 Easy Topic: Dollar and percentage returns Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 10-05 Differentiate the levels of market efficiency and their implications.

62) Paccar's current stock price is $75.10 and it is likely to pay a $3.29 dividend next year. Since analysts estimate Paccar will have a 14.2 percent growth rate, what is its required return? A) 15.39 percent B) 17.94 percent C) 18.58 percent D) 19.62 percent Answer: C Explanation: Use Equation 10.6:

+ g

$3.29

+ 0.142

= 0.1858

= 18.58%

$75.10

Difficulty: 1 Easy Topic: Constant-growth stock Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 10-07 Use the constant-growth model to compute required return. 63) Universal Forest's current stock price is $154.00 and it is likely to pay a $5.23 dividend next year. Since analysts estimate Universal Forest will have a 13.0 percent growth rate, what is its required return? A) 16.40 percent B) 15.28 percent C) 13.62 percent D) 14.71 percent Answer: A Explanation: Use Equation 10.6:

D1 P0

+ g

$5.23

+ 0.13

= 0.1640

= 16.40%

$154.00

64) A manager believes his firm will earn an 18 percent return next year. His firm has a beta of 1.75, the expected return on the market is 13 percent, and the risk-free rate is 5 percent. Compute the return the firm should earn given its level of risk and determine whether the manager is saying the firm is under-valued or over-valued. A) 19 percent; overvalued B) 19 percent; undervalued C) 16.7 percent; overvalued D) 16.7 percent; undervalued Answer: A Explanation: Use CAPM to determine the firm's required return = 5% + 1.75 × (13% − 5%) = 19%. Since the return required for the level of risk is 19 percent and the manager believes an 18 percent return will be achieved, the manager is saying the firm is overvalued. Difficulty: 2 Medium Topic: Capital asset pricing model Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 10-03 Know and apply the Capital Asset Pricing Model (CAPM). 65) You own $9,000 of Olympic Steel stock that has a beta of 2.5. You also own $7,000 of Renta-Center (beta = 1.2) and $8,000 of Lincoln Educational (beta = 0.4). What is the beta of your portfolio? A) 1.18 B) 1.07 C) 1.42 D) 1.53 Answer: C Explanation: First determine the total value of the portfolio and the weights of each stock in the portfolio: Total value = $9,000 + $7,000 + $8,000 = $24,000. Olympic Steel weight = $9,000/$24,000 = 37.5%. Rent-a-Center weight = $7,000/$24,000 = 29.17%. Lincoln Educational weight = $8,000/$24,000 = 33.33%. Now compute the portfolio beta = 0.375 × 2.5 + 0.2917 × 1.2 + 0.3333 × 0.4 = 1.42. Difficulty: 2 Medium Topic: Beta Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 10-03 Know and apply the Capital Asset Pricing Model (CAPM).

66) Compute the expected return and standard deviation given these four economic states, their likelihoods, and the potential returns: Economic State Fast Growth Slow Growth Recession Depression

Probability 0.20 0.50 0.15 0.15

Return 60% 13% − 15% − 45%

A) 9.5 percent; 32.43 percent B) 9.5 percent; 21.96 percent C) 9.5 percent; 18.97 percent D) 9.5 percent; 29.18 percent Answer: A Explanation: Expected return = 0.2 × 60% + 0.5 × 13% + 0.15 × − 15% + 0.15 × − 45% = 9.5%.

Standard Deviation =

= = 32.43% Difficulty: 3 Hard Topic: Standard deviation and variance Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 10-01 Compute forward-looking expected return and risk.

67) You own $10,000 of Denny's Corp. stock that has a beta of 3.2. You also own $15,000 of Qwest Communications (beta = 1.9) and $15,000 of Southwest Airlines (beta = 0.4). Assume that the market return will be 13 percent and the risk-free rate is 5.5 percent. What is the risk premium of the portfolio? A) 10.51 percent B) 11.49 percent C) 12.45 percent D) 13.62 percent Answer: C Explanation: Total value = $10,000 + $15,000 + $15,000 = $40,000. Denny's weight = $10,000/$40,000 = 25%. Qwest's weight = $15,000/$40,000 = 37.5%. Southwest Airlines weight = $15,000/$40,000 = 37.5%. Now compute the portfolio beta = 0.25 × 3.2 + 0.375 × 1.9 + 0.375 × 0.4 = 1.66. So the portfolio's risk premium = 1.66 × (13% − 5.5%) = 12.45%. Difficulty: 3 Hard Topic: Capital asset pricing model Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 10-03 Know and apply the Capital Asset Pricing Model (CAPM).

68) You hold the positions in the following table. What is the beta of your portfolio? If you expect the market to earn 12 percent and the risk-free rate is 3.5 percent, what is the required return of the portfolio?

Amazon.com Family Dollar Stores McKesson Corp. Schering-Plough Corp.

Price $ 40 $ 30 $ 50 $ 20

Shares 100 100 100 100

Beta 3.8 1.2 0.4 0.5

A) 14.21 percent B) 16.76 percent C) 13.97 percent D) 15.38 percent Answer: B Explanation: Total value = 100 × (40 + 30 + 50 + 20) = $14,000. Amazon.com weight = $40 × 100/$14,000 = 28.6%. Family Dollar weight = $30 × 100/$14,000 = 21.4%. McKesson weight = $50 × 100/$14,000 = 35.7%. Schering-Plough weight = $20 × 100/$14,000 = 14.3%. Now compute the portfolio beta = 0.286 × 3.8 + 0.214 × 1.2 + 0.357 × 0.4 + 0.143 × 0.5 = 1.56. So the portfolio's required return = 3.5% + 1.56 × (12% − 3.5%) = 16.76%. Difficulty: 3 Hard Topic: Capital asset pricing model Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 10-03 Know and apply the Capital Asset Pricing Model (CAPM).

69) You hold the positions in the following table. What is the beta of your portfolio? If you expect the market to earn 10 percent and the risk-free rate is 4 percent, what is the required return of the portfolio?

Advanced Micro Devices FedEx Corp. Microsoft Sara Lee Corp.

Price $ 10 $ 100 $ 30 $ 15

Shares 200 50 150 200

Beta 4.2 1.1 0.7 0.5

A) 12.37 percent B) 9.73 percent C) 10.17 percent D) 11.68 percent Answer: D Explanation: Total value = $10 × 200 + $100.00 × 50 + $30 × 150 + $15 × 200 = $14,500. Advanced Micro Devices weight = $2,000/$14,500 = 13.8%. FedEx Corp. weight = $5,000/$14,500 = 34.5%. Microsoft weight = $4,500/$14,500 = 31.0%. Sara Lee Corp. weight = $3,000/$14,500 = 20.7%. Now compute the portfolio beta = 0.138 × 4.2 + 0.345 × 1.1 + 0.31 × 0.7 + 0.207 × 0.5 = 1.28. So the portfolio's required return = 4% + 1.28 × (10% − 4%) = 11.68% Difficulty: 3 Hard Topic: Capital asset pricing model Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 10-03 Know and apply the Capital Asset Pricing Model (CAPM).

70) Praxair's upcoming dividend is expected to be $2.25 and its stock is selling at $65. The firm has a beta of 0.8 and is expected to grow at 10 percent for the foreseeable future. Compute Praxair's required return using both CAPM and the constant growth model. Assume that the market portfolio will earn 10 percent and the risk-free rate is 3 percent. A) CAPM: 8.6 percent; Constant Growth Model: 13.46 percent B) CAPM: 9.7 percent; Constant Growth Model: 12.56 percent C) CAPM: 10.1 percent; Constant Growth Model: 11.46 percent D) CAPM: 8.2 percent; Constant Growth Model: 9.56 percent Answer: A Explanation: Step 1: Praxair required return = 3% + 0.8 × (10% − 3%) = 8.6%.

Step 2:

Praxair required return

= $2.25 + 0.10 = 0.1346

= 13.46%.

$65 Difficulty: 3 Hard Topic: Capital asset pricing model Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 10-03 Know and apply the Capital Asset Pricing Model (CAPM).; 10-07 Use the constant-growth model to compute required return.

71) Estee Lauder's upcoming dividend is expected to be $0.65 and its stock is selling at $45. The firm has a beta of 1.1 and is expected to grow at 10 percent for the foreseeable future. Compute Estee Lauder's required return using both CAPM and the constant growth model. Assume that the market portfolio will earn 11 percent and the risk-free rate is 4 percent. A) CAPM: 11.2 percent; Constant Growth Model: 10.97 percent B) CAPM: 11.7 percent; Constant Growth Model: 11.44 percent C) CAPM: 10.1 percent; Constant Growth Model: 11.46 percent D) CAPM: 9.2 percent; Constant Growth Model: 9.56 percent Answer: B Explanation: Step 1: Estee Lauder's required return = 4% + 1.1 × (11% − 4%) = 11.7%.

Step 2:

Estee Lauder's required return

= $0.65 + 0.10 = 0.1144

= 11.44%.

$45 Difficulty: 3 Hard Topic: Capital asset pricing model Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 10-03 Know and apply the Capital Asset Pricing Model (CAPM).; 10-07 Use the constant-growth model to compute required return. 72) ABC Inc. has a dividend yield equal to 3 percent and is expected to grow at a 7 percent rate for the next seven years. What is ABC's required return? A) 10 percent B) 11 percent C) 4 percent D) 5 percent Answer: A Explanation: 3 + 7 = 10. Difficulty: 1 Easy Topic: Total return Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 10-07 Use the constant-growth model to compute required return.

73) U.S. Bancorp holds a press conference to announce a positive news event that was unexpected to the market. As soon as the announcement is made, the stock price increases $8 per share but then over the next hour the price continues to increase resulting in a total increase of $11. Given this information which of the following statements is correct? A) This is an example of a market overreaction. B) This is an example of a market underreaction. C) This is an example of a semi-strong efficient market. D) none of these choices are correct. Answer: B Difficulty: 3 Hard Topic: Market efficiency - implications Bloom's: Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 10-05 Differentiate the levels of market efficiency and their implications. 74) U.S. Bancorp holds a press conference to announce a positive news event that was unexpected to the market. As soon as the announcement is made, the stock price increases $8 per share but then over the next hour the price falls resulting in a net increase of only $4. Given this information which of the following statements is correct? A) This is an example of a market overreaction. B) This is an example of a market underreaction. C) This is an example of a semi-strong efficient market. D) none of these choices are correct. Answer: A Difficulty: 3 Hard Topic: Market efficiency - implications Bloom's: Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 10-05 Differentiate the levels of market efficiency and their implications.

75) Which of the following is incorrect? A) Technical analysis is expected to work if markets are weak-form efficient. B) If markets are strong-form efficient then they must also be weak-form efficient. C) It is not likely that the market is strong-form efficient. D) none of these choices are incorrect. Answer: A Difficulty: 3 Hard Topic: Market efficiency - implications Bloom's: Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 10-05 Differentiate the levels of market efficiency and their implications. 76) Which of the following is correct? A) Hedge funds often sell stock they don't even own. B) Hedge funds maintain secrecy about their holdings, trading, and strategies. C) Hedge funds are limited to sophisticated investors. D) All of these choices are correct. Answer: D Difficulty: 2 Medium Topic: Hedging Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 10-04 Calculate and apply beta, a measure of market risk. 77) Which of the following statements is incorrect? A) The capital market line shows the relationship between return and risk as measured by the standard deviation. B) The Efficient Market Hypothesis states that security prices fully reflect all available information. C) The security market line shows the relationship between return and risk as measured by beta. D) none of these choices are incorrect. Answer: D Difficulty: 1 Easy Topic: Capital asset pricing model; Efficient market hypothesis; Security market line Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 10-02 Understand risk premiums.; 10-03 Know and apply the Capital Asset Pricing Model (CAPM).; 10-05 Differentiate the levels of market efficiency and their implications.

78) Stock A has a required return of 19 percent. Stock B has a required return of 11 percent. Assume a risk-free rate of 4.75 percent. Which of the following is a correct statement about the two stocks? A) Stock A is riskier. B) Stock B is riskier. C) The stocks have the same risk. D) We would need to know if the markets are efficient to answer this question. Answer: A Difficulty: 2 Medium Topic: Capital asset pricing model Bloom's: Evaluate AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 10-03 Know and apply the Capital Asset Pricing Model (CAPM). 79) Stock A has a required return of 19 percent. Stock B has a required return of 11 percent. Assume a risk-free rate of 4.75 percent. By how much does Stock A's risk premium exceed the risk premium of Stock B? A) 3.25 percent B) 6.25 percent C) 8.00 percent D) 7.00 percent Answer: C Explanation: Step 1: RP of Stock A = 19 − 4.75 = 14.25. Step 2: RP of Stock B = 11 − 4.75 = 6.25. Step 3: Difference = 14.25 − 6.25 = 8.00. Difficulty: 2 Medium Topic: Capital asset pricing model Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 10-03 Know and apply the Capital Asset Pricing Model (CAPM).

80) Stock A has a required return of 12 percent. Stock B has a required return of 15 percent. Assume a risk-free rate of 4.75 percent. Which of the following is a correct statement about the two stocks? A) Stock A is riskier. B) Stock B is riskier. C) The stocks have the same risk. D) We would need to know if the markets are efficient to answer this question. Answer: B Difficulty: 2 Medium Topic: Capital asset pricing model Bloom's: Evaluate AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 10-03 Know and apply the Capital Asset Pricing Model (CAPM). 81) IBM's stock price is $22, it is expected to pay a $2 dividend, and analysts expect the firm to grow at 10 percent per year for the next five years. TDI's stock price is $10, it is expected to pay a $1 dividend, and analysts expect the firm to grow at 12 percent per year for the next five years. What is the difference in the two firms' required rates of return? A) 2.91 percent B) 1.82 percent C) 2.03 percent D) 3.23 percent Answer: A Explanation: Step 1: IBM: 2/22 + 0.10 = 19.09%. Step 2: TDI: 1/10 + 0.12 = 22%. Step 3: 22 − 19.09% = 2.91%. Difficulty: 3 Hard Topic: Total return Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 10-07 Use the constant-growth model to compute required return.

82) Expected return is calculated by: A) multiplying each possible return by the probability, p, of the return occurring. B) adding each possible return by the probability, p, of the return occurring. C) dividing each possible return by the probability, p, of the return occurring. D) None of the above Answer: A Difficulty: 1 Easy Topic: Expected return Bloom's: Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 10-01 Compute forward-looking expected return and risk. 83) The level of total return needed to be compensated for the risk taken is A) required return B) made up of a risk-free rate and a risk premium C) both a and b D) None of the above

Answer: C Difficulty: 1 Easy Topic: Required Risk Bloom's: Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 10-02 Understand risk premiums. 84) The return on the market portfolio minus the risk-free rate is A) required return B) the reward for taking general stock market risk C) market risk premium D) both b and c Answer: D Difficulty: 1 Easy Topic: Required Risk Bloom's: Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 10-02 Understand risk premiums.

85) Which of the following statements is correct? A) If the market is strong-form efficient it must also be weak-form efficient and semi-strong efficient. B) There is evidence to suggest that the market is strong-form efficient because corporate insiders have made extraordinary profits by trading on inside information. C) The Efficient Market Hypothesis states that security prices will be based on their expected return. D) none of these choices are correct. Answer: A Difficulty: 3 Hard Topic: Market efficiency - implications Bloom's: Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 10-05 Differentiate the levels of market efficiency and their implications. 86) An asset pricing theory based on beta, a measure of risk is A) The best known asset pricing equation B) Starts with the modern portfolio theory C) CAPM D) All of the above

Answer: D Difficulty: 1 Easy Topic: Capital asset pricing model Bloom's: Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 10-02 Understand risk premiums.; 10-03 Know and apply the Capital Asset Pricing Model (CAPM).

87) The line on a graph of return and risk (standard deviation) from the risk-free rate through the market portfolio is . A) capital market line B) expected return C) security market line D) financial leverage Answer: A Difficulty: 1 Easy Topic: Capital asset pricing model Bloom's: Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 10-02 Understand risk premiums.; 10-03 Know and apply the Capital Asset Pricing Model (CAPM). 88) Which of the following statements regarding the security market line is NOT true? A) illustrates how required return relates to risk at any particular time. B) shows the market portfolio's risk premium or any stock's risk premium. C) is similar to the capital market line except risk is characterized by the standard deviation instead of beta. D) can be used to show the relationship between risk and return for any stock or portfolio. Answer: C Difficulty: 1 Easy Topic: Capital asset pricing model Bloom's: Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 10-02 Understand risk premiums.; 10-03 Know and apply the Capital Asset Pricing Model (CAPM).

89) IBM has a beta of 1.0 and Apple Computer has a beta of 3.0. Which of the following statements must be correct? A) The market risk premium for Apple must be larger than the market risk premium of IBM. B) If investors become more risk averse, the expected return of Apple will increase more than the expected return on IBM. C) Apple's expected rate of return must be three times as large as IBM's. D) none of these choices are correct. Answer: B Difficulty: 3 Hard Topic: Capital asset pricing model Bloom's: Create AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 10-02 Understand risk premiums.; 10-03 Know and apply the Capital Asset Pricing Model (CAPM). 90) You hold a diversified portfolio consisting of $1,000 investment in each of 10 different stocks. The portfolio has a beta of 0.8. You have decided to sell one of your stocks that has a beta equal to 1.1 for $1,000. You will purchase $1,000 of a new stock with a beta of 2.5. After these two transactions (sell and buy), what will be the beta of the new portfolio? A) 1.1 B) 0.99 C) 0.87 D) 0.94 Answer: D Explanation: 0.9x + 0.1(1.1) = 0.8; x = 0.77; 0.9(0.77) + 0.1(2.5) = 0.94. Difficulty: 3 Hard Topic: Beta Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 10-03 Know and apply the Capital Asset Pricing Model (CAPM).

91) A stock has an expected return of 14.5 percent, the risk-free rate is 4 percent and the return on the market is 11 percent. What is this stock's beta? A) 1.5 B) 3.0 C) 1.05 D) 0.94 Answer: A Explanation: 14.5 = 4 + beta(11 − 4); beta = 10.5/7 = 1.5. Difficulty: 3 Hard Topic: Capital asset pricing model Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 10-03 Know and apply the Capital Asset Pricing Model (CAPM). 92) In 2000, the S&P 500 Index earned 11 percent while the T-bill yield was 4.4 percent. Given this information, which of the following statements is correct with respect to the market risk premium? A) The market risk premium must have been negative. B) The market risk premium must have been positive. C) The market risk premium must have been zero. D) Unable to answer without more information. Answer: B Difficulty: 2 Medium Topic: Capital asset pricing model Bloom's: Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 10-02 Understand risk premiums. 93) How might a small market risk premium impact people's desire to buy stocks? A) Investors with high risk aversion will be less willing to invest in stocks. B) Investors with high risk aversion will be more willing to invest in stocks. C) It will only impact the share prices. D) none of these choices are correct. Answer: A Difficulty: 2 Medium Topic: Risks and returns Bloom's: Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 10-02 Understand risk premiums.

94) How might a large market risk premium impact people's desire to buy stocks? A) Investors with high risk aversion will be less willing to invest in stocks. B) Investors with high risk aversion will be more willing to invest in stocks. C) It will only impact the share prices. D) none of these choices are correct. Answer: B Difficulty: 2 Medium Topic: Risks and returns Bloom's: Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 10-02 Understand risk premiums. 95) Consider an asset that provides the same return no matter what economic state occurs. What would be the standard deviation of this asset? A) Unable to answer since there is no data to calculate the standard deviation. B) A very low number since it would have very low risk. C) 1 D) 0 Answer: D Difficulty: 2 Medium Topic: Standard deviation and variance Bloom's: Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 10-01 Compute forward-looking expected return and risk. 96) Whenever a set of stock prices go unnaturally high and subsequently crash down, the market experiences what we call a(n) A) financial meltdown. B) irrational behavior. C) stock market bubble. D) none of these choices are correct. Answer: C Difficulty: 1 Easy Topic: Market efficiency - implications Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 10-05 Differentiate the levels of market efficiency and their implications.

97) Which of the following statements is NOT true regarding weak form efficiency? A) is described as current prices reflect all information derived from trading. B) current prices include privately held information. C) both a and b. D) none of the above. Answer: B Difficulty: 1 Easy Topic: Market efficiency - implications Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 10-05 Differentiate the levels of market efficiency and their implications. 98) All of the following are necessary conditions for an efficient market EXCEPT A) low trading or transaction costs. B) many buyers and sellers. C) free and readily available information to market participants. D) low stock prices. Answer: D Difficulty: 1 Easy Topic: Market efficiency - foundations and types Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 10-05 Differentiate the levels of market efficiency and their implications. 99) Which of the following is most correct? A) In an efficient market, investors will buy overvalued stock which will drive its price down. B) In an efficient market, investors will sell undervalued stock which will drive its price down. C) In an efficient market, investors will sell overvalued stock which will drive its price down. D) none of these choices are correct. Answer: C Difficulty: 1 Easy Topic: Market efficiency - implications Bloom's: Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 10-05 Differentiate the levels of market efficiency and their implications.

100) Which of the following statements is incorrect? A) The security market line shows the relationship between risk and return for any stock or portfolio. B) The y-intercept of the security market line represents the return on the risk-free asset. C) The measure of risk used in creating the security market line is the standard deviation. D) none of these choices are incorrect. Answer: C Difficulty: 2 Medium Topic: Security market line Bloom's: Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 10-03 Know and apply the Capital Asset Pricing Model (CAPM). 101) Which of the following statements is correct? A) Penny stocks are the stocks of small companies that are priced below $1 per share. B) Restricted stocks are shares of stock issued to executives that have limitations on voting rights. C) The Capital Market Line graphs the relationship between return and risk (beta). D) All of these choices are correct. Answer: A Difficulty: 1 Easy Topic: Classes of stock Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 10-03 Know and apply the Capital Asset Pricing Model (CAPM).; 10-05 Differentiate the levels of market efficiency and their implications.; 10-06 Calculate and explain investors' required return and risk.

102) You obtain beta estimates of General Electric from two different online sources and you are surprised to find that they are so different. Which of the following would NOT be a correct explanation for the difference? A) One source used weekly data and another used monthly data. B) One source used the S&P 500 for a market proxy and the other used the Dow Jones Industrial Average. C) One used regression analysis and the other used geometric analysis. D) All of these choices are correct. Answer: C Difficulty: 2 Medium Topic: Beta Bloom's: Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 10-04 Calculate and apply beta, a measure of market risk. 103) Which of the following is incorrect? A) Most firms would want to sell additional shares of common stock if they feel their stock is undervalued. B) Most firms would not want to repurchase shares of common stock if they feel their stock is overvalued. C) It is important for financial managers to understand market efficiency because it helps them understand how their stock prices will react to different types of decisions and news announcements. D) none of these choices are incorrect. Answer: A Difficulty: 2 Medium Topic: Market efficiency - implications Bloom's: Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 10-06 Calculate and explain investors' required return and risk.

104) Which of the following is a concern regarding beta? A) Using different market proxies will result in different estimates of beta. B) A company can alter its risk level which may make the beta estimate obsolete. C) Research indicates that a company's beta does not appear to predict its future return very well. D) All of these choices are correct. Answer: D Difficulty: 2 Medium Topic: Beta Bloom's: Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 10-04 Calculate and apply beta, a measure of market risk. 105) Which of the following statements is incorrect regarding how beta is calculated? A) The company return is the independent variable. B) The market portfolio return is the dependent variable. C) Using the oldest data possible will yield the most accurate results. D) All of the statements are incorrect. Answer: D Difficulty: 2 Medium Topic: Beta Bloom's: Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 10-04 Calculate and apply beta, a measure of market risk. 106) You have a portfolio consisting of 20 percent Boeing (beta = 1.3) and 40 percent HewlettPackard (beta = 1.6) and 40 percent McDonald's stock (beta = 0.7). How much market risk does the portfolio have? A) This portfolio has 18 percent less risk than the general market. B) This portfolio has 28 percent more risk than the general market. C) This portfolio has 18 percent more risk than the general market. D) This portfolio has 28 percent less risk than the general market. Answer: C Explanation: 0.2 × 1.3 + 0.4 × 1.6 + 0.4 × 0.7 = 1.18. 18 percent more risk than the general market. Difficulty: 1 Easy Topic: Beta Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 10-03 Know and apply the Capital Asset Pricing Model (CAPM).

107) A company's current stock price is $22.00 and its most recent dividend was $0.75 per share. Since analysts estimate the company will have a 12 percent growth rate, what is its expected return? A) 3.00 percent B) 3.48 percent C) 12.00 percent D) 15.82 percent Answer: D Explanation: Use Equation 10.6: D0 = $0.75. D1 = D0 × (1 + 0.12) = ($0.75 × 1.12) = $0.84. i = D1/P0 + g or ($0.84/$22.00) + 0.12 = 15.82%. Difficulty: 1 Easy Topic: Expected return Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 10-07 Use the constant-growth model to compute required return. 108) A manager believes his firm will earn a 15 percent return next year. His firm has a beta of 2.1, the expected return on the market is 6 percent, and the risk-free rate is 2 percent. Compute the return the firm should earn given its level of risk and determine whether the manager is saying the firm is undervalued or overvalued. A) 10.4 percent, undervalued B) 10.4 percent, overvalued C) 12.3 percent, undervalued D) 12.3 percent, overvalued Answer: A Explanation: Use CAPM to determine the firm's required return = 2% + 2.1 × (6% − 2%) = 10.4%. Since the return required for the level of risk is 10.4 percent and the manager believes a 15 percent return will be achieved, the manager is saying the firm is undervalued. Difficulty: 2 Medium Topic: Capital asset pricing model Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 10-03 Know and apply the Capital Asset Pricing Model (CAPM).

109) You own $8,000 of City Steel stock that has a beta of 2.1. You also own $12,000 of RentN-Co (beta = 1.75) and $5,000 of Lincoln Corporation (beta = 0.50). What is the beta of your portfolio? A) 1.45 B) 1.61 C) 2.10 D) 4.35 Answer: B Explanation: First determine the total value of the portfolio and the weights of each stock in the portfolio: Total value = $8,000 + $12,000 + $5,000 = $25,000. City Steel weight = $8,000/$25,000 = 32%. Rent-N-Co weight = $12,000/$25,000 = 48%. Lincoln Corporation weight = $5,000/$25,000 = 20%. Now compute the portfolio beta = 0.32 × 2.1 + 0.48 × 1.75 + 0.20 × 0.50 = 1.612. Difficulty: 2 Medium Topic: Beta Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 10-03 Know and apply the Capital Asset Pricing Model (CAPM).

110) You own $7,000 of Diner's Corp. stock that has a beta of 1.75. You also own $13,000 of Comm Corp. (beta = 1.15) and $20,000 of Airlines Corp. (beta = 0.7). Assume that the market return will be 12 percent and the risk-free rate is 3.5 percent. What is the total risk premium of the portfolio? A) 8.76 percent B) 8.86 percent C) 10.20 percent D) 12.36 percent Answer: A Explanation: For the portfolio, determine the total value of the portfolio and the weights of each stock in the portfolio: Total value = $7,000 + $13,000 + $20,000 = $40,000. Diner's weight = $7,000/$40,000 = 17.5%. Comm's weight = $13,000/$40,000 = 32.5%. Airlines' weight = $20,000/$40,000 = 50%. Now compute the portfolio beta = 0.175 × 1.75 + 0.325 × 1.15 + 0.50 × 0.7 = 1.03. So the portfolio's risk premium = 1.03 × (12% − 3.5%) = 8.755%. Difficulty: 3 Hard Topic: Risks and returns; Capital asset pricing model Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 10-03 Know and apply the Capital Asset Pricing Model (CAPM).

111) You hold the positions in the following table. If you expect the market to earn 10 percent and the risk-free rate is 3 percent, what is the required return of the portfolio?

Website.com Budget Stores Manufacturing Corp. Pharmacy Corp.

Price $ 25.00 $ 38.50 $ 52.00 $ 18.50

Shares 100 200 50 200

Beta 2.72 1.65 2.30 0.65

A) 14.83 percent B) 15.81 percent C) 28.67 percent D) 32.83 percent Answer: A Explanation: For the portfolio, determine the total value of the portfolio and the weights of each stock in the portfolio: Total value = $25.00 × 100 + $38.50 × 200 + $52.00 × 50 + $18.50 × 200 = $16,500. Website.com weight = $25.00 × 100/$16,500 = 15.15%. Budget weight = $38.50 × 200/$16,500 = 46.67% Manufacturing weight = $52.00 × 50/$16,500 = 15.76 %. Pharmacy weight = $18.50 × 200/$16,500 = 22.42%. Now compute the portfolio beta = 0.1515 × 2.72 + 0.4667 × 1.65 + 0.1576 × 2.3 + 0.2242 × 0.65 = 1.690345. So the portfolio's required return = 3% + 1.69 × (10% − 3%) = 14.83%. Difficulty: 3 Hard Topic: Capital asset pricing model; Beta Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 10-03 Know and apply the Capital Asset Pricing Model (CAPM).

112) A company has a beta of 0.85. If the market return is expected to be 9 percent and the riskfree rate is 2.5 percent, what is the company's required return? A) 7.350 percent B) 8.025 percent C) 10.150 percent D) 21.775 percent Answer: B Explanation: Required return = 2.5% + 0.85 ×(9% − 2.5%) = 8.025%. Difficulty: 1 Easy Topic: Capital asset pricing model Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 10-03 Know and apply the Capital Asset Pricing Model (CAPM). 113) A company has a beta of 0.25. If the market return is expected to be 8 percent and the riskfree rate is 2 percent, what is the company's required return? A) 1.50 percent B) 3.50 percent C) 4.00 percent D) 13.50 percent Answer: B Explanation: Required return = 2% + 0.25 × (8% − 2%) = 3.5%. Difficulty: 1 Easy Topic: Capital asset pricing model Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 10-03 Know and apply the Capital Asset Pricing Model (CAPM).

114) Compute the expected return given these three economic states, their likelihoods, and the potential returns: Economic State Fast Growth Slow Growth Recession

Probability 0.40 0.55 0.05

Return 25% 12% − 50%

A) −4.3 percent B) 14.1 percent C) 19.1 percent D) 29.0 percent Answer: B Explanation: Expected return = 0.4 × 25% + 0.55 × 12% + 0.05 × −50% = 14.1%. Difficulty: 1 Easy Topic: Expected return Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 10-01 Compute forward-looking expected return and risk. 115) A stock has an expected return of 9.5 percent, the risk-free rate is 2 percent and the return on the market is 8 percent. What is this stock's beta? A) 1.50 B) 1.25 C) 1.19 D) 0.94 Answer: B Explanation: 9.5 = 2 + beta(8 − 2). beta = 7.5/6 = 1.25. Difficulty: 3 Hard Topic: Capital asset pricing model Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 10-03 Know and apply the Capital Asset Pricing Model (CAPM).

116) A company's current stock price is $50.00 and its most recent dividend was $1.00 per share. Since analysts estimate the company will have a 5 percent growth rate, what is its expected return? A) 2.20 percent B) 5.02 percent C) 7.00 percent D) 7.10 percent Answer: D Explanation: Use Equation 10.6: D0 = $1.00 D1 = D0 × (1 + 0.05) = ($1.00 × 1.05) = $1.05. i = D1/P0 + g or ($1.05/$50.00) + 0.05 = 7.1%. Difficulty: 1 Easy Topic: Expected return Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 10-07 Use the constant-growth model to compute required return. 117) ABC Inc. has a dividend yield equal to 5 percent and is expected to grow at a 12 percent rate for the next seven years. What is ABC's required return? A) 17.0 percent B) 7.0 percent C) 6.7 percent D) 2.4 percent Answer: A Explanation: 5 + 12 = 17. Difficulty: 1 Easy Topic: Total return Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 10-07 Use the constant-growth model to compute required return.

Finance, 5e (Cornett) Chapter 11 Calculating the Cost of Capital 1) When calculating the weighted average cost of capital, weights are based on A) book values. B) book weights. C) market values. D) market betas. Answer: C Difficulty: 1 Easy Topic: Capital structure weights Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 11-01 Understand the relationship of cost of capital to the investor's required return. 2) Which of these completes this statement to make it true? The constant growth model is A) always going to have assumptions that will hold true. B) adjustable for stocks that don't expect constant growth without sizeable errors. C) only going to be appropriate for the limited number of stocks that just happen to expect constant growth. D) only going to be appropriate for the limited number of stocks that just happen to expect nonconstant growth. Answer: C Difficulty: 2 Medium Topic: Constant-growth stock Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 11-01 Understand the relationship of cost of capital to the investor's required return.

3) When firms use multiple sources of capital, they need to calculate the appropriate discount rate for valuing their firm's cash flows as A) a simple average of the capital components costs. B) a sum of the capital components costs. C) a weighted average of the capital components costs. D) they apply to each asset as they are purchased with their respective forms of debt or equity. Answer: C Difficulty: 1 Easy Topic: Weighted average cost of capital Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 11-01 Understand the relationship of cost of capital to the investor's required return. 4) Which of the following is a true statement? A) To estimate the before-tax cost of debt, we need to solve for the Yield to Maturity (YTM) on the firm's existing debt. B) To estimate the before-tax cost of debt, we need to solve for the Yield to Call (YTC) on the firm's existing debt. C) To estimate the before-tax cost of debt, we use the coupon rate on the firm's existing debt. D) To estimate the before-tax cost of debt, we use the average rate on the firm's existing debt. Answer: A Difficulty: 1 Easy Topic: Cost of debt Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 11-02 Use the weighted-average cost of capital (WACC) formula to calculate a project's cost of capital.

5) Which of the following is a true statement regarding the appropriate tax rate to be used in the WACC? A) One would use the marginal tax rate that the firm paid the prior year. B) One would use the average tax rate that the firm paid the prior year. C) One would use the weighted average of the marginal tax rates that would have been paid on the taxable income shielded by the interest deduction. D) One would use the marginal tax rates that would have been paid on the taxable income shielded by the interest deduction. Answer: C Difficulty: 1 Easy Topic: Cost of debt Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 11-03 Explain how the firm chooses among estimating costs of equity, preferred stock, and debt. 6) Which of these statements is true regarding calculating weights for WACC? A) If we are calculating WACC for the firm, then equity, preferred stock and debt would be the entire book value of each source of capital. B) If we are calculating WACC for the firm, then equity, preferred stock and debt would be the entire market value of each source of capital. C) If we are calculating WACC for a project, then equity, preferred stock and debt would be the entire book value of each source of capital. D) If we are calculating WACC for a project, then equity, preferred stock and debt would be the entire market value of each source of capital. Answer: B Difficulty: 2 Medium Topic: Capital structure weights Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 11-03 Explain how the firm chooses among estimating costs of equity, preferred stock, and debt.

7) Which of the following statements is true? A) If the new project is riskier than the firm's existing projects, then it should be charged a higher cost of capital. B) If the new project is riskier than the firm's existing projects, then it should be charged a lower cost of capital. C) If the new project is riskier than the firm's existing projects, then it should be charged the firm's cost of capital. D) The new project's risk is not a factor in determining its cost of capital. Answer: A Difficulty: 2 Medium Topic: Divisional and project costs of capital Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 11-05 Identify which elements of WACC are used to calculate a projectspecific WACC. 8) Which of the following makes this a true statement? If the new project does significantly increase the firm's overall risk A) the increased risk will be borne equally amongst the bondholders, preferred stockholders, and common stockholders. B) the increased risk will be borne disproportionately by bondholders. C) the increased risk will be borne disproportionately by preferred stockholders. D) the increased risk will be borne disproportionately by common stockholders. Answer: D Difficulty: 2 Medium Topic: Divisional and project costs of capital Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 11-05 Identify which elements of WACC are used to calculate a projectspecific WACC.

9) An average of which of the following will give a fairly accurate estimate of what a project's beta will be? A) flotation beta B) proxy beta C) pure-play proxies D) weighted average beta Answer: B Difficulty: 1 Easy Topic: Beta Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 11-05 Identify which elements of WACC are used to calculate a projectspecific WACC. 10) Which of the following makes this a true statement? Ideally, when searching for a beta for a new line of business A) one could find other firms engaged in the proposed new line of business and use their betas as proxies to estimate the project's risk. B) one would like to find at least three or four pure-play proxies. C) two (or even one) proxies might represent a suitable sample if their line of business resembles the proposed new project closely enough. D) All of these choices are correct. Answer: D Difficulty: 2 Medium Topic: Beta Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 11-05 Identify which elements of WACC are used to calculate a projectspecific WACC.

11) Which of these is an estimated WACC computed using some sort of proxy for the average equity risk of the projects in a particular division? A) average WACC B) divisional WACC C) proxy WACC D) pure-play WACC Answer: B Difficulty: 1 Easy Topic: Divisional and project costs of capital Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 11-06 Evaluate trade-offs between a firmwide WACC and a divisional cost of capital approach. 12) Which of these statements is true regarding divisional WACC? A) Using a divisional WACC versus a WACC for the firm's current operations will result in quite a few incorrect decisions. B) Using a simple firmwide WACC to evaluate new projects would give an unfair advantage to projects that present more risk than the firm's average beta. C) Using a simple firmwide WACC to evaluate new projects would give an unfair advantage to projects that present less risk than the firm's average beta. D) Using a firmwide WACC to evaluate new projects would have no impact on projects that present less risk than the firm's average beta. Answer: B Difficulty: 2 Medium Topic: Divisional and project costs of capital Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 11-06 Evaluate trade-offs between a firmwide WACC and a divisional cost of capital approach.

13) An objective approach to calculating divisional WACCs would be done by A) simply considering the project's risk relative to the firm's lines of business and adjusting upward or downward to account for subjective opinions of project risk. B) computing the average beta for the firm, the firm's CAPM formula, and the firm's WACC. C) computing the average beta per division, using these figures for each division in the CAPM formula, and then constructing divisional WACCs. D) simply averaging out all the WACCs for all the firm's projects. Answer: C Difficulty: 2 Medium Topic: Divisional and project costs of capital Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 11-06 Evaluate trade-offs between a firmwide WACC and a divisional cost of capital approach. 14) Which statement makes this a false statement? When a firm pays commissions to underwriting firms that float the issuance of new stock A) the component cost will need to be integrated to figure project WACCs. B) the component cost will need to be integrated only for the firm's WACC. C) the firm can increase the project's WACC to incorporate the flotation costs' impact. D) the firm can leave the WACC alone and adjust the project's initial investment upwards. Answer: A Difficulty: 1 Easy Topic: Flotation costs Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 11-08 Demonstrate how to adjust the WACC to reflect flotation costs. 15) Which of the following is a principle of capital budgeting which states that the calculations of cash flows should remain independent of financing? A) generally accepted accounting principle B) financing principle C) separation principle D) WACC principle Answer: C Difficulty: 1 Easy Topic: Flotation costs Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 11-08 Demonstrate how to adjust the WACC to reflect flotation costs. 7

16) When we adjust the WACC to reflect flotation costs, this approach A) raises each capital source's effective cost. B) raises only the cost of external equity. C) reduces the cost of debt. D) reduces each capital source's effective cost. Answer: A Difficulty: 1 Easy Topic: Flotation costs Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 11-08 Demonstrate how to adjust the WACC to reflect flotation costs. 17) Which of these makes this a true statement? The WACC formula A) is not impacted by taxes. B) uses the after-tax costs of capital to compute the firm's weighted average cost of debt financing. C) uses the pre-tax costs of capital to compute the firm's weighted average cost of debt financing. D) focuses on operating costs only to keep them separate from financing costs. Answer: B Difficulty: 1 Easy Topic: Weighted average cost of capital Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 11-02 Use the weighted-average cost of capital (WACC) formula to calculate a project's cost of capital. 18) Which of these makes this a true statement? When determining the appropriate weights used in calculating a WACC, it should reflect A) the relative sizes of the total book capitalizations for each kind of security that the firm issues. B) the relative sizes of the total market capitalizations for each kind of security that the firm issues. C) only the market after-tax cost of debt. D) only the market after-tax cost of equity. Answer: B Difficulty: 1 Easy Topic: Capital structure weights Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 11-04 Calculate the weights used for WACC projections. 8

19) Any debt and preferred stock components of capital should A) use project-specific, not firmwide, WACC figures. B) use firmwide, not project-specific, WACC figures. C) use project-specific figures. D) not be issued. Answer: B Difficulty: 1 Easy Topic: Cost of debt Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 11-05 Identify which elements of WACC are used to calculate a projectspecific WACC. 20) Which of these are fees paid by firms to investment bankers for issuing new securities? A) flotation costs B) interest expense C) seller financing charges D) user fees Answer: A Difficulty: 1 Easy Topic: Flotation costs Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 11-08 Demonstrate how to adjust the WACC to reflect flotation costs. 21) FlavR Co. stock has a beta of 2.0, the current risk-free rate is 2, and the expected return on the market is 9 percent. What is FlavR Co's cost of equity? A) 11 percent B) 13 percent C) 16 percent D) 20 percent Answer: C Explanation: 2 + 2.0 × (9 − 2) = 16 percent. Difficulty: 1 Easy Topic: Cost of equity Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-03 Explain how the firm chooses among estimating costs of equity, preferred stock, and debt. 9

22) TJ Co. stock has a beta of 1.45, the current risk-free rate is 5.75, and the expected return on the market is 14 percent. What is TJ Co's cost of equity? A) 17.71 percent B) 21.20 percent C) 26.05 percent D) 28.64 percent Answer: A Explanation: 5.75 + 1.45 × (14 − 5.75) = 17.7125 percent. Difficulty: 1 Easy Topic: Cost of equity Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-03 Explain how the firm chooses among estimating costs of equity, preferred stock, and debt. 23) CJ Co. stock has a beta of 0.9, the current risk-free rate is 5.6, and the expected return on the market is 13 percent. What is CJ Co's cost of equity? A) 12.26 percent B) 17.30 percent C) 19.50 percent D) 22.34 percent Answer: A Explanation: 5.6 + 0.9 × (13 − 5.6) = 12.26 percent. Difficulty: 1 Easy Topic: Cost of equity Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-03 Explain how the firm chooses among estimating costs of equity, preferred stock, and debt.

24) WC Inc. has a $10 million (face value), 10-year bond issue selling for 99 percent of par that pays an annual coupon of 9 percent. What would be WC's before-tax component cost of debt? A) 9.00 percent B) 9.10 percent C) 9.16 percent D) 18.32 percent Answer: C Explanation: N = 10, PV = 990, PMT = 90, FV = 1000, CPT I = 9.16 Difficulty: 1 Easy Topic: Cost of debt Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-03 Explain how the firm chooses among estimating costs of equity, preferred stock, and debt. 25) IVY has preferred stock selling for 98 percent of par that pays a 7 percent annual coupon. What would be IVY's component cost of preferred stock? A) 6.86 percent B) 7.00 percent C) 7.14 percent D) 14.00 percent Answer: C Explanation: 7/98 = 7.14 percent. Difficulty: 1 Easy Topic: Cost of preferred stock Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-03 Explain how the firm chooses among estimating costs of equity, preferred stock, and debt.

26) Fern has preferred stock selling for 95 percent of par that pays an 8 percent annual coupon. What would be Fern's component cost of preferred stock? A) 7.60 percent B) 8.00 percent C) 8.42 percent D) 9.00 percent Answer: C Explanation: 8/95 = 8.42 percent. Difficulty: 1 Easy Topic: Cost of preferred stock Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-03 Explain how the firm chooses among estimating costs of equity, preferred stock, and debt. 27) Rose has preferred stock selling for 99 percent of par that pays a 9 percent annual coupon. What would be Rose's component cost of preferred stock? A) 4.55 percent B) 8.91 percent C) 9.00 percent D) 9.09 percent Answer: D Explanation: 9/99 = 9.09 percent. Difficulty: 1 Easy Topic: Cost of preferred stock Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-03 Explain how the firm chooses among estimating costs of equity, preferred stock, and debt.

28) Sports Corp. has 10 million shares of common stock outstanding, 5 million shares of preferred stock outstanding, and 1 million bonds. If the common shares are selling for $25 per share, the preferred shares are selling for $12.50 per share, and the bonds are selling for 97 percent of par, what would be the weight used for common stock in the computation of Sports' WACC? A) 18.59 percent B) 19.49 percent C) 62.50 percent D) 79.75 percent Answer: B Explanation: (10,000,000 × 25)/(10,000,000 × 25 + 5,000,000 × 12.50 + 1,000,000 × 0.97 × 1,000) = 250m./1,282.5m. = 19.49 percent. Difficulty: 1 Easy Topic: Capital structure weights Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-04 Calculate the weights used for WACC projections. 29) JackITs has 5 million shares of common stock outstanding, 1 million shares of preferred stock outstanding, and 20 thousand bonds. If the common shares are selling for $28 per share, the preferred shares are selling for $13.50 per share, and the bonds are selling for 98 percent of par, what would be the weight used for common stock in the computation of JackITs' WACC? A) 33.33 percent B) 80.88 percent C) 83.08 percent D) 91.19 percent Answer: B Explanation: (5,000,000 × 28)/(5,000,000 × 28 + 1,000,000 × 13.50 + 20,000 × 0.98 × 1,000) = $140m./$173.1m. = 80.88 percent. Difficulty: 1 Easy Topic: Capital structure weights Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-04 Calculate the weights used for WACC projections.

30) Carrie D's has 6 million shares of common stock outstanding, 2 million shares of preferred stock outstanding, and 10 thousand bonds. If the common shares are selling for $15 per share, the preferred shares are selling for $28 per share, and the bonds are selling for 109 percent of par, what would be the weight used for common stock in the computation of Carrie D's WACC? A) 33.33 percent B) 57.36 percent C) 61.64 percent D) 75.00 percent Answer: B Explanation: (6,000,000 × 15)/(6,000,000 × 15 + 2,000,000 × 28 + 10,000 × 1.09 × 1,000) = 90,000,000/156,900,000 = 57.36 percent. Difficulty: 1 Easy Topic: Capital structure weights Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-04 Calculate the weights used for WACC projections. 31) Solar Shades has 8 million shares of common stock outstanding, 4 million shares of preferred stock outstanding, and 10 thousand bonds. If the common shares are selling for $13 per share, the preferred shares are selling for $30 per share, and the bonds are selling for 105 percent of par, what would be the weight used for common stock in the computation of Solar Shades' WACC? A) 33.33 percent B) 44.35 percent C) 46.42 percent D) 66.61 percent Answer: B Explanation: (8,000,000 × 13)/(8,000,000 × 13 + 4,000,000 × 30 + 10,000 × 1.05 × 1,000) = 104m./234.5m. = 44.35 percent. Difficulty: 1 Easy Topic: Capital structure weights Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-04 Calculate the weights used for WACC projections.

32) TellAll has 10 million shares of common stock outstanding, 20 million shares of preferred stock outstanding, and 100 thousand bonds. If the common shares are selling for $32 per share, the preferred shares are selling for $20 per share, and the bonds are selling for 106 percent of par, what would be the weight used for preferred stock in the computation of TellAll's WACC? A) 33.33 percent B) 48.43 percent C) 55.55 percent D) 66.45 percent Answer: B Explanation: (20,000,000 × 20)/(10,000,000 × 32 + 20,000,000 × 20 + 100,000 × 1.06 × 1,000) = 400m./826m. = 48.43 percent. Difficulty: 1 Easy Topic: Capital structure weights Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-04 Calculate the weights used for WACC projections. 33) Paper Exchange has 80 million shares of common stock outstanding, 60 million shares of preferred stock outstanding, and 50 thousand bonds. If the common shares are selling for $20 per share, the preferred shares are selling for $10 per share, and the bonds are selling for 105 percent of par, what would be the weight used for preferred stock in the computation of Paper's WACC? A) 26.64 percent B) 27.27 percent C) 33.33 percent D) 42.84 percent Answer: A Explanation: (60,000,000 × 10)/(80,000,000 × 20 + 60,000,000 × 10 + 50,000 × 1.05 × 1,000) = 600m./2252.5m. = 26.64 percent. Difficulty: 1 Easy Topic: Capital structure weights Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-04 Calculate the weights used for WACC projections.

34) Town Crier has 10 million shares of common stock outstanding, 2 million shares of preferred stock outstanding, and 10 thousand bonds. If the common shares are selling for $28 per share, the preferred shares are selling for $15.50 per share, and the bonds are selling for 97 percent of par, what would be the weight used for debt in the computation of Town Crier's WACC? A) 3.02 percent B) 3.12 percent C) 3.20 percent D) 3.33 percent Answer: A Explanation: (10,000 × 0.97 × 1,000)/(10,000,000 × 28 + 2,000,000 × 15.50 + 10,000 × 0.97 × 1,000) = 9.7m./320.7m. = 3.02 percent. Difficulty: 1 Easy Topic: Capital structure weights Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-04 Calculate the weights used for WACC projections. 35) Bill's Boards has 20 million shares of common stock outstanding, 4 million shares of preferred stock outstanding, and 20 thousand bonds. If the common shares are selling for $30 per share, the preferred shares are selling for $17 per share, and the bonds are selling for 96 percent of par, what would be the weight used for debt in the computation of Bill's WACC? A) 0.83 percent B) 2.79 percent C) 2.87 percent D) 3.33 percent Answer: B Explanation: (20,000 × 0.96 × 1,000)/(20,000,000 × 30 + 4,000,000 × 17 + 20,000 × 0.96 × 1,000) = 19.2m./687.2m. = 2.79 percent. Difficulty: 1 Easy Topic: Capital structure weights Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-04 Calculate the weights used for WACC projections.

36) Suppose that TipsNToes, Inc.'s capital structure features 40 percent equity, 60 percent debt, and that its before-tax cost of debt is 9 percent, while its cost of equity is 15 percent. If the appropriate weighted average tax rate is 21 percent, what will be TipsNToes' WACC? A) 9.36 percent B) 10.27 percent C) 11.84 percent D) 24.00 percent Answer: B Explanation: 0.40 × 15% + 0 × 0% + 0.60 × 9% × (100% − 21%) = 10.266%. Difficulty: 2 Medium Topic: Weighted average cost of capital Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-02 Use the weighted-average cost of capital (WACC) formula to calculate a project's cost of capital. 37) Suppose that Model Nails, Inc.'s capital structure features 60 percent equity, 40 percent debt, and that its before-tax cost of debt is 6 percent, while its cost of equity is 10 percent. If the appropriate weighted average tax rate is 21 percent, what will be Model Nails' WACC? A) 7.90 percent B) 6.84 percent C) 8.40 percent D) 16.00 percent Answer: A Explanation: 0.60 × 10% + 0 × 0% + 0.40 × 6% × (100% − 21%) = 7.896%. Difficulty: 2 Medium Topic: Weighted average cost of capital Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-02 Use the weighted-average cost of capital (WACC) formula to calculate a project's cost of capital.

38) Suppose that Hanna Nails, Inc.'s capital structure features 45 percent equity, 55 percent debt, and that its before-tax cost of debt is 5 percent, while its cost of equity is 9 percent. If the appropriate weighted average tax rate is 21 percent, what will be Hanna Nails' WACC? A) 5.18 percent B) 6.22 percent C) 6.72 percent D) 6.80 percent Answer: B Explanation: 0.45 × 9% + 0 × 0% + 0.55 × 5% × (100% − 21%) = 6.2225%. Difficulty: 2 Medium Topic: Weighted average cost of capital Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-02 Use the weighted-average cost of capital (WACC) formula to calculate a project's cost of capital. 39) Suppose that Glamour Nails, Inc.'s capital structure features 30 percent equity, 70 percent debt, and that its after-tax cost of debt is 4 percent, while its cost of equity is 10 percent. If the appropriate weighted average tax rate is 21 percent, what will be Glamour Nails' WACC? A) 4.78 percent B) 5.80 percent C) 7.94 percent D) 7.00 percent Answer: B Explanation: 0.30 × 10% + 0 × 0% + 0.70 × 4% = 5.8%. Difficulty: 2 Medium Topic: Weighted average cost of capital Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-02 Use the weighted-average cost of capital (WACC) formula to calculate a project's cost of capital.

40) TJ Industries has 7 million shares of common stock outstanding with a market price of $20.00 per share. The company also has outstanding preferred stock with a market value of $10 million, and 100,000 bonds outstanding, each with face value $1,000 and selling at 95 percent of par value. The cost of common stock is 12 percent, the cost of preferred stock is 10 percent, and the cost of debt is 6.45 percent. All costs are given at the before-tax level. If TJ's tax rate is 21 percent, what is the WACC? A) 9.24 percent B) 9.77 percent C) 12.59 percent D) 8.44 percent Answer: A Explanation: To calculate weights: Calculate total value of stocks and bonds = (7,000,000 × 20) + (10,000,000) + (95% × 1,000 × 100,000) = 245,000,000 Common Stock: (7,000,000 × $20)/245,000,000 = 0.5714. Preferred Stock: (10,000,000)/245,000,000 = 0.0408 Bonds: (100,000 × 0.95 × 1,000)/245,000,000 = 0.3878. To calculate WACC: 0.5714 × 12% + 0.0408 × 10% + 0.3878 × 6.45% × (100% − 21%) = 9.24083% Difficulty: 2 Medium Topic: Weighted average cost of capital Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-02 Use the weighted-average cost of capital (WACC) formula to calculate a project's cost of capital.

41) PNB Industries has 20 million shares of common stock outstanding with a market price of $18.00 per share. The company also has outstanding preferred stock with a market value of $50 million, and 500,000 bonds outstanding, each with face value $1,000 and selling at 104 percent of par value. The cost of common stock is 15 percent, the cost of preferred stock is 12 percent, and the cost of debt is 8.50 percent. All costs are given at the before-tax level. If PNB's tax rate is 21 percent, what is the WACC? A) 7.05 percent B) 10.21 percent C) 8.85 percent D) 11.83 percent Answer: B Explanation: To calculate weights: Calculate total value of stocks and bonds = (20,000,000 × 18) + (50,000,000) + (104% × 1,000 × 500,000) = 930,000,000 Common Stock: (20,000,000 × $18)/930,000,000 = 0.3871 Preferred Stock: (50,000,000)/930,000,000 = 0.0538 Bonds: (500,000 × 1.04 × 1,000)/930,000,000 = 0.5591 To calculate WACC: 0.3871 × 15% + 0.0538 × 12% + 0.5591 × 8.5% × (1 − .21) = 10.21% Difficulty: 2 Medium Topic: Weighted average cost of capital Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-02 Use the weighted-average cost of capital (WACC) formula to calculate a project's cost of capital.

42) PAW Industries has 5 million shares of common stock outstanding with a market price of $8.00 per share and par value of $1 per share. The company also has outstanding preferred stock with a market value of $10 million, and 100,000 bonds outstanding, each with face value $1,000 and selling at 96 percent of par value. The cost of common stock is 19 percent, the cost of preferred stock is 15 percent, and the cost of debt is 9 percent. All costs are given at the beforetax level. If PAW's tax rate is 21 percent, what is the WACC? A) 10.91 percent B) 10.38 percent C) 12.51 percent D) 14.33 percent Answer: A Explanation: To calculate weights: Calculate total value of stocks and bonds = (5,000,000 × 8) + (10,000,000) + (96% × 1,000 × 100,000) = 146,000,000 Common Stock: (5,000,000 × $8)/146,000,000 = 0.2740 Preferred Stock: (10,000,000)/146,000,000 = 0.0685 Bonds: (100,000 × 0.96 × 1,000)/146,000,000 = 0.6575 To calculate WACC: 0.2740 × 19% + 0.0685 × 15% + 0.6575 × 9% × (1 − 0.21) = 10.91% Difficulty: 2 Medium Topic: Weighted average cost of capital Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-02 Use the weighted-average cost of capital (WACC) formula to calculate a project's cost of capital. 43) Suppose that TW, Inc. has a capital structure of 25 percent equity, 15 percent preferred stock, and 60 percent debt. If the before-tax component costs of equity, preferred stock and debt are 13.5 percent, 9.5 percent and 4 percent, respectively, what is TW's WACC if the firm faces an average tax rate of 21 percent? A) 7.19 percent B) 6.70 percent C) 2.90 percent D) 9.0 percent Answer: B Explanation: To calculate WACC: 0.25 × 13.5% + 0.15 × 9.5% + 0.60 × 4% × (1 − 0.21) = 6.696%. Difficulty: 2 Medium Topic: Weighted average cost of capital Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-02 Use the weighted-average cost of capital (WACC) formula to calculate a project's cost of capital. 21

44) Suppose that PAW, Inc. has a capital structure of 60 percent equity, 10 percent preferred stock, and 30 percent debt. If the before-tax component costs of equity, preferred stock and debt are 17.5 percent, 12 percent and 6.5 percent, respectively, what is PAW's WACC if the firm faces an average tax rate of 21 percent? A) 10.71 percent B) 4.00 percent C) 13.24 percent D) 13.10 percent Answer: C Explanation: To calculate WACC: 0.6 × 17.5% + 0.1 × 12% + 0.3 × 6.5% × (1 − 0.21) = 13.2405%. Difficulty: 2 Medium Topic: Weighted average cost of capital Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-02 Use the weighted-average cost of capital (WACC) formula to calculate a project's cost of capital. 45) Suppose that TNT, Inc. has a capital structure of 43 percent equity, 23 percent preferred stock, and 34 percent debt. If the after-tax component costs of equity, preferred stock and debt are 15.4 percent, 10 percent and 7 percent, respectively, what is TNT's WACC if the firm faces an average tax rate of 21 percent? A) 9.45 percent B) 11.30 percent C) 10.64 percent D) 8.93 percent Answer: B Explanation: To calculate WACC: 0.43 × 15.4% + 0.23 × 10% + 0.34 × 7% = 11.302%. Difficulty: 2 Medium Topic: Weighted average cost of capital Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-02 Use the weighted-average cost of capital (WACC) formula to calculate a project's cost of capital.

46) JAK Industries has 5 million shares of stock outstanding selling at $25 per share and an issue of $40 million in 8 percent, annual coupon bonds with a maturity of 15 years, selling at 108 percent of par ($1,000). If JAK's weighted average tax rate is 21 percent and its cost of equity is 15 percent, what is JAK's WACC? A) 9.19 percent B) 12.59 percent C) 12.50 percent D) 12.77 percent Answer: B Explanation: To calculate market interest rate of Bonds: N=15, I=?, FV= 40,000,000, PMT= 40,000,000 × 0.08, PV= −(40,000,000 × 1.08)... Solve for I = 7.12 To calculate weights: Calculate total value of stocks and bonds = (5,000,000 × 25) + (0) + (108% × 40,000,000) = 168,200,000 Common Stock: (5,000,000 × $25)/168,200,000 = 0.7432 Preferred Stock: $0 = 0 Bonds: (40,000,000 × 1.08)/168,200,000 = 0.2568 To calculate WACC: 0.7432 × 15% + 0.0 × 0% + 0.2568 × 7.12% × (1 − 0.21) = 12.59245% Difficulty: 2 Medium Topic: Weighted average cost of capital Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-03 Explain how the firm chooses among estimating costs of equity, preferred stock, and debt.

47) FDR Industries has 50 million shares of stock outstanding selling at $30 per share and an issue of $200 million in 9.5 percent, annual coupon bonds with a maturity of 10 years, selling at 97 percent of par ($1,000). If FDR's weighted average tax rate is 21 percent and its cost of equity is 16 percent, what is FDR's WACC? A) 12.75 percent B) 15.07 percent C) 14.88 percent D) 15.11 percent Answer: B Explanation: To calculate market interest rate of Bonds: N=10, I=?, FV= 200,000,000, PMT= 200,000,000 × 0.095, PV= −(200,000,000 × 0.97)…. Solve for I = 9.99 To calculate weights: Calculate total value of stocks and bonds = (50,000,000 × 30) + (0) + (97% × 200,000,000) = 1,694,000,000 Common Stock: (50,000,000 × $30)/1,694,000,000 = 0.8855 Preferred Stock: $0 = 0 Bonds: (200,000,000 × 0.97)/1,694,000,000 = 0.1145 To calculate WACC: 0.8855 × 16% + 0.0 × 0% + 0.1145 × 9.99% × (1 − 0.21) = 15.07165% Difficulty: 2 Medium Topic: Weighted average cost of capital Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-03 Explain how the firm chooses among estimating costs of equity, preferred stock, and debt.

48) XYZ Industries has 10 million shares of stock outstanding selling at $10 per share with par of $1 per share. The company also has an issue of $30 million in 8.5 percent, annual coupon bonds with a maturity of 25 years, selling at 102 percent of par ($1,000). If XYZ's weighted average tax rate is 21 percent and its cost of equity is 15 percent, what is XYZ's WACC? A) 8.06 percent B) 11.75 percent C) 13.02 percent D) 13.43 percent Answer: C Explanation: To calculate market interest rate of Bonds: N=25, I=?, FV= 30,000,000, PMT= 30,000,000 × 0.085, PV= −(30,000,000 × 1.02)…. Solve for I = 8.31 To calculate weights: Calculate total value of stocks and bonds = (10,000,000 × 10) + (0) + (102% × 30,000,000) = 130,600,000 Common Stock: (10,000,000 × $10)/130,600,000 = 0.7657 Preferred Stock: $0 = 0. Bonds: (30,000,000 × 1.02)/130,600,000 = 0.2343 To calculate WACC: 0.7657 × 15% + 0.0 × 0% + 0.2343 × 8.31% × (1 − 0.21) = 13.02% Difficulty: 2 Medium Topic: Weighted average cost of capital Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-03 Explain how the firm chooses among estimating costs of equity, preferred stock, and debt.

49) Cup Cake Ltd. has 20 million shares of stock outstanding selling at $25 per share and an issue of $30 million in 8 percent, annual coupon bonds with a maturity of 16 years, selling at 98 percent of par ($1,000). If Cup Cake's weighted average tax rate is 21 percent, its next dividend is expected to be $2.00 per share, and all future dividends are expected to grow at 4 percent per year, indefinitely, what is its WACC? A) 7.94 percent B) 10.00 percent C) 11.69 percent D) 11.79 percent Answer: C Explanation: To calculate market interest rate of Bonds: N=16, I=?, FV= 30,000,000, PMT= 30,000,000 × 0.08, PV= −(30,000,000 × 0.98)…. Solve for I = 8.23 To calculate Rs: Rs = ($2/$25) + 4% = 12% To calculate weights: Calculate total value of stocks and bds = (20,000,000 × 25) + (0) + (98% × 30,000,000) = 529,400,000 Common Stock: (20,000,000 × $25)/529,400,000 = 0.9445 Preferred Stock: $0 = 0 Bonds: (30,000,000 × 0.98)/529,400,000 = 0.0555 To calculate WACC: 0.9445 × 12% + 0.0 × 0% + 0.0555 × 8.23% × (1 − 0.21) = 11.69484% Difficulty: 2 Medium Topic: Weighted average cost of capital Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-03 Explain how the firm chooses among estimating costs of equity, preferred stock, and debt.

50) Crab Cakes Ltd. has 5 million shares of stock outstanding selling at $15 per share and par value $1 per share. The company has an issue of $10 million in 10 percent, annual coupon bonds with a maturity of 25 years, selling at 97 percent of par ($1,000). If Crab Cakes' weighted average tax rate is 21 percent, its next dividend is expected to be $1.00 per share, and all future dividends are expected to grow at 5 percent per year, indefinitely, what is its WACC? A) 8.42 percent B) 10.84 percent C) 11.27 percent D) 11.52 percent Answer: C Explanation: To calculate market interest rate of Bonds: N=25, I=?, FV= 10,000,000, PMT= 10,000,000 × 0.10, PV= −(10,000,000 × 0.97)…. Solve for I = 10.34 To calculate Rs: Rs = ($1/$15) + 5% = 11.67% To calculate weights: Calculate total value of stocks and bds = (5,000,000 × 15) + (0) + (97% × 10,000,000) = 84,700,000 Common Stock: (5,000,000 × $15)/84,700,000 = 0.8855 Preferred Stock: $0 = 0 Bonds: (10,000,000 × 0.97)/84,700,000 = 0.1145 To calculate WACC: 0.8855 × 11.67% + 0.0 × 0% + 0.1145 × 10.34% × (1 − 0.21) = 11.26909% Difficulty: 2 Medium Topic: Weighted average cost of capital Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-03 Explain how the firm chooses among estimating costs of equity, preferred stock, and debt.

51) Pumpkin Pie Industries has 5 million shares of common stock outstanding, 1 million shares of preferred stock outstanding, and 10 thousand bonds. If the common shares are selling for $50 per share, the preferred shares are selling for $31 per share, and the bonds are selling for 98 percent of par ($1,000), what would be the weights used in the calculation of Pumpkin Pie's WACC for common stock, preferred stock, and bonds, respectively? A) 33.33 percent, 33.33 percent, 33.33 percent B) 83.19 percent, 16.64 percent, 0.17 percent C) 85.97 percent, 10.67 percent, 3.38 percent D) 27.93 percent, 17.32 percent, 54.75 percent Answer: C Explanation: Total Value = (5,000,000 × 50) + (1,000,000 × 31) + (10,000 × 0.98 × 1,000) = 290,800,000 Common Stock: (5,000,000 × $50 )/290,800,000 = 0.8597 Preferred Stock: (1,000,000 × $31 )/290,800,000 = 0.1067 Bonds: (10,000 × 0.98 × 1,000) /290,800,000 = 0.0338 Difficulty: 2 Medium Topic: Capital structure weights Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-04 Calculate the weights used for WACC projections.

52) Sea Shell Industries has 50 million shares of common stock outstanding, 10 million shares of preferred stock outstanding, and 100 thousand bonds. If the common shares are selling for $19 per share, the preferred shares are selling for $8.50 per share, and the bonds are selling for 97 percent of par ($1,000), what would be the weights used in the calculation of Sea Shell's WACC for common stock, preferred stock, and bonds, respectively? A) 33.33 percent, 33.33 percent, 33.33 percent B) 83.19 percent, 16.64 percent, 0.17 percent C) 15.26 percent, 6.83 percent, 77.91 percent D) 83.92 percent, 7.51 percent, 8.57 percent Answer: D Explanation: Common Stock: 50,000,000 × $19 = $950,000,000, so 950,000,000/1,132,000,000 = 0.8392. Preferred Stock: $10,000,000 × 8.50 = 85,000,000, so 85,000,000/1,132,000,000 = 0.0751. Bonds: 100,000 × 0.97 × 1,000 = $97,000,000, so 97,000,000/1,132,000,000 = 0.0857. Total = $1,132,000,000 Difficulty: 2 Medium Topic: Capital structure weights Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-04 Calculate the weights used for WACC projections.

53) Rings N Things Industries has 40 million shares of common stock outstanding, 20 million shares of preferred stock outstanding, and 50 thousand bonds. If the common shares are selling for $25 per share, the preferred shares are selling for $15 per share, and the bonds are selling for 100 percent of par ($1,000), what would be the weights used in the calculation of Rings' WACC for common stock, preferred stock, and bonds, respectively? A) 33.33 percent, 33.33 percent, 33.33 percent B) 74.07 percent, 22.22 percent, 3.71 percent C) 66.61 percent, 33.31 percent, 0.08 percent D) 17.86 percent, 10.71 percent, 71.43 percent Answer: B Explanation: Common Stock: 40,000,000 × $25 = $1,000,000,000, so 1,000,000,000/1,350,000,000 = 0.7407. Preferred Stock: $20,000,000 × 15 = 300,000,000, so 300,000,000/1,350,000,000 = 0.2222. Bonds: 50,000 × 1.00 × 1,000 = $50,000,000, so 50,000,000/1,350,000,000 = 0.0371. Total = $1,350,000,000 Difficulty: 2 Medium Topic: Capital structure weights Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-04 Calculate the weights used for WACC projections.

54) Accessory Industries has 2 million shares of common stock outstanding, 1 million shares of preferred stock outstanding, and 100 thousand bonds. If the common shares are selling for $22 per share, the preferred shares are selling for $10.50 per share, and the bonds are selling for 96 percent of par ($1,000), what would be the weights used in the calculation of Accessory's WACC for common stock, preferred stock, and bonds, respectively? A) 33.33 percent, 33.33 percent, 33.33 percent B) 29.23 percent, 6.98 percent, 63.79 percent C) 64.52 percent, 32.26 percent, 3.22 percent D) 17.12 percent, 8.17 percent, 74.71 percent Answer: B Explanation: Common Stock: 2,000,000 × $22 = $44,000,000, so 44,000,000/150,500,000 = 0.2923. Preferred Stock: $1,000,000 × 10.50 = 10,500,000, so 10,500,000/150,500,000 = 0.0698. Bonds: 100,000 × 0.96 × 1,000 = $96,000,000, so 96,000,000/150,500,000 = 0.6379. Total = $150,500,000. Difficulty: 2 Medium Topic: Capital structure weights Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-04 Calculate the weights used for WACC projections. 55) Suppose that Tan Lines' common shares sell for $20 per share, are expected to set their next annual dividend at $1.00 per share, and that all future dividends are expected to grow by 5 percent per year, indefinitely. If Tan Lines faces a flotation cost of 10 percent on new equity issues, what will be the flotation-adjusted cost of equity? A) 5.06 percent B) 5.50 percent C) 10.00 percent D) 10.56 percent Answer: D Explanation: $1/[$20 − (0.10 × $20)] + 0.05 = ($1/$18) + 0.05 = 0.1055556 = 10.56%. Difficulty: 2 Medium Topic: Flotation costs Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-08 Demonstrate how to adjust the WACC to reflect flotation costs.

56) Suppose that Wave Runners' common shares sell for $35 per share, are expected to set their next annual dividend at $2.00 per share, and that all future dividends are expected to grow by 10 percent per year, indefinitely. If Wave faces a flotation cost of 15 percent on new equity issues, what will be the flotation-adjusted cost of equity? A) 6.73 percent B) 10.07 percent C) 15.71 percent D) 16.72 percent Answer: D Explanation: $2/[$35 − (0.15 × $35)] + 0.10 = ($2/$29.75) + 0.10 = 0.1672 = 16.72%. Difficulty: 2 Medium Topic: Flotation costs Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-08 Demonstrate how to adjust the WACC to reflect flotation costs. 57) Suppose that Beach Blanket's common shares sell for $55 per share, are expected to set their next annual dividend at $3.00 per share, and that all future dividends are expected to grow by 8 percent per year, indefinitely. If Beach faces a flotation cost of 10 percent on new equity issues, what will be the flotation-adjusted cost of equity? A) 5.45 percent B) 8.06 percent C) 13.45 percent D) 14.06 percent Answer: D Explanation: $3/[$55 − (0.10 × $55)] + 0.08 = ($3/$49.50) + 0.08 = 0.1406 = 14.06%. Difficulty: 2 Medium Topic: Flotation costs Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-08 Demonstrate how to adjust the WACC to reflect flotation costs.

58) Suppose that Tan Lotion's common shares sell for $18 per share, are expected to set their next annual dividend at $1.00 per share, and that all future dividends are expected to grow by 7 percent per year, indefinitely. If Tan Lotion faces a flotation cost of 12 percent on new equity issues, what will be the flotation-adjusted cost of equity? A) 6.37 percent B) 7.06 percent C) 12.56 percent D) 13.31 percent Answer: D Explanation: $1/[$18 − (0.12 × $18)] + 0.07 = ($1/$15.84) + 0.07 = 0.1331 = 13.31%. Difficulty: 2 Medium Topic: Flotation costs Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-08 Demonstrate how to adjust the WACC to reflect flotation costs.

34) A firm has 1,000,000 shares of common stock outstanding, each with a market price of $10.00 per share. It has 15,000 bonds outstanding, each selling for $900 (with a face value of $1,000). The bonds mature in 15 years, have a coupon rate of 10 percent, and pay coupons annually. The firm's equity has a beta of 1.5, and the expected market return is 20 percent. The tax rate is 21 percent and the WACC is 16 percent. What is the risk-free rate? A) 9.16 percent B) 11.4 percent C) 4.8 percent D) 16.0 percent Answer: A Explanation: To calculate market interest rate of Bonds: N=15, I=?, FV= 15,000,000, PMT= 15,000,000 × 0.10, PV= −(15,000,000 × 0.90)…. Solve for I = 11.42 To calculate weights: Total Value = (1,000,000 × 10) + (15,000 × 900) = 23,500,000 Common Stock: (1,000,000 × $10)/23,500,000 = 0.4255 Preferred Stock: 0 Bonds: (15,000 × 900) /23,500,000 = 0.5745 To calculate Rs: 16% = (0.4255 × Rs ) + (0.5745 × 11.42% × (1 − 0.21)) solve for Rs = 0.2542 Now calculate risk free: 25.42 = Rf + (20 − Rf) 1.5 => 25.42 = Rf + 30 − 1.5Rf => −4.58 = −.5Rf Rf = 9.16% Difficulty: 3 Hard Topic: Weighted average cost of capital Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-02 Use the weighted-average cost of capital (WACC) formula to calculate a project's cost of capital.

35) A firm has 4,000,000 shares of common stock outstanding, each with a market price of $12.00 per share. It has 25,000 bonds outstanding, each selling for $980 (with a face value of $1,000). The bonds mature in 20 years, have a coupon rate of 9 percent, and pay coupons semiannually. The firm's equity has a beta of 1.5, and the expected market return is 21 percent. The tax rate is 21 percent and the WACC is 15 percent. What is the risk-free rate? A) 7.12 percent B) 6.28 percent C) 9.22 percent D) 19.36 percent Answer: A Explanation: To calculate market interest rate of Bonds: N=40, I=?, FV= 25,000,000, PMT= 25,000,000 × 0.09/2, PV= −(25,000,000 × 0.98)…. Solve for I = 4.61 × 2 = 9.22 To calculate weights: Total Value = (4,000,000 × 12) + (25,000 × 980) = 72,500,000 Common Stock: (4,000,000 × $12)/72,500,000 = 0.6621 Preferred Stock: 0 Bonds: (25,000 × 980 )/72,500,000 = 0.3379 To calculate Rs: 15% = (0.6621 × Rs) + (0.3379 × 9.22 × (1 − 0.21)) => Rs = 18.94% Now calculate risk free: 18.94 = Rf + (15 − Rf) 1.5 => 18.94 = Rf + 22.5 − 1.5Rf => −3.56 = −0.5 Rf => Rf = 7.12% Difficulty: 3 Hard Topic: Weighted average cost of capital Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-02 Use the weighted-average cost of capital (WACC) formula to calculate a project's cost of capital.

61) An all-equity firm is considering the projects shown as follows. The T-bill rate is 3 percent and the market risk premium is 6 percent. If the firm uses its current WACC of 12 percent to evaluate these projects, which project(s) will be incorrectly rejected?

Project A B C D

Expected Return 10.0% 17.0% 12.5% 15.0%

Beta 0.9 1.1 1.4 2.2

A) Project A B) Projects B and C C) Project D D) Project B Answer: A Explanation: Using WACC accept B, C, D Project A: 3 + 6 (0.9) = 8.4 percent, accept Project B: 3 + 6 (1.1) = 9.6 percent, accept Project C: 3 + 6 (1.4) = 11.4 percent, accept Project D: 3 + 6 (2.2) = 16.2% percent, reject. Difficulty: 3 Hard Topic: Divisional and project costs of capital Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-06 Evaluate trade-offs between a firmwide WACC and a divisional cost of capital approach.

37) An all-equity firm is considering the projects shown as follows. Project A B C D

Expected Return 9.0% 20.0% 15.0% 18.0%

Beta 0.7 1.1 1.5 1.9

The T-bill rate is 4 percent and the market risk premium is 8 percent. If the firm uses its current WACC of 13 percent to evaluate these projects, which project(s) will be incorrectly accepted? A) Project A B) Project C C) Project D D) Projects C and D Answer: D Explanation: Using WACC accept B, C, D Project A: 4 + 8 (0.7) = 9.6 percent, reject Project B: 4 + 8 (1.1) = 12.8 percent, accept Project C: 4 + 8 (1.5) = 16 percent, reject Project D: 4 + 8 (1.9) = 19.2 percent, reject. Difficulty: 3 Hard Topic: Divisional and project costs of capital Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-06 Evaluate trade-offs between a firmwide WACC and a divisional cost of capital approach.

38) An all-equity firm is considering the projects shown as follows. Project A B C D

Expected Return 7.0% 17.0% 12.0% 10.0%

Beta 0.25 1.3 1.6 2.1

The T-bill rate is 4 percent and the market risk premium is 9 percent. If the firm uses its current WACC of 14 percent to evaluate these projects, which project(s) will be incorrectly rejected? A) Project A B) Project B C) Project C D) Project D Answer: A Explanation: Using WACC accept B Project A: 4 + 9 (0.25) = 6.25 percent, accept Project B: 4 + 9 (1.3) = 15.7 percent, accept Project C: 4 + 9 (1.6) = 18.4 percent, reject Project D: 4 + 9 (2.1) = 22.9 percent, reject. Difficulty: 3 Hard Topic: Divisional and project costs of capital Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-06 Evaluate trade-offs between a firmwide WACC and a divisional cost of capital approach.

64) Diddy Corp. stock has a beta of 1.0, the current risk-free rate is 5 percent, and the expected return on the market is 15.5 percent. What is Diddy's cost of equity? A) 15.50 percent B) 14.20 percent C) 18.50 percent D) 16.30 percent Answer: A Explanation: 5 + 1(15.5 − 5) = 15.50. Difficulty: 1 Easy Topic: Cost of equity Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-03 Explain how the firm chooses among estimating costs of equity, preferred stock, and debt. 65) JaiLai Cos. stock has a beta of 1.7, the current risk-free rate is 6.2 percent, and the expected return on the market is 11 percent. What is JaiLai's cost of equity? A) 13.81 percent B) 15.19 percent C) 13.41 percent D) 14.36 percent Answer: D Explanation: 6.2 + 1.7(11 − 6.2) = 14.36. Difficulty: 1 Easy Topic: Cost of equity Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-03 Explain how the firm chooses among estimating costs of equity, preferred stock, and debt.

66) Oberon Inc. has a $20 million ($1,000 face value) 10-year bond issue selling for 99 percent of par that pays an annual coupon of 7.25 percent. What would be Oberon's before-tax component cost of debt? A) 6.12 percent B) 7.02 percent C) 7.40 percent D) 8.15 percent Answer: C Explanation: PV = −990; FV = 1000; PMT = 72.50; N = 10; I = 7.40 percent Difficulty: 1 Easy Topic: Cost of debt Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-03 Explain how the firm chooses among estimating costs of equity, preferred stock, and debt. 67) KatyDid Clothes has a $150 million ($1,000 face value) 15-year bond issue selling for 106 percent of par that carries a coupon rate of 8 percent, paid semiannually. What would be KatyDid's before-tax component cost of debt? A) 3.67 percent B) 7.34 percent C) 8.12 percent D) 7.09 percent Answer: B Explanation: PV = −1060; FV = 1000; N = 30; PMT = 40; I = 3.67; 3.67 × 2 = 7.34 percent Difficulty: 1 Easy Topic: Cost of debt Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-03 Explain how the firm chooses among estimating costs of equity, preferred stock, and debt.

68) KatyDid Clothes has a $150 million ($1,000 face value) 15-year bond issue selling for 86 percent of par that carries a coupon rate of 8 percent, paid semiannually. What would be KatyDid's before-tax component cost of debt? A) 4.90 percent B) 8.13 percent C) 9.80 percent D) 7.09 percent Answer: C Explanation: PV= −860; FV = 1000; N = 30; PMT= 40; I = 4.9; 4.9 × 2 = 9.80 percent Difficulty: 1 Easy Topic: Cost of debt Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-03 Explain how the firm chooses among estimating costs of equity, preferred stock, and debt. 69) Marme Inc. has preferred stock selling for 137 percent of par that pays an 11 percent annual dividend. What would be Marme's component cost of preferred stock? A) 11.00 percent B) 8.03 percent C) 8.17 percent D) 10.16 percent Answer: B Explanation: 11/137 = 8.03 percent. Difficulty: 1 Easy Topic: Cost of preferred stock Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-03 Explain how the firm chooses among estimating costs of equity, preferred stock, and debt.

70) FarCry Industries, a maker of telecommunications equipment, has 6 million shares of common stock outstanding, 1 million shares of preferred stock outstanding, and 10 thousand bonds. If the common shares are selling for $27 per share, the preferred shares are selling for $15 per share, and the bonds are selling for 119 percent of par ($1,000), what weight should you use for debt in the computation of FarCry's WACC? A) 4.93 percent B) 5.07 percent C) 5.81 percent D) 6.30 percent Answer: D Explanation: 1,190 × 0.01/[1190 × 0.01 + 6 × 27 + 1 × 15] = 6.30 percent. Difficulty: 1 Easy Topic: Capital structure weights Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-04 Calculate the weights used for WACC projections. 71) OMG Inc. has 4 million shares of common stock outstanding, 3 million shares of preferred stock outstanding, and 50 thousand bonds. If the common shares are selling for $21 per share, the preferred shares are selling for $10 per share, and the bonds are selling for 111 percent of par ($1,000), what weight should you use for debt in the computation of OMG's WACC? A) 32.74 percent B) 29.86 percent C) 25.79 percent D) 21.86 percent Answer: A Explanation: 1,110 × 0.05/[1,110 × 0.05 + 3 × 10 + 4 × 21] = 32.74 percent. Difficulty: 1 Easy Topic: Capital structure weights Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-04 Calculate the weights used for WACC projections.

72) FarCry Industries, a maker of telecommunications equipment, has 26 million shares of common stock outstanding, 1 million shares of preferred stock outstanding, and 10 thousand bonds. If the common shares sell for $12 per share, the preferred shares sell for $114.50 per share, and the bonds sell for 98 percent of par ($1,000), what weight should you use for preferred stock in the computation of FarCry's WACC? A) 28.52 percent B) 27.51 percent C) 26.24 percent D) 25.01 percent Answer: C Explanation: 114.5 × 1/[26 × 12 + 114.5 × 1 + 980 × 0.01] = 26.24 percent. Difficulty: 1 Easy Topic: Capital structure weights Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-04 Calculate the weights used for WACC projections. 73) FarCry Industries, a maker of telecommunications equipment, has 26 million shares of common stock outstanding, 1 million shares of preferred stock outstanding, and 10 thousand bonds. If the common shares sell for $15 per share, the preferred shares sell for $114.50 per share, and the bonds sell for 101 percent of par ($1,000), what weight should you use for preferred stock in the computation of FarCry's WACC? A) 28.52 percent B) 27.51 percent C) 26.24 percent D) 22.25 percent Answer: D Explanation: 114.5 × 1/[26 × 15 + 114.5 × 1 + 1,010 × 0.01] = 22.25 percent. Difficulty: 1 Easy Topic: Capital structure weights Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-04 Calculate the weights used for WACC projections.

74) OMG Inc. has 4 million shares of common stock outstanding, 3 million shares of preferred stock outstanding, and 5 thousand bonds. If the common shares sell for $17 per share, the preferred shares sell for $126 per share, and the bonds sell for 117 percent of par ($1,000), what weight should you use for preferred stock in the computation of OMG's WACC? A) 28.91 percent B) 31.58 percent C) 47.91 percent D) 83.66 percent Answer: D Explanation: 126 × 3/[3 × 126 + 1,170 × 0.005 + 4 × 17] = 83.66 percent. Difficulty: 1 Easy Topic: Capital structure weights Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-04 Calculate the weights used for WACC projections. 75) JLP Industries has 6.5 million shares of common stock outstanding with a market price of $20.00 per share. The company also has outstanding preferred stock with a market value of $10 million, and 25,000 bonds outstanding, each with face value $1,000 and selling at 90 percent of par value. The cost of equity is 14 percent, the cost of preferred stock is 10 percent, and the yield of the debt is 6.25%. If JLP's tax rate is 34 percent, what is the WACC? A) 12.39 percent B) 12.98 percent C) 13.13 percent D) 13.72 percent Answer: A Explanation: 0.0625 × (1 − 0.34)[(25,000 × 900)/[25,000 × 900 + 10,000,000 + 6,500,000 × 20]] + 0.14 × [(6,500,000 × 20)/[25,000 × 900 + 10,000,000 + 6,500,000 × 20]] + 0.1 × [[10,000,000]/[25,000 × 900 + 10,000,000 + 6,500,000 × 20]] = 12.39%. Difficulty: 2 Medium Topic: Weighted average cost of capital Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-02 Use the weighted-average cost of capital (WACC) formula to calculate a project's cost of capital.

76) TAFKAP Industries has 8 million shares of stock outstanding selling at $17 per share and an issue of $20 million in 7.5 percent, annual coupon bonds with a maturity of 15 years, selling at 109 percent of par ($1,000). If TAFKAP's weighted average tax rate is 21% and its cost of equity is 12.5 percent, what is TAFKAP's WACC? A) 11.02 percent B) 11.49 percent C) 12.16 percent D) 12.83 percent Answer: B Explanation: Step 1: Cost of debt => PV = −1090; PMT = 75; FV = 1000; N = 15; => I = 6.54. Step 2: To calculate weights: Total Value = (8,000,000 × 17) + (20,000,000 × 1.09) = 157,800,000 Step 3: Common Stock: (8,000,000 × $17)/157,800,000 = 0.8619 Preferred Stock: 0 Bonds: (20,000,000 × 1.09)/157,800,000 = 0.1381 WACC = (0.8619 × 0.125) + (0.1381 × 0.0654 × [1 − 0.21]) = 11.49% Difficulty: 2 Medium Topic: Weighted average cost of capital Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-02 Use the weighted-average cost of capital (WACC) formula to calculate a project's cost of capital.

77) Johnny Cake Ltd. has 10 million shares of stock outstanding selling at $20 per share and an issue of $50 million in 5.12 percent, annual coupon bonds with a maturity of 13 years, selling at 93.5 percent of par ($1,000). If Johnny Cake's weighted average tax rate is 21 percent, its next dividend is expected to be $2.00 per share, and all future dividends are expected to grow at 5 percent per year, indefinitely, what is its WACC? A) 12.64 percent B) 13.27 percent C) 13.03 percent D) 14.06 percent Answer: C Explanation: Step 1: cost of debt => PV = −935; PMT = 51.2; FV = 1000; N = 13; => solve for I: I = 5.85% Step 2: cost of equity => (2/20) + 0.05 = 15% Step 3: To calculate weights: Total Value = (10,000,000 × 20) + (50,000,000 × 0.935) = 246,750,000 Common Stock: (10,000,000 × $20)/246,750,000 = 0.8105 Preferred Stock: 0 Bonds: (50,000,000 × 0.935)/246,750,000 = 0.1895 WACC = (0.8105 × 0.15) + (0.1895 × 0.0585 × [1 − 0.21]) = 13.03% Difficulty: 2 Medium Topic: Weighted average cost of capital Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-03 Explain how the firm chooses among estimating costs of equity, preferred stock, and debt.

78) A firm has 5,000,000 shares of common stock outstanding, each with a market price of $8.00 per share. It has 25,000 bonds outstanding, each selling for $1,100 with a $1,000 face value. The bonds mature in 12 years, have a coupon rate of 9 percent, and pay coupons semiannually. The firm's equity has a beta of 1.4, and the expected market return is 15 percent. The tax rate is 21 percent and the WACC is 14 percent. Calculate the risk-free rate. A) 3.90 percent B) 15.27 percent C) 20.18 percent D) 1.19 percent Answer: A Explanation: Step 1: Cost of debt: PV = −1100; PMT = 1000 × 0.09/2 =45; N = 12 × 2=24; FV = 1000; solve for I : I = 3.85%; Cost of debt = 3.85% × 2 = 7.71%; Step 2: To calculate weights: Total Value = (5,000,000 × 8) + (25,000,000 × 110%) = 67,500,000 Common Stock: (5,000,000 × $8)/67,500,000 = 0.5926 Preferred Stock: 0 Bonds: (25,000,000 × 1.10)/67,500,000 = 0.4074 Step 3: Use WACC to solve for cost of equity: 14% = (0.5926 × x) + (0.4074 × 0.0771 × (1 − 0.21)) => 0.1152 = 0.5926x => cost of equity or x = 19.44%; Step 4: 19.44% = Risk-free rate + 1.4(15% − Risk-free rate) => Risk-free rate = 3.9% Difficulty: 3 Hard Topic: Weighted average cost of capital Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-02 Use the weighted-average cost of capital (WACC) formula to calculate a project's cost of capital.

79) A firm has 5,000,000 shares of common stock outstanding, each with a market price of $10.00 per share. It has 55,000 bonds outstanding, each selling for $990 with a $1,000 face value. The bonds mature in 15 years, have a coupon rate of 8 percent, and pay coupons semiannually. The firm's equity has a beta of 2.0, and the expected market return is 15 percent. The tax rate is 21 percent and the WACC is 16 percent. Calculate the risk-free rate. A) 27.68 percent B) 1.79 percent C) 3.56 percent D) 2.12 percent Answer: C Explanation: Step 1: Cost of debt: PV = −990; PMT = (0.08/2 × 1000) = 40; N = 15 × 2 = 30; FV = 1000; solve for I: I = 4.06%; Cost of debt = 4.06% × 2 = 8.12%; Step 2: To calculate weights: Total Value = (5,000,000 × 10) + (55,000,000 × 99%) = 104,450,000 Common Stock: (5,000,000 × $10)/104,450,000 = 0.4787 Preferred Stock: 0 Bonds: (55,000,000 × 0.99)/104,450,000 = 0.5213 Step 3: Use WACC to solve for cost of equity: 16% = 0.4787 × (cost of equity) + (.5213 × (8.12%) × (1 − 0.21) => cost of equity = 26.44%; Step 4: 26.44% = Risk-free rate + 2.0 (15% − Risk free rate) => Risk-free rate = 3.56% Difficulty: 3 Hard Topic: Weighted average cost of capital Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-02 Use the weighted-average cost of capital (WACC) formula to calculate a project's cost of capital.

49) An all-equity firm is considering the projects shown as follows. The T-bill rate is 3 percent and the market risk premium is 6 percent. If the firm uses its current WACC of 12 percent to evaluate these projects, which project(s), if any, will be incorrectly rejected?

Project A B C D

Expected Return 9.0% 20.0% 13.0% 17.0%

Beta 0.8 1.2 1.4 1.5

A) Only Project A would be incorrectly rejected. B) Both Projects A and C would be incorrectly rejected. C) Projects A, B, and C would be incorrectly rejected. D) None of the projects would be incorrectly rejected. Answer: A Explanation: Step 1: Find Project Required Returns using CAPM. Project A: 7.8 percent; Project B: 10.2 percent; Project C: 11.4 percent; Project D: 12 percent; only Project A would be incorrectly rejected since its required return is only 7.8 percent given its risk and it is expected to return 9 percent. Difficulty: 3 Hard Topic: Divisional and project costs of capital Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-06 Evaluate trade-offs between a firmwide WACC and a divisional cost of capital approach.

81) An all-equity firm is considering the projects shown as follows. The T-bill rate is 4 percent and the market risk premium is 7 percent. If the firm uses its current WACC of 12 percent to evaluate these projects, which project(s), if any, will be incorrectly accepted or rejected?

Project A B C D

Expected Return 9.0% 20.0% 13.0% 17.0%

Beta 0.6 1.2 1.4 1.5

A) Project A would be incorrectly rejected. B) Both Projects A and C would be incorrectly rejected. C) Project A will be incorrectly rejected and Project C would be incorrectly accepted. D) None of the projects will be incorrectly accepted or rejected. Answer: C Explanation: Step 1: Find Project Required Returns using CAPM. Project A: 8.2 percent; Project B: 12.4 percent; Project C: 13.8 percent; Project D: 14.5 percent; Project A would be incorrectly rejected since its required return is only 8.2 percent given its risk and it is expected to return 9 percent. Project C would be incorrectly accepted since it should earn 13.8 percent given its risk. Difficulty: 3 Hard Topic: Divisional and project costs of capital Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-06 Evaluate trade-offs between a firmwide WACC and a divisional cost of capital approach.

51) Suppose your firm has decided to use a divisional WACC approach to analyze projects. The firm currently has four divisions, A through D, with average betas for each division of 0.5, 1.0, 1.3 and 1.6, respectively. If all current and future projects will be financed with half debt and half equity, and if the current cost of equity (based on an average firm beta of 1.0 and a current risk-free rate of 7 percent) is 14 percent and the after-tax yield on the company's bonds is 8 percent, what are the WACCs for divisions A through D? A) 9.00 percent; 10.25 percent; 12.95 percent; 13.15 percent B) 9.75 percent; 12.00 percent; 12.65 percent; 13.75 percent C) 9.25 percent; 11.00 percent; 12.05 percent; 13.10 percent D) 8.95 percent; 10.15 percent; 12.50 percent; 13.45 percent Answer: C Explanation: Step 1: Find the market risk premium. 14% = 7% + 1.0(MRP); => MRP = 7%. Step 2: Find the cost of equity for each division using CAPM; A: 7 + 0.5 × 7 = 10.5%; B: 14%; C: 16.1%; D: 18.2%. Step 3: Find the WAACs for each division; A: 0.5(10.5%) + 0.5(8%) = 9.25%; B: 11%; C: 12.05%; D: 13.1%. Difficulty: 3 Hard Topic: Divisional and project costs of capital Bloom's: Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-02 Use the weighted-average cost of capital (WACC) formula to calculate a project's cost of capital.

52) Suppose your firm has decided to use a divisional WACC approach to analyze projects. The firm currently has 2 divisions, A and B, with betas for each division of 0.5 and 1.5, respectively. If all current and future projects will be financed with half debt and half equity, and if the current cost of equity (based on an average firm beta of 1.0 and a current risk-free rate of 5 percent) is 14 percent and the after-tax yield on the company's bonds is 6 percent, what are the WACCs for divisions A and B? A) 7.75 percent; 12.25 percent B) 8.75 percent; 12.00 percent C) 9.25 percent; 11.00 percent D) 8.95 percent; 10.15 percent Answer: A Explanation: Step 1: Find the market risk premium. 14% = 5% + 1.0(MRP); => MRP = 9%. Step 2: Find the cost of equity for each division using CAPM; A: 5 + 0.5 × 9 = 9.5%; B: 18.5. Step 3: Find the WAACs for each division; A: 0.5(9.5%) + 0.5(6%) = 7.75%; B: 12.25%. Difficulty: 3 Hard Topic: Divisional and project costs of capital Bloom's: Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-02 Use the weighted-average cost of capital (WACC) formula to calculate a project's cost of capital. 84) Which of the following statements is correct? A) The weighted average cost of capital is calculated on a before-tax basis. B) An increase in the market risk premium is likely to increase the weighted average cost of capital. C) The weights of debt and equity should be based on the balance sheet because this is the most accurate assessment of the valuation. D) All of these choices are correct. Answer: B Difficulty: 1 Easy Topic: Weighted average cost of capital Bloom's: Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-02 Use the weighted-average cost of capital (WACC) formula to calculate a project's cost of capital.

85) Which of the following statements is correct? A) If the risk-free rate increases, it will have no impact on the weighted average cost of capital. B) Investor returns are reduced when float costs increase, and therefore float costs reduce the weighted average cost of capital. C) The weighted average cost of capital is a historical cost. D) None of these choices are correct. Answer: D Difficulty: 2 Medium Topic: Weighted average cost of capital Bloom's: Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-02 Use the weighted-average cost of capital (WACC) formula to calculate a project's cost of capital. 86) Which of the following will impact the cost of equity component in the weighted average cost of capital? A) the risk-free rate B) beta C) expected return on the market D) all of these choices are correct. Answer: D Difficulty: 1 Easy Topic: Cost of equity Bloom's: Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-02 Use the weighted-average cost of capital (WACC) formula to calculate a project's cost of capital.

87) ADK Industries common shares sell for $40 per share. ADK expects to set their next annual dividend at $1.75 per share. If ADK expects future dividends to grow at 7 percent per year, indefinitely, the current risk-free rate is 4 percent, the expected rate on the market is 11 percent, and the stock has a beta of 1.2, what should be the best estimate of the firm's cost of equity, by taking an average of the 2 estimates? A) 11.89 percent B) 11.38 percent C) 12.40 percent D) 12.71 percent Answer: A Explanation: Step 1: Find the cost of equity using constant-growth formula: 1.75/40 + 0.07 = 11.38 percent. Step 2: Find the cost of equity using CAPM: 4 + 1.2(11 − 4) = 12.4 percent. Step 3: Find the average of the two estimates: 11.89 percent. Difficulty: 2 Medium Topic: Cost of equity Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-02 Use the weighted-average cost of capital (WACC) formula to calculate a project's cost of capital. 88) ADK Industries common shares sell for $60 per share. ADK expects to set their next annual dividend at $3.75 per share. If ADK expects future dividends to grow at 9 percent per year, indefinitely, the current risk-free rate is 4 percent, the expected rate on the market is 11 percent, and the stock has a beta of 1.5, what should be the best estimate of the firm's cost of equity, by taking an average of the 2 estimates? A) 15.25 percent B) 14.50 percent C) 14.88 percent D) 15.03 percent Answer: C Explanation: Step 1: Find the cost of equity using constant-growth formula: 3.75/60 + 0.09 = 15.25 percent. Step 2: Find the cost of equity using CAPM: 4 + 1.5(11 − 4) = 14.5 percent. Step 3: Find the average of the two estimates: 14.88 percent. Difficulty: 2 Medium Topic: Cost of equity Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-02 Use the weighted-average cost of capital (WACC) formula to calculate a project's cost of capital.

89) Which of the following will directly impact the cost of equity? A) expected growth rate in sales B) expected future tax rates C) stock price D) profit margins Answer: C Difficulty: 1 Easy Topic: Cost of equity Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-02 Use the weighted-average cost of capital (WACC) formula to calculate a project's cost of capital. 90) Which of the following will directly impact the cost of debt? A) capital structure B) debt ratio C) coupon rate D) competition within the industry Answer: C Difficulty: 1 Easy Topic: Cost of debt Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-03 Explain how the firm chooses among estimating costs of equity, preferred stock, and debt.

91) ADK has 30,000 15-year, 9 percent annual coupon bonds outstanding. If the bonds currently sell for 111 percent of par and the firm pays an average tax rate of 21 percent, what will be the before-tax and after-tax component cost of debt? A) 7.74 percent; 6.11 percent B) 7.91 percent; 5.06 percent C) 8.05 percent; 5.15 percent D) 9 percent; 5 percent Answer: A Explanation: Step 1: PV = −1110; FV = 1000; PMT = 90; N = 15; solve for I: I = 7.74% Step 2: 7.74%(1 − 0.21) = 6.11% Difficulty: 1 Easy Topic: Cost of debt Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-03 Explain how the firm chooses among estimating costs of equity, preferred stock, and debt. 92) ADK has 30,000 15-year, 9 percent semi-annual coupon bonds outstanding. If the bonds currently sell for 90 percent of par and the firm pays an average tax rate of 21 percent, what will be the before-tax and after-tax component cost of debt? A) 11.19 percent; 7.61 percent B) 10.32 percent; 8.15 percent C) 9.85 percent; 6.70 percent D) 10.12 percent; 6.88 percent Answer: B Explanation: Step 1: PV = −900; FV = 1000; N = 15 × 2=30; PMT = 1000 × 0.09/2=45; solve for I: I = 5.16; cost of debt = 5.16 × 2 = 10.32%; Step 2: 10.32%(1 − 0.21) = 8.15% Difficulty: 1 Easy Topic: Cost of debt Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-03 Explain how the firm chooses among estimating costs of equity, preferred stock, and debt.

93) An estimated WACC computed using some sort of proxy for the average equity risk of the projects in a particular business unit is known as the A) business unit WACC B) pure-play beta C) divisional WACC D) component cost Answer: C Difficulty: 1 Easy Topic: Divisional and project costs of capital Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-06 Evaluate trade-offs between a firmwide WACC and a divisional cost of capital approach. 94) The approach to computing a divisional weighted average cost of capital (WACC) uses the average beta of projects in each division to calculate the WACC. A) subjective B) objective C) firmwide D) implicit Answer: B Difficulty: 2 Medium Topic: Divisional and project costs of capital Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-07 Distinguish subjective and objective approaches to divisional cost of capital.

95) The approach to computing a divisional weighted average cost of capital (WACC) requires only that WACCs for "risky" and "relatively safe" divisions be adjusted. A) subjective B) objective C) firmwide D) implicit Answer: A Difficulty: 2 Medium Topic: Divisional and project costs of capital Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-07 Distinguish subjective and objective approaches to divisional cost of capital. 96) Flotation costs are A) insignificant and can be assumed away. B) the difference between the bid-ask spread on the sale of the security. C) commissions to the underwriting firm that floats the issue. D) None of these choices are correct. Answer: C Difficulty: 1 Easy Topic: Flotation costs Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-08 Demonstrate how to adjust the WACC to reflect flotation costs. 97) Which of the following statements is correct? A) The flotation-adjusted cost of equity will always be less than the cost of equity that has not been adjusted for flotation costs. B) The flotation-adjusted cost of equity will always be more than the cost of equity that has not been adjusted for flotation costs. C) The flotation-adjusted cost of equity may be more than or less than the cost of equity that has not been adjusted for flotation costs. D) None of these choices are correct. Answer: B Difficulty: 2 Medium Topic: Flotation costs Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-08 Demonstrate how to adjust the WACC to reflect flotation costs. 58

98) What is the theoretical minimum for the weighted average cost of capital? A) the after-tax cost of debt B) the cost of preferred stock C) CAPM D) the cost of equity Answer: A Difficulty: 2 Medium Topic: Weighted average cost of capital Bloom's: Understand; Evaluate AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 11-02 Use the weighted-average cost of capital (WACC) formula to calculate a project's cost of capital. 99) Which of the following is a situation in which you would want to use the CAPM approach for estimating the component cost of equity? A) when you are able to estimate the market risk premium with certainty B) when you are able to estimate the risk-free rate with certainty C) when you are able to estimate the firm's beta with certainty D) when the firm pays a constant dividend Answer: C Difficulty: 2 Medium Topic: Cost of equity Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-03 Explain how the firm chooses among estimating costs of equity, preferred stock, and debt.

100) Which of the following is a situation in which you would want to use the constant-growth model approach for estimating the component cost of equity? A) when the firm has a low beta B) when the firm has multiple divisions C) when the firm's stock is expected to experience constant dividend growth D) when the firm has a high level of financial leverage Answer: C Difficulty: 2 Medium Topic: Cost of equity Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-03 Explain how the firm chooses among estimating costs of equity, preferred stock, and debt. 101) The reason that we do not use an after-tax cost of preferred stock is A) because preferred dividends are paid out of before-tax income. B) because most of the investors in preferred stock do not pay tax on the dividends. C) because we can only estimate the marginal tax rate of the preferred stockholders. D) none of these choices are correct. Answer: D Difficulty: 1 Easy Topic: Cost of preferred stock Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-03 Explain how the firm chooses among estimating costs of equity, preferred stock, and debt. 102) Why do we use market-value weights instead of book-value weights? A) Because firms often "window-dress" their financial statements. B) Because we are interested in determining what the cost of financing the firm's assets would be given today's market situation and the component costs the firm currently faces, not what the historical prices would have been. C) Because it is required in the Sarbanes-Oxley regulations. D) None of these choices are correct. Answer: B Difficulty: 2 Medium Topic: Capital structure weights Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-04 Calculate the weights used for WACC projections. 60

103) Suppose a new project was going to be financed partially with retained earnings. What flotation costs should you use for retained earnings? A) use the same flotation cost that would be used to issue new common stock B) use an average of the flotation costs for debt, preferred and common stock C) use the industry average flotation cost for common stock D) zero Answer: D Difficulty: 2 Medium Topic: Flotation costs Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-08 Demonstrate how to adjust the WACC to reflect flotation costs. 104) Which of the following is a reason why the divisional cost of capital approach may cause problems if new projects are assigned to the wrong division? A) Managers in different divisions may use different methods to calculate the WACC. B) The expected return of the new project may be incorrect. C) If projects are assigned to the wrong division, the risk of that division may be significantly different than the risk of the project, implying that the project will be evaluated with a divisional cost of capital that is much different from what a project-specific cost of capital would be. D) None of these choices are correct. Answer: C Difficulty: 2 Medium Topic: Divisional and project costs of capital Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-06 Evaluate trade-offs between a firmwide WACC and a divisional cost of capital approach.

105) Which of the following statements is correct? A) If a new project is riskier than the firm's existing projects, then it should expect to be "charged" a higher cost of capital than the firm's overall WACC. B) If a new project is riskier than the firm's existing projects, then it should expect to be "charged" a lower cost of capital than the firm's overall WACC. C) The project's risk and the cost of capital to which it is compared are independent. D) None of these choices are correct. Answer: A Difficulty: 2 Medium Topic: Divisional and project costs of capital Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-05 Identify which elements of WACC are used to calculate a projectspecific WACC. 106) A proxy beta is A) the average beta of firms that are only engaged in the proposed new line of business. B) the industry average beta that is used in lieu of the firm's beta because the firm has not existed long enough to have a beta calculated. C) the beta used when the firm has a great deal of business risk. D) None of these choices are correct. Answer: A Difficulty: 2 Medium Topic: Divisional and project costs of capital Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-05 Identify which elements of WACC are used to calculate a projectspecific WACC.

107) Which of the following statements is correct? A) The WACC is a measure of the before-tax cost of capital. B) The WACC measures the marginal cost of capital. C) It is common that the after-tax cost of debt exceeds the cost of equity. D) None of these choices are correct. Answer: B Difficulty: 1 Easy Topic: Weighted average cost of capital Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-03 Explain how the firm chooses among estimating costs of equity, preferred stock, and debt. 108) Which of the following statements is correct? A) The WACC measures the before-tax cost of capital. B) An increase in the firm's marginal corporate tax rate will decrease the weighted average cost of capital. C) Flotation costs can decrease the weighted average cost of capital. D) None of these choices are correct. Answer: B Difficulty: 2 Medium Topic: Weighted average cost of capital Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-02 Use the weighted-average cost of capital (WACC) formula to calculate a project's cost of capital. 109) Which of the following statements is correct? A) A decrease in the firm's marginal corporate tax rate will decrease the weighted average cost of capital. B) Flotation costs can decrease the weighted average cost of capital. C) The cost of debt is based on the cost of all liabilities, including accounts payable and accruals. D) None of these choices are correct. Answer: D Difficulty: 3 Hard Topic: Weighted average cost of capital Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-02 Use the weighted-average cost of capital (WACC) formula to calculate a project's cost of capital. 63

110) Which of the following will increase the cost of equity? A) The firm's share price falls 10 percent. B) The firm is expected to reduce its dividend. C) The firm's corporate tax rate increases. D) None of these choices are correct. Answer: A Difficulty: 2 Medium Topic: Cost of equity Bloom's: Evaluate AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 11-03 Explain how the firm chooses among estimating costs of equity, preferred stock, and debt. 111) Which of the following is most correct? A) When comparing two firms within the same industry, most analysts calculate the weighted average cost of capital on a before-tax basis to facilitate comparisons. B) Firms should use historical costs rather than marginal costs of capital. C) An increase in the risk-free rate will increase the cost of equity. D) All of these choices are correct. Answer: C Difficulty: 2 Medium Topic: Cost of equity Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-02 Use the weighted-average cost of capital (WACC) formula to calculate a project's cost of capital.; 11-03 Explain how the firm chooses among estimating costs of equity, preferred stock, and debt.

112) Apple's 9 percent annual coupon bond has 10 years until maturity and the bonds are selling in the market for $890. The firm's tax rate is 21 percent. What is the firm's after-tax cost of debt? A) 10.86 percent B) 3.91 percent C) 9.81 percent D) 8.58 percent Answer: D Explanation: Step 1: PV = −890; PMT = 90; FV = 1000; N = 10; => I = 10.86%. Step 2: 10.86%(1 − 0.21) = 8.58%. Difficulty: 1 Easy Topic: Cost of debt Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-02 Use the weighted-average cost of capital (WACC) formula to calculate a project's cost of capital. 113) A firm uses only debt and equity in its capital structure. The firm's weight of debt is 40 percent. The firm could issue new bonds at a yield to maturity of 9 percent and the firm has a tax rate of 21 percent. If the firm's WACC is 11 percent, what is the firm's cost of equity? A) 15.92 percent B) 13.59 percent C) 15.03 percent D) 15.68 percent Answer: B Explanation: 11% = 0.4(9%)(1 − 0.21) + (1 − 0.4)(cost of equity); cost of equity = 13.59% Difficulty: 3 Hard Topic: Weighted average cost of capital Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-02 Use the weighted-average cost of capital (WACC) formula to calculate a project's cost of capital.

114) A firm uses only debt and equity in its capital structure. The firm's weight of debt is 45 percent. The firm could issue new bonds at a yield to maturity of 10 percent and the firm has a tax rate of 21 percent. If the firm's WACC is 12 percent, what is the firm's cost of equity? A) 15.35 percent B) 15.63 percent C) 16.09 percent D) 14.57 percent Answer: A Explanation: 12% = 0.45(10%)(1 − 0.21) + (1 − 0.45)(cost of equity); cost of equity = 15.35% Difficulty: 3 Hard Topic: Weighted average cost of capital Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-02 Use the weighted-average cost of capital (WACC) formula to calculate a project's cost of capital. 115) A firm uses only debt and equity in its capital structure. The firm's weight of equity is 70 percent. The firm's cost of equity is 13 percent and it has a tax rate of 21 percent. If the firm's WACC is 11 percent, what is the firm's before-tax cost of debt? A) 7.19 percent B) 8.02 percent C) 6.38 percent D) 1.9 percent Answer: B Explanation: 11% = 0.7(13%) + (1 − 0.7)(cost of debt)(1 − 0.21); => .019 = 0.2370 × cost of debt => ; cost of debt = 8.02% Difficulty: 3 Hard Topic: Weighted average cost of capital Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-02 Use the weighted-average cost of capital (WACC) formula to calculate a project's cost of capital.

116) A firm uses only debt and equity in its capital structure. The firm's weight of equity is 75 percent. The firm's cost of equity is 16 percent and it has a tax rate of 21 percent. If the firm's WACC is 13%, what is the firm's before-tax cost of debt? A) 6.89 percent B) 6.28 percent C) 5.71 percent D) 5.06 percent Answer: D Explanation: 13% = 0.75(16%) + (1 − 0.75)(cost of debt)(1 − 0.21); => 0.010 = 0.1975 × cost of debt => cost of debt = 5.06% Difficulty: 3 Hard Topic: Weighted average cost of capital Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-02 Use the weighted-average cost of capital (WACC) formula to calculate a project's cost of capital. 117) Uptown Inc. has preferred stock selling for 102 percent of par that pays a 6 percent annual coupon. What would be Uptown's component cost of preferred stock? A) 6.12 percent B) 6.00 percent C) 5.88 percent D) 1.02 percent Answer: C Explanation: 6/102 = 5.88 percent. Difficulty: 1 Easy Topic: Cost of preferred stock Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-03 Explain how the firm chooses among estimating costs of equity, preferred stock, and debt.

118) Paper Exchange has 10 million shares of common stock outstanding, 5 million shares of preferred stock outstanding, and 100 thousand bonds. If the common shares are selling for $25 per share, the preferred shares are selling for $10 per share, and the bonds are selling for 98 percent of par, what would be the weight used for preferred stock in the computation of Paper's WACC? A) 12.00 percent B) 12.56 percent C) 5.00 percent D) 3.33 percent Answer: B Explanation: (5,000,000 × 10)/(10,000,000 × 25 + 5,000,000 × 10 + 100,000 × 0.98 × 1,000) = 50m./398m. = 12.56 percent. Difficulty: 1 Easy Topic: Capital structure weights Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-04 Calculate the weights used for WACC projections. 119) Suppose that T-shirts, Inc.'s capital structure features 25 percent equity, 75 percent debt, and that its before-tax cost of debt is 8 percent, while its cost of equity is 12 percent. If the appropriate weighted average tax rate is 21 percent, what will be T-shirts' WACC? A) 9.00 percent B) 7.74 percent C) 7.20 percent D) 4.75 percent Answer: B Explanation: (0.25 × 12% ) + (0.75 × 8% × (1 − 0.21)) = 7.74% Difficulty: 2 Medium Topic: Weighted average cost of capital Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-02 Use the weighted-average cost of capital (WACC) formula to calculate a project's cost of capital.

120) A firm uses only debt and equity in its capital structure. The firm's weight of equity is 35 percent. The firm's cost of equity is 14 percent and it has a tax rate of 21 percent. If the firm's WACC is 11 percent, what is the firm's before-tax cost of debt? A) 11.88 percent B) 9.38 percent C) 5.50 percent D) −3.00 percent Answer: A Explanation: 11% = 0.35(14%) + (1 − 0.35)(cost of debt)(1 − 0.21); => 6.1% = (0.5135)(cost of debt); => cost of debt = 11.88% Difficulty: 3 Hard Topic: Weighted average cost of capital Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-02 Use the weighted-average cost of capital (WACC) formula to calculate a project's cost of capital. 121) Amino Industries common shares sell for $100 per share. Amino expects to set their next annual dividend at $4.00 per share. If Amino expects future dividends to grow at 5 percent per year, indefinitely, the current risk-free rate is 2 percent, the expected rate on the market is 7 percent, and the stock has a beta of 1.5, what should be the best estimate of the firm's cost of equity, by taking an average of the 2 estimates? A) 18.50 percent B) 13.25 percent C) 9.25 percent D) 7.27 percent Answer: C Explanation: Step 1: Find the cost of equity using constant-growth formula: 4.00/100 + 0.05 = 9.00 percent. Step 2: Find the cost of equity using CAPM: 2 + 1.5(7 − 2) = 9.5 percent. Step 3: Find the average of the two estimates: 9.25 percent. Difficulty: 2 Medium Topic: Cost of equity Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-02 Use the weighted-average cost of capital (WACC) formula to calculate a project's cost of capital.

122) Suppose your firm has decided to use a divisional WACC approach to analyze projects. The firm currently has 2 divisions, A and B, with betas for each division of 1.25 and 2.5, respectively. If all current and future projects will be financed with half debt and half equity, and if the current cost of equity (based on an average firm beta of 1.0 and a current risk-free rate of 4 percent) is 12 percent and the after-tax yield on the company's bonds is 8 percent, what are the WACCs for divisions A and B? A) 11.00 percent; 16.00 percent B) 15.00 percent; 30.00 percent C) 25.00 percent; 30.00 percent D) 20.00 percent; 34.00 percent Answer: A Explanation: Step 1: Find the market risk premium. 12% = 4% + 1.0(MRP); => MRP = 8%. Step 2: Find the cost of equity for each division using CAPM; A: 4 + 1.25 × 8 = 14%; B: 24%. Step 3: Find the WAACs for each division; A: 0.5(14%) + 0.5(8%) = 11.00%; B: 16.00%. Difficulty: 3 Hard Topic: Divisional and project costs of capital Bloom's: Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-02 Use the weighted-average cost of capital (WACC) formula to calculate a project's cost of capital. 123) A firm uses only debt and equity in its capital structure. The firm's weight of debt is 75 percent. The firm could issue new bonds at a yield to maturity of 12 percent and the firm has a tax rate of 21 percent. If the firm's WACC is 13 percent, what is the firm's cost of equity? A) 38.29 percent B) 36.00 percent C) 23.56 percent D) 4.00 percent Answer: C Explanation: 13% = 0.75(12%)(1 − 0.21) + (1 − 0.75)(Cost of equity); Cost of equity = 23.56%. Difficulty: 3 Hard Topic: Weighted average cost of capital Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 11-02 Use the weighted-average cost of capital (WACC) formula to calculate a project's cost of capital.

Finance, 5e (Cornett) Chapter 12 Estimating Cash Flows on Capital Budgeting Projects 1) As new capital budgeting projects arise, we must estimate A) the float costs for financing the project. B) when such projects will require cash flows. C) the cost of the loan for the specific project. D) the cost of the stock being sold for the specific project. Answer: B Difficulty: 1 Easy Topic: Cash flows Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 12-01 Explain why we use pro forma statements to analyze project cash flows. 2) Which of these is the process of estimating expected future cash flows of a project using only the relevant parts of the balance sheet and income statements? A) Incremental cash flows B) Cash flow analysis C) Pro forma analysis D) Substitutionary analysis Answer: C Difficulty: 1 Easy Topic: Pro forma statements Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 12-01 Explain why we use pro forma statements to analyze project cash flows.

3) If a firm has already paid an expense or is obligated to pay one in the future, regardless of whether a particular project is undertaken, that expense is a A) committed cost. B) complementary cost. C) obligated cost. D) sunk cost. Answer: D Difficulty: 1 Easy Topic: Cash flows Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 12-02 Identify which cash flows we can incrementally apply to a project and which ones we cannot. 4) Effects that arise from a new product or service that increase sales of the firm's existing products or services are referred to as A) complementary effects. B) substitutionary effects. C) sunk effects. D) marginal effects. Answer: A Difficulty: 1 Easy Topic: Cash flows Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 12-02 Identify which cash flows we can incrementally apply to a project and which ones we cannot.

5) Effects that arise from a new product or service that decrease sales of the firm's existing products or services are referred to as A) complementary effects. B) substitutionary effects. C) sunk effects. D) marginal effects. Answer: B Difficulty: 1 Easy Topic: Cash flows Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 12-02 Identify which cash flows we can incrementally apply to a project and which ones we cannot. 6) Concerning incremental project cash flow, which of these is a cost one would never count as an expense of the project? A) Initial investment B) Taxes paid C) Operating expenses of the project D) Financing costs Answer: D Difficulty: 1 Easy Topic: Cash flows Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 12-02 Identify which cash flows we can incrementally apply to a project and which ones we cannot. 7) Which of these is used as a measure of the total amount of available cash flow from a project? A) Free cash flow B) Operating cash flow C) Investment in operating capital D) Sunk cash flow Answer: A Difficulty: 1 Easy Topic: Free cash flow Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 12-03 Calculate a project's expected cash flows using the free cash flow approach. 3

8) Which of the following is NOT included when calculating the depreciable basis for real property? A) Freight charges for item B) Sales tax paid for item C) Financing fees D) Installation and testing fees Answer: C Difficulty: 1 Easy Topic: Depreciation Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 12-03 Calculate a project's expected cash flows using the free cash flow approach. 9) When calculating operating cash flow for a project, one would calculate it as being mathematically equal to which of the following? A) EBIT − Interest − Taxes + Depreciation B) EBIT − Taxes C) EBIT + Depreciation D) EBIT − Taxes + Depreciation Answer: D Difficulty: 2 Medium Topic: Operating cash flow Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 12-03 Calculate a project's expected cash flows using the free cash flow approach.

10) Which of these is the concept that a unit's sales will follow an approximate bell-shaped curve versus a steady sales life? A) Bell curve cycle B) Coefficient of variation C) Product life cycle D) NWC life cycle Answer: C Difficulty: 1 Easy Topic: Cash flows Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 12-03 Calculate a project's expected cash flows using the free cash flow approach. 11) A decrease in net working capital (NWC) is treated as a A) cash inflow. B) cash outflow. C) sunk cost. D) historical cost. Answer: A Difficulty: 2 Medium Topic: Change in net working capital Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 12-03 Calculate a project's expected cash flows using the free cash flow approach. 12) Which of the following is the IRS convention that requires that all property placed in service during a given period is assumed to be placed in service at the midpoint of that period? A) Mid-point convention B) Mid-month convention C) Mid-quarter convention D) Half-year convention Answer: D Difficulty: 2 Medium Topic: Depreciation Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 12-04 Explain how accelerated depreciation affects project cash flows.

13) Accelerated depreciation allows firms to A) receive less of the dollars of depreciation earlier in the asset's life. B) receive more of the dollars of depreciation earlier in the asset's life. C) not pay any taxes during an asset's life. D) receive more of the dollars of depreciation later in the asset's life. Answer: B Difficulty: 1 Easy Topic: Depreciation Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 12-04 Explain how accelerated depreciation affects project cash flows. 14) Section 179 allows a business, with certain restrictions, to do which of the following? A) Offset the tax liability with the cost of the asset in the year of purchase. B) Expense the asset immediately in the year of purchase. C) Expense the asset using double declining balance depreciation during the life of the asset. D) Get a government grant to purchase the asset. Answer: B Difficulty: 1 Easy Topic: Depreciation Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 12-04 Explain how accelerated depreciation affects project cash flows. 15) For which situation below would one need to "smooth out" the variation in each set of cash flows so that each becomes a perpetuity? A) Choosing between projects with differing risks B) Choosing between independent projects C) Choosing between alternative assets with differing lives D) Choosing between alternative assets with equal lives Answer: C Difficulty: 2 Medium Topic: Equivalent annual costs Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 12-07 Demonstrate the EAC approach to choosing among alternative cash streams for recurring projects.

16) The best approach to convert an infinite series of asset purchases into a perpetuity is known as the A) net working capital approach. B) net present value approach. C) equivalent annual cost approach. D) equivalent annual cash flow approach. Answer: C Difficulty: 2 Medium Topic: Equivalent annual costs Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 12-07 Demonstrate the EAC approach to choosing among alternative cash streams for recurring projects. 17) One way to account for flotation costs of raising capital is to A) adjust all the project's cash flows so that each year it will reflect the flotation costs. B) adjust the project's initial cash flow so that it will reflect the flotation costs. C) adjust only the project's operating cash flows to account for paying back the shareholders. D) adjust the project's tax burden to account for the tax implications of raising capital. Answer: B Difficulty: 2 Medium Topic: Flotation costs Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 12-08 Adjust initial project investments to account for flotation costs. 18) With regard to depreciation, the time value of money concept tells us that A) delaying the depreciation expense is always better. B) taking the depreciation expense sooner is always better. C) delaying the depreciation expense is sometimes better. D) taking the depreciation expense sooner is sometimes better. Answer: B Difficulty: 1 Easy Topic: Time value of money Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 12-04 Explain how accelerated depreciation affects project cash flows.

19) When looking at which of these types of projects, one must consider any cash flows that arise from surrendering old equipment before the end of its useful life? A) Incremental projects B) Replacement projects C) Cost-cutting projects D) New projects Answer: B Difficulty: 1 Easy Topic: Cash flows Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 12-05 Calculate free cash flows for replacement equipment. 20) Which of the following measures the operating cash flow a project produces minus the necessary investment in operating capital, and is as valid for proposed new projects as it is for the firm's current operations? A) Free cash flow B) Operating cash flow C) Investment in operating capital D) Sunk cash flow Answer: A Difficulty: 1 Easy Topic: Free cash flow Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 12-03 Calculate a project's expected cash flows using the free cash flow approach. 21) Which statement is true regarding cost-cutting proposals? A) The main benefits are from changes in sales and changes in costs. B) The main benefits come only from changes in sales. C) The main benefits come only from changes in costs. D) The main benefits come from the change in sales due to the response from the cost-cutting proposal. Answer: C Difficulty: 1 Easy Topic: Special projects Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 12-06 Calculate cash flows associated with cost-cutting proposals. 8

22) Suppose you sell a fixed asset for $90,000 when its book value is $95,000. If your company's marginal tax rate is 21 percent, what will be the effect on cash flows of this sale (i.e., what will be the after-tax cash flow of this sale)? A) $3,000 B) $5,000 C) $91,050 D) $90,000 Answer: C Explanation: AT CF = $95,000 + ($90,000 − $95,000) × (1 − 0.21) = $91,050. Difficulty: 1 Easy Topic: Cash flows Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 12-03 Calculate a project's expected cash flows using the free cash flow approach. 23) Suppose you sell a fixed asset for $75,000 when its book value is $80,000. If your company's marginal tax rate is 21 percent, what will be the effect on cash flows of this sale (i.e., what will be the after-tax cash flow of this sale)? A) $5,000 B) $48,750 C) $76,050 D) $75,000 Answer: C Explanation: AT CF = $80,000 + ($75,000 − $80,000) × (1 − 0.21) = $76,050. Difficulty: 1 Easy Topic: Cash flows Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 12-03 Calculate a project's expected cash flows using the free cash flow approach.

24) Your company is considering a new project that will require $10,000 of new equipment at the start of the project. The equipment will have a depreciable life of five years and will be depreciated to a book value of $3,000 using straight-line depreciation. The cost of capital is 9 percent, and the firm's tax rate is 21 percent. Estimate the present value of the tax benefits from depreciation. A) $476 B) $924 C) $5,446 D) $1,143.56 Answer: D Explanation: Depreciation = ($10,000 − $3,000)/5 = $1,400. $1,400 × 0.21 = $294 tax savings each period. Across the entire project, these savings will constitute a 5-period annuity. Pmt = 294, FV = 0, I = 9, N = 5, PV = 1,143.56. Difficulty: 1 Easy Topic: Depreciation Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 12-04 Explain how accelerated depreciation affects project cash flows.

25) Your company is considering a new project that will require $2,000,000 of new equipment at the start of the project. The equipment will have a depreciable life of 10 years and will be depreciated to a book value of $250,000 using straight-line depreciation. The cost of capital is 12 percent, and the firm's tax rate is 21 percent. Estimate the present value of the tax benefits from depreciation. A) $68,250 B) $988,789 C) $175,000 D) $207,646 Answer: D Explanation: Depreciation = ($2,000,000 − $250,000)/10 = $175,000. $175,000 × 0.21 = $36,750 tax savings each period. Across the entire project, these savings will constitute a 10-period annuity. Pmt = 36,750, FV = 0, I = 12, N = 10, PV = 207,645.70. Difficulty: 1 Easy Topic: Depreciation Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 12-04 Explain how accelerated depreciation affects project cash flows.

12) You are trying to pick the least-expensive machine for your company. You have two choices: machine A, which will cost $50,000 to purchase and which will have OCF of −$3,500 annually throughout the machine's expected life of three years; and machine B, which will cost $75,000 to purchase and which will have OCF of −$4,900 annually throughout that machine's four-year life. Both machines will be worthless at the end of their life. If you intend to replace whichever type of machine you choose with the same thing when its life runs out, again and again out into the foreseeable future, and if your business has a cost of capital of 14 percent, using EAC which one should you choose? A) Machine A B) Machine B C) All of these choices are correct. D) Neither machine A nor B Answer: A Explanation: One iteration of each machine will consist of the following cash flows: Year Machine A CFs Machine B CFs

−$

50,000

−$ 3,500

−$

75,000

−$ 4,900

The NPV of one machine A will be: PMT = 3,500, N = 3, I = 14, FV = 0, PV = −8,125.71 − 50,000 = −58,125.71. Treating this as the present value of a 3-period annuity, setting i to 14 percent, and solving for payment will yield a payment of −$25,036.57, which is machine A's EAC. The NPV of one machine B will be: PMT = 4,900, N = 4, I = 14, FV = 0, PV = −14,277.19 − 75,000 = −89,277.19. Treating this as the present value of a 4-period annuity, setting i to 14 percent, and solving for payment will yield a payment of −$30,640.36, which is machine B's EAC. Difficulty: 2 Medium Topic: Equivalent annual costs Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 12-07 Demonstrate the EAC approach to choosing among alternative cash streams for recurring projects.

13) You are trying to pick the least-expensive machine for your company. You have two choices: machine A, which will cost $100,000 to purchase and which will have OCF of −$7,000 annually throughout the machine's expected life of three years; and machine B, which will cost $125,000 to purchase and which will have OCF of −$2,600 annually throughout that machine's four-year life. Both machines will be worthless at the end of their life. If you intend to replace whichever type of machine you choose with the same thing when its life runs out, again and again out into the foreseeable future, and if your business has a cost of capital of 15 percent, using EAC which one should you choose? A) Machine A B) Machine B C) All of these choices are correct. D) Neither machine A nor B Answer: B Explanation: One iteration of each machine will consist of the following cash flows: Year Machine A CFs Machine B CFs

−$

100,000

−$

7,000

−$ 7,000

−$

125,000

−$

2,600

−$ 2,600

The NPV of one machine A will be: PMT = 7000, N = 3, I = 15, FV = 0, PV = −15,982.58 − 100,000 = −115,982.58. Treating this as the present value of a 3-period annuity, setting i to 15 percent, and solving for payment will yield a payment of −$50,797.70, which is machine A's EAC. The NPV of one machine B will be: PMT = 2,600, N = 4, I = 15, FV = 0, PV = −7,422.94 − 125,000 = −132,422.94. Treating this as the present value of a 4-period annuity, setting i to 15 percent, and solving for payment will yield a payment of −$46,383.17, which is machine B's EAC. Difficulty: 2 Medium Topic: Equivalent annual costs Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 12-07 Demonstrate the EAC approach to choosing among alternative cash streams for recurring projects.

14) You are evaluating two different machines. Machine A costs $10,000, has a five-year life, and has an annual OCF (after-tax) of −$2,500 per year. Machine B costs $15,000, has a sevenyear life, and has an annual OCF (after-tax) of −$2,000 per year. If your discount rate is 14 percent, using EAC which machine would you choose? A) Machine A B) Machine B C) All of these choices are correct. D) Neither machine A nor B Answer: A Explanation: One iteration of each machine will consist of the following cash flows: Year Machine A CFs Machine B CFs

−$10,000 −$2,500 −$2,500 −$2,500 −$2,500 −$2,500 −$15,000 −$2,000 −$2,000 −$2,000 −$2,000 −$2,000 −$2,000 −$2,000

The NPV of one Machine A will be: PMT = 2,500, N = 5, I = 14, FV = 0, PV = −8,582.70 − 10,000 = −18,582.70. Treating this as the present value of a 5-period annuity, setting i to 14 percent, and solving for payment will yield a payment of −$5412.83, which is machine A's EAC. The NPV of Machine B will be: PMT = 2,000, N = 7, I = 14, FV = 0, PV = −8,576.61 − 15,000 = −23,576.61. Treating this as the present value of a 7-period annuity, setting i to 14 percent, and solving for payment will yield a payment of −$5,497.89, which is machine B's EAC. Difficulty: 2 Medium Topic: Equivalent annual costs Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 12-08 Adjust initial project investments to account for flotation costs.

15) You are evaluating two different machines. Machine A costs $25,000, has a five-year life, and has an annual OCF (after-tax) of −$6,000 per year. Machine B costs $30,000, has a sevenyear life, and has an annual OCF (after-tax) of −$5,500 per year. If your discount rate is 10 percent, using EAC which machine would you choose? A) Machine A B) Machine B C) All of these choices are correct. D) Neither machine A nor B Answer: B Explanation: One iteration of each machine will consist of the following cash flows: Year

Machine A CFs

−$25,000 −$6,000 −$6,000 −$6,000 −$6,000 −$6,000

Machine B CFs

−$30,000 −$5,500 −$5,500 −$5,500 −$5,500 −$5,500 −$5,500

−$5,500

The NPV of one machine A will be: PMT = 6,000, N = 5, I = 10, FV = 0, PV = −22,744.72 − 25,000 = −47,744.72. Treating this as the present value of a 5-period annuity, setting i to 10 percent, and solving for payment will yield a payment of −$12,594.94, which is machine A's EAC. The NPV of machine B will be: PMT = 5,500, N = 7, I = 10, FV = 0, PV = −26,776.30 − 30,000 = −56,776.30. Treating this as the present value of a 7-period annuity, setting i to 10 percent, and solving for payment will yield a payment of −$11,662.16, which is machine B's EAC. Difficulty: 2 Medium Topic: Equivalent annual costs Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 12-08 Adjust initial project investments to account for flotation costs.

16) You are considering the purchase of one of two machines used in your manufacturing plant. Machine A has a life of two years, costs $100 initially, and then $150 per year in maintenance costs. Machine B costs $200 initially, has a life of three years, and requires $120 in annual maintenance costs. Either machine must be replaced at the end of its life with an equivalent machine. Using EAC which is the better machine for the firm? The discount rate is 12 percent and tax can be ignored. A) Machine A B) Machine B C) All of these choices are correct. D) Neither machine A nor B Answer: B Explanation: One iteration of each machine will consist of the following cash flows: Year Machine A CFs Machine B CFs

0 –$ 100 –$ 200

1 –$ 150 –$ 120

2 –$ 150 –$ 120

3 –$ 120

The NPV of one machine A will be: PMT = 150, N = 2, I = 12, FV = 0, PV = −253.51 − 100 = −353.51. Treating this as the present value of a 2-period annuity, setting i to 12 percent, and solving for payment will yield a payment of −$209.17, which is machine A's EAC. The NPV of one machine B will be: PMT = 120, N = 3, I = 12, FV = 0, PV = −288.22 − 200 = −488.22. Treating this as the present value of a 3-period annuity, setting i to 12 percent, and solving for payment will yield a payment of −$203.27, which is machine B's EAC. Difficulty: 2 Medium Topic: Equivalent annual costs Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 12-08 Adjust initial project investments to account for flotation costs.

17) You are considering the purchase of one of two machines used in your manufacturing plant. Machine A has a life of two years, costs $20,000 initially, and then $4,000 per year in maintenance costs. Machine B costs $25,000 initially, has a life of three years, and requires $3,500 in annual maintenance costs. Either machine must be replaced at the end of its life with an equivalent machine. Using EAC which is the better machine for the firm? The discount rate is 14 percent and tax can be ignored. A) Machine A B) Machine B C) All of these choices are correct. D) Neither machine A nor B Answer: B Explanation: One iteration of each machine will consist of the following cash flows: Year Machine A CFs Machine B CFs

0 −$ 20,000 −$ 25,000

1 −$ 4,000 −$ 3,500

2 −$ 4,000 −$ 3,500

3 −$ 3,500

The NPV of one machine A will be: PMT = 4,000, N = 2, I = 14, FV = 0, PV = −6,586.64 − 20,000 = −26,586.64. Treating this as the present value of a 2-period annuity, setting i to 14 percent, and solving for payment will yield a payment of −$16,145.79, which is machine A's EAC. The NPV of one machine B will be: PMT = 3,500, N = 3, I = 14, FV = 0, PV = −8,125.71 − 25,000 = −33,125.71. Treating this as the present value of a 3-period annuity, setting i to 14 percent, and solving for payment will yield a payment of −$14,268.29, which is machine B's EAC. Difficulty: 2 Medium Topic: Equivalent annual costs Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 12-08 Adjust initial project investments to account for flotation costs.

32) Your company has spent $200,000 on research to develop a new computer game. The firm is planning to spend $40,000 on a machine to produce the new game. Shipping and installation costs of the machine will be capitalized and depreciated; they total $5,000. The machine has an expected life of five years, a $25,000 estimated resale value, and falls under the MACRS fiveyear class life. Revenue from the new game is expected to be $300,000 per year, with costs of $100,000 per year. The firm has a tax rate of 21 percent, an opportunity cost of capital of 14 percent, and it expects net working capital to increase by $50,000 at the beginning of the project. What will be the operating cash flow for year one of this project? A) −$49,150 B) $3,150 C) $150,890 D) $159,890 Answer: D Explanation: Sales

$ −Fixed costs −Depreciation =EBIT −Taxes =Net income +Depreciation

$ $

OCF

300,000 (100,000) (9,000) 191,000 (40,110) 150,890 9,000 159,890

Difficulty: 2 Medium Topic: Operating cash flow Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 12-03 Calculate a project's expected cash flows using the free cash flow approach.

33) Your firm needs a machine which costs $100,000, and requires $25,000 in maintenance for each year of its three-year life. After three years, this machine will be replaced. The machine falls into the MACRS three-year class life category. Assume a tax rate of 21 percent and a discount rate of 14 percent. What is the depreciation tax shield for this project in year 3? A) $2,073.40 B) $3,110.10 C) $9,626.50 D) $14,810.00 Answer: B Explanation: Depreciation in year 3 will be 14.81 percent × $100,000 = $14,810. This will save the firm $14,810 × 0.21 = $3,110.10 in taxes. Difficulty: 2 Medium Topic: Depreciation Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 12-04 Explain how accelerated depreciation affects project cash flows. 34) Your firm needs a machine which costs $500,000, and requires $10,000 in maintenance for each year of its three-year life. After three years, this machine will be replaced. The machine falls into the MACRS three-year class life category. Assume a tax rate of 21 percent and a discount rate of 15 percent. What is the depreciation tax shield for this project in year 3? A) $7,219.88 B) $24,500.00 C) $15,550.50 D) $48,132.50 Answer: C Explanation: Depreciation in year 3 will be 14.81 percent × $500,000 = $74,050. This will save the firm $74,050 × 0.21 = $15,550.50 in taxes. Difficulty: 2 Medium Topic: Depreciation Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 12-04 Explain how accelerated depreciation affects project cash flows.

35) Your firm needs a machine which costs $90,000, and requires $30,000 in maintenance for each year of its five-year life. After five years, this machine will be replaced. The machine falls into the MACRS five-year class life category. Assume a tax rate of 21 percent and a discount rate of 13 percent. What is the depreciation tax shield for this project in year 5? A) $471.74 B) $1,347.84 C) $2,177.28 D) $6,739.20 Answer: C Explanation: Depreciation in year 5 will be 11.52 percent × $90,000 = $10,368. This will save the firm $10,368 × 0.21 = $2,177.28 in taxes. Difficulty: 2 Medium Topic: Depreciation Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 12-04 Explain how accelerated depreciation affects project cash flows. 36) Your firm needs a machine which costs $125,000, and requires $5,000 in maintenance for each year of its three-year life. After three years, this machine will be replaced. The machine falls into the MACRS three-year class life category. Assume a tax rate of 21 percent and a discount rate of 10 percent. If this machine can be sold for $15,000 at the end of year 3, what is the after-tax salvage value? A) $9,262.50 B) $9,750.00 C) $11,692.69 D) $13,795.13 Answer: D Explanation: The machine will have a remaining book value of 7.41% × $125,000 = $9,262.50. Using Equation 12−3, the after-tax cash flows from the sale of the machine will be: $9,262.50 + ($15,000 − $9,262.50) × (1 − 0.21) = $13,795.13. Difficulty: 2 Medium Topic: Cash flows Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 12-04 Explain how accelerated depreciation affects project cash flows.

37) Your firm needs a machine which costs $60,000, and requires $15,000 in maintenance for each year of its five-year life. After five years, this machine will be replaced. The machine falls into the MACRS five-year class life category. Assume a tax rate of 21 percent and a discount rate of 10 percent. If this machine can be sold for $8,000 at the end of year 5, what is the aftertax salvage value? A) $3,456.00 B) $4,544.00 C) $5,200.00 D) $7,045.76 Answer: D Explanation: The machine will have a remaining book value of 5.76 percent × $60,000 = $3,456. Using Equation 12-3, the after-tax cash flows from the sale of the machine will be: $3,456 + ($8,000 − $3,456) × (1 − 0.21) = $7,045.76. Difficulty: 2 Medium Topic: Cash flows Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 12-04 Explain how accelerated depreciation affects project cash flows.

38) You have been asked by the president of your company to evaluate the proposed acquisition of a new special-purpose truck for $50,000. The truck falls into the MACRS three-year class, and it will be sold after three years for $5,000. Use of the truck will require an increase in NWC (spare parts inventory) of $2,000. The truck will have no effect on revenues, but it is expected to save the firm $25,000 per year in before-tax operating costs, mainly labor. The firm's marginal tax rate is 21 percent. What will the operating cash flow for this project be during year 2? A) $21,890 B) $22,225 C) $22,690 D) $24,417 Answer: D Explanation: +Fixed costs save −Depreciation =EBIT −Taxes =Net income +Depreciation OCF

25,000 (22,225) $ 2,775 (583) $ 2,192 22,225 $ 24,417

Difficulty: 2 Medium Topic: Operating cash flow Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 12-06 Calculate cash flows associated with cost-cutting proposals.

23) You have been asked by the president of your company to evaluate the proposed acquisition of a new special-purpose truck for $70,000. The truck falls into the MACRS three-year class, and it will be sold after three years for $5,000. Use of the truck will require an increase in NWC (spare parts inventory) of $10,000. The truck will have no effect on revenues, but it is expected to save the firm $32,000 per year in before-tax operating costs, mainly labor. The firm's marginal tax rate is 21 percent. What will the operating cash flow for this project be during year 2? A) $531 B) $885 C) $31,814 D) $50,315 Answer: C Explanation: +Fixed costs save –Depreciation =EBIT –Taxes =Net income +Depreciation OCF

32,000 (31,115) $ 885 (186) $ 699 31,115 $ 31,814

24) You have been asked by the president of your company to evaluate the proposed acquisition of a new special-purpose truck for $250,000. The truck falls into the MACRS three-year class, and it will be sold after three years for $50,000. Use of the truck will require an increase in NWC (spare parts inventory) of $5,000. The truck will have no effect on revenues, but it is expected to save the firm $80,000 per year in before-tax operating costs, mainly labor. The firm's marginal tax rate is 21 percent. What will the operating cash flow for this project be during year 3? A) $25,785 B) $70,975 C) $81,333 D) $85,025 Answer: B Explanation: +Fixed costs save −Depreciation =EBIT –Taxes =Net income +Depreciation OCF

80,000 (37,025) $ 42,975 (9,025) $ 33,950 37,025 $ 70,975

25) You have been asked by the president of your company to evaluate the proposed acquisition of a new special-purpose truck for $60,000. The truck falls into the MACRS three-year class, and it will be sold after three years for $14,000. Use of the truck will require an increase in NWC (spare parts inventory) of $3,000. The truck will have no effect on revenues, but it is expected to save the firm $20,000 per year in before-tax operating costs, mainly labor. The firm's marginal tax rate is 21 percent. What will the operating cash flow for this project be during year 3? A) $6,668 B) $11,114 C) $12,554 D) $17,666 Answer: D Explanation: +Fixed costs save –Depreciation =EBIT –Taxes =Net income +Depreciation OCF

20,000 (8,886) $ 11,114 (2,334) $ 8,780 8,886 $ 17,666

26) You have been asked by the president of your company to evaluate the proposed acquisition of a new special-purpose truck for $75,000. The truck falls into the MACRS three-year class, and it will be sold after three years for $13,000. Use of the truck will require an increase in NWC (spare parts inventory) of $5,000. The truck will have no effect on revenues, but it is expected to save the firm $20,000 per year in before-tax operating costs, mainly labor. The firm's marginal tax rate is 21 percent. What will the operating cash flow for this project be during year 3? A) $5,335 B) $8,892 C) $9,443 D) $18,133 Answer: D Explanation: +Fixed costs save –Depreciation =EBIT –Taxes =Net income +Depreciation OCF

20,000 (11,108) $ 8,893 (1,867) $ 7,025 11,108 $ 18,133

43) You are evaluating a project for your company. You estimate the sales price to be $500 per unit and sales volume to be 2000 units in year 1; 3000 units in year 2; and 1500 units in year 3. The project has a three-year life. Variable costs amount to $300 per unit and fixed costs are $200,000 per year. The project requires an initial investment of $325,000 in assets that will be depreciated straight-line to zero over the three-year project life. The actual market value of these assets at the end of year 3 is expected to be $50,000. NWC requirements at the beginning of each year will be approximately 25 percent of the projected sales during the coming year. The tax rate is 21 percent and the required return on the project is 12 percent. What is the operating cash flow for the project in year 2? A) $74,167 B) $192,500 C) $338,750 D) $374,500 Answer: C Explanation: Sales −Variable costs −Fixed costs −Depreciation =EBIT −Taxes =Net income +Depreciation OCF

$ 1,500,000 (900,000) (200,000) (108,333) $ 291,667 (61,250) $ 230,417 108,333 $ 338,750

Difficulty: 3 Hard Topic: Operating cash flow Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 12-03 Calculate a project's expected cash flows using the free cash flow approach.

28) You are evaluating a project for your company. You estimate the sales price to be $50 per unit and sales volume to be 5,000 units in year 1; 10,000 units in year 2; and 2,500 units in year 3. The project has a three-year life. Variable costs amount to $10 per unit and fixed costs are $75,000 per year. The project requires an initial investment of $25,000 in assets that will be depreciated straight-line to zero over the three-year project life. The actual market value of these assets at the end of year 3 is expected to be $5,000. NWC requirements at the beginning of each year will be approximately 20 percent of the projected sales during the coming year. The tax rate is 21 percent and the required return on the project is 13 percent. What change in NWC occurs at the end of year 1? A) $13,000 B) $34,000 C) $50,000 D) $75,000 Answer: C Explanation: Sales will go from $250,000 to $500,000 between years 1 and 2, so NWC will have to increase from $50,000 to $100,000, an increase of $50,000. Difficulty: 3 Hard Topic: Change in net working capital Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 12-03 Calculate a project's expected cash flows using the free cash flow approach.

29) You are evaluating a project for your company. You estimate the sales price to be $10 per unit and sales volume to be 3,000 units in year 1; 10,000 units in year 2; and 1,000 units in year 3. The project has a three-year life. Variable costs amount to $3 per unit and fixed costs are $25,000 per year. The project requires an initial investment of $50,000 in assets that will be depreciated straight-line to zero over the three-year project life. The actual market value of these assets at the end of year 3 is expected to be $10,000. NWC requirements at the beginning of each year will be approximately 25 percent of the projected sales during the coming year. The tax rate is 21 percent and the required return on the project is 15 percent. What change in NWC occurs at the end of year 1? A) $11,550 B) $14,875 C) $17,500 D) $23,167 Answer: C Explanation: Sales will go from $30,000 to $100,000 between years 1 and 2, so NWC will have to increase from $7,500 to $25,000, an increase of $17,500. Difficulty: 3 Hard Topic: Change in net working capital Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 12-03 Calculate a project's expected cash flows using the free cash flow approach.

30) You are evaluating a project for your company. You estimate the sales price to be $10 per unit and sales volume to be 3,000 units in year 1; 10,000 units in year 2; and 1,000 units in year 3. The project has a three-year life. Variable costs amount to $3 per unit and fixed costs are $25,000 per year. The project requires an initial investment of $50,000 in assets that will be depreciated straight-line to zero over the three-year project life. The actual market value of these assets at the end of year 3 is expected to be $10,000. NWC requirements at the beginning of each year will be approximately 25 percent of the projected sales during the coming year. The tax rate is 21 percent and the required return on the project is 15 percent. What is the operating cash flow for the project in year 2? A) $18,700 B) $18,867 C) $39,050 D) $40,317 Answer: C Explanation: Sales −Variable costs −Fixed costs −Depreciation =EBIT −Taxes =Net income +Depreciation OCF

$ 100,000 (30,000) (25,000) (16,667) $ 28,333 (5,950) $ 22,383 16,667 $ 39,050

31) You are evaluating a project for your company. You estimate the sales price to be $25 per unit and sales volume to be 4,000 units in year 1; 7,000 units in year 2; and 1,000 units in year 3. The project has a three-year life. Variable costs amount to $10 per unit and fixed costs are $50,000 per year. The project requires an initial investment of $10,000 in assets that will be depreciated straight-line to zero over the three-year project life. The actual market value of these assets at the end of year 3 is expected to be $1,000. NWC requirements at the beginning of each year will be approximately 10 percent of the projected sales during the coming year. The tax rate is 21 percent and the required return on the project is 10 percent. What change in NWC occurs at the end of year 1? A) $1,750 B) $7,500 C) $11,550 D) $17,500 Answer: B Explanation: Sales will go from $100,000 to $175,000 between years 1 and 2, so NWC will have to increase from $10,000 to $17,500, an increase of $7,500. Difficulty: 3 Hard Topic: Change in net working capital Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 12-03 Calculate a project's expected cash flows using the free cash flow approach.

32) You are evaluating a project for your company. You estimate the sales price to be $25 per unit and sales volume to be 4,000 units in year 1; 7,000 units in year 2; and 1,000 units in year 3. The project has a three-year life. Variable costs amount to $10 per unit and fixed costs are $50,000 per year. The project requires an initial investment of $10,000 in assets that will be depreciated straight-line to zero over the three-year project life. The actual market value of these assets at the end of year 3 is expected to be $1,000. NWC requirements at the beginning of each year will be approximately 10 percent of the projected sales during the coming year. The tax rate is 21 percent and the required return on the project is 10 percent. What is the operating cash flow for the project in year 2? A) $34,100 B) $37,093 C) $44,150 D) $39,700 Answer: C Explanation: Sales −Variable costs −Fixed costs −Depreciation =EBIT −Taxes =Net income +Depreciation OCF

$ 175,000 (70,000) (50,000) (3,333) $ 51,667 (10,850) $ 40,817 3,333 $ 44,150

33) You are evaluating a product for your company. You estimate the sales price of the product to be $300 per unit and sales volume to be 8,000 units in year 1; 10,000 units in year 2; and 2,000 units in year 3. The project has a three-year life. Variable costs amount to $125 per unit and fixed costs are $150,000 per year. The project requires an initial investment of $225,000 in assets that will be depreciated straight-line to zero over the three-year project life. The actual market value of these assets at the end of year 3 is expected to be $25,000. NWC requirements at the beginning of each year will be approximately 20 percent of the projected sales during the coming year. The tax rate is 21 percent and the required return on the project is 14 percent. What will the year 2 free cash flow for this project be? A) $940,710 B) $961,500 C) $1,279,750 D) $1,759,750 Answer: D Explanation: Sales −Variable costs −Fixed costs −Depreciation =EBIT −Taxes =Net income +Depreciation =OCF −Change in NWC

3,000,000 (1,250,000) (150,000) (75,000) $ 1,525,000 (320,250) $ 1,204,750 75,000 $ 1,279,750 (480,000)*

Total free cash flow

1,759,750

* (year 2 sales 10,000 × $300 × 0.2) − (year 3 sales 2,000 × $300 × 0.2)

Difficulty: 3 Hard Topic: Free cash flow Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 12-03 Calculate a project's expected cash flows using the free cash flow approach.

34) You are evaluating a product for your company. You estimate the sales price of the product to be $375 per unit and sales volume to be 500 units in year 1; 1,000 units in year 2; and 200 units in year 3. The project has a three-year life. Variable costs amount to $200 per unit and fixed costs are $100,000 per year. The project requires an initial investment of $175,000 in assets that will be depreciated straight-line to zero over the three-year project life. The actual market value of these assets at the end of year 3 is expected to be $20,000. NWC requirements at the beginning of each year will be approximately 25 percent of the projected sales during the coming year. The tax rate is 21 percent and the required return on the project is 10 percent. What will the year 2 free cash flow for this project be? A) $8,933 B) $22,458 C) $88,167 D) $146,500 Answer: D Explanation: Sales −Variable costs −Fixed costs −Depreciation =EBIT −Taxes =Net income +Depreciation =OCF −Change in NWC

375,000 (200,000) (100,000) (58,333) $ 16,667 (3,500) $ 13,167 58,333 $ 71,500 (75,000) *

Total free cash flow

146,500

*(year 2 sales 1,000 × $375 × 0.25) − (year 3 sales 200 × $375 × 0.25)

35) You are evaluating a product for your company. You estimate the sales price of the product to be $200 per unit and sales volume to be 2,000 units in year 1; 5,000 units in year 2; and 1,000 units in year 3. The project has a three-year life. Variable costs amount to $75 per unit and fixed costs are $200,000 per year. The project requires an initial investment of $360,000 in assets that will be depreciated straight-line to zero over the three-year project life. The actual market value of these assets at the end of year 3 is expected to be $40,000. NWC requirements at the beginning of each year will be approximately 20 percent of the projected sales during the coming year. The tax rate is 21 percent and the required return on the project is 13 percent. What will the year 2 free cash flow for this project be? A) $170,412 B) $192,500 C) $201,300 D) $520,950 Answer: D Explanation: Sales −Variable costs −Fixed costs −Depreciation =EBIT −Taxes =Net income +Depreciation =OCF −Change in NWC

$ 1,000,000 (375,000) (200,000) (120,000) $ 305,000 (64,050) $ 240,950 120,000 $ 360,950 (160,000) *

Total free cash flow

520,950

* (year 2 sales 5,000 × $200 × 0.20) − (year 3 sales 1,000 × $200 × 0.20)

36) You are evaluating a product for your company. You estimate the sales price of the product to be $50 per unit and sales volume to be 50,000 units in year 1; 75,000 units in year 2; and 10,000 units in year 3. The project has a three-year life. Variable costs amount to $15 per unit and fixed costs are $100,000 per year. The project requires an initial investment of $275,000 in assets that will be depreciated straight-line to zero over the three-year project life. The actual market value of these assets at the end of year 3 is expected to be $25,000. NWC requirements at the beginning of each year will be approximately 10 percent of the projected sales during the coming year. The tax rate is 21 percent and the required return on the project is 9 percent. What will the year 2 free cash flow for this project be? A) $1,556,332 B) $1,572,667 C) $1,697,667 D) $2,339,000 Answer: D Explanation: Sales −Variable costs −Fixed costs −Depreciation =EBIT −Taxes =Net income +Depreciation =OCF −Change in NWC

3,750,000 (1,125,000) (100,000) (91,667) $ 2,433,333 (511,000) $ 1,922,333 91,667 $ 2,014,000 (325,000) *

Total free cash flow

2,339,000

* (year 2 sales 75,000 × $50 × 0.10) − (year 3 sales 10,000 × $50 × 0.10)

37) Your company is considering the purchase of a new machine. The original cost of the old machine was $100,000; it is now five years old, and it has a current market value of $40,000. The old machine is being depreciated over a 10-year life toward a zero estimated salvage value on a straight-line basis, resulting in a current book value of $50,000 and an annual depreciation expense of $10,000. The old machine can be used for six more years but has no market value after its depreciable life is over. Management is contemplating the purchase of a new machine whose cost is $80,000 and whose estimated salvage value is zero. Expected before-tax cash savings from the new machine are $13,000 a year over its full MACRS depreciable life. Depreciation is computed using MACRS over a five-year life, and the cost of capital is 10 percent. Assume a 21 percent tax rate. What will the year 1 operating cash flow for this project be? A) $2,200 B) $4,900 C) $11,530 D) $14,200 Answer: C Explanation: Net incremental variable costs Depreciation on new machine Depreciation forgone on old machine EBIT Less Tax Net income Plus Depreciation OCF

$ (13,000) $

16,000 (10,000)

6,000 7,000 (1,470) 5,530 6,000 11,530

Difficulty: 3 Hard Topic: Operating cash flow Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 12-05 Calculate free cash flows for replacement equipment.

38) Your company is considering the purchase of a new machine. The original cost of the old machine was $75,000; it is now five years old, and it has a current market value of $35,000. The old machine is being depreciated over a 10-year life toward a zero estimated salvage value on a straight-line basis, resulting in a current book value of $37,500 and an annual depreciation expense of $7,500. The old machine can be used for six more years but has no market value after its depreciable life is over. Management is contemplating the purchase of a new machine whose cost is $80,000 and whose estimated salvage value is zero. Expected before-tax cash savings from the new machine are $15,000 a year over its full MACRS depreciable life. Depreciation is computed using MACRS over a five-year life, and the cost of capital is 15 percent. Assume a 21 percent tax rate. What will the year 1 operating cash flow for this project be? A) $3,940 B) $4,480 C) $13,635 D) $16,600 Answer: C Explanation: Net incremental variable costs Depreciation on new machine Depreciation forgone on old machine EBIT Less Tax Net income Plus Depreciation OCF

$ (15,000) $ 16,000 (7,500)

8,500 6,500 (1,365) 5,135 8,500 13,635

55) Your company is considering the purchase of a new machine. The original cost of the old machine was $25,000; it is now five years old, and it has a current market value of $10,000. The old machine is being depreciated over a 10-year life toward a zero estimated salvage value on a straight-line basis, resulting in a current book value of $12,500 and an annual depreciation expense of $2,500. The old machine can be used for six more years but has no market value after its depreciable life is over. Management is contemplating the purchase of a new machine whose cost is $20,000 and whose estimated salvage value is zero. Expected before-tax cash savings from the new machine are $3,500 a year over its full MACRS depreciable life. Depreciation is computed using MACRS over a five-year life, and the cost of capital is 13 percent. Assume a 21 percent tax rate. What will the year 1 operating cash flow for this project be? A) $984 B) $1,200 C) $3,080 D) $5,000 Answer: C Explanation: Net incremental variable costs Depreciation on new machine Depreciation forgone on old machine EBIT Less Tax Net income Plus Depreciation OCF

$ (3,500) $

4,000 (2,500)

1,500 2,000 (420) 1,580 1,500 3,080

56) Your company is considering the purchase of a new machine. The original cost of the old machine was $75,000; it is now five years old, and it has a current market value of $20,000. The old machine is being depreciated over a 10-year life toward a zero estimated salvage value on a straight-line basis, resulting in a current book value of $37,500 and an annual depreciation expense of $7,500. The old machine can be used for six more years but has no market value after its depreciable life is over. Management is contemplating the purchase of a new machine whose cost is $60,000 and whose estimated salvage value is zero. Expected before-tax cash savings from the new machine are $10,000 a year over its full MACRS depreciable life. Depreciation is computed using MACRS over a five-year life, and the cost of capital is 9 percent. Assume a 21 percent tax rate. What will the year 1 operating cash flow for this project be? A) $3,300 B) $4,236 C) $8,845 D) $13,200 Answer: C Explanation: Net incremental variable costs Depreciation on new machine Depreciation forgone on old machine EBIT Less Tax Net income Plus Depreciation OCF

$ (10,000) $ 12,000 (7,500)

4,500 5,500 1,155 4,345 4,500 8,845

57) Suppose you sell a fixed asset for $99,000 when its book value is $129,000. If your company's marginal tax rate is 21 percent, what will be the effect on cash flows of this sale (i.e., what will be the after-tax cash flow of this sale)? A) $80,700 B) $105,300 C) $77,300 D) $84,800 Answer: B Explanation: 129,000 + (99,000 − 129,000) (1 − 0.21) = $105,300. Difficulty: 1 Easy Topic: Cash flows Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 12-01 Explain why we use pro forma statements to analyze project cash flows. 58) Suppose you sell a fixed asset for $112,000 when its book value is $112,000. If your company's marginal tax rate is 21 percent, what will be the effect on cash flows of this sale (i.e., what will be the after-tax cash flow of this sale)? A) $0 B) $68,320 C) $112,000 D) $34,720 Answer: C Explanation: 112,000 + (112,000 − 112,000) (1 − 0.21) = $112,000. Difficulty: 1 Easy Topic: Cash flows Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 12-01 Explain why we use pro forma statements to analyze project cash flows.

59) Your company is considering a new project that will require $100,000 of new equipment at the start of the project. The equipment will have a depreciable life of 10 years and will be depreciated to a book value of $25,000 using straight-line depreciation. The cost of capital is 11 percent, and the firm's tax rate is 21 percent. Estimate the present value of the tax benefits from depreciation. A) $34,894 B) $44,169 C) $9,276 D) $16,997 Answer: C Explanation: Step 1: Annual depreciation expense = [100,000 − 25,000]/10 = 7,500. Step 2: Tax benefit = 7,500(0.21) = 1,575. Step 3: PV of tax benefits: PMT = 1,575, FV = 0, N = 10, I = 11, => PV = 9,276. Difficulty: 1 Easy Topic: Depreciation Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 12-04 Explain how accelerated depreciation affects project cash flows. 60) Your company is considering a new project that will require $250,000 of new equipment at the start of the project. The equipment will have a depreciable life of eight years and will be depreciated to a book value of $10,000 using straight-line depreciation. The cost of capital is 12 percent, and the firm's tax rate is 21 percent. Estimate the present value of the tax benefits from depreciation. A) $63,618 B) $31,296 C) $117,733 D) $86,997 Answer: B Explanation: Step 1: Annual depreciation expense = [250,000 − 10,000]/8 = 30,000. Step 2: Tax benefit = 30,000(0.21) = 6,300. Step 3: PV of tax benefits: PMT = 6,300, FV = 0, N = 8, I = 12, => PV = 31,296. Difficulty: 1 Easy Topic: Depreciation Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 12-04 Explain how accelerated depreciation affects project cash flows.

61) Your company is considering a new project that will require $100,000 of new equipment at the start of the project. The equipment will have a depreciable life of 10 years and will be depreciated to a book value of $5,000 using straight-line depreciation. The cost of capital is 14 percent, and the firm's tax rate is 21 percent. Estimate the present value of the tax benefits from depreciation. A) $10,406 B) $14,031 C) $15,017 D) $39,147 Answer: A Explanation: Step 1: Annual depreciation expense = [100,000 − 5,000]/10 = 9,500. Step 2: Tax benefit = 9,500(0.21) = 1,995. Step 3: PV of tax benefits: PMT = 1,995, FV = 0, N = 10, I = 14, => PV = 10,406. Difficulty: 1 Easy Topic: Depreciation Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 12-04 Explain how accelerated depreciation affects project cash flows.

62) You are trying to pick the least expensive car for your new delivery service. You have two choices: the Scion xA, which will cost $15,000 to purchase and which will have OCF of −$1,600 annually throughout the vehicle's expected life of four years as a delivery vehicle; and the Toyota Prius, which will cost $27,000 to purchase and which will have OCF of −$750 annually throughout that vehicle's expected six-year life. Both cars will be worthless at the end of their life. If you intend to replace whichever type of car you choose with the same thing when its life runs out, again and again out into the foreseeable future, and if your business has a cost of capital of 10 percent, what is the EAC of the most expensive car? A) −$6,949.40 B) −$6,332.06 C) −$7,008.27 D) −$7,371.81 Answer: A Explanation: Step 1: Using financial calculator: NPV of Scion = −20,071.78, NPV of Prius = −30,266.45; Step 2: Find EAC of each: EAC of Scion: I = 10, FV = 0, PV = −20,071.78, N = 4, PMT = EAC = −$6,332.06; EAC of Prius: I = 10, N = 6, PV = −30,266.45, FV = 0, PMT = EAC = −$6,949.40 Difficulty: 2 Medium Topic: Equivalent annual costs Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 12-07 Demonstrate the EAC approach to choosing among alternative cash streams for recurring projects.

63) You are evaluating two different cookie-baking ovens. The Pillsbury 707 costs $25,000, has a six-year life, and has an annual OCF (after-tax) of −$5,000 per year. The Keebler Cookie Munster costs $40,000, has a seven-year life, and has an annual OCF (after-tax) of −$500 per year. If your discount rate is 10 percent, what is each machine's EAC? A) Pillsbury: −$11,594.9, Keebler: $8,716.22 B) Pillsbury: −$11,594.94, Keebler: −$9,145.62 C) Pillsbury: −$10,740.18, Keebler: −$9,145.62 D) Pillsbury: −$10,740.18, Keebler: −$8,716.22 Answer: D Explanation: Step 1: Using financial calculator: NPV of Pillsbury = −46,776.30, NPV of Keebler = −42,434.21. Step 2: Find EAC of each: EAC of Pillsbury: I = 10, FV = 0, PV = −46,776.30, N = 6, PMT = EAC = −$10,740.18; EAC of Keebler: I = 10, N = 7, PV = −42,434.21, FV = 0, PMT = EAC = −$8,716.22. Difficulty: 2 Medium Topic: Equivalent annual costs Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 12-04 Explain how accelerated depreciation affects project cash flows. 64) KADS, Inc., has spent $400,000 on research to develop a new computer game. The firm is planning to spend $250,000 on a machine to produce the new game. Shipping and installation costs of the machine will be capitalized and depreciated; they total $50,000. The machine has an expected life of three years, a $75,000 estimated resale value, and falls under the MACRS sevenyear class life. Revenue from the new game is expected to be $600,000 per year, with costs of $250,000 per year. The firm has a tax rate of 21 percent, an opportunity cost of capital of 15 percent, and it expects net working capital to increase by $100,000 at the beginning of the project. What will the year 0 free cash flow for this project be? A) −$400,000 B) −$350,000 C) −$250,000 D) −$300,000 Answer: A Explanation: YR0 Cash OutFlow = <250,000 + 50,000> + <100,000> = −$400,000. Difficulty: 2 Medium Topic: Free cash flow Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 12-03 Calculate a project's expected cash flows using the free cash flow approach.

65) KADS, Inc., has spent $400,000 on research to develop a new computer game. The firm is planning to spend $150,000 on a machine to produce the new game. Shipping and installation costs of the machine will be capitalized and depreciated; they total $50,000. The machine has an expected life of three years, a $75,000 estimated resale value, and falls under the MACRS sevenyear class life. Revenue from the new game is expected to be $600,000 per year, with costs of $250,000 per year. The firm has a tax rate of 21 percent, an opportunity cost of capital of 15 percent, and it expects net working capital to increase by $100,000 at the beginning of the project. What will the year 0 free cash flow for this project be? A) −$250,000 B) −$150,000 C) −$200,000 D) −$300,000 Answer: D Explanation: YR0 Cash OutFlow = <150,000 + 50,000> + <100,000> = −$300,000. Difficulty: 2 Medium Topic: Free cash flow Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 12-03 Calculate a project's expected cash flows using the free cash flow approach. 66) KADS, Inc., has spent $400,000 on research to develop a new computer game. The firm is planning to spend $250,000 on a machine to produce the new game. Shipping and installation costs of the machine will be capitalized and depreciated; they total $50,000. The machine has an expected life of three years, a $75,000 estimated resale value, and falls under the MACRS sevenyear class life. Revenue from the new game is expected to be $500,000 per year, with costs of $200,000 per year. The firm has a tax rate of 21 percent, an opportunity cost of capital of 15 percent, and it expects net working capital to increase by $100,000 at the beginning of the project. What will the year 1 operating cash flow for this project be? A) $195,000 B) $167,135 C) $246,003 D) $300,000 Answer: C Explanation: YR1 Cash Flow = [500,000 − 200,000 − (0.1429 × 300,000)] (1 − 0.21) + (0.1429 × 300,000) = 246,003. Difficulty: 2 Medium Topic: Free cash flow Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 12-03 Calculate a project's expected cash flows using the free cash flow approach. 46

67) KADS, Inc., has spent $400,000 on research to develop a new computer game. The firm is planning to spend $50,000 on a machine to produce the new game. Shipping and installation costs of the machine will be capitalized and depreciated; they total $50,000. The machine has an expected life of three years, a $75,000 estimated resale value, and falls under the MACRS fiveyear class life. Revenue from the new game is expected to be $500,000 per year, with costs of $200,000 per year. The firm has a tax rate of 21 percent, an opportunity cost of capital of 15 percent, and it expects net working capital to increase by $100,000 at the beginning of the project. What will the year 2 operating cash flow for this project be? A) $243,720 B) $174,200 C) $194,200 D) $195,000 Answer: A Explanation: YR2 Cash Flow = [500,000 − 200,000 − (0.32 × 100,000)] (1 − 0.21) + (0.32 × 100,000) = 243,720. Difficulty: 2 Medium Topic: Free cash flow Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 12-03 Calculate a project's expected cash flows using the free cash flow approach.

68) KADS, Inc., has spent $400,000 on research to develop a new computer game. The firm is planning to spend $50,000 on a machine to produce the new game. Shipping and installation costs of the machine will be capitalized and depreciated; they total $50,000. The machine has an expected life of three years, a $10,000 estimated resale value, and falls under the MACRS fiveyear class life. Revenue from the new game is expected to be $500,000 per year, with costs of $200,000 per year. The firm has a tax rate of 21 percent, an opportunity cost of capital of 15 percent, and it expects net working capital to increase by $25,000 at the beginning of the project. What will the year 3 free cash flow for this project be? A) $222,600 B) $197,400 C) $212,200 D) $279,980 Answer: D Explanation: YR3 Cash Flow = [500,000 − 200,000 − (0.192 × 100,000)] (1 − 0.21) + (0.192 × 100,000) + 25,000 + [10,000 − (10,000 − 28,800) × 0.21] = 279,980. Difficulty: 2 Medium Topic: Free cash flow Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 12-03 Calculate a project's expected cash flows using the free cash flow approach.

69) KADS, Inc., has spent $400,000 on research to develop a new computer game. The firm is planning to spend $50,000 on a machine to produce the new game. Shipping and installation costs of the machine will be capitalized and depreciated; they total $50,000. The machine has an expected life of three years, a $15,000 estimated resale value, and falls under the MACRS fiveyear class life. Revenue from the new game is expected to be $500,000 per year, with costs of $300,000 per year. The firm has a tax rate of 21 percent, an opportunity cost of capital of 15 percent, and it expects net working capital to increase by $55,000 at the beginning of the project. What will the year 3 free cash flow for this project be? A) $222,670 B) $234,930 C) $252,920 D) $243,640 Answer: B Explanation: YR3 Cash Flow = [500,000 − 300,000 − (0.192 × 100,000)] (1 − 0.21) + (0.192 × 100,000) + 55,000 + [15,000 − (15,000 − 28,800) × 0.21] = 234,930. Difficulty: 2 Medium Topic: Free cash flow Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 12-03 Calculate a project's expected cash flows using the free cash flow approach. 70) Your firm needs a computerized machine tool lathe that costs $50,000, requires $10,000 in installation, and another $12,000 in maintenance for each year of its three-year life. After three years, this machine will be replaced. The machine falls into the MACRS three-year class life category. Assume a tax rate of 21 percent and a discount rate of 12 percent. Calculate the depreciation tax shield for this project in year 1. A) $7,199.20 B) $8,886.00 C) $4,199.58 D) $6,554.40 Answer: C Explanation: (60,000) × 0.3333 = $19,998.00; $19,998 × 0.21 = $4,199.58. Difficulty: 2 Medium Topic: Depreciation Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 12-04 Explain how accelerated depreciation affects project cash flows.

71) Your firm needs a computerized machine tool lathe that costs $50,000, requires $10,000 in installation, $5,000 in freight charges, and another $12,000 in maintenance for each year of its three-year life. After three years, this machine will be replaced. The machine falls into the MACRS three-year class life category. Assume a tax rate of 21 percent and a discount rate of 12 percent. Calculate the depreciation tax shield for this project in year 1. A) $4,549.55 B) $6,886.00 C) $5,999.40 D) $21,664.50 Answer: A Explanation: (65,000) × 0.3333 = $21,664.50; $21,664.50 × 0.21 = $4,549.55. Difficulty: 2 Medium Topic: Depreciation Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 12-04 Explain how accelerated depreciation affects project cash flows. 72) Your firm needs a computerized machine tool lathe that costs $50,000, requires $10,000 in installation, $5,000 in freight charges, and another $12,000 in maintenance for each year of its three-year life. After three years, this machine will be replaced. The machine falls into the MACRS three-year class life category. Assume a tax rate of 21 percent and a discount rate of 12 percent. If the lathe can be sold for $7,000 at the end of year 3, what is the after-tax salvage value? A) $6,499.35 B) $6,541.47 C) $5,999.45 D) $4,816.50 Answer: B Explanation: (65,000) × 0.0741 = $4,816.50; $7,000 − ($7,000 − $4,816.50) × 0.21 = $6,541.47. Difficulty: 2 Medium Topic: Cash flows Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 12-04 Explain how accelerated depreciation affects project cash flows.

73) Your firm needs a computerized machine tool lathe that costs $50,000, requires $10,000 in installation, and another $12,000 in maintenance for each year of its three-year life. After three years, this machine will be replaced. The machine falls into the MACRS three-year class life category. Assume a tax rate of 21 percent and a discount rate of 12 percent. If the lathe can be sold for $7,000 at the end of year 3, what is the after-tax salvage value? A) $6,463.66 B) $4,446.00 C) $5,927.20 D) $6,154.20 Answer: A Explanation: (60,000) × 0.0741 = $4,446.00; $7,000 − ($7,000 − $4,446.00) × 0.21 = $6,463.66. Difficulty: 2 Medium Topic: Cash flows Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 12-04 Explain how accelerated depreciation affects project cash flows. 74) Your firm needs a computerized machine tool lathe that costs $50,000 and another $12,000 in maintenance for each year of its three-year life. After three years, this machine will be replaced. The machine falls into the MACRS three-year class life category. Assume a tax rate of 21 percent and a discount rate of 12 percent. If the lathe can be sold for $6,000 at the end of year 3, what is the after-tax salvage value? A) $3,705.00 B) $4,344.50 C) $5,499.50 D) $5,518.05 Answer: D Explanation: (50,000) × 0.0741 = $3,705.00; $6,000 − ($6,000 − $3,705) × 0.21 = $5,518.05. Difficulty: 2 Medium Topic: Cash flows Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 12-04 Explain how accelerated depreciation affects project cash flows.

75) You have been asked by the president of your company to evaluate the proposed acquisition of a new special-purpose truck for $50,000. The truck falls into the MACRS three-year class, and it will be sold after three years for $20,000. Use of the truck will require an increase in NWC (spare parts inventory) of $2,000. The truck will have no effect on revenues, but it is expected to save the firm $20,000 per year in before-tax operating costs, mainly labor. The firm's marginal tax rate is 21 percent. What will the free cash flows for this project be? A) Year 0 Cash flow: −$50,000; Year 1 Cash flow: $18,666; Year 2 Cash flow: $20,890; Year 3 Cash flow: $28,444 B) Year 0 Cash flow: −$50,000; Year 1 Cash flow: $18,666; Year 2 Cash flow: $21,890; Year 3 Cash flow: $28,444 C) Year 0 Cash flow: −$52,000; Year 1 Cash flow: $19,300; Year 2 Cash flow: $20,467; Year 3 Cash flow: $35,933 D) Year 0 Cash flow: −$52,500; Year 1 Cash flow: $18,666; Year 2 Cash flow: $22,890; Year 3 Cash flow: $30,944 Answer: C Explanation: Step 1: Year 0 cash outlay = <50,000> + <2,000> = −$52,000. Step 2: Year 1 cash flow = [20,000 − (50,000 × 0.3333)] (1 − 0.21) + (50,000 × 0.3333) = $19,299.65. Step 3: Year 2 cash flow = [20,000 − (50,000 × 0.4445)] (1 − 0.21) + (50,000 × 0.21445) = $20,467.25. Step 4: Year 3 cash flow = [20,000 − (50,000 × 0.1481)] (1 − 0.21) + (50,000 × 0.1481) + 2,000 + [20,000 − ((20,000 − (50,000 × 0.0741)) × 0.21] = $35,933.10. Difficulty: 2 Medium Topic: Free cash flow Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 12-06 Calculate cash flows associated with cost-cutting proposals.

76) You are evaluating a project for The Tiff-any golf club, guaranteed to correct that nasty slice. You estimate the sales price of The Tiff-any to be $375 per unit and sales volume to be 1,000 units in year 1, 1,400 units in year 2, and 1,325 units in year 3. The project has a three-year life. Variable costs amount to $225 per unit and fixed costs are $100,000 per year. The project requires an initial investment of $165,000 in assets that will be depreciated straight-line to zero over the three-year project life. The actual market value of these assets at the end of year 3 is expected to be $35,000. NWC requirements at the beginning of each year will be approximately 10 percent of the projected sales during the coming year. The tax rate is 21 percent and the required return on the project is 10 percent. What change in NWC occurs at the end of year 1? A) $25,000 B) $15,000 C) $10,000 D) $17,500 Answer: B Explanation: Step 1: Change in sales = 150,000; Increase in NWC = 150,000 × 0.1 = $15,000. Difficulty: 3 Hard Topic: Change in net working capital Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 12-03 Calculate a project's expected cash flows using the free cash flow approach.

77) You are evaluating a project for The Ultimate recreational tennis racket, guaranteed to correct that wimpy backhand. You estimate the sales price of The Ultimate to be $300 per unit and sales volume to be 1,000 units in year 1, 1,250 units in year 2, and 1,325 units in year 3. The project has a three-year life. Variable costs amount to $200 per unit and fixed costs are $50,000 per year. The project requires an initial investment of $150,000 in assets that will be depreciated straight-line to zero over the three-year project life. The actual market value of these assets at the end of year 3 is expected to be $25,000. NWC requirements at the beginning of each year will be approximately 10 percent of the projected sales during the coming year. The tax rate is 21 percent and the required return on the project is 10 percent. What will the free cash flow for this project be in year 2? A) $53,000 B) $49,950 C) $102,450 D) $107,250 Answer: D Explanation: Year 2 cash flows = [(300 × 1,250) − (200 × 1,250) − 50,000 − (150,000/3)](1 − 0.21) + 50,000 + (300 × 1250 × 0.1) = $107,250. Difficulty: 3 Hard Topic: Free cash flow Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 12-03 Calculate a project's expected cash flows using the free cash flow approach.

78) You are evaluating a project for The Ultimate recreational tennis racket, guaranteed to correct that wimpy backhand. You estimate the sales price of The Ultimate to be $300 per unit and sales volume to be 1,000 units in year 1; 1,250 units in year 2; and 1,325 units in year 3. The project has a three-year life. Variable costs amount to $200 per unit and fixed costs are $50,000 per year. The project requires an initial investment of $150,000 in assets which will be depreciated straight-line to zero over the three-year project life. The actual market value of these assets at the end of year 3 is expected to be $25,000. NWC requirements at the beginning of each year will be approximately 10 percent of the projected sales during the coming year. The tax rate is 21 percent and the required return on the project is 10 percent. What will the free cash flow for this project be in year 3? A) $142,000 B) $167,000 C) $135,175 D) $122,250 Answer: C Explanation: Year 3 cash flows = [(300 × 1,325) − (200 × 1,325) − 50,000 − (150,000/3)](1 − 0.21) + 50,000 + (300 × 1,325 × 10%) + [25,000 − ((25,000 − 0) × 0.21)] = $135,175. Difficulty: 3 Hard Topic: Free cash flow Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 12-03 Calculate a project's expected cash flows using the free cash flow approach. 79) A new project would require an immediate increase in raw materials in the amount of $12,000. The firm expects that accounts payable will automatically increase $8,500. How much must the firm expect its investment in net working capital to change if they accept this project? A) +$20,000 B) +$3,500 C) −$20,500 D) −$3,500 Answer: B Explanation: $12,000 − $8,500 = $3,500. Difficulty: 1 Easy Topic: Change in net working capital Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 12-03 Calculate a project's expected cash flows using the free cash flow approach.

80) A new project would require an immediate increase in raw materials in the amount $17,000. The firm expects that accounts payable will automatically increase $7,000. How much must thefirm expect its investment in net working capital to increase if they accept this project? A) $17,000 B) $7,000 C) $10,000 D) $24,000 Answer: C Explanation: $17,000 − $7,000 = $10,000. Difficulty: 1 Easy Topic: Change in net working capital Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 12-03 Calculate a project's expected cash flows using the free cash flow approach. 81) To correctly project cash flows, we need to consider all of the factors EXCEPT A) use of assets or employees already employed by the firm. B) the likely impact that the new service or product will have on the firm's existing products' costs and revenues. C) the new product's or service's costs and revenues. D) All of these choices are correct. Answer: D Difficulty: 1 Easy Topic: Cash flows Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 12-01 Explain why we use pro forma statements to analyze project cash flows.

82) A financial analyst calculated that the after-tax salvage value for a machine was $10,200. The current book value of the asset is $25,000 and the firm's tax rate is 20 percent. How much could the machine be sold for today? A) $6,500 B) $7,500 C) $11,500 D) $9,500 Answer: A Explanation: 10,200 = X − (X − 25,000) × 0.2; => X = Market value of asset = $6,500. Difficulty: 2 Medium Topic: Cash flows Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 12-04 Explain how accelerated depreciation affects project cash flows. 83) A financial analyst calculated that the after-tax salvage value for a machine was $10,200. The current book value of the asset is $12,000 and the firm's tax rate is 21 percent. How much could the machine be sold for today? A) $6,953.07 B) $7,151.63 C) $9,721.52 D) $9,103.49 Answer: C Explanation: 10,200 = X − ((X − 12,000) × 0.21); => 10,200 = X − 0.21X + 2,520 => X = Market value of asset = $9,721.52. Difficulty: 2 Medium Topic: Cash flows Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 12-04 Explain how accelerated depreciation affects project cash flows.

84) Which of the following statements is correct? A) A decrease in NWC involves either a reduction in current assets, which generates cash, or an increase in current liabilities, thereby freeing up the shareholder's cash for other things. B) A decrease in NWC involves either an increase in current assets, which generates cash, or a decrease in current liabilities, thereby freeing up the shareholder's cash for other things. C) An example of an increase in net working capital is to buy more machines or another plant. D) None of these choices are correct. Answer: A Difficulty: 2 Medium Topic: Change in net working capital Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 12-03 Calculate a project's expected cash flows using the free cash flow approach. 85) Which of the following statements is correct? A) Most current assets are depreciated using the MACRS depreciation calculation. B) Most large corporations use Section 179 to depreciate their assets. C) Most businesses benefit from accelerated depreciation; therefore the straight-line depreciation method is preferred by most businesses. D) None of these choices are correct. Answer: D Difficulty: 2 Medium Topic: Depreciation Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 12-04 Explain how accelerated depreciation affects project cash flows.

86) Your company is considering a project that will cost $100. The project will generate after-tax cash flows of $37.50 per year for five years. The WACC is 10 percent and the firm's D/A ratio is 0.70. The flotation cost for equity is 6 percent, the flotation cost for debt is 3 percent, and your firm does not plan on issuing any preferred stock within its capital structure. If your firm follows the practice of incorporating flotation costs into the project's initial investment, what is the firm's flotation-adjusted cash flow in year 0? A) −$90.16 B) −$104.06 C) −$96.25 D) −$102.72 Answer: B Explanation: Step 1: (0.7)(3%) + (0.3)(6%) = 3.9%; Step 2: −100/[1 − 0.039] = −104.06. Difficulty: 3 Hard Topic: Flotation costs Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 12-08 Adjust initial project investments to account for flotation costs. 87) Your company is considering a project that will cost $175. The project will generate after-tax cash flows of $37.50 per year for five years. The WACC is 10 percent and the firm's D/A ratio is 0.62. The flotation cost for equity is 5 percent, the flotation cost for debt is 3 percent, and your firm does not plan on issuing any preferred stock within its capital structure. If your firm follows the practice of incorporating flotation costs into the project's initial investment, what is the firm's flotation-adjusted cash flow in year 0? A) −$90.26 B) −$88.14 C) −$196.25 D) −$181.84 Answer: D Explanation: Step 1: (0.62)(3%) + (0.38)(5%) = 3.76%; Step 2: −175/[1 − 0.0376] = −181.84. Difficulty: 3 Hard Topic: Flotation costs Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 12-08 Adjust initial project investments to account for flotation costs.

88) Your company is considering a project that will cost $100. The project will generate after-tax cash flows of $37.50 per year for five years. The WACC is 10 percent and the firm's D/A ratio is 0.70. The flotation cost for equity is 6 percent, the flotation cost for debt is 3 percent, and your firm does not plan on issuing any preferred stock within its capital structure. If your firm follows the practice of incorporating flotation costs into the project's initial investment, what is the weighted average flotation cost for the firm? A) 2.90 percent B) 3.90 percent C) 3.30 percent D) 4.30 percent Answer: B Explanation: 0.7(3%) + 0.3(6%) = 3.9% Difficulty: 3 Hard Topic: Flotation costs Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 12-08 Adjust initial project investments to account for flotation costs. 89) Your company is considering a project that will cost $100. The project will generate after-tax cash flows of $37.50 per year for five years. The WACC is 10 percent and the firm's D/A ratio is 0.35. The flotation cost for equity is 5 percent, the flotation cost for debt is 2 percent, and your firm does not plan on issuing any preferred stock within its capital structure. If your firm follows the practice of incorporating flotation costs into the project's initial investment, what is the weighted average flotation cost for the firm? A) 2.95 percent B) 3.15 percent C) 3.95 percent D) 4.80 percent Answer: C Explanation: 0.35(2%) + 0.65(5%) = 3.95%. Difficulty: 3 Hard Topic: Flotation costs Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 12-08 Adjust initial project investments to account for flotation costs.

90) Your company is considering a project that will cost $100. The project will generate after-tax cash flows of $37.50 per year for five years. The WACC is 10 percent and the firm's D/A ratio is 0.40. The flotation cost for equity is 3 percent, the flotation cost for debt is 2 percent, and your firm does not plan on issuing any preferred stock within its capital structure. If your firm follows the practice of incorporating flotation costs into the project's initial investment, what is the weighted average flotation cost for the firm? A) 2.6 percent B) 3.2 percent C) 3.7 percent D) 4.1 percent Answer: A Explanation: 0.4(2%) + 0.6(3%) = 2.6%. Difficulty: 3 Hard Topic: Flotation costs Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 12-08 Adjust initial project investments to account for flotation costs. 91) Suppose you sell a fixed asset for $99,000 when its book value is $75,000. If your company's marginal tax rate is 39 percent, what is the gain or loss on the sale of the asset? A) $10,300 B) $11,600 C) $14,640 D) $24,000 Answer: D Explanation: $99,000 − $75,000 = $24,000. Difficulty: 1 Easy Topic: Cash flows Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 12-03 Calculate a project's expected cash flows using the free cash flow approach.

92) You are trying to pick the least expensive car for your new delivery service. You have two choices: the Scion xA, which will cost $13,000 to purchase and which will have OCF of −$1,200 annually throughout the vehicle's expected life of three years as a delivery vehicle; and the Toyota Prius, which will cost $23,000 to purchase and which will have OCF of −$550 annually throughout that vehicle's expected five-year life. Both cars will be worthless at the end of their life. If you intend to replace whichever type of car you choose with the same thing when its life runs out, again and again out into the foreseeable future, and if your business has a cost of capital of 12 percent, what is the difference in the EAC of the two cars? A) $317.88 B) $310.38 C) $413.25 D) $361.13 Answer: A Explanation: Step 1: Using financial calculator: NPV of Scion = −15882.20; NPV of Prius = −24982.63. Step 2: Find EAC of each: EAC of Scion: I = 12, FV = 0, PV = −15,882.20, N = 3, PMT = EAC = −$6,612.54; EAC of Prius: I = 12, N = 5, PV = −24,982.63, FV = 0, PMT = EAC = −$6,930.42. Step 3: Difference = 317.88. Difficulty: 1 Easy Topic: Equivalent annual costs Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 12-07 Demonstrate the EAC approach to choosing among alternative cash streams for recurring projects.

93) You are trying to pick the least expensive car for your new delivery service. You have two choices: the Scion xA, which will cost $13,000 to purchase and which will have OCF of −$1,200 annually throughout the vehicle's expected life of three years as a delivery vehicle; and the Toyota Prius, which will cost $23,000 to purchase and which will have OCF of −$550 annually throughout that vehicle's expected five-year life. Both cars will be worthless at the end of their life. If you intend to replace whichever type of car you choose with the same thing when its life runs out, again and again out into the foreseeable future, and if your business has a cost of capital of 16 percent, what is the difference in the EAC of the two cars? A) $381.36 B) $428.04 C) $586.07 D) $601.51 Answer: C Explanation: Step 1: Using financial calculator: NPV of Scion = −15695.07; NPV of Prius = −24800.86. Step 2: Find EAC of each: EAC of Scion: I = 16, FV = 0, PV = −15,695.07, N = 3, PMT = EAC = −$6,988.35; EAC of Prius: I = 16, N = 5, PV = −24,800.86, FV = 0, PMT = EAC = −$7,574.42. Step 3: Difference = 586.07. Difficulty: 1 Easy Topic: Equivalent annual costs Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 12-07 Demonstrate the EAC approach to choosing among alternative cash streams for recurring projects. 94) Due to rapid growth, a computer superstore is contemplating expanding by adding another location. Which of the following items should the financial officer NOT include in estimating the cash flow associated with this expansion? A) The company owns the land of the future site of the new location. B) The new location is expected to take sales away from the existing location. C) The company spent $100,000 six months ago in a major advertising campaign that will help the new store become profitable sooner. D) All of these choices are correct. Answer: C Difficulty: 2 Medium Topic: Cash flows Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 12-02 Identify which cash flows we can incrementally apply to a project and which ones we cannot. 63

95) ABC Engineering just bought a new machine. All of the following are examples of incremental cash flows EXCEPT A) interest expense on the loan used to purchase the machine. B) installation costs on the new machine. C) increase in costs as a result of the new machine. D) increases in depreciation expenses as a result of the new machine. Answer: A Difficulty: 2 Medium Topic: Cash flows Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 12-02 Identify which cash flows we can incrementally apply to a project and which ones we cannot. 96) Which of the following statements is correct with respect to Section 179 deductions? A) It was designed to help small businesses. B) It allows the firm to expense the asset immediately in the year of purchase. C) Most businesses can expense up to $1,000,000 of property placed in service during each year. D) All of these choices are correct. Answer: D Difficulty: 2 Medium Topic: Depreciation Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 12-04 Explain how accelerated depreciation affects project cash flows. 97) ABC Engineering just purchased a new machine. All of the following are examples of incremental cash flows EXCEPT A) freight charged to ship the machine. B) developmental costs to determine which machine would best work with their unique process. C) increase in electric bill to run the machine. D) reduction in maintenance expense associated with the new machine. Answer: B Difficulty: 2 Medium Topic: Cash flows Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 12-02 Identify which cash flows we can incrementally apply to a project and which ones we cannot. 64

98) All of the following are incremental cash flows attributable to the project EXCEPT A) opportunity costs. B) financing costs. C) substitutionary effects. D) complementary effects. Answer: B Difficulty: 1 Easy Topic: Cash flows Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 12-02 Identify which cash flows we can incrementally apply to a project and which ones we cannot. 99) Equipment was purchased for $45,000 plus $2,000 in freight charges. Installation costs were $1,500 and sales tax totaled $1,000. Hiring a special consultant to provide advice during the selection of the equipment cost $3,000. What is this asset's depreciable basis? A) $51,500 B) $49,500 C) $48,500 D) $52,500 Answer: B Explanation: $45,000 + $2,000 + $1,500 + $1,000 = $49,500. Difficulty: 1 Easy Topic: Depreciation Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 12-03 Calculate a project's expected cash flows using the free cash flow approach.

100) Equipment was purchased for $50,000 plus $2,500 in freight charges. Installation costs were $1,500 and sales tax totaled $1,000. Hiring a special consultant to provide advice during the selection of the equipment cost $3,000. What is this asset's depreciable basis? A) $55,000 B) $58,000 C) $57,000 D) $51,000 Answer: A Explanation: $50,000 + $2,500 + $1,500 + $1,000 = $55,000. Difficulty: 1 Easy Topic: Depreciation Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 12-03 Calculate a project's expected cash flows using the free cash flow approach. 101) All of the following can be included in the depreciable basis of an asset EXCEPT A) freight charges. B) installation fees. C) sales tax. D) variable costs. Answer: D Difficulty: 1 Easy Topic: Depreciation Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 12-03 Calculate a project's expected cash flows using the free cash flow approach.

102) A manufacturing firm is planning on expanding its existing operations. The expansion project is significant and will require the firm to house the expansion in a different location. The firm is considering building on a lot they own across town. The lot is currently vacant and it was paid for nearly 20 years ago. Given this information, which of the following statements is correct? A) The lot is not an incremental cash flow because it is not being utilized at this time. B) The lot is an incremental cash flow because it represents an opportunity cost. C) The lot is an incremental cash flow because it represents a sunk cost. D) The lot is not an incremental cash flow because it has already been paid for. Answer: B Difficulty: 2 Medium Topic: Cash flows Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 12-02 Identify which cash flows we can incrementally apply to a project and which ones we cannot. 103) A local bank is contemplating opening a new branch bank in a large superstore across town from their main office. It is estimated that the new branch will generate $20,000 after expenses each month. The manager wonders if all these revenues should be considered an incremental cash flow. Given this information, which of the following statements is correct? A) $20,000 is generated by the new branch bank and therefore it is an incremental cash flow. B) We would first need to assess the opportunity cost of placing a branch in a different location to answer this question. C) Some amount less than the $20,000 is incremental because of substitutionary effects. D) Some amount less than the $20,000 is incremental because of complementary effects. Answer: C Difficulty: 2 Medium Topic: Cash flows Bloom's: Remember; Understand; Evaluate AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 12-02 Identify which cash flows we can incrementally apply to a project and which ones we cannot.

104) A local bank is contemplating adding a new ATM to their lobby. They will need another phone line to provide communications that has a monthly cost of $50 per month. This is an example of A) incremental cash flow. B) sunk cost. C) complementary costs. D) none of the options. Answer: A Difficulty: 1 Easy Topic: Cash flows Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 12-02 Identify which cash flows we can incrementally apply to a project and which ones we cannot. 105) The research chemists at MegaClean created a new cleaner that keeps car and truck tires shiny and clean for one year. They believe that this product will be highly successful and will attract customers to purchase their existing line of household cleaning products. This is an example of A) substitutionary effect. B) complementary effect. C) opportunity effect. D) sunk cost. Answer: B Difficulty: 1 Easy Topic: Cash flows Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 12-02 Identify which cash flows we can incrementally apply to a project and which ones we cannot.

106) Coke is planning on marketing a new drink called Very Berry Coke which is a mixture of raspberry and blackberry flavors blended to perfection and added to the highly secret Coca-Cola formula. This new product is expected to reduce the sales of their existing product, Cherry Coke, by $10 million per year. This is an example of a A) pro forma effect. B) complementary effect. C) substitutionary effect. D) opportunity effect. Answer: C Difficulty: 1 Easy Topic: Cash flows Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 12-02 Identify which cash flows we can incrementally apply to a project and which ones we cannot. 107) AB Mining Company just commissioned a firm to identify if an unused portion of their mine contains any silver or gold at a cost of $125,000. This is an example of a(n) A) opportunity cost. B) sunk cost. C) incremental cash flow. D) relevant cash flow. Answer: B Difficulty: 1 Easy Topic: Cash flows Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 12-02 Identify which cash flows we can incrementally apply to a project and which ones we cannot.

108) An asset's cost plus the amounts you paid for items such as sales tax, freight charges, and installation and testing fees is referred to as the . A) opportunity cost B) sunk cost C) asset costing reference D) depreciable basis Answer: D Difficulty: 1 Easy Topic: Depreciation Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 12-03 Calculate a project's expected cash flows using the free cash flow approach. 109) The process of estimating expected future cash flows of a project using only the relevant parts of the balance sheet and income statements is referred to as A) substitute and complement. B) pro forma analysis. C) incremental cash flows. D) estimation and depreciation analysis. Answer: B Difficulty: 1 Easy Topic: Pro forma statements Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 12-01 Explain why we use pro forma statements to analyze project cash flows. 110) If a firm has already paid an expense or is obligated to pay one in the future, regardless of whether a particular project is undertaken, that expense is a(n) A) incremental cash outflow. B) opportunity cost. C) sunk cost. D) expensible item. Answer: C Difficulty: 1 Easy Topic: Cash flows Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 12-02 Identify which cash flows we can incrementally apply to a project and which ones we cannot. 70

111) Your firm needs a machine which costs $500,000, and requires $15,000 in maintenance for each year of its three-year life. After three years, this machine will be replaced. The machine falls into the MACRS three-year class life category. Assume a tax rate of 21 percent and a discount rate of 10 percent. If this machine can be sold for $50,000 at the end of year 3, what is the after-tax salvage value? A) $12,250.00 B) $39,769.50 C) $32,500.00 D) $47,280.50 Answer: D Explanation: The machine will have a remaining book value of 7.41% × $500,000 = $37,050. Using Equation 12−3, the after-tax cash flows from the sale of the machine will be: $37,050 + ($50,000 − $37,050) × (1 − 0.21) = $47,280.50. Difficulty: 2 Medium Topic: Cash flows Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 12-04 Explain how accelerated depreciation affects project cash flows. 112) Your firm needs a machine which costs $50,000, and requires $2,000 in maintenance for each year of its five-year life. After five years, this machine will be replaced. The machine falls into the MACRS five-year class life category. Assume a tax rate of 21 percent and a discount rate of 10 percent. If this machine can be sold for $3,000 at the end of year 5, what is the aftertax salvage value? A) $1,050.00 B) $1,872.00 C) $2,905.20 D) $2,974.80 Answer: D Explanation: The machine will have a remaining book value of 5.76 percent × $50,000 = $2,880. Using Equation 12−3, the after-tax cash flows from the sale of the machine will be: $2,880 + ($3,000 − $2,880) × (1 − 0.21) = $2,974.80. Difficulty: 2 Medium Topic: Cash flows Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 12-04 Explain how accelerated depreciation affects project cash flows.

113) Equipment was purchased for $100,000 plus $1,000 in freight charges. Installation costs were $500 and sales tax totaled $7,500. Hiring a special consultant to provide advice during the selection of the equipment cost $1,000. What is this asset's depreciable basis? A) $110,000 B) $109,000 C) $108,000 D) $107,500 Answer: B Explanation: $100,000 + $1,000 + $500 + $7,500 = $109,000. Difficulty: 1 Easy Topic: Depreciation Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 12-03 Calculate a project's expected cash flows using the free cash flow approach. 114) Equipment was purchased for $250,000 plus $500 in freight charges. Installation costs were $750 and sales tax totaled $18,750. Hiring a special consultant to provide advice during the selection of the equipment cost $500. What is this asset's depreciable basis? A) $270,500 B) $270,000 C) $269,250 D) $268,750 Answer: B Explanation: $250,000 + $500 + $750 + $18,750 = $270,000. Difficulty: 1 Easy Topic: Depreciation Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 12-03 Calculate a project's expected cash flows using the free cash flow approach.

73) You are evaluating a project for your company. You estimate the sales price to be $100 per unit and sales volume to be 5,000 units in year 1, 10,000 units in year 2, and 2,500 units in year 3. The project has a three-year life. Variable costs amount to $50 per unit and fixed costs are $75,000 per year. The project requires an initial investment of $250,000 in assets that will be depreciated straight-line to zero over the three-year project life. The actual market value of these assets at the end of year 3 is expected to be $25,000. NWC requirements at the beginning of each year will be approximately 20 percent of the projected sales during the coming year. The tax rate is 21 percent and the required return on the project is 14 percent. What change in NWC occurs at the end of year 1? A) $65,000 B) $70,000 C) $100,000 D) $250,000 Answer: C Explanation: Sales will go from $500,000 to $1,000,000 between years 1 and 2, so NWC will have to increase from $100,000 to $200,000, an increase of $100,000. Difficulty: 3 Hard Topic: Change in net working capital Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 12-03 Calculate a project's expected cash flows using the free cash flow approach.

74) You are evaluating a project for your company. You estimate the sales price to be $40 per unit and sales volume to be 2,000 units in year 1, 8,000 units in year 2, and 4,000 units in year 3. The project has a three-year life. Variable costs amount to $25 per unit and fixed costs are $20,000 per year. The project requires an initial investment of $16,000 in assets that will be depreciated straight-line to zero over the three-year project life. The actual market value of these assets at the end of year 3 is expected to be $1,000. NWC requirements at the beginning of each year will be approximately 25 percent of the projected sales during the coming year. The tax rate is 21 percent and the required return on the project is 10 percent. What change in NWC occurs at the end of year 1? A) $16,000 B) $44,000 C) $60,000 D) $90,000 Answer: C Explanation: Sales will go from $80,000 to $320,000 between years 1 and 2, so NWC will have to increase from $20,000 to $80,000, an increase of $60,000. Difficulty: 3 Hard Topic: Change in net working capital Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 12-03 Calculate a project's expected cash flows using the free cash flow approach. 117) Your firm needs a machine which costs $50,000, and requires $2,000 in maintenance for each year of its three-year life. After three years, this machine will be replaced. The machine falls into the MACRS three-year class life category. Assume a tax rate of 21 percent and a discount rate of 10 percent. What is the depreciation tax shield for this project in year 3? A) $1,555.05 B) $3,291.75 C) $4,813.25 D) $5,833.33 Answer: A Explanation: Depreciation in year 3 will be 14.81 percent × $50,000 = $7,405. This will save the firm $7,405 × 0.21 = $1,555.05 in taxes. Difficulty: 2 Medium Topic: Depreciation Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 12-04 Explain how accelerated depreciation affects project cash flows.

118) Your firm needs a machine which costs $20,000, and requires $1,000 in maintenance for each year of its three-year life. After three years, this machine will be replaced. The machine falls into the MACRS three-year class life category. Assume a tax rate of 21 percent and a discount rate of 9 percent. What is the depreciation tax shield for this project in year 3? A) $622.02 B) $1,777.20 C) $3,640.00 D) $2,339.98 Answer: A Explanation: Depreciation in year 3 will be 14.81 percent × $20,000 = $2,962. This will save the firm $2,962 × 0.21 = $622.02 in taxes. Difficulty: 2 Medium Topic: Depreciation Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 12-04 Explain how accelerated depreciation affects project cash flows. 119) A new project would require an immediate increase in raw materials in the amount of $1,000. The firm expects that accounts payable will automatically increase $800. How much must the firm expect its investment in net working capital to change if they accept this project? A) +$1,800 B) +$200 C) −$200 D) −$1,800 Answer: B Explanation: $1,000 − $800 = $200. Difficulty: 1 Easy Topic: Change in net working capital Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 12-03 Calculate a project's expected cash flows using the free cash flow approach.

120) A new project would require an immediate increase in raw materials in the amount $6,000. The firm expects that accounts payable will automatically increase $2,000. How much must the firm expect its investment in net working capital to increase if they accept this project? A) −$6,000 B) −$4,000 C) +$4,000 D) +$6,000 Answer: C Explanation: $6,000 − $2,000 = $4,000. Difficulty: 1 Easy Topic: Change in net working capital Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 12-03 Calculate a project's expected cash flows using the free cash flow approach. 121) Suppose you sell a fixed asset for $10,000 when its book value is $2,000. If your company's marginal tax rate is 21 percent, what will be the effect on cash flows of this sale (i.e., what will be the after-tax cash flow of this sale)? A) $3,680 B) $8,320 C) $420 D) $6,500 Answer: B Explanation: AT CF = $10,000 − ($10,000 − $2,000) × 0.21 = $8,320. Difficulty: 1 Easy Topic: Cash flows Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 12-03 Calculate a project's expected cash flows using the free cash flow approach.

Finance, 5e (Cornett) Chapter 13 Weighing Net Present Value and Other Capital Budgeting Criteria 1) Of the capital budgeting techniques discussed, which works equally well with normal and non-normal cash flows and with independent and mutually exclusive projects? A) Payback period B) Discounted payback period C) Modified internal rate of return D) Net present value Answer: D Difficulty: 2 Medium Topic: Net present value Bloom's: Create; Evaluate AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 13-03 Calculate and use the net present value (NPV) method for evaluating capital investment opportunities. 2) The net present value decision technique uses a statistic denominated in A) years. B) currency. C) a percentage. D) time lines. Answer: B Difficulty: 1 Easy Topic: Net present value Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 13-03 Calculate and use the net present value (NPV) method for evaluating capital investment opportunities.

3) The net present value decision technique may not be the only pertinent unit of measure if the firm is facing A) time or resource constraints. B) a labor union. C) the election of a new board of directors. D) a major investment. Answer: A Difficulty: 1 Easy Topic: Net present value Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 13-01 Analyze the logic underlying capital budgeting decision techniques. 4) When choosing a capital budgeting technique(s) to use, which of the following sub-choices is affected? A) the statistical format chosen B) the benchmark used to compare with C) computations using or not using time value of money D) all of the above Answer: D Difficulty: 1 Easy Topic: Capital Budgeting Techniques Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 13-01 Analyze the logic underlying capital budgeting decision techniques. 5) Which capital budgeting technique step in the decision process is not used to evaluate a group of independent projects? A) compute the statistic B) have a run off between the mutually exclusive projects choosing the one with the best statistic C) compare the computed statistic with the benchmark to decide to accept or reject the project. D) all of the above are used Answer: B Difficulty: 1 Easy Topic: Capital Budgeting Techniques Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 13-01 Analyze the logic underlying capital budgeting decision techniques.

6) Which of the following statements regarding payback (PB) is/are true? A) The statistic requires keeping a running subtotal of the cumulative sum of the cash flows up to the point that this sum exactly offsets the initial investment. B) Is a capital budgeting technique that generates decision rules and associated metrics for choosing projects based on how quickly they return their initial investment. C) both a and b are true D) none of the above Answer: C Difficulty: 1 Easy Topic: Payback Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 13-02 Calculate and use the payback (PB) and discounted payback (DPB) methods for valuing capital investment opportunities. 7) Which of the following statements regarding discounted payback (DPB) is/are not true? A) It ignores any cash flows that accrue after the project reaches its respective payback benchmark. B) Is a capital budgeting method that generates decision rules and associated metrics that choose projects based on how quickly they return their initial investment plus interest. C) both a and b are not true. D) none of the above. Answer: C Difficulty: 1 Easy Topic: Payback Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 13-02 Calculate and use the payback (PB) and discounted payback (DPB) methods for valuing capital investment opportunities.

8) All capital budgeting techniques A) render the same investment decision. B) use the same measurement units. C) include all crucial information. D) exclude some crucial information. Answer: D Difficulty: 2 Medium Topic: Capital budgeting Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 13-01 Analyze the logic underlying capital budgeting decision techniques. 9) Rate-based statistics represent summary cash flows, and these summaries tend to lose which two important details? A) The investment size and cash inflows that occur after the rather arbitrary testing period B) The investment size and the cash inflows that occur before the testing period C) The investment size and the cash outflows that occur before the testing period D) The investment size and the cash inflows that occur during the testing period Answer: A Difficulty: 2 Medium Topic: Capital budgeting Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 13-01 Analyze the logic underlying capital budgeting decision techniques. 10) Which of the following is a technique for evaluating capital projects that tells how long it will take a firm to earn back the money invested in a project? A) Payback B) Internal rate of return C) Net present value D) Profitability index Answer: A Difficulty: 1 Easy Topic: Payback Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 13-02 Calculate and use the payback (PB) and discounted payback (DPB) methods for valuing capital investment opportunities.

11) Which of the following is a technique for evaluating capital projects that tells how long it will take a firm to earn back the money invested in a project plus interest at market rates? A) Payback B) Discounted payback C) Net present value D) Profitability index Answer: B Difficulty: 1 Easy Topic: Discounted payback Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 13-02 Calculate and use the payback (PB) and discounted payback (DPB) methods for valuing capital investment opportunities. 12) Which of the following is a technique for evaluating capital projects that is particularly useful when firms face time constraints in repaying investors? A) Payback B) Internal rate of return C) Net present value D) Profitability index Answer: A Difficulty: 1 Easy Topic: Payback Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 13-02 Calculate and use the payback (PB) and discounted payback (DPB) methods for valuing capital investment opportunities.

13) Neither payback period nor discounted payback period techniques for evaluating capital projects account for A) time value of money. B) market rates of return. C) cash flows that occur after payback. D) cash flows that occur during payback. Answer: C Difficulty: 1 Easy Topic: Discounted payback Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 13-02 Calculate and use the payback (PB) and discounted payback (DPB) methods for valuing capital investment opportunities. 14) When choosing between two mutually exclusive projects using the payback period method for evaluating capital projects, one would choose A) either project if they both are more than managers' maximum payback period. B) neither project if they both are less than managers' maximum payback period. C) the project that pays back the soonest. D) the project that pays back the soonest if it is equal to or less than managers' maximum payback period. Answer: D Difficulty: 1 Easy Topic: Mutually exclusive projects Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 13-02 Calculate and use the payback (PB) and discounted payback (DPB) methods for valuing capital investment opportunities.

15) Which rate-based decision statistic measures the excess return (the amount above and beyond the cost of capital for a project), rather than the gross return? A) Internal rate of return (IRR) B) Modified internal rate of return (MIRR) C) Profitability index (PI) D) Net present value (NPV) Answer: C Difficulty: 1 Easy Topic: Profitability index Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 13-06 Compute and use the profitability index (PI). 16) The benchmark for the profitability index (PI) is the A) cost of capital. B) managers' maximum number of years. C) zero or anything larger than zero. D) zero or anything less than zero. Answer: C Difficulty: 1 Easy Topic: Profitability index Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 13-06 Compute and use the profitability index (PI). 17) Which of these describe groups or pairs of projects where you can accept one but not all? A) Dependent B) Independent C) Mutually exclusive D) Mutually dependent Answer: C Difficulty: 1 Easy Topic: Mutually exclusive projects Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 13-01 Analyze the logic underlying capital budgeting decision techniques.

18) Which of these are sets of cash flows where all the initial cash flows are negative and all the subsequent ones are either zero or positive? A) Expected cash flows B) Time line cash flows C) Non-normal cash flows D) Normal cash flows Answer: D Difficulty: 1 Easy Topic: Cash flows Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 13-01 Analyze the logic underlying capital budgeting decision techniques. 19) Which of these is a capital budgeting technique that generates a decision rule and associated metric for choosing projects based on the total discounted value of their cash flows? A) Discounted payback B) Net present value C) Internal rate of return D) Profitability index Answer: B Difficulty: 1 Easy Topic: Net present value Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 13-05 Use NPV profiles to reconcile sources of conflict between NPV and IRR methods. 20) is a decision making process that includes the cost of capital calculation? A) Interest-rate cognizant B) Net present value C) Internal rate of return D) modified internal rate of return Answer: A Difficulty: 1 Easy Topic: Net present value Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 13-05 Use NPV profiles to reconcile sources of conflict between NPV and IRR methods.

21) is a decision rule and associated methodology for converting the net present value statistic into a rate-based metric. A) Profitability index B) payback method C) Internal rate of return D) modified internal rate of return Answer: A Difficulty: 1 Easy Topic: Profitability index Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 13-06 Compute and use the profitability index (PI). 22) Which of these is a capital budgeting technique that generates decision rules and associated metrics for choosing projects based upon the implicit expected geometric average of a project's rate of return? A) Discounted payback B) Net present value C) Internal rate of return D) Profitability index Answer: C Difficulty: 1 Easy Topic: Internal rate of return Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 13-04 Calculate and use the internal rate of return (IRR) and the modified internal rate of return (MIRR) methods for evaluating capital investment opportunities.

23) Which of the following is a capital budgeting technique that converts a project's cash flows using a more consistent reinvestment rate prior to applying the internal rate of return, IRR, decision rule? A) Discounted payback B) Net present value C) Modified internal rate of return D) Profitability index Answer: C Difficulty: 1 Easy Topic: Modified internal rate of return Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 13-04 Calculate and use the internal rate of return (IRR) and the modified internal rate of return (MIRR) methods for evaluating capital investment opportunities. 24) A graph of a project's A) internal rate of return B) net present value C) modified internal rate of return D) all of these choices are correct

is a function of cost of capital.

Answer: B Difficulty: 2 Medium Topic: Net present value Bloom's: Create; Evaluate AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 13-03 Calculate and use the net present value (NPV) method for evaluating capital investment opportunities.

25) Compute the NPV for Project X and accept or reject the project with the cash flows shown as follows if the appropriate cost of capital is 10 percent.

Time: Cash flow:

0 −75

1 −75

2 0

3 100

4 75

5 50

A) $12.93 B) $14.22 C) $62.07 D) $136.90 Answer: B Explanation: −75 CFO −75 CF1, 1 F1 0 CF2, 1 F2 100 CF3, 1 F3 75 CF4, 1 F4 50 CF5, 1 F5 10 I Difficulty: 1 Easy Topic: Net present value; NPV with Normal Cash Flows Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 13-03 Calculate and use the net present value (NPV) method for evaluating capital investment opportunities.

26) Compute the NPV for Project X with the cash flows shown as follows if the appropriate cost of capital is 9 percent.

Time: Cash flow:

0 −1,000

1 −75

2 100

3 100

4 0

5 2,000

A) −$639.96 B) $360.04 C) $392.44 D) $486.29 Answer: C Explanation: Using the financial calculator: NPV = 392.44 −1,000 CFO 75 CF1, 1 F1 100 CF2, 2 F2 0 CF3, 1 F3 2,000 CF4, 1 F4 9I Difficulty: 1 Easy Topic: Net present value Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 13-03 Calculate and use the net present value (NPV) method for evaluating capital investment opportunities.

13) Compute the payback statistic for Project X and recommend whether the firm should accept or reject the project with the cash flows shown as follows if the appropriate cost of capital is 10 percent and the maximum allowable payback is five years.

Time: Cash flow:

0 −75

1 −75

2 0

3 100

4 75

4 25

5 75

5 50

A) 3.67 years, accept B) 4.67 years, accept C) 3.67 years, reject D) 4.67 years, reject Answer: A Explanation: Time: Cumulative Cash flow:

0 −75

1 2 −150 −150

3 −50

3 + (50/75) = 3.67 years. Difficulty: 1 Easy Topic: Payback Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 13-02 Calculate and use the payback (PB) and discounted payback (DPB) methods for valuing capital investment opportunities.

14) Compute the payback statistic for Project X and recommend whether the firm should accept or reject the project with the cash flows shown as follows if the appropriate cost of capital is 9 percent and the maximum allowable payback is four years.

Time: Cash flow:

0 −1,000

1 −75

2 100

3 100

4 0

5 2,000

A) 3.4375 years, accept B) 3.78 years, reject C) 4.4375 years, reject D) 4.78 years, accept Answer: C Explanation: Time: Cumulative Cash flow:

0 −1,000

−1,075 −975 −875 −875

1,125

4 + (875/2,000) = 4.4375 years. Difficulty: 1 Easy Topic: Payback Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 13-02 Calculate and use the payback (PB) and discounted payback (DPB) methods for valuing capital investment opportunities.

29) Compute the payback statistic for Project Y and recommend whether the firm should accept or reject the project with the cash flows shown as follows if the appropriate cost of capital is 11 percent and the maximum allowable payback is one year.

Time: Cash flow:

0 −100

1 75

2 100

1 −25

2 75

3 300

4 75

5 200

A) 1.25 years, reject B) 1.25 years, accept C) 1.33 years, accept D) 2.25 years, accept Answer: A Explanation: Time: Cumulative Cash flow:

0 −100

3 375

4 450

5 650

1 + (25/100) = 1.25 years. Difficulty: 1 Easy Topic: Payback Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 13-02 Calculate and use the payback (PB) and discounted payback (DPB) methods for valuing capital investment opportunities.

30) Compute the discounted payback statistic for Project X and recommend whether the firm should accept or reject the project with the cash flows shown as follows if the appropriate cost of capital is 10 percent and the maximum allowable discounted payback is three years.

Time: Cash flow:

0 −1,000

1 500

2 480

3 400

4 300

5 150

A) 2.49 years, accept B) 2.98 years, accept C) 3.49 years, reject D) 4.98 years, reject Answer: A Explanation: Time: Disc'd Cash flow Cumulative Cash flow:

0 −1,000 −1,000

1 454.55 −545.45

2 396.69 −148.76

3 300.53 151.77

2 + 148.76/300.53 = 2.49. Difficulty: 1 Easy Topic: Discounted payback Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 13-02 Calculate and use the payback (PB) and discounted payback (DPB) methods for valuing capital investment opportunities.

31) Compute the discounted payback statistic for Project Y and recommend whether the firm should accept or reject the project with the cash flows shown as follows if the appropriate cost of capital is 12 percent and the maximum allowable discounted payback is three years.

Time: Cash flow:

0 −5,000

1 500

2 2,000

3 3,000

4 1,500

0 −5,000

1 446.43

2 1,594.39

3 4 2,135.34 953.28

−5,000

−4,553.57

−2,959.18

−823.84 129.44

5 500

A) 3.45 years, reject B) 3.86 years, reject C) 3.45 years, accept D) 3.86 years, accept Answer: B Explanation: Time: Disc'd Cash flow Cumulative Cash flow:

3 + 823.84/953.28 = 3.86. Difficulty: 1 Easy Topic: Discounted payback Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 13-02 Calculate and use the payback (PB) and discounted payback (DPB) methods for valuing capital investment opportunities.

32) Compute the IRR statistic for Project X and note whether the firm should accept or reject the project with the cash flows shown as follows if the appropriate cost of capital is 10 percent.

Time: Cash flow:

0 −75

1 −75

2 0

3 100

4 75

5 50

A) 10 percent, accept B) 10 percent, reject C) 13.26 percent, accept D) 13.26 percent, reject Answer: C Explanation: −75 CFO −75 CF1, 1 F1 0 CF2, 1 F2 100 CF3, 1 F3 75 CF4, 1 F4 50 CF5, 1 F5 Difficulty: 1 Easy Topic: Internal rate of return Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 13-04 Calculate and use the internal rate of return (IRR) and the modified internal rate of return (MIRR) methods for evaluating capital investment opportunities.

33) Compute the IRR for Project X and note whether the firm should accept or reject the project with the cash flows shown as follows if the appropriate cost of capital is 9 percent.

Time: Cash flow:

0 −1,000

1 −75

2 100

3 100

4 0

5 2,000

A) 9 percent, accept B) 9 percent, reject C) 16.61 percent, accept D) 16.61 percent, reject Answer: C Explanation: −1,000 CFO −75 CF1, 1 F1 100 CF2, 2 F2 0 CF3, 1 F3 2,000 CF4, 1 F4 Difficulty: 1 Easy Topic: Internal rate of return Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 13-04 Calculate and use the internal rate of return (IRR) and the modified internal rate of return (MIRR) methods for evaluating capital investment opportunities.

34) Compute the MIRR statistic for Project X and note whether the firm should accept or reject the project with the cash flows shown as follows if the appropriate cost of capital is 10 percent.

Time: Cash flow:

0 −175

1 75

2 0

3 100

4 75

5 50

A) 13.26 percent, accept B) 13.89 percent, accept C) 13.26 percent, reject D) 15.73 percent, accept Answer: D Explanation: Step 1: 0 CFO 75 CF1, 1 F1 0 CF2, 1 F2 100 CF3, 1 F3 75 CF4, 1 F4 50 CF5, 1 F5 10 I NPV 225.59 Step 2: 225.59 PV 0 PMT 5N 10 I FV 363.31 Step 3: −175 PV 0 PMT 5N 363.31 FV I 15.73 Difficulty: 1 Easy Topic: Modified internal rate of return Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 13-04 Calculate and use the internal rate of return (IRR) and the modified internal rate of return (MIRR) methods for evaluating capital investment opportunities.

35) Compute the MIRR for Project Y and accept or reject the project with the cash flows shown as follows if the appropriate cost of capital is 12 percent.

Time: Cash flow:

0 −5,000

1 1,000

2 1,000

3 0

4 2,000

5 2,000

A) 7.62 percent, accept B) 7.62 percent, reject C) 47.09 percent, accept D) 47.09 percent, reject Answer: B Explanation: Step 1: 0 CFO 1,000 CF1, 2 F1 0 CF2, 1 F2 2,000 CF3, 2 F3 12 I NPV 4,095.94 Step 2: 4,095.94 PV 0 PMT 5N 12 I FV 7,218.45 Step 3: −5,000 PV 0 PMT 5N FV 7,218.45 I 7.62 Difficulty: 1 Easy Topic: Modified internal rate of return Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 13-04 Calculate and use the internal rate of return (IRR) and the modified internal rate of return (MIRR) methods for evaluating capital investment opportunities.

22) Compute the PI statistic for Project X and note whether the firm should accept or reject the project with the cash flows shown as follows if the appropriate cost of capital is 10 percent.

Time: Cash flow:

0 −75

1 −75

2 0

3 100

A) 10 percent, reject B) 14.22 percent, accept C) 13.26 percent, accept D) 18.96 percent, accept Answer: D Explanation: −75 CFO −75 CF1, 1 F1 0 CF2, 1 F2 100 CF3, 1 F3 75 CF4, 1 F4 50 CF5, 1 F5 10 I NPV 14.22 $14.22/$75 = .1896 = 18.96 percent Difficulty: 1 Easy Topic: Profitability index Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 13-06 Compute and use the profitability index (PI).

4 75

5 50

23) Compute the PI statistic for Project X and note whether the firm should accept or reject the project with the cash flows shown as follows if the appropriate cost of capital is 10 percent.

Time: Cash flow:

0 −250

1 75

2 0

3 100

A) −0.0977 percent, reject B) −9.77 percent, reject C) −24.41 percent, reject D) 24.41 percent, accept Answer: B Explanation: −250 CFO 75 CF1, 1 F1 0 CF2, 1 F2 100 CF3, 1 F3 75 CF4, 1 F4 50 CF5, 1 F5 10 I NPV −24.41 −$24.41/$250 = −0.0977 = −9.77 percent Difficulty: 1 Easy Topic: Profitability index Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 13-06 Compute and use the profitability index (PI).

4 75

5 50

24) Suppose your firm is considering investing in a project with the cash flows shown as follows, that the required rate of return on projects of this risk class is 8 percent, and that the maximum allowable payback and discounted payback statistic for the project are three and three and a half years, respectively.

Time Cash Flow

0 −100,000

1 30,000

2 45,000

3 55,000

4 30,000

5 10,000

Use the payback decision rule to evaluate this project; should it be accepted or rejected? A) 2.45 years, accept B) 2.83 years, accept C) 3.45 years, accept D) 3.83 years, reject Answer: A Explanation: Time: Cumulative Cash flow:

0 −100,000

1 −70,000

2 −25,000

3 30,000

2 + 25,000/55,000 = 2.45 years Difficulty: 2 Medium Topic: Payback Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 13-02 Calculate and use the payback (PB) and discounted payback (DPB) methods for valuing capital investment opportunities.

25) Suppose your firm is considering investing in a project with the cash flows shown as follows, that the required rate of return on projects of this risk class is 8 percent, and that the maximum allowable payback and discounted payback statistic for the project are three and three and a half years, respectively.

Time Cash Flow

0 −100,000

1 30,000

2 45,000

3 55,000

4 30,000

5 10,000

Use the discounted payback decision rule to evaluate this project; should it be accepted or rejected? A) 1.23 years, accept B) 2.45 years, accept C) 2.77 years, accept D) 5.36 years, reject Answer: C Explanation: Time: Disc'd Cash flow Cumulative Cash flow:

−100,000

27,777.78

38,580.25 43,660.77 22,050.90 6,805.83

−100,000 −72,222.22 −33,641.97 10,018.80

2 + (33,641.97/43,660.77) = 2.77 years. Difficulty: 2 Medium Topic: Discounted payback Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 13-02 Calculate and use the payback (PB) and discounted payback (DPB) methods for valuing capital investment opportunities.

26) Suppose your firm is considering investing in a project with the cash flows shown as follows, that the required rate of return on projects of this risk class is 8 percent, and that the maximum allowable payback and discounted payback statistic for the project are three and three and a half years, respectively.

Time Cash Flow

0 −100,000

1 30,000

2 45,000

3 55,000

4 30,000

5 10,000

Use the IRR decision rule to evaluate this project; should it be accepted or rejected? A) −4.95 percent, reject B) 4.95 percent, accept C) −23.18 percent, reject D) 23.18 percent, accept Answer: D Explanation: −100,000 CFO 30,000 CF1, 1 F1 45,000 CF2, 1 F2 55,000 CF3, 1 F3 30,000 CF4, 1 F4 10,000 CF5, 1 F5 Difficulty: 2 Medium Topic: Internal rate of return Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 13-04 Calculate and use the internal rate of return (IRR) and the modified internal rate of return (MIRR) methods for evaluating capital investment opportunities.

27) Suppose your firm is considering investing in a project with the cash flows shown as follows, that the required rate of return on projects of this risk class is 8 percent, and that the maximum allowable payback and discounted payback statistic for the project are three and three and a half years, respectively. Time Cash Flow

0 −100,000

1 30,000

2 45,000

3 55,000

4 30,000

5 10,000

Use the MIRR decision rule to evaluate this project; should it be accepted or rejected? A) −10.60 percent, reject B) 10.60 percent, accept C) −15.33 percent, reject D) 15.33 percent, accept Answer: D Explanation: Step 1: 0 CFO 30,000 CF1, 1 F1 45,000 CF2, 1 F2 55,000 CF3, 1 F3 30,000 CF4, 1 F4 10,000 CF5, 1 F5 8I NPV 138,875.53 Step 2: 138,875.53 PV 0 PMT 5N 8I FV 204,053.71 Step 3: −100,000 PV 0 PMT 5N 204,053.71 FV I 15.33 Difficulty: 2 Medium Topic: Modified internal rate of return Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 13-04 Calculate and use the internal rate of return (IRR) and the modified internal rate of return (MIRR) methods for evaluating capital investment opportunities. 27

42) Suppose your firm is considering investing in a project with the cash flows shown as follows, that the required rate of return on projects of this risk class is 8 percent, and that the maximum allowable payback and discounted payback statistic for the project are three and three and a half years, respectively.

Time Cash Flow

0 −100,000

1 30,000

2 45,000

3 55,000

4 30,000

5 10,000

Use the NPV decision rule to evaluate this project; should it be accepted or rejected? A) $35,995.86, reject B) $38,875.53, accept C) $138,875.53, accept D) $238,875.53, accept Answer: B Explanation: −100,000 CFO 30,000 CF1, 1 F1 45,000 CF2, 1 F2 55,000 CF3, 1 F3 30,000 CF4, 1 F4 10,000 CF5, 1 F5 8I NPV 38,875.53 Difficulty: 2 Medium Topic: Net present value Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 13-03 Calculate and use the net present value (NPV) method for evaluating capital investment opportunities.

29) Suppose your firm is considering investing in a project with the cash flows shown as follows, that the required rate of return on projects of this risk class is 8 percent, and that the maximum allowable payback and discounted payback statistic for the project are three and three and a half years, respectively.

Time Cash Flow

0 −100,000

1 30,000

2 45,000

3 55,000

4 30,000

5 10,000

Use the PI decision rule to evaluate this project; should it be accepted or rejected? A) −0.39 percent, reject B) 0.39 percent, accept C) −38.88 percent, reject D) 38.88 percent, accept Answer: D Explanation: −100,000 CFO 30,000 CF1, 1 F1 45,000 CF2, 1 F2 55,000 CF3, 1 F3 30,000 CF4, 1 F4 10,000 CF5, 1 F5 8I NPV 38,875.53 $38,875.53/$100,000 = 0.3888 = 38.88%. Difficulty: 2 Medium Topic: Profitability index Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 13-06 Compute and use the profitability index (PI).

30) Suppose your firm is considering investing in a project with the cash flows shown as follows, that the required rate of return on projects of this risk class is 12 percent, and that the maximum allowable payback and discounted payback statistic for the project are two and two and a half years, respectively.

Time Cash Flow

0 −125,000

1 65,000

2 78,000

3 105,000

4 105,000

5 25,000

Use the payback decision rule to evaluate this project; should it be accepted or rejected? A) 0.23 years, accept B) 1.77 years, accept C) 2 years, accept D) 4.33 years, reject Answer: B Explanation: Time: Cumulative Cash flow:

0 −125,000

1 −60,000

2 18,000

1 + (60,000/78,000) = 1.77 years. Difficulty: 2 Medium Topic: Payback Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 13-02 Calculate and use the payback (PB) and discounted payback (DPB) methods for valuing capital investment opportunities.

31) Suppose your firm is considering investing in a project with the cash flows shown as follows, that the required rate of return on projects of this risk class is 12 percent, and that the maximum allowable payback and discounted payback statistic for the project are two and two and a half years, respectively.

Time Cash Flow

0 −125,000

1 65,000

2 78,000

3 105,000

4 105,000

5 25,000

Use the discounted payback decision rule to evaluate this project; should it be accepted or rejected? A) 1.77 years, reject B) 1.94 years, accept C) 2.06 years, accept D) 3.00 years, reject Answer: C Explanation: Time: Disc'd Cash flow Cumulative Cash flow:

0 −125,000

1 58,035.71

2 3 62,181.12 74,736.93

−125,000 −66,964.29

−4,783.17 69,953.76

2 + (4,783.17/74,736.93) = 2.06 years. Difficulty: 2 Medium Topic: Discounted payback Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 13-02 Calculate and use the payback (PB) and discounted payback (DPB) methods for valuing capital investment opportunities.

32) Suppose your firm is considering investing in a project with the cash flows shown as follows, that the required rate of return on projects of this risk class is 12 percent, and that the maximum allowable payback and discounted payback statistic for the project are two and two and a half years, respectively.

Time Cash Flow

0 −125,000

1 65,000

2 78,000

3 105,000

4 105,000

5 25,000

Use the MIRR decision rule to evaluate this project; should it be accepted or rejected? A) 12.00 percent, reject B) 31.21 percent, accept C) 54.22 percent, accept D) 80.67 percent, accept Answer: B Explanation: Step 1: −125,000 CFO 65,000 CF1, 1 F1 78,000 CF2, 1 F2 105,000 CF3, 2 F3 25,000 CF4, 1 F4 12 I NPV 275,868.83 Step 2: 275,868.83 PV 0 PMT 5N 12 I FV 486,175.14 Step 3: −125,000 PV 0 PMT 5N FV 486,175.14 I 31.21 percent Difficulty: 2 Medium Topic: Modified internal rate of return Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 13-04 Calculate and use the internal rate of return (IRR) and the modified internal rate of return (MIRR) methods for evaluating capital investment opportunities. 32

47) Suppose your firm is considering investing in a project with the cash flows shown as follows, that the required rate of return on projects of this risk class is 12 percent, and that the maximum allowable payback and discounted payback statistic for the project are two and two and a half years, respectively.

Time Cash Flow

0 −125,000

1 65,000

2 78,000

3 105,000

4 105,000

5 25,000

Use the NPV decision rule to evaluate this project; should it be accepted or rejected? A) $9,704.31, reject B) $84,140.71, accept C) $134,704.31, accept D) $150,868.83, accept Answer: D Explanation: −125,000 CFO 65,000 CF1, 1 F1 78,000 CF2, 1 F2 105,000 CF3, 2 F3 105,000 CF4, 2 F4 25,000 CF5, 1 F5 12 I NPV $150,868.83 Difficulty: 2 Medium Topic: Net present value Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 13-03 Calculate and use the net present value (NPV) method for evaluating capital investment opportunities.

48) Suppose your firm is considering investing in a project with the cash flows shown as follows, that the required rate of return on projects of this risk class is 12 percent, and that the maximum allowable payback and discounted payback statistic for the project are two and two and a half years, respectively.

Time Cash Flow

0 −125,000

1 65,000

2 78,000

3 105,000

4 105,000

5 25,000

Use the PI decision rule to evaluate this project; should it be accepted or rejected? A) −1.21 percent, reject B) 1.08 percent, accept C) 1.21 percent, accept D) 121 percent, accept Answer: D Explanation: −125,000 CFO 65,000 CF1, 1 F1 78,000 CF2, 1 F2 105,000 CF3, 2 F3 105,000 CF4, 2 F4 25,000 CF5, 1 F5 12 I NPV $150,868.83 $150,868.83/$125,000 = 1.21 = 121 percent. Difficulty: 2 Medium Topic: Profitability index Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 13-06 Compute and use the profitability index (PI).

35) Suppose your firm is considering two mutually exclusive, required projects with the cash flows shown as follows. The required rate of return on projects of both of their risk class is 10 percent, and the maximum allowable payback and discounted payback statistic for the projects are two and a half and three and a half years, respectively.

Time Project A Cash Flow Project B Cash Flow

0 −1,000 −500

2 300 200

3 400 400

700 300

Use the payback decision rule to evaluate these projects; which one(s) should be accepted or rejected? A) Accept both A and B B) Accept neither A nor B C) Accept A, reject B D) Reject A, accept B Answer: D Explanation: Time: Cumulative Cash Flow A: Cumulative Cash Flow B:

0 −1,000 −500

1 −700 −300

2 −300 100

3 400 400

Cumulative Cash Flow A: 2 + (300/700) = 2.43 years. Cumulative Cash Flow B: 1 + (300/400) = 1.75 years. Difficulty: 2 Medium Topic: Payback Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 13-02 Calculate and use the payback (PB) and discounted payback (DPB) methods for valuing capital investment opportunities.

36) Suppose your firm is considering two mutually exclusive, required projects with the cash flows shown as follows. The required rate of return on projects of both of their risk class is 10 percent, and the maximum allowable payback and discounted payback statistic for the projects are two and a half and three and a half years, respectively.

Time Project A Cash Flow Project B Cash Flow

0 −1,000 −500

2 300 200

3 400 400

700 300

Use the discounted payback decision rule to evaluate these projects; which one(s) should be accepted or rejected? A) Accept both A and B B) Accept neither A nor B C) Accept A, reject B D) Reject A, accept B Answer: D Explanation: Time: Disc'd Cash flow A: Cumulative Cash flow A:

0 −1,000 −1,000

1 272.73 −727.27

2 330.58 −396.69

3 525.92 129.23

0 −500 −500

1 181.82 −318.18

2 330.58 12.40

3 225.39 237.79

2 + (396.69/525.92) = 2.75 years.

Time: Disc'd Cash flow B: Cumulative Cash flow B:

1 + (318.18/330.58) = 1.96 years. Difficulty: 2 Medium Topic: Discounted payback Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 13-02 Calculate and use the payback (PB) and discounted payback (DPB) methods for valuing capital investment opportunities.

37) Suppose your firm is considering two mutually exclusive, required projects with the cash flows shown as follows. The required rate of return on projects of both of their risk class is 10 percent, and the maximum allowable payback and discounted payback statistic for the projects are two and a half and three and a half years, respectively.

Time Project A Cash Flow Project B Cash Flow

0 −1,000 −500

2 300 200

3 400 400

700 300

Use the IRR decision rule to evaluate these projects; which one(s) should be accepted or rejected? A) Accept both A and B B) Accept neither A nor B C) Accept A, reject B D) Reject A, accept B Answer: D Explanation: A: −1,000 CFO 300 CF1, 1 F1 400 CF2, 1 F2 700 CF3, 1 F3 I = 16.23% B: −500 CFO 200 CF1, 1 F1 400 CF2, 1 F2 300 CF3, 1 F3 I = 33.55% Difficulty: 2 Medium Topic: Internal rate of return Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 13-05 Use NPV profiles to reconcile sources of conflict between NPV and IRR methods.

38) Suppose your firm is considering two mutually exclusive, required projects with the cash flows shown as follows. The required rate of return on projects of both of their risk class is 10 percent, and the maximum allowable payback and discounted payback statistic for the projects are two and a half and three and a half years, respectively.

Time Project A Cash Flow Project B Cash Flow

0 −1,000 −500

2 300 200

3 400 400

700 300

Use the MIRR decision rule to evaluate these projects; which one(s) should be accepted or rejected? A) Accept both A and B B) Accept neither A nor B C) Accept A, reject B D) Reject A, accept B Answer: D Explanation: A: Step 1: 0 CFO 300 CF1, 1 F1 400 CF2, 1 F2 700 CF3, 1 F3 10 I NPV 1,129.23 Step 2: 1,129.23 PV 0 PMT 3N 10 I FV 1,503.01 Step 3: −1,000 PV 0 PMT 3N FV 1,503.01 I = 14.55

B: Step 1: 0 CFO 200 CF1, 1 F1 400 CF2, 1 F2 300 CF3, 1 F3 10 I NPV 737.79 Step 2: 737.79 PV 0 PMT 3N 10 I FV 982.00 Step 3: −500 PV 0 PMT 3N FV 982.00 I = 25.23 Difficulty: 2 Medium Topic: Modified internal rate of return Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 13-05 Use NPV profiles to reconcile sources of conflict between NPV and IRR methods.

40) Suppose your firm is considering two mutually exclusive, required projects with the cash flows shown as follows. The required rate of return on projects of both of their risk class is 10 percent, and the maximum allowable payback and discounted payback statistic for the projects are two and a half and three and a half years, respectively.

Time Project A Cash Flow Project B Cash Flow

0 −1,000 −500

2 300 200

3 400 400

700 300

Use the NPV decision rule to evaluate these projects; which one(s) should be accepted or rejected? A) Accept both A and B B) Accept neither A nor B C) Accept A, reject B D) Reject A, accept B Answer: D Explanation: A: −1,000 CFO 300 CF1, 1 F1 400 CF2, 1 F2 700 CF3, 1 F3 10 I NPV 129.23 B: −500 CFO 200 CF1, 1 F1 400 CF2, 1 F2 300 CF3, 1 F3 10 I NPV 237.79 Difficulty: 2 Medium Topic: Net present value Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 13-03 Calculate and use the net present value (NPV) method for evaluating capital investment opportunities.

41) Suppose your firm is considering two mutually exclusive, required projects with the cash flows shown as follows. The required rate of return on projects of both of their risk class is 10 percent, and the maximum allowable payback and discounted payback statistic for the projects are two and a half and three and a half years, respectively.

Time Project A Cash Flow Project B Cash Flow

0 −1,000 −500

2 300 200

3 400 400

700 300

Use the PI decision rule to evaluate these projects; which one(s) should be accepted or rejected? A) Accept both A and B B) Accept neither A nor B C) Accept A, reject B D) Reject A, accept B Answer: D Explanation: A: −1,000 CFO 300 CF1, 1 F1 400 CF2, 1 F2 700 CF3, 1 F3 10 I NPV 129.23 B: −500 CFO 200 CF1, 1 F1 400 CF2, 1 F2 300 CF3, 1 F3 10 I NPV 237.79 Project A: $129.23/$1,000 = 0.12923 = 12.92 percent. Project B: $237.79/$500 = 0.47558 = 47.56 percent. Difficulty: 2 Medium Topic: Profitability index Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 13-06 Compute and use the profitability index (PI).

42) Suppose your firm is considering two mutually exclusive, required projects with the cash flows shown as follows. The required rate of return on projects of both of their risk class is 8 percent, and the maximum allowable payback and discounted payback statistic for the projects are two and three years, respectively.

Time Project A Cash Flow Project B Cash Flow

0 −20,000 −30,000

1 10,000 10,000

2 30,000 20,000

3 1,000 50,000

Use the payback decision rule to evaluate these projects; which one(s) should be accepted or rejected? A) Accept both A and B B) Accept neither A nor B C) Accept A, reject B D) Reject A, accept B Answer: C Explanation: Time: Cumulative Cash Flow A: Cumulative Cash Flow B:

0 −20,000 −30,000

1 −10,000 −20,000

2 20,000 0

3 21,000 50,000

Project A: 1+(10,000/30,000) = 1.33 years Project B: 2 years Difficulty: 2 Medium Topic: Payback Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 13-02 Calculate and use the payback (PB) and discounted payback (DPB) methods for valuing capital investment opportunities.

43) Suppose your firm is considering two mutually exclusive, required projects with the cash flows shown as follows. The required rate of return on projects of both of their risk class is 8 percent, and the maximum allowable payback and discounted payback statistic for the projects are two and three years, respectively.

Time Project A Cash Flow Project B Cash Flow

0 −20,000 −30,000

1 10,000 10,000

2 30,000 20,000

3 1,000 50,000

Use the discounted payback decision rule to evaluate these projects; which one(s) should be accepted or rejected? A) Accept both A and B B) Accept neither A nor B C) Accept A, reject B D) Reject A, accept B Answer: C Explanation: Time: Disc'd Cash flow A Cumulative Cash flow A:

0 −20,000 −20,000

1 9,259.26

2 25,720.16

3 793.83

−10,740.74 14,979.42

15,773.25

1 + (10,740.74/25,720.16) = 1.42 years.

Time: Disc'd Cash flow B Cumulative Cash flow B:

0 −30,000

1 9,259.26

2 17,146.78

3 39,691.61

−30,000

−20,740.74

−3,593.96

36,097.65

2 + (3,593.96/39,691.61) = 2.09 years. Difficulty: 2 Medium Topic: Discounted payback Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 13-02 Calculate and use the payback (PB) and discounted payback (DPB) methods for valuing capital investment opportunities.

44) Suppose your firm is considering two mutually exclusive, required projects with the cash flows shown as follows. The required rate of return on projects of both of their risk class is 8 percent, and the maximum allowable payback and discounted payback statistic for the projects are two and three years, respectively.

Time Project A Cash Flow Project B Cash Flow

0 −20,000 −30,000

1 10,000 10,000

2 30,000 20,000

3 1,000 50,000

Use the IRR decision rule to evaluate these projects; which one(s) should be accepted or rejected? A) Accept both A and B B) Accept neither A nor B C) Accept A, reject B D) Reject A, accept B Answer: C Explanation: A: −20,000 CFO 10,000 CF1, 1 F1 30,000 CF2, 1 F2 1,000 CF3, 1 F3 I = 51.31% B: −30,000 CFO 10,000 CF1, 1 F1 20,000 CF2, 1 F2 50,000 CF3, 1 F3 I = 50.81% Difficulty: 2 Medium Topic: Internal rate of return Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 13-05 Use NPV profiles to reconcile sources of conflict between NPV and IRR methods.

45) Suppose your firm is considering two mutually exclusive, required projects with the cash flows shown as follows. The required rate of return on projects of both of their risk class is 8 percent, and the maximum allowable payback and discounted payback statistic for the projects are two and three years, respectively.

Time Project A Cash Flow Project B Cash Flow

0 −20,000 −30,000

1 10,000 10,000

2 30,000 20,000

3 1,000 50,000

Use the MIRR decision rule to evaluate these projects; which one(s) should be accepted or rejected? A) Accept both A and B B) Accept neither A nor B C) Accept A, reject B D) Reject A, accept B Answer: D Explanation: A: Step 1: 0 CFO 10,000 CF1, 1 F1 30,000 CF2, 1 F2 1,000 CF3, 1 F3 8I NPV 35,773.26 Step 2: 35,773.26 PV 0 PMT 3N 8I FV 45,064.00 Step 3: −20,000 PV 0 PMT 3N 45,064.00 FV I = 31.10

B: Step 1: 0 CFO 10,000 CF1, 1 F1 20,000 CF2, 1 F2 50,000 CF3, 1 F3 8I NPV 66,097.65 Step 2: 66,097.65 PV 0 PMT 3N 8I FV 83,264.00 Step 3: −30,000 PV 0 PMT 3N 83,264.00 FV I = 40.53 Difficulty: 2 Medium Topic: Modified internal rate of return Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 13-05 Use NPV profiles to reconcile sources of conflict between NPV and IRR methods.

47) Suppose your firm is considering two mutually exclusive, required projects with the cash flows shown as follows. The required rate of return on projects of both of their risk class is 8 percent, and the maximum allowable payback and discounted payback statistic for the projects are two and three years, respectively.

Time Project A Cash Flow Project B Cash Flow

0 −20,000 −30,000

1 10,000 10,000

2 30,000 20,000

3 1,000 50,000

Use the NPV decision rule to evaluate these projects; which one(s) should be accepted or rejected? A) Accept both A and B B) Accept neither A nor B C) Accept A, reject B D) Reject A, accept B Answer: D Explanation: A: −20,000 CFO 10,000 CF1, 1 F1 30,000 CF2, 1 F2 1,000 CF3, 1 F3 8I NPV 15,773.26 B: −30,000 CFO 10,000 CF1, 1 F1 20,000 CF2, 1 F2 50,000 CF3, 1 F3 8I NPV 36,097.65 Difficulty: 2 Medium Topic: Net present value Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 13-03 Calculate and use the net present value (NPV) method for evaluating capital investment opportunities.

48) Suppose your firm is considering two mutually exclusive, required projects with the cash flows shown as follows. The required rate of return on projects of both of their risk class is 8 percent, and the maximum allowable payback and discounted payback statistic for the projects are two and three years, respectively.

Time Project A Cash Flow Project B Cash Flow

0 −20,000 −30,000

1 10,000 10,000

2 30,000 20,000

3 1,000 50,000

Use the PI decision rule to evaluate these projects; which one(s) should be accepted or rejected? A) Accept both A and B B) Accept neither A nor B C) Accept A, reject B D) Reject A, accept B Answer: D Explanation: A: −20,000 CFO 10,000 CF1, 1 F1 30,000 CF2, 1 F2 1,000 CF3, 1 F3 8I NPV 15,773.26 B: −30,000 CFO 10,000 CF1, 1 F1 20,000 CF2, 1 F2 50,000 CF3, 1 F3 8I NPV 36,097.65 Project A: $15,773.26/$20,000 = 0.7887 = 78.87 percent. Project B: $36,097.65/$30,000 = 1.2033 = 120.33 percent. Difficulty: 2 Medium Topic: Profitability index Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 13-06 Compute and use the profitability index (PI).

49) Suppose your firm is considering two independent projects with the cash flows shown as follows. The required rate of return on projects of both of their risk class is 12 percent, and the maximum allowable payback and discounted payback statistic for the projects are two and a half and three years, respectively.

Time Project A Cash Flow Project B Cash Flow

0 −5,000 −10,000

1 1,000 5,000

2 3,000 5,000

3 5,000 5,000

Use the payback decision rule to evaluate these projects; which one(s) should be accepted or rejected? A) Accept both A and B B) Accept neither A nor B C) Accept A, reject B D) Reject A, accept B Answer: A Explanation: Time: Cumulative Cash flow A: Cumulative Cash flow B:

0 1 −5,000 −4,000 −10,000 −5,000

2 3 −1,000 4,000 0 5,000

Cumulative Cash Flow A: 2 + (1,000/5,000) = 2.2 years. Cumulative Cash Flow B: 1 + (5,000/5,000) = 2 years. Difficulty: 2 Medium Topic: Payback Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 13-02 Calculate and use the payback (PB) and discounted payback (DPB) methods for valuing capital investment opportunities.

50) Suppose your firm is considering two independent projects with the cash flows shown as follows. The required rate of return on projects of both of their risk class is 12 percent, and the maximum allowable payback and discounted payback statistic for the projects are two and a half and three years, respectively.

Time Project A Cash Flow Project B Cash Flow

0 −5,000 −10,000

1 1,000 5,000

2 3,000 5,000

3 5,000 5,000

Use the discounted payback decision rule to evaluate these projects; which one(s) should be accepted or rejected? A) Accept both A and B B) Accept neither A nor B C) Accept A, reject B D) Reject A, accept B Answer: A Explanation: Time: Disc'd Cash flow A Cumulative Cash flow A:

0 −5,000 −5,000

1 892.86 −4,107.14

2 2,391.58 −1,715.56

3 3,558.90 1,843.34

1 4,464.29

2 3 3,985.97 3,558.90

−10,000 −5,535.71

−1,549.74 2,009.16

2 + (1,715.56/3,558.90) = 2.48 years.

Time: Disc'd Cash flow B Cumulative Cash flow B:

0 −10,000

2 + (1,549.74/3,558.90) = 2.44 years. Difficulty: 2 Medium Topic: Discounted payback Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 13-02 Calculate and use the payback (PB) and discounted payback (DPB) methods for valuing capital investment opportunities.

51) Suppose your firm is considering two independent projects with the cash flows shown as follows. The required rate of return on projects of both of their risk class is 12 percent, and the maximum allowable payback and discounted payback statistic for the projects are two and a half and three years, respectively.

Time Project A Cash Flow Project B Cash Flow

0 −5,000 −10,000

1 1,000 5,000

2 3,000 5,000

3 5,000 5,000

Use the IRR decision rule to evaluate these projects; which one(s) should be accepted or rejected? A) Accept both A and B B) Accept neither A nor B C) Accept A, reject B D) Reject A, accept B Answer: A Explanation: A: −5,000 CFO 1,000 CF1, 1 F1 3,000 CF2, 1 F2 5,000 CF3, 1 F3 I = 27.96% B: −10,000 CFO 5,000 CF1, 3 F1 I = 23.38% Difficulty: 2 Medium Topic: Internal rate of return Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 13-04 Calculate and use the internal rate of return (IRR) and the modified internal rate of return (MIRR) methods for evaluating capital investment opportunities.

52) Suppose your firm is considering two independent projects with the cash flows shown as follows. The required rate of return on projects of both of their risk class is 12 percent, and the maximum allowable payback and discounted payback statistic for the projects are two and a half and three years, respectively.

Time Project A Cash Flow Project B Cash Flow

0 −5,000 −10,000

1 1,000 5,000

2 3,000 5,000

3 5,000 5,000

Use the MIRR decision rule to evaluate these projects; which one(s) should be accepted or rejected? A) Accept both A and B B) Accept neither A nor B C) Accept A, reject B D) Reject A, accept B Answer: A Explanation: A: Step 1: 0 CFO 1,000 CF1, 1 F1 3,000 CF2, 1 F2 5,000 CF3, 1 F3 12 I NPV 6,843.34 Step 2: 6,843.34 PV 0 PMT 3N 12 I FV 9,614.40 Step 3: −5,000 PV 0 PMT 3N 9,614.40 FV I = 24.35

B: Step 1: 0 CFO 5,000 CF1, 3 F1 12 I NPV 12,009.16 Step 2: 12,009.16 PV 0 PMT 3N 12 I FV 16,872.00 Step 3: −10,000 PV 0 PMT 3N 16,872.00 FV I = 19.05 Difficulty: 2 Medium Topic: Modified internal rate of return Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 13-04 Calculate and use the internal rate of return (IRR) and the modified internal rate of return (MIRR) methods for evaluating capital investment opportunities.

54) Suppose your firm is considering two independent projects with the cash flows shown as follows. The required rate of return on projects of both of their risk class is 12 percent, and the maximum allowable payback and discounted payback statistic for the projects are two and a half and three years, respectively.

Time Project A Cash Flow Project B Cash Flow

0 −5,000 −10,000

1 1,000 5,000

2 3,000 5,000

3 5,000 5,000

Use the NPV decision rule to evaluate these projects; which one(s) should be accepted or rejected? A) Accept both A and B B) Accept neither A nor B C) Accept A, reject B D) Reject A, accept B Answer: A Explanation: A: −5,000 CFO 1,000 CF1, 1 F1 3,000 CF2, 1 F2 5,000 CF3, 1 F3 12 I NPV 1,843.34 B: −10,000 CFO 5,000 CF1, 3 F1 12 I NPV 2,009.16 Difficulty: 2 Medium Topic: Net present value Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 13-03 Calculate and use the net present value (NPV) method for evaluating capital investment opportunities.

55) Suppose your firm is considering two independent projects with the cash flows shown as follows. The required rate of return on projects of both of their risk class is 12 percent, and the maximum allowable payback and discounted payback statistic for the projects are two and a half and three years, respectively.

Time Project A Cash Flow Project B Cash Flow

0 −5,000 −10,000

1 1,000 5,000

2 3,000 5,000

3 5,000 5,000

Use the PI decision rule to evaluate these projects; which one(s) should be accepted or rejected? A) Accept both A and B B) Accept neither A nor B C) Accept A, reject B D) Reject A, accept B Answer: A Explanation: A: −5,000 CFO 1,000 CF1, 1 F1 3,000 CF2, 1 F2 5,000 CF3, 1 F3 12 I NPV 1,843.34 B: −10,000 CFO 5,000 CF1, 3 F1 12 I NPV 2,009.16 Project A: $1,843.34/$5,000 = 0.3687 = 36.87 percent. Project B: $2,009.16/$10,000 = 0.2009 = 20.09 percent. Difficulty: 2 Medium Topic: Profitability index Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 13-06 Compute and use the profitability index (PI).

67) Compute the NPV statistic for Project Y given the following cash flows if the appropriate cost of capital is 10 percent. Project Y Time Cash Flow

0 –$ 8,000

1 $ 3,350

2 $ 4,180

3 $ 1,520

4 $ 2,000

A) $894.37 B) $993.97 C) $964.72 D) $1,008.03 Answer: D Explanation: Using a financial calculator: NPV = 1,008.03 −8,000 CFO 3,350 CF1, 1 F1 4,180 CF2, 2 F2 1,520 CF3, 1 F3 2,000 CF4, 1 F4 10 I Difficulty: 1 Easy Topic: Net present value Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 13-03 Calculate and use the net present value (NPV) method for evaluating capital investment opportunities.

68) Compute the NPV statistic for Project U given the following cash flows if the appropriate cost of capital is 9 percent. Project U Time Cash Flow

–$ 1,000

$ 350

$ 1,480

–$ 520

$ 400

–$ 100

A) $201.69 B) $273.82 C) $383.63 D) $397.21 Answer: C Explanation: Using a financial calculator: NPV = 383.63 −1,000 CFO 350 CF1, 1 F1 1,480 CF2, 2 F2 −520 CF3, 1 F3 400 CF4, 1 F4 −100 CF5, 1 F5 9I Difficulty: 1 Easy Topic: Net present value Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 13-03 Calculate and use the net present value (NPV) method for evaluating capital investment opportunities.

69) Compute the MIRR statistic for Project I and note whether to accept or reject the project with the cash flows shown as follows if the appropriate cost of capital is 15 percent. Project I Time Cash Flow

–$ 1,000

$ 400

$ 300

$ 200

$ 300

$ 50

A) The project's MIRR is 10.29 percent and the project should be rejected. B) The project's MIRR is 12.67 percent and the project should be rejected. C) The project's MIRR is 17.17 percent and the project should be accepted. D) The project's MIRR is 18.19 percent and the project should be accepted. Answer: B Explanation: Cash flows will be moved as shown: Year Cash Flow Future Value (If Positive) Sum of FV Modified CFs

0 –$ 1,000 $

2 400 $

699.60

3 300 $

456.26

200 $ 264.50

–$ 1,000

4 300 $

5 50

345.00 $ 50 $ 1,815.36 $ 1,815.36

Using a financial calculator: PV = –1,000; FV = 1,815.36; N = 5; PMT = 0; I = MIRR = 12.67 percent, Reject since MIRR < Cost of capital. Difficulty: 1 Easy Topic: Modified internal rate of return Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 13-04 Calculate and use the internal rate of return (IRR) and the modified internal rate of return (MIRR) methods for evaluating capital investment opportunities.

70) Compute the MIRR statistic for Project J and advise whether to accept or reject the project with the cash flows shown as follows if the appropriate cost of capital is 10 percent. Project J Time Cash Flow

–$ 1,000

$ 300

$ 1,480

–$ 500

$ 300

–$100

A) The project's MIRR is 14.77 percent and the project should be accepted. B) The project's MIRR is 9.29 percent and the project should be rejected. C) The project's MIRR is 13.76 percent and the project should be accepted. D) The project's MIRR is 15.31 percent and the project should be accepted. Answer: C Explanation: Year Cash Flow Present Value (If Negative) Sum of PV Future Value (If Positive) Sum of FV Modified CFs

0 −$

1 1,000 $

300 $

2 3 4 1,480 −$ 500 $ 300 −$

−$ 1,000 −$ 1,437.75

− 375.66

439.23

1,969.88

−

5 100 62.09

330.00 $ 2,739.11 $ 2,739.11

−$ 1,437.75

Using a financial calculator: PV = –1,437.75; FV = 2,739.11; N = 5; PMT = 0; I = MIRR = 13.76 percent, Accept since MIRR > Cost of capital.

Difficulty: 1 Easy Topic: Modified internal rate of return Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 13-04 Calculate and use the internal rate of return (IRR) and the modified internal rate of return (MIRR) methods for evaluating capital investment opportunities.

71) Compute the PI statistic for Project Z and advise the firm whether to accept or reject the project with the cash flows shown as follows if the appropriate cost of capital is 10 percent. Project Z Time Cash Flow

–$ 1,000

$ 350

$ 380

$ 420

$ 300

$ 100

A) The project's PI is 8.48 percent and the project should be accepted. B) The project's PI is 8.48 percent and the project should be rejected. C) The project's PI is 16.48 percent and the project should be accepted. D) The project's PI is 21.48 percent and the project should be accepted. Answer: D Explanation: Step 1: Find NPV using financial calculator: NPV = 214.78. Step 2: 214.78/1,000 = 21.48 percent and since PI > 0 accept. Difficulty: 1 Easy Topic: Profitability index Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 13-06 Compute and use the profitability index (PI).

72) Compute the PI statistic for Project Q and advise the firm whether to accept or reject the project with the cash flows shown as follows if the appropriate cost of capital is 12 percent. Project Q Time Cash Flow

–$ 1,000

$ 250

$ 180

$ 420

$ 300

$ 100

A) The project's PI is −8.70 percent and the project should be rejected. B) The project's PI is −11.70 percent and the project should be rejected. C) The project's PI is 3.70 percent and the project should be accepted. D) The project's PI is 5.70 percent and the project should be accepted. Answer: A Explanation: Step 1: Find NPV using financial calculator: NPV = −86.95. Step 2: −86.95/1,000 = −8.70 percent and since PI < 0 reject. Difficulty: 1 Easy Topic: Profitability index Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 13-06 Compute and use the profitability index (PI). 73) How many possible IRRs could you find for the following set of cash flows? Time Cash Flow

0 –$ 10,000

1 $ 5,350

2 $ 4,180

3 $ 1,520

4 $ 2,000

A) 1 B) 2 C) 3 D) Unable to determine unless we have the cost of capital. Answer: A Explanation: Since there's only one change in sign, there can only be one IRR. Difficulty: 1 Easy Topic: Internal rate of return Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 13-05 Use NPV profiles to reconcile sources of conflict between NPV and IRR methods. 61

74) How many possible IRRs could you find for the following set of cash flows?

Time Cash Flow

–$ 201,000

–$ 37,350

$ 460,180

$ 217,020

–$ 5,000

A) 1 B) 2 C) 3 D) 4 Answer: B Explanation: Since there are two changes in sign, there could potentially be as many as two IRRs. Difficulty: 1 Easy Topic: Internal rate of return Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 13-05 Use NPV profiles to reconcile sources of conflict between NPV and IRR methods.

75) Suppose your firm is considering investing in a project with the cash flows shown as follows, that the required rate of return on projects of this risk class is 8 percent, and that the maximum allowable payback and discounted payback statistics for the project are three and a half and four and a half years, respectively. Use the payback decision to evaluate this project; should it be accepted or rejected? Time Cash Flow

–$

0 1 2 3 4 5 6 5,000 $ 1,300 $ 1,400 $ 1,600 $ 1,600 $ 1,100 $ 2,000

A) Payback = 4.44 years, reject B) Payback = 3.44 years, accept C) Payback = 3.54 years, reject D) Payback = 3.24 years, reject Answer: B Explanation: Payback = 3 + 700/1,600 = 3.44 years; accept. Difficulty: 2 Medium Topic: Payback Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 13-02 Calculate and use the payback (PB) and discounted payback (DPB) methods for valuing capital investment opportunities.

64) Suppose your firm is considering investing in a project with the cash flows shown as follows, that the required rate of return on projects of this risk class is 10 percent, and that the maximum allowable payback and discounted payback statistics for the project are three and a half and four and a half years, respectively. Use the discounted payback decision to evaluate this project; should it be accepted or rejected?

Time Cash Flow

–$

0 1 2 3 4 5 6 5,000 $ 1,200 $ 1,400 $ 1,600 $ 1,600 $ 1,100 $ 2,000

A) Discounted payback = 4.25 years, accept the project B) Discounted payback = 3.50 years, accept the project C) Discounted payback > 5 years, reject the project D) Discounted payback = 4.67 years, reject the project Answer: D Explanation: Find the PV of each lump sum; discount at 10 percent. Accumulate the cash flows. Discounted payback = 4 + 457.15/683.01 = 4.67 years; reject since greater than benchmark. Difficulty: 2 Medium Topic: Discounted payback Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 13-02 Calculate and use the payback (PB) and discounted payback (DPB) methods for valuing capital investment opportunities.

65) Suppose your firm is considering investing in a project with the cash flows shown as follows, that the required rate of return on projects of this risk class is 8 percent, and that the maximum allowable payback and discounted payback statistics for the project are 3.5 and 4.5 years, respectively. Use the IRR decision to evaluate this project; should it be accepted or rejected?

Time Cash Flow

–$

0 1 2 3 4 5 6 5,000 $ 1,200 $ 1,400 $ 1,600 $ 1,600 $ 1,100 $ 2,000

A) IRR = 16.92 percent, accept the project B) IRR = 7.123 percent, reject the project C) IRR = 18.32 percent, accept the project D) IRR = 7.59 percent, reject the project Answer: C Explanation: Using a financial calculator: IRR = 18.32 percent; accept since IRR > Cost of capital. Difficulty: 2 Medium Topic: Internal rate of return Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 13-04 Calculate and use the internal rate of return (IRR) and the modified internal rate of return (MIRR) methods for evaluating capital investment opportunities.

66) Suppose your firm is considering investing in a project with the cash flows shown as follows, that the required rate of return on projects of this risk class is 8 percent, and that the maximum allowable payback and discounted payback statistics for the project are three and a half and four and a half years, respectively. Use the NPV decision to evaluate this project; should it be accepted or rejected?

Time Cash Flow

–$

0 1 2 3 4 5 6 5,000 $ 1,200 $ 1,400 $ 1,600 $ 1,600 $ 1,100 $ 2,000

A) NPV = $1,766.55, accept the project B) NPV = $892.19, accept the project C) NPV = $1,288.94, accept the project D) NPV = −$104.73, reject the project Answer: A Explanation: Using a financial calculator: NPV = 1,766.55; accept since NPV > 0. Difficulty: 2 Medium Topic: Net present value Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 13-03 Calculate and use the net present value (NPV) method for evaluating capital investment opportunities.

79) Suppose your firm is considering investing in a project with the cash flows shown as follows, that the required rate of return on projects of this risk class is 8 percent, and that the maximum allowable payback and discounted payback statistics for the project are three and a half and four and a half years, respectively. Use the MIRR decision to evaluate this project; should it be accepted or rejected? Time Cash Flow

–$

0 1 2 3 4 5 6 5,000 $ 1,200 $ 1,400 $ 1,600 $ 1,600 $ 1,100 $ 2,000

A) MIRR = 13.59 percent, accept the project B) MIRR = 7.96 percent, reject the project C) MIRR = 7.19 percent, reject the project D) MIRR = 12.58 percent, accept the project Answer: A Explanation: Step 1: Find the FV of all positive cash flows: FV = 10,737.65. Step 2: PV = −5,000, PMT = 0, N = 6; FV = 10,737.65, I = MIRR = 13.59 percent. Difficulty: 2 Medium Topic: Modified internal rate of return Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 13-04 Calculate and use the internal rate of return (IRR) and the modified internal rate of return (MIRR) methods for evaluating capital investment opportunities.

80) Suppose your firm is considering investing in a project with the cash flows shown as follows, that the required rate of return on projects of this risk class is 8 percent, and that the maximum allowable payback and discounted payback statistics for the project are three and a half and four and a half years, respectively. Use the PI decision to evaluate this project; should it be accepted or rejected? Time Cash Flow

–$

0 1 2 3 4 5 6 5,000 $ 1,200 $ 1,400 $ 1,600 $ 1,600 $ 1,100 $ 2,000

A) PI = 6.94 percent, reject the project B) PI = 7.52 percent, reject the project C) PI = 23.61 percent, accept the project D) PI = 35.33 percent, accept the project Answer: D Explanation: Step 1: Find NPV using a financial calculator: NPV = 1,766.55. Step 2: PI = 1,766.55/5,000 = 35.33 percent and accept since PI > 0. Difficulty: 2 Medium Topic: Profitability index Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 13-06 Compute and use the profitability index (PI).

81) Suppose your firm is considering investing in a project with the cash flows shown as follows, that the required rate of return on projects of this risk class is 10 percent, and that the maximum allowable payback and discounted payback statistics for the project are three and three and a half years, respectively. Use the payback decision to evaluate this project; should it be accepted or rejected? Time Cash Flow

–$ 85,000 $ 12,000

2 3 4 5 6 $ 11,000 $ 13,000 $ 21,000 $ 31,000 $ 32,000

A) Payback = 4.90 years, reject B) Payback = 4.40 years, reject C) Payback = 5.80 years, reject D) Payback > 6.00 years, reject Answer: A Explanation: Payback = 4 + 28,000/31,000 = 4.90 years; reject. Difficulty: 2 Medium Topic: Payback Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 13-02 Calculate and use the payback (PB) and discounted payback (DPB) methods for valuing capital investment opportunities.

82) Suppose your firm is considering investing in a project with the cash flows shown as follows, that the required rate of return on projects of this risk class is 10 percent, and that the maximum allowable payback and discounted payback statistics for the project are three and a half and four and a half years, respectively. Use the discounted payback decision to evaluate this project; should it be accepted or rejected? Time Cash Flow

–$ 85,000 $ 12,000

2 3 4 5 6 $ 11,000 $ 13,000 $ 21,000 $ 31,000 $ 32,000

A) Discounted payback = 4.29 years, accept the project B) Discounted payback = 3.97 years, accept the project C) Discounted payback > 4.5 years, reject the project D) Discounted payback = 4.4 years, accept the project Answer: C Explanation: Find the present value of each lump sum discounted at 10 percent; accumulate all cash flows. Discounted payback does not = payback during the life of the project; reject. Difficulty: 2 Medium Topic: Discounted payback Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 13-02 Calculate and use the payback (PB) and discounted payback (DPB) methods for valuing capital investment opportunities.

83) Suppose your firm is considering investing in a project with the cash flows shown as follows, that the required rate of return on projects of this risk class is 10 percent, and that the maximum allowable payback and discounted payback statistics for the project are three and a half and four and a half years, respectively. Use the IRR decision to evaluate this project; should it be accepted or rejected? Time Cash Flow

–$ 85,000 $ 12,000

2 3 4 5 6 $ 11,000 $ 13,000 $ 21,000 $ 31,000 $ 32,000

A) IRR = 16.92 percent, accept the project B) IRR = 7.123 percent, reject the project C) IRR = 8.81 percent, reject the project D) IRR = 10.59 percent, accept the project Answer: C Explanation: Using a financial calculator: IRR = 8.81 percent; reject since IRR < Cost of capital. Difficulty: 2 Medium Topic: Internal rate of return Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 13-04 Calculate and use the internal rate of return (IRR) and the modified internal rate of return (MIRR) methods for evaluating capital investment opportunities.

84) Suppose your firm is considering investing in a project with the cash flows shown as follows, that the required rate of return on projects of this risk class is 10 percent, and that the maximum allowable payback and discounted payback statistics for the project are three and a half and four and a half years, respectively. Use the NPV decision to evaluate this project; should it be accepted or rejected? Time Cash Flow

–$ 85,000 $ 12,000

2 3 4 5 6 $ 11,000 $ 13,000 $ 21,000 $ 31,000 $ 32,000

A) NPV = $1,766.55, accept the project B) NPV = −$892.19, reject the project C) NPV = $1,288.94, accept the project D) NPV = −$3,577.90, reject the project Answer: D Explanation: Using a financial calculator: NPV = −3,577.90; reject since NPV < 0. Difficulty: 2 Medium Topic: Net present value Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 13-03 Calculate and use the net present value (NPV) method for evaluating capital investment opportunities.

85) Suppose your firm is considering investing in a project with the cash flows shown as follows, that the required rate of return on projects of this risk class is 10 percent, and that the maximum allowable payback and discounted payback statistics for the project are three and a half and four and a half years, respectively. Use the MIRR decision to evaluate this project; should it be accepted or rejected? Time Cash Flow

0 1 2 3 4 5 6 –$ 85,000 $ 12,000 $ 11,000 $ 13,000 $ 21,000 $ 31,000 $ 32,000

A) MIRR = 11.59 percent, accept the project B) MIRR = 9.21 percent, reject the project C) MIRR = 7.19 percent, reject the project D) MIRR = 10.58 percent, accept the project Answer: B Explanation: Step 1: Find the FV of all positive cash flows: FV = 144,244.22. Step 2: PV = −85,000, PMT = 0, N = 6, FV = 144,244.22, I = MIRR = 9.21 percent. Difficulty: 2 Medium Topic: Modified internal rate of return Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 13-04 Calculate and use the internal rate of return (IRR) and the modified internal rate of return (MIRR) methods for evaluating capital investment opportunities.

86) Suppose your firm is considering investing in a project with the cash flows shown as follows, that the required rate of return on projects of this risk class is 10 percent, and that the maximum allowable payback and discounted payback statistics for the project are three and a half and four and a half years, respectively. Use the PI decision to evaluate this project; should it be accepted or rejected? Time Cash Flow

0 1 2 3 4 5 6 –$ 85,000 $ 12,000 $ 11,000 $ 13,000 $ 21,000 $ 31,000 $ 32,000

A) PI = 6.94 percent, reject the project B) PI = −7.52 percent, reject the project C) PI = −4.21 percent, reject the project D) PI = 5.33 percent, accept the project Answer: C Explanation: Step 1: Find NPV using a financial calculator: NPV = −3,577.90. Step 2: PI = −3,577.90/85,000 = −4.21 percent and reject since PI < 0. Difficulty: 2 Medium Topic: Profitability index Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 13-06 Compute and use the profitability index (PI). 87) Which of the following tools is suitable for choosing between mutually exclusive projects? A) NPV B) IRR C) MIRR D) None are suitable Answer: A Difficulty: 2 Medium Topic: Mutually exclusive projects Bloom's: Evaluate AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 13-03 Calculate and use the net present value (NPV) method for evaluating capital investment opportunities.

88) All of the following capital budgeting tools are suitable for firms facing time constraints EXCEPT A) NPV. B) payback. C) discounted payback. D) All of these choices are correct. Answer: A Difficulty: 2 Medium Topic: Net present value Bloom's: Evaluate AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 13-03 Calculate and use the net present value (NPV) method for evaluating capital investment opportunities.; 13-01 Analyze the logic underlying capital budgeting decision techniques. 89) All of the following capital budgeting tools are suitable for non-normal cash flows EXCEPT A) MIRR. B) profitability index. C) payback. D) NPV. Answer: C Difficulty: 2 Medium Topic: Payback Bloom's: Evaluate AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 13-01 Analyze the logic underlying capital budgeting decision techniques. 90) All of the following capital budgeting tools are suitable for non-normal cash flows EXCEPT A) MIRR. B) profitability index. C) discounted payback. D) NPV. Answer: C Difficulty: 2 Medium Topic: Discounted payback Bloom's: Evaluate AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 13-01 Analyze the logic underlying capital budgeting decision techniques.

91) All of the following capital budgeting tools are suitable for non-normal cash flows EXCEPT A) MIRR. B) profitability index. C) IRR. D) NPV. Answer: C Difficulty: 2 Medium Topic: Internal rate of return Bloom's: Evaluate AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 13-01 Analyze the logic underlying capital budgeting decision techniques. 92) A decision rule and associated methodology for converting the NPV statistic into a ratebased metric is referred to as A) NPV. B) profitability index. C) MIRR. D) discounted payback. Answer: B Difficulty: 1 Easy Topic: Profitability index Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 13-06 Compute and use the profitability index (PI). 93) A capital budgeting method that converts a project's cash flows using a more consistent reinvestment rate prior to applying the IRR decision rule is referred to as A) IRR. B) EAR. C) NPV. D) MIRR. Answer: D Difficulty: 1 Easy Topic: Modified internal rate of return Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 13-05 Use NPV profiles to reconcile sources of conflict between NPV and IRR methods.

94) A capital budgeting technique that generates a decision rule and associated metric for choosing projects based on the total discounted value of their cash flows is referred to as A) PI. B) IRR. C) NPV. D) MIRR. Answer: C Difficulty: 1 Easy Topic: Net present value Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 13-03 Calculate and use the net present value (NPV) method for evaluating capital investment opportunities. 95) Suppose you have a project whose discounted payback is equal to its termination date. What can you say for sure about its PI? A) The discounted payback will be greater than zero. B) It will have a PI and NPV of zero. C) The NPV and IRR will yield the same decision. D) The IRR will just equal the cost of capital. Answer: B Difficulty: 3 Hard Topic: Discounted payback Bloom's: Evaluate AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 13-06 Compute and use the profitability index (PI). 96) Under what conditions can a rate-based statistic yield a different accept/reject decision than NPV? A) Independent projects that are evaluated at a high cost of capital. B) Mutually exclusive projects that are evaluated at a low cost of capital. C) Any projects that exhibit differences in scale or timing. D) Mutually exclusive projects that exhibit differences in scale or timing. Answer: D Difficulty: 2 Medium Topic: Mutually exclusive projects Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 13-05 Use NPV profiles to reconcile sources of conflict between NPV and IRR methods. 77

97) A project's IRR is the interest rate that A) causes the project's NPV to equal zero. B) is used to discount cash flows when computing the project's NPV. C) is used to determine which one of two mutually exclusive projects should be accepted. D) is used to compute the project's discounted payback period. Answer: A Difficulty: 2 Medium Topic: Internal rate of return Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 13-04 Calculate and use the internal rate of return (IRR) and the modified internal rate of return (MIRR) methods for evaluating capital investment opportunities. 98) A project has normal cash flows. Its IRR is 15 percent and its cost of capital is 10 percent. Which of the following statements is incorrect? A) The project has only one negative cash flow. B) The project's MIRR is less than 15 percent but greater than 10 percent. C) The project's discounted payback is less than the project's payback. D) The project's NPV > 0. Answer: C Difficulty: 2 Medium Topic: Internal rate of return Bloom's: Create AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 13-03 Calculate and use the net present value (NPV) method for evaluating capital investment opportunities.; 13-04 Calculate and use the internal rate of return (IRR) and the modified internal rate of return (MIRR) methods for evaluating capital investment opportunities.

99) All of the following are strengths of NPV EXCEPT A) it works equally well for independent and mutually exclusive projects. B) managers have a preference for using a statistic that is in percent instead of dollars. C) it uses a conservative reinvestment rate assumption. D) these are all strengths of the NPV statistic. Answer: B Difficulty: 1 Easy Topic: Net present value Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 13-03 Calculate and use the net present value (NPV) method for evaluating capital investment opportunities.; 13-05 Use NPV profiles to reconcile sources of conflict between NPV and IRR methods. 100) All of the following are strengths of payback EXCEPT A) its benchmark is not determined by a relevant external constraint. B) it incorporates the time value of money. C) it uses a conservative reinvestment rate. D) none of the options. Answer: D Difficulty: 1 Easy Topic: Payback Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 13-02 Calculate and use the payback (PB) and discounted payback (DPB) methods for valuing capital investment opportunities. 101) Which of the following statements is correct? A) Discounted payback solves all the shortcomings of payback. B) The reinvestment rates of NPV and MIRR are the same. C) The MIRR and IRR have the same reinvestment rate. D) All of these choices are correct. Answer: B Difficulty: 2 Medium Topic: Discounted payback; Modified internal rate of return Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 13-01 Analyze the logic underlying capital budgeting decision techniques.; 1305 Use NPV profiles to reconcile sources of conflict between NPV and IRR methods.

102) Which of the following is incorrect regarding the IRR statistic? A) For independent projects, IRR will give the same accept/reject decision as NPV. B) For the IRR statistic to give a different accept/reject decision from NPV, the cash flows must be non-normal and the projects must be mutually exclusive. C) To solve for the IRR, one can simply solve the NPV formula for the rate that will make the NPV equal to zero. D) None of the statements are incorrect. Answer: B Difficulty: 3 Hard Topic: Internal rate of return Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 13-01 Analyze the logic underlying capital budgeting decision techniques.; 1305 Use NPV profiles to reconcile sources of conflict between NPV and IRR methods. 103) Which of the following statements is correct? A) A weakness of both payback and discounted payback is that neither accounts for cash flows received after the payback. B) Discounted payback uses a more aggressive reinvestment rate assumption than payback. C) Neither payback nor discounted payback uses time value of money concepts. D) None of the statements are correct. Answer: A Difficulty: 1 Easy Topic: Payback; Discounted payback strengths and weaknesses Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 13-01 Analyze the logic underlying capital budgeting decision techniques.; 1302 Calculate and use the payback (PB) and discounted payback (DPB) methods for valuing capital investment opportunities.

104) Which of the following best describes the NPV profile? A) A graph of a project's NPV as a function of possible IRRs. B) A graph of a project's NPV over time. C) A graph of a project's NPV as a function of possible capital costs. D) None of the statements are correct. Answer: C Difficulty: 1 Easy Topic: Net present value Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 13-05 Use NPV profiles to reconcile sources of conflict between NPV and IRR methods. 105) Which of the following statements is correct regarding the NPV profile? A) The IRR appears as the intersection of the NPV profile with the x-axis. B) The IRR appears at the crossover point or where the two profiles intersect. C) NPV profiles for independent projects with normal cash flows will intersect. D) All of these choices are correct. Answer: A Difficulty: 2 Medium Topic: Net present value Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 13-05 Use NPV profiles to reconcile sources of conflict between NPV and IRR methods.

106) A firm is evaluating a potential investment that is expected to generate cash flows of $100 in years 1 through 4 and $400 in years 5 through 7. The initial investment is $750. What is the payback for this investment? A) 4.88 years B) 4.48 years C) 5.88 years D) 5.48 years Answer: A Explanation: Accumulate the cash flows; 4 + (350/400) = 4.88 years. Difficulty: 1 Easy Topic: Payback Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 13-02 Calculate and use the payback (PB) and discounted payback (DPB) methods for valuing capital investment opportunities. 107) A company is considering two mutually exclusive projects, A and B. Project A requires an initial investment of $100, followed by cash flows of $95, $20, and $5. Project B requires an initial investment of $100, followed by cash flows of $0, $20, and $130. What is the IRR of the project that is best for the company's shareholders? The firm's cost of capital is 10 percent. A) 15.24 percent B) 15.96 percent C) 16.17 percent D) 15.42 percent Answer: A Explanation: Using a financial calculator: Project A: NPV = 6.65, IRR = 15.96 percent; Project B: NPV = 14.20, IRR = 15.24 percent; NPV is best statistic, therefore the IRR of the best project is 15.24 percent. Difficulty: 3 Hard Topic: Mutually exclusive projects Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 13-03 Calculate and use the net present value (NPV) method for evaluating capital investment opportunities.; 13-04 Calculate and use the internal rate of return (IRR) and the modified internal rate of return (MIRR) methods for evaluating capital investment opportunities.

108) A company is considering two mutually exclusive projects, A and B. Project A requires an initial investment of $200, followed by cash flows of $185, $40, and $15. Project B requires an initial investment of $200, followed by cash flows of $0, $50, and $230. What is the IRR of the project that is best for the company's shareholders? The firm's cost of capital is 10 percent. A) 15.45 percent B) 15.12 percent C) 13.57 percent D) 12.71 percent Answer: D Explanation: Using a financial calculator: Project A: NPV = 12.51, IRR = 15.45 percent; Project B: NPV = 14.12, IRR = 12.71 percent; NPV is best statistic, Project B is better, therefore the IRR of the best project is 12.71 percent. Difficulty: 3 Hard Topic: Mutually exclusive projects Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 13-03 Calculate and use the net present value (NPV) method for evaluating capital investment opportunities.; 13-04 Calculate and use the internal rate of return (IRR) and the modified internal rate of return (MIRR) methods for evaluating capital investment opportunities. 109) A financial asset will pay you $10,000 at the end of 10 years if you pay premiums of $175 per year at the end of each year for 10 years. What is the IRR of this financial asset? A) 33.26 percent B) 34.98 percent C) 35.93 percent D) 36.72 percent Answer: C Explanation: Using a financial calculator; IRR = 35.93 percent. Note the last cash flow is $10,000 − 175 = 9,825. Difficulty: 3 Hard Topic: Internal rate of return Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 13-04 Calculate and use the internal rate of return (IRR) and the modified internal rate of return (MIRR) methods for evaluating capital investment opportunities.

110) A financial asset will pay you $50,000 at the end of 20 years if you pay premiums of $975 per year at the end of each year for 20 years. What is the IRR of this financial asset? A) 8.64 percent B) 9.02 percent C) 10.51 percent D) 11.29 percent Answer: B Explanation: Using a financial calculator; IRR = 9.02 percent. Note the last cash flow is $50,000 − 975 = 49,025. Difficulty: 3 Hard Topic: Internal rate of return Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 13-04 Calculate and use the internal rate of return (IRR) and the modified internal rate of return (MIRR) methods for evaluating capital investment opportunities. 111) Projects A and B are mutually exclusive. Project A costs $10,000 and is expected to generate cash inflows of $4,000 for four years. Project B costs $10,000 and is expected to generate a single cash flow in year 4 of $20,000. The cost of capital is 12 percent. Which project would you accept and why? A) Project B because it has the higher NPV B) Project B because it has the higher IRR C) Project A because it has the higher NPV D) Project A because it has the higher IRR Answer: A Explanation: Using a financial calculator, NPV of Project A = $2,149.40; NPV of Project B = $2,710.36. Using IRRs will cause you to accept the wrong project. Difficulty: 3 Hard Topic: Mutually exclusive projects Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 13-03 Calculate and use the net present value (NPV) method for evaluating capital investment opportunities.; 13-05 Use NPV profiles to reconcile sources of conflict between NPV and IRR methods.

112) Projects A and B are mutually exclusive. Project A costs $20,000 and is expected to generate cash inflows of $7,500 for 4 years. Project B costs $10,000 and is expected to generate a single cash flow in year 4 of $20,000. The cost of capital is 12%. Which project would you accept and why? A) Project B because it has the higher NPV B) Project B because it has the higher IRR C) Project A because it has the higher NPV D) Project A because it has the higher IRR Answer: C Explanation: Using a financial calculator, NPV of Project A = $2,780.12; NPV of Project B = $2,710.36. Using IRRs will cause you to accept the wrong project. Difficulty: 3 Hard Topic: Mutually exclusive projects Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 13-03 Calculate and use the net present value (NPV) method for evaluating capital investment opportunities. 113) The least-used capital budgeting technique in industry is A) NPV. B) IRR. C) Payback D) MIRR. Answer: C Difficulty: 2 Medium Topic: Modified internal rate of return Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 13-01 Analyze the logic underlying capital budgeting decision techniques.

114) We accept projects with a positive NPV because it means that A) we have recovered all our costs. B) we are creating wealth for shareholders. C) the project's expected return exceeds the cost of capital. D) all of the options. Answer: D Difficulty: 1 Easy Topic: Net present value Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 13-03 Calculate and use the net present value (NPV) method for evaluating capital investment opportunities.; 13-01 Analyze the logic underlying capital budgeting decision techniques. 115) The MIRR statistic is different from the IRR statistic in that A) the MIRR assumes that the cash inflows can be reinvested at the cost of capital. B) the MIRR assumes that the cash inflows can be reinvested at the IRR. C) the MIRR uses weighted average dollars. D) the MIRR uses input from the NPV whereas the IRR does not. Answer: A Difficulty: 1 Easy Topic: Internal rate of return Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 13-05 Use NPV profiles to reconcile sources of conflict between NPV and IRR methods.; 13-04 Calculate and use the internal rate of return (IRR) and the modified internal rate of return (MIRR) methods for evaluating capital investment opportunities. 116) A disadvantage of the payback statistic is that A) it does not reflect the time value of money. B) it does not give an indication of the project's riskiness. C) it does not consider cash flows beyond the payback period. D) All of these choices are correct. Answer: D Difficulty: 1 Easy Topic: Payback Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 13-02 Calculate and use the payback (PB) and discounted payback (DPB) methods for valuing capital investment opportunities. 86

117) A project costs $91,000 today and is expected to generate cash flows of $11,000 per year for the next 20 years. The firm has a cost of capital of 8 percent. Should this project be accepted, and why? A) Yes, the project should be accepted since it has a NPV = $15,391.23. B) Yes, the project should be accepted since it has a NPV = $13,610.89. C) Yes, the project should be accepted since it has a NPV = $16,999.62. D) None of the options are correct. Answer: C Explanation: Using a financial calculator, NPV = $16,999.62. Accept since the NPV > 0. Difficulty: 1 Easy Topic: Net present value Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 13-03 Calculate and use the net present value (NPV) method for evaluating capital investment opportunities. 118) A project costs $101,000 today and is expected to generate cash flows of $31,000 per year for the next 15 years. At what rate is the NPV equal to zero? A) 30.10 percent B) 29.83 percent C) 22.47 percent D) 31.38 percent Answer: A Explanation: This is the definition of the IRR. IRR of this project = 30.10 percent. Difficulty: 2 Medium Topic: Internal rate of return Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 13-04 Calculate and use the internal rate of return (IRR) and the modified internal rate of return (MIRR) methods for evaluating capital investment opportunities.

119) How many possible IRRs could you find for the following set of cash flows?

Time Cash Flow

–$ 15,000

$ 6,000

$ 10,000

$ 12,000

$ 1,000

120) Compute the NPV statistic for Project X given the following cash flows if the appropriate cost of capital is 12 percent. Project X Time Cash Flow

–$ 15,000

$ 6,000

$ 10,000

$ 12,000

–$ 1,000

A) $6,234.93 B) $7,505.96 C) $8,417.80 D) $37,505.96 Answer: A Explanation: Using a financial calculator: NPV = 6,234.93 −15,000 CFO 6,000 CF1, 1 F1 10,000 CF2, 2 F2 12,000 CF3, 1 F3 −1,000 CF4, 1 F4 12 I Difficulty: 1 Easy Topic: Net present value Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 13-03 Calculate and use the net present value (NPV) method for evaluating capital investment opportunities.

121) Compute the NPV statistic for Project X given the following cash flows if the appropriate cost of capital is 10 percent. Project X Time Cash Flow

–$ 100,000

–$ 36,000

$ 200,000

$ 210,000

–$ 10,000

A) $183,507.96 B) $247,410.67 C) $248,962.50 D) $262,622.77 Answer: A Explanation: Using a financial calculator: NPV = 183,507.96 −100,000 CFO −36,000 CF1, 1 F1 200,000 CF2, 2 F2 210,000 CF3, 1 F3 −10,000 CF4, 1 F4 10 I Difficulty: 1 Easy Topic: Net present value Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 13-03 Calculate and use the net present value (NPV) method for evaluating capital investment opportunities.

122) Compute the NPV for Project X with the cash flows shown as follows if the appropriate cost of capital is 10 percent. Time Cash Flow

–$ 100,000

$ 36,000

$ 200,000

$ 210,000

$ 10,000

A) $183,507.96 B) $247,410.67 C) $248,962.50 D) $262,622.77 Answer: D Explanation: Using a financial calculator: NPV = 262,622.77 −100,000 CFO 36,000 CF1, 1 F1 200,000 CF2, 2 F2 210,000 CF3, 1 F3 10,000 CF4, 1 F4 10 I Difficulty: 1 Easy Topic: Net present value Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 13-03 Calculate and use the net present value (NPV) method for evaluating capital investment opportunities.

123) Compute the NPV statistic for Project Y given the following cash flows if the appropriate cost of capital is 10 percent. Project Y Time Cash Flow

–$ 50,000

$ 7,000

$ 20,000

$ 10,000

A) −$19,594.29 B) $7,788.34 C) $9,367.11 D) $107,788.34 Answer: B Explanation: Using a financial calculator: NPV = 7,788.34 −50,000 CFO 7,000 CF1, 1 F1 20,000 CF2, 3 F2 10,000 CF3, 1 F3 10 I Difficulty: 1 Easy Topic: Net present value Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 13-03 Calculate and use the net present value (NPV) method for evaluating capital investment opportunities.

124) Compute the NPV for Project X with the cash flows shown as follows if the appropriate cost of capital is 9 percent. Time Cash Flow

0 –$

5,000

1 $ 1,000

2 $

2,000

$500

A) −$2,013.18 B) −$175.66 C) $486.29 D) $9,824.34 Answer: B Explanation: Using the financial calculator: NPV = −175.66 −5,000 CFO 1,000 CF1, 1 F1 2,000 CF2, 2 F2 500 CF3, 2 F3 9I Difficulty: 1 Easy Topic: Net present value Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 13-03 Calculate and use the net present value (NPV) method for evaluating capital investment opportunities.

125) Compute the NPV statistic for Project Y given the following cash flows and if the appropriate cost of capital is 12 percent. Project Y Time Cash Flow

–$ 10,000

$ 3,000

2 $

4,000

1,000

$2,000

$500

A) $18,133,88 B) −$1,366.99 C) −$1,539.14 D) −$1,866.12 Answer: D Explanation: Using a financial calculator: NPV = −1,866.1232 −10,000 CFO 3,000 CF1, 1 F1 4,000 CF2, 1 F1 1,000 CF3, 1 F3 2,000 CF4, 1 F4 500 CF5, 1 F5 12 I Difficulty: 1 Easy Topic: Net present value Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 13-03 Calculate and use the net present value (NPV) method for evaluating capital investment opportunities.

Finance, 5e (Cornett) Chapter 14 Working Capital Management and Policies 1) The area of management concerned with designing and overseeing the process of production is which of the following? A) Production science B) Production management C) Operations management D) Operations science Answer: C Difficulty: 1 Easy Topic: Managerial positions and duties Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 14-01 Set overall objectives of a good working capital policy. 2) A production strategy that attempts to improve a firm's return on investment by reducing inprocess inventory and associated carrying costs as much as possible is which of the following? A) Production management B) Operations management C) Almost late D) Just in time Answer: D Difficulty: 1 Easy Topic: Derived-demand inventory management Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 14-01 Set overall objectives of a good working capital policy.

3) The inventory order quantity that minimizes total holding and ordering costs is which of the following? A) Barabas economic order quantity (EOQ) B) Cornett economic order quantity (EOQ) C) Operations management D) Production management Answer: A Difficulty: 1 Easy Topic: Economic order quantity (EOQ) model Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 14-01 Set overall objectives of a good working capital policy. 4) Which of the following is defined as costs associated with not having sufficient cash, inventory, or accounts receivable? A) Net working capital costs B) Opportunity costs C) Shortage costs D) Cash cycle costs Answer: C Difficulty: 1 Easy Topic: Carrying and shortage costs Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 14-01 Set overall objectives of a good working capital policy. 5) Which of the following is defined as the cost or forgone opportunity of using an asset already in use by the firm, or a person already employed by the firm, in a new project? A) Net working capital cost B) Opportunity cost C) Shortage cost D) Cash cycle cost Answer: B Difficulty: 1 Easy Topic: Cash flows Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 14-01 Set overall objectives of a good working capital policy.

6) To trace cash flows through the firm's operations, we must measure which of the following? (It is the time necessary to acquire raw materials, turn them into finished goods, sell them, and receive payment for them.) A) Cash cycle B) Operating cycle C) Transaction cycle D) Production cycle Answer: B Difficulty: 1 Easy Topic: Operating and cash cycles Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 14-01 Set overall objectives of a good working capital policy. 7) Operating cycle is measured as A) inventory turns minus average collection period. B) inventory turns plus average collection period. C) days' sales in inventory minus average collection period. D) days' sales in inventory plus average collection period. Answer: D Difficulty: 1 Easy Topic: Operating and cash cycles Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 14-01 Set overall objectives of a good working capital policy. 8) Which of the following is NOT one of the five basic elements of the kaizen approach of productivity improvement? A) Teamwork B) Improved morale C) Quality circles D) Suggestions for personal discipline Answer: D Difficulty: 1 Easy Topic: Derived-demand inventory management Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 14-02 Discuss how net working capital serves the firm.

9) Choosing the optimal level of investment in each current asset type involves a trade-off between carrying costs and A) opportunity costs. B) financing costs. C) safety costs. D) shortage costs. Answer: D Difficulty: 1 Easy Topic: Carrying and shortage costs Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 14-04 Model the optimal trade-off between carrying costs and shortage costs that dictates the firm's current asset investment. 10) Which of the following current asset financing policies reflects the decision to finance the peaks of current assets with long-term debt and equity that provides the firm with a surplus ofcash and marketable securities most of the time, except during peak asset demand? A) Flexible financing policy B) Restrictive financing policy C) Compromise financing policy D) Alternative financing policy Answer: A Difficulty: 1 Easy Topic: Flexible financial policy Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 14-05 Compare the flexible and restrictive approaches to financing current assets.

11) Which of the following current asset financing policies reflects the firm financing the seasonally-adjusted average level of asset demand with long-term debt and equity enabling it to use both short-term financing and short-term investing as needed? A) Flexible financing policy B) Restrictive financing policy C) Compromise financing policy D) Alternative financing policy Answer: C Difficulty: 1 Easy Topic: Compromise financial policy Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 14-05 Compare the flexible and restrictive approaches to financing current assets. 12) For most businesses, particularly smaller ones, the most common way to cover a short-term financing need is to apply at a bank for which of the following? A) Commercial loan B) Line of credit C) Asset-based loan D) Inventory loan Answer: A Difficulty: 1 Easy Topic: Short-term finance and planning Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 14-06 Differentiate among sources of short-term financing available for funding current assets.

13) Which of these is the requirement of the firm to keep a certain percentage of the borrowed money deposited in the firm's bank accounts, whereby the bank agrees to lend money to the firm? A) Commercial loan B) Line of credit C) Compensating balance D) Inventory loan Answer: C Difficulty: 1 Easy Topic: Short-term finance and planning Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 14-06 Differentiate among sources of short-term financing available for funding current assets. 14) Which of these is a short-term loan secured by a company's assets? A) Commercial loan B) Line of credit C) Asset-based loan D) Inventory loan Answer: C Difficulty: 1 Easy Topic: Short-term finance and planning Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 14-06 Differentiate among sources of short-term financing available for funding current assets.

15) Which of these is an entity who will buy accounts receivable before they are due on a discounted basis, with the spread between the discounted price and the receivable's face value providing them with the expected compensation for both the time value of money and for the expected level of defaults amongst the accounts receivable? A) Commercial bank B) Factor C) Receiver D) Blanket loaner Answer: B Difficulty: 1 Easy Topic: Short-term finance and planning Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 14-06 Differentiate among sources of short-term financing available for funding current assets. 16) Which of the following is NOT an example of an inventory loan? A) Blanket inventory liens B) Trust receipts C) Field warehousing financing D) Inventory factor Answer: D Difficulty: 1 Easy Topic: Short-term finance and planning Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 14-06 Differentiate among sources of short-term financing available for funding current assets.

17) Which of the following is a money-market security, issued by large banks and medium-tolarge corporations, that matures in nine months or less? A) Banker's paper B) Commercial paper C) Banker's acceptance D) Commercial acceptance Answer: B Difficulty: 1 Easy Topic: Short-term finance and planning Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 14-06 Differentiate among sources of short-term financing available for funding current assets. 18) Which of the following is a short-term promissory note issued by a corporation, bearing the unconditional guarantee of a major bank? A) Banker's paper B) Commercial paper C) Banker's acceptance D) Commercial acceptance Answer: C Difficulty: 1 Easy Topic: Short-term finance and planning Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 14-06 Differentiate among sources of short-term financing available for funding current assets. 19) Which of the following is NOT a reason for holding cash? A) Transaction facilitation B) Compensating balances C) Investment opportunities D) Transaction opportunities Answer: D Difficulty: 1 Easy Topic: Reasons to hold cash Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 14-07 Justify the firm's need to hold cash.

20) Which of the following is NOT one of the Baumol model's unrealistic assumptions? A) The firm has a constant, perfectly predictable distribution rate for cash. B) No cash will come in during the period in question. C) no allowance for any safety stock of extra cash to buffer the firm against unexpectedly high demand for cash D) no assumption to start from a replenishment level of cash then decline smoothly to a value of zero Answer: D Difficulty: 2 Medium Topic: Baumol-Allais-Tobin (BAT) model Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 14-08 Use the Baumol and Miller-Orr models for determining cash policy. 21) Which of the following approaches for determining the target cash balance assumes that the distribution of daily net cash flows is normally distributed, and allows for both cash inflows and outflows? A) The Baumol model B) The Miller-Orr model C) The Merton model D) The Interbank Financial model Answer: B Difficulty: 2 Medium Topic: Miller-Orr model Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 14-08 Use the Baumol and Miller-Orr models for determining cash policy.

22) Which of the following is NOT a fundamental factor ignored by the target cash balance models? A) Firms have the option to borrow short-term to meet unexpected demands for cash. B) The costs and delays of trading securities have fallen dramatically since the advent of the Internet. C) Many large firms habitually use all or the majority of their available cash to purchase overnight securities. D) Models take into account that many firms must keep compensating balances in their deposit accounts as part of borrowing agreements with their banks. Answer: D Difficulty: 2 Medium Topic: Baumol-Allais-Tobin (BAT) model Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 14-08 Use the Baumol and Miller-Orr models for determining cash policy. 23) Which of these is defined as the excess amounts of a current asset kept on hand to meet unexpected shocks in demand? A) Liquid current assets B) Safety stock C) Overnight securities D) Float Answer: B Difficulty: 1 Easy Topic: Miller-Orr model Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 14-07 Justify the firm's need to hold cash.

24) Which of these is the period of time after a check has been written, but not yet cleared and deposited? A) Liquid current assets B) Safety stock C) Overnight securities D) Float Answer: D Difficulty: 1 Easy Topic: Cash disbursements management Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 14-09 Identify sources of float and show how to control float for the firm's disbursement and collection functions. 25) Which of the following is the technique for reducing collection float by having funds sent to several geographically situated regional banks and then transferring to a main concentration account in another bank? A) Lockbox system B) Concentration banking C) Wire transfers D) Collection float Answer: B Difficulty: 1 Easy Topic: Cash collections management Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 14-09 Identify sources of float and show how to control float for the firm's disbursement and collection functions.

26) Which of the following describes the place over which the bank-to-bank transfers are conducted within the United States? A) Lockbox system B) Concentration banking C) Wire transfers D) Fedwire Answer: D Difficulty: 1 Easy Topic: Cash collections management Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 14-06 Differentiate among sources of short-term financing available for funding current assets. 27) Which of the following is a checking account that the firm sets up so that the bank agrees to automatically transfer funds from an interest-bearing account to pay off any checks presented? A) Lockbox system B) Concentration banking C) Wire transfers D) Zero-balance account Answer: D Difficulty: 1 Easy Topic: Cash disbursements management Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 14-11 Connect the firm's credit terms and collection policy and the amount of capital the firm has invested in accounts receivable.

28) Which of the following resemble checks, but differ in that they are payable by the firm issuing them rather than payable by a bank? A) Drafts B) Concentration banking C) Wire transfers D) Zero-balance account Answer: A Difficulty: 1 Easy Topic: Cash disbursements management Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 14-11 Connect the firm's credit terms and collection policy and the amount of capital the firm has invested in accounts receivable. 29) Which of the following is NOT one of the "five C's" of credit analysis? A) Capacity B) Character C) Collateral D) Collectability Answer: D Difficulty: 1 Easy Topic: Credit analysis Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 14-11 Connect the firm's credit terms and collection policy and the amount of capital the firm has invested in accounts receivable.

30) Elle Mae Industries has a cash balance of $50,000, accounts payable of $150,000; inventory of $190,000; accounts receivable of $250,000; notes payable of $210,000; and accrued wages and taxes of $40,000. How much net working capital does the firm need to fund? A) $50,000 B) $90,000 C) $110,000 D) $130,000 Answer: B Explanation: NWC = CA − CL = ($50,000 + $250,000 + $190,000) − ($150,000 + $210,000 + $40,000) = $90,000. Difficulty: 1 Easy Topic: Net working capital Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-02 Discuss how net working capital serves the firm. 31) Daisy D Industries has a cash balance of $75,000; accounts payable of $140,000; inventory of $300,000; accounts receivable of $350,000; notes payable of $145,000; and accrued wages and taxes of $80,000. How much net working capital does the firm need to fund? A) $285,000 B) $60,000 C) $440,000 D) $360,000 Answer: D Explanation: NWC = CA − CL = ($75,000 + $350,000 + $300,000) − ($140,000 + $145,000 + $80,000) = $360,000. Difficulty: 1 Easy Topic: Net working capital Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-02 Discuss how net working capital serves the firm.

32) Team Sports Industries has a cash balance of $60,000; accounts payable of $40,000; inventory of $100,000; accounts receivable of $110,000; notes payable of $80,000; and accrued wages and taxes of $10,000. How much net working capital does the firm need to fund? A) $140,000 B) $130,000 C) $150,000 D) $210,000 Answer: A Explanation: NWC = CA − CL = ($60,000 + $110,000 + $100,000) − ($40,000 + $80,000 + $10,000) = $140,000. Difficulty: 1 Easy Topic: Net working capital Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-02 Discuss how net working capital serves the firm. 33) Scribble, Inc. has sales of $80,000 and cost of goods sold of $64,000. The firm had a beginning inventory of $10,000 and an ending inventory of $12,000. What is the length of the days' sales in inventory? A) 13.75 days B) 45.63 days C) 17.19 days D) 68.44 days Answer: D Explanation: ($12,000 × 365)/$64,000 = 68.4375 days. Difficulty: 1 Easy Topic: Operating and cash cycles Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-03 Analyze the firm's operating and cash cycles to determine what funding for current assets the firm needs.

34) Scribble, Inc. has sales of $100,000 and cost of goods sold of $75,000. The firm had a beginning inventory of $20,000 and an ending inventory of $22,000. What is the length of the days' sales in inventory? A) 73.00 days B) 83.30 days C) 97.34 days D) 107.07 days Answer: D Explanation: ($22,000 × 365)/$75,000 = 107.07 days. Difficulty: 1 Easy Topic: Operating and cash cycles Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-03 Analyze the firm's operating and cash cycles to determine what funding for current assets the firm needs. 35) Drawing, Inc. has sales of $860,000 and cost of goods sold of $450,000. The firm had a beginning inventory of $50,000 and an ending inventory of $59,000. What is the length of the days' sales in inventory? A) 23.13 days B) 44.21 days C) 21.22 days D) 47.86 days Answer: D Explanation: ($59,000 × 365)/$450,000 = 47.86 days. Difficulty: 1 Easy Topic: Operating and cash cycles Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-03 Analyze the firm's operating and cash cycles to determine what funding for current assets the firm needs.

36) Painting, Inc. has sales of $400,000 and cost of goods sold of $275,000. The firm had a beginning inventory of $42,000 and an ending inventory of $38,000. What is the length of the days' sales in inventory? A) 53.09 days B) 36.50 days C) 38.33 days D) 50.44 days Answer: D Explanation: ($38,000 × 365)/$275,000 = 50.44 days. Difficulty: 1 Easy Topic: Operating and cash cycles Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-03 Analyze the firm's operating and cash cycles to determine what funding for current assets the firm needs. 37) If a firm has a cash cycle of 25 days and an operating cycle of 80 days, what is its average payment period? A) 25 B) 80 C) 55 D) 105 Answer: C Explanation: Using Equations 14-1 and 14-2: Cash cycle = Operating cycle − Average payment period: Operating cycle − Cash cycle = Average payment period = 80 − 25 = 55. Difficulty: 1 Easy Topic: Operating and cash cycles Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-03 Analyze the firm's operating and cash cycles to determine what funding for current assets the firm needs.

38) If a firm has a cash cycle of 10 days and an operating cycle of 43 days, what is its average payment period? A) 10 B) 33 C) 43 D) 53 Answer: B Explanation: Using Equations 14-1 and 14-2: Cash cycle = Operating cycle − Average payment period: Operating cycle − Cash cycle = Average payment period = 43 − 10 = 33. Difficulty: 1 Easy Topic: Operating and cash cycles Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-03 Analyze the firm's operating and cash cycles to determine what funding for current assets the firm needs. 39) If a firm has a cash cycle of 47 days and an operating cycle of 92 days, what is its average payment period? A) 45 B) 47 C) 92 D) 139 Answer: A Explanation: Using Equation 14-1 and 14-2: Cash cycle = Operating cycle − Average payment period: Operating cycle − Cash cycle = Average payment period = 92 − 47 = 45. Difficulty: 1 Easy Topic: Operating and cash cycles Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-03 Analyze the firm's operating and cash cycles to determine what funding for current assets the firm needs.

40) If a firm has a cash cycle of 25 days and an operating cycle of 80 days, what is its payables turnover? A) 14.6 B) 4.56 C) 6.64 D) 55 Answer: C Explanation: Using Equation 14-2: Cash cycle = Operating cycle − Average payment period: Operating cycle − Cash cycle = Average payment period = 80 − 25 = 55: Payables turnover will be 365/55 = 6.6363. Difficulty: 1 Easy Topic: Operating and cash cycles Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-03 Analyze the firm's operating and cash cycles to determine what funding for current assets the firm needs. 41) If a firm has a cash cycle of 10 days and an operating cycle of 43 days, what is its payables turnover? A) 11.06 B) 36.5 C) 8.48 D) 33 Answer: A Explanation: Using Equation 14-2: Cash cycle = Operating cycle − Average payment: period Operating cycle − Cash cycle = Average payment period = 43 − 10 = 33: Payables turnover will be 365/33 = 11.06. Difficulty: 1 Easy Topic: Operating and cash cycles Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-03 Analyze the firm's operating and cash cycles to determine what funding for current assets the firm needs.

42) If a firm has a cash cycle of 20 days and an operating cycle of 60 days, what is its payables turnover? A) 8.06 B) 9.13 C) 20.00 D) 40.00 Answer: B Explanation: Using Equation 14-2: Cash cycle = Operating cycle − Average payment period: Operating cycle − Cash cycle = Average payment period = 60 − 20 = 40: Payables turnover will be 365/40 = 9.13. Difficulty: 1 Easy Topic: Operating and cash cycles Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-03 Analyze the firm's operating and cash cycles to determine what funding for current assets the firm needs. 43) If a firm has a cash cycle of 32 days and an operating cycle of 67 days, what is its payables turnover? A) 5.45 B) 10.43 C) 11.41 D) 35 Answer: B Explanation: Using Equation 14-2: Cash cycle = Operating cycle − Average payment period: Operating cycle − Cash cycle = Average payment period = 67 − 32 = 35: Payables turnover will be 365/35 = 10.4286. Difficulty: 1 Easy Topic: Operating and cash cycles Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-03 Analyze the firm's operating and cash cycles to determine what funding for current assets the firm needs.

44) If a firm has a cash cycle of 30 days and an operating cycle of 64 days, what is its average payment period? A) 30 days B) 34 days C) 64 days D) 94 days Answer: B Explanation: Using Equation 14-2: Cash cycle = Operating cycle − Average payment period: Operating cycle − Cash cycle = Average payment period = 64 − 30 = 34. Difficulty: 1 Easy Topic: Operating and cash cycles Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-03 Analyze the firm's operating and cash cycles to determine what funding for current assets the firm needs. 45) If a firm has a cash cycle of 25 days and an operating cycle of 57 days, what is its average payment period? A) 25 days B) 32 days C) 57 days D) 82 days Answer: B Explanation: Using Equation 14-2: Cash cycle = Operating cycle − Average payment period: Operating cycle − Cash cycle = Average payment period = 57 − 25 = 32. Difficulty: 1 Easy Topic: Operating and cash cycles Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-03 Analyze the firm's operating and cash cycles to determine what funding for current assets the firm needs.

46) If a firm has a cash cycle of 39 days and an operating cycle of 88 days, what is its average payment period? A) 39 days B) 49 days C) 88 days D) 127 days Answer: B Explanation: Using Equation 14-2: Cash cycle = Operating cycle − Average payment period: Operating cycle − Cash cycle = Average payment period = 88 − 39 = 49. Difficulty: 1 Easy Topic: Operating and cash cycles Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-03 Analyze the firm's operating and cash cycles to determine what funding for current assets the firm needs. 47) If a firm has a cash cycle of 18 days and an operating cycle of 29 days, what is its payables turnover? A) 11 B) 18 C) 29 D) 33.18 Answer: D Explanation: Using Equation 14-2: Cash cycle = Operating cycle − Average payment period: Operating cycle − Cash cycle = Average payment period 29 − 18 = 11: Payables turnover will be 365/11 = 33.1818. Difficulty: 1 Easy Topic: Operating and cash cycles Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-03 Analyze the firm's operating and cash cycles to determine what funding for current assets the firm needs.

48) Would it be worth it to incur a compensating balance of $10,000 in order to get a 1-percentlower interest rate on a 1-year, pure discount loan of $500,000? A) Yes B) No C) Not enough information is given to know Answer: B Explanation: It depends upon whether $500,000 × (1 + i) or $510,000 × (1 + [i − 0.01]) is larger. The compensating balance for the lower loan rate will make sense if: $500,000 × (1 + i) > $510,000 × (1 + [i − 0.01]) ($500,000/$510,000) × (1 + i) > (1 + [i − 0.01]) 0.9804 + 0.9804i > 1 + i − 0.01 −0.0196i > 0.0096 i < −0.489796. In other words, only if the rate is less than −46.98 percent. Since this is not likely to happen, the lower rate associated with the compensating balance isn't worth it. Difficulty: 1 Easy Topic: Short-term finance and planning Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-05 Compare the flexible and restrictive approaches to financing current assets.

24) Would it be worth it to incur a compensating balance of $2,000 in order to get a 1.5-percentlower interest rate on a 1-year, pure discount loan of $100,000? A) Yes B) No C) Not enough information is given to determine Answer: B Explanation: It depends upon whether $100,000 × (1 + i) or $102,000 × (1 + [i − 0.015]) is larger. The compensating balance for the lower loan rate will make sense if: $100,000 × (1 + i) > $102,000 × (1 + [i − 0.015]) ($100,000/$102,000) × (1 + i) > (1 + [i − 0.015]) 0.9804 + 0.9804i > 1 + i − 0.015 −0.0196i > 0.0046 i < −0.234694. In other words, only if the rate is less than −23.47 percent. Since this is not likely to happen, the lower rate associated with the compensating balance isn't worth it. Difficulty: 1 Easy Topic: Short-term finance and planning Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-05 Compare the flexible and restrictive approaches to financing current assets.

25) Would it be worth it to incur a compensating balance of $4,000 in order to get a 1.5-percentlower interest rate on a 1-year, pure discount loan of $300,000? A) Yes, if the interest rate is less than 13.64 percent B) No, if the interest rate is less than 13.64 percent C) Yes, if the interest rate is more than 1.5 percent D) Not enough information is given to determine Answer: A Explanation: It depends upon whether $300,000 × (1 + i) or $304,000 × (1 + [i − 0.015]) is larger. The compensating balance for the lower loan rate will make sense if: $300,000 × (1 + i) > $304,000 × (1 + [i − 0.015]) ($300,000/$304,000) × (1 + i) > (1 + [i − 0.015]) 0.9868 + 0.9868i > 1 + i − 0.015 −0.0132i > -0.0018 i < 0.13636. In other words, only if the rate is less than 13.64 percent. Difficulty: 1 Easy Topic: Short-term finance and planning Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-05 Compare the flexible and restrictive approaches to financing current assets.

51) Would it be worth it to incur a compensating balance of $15,000 in order to get a 2-percentlower interest rate on a 1-year, pure discount loan of $1,000,000? A) Yes B) No C) Not enough information is given to determine Answer: A Explanation: It depends upon whether $1,000,000 × (1 + i) or $1,015,000 × (1 + [i − 0.02]) is larger. The compensating balance for the lower loan rate will make sense if: $1,000,000 × (1 + i) > $1,015,000 × (1 + [i − 0.02]) ($1,000,000/$1,015,000) × (1 + i) > (1 + [i − 0.02]) 0.9852 + 0.9852i > 1 + i − 0.02 −0.0148i > -0.0052 i < 0.35135. In other words, only if the rate is less than 35.14 percent. Since this is likely to happen, the lower rate associated with the compensating balance is worth it. Difficulty: 1 Easy Topic: Short-term finance and planning Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-05 Compare the flexible and restrictive approaches to financing current assets.

52) Would it be worth it to incur a compensating balance of $9,000 in order to get a 0.70 percent lower interest rate on a 1-year, pure discount loan of $250,000? A) Yes B) No C) Not enough information is given to determine Answer: B Explanation: The repayment on the $250,000 loan without the compensating balance would be $250,000 × (1 + i), vs. $259,000 × (1 + [i − 0.007]): $250,000 × (1 + i) > $259,000 × (1 + [i − 0.007]) ($250,000/$259,000) × (1 + i) > (1 + [i − 0.007]) 0.9653 + 0.9653i > 1 + i − 0.007 −0.0347i > 0.0277 i < - 0.7983. In other words, only if the rate is less than −79.83 percent. Since this is not likely to happen, the lower rate associated with the compensating balance isn't worth it. Difficulty: 1 Easy Topic: Short-term finance and planning Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-05 Compare the flexible and restrictive approaches to financing current assets. 53) KJ Enterprises estimates that it takes, on average, three days for their customers' payments to reach them, one day for the payments to be processed and deposited by their bookkeeping department, and two more days for the checks to clear once they're deposited. What is their collection float? A) one day B) two days C) three days D) six days Answer: D Explanation: 3 + 1 + 2 = 6 days. Difficulty: 1 Easy Topic: Float costs and management Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-09 Identify sources of float and show how to control float for the firm's disbursement and collection functions.

54) MC Enterprises estimates that it takes, on average, seven days for their customers' payments to reach them, two days for the payments to be processed and deposited by their bookkeeping department, and three more days for the checks to clear once they're deposited. What is their collection float? A) 12 days B) 10 days C) 9 days D) 7 days Answer: A Explanation: 7 + 2 + 3 = 12 days. Difficulty: 1 Easy Topic: Float costs and management Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-09 Identify sources of float and show how to control float for the firm's disbursement and collection functions. 55) CM Enterprises estimates that it takes, on average, seven days for their customers' payments to reach them, one day for the payments to be processed and deposited by their bookkeeping department, and three more days for the checks to clear once they're deposited. What is their collection float? A) 7 days B) 8 days C) 10 days D) 11 days Answer: D Explanation: 7 + 1 + 3 = 11 days. Difficulty: 1 Easy Topic: Float costs and management Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-09 Identify sources of float and show how to control float for the firm's disbursement and collection functions.

56) PBJ Enterprises estimates that it takes, on average, three days for their customers' payments to reach them, three days for the payments to be processed and deposited by their bookkeeping department, and three more days for the checks to clear once they're deposited. What is their collection float? A) 5 days B) 6 days C) 9 days D) 18 days Answer: C Explanation: 3 + 3 + 3 = 9 days. Difficulty: 1 Easy Topic: Float costs and management Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-09 Identify sources of float and show how to control float for the firm's disbursement and collection functions. 57) B&O Cos. has sales of $850,000 and cost of goods sold of $490,000. The firm had a beginning inventory of $69,000 and an ending inventory of $54,000. What is the length of the days' sales in inventory? A) 40.22 days B) 51.40 days C) 23.19 days D) 29.63 days Answer: A Explanation: ($54,000 × 365)/$490,000 = 40.22 days. Difficulty: 2 Medium Topic: Operating and cash cycles Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-03 Analyze the firm's operating and cash cycles to determine what funding for current assets the firm needs.

58) PNB Cos. has sales of $250,000 and cost of goods sold of $120,000. The firm had a beginning inventory of $19,000 and an ending inventory of $13,000. What is the length of the days' sales in inventory? A) 27.74 days B) 57.79 days C) 18.98 days D) 39.54 days Answer: D Explanation: ($13,000 × 365)/$120,000 = 39.54 days. Difficulty: 2 Medium Topic: Operating and cash cycles Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-03 Analyze the firm's operating and cash cycles to determine what funding for current assets the firm needs. 59) Suppose that Tucker Industries has annual sales of $5 million, cost of goods sold of $2.78 million, average inventories of $1,125,000, and average accounts receivable of $500,000. Assuming that all of Tucker's sales are on credit, what will be the firm's operating cycle? A) 147.71 B) 111.21 C) 184.21 D) 36.5 Answer: C Explanation: Using Equation 14-1: Operating Cycle = Days' Sales in Inventory + Average Collection Period = [(Inventory × 365)/CGS] + [(Accounts Receivable × 365)/Credit Sales] = [($1,125,000 × 365)/$2,780,000] + [($500,000 × 365)/$5,000,000] = 147.7068 + 36.5 = 184.2068. Difficulty: 2 Medium Topic: Operating and cash cycles Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-03 Analyze the firm's operating and cash cycles to determine what funding for current assets the firm needs.

60) Suppose that Mack Industries has annual sales of $10 million, cost of goods sold of $6.5 million, average inventories of $1 million, and average accounts receivable of $600,000. Assuming that all of Mack's sales are on credit, what will be the firm's operating cycle? A) 34.25 B) 21.9 C) 56.15 D) 78.05 Answer: D Explanation: Using Equation 14-1: Operating Cycle = Days' Sales in Inventory + Average Collection Period = [(Inventory × 365)/CGS] + [(Accounts Receivable × 365)/Credit Sales] = [($1,000,000 × 365)/$6,500,000] + [($600,000 × 365/$10,000,000)] = 56.1538 + 21.9 = 78.0538. Difficulty: 2 Medium Topic: Operating and cash cycles Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-03 Analyze the firm's operating and cash cycles to determine what funding for current assets the firm needs. 61) Suppose that Sam Industries has annual sales of $2 million, cost of goods sold of $950,000, average inventories of $45,000, and average accounts receivable of $90,000. Assuming that all of Sam's sales are on credit, what will be the firm's operating cycle? A) 0.85 B) 16.43 C) 17.29 D) 33.72 Answer: D Explanation: Using Equation 14-1: Operating Cycle = Days' Sales in Inventory + Average Collection Period = [(Inventory × 365)/CGS] + [(Accounts Receivable × 365)/Credit Sales] = [($45,000 × 365)/$950,000] + [($90,000 × 365/$2,000,000)] = 17.2895 + 16.425 = 33.7145. Difficulty: 2 Medium Topic: Operating and cash cycles Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-03 Analyze the firm's operating and cash cycles to determine what funding for current assets the firm needs.

62) Suppose that Freddy's Fries has annual sales of $500,000, cost of goods sold of $375,000, average inventories of $9,000, and average accounts receivable of $25,000. Assuming that all of Freddy's sales are on credit, what will be the firm's operating cycle? A) 27.01 B) 18.25 C) 8.76 D) 9.49 Answer: A Explanation: Using Equation 14-1: Operating Cycle = Days' Sales in Inventory + Average Collection Period = [(Inventory × 365)/CGS] + [(Accounts Receivable × 365)/Credit Sales] = [($9,000 × 365)/$375,000] + [($25,000 × 365)/$500,000] = 8.76 + 18.25 = 27.01. Difficulty: 2 Medium Topic: Operating and cash cycles Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-03 Analyze the firm's operating and cash cycles to determine what funding for current assets the firm needs. 63) Suppose that Farrah's Hair Care has annual sales of $100,000, cost of goods sold of $65,000, average inventories of $2,000, and average accounts receivable of $5,000. Assuming that all of Farrah's sales are on credit, what will be the firm's operating cycle? A) 7.02 B) 11.23 C) 18.25 D) 29.48 Answer: D Explanation: Using Equation 14-1: Operating Cycle = Days' Sales in Inventory + Average Collection Period = [(Inventory × 365)/CGS] + [(Accounts Receivable × 365)/Credit Sales] = [($2,000 × 365)/$65,000] + [($5,000 × 365)/$100,000] = 11.23 + 18.25 = 29.48. Difficulty: 2 Medium Topic: Operating and cash cycles Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-03 Analyze the firm's operating and cash cycles to determine what funding for current assets the firm needs.

64) Suppose that Freddie's Fries has annual sales of $500,000, cost of goods sold of $375,000, average inventories of $9,000, average accounts receivable of $25,000, and an average accounts payable balance of $20,000. Assuming that all of Freddie's sales are on credit, what will be the firm's cash cycle? A) 46.48 B) 1.22 C) 7.54 D) 27.01 Answer: C Explanation: Using Equation 14-1: Operating Cycle = Days' Sales in Inventory + Average Collection Period = [(Inventory × 365)/CGS] + [(Accounts Receivable × 365)/Credit Sales] = [($9,000 × 365)/$375,000] + [($25,000 × 365)/$500,000] = 8.76 + 18.25 = 27.01. Using this, in turn, in Equation 14-2: Cash cycle = Operating cycle − Average Payment Period = Operating cycle − [(Accounts Payable × 365)/CGS] = 27.01 − [($20,000 × 365)/$375,000] = 27.01 − 19.47 = 7.54. Difficulty: 2 Medium Topic: Operating and cash cycles Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-03 Analyze the firm's operating and cash cycles to determine what funding for current assets the firm needs.

65) Suppose that Jamie's Jams has annual sales of $900,000; cost of goods sold of $600,000; average inventories of $11,000; average accounts receivable of $50,000; and an average accounts payable balance of $30,000. Assuming that all of Jamie's sales are on credit, what will be the firm's cash cycle? A) 45.22 B) 8.72 C) 18.25 D) 26.97 Answer: B Explanation: Using Equation 14-1: Operating Cycle = Days' Sales in Inventory + Average Collection Period = [(Inventory × 365)/CGS] + [(Accounts Receivable × 365)/Credit Sales] = [($11,000 × 365)/$600,000] + [($50,000 × 365)/$900,000] = 6.69 + 20.28 = 26.97. Using this, in turn, in Equation 14-2: Cash cycle = Operating cycle − Average Payment Period = Operating cycle − [(Accounts Payable × 365)/CGS] = 26.97 − [($30,000 × 365)/$600,000] = 26.97 − 18.25 = 8.72. Difficulty: 2 Medium Topic: Operating and cash cycles Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-03 Analyze the firm's operating and cash cycles to determine what funding for current assets the firm needs.

66) Suppose that Darlene's Donuts has annual sales of $200,000; cost of goods sold of $90,000; average inventories of $4,000; average accounts receivable of $10,000; and an average accounts payable balance of $7,000. Assuming that all of Darlene's sales are on credit, what will be the firm's cash cycle? A) 6.08 B) 28.39 C) 34.47 D) 62.86 Answer: A Explanation: Using Equation 14-1: Operating Cycle = Days' Sales in Inventory + Average Collection Period = [(Inventory × 365)/CGS] + [(Accounts Receivable × 365)/Credit Sales] = [($4,000 × 365)/$90,000] + [($10,000 × 365)/$200,000] = 16.22 + 18.25 = 34.47. Using this, in turn, in Equation 14-2: Cash cycle = Operating cycle − Average Payment Period = Operating cycle − [(Accounts Payable × 365)/CGS] = 34.47 − [($7,000 × 365)/$90,000] = 34.47 − 28.39 = 6.08. Difficulty: 2 Medium Topic: Operating and cash cycles Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-03 Analyze the firm's operating and cash cycles to determine what funding for current assets the firm needs.

67) Suppose your firm is seeking a 7-year, amortizing $100,000 loan with annual payments and your bank is offering you the choice between a $110,000 loan with a $10,000 compensating balance and a $100,000 loan without a compensating balance. If the interest rate on the $100,000 loan is 7 percent, how low would the interest rate on the loan with the compensating balance have to be in order for you to choose it? A) 7 percent B) 10 percent C) 4.34 percent D) Not enough information is given to know Answer: C Explanation: Step 1: Find the loan payment for the loan with no compensating balance: PV = −100,000, N = 7, I = 7, FV = 0, => PMT = 18,555.32. Step 2: Solve for the I that makes these two loan choices equivalent: PV = −110,000, FV = 0, PMT = 18,555.32, => I = 4.3361 percent. The payments on the $100,000 loan would be $18,555.32. Using this as the payment amount and $110,000 as the present value, we can solve for the interest rate, which tells us that the bank would have to offer 4.3361 percent or lower on the loan with the compensating balance to make it worthwhile. Difficulty: 2 Medium Topic: Short-term finance and planning Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-04 Model the optimal trade-off between carrying costs and shortage costs that dictates the firm's current asset investment.

68) Suppose your firm is seeking a five-year, amortizing $900,000 loan with annual payments and your bank is offering you the choice between a $950,000 loan with a $50,000 compensating balance and a $900,000 loan without a compensating balance. If the interest rate on the $900,000 loan is 9.5 percent, how low would the interest rate on the loan with the compensating balance have to be in order for you to choose it? A) 9.5 percent B) 5.56 percent C) 7.43 percent D) Not enough information is given to determine Answer: C Explanation: Step 1: Find the loan payment for the loan with no compensating balance: PV = −900,000, N = 5, I = 9.5, FV = 0, => PMT = 234,392.77. Step 2: Solve for the I that makes these two loan choices equivalent: PV = −950,000, FV = 0, PMT = 234,392.77, => I = 7.4337 percent. The payments on the $900,000 loan would be $234,392.77. Using this as the payment amount and $950,000 as the present value, we can solve for the interest rate, which tells us that the bank would have to offer 7.4337 percent or lower on the loan with the compensating balance to make it worthwhile. Difficulty: 2 Medium Topic: Short-term finance and planning Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-04 Model the optimal trade-off between carrying costs and shortage costs that dictates the firm's current asset investment.

69) Suppose your firm is seeking a 3-year, amortizing $300,000 loan with annual payments and your bank is offering you the choice between a $305,000 loan with a $5,000 compensating balance and a $300,000 loan without a compensating balance. If the interest rate on the $300,000 loan is 8 percent, how low would the interest rate on the loan with the compensating balance have to be in order for you to choose it? A) 8 percent B) 7.09 percent C) 1.67 percent D) 7.98 percent Answer: B Explanation: Step 1: Find the loan payment for the loan with no compensating balance: PV = −300,000, N = 3, I = 8, FV = 0, => PMT = 116,410.05. Step 2: Solve for the I that makes these two loan choices equivalent: PV = −305,000, FV = 0, PMT = 116,410.05, => I = 7.089 percent. The payments on the $300,000 loan would be $116,410.05. Using this as the payment amount and $305,000 as the present value, we can solve for the interest rate, which tells us that the bank would have to offer 7.089 percent or lower on the loan with the compensating balance to make it worthwhile. Difficulty: 2 Medium Topic: Short-term finance and planning Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-04 Model the optimal trade-off between carrying costs and shortage costs that dictates the firm's current asset investment. 70) Rose Resources faces a smooth annual demand for cash of $10 million, incurs transaction costs of $325 every time they sell marketable securities, and can earn 3.9 percent on their marketable securities. What will be their optimal cash replenishment level? A) $28,867.51 B) $288,675.13 C) $40,824.83 D) $408,248.29 Answer: D Explanation: The optimal cash replenishment level will be: C* = (2TF/i)^1/2 = [(2)($10,000,000)($325)/0.039]^1/2 = $408,248.29. Difficulty: 2 Medium Topic: Baumol-Allais-Tobin (BAT) model Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-08 Use the Baumol and Miller-Orr models for determining cash policy. 38

71) Rose N More Resources faces a smooth annual demand for cash of $50 million, incurs transaction costs of $350 every time they sell marketable securities, and can earn 5.2 percent on their marketable securities. What will be their optimal cash replenishment level? A) $18,708.29 B) $187,082.87 C) $82,041.27 D) $820,412.65 Answer: D Explanation: The optimal cash replenishment level will be: C* = (2TF/i)^1/2 = [(2)($50,000,000)($350)/0.052]^1/2 = $820,412.65. Difficulty: 2 Medium Topic: Baumol-Allais-Tobin (BAT) model Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-08 Use the Baumol and Miller-Orr models for determining cash policy. 72) Reese's Resources faces a smooth annual demand for cash of $15 million, incurs transaction costs of $125 every time they sell marketable securities, and can earn 4.5 percent on their marketable securities. What will be their optimal cash replenishment level? A) $28,867.51 B) $288,675.13 C) $61,237.24 D) $6,123.72 Answer: B Explanation: The optimal cash replenishment level will be: C* = (2TF/i)^1/2 = [(2)($15,000,000)($125)/0.045]^1/2 = $288,675.13. Difficulty: 2 Medium Topic: Baumol-Allais-Tobin (BAT) model Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-08 Use the Baumol and Miller-Orr models for determining cash policy.

73) Hollywood Shoes would like to maintain their cash account at a minimum level of $50,000, but expects the standard deviation in net daily cash flows to be $4,000, the effective annual rate on marketable securities to be 6 percent per year, and the trading cost per sale or purchase of marketable securities to be $100 per transaction. What will be their optimal cash return point? A) $59,094.77 B) $69,588.47 C) $181,131.66 D) $54,000.00 Answer: B Explanation: The daily interest rate on marketable securities will be equal to: i day = 1.06^(1/365) − 1 = 0.000159654 and the optimal cash return point will be equal to: Z* = [3($100)($4,000)^2/(4 × 0.000159654)]^(1/3) + $50,000 = $69,588.47. Difficulty: 2 Medium Topic: Miller-Orr model Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-08 Use the Baumol and Miller-Orr models for determining cash policy. 74) Happy Feet would like to maintain their cash account at a minimum level of $75,000, but expects the standard deviation in net daily cash flows to be $5,000, the effective annual rate on marketable securities to be 7 percent per year, and the trading cost per sale or purchase of marketable securities to be $150 per transaction. What will be their optimal cash return point? A) $80,000.00 B) $99,755.64 C) $76,593.42 D) $82,548.18 Answer: B Explanation: The daily interest rate on marketable securities will be equal to: i day = 1.07^(1/365) − 1 = 0.000185383. And the optimal cash return point will be equal to: Z* = [3($150)($5,000)^2/(4 × 0.000185383)]^(1/3) + $75,000 = $99,755.64. Difficulty: 2 Medium Topic: Miller-Orr model Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-08 Use the Baumol and Miller-Orr models for determining cash policy.

75) BOGO Shoes would like to maintain their cash account at a minimum level of $100,000, but expects the standard deviation in net daily cash flows to be $7,000; the effective annual rate on marketable securities to be 6.5 percent per year; and the trading cost per sale or purchase of marketable securities to be $175 per transaction. What will be their optimal cash return point? A) $107,000 B) $133,374.63 C) $144,266.52 D) $101,859.65 Answer: B Explanation: The daily interest rate on marketable securities will be equal to: i day = 1.065^(1/365) − 1 = 0.000173. And the optimal cash return point will be equal to: Z* = [3($175)($7,000)^2/(4 × 0.000173)]^(1/3) + $100,000 = $133,374.63. Difficulty: 2 Medium Topic: Miller-Orr model Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-08 Use the Baumol and Miller-Orr models for determining cash policy. 76) Hollywood Shoes would like to maintain their cash account at a minimum level of $50,000, but expects the standard deviation in net daily cash flows to be $4,000; the effective annual rate on marketable securities to be 6 percent per year; and the trading cost per sale or purchase of marketable securities to be $100 per transaction. What will be their optimal upper cash limit? A) $59,094.77 B) $69,588.47 C) $108,765.41 D) $54,000.00 Answer: C Explanation: The daily interest rate on marketable securities will be equal to: i day = 1.06^(1/365) − 1 = 0.000159654 And the optimal cash return point will be equal to: Z* = [3($100)($4,000)^2/(4 × 0.000159654)]^(1/3) + $50,000 = $69,588.47, H* = 3(69,588.47) − 2(50,000) = $108,765.41 Difficulty: 2 Medium Topic: Miller-Orr model Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-08 Use the Baumol and Miller-Orr models for determining cash policy.

77) Happy Feet would like to maintain their cash account at a minimum level of $75,000, but expects the standard deviation in net daily cash flows to be $5,000; the effective annual rate on marketable securities to be 7 percent per year; and the trading cost per sale or purchase of marketable securities to be $150 per transaction. What will be their optimal upper cash limit? A) $80,000.00 B) $99,755.64 C) $76,593.42 D) $149,266.92 Answer: D Explanation: The daily interest rate on marketable securities will be equal to: i day = 1.07^(1/365) − 1 = 0.000185383. And the optimal cash return point will be equal to: Z* = [3($150)($5,000)^2/(4 × 0.000185383)]^(1/3) + $75,000 = $99,755.64, H* = 3(99,755.64) − 2(75,000) = $149,266.92. Difficulty: 2 Medium Topic: Miller-Orr model Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-08 Use the Baumol and Miller-Orr models for determining cash policy. 78) Stellar Shoes would like to maintain their cash account at a minimum level of $25,000, but expects the standard deviation in net daily cash flows to be $2,000; the effective annual rate on marketable securities to be 5 percent per year; and the trading cost per sale or purchase of marketable securities to be $100 per transaction. What will be their optimal upper cash limit? A) $27,000 B) $38,092.34 C) $114,277.02 D) $64,277.02 Answer: D Explanation: The daily interest rate on marketable securities will be equal to: i day = 1.05^(1/365) − 1 = 0.000133681. And the optimal cash return point will be equal to: Z* = [3($100)($2,000)^2/(4 × 0.000133681)]^(1/3) + $25,000 = $38,092.34, H* = 3(38,092.34) − 2(25,000) = $64,277.02. Difficulty: 2 Medium Topic: Miller-Orr model Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-08 Use the Baumol and Miller-Orr models for determining cash policy.

79) Joe's Burgers would like to maintain their cash account at a minimum level of $300,000, but expects the standard deviation in net daily cash flows to be $20,000; the effective annual rate on marketable securities to be 5.2 percent per year; and the trading cost per sale or purchase of marketable securities to be $22.50 per transaction. What will be their optimal upper cash limit? A) $320,000.00 B) $336,492.68 C) $409,478.04 D) $1,009,478.04 Answer: C Explanation: The daily interest rate on marketable securities will be equal to: i day = 1.052^(1/365) − 1 = 0.000138895. And the optimal cash return point will be equal to: Z* = [3($22.50)($20,000)^2/(4 × 0.000138895)]^(1/3) + $300,000 = $336,492.68, H* = 3(336,492.68) − 2(300,000) = $409,478.04. Difficulty: 2 Medium Topic: Miller-Orr model Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-08 Use the Baumol and Miller-Orr models for determining cash policy. 80) John Boy Industries has a cash balance of $59,000, accounts payable of $139,000, inventory of $115,000, accounts receivable of $220,000, notes payable of $175,000, and accrued wages and taxes of $23,000. How much net working capital does the firm need to fund? A) $140,000 B) $34,000 C) −$25,000 D) $57,000 Answer: D Explanation: NWC = CA − CL = ($59,000 + $220,000 + $115,000) − ($139,000 + $175,000 + $23,000) = $57,000. Difficulty: 1 Easy Topic: Net working capital Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-02 Discuss how net working capital serves the firm.

81) Dandee Lions, Inc. has a cash balance of $105,000, accounts payable of $290,000, inventory of $213,000, accounts receivable of $310,000, notes payable of $95,000, and accrued wages and taxes of $65,000. How much net working capital does the firm need to fund? A) $8,000 B) $83,000 C) $178,000 D) $18,000 Answer: C Explanation: NWC = CA − CL = ($105,000 + $213,000 + $310,000) − ($290,000 + $95,000 + $65,000) = $178,000. Difficulty: 1 Easy Topic: Net working capital Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-02 Discuss how net working capital serves the firm. 82) If a firm has a cash cycle of 71 days and an operating cycle of 139 days, what is its average payment period? A) 210 days B) 68 days C) 53 days D) 41 days Answer: B Explanation: Cash cycle = Operating cycle − Average payment period; 139 − 71 = 68 days. Difficulty: 1 Easy Topic: Operating and cash cycles Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-03 Analyze the firm's operating and cash cycles to determine what funding for current assets the firm needs.

83) If a firm has a cash cycle of 75 days and an operating cycle of 120 days, what is its payables turnover? A) 8.11 B) 7.19 C) 5.97 D) 6.73 Answer: A Explanation: Step 1: Find Average Payment Period: APP = Operating cycle − Cash cycle = 120 − 75 = 45. Step 2: Payable's turnover = 365/APP = 365/45 = 8.11. Difficulty: 1 Easy Topic: Operating and cash cycles Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-03 Analyze the firm's operating and cash cycles to determine what funding for current assets the firm needs. 84) If a firm has a cash cycle of 41 days and an operating cycle of 76 days, what is its average payment period? A) 52 days B) 29 days C) 117 days D) 35 days Answer: D Explanation: Operating cycle − Cash cycle = Average payment period = 76 − 41 = 35 days. Difficulty: 1 Easy Topic: Operating and cash cycles Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-03 Analyze the firm's operating and cash cycles to determine what funding for current assets the firm needs.

85) If a firm has a cash cycle of 38 days and an operating cycle of 82 days, what is its payables turnover? A) 8.79 B) 8.30 C) 9.53 D) 10.89 Answer: B Explanation: Step 1: Average payment period = Operating cycle − cash cycle = 82 − 38 = 44. Step 2: Payable's turnover = 365/APP = 365/44 = 8.30. Difficulty: 1 Easy Topic: Operating and cash cycles Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-03 Analyze the firm's operating and cash cycles to determine what funding for current assets the firm needs. 86) What must the rate be less than to be worth it to incur a compensating balance of $20,000 in order to get a 2 percent lower interest rate on a one-year, pure discount loan of $200,000? A) The rate must be less than 78 percent. B) The rate must be greater than 78 percent. C) The rate must be greater than −78 percent. D) The rate must be less than −78 percent. Answer: D Explanation: To be worth it the following must hold: $200,000 × (1 + i) > $220,000 × (1 + [i − 0.02]) ($200,000/$220,000) × (1 + i) > (1 + [i − 0.02]) 0.9091 + 0.9091i > 1 + i − 0.02 −0.0909i > 0.0709 i < − 0.78 the rate must be less than −78 percent. Therefore, the lower rate associated with the compensating balance is not worth it. Difficulty: 1 Easy Topic: Short-term finance and planning Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-07 Justify the firm's need to hold cash.

87) CM Enterprises estimates that it takes, on average, seven days for their customers' payments to reach them, one day for the payments to be processed and deposited by their bookkeeping department, and three more days for the check to clear once they're deposited. What is their collection float? A) 11 days B) 10 days C) 8 days D) 7 days Answer: A Explanation: 7 + 1 + 3 = 11 days. Difficulty: 1 Easy Topic: Float costs and management Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-09 Identify sources of float and show how to control float for the firm's disbursement and collection functions. 88) B&B Cos. has sales of $732,000 and cost of goods sold of $323,000. The firm had a beginning inventory of $48,000 and an ending inventory of $39,000. What is the length of the days' sales in inventory? A) 37.79 days B) 31.84 days C) 44.07 days D) 49.02 days Answer: C Explanation: ($39,000 × 365)/$323,000 = 44.07 days. Difficulty: 2 Medium Topic: Operating and cash cycles Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-03 Analyze the firm's operating and cash cycles to determine what funding for current assets the firm needs.

89) Suppose that Dunn Industries has annual sales of $2.5 million, cost of goods sold of $1,850,000, average inventories of $1,900,000, and average accounts receivable of $660,000. Assuming that all of Dunn's sales are on credit, what will be the firm's operating cycle? A) 471.22 days B) 374.86 days C) 418.61 days D) 515.39 days Answer: A Explanation: [Inv × 365/COGS] + [A/R × 365/Credit sales] = Operating cycle = [1,900,000 × 365/1,850,000] + [660,000 × 365/2,500,000] = 471.22 days. Difficulty: 2 Medium Topic: Operating and cash cycles Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-03 Analyze the firm's operating and cash cycles to determine what funding for current assets the firm needs. 90) Suppose that LilyMac Photography has annual sales of $218,000, cost of goods sold of $123,000, average inventories of $1,250, and average accounts receivable of $22,000. Assuming that all of LilyMac's sales are on credit, what will be the firm's operating cycle? A) 40.54 days B) 45.13 days C) 41.16 days D) 37.82 days Answer: A Explanation: [Inv × 365/COGS] + [A/R × 365/Credit sales] = Operating cycle = [1,250 × 365/123,000] + [22,000 × 365/218,000] = 40.54 days. Difficulty: 2 Medium Topic: Operating and cash cycles Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-03 Analyze the firm's operating and cash cycles to determine what funding for current assets the firm needs.

91) Suppose that LilyMac Photography has annual sales of $290,000, cost of goods sold of $155,000, average inventories of $3,500, average accounts receivable of $21,000, and an average accounts payable balance of $10,000. Assuming that all of LilyMac's sales are on credit, what will be the firm's cash cycle? A) 11.12 days B) 13.01 days C) 14.99 days D) 16.97 days Answer: A Explanation: [Inv × 365/COGS] + [A/R × 365/Credit Sales] = Operating cycle = [3,500 × 365/155,000] + [21,000 × 365/290,000] = 34.67 days; Cash cycle = Operating cycle − APP = 34.67 − [A/P × 365/COGS] = 34.67 − [10,000 × 365/155,000] = 34.67 − 23.55 = 11.12 days. Difficulty: 2 Medium Topic: Operating and cash cycles Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-03 Analyze the firm's operating and cash cycles to determine what funding for current assets the firm needs. 92) Suppose your firm is seeking a seven-year, amortizing $400,000 loan with annual payments and your bank is offering you the choice between a $410,000 loan with a $10,000 compensating balance and a $400,000 loan without a compensating balance. If the interest rate on the $400,000 loan is 9.5 percent, how low would the interest rate on the loan with the compensating balance have to be in order for you to choose it? A) The rate would have to be lower than 8.76 percent. B) The rate would have to be lower than 8.29 percent. C) The rate would have to be lower than 8.14 percent. D) The rate would have to be lower than 7.99 percent. Answer: A Explanation: Step 1: Find the loan payment for the loan with no compensating balance: PV = −400,000, N = 7, I = 9.5, FV = 0, => PMT = 80,814.41. Step 2: Solve for the I that makes these two loan choices equivalent: PV = −410,000, FV = 0, PMT = 80,814.41, => I = 8.76 percent. Difficulty: 2 Medium Topic: Short-term finance and planning Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-04 Model the optimal trade-off between carrying costs and shortage costs that dictates the firm's current asset investment.

93) Rose Axels faces a smooth annual demand for cash of $8 million; incurs transaction costs of $200 every time they sell marketable securities; and can earn 3.8 percent on their marketable securities. What will be their optimal cash replenishment level? A) $264,583.03 B) $278,997.38 C) $290,190.50 D) $313,809.26 Answer: C Explanation: SQRT [2TF/i] = SQRT [2 × 8,000,000 × 200/0.038] = $290,190.50 Difficulty: 2 Medium Topic: Baumol-Allais-Tobin (BAT) model Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-08 Use the Baumol and Miller-Orr models for determining cash policy. 94) HotFoot Shoes would like to maintain their cash account at a minimum level of $35,000, but expect the standard deviation in net daily cash flows to be $2,000, the effective annual rate on marketable securities to be 5 percent per year, and the trading cost per sale or purchase of marketable securities to be $210 per transaction. What will be their optimal cash return point? A) $41,899.45 B) $45,901.75 C) $51,752.46 D) $56,780.25 Answer: C Explanation: Step 1: Find the daily interest rate on marketable securities: [1.05]^(1/365) − 1 = 0.000134. Step 2: Optimal cash return point = [3 × 210 × (2,000)^2/(4 × 0.000134)]^(1/3) + 35,000 = 51,752.46. Difficulty: 2 Medium Topic: Miller-Orr model Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-08 Use the Baumol and Miller-Orr models for determining cash policy.

95) Betty Boop has saved enough money to go back to grad school. She is planning to put the money in a money market account where it will earn 2.5 percent. If she anticipates slowly drawing the money out over the course of her time in grad school at a constant rate of $29,000 per year, but is charged a commission of $7.95 every time she sells shares, how much should she take out of the mutual fund at a time? A) $4,589.52 B) $4,437.04 C) $4,294.65 D) $4,101.83 Answer: C Explanation: SQRT [(2 × 7.95 × 29,000)/0.025] = $4,294.65. Difficulty: 2 Medium Topic: Baumol-Allais-Tobin (BAT) model Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-08 Use the Baumol and Miller-Orr models for determining cash policy. 96) What effect does increasing the standard deviation in daily cash flows have on the cash return point in the Miller-Orr model? A) It will cause the cash return point to increase. B) It will cause the cash return point to decrease. C) It has no impact on the cash return point. D) It will cause the cash return point to first increase, then decrease. Answer: A Difficulty: 2 Medium Topic: Miller-Orr model Bloom's: Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-08 Use the Baumol and Miller-Orr models for determining cash policy.

97) What effect does decreasing the standard deviation in daily cash flows have on the cash return point in the Miller-Orr model? A) It will cause the cash return point to increase. B) It will cause the cash return point to decrease. C) It has no impact on the cash return point. D) It will cause the cash return point to first decrease, then increase. Answer: B Difficulty: 2 Medium Topic: Miller-Orr model Bloom's: Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-08 Use the Baumol and Miller-Orr models for determining cash policy. 98) Which of the following actions will cause a firm's net working capital to increase? A) The firm uses more trade credit. B) The firm increases its inventory in anticipation of seasonal sales. C) The firm pays off a short-term bank loan with cash. D) All of these choices are correct. Answer: B Difficulty: 2 Medium Topic: Net working capital Bloom's: Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-02 Discuss how net working capital serves the firm. 99) Which of the following actions will cause a firm's net working capital to decrease? A) The firm relaxes its credit policy. B) The firm increases its usage of accruals. C) The firm pays off a short-term bank loan with cash. D) None of the options will cause a firm's net working capital to decrease. Answer: B Difficulty: 2 Medium Topic: Net working capital Bloom's: Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-02 Discuss how net working capital serves the firm.

100) Imagine a firm has a temporary surplus of cash meant to fund an expansion project in the next nine months. Which of the following statements is correct? A) The firm will probably want to invest this in preferred stock. B) The firm will probably want to invest this surplus in U.S. Treasury bonds. C) The firm will probably want to invest this surplus in U.S. Treasury bills. D) The firm will probably want to invest this surplus in whichever security yields the highest return. Answer: C Difficulty: 2 Medium Topic: Cash management - general Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-10 Identify firms' choices for using excess cash. 101) Why do firms offer customers discounts for paying early? A) If customers pay early, the firm increases the likelihood of being paid. B) If customers pay early, the firm's cash cycle is shortened. C) If customers pay early, the firm improves its credit policy. D) All of these choices are correct. Answer: B Difficulty: 2 Medium Topic: Credit terms Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-11 Connect the firm's credit terms and collection policy and the amount of capital the firm has invested in accounts receivable.

102) What is the difference between a lockbox system and concentration banking? A) In concentration banking, both physical collection and processing take place close to the customer but in a lockbox system, neither the collections nor processing take place close to the customer. B) In a lockbox system, customers' payments are physically collected close to them and much of the processing takes place close to the bank, but in concentration banking both physical collection and processing take place close to the bank. C) Concentration banking involves using several banks to fund a large loan and lockbox systems deal with the ability to speed up collections. D) None of the options. Answer: D Difficulty: 2 Medium Topic: Float costs and management Bloom's: Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-09 Identify sources of float and show how to control float for the firm's disbursement and collection functions. 103) All of the following are different techniques that can be used to help firms reduce collection float EXCEPT A) using drafts. B) using wire transfers. C) using concentration banking. D) using a lockbox system. Answer: A Difficulty: 2 Medium Topic: Float costs and management Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-09 Identify sources of float and show how to control float for the firm's disbursement and collection functions.

104) All of the following are the different types of float the firm may experience in its collections EXCEPT A) mail float. B) availability float. C) check kiting float. D) processing float. Answer: C Difficulty: 2 Medium Topic: Float costs and management Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-09 Identify sources of float and show how to control float for the firm's disbursement and collection functions. 105) If a firm starts selling its accounts receivable to a factor, how will the firm's cash cycle change? A) The firm will increase its cash cycle since it will now have to wait longer for payment. B) The firm will decrease its cash cycle since accounts receivable is reduced. C) Depending on conditions, the cash cycle could either increase or decrease. D) There will be no change. Answer: B Difficulty: 2 Medium Topic: Operating and cash cycles Bloom's: Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-06 Differentiate among sources of short-term financing available for funding current assets. 106) If demand for a firm's products suddenly slows down so that inventory increases while sales decrease, how will the firm's needs for net working capital react? A) Net working capital would increase. B) Net working capital would decrease. C) There would be no change in net working capital. D) Net working capital would first decrease, then increase slowly over time. Answer: A Difficulty: 2 Medium Topic: Net working capital Bloom's: Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-02 Discuss how net working capital serves the firm. 55

107) If demand for a firm's products suddenly increases so that inventory decreases while sales increase, how will the firm's needs for net working capital react? A) Net working capital would increase. B) Net working capital would decrease. C) There would be no change in net working capital. D) Net working capital would first decrease, then increase slowly over time. Answer: B Difficulty: 2 Medium Topic: Net working capital Bloom's: Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-02 Discuss how net working capital serves the firm. 108) Which of the following is the best description of the operating cycle? A) The length of time that it takes to convert raw materials into inventory B) The length of time that it takes to convert raw materials into accounts receivable C) The length of time to acquire raw materials and receive payment for them when sold D) None of the options Answer: C Difficulty: 2 Medium Topic: Operating and cash cycles Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-03 Analyze the firm's operating and cash cycles to determine what funding for current assets the firm needs. 109) When the firm finances the seasonally adjusted average level of asset demand with longterm debt and equity, the firm is said to follow a A) seasonal-dependent financing policy. B) relaxed financing policy. C) restricted financing policy. D) compromise financing policy. Answer: D Difficulty: 2 Medium Topic: Compromise financial policy Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-05 Compare the flexible and restrictive approaches to financing current assets. 56

110) Why would a firm ever use short-term debt to finance permanent current assets? A) This would be illogical and is rarely observed. B) This would occur if short-term rates were much lower than long-term rates. C) This would only occur if the managers were very conservative. D) None of the options. Answer: B Difficulty: 2 Medium Topic: Short-term finance and planning Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-05 Compare the flexible and restrictive approaches to financing current assets. 111) Everything else held constant, will an increase in the amount of inventory on hand increase or decrease the firm's profitability? A) Decrease the profitability. B) Increase the profitability. C) It could either increase or decrease the profitability depending on net profit margins. D) It could either increase or decrease the profitability depending on the debt ratio. Answer: A Difficulty: 2 Medium Topic: Inventory management Bloom's: Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-04 Model the optimal trade-off between carrying costs and shortage costs that dictates the firm's current asset investment. 112) If a firm's inventory ratio increases, what will happen to the firm's cash cycle? A) It will increase. B) It will decrease. C) It will increase and then slowly decrease back to the initial level. D) It will decrease and then slowly increase back to the initial level. Answer: A Difficulty: 2 Medium Topic: Operating and cash cycles Bloom's: Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-03 Analyze the firm's operating and cash cycles to determine what funding for current assets the firm needs. 57

113) All of the following will result in an increase in net working capital EXCEPT A) an increase in inventory. B) a decrease in accounts payable. C) an increase in cash. D) an increase in accruals. Answer: D Difficulty: 2 Medium Topic: Net working capital Bloom's: Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-02 Discuss how net working capital serves the firm. 114) If a firm's inventory ratio increases, what will happen to the firm's operating cycle? A) It will increase. B) It will decrease. C) It will increase and then slowly decrease back to the initial level. D) It will decrease and then slowly increase back to the initial level. Answer: A Difficulty: 2 Medium Topic: Operating and cash cycles Bloom's: Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-03 Analyze the firm's operating and cash cycles to determine what funding for current assets the firm needs. 115) A firm wants to reduce its cash cycle. Which of the following actions will reduce its cash cycle? A) The firm reduces its Days' sales outstanding. B) The firm increases its inventory. C) The firm reduces its accounts payable. D) All of these choices are correct. Answer: A Difficulty: 2 Medium Topic: Operating and cash cycles Bloom's: Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-10 Identify firms' choices for using excess cash.

116) If the firm wants to identify the percentage of accounts receivable that are over 90 days old, the firm should prepare A) a detailed analysis of accounts receivable. B) an aging schedule. C) a credit analysis. D) an analysis of the cash cycle. Answer: B Difficulty: 1 Easy Topic: Accounts receivable Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-11 Connect the firm's credit terms and collection policy and the amount of capital the firm has invested in accounts receivable. 117) The financing policy that will result in investing in marketable securities when asset requirements are low is referred to as A) compromise financing. B) restrictive financing. C) flexible financing. D) none of the options. Answer: C Difficulty: 1 Easy Topic: Flexible financial policy Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-05 Compare the flexible and restrictive approaches to financing current assets. 118) The optimal cash replenishment level will increase with all of the following changes EXCEPT A) the transaction cost decreases. B) the annual demand for cash increases. C) the interest rate decreases. D) All of these choices are correct. Answer: A Difficulty: 1 Easy Topic: Baumol-Allais-Tobin (BAT) model Bloom's: Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-08 Use the Baumol and Miller-Orr models for determining cash policy. 59

119) The optimal cash replenishment level will decrease with all of the following changes EXCEPT A) the transaction cost decreases. B) the annual demand for cash decreases. C) the interest rate decreases. D) All of these choices are correct. Answer: C Difficulty: 1 Easy Topic: Baumol-Allais-Tobin (BAT) model Bloom's: Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-08 Use the Baumol and Miller-Orr models for determining cash policy. 120) The operating cycle will increase with all of the following changes EXCEPT A) the cost of goods sold increases. B) the level of accounts receivable increases. C) the level of inventory increases. D) All of these choices are correct. Answer: A Difficulty: 2 Medium Topic: Operating and cash cycles Bloom's: Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-03 Analyze the firm's operating and cash cycles to determine what funding for current assets the firm needs. 121) The operating cycle will decrease with all of the following changes EXCEPT A) the cost of goods sold increases. B) the level of credit sales increases. C) the level of inventory decreases. D) All of these choices are correct. Answer: D Difficulty: 2 Medium Topic: Operating and cash cycles Bloom's: Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-03 Analyze the firm's operating and cash cycles to determine what funding for current assets the firm needs.

122) Safety stock is referred to as the A) excess amounts of fixed assets kept on hand to meet unexpected shocks in demand. B) excess amounts of accruals used to fund short-term demands for cash. C) excess amounts of a current asset kept on hand to meet unexpected shocks in demand. D) none of the options. Answer: C Difficulty: 1 Easy Topic: Miller-Orr model Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-08 Use the Baumol and Miller-Orr models for determining cash policy. 123) All of the following are examples of carrying costs EXCEPT A) rental payments on storage facilities where inventory is maintained. B) the lost sale if the company runs out of a particular model. C) the opportunity costs associated with having capital tied up in current assets instead of more productive fixed assets. D) All of these choices are correct. Answer: B Difficulty: 2 Medium Topic: Carrying and shortage costs Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-04 Model the optimal trade-off between carrying costs and shortage costs that dictates the firm's current asset investment. 124) All of the following are examples of carrying costs EXCEPT A) rental payments on buildings where the business is located. B) maintenance costs on the inventory. C) the opportunity costs associated with having capital tied up in current assets instead of more productive fixed assets. D) All of these choices are correct. Answer: A Difficulty: 2 Medium Topic: Carrying and shortage costs Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-04 Model the optimal trade-off between carrying costs and shortage costs that dictates the firm's current asset investment.

125) Which of the following will decrease the operating cycle? A) The cash cycle increases. B) The days' sales in inventory decreases by three days but the average collection period increases by two days. C) The average payment period increases. D) All of these choices are correct. Answer: B Difficulty: 2 Medium Topic: Operating and cash cycles Bloom's: Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-03 Analyze the firm's operating and cash cycles to determine what funding for current assets the firm needs. 126) Which of the following statements regarding operating cycles are true? A) The firm's cash cycle is the portion of the operating cycle that the firm must finance. B) Is the time required to acquire raw materials and to produce, sell, and receive payment for the finished goods. C) The firm's cash cycle is the operating cycle minus the average payment period. D) all of the above Answer: D Difficulty: 2 Medium Topic: Operating and cash cycles Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-03 Analyze the firm's operating and cash cycles to determine what funding for current assets the firm needs. 127) Which of the following is not a basic element of Kaizen? A) teamwork B) personal discipline C) improved moral D) flexible work schedules Answer: D Difficulty: 2 Medium Topic: Kaizen Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-04 Model the optimal trade-off between carrying costs and shortage costs that dictates the firm's current asset investment. 62

128) Carrying costs are associated with having current assets and fall into which general category? A) The opportunity costs associated with having capital tied up in current assets instead of more productive fixed assets. B) Explicit costs necessary to maintain the value of current assets. C) both a and b D) neither a or b Answer: C Difficulty: 2 Medium Topic: Carrying costs Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-04 Model the optimal trade-off between carrying costs and shortage costs that dictates the firm's current asset investment. 129) Which of the following will increase the operating cycle? A) The cash cycle decreases by one day but the average payment period increases by two and a half days. B) The days' sales in inventory decreases by one day but the average collection period increases by two days. C) COGS stays the same but inventory increases. D) All of these choices are correct. Answer: D Difficulty: 2 Medium Topic: Operating and cash cycles Bloom's: Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-03 Analyze the firm's operating and cash cycles to determine what funding for current assets the firm needs.

130) Inventory loans that firms use to purchase inventory can include: A) blanket inventory liens B) trust receipts C) field warehousing financing D) all of the above Answer: D Difficulty: 2 Medium Topic: Inventory loans Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-06 Differentiate among sources of short-term financing available for funding current assets. 131) is a cheap source of funds for the lender and represent opportunity costs for borrowing firms. A) compensating balances B) transaction facilitation C) investment opportunities D) cash account Answer: A Difficulty: 1 Easy Topic: Compensating balances Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-07 Justify the firm's need to hold cash. 132) Which is not one of the five C's in credit analysis? A) collection B) character C) capital D) collateral Answer: A Difficulty: 1 Easy Topic: Credit analysis Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-09 Identify sources of float and show how to control float for the firm's disbursement and collection functions.

133) "The net amount of current assets that the firm has to fund, above and beyond those that someone else funds for them" is referred to as A) net working capital. B) excess capacity. C) safety stock. D) unfunded assets. Answer: A Difficulty: 1 Easy Topic: Net working capital Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-02 Discuss how net working capital serves the firm. 134) If a firm has a cash cycle of 8 days and an operating cycle of 39 days, what is its average payment period? A) 47 days B) 39 days C) 31 days D) 8 days Answer: C Explanation: Cash cycle = Operating cycle − Average payment period; 39 − 8 = 31 days. Difficulty: 1 Easy Topic: Operating and cash cycles Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-03 Analyze the firm's operating and cash cycles to determine what funding for current assets the firm needs.

135) If a firm has a cash cycle of 55 days and an operating cycle of 150 days, what is its payables turnover? A) 9.50 B) 6.64 C) 3.84 D) 2.60 Answer: C Explanation: Step 1: Find Average Payment Period: APP = Operating cycle − Cash cycle = 150 − 55 = 95. Step 2: Payable's turnover = 365/APP = 365/95 = 3.84. Difficulty: 1 Easy Topic: Operating and cash cycles Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-03 Analyze the firm's operating and cash cycles to determine what funding for current assets the firm needs. 136) If a firm has a cash cycle of 30 days and an operating cycle of 92 days, what is its average payment period? A) 92 days B) 62 days C) 34 days D) 30 days Answer: B Explanation: Operating cycle − Cash cycle = Average payment period = 92 − 30 = 62 days. Difficulty: 1 Easy Topic: Operating and cash cycles Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-03 Analyze the firm's operating and cash cycles to determine what funding for current assets the firm needs.

137) If a firm has a cash cycle of 18 days and an operating cycle of 34 days, what is its payables turnover? A) 16.00 B) 20.28 C) 22.81 D) 34.00 Answer: C Explanation: Step 1: Average payment period = Operating cycle − cash cycle = 34 − 18 = 16. Step 2: Payable's turnover = 365/APP = 365/16 = 22.8125. Difficulty: 1 Easy Topic: Operating and cash cycles Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-03 Analyze the firm's operating and cash cycles to determine what funding for current assets the firm needs. 138) If a firm has a cash cycle of 32 days and an operating cycle of 52 days, what is its payables turnover? A) 7.02 B) 11.41 C) 18.25 D) 20.00 Answer: C Explanation: Step 1: Average payment period = Operating cycle − cash cycle = 52 − 32 = 20. Step 2: Payable's turnover = 365/APP = 365/20 = 18.25. Difficulty: 1 Easy Topic: Operating and cash cycles Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-03 Analyze the firm's operating and cash cycles to determine what funding for current assets the firm needs.

139) Suppose that Professional Photography has annual sales of $900,000, cost of goods sold of $450,000, average inventories of $5,000, average accounts receivable of $40,000, and an average accounts payable balance of $20,000. Assuming that all of Professional's sales are on credit, what will be the firm's cash cycle? A) 4.06 days B) 12.17 days C) 18.25 days D) 36.50 days Answer: A Explanation: [Inv × 365/COGS] + [A/R × 365/Credit sales] = Operating cycle = [5,000 × 365/450,000] + [40,000 × 365/900,000] = 20.278 days; Cash cycle = Operating cycle − APP = 20.278 − [A/P × 365/COGS] = 20.278 − [20,000 × 365/450,000] = 20.278 − 16.222 = 4.056 days. Difficulty: 2 Medium Topic: Short-term finance and planning Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-03 Analyze the firm's operating and cash cycles to determine what funding for current assets the firm needs. 140) What must the rate be less than to be worth it to incur a compensating balance of $2,000 in order to get a 2 percent lower interest rate on a one-year, pure discount loan of $50,000? A) The rate must be less than 48 percent. B) The rate must be greater than 48 percent. C) The rate must be greater than −48 percent. D) The rate must be less than −48 percent. Answer: D Explanation: To be worth it the following must hold: $50,000 × (1 + i) > $52,000 × (1 + [i − 0.02]) ($50,000/$52,000) × (1 + i) > (1 + [i − 0.02]) 0.9615 + 0.9615i > 1 + i − 0.02 −0.0385i > 0.0185 i < − 0.4805. the rate must be less than −48 percent. Therefore, the lower rate associated with the compensating balance is not worth it. Difficulty: 1 Easy Topic: Float costs and management Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-07 Justify the firm's need to hold cash. 68

141) CJ Enterprises estimates that it takes, on average, three days for their customers' payments to reach them, one day for the payments to be processed and deposited by their bookkeeping department, and two more days for the check to clear once they're deposited. What is their collection float? A) 6 days B) 5 days C) 4 days D) 3 days Answer: A Explanation: 3 + 1 + 2 = 6 days. Difficulty: 1 Easy Topic: Operating and cash cycles Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-09 Identify sources of float and show how to control float for the firm's disbursement and collection functions. 142) PB&J Company has sales of $900,000 and cost of goods sold of $450,000. The firm had a beginning inventory of $70,000 and an ending inventory of $65,000. What is the length of the days' sales in inventory? A) 56.78 days B) 54.75 days C) 52.72 days D) 26.36 days Answer: C Explanation: ($65,000 × 365)/$450,000 = 52.72 days. Difficulty: 2 Medium Topic: Operating and cash cycles Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-03 Analyze the firm's operating and cash cycles to determine what funding for current assets the firm needs.

143) BK Industries has sales of $500,000 and cost of goods sold of $230,000. The firm had a beginning inventory of $10,000 and an ending inventory of $15,000. What is the length of the days' sales in inventory? A) 10.95 days B) 15.87 days C) 19.84 days D) 23.80 days Answer: D Explanation: ($15,000 × 365)/$230,000 = 23.80 days. Difficulty: 2 Medium Topic: Operating and cash cycles Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 14-03 Analyze the firm's operating and cash cycles to determine what funding for current assets the firm needs.

Finance, 5e (Cornett) Chapter 15 Financial Planning and Forecasting 1) Which of the following is a set of financial statements depicting an operating division of a firm's expected financial situation in the foreseeable future under the most reasonable set of assumptions concerning relevant factors? A) Base case projections B) Deseasonalized financial statements C) Naïve financial statements D) Pro forma financial statements Answer: D Difficulty: 1 Easy Topic: Pro forma statements Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 15-01 Describe the process of financial planning in the context of the firm and how base case projections are used in the strategic planning process. 2) The set of assumptions underlying the firm's financial plan and the resulting projected financial statements are accordingly often referred to as which of the following? A) Base case projections B) Deseasonalized financial statements C) Naïve financial statements D) Pro forma financial statements Answer: A Difficulty: 1 Easy Topic: Financial planning and forecasting Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 15-01 Describe the process of financial planning in the context of the firm and how base case projections are used in the strategic planning process.

3) Financial planning involves estimating projected cash flows, which is useful for all of the following EXCEPT A) setting internal goals. B) providing information to shareholders and other external stakeholders concerning the firm's future expectations. C) estimating the firm's future needs for internal and external financing. D) auditors to determine if the company's annual report is true and correct. Answer: D Difficulty: 1 Easy Topic: Financial planning and forecasting Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 15-01 Describe the process of financial planning in the context of the firm and how base case projections are used in the strategic planning process. 4) The simplest approach to estimating a future period's sales is to assume that they will be equal to those of the latest observed period. In statistics, this is often simply referred to as which of the following? A) Base case approach B) Deseasonalized approach C) Naïve approach D) Pro forma approach Answer: C Difficulty: 1 Easy Topic: Sales forecasts Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 15-02 Identify how forecasting sales supports the process of financial planning. 5) Forecasted sales drive all of the following EXCEPT A) the amount of assets needed. B) the liabilities needed. C) the external funds needed. D) earnings per share on the annual report. Answer: D Difficulty: 1 Easy Topic: Financial planning and forecasting Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 15-02 Identify how forecasting sales supports the process of financial planning. 2

6) Which of the following is defined as assuming that future sales will be equal to the average historical value across some relevant period? A) Average approach B) Base case approach C) Naïve approach D) Pro forma approach Answer: A Difficulty: 1 Easy Topic: Sales forecasts Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 15-03 Compare and contrast the naive, average, and seasonality-and trendadjusted approaches to forecasting sales and how they are implemented. 7) Which of the following is used to remove the effects of seasonality from historic data? A) Average approach B) Base case approach C) Deseasonalized approach D) Pro forma approach Answer: C Difficulty: 1 Easy Topic: Financial planning models Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 15-03 Compare and contrast the naive, average, and seasonality-and trendadjusted approaches to forecasting sales and how they are implemented. 8) Which of the following is the practice of one firm selling to another on credit terms? A) Accounts payable B) Accounts receivable C) Barter transactions D) Trade credit Answer: D Difficulty: 1 Easy Topic: Sales forecasts Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 15-04 Explain and demonstrate the additional funds needed (AFN) approach to estimating a firm's need to seek external financing. 3

9) What is computed by dividing the amount of assets tied directly to sales (A*) by the amount of current sales (S0)? A) Capital intensity ratio B) Current ratio C) Quick ratio D) Spontaneous assets Answer: A Difficulty: 2 Medium Topic: External financing need Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 15-04 Explain and demonstrate the additional funds needed (AFN) approach to estimating a firm's need to seek external financing. 10) Which of the following is the amount of external financing a firm must seek in order to change the asset base as necessary to support a different level of sales? A) Additional funds needed B) Capital intensity ratio C) Current ratio D) Spontaneous assets Answer: A Difficulty: 2 Medium Topic: External financing need Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 15-04 Explain and demonstrate the additional funds needed (AFN) approach to estimating a firm's need to seek external financing.

11) Which of the following can be computed as: necessary increase in assets minus spontaneous increase in liabilities minus projected increase in retained earnings? A) Additional funds needed B) Capital intensity ratio C) Current ratio D) Spontaneous assets Answer: A Difficulty: 1 Easy Topic: External financing need Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 15-04 Explain and demonstrate the additional funds needed (AFN) approach to estimating a firm's need to seek external financing. 12) If a firm has excess capacity when calculating AFN (Additional Funds Needed), A* will most likely equal which of the following? A) Total assets B) Current assets C) Fixed assets D) Lumpy assets Answer: B Difficulty: 2 Medium Topic: External financing need Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 15-04 Explain and demonstrate the additional funds needed (AFN) approach to estimating a firm's need to seek external financing. 13) Which of the following are considered "chunky" or "lumpy" assets? A) Total assets B) Current assets C) Fixed assets D) Additional funds needed (AFN) Answer: C Difficulty: 2 Medium Topic: External financing need Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 15-04 Explain and demonstrate the additional funds needed (AFN) approach to estimating a firm's need to seek external financing. 5

14) The additional funds needed by the firm can be calculated by assuming which of the following? A) The firm's additional sales will grow proportionately as assets are purchased. B) The firm's additional capital needed will grow proportionately with projected changes in sales. C) The firm's balance sheet will grow proportionately with projected changes in sales. D) The firm's additional sales will grow proportionately as capital is brought on to the balance sheet. Answer: C Difficulty: 1 Easy Topic: External financing need Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 15-04 Explain and demonstrate the additional funds needed (AFN) approach to estimating a firm's need to seek external financing. 15) Which statement is most correct regarding how pro forma financial statements can be used to estimate additional funds needed? A) Pro forma statements can be used to iteratively refine the amount of additional funds needed. B) Pro forma statements are less precise than other methods for determining additional funds needed. C) Pro forma statements take into account changes in cost of goods sold that other methods of determining additional funds needed ignore. D) Pro forma statements take into account dividend payments that other methods of determining additional funds needed ignore. Answer: A Difficulty: 1 Easy Topic: Pro forma statements Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 15-05 Use pro forma financial statements to estimate additional funds needed.

16) Which of the following defines the term deseasonalize? A) To use pro forma statements to determine future years' forecasts B) To remove the effects of seasonality from historic data C) To remove fixed asset growth that does not tie into sales growth D) To fix asset growth to smooth out the seasonality of sales growth Answer: B Difficulty: 1 Easy Topic: Sales forecasts Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 15-03 Compare and contrast the naive, average, and seasonality-and trendadjusted approaches to forecasting sales and how they are implemented. 17) Which of the following defines MAPE? A) Median absolute percentage error, a measure of a financial statement's accuracy B) Median absolute percentage error, a measure of a forecast's accuracy C) Mean absolute percentage error, a measurement of a forecast's accuracy D) Mean absolute percentage error, a measure of a financial statement's accuracy Answer: C Difficulty: 2 Medium Topic: Sales forecasts Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 15-03 Compare and contrast the naive, average, and seasonality-and trendadjusted approaches to forecasting sales and how they are implemented. 18) First order effects are defined as which of the following? A) The subsequent, less observable effects of the change B) The subsequent, more observable effects of the change C) Higher order effects of the change D) The immediately observable effects of changing one item on another Answer: D Difficulty: 2 Medium Topic: Pro forma statements Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 15-05 Use pro forma financial statements to estimate additional funds needed.

19) Which of the following defines iterative calculation? A) The practice of overriding a spreadsheet program or calculator in order to be able to compute an answer so as to take into account circular dependency in a system of equations B) The practice of ensuring there are no circular dependencies in a system of equations C) The practice of letting a spreadsheet program or calculator repeatedly compute an answer so as to take into account circular dependency in a system of equations D) The practice of using the AFN formula to calculate an answer in order to avoid circular dependencies in a system of equations Answer: C Difficulty: 2 Medium Topic: Pro forma statements Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 15-05 Use pro forma financial statements to estimate additional funds needed. 20) Suppose a firm has had the historical sales figures shown as follows. What would be the forecast for next year's sales using the naïve approach? Year Sales

2013 $ 1,000,000

2014 $ 2,000,000

2015 $ 1,700,000

2016 $ 1,800,000

2017 $ 2,200,000

A) $1,000,000 B) $1,740,000 C) $1,925,000 D) $2,200,000 Answer: D Explanation: Naïve uses the last occurrence. Difficulty: 1 Easy Topic: Sales forecasts Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 15-03 Compare and contrast the naive, average, and seasonality-and trendadjusted approaches to forecasting sales and how they are implemented.

21) Suppose a firm has had the historical sales figures shown as follows. What would be the forecast for next year's sales using the naïve approach? Year Sales

2013 $ 10,000,000

2014 $ 10,500,000

2015 $ 10,700,000

2016 $ 11,000,000

2017 $ 12,000,000

A) $10,000,000 B) $10,550,000 C) $10,840,000 D) $12,000,000 Answer: D Explanation: Naïve uses the last occurrence. Difficulty: 1 Easy Topic: Sales forecasts Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 15-03 Compare and contrast the naive, average, and seasonality-and trendadjusted approaches to forecasting sales and how they are implemented. 22) Suppose a firm has had the historical sales figures shown as follows. What would be the forecast for next year's sales using the average approach? Year Sales

2013 $ 1,000,000

2014 $ 2,000,000

2015 $ 1,700,000

2016 $ 1,800,000

2017 $ 2,200,000

A) $1,000,000 B) $1,740,000 C) $1,925,000 D) $2,200,000 Answer: B Explanation: ($1,000,000 + $2,000,000 + $1,700,000 + $1,800,000 + $2,200,000)/5 = $1,740,000. Difficulty: 1 Easy Topic: Sales forecasts Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 15-03 Compare and contrast the naive, average, and seasonality-and trendadjusted approaches to forecasting sales and how they are implemented.

23) Suppose a firm has had the historical sales figures shown as follows. What would be the forecast for next year's sales using the average approach? Year Sales

2013 500,000

2014 600,000

2015 $ 700,000

2016 $ 400,000

2017 $ 700,000

A) $500,000 B) $580,000 C) $625,000 D) $700,000 Answer: B Explanation: ($500,000 + $600,000 + $700,000 + $400,000 + $700,000)/5 = $580,000. Difficulty: 1 Easy Topic: Sales forecasts Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 15-03 Compare and contrast the naive, average, and seasonality-and trendadjusted approaches to forecasting sales and how they are implemented. 24) Suppose a firm has had the historical sales figures shown as follows. What would be the forecast for next year's sales using the average approach? Year Sales

2013 $ 10,000,000

2014 $ 10,500,000

2015 $ 10,700,000

2016 $ 11,000,000

2017 $ 12,000,000

A) $10,000,000 B) $10,550,000 C) $10,840,000 D) $12,000,000 Answer: C Explanation: ($10,000,000 + $10,500,000 + $10,700,000 + $11,000,000 + $12,000,000)/5 = $10,840,000. Difficulty: 1 Easy Topic: Sales forecasts Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 15-03 Compare and contrast the naive, average, and seasonality-and trendadjusted approaches to forecasting sales and how they are implemented.

25) Suppose a firm has had the historical sales figures shown as follows. What would be the forecast for next year's sales using the average approach if it was determined that 2013 is a "stale" year? Year Sales

2013 $ 1,000,000

2014 $ 2,000,000

2015 $ 1,700,000

2016 $ 1,800,000

2017 2,200,000

A) $1,000,000 B) $1,740,000 C) $1,925,000 D) $2,200,000 Answer: C Explanation: ($2,000,000 + $1,700,000 + $1,800,000 + $2,200,000)/4 = $1,925,000. Difficulty: 1 Easy Topic: Sales forecasts Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 15-03 Compare and contrast the naive, average, and seasonality-and trendadjusted approaches to forecasting sales and how they are implemented. 26) Suppose a firm has had the historical sales figures shown as follows. What would be the forecast for next year's sales using the average approach if it was determined that years 2013 and 2014 were "stale"? Year Sales

2013 $ 1,900,000

2014 $ 2,100,000

2015 $ 2,700,000

2016 $ 2,800,000

2017 $ 3,000,000

A) $1,900,000 B) $2,500,000 C) $2,833,333 D) $3,000,000 Answer: C Explanation: ($2,700,000 + $2,800,000 + $3,000,000)/3 = $2,833,333. Difficulty: 1 Easy Topic: Sales forecasts Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 15-03 Compare and contrast the naive, average, and seasonality-and trendadjusted approaches to forecasting sales and how they are implemented.

27) Suppose a firm has had the historical sales figures shown as follows. What would be the forecast for next year's sales using the average approach if it is determined that 2016 is a "stale" year? Year Sales

2013 500,000

2014 600,000

2015 $ 700,000

2016 $ 400,000

2017 700,000

A) $400,000 B) $580,000 C) $625,000 D) $700,000 Answer: C Explanation: ($500,000 + $600,000 + $700,000 + $700,000)/4 = $625,000. Difficulty: 1 Easy Topic: Sales forecasts Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 15-03 Compare and contrast the naive, average, and seasonality-and trendadjusted approaches to forecasting sales and how they are implemented. 28) Suppose a firm has had the historical sales figures shown as follows. What would be the forecast for next year's sales using the average approach if it is determined that none of the years are "stale"? Year Sales

2013 $ 1,600,000

2014 $ 1,500,000

2015 $ 1,700,000

2016 $ 1,700,000

2017 $ 1,800,000

A) $1,600,000 B) $1,660,000 C) $1,700,000 D) $1,800,000 Answer: B Explanation: ($1,600,000 + $1,500,000 + $1,700,000 + $1,700,000 + $1,800,000)/5 = $1,660,000. Difficulty: 1 Easy Topic: Sales forecasts Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 15-03 Compare and contrast the naive, average, and seasonality-and trendadjusted approaches to forecasting sales and how they are implemented. 12

29) Suppose that PBJ Industries, Inc. currently has the balance sheet shown as follows, and that sales for the year just ended were $10 million. The firm also has a profit margin of 10 percent, a retention ratio of 25 percent, and expects sales of $12 million next year. If all assets and current liabilities are expected to increase with sales, what amount of additional funds will the company need from external sources to fund the expected growth?

Assets Current assets Fixed assets Total assets

Liabilities and Equity $ 1,000,000 Current liabilities $ 1,000,000 2,000,000 Long-term debt 1,000,000 Equity 1,000,000 $ 3,000,000 Total liabilities and equity $ 3,000,000

A) $0 B) $6,250 C) $30,000 D) $100,000 Answer: D Explanation: [($12,000,000/$10,000,000) × ($3,000,000)] − [($12,000,000/$10,000,000) × ($1,000,000)] − ($1,000,000) − ($1,000,000) − (0.10 × $12,000,000 × 0.25) = $3,600,000 − $1,200,000 − $1,000,000 − $1,000,000 − $300,000 = $100,000. Difficulty: 1 Easy Topic: External financing need Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 15-04 Explain and demonstrate the additional funds needed (AFN) approach to estimating a firm's need to seek external financing.

30) Suppose that BBM Industries, Inc. currently has the balance sheet shown as follows, and that sales for the year just ended were $2 million. The firm also has a profit margin of 5 percent, a retention ratio of 50 percent, and expects sales of $2.5 million next year. If all assets and current liabilities are expected to increase with sales, what amount of additional funds will the company need from external sources to fund the expected growth?

Assets Current Assets Fixed Assets Total Assets

Liabilities and Equity $ 1,000,000 Current Liabilities $ 1,000,000 2,000,000 Long-term Debt 1,000,000 Equity 1,000,000 $ 3,000,000 Total Liabilities and Equity $ 3,000,000

A) $0 B) $62,500 C) $437,500 D) $500,000 Answer: C Explanation: [($2,500,000/$2,000,000) × ($3,000,000)] − [($2,500,000/$2,000,000) × ($1,000,000)] − ($1,000,000) − ($1,000,000) − (0.05 × $2,500,000 × 0.50) = $3,750,000 − $1,250,000 − $1,000,000 − $1,000,000 − $62,500 = $437,500. Difficulty: 1 Easy Topic: External financing need Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 15-04 Explain and demonstrate the additional funds needed (AFN) approach to estimating a firm's need to seek external financing.

31) Suppose that TV Industries, Inc. currently has the balance sheet shown as follows, and that sales for the year just ended were $5 million. The firm also has a profit margin of 15 percent, a retention ratio of 25 percent, and expects sales of $5.5 million next year. If all assets and current liabilities are expected to increase with sales, what amount of additional funds will the company need from external sources to fund the expected growth?

Assets Current Assets Fixed Assets Total Assets

Liabilities and Equity $ 1,000,000 Current Liabilities $ 1,000,000 2,000,000 Long-term Debt 1,000,000 Equity 1,000,000 $ 3,000,000 Total Liabilities and Equity $ 3,000,000

A) $0 B) $6,250 C) $206,250 D) $12,500 Answer: A Explanation: [($5,500,000/$5,000,000) × ($3,000,000)] − [($5,500,000/$5,000,000) × ($1,000,000)] − ($1,000,000) − ($1,000,000) − (0.15 × $5,500,000 × 0.25) = $3,300,000 − $1,100,000 − $1,000,000 − $1,000,000 − $206,250 = −$6,250, so none Difficulty: 1 Easy Topic: External financing need Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 15-04 Explain and demonstrate the additional funds needed (AFN) approach to estimating a firm's need to seek external financing.

32) Suppose that Team Industries, Inc. currently has the balance sheet shown as follows, and that sales for the year just ended were $3 million. The firm also has a profit margin of 20 percent, a retention ratio of 30 percent, and expects sales of $6 million next year. If all assets and current liabilities are expected to increase with sales, what amount of additional funds will the company need from external sources?

Assets Current Assets Fixed Assets Total Assets

Liabilities and Equity $ 2,000,000 Current Liabilities $ 2,000,000 2,500,000 Long-term Debt 1,500,000 Equity 1,000,000 $ 4,500,000 Total Liabilities and Equity $ 4,500,000

A) $2,140,000 B) $2,320,000 C) $2,500,000 D) $4,500,000 Answer: A Explanation: [($6,000,000/$3,000,000) × ($4,500,000)] − [($6,000,000/$3,000,000) × ($2,000,000)] − ($1,500,000) − ($1,000,000) − (0.20 × $6,000,000 × 0.30) = $9,000,000 − $4,000,000 − $1,500,000 − $1,000,000 − $360,000 = $2,140,000 Difficulty: 1 Easy Topic: External financing need Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 15-04 Explain and demonstrate the additional funds needed (AFN) approach to estimating a firm's need to seek external financing.

17) Suppose a firm has had the historical sales figures shown as follows. What would be the forecast for next year's sales using regression to estimate a trend? Year Sales

2013 $ 2,000,000

2014 $ 1,800,000

2015 $ 2,200,000

2016 $ 2,400,000

2017 $ 2,300,000

A) $2,140,000 B) $2,225,000 C) $2,300,000 D) $2,500,000 Answer: D Explanation: Use Regression (in Microsoft Excel, choose "Data" tab, "Data Analysis" selection, "Regression" selection), and designate the Sales values as the "Input Y Range," Year values as the "Input X Range," and specify an output range. You should get an Intercept of −239,060,000 and an X Variable coefficient of 120,000. Using these values, the forecast value for 2018 will be y = a + (b × x) = −239,660,000 + (120,000 × 2018) = 2,500,000. Difficulty: 2 Medium Topic: Sales forecasts Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 15-03 Compare and contrast the naive, average, and seasonality-and trendadjusted approaches to forecasting sales and how they are implemented.

18) Suppose a firm has had the historical sales figures shown as follows. What would be the forecast for next year's sales using regression to estimate a trend? Year Sales

2013 2,500,000

2014 $ 2,800,000

2015 $ 2,200,000

2016 2,400,000

2017 2,600,000

A) $2,340,000 B) $2,500,000 C) $2,575,000 D) $2,600,000 Answer: A Explanation: Use Regression (in Microsoft Excel, choose "Data" tab, "Data Analysis" selection, "Regression" selection), and designate the Sales values as the "Input Y Range," Year values as the "Input X Range," and specify an output range. You should get an Intercept of 42,700,000 and an X Variable coefficient of −20,000. Using these values, the forecast value for 2018 will be y = a + (b × x) = 42,700,000 + (−20,000 × 2018) = 2,340,000. Difficulty: 2 Medium Topic: Sales forecasts Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 15-03 Compare and contrast the naive, average, and seasonality-and trendadjusted approaches to forecasting sales and how they are implemented.

19) Suppose a firm has had the historical sales figures shown as follows. What would be the forecast for next year's sales using regression to estimate a trend? Year Sales

2013 $ 12,000,000

2014 $ 11,800,000

2015 $ 12,200,000

2016 $ 12,400,000

2017 $ 12,300,000

A) $12,000,000 B) $12,140,000 C) $12,300,000 D) $13,100,000 Answer: D Explanation: Use Regression (in Microsoft Excel, choose "Data" tab, "Data Analysis" selection, "Regression" selection), and designate the Sales values as the "Input Y Range," Year values as the "Input X Range," and specify an output range. You should get an Intercept of −229,060,000 and an X Variable coefficient of 120,000. Using these values, the forecast value for 2018 will be y = a + (b × x) = −229,060,000 + (120,000 × 2018) = 13,100,000. Difficulty: 2 Medium Topic: Sales forecasts Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 15-03 Compare and contrast the naive, average, and seasonality-and trendadjusted approaches to forecasting sales and how they are implemented.

20) Suppose a firm has had the historical sales figures shown as follows. What would be the forecast for next year's sales using regression to estimate a trend? Year Sales

2013 800,000

2014 810,000

2015 $ 825,000

2016 $ 835,000

2017 850,000

A) $850,000 B) $860,000 C) $924,000 D) $874,000 Answer: C Explanation: Use Regression (in Microsoft Excel, choose "Data" tab, "Data Analysis" selection, "Regression" selection), and designate the Sales values as the "Input Y Range," Year values as the "Input X Range," and specify an output range. You should get an Intercept of −24,301,000 and an X Variable coefficient of 12,500. Using these values, the forecast value for 2018 will be y = a + (b × x) = −24,301,000 + (12,500 × 2018) = 924,000. Difficulty: 2 Medium Topic: Sales forecasts Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 15-03 Compare and contrast the naive, average, and seasonality-and trendadjusted approaches to forecasting sales and how they are implemented.

37) Suppose that Runner Industries currently has the balance sheet shown as follows, and that sales for the year just ended were $5 million. The firm also has a profit margin of 10 percent, a retention ratio of 20 percent, and expects sales of $7 million next year. If fixed assets have enough capacity to cover the increase in sales and all other assets and current liabilities are expected to increase with sales, what amount of additional funds will the company need from external sources to fund the expected growth? Assets Current Assets Fixed Assets Total Assets

Liabilities and Equity $ 1,500,000 Current Liabilities $ 600,000 3,000,000 Long-term Debt 1,400,000 Equity 2,500,000 $ 4,500,000 Total Liabilities and Equity $ 4,500,000

A) $0 B) $140,000 C) $220,000 D) $180,000 Answer: C Explanation: [($7,000,000/$5,000,000) × ($1,500,000] + ($3,000,000) − [($7,000,000/$5,000,000) × ($600,000)] − $1,400,000 − $2,500,000 − (0.10 × $7,000,000 × 0.20) = $2,100,000 + $3,000,000 − $840,000 − $1,400,000 − $2,500,000 − $140,000 = $220,000. Difficulty: 2 Medium Topic: External financing need Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 15-04 Explain and demonstrate the additional funds needed (AFN) approach to estimating a firm's need to seek external financing.

38) Suppose that Wave Industries currently has the balance sheet shown as follows, and that sales for the year just ended were $25 million. The firm also has a profit margin of 10 percent, a retention ratio of 20 percent, and expects sales of $27 million next year. If fixed assets have enough capacity to cover the increase in sales and all other assets and current liabilities are expected to increase with sales, what amount of additional funds will the company need from external sources to fund the expected growth? Assets Current Assets Fixed Assets Total Assets

Liabilities and Equity 6,500,000 Current Liabilities $ 4,000,000 13,000,000 Long-term Debt 6,500,000 Equity 9,000,000 $ 19,500,000 Total Liabilities and Equity $ 19,500,000 $

A) $0 B) $300,000 C) $340,000 D) $20,000 Answer: A Explanation: [($27,000,000/$25,000,000) × ($6,500,000)] + $13,000,000 − [($27,000,000/$25,000,000) × ($4,000,000)] − $6,500,000 − $9,000,000 − (0.10 × $27,000,000 × 0.20) = $7,020,000 + $13,000,000 − $4,320,000 − $6,500,000 − $9,000,000 − $540,000 = −$340,000, so none. Difficulty: 2 Medium Topic: External financing need Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 15-04 Explain and demonstrate the additional funds needed (AFN) approach to estimating a firm's need to seek external financing.

39) Suppose that Road Industries currently has the balance sheet shown as follows, and that sales for the year just ended were $80 million. The firm also has a profit margin of 5 percent, a retention ratio of 10 percent, and expects sales of $82 million next year. If fixed assets have enough capacity to cover the increase in sales and all other assets and current liabilities are expected to increase with sales, what amount of additional funds will the company need from external sources to fund the expected growth?

Assets Current Assets Fixed Assets Total Assets

Liabilities and Equity $ 21,500,000 Current Liabilities $ 10,000,000 53,000,000 Long-term Debt 34,000,000 Equity 30,500,000 $ 74,500,000 Total Liabilities and Equity $ 74,500,000

A) $0 B) $122,500 C) $112,500 D) $287,500 Answer: A Explanation: [($82,000,000/$80,000,000) × ($21,500,000] + $53,000,000 − [($82,000,000/$80,000,000) × ($10,000,000)] − $34,000,000 − $30,500,000 − (0.05 × $82,000,000 × 0.10) = $22,037,500 + $53,000,000 − $10,250,000 − $34,000,000 − $30,500,000 − $410,000 = −$122,500, so none. Difficulty: 2 Medium Topic: External financing need Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 15-04 Explain and demonstrate the additional funds needed (AFN) approach to estimating a firm's need to seek external financing.

40) Suppose a firm has had the historical sales figures shown as follows. What would be the forecast for next year's sales using the naïve approach? Year Sales

2013 $ 1,500,000

2014 $ 1,750,000

2015 $ 1,400,000

2016 $ 2,000,000

2017 $ 1,780,000

A) $1,780,000 B) $1,650,000 C) $2,100,000 D) $1,686,000 Answer: A Explanation: The naïve estimate for 2018 is the most recent sales figure of $1,780,000. Difficulty: 1 Easy Topic: Sales forecasts Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 15-03 Compare and contrast the naive, average, and seasonality-and trendadjusted approaches to forecasting sales and how they are implemented. 41) Suppose a firm has had the historical sales figures shown as follows. What would be the forecast for next year's sales using the naïve approach? Year Sales

2013 $ 1,500,000

2014 $ 1,750,000

2015 $ 1,400,000

2016 $ 2,000,000

2017 $ 2,200,000

A) $2,100,000 B) $2,200,000 C) $1,780,000 D) $1,730,000 Answer: B Explanation: The naïve estimate for 2018 is the most recent sales figure of $2,200,000. Difficulty: 1 Easy Topic: Sales forecasts Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 15-03 Compare and contrast the naive, average, and seasonality-and trendadjusted approaches to forecasting sales and how they are implemented.

42) Suppose a firm has had the historical sales figures shown as follows. What would be the forecast for next year's sales using the naïve approach? Year Sales

2013 $ 2,500,000

2014 $ 3,750,000

2015 $ 2,400,000

2016 $ 2,000,000

2017 $ 2,900,000

A) $2,450,000 B) $2,900,000 C) $2,350,000 D) $2,585,000 Answer: B Explanation: The naïve estimate for 2018 is the most recent sales figure of $2,900,000. Difficulty: 1 Easy Topic: Sales forecasts Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 15-03 Compare and contrast the naive, average, and seasonality-and trendadjusted approaches to forecasting sales and how they are implemented. 43) Suppose a firm has had the historical sales figures shown as follows. What would be the forecast for next year's sales using the average approach? Year Sales

2013 $ 1,200,000

2014 $ 1,750,000

2015 $ 1,100,000

2016 $ 2,000,000

2017 $ 1,500,000

A) $1,370,000 B) $1,430,000 C) $1,510,000 D) $1,625,000 Answer: C Explanation: [1.2m + 1.75m + 1.1m + 2m + 1.5m]/5 = $1.51m. Difficulty: 1 Easy Topic: Sales forecasts Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 15-03 Compare and contrast the naive, average, and seasonality-and trendadjusted approaches to forecasting sales and how they are implemented.

44) Suppose a firm has had the historical sales figures shown as follows. What would be the forecast for next year's sales using the average approach? Year Sales

2013 $ 1,800,000

2014 $ 1,950,000

2015 $ 1,700,000

2016 $ 2,000,000

2017 $ 2,500,000

A) $1,990,000 B) $1,830,000 C) $2,160,000 D) $2,080,000 Answer: A Explanation: [1.8m + 1.95m + 1.7m + 2m + 2.5m]/5 = $1.99m. Difficulty: 1 Easy Topic: Sales forecasts Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 15-03 Compare and contrast the naive, average, and seasonality-and trendadjusted approaches to forecasting sales and how they are implemented. 45) Suppose a firm has had the historical sales figures shown as follows. What would be the forecast for next year's sales using the average approach? Year Sales

2013 $ 4,300,000

2014 $ 3,950,000

2015 $ 2,100,000

2016 $ 2,000,000

2017 $ 2,200,000

A) $2,730,000 B) $2,810,000 C) $2,910,000 D) $2,990,000 Answer: C Explanation: [4.3m + 3.95m + 2.0m + 2.1m + 2.2m]/5 = $2.91m. Difficulty: 1 Easy Topic: Sales forecasts Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 15-03 Compare and contrast the naive, average, and seasonality-and trendadjusted approaches to forecasting sales and how they are implemented.

46) Suppose that Gyp Sum Industries currently has the balance sheet shown as follows, and that sales for the year just ended were $20 million. The firm also has a profit margin of 22 percent, a retention ratio of 42 percent, and expects sales of $30 million next year. If all assets and current liabilities are expected to grow with sales, how much additional funds will Gyp Sum need from external sources to fund the expected growth?

Assets Current Assets Fixed Assets Total Assets

Liabilities and Equity $ 2,000,000 Current Liabilities $ 1,500,000 14,000,000 Long-term Debt 1,500,000 Equity 13,000,000 $ 16,000,000 Total Liabilities and Equity $ 16,000,000

A) $3,925,000 B) $3,695,000 C) $4,124,000 D) $4,478,000 Answer: D Explanation: AFN = [(30/20) × 16] − [(30/20) × 1.5] − 1.5 − 13 − [0.22 × 30 × 0.42] = 4.478m. Difficulty: 1 Easy Topic: External financing need Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 15-04 Explain and demonstrate the additional funds needed (AFN) approach to estimating a firm's need to seek external financing.

47) Suppose that Psy Ops Industries currently has the balance sheet shown as follows, and that sales for the year just ended were $6 million. The firm also has a profit margin of 9 percent, a retention ratio of 5 percent, and expects sales of $8.5 million next year. If fixed assets have enough capacity to cover the increase in sales and all other assets and current liabilities are expected to increase with sales, how much additional funds will Psy Ops need from external sources to fund the expected growth? Assets Current Assets Fixed Assets Total Assets

Liabilities and Equity $ 2,500,000 Current Liabilities $ 500,000 3,500,000 Long-term Debt 2,000,000 Equity 3,500,000 $ 6,000,000 Total Liabilities and Equity $ 6,000,000

A) $795,100 B) $141,300 C) $783,600 D) $214,900 Answer: A Explanation: [8.5/6 × 2.5 + 3.5 − 8.5/6 × 0.5 − 2 − 3.5 − (0.09 × 8.5 × 0.05)] = 3.5417 + 3.5 − 0.7083 − 2 − 3.5 − 0.0383 = 0.7951m. Difficulty: 2 Medium Topic: External financing need Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 15-04 Explain and demonstrate the additional funds needed (AFN) approach to estimating a firm's need to seek external financing.

48) Goldilochs Inc. reported sales of $5 million and net income of $1 million. The firm has $10.5 million in total assets. The firm's chief financial officer is projecting a 20 percent increase in sales. If the firm's sales do increase by 20 percent, it is expected that spontaneous liabilities will increase by $1 million. The firm currently pays out 30 percent of its net income to shareholders. Assuming that all assets are expected to grow with sales, how much in additional funds will Goldilochs need from external sources to fund the expected growth? A) $245,000 B) $197,000 C) $221,000 D) $260,000 Answer: D Explanation: [10.5/5 × (0.2 × 5) − 1 − 1.2 × 5 × (1/5) × (1 − 0.3)] = 2.1 − 1 − 0.84 = 0.26m. Difficulty: 3 Hard Topic: External financing need Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 15-04 Explain and demonstrate the additional funds needed (AFN) approach to estimating a firm's need to seek external financing. 49) Goldilochs Inc. reported sales of $8 million and net income of $1.5 million. The firm has $10.5 million in total assets. The firm's chief financial officer is projecting a 20 percent increase in sales. If the firm's sales do increase by 20 percent, it is expected that spontaneous liabilities will increase by $500,000. The firm currently pays out 30 percent of its net income to shareholders. Assuming that all assets are expected to grow with sales, how much in additional funds will Goldilochs need from external sources to fund the expected growth? A) $340,000 B) $299,000 C) $321,000 D) $360,000 Answer: A Explanation: [10.5/8 × (0.2 × 8) − 0.5 − 1.2 × 8 × (1.5/8) × (1 − 0.3)] = 2.1 − 0.5 − 1.26 = 0.34m. Difficulty: 3 Hard Topic: External financing need Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 15-04 Explain and demonstrate the additional funds needed (AFN) approach to estimating a firm's need to seek external financing.

30) Suppose that Wind Em Corp. currently has the balance sheet shown as follows, and that sales for the year just ended were $15 million. The firm also has a profit margin of 23 percent, a retention ratio of 40 percent, and expects sales of $20 million next year. If all assets and current liabilities are expected to grow with sales, what is the projected increase in retained earnings?

Assets Current Assets Fixed Assets Total Assets

Liabilities and Equity 2,000,000 Current Liabilities $ 2,500,000 8,000,000 Long-term Debt 1,500,000 Equity 6,000,000 $ 10,000,000 Total Liabilities and Equity $ 10,000,000 $

A) $1,050,000 B) $1,240,000 C) $1,366,957.14 D) $1,840,000 Answer: D Explanation: [0.23 × 20 × 0.40] = 1.84m. Difficulty: 1 Easy Topic: Pro forma statements Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 15-04 Explain and demonstrate the additional funds needed (AFN) approach to estimating a firm's need to seek external financing.

31) Suppose that Wind Em Corp. currently has the balance sheet shown as follows, and that sales for the year just ended were $15 million. The firm also has a profit margin of 23 percent, a retention ratio of 40 percent, and expects sales of $20 million next year. If all assets and current liabilities are expected to grow with sales, how much will spontaneous liabilities increase with the increase in sales? Assets Current Assets Fixed Assets Total Assets

Liabilities and Equity $ 2,000,000 Current Liabilities $ 2,500,000 8,000,000 Long-term Debt 1,500,000 Equity 6,000,000 $ 10,000,000 Total Liabilities and Equity $ 10,000,000

A) $833,333 B) $240,000 C) $366,957.14 D) $1,125,000 Answer: A Explanation: (2.5/15) × 5 = 0.8333m. Difficulty: 1 Easy Topic: Pro forma statements Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 15-04 Explain and demonstrate the additional funds needed (AFN) approach to estimating a firm's need to seek external financing.

32) Suppose that Wind Em Corp. currently has the balance sheet shown as follows, and that sales for the year just ended were $15 million. The firm also has a profit margin of 23 percent, a retention ratio of 40 percent, and expects sales of $20 million next year. If all assets and current liabilities are expected to grow with sales, what is the necessary increase in assets?

Assets Current Assets Fixed Assets Total Assets

Liabilities and Equity 2,000,000 Current Liabilities $ 2,500,000 8,000,000 Long-term Debt 1,500,000 Equity 6,000,000 $ 10,000,000 Total Liabilities and Equity $ 10,000,000 $

A) $240,000 B) $3,333,333.33 C) $1,366,957.14 D) $1,840,000 Answer: B Explanation: [(10/15) × 5] = 3.33m. Difficulty: 1 Easy Topic: Pro forma statements Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 15-04 Explain and demonstrate the additional funds needed (AFN) approach to estimating a firm's need to seek external financing.

53) Suppose that Wind Em Corp. currently has the balance sheet shown as follows, and that sales for the year just ended were $15 million. The firm also has a profit margin of 19 percent, a retention ratio of 30 percent, and expects sales of $22 million next year. If all assets and current liabilities are expected to grow with sales, what is the projected increase in retained earnings?

Assets Current Assets Fixed Assets Total Assets

Liabilities and Equity 2,000,000 Current Liabilities $ 2,500,000 8,000,000 Long-term Debt 1,500,000 Equity 6,000,000 $ 10,000,000 Total Liabilities and Equity $ 10,000,000

A) $1,254,000 B) $1,240,000 C) $1,366,957.14 D) $1,840,000 Answer: A Explanation: [0.19 × 22 × 0.30] = 1.25m. Difficulty: 1 Easy Topic: Pro forma statements Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 15-04 Explain and demonstrate the additional funds needed (AFN) approach to estimating a firm's need to seek external financing.

54) Suppose that Wind Em Corp. currently has the balance sheet shown as follows, and that sales for the year just ended were $15 million. The firm also has a profit margin of 20 percent, a retention ratio of 30 percent, and expects sales of $22 million next year. If all assets and current liabilities are expected to grow with sales, how much will spontaneous liabilities increase with the increase in sales? Assets Current Assets Fixed Assets Total Assets

Liabilities and Equity $ 2,000,000 Current Liabilities $ 2,500,000 8,000,000 Long-term Debt 1,500,000 Equity 6,000,000 $ 10,000,000 Total Liabilities and Equity $ 10,000,000

A) $1,950,000 B) $2,240,000 C) $2,366,000 D) $1,166,667 Answer: D Explanation: (2.5/15) × 7 = 1.167m. Difficulty: 1 Easy Topic: Pro forma statements Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 15-04 Explain and demonstrate the additional funds needed (AFN) approach to estimating a firm's need to seek external financing.

55) Suppose that Wind Em Corp. currently has the balance sheet shown as follows, and that sales for the year just ended were $12 million. The firm also has a profit margin of 20 percent, a retention ratio of 30 percent, and expects sales of $22 million next year. If all assets and current liabilities are expected to grow with sales, what is the necessary increase in assets? Assets Current Assets Fixed Assets Total Assets

Liabilities and Equity 2,000,000 Current Liabilities $ 2,500,000 8,000,000 Long-term Debt 1,500,000 Equity 6,000,000 $ 10,000,000 Total Liabilities and Equity $ 10,000,000

A) $6,240,000 B) $6,333,333 C) $8,333,333 D) $4,833,000 Answer: C Explanation: [(10/12) × 10] = 8,333,333.33. Difficulty: 1 Easy Topic: Pro forma statements Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 15-04 Explain and demonstrate the additional funds needed (AFN) approach to estimating a firm's need to seek external financing. 56) Which of the following will increase the additional funds needed from external sources? A) The firm's profit margin increases. B) The firm's dividend payout ratio decreases. C) The firm's debt ratio increases. D) The firm becomes more capital intensive. Answer: D Difficulty: 2 Medium Topic: External financing need Bloom's: Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 15-04 Explain and demonstrate the additional funds needed (AFN) approach to estimating a firm's need to seek external financing.

57) Which of the following will increase the additional funds needed from external sources? A) The firm's profit margin increases. B) The firm's sales forecast is decreased. C) The firm reduces its usage of trade credit. D) The firm's retention ratio is increased. Answer: C Difficulty: 2 Medium Topic: External financing need Bloom's: Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 15-04 Explain and demonstrate the additional funds needed (AFN) approach to estimating a firm's need to seek external financing. 58) Which of the following will decrease the additional funds needed from external sources? A) The firm's profit margin decreases. B) The firm's retention ratio is decreased. C) The firm becomes less capital intensive. D) The firm reduces its usage of trade credit. Answer: C Difficulty: 2 Medium Topic: External financing need Bloom's: Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 15-04 Explain and demonstrate the additional funds needed (AFN) approach to estimating a firm's need to seek external financing. 59) Which of the following statements is correct? A) An auto manufacturer is less capital intensive than a bakery. B) An accounting firm is more capital intensive than a railroad. C) An oil refinery is more capital intensive than Starbucks. D) None of the options are correct. Answer: C Difficulty: 2 Medium Topic: External financing need Bloom's: Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 15-04 Explain and demonstrate the additional funds needed (AFN) approach to estimating a firm's need to seek external financing.

60) All of the following will tend to increase spontaneously with sales EXCEPT A) accrued wages. B) notes payable. C) accounts payable. D) All of the options will tend to increase spontaneously with sales. Answer: B Difficulty: 2 Medium Topic: Pro forma statements Bloom's: Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 15-04 Explain and demonstrate the additional funds needed (AFN) approach to estimating a firm's need to seek external financing. 61) Which of the following will increase a firm's need for additional funds? A) An increase in the firm's average collection period B) An increase in the retention ratio C) A decrease in sales growth D) An increase in accrued wages Answer: A Difficulty: 2 Medium Topic: External financing need Bloom's: Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 15-04 Explain and demonstrate the additional funds needed (AFN) approach to estimating a firm's need to seek external financing.

62) What would be the appropriate way to forecast sales for a firm that has stable year-to-year sales, but seasonally fluctuating month-to-month sales? A) Forecasts would need to be adjusted for a trend, but would not need a regression to adjust for seasonality. B) Forecasts would need to be adjusted for seasonality, but would not need a regression to adjust for a trend. C) Ignore both the trend and the seasonality. D) None of the options. Answer: B Difficulty: 2 Medium Topic: Sales forecasts Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 15-03 Compare and contrast the naive, average, and seasonality-and trendadjusted approaches to forecasting sales and how they are implemented. 63) Silly Putty Inc. has had sales of $12 million, $17 million, and $16 million for each of the last three years. What would be the MAPE if the actual sales were $15 million using the naïve approach? A) 6.71 percent B) 5.73 percent C) −8.14 percent D) −6.67 percent Answer: D Explanation: [15 − 16]/15 = −6.67 percent. Difficulty: 1 Easy Topic: Sales forecasts Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 15-03 Compare and contrast the naive, average, and seasonality-and trendadjusted approaches to forecasting sales and how they are implemented.

64) Silly Putty Inc. has had sales of $12 million, $17 million, and $16 million for each of the last three years. What would be the MAPE if the actual sales were $15 million using the average approach? A) 0.24 percent B) 1.01 percent C) 0 percent D) −0.43 percent Answer: C Explanation: Step 1: Compute average sales: [12 + 17 + 16]/3 = 15; MAPE = [15 − 15]/15 = 0 percent. Difficulty: 1 Easy Topic: Sales forecasts Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 15-03 Compare and contrast the naive, average, and seasonality-and trendadjusted approaches to forecasting sales and how they are implemented. 65) Abracadabra Inc. has total assets of $106,000 and a debt ratio of 40 percent. If last year's sales were $145,000 and sales are expected to grow 10 percent in the future, what is Abracadabra's capital intensity ratio? A) 0.73 B) 1.37 C) 0.44 D) 2.27 Answer: A Explanation: 106/145 = 0.73. Difficulty: 1 Easy Topic: External financing need Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 15-04 Explain and demonstrate the additional funds needed (AFN) approach to estimating a firm's need to seek external financing.

66) Goldilochs Inc. reported sales of $8 million and net income of $1.5 million. The firm has $10.5 million in total assets and $1 million in current liabilities. The firm currently pays out 75 percent of its net income to shareholders. Assume that all assets and current liabilities are expected to grow with sales. If Goldilochs does not want to rely on any external sources of funds, what is the most sales can grow (in dollars)? A) $187,900 B) $299,900 C) $328,800 D) $364,100 Answer: C Explanation: [10.5/8 × (x) − 1/8 × (x) − (8 + x) × (1.5/8) × (1 − 0.75)] = 0; x = 0.3288m. Difficulty: 3 Hard Topic: External financing need Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 15-04 Explain and demonstrate the additional funds needed (AFN) approach to estimating a firm's need to seek external financing. 67) Goldilochs Inc. reported sales of $8 million and net income of $1.5 million. The firm has $12 million in total assets and $500,000 in current liabilities. The firm currently pays out 25 percent of its net income to shareholders. Assume that all assets and current liabilities are expected to grow with sales. If Goldilochs does not want to rely on any external sources of funds, what is the most sales can grow (in dollars)? A) $887,900 B) $867,500 C) $928,800 D) $964,100 Answer: B Explanation: [12/8 × (x) − 0.5/8 × (x) − (8 + x) × (1.5/8) × (1 − 0.25)] = 0; x = 0.8675m. Difficulty: 3 Hard Topic: External financing need Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 15-04 Explain and demonstrate the additional funds needed (AFN) approach to estimating a firm's need to seek external financing.

68) Goldilochs Inc. reported sales of $8 million and net income of $1.5 million. The firm has $12 million in total assets and $500,000 in current liabilities. The firm currently pays out 25 percent of its net income to shareholders. Assume that all assets and current liabilities are expected to grow with sales. If Goldilochs does not want to rely on any external sources of funds, what is the most sales can grow (in percent)? A) 11.13 percent B) 10.84 percent C) 10.28 percent D) 9.69 percent Answer: B Explanation: [12/8 × (x) − 0.5/8 × (x) − (8 + x) × (1.5/8) × (1 − 0.25)] = 0; x = 0.8675m. 0.8675/8 = 10.84%. Difficulty: 3 Hard Topic: External financing need Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 15-04 Explain and demonstrate the additional funds needed (AFN) approach to estimating a firm's need to seek external financing. 69) Goldilochs Inc. reported sales of $8 million and net income of $1.5 million. The firm has $10.5 million in total assets and $1 million in current liabilities. The firm currently pays out 75 percent of its net income to shareholders. Assume that all assets and current liabilities are expected to grow with sales. If Goldilochs does not want to rely on any external sources of funds, what is the most sales can grow (in percent)? A) 3.18 percent B) 2.99 percent C) 4.11 percent D) 3.64 percent Answer: C Explanation: [10.5/8 × (x) − 1/8 × (x) − (8 + x) × (1.5/8) × (1 − 0.75)] = 0; x = 0.3288m. 0.3288/8 = 4.11%. Difficulty: 3 Hard Topic: External financing need Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 15-04 Explain and demonstrate the additional funds needed (AFN) approach to estimating a firm's need to seek external financing.

70) Goldilochs Inc. reported sales of $8 million and net income of $1.5 million. The firm has $10.5 million in total assets. The firm's chief financial officer is projecting a 25 percent increase in sales. The firm has $1.25 million in accounts payable and $1,500,000 in long-term debt (bonds). The firm currently pays out 20 percent of its net income to shareholders. Assuming that all assets and spontaneous liabilities are expected to grow with sales, how much in additional funds will Goldilochs need from external sources to fund the expected growth? A) $902,700 B) $812,500 C) $821,000 D) $746,600 Answer: B Explanation: [10.5/8 × (0.25 × 8) − 1.25/8 × (0.25 × 8) − (1.5/8 × (1.25 × 8)) × (1 − 0.2)] = 2.625 − 0.3125 − 1.5 = 0.8125m. Difficulty: 3 Hard Topic: External financing need Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 15-04 Explain and demonstrate the additional funds needed (AFN) approach to estimating a firm's need to seek external financing. 71) is the amount of external financing a firm must seek in order to change the assets base as necessary to support a different level of sales. A) additional funds needed B) capital intensity ratio C) trade credit D) spontaneous liabilities ratio Answer: A Difficulty: 1 Easy Topic: External financing need Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 15-04 Explain and demonstrate the additional funds needed (AFN) approach to estimating a firm's need to seek external financing.

72) is relevant assets divided by current sales. A) additional funds needed B) capital intensity ratio C) trade credit D) spontaneous liabilities ratio Answer: B Difficulty: 1 Easy Topic: Financial planning and forecasting Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 15-04 Explain and demonstrate the additional funds needed (AFN) approach to estimating a firm's need to seek external financing. 73) Which of the following statements is incorrect? A) For most businesses, increases in spontaneous liabilities will be enough to fund the necessary increases in assets. B) The capital intensity ratio indicates the amount of assets the firm needs to invest to generate each dollar in sales. C) The vast majority of fixed assets are "chunky" or "lumpy" since they have to be bought in non-divisible quantities. D) All of these choices are correct. Answer: A Difficulty: 2 Medium Topic: External financing need Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 15-03 Compare and contrast the naive, average, and seasonality-and trendadjusted approaches to forecasting sales and how they are implemented.

74) Goldilochs Inc. reported sales of $8 million and net income of $2 million. The firm has a total asset turnover of 3.2. The firm's chief financial officer is projecting a $5 million increase in sales and that spontaneous liabilities will increase by $350,000 automatically. The firm currently pays out 80 percent of its net income to shareholders. Assuming that all assets and current liabilities are expected to grow with sales, how much in additional funds will Goldilochs need from external sources to fund the expected growth? A) $501,900 B) $562,500 C) $601,800 D) $446,600 Answer: B Explanation: [(1/3.2 × 5) − 0.35 − (2/8 × 13) × (1 − 0.8)] = 1.5625 − 0.35 − 0.65 = 0.5625m. Difficulty: 3 Hard Topic: External financing need Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 15-04 Explain and demonstrate the additional funds needed (AFN) approach to estimating a firm's need to seek external financing. 75) Goldilochs Inc. reported sales of $8 million and net income of $2 million. The firm has a total asset turnover of 1.2. The firm's chief financial officer is projecting a $6 million increase in sales and that spontaneous liabilities will increase by $1 million automatically. The firm currently pays out 50 percent of its net income to shareholders. Assuming that all assets and current liabilities are expected to grow with sales, how much in additional funds will Goldilochs need from external sources to fund the expected growth? A) $1,250,000 B) $1,750,000 C) $2,500,000 D) $2,250,000 Answer: D Explanation: [(1/1.2 × 6) − 1 − (2/8 × 14) × (1 − 0.5)] = 5 − 1 − 1.75 = 2.25m. Difficulty: 3 Hard Topic: External financing need Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 15-04 Explain and demonstrate the additional funds needed (AFN) approach to estimating a firm's need to seek external financing.

76) Which of the following is likely to increase the firm's additional funds needed? A) The firm cuts its dividend by 50 percent. B) The firm reduces its usage of trade credit. C) The firm has unused fixed assets. D) All of the options would increase the firm's additional funds needed. Answer: B Difficulty: 2 Medium Topic: External financing need Bloom's: Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 15-03 Compare and contrast the naive, average, and seasonality-and trendadjusted approaches to forecasting sales and how they are implemented.; 15-04 Explain and demonstrate the additional funds needed (AFN) approach to estimating a firm's need to seek external financing. 77) Suppose a firm was planning to greatly reduce its raw materials inventory next year by introducing just-in-time inventory control procedures. Assuming no other changes to the firm's operations, what would this do to AFN? A) It would not change the AFN. B) The AFN would decrease. C) The AFN would increase. D) It cannot be determined without knowing the impact on the profit margin. Answer: B Difficulty: 2 Medium Topic: External financing need Bloom's: Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 15-03 Compare and contrast the naive, average, and seasonality-and trendadjusted approaches to forecasting sales and how they are implemented.

78) Which of the following statements is correct? A) The sales forecast is the driver for corporate financial planning. B) The addition to retained earnings is the driver for corporate financial planning. C) The debt ratio is the driver for corporate financial planning. D) None of the statements are correct. Answer: A Difficulty: 1 Easy Topic: Financial planning and forecasting Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 15-01 Describe the process of financial planning in the context of the firm and how base case projections are used in the strategic planning process.; 15-02 Identify how forecasting sales supports the process of financial planning. 79) Which of the following statements are a reason for base case projections? A) Useful in the strategic planning process for setting internal goals. B) For providing information to shareholders and other stakeholders concerning firm's future expectations. C) For estimating the firm's future needs for internal and external financing D) all of the above Answer: D Difficulty: 1 Easy Topic: Financial planning and forecasting Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 15-01 Describe the process of financial planning in the context of the firm and how base case projections are used in the strategic planning process.

80) is the process of determining where a firm is going over the next year or more, how it's going to get there, and how it will know if it gets there or not. A) financial planning B) strategic planning. C) base case D) base case projections Answer: B Difficulty: 1 Easy Topic: Financial planning and forecasting Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 15-01 Describe the process of financial planning in the context of the firm and how base case projections are used in the strategic planning process. 81) Suppose you were forecasting sales for a firm that exhibited a cyclical pattern within each week. How would you go about forecasting sales for this firm? A) You would need to compute day-of-the week indices centered on the seven days around each day of the week and use these indices to deseasonalize the historical observations B) Calculate the monthly average because it automatically deseasonalizes the historical observations. C) Ignore the seasonality. D) Compute the daily change as a percent of sales and calculate the geometric average. Answer: A Difficulty: 2 Medium Topic: Sales forecasts Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 15-02 Identify how forecasting sales supports the process of financial planning.

82) assumes that future sales will be equal to the average historical value across some relevant period. A) naïve approach B) average approach C) mean absolute percentage error D) none of the above Answer: B Difficulty: 1 Easy Topic: Sales forecasts Bloom's: Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 15-03 Compare and contrast the naive, average, and seasonality-and trendadjusted approaches to forecasting sales and how they are implemented. 83) Silly Putty Inc. has had sales of $10 million, $15 million, and $8 million for each of the last three years. What would be the MAPE if the actual sales were $12 million using the naïve approach? A) 66.66 percent B) 33.33 percent C) −33.33 percent D) −66.66 percent Answer: B Explanation: [12 − 8]/12 = 33.33 percent. Difficulty: 1 Easy Topic: Sales forecasts Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 15-03 Compare and contrast the naive, average, and seasonality-and trendadjusted approaches to forecasting sales and how they are implemented.

84) Silly Putty Inc. has had sales of $10 million, $15 million, and $8 million for each of the last three years. What would be the MAPE if the actual sales were $15 million using the average approach? A) 11.00 percent B) 20.00 percent C) 26.67 percent D) 33.33 percent Answer: C Explanation: Step 1: Compute average sales: [10 + 15 + 8]/3 = 11; MAPE = [15 − 11]/15 = 26.67 percent. Difficulty: 1 Easy Topic: Sales forecasts Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 15-03 Compare and contrast the naive, average, and seasonality-and trendadjusted approaches to forecasting sales and how they are implemented. 85) Suppose a firm has had the historical sales figures shown as follows. What would be the forecast for next year's sales using the naïve approach? Year Sales

2013 500,000

2014 750,000

2015 $ 700,000

2016 $ 750,000

2017 775,000

A) $695,000 B) $700,000 C) $750,000 D) $775,000 Answer: D Explanation: Naïve uses the last occurrence. Difficulty: 1 Easy Topic: Sales forecasts Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 15-03 Compare and contrast the naive, average, and seasonality-and trendadjusted approaches to forecasting sales and how they are implemented.

86) Suppose a firm has had the historical sales figures shown as follows. What would be the forecast for next year's sales using the naïve approach? Year Sales

2013 50,000

2014 100,000

2015 $ 110,000

2016 $ 150,000

2017 165,000

A) $115,000 B) $140,000 C) $165,000 D) $180,000 Answer: C Explanation: Naïve uses the last occurrence. Difficulty: 1 Easy Topic: Sales forecasts Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 15-03 Compare and contrast the naive, average, and seasonality-and trendadjusted approaches to forecasting sales and how they are implemented. 87) Suppose a firm has had the historical sales figures shown as follows. What would be the forecast for next year's sales using the average approach? Year Sales

2013 500,000

2014 750,000

2015 $ 700,000

2016 $ 750,000

2017 775,000

A) $695,000 B) $700,000 C) $750,000 D) $775,000 Answer: A Explanation: [500,000 + 750,000 + 700,000 + 750,000 + 775,000]/5 = $695,000. Difficulty: 1 Easy Topic: Sales forecasts Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 15-03 Compare and contrast the naive, average, and seasonality-and trendadjusted approaches to forecasting sales and how they are implemented.

88) Suppose a firm has had the historical sales figures shown as follows. What would be the forecast for next year's sales using the average approach? Year Sales

2013 50,000

2014 100,000

2015 $ 110,000

2016 $ 150,000

2017 165,000

A) $115,000 B) $140,000 C) $165,000 D) $180,000 Answer: A Explanation: [50,000 + 100,000 + 110,000 + 150,000 + 165,000]/5 = $115,000. Difficulty: 1 Easy Topic: Sales forecasts Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 15-03 Compare and contrast the naive, average, and seasonality-and trendadjusted approaches to forecasting sales and how they are implemented.

52) Suppose that Wind Em Corp. currently has the balance sheet shown as follows, and that sales for the year just ended were $1 million. The firm also has a profit margin of 10 percent, a retention ratio of 20 percent, and expects sales of $2 million next year. If all assets and current liabilities are expected to grow with sales, what is the necessary increase in assets?

Assets Current Assets Fixed Assets Total Assets

Liabilities and Equity $ 500,000 Current Liabilities $ 200,000 250,000 Long-term Debt 300,000 Equity 250,000 $ 750,000 Total Liabilities and Equity $ 750,000

A) $100,000 B) $250,000 C) $750,000 D) $500,000 Answer: C Explanation: (750,000/1m) x 1m = 750,000. Difficulty: 1 Easy Topic: Pro forma statements Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 15-04 Explain and demonstrate the additional funds needed (AFN) approach to estimating a firm's need to seek external financing.

53) Suppose that Wind Em Corp. currently has the balance sheet shown as follows, and that sales for the year just ended were $1 million. The firm also has a profit margin of 10 percent, a retention ratio of 20 percent, and expects sales of $2 million next year. If all assets and current liabilities are expected to grow with sales, how much will spontaneous liabilities increase with the increase in sales?

Assets Current Assets Fixed Assets Total Assets

Liabilities and Equity $ 500,000 Current Liabilities $ 200,000 250,000 Long-term Debt 300,000 Equity 250,000 $ 750,000 Total Liabilities and Equity $ 750,000

A) $100,000 B) $250,000 C) $200,000 D) $500,000 Answer: C Explanation: (200,000/1m) x 1m = 200,000. Difficulty: 1 Easy Topic: Pro forma statements Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 15-04 Explain and demonstrate the additional funds needed (AFN) approach to estimating a firm's need to seek external financing. 91) ABC Inc. has total assets of $550,000 and a debt ratio of 60 percent. If last year's sales were $950,000 and sales are expected to grow 10 percent in the future, what is ABC Inc. capital intensity ratio? A) 1.72 B) 0.52 C) 1.90 D) 0.58 Answer: D Explanation: 550,000/950,000 = 0.5789. Difficulty: 1 Easy Topic: External financing need Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 15-04 Explain and demonstrate the additional funds needed (AFN) approach to estimating a firm's need to seek external financing. 53

Finance, 5e (Cornett) Chapter 16 Assessing Long-Term Debt, Equity, and Capital Structure 1) The mix of debt and equity that a firm uses to finance its operations is known as: A) capital structure. B) capital management. C) separation structure. D) break even. Answer: A Difficulty: 1 Easy Topic: Capital structure Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 16-01 Differentiate between active and passive changes to capital structure. 2) If a firm changes their capital structure by immediately selling additional claims of one type of capital and using the proceeds to retire another kind of claim, they are using which type of capital structure change? A) Active B) Passive C) Separation D) Supportive Answer: A Difficulty: 1 Easy Topic: Capital structure basics Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 16-01 Differentiate between active and passive changes to capital structure.

3) If a firm changes their capital structure by waiting until the firm requires additional capital to cover capital budgeting needs and then selling more of the type of claims they wish to increase, they are using which type of capital structure change? A) Active B) Passive C) Separation D) Supportive Answer: B Difficulty: 1 Easy Topic: Capital structure basics Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 16-01 Differentiate between active and passive changes to capital structure. 4) Which of the following is NOT a factor for determining whether to use the active or passive approach to capital structure changes? A) How much the firm faces in flotation costs under the active management approach B) How much the firm faces in debt costs under the active management approach C) How quickly the firm is growing D) How strongly and how quickly they wish to change the capital structure Answer: B Difficulty: 1 Easy Topic: Capital structure basics Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 16-01 Differentiate between active and passive changes to capital structure. 5) Another name for debt in the capital structure is: A) active. B) leverage. C) passive. D) long position. Answer: B Difficulty: 1 Easy Topic: Financial and operating leverage Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 16-02 Explain why finance professionals refer to debt as "leverage."

6) Which of the following is NOT a feature of the "perfect world" in M&M's theorem for optimal capital structure? A) No taxes B) No chance of bankruptcy C) Perfectly efficient markets D) Asymmetric information sets for all participants Answer: D Difficulty: 1 Easy Topic: MM Proposition I without taxes Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 16-02 Explain why finance professionals refer to debt as "leverage." 7) Which of the following is a feature of the "perfect world" in M&M's theorem for optimal capital structure? A) Income taxes B) The chance of bankruptcy C) Perfectly efficient markets D) Asymmetric information sets for all participants Answer: C Difficulty: 1 Easy Topic: MM Proposition I without taxes Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 16-02 Explain why finance professionals refer to debt as "leverage." 8) In M&M's perfect world, their theorem's two main propositions are referred to as which of the following? A) Active capital structure management B) Passive capital structure management C) Capital structure irrelevance assertion D) Capital structure relevance assertion Answer: C Difficulty: 2 Medium Topic: MM Proposition I without taxes Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 16-02 Explain why finance professionals refer to debt as "leverage."

9) Which of these is the assumption that decisions about which projects to fund are separate from the decisions about how to fund them? A) Break-even principle B) Capital structure principle C) Separation principle D) Long position principle Answer: C Difficulty: 1 Easy Topic: Capital structure basics Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 16-02 Explain why finance professionals refer to debt as "leverage." 10) Which of the following is a true statement? A) A firm's cost of debt increases with the use of equity in the capital structure. B) A firm's cost of equity increases with the use of equity in the capital structure. C) A firm's cost of equity increases with the use of debt in the capital structure. D) A firm's cost of equity decreases with the use of debt in the capital structure. Answer: C Difficulty: 1 Easy Topic: MM Proposition II without taxes Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 16-02 Explain why finance professionals refer to debt as "leverage." 11) Which of the following makes this a true statement? In this slightly more realistic world with corporate taxes, managers can: A) minimize the firm's value by taking on as much debt as possible. B) maximize the firm's value by taking on as much debt as possible. C) maximize the firm's value by taking on as much equity as possible. D) maximize the firm's value by financing only with debt. Answer: B Difficulty: 1 Easy Topic: MM Proposition I with taxes Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 16-04 Describe how the optimal capital structure changes under corporate taxation.

12) What causes the change in optimal strategy when taxes are added back to the M&M theorem? A) The fact that we have added taxation differentially B) The fact that both dividends and interest are taxable to the receiver C) The fact that it changes the effect that an increase in leverage has on the stockholders' expected returns D) The fact that it changes the volatility of stockholders' expected returns Answer: A Difficulty: 3 Hard Topic: MM Proposition I with taxes Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 16-04 Describe how the optimal capital structure changes under corporate taxation. 13) Which of the following is a true statement regarding Proposition I? A) Vu in a world with taxes is going to be more than Vu in a world without taxes. B) Vu in a world with taxes is going to be less than Vu in a world without taxes. C) Vu in a world with taxes is going to be equal to Vu in a world without taxes. D) Vu in a world with taxes cannot be compared to Vu in a world without taxes. Answer: B Difficulty: 2 Medium Topic: MM Proposition I with taxes Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 16-04 Describe how the optimal capital structure changes under corporate taxation. 14) How can an investor leverage itself more than the firm? A) By borrowing money and investing it in stock along with the money with which they started B) By buying the firm's bonds C) By buying the firm's preferred stock D) Investors cannot leverage themselves more than the firm. Answer: A Difficulty: 1 Easy Topic: Homemade leverage Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 16-05 Demonstrate how individual shareholders can affect capital structure by borrowing and lending on their own account. 5

15) Which of the following is one of the most extreme examples of firm re-leveraging that occurs when someone uses a firm's debt capacity to buy out the majority of the firm's equity holders? A) Debt buyout B) Equity buyout C) Leveraged buyout D) Separation buyout Answer: C Difficulty: 1 Easy Topic: Private placements and leveraged buyouts Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 16-06 Calculate the EBIT and EPS levels at which shareholders become indifferent when choosing between two capital structures. 16) The level of EBIT at which EPS will be equal for two different capital structures is known as: A) break-even EBIT. B) break-even EPS. C) break-even capital structures. D) break-even financial structures. Answer: A Difficulty: 1 Easy Topic: Break-even analysis Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 16-06 Calculate the EBIT and EPS levels at which shareholders become indifferent when choosing between two capital structures.

17) Which of the following allows for two types of bankruptcy for which most businesses can file? A) Securities Exchange Commission B) Generally Accepted Accounting Principles C) The Internal Revenue Service D) The United States Bankruptcy Code Answer: D Difficulty: 1 Easy Topic: Bankruptcy Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 16-07 Describe how the firm's choice of optimal capital structure changes under the possibility of bankruptcy. 18) Which type of bankruptcy involves a business liquidating their assets? A) Chapter 7 B) Chapter 11 C) Chapter 13 D) Chapter 9 Answer: A Difficulty: 1 Easy Topic: Bankruptcy Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 16-07 Describe how the firm's choice of optimal capital structure changes under the possibility of bankruptcy. 19) Which type of bankruptcy involves an attempt to allow the firm to reorganize the business under court supervision? A) Chapter 7 B) Chapter 11 C) Chapter 13 D) Chapter 9 Answer: B Difficulty: 1 Easy Topic: Bankruptcy Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 16-07 Describe how the firm's choice of optimal capital structure changes under the possibility of bankruptcy. 7

20) Which of these is the rule under which claimants are paid in a Chapter 7 bankruptcy? A) First come, first served B) Absolute priority C) Term structure priority D) Date due priority Answer: B Difficulty: 1 Easy Topic: Bankruptcy Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 16-07 Describe how the firm's choice of optimal capital structure changes under the possibility of bankruptcy. 21) Which of the following is the condition in which a firm is near bankruptcy? A) Passive capital structure B) Active capital structure C) Financial distress D) Call position Answer: C Difficulty: 1 Easy Topic: Financial distress Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 16-07 Describe how the firm's choice of optimal capital structure changes under the possibility of bankruptcy.

22) A situation that arises when a firm's equity is close to worthless, and equity holders will prefer to invest in overly risky projects with a small chance of success rather than simply paying debt holders their regularly scheduled payments is known as a(n): A) leverage problem. B) overinvestment problem. C) underinvestment problem. D) long position. Answer: B Difficulty: 1 Easy Topic: Financial distress Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 16-07 Describe how the firm's choice of optimal capital structure changes under the possibility of bankruptcy. 23) Which of these is a situation that arises when a firm's equity is close to worthless, and equity holders will prefer to not invest in safe projects? A) Leverage problem B) Overinvestment problem C) Underinvestment problem D) Long position Answer: C Difficulty: 1 Easy Topic: Financial distress Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 16-07 Describe how the firm's choice of optimal capital structure changes under the possibility of bankruptcy.

24) Which of the following is a true statement? A) Sectors of the U.S. economy that tend to have quite variable income streams also carry the highest D/E ratios. B) Sectors of the U.S. economy that tend to have quite variable income streams also carry the lowest D/E ratios. C) Conglomerates tend to have high, unstable income streams. D) Utilities have variable income streams and carry low D/E ratios. Answer: B Difficulty: 1 Easy Topic: Capital structure observations Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 16-08 Analyze whether real-world business practices reflect the theoretical basis for optimal capital structure. 25) Suppose that a company's equity is currently selling for $22 per share and that there are 4 million shares outstanding and 30 thousand bonds outstanding, which are selling at 101 percent of par ($1,000). If the firm was considering an active change to their capital structure so that the firm would have a D/E of 0.9, which type of security (stocks or bonds) would they need to sell to accomplish this, and how much would they have to sell? A) $25,736,842 in new debt B) $10,434,060 in new debt C) $10,434,060 in new equity D) $25,742,080 in new equity Answer: A Explanation: Equity = 4,000,000 × $22 = $88,000,000, so 0.7439 Debt = 30,000 × 1.01 × 1,000 = $30,300,000, so 0.2561 Total = $118,300,000. The current D/E ratio is 0.2561/0.7439 = 0.3443, so they would be contemplating increasing the D/E ratio to 0.9 by issuing more debt and reducing outstanding equity. (30.3m + x)/(88m − x) = 0.9 therefore x = $25,736,842 Difficulty: 1 Easy Topic: Capital structure basics Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 16-01 Differentiate between active and passive changes to capital structure.

26) Suppose that a company's equity is currently selling for $19 per share and that there are 3 million shares outstanding and 10 thousand bonds outstanding, which are selling at 100 percent of par ($1,000). If the firm was considering an active change to their capital structure so that the firm would have a D/E of 0.5, which type of security (stocks or bonds) would they need to sell to accomplish this, and how much would they have to sell? A) $12,333,333 in new debt B) $1,755,400 in new debt C) $12,328,000 in new equity D) $1,755,400 in new equity Answer: A Explanation: Equity = 3,000,000 × $19 = $57,000,000, so 0.8507 Debt = 10,000 × 1.00 × 1,000 = $10,000,000, so 0.1493 Total = $67,000,000. The current D/E ratio is 0.1493/0.8507 = 0.1755, so they would be contemplating increasing the D/E ratio to 0.5 by issuing more debt and reducing outstanding equity. (10m + x)/(57m − x) = 0.5 therefore x = $12,333,333 Difficulty: 1 Easy Topic: Capital structure basics Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 16-01 Differentiate between active and passive changes to capital structure. 27) Suppose that a company's equity is currently selling for $45 per share and that there are 1 million shares outstanding. If the firm also has 7 thousand bonds outstanding, which are selling at 97 percent of par ($1,000), what are the firm's current capital structure weights for equity and debt respectively? A) 50 percent, 50 percent B) 86.89 percent, 13.11 percent C) 12.50 percent, 87.50 percent D) 31.69 percent, 68.31 percent Answer: B Explanation: Equity = 1,000,000 × $45 = $45,000,000, so 0.8689 Debt = 7,000 × 0.97 × 1,000 = $6,790,000, so 0.1311 Total = $51,790,000 Difficulty: 1 Easy Topic: Capital structure weights Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 16-03 Show how the firm apportions risk and return among stockholders and bondholders in a "perfect world".

28) Suppose that a company's equity is currently selling for $30 per share and that there are 5 million shares outstanding. If the firm also has 20 thousand bonds outstanding, which are selling at 98 percent of par ($1,000), what are the firm's current capital structure weights for equity and debt respectively? A) 50 percent, 50 percent B) 88.44 percent, 11.56 percent C) 99.60 percent, 0.40 percent D) 88.23 percent, 11.77 percent Answer: B Explanation: Equity = 5,000,000 × $30 = $150,000,000, so 0.8844 Debt = 20,000 × 0.98 × 1,000 = $19,600,000, so 0.1156 Total = $169,600,000 Difficulty: 1 Easy Topic: Capital structure weights Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 16-03 Show how the firm apportions risk and return among stockholders and bondholders in a "perfect world". 29) Suppose that a company's equity is currently selling for $20 per share and that there are 2 million shares outstanding. If the firm also has 8 thousand bonds outstanding, which are selling at 99 percent of par ($1,000), what are the firm's current capital structure weights for equity and debt respectively? A) 50 percent, 50 percent B) 16.81 percent, 83.19 percent C) 83.47 percent, 16.53 percent D) 83.33 percent, 16.67 percent Answer: C Explanation: Equity = 2,000,000 × $20 = $40,000,000, so 0.8347 Debt = 8,000 × 0.99 × 1,000 = $7,920,000, so 0.1653 Total = $47,920,000 Difficulty: 1 Easy Topic: Capital structure weights Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 16-03 Show how the firm apportions risk and return among stockholders and bondholders in a "perfect world".

30) Suppose that a company's equity is currently selling for $55 per share and that there are 1 million shares outstanding. If the firm also has 50 thousand bonds outstanding, which are selling at 95 percent of par ($1,000), what are the firm's current capital structure weights for equity and debt respectively? A) 50 percent, 50 percent B) 53.66 percent, 46.34 percent C) 52.38 percent, 47.62 percent D) 36.67 percent, 63.33 percent Answer: B Explanation: Equity = 1,000,000 × $55 = $55,000,000, so 0.5366 Debt = 50,000 × 0.95 × 1,000 = $47,500,000, so 0.4634 Total = $102,500,000 Difficulty: 1 Easy Topic: Capital structure weights Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 16-03 Show how the firm apportions risk and return among stockholders and bondholders in a "perfect world".

31) Your company doesn't face any taxes and has $500 million in assets, currently financed entirely with equity. Equity is worth $40 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities as shown as follows: State Probability of state Expected EBIT in state

Recession 0.30 $ 50 million

Average 0.45 $ 100 million

Boom 0.25 $ 170 million

The firm is considering switching to a 30 percent debt capital structure, and has determined that they would have to pay a 9 percent yield on perpetual debt in either event. What will be the standard deviation in EPS if they switch to the proposed capital structure? A) 5.07 B) 9.78 C) 25.73 D) 95.68 Answer: A Explanation: Recession Average Boom EBIT $ 50,000,000 $ 100,000,000 $ 170,000,000 −Interest − 13,500,000 − 13,500,000 − 13,500,000 =EBT/NI $ 36,500,000 $ 86,500,000 $ 156,500,000 Shares = $500,000,000 × (1 − 0.30) = $350,000,000/$40 = 8,750,000 EPS $ 4.17 $ 9.89 $ 17.89

The expected EPS will be equal to (0.30 × 4.17) + (0.45 × 9.89) + (0.25 × 17.89) = $10.17

= 5.07 Difficulty: 2 Medium Topic: Standard deviation and variance Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 16-03 Show how the firm apportions risk and return among stockholders and bondholders in a "perfect world".

32) Your company doesn't face any taxes and has $200 million in assets, currently financed entirely with equity. Equity is worth $25 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities shown as follows: State Probability of state Expected EBIT in state

Recession 0.20 $ 10 million

Average 0.70 $ 20 million

Boom 0.10 $ 35 million

The firm is considering switching to a 40 percent debt capital structure, and has determined that they would have to pay a 7 percent yield on perpetual debt in either event. What will be the standard deviation in EPS if they switch to the proposed capital structure? A) 1.05 B) 1.35 C) 2.67 D) 7.15 Answer: B Explanation: Recession Average Boom EBIT $ 10,000,000 $ 20,000,000 $ 35,000,000 −Interest − 5,600,000 − 5,600,000 − 5,600,000 =EBT/NI 4,400,000 14,400,000 29,400,000 $200,000,000 × (1 − 0.40) = $120,000,000/$25 = 4,800,000 shares EPS $ 0.92 $ 3.00 $ 6.125

The expected EPS will be equal to (0.2 × 0.92) + (0.7 × 3.00) + (0.1 × 6.125) = 2.8965 The standard deviation is the square root of 0.20(0.92 − 2.8965)2 + 0.70(3.00 − 2.8965)2 + .10(6.125 − 2.8965)2 = 1.35 Difficulty: 2 Medium Topic: Standard deviation and variance Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 16-03 Show how the firm apportions risk and return among stockholders and bondholders in a "perfect world".

33) Your company doesn't face any taxes and has $750 million in assets, currently financed entirely with equity. Equity is worth $50 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities shown as follows: State Probability of state Expected EBIT in state

Recession 0.15 $ 100million

Average 0.65 $ 175 million

Boom 0.20 $ 235 million

The firm is considering switching to a 30 percent debt capital structure, and has determined that they would have to pay a 9 percent yield on perpetual debt in either event. What will be the standard deviation in EPS if they switch to the proposed capital structure? A) 3.76 B) 9.15 C) 14.17 D) 83.79 Answer: A Explanation: Recession Average Boom EBIT $ 100,000,000 $ 175,000,000 $ 235,000,000 −Interest − 20,250,000 − 20,250,000 − 20,250,000 =EBT/NI 79,750,000 154,750,000 214,750,000 $750,000,000 × (1 − 0.30) = $525,000,000/$50 = 10,500,000 shares EPS $ 7.595 $ 14.74 $ 20.45

The expected EPS will be equal to (0.15 × 7.595) + (0.65 × 14.74) + (0.20 × 20.45) = 14.81

= 3.76 Difficulty: 2 Medium Topic: Standard deviation and variance Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 16-03 Show how the firm apportions risk and return among stockholders and bondholders in a "perfect world".

34) Your company doesn't face any taxes and has $800 million in assets, currently financed entirely with equity. Equity is worth $60 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities shown as follows: State Probability of state Expected EBIT in state

Recession 0.15 $ 20 million

Average 0.60 $ 50 million

Boom 0.25 $ 100 million

The firm is considering switching to a 20 percent debt capital structure, and has determined that they would have to pay a 10 percent yield on perpetual debt in either event. What will be the standard deviation in EPS if they switch to the proposed capital structure? A) 2.47 B) 5.36 C) 6.12 D) 28.76 Answer: A Explanation: RECESSION AVERAGE BOOM EBIT $ 20,000,000 $ 50,000,000 $ 100,000,000 −Interest − 16,000,000 − 16,000,000 − 16,000,000 =EBT/NI $ 4,000,000 $ 34,000,000 $ 84,000,000 $800,000,000 × (1 − 0.20) = $640,000,000/$60 = 10,666,667 shares EPS $ 0.3750 $ 3.1875 $ 7.8750

The expected EPS will be equal to (0.15 × 0.375) + (0.60 × 3.19) + (0.25 × 7.88) = 3.94

= 2.47 Difficulty: 2 Medium Topic: Standard deviation and variance Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 16-03 Show how the firm apportions risk and return among stockholders and bondholders in a "perfect world".

35) Your company doesn't face any taxes and has $250 million in assets, currently financed entirely with equity. Equity is worth $8 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities shown as follows: State

Pessimistic 0.25 $ 10 million

Probability of state Expected EBIT in state

Optimistic 0.75 $ 50 million

The firm is considering switching to a 20 percent debt capital structure, and has determined that they would have to pay a 9 percent yield on perpetual debt in either event. What will be the level of expected EPS if they switch to the proposed capital structure? A) $1.02 B) $1.42 C) $1.82 D) $2.00 Answer: B Explanation: Pessimistic Optimistic EBIT 10,000,000 50,000,000 −Interest −4,500,000 −4,500,000 =EBT/NI 5,500,000 45,500,000 Number of shares = $250,000,000 × (1 − 0.2) = $200,000,000/$8 = 25,000,000 shares EPS $ 0.22 $ 1.82 The expected EPS will be equal to (0.25 × 0.22) + (0.75 × 1.82) = $1.42 Difficulty: 2 Medium Topic: Earnings per share Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 16-03 Show how the firm apportions risk and return among stockholders and bondholders in a "perfect world".

36) Your company doesn't face any taxes and has $300 million in assets, currently financed entirely with equity. Equity is worth $15 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities shown as follows: State

Pessimistic 0.40 $ 12 million

Probability of state Expected EBIT in state

Optimistic 0.60 $ 40 million

The firm is considering switching to a 30 percent debt capital structure, and has determined that they would have to pay a 10 percent yield on perpetual debt in either event. What will be the level of expected EPS if they switch to the proposed capital structure? A) $1.21 B) $1.41 C) $1.55 D) $2.21 Answer: B Explanation: Pessimistic Optimistic EBIT 12,000,000 40,000,000 −Interest −9,000,000 −9,000,000 =EBT/NI 3,000,000 31,000,000 Number of shares = $300,000,000 × (1 − 0.3) = $210,000,000/$15 = 14,000,000 shares EPS $ 0.2143 $ 2.2143

The expected EPS will be equal to (0.4 × 0.2143) + (0.6 × 2.2143) = $1.4143 Difficulty: 2 Medium Topic: Earnings per share Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 16-03 Show how the firm apportions risk and return among stockholders and bondholders in a "perfect world".

37) Your company doesn't face any taxes and has $750 million in assets, currently financed entirely with equity. Equity is worth $25 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities shown as follows: State

Pessimistic 0.55 $ 20 million

Probability of state Expected EBIT in state

Optimistic 0.45 $ 70 million

The firm is considering switching to a 25 percent debt capital structure, and has determined that they would have to pay a 10 percent yield on perpetual debt in either event. What will be the level of expected EPS if they switch to the proposed capital structure? A) $1.06 B) $1.17 C) $2.27 D) $2.28 Answer: A Explanation: Pessimistic Optimistic EBIT 20,000,000 70,000,000 −Interest −18,750,000 −18,750,000 =EBT/NI 1,250,000 51,250,000 Number of shares = $750,000,000 × (1 − 0.25) = $562,500,000/$25 = 22,500,000 shares EPS $ 0.056 $ 2.28

The expected EPS will be equal to (0.55 × 0.056) + (0.45 × 2.28) = $1.0568 Difficulty: 2 Medium Topic: Earnings per share Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 16-03 Show how the firm apportions risk and return among stockholders and bondholders in a "perfect world".

38) Your company doesn't face any taxes and has $200 million in assets, currently financed entirely with equity. Equity is worth $10 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities as shown below: State

Pessimistic 0.25 $ 5 million

Probability of state Expected EBIT in state

Optimistic 0.75 $ 25 million

The firm is considering switching to a 40 percent debt capital structure, and has determined that they would have to pay an 8 percent yield on perpetual debt in either event. What will be the level of expected EPS if they switch to the proposed capital structure? A) $0.75 B) $1.1325 C) $1.1925 D) $1.55 Answer: B Explanation: Pessimistic Optimistic EBIT 5,000,000 25,000,000 −Interest −6,400,000 −6,400,000 =EBT/NI −1,400,000 18,600,000 Number of shares = $200,000,000 × (1 − 0.4) = $120,000,000/$10 = 12,000,000 shares EPS $ −0.12 $ 1.55 The expected EPS will be equal to (0.25 × −0.12) + (0.75 × 1.55) = $1.1325 Difficulty: 2 Medium Topic: Earnings per share Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 16-03 Show how the firm apportions risk and return among stockholders and bondholders in a "perfect world".

39) Your company doesn't face any taxes and has $750 million in assets, currently financed entirely with equity. Equity is worth $25 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities shown as follows: State

Pessimistic 0.55 $ 20 million

Probability of state Expected EBIT in state

Optimistic 0.45 $ 70 million

The firm is considering switching to a 25 percent debt capital structure, and has determined that they would have to pay a 10 percent yield on perpetual debt in either event. What will be the break-even level of EBIT? A) $20 million B) $23.75 million C) $42.5 million D) $75 million Answer: D Explanation: [(EBIT − 18,750,000) × (1 − 0)]/22,500,000 = [(EBIT) × (1 − 0)]/30,000,000 30,000,000 EBIT − 5.625 E14 = 22,500,000 EBIT 7,500,000 EBIT = 5.625 E14 EBIT = $75,000,000 Difficulty: 2 Medium Topic: Break-even analysis Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 16-06 Calculate the EBIT and EPS levels at which shareholders become indifferent when choosing between two capital structures.

23) Your company doesn't face any taxes and has $300 million in assets, currently financed entirely with equity. Equity is worth $10 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities shown as follows: State

Pessimistic 0.4 $ 8 million

Probability of state Expected EBIT in state

Optimistic 0.6 $ 30 million

The firm is considering switching to a 30 percent debt capital structure, and has determined that they would have to pay a 9 percent yield on perpetual debt in either event. What will be the break-even EBIT? A) $19,000,000 B) $21,200,000 C) $27,000,000 D) $30,000,000 Answer: C Explanation: [(EBIT − 8,100,000) × (1 − 0)]/21,000,000 = [(EBIT) × (1 − 0)]/30,000,000 30,000,000 EBIT − 2.43 E14 = 21,000,000 EBIT 9,000,000 EBIT = 2.43 E14 EBIT = $27,000,000 Difficulty: 2 Medium Topic: Break-even analysis Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 16-06 Calculate the EBIT and EPS levels at which shareholders become indifferent when choosing between two capital structures.

24) Your company doesn't face any taxes and has $200 million in assets, currently financed entirely with equity. Equity is worth $10 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities shown as follows: State

Pessimistic 0.25 $ 5 million

Probability of state Expected EBIT in state

Optimistic 0.75 $ 25 million

The firm is considering switching to a 40 percent debt capital structure, and has determined that they would have to pay an 8 percent yield on perpetual debt in either event. What will be the break-even EBIT? A) $13.6 million B) $15 million C) $16 million D) $20 million Answer: C Explanation: [(EBIT − 6,400,000) × (1 − 0)]/12,000,000 = [(EBIT) × (1 − 0)]/20,000,000 20,000,000 EBIT − 1.28 E14 = 12,000,000 EBIT 8,000,000 EBIT = 1.28 E14 EBIT = $16,000,000 Difficulty: 2 Medium Topic: Break-even analysis Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 16-06 Calculate the EBIT and EPS levels at which shareholders become indifferent when choosing between two capital structures.

42) Your company doesn't face any taxes and has $150 million in assets, currently financed entirely with equity. Equity is worth $8 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities shown as follows: State

Pessimistic 0.3 $ 15 million

Probability of state Expected EBIT in state

Optimistic 0.7 $ 40 million

The firm is considering switching to a 25 percent debt capital structure, and has determined that they would have to pay a 12 percent yield on perpetual debt in either event. What will be the break-even EBIT? A) $18 million B) $27.5 million C) $32.5 million D) $40 million Answer: A Explanation: [(EBIT − 4,500,000) × (1 − 0)]/14,062,500 = [(EBIT) × (1 − 0)]/18,750,000 18,750,000 EBIT − 8.4375 E13 = 14,062,500 EBIT 4,687,500 EBIT = 8.4375 E13 EBIT = $18,000,000 Difficulty: 2 Medium Topic: Break-even analysis Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 16-06 Calculate the EBIT and EPS levels at which shareholders become indifferent when choosing between two capital structures.

43) Your company has a 21 percent tax rate and has $750 million in assets, currently financed entirely with equity. Equity is worth $50 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities shown as follows: State Probability of state Expected EBIT in state

Recession 0.15 $ 100 million

Average 0.65 $ 175 million

Boom 0.20 $ 235 million

The firm is considering switching to a 30 percent debt capital structure, and has determined that they would have to pay a 9 percent yield on perpetual debt in either event. What will be the level of expected EPS if they switch to the proposed capital structure? A) $8.56 B) $8.84 C) $11.70 D) $25.67 Answer: C Explanation: EBIT −Interest =EBT −Taxes =Net income EPS *

Recession 100,000,000 (20,250,000) 79,750,000 (16,747,500)

Average 175,000,000 (20,250,000) 154,750,000 (32,497,500)

63,002,500 6.00

Boom 235,000,000 (20,250,000) 214,750,000 (45,097,500)

122,252,500 11.64

169,652,500 16.16

*Shares = (750,000,000 × 1 − 0.30))/50 = 10,500,000 Expected EPS = (0.15 × 6) + (0.65 × 11.64) + (0.2 × 16.16) = 11.698

Difficulty: 3 Hard Topic: Earnings per share Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 16-04 Describe how the optimal capital structure changes under corporate taxation.

44) Your company has a 21 percent tax rate and has $600 million in assets, currently financed entirely with equity. Equity is worth $20 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities shown as follows: State Probability of state Expected EBIT in state

Recession 0.05 $ 5 million

Average 0.70 $ 20 million

Boom 0.25 $ 50 million

The firm is considering switching to a 30 percent debt capital structure, and has determined that they would have to pay a 9 percent yield on perpetual debt in either event. What will be the level of expected EPS if they switch to the proposed capital structure? A) $0.32 B) $0.14 C) $0.39 D) $0.95 Answer: C Explanation: EBIT −Interest =EBT −Taxes =Net income EPS *

Recession 5,000,000 (16,200,000) (11,200,000) 2,352,000

Average

Boom

20,000,000 (16,200,000) 3,800,000 (798,000)

50,000,000 (16,200,000) 33,800,000 (7,098,000)

(8,848,000)

3,002,000

26,702,000

(0.42)

0.14

1.27

*Shares = (600,000,000 × (1 − 0.30))/20 = 21,000,000 Expected EPS = (0.05 × −0.42) + (0.70 × 0.14) + (0.25 × 1.27) = 0.3945 Difficulty: 3 Hard Topic: Earnings per share Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 16-04 Describe how the optimal capital structure changes under corporate taxation.

45) Your company has a 21 percent tax rate and has $800 million in assets, currently financed entirely with equity. Equity is worth $60 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities shown as follows: State Probability of state Expected EBIT in state

Recession 0.15 $ 20 million

Average 0.60 $ 50 million

Boom 0.25 $ 100 million

The firm is considering switching to a 20 percent debt capital structure, and has determined that they would have to pay a 10 percent yield on perpetual debt in either event. What will be the level of expected EPS if they switch to the proposed capital structure? A) $1.98 B) $2.29 C) $2.36 D) $3.11 Answer: D Explanation: EBIT −Interest =EBT −Taxes =Net income

Recession 20,000,000 (16,000,000) 4,000,000 (840,000)

Average

Boom

50,000,000 (16,000,000) 34,000,000 (7,140,000)

100,000,000 (16,000,000) 84,000,000 (17,640,000)

3,160,000

26,860,000

0.30

2.52

66,360,000 EPS * 6.22

*Shares = (800,000,000 × (1 − 0.20))/60 = 10,666,667 Expected EPS = (0.15 × 0.30) + (0.60 × 2.52) + (0.25 × 6.22) = 3.112 Difficulty: 3 Hard Topic: Earnings per share Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 16-04 Describe how the optimal capital structure changes under corporate taxation.

46) Your company has a 21 percent tax rate and has $750 million in assets, currently financed entirely with equity. Equity is worth $50 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities shown follows: State Probability of state Expected EBIT in state

Recession 0.15 $ 100 million

Average 0.65 $ 175 million

Boom 0.20 $ 235 million

The firm is considering switching to a 30 percent debt capital structure, and has determined that they would have to pay a 9 percent yield on perpetual debt in either event. What will be the standard deviation in EPS if they switch to the proposed capital structure? A) 2.98 B) 5.10 C) 10.05 D) 30.16 Answer: A Explanation: EBIT −Interest =EBT −Taxes =Net income

Recession 100,000,000 (20,250,000) 79,750,000 (16,747,500)

Average 175,000,000 (20,250,000) 154,750,000 (32,497,500)

63,002,500

122,252,500

6.00

11.64

Boom 235,000,000 (20,250,000) 214,750,000 (45,097,500) 169,652,500 EPS * 16.16

*Shares = (750,000,000 × (1 − 0.30))/50 = 10,500,000 Expected EPS = (0.15 × 6) + (0.65 × 11.64) + (0.2 × 16.16) = 11.698 Square Root of (0.15(6 − 11.698)2 + 0.65(11.64 − 11.698)2 + 0.20(16.16 − 11.698)2) = 2.9756 Difficulty: 3 Hard Topic: Standard deviation and variance Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 16-04 Describe how the optimal capital structure changes under corporate taxation.

47) Your company has a 21 percent tax rate and has $600 million in assets, currently financed entirely with equity. Equity is worth $20 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities shown as follows: State Probability of state Expected EBIT in state

Recession 0.05 $ 5 million

Average 0.70 $ 20 million

Boom 0.25 $ 50 million

The firm is considering switching to a 30 percent debt capital structure, and has determined that they would have to pay a 9 percent yield on perpetual debt in either event. What will be the standard deviation in EPS if they switch to the proposed capital structure? A) 0.46 B) 0.52 C) 0.88 D) 1.16 Answer: B Explanation: EBIT −Interest =EBT −Taxes =Net income

Recession 5,000,000 (16,200,000) (11,200,000) 2,352,000

Average 20,000,000 (16,200,000) 3,800,000 (798,000)

(8,848,000)

3,002,000

(0.42)

0.14

Boom 50,000,000 (16,200,000) 33,800,000 (7,098,000) 26,702,000 EPS * 1.27

*Shares = (600,000,000 × (1 − 0.30)) / 20 = 21,000,000 Expected EPS = (0.05 × −0.42) + (0.70 × 0.14) + (0.25 × 1.27) = 0.3945 Square Root of (0.05(−0.42 − 0.39)2 + 0.70(0.14 − 0.39)2 + 0.25(1.27 − 0.39)2) = 0.5198 Difficulty: 3 Hard Topic: Standard deviation and variance Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 16-04 Describe how the optimal capital structure changes under corporate taxation.

48) Your company has a 21% tax rate and has $800 million in assets, currently financed entirely with equity. Equity is worth $60 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities shown as follows: State Probability of state Expected EBIT in state

Recession 0.15 $ 20 million

Average 0.60 $ 50 million

Boom 0.25 $ 100 million

The firm is considering switching to a 20 percent debt capital structure, and has determined that they would have to pay a 10 percent yield on perpetual debt in either event. What will be the standard deviation in EPS if they switch to the proposed capital structure? A) 1.95 B) 2.35 C) 3.32 D) 11.04 Answer: A Explanation: EBIT −Interest =EBT −Taxes =Net income

Recession 20,000,000 (16,000,000) 4,000,000 (840,000)

Average

Boom

50,000,000 (16,000,000) 34,000,000 (7,140,000)

100,000,000 (16,000,000) 84,000,000 (17,640,000)

3,160,000

26,860,000

0.30

2.52

66,360,000 EPS * 6.22

*Shares = (800,000,000 × (1 − 0.20)) / 60 = 10,666,667 Expected EPS = (0.15 × 0.30) + (0.60 × 2.52) + (0.25 × 6.22) = 3.112 Square Root of (0.15(0.3 − 3.11)2 + 0.60(2.52 − 3.11)2 + 0.25(6.22 − 3.11)2) = 1.9523 Difficulty: 3 Hard Topic: Standard deviation and variance Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 16-04 Describe how the optimal capital structure changes under corporate taxation.

49) Your company has a 21 percent tax rate and has $600 million in assets, currently financed entirely with equity. Equity is worth $20 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities shown as follows: State Probability of state Expected EBIT in state

Recession 0.05 $ 5 million

Average 0.70 $ 20 million

Boom 0.25 $ 50 million

The firm is considering switching to a 30 percent debt capital structure, and has determined that they would have to pay a 9 percent yield on perpetual debt in either event. What will be the break-even level of EBIT? A) $16,758,621 B) $20,000,000 C) $25,000,000 D) $54,000,037 Answer: D Explanation: Interest in all states will be equal to 0.09 × (0.30 × $600,000,000) = $16,200,000, and the number of shares outstanding will be equal to (0.70 × $600,000,000)/$20 = 21,000,000 at the 30-percent debt capital structure, and the number of shares outstanding at the current capital structure is $600,000,000/$20 = 30,000,000. Break-even EBIT can be determined by solving: [(EBIT − 16,200,000) × (1 − 0.21)]/21,000,000 = [(EBIT) × (1 − 0.21)]/30,000,000 EBIT = $54,000,037 Difficulty: 3 Hard Topic: Break-even analysis Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 16-06 Calculate the EBIT and EPS levels at which shareholders become indifferent when choosing between two capital structures.

50) Your company has a 21 percent tax rate and has $800 million in assets, currently financed entirely with equity. Equity is worth $60 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities shown as follows: State Probability of state Expected EBIT in state

Recession 0.15 $ 20 million

Average 0.60 $ 50 million

Boom 0.25 $ 100 million

The firm is considering switching to a 20 percent debt capital structure, and has determined that they would have to pay a 10 percent yield on perpetual debt in either event. What will be the break-even level of EBIT? A) $26.67 million B) $50 million C) $56.67 million D) $80.1 million Answer: D Explanation: [(EBIT − 16,000,000) × (1 − 0.21)]/10,666,667 = [(EBIT) × (1 − 0.21)]/13,333,333 EBIT = $80,060,533 Difficulty: 3 Hard Topic: Break-even analysis Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 16-06 Calculate the EBIT and EPS levels at which shareholders become indifferent when choosing between two capital structures.

34) Your company faces a 21 percent tax rate and has $300 million in assets, currently financed entirely with equity. Equity is worth $10 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities shown as follows: State

Pessimistic 0.4 $ 8 million

Probability of state Expected EBIT in state

Optimistic 0.6 $ 30 million

The firm is considering switching to a 30 percent debt capital structure, and has determined that they would have to pay a 9 percent yield on perpetual debt in either event. What will be the level of expected EPS if they switch to the proposed capital structure? A) $0.30 B) $0.365 C) $0.49 D) $0.73 Answer: C Explanation: EBIT −Interest =EBT −Taxes =Net income EPS*

Pessimistic 8,000,000 (8,100,000) (100,000) 21,000 (79,000) (0.004)

Optimistic 30,000,000 (8,100,000) 21,900,000 (4,599,000) 17,301,000 0.82

*Shares = (300,000,000 × (1 − 0.30)) / 10 = 21,000,000 Expected EPS = (0.40 × −0.004) + (0.60 × 0.82) = 0.49 Difficulty: 3 Hard Topic: Earnings per share Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 16-04 Describe how the optimal capital structure changes under corporate taxation.

35) Your company faces a 21 percent tax rate and has $200 million in assets, currently financed entirely with equity. Equity is worth $10 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities shown as follows: State

Pessimistic 0.25 $ 5 million

Probability of state Expected EBIT in state

Optimistic 0.75 $ 25 million

Pessimistic 5,000,000 (6,400,000) (1,400,000) 294,000 (1,106,000) (0.09)

Optimistic 25,000,000 (6,400,000) 18,600,000 (3,906,000) 14,694,000 1.22

*Shares = (200,000,000 × (1 − 0.40)) / 10 = 12,000,000 Expected EPS = (0.25 × −0.09) + (0.75 × 1.22) = 0.8925 Difficulty: 3 Hard Topic: Earnings per share Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 16-04 Describe how the optimal capital structure changes under corporate taxation.

53) Your company faces a 21 percent tax rate and has $150 million in assets, currently financed entirely with equity. Equity is worth $8 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities shown as follows: State

Pessimistic 0.3 $ 15 million

Probability of state Expected EBIT in state

Optimistic 0.7 $ 40 million

The firm is considering switching to a 25 percent debt capital structure, and has determined that they would have to pay a 12 percent yield on perpetual debt in either event. What will be the level of expected EPS if they switch to the proposed capital structure? A) $0.49 B) $1.08 C) $1.57 D) $1.69 Answer: C Explanation: EBIT −Interest =EBT −Taxes =Net income EPS*

Pessimistic 15,000,000 (4,500,000) 10,500,000 (2,205,000) 8,295,000 0.59

Optimistic 40,000,000 (4,500,000) 35,500,000 (7,455,000) 28,045,000 1.99

*Shares = (150,000,000 × (1 − 0.25)) / 8 = 14,062,500 Expected EPS = (0.30 × 0.59) + (0.70 × 1.99) = 1.57 Difficulty: 3 Hard Topic: Earnings per share Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 16-04 Describe how the optimal capital structure changes under corporate taxation.

54) Your company faces a 21 percent tax rate and has $750 million in assets, currently financed entirely with equity. Equity is worth $25 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities shown as follows: State

Pessimistic 0.55 $ 20 million

Probability of state Expected EBIT in state

Optimistic 0.45 $ 70 million

The firm is considering switching to a 25 percent debt capital structure, and has determined that they would have to pay a 10 percent yield on perpetual debt in either event. What will be the standard deviation in EPS if they switch to the proposed capital structure? A) 0.689 B) 0.876 C) 1.186 D) 1.406 Answer: B Explanation: EBIT −Interest =EBT −Taxes =Net income EPS*

Pessimistic 20,000,000 (18,750,000) 1,250,000 (262,500) 987,500 0.04

Optimistic 70,000,000 (18,750,000) 51,250,000 (10,762,500) 40,487,500 1.80

*Shares = (750,000,000 × (1 − 0.25)) / 25 = 22,500,000 Expected EPS = (0.55 × 0.04) + (0.45 × 1.80) = 0.832 Square Root of (0.55(0.04 − 0.83)2 + 0.45(1.80 − 0.83)2) = 0.8756 Difficulty: 3 Hard Topic: Standard deviation and variance Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 16-04 Describe how the optimal capital structure changes under corporate taxation.

55) Your company faces a 21 percent tax rate and has $300 million in assets, currently financed entirely with equity. Equity is worth $10 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities shown as follows: State

Pessimistic 0.4 $ 8 million

Probability of state Expected EBIT in state

Optimistic 0.6 $ 30 million

The firm is considering switching to a 30 percent debt capital structure, and has determined that they would have to pay a 9 percent yield on perpetual debt in either event. What will be the standard deviation in EPS if they switch to the proposed capital structure? A) 0.123 B) 0.246 C) 0.406 D) 0.496 Answer: C Explanation: EBIT −Interest =EBT −Taxes =Net income EPS*

Pessimistic 8,000,000 (8,100,000) (100,000) 21,000 (79,000) (0.004)

Optimistic 30,000,000 (8,100,000) 21,900,000 (4,599,000) 17,301,000 0.824

*Shares = (300,000,000 × (1 − 0.30)) / 10 = 21,000,000 Expected EPS = (0.40 × −0.004) + (0.60 × 0.824) = 0.493 Square Root of (0.40(−0.004 − 0.493)2 + 0.60(0.824 − 0.493)2) = 0.4059 Difficulty: 3 Hard Topic: Standard deviation and variance Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 16-04 Describe how the optimal capital structure changes under corporate taxation.

56) Your company faces a 21 percent tax rate and has $150 million in assets, currently financed entirely with equity. Equity is worth $8 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities shown as follows: State

Pessimistic 0.3 $ 15 million

Probability of state Expected EBIT in state

Optimistic 0.7 $ 40 million

The firm is considering switching to a 25 percent debt capital structure, and has determined that they would have to pay a 12 percent yield on perpetual debt in either event. What will be the standard deviation in EPS if they switch to the proposed capital structure? A) 0.289 B) 0.643 C) 0.798 D) 0.894 Answer: B Explanation: EBIT −Interest =EBT −Taxes =Net income EPS*

Pessimistic 15,000,000 (4,500,000) 10,500,000 (2,205,000) 8,295,000 0.590

Optimistic 40,000,000 (4,500,000) 35,500,000 (7,455,000) 28,045,000 1.994

*Shares = (150,000,000 × (1 − 0.25)) / 8 = 14,062,500 Expected EPS = (0.30 × 0.59) + (0.70 × 1.994) = 1.573 Square Root of (0.30(0.59 − 1.573)2 + 0.70(1.994 − 1.573)2) = 0.6434 Difficulty: 3 Hard Topic: Standard deviation and variance Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 16-04 Describe how the optimal capital structure changes under corporate taxation.

57) Suppose that Lil John Industries' equity is currently selling for $64 per share and that there are 1 million shares outstanding. If the firm also has 20 thousand bonds outstanding, which are selling at 108 percent of par ($1,000), what are the firm's current capital structure weights? A) Weight of Equity = 25.23 percent; Weight of Debt = 74.77 percent B) Weight of Equity = 84.77 percent; Weight of Debt = 15.23 percent C) Weight of Equity = 74.77 percent; Weight of Debt = 25.23 percent D) Weight of Equity = 32.23 percent; Weight of Debt = 67.77 percent Answer: C Explanation: Step 1: Find E: 1m × 64 = $64m; Step 2: Find D: 20,000 × 1.08 × 1,000 = $21.6m; Step 3: Find E/(E + D) = $64m/($64m + $21.6m) = 74.77%; Step 4: D/(E + D) = 1 − E/(E + D) = 25.23% Difficulty: 1 Easy Topic: Capital structure weights Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 16-03 Show how the firm apportions risk and return among stockholders and bondholders in a "perfect world". 58) Suppose that Papa Bell Inc.'s equity is currently selling for $30 per share, with 4 million shares outstanding. If the firm also has 70 thousand bonds outstanding, which are selling at 95 percent of par ($1,000), what are the firm's current capital structure weights? A) Weight of Equity = 74.11 percent; Weight of Debt = 25.89 percent B) Weight of Equity = 64.34 percent; Weight of Debt = 35.66 percent C) Weight of Equity = 67.80 percent; Weight of Debt = 32.20 percent D) Weight of Equity = 65.19 percent; Weight of Debt = 34.81 percent Answer: B Explanation: Step 1: Find E: 4m × 30 = $120m; Step 2: Find D: 70,000 × 0.95 × 1,000 = $66.5m; Step 3: Find E/(E + D) = $120m/($120m + $66.5m) = 64.34%; Step 4: D/(E + D) = 1 − E/(E + D) = 35.66% Difficulty: 1 Easy Topic: Capital structure weights Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 16-03 Show how the firm apportions risk and return among stockholders and bondholders in a "perfect world".

59) Suppose that Papa Bell Inc.'s equity is currently selling for $95 per share, with 4 million shares outstanding. If the firm also has 80 thousand bonds outstanding, which are selling at 91.5 percent of par ($1,000), what are the firm's current capital structure weights? A) Weight of Equity = 83.85 percent; Weight of Debt = 16.15 percent B) Weight of Equity = 81.29 percent; Weight of Debt = 18.71 percent C) Weight of Equity = 77.80 percent; Weight of Debt = 12.20 percent D) Weight of Equity = 65.19 percent; Weight of Debt = 34.81 percent Answer: A Explanation: Step 1: Find E: 4m × 95 = $380m; Step 2: Find D: 80,000 × 0.915 × 1,000 = $73.2m; Step 3: Find E/(E + D) = $380m/($380m + $73.2m) = 83.85%; Step 4: D/(E + D) = 1 − E/(E + D) = 16.15% Difficulty: 1 Easy Topic: Capital structure weights Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 16-03 Show how the firm apportions risk and return among stockholders and bondholders in a "perfect world".

60) Daddi Mac, Inc., doesn't face any taxes and has $250 million in assets, currently financed entirely with equity. Equity is worth $13 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities shown as follows: State Probability of state Expected EBIT in state

Recession 0.25 $ 5 million

Average 0.55 $ 10 million

Boom 0.20 $ 17 million

The firm is considering switching to a 25 percent debt capital structure, and has determined that they would have to pay a 10 percent yield on perpetual debt. What will be the level of expected EPS if they switch to the proposed capital structure? A) $0.13 B) $0.21 C) $0.27 D) $0.16 Answer: C Explanation: Step 1: Find Interest expense: 250m × 0.25 × 0.10 = $6.25m per year; Step 2: Find NI for each state: Recession NI = 5m − 6.25m = −$1.25m; Average NI = $10m − $6.25m = $3.75m; Boom NI = $17m − $6.25m = $10.75m; Step 3: Find new number of shares: $250m × 0.75 = $187.5m in equity; $187.5m/$13 = 14.4231m shares; Step 4: Find EPS for each state: Recession EPS = −$1.25m/14.4231m = −$0.09; Average EPS = $3.75m/14.4231m = $0.26; Boom EPS = $10.75m/14.4231m = $0.75; Step 5: Find expected EPS = 0.25 × (−0.09) + 0.55 × (0.26) + 0.20 × (0.75) = $0.27 Difficulty: 2 Medium Topic: Earnings per share Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 16-03 Show how the firm apportions risk and return among stockholders and bondholders in a "perfect world".

61) Daddi Mac, Inc., doesn't face any taxes and has $250 million in assets, currently financed entirely with equity. Equity is worth $20 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities shown as follows: State Probability of state Expected EBIT in state

Recession 0.20 $ 5 million

Average 0.60 $ 10 million

Boom 0.20 $ 15 million

The firm is considering switching to a 30 percent debt capital structure, and has determined that they would have to pay a 10 percent yield on perpetual debt. What will be the level of expected EPS if they switch to the proposed capital structure? A) $0.33 B) $0.21 C) $0.37 D) $0.29 Answer: D Explanation: Step 1: Find Interest expense: 250m × 0.30 × 0.10 = $7.5m per year; Step 2: Find NI for each state: Recession NI = 5m − 7.5m = −$2.5m; Average NI = $10m − $7.5m = $2.5m; Boom NI = $15m − $7.5m = $7.5m; Step 3: Find new number of shares: $250m × 0.70 = $175m in equity; $175m/$20 = 8.75m shares; Step 4: Find EPS for each state: Recession EPS = −$2.5m/8.75m = −$0.29; Average EPS = $2.5m/8.75m = $0.29; Boom EPS = $7.5m/8.75m = $0.86; Step 5: Find expected EPS = 0.20 × (−0.29) + 0.60 × (0.29) + 0.20 × (0.86) = $0.29 Difficulty: 2 Medium Topic: Earnings per share Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 16-03 Show how the firm apportions risk and return among stockholders and bondholders in a "perfect world".

62) Daddi Mac, Inc., doesn't face any taxes and has $250 million in assets, currently financed entirely with equity. Equity is worth $13 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities shown as follows: State Probability of state Expected EBIT in state

Recession 0.05 $ 5 million

Average 0.25 $ 10 million

Boom 0.70 $ 17 million

The firm is considering switching to a 25 percent debt capital structure, and has determined that they would have to pay a 10 percent yield on perpetual debt. What will be the level of expected EPS if they switch to the proposed capital structure? A) $0.19 B) $0.59 C) $0.41 D) $0.27 Answer: B Explanation: Step 1: Find Interest expense: 250m × 0.25 × 0.10 = $6.25m per year; Step 2: Find NI for each state: Recession NI = 5m − 6.25m = −$1.25m; Average NI = $10m − $6.25m = $3.75m; Boom NI = $17m − $6.25m = $10.75m; Step 3: Find new number of shares: $250m × 0.75 = $187.5m in equity; $187.5m/$13 = 14.4231m shares; Step 4: Find EPS for each state: Recession EPS = −$1.25m/14.4231m = −$0.09; Average EPS = $3.75m/14.4231m = $0.26; Boom EPS = $10.75m/14.4231m = $0.75; Step 5: Find expected EPS = 0.05 × (−0.09) + 0.25 × (0.26) + 0.70 × (0.75) = $0.59 Difficulty: 2 Medium Topic: Earnings per share Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 16-03 Show how the firm apportions risk and return among stockholders and bondholders in a "perfect world".

63) Daddi Mac, Inc., doesn't face any taxes and has $250 million in assets, currently financed entirely with equity. Equity is worth $13 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities as shown below: State Probability of state Expected EBIT in state

Recession 0.25 $ 5 million

Average 0.55 $ 10 million

Boom 0.20 $ 17 million

The firm is considering switching to a 25 percent debt capital structure, and has determined that they would have to pay a 10 percent yield on perpetual debt. What will be the standard deviation in EPS if they switch to the proposed capital structure? A) $0.28 B) $0.33 C) $0.41 D) $0.11 Answer: A Explanation: Step 1: Find Interest expense: 250m × 0.25 × 0.10 = $6.25m per year; Step 2: Find NI for each state: Recession NI = 5m − 6.25m = −$1.25m; Average NI = $10m − $6.25m = $3.75m; Boom NI = $17m − $6.25m = $10.75m; Step 3: Find new number of shares: $250m × 0.75 = $187.5m in equity; $187.5m/$13 = 14.4231m shares; Step 4: Find EPS for each state: Recession EPS = −$1.25m/14.4231m = −$0.09; Average EPS = $3.75m/14.4231m = $0.26; Boom EPS = $10.75m/14.4231m = $0.75; Step 5: Find expected EPS = 0.25 × (−0.09) + 0.55 × (0.26) + 0.20 × (0.75) = $0.27; Step 6: Calculate the standard deviation: SQRT of [0.25 × (−0.09 − 0.27)2 + 0.55 × (0.26 − 0.27)2 + 0.2 × (0.75 − 0.27)2] = 0.28 Difficulty: 2 Medium Topic: Standard deviation and variance Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 16-03 Show how the firm apportions risk and return among stockholders and bondholders in a "perfect world".

64) Daddi Mac, Inc., doesn't face any taxes and has $250 million in assets, currently financed entirely with equity. Equity is worth $13 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities shown as follows: State Probability of state Expected EBIT in state

Recession 0.05 $ 5 million

Average 0.25 $ 10 million

Boom 0.70 $ 17 million

The firm is considering switching to a 25 percent debt capital structure, and has determined that they would have to pay a 10 percent yield on perpetual debt. What will be the standard deviation in EPS if they switch to the proposed capital structure? A) $0.33 B) $0.26 C) $0.21 D) $0.16 Answer: B Explanation: Step 1: Find Interest expense: 250m × 0.25 × 0.10 = $6.25m per year; Step 2: Find NI for each state: Recession NI = 5m − 6.25m = −$1.25m; Average NI = $10m − $6.25m = $3.75m; Boom NI = $17m − $6.25m = $10.75m; Step 3: Find new number of shares: $250m × 0.75 = $187.5m in equity; $187.5m/$13 = 14.4231m shares; Step 4: Find EPS for each state: Recession EPS = −$1.25m/14.4231m = −$0.09; Average EPS = $3.75m/14.4231m = $0.26; Boom EPS = $10.75m/14.4231m = $0.75; Step 5: Find expected EPS = 0.05 × (−0.09) + 0.25 × (0.26) + 0.70 × (0.75) = $0.59; Step 6: Calculate the standard deviation: SQRT of [0.05 × (−0.09 − 0.59)2 + 0.25 × (0.26 − 0.59)2 + 0.7 × (0.75 − 0.59)2] = 0.26 Difficulty: 2 Medium Topic: Standard deviation and variance Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 16-03 Show how the firm apportions risk and return among stockholders and bondholders in a "perfect world".

65) Daddi Mac, Inc., doesn't face any taxes and has $250 million in assets, currently financed entirely with equity. Equity is worth $20 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities shown as follows: State Probability of state Expected EBIT in state

Recession 0.20 $ 5 million

Average 0.60 $ 10 million

Boom 0.20 $ 15 million

The firm is considering switching to a 30 percent debt capital structure, and has determined that they would have to pay a 10 percent yield on perpetual debt. What will be the standard deviation in EPS if they switched to the proposed capital structure? A) $0.37 B) $0.21 C) $0.36 D) $0.29 Answer: C Explanation: Step 1: Find Interest expense: 250m × 0.30 × 0.10 = $7.5m per year; Step 2: Find NI for each state: Recession NI = 5m − 7.5m = −$2.5m; Average NI = $10m − $7.5m = $2.5m; Boom NI = $15m − $7.5m = $7.5m; Step 3: Find new number of shares: $250m × 0.70 = $175m in equity; $175m/$20 = 8.75m shares; Step 4: Find EPS for each state: Recession EPS = −$2.5m/8.75m = −$0.29; Average EPS = $2.5m/8.75m = $0.29; Boom EPS = $7.5m/8.75m = $0.86; Step 5: Find expected EPS = 0.20 × (−0.29) + 0.60 × (0.29) + 0.20 × (0.86) = $0.29; Step 6: Calculate the standard deviation: SQRT of [0.20 × (−0.29 − 0.29)2 + 0.60 × (0.29 − 0.29)2 + 0.2 × (0.86 − 0.29)2] = 0.36 Difficulty: 2 Medium Topic: Standard deviation and variance Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 16-03 Show how the firm apportions risk and return among stockholders and bondholders in a "perfect world".

48) HiLo, Inc., doesn't face any taxes and has $100 million in assets, currently financed entirely with equity. Equity is worth $50 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities shown as follows: State

Pessimistic 0.62 $ 5 million

Probability of state Expected EBIT in state

Optimistic 0.38 $ 15 million

The firm is considering switching to a 40 percent debt capital structure, and has determined that they would have to pay a 10 percent yield on perpetual debt. What will be the level of expected EPS if they switch to the proposed capital structure? A) $3.19 B) $4.00 C) $4.72 D) $5.97 Answer: B Explanation: Step 1: Find Interest expense: 100m × 0.40 × 0.10 = $4m per year; Step 2: Find NI for each state: Pessimistic NI = 5m − 4m = $1m; Optimistic NI = $15m − $4m = $11m; Step 3: Find new number of shares: $100m × 0.6 = $60m in equity; $60m/$50 = 1.2m shares; Step 4: Find EPS for each state: Pessimistic EPS = $1m/1.2m = $0.83; Optimistic EPS = $11m/1.2m = $9.17; Step 5: Find expected EPS = 0.62 × (0.83) + 0.38 × (9.17) = $4.00 Difficulty: 2 Medium Topic: Earnings per share Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 16-03 Show how the firm apportions risk and return among stockholders and bondholders in a "perfect world".

49) HiLo, Inc., doesn't face any taxes and has $100 million in assets, currently financed entirely with equity. Equity is worth $50 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities shown as follows: State

Pessimistic 0.33 $ 8 million

Probability of state Expected EBIT in state

Optimistic 0.67 $ 15 million

The firm is considering switching to a 40 percent debt capital structure, and has determined that they would have to pay a 10 percent yield on perpetual debt. What will be the level of expected EPS if they switch to the proposed capital structure? A) $7.24 B) $6.94 C) $5.59 D) $5.67 Answer: A Explanation: Step 1: Find Interest expense: 100m × 0.40 × 0.10 = $4m per year; Step 2: Find NI for each state: Pessimistic NI = 8m - 4m = $4m; Optimistic NI = $15m − $4m = $11m; Step 3: Find new number of shares: $100m × 0.6 = $60m in equity; $60m/$50 = 1.2m shares; Step 4: Find EPS for each state: Pessimistic EPS = $4m/1.2m = $3.33; Optimistic EPS = $11m/1.2m = $9.17; Step 5: Find expected EPS = 0.33 × (3.33) + 0.67 × (9.17) = $7.24 Difficulty: 2 Medium Topic: Earnings per share Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 16-03 Show how the firm apportions risk and return among stockholders and bondholders in a "perfect world".

50) HiLo, Inc., doesn't face any taxes and has $100 million in assets, currently financed entirely with equity. Equity is worth $50 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities shown as follows: State

Pessimistic 0.42 $ 5 million

Probability of state Expected EBIT in state

Optimistic 0.58 $ 15 million

The firm is considering switching to a 40 percent debt capital structure, and has determined that they would have to pay a 10 percent yield on perpetual debt. What will be the level of expected EPS if they switch to the proposed capital structure? A) $3.19 B) $3.94 C) $4.41 D) $5.67 Answer: D Explanation: Step 1: Find Interest expense: 100m × 0.40 × 0.10 = $4m per year; Step 2: Find NI for each state: Pessimistic NI = 5m − 4m = $1m; Optimistic NI = $15m − $4m = $11m; Step 3: Find new number of shares: $100m × 0.6 = $60m in equity; $60m/$50 = 1.2m shares; Step 4: Find EPS for each state: Pessimistic EPS = $1m/1.2m = $0.83; Optimistic EPS = $11m/1.2m = $9.17; Step 5: Find expected EPS = 0.42 × (0.83) + 0.58 × (9.17) = $5.67 Difficulty: 2 Medium Topic: Earnings per share Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 16-03 Show how the firm apportions risk and return among stockholders and bondholders in a "perfect world".

69) HiLo, Inc., faces a 21 percent tax rate and has $100 million in assets, currently financed entirely with equity. Equity is worth $50 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities as shown below: State Probability of state Expected EBIT in state

Pessimistic 0.65 $ 5 million

Optimistic 0.35 $ 15 million

The firm is considering switching to a 40 percent debt capital structure, and has determined that they would have to pay a 10 percent yield on perpetual debt. What will be the level of expected EPS if they switch to the proposed capital structure? A) $2.96 B) $3.68 C) $4.17 D) $4.91 Answer: A Explanation: Step 1: Find Interest expense: 100m × 0.40 × 0.10 = $4m per year; Step 2: Find NI for each state: Pessimistic NI = [5m − 4m](1 − 0.21) = $790,000; Optimistic NI = [$15m − $4m](1 − 0.21) = $8,690,000; Step 3: Find new number of shares: $100m × 0.6 = $60m in equity; $60m/$50 = 1,200,000 shares; Step 4: Find EPS for each state: Pessimistic EPS = $790,000/1,200,000 = $0.66; Optimistic EPS = $8,690,000/1,200,000 = $7.24 Step 5: Find expected EPS = 0.65 × (0.66) + 0.35 × (7.24) = $2.96. Difficulty: 2 Medium Topic: Earnings per share Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 16-03 Show how the firm apportions risk and return among stockholders and bondholders in a "perfect world".

52) HiLo, Inc., doesn't face any taxes and has $100 million in assets, currently financed entirely with equity. Equity is worth $50 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities shown as follows: State Probability of state Expected EBIT in state

Pessimistic 0.42 $ 5 million

Optimistic 0.58 $ 15 million

The firm is considering switching to a 40 percent debt capital structure, and has determined that they would have to pay a 10 percent yield on perpetual debt. What will be the standard deviation in EPS if they switch to the proposed capital structure? A) $4.12 B) $14.57 C) $15.82 D) $15.09 Answer: A Explanation: Step 1: Find Interest expense: 100m × 0.40 × 0.10 = $4m per year; Step 2: Find NI for each state: Pessimistic NI = 5m − 4m = $1m; Optimistic NI = $15m − $4m = $11m; Step 3: Find new number of shares: $100m × 0.6 = $60m in equity; $60m/$50 = 1.2m shares; Step 4: Find EPS for each state: Pessimistic EPS = $1m/1.2m = $0.83; Optimistic EPS = $11m/1.2m = $9.17; Step 5: Find expected EPS = 0.42 × (0.83) + 0.58 × (9.17) = $5.67; Step 6: Calculate the standard deviation: SQRT of [0.42 × (0.83 − 5.67)2 + 0.58 × (9.17 − 5.67)2] = 4.12 Difficulty: 2 Medium Topic: Standard deviation and variance Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 16-03 Show how the firm apportions risk and return among stockholders and bondholders in a "perfect world".

53) HiLo, Inc., doesn't face any taxes and has $100 million in assets, currently financed entirely with equity. Equity is worth $50 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities shown as follows: State Probability of state Expected EBIT in state

Pessimistic 0.33 $ 8 million

Optimistic 0.67 $ 15 million

The firm is considering switching to a 40 percent debt capital structure, and has determined that they would have to pay a 10 percent yield on perpetual debt. What will be the standard deviation in EPS if they switch to the proposed capital structure? A) $7.91 B) $2.75 C) $6.59 D) $6.13 Answer: B Explanation: Step 1: Find Interest expense: 100m × 0.40 × 0.10 = $4m per year; Step 2: Find NI for each state: Pessimistic NI = 8m − 4m = $4m; Optimistic NI = $15m − $4m = $11m; Step 3: Find new number of shares: $100m × 0.6 = $60m in equity; $60m/$50 = 1.2m shares; Step 4: Find EPS for each state: Pessimistic EPS = $4m/1.2m = $3.33; Optimistic EPS = $11m/1.2m = $9.17; Step 5: Find expected EPS = 0.33 × (3.33) + 0.67 × (9.17) = $7.24; Step 6: Calculate the standard deviation: SQRT of [0.33 × (3.33 − 7.24)2 + 0.67 × (9.17 − 7.24)2] = 2.75 Difficulty: 2 Medium Topic: Standard deviation and variance Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 16-03 Show how the firm apportions risk and return among stockholders and bondholders in a "perfect world".

54) HiLo, Inc., doesn't face any taxes and has $100 million in assets, currently financed entirely with equity. Equity is worth $50 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities shown as follows: State Probability of state Expected EBIT in state

Pessimistic 0.33 $ 8 million

Optimistic 0.67 $ 15 million

The firm is considering switching to a 40 percent debt capital structure, and has determined that they would have to pay a 10 percent yield on perpetual debt. What will be the break-even level of EBIT? A) $7.25 million B) $7 million C) $10 million D) $11.2 million Answer: C Explanation: Step 1: Find Interest expense: 100m × 0.40 × 0.10 = $4m per year; Step 2: Find new number of shares: $100m × 0.6 = $60m in equity; $60m/$50 = 1.2m shares; Step 3: Set EPS of 40 percent debt equal to EPS of the all equity firm and solve EBIT. [EBIT − 4m]/1.2m = EBIT/2m; EBIT = 10m Difficulty: 2 Medium Topic: Break-even analysis Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 16-06 Calculate the EBIT and EPS levels at which shareholders become indifferent when choosing between two capital structures.

55) HiLo, Inc., doesn't face any taxes and has $100 million in assets, currently financed entirely with equity. Equity is worth $50 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities shown as follows: State Probability of state Expected EBIT in state

Pessimistic 0.65 $ 5 million

Optimistic 0.35 $ 19 million

The firm is considering switching to a 40 percent debt capital structure, and has determined that they would have to pay a 15 percent yield on perpetual debt. What will be the break-even level of EBIT? A) $11.2 million B) $9.5 million C) $13.0 million D) $15.0 million Answer: D Explanation: Step 1: Find Interest expense: 100m × 0.40 × 0.15 = $6m per year; Step 2: Find new number of shares: $100m × 0.6 = $60m in equity; $60m/$50 = 1.2m shares; Step 3: Set EPS of 40 percent debt equal to EPS of the all equity firm and solve EBIT. [EBIT − 6m]/1.2m = EBIT/2m; EBIT = 15m Difficulty: 2 Medium Topic: Break-even analysis; Break-even EBIT Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 16-06 Calculate the EBIT and EPS levels at which shareholders become indifferent when choosing between two capital structures.

74) Ultras Inc. has a 21 percent tax rate and has $350 million in assets, currently financed entirely with equity. Equity is worth $80 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities shown as follows: State Probability of state Expected EBIT in state

Recession 0.25 $ 5 million

Average 0.55 $ 10 million

Boom 0.20 $ 17 million

The firm is considering switching to a 20 percent debt capital structure, and has determined that they would have to pay a 7 percent yield on perpetual debt in either event. What will be the level of expected EPS if they switch to the proposed capital structure? A) $1.18 B) $1.04 C) $0.93 D) $1.29 Answer: A Explanation: Step 1: Find Interest expense: 350m × 0.20 × 0.07 = $4.9m per year; Step 2: Find NI for each state: Recession NI = [$5m − $4.9m](1 − 0.21) = $79,000; Average NI = [$10m − $4.9m](1 − 0.21) = $4,029,000; Boom NI = [$17m − $4.9m](1 − 0.21) = $9,559,000; Step 3: Find new number of shares: $350m × 0.80 = $280m in equity; $280m/$80 = 3.5m shares; Step 4: Find EPS for each state: Recession EPS = $79,000/3,500,000 = $0.02; Average EPS = $4,029,000/3,500,000 = $1.15; Boom EPS 9,559,000/3,500,000= $2.73; Step 5: Find expected EPS = 0.25 × (0.02) + 0.55 × (1.15) + 0.20 × (2.73) = $1.18 Difficulty: 3 Hard Topic: Earnings per share Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 16-04 Describe how the optimal capital structure changes under corporate taxation.

75) Ultras Inc. has a 21 percent tax rate and has $100 million in assets, currently financed entirely with equity. Equity is worth $90 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities shown as follows: State Probability of state Expected EBIT in state

Recession 0.25 $ 6 million

Average 0.55 $ 10 million

Boom 0.20 $ 17 million

The firm is considering switching to a 10 percent debt capital structure, and has determined that they would have to pay a 9 percent yield on perpetual debt in either event. What will be the level of expected EPS if they switch to the proposed capital structure? A) $6.27 B) $6.83 C) $7.17 D) $7.51 Answer: D Explanation: Step 1: Find Interest expense: 100m × 0.10 × 0.09 = $0.9m per year; Step 2: Find NI for each state: Recession NI = [$6m − $0.9m](1 − 0.21) = $4,029,000; Average NI = [$10m − $0.9m](1 − 0.21) = $7,189,000; Boom NI = [$17m − $0.9m](1 − 0.21) = $12,719,000 Step 3: Find new number of shares: $100m x 0.9 = $90m in equity; $90m/$90 = 1m shares; Step 4: Find EPS for each state: Recession EPS = $4.029m/1m = $4.03; Average EPS = $7.189m/1m = $7.19; Boom EPS = $12.719m/1m = $12.72; Step 5: Find expected EPS = 0.25 × (4.03) + 0.55 × (7.19) + 0.20 × (12.72) = $7.51 Difficulty: 3 Hard Topic: Earnings per share Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 16-04 Describe how the optimal capital structure changes under corporate taxation.

76) Ultras Inc. has a 21 percent tax rate and has $350 million in assets, currently financed entirely with equity. Equity is worth $80 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities shown as follows: State Probability of state Expected EBIT in state

Recession 0.25 $ 5 million

Average 0.55 $ 10 million

Boom 0.20 $ 17 million

The firm is considering switching to a 20 percent debt capital structure, and has determined that they would have to pay a 7 percent yield on perpetual debt in either event. What will be the standard deviation in EPS if the firm switches to the proposed capital structure? A) $1.17 B) $0.90 C) $0.81 D) $1.06 Answer: B Explanation: Step 1: Find Interest expense: 350m × 0.20 × 0.07 = $4.9m per year; Step 2: Find NI for each state: Recession NI = [$5m − $4.9m](1 − 0.21) = $0.079m; Average NI = [$10m − $4.9m](1 − 0.21) = $4.029m; Boom NI = [$17m − $4.9m](1 − 0.21) = $9.559m; Step 3: Find new number of shares: $350m × 0.80 = $280m in equity; $280m/$80 = 3.5m shares; Step 4: Find EPS for each state: Recession EPS = $0.079m/3.5m = $0.02; Average EPS = $4.029m/3.5m = $1.15; Boom EPS = $9.559m/3.5m = $2.73; Step 5: Find expected EPS = 0.25 × (0.02) + 0.55 × (1.15) + 0.20 × (2.73) = $1.18; Step 6: Calculate the standard deviation: SQRT of [0.25 × (0.02 − 1.18)2 + 0.55 × (1.15 − 1.18)2 + 0.2 × (2.73 − 1.18)2] = $0.904 Difficulty: 3 Hard Topic: Standard deviation and variance Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 16-04 Describe how the optimal capital structure changes under corporate taxation.

77) GTB, Inc., has a 21 percent tax rate and has $100 million in assets, currently financed entirely with equity. Equity is worth $10 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities shown as follows: State

Pessimistic 0.45 $ 10 million

Probability of state Expected EBIT in state

Optimistic 0.55 $ 20 million

The firm is considering switching to a 40 percent debt capital structure, and has determined that they would have to pay a 5 percent yield on perpetual debt in either event. What will be the standard deviation in EPS if they switch to the proposed capital structure? A) $1.03 B) $0.42 C) $0.62 D) $0.66 Answer: D Explanation: Step 1: Find Interest expense: 100m × 0.40 × 0.05 = $2.0m per year; Step 2: Find NI for each state: Pessimistic NI = [$10m − $2m](1 − 0.21) = $6.32m; Optimistic NI = [$20m − $2m](1 − 0.21) = $14.22m; Step 3: Find new number of shares: $100m × 0.60 = $60m in equity; $60m/$10 = 6m shares; Step 4: Find EPS for each state: Pessimistic EPS = $6.32m/6m = $1.05; Optimistic EPS = $14.22m/6m = $2.37; Step 5: Find expected EPS = 0.45 × (1.05) + 0.55 × (2.37) = $1.776; Step 6: Calculate the standard deviation: SQRT of [0.45 × (1.05 − 1.78)2 + 0.55 × (2.37 − 1.78)2] = $0.657 Difficulty: 3 Hard Topic: Standard deviation and variance Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 16-04 Describe how the optimal capital structure changes under corporate taxation.

78) The policy of changing the capital structure gradually over time by funding new capital projects disproportionately with the type of capital you want to increase in the capital structure is referred to as: A) separation principle. B) overinvestment problem. C) passive capital structure management. D) active capital structure management. Answer: C Difficulty: 1 Easy Topic: Capital structure basics Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 16-01 Differentiate between active and passive changes to capital structure. 79) A situation that arises when a firm's equity is close to worthless, and equity holders will prefer to invest in overly risky projects with a small chance of success rather than simply paying debt holders their regularly scheduled payments is referred to as: A) separation principle. B) underinvestment problem. C) overinvestment problem. D) passive capital structure management. Answer: C Difficulty: 1 Easy Topic: Financial distress Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 16-07 Describe how the firm's choice of optimal capital structure changes under the possibility of bankruptcy.

80) Which of the following is incorrect with respect to leverage buyouts (LBOs)? A) They originated in the 1960s and were originally known as bootstrap transactions that reflected the general consensus that the firm was, more or less, paying for its own acquisition. B) The typical LBO uses a ratio of 70 percent debt to 30 percent equity but levels of debt can reach much higher. C) LBOs are an extreme example of re-leveraging because debt is used to buy out the majority of the equity holders to gain control of the firm. D) None of the statements are incorrect. Answer: D Difficulty: 2 Medium Topic: Private placements and leveraged buyouts Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 16-05 Demonstrate how individual shareholders can affect capital structure by borrowing and lending on their own account. 81) When a stockholder's stake is worthless the firm runs the risk of: A) underinvestment because there isn't much capital for investment. B) overinvestment because there isn't much wealth at risk. C) having bondholders invoke the separation principle to obtain first rights on the firm's assets. D) none of the options. Answer: B Difficulty: 2 Medium Topic: Financial distress Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 16-07 Describe how the firm's choice of optimal capital structure changes under the possibility of bankruptcy.

82) All else the same, firms facing relatively high tax rates should: A) use more debt. B) use less debt. C) have lower D/E ratios. D) none of the options. Answer: A Difficulty: 1 Easy Topic: Capital structure basics Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 16-08 Analyze whether real-world business practices reflect the theoretical basis for optimal capital structure. 83) All else the same, firms with stable, predictable income streams will be able to: A) use less debt. B) use more debt. C) have lower D/E ratios. D) none of the options. Answer: B Difficulty: 1 Easy Topic: Capital structure basics Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 16-08 Analyze whether real-world business practices reflect the theoretical basis for optimal capital structure. 84) All of the following are examples of the costs of financial distress EXCEPT: A) excellent employees find employment elsewhere. B) suppliers are reluctant to sell on credit to the firm. C) bondholders decide to exercise their call option. D) customers may be leery of buying from the firm. Answer: C Difficulty: 1 Easy Topic: Financial distress Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 16-07 Describe how the firm's choice of optimal capital structure changes under the possibility of bankruptcy.

85) All of the following are examples of the costs of financial distress EXCEPT: A) excellent employees find employment elsewhere. B) suppliers are reluctant to sell on credit to the firm. C) other firms will be less likely to offer the firm partnering opportunities. D) All of the options are examples of the costs of financial distress. Answer: D Difficulty: 1 Easy Topic: Financial distress Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 16-07 Describe how the firm's choice of optimal capital structure changes under the possibility of bankruptcy. 86) The two main factors that determine a firm's capital structure are: A) whether debt interest payments are tax deductible and how increased debt might affect the likelihood of the firm going bankrupt. B) whether debt interest payments are tax deductible and whether or not the bonds could be sold at a premium. C) whether the markets are perfectly efficient and whether or not all participants have symmetric information. D) none of the options. Answer: A Difficulty: 2 Medium Topic: Capital structure basics Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 16-01 Differentiate between active and passive changes to capital structure.

87) JJJ Corp. has $10 million in assets and is currently financed with 100 percent equity. The firm decides to switch to a 60 percent equity/40 percent debt structure and decides to sell $4 million of debt and use the proceeds to retire $4 million in equity today. This is an example of: A) underinvestment. B) active capital structure management. C) Modigliani-Miller theorem in practice. D) none of the options. Answer: B Difficulty: 1 Easy Topic: Capital structure basics Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 16-01 Differentiate between active and passive changes to capital structure. 88) JJJ Corp. has $10 million in assets and is currently financed with 100 percent equity. The firm decides to switch to a 60 percent equity/40 percent debt structure and decides to fund the next $4 million of assets for future projects entirely with debt, resulting in the desired capital structure at some point in the future. This is an example of: A) active capital structure management. B) separation principle. C) Modigliani-Miller theorem in practice. D) passive capital structure management. Answer: D Difficulty: 1 Easy Topic: Capital structure basics Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 16-01 Differentiate between active and passive changes to capital structure. 89) We use the term leverage to describe the use of debt in the firm's capital structure because: A) it magnifies the potential expected return to equity and the variability of that expected return. B) it magnifies the risk of bankruptcy. C) it magnifies earnings per share. D) none of the options. Answer: A Difficulty: 1 Easy Topic: Financial and operating leverage Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 16-02 Explain why finance professionals refer to debt as "leverage." 64

90) If the U.S. government completely eliminated taxation at the corporate level: A) we would expect no change in the capital structure since it is independent of the tax rate. B) we would expect to see lower debt levels since debt would no longer enjoy a tax advantage. C) we would expect to see higher debt levels since debt would become cheaper relative to equity. D) we would expect to see higher percentages of preferred stock since it enjoys a tax advantage over debt. Answer: B Difficulty: 2 Medium Topic: MM Proposition I with taxes Bloom's: Remember; Understand; Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 16-07 Describe how the firm's choice of optimal capital structure changes under the possibility of bankruptcy. 91) If the U.S. government increased the corporate tax rates: A) we would expect no change in the capital structure since it is independent of the component costs of capital. B) we would expect to see higher levels of equity since there would be less of a tax advantage for debt. C) we would expect to see higher debt levels since debt would become cheaper relative to equity. D) We would expect to see higher percentages of preferred stock since 70 percent of dividends are not taxed by corporations. Answer: C Difficulty: 2 Medium Topic: MM Proposition I with taxes Bloom's: Remember; Understand; Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 16-07 Describe how the firm's choice of optimal capital structure changes under the possibility of bankruptcy.

92) If bondholders of a firm in financial distress felt that they could recoup more of their investment by renegotiating their claims with the firm and allowing it to continue to operate, what type of bankruptcy would they probably push for? A) Chapter 11 B) Chapter 13 C) Chapter 7 D) Chapter 9 Answer: A Difficulty: 1 Easy Topic: Financial distress Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 16-07 Describe how the firm's choice of optimal capital structure changes under the possibility of bankruptcy. 93) Which of the following statements is correct? A) Increasing the amount of firm debt increases both the expected cash flows to equity holders and the number of shares outstanding. B) Increasing the amount of firm debt increases both the expected cash flows to equity holders and the amortization. C) Increasing the amount of firm debt increases both the expected cash flows to equity holders and the volatility of those cash flows. D) Increasing the amount of firm debt increases both the expected cash flows to equity holders and the tax liability. Answer: C Difficulty: 1 Easy Topic: MM Proposition I with taxes Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 16-04 Describe how the optimal capital structure changes under corporate taxation.

94) Which of the following statements is correct? A) Adding corporate taxes to the M&M model reduces both the level and volatility of EPS. B) Adding corporate taxes to the M&M model has no impact on the level and volatility of EPS. C) Adding corporate taxes to the M&M model increases both the level and volatility of EPS. D) None of the statements are correct. Answer: A Difficulty: 2 Medium Topic: MM Proposition I with taxes Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 16-04 Describe how the optimal capital structure changes under corporate taxation. 95) Why does allowing for the existence of corporate taxation cause firms to prefer the maximum amount of debt possible? A) Because the flotation costs associated with debt are significantly lower than the flotation costs associated with equity. B) Because debt is tax-deductible, the effective cost of debt is much cheaper than using equity. C) Because debt places fewer demands on the firm's cash flows. D) None of the options cause firms to prefer the maximum amount of debt possible. Answer: B Difficulty: 2 Medium Topic: MM Proposition I with taxes Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 16-04 Describe how the optimal capital structure changes under corporate taxation.

68) A firm faces a 21 percent tax rate and has $200m in assets, currently financed entirely with equity. Equity is worth $10 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected EBIT is $10m. The firm is considering switching to a 25 percent debt capital structure, and has determined that they would have to pay a 10 percent yield on perpetual debt. What will be the firm's new ROE if they switch to the proposed capital structure? A) 2.63 percent B) 2.86 percent C) 2.39 percent D) 1.98 percent Answer: A Explanation: Step 1: Find Interest expense: 200m × 0.25 × 0.10 = $5m per year; Step 2: Find NI: NI = [10m − 5m](1 − 0.21) = $3,950,000 Step 3: Find ROE: 3,950,000/(200,000,000 × (1 − 25%)) = 2.63% Difficulty: 2 Medium Topic: Capital structure basics Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 16-03 Show how the firm apportions risk and return among stockholders and bondholders in a "perfect world".

69) A firm faces a 21 percent tax rate and has $500m in assets, currently financed entirely with equity. Equity is worth $100 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected EBIT is $70m. The firm is considering switching to an 18 percent debt capital structure, and has determined that they would have to pay an 8 percent yield on perpetual debt. How much will ROE change if they switch to the proposed capital structure? A) There will be no change in the firm's ROE. B) The ROE will decrease by 0.52 percent. C) The ROE will increase by 1.58 percent. D) The ROE will increase by 1.04 percent. Answer: D Explanation: Step 1: Find Interest expense: 500m × 0.18 × 0.08 = $7.2m per year; Step 2: Find NI: NI = [70m − 7.2m](1 − 0.21) = $49.612m; Step 3: Find ROE: 49,612,000/(500,000,000 × (1 − 18%)) = 12.10%; Step 4: Find old ROE: 70m(1 − 0.21)/500m = 11.06%; Step 5: Change in ROE = 12.10% − 11.06% = 1.04% Difficulty: 2 Medium Topic: Capital structure basics Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 16-03 Show how the firm apportions risk and return among stockholders and bondholders in a "perfect world".

70) A firm faces a 21 percent tax rate and has $500m in assets, currently financed entirely with equity. Equity is worth $100 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected EBIT is $60m. The firm is considering switching to a 25 percent debt capital structure, and has determined that they would have to pay a 10 percent yield on perpetual debt. How much will ROE change if they switch to the proposed capital structure? A) There will be no change in the firm's ROE. B) The ROE will increase by 0.53 percent. C) The ROE will increase by 1.15 percent. D) The ROE will increase by 0.82 percent. Answer: B Explanation: Step 1: Find Interest expense: 500m × 0.25 × 0.10 = $12.5m per year; Step 2: Find NI: NI = [60m − 12.5m](1 − 0.21) = $37.525m; Step 3: Find new ROE: 37.525m/(500m × (1 − 25%)) = 10.01%; Step 4: Find old ROE: 60(1 − 0.21)/500 = 9.48%; Step 5: Change in ROE = 10.01% − 9.48% = 0.53% Difficulty: 2 Medium Topic: Capital structure basics Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 16-03 Show how the firm apportions risk and return among stockholders and bondholders in a "perfect world". 99) Which of the following statements is correct? A) The effect of increasing a firm's use of financial leverage is to decrease the volatility of the firm's earnings. B) The effect of increasing a firm's use of financial leverage could be either to increase or decrease the volatility of the firm's earnings depending on how much leverage is utilized. C) The effect of increasing a firm's use of financial leverage is to increase the volatility of the firm's earnings. D) None of the statements are correct. Answer: C Difficulty: 1 Easy Topic: Financial and operating leverage Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 16-02 Explain why finance professionals refer to debt as "leverage."

100) The Modigilian-Miller (M&M) theorem states that: A) in an efficient market without taxes and bankruptcy costs, the value of a firm depends upon the firm's capital structure. B) in an efficient market without taxes and bankruptcy costs, the value of a firm does not depend upon the firm's capital structure. C) in an efficient market without taxes and bankruptcy costs, the value of a firm does not depend upon the firm's cost of capital. D) none of the options. Answer: B Difficulty: 1 Easy Topic: MM Proposition I without taxes Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 16-02 Explain why finance professionals refer to debt as "leverage." 101) If an investor wanted to reduce the risk of a levered stock in their portfolio, how could they go about doing so while still retaining shares in the company? A) They could sell some of their shares and use the proceeds to buy the firm's bonds. B) They could sell some of their bonds and use the proceeds to buy the firm's stock. C) They could use borrowed funds to buy more of the firm's stock. D) None of the options. Answer: A Difficulty: 2 Medium Topic: Homemade leverage Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 16-05 Demonstrate how individual shareholders can affect capital structure by borrowing and lending on their own account. 102) Why is debt often referred to as leverage in finance? A) Debt magnifies the firm's total asset turnover. B) Debt magnifies both the potential returns and the risk to bondholders. C) Debt magnifies both the potential returns and the risk to equity holders. D) None of the options. Answer: C Difficulty: 1 Easy Topic: Financial and operating leverage Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 16-02 Explain why finance professionals refer to debt as "leverage." 71

103) An all-equity financed firm has $450 in assets and the stock price is $45. If the firm restructures with 20 percent debt which creates interest expense of $10 per year and the firm's tax rate is 21 percent, what is the break-even EBIT? A) $30 B) $35 C) $45 D) $50 Answer: D Explanation: Step 1: Find the number of shares for the all equity firm: 450/45 = 10; Step 2: Find the number of shares of the firm with 20 percent debt: 360/45 = 8; Step 3: Set the EPS of all equity firm = EPS of 20 percent debt; EBIT (1 − 0.21)/10 = [EBIT − 10](1 − 0.21)/8; EBIT = 50 Difficulty: 2 Medium Topic: Break-even analysis Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 16-06 Calculate the EBIT and EPS levels at which shareholders become indifferent when choosing between two capital structures. 104) An all-equity financed firm has $350 in assets and the stock price is $10. If the firm restructures with 20 percent debt which creates interest expense of $14 per year and the firm's tax rate is 21 percent, what is the break-even EBIT? A) $70 B) $67 C) $74 D) $79 Answer: A Explanation: Step 1: Find the number of shares for the all equity firm: 350/10 = 35; Step 2: Find the number of shares of the firm with 20 percent debt: 280/10 = 28; Step 3: Set the EPS of all equity firm = EPS of 20 percent debt; EBIT (1 − 0.21)/35 = [EBIT − 14](1 − 0.21)/28; EBIT = 70 Difficulty: 2 Medium Topic: Break-even analysis Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 16-06 Calculate the EBIT and EPS levels at which shareholders become indifferent when choosing between two capital structures.

105) An all-equity financed firm has $650 in assets and the stock price is $20. If the firm restructures with 40 percent debt which creates interest expense of $17 per year and the firm's tax rate is 21 percent, what is the break-even EBIT? A) $37.50 B) $31.50 C) $49.50 D) $42.50 Answer: D Explanation: Step 1: Find the number of shares for the all equity firm: 650/20 = 32.5; Step 2: Find the number of shares of the firm with 40 percent debt: 390/20 = 19.5; Step3: Set the EPS of all equity firm = EPS of 40 percent debt; EBIT (1 − 0.21)/32.5 = [EBIT − 17](1 − 0.21)/19.5; EBIT = 42.50 Difficulty: 2 Medium Topic: Break-even analysis Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 16-06 Calculate the EBIT and EPS levels at which shareholders become indifferent when choosing between two capital structures. 106) An all-equity financed firm has $500 in assets and the stock price is $20. If the firm restructures with 15 percent debt which creates interest expense of $30 per year and the firm's tax rate is 21 percent, what is the break-even EBIT? A) $20 B) $150 C) $200 D) $500 Answer: C Explanation: Step 1: Find the number of shares for the all equity firm: 500/20 = 25; Step 2: Find the number of shares of the firm with 15 percent debt: 425/20 = 21.25; Step 3: Set the EPS of all equity firm = EPS of 15 percent debt; EBIT (1 − 0.21)/25 = [EBIT − 30](1 − 0.21)/21.25; EBIT = 200 Difficulty: 2 Medium Topic: Break-even analysis Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 16-06 Calculate the EBIT and EPS levels at which shareholders become indifferent when choosing between two capital structures.

107) A firm faces a 21 percent tax rate and has $700m in assets, currently financed entirely with equity. Equity is worth $100 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected EBIT is $100m. The firm is considering switching to a 45 percent debt capital structure, and has determined that they would have to pay a 10 percent yield on perpetual debt. How much will ROE change if they switch to the proposed capital structure? A) There will be no change in the firm's ROE. B) The ROE will increase by 3.50 percent. C) The ROE will increase by 2.77 percent. D) The ROE will increase by 0.02 percent. Answer: C Explanation: Step 1: Find Interest expense: 700m × 0.45 × 0.10 = $31.5m per year; Step 2: Find NI: NI = [100m − 31.5m](1 − 0.21) = $54.12m; Step 3: Find new ROE: 54.12m/385m = 14.06%; Step 4: Find old ROE: 100(1 − 0.21)/700 = 11.29%; Step 5: Change in ROE = 14.06% − 11.29% = 2.77% Difficulty: 2 Medium Topic: Capital structure basics Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 16-03 Show how the firm apportions risk and return among stockholders and bondholders in a "perfect world".

108) A firm faces a 21 percent tax rate and has $6m in assets, currently financed entirely with equity. Equity is worth $200 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected EBIT is $50m. The firm is considering switching to a 50 percent debt capital structure, and has determined that they would have to pay an 8 percent yield on perpetual debt. How much will ROE change if they switch to the proposed capital structure? A) There will be no change in the firm's ROE. B) The ROE will increase by 0.61 percent. C) The ROE will increase by 3.00 percent. D) The ROE will increase by 6.52 percent. Answer: D Explanation: Step 1: Find Interest expense: 6m × 0.5 × 0.08 = $240,000 per year; Step 2: Find NI: NI = [50m − 240,000](1 − 0.21) = $39.31m; Step 3: Find new ROE: 39.31m/3m = 13.10%; Step 4: Find old ROE: 50(1 − 0.21)/6 = 6.58%; Step 5: Change in ROE = 13.10% − 6.58% = 6.52% Difficulty: 2 Medium Topic: Capital structure basics Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 16-03 Show how the firm apportions risk and return among stockholders and bondholders in a "perfect world". 109) An all-equity financed firm has $6m in assets and the stock price is $200. If the firm restructures with 40 percent debt which creates interest expense of $240,000 per year and the firm's tax rate is 21 percent, what is the break-even EBIT? A) $336,000 B) $380,000 C) $432,000 D) $600,000 Answer: D Explanation: Step 1: Find the number of shares for the all equity firm: 6m/200 = 30,000; Step 2: Find the number of shares of the firm with 40 percent debt: 3.6m/200 = 18,000; Step 3: Set the EPS of all equity firm = EPS of 40 percent debt; EBIT (1 − 0.21)/30,000 = [EBIT − 240,000](1 − 0.21)/18,000; EBIT = $600,000 Difficulty: 2 Medium Topic: Break-even analysis Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 16-06 Calculate the EBIT and EPS levels at which shareholders become indifferent when choosing between two capital structures.

110) An all-equity financed firm has $45,000 in assets and the stock price is $10. If the firm restructures with 30 percent debt which creates interest expense of $810 per year and the firm's tax rate is 21 percent, what is the break-even EBIT? A) $1,157 B) $1,500 C) $1,967 D) $2,700 Answer: D Explanation: Step 1: Find the number of shares for the all equity firm: 45,000/10 = 4,500; Step 2: Find the number of shares of the firm with 30 percent debt: 31,500/10 = 3,150; Step 3: Set the EPS of all equity firm = EPS of 30 percent debt; EBIT (1 − 0.21)/4,500 = [EBIT − 810](1 − 0.21)/3,150; EBIT = 2,700 Difficulty: 2 Medium Topic: Break-even analysis Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 16-06 Calculate the EBIT and EPS levels at which shareholders become indifferent when choosing between two capital structures.

111) Epic Inc. has a 21 percent tax rate and has $13 million in assets, currently financed entirely with equity. Equity is worth $25 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities shown as follows: State Probability of state Expected EBIT in state

Recession 0.10 $ 5 million

Average 0.70 $ 10 million

Boom 0.20 $ 15 million

The firm is considering switching to a 30 percent debt capital structure, and has determined that they would have to pay an 8 percent yield on perpetual debt in either event. What will be the level of expected EPS if they switch to the proposed capital structure? A) $19.23 B) $22.11 C) $16.10 D) $15.97 Answer: B Explanation: Step 1: Find Interest expense: 13m × 0.30 × 0.08 = $312,000 per year; Step 2: Find NI for each state: Recession NI = [$5m − $312,000](1 − 0.21) = $3,703,520; Average NI = [$10m − $312,000](1 − 0.21) = $7,653,520; Boom NI = [$15m − $312,000](1 − 0.21) = $11,603,520; Step 3: Find new number of shares: $13m × 0.70 = $9.1m in equity; $9.1m/$25 = 364,000 shares; Step 4: Find EPS for each state: Recession EPS = $3,703,520/364,000 = $10.17; Average EPS = $7,653,520/364,000 = $21.03; Boom EPS = $11,603,520/364,000 = $31.88; Step 5: Find expected EPS = 0.10 × (10.17) + 0.70 × (21.03) + 0.20 × (31.88) = $22.11 Difficulty: 3 Hard Topic: Earnings per share Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 16-04 Describe how the optimal capital structure changes under corporate taxation.

112) Epic Inc. has a 21 percent tax rate and has $40 million in assets, currently financed entirely with equity. Equity is worth $10 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities shown as follows: State Probability of state Expected EBIT in state

Recession 0.10 $ 10 million

Average 0.60 $ 30 million

Boom 0.30 $ 50 million

The firm is considering switching to a 40 percent debt capital structure, and has determined that they would have to pay a 10 percent yield on perpetual debt in either event. What will be the level of expected EPS if they switch to the proposed capital structure? A) $10.67 B) $8.25 C) $8.04 D) $4.50 Answer: A Explanation: Step 1: Find Interest expense: 40m × 0.40 × 0.10 = $1.6m per year; Step 2: Find NI for each state: Recession NI = [$10m − $1.6m](1 − 0.21) = $6.636m; Average NI = [$30m − $1.6m](1 − 0.21) = $22.436m; Boom NI = [$50m − $1.6m](1 − 0.21) = $38.236m; Step 3: Find new number of shares: $40m × 0.60 = $24m in equity; $24m/$10 = 2.4m shares; Step 4: Find EPS for each state: Recession EPS = $6.636m/2.4m = $2.77; Average EPS = $22.436m/2.4m = $9.35; Boom EPS = $38.236m/2.4m = $15.93; Step 5: Find expected EPS = 0.10 × (2.77) + 0.60 × (9.35) + 0.30 × (15.93) = $10.67 Difficulty: 3 Hard Topic: Earnings per share Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 16-04 Describe how the optimal capital structure changes under corporate taxation.

113) Your company doesn't face any taxes and has $10 million in assets, currently financed entirely with equity. Equity is worth $10 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities shown as follows: State Probability of state Expected EBIT in state

Pessimistic 0.15 $ 2 million

Optimistic 0.85 $ 8 million

The firm is considering switching to a 40 percent debt capital structure, and has determined that they would have to pay a 9 percent yield on perpetual debt in either event. What will be the level of expected EPS if they switch to the proposed capital structure? A) $12.73 B) $11.23 C) $7.73 D) $5.00 Answer: B Explanation: Pessimistic Optimistic EBIT 2,000,000 8,000,000 −Interest −360,000 −360,000 =EBT/NI 1,640,000 7,640,000 Number of shares = $10,000,000 × (1 − 0.40) = $6,000,000/$10 = 600,000 shares EPS $ 2.73 $ 12.73

The expected EPS will be equal to (0.15 × 2.73) + (0.85 × 12.73) = $11.23 Difficulty: 2 Medium Topic: Earnings per share Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 16-03 Show how the firm apportions risk and return among stockholders and bondholders in a "perfect world".

114) Your company doesn't face any taxes and has $5 million in assets, currently financed entirely with equity. Equity is worth $5 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities shown as follows: State Probability of state Expected EBIT in state

Pessimistic 0.45 $ 2 million

Optimistic 0.55 $ 8 million

The firm is considering switching to a 30 percent debt capital structure, and has determined that they would have to pay an 11 percent yield on perpetual debt in either event. What will be the level of expected EPS if they switch to the proposed capital structure? A) $9.67 B) $7.33 C) $6.91 D) $4.84 Answer: B Explanation: Pessimistic Optimistic EBIT 2,000,000 8,000,000 −Interest −165,000 −165,000 =EBT/NI 1,835,000 7,835,000 Number of shares = $5,000,000 × (1 − 0.30) = $3,500,000/$5 = 700,000 shares EPS $ 2.62 $ 11.19

The expected EPS will be equal to (0.45 × 2.62) + (0.55 × 11.19) = $7.33 Difficulty: 2 Medium Topic: Earnings per share Bloom's: Analyze; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 16-03 Show how the firm apportions risk and return among stockholders and bondholders in a "perfect world".

Finance, 5e (Cornett) Chapter 17 Sharing Firm Wealth: Dividends, Share Repurchases, and Other Payouts 1) Which of the following is the primary goal of a firm? A) Maximize sales B) Maximize net income C) Maximize earnings per share D) Maximize shareholder wealth Answer: D Difficulty: 1 Easy Topic: Goal of financial management Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 17-01 Identify factors that affect a firm's payout policies. 2) Which of these is the idea that it does not matter whether a firm pays dividends or not as derived from a Modigliani and Miller Theorem? A) Dividend indifference theory B) Dividend irrelevance theorem C) Shareholder maximization theorem D) Shareholder rationalization theorem Answer: B Difficulty: 1 Easy Topic: Dividend policy irrelevance Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 17-02 Discuss how investors' preferences regarding differential tax rates and timing can guide the firm's policies on the distribution of dividends and capital gains.

3) The is a 2017 law that included a large reduction in the corporate tax rate. A) Jobs and Growth Tax Relief Reconciliation Act B) Tax Cuts and Jobs Act C) both a and b D) none of the above Answer: B Difficulty: 1 Easy Topic: TCJA of 2017 Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 17-02 Discuss how investors' preferences regarding differential tax rates and timing can guide the firm's policies on the distribution of dividends and capital gains. 4) For most investors, the equalization of the tax rates on capital gains and dividends did which of the following? A) Moved the real world further from the concept of the dividend indifference theory B) Moved the real world closer to the concept of the dividend indifference theory C) Moved the real world closer to the concept of the dividend irrelevance theorem D) Moved the real world further from the concept of the dividend irrelevance theorem Answer: C Difficulty: 1 Easy Topic: Tax effects on dividends and payouts Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 17-02 Discuss how investors' preferences regarding differential tax rates and timing can guide the firm's policies on the distribution of dividends and capital gains. 5) Which of the following argues that dividends that the firm has committed to pay are less risky to risk-averse investors than are potential future capital gains? A) Dividend irrelevance theorem B) Dividend indifference theory C) Bird-in-the-hand theory D) Jobs and Growth Tax Relief Reconciliation Act Answer: C Difficulty: 1 Easy Topic: Payout policy considerations Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 17-02 Discuss how investors' preferences regarding differential tax rates and timing can guide the firm's policies on the distribution of dividends and capital gains. 2

6) Modigliani and Miller disagreed with the proposal by Gordon and Lintner regarding dividends. Why? A) M&M claimed that many, if not most, investors will spend their dividends on consumer goods. B) M&M claimed that many, if not most, investors will reinvest their dividends in the same or similar manner that the firms would. C) M&M claimed that many, if not most, investors would prefer capital gains. D) M&M claimed that firms only attract investors who would prefer dividends. Answer: B Difficulty: 2 Medium Topic: Payout policy considerations Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 17-02 Discuss how investors' preferences regarding differential tax rates and timing can guide the firm's policies on the distribution of dividends and capital gains. 7) What important tax-based reason suggests why some investors might prefer capital gains? A) Investors pay taxes only on dividends, not on capital gains. B) Investors pay capital gains taxes as their stock appreciates, not at the time of sale, so they will be indifferent to selling the stock. C) Investors who don't need or want any cash will not accept their dividend and they therefore will not incur any obligation to pay taxes. D) Investors who don't need or want any cash will not sell their stock and they therefore will not incur any obligation to pay taxes. Answer: D Difficulty: 2 Medium Topic: Tax effects on dividends and payouts Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 17-02 Discuss how investors' preferences regarding differential tax rates and timing can guide the firm's policies on the distribution of dividends and capital gains.

8) Which of the following is true regarding the information effect of dividend policies? A) Increases in dividends are seen as negative signals concerning the firm's performance. B) Increases in dividends are seen as negative signals concerning the firm's expected future cash flow levels. C) If a firm announces an increase in the next dividend, analysts see such announcements as a very positive signal. D) If a firm announces an increase in the next dividend, analysts see such announcements as a very negative signal. Answer: C Difficulty: 1 Easy Topic: Dividend policy considerations Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 17-03 Summarize the information effect, the clientele effect, and other corporate control issues. 9) Which of the following refers to the fact that, in real life, investors do not have identical desires about taxability and timing of firm payouts? A) Clientele effect B) Dividend irrelevance effect C) Capital gain theory D) Bird-in-the-hand theory Answer: A Difficulty: 1 Easy Topic: Clientele effect Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 17-03 Summarize the information effect, the clientele effect, and other corporate control issues.

10) Which of the following can be a benefit of the clientele effect? A) New investors who were previously uninterested in the stock may be attracted to it because of a policy change. B) If firms change their dividend policy, the investors who desire the previous policy will sell their shares. C) If the firms change their dividend policy, the investors will be unaffected by the change due to the dividend irrelevance theorem. D) If the firms change their dividend policy, it will maximize shareholder wealth. Answer: A Difficulty: 1 Easy Topic: Clientele effect Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 17-03 Summarize the information effect, the clientele effect, and other corporate control issues. 11) Which of the following is the tendency of investors to find a payout policy that they prefer and stick with it? A) Bird-in-the-hand theory B) Clientele effect policy C) Residual dividend model D) Dividend irrelevance theorem Answer: B Difficulty: 1 Easy Topic: Clientele effect Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 17-03 Summarize the information effect, the clientele effect, and other corporate control issues.

12) Which of the following is a policy of a firm paying out only funds that are left over after all positive NPV projects are funded? A) Bird-in-the-hand theory B) Clientele effect policy C) Residual dividend model D) Dividend irrelevance theorem Answer: C Difficulty: 1 Easy Topic: Dividends and payout policy Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 17-04 Analyze a firm's decision to distribute constant ordinary dividends or extraordinary dividends. 13) Which of the following firms is more likely to use extraordinary dividends? A) One with cyclical sales B) One with stable sales C) Firms with either cyclical or stable sales D) Firms with neither cyclical nor stable sales Answer: A Difficulty: 1 Easy Topic: Dividends and payout policy Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 17-04 Analyze a firm's decision to distribute constant ordinary dividends or extraordinary dividends. 14) When does a dividend become a firm obligation? A) When the firm declares them B) When the firm pays them C) When the firm records them D) On the ex-dividend date Answer: A Difficulty: 2 Medium Topic: Chronology of dividend payments Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 17-05 Explain the effect that cash dividend payment procedures have on stock prices.

15) Which of the following is when the Board of Directors announces its intention to pay a dividend? A) Declaration date B) Ex-dividend date C) Record date D) Payment date Answer: A Difficulty: 1 Easy Topic: Chronology of dividend payments Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 17-05 Explain the effect that cash dividend payment procedures have on stock prices. 16) Regarding dividend payment procedures, which of the following is the first day that the shares will be traded without the dividend attached? A) Declaration date B) Ex-dividend date C) Record date D) Payment date Answer: B Difficulty: 1 Easy Topic: Chronology of dividend payments Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 17-05 Explain the effect that cash dividend payment procedures have on stock prices.

17) Regarding dividend payment procedures, which of the following is the date the firm would look on its books to find to whom they can start addressing payments? A) Declaration date B) Ex-dividend date C) Record date D) Payment date Answer: C Difficulty: 1 Easy Topic: Chronology of dividend payments Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 17-05 Explain the effect that cash dividend payment procedures have on stock prices. 18) Which of the following is the date the firm sends dividends out to the shareholders? A) Declaration date B) Ex-dividend date C) Record date D) Payment date Answer: D Difficulty: 1 Easy Topic: Chronology of dividend payments Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 17-05 Explain the effect that cash dividend payment procedures have on stock prices. 19) As the number of days until the next dividend decreases, what will happen to the present value of the stock? A) It will decrease. B) It will increase. C) It will stay the same. D) One cannot determine what will happen to the price of the stock in this situation. Answer: B Difficulty: 2 Medium Topic: Chronology of dividend payments Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 17-05 Explain the effect that cash dividend payment procedures have on stock prices. 8

20) What will happen to the price of the stock once the stock goes ex-dividend? A) It will decrease. B) It will increase. C) It will stay the same. D) One cannot determine what will happen to the price of the stock in this situation. Answer: A Difficulty: 2 Medium Topic: Chronology of dividend payments Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 17-05 Explain the effect that cash dividend payment procedures have on stock prices. 21) A pro-rata distribution of additional shares of stock to the current owners of the stock is which of the following? A) Stock dividend B) Stock split C) Payment date D) Ex-dividend Answer: A Difficulty: 1 Easy Topic: Stock dividends Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 17-06 Differentiate between a stock dividend's impact and a stock split's impact on the firm's books.

22) Which of the following is an exchange of existing shares for a different (usually larger) number of "new shares," with proportionately different par and market values? A) Stock dividend B) Stock split C) Payment date D) Ex-dividend Answer: B Difficulty: 1 Easy Topic: Stock splits Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 17-06 Differentiate between a stock dividend's impact and a stock split's impact on the firm's books. 23) Which of the following is described as a firm buying back shares of its own stock? A) Ex-dividend B) Ex-stock purchase C) Repurchase or buyback D) Repossession Answer: C Difficulty: 1 Easy Topic: Stock repurchases Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 17-07 Note the advantages and disadvantages of a firm's stock repurchases. 24) Which of the following is an offer announced publicly that specifies in advance a single purchase price, the number of shares sought, and the duration of the offer? A) Fixed-price tender offer B) Fixed-duration tender offer C) Fixed-shares tender offer D) Open-market stock repurchase Answer: A Difficulty: 1 Easy Topic: Stock repurchases Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 17-07 Note the advantages and disadvantages of a firm's stock repurchases.

25) Which of the following is a repurchase where the firm simply buys shares of its own stock on the stock market just like any other investor would? A) Fixed-price tender offer B) Fixed-duration tender offer C) Fixed-shares tender offer D) Open-market stock repurchase Answer: D Difficulty: 1 Easy Topic: Stock repurchases Bloom's: Remember; Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 17-07 Note the advantages and disadvantages of a firm's stock repurchases. 26) Suppose a firm pays total dividends of $250,000 out of net income of $2 million. What would the firm's payout ratio be? A) 0.125 B) 0.25 C) 1.25 D) 8.00 Answer: A Explanation: The payout ratio would be $250,000/$2,000,000 = 0.125. Difficulty: 1 Easy Topic: Dividends and payout policy Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 17-02 Discuss how investors' preferences regarding differential tax rates and timing can guide the firm's policies on the distribution of dividends and capital gains.

27) Suppose a firm pays total dividends of $100,000 out of net income of $1 million. What would the firm's payout ratio be? A) 0.01 B) 0.10 C) 1.00 D) 10.00 Answer: B Explanation: The payout ratio would be $100,000/$1,000,000 = 0.10. Difficulty: 1 Easy Topic: Dividends and payout policy Bloom's: Apply; Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 17-02 Discuss how investors' preferences regarding differential tax rates and timing can guide the firm's policies on the distribution of dividends and capital gains. 28) Suppose a firm pays total dividends of $200,000 out of net income of $2.5 million. What would the firm's payout ratio be? A) 0.08 B) 0.80 C) 8.00 D) 80.00 Answer: A Explanation: The payout ratio would be $200,000/$2,500,000 = 0.08. Difficulty: 1 Easy Topic: Dividends and payout policy Bloom's: Apply; Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 17-02 Discuss how investors' preferences regarding differential tax rates and timing can guide the firm's policies on the distribution of dividends and capital gains.

29) Suppose a firm pays total dividends of $50,000 out of net income of $500,000. What would the firm's payout ratio be? A) 0.10 B) 1.00 C) 10.00 D) 50.00 Answer: A Explanation: The payout ratio would be $50,000/$500,000 = 0.10 Difficulty: 1 Easy Topic: Dividends and payout policy Bloom's: Apply; Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 17-02 Discuss how investors' preferences regarding differential tax rates and timing can guide the firm's policies on the distribution of dividends and capital gains. 30) Suppose a firm pays total dividends of $25,000 out of net income of $100,000. What would the firm's payout ratio be? A) 0.25 B) 2.50 C) 4.00 D) 25.00 Answer: A Explanation: The payout ratio would be $25,000/$100,000 = 0.25 Difficulty: 1 Easy Topic: Dividends and payout policy Bloom's: Apply; Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 17-02 Discuss how investors' preferences regarding differential tax rates and timing can guide the firm's policies on the distribution of dividends and capital gains.

31) Suppose a firm has a retention ratio of 35 percent and net income of $2 million. How much does it pay out in dividends? A) $700,000 B) $1.3 million C) $2 million D) $3.07 million Answer: B Explanation: Since the dividend payout ratio is one minus the retention ratio, the firm would pay out (1 − 0.35) × $2,000,000 = $1,300,000. Difficulty: 1 Easy Topic: Dividends and payout policy Bloom's: Apply; Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 17-02 Discuss how investors' preferences regarding differential tax rates and timing can guide the firm's policies on the distribution of dividends and capital gains. 32) Suppose a firm has a retention ratio of 40 percent and net income of $10 million. How much does it pay out in dividends? A) $4 million B) $6 million C) $10 million D) $16.67 million Answer: B Explanation: Since the dividend payout ratio is one minus the retention ratio, the firm would pay out (1 − 0.40) × $10,000,000 = $6,000,000. Difficulty: 1 Easy Topic: Dividends and payout policy Bloom's: Apply; Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 17-02 Discuss how investors' preferences regarding differential tax rates and timing can guide the firm's policies on the distribution of dividends and capital gains.

33) Suppose a firm has a retention ratio of 35 percent, net income of $35 million, and 10 million shares outstanding. What would be the dividend per share paid out on the firm's stock? A) $1.225 B) $2.275 C) $3.50 D) $7.00 Answer: B Explanation: Total dividends paid would be equal to (1 − 0.35) × $35,000,000 = $22,750,000, so dividends per share would be equal to $22,750,000/10,000,000 = $2.275. Difficulty: 1 Easy Topic: Dividends and payout policy Bloom's: Apply; Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 17-02 Discuss how investors' preferences regarding differential tax rates and timing can guide the firm's policies on the distribution of dividends and capital gains. 34) Suppose a firm has a retention ratio of 25 percent, net income of $30 million, and 5 million shares outstanding. What would be the dividend per share paid out on the firm's stock? A) $1.50 B) $4.50 C) $6.00 D) $16.67 Answer: B Explanation: Total dividends paid would be equal to (1 − 0.25) × $30,000,000 = $22,500,000, so dividends per share would be equal to $22,500,000/5,000,000 = $4.50. Difficulty: 1 Easy Topic: Dividends and payout policy Bloom's: Apply; Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 17-02 Discuss how investors' preferences regarding differential tax rates and timing can guide the firm's policies on the distribution of dividends and capital gains.

35) Suppose a firm has a retention ratio of 10 percent, net income of $40 million, and 4 million shares outstanding. What would be the dividend per share paid out on the firm's stock? A) $0.10 B) $1.00 C) $9.00 D) $10.00 Answer: C Explanation: Total dividends paid would be equal to (1 − 0.10) × $40,000,000 = $36,000,000, so dividends per share would be equal to $36,000,000/4,000,000 = $9.00. Difficulty: 1 Easy Topic: Dividends and payout policy Bloom's: Apply; Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 17-02 Discuss how investors' preferences regarding differential tax rates and timing can guide the firm's policies on the distribution of dividends and capital gains. 36) Suppose a firm has a retention ratio of 15 percent, net income of $60 million, and 15 million shares outstanding. What would be the dividend per share paid out on the firm's stock? A) $0.25 B) $0.60 C) $3.40 D) $4.00 Answer: C Explanation: Total dividends paid would be equal to (1 − 0.15) × $60,000,000 = $51,000,000, so dividends per share would be equal to $51,000,000/15,000,000 = $3.40. Difficulty: 1 Easy Topic: Dividends and payout policy Bloom's: Apply; Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 17-02 Discuss how investors' preferences regarding differential tax rates and timing can guide the firm's policies on the distribution of dividends and capital gains.

37) Suppose a firm has a retention ratio of 80 percent, net income of $10 million, and 2 million shares outstanding. What would be the dividend per share paid out on the firm's stock? A) $1.00 B) $2.00 C) $4.00 D) $5.00 Answer: A Explanation: Total dividends paid would be equal to (1 − 0.80) × $10,000,000 = $2,000,000, so dividends per share would be equal to $2,000,000/2,000,000 = $1.00 Difficulty: 1 Easy Topic: Dividends and payout policy Bloom's: Apply; Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 17-02 Discuss how investors' preferences regarding differential tax rates and timing can guide the firm's policies on the distribution of dividends and capital gains. 38) Suppose a firm has a retention ratio of 25 percent, net income of $21 million, and 3 million shares outstanding. What would be the dividend per share paid out on the firm's stock? A) $0.14 B) $1.75 C) $5.25 D) $7.00 Answer: C Explanation: Total dividends paid would be equal to (1 − 0.25) × $21,000,000 = $15,750,000, so dividends per share would be equal to $15,750,000/3,000,000 = $5.25. Difficulty: 1 Easy Topic: Dividends and payout policy Bloom's: Apply; Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 17-02 Discuss how investors' preferences regarding differential tax rates and timing can guide the firm's policies on the distribution of dividends and capital gains.

18) If a firm has retained earnings of $10 million, a common shares account of $15 million, and additional paid-in-capital of $5 million, how much would be transferred in (or out) of these accounts in response to a 50 percent stock dividend, respectively? A) − 100 percent, 0 percent, + 100 percent B) − 100 percent, + 100 percent, 0 percent C) − 100 percent, + 50 percent, + 50 percent D) − 50 percent, + 50 percent, + 50 percent Answer: C Explanation: Since the current value of outstanding shares would be $15,000,000 + $5,000,000 = $20,000,000, the stock dividend would involve transferring 0.50 × $20,000,000 = $10,000,000 from the retained earnings account into the other two accounts. Assuming that fair market value is reflected in the relative size of those two accounts, 15/20 = 0.75 × 10,000,000 = 7,500,000/15,000,000 = 50 percent would be transferred into the common shares account and 5/20 = 0.25 × 10,000,000 = 2,500,000/5,000,000 = 50 percent into the additional paid-in-capital account. Difficulty: 1 Easy Topic: Accounting for dividends and other payouts Bloom's: Apply; Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 17-02 Discuss how investors' preferences regarding differential tax rates and timing can guide the firm's policies on the distribution of dividends and capital gains.; 17-06 Differentiate between a stock dividend's impact and a stock split's impact on the firm's books.

19) If a firm has retained earnings of $40 million, a common shares account of $50 million, and additional paid-in-capital of $25 million, how much would be transferred in (or out) of these accounts in response to a 40 percent stock dividend, respectively? A) − 40 percent, 0 percent, + 40 percent B) − 40 percent, + 40 percent, 0 percent C) − 75 percent, + 37.5 percent, + 37.5 percent D) − 75 percent, + 40 percent, + 40 percent Answer: D Explanation: Since the current value of outstanding shares would be $50,000,000 + $25,000,000 = $75,000,000, the stock dividend would involve transferring 0.40 × $75,000,000 = $30,000,000 from the retained earnings account into the other two accounts. Assuming that fair market value is reflected in the relative size of those two accounts, 50/75 = 0.6667 × 30,000,000 = 20,000,000/50,000,000 = 40 percent would be transferred into the common shares account and 25/75 = 0.3333 × 30,000,000 = 10,000,000/25,000,000 = 40 percent into the additional paid-incapital account. Difficulty: 1 Easy Topic: Accounting for dividends and other payouts Bloom's: Apply; Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 17-02 Discuss how investors' preferences regarding differential tax rates and timing can guide the firm's policies on the distribution of dividends and capital gains.; 17-06 Differentiate between a stock dividend's impact and a stock split's impact on the firm's books.

20) If a firm has retained earnings of $4 million, a common shares account of $7 million, and additional paid-in-capital of $3 million, how much would be transferred in (or out) of these accounts in response to a 20 percent stock dividend, respectively? A) − 20 percent, 0 percent, + 20 percent B) − 20 percent, + 20 percent, 0 percent C) − 50 percent, + 20 percent, + 20 percent D) − 50 percent, + 25 percent, + 25 percent Answer: C Explanation: Since the current value of outstanding shares would be $7,000,000 + $3,000,000 = $10,000,000, the stock dividend would involve transferring 0.20 × $10,000,000 = $2,000,000 from the retained earnings account into the other two accounts. Assuming that fair market value is reflected in the relative size of those two accounts, 7/10 = 0.70 × 2,000,000 = 1,400,000/7,000,000 = 20 percent would be transferred into the common shares account and 3/10 = 0.30 × 2,000,000 = 600,000/3,000,000 = 20 percent into the additional paid-in-capital account. Difficulty: 1 Easy Topic: Accounting for dividends and other payouts Bloom's: Apply; Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 17-02 Discuss how investors' preferences regarding differential tax rates and timing can guide the firm's policies on the distribution of dividends and capital gains.; 17-06 Differentiate between a stock dividend's impact and a stock split's impact on the firm's books.

21) If a firm has retained earnings of $20 million, a common shares account of $25 million, and additional paid-in-capital of $15 million, how much would be transferred in (or out) of these accounts in response to a 15 percent stock dividend, respectively? A) − 15 percent, 0 percent, + 15 percent B) − 15 percent, + 15 percent, 0 percent C) − 30 percent, + 15 percent, + 15 percent D) − 30 percent, + 30 percent, + 30 percent Answer: C Explanation: Since the current value of outstanding shares would be $25,000,000 + $15,000,000 = $40,000,000, the stock dividend would involve transferring 0.15 × $40,000,000 = $6,000,000 from the retained earnings account into the other two accounts. Assuming that fair market value is reflected in the relative size of those two accounts, 25/40 = 0.625 × 6,000,000 = 3,750,000/25,000,000 = 15 percent would be transferred into the common shares account and 15/40 = 0.375 × 6,000,000 = 2,250,000/15,000,000 = 15 percent into the additional paid-incapital account. Difficulty: 1 Easy Topic: Accounting for dividends and other payouts Bloom's: Apply; Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 17-06 Differentiate between a stock dividend's impact and a stock split's impact on the firm's books.

22) If a firm has retained earnings of $20 million, a common shares account of $40 million, and additional paid-in-capital of $10 million, how much would be transferred in (or out) of these accounts in response to a 30 percent stock dividend, respectively? A) − 30 percent, 0 percent, + 30 percent B) − 30 percent, + 30 percent, 0 percent C) − 75 percent, + 30 percent, + 30 percent D) − 75 percent, + 37.5 percent, + 37.5 percent Answer: C Explanation: Since the current value of outstanding shares would be $40,000,000 + $10,000,000 = $50,000,000, the stock dividend would involve transferring 0.30 × $50,000,000 = $15,000,000 from the retained earnings account into the other two accounts. Assuming that fair market value is reflected in the relative size of those two accounts, 40/50 = 0.8 × 15,000,000 = 12,000,000/40,000,000 = 30 percent would be transferred into the common shares account and 10/50 = 0.2 × 15,000,000 = 3,000,000/10,000,000 = 30 percent into the additional paid-in-capital account. Difficulty: 1 Easy Topic: Accounting for dividends and other payouts Bloom's: Apply; Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 17-06 Differentiate between a stock dividend's impact and a stock split's impact on the firm's books.

44) Balloons, Inc. normally pays a annual dividend. The last such dividend paid was $0.80, all future annual dividends are expected to grow at 8 percent, and the firm faces a required rate of return on equity of 13 percent. If the firm just announced that the next dividend will be an extraordinary dividend of $2.00 per share that is not expected to affect any other future dividends, what should the stock price be? A) $16.00 B) $17.01 C) $17.28 D) $18.29 Answer: D Explanation: Using equation 17-6, the price if only the ordinary dividend were paid would be: P0 = D1/(i − g) = $0.80(1.08)/(0.13 − 0.08) = $0.864/0.05 = $17.28 However, the next dividend will be $2.00 − $0.864 = $1.136 higher than the model accounts for, so we would need to add the present value of this difference to get the actual stock price: P0 = $17.28 + ($1.136/1.13) = $18.2853 Difficulty: 2 Medium Topic: Types of cash dividends Bloom's: Apply; Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 17-04 Analyze a firm's decision to distribute constant ordinary dividends or extraordinary dividends.

45) Cups N Saucers, Inc. normally pays a annual dividend. The last such dividend paid was $1.00, all future annual dividends are expected to grow at 7 percent, and the firm faces a required rate of return on equity of 15 percent. If the firm just announced that the next dividend will be an extraordinary dividend of $3.00 per share that is not expected to affect any other future dividends, what should the stock price be? A) $12.00 B) $13.38 C) $14.18 D) $15.05 Answer: D Explanation: Using equation 17-6, the price if only the ordinary dividend were paid would be: P0 = D1/(i − g) = $1.00(1.07)/(0.15 − 0.07) = $1.07/0.08 = $13.375 However, the next dividend will be $3.00 − $1.07 = $1.93 higher than the model accounts for, so we would need to add the present value of this difference to get the actual stock price: P0 = $13.375 + ($1.93/1.15) = $15.0532 Difficulty: 2 Medium Topic: Types of cash dividends Bloom's: Apply; Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 17-04 Analyze a firm's decision to distribute constant ordinary dividends or extraordinary dividends.

46) Candy Town, Inc. normally pays a annual dividend. The last such dividend paid was $2.00, all future annual dividends are expected to grow at 10 percent, and the firm faces a required rate of return on equity of 15 percent. If the firm just announced that the next dividend will be an extraordinary dividend of $5.00 per share that is not expected to affect any other future dividends, what should the stock price be? A) $40.00 B) $42.44 C) $44.00 D) $46.43 Answer: D Explanation: Using equation 17-6, the price if only the ordinary dividend were paid would be: P0 = D1/(i − g) = $2.00(1.10)/(0.15 − 0.10) = $2.20/0.05 = $44.00 However, the next dividend will be $5.00 − $2.20 = $2.80 higher than the model accounts for, so we would need to add the present value of this difference to get the actual stock price: P0 = $44.00 + ($2.80/1.15) = $46.43478 Difficulty: 2 Medium Topic: Types of cash dividends Bloom's: Apply; Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 17-04 Analyze a firm's decision to distribute constant ordinary dividends or extraordinary dividends.

47) Choc Hut, Inc. normally pays a annual dividend. The last such dividend paid was $1.50, all future annual dividends are expected to grow at 6 percent, and the firm faces a required rate of return on equity of 18 percent. If the firm just announced that the next dividend will be an extraordinary dividend of $5.00 per share that is not expected to affect any other future dividends, what should the stock price be? A) $8.83 B) $12.50 C) $13.25 D) $16.14 Answer: D Explanation: Using equation 17-6, the price if only the ordinary dividend were paid would be: P0 = D1/(i − g) = $1.50(1.06)/(0.18 − 0.06) = $1.59/0.12 = $13.25 However, the next dividend will be $5.00 − $1.59 = $3.41 higher than the model accounts for, so we would need to add the present value of this difference to get the actual stock price: P0 = $13.25 + ($3.41/1.18) = $16.14 Difficulty: 2 Medium Topic: Types of cash dividends Bloom's: Apply; Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 17-04 Analyze a firm's decision to distribute constant ordinary dividends or extraordinary dividends.

48) Sky, Inc. normally pays a annual dividend. The last such dividend paid was $2.50, all future annual dividends are expected to grow at 4 percent, and the firm faces a required rate of return on equity of 16.5 percent. If the firm just announced that the next dividend will be an extraordinary dividend of $10.00 per share that is not expected to affect any other future dividends, what should the stock price be? A) $20.00 B) $20.80 C) $26.35 D) $27.15 Answer: D Explanation: Using equation 17-6, the price if only the ordinary dividend were paid would be: P0 = D1/(i − g) = $2.50(1.04)/(0.165 − 0.04) = $2.60/0.125 = $20.80 However, the next dividend will be $10.00 − $2.60 = $7.40 higher than the model accounts for, so we would need to add the present value of this difference to get the actual stock price: P0 = $20.80 + ($7.40/1.165) = $27.15 Difficulty: 2 Medium Topic: Types of cash dividends Bloom's: Apply; Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 17-04 Analyze a firm's decision to distribute constant ordinary dividends or extraordinary dividends.

49) Wheels and More, Inc. normally pays an annual dividend. The last such dividend paid was $3.00, all future dividends are expected to grow at a rate of 8 percent per year, and the firm faces a required rate of return on equity of 12 percent. If the firm just announced that the next dividend will be an extraordinary dividend of $7 per share that is not expected to affect any other future dividends, what should the stock price be? A) $78.76 B) $81.00 C) $82.00 D) $84.36 Answer: D Explanation: Using equation 17-6, the price if only the ordinary dividend were paid would be: P0 = D1/(i − g) = $3.00(1.08)/(.12 − 0.08) = $3.24/0.04 = $81.00 However, the next dividend will be $7.00 − $3.24 = $3.76 higher than the model accounts for, so we would need to add the present value of this difference to get the actual stock price: P0 = $81.00 + ($3.76/1.12) = $84.36 Difficulty: 2 Medium Topic: Types of cash dividends Bloom's: Apply; Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 17-04 Analyze a firm's decision to distribute constant ordinary dividends or extraordinary dividends. 50) JEN Corp. is expected to pay a dividend of $2.00 per year indefinitely. If the appropriate rate of return on this stock is 12 percent per year, and the stock consistently goes ex-dividend 25 days before the dividend payment date, what will be the expected minimum price in light of the dividend payment logistics? A) $1.14 B) $16.54 C) $16.67 D) $18.52 Answer: B Explanation: The minimum stock price, which will occur right after the stock goes ex-dividend, will be: P0 = ($2.00/0.12) × (1/[(1 + 0.000311) 25th power]) = $16.54 Difficulty: 2 Medium Topic: Chronology of dividend payments Bloom's: Apply; Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 17-05 Explain the effect that cash dividend payment procedures have on stock prices.

51) JEN Corp. is expected to pay a dividend of $2.00 per year indefinitely. If the appropriate rate of return on this stock is 12 percent per year, and the stock consistently goes ex-dividend 25 days before the dividend payment date, what will be the expected maximum price in light of the dividend payment logistics? A) $1.14 B) $16.54 C) $16.67 D) $18.52 Answer: D Explanation: So the maximum stock price, which will occur right before the stock goes exdividend, will be: P0 = {$2.00/[(1 + 0.000311) 25th power]} + {($2.00/0.12) × (1/[(1 + 0.000311) 25th power])} = $18.5245 Difficulty: 2 Medium Topic: Chronology of dividend payments Bloom's: Apply; Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 17-05 Explain the effect that cash dividend payment procedures have on stock prices. 52) JAY Corp. is expected to pay a dividend of $5.00 per year indefinitely. If the appropriate rate of return on this stock is 13 percent per year, and the stock consistently goes ex-dividend 30 days before the dividend payment date, what will be the expected minimum price in light of the dividend payment logistics? A) $3.16 B) $38.08 C) $38.46 D) $43.03 Answer: B Explanation: And the minimum stock price, which will occur right after the stock goes exdividend, will be: P0 = ($5.00/0.13) × (1/[(1 + 0.000335) 30th power]) = $38.07699 Difficulty: 2 Medium Topic: Chronology of dividend payments Bloom's: Apply; Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 17-05 Explain the effect that cash dividend payment procedures have on stock prices.

53) JAY Corp. is expected to pay a dividend of $5.00 per year indefinitely. If the appropriate rate of return on this stock is 13 percent per year, and the stock consistently goes ex-dividend 30 days before the dividend payment date, what will be the expected maximum price in light of the dividend payment logistics? A) $3.16 B) $38.08 C) $38.46 D) $43.03 Answer: D Explanation: So the maximum stock price, which will occur right before the stock goes exdividend, will be: P0 = {$5.00/[(1 + 0.000335) 30th power]} + {($5.00/0.13) × (1/[(1 + 0.000335) 30th power])} = $43.026999 Difficulty: 2 Medium Topic: Chronology of dividend payments Bloom's: Apply; Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 17-05 Explain the effect that cash dividend payment procedures have on stock prices. 54) TJ Corp. is expected to pay a dividend of $3.00 per year indefinitely. If the appropriate rate of return on this stock is 10 percent per year, and the stock consistently goes ex-dividend 45 days before the dividend payment date, what will be the expected minimum price in light of the dividend payment logistics? A) $3.70 B) $26.68 C) $29.65 D) $30.00 Answer: C Explanation: And the minimum stock price, which will occur right after the stock goes exdividend, will be: P0 = ($3.00/0.10) × (1/[(1 + 0.000261) 45th power]) = $29.6498 Difficulty: 2 Medium Topic: Chronology of dividend payments Bloom's: Apply; Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 17-05 Explain the effect that cash dividend payment procedures have on stock prices.

55) CJ Corp. is expected to pay a dividend of $10.00 per year indefinitely. If the appropriate rate of return on this stock is 15 percent per year, and the stock consistently goes ex-dividend 25 days before the dividend payment date, what will be the expected minimum price in light of the dividend payment logistics? A) $45.66 B) $66.03 C) $66.67 D) $75.93 Answer: B Explanation: And the minimum stock price, which will occur right after the stock goes exdividend, will be: P0 = ($10.00/0.15) × (1/[(1 + 0.000383) 25th power]) = $66.03 Difficulty: 2 Medium Topic: Chronology of dividend payments Bloom's: Apply; Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 17-05 Explain the effect that cash dividend payment procedures have on stock prices. 56) PQR Corp. is expected to pay a dividend of $1.50 per year indefinitely. If the appropriate rate of return on this stock is 8 percent per year, and the stock consistently goes ex-dividend 25 days before the dividend payment date, what will be the expected minimum price in light of the dividend payment logistics? A) 12.84 B) $18.65 C) $18.75 D) $20.09 Answer: B Explanation: And the minimum stock price, which will occur right after the stock goes exdividend, will be: P0 = ($1.50/0.08) × (1/[(1 + 0.000211) 25th power]) = $18.6514 Difficulty: 2 Medium Topic: Chronology of dividend payments Bloom's: Apply; Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 17-05 Explain the effect that cash dividend payment procedures have on stock prices.

57) ABC Corp. is expected to pay a dividend of $5.00 per year indefinitely. If the appropriate rate of return on this stock is 5 percent per year, and the stock consistently goes ex-dividend 45 days before the dividend payment date, what will be the expected minimum price in light of the dividend payment logistics? A) $99.40 B) $100.00 C) $103.77 D) $123.29 Answer: A Explanation: And the minimum stock price, which will occur right after the stock goes exdividend, will be: P0 = ($5.00/0.05) × (1/[(1 + 0.00013) 45th power]) = $99.40 Difficulty: 2 Medium Topic: Chronology of dividend payments Bloom's: Apply; Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 17-05 Explain the effect that cash dividend payment procedures have on stock prices. 58) ABC Corp. is expected to pay a dividend of $5.00 per year indefinitely. If the appropriate rate of return on this stock is 5 percent per year, and the stock consistently goes ex-dividend 45 days before the dividend payment date, what will be the expected maximum price in light of the dividend payment logistics? A) $98.83 B) $100.00 C) $104.37 D) $123.29 Answer: C Explanation: So the maximum stock price, which will occur right before the stock goes exdividend, will be: P0 = {$5.00/[(1 + 0.00013) 45th power]} + {($5.00/0.05) × (1/[(1 + 0.00013) 45th power])} = $103.37 Difficulty: 2 Medium Topic: Chronology of dividend payments Bloom's: Apply; Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 17-05 Explain the effect that cash dividend payment procedures have on stock prices.

33) Suppose that a firm always announces a yearly dividend at the end of the first quarter of the year, but then pays the dividend out as four equal quarterly payments. If the next such "annual" dividend has been announced as $5, it is exactly one quarter until the first quarterly dividend from that $5, the effective annual required rate of return on the company's stock is 14 percent, and all future "annual" dividends are expected to grow at 4 percent per year indefinitely, how much will this stock be worth? A) $17.10 B) $50.00 C) $52.55 D) $57.00 Answer: C Explanation: Since dividends come quarterly, we first need to convert the 14 percent EAR into an effective quarterly rate: 3.33 percent. The present value of the first year's dividends will be the present value of a four-period annuity with payments of $1.25. PMT = 1.25, N= 4, I = 3.33, FV = 0, PV = 4.6099 Since each year's dividends are expected to grow at 4 percent, the present value of each year's dividends at the beginning of that year will also grow at 4 percent, so we can value the stock's dividends as the present value of a growing, perpetuity due: PV = $4.6099 + {(4.6099 × 1.04)/(0.14 − 0.04)} = $52.55 Difficulty: 3 Hard Topic: Perpetuities Bloom's: Apply; Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 17-04 Analyze a firm's decision to distribute constant ordinary dividends or extraordinary dividends.

34) Suppose that a firm always announces a yearly dividend at the end of the first quarter of the year, but then pays the dividend out as four equal quarterly payments. If the next such "annual" dividend has been announced as $2, it is exactly one quarter until the first quarterly dividend from that $2, the effective annual required rate of return on the company's stock is 15 percent, and all future "annual" dividends are expected to grow at 10 percent per year indefinitely, how much will this stock be worth? A) $40.00 B) $41.83 C) $45.00 D) $42.09 Answer: D Explanation: Since dividends come quarterly, we first need to convert the 15 percent EAR into an effective quarterly rate: 3.556 percent. The present value of the first year's dividends will be the present value of a four-period annuity with payments of $0.50. PMT = 0.50, N= 4, I = 3.556, FV = 0, PV = 1.83 Since each year's dividends are expected to grow at 10 percent, the present value of each year's dividends at the beginning of that year will also grow at 10 percent, so we can value the stock's dividends as the present value of a growing, perpetuity due: PV = $1.83 + {(1.83 × 1.10)/(0.15 − 0.10)} = $42.09 Difficulty: 3 Hard Topic: Perpetuities Bloom's: Apply; Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 17-04 Analyze a firm's decision to distribute constant ordinary dividends or extraordinary dividends.

35) Suppose that a firm always announces a yearly dividend at the end of the first quarter of the year, but then pays the dividend out as four equal quarterly payments. If the next such "annual" dividend has been announced as $1, it is exactly one quarter until the first quarterly dividend from that $1, the effective annual required rate of return on the company's stock is 10 percent, and all future "annual" dividends are expected to grow at 5 percent per year indefinitely, how much will this stock be worth? A) $19.79 B) $20.74 C) $21.26 D) $21.37 Answer: B Explanation: Since dividends come quarterly, we first need to convert the 10 percent EAR into an effective quarterly rate: 2.411 percent. The present value of the first year's dividends will be the present value of a four-period annuity with payments of $0.25. PMT = 0.25, N = 4, I = 2.411, FV = 0, PV = 0.9425 Since each year's dividends are expected to grow at 5 percent, the present value of each year's dividends at the beginning of that year will also grow at 5 percent, so we can value the stock's dividends as the present value of a growing, perpetuity due: PV = $0.9425 + {(0.9425 × 1.05)/(0.10 − 0.05)} = $20.74 Difficulty: 3 Hard Topic: Perpetuities Bloom's: Apply; Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 17-04 Analyze a firm's decision to distribute constant ordinary dividends or extraordinary dividends. 62) Suppose a firm pays total dividends of $750,000 out of net income of $2 million. What would the firm's retention ratio be? A) 37.50 percent B) 47.50 percent C) 25.50 percent D) 62.50 percent Answer: D Explanation: The payout ratio would be $750,000/$2,000,000 = 0.375 = 37.50 percent; Retention ratio = 1 − payout ratio = 62.50 percent Difficulty: 1 Easy Topic: Dividends and payout policy Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 17-02 Discuss how investors' preferences regarding differential tax rates and timing can guide the firm's policies on the distribution of dividends and capital gains.

63) Suppose a firm pays total dividends of $489,000 out of net income of $5 million. What would the firm's retention ratio be? A) 9.78 percent B) 90.22 percent C) 81.24 percent D) 19.78 percent Answer: B Explanation: $489,000/$5,000,000 = 0.0978 = 9.78 percent; Retention ratio = 1 − payout ratio = 90.22 percent Difficulty: 1 Easy Topic: Dividends and payout policy Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 17-02 Discuss how investors' preferences regarding differential tax rates and timing can guide the firm's policies on the distribution of dividends and capital gains. 64) Suppose a firm pays total dividends of $125,000 out of net income of $500,000. What would the firm's retention ratio be? A) 22.00 percent B) 69.00 percent C) 25.00 percent D) 75.00 percent Answer: D Explanation: $125,000/$500,000 = 0.25 = 25 percent; Retention ratio = 1 − payout ratio = 75.00 percent Difficulty: 1 Easy Topic: Dividends and payout policy Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 17-02 Discuss how investors' preferences regarding differential tax rates and timing can guide the firm's policies on the distribution of dividends and capital gains.

65) Suppose a firm has a dividend payout ratio of 25 percent and net income of $5 million. What would be the annual addition to retained earnings? A) $3,750,000 B) $5,250,000 C) $1,750,000 D) $750,000 Answer: A Explanation: Since the dividend payout ratio is one minus the retention ratio, the firm would retain (1 − 0.25) × $5,000,000 = $3,750,000. Difficulty: 1 Easy Topic: Dividends and payout policy Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 17-02 Discuss how investors' preferences regarding differential tax rates and timing can guide the firm's policies on the distribution of dividends and capital gains. 66) Suppose a firm has a dividend payout ratio of 65 percent and net income of $5 million. What would be the annual addition to retained earnings? A) $3,250,000 B) $5,250,000 C) $1,750,000 D) $750,000 Answer: C Explanation: Since the dividend payout ratio is one minus the retention ratio, the firm would retain (1 − 0.65) × $5,000,000 = $1,750,000. Difficulty: 1 Easy Topic: Dividends and payout policy Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 17-02 Discuss how investors' preferences regarding differential tax rates and timing can guide the firm's policies on the distribution of dividends and capital gains.

67) Suppose a firm has a retention ratio of 55 percent and net income of $7 million. How much does it pay out in dividends? A) $3,850,000 B) $3,150,000 C) $3,450,000 D) $3,550,000 Answer: B Explanation: Since the retention ratio is one minus the dividend payout ratio, the firm would pay out (1 − 0.55) × $7,000,000 = $3,150,000. Difficulty: 1 Easy Topic: Dividends and payout policy Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 17-02 Discuss how investors' preferences regarding differential tax rates and timing can guide the firm's policies on the distribution of dividends and capital gains. 68) Suppose a firm has a dividend payout ratio of 47 percent and net income of $7 million. What would be the annual addition to retained earnings? A) $3,890,000 B) $3,290,000 C) $3,710,000 D) $3,510,000 Answer: C Explanation: Since the dividend payout ratio is one minus the retention ratio, the firm would retain (1 − 0.47) × $7,000,000 = $3,710,000. Difficulty: 1 Easy Topic: Dividends and payout policy Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 17-02 Discuss how investors' preferences regarding differential tax rates and timing can guide the firm's policies on the distribution of dividends and capital gains.

69) Suppose a firm has a retention ratio of 33 percent and net income of $6.25 million. How much does it pay out in dividends? A) $4,187,500 B) $2,062,500 C) $1,987,500 D) $4,375,500 Answer: A Explanation: Since the retention ratio is one minus the dividend payout ratio, the firm would pay out (1 − 0.33) × $6,250,000 = $4,187,500. Difficulty: 1 Easy Topic: Dividends and payout policy Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 17-02 Discuss how investors' preferences regarding differential tax rates and timing can guide the firm's policies on the distribution of dividends and capital gains. 70) Suppose a firm has a dividend payout ratio of 42 percent and net income of $9.25 million. What would be the annual addition to retained earnings? A) $4,875,000 B) $6,255,000 C) $6,987,000 D) $5,365,000 Answer: D Explanation: Since the dividend payout ratio is one minus the retention ratio, the firm would retain (1 − 0.42) × $9,250,000 = $5,365,000. Difficulty: 1 Easy Topic: Dividends and payout policy Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 17-02 Discuss how investors' preferences regarding differential tax rates and timing can guide the firm's policies on the distribution of dividends and capital gains.

71) A firm has retained earnings of $11 million, a common shares account of $2 million, and additional paid-in-capital of $6 million, and the firm just paid a 5 percent stock dividend. Assume that fair market value is reflected in the relative size of both the common shares account and the additional paid-in-capital account. Which of the following statements is correct? A) Retained earnings will increase by $400,000. B) Common shares will increase by $266,667. C) Additional paid-in-capital will increase by $300,000. D) None of the statements are correct. Answer: C Explanation: Since the current value of outstanding shares would be $2,000,000 + $6,000,000 = $8,000,000, the stock dividend would involve transferring 0.05 × $8,000,000 = $400,000 from the retained earnings account into the other two accounts. Assuming that fair market value is reflected in the relative size of those two accounts, 1/4 would be transferred into the common shares account and 3/4 into the additional paid-in-capital account. Difficulty: 1 Easy Topic: Accounting for dividends and other payouts Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 17-06 Differentiate between a stock dividend's impact and a stock split's impact on the firm's books. 72) A firm has retained earnings of $11 million, a common shares account of $2 million, and additional paid-in-capital of $6 million, and the firm just paid a 15 percent stock dividend. Assume that fair market value is reflected in the relative size of both the common shares account and the additional paid-in-capital account. Which of the following statements is correct? A) Retained earnings will decrease by $1,200,000. B) Common shares will increase by $300,000. C) Additional paid-in-capital will increase by $900,000. D) All of the statements are correct. Answer: D Explanation: Since the current value of outstanding shares would be $2,000,000 + $6,000,000 = $8,000,000, the stock dividend would involve transferring 0.15 × $8,000,000 = $1,200,000 from the retained earnings account into the other two accounts. Assuming that fair market value is reflected in the relative size of those two accounts, 1/4 would be transferred into the common shares account and 3/4 into the additional paid-in-capital account. Difficulty: 1 Easy Topic: Accounting for dividends and other payouts Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 17-06 Differentiate between a stock dividend's impact and a stock split's impact on the firm's books.

73) A firm has retained earnings of $6 million, a common shares account of $3 million, and additional paid-in-capital of $6 million, and the firm just paid a 10 percent stock dividend. Assume that fair market value is reflected in the relative size of both the common shares account and the additional paid-in-capital account. What are the new levels in each account? A) Retained earnings = $900,000; Common shares = $300,000; Additional paid-in-capital = $600,000 B) Retained earnings = $5,100,000; Common shares = $2,700,000; Additional paid-in-capital = $5,400,000 C) Retained earnings = $5,100,000; Common shares = $3,300,000; Additional paid-in-capital = $6,600,000 D) Retained earnings = $5,900,000; Common shares = $2,700,000; Additional paid-in-capital = $5,400,000 Answer: C Explanation: Since the current value of outstanding shares would be $3,000,000 + $6,000,000 = $9,000,000, the stock dividend would involve transferring 0.10 × $9,000,000 = $900,000 from the retained earnings account into the other two accounts. Assuming that fair market value is reflected in the relative size of those two accounts, 1/3 would be transferred into the common shares account and 2/3 into the additional paid-in-capital account. Difficulty: 1 Easy Topic: Accounting for dividends and other payouts Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 17-06 Differentiate between a stock dividend's impact and a stock split's impact on the firm's books.

74) MMK Cos. normally pays an annual dividend. The last such dividend paid was $2.00, all future dividends are expected to grow at a rate of 6 percent per year, and the firm faces a required rate of return on equity of 13 percent. If the firm just announced that the next dividend will be an extraordinary dividend of $22 per share that is not expected to affect any other future dividends, what should the stock price be? A) $39.63 B) $47.88 C) $49.02 D) $32.71 Answer: B Explanation: Step 1: Find value of stock using "normal" annual dividend: Price = 2.00(1.06)/(0.13 − 0.06) = $30.29; Step 2: Find the present value of the additional cash flow = PV (Extraordinary Div Normal Div): PV [$22 − 2.00(1.06)] = $19.88/1.13 = $17.59; Step 3: Value of stock = Value of stock + Value of Additional Dividend = $47.88 Difficulty: 2 Medium Topic: Types of cash dividends Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 17-04 Analyze a firm's decision to distribute constant ordinary dividends or extraordinary dividends. 75) GBH Inc. is planning on announcing a 5-for-2 stock split. The stock is currently trading at $90 per share. Based on this information, what will be the new stock price? A) $36.00 B) $225.00 C) $52.00 D) $34.00 Answer: A Explanation: $90 × 2/5 = $36 Difficulty: 1 Easy Topic: Stock splits Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 17-06 Differentiate between a stock dividend's impact and a stock split's impact on the firm's books.

76) GBH Inc. is planning on announcing a 2-for-5 stock split. The stock is currently trading at $12 per share. Based on this information, what will be the new stock price? A) $4.80 B) $5.10 C) $27.00 D) $30.00 Answer: D Explanation: $12 × 5/2 = $30 Difficulty: 1 Easy Topic: Stock splits Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 17-06 Differentiate between a stock dividend's impact and a stock split's impact on the firm's books. 77) GBH Inc. is planning on announcing a 7-for-3 stock split. The stock is currently trading at $119 per share. Based on this information, what will be the new stock price? A) $62.67 B) $51.00 C) $277.67 D) $39.17 Answer: B Explanation: $119 × 3/7 = $51 Difficulty: 1 Easy Topic: Stock splits Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 17-06 Differentiate between a stock dividend's impact and a stock split's impact on the firm's books.

78) Which of the following statements is correct? A) Generally speaking, investors interpret a firm's decision to repurchase their own stock as a positive signal. B) A stock repurchase may be viewed as a sign that the firm doesn't have enough attractive capital budgeting projects. C) The IRS can impose penalties on a firm if tax authorities can show that the repurchase was performed primarily to avoid dividend taxation. D) All of the options are correct. Answer: D Difficulty: 2 Medium Topic: Payout policy considerations Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 17-07 Note the advantages and disadvantages of a firm's stock repurchases. 79) Which of the following statements is correct? A) The Dutch auction relies on the firm's shareholders to value the stock. B) The Dutch auction tends to attract arbitrageurs who often drive up the price. C) The Dutch auction offers the possibility that the firm will pay more than the maximum price of the specified range. D) All of the options are correct. Answer: A Difficulty: 2 Medium Topic: Stock repurchases Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 17-06 Differentiate between a stock dividend's impact and a stock split's impact on the firm's books.

80) Which of the following is a reason for a firm to announce a stock split? A) The price of the stock is too high. B) The firm wants to reduce its dividend. C) It is an alternative to a stock repurchase, which is more costly. D) All of the options are correct. Answer: A Difficulty: 1 Easy Topic: Stock splits Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 17-06 Differentiate between a stock dividend's impact and a stock split's impact on the firm's books. 81) Which of the following statements is incorrect? A) Stock dividends increase the number of shares and increase the total market value of owner's equity. B) Stock splits increase the number of shares but do not increase the total market value of owner's equity. C) In a stock dividend, the par value of the stock on the company's books is not altered. D) In a stock split, the par value of the stock on the company's books is altered. Answer: A Difficulty: 2 Medium Topic: Stock dividends Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 17-06 Differentiate between a stock dividend's impact and a stock split's impact on the firm's books.

82) Brady inherited 1,000 shares of LNM, Inc. The stock is selling in the market for $177 per share and the company is contemplating a 2-for-6 stock split. Given this information, which of the following statements is correct? A) Brady will have 3,000 shares and stock's price will be near $531. B) Brady will have 3,000 shares and stock's price will be near $59. C) Brady will have 333.33 shares and stock's price will be near $531. D) Brady will have 333.33 shares and stock's price will be near $59. Answer: C Explanation: Step 1: Number of shares = 1,000/6 × 2 = 333.33; Step 2: Price = $177/2 × 6 = $531 Difficulty: 2 Medium Topic: Stock splits Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 17-06 Differentiate between a stock dividend's impact and a stock split's impact on the firm's books. 83) Brady inherited 500 shares of LNM, Inc. The stock is selling in the market for $92 per share and the company is contemplating a 5-for-3 stock split. Given this information, which of the following statements is correct? A) Brady will have 300 shares and stock's price will be near $153.33. B) Brady will have 300 shares and stock's price will be near $55.20. C) Brady will have 833.33 shares and stock's price will be near $55.20. D) Brady will have 833.33 shares and stock's price will be near $153.33. Answer: C Explanation: Step 1: Number of shares = 500/3 × 5 = 833.33; Step 2: Price = $92/5 × 3 = $55.20 Difficulty: 2 Medium Topic: Stock splits Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 17-06 Differentiate between a stock dividend's impact and a stock split's impact on the firm's books.

84) Brady inherited 1,750 shares of LNM, Inc. The stock is selling in the market for $82 per share and the company is contemplating a 1-for-3 stock split. Given this information, which of the following statements is correct? A) Brady will have 583.33 shares and stock's price will be near $246.00. B) Brady will have 583.33 shares and stock's price will be near $27.33. C) Brady will have 5,250 shares and stock's price will be near $246.00. D) Brady will have 5,250 shares and stock's price will be near $27.33. Answer: A Explanation: Step 1: Number of shares = 1,750/3 × 1 = 583.33; Step 2: Price = $82/1 × 3 = $246.00 Difficulty: 2 Medium Topic: Stock splits Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 17-06 Differentiate between a stock dividend's impact and a stock split's impact on the firm's books. 85) The Tax Cut Jobs Act of 2017 included which of the following changes? A) a new preferential tax regime applied to some pass-through income from partnership, limited liability companies, and Subchapter S corporations. B) changes in the taxation of foreign-source income. C) a large reduction in the corporate tax rate from 35% to 21% D) all of the above Answer: D Difficulty: 1 Easy Topic: TCJA of 2017 Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 17-02 Discuss how investors' preferences regarding differential tax rates and timing can guide the firm's policies on the distribution of dividends and capital gains.

86) The first day that the shares will trade without the dividend attached is referred to as the: A) dividend date. B) declaration date. C) record date. D) none of the options. Answer: D Difficulty: 1 Easy Topic: Chronology of dividend payments Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 17-05 Explain the effect that cash dividend payment procedures have on stock prices. 87) On the , the firm will look on its books to find the registered owners so that they can start addressing payments. A) owner date B) record date C) owner of record date D) ex-dividend date Answer: B Difficulty: 1 Easy Topic: Chronology of dividend payments Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 17-05 Explain the effect that cash dividend payment procedures have on stock prices. 88) The board of directors announces its intention to pay a dividend on the: A) ex-dividend date. B) record date. C) declaration date. D) dividend announcement date. Answer: C Difficulty: 1 Easy Topic: Chronology of dividend payments Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 17-05 Explain the effect that cash dividend payment procedures have on stock prices.

89) Which of the following statements is correct? A) A stock's price will increase upon announcing a dividend. B) Stock repurchases increase the number of shares. C) Paying a fixed percentage of net income is consistent with the clientele effect. D) None of the options. Answer: A Difficulty: 2 Medium Topic: Chronology of dividend payments Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 17-02 Discuss how investors' preferences regarding differential tax rates and timing can guide the firm's policies on the distribution of dividends and capital gains.; 17-05 Explain the effect that cash dividend payment procedures have on stock prices.; 17-07 Note the advantages and disadvantages of a firm's stock repurchases. 90) The theory that argues that dividends that the firm has committed to pay are less risky to risk-averse investors than are potential future capital gains is referred to as: A) dividend irrelevance theory. B) bird-in-the-hand theory. C) residual dividend model. D) none of the options. Answer: B Difficulty: 1 Easy Topic: Payout policy considerations Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 17-02 Discuss how investors' preferences regarding differential tax rates and timing can guide the firm's policies on the distribution of dividends and capital gains.

91) The bird-in-the-hand fallacy refers to: A) the fact that many, if not most, investors will reinvest their dividends in the firm anyway. B) the fact that most investors are indifferent between capital gains and dividends. C) the fact that most firms pay such a low amount of dividends that it becomes irrelevant to the average investor. D) none of the options. Answer: A Difficulty: 2 Medium Topic: Payout policy considerations Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 17-02 Discuss how investors' preferences regarding differential tax rates and timing can guide the firm's policies on the distribution of dividends and capital gains. 92) Which of the following is correct? A) Stock prices increase as the next dividend approaches and then fall by the present value of that dividend once the stock goes ex-dividend. B) Stock prices decrease as the next dividend approaches and then fall by the present value of that dividend once the stock goes ex-dividend. C) Stock prices increase as the next dividend approaches and then increase by the present value of that dividend once the stock goes ex-dividend. D) None of the options. Answer: A Difficulty: 2 Medium Topic: Chronology of dividend payments Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 17-05 Explain the effect that cash dividend payment procedures have on stock prices.

93) Why might a firm's investors wish to delay receiving cash from the firm? A) They might prefer to wait for the firm to split its stock. B) They might prefer to wait until the residual dividend model is employed. C) They might prefer to wait until an extraordinary dividend is paid which is taxed more favorably. D) They might wish to delay receiving cash if they expected to be in a lower tax bracket in the future. Answer: D Difficulty: 1 Easy Topic: Payout policy considerations Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 17-01 Identify factors that affect a firm's payout policies. 94) Why might a firm announce a "reverse stock dividend"? A) This only occurs when the firm wants its price to increase, perhaps due to listing requirements. B) This is impossible. C) This only occurs when the firm is in financial hardship and the management team wants to execute a leveraged buyout. D) None of the options are reasons for a reverse stock dividend. Answer: B Difficulty: 1 Easy Topic: Stock dividends Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 17-06 Differentiate between a stock dividend's impact and a stock split's impact on the firm's books.

95) Which of the following would cause dividends to decrease if the firm was using the residual dividend model? A) The firm has more positive NPV projects. B) The firm's dividend payout ratio decreases. C) The firm's average collection period increases. D) All of the options would cause dividends to decrease. Answer: A Difficulty: 2 Medium Topic: Dividends and payout policy Bloom's: Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 17-04 Analyze a firm's decision to distribute constant ordinary dividends or extraordinary dividends. 96) Which of the following would cause dividends to decrease if the firm was using the residual dividend model? A) The firm has fewer positive NPV projects. B) The firm's dividend payout ratio decreases. C) Net income decreases. D) All of the options would cause dividends to decrease. Answer: C Difficulty: 2 Medium Topic: Dividends and payout policy Bloom's: Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 17-04 Analyze a firm's decision to distribute constant ordinary dividends or extraordinary dividends.

97) Which of the following would cause dividends to decrease if the firm was using the residual dividend model? A) The firm has more positive NPV projects. B) The firm uses less debt in its capital structure. C) Net income decreases. D) All of the options would cause dividends to decrease. Answer: D Difficulty: 2 Medium Topic: Dividends and payout policy Bloom's: Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 17-04 Analyze a firm's decision to distribute constant ordinary dividends or extraordinary dividends. 98) Which of the following would cause dividends to increase if the firm was using the residual dividend model? A) The firm has less positive NPV projects. B) The firm uses more debt in its capital structure. C) Net income increases. D) All of the options would cause dividends to increase. Answer: D Difficulty: 2 Medium Topic: Dividends and payout policy Bloom's: Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 17-04 Analyze a firm's decision to distribute constant ordinary dividends or extraordinary dividends.

99) Suppose that a firm always announces a yearly dividend at the end of the first quarter of the year, but then pays the dividend out as four equal quarterly payments. If the next such "annual" dividend has been announced as $4, it is exactly one quarter until the first quarterly dividend from that $1, the effective annual required rate of return on the company's stock is 14 percent, and all future "annual" dividends are expected to grow at 7 percent per year indefinitely, how much will this stock be worth? A) $111.49 B) $61.40 C) $57.63 D) $53.86 Answer: B Explanation: Since dividends come quarterly, we first need to convert the 10 percent EAR into an effective quarterly rate: 2.411 percent. The present value of the first year's dividends will be the present value of a four-period annuity with payments of $1.00. PMT = 1.00, N = 4, I = 2.411, FV = 0, PV = 3.7701 Since each year's dividends are expected to grow at 7 percent, the present value of each year's dividends at the beginning of that year will also grow at 7 percent, so we can value the stock's dividends as the present value of a growing, perpetuity due: PV = $3.7701 + {(3.7701 × 1.07)/(0.14 − 0.07)} = $61.3988 Difficulty: 3 Hard Topic: Perpetuities Bloom's: Apply; Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 17-04 Analyze a firm's decision to distribute constant ordinary dividends or extraordinary dividends. 100) Suppose a firm pays total dividends of $5,000 out of net income of $250,000. What would the firm's retention ratio be? A) 0.98 percent B) 1.02 percent C) 2.00 percent D) 98.00 percent Answer: D Explanation: The payout ratio would be $5,000/$250,000 = 0.02 = 2.00 percent; Retention ratio = 1 − payout ratio = 98 percent Difficulty: 1 Easy Topic: Dividends and payout policy Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 17-02 Discuss how investors' preferences regarding differential tax rates and timing can guide the firm's policies on the distribution of dividends and capital gains.

101) Suppose a firm pays total dividends of $35,000 out of net income of $50,000. What would the firm's retention ratio be? A) 0.30 percent B) 0.70 percent C) 30.00 percent D) 70.00 percent Answer: C Explanation: The payout ratio would be $35,000/$50,000 = 0.70 = 70 percent; Retention ratio = 1 − payout ratio = 30 percent Difficulty: 1 Easy Topic: Dividends and payout policy Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 17-02 Discuss how investors' preferences regarding differential tax rates and timing can guide the firm's policies on the distribution of dividends and capital gains. 102) Suppose a firm pays total dividends of $165,000 out of net income of $1 million. What would the firm's retention ratio be? A) 1.65 percent B) 8.35 percent C) 16.50 percent D) 83.50 percent Answer: D Explanation: $165,000/$1,000,000 = 0.165 = 16.5 percent; Retention ratio = 1 − payout ratio = 83.5 percent Difficulty: 1 Easy Topic: Dividends and payout policy Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 17-02 Discuss how investors' preferences regarding differential tax rates and timing can guide the firm's policies on the distribution of dividends and capital gains.

103) A firm has retained earnings of $10 million, a common shares account of $1 million, and additional paid-in-capital of $4 million, and the firm just paid a 10 percent stock dividend. Assume that fair market value is reflected in the relative size of both the common shares account and the additional paid-in-capital account. What are the new levels in each account? A) Retained earnings = $9,500,000; Common shares = $1,000,000; Additional paid-in-capital = $4,500,000 B) Retained earnings = $9,500,000; Common shares = $1,500,000; Additional paid-in-capital = $4,000,000 C) Retained earnings = $9,500,000; Common shares = $1,100,000; Additional paid-in-capital = $4,400,000 D) Retained earnings = $10,000,000; Common shares = $1,000,000; Additional paid-in-capital = $4,000,000 Answer: C Explanation: Since the current value of outstanding shares would be $1,000,000 + $4,000,000 = $5,000,000, the stock dividend would involve transferring 0.10 × $5,000,000 = $500,000 from the retained earnings account into the other two accounts. Assuming that fair market value is reflected in the relative size of those two accounts, 1/5 would be transferred into the common shares account and 4/5 into the additional paid-in-capital account. Difficulty: 1 Easy Topic: Accounting for dividends and other payouts Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 17-06 Differentiate between a stock dividend's impact and a stock split's impact on the firm's books.

104) LMNOP Cos. normally pays an annual dividend. The last such dividend paid was $5.00, all future dividends are expected to grow at a rate of 5 percent per year, and the firm faces a required rate of return on equity of 15 percent. If the firm just announced that the next dividend will be an extraordinary dividend of $10 per share that is not expected to affect any other future dividends, what should the stock price be? A) $52.50 B) $56.63 C) $100.00 D) $150.00 Answer: B Explanation: Step 1: Find value of stock using "normal" annual dividend: Price = 5.00 (1.05)/(0.15 − 0.05) = $52.50; Step 2: Find the present value of the additional cash flow = PV (Extraordinary Div Normal Div): PV [$10 − 5.00 (1.05)] = $4.75/1.15 = $4.13; Step 3: Value of stock = Value of stock + Value of Additional Dividend = $56.63 Difficulty: 2 Medium Topic: Types of cash dividends Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 17-04 Analyze a firm's decision to distribute constant ordinary dividends or extraordinary dividends. 105) GB Inc. is planning on announcing a 4-for-1 stock split. The stock is currently trading at $25 per share. Based on this information, what will be the new stock price? A) $6.25 B) $25.00 C) $31.25 D) $100.00 Answer: A Explanation: $25 × 1/4 = $6.25 Difficulty: 1 Easy Topic: Stock splits Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 17-06 Differentiate between a stock dividend's impact and a stock split's impact on the firm's books.

106) Suppose a firm has a retention ratio of 85 percent and net income of $225 million. How much does it pay out in dividends? A) $33,750,000 B) $175,000,000 C) $191,250,000 D) $225,000,000 Answer: A Explanation: Since the retention ratio is one minus the dividend payout ratio, the firm would pay out (1 − 0.85) × $225,000,000 = $33,750,000. Difficulty: 1 Easy Topic: Dividends and payout policy Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 17-02 Discuss how investors' preferences regarding differential tax rates and timing can guide the firm's policies on the distribution of dividends and capital gains. 107) Suppose a firm has a dividend payout ratio of 45 percent and net income of $500,000. What would be the annual addition to retained earnings? A) $45,000 B) $225,000 C) $275,000 D) $500,000 Answer: C Explanation: Since the dividend payout ratio is one minus the retention ratio, the firm would retain (1 − 0.45) × $500,000 = $275,000. Difficulty: 1 Easy Topic: Dividends and payout policy Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 17-02 Discuss how investors' preferences regarding differential tax rates and timing can guide the firm's policies on the distribution of dividends and capital gains.

108) Cole inherited 2,000 shares of JPW, Inc. The stock is selling in the market for $75 per share and the company is contemplating a 1-for-4 stock split. Given this information, which of the following statements is correct? A) Brady will have 500 shares and stock's price will be near $300.00. B) Brady will have 500 shares and stock's price will be near $18.75. C) Brady will have 8,000 shares and stock's price will be near $300.00. D) Brady will have 8,000 shares and stock's price will be near $18.75. Answer: A Explanation: Step 1: Number of shares = 2,000/4 × 1 = 500; Step 2: Price = $75/1 × 4 = $300.00 Difficulty: 2 Medium Topic: Stock splits Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 17-06 Differentiate between a stock dividend's impact and a stock split's impact on the firm's books. 109) Which of the following tasks require corporations to establish a definitive set of dates associated with paying out a dividend? A) the declaration date and ex-dividend date B) the record date and payment date C) Both a and b D) None of the above Answer: C Difficulty: 2 Medium Topic: Paying dividends Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 17-05 Explain the effect that cash dividend payment procedures have on stock prices.

110) is an exchange of existing shares for a different (usually large) number of "new" shares, with proportionally different par and market values. A) stock split B) stock dividend C) stock prices D) none of the above Answer: A Difficulty: 1 Easy Topic: Stock splits Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 17-06 Differentiate between a stock dividend's impact and a stock split's impact on the firm's books. 111) Which of the following is a disadvantage of a stock repurchase? A) Management may have information about good future prospects for the firm that was not previously publically announced prior to the repurchase. B) The firm ends up paying more for the shares than they are worth. C) The IRS may impose penalties on the firm if tax authorities can show that the repurchase was performed to avoid dividend taxation. D) All of the above Answer: D Difficulty: 2 Medium Topic: Stock repurchases Bloom's: Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 17-07 Note the advantages and disadvantages of a firm's stock repurchases.

Finance, 5e (Cornett) Chapter 18 Issuing Capital and the Investment Banking Process 1) Which of the following is the type of financing that includes capital funds borrowed from personal savings, friends and relatives, financial institutions such as commercial banks, or venture capitalists? A) Debt financing B) Equity financing C) Public financing D) Capital financing Answer: A Difficulty: 1 Easy Topic: Raising capital Bloom's: Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 18-01 Evaluate different methods for small firms to get funding. 2) Which of the following is the type of financing that includes capital funds invested or venture capitalists? A) Debt financing B) Equity financing C) Public financing D) Capital financing Answer: B Difficulty: 1 Easy Topic: Raising capital Bloom's: Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 18-01 Evaluate different methods for small firms to get funding.

3) Which of the following best describes the type of financing provided by government agencies such as the Small Business Administration? A) Debt financing B) Equity financing C) Public sources of financing D) Capital financing Answer: C Difficulty: 1 Easy Topic: Raising capital Bloom's: Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 18-01 Evaluate different methods for small firms to get funding. 4) Which of these is the type of loan where the firm would receive the funds as soon as the bank approved the loan? A) Loan commitment agreements B) Spot loans C) Take-down loans D) Back-end loans Answer: B Difficulty: 1 Easy Topic: Raising capital Bloom's: Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 18-01 Evaluate different methods for small firms to get funding. 5) Which of these is the type of loan where the firm borrows against pre-negotiated lines of credit or loan commitments? A) Loan commitment agreements B) Spot loans C) Take-down loans D) Back-end loans Answer: C Difficulty: 1 Easy Topic: Raising capital Bloom's: Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 18-01 Evaluate different methods for small firms to get funding.

6) Which of these is a contractual commitment to loan the firm a certain maximum amount at a given interest rate? A) Loan commitment agreements B) Spot loans C) Take-down loans D) Back-end loans Answer: A Difficulty: 1 Easy Topic: Raising capital Bloom's: Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 18-01 Evaluate different methods for small firms to get funding. 7) Which of these is the fee charged by a bank for making funds available through a loan commitment? A) Back-end (or commitment) fee B) Simple interest expense C) Discounted interest D) Up-front (or facility) fees Answer: D Difficulty: 1 Easy Topic: Raising capital Bloom's: Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 18-01 Evaluate different methods for small firms to get funding. 8) Which of these is the fee charged by a bank on any unused balances of a loan commitment line at the end of the loan commitment period? A) Back-end (or commitment) fee B) Simple interest expense C) Discounted interest D) Up-front (or facility) fees Answer: A Difficulty: 1 Easy Topic: Raising capital Bloom's: Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 18-01 Evaluate different methods for small firms to get funding.

9) Which of these is the type of loan where the firm makes fixed interest payments over the life of the loan? A) Fixed-rate loans B) Variable-rate loans C) Take-down loans D) Spot loans Answer: A Difficulty: 1 Easy Topic: Raising capital Bloom's: Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 18-01 Evaluate different methods for small firms to get funding. 10) Which of these is the type of loan where the interest payments change over the life of the loan? A) Fixed-rate loans B) Variable-rate loans C) Take-down loans D) Spot loans Answer: B Difficulty: 1 Easy Topic: Raising capital Bloom's: Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 18-01 Evaluate different methods for small firms to get funding. 11) Which of these is defined as a professionally managed pool of money used to finance new and often high-risk firms? A) Equity capital B) Debt capital C) Venture capital D) Expertise capital Answer: C Difficulty: 1 Easy Topic: Venture capital Bloom's: Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 18-02 Appreciate what venture capital is and how it encourages entrepreneurship.

12) Which of the following describes the type of venture capital firms whose sole purpose is to find and fund the most promising new firms? A) Blue chip venture capital firms B) Institutional venture capital firms C) Angel venture capitalists D) Expertise venture capitalists Answer: B Difficulty: 1 Easy Topic: Venture capital Bloom's: Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 18-02 Appreciate what venture capital is and how it encourages entrepreneurship. 13) Which of the following describes the type of venture capital firms who are wealthy individuals who make equity investments? A) Blue chip venture capital firms B) Institutional venture capital firms C) Angel venture capitalists D) Expertise venture capitalists Answer: C Difficulty: 1 Easy Topic: Venture capital Bloom's: Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 18-02 Appreciate what venture capital is and how it encourages entrepreneurship.

14) Which of the following is the firm allowing its equity, some of which was held privately by managers and venture capital investors, to be publicly traded in stock markets for the first time? A) Over the counter market transaction B) Private market transaction C) Initial public offering D) Public market transaction Answer: C Difficulty: 1 Easy Topic: Initial public offerings Bloom's: Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 18-02 Appreciate what venture capital is and how it encourages entrepreneurship. 15) Which of the following is an unsecured short-term promissory note issued by a public firm to raise short-term cash, often to finance working capital requirements? A) Initial public offering B) Angel capital C) Venture capital D) Commercial paper Answer: D Difficulty: 1 Easy Topic: Raising capital Bloom's: Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 18-03 Differentiate among sources of capital funding for public firms.

16) Which of the following is a security issue in which the investment bank guarantees the issuer a price for newly issued securities by buying the whole issue at a fixed price from the security issuer, and where the investment bank then seeks to resell the securities to investors at a higher price? A) Best efforts underwriting B) Firm commitment underwriting C) Underwriter's spread D) Venture capital Answer: B Difficulty: 2 Medium Topic: Underwriting Bloom's: Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 18-04 Trace the process by which securities are underwritten. 17) Which of the following is a security issue in which the underwriter does not guarantee a firm price to the issuer and acts more as a placing or distribution agent for a fee? A) Best efforts underwriting B) Firm commitment underwriting C) Underwriter's spread D) Venture capital Answer: A Difficulty: 2 Medium Topic: Underwriting Bloom's: Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 18-04 Trace the process by which securities are underwritten. 18) Which of the following refers to when the bond issuing firm invites bids from a number of underwriters? A) Competitive sale B) Negotiated sale C) Commercial sale D) Auction Answer: A Difficulty: 2 Medium Topic: Underwriting Bloom's: Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 18-04 Trace the process by which securities are underwritten. 7

19) Which of the following refers to when a single investment bank obtains the exclusive right to originate, underwrite, and distribute the new bonds through a one-on-one negotiation process? A) Competitive sale B) Negotiated sale C) Commercial sale D) Silent auction sale Answer: B Difficulty: 2 Medium Topic: Underwriting Bloom's: Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 18-04 Trace the process by which securities are underwritten. 20) Which of these are the markets in which corporations raise funds through new stock issues? A) Primary B) Secondary C) Commercial D) Over the counter Answer: A Difficulty: 1 Easy Topic: Primary and secondary markets Bloom's: Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 18-04 Trace the process by which securities are underwritten. 21) Which of these is defined as the compensation for the expenses and risks incurred by the investment bank to conduct primary sales of stock for a firm? A) Net proceeds B) Gross proceeds C) Underwriter's spread D) Initial public offering Answer: C Difficulty: 1 Easy Topic: Underwriting Bloom's: Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 18-04 Trace the process by which securities are underwritten.

22) Which of the following terms is defined as the group of investment banks used to help sell and distribute a new security issue? A) Take down B) Syndicate C) Underwriter's spread D) Originating house Answer: B Difficulty: 1 Easy Topic: Underwriting Bloom's: Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 18-04 Trace the process by which securities are underwritten. 23) Which of the following terms is defined as the lead bank(s) in a syndicate, who directly negotiate with the issuing firm on behalf of the syndicate? A) Take down B) Syndicator C) Underwriter's spread D) Originating house Answer: D Difficulty: 1 Easy Topic: Underwriting Bloom's: Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 18-04 Trace the process by which securities are underwritten. 24) The preliminary registration statement filed with the SEC is known as: A) shelf prospectus. B) red herring prospectus. C) SEC prospectus. D) originating prospectus. Answer: B Difficulty: 2 Medium Topic: Basics of issuing securities Bloom's: Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 18-04 Trace the process by which securities are underwritten.

25) A method of registering securities that allows firms that plan to offer multiple issues of the security over a three-year period to submit one registration statement is known as: A) shelf registration. B) shelf prospectus. C) SEC registration. D) originating registration. Answer: A Difficulty: 2 Medium Topic: Basics of issuing securities Bloom's: Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 18-04 Trace the process by which securities are underwritten. 26) You have approached your local bank for a start-up loan commitment for $1,000,000 needed to open an auto repair store. You have requested that the term of the loan be one year. Your bank has offered you the following terms: size of loan commitment = $1,000,000, term = one year, upfront fee = 20 basis points, back-end fee = 50 basis points. If you take down 90 percent of the total loan commitment, calculate the total fees you have paid on this loan commitment. A) $2,000 B) $2,500 C) $5,000 D) $6,500 Answer: B Explanation: Up-front fee Back-end fee Total

= $1,000,000 × 0.0020 = $1,000,000 × 0.0050 × 0.10

= = =

$ 2,000 500 $ 2,500

27) You have approached your local bank for a start-up loan commitment for $200,000 needed to open a computer repair store. You have requested that the term of the loan be one year. Your bank has offered you the following terms: size of loan commitment = $200,000, term = one year, up-front fee = 50 basis points, back-end fee = 80 basis points. If you take down 95 percent of the total loan commitment, calculate the total fees you have paid on this loan commitment. A) $1,000 B) $1,080 C) $1,600 D) $2,520 Answer: B Explanation: Up-front fee Back-end fee Total

= = =

$ 200,000 × $ 200,000 ×

0.0050 0.0080 ×

= 0.05 = =

$ 1,000 80 $ 1,080

28) Calculate the total fees a firm would have to pay when its bank offers the firm the following loan commitment: A loan commitment of $5,000,000 with an up-front fee of 50 basis points and a back-end fee of 20 basis points. The take-down on the loan is 80 percent. A) $10,000 B) $25,000 C) $27,000 D) $33,000 Answer: C Explanation: Up-front fee Back-end fee Total

= = =

$ 5,000,000 × $ 5,000,000 ×

0.0050 0.0020 ×

= 0.20 = =

$ 25,000 2,000 $ 27,000

Difficulty: 1 Easy Topic: Raising capital Bloom's: Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 18-01 Evaluate different methods for small firms to get funding. 29) Calculate the total fees a firm would have to pay when its bank offers the firm the following loan commitment: A loan commitment of $7,500,000 with an up-front fee of 80 basis points and a back-end fee of 50 basis points. The take-down on the loan is 60 percent. A) $37,500 B) $60,000 C) $61,500 D) $75,000 Answer: D Explanation: Up-front fee Back-end fee Total

= = =

$ 7,500,000 × $ 7,500,000 ×

0.0080 0.0050 ×

= 0.40 = =

$ 60,000 15,000 $ 75,000

30) WuShock, Inc., needs to raise $500 million to finance its plan for nationwide expansion. In discussions with its investment bank, WuShock learns that the bankers recommend an offer price (or gross price) of $50 per share and they will charge an underwriter's spread of $2.00 per share. Calculate the net proceeds to WuShock from the sale of stock. How many shares of stock will WuShock need to sell in order to receive the $500 million they need? A) 10,000,000 B) 10,416,667 C) 250,000,000 D) 500,000,000 Answer: B Explanation: Net proceeds = Gross proceeds − Underwriter's spread = $50 − $2.00 = $48.00 Funds needed = $500 million = $48.00 × Number of shares sold => Number of shares sold = $500 million/$48.00 = 10,416,666.67 shares Difficulty: 1 Easy Topic: Costs of issuing securities Bloom's: Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 18-04 Trace the process by which securities are underwritten. 31) Wildcat, Inc., needs to raise $750 million to finance its plan for nationwide expansion. In discussions with its investment bank, Wildcat learns that the bankers recommend an offer price (or gross price) of $25 per share and they will charge an underwriter's spread of $1.50 per share. Calculate the net proceeds to Wildcat from the sale of stock. How many shares of stock will Wildcat need to sell in order to receive the $750 million they need? A) 30,000,000 B) 31,914,894 C) 500,000,000 D) 750,000,000 Answer: B Explanation: Net proceeds = Gross proceeds − Underwriter's spread = $25 − $1.50 = $23.50 Funds needed = $750 million = $23.50 × Number of shares sold => Number of shares sold = $750 million/$23.50 = 31,914,893.62 shares Difficulty: 1 Easy Topic: Costs of issuing securities Bloom's: Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 18-04 Trace the process by which securities are underwritten.

32) Blue Dragon, Inc., needs to raise $600 million to finance its plan for nationwide expansion. In discussions with its investment bank, Blue Dragon learns that the bankers recommend an offer price (or gross price) of $60 per share and they will charge an underwriter's spread of $3.00 per share. Calculate the net proceeds to Blue Dragon from the sale of stock. How many shares of stock will Blue Dragon need to sell in order to receive the $600 million they need? A) 10,000,000 B) 10,526,316 C) 200,000,000 D) 600,000,000 Answer: B Explanation: Net proceeds = Gross proceeds − Underwriter's spread = $60 − $3.00 = $57.00 Funds needed = $600 million = $57.00 × Number of shares sold => Number of shares sold = $600 million/$57.00 = 10,526,315.79 shares Difficulty: 1 Easy Topic: Costs of issuing securities Bloom's: Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 18-04 Trace the process by which securities are underwritten. 33) Paige's Purses, Inc., needs to raise $25 million to finance plant expansion. In discussions with its investment bank, Paige's Purses learns that the bankers recommend an offer price (or gross proceeds) of $50 per share and Paige's Purses will receive $45 per share. What is the underwriter's spread on the issue? A) $5 B) $45 C) $50 D) $0 Answer: A Explanation: Underwriter's spread = Gross proceeds − Net proceeds = $50 − $45 = $5 Difficulty: 1 Easy Topic: Costs of issuing securities Bloom's: Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 18-04 Trace the process by which securities are underwritten.

34) Amy's Accessories, Inc., needs to raise $10 million to finance plant expansion. In discussions with its investment bank, Amy's Accessories learns that the bankers recommend an offer price (or gross proceeds) of $25 per share and Amy's Accessories will receive $23 per share. What is the underwriter's spread on the issue? A) $0 B) $2 C) $23 D) $25 Answer: B Explanation: Underwriter's spread = Gross proceeds − Net proceeds = $25 − $23 = $2 Difficulty: 1 Easy Topic: Costs of issuing securities Bloom's: Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 18-04 Trace the process by which securities are underwritten. 35) Tennis Games, Inc., with the help of its investment bank recently issued $25 million of new debt. The offer price (and face value) on the debt was $1,000 per bond and the underwriter's spread was 8 percent of the gross proceeds. What is the amount of capital funding Tennis Games raised through this debt offering? A) $1,000 B) $2 million C) $23 million D) $25 million Answer: C Explanation: Underwriter's fees = 0.08 × $25m = $2 million => Funds received by Tennis Games = $25 million − $2 million = $23 million Difficulty: 1 Easy Topic: Costs of issuing securities Bloom's: Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 18-04 Trace the process by which securities are underwritten.

36) Soccer Games, Inc., with the help of its investment bank recently issued $10 million of new debt. The offer price (and face value) on the debt was $1,000 per bond and the underwriter's spread was 5 percent of the gross proceeds. What is the amount of capital funding Soccer Games raised through this debt offering? A) $1,000 B) $0.5 million C) $9.5 million D) $10 million Answer: C Explanation: Underwriter's fees = 0.05 × $10m = $500,000 => Funds received by Soccer Games = $10 million − $500,000 = $9.5 million Difficulty: 1 Easy Topic: Costs of issuing securities Bloom's: Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 18-04 Trace the process by which securities are underwritten. 37) Basketball Games, Inc., with the help of its investment bank recently issued $5 million of new debt. The offer price (and face value) on the debt was $1,000 per bond and the underwriter's spread was 6 percent of the gross proceeds. What is the amount of capital funding Basketball Games raised through this debt offering? A) $1,000 B) $0.30 million C) $4.7 million D) $5 million Answer: C Explanation: Underwriter's fees = 0.06 × $5m = $0.3 million => Funds received by Basketball Games = $5 million − $0.30 million = $4.7 million Difficulty: 1 Easy Topic: Costs of issuing securities Bloom's: Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 18-04 Trace the process by which securities are underwritten.

38) Just Add Water, Inc., with the help of its investment bank recently issued $200,000,000 of new debt. The offer price on the debt was $1,000 per bond and the underwriter's spread was 4 percent of the gross proceeds. What amount of capital funding did Just Add Water raise through this bond issue? A) $1,000 B) $8,000,000 C) $192,000,000 D) $200,000,000 Answer: C Explanation: Underwriter's fees = 0.04 × $200,000,000 = $8,000,000 => Funds received by Just Add Water = $200,000,000 − $8,000,000 = $192,000,000 Difficulty: 1 Easy Topic: Costs of issuing securities Bloom's: Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 18-04 Trace the process by which securities are underwritten. 39) You have approached your local bank for a start-up loan commitment for $1,000,000 needed to open a car repair store. You have requested that the term of the loan be one year. Your bank has offered you the following terms: size of loan commitment = $1,000,000, term = one year, upfront fee = 20 basis points, back-end fee = 50 basis points, and rate on the loan = 9 percent. If you immediately take down $750,000 and no more during the year, what is the total interest and fees you have paid on this loan commitment? A) $70,250 B) $70,750 C) $74,500 D) $93,250 Answer: B Explanation: Up-front fees Interest income Back-end fee Total interest and fees

= = =

0.0020 × 0.09 × 0.0050 ×

$ 1,000,000 = $ 750,000 = $ 250,000 = =

2,000 67,500 1,250 $ 70,750

40) You have approached your local bank for a start-up loan commitment for $500,000 needed to open a furniture repair store. You have requested that the term of the loan be one year. Your bank has offered you the following terms: size of loan commitment = $500,000, term = one year, up-front fee = 30 basis points, back-end fee = 60 basis points, and rate on the loan = 10 percent. If you immediately take down $250,000 and no more during the year, what is the total interest and fees you have paid on this loan commitment? A) $27,250 B) $28,000 C) $29,500 D) $53,000 Answer: B Explanation: Up-front fees Interest income Back-end fee Total interest and fees

= = =

0.0030 × 0.10 × 0.0060 ×

$ 500,000 = $ 250,000 = $ 250,000 = =

1,500 25,000 1,500 $ 28,000

Difficulty: 2 Medium Topic: Raising capital Bloom's: Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 18-01 Evaluate different methods for small firms to get funding. 41) Starr Co. has been approved for a $100,000 loan commitment from its local bank. The bank has offered the following terms: term = one year, up-front fee = 75 basis points, back-end fee = 25 basis points, and rate on the loan = 8.00 percent. Starr expects to immediately take down $80,000 and no more during the year unless there is some unforeseen need. What is the total interest and fees Starr can expect to pay on this loan commitment? A) $7,050 B) $7,175 C) $7,200 D) $7,400 Answer: C Explanation: Upfront = 0.0075 × $100,000, Interest Income = 0.08 × $80,000; Back-end fee = 0.0025 × 20,000 Difficulty: 2 Medium Topic: Raising capital Bloom's: Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation 18

Learning Goal: 18-01 Evaluate different methods for small firms to get funding.

42) Home Improvement, Inc., needs to raise $2 million to finance plant expansion. In discussions with its investment bank, Home Improvement learns that the bankers recommend a debt issue with gross proceeds of $1,000 per bond and they will charge an underwriter's spread of 7 percent of the gross proceeds. How many bonds will Home Improvement need to sell in order to receive the $2 million they need? A) 2,140 B) 2,151 C) 2,150,537 D) 2,140,000 Answer: B Explanation: Funds received by Home = issue size − (0.07 × issue size) = $2,000,000 = issue size (1 − 0.07) => issue size = $2,000,000/(1 − 0.07) = $2,150,537.634 => number of bonds = $2,150,537.634/$1,000 = 2,150.537634 or 2,151 Difficulty: 2 Medium Topic: Costs of issuing securities Bloom's: Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 18-04 Trace the process by which securities are underwritten. 43) American Movers, Inc., needs to raise $5 million to finance an expansion. In discussions with its investment bank, American learns that the bankers recommend a debt issue with gross proceeds of $1,000 per bond and they will charge an underwriter's spread of 5 percent of the gross proceeds. How many bonds will American Movers need to sell in order to receive the $5 million they need? A) 4,750 B) 5,000 C) 5,250 D) 5,264 Answer: D Explanation: Funds received by Home = issue size − (0.05 × issue size) = $5,000,000 = issue size (1 − 0.05) => issue size = $5,000,000/(1 − 0.05) = $5,263,157.895 => number of bonds = $5,263,157.895/$1,000 = 5,263.157895 or 5,264 Difficulty: 2 Medium Topic: Costs of issuing securities Bloom's: Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 18-04 Trace the process by which securities are underwritten.

44) Roy's Bar, Inc., needs to raise $25 million to finance firm expansion. In discussions with its investment bank, Roy's learns that the bankers recommend a debt issue with an offer price of $1,000 per bond and they will charge an underwriter's spread of 6 percent of the gross price. How many bonds will Roy's need to sell in order to receive the $25 million they need? A) 23,500 B) 25,000 C) 26,500 D) 26,596 Answer: D Explanation: Funds received by Roy's = issue size − (0.06 × issue size) = $25,000,000 = issue size (1 − 0.06) => issue size = $25,000,000/(1 − 0.06) = $26,595,744.68 => number of bonds = $26,595,744.68/$1,000 = 26,595.74468 or 26,596 Difficulty: 2 Medium Topic: Costs of issuing securities Bloom's: Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 18-04 Trace the process by which securities are underwritten. 45) R&D, Inc., needs to raise $200 million to finance firm expansion. In discussions with its investment bank, R&D's learns that the bankers recommend a debt issue with an offer price of $1,000 per bond and they will charge an underwriter's spread of 3 percent of the gross price. How many bonds will R&D need to sell in order to receive the $200 million they need? A) 194,000 B) 200,000 C) 206,000 D) 206,186 Answer: D Explanation: Funds received by R&D = issue size − (0.03 × issue size) = $200,000,000 = issue size (1 − 0.03) => issue size = $200,000,000/(1 − 0.03) = $206,185,567 => number of bonds = $206,185,567/$1,000 = 206,185.567 or 206,186 Difficulty: 2 Medium Topic: Costs of issuing securities Bloom's: Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 18-04 Trace the process by which securities are underwritten.

46) Video Games, Inc., with the help of its investment bank recently issued 10 million shares of new stock. The offer price on the stock was $47.50 per share and Video Games received a total of $446,500,000 through this stock offering. Calculate the net proceeds and the underwriter's spread on the stock offering. What percentage of the gross price is the investment bank charging Video Games for underwriting the stock issue? A) 3 percent B) 30 percent C) 6 percent D) 9 percent Answer: C Explanation: Net proceeds = $446,500,000/10,000,000 = $44.65 Gross funds received = $47.50 × 10,000,000 = $475,000,000 Underwriter's funds = $475,000,000 − $446,500,000 = $28,500,000 => Underwriter's spread = $28,500,000/10,000,000 = $2.85 Investment bank's percentage of gross = $2.85/$47.50 = 0.06 or 6 percent Difficulty: 2 Medium Topic: Costs of issuing securities Bloom's: Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 18-04 Trace the process by which securities are underwritten. 47) Volleyball Gear, Inc., with the help of its investment bank recently issued 1.5 million shares of new stock. The offer price on the stock was $18.50 per share and Volleyball Gear received a total of $26,917,500 through this stock offering. Calculate the net proceeds and the underwriter's spread on the stock offering. What percentage of the gross price is the investment bank charging Volleyball Gear for underwriting the stock issue? A) 3 percent B) 4.5 percent C) 6 percent D) 9 percent Answer: A Explanation: Net proceeds = $26,917,500/1,500,000 = $17.945 Gross funds received = $18.50 × 1,500,000 = $27,750,000 Underwriter's funds = $27,750,000 − $26,917,500 = $832,500 => Underwriter's spread = $832,500/1,500,000 = $0.555 Investment bank's percentage of gross = $0.555/$18.50 = 0.03 or 3 percent Difficulty: 2 Medium Topic: Costs of issuing securities Bloom's: Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 18-04 Trace the process by which securities are underwritten.

48) Polly's Ponies, Inc., with the help of its investment bank recently issued 7.5 million shares of new stock. The offer price on the stock was $15.00 per share and Polly's Ponies received a total of $105.75 million from the stock offering. Calculate the net proceeds and the underwriter's spread charged by the underwriter to Polly's Ponies. What percentage of the gross proceeds is the investment bank charging Polly's Ponies for underwriting the stock issue? A) 3 percent B) 6 percent C) 9 percent D) 94 percent Answer: B Explanation: Net proceeds = $105,750,000/7,500,000 = $14.10 Gross funds received = $15.00 × 7,500,000 = $112,500,000 Underwriter's funds = $112,500,000 − $105,750,000 = $6,750,000 => Underwriter's spread = $6,750,000/7,500,000 = $0.90 Investment bank's percentage of gross = $0.90/$15.00 = 0.06 or 6 percent Difficulty: 2 Medium Topic: Costs of issuing securities Bloom's: Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 18-04 Trace the process by which securities are underwritten. 49) Saddles and Bridles, Inc., with the help of its investment bank recently issued 3 million shares of new stock. The offer price on the stock was $23.50 per share and Saddles and Bridles received a total of $68.385 million from the stock offering. Calculate the net proceeds and the underwriter's spread charged by the underwriter to Saddles and Bridles. What percentage of the gross proceeds is the investment bank charging Saddles and Bridles for underwriting the stock issue? A) 3 percent B) 6 percent C) 9 percent D) 97 percent Answer: A Explanation: Net proceeds = $68,385,000/3,000,000 = $22.795 Gross funds received = $23.50 × 3,000,000 = $70,500,000 Underwriter's funds = $70,500,000 − $68,385,000 = $2,115,000 => Underwriter's spread = $2,115,000/3,000,000 = $0.705 Investment bank's percentage of gross = $0.705/$23.50 = 0.03 or 3 percent Difficulty: 2 Medium Topic: Costs of issuing securities Bloom's: Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 18-04 Trace the process by which securities are underwritten. 23

50) Turbo Technology Corp. recently went public with an initial public offering of 3 million shares of stock. The underwriter used a firm commitment offering in which the net proceeds was $7.50 per share and the underwriter's spread was 9 percent of the gross proceeds. Turbo Technology also paid legal and other administrative costs of $200,000 for the IPO. Calculate the gross proceeds per share received by Turbo Technology from the sale of the 3 million shares of stock. A) $7.50 B) $7.57 C) $8.24 D) $8.32 Answer: D Explanation: 3,000,000 × $7.50 = $22,500,000 = Total funds received by Turbo Technology Legal and other administrative expenses per share = $200,000/3,000,000 = $0.0667 Underwriter's spread + Net proceeds = Gross proceeds => ((0.09 × Gross proceeds) + $0.0667) + $7.50 = Gross proceeds => Gross proceeds − (0.09 × Gross proceeds) = 7.50 + $0.0667 => Gross proceeds = $7.5667/(1 − 0.09) = $8.315 Difficulty: 2 Medium Topic: Costs of issuing securities Bloom's: Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 18-04 Trace the process by which securities are underwritten.

51) Computer Technology Corp. recently went public with an initial public offering of 7 million shares of stock. The underwriter used a firm commitment offering in which the net proceeds was $8.35 per share and the underwriter's spread was 7 percent of the gross proceeds. Computer Technology also paid legal and other administrative costs of $300,000 for the IPO. Calculate the gross proceeds per share received by Computer Technology from the sale of the 7 million shares of stock. A) $8.35 B) $8.39 C) $8.98 D) $9.02 Answer: D Explanation: 7,000,000 × $8.35 = $58,450,000 = Total funds received by Computer Technology Legal and other administrative expenses per share = $300,000/7,000,000 = $0.04 Underwriter's spread + Net proceeds = Gross proceeds => ((0.07 × Gross proceeds) + $0.04) + $8.35 = Gross proceeds => Gross proceeds − (0.07 × Gross proceeds) = 8.35 + $0.04 => Gross proceeds = $8.39/(1 − 0.07) = $9.02 Difficulty: 2 Medium Topic: Costs of issuing securities Bloom's: Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 18-04 Trace the process by which securities are underwritten.

52) TV Technology Corp. recently went public with an initial public offering of 1.5 million shares of stock. The underwriter used a firm commitment offering in which the net proceeds was $24.50 per share and the underwriter's spread was 5 percent of the gross proceeds. TV Technology also paid legal and other administrative costs of $300,000 for the IPO. Calculate the gross proceeds per share received by TV Technology from the sale of the 1.5 million shares of stock. A) $24.50 B) $24.70 C) $25.79 D) $26.00 Answer: D Explanation: 1,500,000 × $24.50 = $36,750,000 = Total funds received by TV Technology Legal and other administrative expenses per share = $300,000/1,500,000 = $0.20 Underwriter's spread + Net proceeds = Gross proceeds => ((0.05 × Gross proceeds) + $0.20) + $24.50 = Gross proceeds => Gross proceeds − (0.05 × Gross proceeds) = 24.50 + $0.20 => Gross proceeds = $24.70/(1 − 0.05) = $26 Difficulty: 2 Medium Topic: Costs of issuing securities Bloom's: Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 18-04 Trace the process by which securities are underwritten.

53) Mick E Inc. plans to issue 25 million new shares of its stock. In discussions with its investment bank, Mick E learns that the bankers recommend a net proceed of $29.80 per share and they will charge an underwriter's spread of 8.5 percent of the gross proceeds. In addition, Mick E must pay $3 million in legal and other administrative expenses for the seasoned stock offering. Calculate the gross proceeds per share received by Mick E from the sale of the 25 million shares of stock. A) $29.80 B) $32.45 C) $32.57 D) $32.70 Answer: D Explanation: 25,000,000 × $29.80 = $745,000,000 = Total funds received by Mick E Legal and other administrative expenses per share = $3,000,000/25,000,000 = $0.12 Underwriter's spread + Net proceeds = Gross proceeds => ((0.085 × Gross proceeds) + $0.12) + $29.80 = Gross proceeds => Gross proceeds − (0.085 × Gross proceeds) = 29.80 + $0.12 => Gross proceeds = $29.92/(1 − 0.085) = $32.69945 Difficulty: 2 Medium Topic: Costs of issuing securities Bloom's: Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 18-04 Trace the process by which securities are underwritten.

54) During the last year you have had a loan commitment from your bank to fund inventory purchases for your small business. The total line available was $500,000, of which you took down $400,000. It is now the end of the loan commitment period and your bank is asking you to pay the back-end fees. You have misplaced the paperwork that listed the terms of the commitment, but you know you paid total fees (this does not include any interest paid to borrow the $400,000) of $1,750 on this loan commitment. You remember that the up-front fee was 25 basis points. What is the back-end fee on this loan commitment? A) 5 basis points B) 50 basis points C) 10 basis points D) 20 basis points Answer: B Explanation: Up-front fees Back-end fee Total fees

= = =

0.0025 × 1,750 −

$ 500,000 = 1,250 = =

$ 1,250 500 $ 1,750

=> Back-end fee = $500/($500,000 − $400,000) = 0.005 = 50 basis points Difficulty: 3 Hard Topic: Raising capital Bloom's: Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 18-01 Evaluate different methods for small firms to get funding.

55) During the last year you have had a loan commitment from your bank to fund inventory purchases for your small business. The total line available was $500,000, of which you took down $300,000. It is now the end of the loan commitment period and your bank is asking you to pay the back-end fees. You have misplaced the paperwork that listed the terms of the commitment, but you know you paid total fees (this does not include any interest paid to borrow the $300,000) of $5,000 on this loan commitment. You remember that the up-front fee was 75 basis points. What is the back-end fee on this loan commitment? A) 6 basis points B) 62.5 basis points C) 75 basis points D) 2.5 basis points Answer: B Explanation: Up-front fees Back-end fee Total fees

= = =

0.0075 × 5,000 −

$ 500,000 = 3,750 = =

$ 3,750 1,250 $ 5,000

Back-end fee = $1,250/($500,000 − $300,000) = 0.00625 = 62.5 basis points Difficulty: 3 Hard Topic: Raising capital Bloom's: Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 18-01 Evaluate different methods for small firms to get funding.

30) During the last year you have had a loan commitment from your bank to fund working capital for your business. The total line available was $2,500,000, of which you took down $1,000,000. It is now the end of the loan commitment period and your bank is asking you to pay the back-end fees. You have misplaced the paperwork that listed the terms of the commitment, but you know you paid total fees (this does not include any interest paid to borrow the $1,000,000) of $15,000 on this loan commitment. You remember that the back-end fee was 30 basis points. Calculate the front-end fee on this loan commitment. A) 30 basis points B) 42 basis points C) 60 basis points D) 70 basis points Answer: B Explanation: Up-front = fees Back-end fee =

15,000 −

$4,500

0.003 ×

($ 2,500,000 −

$ 1,000,000)

Total interest and fees

$10,500

4,500

$ 15,000

=> front-end fee = $10,500/2,500,000 = 0.0042 = 42 basis points

Difficulty: 3 Hard Topic: Raising capital Bloom's: Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 18-01 Evaluate different methods for small firms to get funding.

31) During the last year you have had a loan commitment from your bank to fund working capital for your business. The total line available was $25,000,000, of which you took down $20,000,000. It is now the end of the loan commitment period and your bank is asking you to pay the back-end fees. You have misplaced the paperwork that listed the terms of the commitment, but you know you paid total fees (this does not include any interest paid to borrow the $20,000,000) of $110,000 on this loan commitment. You remember that the back-end fee was 60 basis points. Calculate the front-end fee on this loan commitment. A) 60 basis points B) 32 basis points C) 40 basis points D) 16 basis points Answer: B Explanation: Up-front = $ 110,000 − fees Back-end fee= 0.006 ×

$30,000 ($ 25,000,000 −

= $ 20,000,000)

Total interest and fees

= =

80,000 30,000

110,000

=> front-end fee = $80,000/25,000,000 = 0.0032 = 32 basis points Difficulty: 3 Hard Topic: Raising capital Bloom's: Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 18-01 Evaluate different methods for small firms to get funding.

58) Your company needs to raise $4 million to finance plant expansion. In discussions with its investment bank, you learn that the bankers recommend a gross price of $50 per share and that 90,000 shares of stock be sold. If the net proceeds on the stock sale leaves your company with $4 million, what is the underwriter's spread per share on the stock issue? A) $2.78 B) $5.55 C) $44.44 D) $38.89 Answer: B Explanation: $50 × 90,000 = $4,500,000 = Gross funds received from sale $4,500,000 − $4,000,000 = $500,000 = Underwriter's funds received => Underwriter's spread = $500,000/90,000 = $5.55 Difficulty: 3 Hard Topic: Costs of issuing securities Bloom's: Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 18-04 Trace the process by which securities are underwritten. 59) Your company needs to raise $10 million to finance plant expansion. In discussions with its investment bank, you learn that the bankers recommend a gross price of $45 per share and that 240,000 shares of stock be sold. If the net proceeds on the stock sale leave your company with $10 million, what is the underwriter's spread per share on the stock issue? A) $3.33 B) $6.66 C) $45.00 D) $41.67 Answer: A Explanation: $45 × 240,000 = $10,800,000 = Gross funds received from sale $10,800,000 − $10,000,000 = $800,000 = Underwriter's funds received => Underwriter's spread = $800,000/240,000 = $3.33 Difficulty: 3 Hard Topic: Costs of issuing securities Bloom's: Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 18-04 Trace the process by which securities are underwritten.

60) Your company needs to raise $50 million to finance plant expansion. In discussions with its investment bank, you learn that the bankers recommend a gross price of $75 per share and that 675,000 shares of stock be sold. If the net proceeds on the stock sale leave your company with $50 million, what is the underwriter's spread per share on the stock issue? A) $0.93 B) $1.85 C) $6.67 D) $9.00 Answer: A Explanation: $75 × 675,000 = $50,625,000 = Gross funds received from sale $50,625,000 − $50,000,000 = $625,000 = Underwriter's funds received => Underwriter's spread = $625,000/675,000 = $0.9259 Difficulty: 3 Hard Topic: Costs of issuing securities Bloom's: Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 18-04 Trace the process by which securities are underwritten. 61) Sandal Etc., Inc., needs to raise $49 million to finance firm expansion. In discussions with its investment bank, Sandals learns that the bankers recommend an offer price of $25 per share and that 2 million shares of stock be sold. If the net proceeds on the stock sale leaves Sandal with $49 million, what is the underwriter's spread per share on the stock issue? A) $0.50 B) $1.00 C) $2.90 D) $2.00 Answer: A Explanation: $25 × 2,000,000 = $50,000,000 = Gross funds received from sale $50,000,000 − $49,000,000 = $1,000,000 = Underwriter's funds received => Underwriter's spread = $1,000,000/2,000,000 = $0.50 Difficulty: 3 Hard Topic: Costs of issuing securities Bloom's: Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 18-04 Trace the process by which securities are underwritten.

62) TriState Corp. recently went public with an initial public offering in which they received a total of $50 million in new capital funding. The underwriter used a firm commitment offering in which the offer price was $30 and the underwriter's spread was $1.50. TriState also paid legal and other administrative costs of $950,000 for the IPO. What is the number of shares issued through this IPO? A) 1,698,333 B) 1,787,720 C) 1,754,386 D) 1,666,667 Answer: B Explanation: Net proceeds (not including legal and other administrative expenses) = $30 − $1.50 = $28.50 Funds received from sale plus legal and other administrative expenses = $50,950,000 Shares sold = $50,950,000/$28.50 = 1,787,719.298 Difficulty: 3 Hard Topic: Costs of issuing securities Bloom's: Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 18-04 Trace the process by which securities are underwritten. 63) Plains Corp. recently went public with an initial public offering in which they received a total of $25 million in new capital funding. The underwriter used a firm commitment offering in which the offer price was $25 and the underwriter's spread was $1.00. Plains also paid legal and other administrative costs of $800,000 for the IPO. What is the number of shares issued through this IPO? A) 1,075,000 B) 1,041,667 C) 1,032,000 D) 1,008,334 Answer: A Explanation: Net proceeds (not including legal and other administrative expenses) = $25.00 − $1.00 = $24.00 Funds received from sale plus legal and other administrative expenses = $25,800,000 Shares sold = $25,800,000/$24.00 = 1,075,000 Difficulty: 3 Hard Topic: Costs of issuing securities Bloom's: Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 18-04 Trace the process by which securities are underwritten.

64) River Valley Corp. recently went public with an initial public offering in which they received a total of $40 million in new capital funding. The underwriter used a firm commitment offering in which the offer price was $10 and the underwriter's spread was $0.50. River Valley also paid legal and other administrative costs of $750,000 for the IPO. What is the number of shares issued through this IPO? A) 3,925,000 B) 4,131,579 C) 4,075,000 D) 4,289,474 Answer: D Explanation: Net proceeds (not including legal and other administrative expenses) = $10 − $0.50 = $9.50 Funds received from sale plus legal and other administrative expenses = $40,750,000 Shares sold = $40,750,000/$9.50 = 4,289,473.684 Difficulty: 3 Hard Topic: Costs of issuing securities Bloom's: Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 18-04 Trace the process by which securities are underwritten. 65) Paige's Purses, Inc., needs to raise $30 million in new capital funding from a seasoned equity offering. In discussions with its investment bank, Paige's Purses learns that the bankers recommend a gross price of $25.00 per share and they will charge an underwriter's spread of $2.00 of the gross price. In addition, Paige's Purses must pay $2 million in legal and other administrative expenses for the seasoned stock offering. What is the number of shares of stock that Paige's Purses will need to sell to raise the $30 million? A) 1,391,305 B) 1,280,000 C) 1,120,000 D) 1,127,392 Answer: A Explanation: Net proceeds (not including legal and other administrative expenses) = $25.00 − $2.00 = $23.00 Funds received from sale plus legal and other administrative expenses = $32,000,000 Shares sold = $32,000,000/$23.00 = 1,391,304.348 Difficulty: 3 Hard Topic: Costs of issuing securities Bloom's: Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 18-04 Trace the process by which securities are underwritten.

66) Beach Stuff, Inc., needs to raise $10 million in new capital funding from a seasoned equity offering. In discussions with its investment bank, Beach Stuff learns that the bankers recommend a gross price of $20.00 per share and they will charge an underwriter's spread of $1.75 of the gross price. In addition, Beach Stuff must pay $1.5 million in legal and other administrative expenses for the seasoned stock offering. What is the number of shares of stock that Beach Stuff will need to sell to raise the $10 million? A) 630,137 B) 575,000 C) 500,000 D) 547,946 Answer: A Explanation: Net proceeds (not including legal and other administrative expenses) = $20.00 − $1.75 = $18.25 Funds received from sale plus legal and other administrative expenses = $11,500,000 Shares sold = $11,500,000/$18.25 = 630,136.9863 Difficulty: 3 Hard Topic: Costs of issuing securities Bloom's: Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 18-04 Trace the process by which securities are underwritten. 67) You have approached your local bank for a start-up loan commitment for $175,000 needed to open a computer repair store. You have requested that the term of the loan be one year. Your bank has offered you the following terms: size of loan commitment = $175,000, term = one year, up-front fee = 75 basis points, back-end fee = 80 basis points. If you take down 75 percent of the total loan commitment, calculate the total fees you have paid on this loan commitment. A) $2,712.50 B) $1,312.50 C) $1,550.00 D) $1,662.50 Answer: D Explanation: Step 1: Up-front fee = $175,000(0.0075) = $1,312.50; Step 2: Back-end fee = $175,000(0.008) × 0.25 = $350; Step 3: Total fees = $1,312.50 + $350 = $1,662.50 Difficulty: 1 Easy Topic: Raising capital Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 18-01 Evaluate different methods for small firms to get funding.

68) Calculate the total fees a firm would have to pay when its bank offers the firm the following loan commitment: A loan commitment of $1,500,000 with an up-front fee of 95 basis points and a back-end fee of 25 basis points. The take-down on the loan is 50 percent. A) $15,550 B) $16,125 C) $18,125 D) $15,955 Answer: B Explanation: Step 1: Up-front fee = $1,500,000(0.0095) = $14,250; Step 2: Back-end fee = $1,500,000(0.0025) × 0.5 = $1,875; Step 3: Total fees = $14,250 + $1,875 = $16,125 Difficulty: 1 Easy Topic: Raising capital Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 18-01 Evaluate different methods for small firms to get funding. 69) Husker's Tuxedos, Inc., needs to raise $135 million to finance its plan for nationwide expansion. In discussions with its investment bank, Husker's learns that the bankers recommend an offer price (or gross price) of $43.55 per share and they will charge an underwriter's spread of $2.25 per share. Calculate the net proceeds to Husker's from the sale of stock. How many shares of stock will Husker's need to sell in order to receive the $135 million they need? A) 3,702,742 shares B) 1,965,591 shares C) 2,857,905 shares D) 3,268,766 shares Answer: D Explanation: Step 1: Net proceeds = Gross proceeds − Underwriter's spread = 43.55 − 2.25 = $41.3; Step 2: Number of shares sold = $135m/41.3 = 3,268,766 Difficulty: 1 Easy Topic: Costs of issuing securities Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 18-04 Trace the process by which securities are underwritten.

70) Don's Captain Morgan, Inc., needs to raise $25.5 million to finance plant expansion. In discussions with its investment bank, Don's Captain Morgan learns that the bankers recommend an offer price (or gross proceeds) of $19 per share and Don's Captain Morgan will receive $14.50 per share. How many shares of stock will Don's Captain Morgan need to sell in order to receive the $25.5 million they need? A) 1,758,621 shares B) 2,093,618 shares C) 1,068,966 shares D) 1,347,113 shares Answer: A Explanation: Number of shares sold = 25.5m/14.5 = 1,758,621 shares Difficulty: 1 Easy Topic: Costs of issuing securities Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 18-04 Trace the process by which securities are underwritten. 71) Kelly Girl's Golf Games, Inc., with the help of its investment bank recently issued $7.95 million of new debt. The offer price (and face value) on the debt was $1,000 per bond and the underwriter's spread was 4 percent of the gross proceeds. Calculate the amount of capital funding Kelly Girl's Golf Games raised through this debt offering. A) $6,992,500 B) $7,632,000 C) $8,281,300 D) $8,794,200 Answer: B Explanation: $7.95m − (0.04)($7.95m) = $7.6320m Difficulty: 1 Easy Topic: Costs of issuing securities Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 18-04 Trace the process by which securities are underwritten.

72) Bailey's Dog Pens, Inc., with the help of its investment bank recently issued $165,500,000 of new debt. The offer price on the debt was $1,000 per bond and the underwriter's spread was 7 percent of the gross proceeds. Calculate the amount of capital funding Bailey's Dog Pens raised through this bond issue. A) $159,915,000 B) $151,915,000 C) $153,915,000 D) $150,915,000 Answer: C Explanation: $165,500,000 − 0.07(165,500,000) = $153,915,000 Difficulty: 1 Easy Topic: Costs of issuing securities Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 18-04 Trace the process by which securities are underwritten. 73) You have approached your local bank for a start-up loan commitment for $290,000 needed to open a computer repair store. You have requested that the term of the loan be one year. Your bank has offered you the following terms: size of loan commitment = $290,000, term = one year, up-front fee = 45 basis points, back-end fee = 80 basis points, and rate on the loan = 9.5 percent. If you immediately take down $175,000 and no more during the year, calculate the total interest and fees you have paid on this loan commitment. A) $17,995 B) $18,850 C) $19,125 D) $18,295 Answer: B Explanation: (0.0045 × 290,000) + 0.095 × 175,000 + [0.008 × (290,000 − 175,000)] = $18,850 Difficulty: 2 Medium Topic: Raising capital Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 18-01 Evaluate different methods for small firms to get funding.

74) Casey's One Stop has been approved for a $55,000 loan commitment from its local bank. The bank has offered the following terms: term = one year, up-front fee = 85 basis points, backend fee = 35 basis points, and rate on the loan = 9.75 percent. Casey's expects to immediately take down $45,000 and no more during the year unless there is some unforeseen need. Calculate the total interest and fees Casey's One Stop can expect to pay on this loan commitment. A) $5,050 B) $5,115 C) $4,890 D) $4,650 Answer: C Explanation: (0.0085 × 55,000) + 0.0975 × 45,000 + [0.0035 × (55,000 − 45,000)] = $4,890 Difficulty: 2 Medium Topic: Raising capital Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 18-01 Evaluate different methods for small firms to get funding. 75) Sipe's Paint and Wallpaper, Inc., needs to raise $1.25 million to finance plant expansion. In discussions with its investment bank, Sipe's Paint and Wallpaper learns that the bankers recommend a debt issue with gross proceeds of $1,000 per bond and they will charge an underwriter's spread of 8.25 percent of the gross proceeds. How many bonds will Sipe's Paint and Wallpaper need to sell in order to receive the $1.25 million they need? A) 1,417 B) 1,363 C) 1,162 D) 1,298 Answer: B Explanation: $1,250,000/(1 − 0.0825)/$1,000 = 1,362.40 or 1,363 Difficulty: 2 Medium Topic: Costs of issuing securities Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 18-04 Trace the process by which securities are underwritten.

76) Renee's Boutique, Inc., needs to raise $300 million to finance firm expansion. In discussions with its investment bank, Renee's Boutique learns that the bankers recommend a debt issue with an offer price of $1,000 per bond and they will charge an underwriter's spread of 7.125 percent of the gross price. How many bonds will Renee's Boutique need to sell in order to receive the $300 million they need? A) 302,396 B) 329,048 C) 316,947 D) 323,015 Answer: D Explanation: $300,000,000/(1 − 0.07125)/$1,000 = 323,014.80 or 323,015 Difficulty: 2 Medium Topic: Costs of issuing securities Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 18-04 Trace the process by which securities are underwritten. 77) Kelly Girl's Golf Games, Inc., with the help of its investment bank recently issued 1.5 million shares of new stock. The offer price on the stock was $36.25 per share and Kelly Girl's Golf Games received a total of $50,000,000 through this stock offering. Calculate the net proceeds and the underwriter's spread on the stock offering. What percentage of the gross price is the investment bank charging Kelly Girl's Golf Games for underwriting the stock issue? A) 7.39 percent B) 7.64 percent C) 7.12 percent D) 8.05 percent Answer: D Explanation: $50m/1.5m = $33.33 = net per share; (36.25-33.33)/36.25 = 0.0806 or 8.06 percent = percentage charged Difficulty: 2 Medium Topic: Costs of issuing securities Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 18-04 Trace the process by which securities are underwritten.

78) Bailey's Dog Pens, Inc., with the help of its investment bank recently issued 5 million shares of new stock. The offer price on the stock was $15 per share and Bailey's Dog Pens received a total of $65 million from the stock offering. What percentage of the gross proceeds is the investment bank charging Bailey's Dog Pens for underwriting the stock issue? A) 11.29 percent B) 12.10 percent C) 10.62 percent D) 13.33 percent Answer: D Explanation: $65M/5M = $13 = net per share; 2/15 = 0.1333 or 13.33 percent = percentage charged Difficulty: 2 Medium Topic: Costs of issuing securities Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 18-04 Trace the process by which securities are underwritten. 79) Bailey's Dog Pens, Inc., with the help of its investment bank recently issued 5 million shares of new stock. The offer price on the stock was $19.5 per share and Bailey's Dog Pens received a total of $70 million from the stock offering. What percentage of the gross proceeds is the investment bank charging Bailey's Dog Pens for underwriting the stock issue? A) 27.29 percent B) 28.21 percent C) 26.92 percent D) 25.31 percent Answer: B Explanation: $70m/5m = $14 = net per share; 5.5/19.5 = 0.2821 or 28.21 percent = percentage charged Difficulty: 2 Medium Topic: Costs of issuing securities Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 18-04 Trace the process by which securities are underwritten.

80) Howett Pockett, Inc., plans to issue 10 million new shares of its stock. In discussions with its investment bank, Howett Pockett learns that the bankers recommend a net proceed of $15 per share and they will charge an underwriter's spread of 6.5 percent of the gross proceeds. In addition, Howett Pockett must pay $1 million in legal and other administrative expenses for the seasoned stock offering. Calculate the gross proceeds per share from the sale of the 10 million shares of stock. A) $17.29 B) $16.15 C) $19.37 D) $18.03 Answer: B Explanation: Legal and other administrative expenses per share = $1,000,000/10,000,000 = $0.10 Underwriter's spread + Net proceeds = Gross proceeds; ((0.065 × Gross proceeds) + $0.10) + $15 = Gross proceeds => Gross proceeds − (0.065 × Gross proceeds) = 15.10 => Gross proceeds = $15.10/(1 − 0.065) = $16.15 Difficulty: 2 Medium Topic: Costs of issuing securities Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 18-04 Trace the process by which securities are underwritten. 81) During the last year you have had a loan commitment from your bank to fund working capital for your business. The total line available was $10,000,000, of which you took down $9,125,000. It is now the end of the loan commitment period and your bank had you pay the back-end fees. You have misplaced the paperwork that listed the terms of the commitment, but you know you paid total fees (this does not include any interest paid to borrow the $9,125,000) of $31,100 on this loan commitment. You remember that the back-end fee was 85 basis points. Calculate the front-end fee on this loan commitment. A) 31 basis points B) 28 basis points C) 26 basis points D) 24 basis points Answer: D Explanation: Step 1: Back end fees = 0.0085 × (10,000,000 − 9,125,000) = $7,437.50; Step 2: Up-front fees = 31,100 − 7,437.50 = 23,662.50; 23,662.50/10,000,000 = 0.0024 or 24 basis points Difficulty: 3 Hard Topic: Raising capital Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 18-01 Evaluate different methods for small firms to get funding. 43

82) During the last year you have had a loan commitment from your bank to fund working capital for your business. The total line available was $10,000,000, of which you took down $7,800,000. It is now the end of the loan commitment period and your bank had you pay the back-end fees. You have misplaced the paperwork that listed the terms of the commitment, but you know you paid total fees (this does not include any interest paid to borrow the $7,800,000) of $51,200 on this loan commitment. You remember that the back-end fee was 112 basis points. Calculate the front-end fee on this loan commitment. A) 31 basis points B) 27 basis points C) 25 basis points D) 23 basis points Answer: B Explanation: Step 1: Back end fees = 0.0112 × (10,000,000 − 7,800,000) = $24,640; Step 2: Up-front fees = 51,200 − 24,640 = 26,560; 26,560/10,000,000 = 0.0027 or 27 basis points Difficulty: 3 Hard Topic: Raising capital Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 18-01 Evaluate different methods for small firms to get funding. 83) Sipe's Paint and Wallpaper, Inc., needs to raise $1.25 million to finance plant expansion. In discussions with its investment bank, Sipe's Paint and Wallpaper learns that the bankers recommend a gross price of $37.20 per share and that 48,500 shares of stock be sold. If the net proceeds on the stock sale leaves Sipe's Paint and Wallpaper with $1.25 million, calculate the underwriter's spread per share on the stock issue. A) $11.43 B) $9.28 C) $7.14 D) $6.91 Answer: A Explanation: [(37.2 × 48,500) − 1,250,000]/48,500 = $11.43 Difficulty: 3 Hard Topic: Costs of issuing securities Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 18-04 Trace the process by which securities are underwritten.

84) Renee's Boutique, Inc., needs to raise $75.25 million to finance firm expansion. In discussions with its investment bank, Renee's Boutique learns that the bankers recommend an offer price of $67 per share and that 1.25 million shares of stock be sold. If the net proceeds on the stock sale leaves Renee's Boutique with $75.25 million, calculate the underwriter's spread per share on the stock issue. A) $4.98 B) $5.12 C) $5.59 D) $6.80 Answer: D Explanation: [(67 × 1,250,000) − 75,250,000]/1,250,000 = $6.80 Difficulty: 3 Hard Topic: Costs of issuing securities Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 18-04 Trace the process by which securities are underwritten. 85) Hughes Technology Corp. recently went public with an initial public offering in which they received a total of $42 million in new capital funding. The underwriter used a firm commitment offering in which the offer price was $22 and the underwriter's spread was $0.85. Hughes Technology also paid legal and other administrative costs of $825,000 for the IPO. Calculate the number of shares issued through this IPO. A) 2,024,823 B) 3,125,000 C) 3,328,864 D) 4,002,179 Answer: A Explanation: [42,825,000/(22 − 0.85)] = 2,024,823 Difficulty: 3 Hard Topic: Costs of issuing securities Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 18-04 Trace the process by which securities are underwritten.

86) Howett Pockett, Inc., needs to raise $80 million in new capital funding from a seasoned equity offering. In discussions with its investment bank, Howett Pocket learns that the bankers recommend a gross price of $47.50 per share and they will charge an underwriter's spread of $2.50. In addition, Howett Pockett must pay $3 million in legal and other administrative expenses for the seasoned stock offering. Calculate the number of shares of stock that Howett Pockett will need to sell to raise the $80 million. A) 1,844,445 B) 1,812,007 C) 1,763,415 D) 1,702,369 Answer: A Explanation: [83,000,000/(47.5 − 2.5)] = 1,844,445 Difficulty: 3 Hard Topic: Costs of issuing securities Bloom's: Understand; Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 18-04 Trace the process by which securities are underwritten. 87) A security issued in which the underwriter does not guarantee a firm price to the issuer and acts more as a placing or distribution agent for a fee is referred to as: A) negotiated sale. B) competitive sale. C) best efforts underwriting. D) none of the options. Answer: C Difficulty: 1 Easy Topic: Underwriting Bloom's: Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 18-04 Trace the process by which securities are underwritten.

88) Wealthy individuals who make equity investments in firms are referred to as: A) equity consolidators B) red herring investors C) private equity investors D) angel venture capitalists Answer: D Difficulty: 1 Easy Topic: Venture capital Bloom's: Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 18-02 Appreciate what venture capital is and how it encourages entrepreneurship. 89) All of the following are advantages of an IPO EXCEPT: A) the market provides a market value for the firm's common stock. B) the original owners can reallocate their personal wealth away from the firm into more diversified portfolios. C) the market provides a transparent measure of firm performance which can attract more investors. D) IPOs are traditionally priced at a premium to cover the costs of the underwriters. Answer: D Difficulty: 2 Medium Topic: Initial public offerings Bloom's: Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 18-02 Appreciate what venture capital is and how it encourages entrepreneurship.

90) The advantage of the shelf registration is that: A) the firm can use their red herring prospectus as a substitute for the master registration statement. B) the firm can get stocks into the market quickly if the firm feels conditions are right without the time lag. C) the firm can bypass the lengthy SEC process. D) none of the options. Answer: B Difficulty: 2 Medium Topic: Basics of issuing securities Bloom's: Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 18-04 Trace the process by which securities are underwritten. 91) A syndicate is: A) a small group of institutional investors. B) several investment banks working together to sell and distribute a new security issue. C) several banks working together to lend a company money for a project or expansion. D) a group of equity investors that infuse distressed firms with major amounts of capital. Answer: B Difficulty: 2 Medium Topic: Underwriting Bloom's: Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 18-04 Trace the process by which securities are underwritten. 92) Most business loans today are: A) pre-negotiated lines of credit. B) spot loans. C) collateralized lines of credit. D) None of the options. Answer: A Difficulty: 1 Easy Topic: Raising capital Bloom's: Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 18-01 Evaluate different methods for small firms to get funding.

93) A facility fee is: A) the back-end fee. B) the commitment fee. C) the fee for processing the loan documents. D) none of the options. Answer: D Difficulty: 1 Easy Topic: Raising capital Bloom's: Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 18-01 Evaluate different methods for small firms to get funding. 94) A commitment fee is: A) the back-end fee. B) the facility fee. C) the up-front fee. D) none of the options. Answer: A Difficulty: 1 Easy Topic: Raising capital Bloom's: Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 18-01 Evaluate different methods for small firms to get funding. 95) Which of the following is an example of an appropriate loan covenant? A) The firm must increase its debt ratio by at least 10 percent. B) The firm must reduce its total asset turnover by 10 percent. C) The firm must purchase an insurance policy on a key employee. D) All of the options are examples of an appropriate loan covenant. Answer: C Difficulty: 2 Medium Topic: Raising capital Bloom's: Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 18-01 Evaluate different methods for small firms to get funding.

96) A is a contractual commitment by a bank to loan a firm up to a certain maximum amount at given interest rate for a stated length of time over which the firm has the option to take down this loan. A) Loan commitment agreement B) Spot loan C) Facility fee D) Commitment fee Answer: A Difficulty: 1 Easy Topic: Loan commitment agreement Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 18-01 Evaluate different methods for small firms to get funding. 97) Which of the following statements regarding the Small Business Administration (SBA) is not true? A) SBA loans require at least 15% owner's equity. B) The SBA Microloan Program provides up to $75,000 in long-term loans to small businesses. C) SBA Microloans have repayment terms of up to 10 years. D) All of the above Answer: D Difficulty: 1 Easy Topic: SBA Loans Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 18-01 Evaluate different methods for small firms to get funding. 98) Which of the following is an example of an appropriate loan covenant? A) The firm must not increase its debt ratio by more than 3 percent. B) The firm must keep its current ratio above 2.2. C) The firm must purchase an insurance policy on a key employee. D) All of the options are examples of appropriate loan covenants. Answer: D Difficulty: 2 Medium Topic: Raising capital Bloom's: Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 18-01 Evaluate different methods for small firms to get funding.

99) Which of the following statements is incorrect? A) The SBA can guarantee up to $3.75 million at an interest rate not to exceed 2.75 percent more than the prime lending rate. B) The primary function of the SBA is to guarantee loans made to new and small businesses. C) For qualified new and small firms that are unable to obtain long-term financing on reasonable terms from banks or other financial institutions, the SBA offers a basic loan guarantee program. D) All of the statements are correct. Answer: D Difficulty: 1 Easy Topic: Raising capital Bloom's: Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 18-01 Evaluate different methods for small firms to get funding. 100) Which of the following statements regarding the Small Business Investment Companies (SBIC) is true? A) SBICs are privately organized venture capital firms licensed by the SBA. B) SBIC make equity investments and loans to entrepreneurs for start-up activities and expansions. C) SBICs rely on investment funds from the U.S. Treasury. D) All of the above Answer: D Difficulty: 1 Easy Topic: SBIC Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 18-01 Evaluate different methods for small firms to get funding.

101) One of the reasons that so much commercial paper is outstanding is because: A) companies with strong credit ratings can generally borrow money at a lower interest rate by issuing commercial paper than by directly borrowing from banks. B) many banks prefer to lend to small and mid-sized companies because they can charge higher interest rates. C) commercial paper is generally unsecured which gives firms more flexibility if they suddenly want to sell fixed assets. D) none of the options are reasons why commercial paper is outstanding. Answer: A Difficulty: 1 Easy Topic: Raising capital Bloom's: Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 18-03 Differentiate among sources of capital funding for public firms. 102) The rate on commercial paper is generally higher than the prime rate. True or false? Answer: FALSE Difficulty: 1 Easy Topic: Raising capital Bloom's: Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 18-03 Differentiate among sources of capital funding for public firms. 103) Which of the following statements is incorrect? A) Standard & Poor's rates commercial paper. B) Commercial paper issuers with lower than prime credit ratings are unable to sell commercial paper. C) Commercial paper can be sold either directly or indirectly through brokers and dealers. D) All of the statements are correct. Answer: B Difficulty: 2 Medium Topic: Raising capital Bloom's: Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 18-03 Differentiate among sources of capital funding for public firms.

104) Which of the following statements is incorrect? A) In a private placement, a public firm seeks to find a large institutional buyer or group of buyers to purchase the whole issue. B) In a competitive sale, the bond-issuing firm invites bids from a number of underwriters. C) In a negotiated sale, a single investment bank obtains the exclusive right to originate, underwrite and distribute the new bonds through a one-on-one negotiation process. D) All of the statements are correct. Answer: D Difficulty: 1 Easy Topic: Private placements and leveraged buyouts Bloom's: Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 18-04 Trace the process by which securities are underwritten. 105) Which of the following statement regarding a competitive sale is true? A) The bond-issuing firm invites bids from a number of underwriters. B) The investment bank that submits the highest bid to the bond issuer wins. C) both A and B D) neither A or B Answer: C Difficulty: 1 Easy Topic: Competitive sale Bloom's: Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 18-04 Trace the process by which securities are underwritten. 106) Shelf registration _ . A) allows a firm to get stocks into the market quickly. B) is a method of registering securities that allows multiple issues of the security over a two-year period to submit multiple registration statements. C) allows a firm to offer one stock issue at a time over a three-year period. D) none of the above. Answer: A Difficulty: 1 Easy Topic: Competitive sale Bloom's: Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 18-04 Trace the process by which securities are underwritten.

107) Which of the following statements is correct? A) Most securities are offered on a best efforts underwriting. B) In a competitive sale, the bond-issuing firm invites bids from a number of institutional buyers such as mutual funds and pension funds. C) In a negotiated sale, a single investment bank obtains the exclusive right to originate, underwrite and distribute the new bonds through a one-on-one negotiation process. D) All of the statements are correct. Answer: C Difficulty: 1 Easy Topic: Underwriting Bloom's: Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 18-04 Trace the process by which securities are underwritten. 108) Which of the following statements is correct? A) Most often, corporate bonds are offered publicly through investment banking firms such as underwriters which use a best effort underwriting. B) In a competitive sale, the bond-issuing firm invites bids from a number of institutional buyers such as mutual funds and pension funds. C) In a negotiated sale, a consortium of investment banks obtains the right to originate, underwrite, and distribute the new bonds through a Dutch auction process. D) None of the statements are correct. Answer: D Difficulty: 1 Easy Topic: Underwriting Bloom's: Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 18-04 Trace the process by which securities are underwritten.

109) What is the difference between a prospectus and a red herring prospectus? A) The red herring prospectus is a preliminary version distributed to potential equity investors. B) The red herring prospectus is a corrected version of the prospectus. C) The red herring prospectus is only for issuing long-term bonds. D) The red herring prospectus is the report filed with the SEC but not necessarily distributed to equity investors. Answer: A Difficulty: 2 Medium Topic: Basics of issuing securities Bloom's: Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 18-04 Trace the process by which securities are underwritten. 110) When stock market values are relatively high: A) you will tend to observe more IPOs and new stock issuances. B) you will tend to observe more bond issuances. C) you will tend to observe firms raising more money from venture capitalists. D) you will tend to observe firms borrowing more money from banks. Answer: A Difficulty: 2 Medium Topic: Initial public offerings Bloom's: Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 18-04 Trace the process by which securities are underwritten. 111) A professionally managed pool of money used to finance new and often high-risk firms is referred to as: A) venture capital. B) take-down. C) high-risk investments. D) Small Business Administration Series A funding. Answer: A Difficulty: 1 Easy Topic: Venture capital Bloom's: Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 18-02 Appreciate what venture capital is and how it encourages entrepreneurship.

112) A lead bank in a syndicate, which directly negotiates with the issuing firm on behalf of the syndicate, is referred to as the: A) angel investor. B) venture capitalist. C) originating house. D) institutional investor. Answer: C Difficulty: 1 Easy Topic: Underwriting Bloom's: Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 18-04 Trace the process by which securities are underwritten. 113) Sipe's Paint and Wallpaper, Inc., needs to raise $1.05 million to finance plant expansion. In discussions with its investment bank, Sipe's Paint and Wallpaper learns that the bankers recommend a gross price of $22 per share and that 50,000 shares of stock be sold. If the net proceeds on the stock sale leave Sipe's Paint and Wallpaper with $1.05 million, what percent of the stock price does the underwriter's spread represent? A) 4.29 percent B) 4.55 percent C) 5.62 percent D) 6.15 percent Answer: B Explanation: [(22 × 50,000) − 1,050,000]/50,000 = $1; 1/22 = 4.55 percent Difficulty: 3 Hard Topic: Costs of issuing securities Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 18-04 Trace the process by which securities are underwritten.

114) Sipe's Paint and Wallpaper, Inc., needs to raise $1 million to finance plant expansion. In discussions with its investment bank, Sipe's Paint and Wallpaper learns that the bankers recommend a gross price of $40 per share and that 30,000 shares of stock be sold. If the net proceeds on the stock sale leave Sipe's Paint and Wallpaper with $1 million, what percent of the stock price does the underwriter's spread represent? A) 15.24 percent B) 15.57 percent C) 16.09 percent D) 16.67 percent Answer: D Explanation: [(40 × 30,000) − 1,000,000]/30,000 = $6.67; 6.67/40 = 16.67 percent Difficulty: 3 Hard Topic: Costs of issuing securities Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 18-04 Trace the process by which securities are underwritten. 115) Sipe's Paint and Wallpaper, Inc., needs to raise $1 million to finance plant expansion. In discussions with its investment bank, Sipe's Paint and Wallpaper learns that the bankers recommend a gross price of $40 per share and that 30,000 shares of stock be sold. If the net proceeds on the stock sale leave Sipe's Paint and Wallpaper with $1 million, what percent of the total raised represents net proceeds to the firm? A) 81.98 percent B) 75.57 percent C) 83.33 percent D) 86.67 percent Answer: C Explanation: 1m/(30,000 × 40) = 83.33 percent Difficulty: 3 Hard Topic: Costs of issuing securities Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 18-04 Trace the process by which securities are underwritten.

116) Sipe's Paint and Wallpaper, Inc., needs to raise $1.19 million to finance plant expansion. In discussions with its investment bank, Sipe's Paint and Wallpaper learns that the bankers recommend a gross price of $42 per share and that 33,000 shares of stock be sold. If the net proceeds on the stock sale leave Sipe's Paint and Wallpaper with $1.19 million, what percent of the total raised represents net proceeds to the firm? A) 81.98 percent B) 79.57 percent C) 85.86 percent D) 87.67 percent Answer: C Explanation: 1.19m/(33,000 × 42) = 85.86 percent Difficulty: 3 Hard Topic: Costs of issuing securities Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 18-04 Trace the process by which securities are underwritten. 117) A market in which corporations raise funds through new issues of securities is referred to as a: A) dealer market. B) primary market. C) spot market. D) venture market. Answer: B Difficulty: 1 Easy Topic: Primary and secondary markets Bloom's: Understand; Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 18-04 Trace the process by which securities are underwritten.

118) A "thin" market is characterized by: A) infrequent trades. B) lower-priced assets. C) unrated financial securities. D) risky assets. Answer: A Difficulty: 2 Medium Topic: Basics of issuing securities Bloom's: Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 18-04 Trace the process by which securities are underwritten. 119) Renee's Boutique, Inc., needs to raise $25 million to finance firm expansion. In discussions with its investment bank, Renee's Boutique learns that the bankers recommend an offer price of $9 per share and that 5 million shares of stock be sold. If the net proceeds on the stock sale leaves Renee's Boutique with $25 million, calculate the underwriter's spread per share on the stock issue. A) $10.00 B) $9.00 C) $5.00 D) $4.00 Answer: D Explanation: [(9 × 5,000,000) − 25,000,000]/5,000,000 = $4.00 Difficulty: 3 Hard Topic: Costs of issuing securities Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 18-04 Trace the process by which securities are underwritten.

120) Hughes Technology Corp. recently went public with an initial public offering in which they received a total of $9 million in new capital funding. The underwriter used a firm commitment offering in which the offer price was $102 and the underwriter's spread was $1.35. Hughes Technology also paid legal and other administrative costs of $400,000 for the IPO. Calculate the number of shares issued through this IPO. A) 93,393 B) 92,157 C) 89,419 D) 88,235 Answer: A Explanation: [9,400,000/(102 − 1.35)] = 93,392.95 Difficulty: 3 Hard Topic: Costs of issuing securities Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 18-04 Trace the process by which securities are underwritten. 121) Calculate the total fees a firm would have to pay when its bank offers the firm the following loan commitment: A loan commitment of $1,000,000 with an up-front fee of 40 basis points and a back-end fee of 20 basis points. The take-down on the loan is 30 percent. A) $1,400 B) $4,000 C) $5,400 D) $6,000 Answer: C Explanation: Up-front fee = $1,000,000 × 0.0040 Back-end fee = $1,000,000 × 0.0020 × 0.70

= =

$ 4,000 $ 1,400

Total

$ 5,400

122) Shocks and Struts, Inc., needs to raise $40 million to finance its plan for nationwide expansion. In discussions with its investment bank, they learn that the bankers recommend an offer price (or gross price) of $125 per share and they will charge an underwriter's spread of $12.50 per share. Calculate the net proceeds to Shocks and Struts from the sale of stock. How many shares of stock will Shocks and Struts need to sell in order to receive the $40 million they need? A) 160,000 B) 313,726 C) 320,000 D) 355,556 Answer: D Explanation: Net proceeds = Gross proceeds − Underwriter's spread = $125.00 − $12.50 = $112.50 Funds needed = $40 million = $112.50 × Number of shares sold => Number of shares sold = $40 million/$112.50 = 355,555.55 shares Difficulty: 1 Easy Topic: Costs of issuing securities Bloom's: Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 18-04 Trace the process by which securities are underwritten. 123) Just Add Water, Inc., with the help of its investment bank recently issued $45,000,000 of new debt. The offer price on the debt was $1,000 per bond and the underwriter's spread was 3 percent of the gross proceeds. What amount of capital funding did Just Add Water raise through this bond issue? A) $1,350,000 B) $43,650,000 C) $45,000,000 D) $46,350,000 Answer: B Explanation: Underwriter's fees = 0.03 × $45,000,000 = $1,350,000 => Funds received by Just Add Water = $45,000,000 − $1,350,000 = $43,650,000 Difficulty: 1 Easy Topic: Costs of issuing securities Bloom's: Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 18-04 Trace the process by which securities are underwritten.

124) You have approached your local bank for a start-up loan commitment for $5,000,000 needed to open a car repair store. You have requested that the term of the loan be one year. Your bank has offered you the following terms: size of loan commitment = $5,000,000, term = one year, up-front fee = 30 basis points, back-end fee = 40 basis points, and rate on the loan = 8 percent. If you immediately take down $1,000,000 and no more during the year, what is the total interest and fees you have paid on this loan commitment? A) $150,000 B) $111,000 C) $87,000 D) $80,000 Answer: B Explanation: Up-front fees = 0.0030 × $5,000,000 Interest income = 0.08 × $1,000,000 Back-end fees = 0.0040 × 4,000,000

= $ = $ = $

Total interest and fees =

15,000.00 80,000.00 16,000.00

$ 111,000.00

125) TV Technology Corp. recently went public with an initial public offering of 2 million shares of stock. The underwriter used a firm commitment offering in which the net proceeds was $50.75 per share and the underwriter's spread was 6 percent of the gross proceeds. TV Technology also paid legal and other administrative costs of $400,000 for the IPO. Calculate the gross proceeds per share received by TV Technology from the sale of the 2 million shares of stock. A) $48.07 B) $50.95 C) $53.99 D) $54.20 Answer: D Explanation: 2,000,000 × $50.75 = $101,500,000 = Total funds received by TV Technology Legal and other administrative expenses per share = $400,000/2,000,000 = $0.20 Underwriter's spread + Net proceeds = Gross proceeds => ((0.06 × Gross proceeds) + $0.20) + $50.75 = Gross proceeds => Gross proceeds − (0.06 × Gross proceeds) = 50.75 + $0.20 => Gross proceeds = $50.95/(1 − 0.06) = $54.20 Difficulty: 2 Medium Topic: Costs of issuing securities Bloom's: Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 18-04 Trace the process by which securities are underwritten.

126) Elle Inc. plans to issue 4 million new shares of its stock. In discussions with its investment bank, Elle learns that the bankers recommend a net proceed of $75.10 per share and they will charge an underwriter's spread of 7 percent of the gross proceeds. In addition, Elle must pay $2 million in legal and other administrative expenses for the seasoned stock offering. Calculate the gross proceeds per share received by Elle from the sale of the 4 million shares of stock. A) $75.60 B) $80.14 C) $80.75 D) $81.29 Answer: D Explanation: 4,000,000 × $75.10 = $300,400,000 = Total funds received by Elle Legal and other administrative expenses per share = $2,000,000/4,000,000 = $0.50 Underwriter's spread + Net proceeds = Gross proceeds => ((0.07 × Gross proceeds) + $0.50) + $75.10 = Gross proceeds => Gross proceeds − (0.07 × Gross proceeds) = 75.10 + $0.50 => Gross proceeds = $75.60/(1 − 0.07) = $81.29 Difficulty: 2 Medium Topic: Costs of issuing securities Bloom's: Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 18-04 Trace the process by which securities are underwritten. 127) Bailey's Dog Pens, Inc., with the help of its investment bank recently issued $9,000,000 of new debt. The offer price on the debt was $1,000 per bond and the underwriter's spread was 5.5 percent of the gross proceeds. Calculate the amount of capital funding Bailey's Dog Pens raisedthrough this bond issue. A) $4,050,000 B) $8,505,000 C) $9,000,000 D) $9,495,000 Answer: B Explanation: $9,000,000 − 0.055(9,000,000) = $8,505,000 Difficulty: 1 Easy Topic: Costs of issuing securities Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 18-04 Trace the process by which securities are underwritten.

128) You have approached your local bank for a start-up loan commitment for $450,000 needed to open a computer repair store. You have requested that the term of the loan be one year. Your bank has offered you the following terms: size of loan commitment = $450,000, term = one year, up-front fee = 20 basis points, back-end fee = 50 basis points, and rate on the loan = 12 percent. If you immediately take down $200,000 and no more during the year, calculate the total interest and fees you have paid on this loan commitment. A) $34,250 B) $26,150 C) $24,900 D) $24,000 Answer: B Explanation: (0.0020 × 450,000) + 0.12 × 200,000 + [0.005 × (450,000 − 200,000)] = $26,150 Difficulty: 2 Medium Topic: Raising capital Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 18-01 Evaluate different methods for small firms to get funding.

Finance, 5e (Cornett) Chapter 19 International Corporate Finance 1) Which of these seeks to reduce, or even eliminate, trade restrictions and tariffs to ease trade between countries? A) Commerce bureaus B) Tariff agreements C) Trade agreements D) Economic analysts Answer: C Difficulty: 1 Easy Topic: International transactions Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 19-01 Gauge the dynamics of the global economy and recognize potential international opportunities. 2) Which of these is the trade agreement between South American countries to create their own free trade zone? A) South American Union B) South American Free Trade Agreement (SAFTA) C) South American Monetary Fund (SAMF) D) Mercosur Answer: D Difficulty: 1 Easy Topic: International organizations and agreements Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 19-01 Gauge the dynamics of the global economy and recognize potential international opportunities.

3) Which of these is a political and economic union of 27 European countries? A) European Union B) European Free Trade Agreement (EFTA) C) European Monetary Fund (EMF) D) Mercosur Answer: A Difficulty: 1 Easy Topic: International organizations and agreements Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 19-01 Gauge the dynamics of the global economy and recognize potential international opportunities. 4) Which of these is an international organization that deals with international trade rules and helps settle disputes between its member governments? A) World Trade Union B) World Free Trade Agreement C) International Monetary Fund D) World Trade Organization Answer: D Difficulty: 1 Easy Topic: International organizations and agreements Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 19-01 Gauge the dynamics of the global economy and recognize potential international opportunities. 5) Which of these is an organization of 189 countries that monitors currency exchange, examines financial stability, and watches the global financial system? A) World Monetary Union B) World Monetary Organization C) International Monetary Fund D) International Monetary Union Answer: C Difficulty: 1 Easy Topic: International organizations and agreements Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 19-01 Gauge the dynamics of the global economy and recognize potential international opportunities. 2

6) Which of these is a company that operates production and/or sales facilities in multiple countries? A) World trade corporation B) Multinational corporation C) Free trade corporation D) Managed-floating corporation Answer: B Difficulty: 2 Medium Topic: Multinational corporations and operations Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 19-02 Recognize patterns of increasing capital involvement as the firm seeks to expand business internationally. 7) Which of these is defined as long-term investment in capital in a business operation located in an economy other than that in which the company is based? A) Managed-floating corporation B) Multinational investment C) Multinational corporation D) Foreign direct investment Answer: D Difficulty: 2 Medium Topic: Multinational corporations and operations Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 19-02 Recognize patterns of increasing capital involvement as the firm seeks to expand business internationally. 8) Which of these is defined as the price of one currency in terms of another? A) Exchange rate B) Spot transaction C) Indirect exchange quote D) Direct exchange quote Answer: A Difficulty: 1 Easy Topic: Exchange rates Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 19-03 Compute currency exchanges. 3

9) Which of these is defined as exchanging one currency for another today? A) Exchange rate B) Spot transaction C) Indirect quote D) Direct quote Answer: B Difficulty: 1 Easy Topic: Exchange rates Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 19-03 Compute currency exchanges. 10) Which of these is defined as the amount of foreign currency it takes to buy one unit of domestic currency? A) Exchange rate B) Spot transaction C) Indirect quote D) Direct quote Answer: C Difficulty: 1 Easy Topic: Exchange rates Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 19-03 Compute currency exchanges. 11) Which of these is defined as the amount of domestic currency it takes to buy one unit of foreign currency? A) Exchange rate B) Spot transaction C) Indirect quote D) Direct quote Answer: D Difficulty: 1 Easy Topic: Exchange rates Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 19-03 Compute currency exchanges.

12) Which of these is defined as the currency exchange rate between two foreign currencies, each of which is not the currency of the domestic country? A) Exchange rates B) Spot rates C) Indirect rates D) Cross rates Answer: D Difficulty: 1 Easy Topic: Exchange rates Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 19-03 Compute currency exchanges. 13) Which of these is defined as the practice of simultaneously purchasing and selling an asset in different forms or markets to take advantage of an imbalance in price? A) Arbitrage B) Spot transaction C) Indirect quote D) Cross quote Answer: A Difficulty: 1 Easy Topic: Exchange rates Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 19-03 Compute currency exchanges. 14) Which of these is defined as the possibility that the spot currency exchange rate will change and reduce the value of foreign assets and cash flows? A) Foreign rate risk B) Exchange rate risk C) Spot rate risk D) Value rate risk Answer: B Difficulty: 1 Easy Topic: Exchange rate risk Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 19-04 Recognize situations that evoke exchange rate risk and develop tools to manage those risks.

15) Which of these is defined as an exchange rate regime where the currency is completely determined by the foreign-exchange market through supply and demand? A) Foreign market regime B) Freely floating regime C) Currency market regime D) Managed-floating regime Answer: B Difficulty: 1 Easy Topic: Exchange rate risk Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 19-04 Recognize situations that evoke exchange rate risk and develop tools to manage those risks. 16) Which of these is defined as an exchange rate regime where the country's central bank allows its currency price to float freely between an upper and lower bound and may buy and sell large amounts of it in order to provide price support or resistance? A) Foreign market regime B) Freely floating regime C) Currency market regime D) Managed-floating regime Answer: D Difficulty: 1 Easy Topic: Exchange rate risk Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 19-04 Recognize situations that evoke exchange rate risk and develop tools to manage those risks.

17) Which of these is defined as an exchange rate regime where a currency's price is fixed to the value of another currency or to a basket of other currencies? A) Fixed peg arrangement B) Freely floating regime C) Currency market regime D) Managed-floating regime Answer: A Difficulty: 1 Easy Topic: Exchange rate risk Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 19-04 Recognize situations that evoke exchange rate risk and develop tools to manage those risks. 18) Which of these is defined as a contractual agreement that states the exchange rate to be used at a future exchange date? A) Fixed peg rate B) Forward exchange rate C) Managed exchange rate D) Future strategy rate Answer: B Difficulty: 1 Easy Topic: Exchange rate risk Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 19-04 Recognize situations that evoke exchange rate risk and develop tools to manage those risks.

19) Which of the following is NOT an example of how a company could hedge to reduce currency risk? A) Buying futures contracts B) Buying options C) Currency swaps D) Fixed peg arrangements Answer: D Difficulty: 1 Easy Topic: Exchange rate risk Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 19-04 Recognize situations that evoke exchange rate risk and develop tools to manage those risks. 20) Which of the following is a theory that the difference in interest rates between two countries is equal to the difference between the forward currency exchange rate and the spot exchange rate? A) Purchasing power parity B) Interest rate parity C) Law of one price D) Currency swap parity Answer: B Difficulty: 2 Medium Topic: Interest rate parity Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 19-05 Apply theories of how interest rates and inflation influence forward exchange rates and future spot rates.

21) Which of the following is the theory relating the expected adjustment needed in the future spot exchange rate between countries to the inflation rate in each country? A) Purchasing power parity B) Interest rate parity C) Law of one price D) Currency swap parity Answer: A Difficulty: 2 Medium Topic: Purchasing power parity Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 19-05 Apply theories of how interest rates and inflation influence forward exchange rates and future spot rates. 22) Which of the following is an economic principle that states all identical goods in different markets must have the same price? A) Purchasing power parity B) Interest rate parity C) Law of one price D) Price swap parity Answer: C Difficulty: 2 Medium Topic: Purchasing power parity Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 19-05 Apply theories of how interest rates and inflation influence forward exchange rates and future spot rates.

23) Which of the following is the definition of political risk? A) The possibility that changes in the corporation will occur that reduce the profitability of doing business in that country. B) The possibility that changes in the political environment will occur that reduce the profitability of doing business in that country. C) The possibility that changes in the business environment will occur that increase the profitability of doing business in that country. D) The possibility that international rules will occur that reduce the profitability of doing business in one particular country. Answer: B Difficulty: 2 Medium Topic: Political risk Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 19-06 Anticipate political risks when investing internationally. 24) Purchasing power parity (PPP) may not hold exactly because of which of the following? A) Shipping costs B) Insurance costs C) Trading costs D) All of the options are transaction costs that may not allow PPP to hold exactly. Answer: D Difficulty: 1 Easy Topic: Purchasing power parity Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 19-04 Recognize situations that evoke exchange rate risk and develop tools to manage those risks.

25) Convert the following direct quote to a dollar indirect quote: 1 Danish krone = $0.1755 A) 0.1755 krone B) 0.8245 krone C) 1.1755 krone D) 5.698 krone Answer: D Explanation: $1 = 1 ÷ 0.1755 = 5.698 krone Difficulty: 1 Easy Topic: Exchange rates Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-03 Compute currency exchanges. 26) Convert the following direct quote to a dollar indirect quote: 1 Indian rupee = $0.02250 A) 0.02250 rupee B) 0.9775 rupee C) 1.0225 rupee D) 44.44 rupee Answer: D Explanation: $1 = 1 ÷ 0.02250 = 44.4444 rupee Difficulty: 1 Easy Topic: Exchange rates Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-03 Compute currency exchanges. 27) Convert the following direct quote to a dollar indirect quote: 1 Israeli shekel = $0.2351 A) 0.2351 shekel B) 0.7649 shekel C) 1.2351 shekel D) 4.2535 shekel Answer: D Explanation: $1 = 1 ÷ 0.2351 = 4.2535 shekel Difficulty: 1 Easy Topic: Exchange rates Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-03 Compute currency exchanges.

28) Convert the following direct quote to a dollar indirect quote: 1 Korean won = $0.001045 A) 0.1045 won B) 1.001045 won C) 9.5694 won D) 956.9378 won Answer: D Explanation: $1 = 1 ÷ 0.001045 = 956.9378 won Difficulty: 1 Easy Topic: Exchange rates Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-03 Compute currency exchanges. 29) Convert the following direct quote to a dollar indirect quote: 1 Malaysian ringget = $0.2875 A) 0.2875 ringget B) 1.2875 ringget C) 3.4783 ringget D) 4.4783 ringget Answer: C Explanation: $1 = 1 ÷ 0.2875 = 3.4783 ringget Difficulty: 1 Easy Topic: Exchange rates Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-03 Compute currency exchanges. 30) Convert the following direct quote to a dollar indirect quote: 1 Thai baht = $0.03057 A) 0.03057 baht B) 1.03057 baht C) 0.96943 baht D) 32.7118 baht Answer: D Explanation: $1 = 1 ÷ 0.03057 = 32.7118 baht Difficulty: 1 Easy Topic: Exchange rates Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-03 Compute currency exchanges.

31) Convert the following indirect quote to a dollar direct quote: $1 = 15,990 Vietnam dong A) $0.00006254 B) $159.90 C) $6.2539 D) $1.00625 Answer: A Explanation: 1 dong = 1 ÷ 15,990 = $0.00006254 Difficulty: 1 Easy Topic: Exchange rates Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-03 Compute currency exchanges. 32) Convert the following indirect quote to a dollar direct quote: $1 = 2,150.4 Venezuelan bolivar A) $0.00046503 B) $4.65 C) $1.465 D) $2.1504 Answer: A Explanation: 1 bolivar = 1 ÷ 2,150.4 = $0.00046503 Difficulty: 1 Easy Topic: Exchange rates Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-03 Compute currency exchanges. 33) Convert the following indirect quote to a dollar direct quote: $1 = 7.2501 South African rand A) $0.1379 B) $0.72501 C) $1.00 D) $1.1379 Answer: A Explanation: 1 rand = 1 ÷ 7.2501 = $0.1379 Difficulty: 1 Easy Topic: Exchange rates Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-03 Compute currency exchanges.

34) Convert the following indirect quote to a dollar direct quote: $1 = 3.8249 Saudi Arabian riyal A) $0.2614 B) $4.8249 C) $0.38249 D) $1.00 Answer: A Explanation: 1 riyal = 1 ÷ 3.8249 = $0.2614 Difficulty: 1 Easy Topic: Exchange rates Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-03 Compute currency exchanges. 35) Convert the following indirect quote to a dollar direct quote: $1 = 48.210 Philippine peso A) $0.0207 B) $1.0207 C) $4.8210 D) $0.4821 Answer: A Explanation: 1 peso = 1 ÷ 48.210 = $0.0207 Difficulty: 1 Easy Topic: Exchange rates Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-03 Compute currency exchanges. 36) Convert the following indirect quote to a dollar direct quote: $1 = 0.5467 Latvian lat A) $1.5467 B) $0.15467 C) $0.018292 D) $1.8292 Answer: D Explanation: 1 lat = 1 ÷ 0.5467 = $1.8292 Difficulty: 1 Easy Topic: Exchange rates Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-03 Compute currency exchanges.

37) Compute the amount of foreign currency that can be purchased for $200,000: 1 Danish krone = $0.1755 A) 200,000 krone B) 11,396 krone C) 35,100 krone D) 1,139,601.14 krone Answer: D Explanation: $200,000 = $200,000 ÷ 0.1755 = 1,139,601.14 krone Difficulty: 1 Easy Topic: Exchange rates Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-03 Compute currency exchanges. 38) Compute the amount of foreign currency that can be purchased for $400,000: 1 Indian rupee = $0.02250 A) 400,000 rupee B) 360,000,000 rupee C) 9,000 rupee D) 17,777,777.78 rupee Answer: D Explanation: $400,000 = 400,000 ÷ 0.02250 = 17,777,777.78 Rupee Difficulty: 1 Easy Topic: Exchange rates Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-03 Compute currency exchanges.

39) Compute the amount of foreign currency that can be purchased for $750,000: 1 Israeli shekel = $0.2351 A) 926,325 shekel B) 750,000 shekel C) 176,325 shekel D) 3,190,131.859 shekel Answer: D Explanation: $750,000 = 750,000 ÷ 0.2351 = 3,190,131.859 shekel Difficulty: 1 Easy Topic: Exchange rates Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-03 Compute currency exchanges. 40) Compute the amount of foreign currency that can be purchased for $600,000: 1 Korean won = $0.001045 A) 627,000 won B) 627 won C) 5,741,640 won D) 574,162,679.4 won Answer: D Explanation: $600,000 = 600,000 ÷ 0.001045 = 574,162,679.4 won Difficulty: 1 Easy Topic: Exchange rates Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-03 Compute currency exchanges.

41) Compute the amount of foreign currency that can be purchased for $1,000,000: 1 Malaysian ringget = $0.2875 A) 287,500 ringget B) 1,287,500 ringget C) 3,478,260.87 ringget D) 4,478,300 ringget Answer: C Explanation: $1,000,000 = 1,000,000 ÷ 0.2875 = 3,478,260.87 ringget Difficulty: 1 Easy Topic: Exchange rates Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-03 Compute currency exchanges. 42) Compute the amount of foreign currency that can be purchased for $1,300,000: 1 Thai baht = $0.03057 A) 39,741 baht B) 1,339,741 baht C) 1,260,259 baht D) 42,525,351.65 baht Answer: D Explanation: $1,300,000 = 1,300,000 ÷ 0.03057 = 42,525,351.65 baht Difficulty: 1 Easy Topic: Exchange rates Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-03 Compute currency exchanges.

43) Compute the number of dollars that can be bought with 2 million of foreign currency units: $1 = 15,990 Vietnam dong A) $125.0782 B) $3,198.00 C) $12,507.82 D) $198.7577 Answer: A Explanation: 2,000,000 dong = 2,000,000 ÷ 15,990 = $125.0782 Difficulty: 1 Easy Topic: Exchange rates Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-03 Compute currency exchanges. 44) Compute the number of dollars that can be bought with 5 million of foreign currency units: $1 = 2,150.4 Venezuelan bolivar A) $2,325.1488 B) $232,514.88 C) $7,325,000 D) $43,008,000.00 Answer: A Explanation: 5,000,000 bolivar = 5,000,000 ÷ 2,150.4 = $2,325.1488 Difficulty: 1 Easy Topic: Exchange rates Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-03 Compute currency exchanges.

45) Compute the number of dollars that can be bought with 8 million of foreign currency units: $1 = 7.2501 South African rand A) $1,103,433.056 B) $5,800,080.00 C) $8,000,000.00 D) $9,103,200.00 Answer: A Explanation: 8,000,000 rand = 8,000,000 ÷ 7.2501 = $1,103,433.056 Difficulty: 1 Easy Topic: Exchange rates Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-03 Compute currency exchanges. 46) Compute the number of dollars that can be bought with 1 million of foreign currency units: $1 = 3.8249 Saudi Arabian riyal A) $261,444.7437 B) $4,824,900.00 C) $382,490.00 D) $1,000,000 Answer: A Explanation: 1,000,000 riyal = 1,000,000 ÷ 3.8249 = $261,444.7437 Difficulty: 1 Easy Topic: Exchange rates Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-03 Compute currency exchanges.

47) Compute the number of dollars that can be bought with 2 million of foreign currency units: $1 = 48.210 Philippine peso A) $41,485.16905 B) $1,959,439.60 C) $414,851.6905 D) $4,148,516.905 Answer: A Explanation: 2,000,000 peso = 2,000,000 ÷ 48.210 = $41,485.16905 Difficulty: 1 Easy Topic: Exchange rates Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-03 Compute currency exchanges. 48) Compute the number of dollars that can be bought with 1.5 million of foreign currency units: $1 = 0.5467 Latvian lat A) $969,806.68520 B) $9,698,066.852 C) $82,003,061.45 D) $2,743,735.138 Answer: D Explanation: 1,500,000 lat = 1,500,000 ÷ 0.5467 = $2,743,735.138 Difficulty: 1 Easy Topic: Exchange rates Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-03 Compute currency exchanges.

49) If the price of silver in England is £7.10 per ounce, what is the expected price of silver in the United States if the spot exchange rate is $1 = £0.5275? A) $7.6275 per ounce B) $7.429 per ounce C) $3.74525 per ounce D) $13.4597 per ounce Answer: D Explanation: £7.10 per ounce = £7.10 ÷ £0.5275 per $ = $13.4597 per ounce Difficulty: 1 Easy Topic: Purchasing power parity Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-05 Apply theories of how interest rates and inflation influence forward exchange rates and future spot rates. 50) If the price of silver in England is £6.85 per ounce, what is the expected price of silver in the United States if the spot exchange rate is $1 = £0.5426? A) $7.3926 per ounce B) $7.921 per ounce C) $3.7168 per ounce D) $12.6244 per ounce Answer: D Explanation: £6.85 per ounce = £6.85 ÷ £0.5426 per $ = $12.6244 per ounce Difficulty: 1 Easy Topic: Purchasing power parity Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-05 Apply theories of how interest rates and inflation influence forward exchange rates and future spot rates.

51) If the price of copper in Europe is €2.22 per ounce, what is the expected price of copper in the United States if the spot exchange rate is $1 = €0.7802? A) $3.0002 per ounce B) $3.514 per ounce C) $1.7320 per ounce D) $2.8454 per ounce Answer: D Explanation: €2.22 per ounce = €2.22 ÷ €0.7802 per $ = $2.8454 per ounce Difficulty: 1 Easy Topic: Purchasing power parity Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-05 Apply theories of how interest rates and inflation influence forward exchange rates and future spot rates. 52) A financial manager has determined that the appropriate discount rate for a foreign project is 15 percent. However, that discount rate applies in the United States using dollars. What discount rate should be used in the foreign country using the foreign currency? The inflation rates in the United States and in the foreign country are expected to be 5 percent and 7 percent, respectively. A) 13 percent B) 17 percent C) 18 percent D) 20 percent Answer: B Explanation: The discount rate in the foreign country should be 15 percent + (7 percent − 5 percent) = 17 percent Difficulty: 1 Easy Topic: International capital budgeting Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-07 As a financial manager, plan to work through capital budgeting issues for international investments.

53) A financial manager has determined that the appropriate discount rate for a foreign project is 16 percent. However, that discount rate applies in the United States using dollars. What discount rate should be used in the foreign country using the foreign currency? The inflation rates in the United States and in the foreign country are expected to be 4 percent and 8 percent, respectively. A) 16 percent B) 20 percent C) 12 percent D) 24 percent Answer: B Explanation: The discount rate in the foreign country should be 16 percent + (8 percent − 4 percent) = 20 percent Difficulty: 1 Easy Topic: International capital budgeting Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-07 As a financial manager, plan to work through capital budgeting issues for international investments. 54) A financial manager has determined that the appropriate discount rate for a foreign project is 15 percent. However, that discount rate applies in the United States using dollars. What discount rate should be used in the foreign country using the foreign currency? The inflation rates in the United States and in the foreign country are expected to be 8 percent and 4 percent, respectively. A) 11 percent B) 19 percent C) 21 percent D) 12 percent Answer: A Explanation: The discount rate in the foreign country should be 15 percent + (4 percent − 8 percent) = 11 percent Difficulty: 1 Easy Topic: International capital budgeting Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-07 As a financial manager, plan to work through capital budgeting issues for international investments.

55) Given these two exchange rates, $1 = 11.25 Mexican peso and $1 = €0.7521, compute the cross rate between the Mexican peso and the euro. State this exchange rate in pesos and in euros. A) 0.0669 euros, 14.9589 pesos B) 1.3296 euros, 0.0889 pesos C) 14.9589 euros, 0.0669 pesos D) 0.0889 euros, 1.3296 pesos Answer: A Explanation: 1 peso = 1 peso × ($1 ÷ 11.25 peso) × (€0.7521 ÷ $1) = €0.0668533 Also, €1 = €1 ÷ €0.06685 per peso = 14.95886 peso Difficulty: 2 Medium Topic: Exchange rates Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-03 Compute currency exchanges. 56) Given these two exchange rates, $1 = 1.3254 Australian dollars and $1 = £0.5233, compute the cross rate between the Australian dollars and the pound. State this exchange rate in Australian dollars and in pounds. A) A$2.5329, 0.3948 pounds B) A$0.3948, 2.5329 pounds C) A$0.3948, 0.6936 pounds D) A$0.6936, 0.3948 pounds Answer: A Explanation: A$1 = A$1 × ($1 ÷ A$1.3254) × (£0.5233 ÷ $1) = £0.3948 Also, £1 = £1 ÷ £0.3948 per A$ = A$2.5329 Difficulty: 2 Medium Topic: Exchange rates Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-03 Compute currency exchanges.

57) In the late 1990s, many East Asian currencies suddenly and dramatically devalued. What is the percentage change in value of a $10 million investment in Indonesia when the exchange rate changes from $1 = 3,000 rupiah to $1 = 10,000 rupiah? A) 30 percent B) 10 percent C) 70 percent D) 90 percent Answer: C Explanation: The company invests $10 million at a value of $10 million × (3,000 rupiah ÷ $1) = 30,000 million rupiah Then the rupiah devalues and the 30,000 million rupiah investment becomes worth: 30,000 million rupiah × ($1 ÷ 10,000 rupiah) = $3 million This is a drop from $10 million to $3 million, or a 70 percent decline (= 7 ÷ 10) Difficulty: 2 Medium Topic: Exchange rate risk Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-04 Recognize situations that evoke exchange rate risk and develop tools to manage those risks. 58) In the late 1990s, many East Asian currencies suddenly and dramatically devalued. What is the percentage change in the value of a $75 million investment in Indonesia when the exchange rate changes from $1 = 1,000 rupiah to $1 = 7,000 rupiah? A) 14.29 percent B) 85.71 percent C) 12.5 percent D) 87.5 percent Answer: B Explanation: The company invests $75 million at a value of $75 million × (1,000 rupiah ÷ $1) = 75,000 million rupiah Then the rupiah devalues and the 75,000 million rupiah investment becomes worth: 75,000 million rupiah × ($1 ÷ 7,000 rupiah) = $10.7143 million This is a drop from $75 million to $10.7143 million, or an 85.71 percent decline (= 64.2857 ÷ 75) Difficulty: 2 Medium Topic: Exchange rate risk Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-04 Recognize situations that evoke exchange rate risk and develop tools to manage those risks.

59) What is the percentage change in the value of a $50 million investment in Russia when the exchange rate changes from $1 = 7 rubles to $1 = 12 rubles? A) 41.67 percent B) 58.33 percent C) 36.84 percent D) 63.16 percent Answer: A Explanation: The company invests $50 million at a value of $50 million × (7 rubles ÷ $1) = 350 million rubles Then the ruble devalues and the 350 million ruble investment becomes worth: 350 million rubles × ($1 ÷ 12 rubles) = $29.17 million This is a drop from $50 million to $29.17 million, or a 41.67 percent decline {= (50 − 29.17) ÷ 50} Difficulty: 2 Medium Topic: Exchange rate risk Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-04 Recognize situations that evoke exchange rate risk and develop tools to manage those risks. 60) If the spot rate between the U.S. dollar and the New Zealand dollar is $1 = NZD1.5215, and if the interest rate in the United States is 8 percent and in New Zealand is 4 percent, then what should be the three-month forward exchange rate? A) $0.6637 B) $0.6572 C) $0.6825 D) $0.6329 Answer: A Explanation: Use equation 19-1. But the quote must be a direct quote and the interest rate must be for the same period as the forward rate. The spot direct quote is 1 ÷ 1.5215 = 0.6572 and the 3-month interest rates are 2 percent and 1 percent respectively. Forward exchange rate = [(1 + 0.02)/(1 + 0.01)] × 0.6572 = $0.6637 per NZD Difficulty: 2 Medium Topic: Interest rate parity Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-05 Apply theories of how interest rates and inflation influence forward exchange rates and future spot rates.

61) Assume the spot rate between the U.S. dollar and the Taiwan dollar is $1 = TWD32.456. If the interest rate in the United States is 4 percent and in Taiwan is 3 percent, then what should be the one-month forward exchange rate? A) $0.0308 B) $0.0311 C) $1.0097 D) $1.0008 Answer: A Explanation: Use equation 19-1. But the quote must be a direct quote and the interest rate must be for the same period as the forward rate. The spot direct quote is 1 ÷ 32.456 = 0.0308 and the 1-month interest rates are 0.3333 percent and 0.25 percent respectively. Forward exchange rate = [(1 + 0.003333)/(1 + 0.0025)] × 0.0308 = $0.0308 per TWD Difficulty: 2 Medium Topic: Interest rate parity Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-05 Apply theories of how interest rates and inflation influence forward exchange rates and future spot rates. 62) If the current spot rate between the U.S. dollar and the Swedish krona was $1 = 7.5423 krona, and if the inflation rate in the United States was 5 percent and in Sweden it was 2 percent, then what would be the expected spot rate in one year? A) $0.1366 B) $0.1326 C) $7.7487 D) $0.1356 Answer: A Explanation: Use equation 19-3. But the quote must be a direct quote. The spot direct quote is 1 ÷ 7.5423 = 0.1326. Expected exchange rate = 0.1326 × (1 + 0.05 − 0.02) = $0.136578 per krona Difficulty: 2 Medium Topic: Purchasing power parity Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-04 Recognize situations that evoke exchange rate risk and develop tools to manage those risks.

63) If the current spot rate between the U.S. dollar and the Netherland Antilles guilder was $1 = 1.68 guilder, and if the inflation rate in the United States was 1 percent and in the Netherland Antilles it was 6 percent, then what would be the expected spot rate in one year? A) $0.5952 B) $0.5654 C) $0.6250 D) $0.6571 Answer: B Explanation: Use equation 19-3. But the quote must be a direct quote. The spot direct quote is 1 ÷ 1.68 = 0.5952 Expected exchange rate = 0.5952 × (1 + 0.01 − 0.06) = $0.5654 per guilder Difficulty: 2 Medium Topic: Purchasing power parity Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-04 Recognize situations that evoke exchange rate risk and develop tools to manage those risks. 64) If the current spot rate between the U.S. dollar and the Netherland Antilles guilder was $1 = 1.54 guilder, and if the inflation rate in the United States was 2 percent and in the Netherland Antilles it was 8 percent, then what would be the expected spot rate in one year? A) $0.6104 B) $0.6494 C) $1.4476 D) $0.6133 Answer: A Explanation: Use equation 19-3. But the quote must be a direct quote. The spot direct quote is 1 ÷ 1.54 = 0.6494 Expected exchange rate = 0.6494 × (1 + 0.02 − 0.08) = $0.6104 per guilder Difficulty: 2 Medium Topic: Purchasing power parity Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-04 Recognize situations that evoke exchange rate risk and develop tools to manage those risks.

65) A U.S. firm is expecting cash flows of 15 million Mexican pesos and 20 million Indian rupees. The current spot exchange rates are: $1 = 11.501 pesos and $1 = 45.525 rupees. If these cash flows are not received for one year and the expected spot rates at that time will be $1 = 11.265 pesos and $1 = 45.005 rupees, then what is the difference in dollars received that was caused by the delay? A) $0.03 million more B) $0.03 million less C) $16.94 million more D) $16.94 million less Answer: A Explanation: If the cash flows are received today, they would be: 15 million pesos × ($1 ÷ 11.501 pesos) + 20 million rupees × ($1 ÷ 45.525 rupees) = $1.74 million If the cash flows come in one year, they would be: 15 million pesos × ($1 ÷ 11.265 pesos) + 20 million rupees × ($1 ÷ 45.005 rupees) = $1.77 million The firm would get $0.03 million more in one year. Difficulty: 3 Hard Topic: Exchange rate risk Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-04 Recognize situations that evoke exchange rate risk and develop tools to manage those risks.

66) A U.S. firm is expecting cash flows of 5 million Mexican pesos and 10 million Indian rupees. The current spot exchange rates are: $1 =11.255 pesos and $1 = 44.864 rupees. If these cash flows are not received for one year and the expected spot rates at that time will be $1 = 10.080 pesos and $1 = 44.125 rupees, then what is the difference in dollars received that was caused by the delay? A) $56,000 more B) $56,000 less C) $13.265 million more D) $9.275 million more Answer: A Explanation: If the cash flows are received today, they would be: 5 million pesos × ($1 ÷ 11.255 pesos) + 10 million rupees × ($1 ÷ 44.864 rupees) = $0.667 million If the cash flows come in one year, they would be: 5 million pesos × ($1 ÷ 10.080 pesos) + 10 million rupees × ($1 ÷ 44.125 rupees) = $0.723 million The firm would get $0.056 million more in one year Difficulty: 3 Hard Topic: Exchange rate risk Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-04 Recognize situations that evoke exchange rate risk and develop tools to manage those risks.

67) A U.S. firm is expecting to pay cash flows of 20 million Egyptian pounds and 25 million Qatar rials. The current spot exchange rates are: $1 = 5.829 pounds and $1 = 3.645 rials. If these cash flows are delayed one year and the expected spot rates at that time will be $1 = 5.895 pounds and $1 = 3.899 rials, then what is the difference in dollars paid that was caused by the delay? A) $0.485 million less B) $0.485 million more C) $7.67 million more D) $7.67 million less Answer: A Explanation: If the cash flows are received today, they would be: 20 million pounds × ($1 ÷ 5.829 pounds) + 25 million rials × ($1 ÷ 3.645 rials) = $10.2898 million If the cash flows come in one year, they would be: 20 million pounds × ($1 ÷ 5.895 pounds) + 25 million rials × ($1 ÷ 3.899 rials) = $9.8046 million The firm would get $0.4852 million less in one year. Difficulty: 3 Hard Topic: Exchange rate risk Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-04 Recognize situations that evoke exchange rate risk and develop tools to manage those risks.

68) Assume the U.S. dollar spot exchange rate with the Canadian dollar is $1 = CA$1.125. The U.S. dollar and Swiss Franc exchange rate is $1 = 1.235. If the cross rate between the franc and Canadian dollar is 1 franc = CA$0.9820, then show that an arbitrage is possible. What positions should be taken to profit from the mispricing? A) Start with U.S. dollars, buy francs and convert them to Canadian dollars, then convert back to U.S. dollars. B) Start with francs, buy U.S. dollars and convert them to Canadian dollars, then convert back to francs. C) Start with Canadian dollars, buy francs and convert to U.S. dollars, then convert back to Canadian dollars. D) Start with U.S. dollars, buy Canadian dollars and convert to francs, then convert back to U.S. dollars. Answer: A Explanation: The inferred cross-rate is 1 franc = 1 franc × ($1 ÷ 1.235 francs) × (CA$1.125 ÷ $1) = CA$0.91093. Since this is not the same as the actual cross-rate, an arbitrage is possible. Starting with U.S. dollars, buy francs and convert them to Canadian dollars and then back to U.S. dollars. Difficulty: 3 Hard Topic: Triangular arbitrage Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-04 Recognize situations that evoke exchange rate risk and develop tools to manage those risks.

33) The U.S. dollar spot exchange rate with the Australian dollar is $1 = AU$1.2835. The U.S. dollar and euro exchange rate is $1 = €0.7605. If the cross-rate between the euro and Australian dollar is €1 = AU$1.610 then show that an arbitrage is possible. What positions should be taken to profit from the mispricing? A) Starting with U.S. dollars, buy Australian dollars and convert them to euros, then convert back to U.S. dollars. B) Starting with U.S. dollars, buy euros and convert them to Australian dollars, then convert back to U.S. dollars. C) Starting with euros, buy U.S. dollars and covert them to Australian dollars, then convert back to euros. D) Starting with Australian dollars, buy euros and convert them to U.S. dollars, then convert back to Australian dollars. Answer: A Explanation: The inferred cross-rate is €1 = €1 × ($1 ÷ €0.7605) × (AU$1.2835 ÷ $1) = AU$1.6877. Since this is not the same as the actual cross-rate, an arbitrage is possible. Starting with U.S. dollars, buy Australian dollars and convert them to euros and then back to U.S. dollars. Difficulty: 3 Hard Topic: Triangular arbitrage Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-04 Recognize situations that evoke exchange rate risk and develop tools to manage those risks.

34) The U.S. dollar spot exchange rate with the Australian dollar is $1 = AU$1.2219. The U.S. dollar and euro exchange rate is $1 = €0.7595. If the cross-rate between the euro and Australian dollar is €1 = AU$1.575 then show that an arbitrage is possible. What positions should be taken to profit from the mispricing? A) Starting with U.S. dollars, buy Australian dollars and convert them to euros, then convert back to U.S. dollars. B) Starting with U.S. dollars, buy euros and convert them to Australian dollars, then convert back to U.S. dollars. C) Starting with euros, buy U.S. dollars and convert them to Australian dollars, then convert back to euros. D) Starting with Australian dollars, buy euros and convert them to U.S. dollars, then convert back to Australian dollars. Answer: A Explanation: The inferred cross-rate is €1 = €1 × ($1 ÷ €0.7595) × (AU$1.2219 ÷ $1) = AU$1.6088. Since this is not the same as the actual cross-rate, an arbitrage is possible. Starting with U.S. dollars, buy Australian dollars and convert them to euros and then back to U.S. dollars. Difficulty: 3 Hard Topic: Triangular arbitrage Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-04 Recognize situations that evoke exchange rate risk and develop tools to manage those risks. 71) Convert the following direct quote to dollar indirect quote: 1 Danish krone = $0.1991. A) 5.0226 krone B) 5.1137 krone C) 5.2814 krone D) 5.3097 krone Answer: A Explanation: 1/0.1991 = 5.0226 krone Difficulty: 1 Easy Topic: Exchange rates Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-03 Compute currency exchanges.

72) Convert the following direct quote to dollar indirect quote: 1 Indian rupee = $0.2110. A) 5.0226 rupee B) 4.7393 rupee C) 4.8814 rupee D) 4.9097 rupee Answer: B Explanation: 1/0.2110 = 4.7393 rupee Difficulty: 1 Easy Topic: Exchange rates Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-03 Compute currency exchanges. 73) Convert each of the following direct quotes to dollar indirect quotes: 1 Korean won = $0.001556 1 Malaysian ringgit = $0.3419 1 Thai baht = $0.03999 $1 equals: A) 642.67 won; 2.9248 ringget; 28.01 baht B) 662.67 won; 2.9248 ringget; 28.01 baht C) 642.67 won; 2.7408 ringget; 25.01 baht D) 642.67 won; 2.9248 ringget; 25.01 baht Answer: D Explanation: won: 1/0.001556 = 642.67; ringget: 1/0.3419 = 2.9248; baht: 1/0.03999 = 25.01 Difficulty: 1 Easy Topic: Exchange rates Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-03 Compute currency exchanges.

74) Convert each of the following indirect quotes to dollar direct quotes: $1 = 805 Vietnam dong $1 = 2,349.6 Venezuelan bolivar $1 = 7.0523 South African rand $1 equals: A) 0.0012 dong; 0.0004 bolivar; 0.1418 rand B) 0.0072 dong; 0.004 bolivar; 0.1418 rand C) 0.0012 dong; 0.004 bolivar; 0.1478 rand D) 0.0022 dong; 0.0004 bolivar; 0.1418 rand Answer: A Explanation: dong: 1/805 = 0.0012; bolivar: 1/2349.6 = 0.0004; rand: 1/7.0523 = 0.1418 Difficulty: 1 Easy Topic: Exchange rates Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-03 Compute currency exchanges. 75) Convert each of the following indirect quotes to dollar direct quotes: $1 = 3.05 Saudi Arabian riyal $1 = 41.45 Philippine peso $1 = 0.52 Latvian lat $1 equals: A) 0.33 riyal; 0.02 peso; 1.92 lat B) 0.33 riyal; 0.02 peso; 1.95 lat C) 0.38 riyal; 0.05 peso; 1.92 lat D) 0.38 riyal; 0.02 peso; 1.95 lat Answer: A Explanation: riyal: 1/3.05 = 0.33; peso: 1/41.45 = 0.02; lat: 1/0.52 = 1.92 Difficulty: 1 Easy Topic: Exchange rates Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-03 Compute currency exchanges.

76) Convert each of the following indirect quotes to dollar direct quotes: $1 = 3.95 Saudi Arabian riyal $1 = 41.45 Philippine peso $1 = 0.58 Latvian lat $1 equals: A) 0.22 riyal; 0.02 peso; 1.75 lat B) 0.25 riyal; 0.02 peso; 1.72 lat C) 0.38 riyal; 0.05 peso; 1.72 lat D) 0.38 riyal; 0.02 peso; 1.95 lat Answer: B Explanation: riyal: 1/3.95 = 0.25; peso: 1/41.45 = 0.02; lat: 1/0.58 = 1.72 Difficulty: 1 Easy Topic: Exchange rates Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-03 Compute currency exchanges. 77) Compute the amount of each foreign currency that can be purchased for $5,000: a. 1 Danish krone = $0.18 b. 1 Indian rupee = $0.15 c. 1 Israeli shekel = $0.37 $5,000 equals: A) 17,777.78 krone; 33,333.33 rupee; 18,513.51 shekel B) 17,777.78 krone; 33,333.33 rupee; 13,513.51 shekel C) 27,777.78 krone; 38,333.33 rupee; 13,513.51 shekel D) 27,777.78 krone; 33,333.33 rupee; 13,513.51 shekel Answer: D Explanation: krone: 5,000/0.18 = 27,777.78 krone; rupee: 5,000/0.15 = 33,333.33 rupee; shekel: 5,000/0.37 = 13,513.51 shekel Difficulty: 1 Easy Topic: Exchange rates Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-03 Compute currency exchanges.

78) Compute the number of dollars that can be bought with 2 million of each foreign currency units: $1 = 19,005 Vietnam dong $1 = 2,949.6 Venezuelan bolivar $1 = 7.9523 South African rand

A) $108.24; $678.06; $251,489.57 B) $105.24; $678.06; $251,499.57 C) $108.24; $675.06; $251,499.57 D) $105.24; $675.06; $251,489.57 Answer: B Explanation: dong: 2,000,000/19,005 = $105.24; bolivar: 2,000,000/2,949.6 = $678.06; rand: 2,000,000/7.9523 = $251,499.57 Difficulty: 1 Easy Topic: Exchange rates Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-03 Compute currency exchanges. 79) Compute the number of dollars that can be bought with 1 million of each foreign currency units: $1 = 3.9 Saudi Arabian riyal $1 = 0.52 Philippine peso $1 = 0.75 Latvian lat

A) $258,410.26; $1,923,076.92; $1,333,888.33 B) $256,410.26; $1,928,076.92; $1,333,333.33 C) $256,410.26; $1,923,076.92; $1,333,333.33 D) $258,410.26; $1,928,076.92; $1,333,333.33 Answer: C Explanation: riyal: 1,000,000/3.9 = $256,410.26; peso: 1,000,000/0.52 = $1,923,076.92; lat: 1,000,000/0.75 = $1,333,333.33 Difficulty: 1 Easy Topic: Exchange rates Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-03 Compute currency exchanges.

80) If the price of silver in England is £6.25 per ounce, what is the expected price of silver in the United States if the spot exchange rate is $1 = £0.55? A) $11.36 B) $13.25 C) $10.17 D) $14.06 Answer: A Explanation: £6.25 per ounce = £6.25 ÷ £0.55 per $ = $11.36 per ounce Difficulty: 1 Easy Topic: Purchasing power parity Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-05 Apply theories of how interest rates and inflation influence forward exchange rates and future spot rates. 81) If the price of copper in Europe is €2.72 per ounce, what is the expected price of copper in the United States if the spot exchange rate is $1 = €0.8623? A) $3.15 B) $3.84 C) $4.17 D) $2.98 Answer: A Explanation: €2.72 per ounce = €2.72 ÷ €0.8623 per $ = $3.15 per ounce Difficulty: 1 Easy Topic: Purchasing power parity Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-05 Apply theories of how interest rates and inflation influence forward exchange rates and future spot rates.

82) A financial manager has determined that the appropriate discount rate for a foreign project is 17 percent. However, that discount rate applies in the United States using dollars. What discount rate should be used in the foreign country using the foreign currency? The inflation rates in the United States and in the foreign country are expected to be 3 percent and 8 percent, respectively. A) 17 percent B) 20 percent C) 22 percent D) 25 percent Answer: C Explanation: The discount rate in the foreign country should be 17 percent + (8 percent − 3 percent) = 22 percent Difficulty: 1 Easy Topic: International capital budgeting Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-07 As a financial manager, plan to work through capital budgeting issues for international investments. 83) Given these two exchange rates, $1 = 12.5 Mexican peso and $1 = €0.75, compute the crossrate between the Mexican peso and the euro. State this exchange rate in pesos. A) 19.14 pesos B) 17.62 pesos C) 16.67 pesos D) 18.03 pesos Answer: C Explanation: 1 peso = 1 peso × ($1 ÷ 12.5 peso) × (€0.75 ÷ $1) = €0.06 Also, €1 = €1 ÷ €0.06 per peso = 16.67 peso Difficulty: 2 Medium Topic: Exchange rates Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-03 Compute currency exchanges.

84) Given these two exchange rates, $1 = 1.32 Australian dollars and $1 = £0.56, compute the cross-rate between the Australian dollar and the pound. State this exchange rate in Australian dollars. A) A$2.49 B) A$2.36 C) A$2.91 D) A$2.17 Answer: B Explanation: A$1 = A$1 × ($1 ÷ A$1.32) × (£0.56 ÷ $1) = £0.4242 Also, £1 = £1 ÷ £0.4242 per A$ = A$2.36 Difficulty: 2 Medium Topic: Exchange rates Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-03 Compute currency exchanges. 85) The Russian financial crisis of 1998 caused Russia's currency to be dramatically devalued. What is the percentage change in value of a $100 million investment in Russia when the exchange rate changes from $1 = 6 rubles to $1 = 25 rubles? A) −49 percent B) −57 percent C) −69 percent D) −76 percent Answer: D Explanation: The company invests $100 million at a value of $100 million × (6 rubles/$1) = 600 million rubles Then the ruble devalues and the 600 million ruble investment becomes worth: 600 million rubles × ($1/25 rubles) = $24 million. This is a drop from $100 million to $24 million, or a 76 percent decline {= (24 − 100)/100} Difficulty: 2 Medium Topic: Exchange rate risk Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-04 Recognize situations that evoke exchange rate risk and develop tools to manage those risks.

86) The spot rate between the U.S. dollar and the New Zealand dollar is $1 = NZD1.6607. If the interest rate in the United States is 6 percent and in New Zealand is 4 percent, then what should be the three-month forward exchange rate? A) $0.5368 per NZD B) $0.6051 per NZD C) $0.7614 per NZD D) $0.8075 per NZD Answer: B Explanation: [1/1.6607] × (1 + 0.015)/(1 + 0.01) = $0.6051 per NZD Difficulty: 2 Medium Topic: Interest rate parity Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-05 Apply theories of how interest rates and inflation influence forward exchange rates and future spot rates. 87) The current spot rate between the U.S. dollar and the Swedish krona is $1 = 7.5500 krona. If the inflation rate in the United States is 4 percent and in Sweden is 1 percent, then what is the expected spot rate in one year? A) $0.1908 per krona B) $0.2116 per krona C) $0.1529 per krona D) $0.1364 per krona Answer: D Explanation: [1/7.55] × (1 + 0.04 − 0.01) = $0.1364 per krona Difficulty: 2 Medium Topic: Purchasing power parity Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-06 Anticipate political risks when investing internationally.

88) A U.S. firm is expecting cash flows of 20 million Mexican pesos and 35 million Indian rupees. The current spot exchange rates are: $1 = 11.792 pesos and $1 = 49.204 rupees. If these cash flows are not received for one year and the expected spot rates at that time will be $1 = 11.118 pesos and $1 = 41.075 rupees, then what is the difference in dollars received that was caused by the delay? A) $0.03 million B) $0.15 million C) $0.24 million D) $0.32 million Answer: C Explanation: If the cash flows are received today, they would be: 20 million pesos × ($1 ÷ 11.792 pesos) + 35 million rupees × ($1 ÷ 49.204 rupees) = $2.41 million. If the cash flows come in one year, they would be: 20 million pesos × ($1 ÷ 11.118 pesos) + 35 million rupees × ($1 ÷ 41.075 rupees) = $2.65 million. The firm would get $0.24 million more in one year. Difficulty: 3 Hard Topic: Exchange rate risk Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-04 Recognize situations that evoke exchange rate risk and develop tools to manage those risks. 89) A U.S. firm is expecting to pay cash flows of 15 million Egyptian pounds and 25 million Qatar rials. The current spot exchange rates are: $1 = 5.25 pounds and $1 = 3.75 rials. If these cash flows are delayed one year and the expected spot rates at that time will be $1 = 5.62 pounds and $1 = 4.00 rials, then what is the difference in dollars paid that was caused by the delay? A) $0.68 million B) $0.84 million C) $1.08 million D) $0.6 million Answer: D Explanation: If the cash flows are received today, they would be: 15 million pounds × ($1 ÷ 5.25 pounds) + 25 million rials × ($1 ÷ 3.75 rials) = $9.52 million. If the cash flows come in one year, they would be: 15 million pounds × ($1 ÷ 5.62 pounds) + 25 million rials × ($1 ÷ 4.00 rials) = $8.92 million. The firm would get $0.6 million less in one year. Difficulty: 3 Hard Topic: Exchange rate risk Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-04 Recognize situations that evoke exchange rate risk and develop tools to manage those risks.

90) The U.S. dollar spot exchange rate with the Canadian dollar is $1 = CA$1.12. The U.S. dollar and Swiss franc exchange rate is $1 =1.275. If the cross-rate between the franc and Canadian dollar is 1 franc = CA$0.9750, which of the following statements is correct? A) Starting with U.S. dollars, buy Swiss francs and convert them to Canadian dollars, and then convert back to U.S. dollars. B) Starting with Canadian dollars, buy Swiss francs and convert them to U.S. dollars, and then convert back to Swiss francs. C) Starting with Swiss francs, buy Canadian dollars and convert them to Swiss francs, and then convert back to U.S. dollars. D) Starting with Canadian dollars, buy U.S. dollars and convert them to Swiss francs, and then convert back to U.S. dollars. Answer: A Explanation: The inferred cross-rate is 1 franc = 1 franc × ($1 ÷ 1.275 francs) × (CA$1.12 ÷ $1) = CA$0.8784. Since this is not the same as the actual cross-rate, an arbitrage is possible. Starting with U.S. dollars, buy francs and convert them to Canadian dollars and then back to U.S. dollars. Difficulty: 3 Hard Topic: Triangular arbitrage Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-03 Compute currency exchanges. 91) An exchange rate regime where the country's central bank allows its currency price to float freely between an upper and lower bound and may buy or sell large amounts of it in order to provide price support or resistance is referred to as: A) forward exchange regime. B) purchasing parity regime. C) freely floating regime. D) managed floating regime. Answer: D Difficulty: 1 Easy Topic: Exchange rate risk Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-04 Recognize situations that evoke exchange rate risk and develop tools to manage those risks.

92) All of the following are political risks to the assets and cash flows of multinational corporations EXCEPT: A) government seizure of a company's assets in the country. B) enactment of new taxation. C) expropriation with minimal compensation. D) improving exchange rates to stimulate foreign investment. Answer: D Difficulty: 1 Easy Topic: Political risk Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-06 Anticipate political risks when investing internationally. 93) All of the following are ways that a multinational corporation can minimize the impact of political risk EXCEPT: A) using local financing. B) purchasing country risk insurance. C) paying off government officials. D) All of the options are ways that a multinational corporation can minimize the impact of political risk. Answer: C Difficulty: 2 Medium Topic: Political risk Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-06 Anticipate political risks when investing internationally. 94) The concept of interest parity describes: A) why spot and forward rates differ. B) how inflation causes exchange rates to change. C) why identical products should have the same price. D) none of the options. Answer: A Difficulty: 1 Easy Topic: Interest rate parity Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-05 Apply theories of how interest rates and inflation influence forward exchange rates and future spot rates.

95) If gold is selling in the U.S. for $1,015 per ounce and if 1 peso = $0.35, then gold should sell for in Mexico. A) $2,900 B) 355.25 pesos C) 2,900 pesos D) $355.25 Answer: C Explanation: 1,015/0.35 = 2,900 pesos Difficulty: 1 Easy Topic: Purchasing power parity Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-05 Apply theories of how interest rates and inflation influence forward exchange rates and future spot rates. 96) If the law of one price does not hold, then: A) investors will not be compensated for their risk. B) inflation rates will be very volatile. C) arbitrageurs can make large profits. D) None of the options will occur. Answer: C Difficulty: 2 Medium Topic: Purchasing power parity Bloom's: Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-05 Apply theories of how interest rates and inflation influence forward exchange rates and future spot rates. 97) China's exchange rate is a: A) freely floating regime. B) managed floating regime. C) fixed peg arrangement. D) none of the options. Answer: C Difficulty: 1 Easy Topic: Exchange rate risk Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-04 Recognize situations that evoke exchange rate risk and develop tools to manage those risks. 46

98) China's exchange rate is pegged to the: A) U.S. dollar. B) price of a barrel of oil. C) euro. D) none of the options. Answer: D Difficulty: 1 Easy Topic: Exchange rate risk Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-04 Recognize situations that evoke exchange rate risk and develop tools to manage those risks. 99) Arbitrage profit can be made by: A) selling assets in future markets and buying them in the spot markets. B) buying assets in markets with high interest rates and selling them in a local market. C) buying assets in a "cheap" market and selling them in another market where the price is higher. D) none of the options. Answer: C Difficulty: 2 Medium Topic: Triangular arbitrage Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-03 Compute currency exchanges. 100) When Starbucks opens a location in Mexico City, this is an example of: A) foreign direct investment. B) arbitrage opportunity. C) management of capital budgeting issues. D) none of the options. Answer: A Difficulty: 1 Easy Topic: Multinational corporations and operations Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-02 Recognize patterns of increasing capital involvement as the firm seeks to expand business internationally.

101) All of the following are ways to conduct international business EXCEPT: A) direct ownership investment. B) import/export operations. C) partnership arrangements. D) all of the options. Answer: D Difficulty: 1 Easy Topic: Multinational corporations and operations Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-02 Recognize patterns of increasing capital involvement as the firm seeks to expand business internationally. 102) All of the following are examples of factors that affect trading activity between countries EXCEPT: A) charging a 0.75 percent import tax on steel imported from China into the United States. B) charging a $3 tariff per barrel of crude oil imported in the United States. C) restricting the importation of produce into the United States from South America. D) all of the options are factors that affect trading activity between countries. Answer: D Difficulty: 2 Medium Topic: International transactions Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-01 Gauge the dynamics of the global economy and recognize potential international opportunities. 103) Trade agreements are intended to: A) reduce or eliminate trade restrictions and tariffs between countries B) reduce or eliminate import and/or export limitations between countries C) avoid retaliatory barriers between two countries D) all of the above Answer: D Difficulty: 1 Easy Topic: Trade agreements Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-01 Gauge the dynamics of the global economy and recognize potential international opportunities.

104) An international organization that monitors exchange rates and balance of payments and oversees the global financial system is the . A) World Trade Organization (WTO) B) International Monetary Fund (IMF) C) European Union (EU) D) North American Free Trade Agreement (NAFTA) Answer: B Difficulty: 1 Easy Topic: Multinational corporations and operations Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-01 Gauge the dynamics of the global economy and recognize potential international opportunities. 105) A golf club costs $100 in the United States. The same club costs AU$129 in Australia. Assume that purchasing power parity holds. What is the exchange rate between the U.S. and Australian dollars? A) $1 U.S. = AU$1.25 B) $1 U.S. = AU$0.7752 C) AU$1 = $0.7752 U.S. D) AU$1 = $1.50 U.S. Answer: C Explanation: 100/129 = 0.7752 Difficulty: 1 Easy Topic: Purchasing power parity Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-05 Apply theories of how interest rates and inflation influence forward exchange rates and future spot rates.

106) A golf club costs $112 in the United States. The same club costs AU$78 in Australia. Assume that purchasing power parity holds. What is the exchange rate between the U.S. and Australian dollars? A) $1 U.S. = AU$1.37 B) $1 U.S. = AU$1.44 C) AU$1 = $1.37 U.S. D) AU$1 = $1.44 U.S. Answer: D Explanation: 112/78 = 1.44 Difficulty: 1 Easy Topic: Purchasing power parity Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-05 Apply theories of how interest rates and inflation influence forward exchange rates and future spot rates. 107) Firms can expand internationally through several methods that require increasingly higher participation in capital at risk and potential for profits and include which of the following? A) import/export B) partnering through sales subsidiary, licensing or franchising, or joint venture C) direct ownership D) all of the above Answer: D Difficulty: 1 Easy Topic: Multinational corporations and operations Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-03 Compute currency exchanges.

108) A large amount of foreign direct investment into a country will most likely result in: A) more jobs. B) higher inflation. C) higher tariffs. D) lower taxes. Answer: A Difficulty: 1 Easy Topic: Multinational corporations and operations Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-02 Recognize patterns of increasing capital involvement as the firm seeks to expand business internationally. 109) Risks inherent in making investments in foreign countries include: A) the value of their investment changes as the exchange rates change. B) cash flows to be received in the future may be worth less when actually received if the foreign exchange rate fluctuates dramatically. C) political risks due to an unstable government. D) All of the options are risks inherent in making investments in foreign countries. Answer: D Difficulty: 1 Easy Topic: Exchange rate risk Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-02 Recognize patterns of increasing capital involvement as the firm seeks to expand business internationally.; 19-06 Anticipate political risks when investing internationally. 110) is a theory relating the expected adjustment needed in the future spot exchange rate between countries to the inflation rate in each economy. A) purchase power parity B) law of one price C) interest rate parity D) hedging Answer: A Difficulty: 1 Easy Topic: Purchasing power parity Bloom's: Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-05 Apply theories of how interest rates and inflation influence forward exchange rates and future spot rates. 51

111) Some political risks to the assets and cash flows of multinational corporations include: A) government seizure of a company's assets in the country; and enactment of a new taxation B) expropriation with minimal compensation; and limiting or blocking the conversion of local currency to the MNC's domestic currency C) both a and b D) none of the above Answer: C Difficulty: 1 Easy Topic: Multinational corporations and operations Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-06 Anticipate political risks when investing internationally. 112) Tools that multinationals can use to help them reduce the risks inherent in making investments in foreign countries include: A) options. B) hedges. C) swaps. D) All of the options are tools that multinationals can use to help them reduce the risks inherent in making investments in foreign countries. Answer: D Difficulty: 1 Easy Topic: Exchange rate risk Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-02 Recognize patterns of increasing capital involvement as the firm seeks to expand business internationally.

113) Over the past decade, China has acquired hundreds of billions of U.S. dollars due to the trade imbalance between the two countries. The Chinese government has used many of these dollars to purchase Treasury bonds. What would be the effect if China suddenly decided to sell the majority of these Treasury bonds and exchange the dollars for pesos? A) The price of Treasury bonds would rise, the yield on the Treasury bonds would fall, the dollar would weaken, and the peso would strengthen. B) The price of Treasury bonds would rise, the yield on the Treasury bonds would fall, the dollar would strengthen, and the peso would weaken. C) The price of Treasury bonds would fall, the yield on the Treasury bonds would rise, the dollar would weaken, and the peso would strengthen. D) The price of Treasury bonds would fall, the yield on the Treasury bonds would fall, the dollar would strengthen, and the peso would weaken. Answer: C Difficulty: 2 Medium Topic: Future exchange rates; Spot and forward rates Bloom's: Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-05 Apply theories of how interest rates and inflation influence forward exchange rates and future spot rates. 114) If the spot rate between the U.S. dollar and the Brazilian real is $1 = 2.0895 real and the 3month forward rate is $1 = 2.1725 real, is the forward real selling at a discount or a premium? A) Discount B) Premium C) Unable to determine with the cross-rates Answer: A Difficulty: 2 Medium Topic: Future exchange rates; Spot and forward rates Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-05 Apply theories of how interest rates and inflation influence forward exchange rates and future spot rates.

115) If the spot rate between the U.S. dollar and the Mexican peso is $1 = 2.45 peso and the 3month forward rate is $1 = 2.05 pesos, is the forward peso selling at a discount or a premium? A) Discount B) Premium C) Unable to determine with the cross-rates Answer: B Difficulty: 2 Medium Topic: Spot and forward rates Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-05 Apply theories of how interest rates and inflation influence forward exchange rates and future spot rates. 116) Suppose exchange rates between the U.S. dollar and the Mexican peso is 12.90 peso = $1 and the exchange rate between the U.S. dollar and the euro is $1 = 0.90 euros. What is the crossrate of the Mexican peso to the euro? A) 16.03 B) 17.21 C) 15.26 D) 14.33 Answer: D Explanation: [12.90/1] × [1/0.90] = 14.33 Difficulty: 2 Medium Topic: Exchange rates Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-05 Apply theories of how interest rates and inflation influence forward exchange rates and future spot rates.

117) International capital budgeting will require that managers: A) recognize all of the risks as well as the rewards. B) increase the discount rate to account for any added risks associated with that country. C) convert all incremental cash flows to the domestic currency or convert the domestic discount rate to an equivalent rate in the foreign country. D) All of the options are required. Answer: D Difficulty: 1 Easy Topic: International capital budgeting Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-07 As a financial manager, plan to work through capital budgeting issues for international investments. 118) If fewer dollars will buy a unit of foreign currency, then the dollar is: A) strengthening. B) weakening. C) violating the law of purchasing power parity. D) not in equilibrium. Answer: A Difficulty: 1 Easy Topic: Exchange rate risk Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-04 Recognize situations that evoke exchange rate risk and develop tools to manage those risks. 119) If fewer dollars will buy a unit of foreign currency, then the foreign currency is: A) strengthening. B) weakening. C) violating the law of purchasing power parity. D) not in equilibrium. Answer: B Difficulty: 1 Easy Topic: Exchange rate risk Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-04 Recognize situations that evoke exchange rate risk and develop tools to manage those risks.

120) If more dollars are required to buy a unit of foreign currency, then the dollar is: A) strengthening. B) weakening. C) violating the law of one price. D) not in equilibrium. Answer: B Difficulty: 1 Easy Topic: Exchange rate risk Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-04 Recognize situations that evoke exchange rate risk and develop tools to manage those risks. 121) If you are told that $1 will buy 25 Korean wons, then you were given a(n): A) indirect quote. B) direct quote. C) cross-rate. D) none of the options. Answer: A Difficulty: 1 Easy Topic: Exchange rates Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-03 Compute currency exchanges. 122) A golf club costs $100 in the United States. The same club costs AU$143 in Australia. Assume that purchasing power parity holds. What is the exchange rate between the U.S. and Australian dollars? A) AU$1 = $1.43 U.S. B) AU$1 = $1.25 U.S. C) AU$1 = $0.6993 U.S. D) AU$1 = $0.7752U.S. Answer: C Explanation: 100/143 = 0.6993 Difficulty: 1 Easy Topic: Purchasing power parity Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-05 Apply theories of how interest rates and inflation influence forward exchange rates and future spot rates. 56

123) A golf club costs $143 in the United States. The same club costs AU$100 in Australia. Assume that purchasing power parity holds. What is the exchange rate between the U.S. and Australian dollars? A) AU$1 = $1.43 U.S. B) AU$1 = $1.25 U.S. C) AU$1 = $0.6993 U.S. D) AU$1 = $0.7752U.S. Answer: A Explanation: 143/100 = 1.43 Difficulty: 1 Easy Topic: Purchasing power parity Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-05 Apply theories of how interest rates and inflation influence forward exchange rates and future spot rates. 124) If the spot rate between the U.S. dollar and the Brazilian real is $1 = 2.5698 real and the 3month forward rate is $1 = 2.9841 real, is the forward real selling at a discount or a premium? A) Discount B) Premium C) Unable to determine with the cross-rates Answer: A Difficulty: 2 Medium Topic: Future exchange rates; Spot and forward rates Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-05 Apply theories of how interest rates and inflation influence forward exchange rates and future spot rates.

125) If the spot rate between the U.S. dollar and the Mexican peso is $1 = 12.9841 peso and the 3-month forward rate is $1 = 12.5698 pesos, is the forward peso selling at a discount or a premium? A) Discount B) Premium C) Unable to determine with the cross-rates Answer: B Difficulty: 2 Medium Topic: Future exchange rates; Spot and forward rates Bloom's: Remember; Understand AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-05 Apply theories of how interest rates and inflation influence forward exchange rates and future spot rates. 126) Suppose exchange rates between the U.S. dollar and the Mexican peso is 11.45 peso = $1 and the exchange rate between the U.S. dollar and the euro is $1 = 1.0866 euros. What is the cross-rate of the Mexican peso to the euro? A) 9.49 B) 10.54 C) 12.44 D) 12.54 Answer: B Explanation: [11.45/1] × [1/1.0866] = 10.5375 Difficulty: 2 Medium Topic: Exchange rates Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-05 Apply theories of how interest rates and inflation influence forward exchange rates and future spot rates.

127) Given these two exchange rates, $1 = 14.96 Mexican peso and $1 = €0.67, compute the cross-rate between the Mexican peso and the euro. State this exchange rate in pesos. A) 10.02 pesos B) 15.63 pesos C) 18.69 pesos D) 22.32 pesos Answer: D Explanation: 1 peso = 1 peso × ($1 ÷ 14.96 peso) × (€0.67 ÷ $1) = €0.0448 Also, €1 = €1 ÷ €0.0448 per peso = 22.32 peso Difficulty: 2 Medium Topic: Exchange rates Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-03 Compute currency exchanges. 128) Given these two exchange rates, $1 = 1.43 Australian dollars and $1 = £0.69, compute the cross-rate between the Australian dollar and the pound. State this exchange rate in Australian dollars. A) A$2.07 B) A$2.12 C) A$2.36 D) A$4.83 Answer: A Explanation: A$1 = A$1 × ($1 ÷ A$1.43) × (£0.69 ÷ $1) = £0.4825 Also, £1 = £1 ÷ £0.4825 per A$ = A$2.07 Difficulty: 2 Medium Topic: Exchange rates Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-03 Compute currency exchanges.

129) A financial manager has determined that the appropriate discount rate for a foreign project is 12 percent. However, that discount rate applies in the United States using dollars. What discount rate should be used in the foreign country using the foreign currency? The inflation rates in the United States and in the foreign country are expected to be 3 percent and 10 percent, respectively. A) 15 percent B) 19 percent C) 22 percent D) 25 percent Answer: B Explanation: The discount rate in the foreign country should be 12 percent + (10 percent − 3 percent) = 19 percent Difficulty: 1 Easy Topic: International capital budgeting Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-07 As a financial manager, plan to work through capital budgeting issues for international investments. 130) Convert each of the following indirect quotes to dollar direct quotes: $1 = 118.115 Yen $1 = 0.9203 Euro $1 = 1.0052 Swiss franc $1 equals: A) 0.0085 Yen; 1.0866 Euro; 0.9948 franc B) 0.8500 Yen; 1.0866 Euro; 0.9948 franc C) 1.1812 Yen; 0.9203 Euro; 1.0052 franc D) 1.1812 Yen; 1.0866 Euro; 0.9948 franc Answer: A Explanation: Yen: 1/118.115 = 0.0085; Euro: 1/0.9203 = 1.0866; franc: 1/1.0052 = 0.9948 Difficulty: 1 Easy Topic: Exchange rates Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-03 Compute currency exchanges.

131) Convert each of the following indirect quotes to dollar direct quotes: $1 = 4.01 Saudi Arabian riyal $1 = 62.05 Philippine peso $1 = 0.76 Latvian lat $1 equals: A) 0.25 riyal; 0.02 peso; 1.32 lat B) 0.45 riyal; 0.07 peso; 1.32 lat C) 0.45 riyal; 0.06 peso; 1.76 lat D) 0.45 riyal; 0.07 peso; 1.76 lat Answer: A Explanation: riyal: 1/4.01 = 0.2494; peso: 1/62.05 = 0.0161; lat: 1/0.76 = 1.3158 Difficulty: 1 Easy Topic: Exchange rates Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 19-03 Compute currency exchanges.

Finance, 5e (Cornett) Chapter 20 Mergers and Acquisitions and Financial Distress 1) Which of the following is defined as a transaction in which two firms combine to form a single firm? A) Merger B) Synergy C) Acquisition D) Assignment Answer: A Difficulty: 1 Easy Topic: Types of mergers and acquisitions Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 20-01 Differentiate among types of and address motives for mergers and acquisitions. 2) Which of the following is defined as the purchase of one firm by another firm? A) Merger B) Synergy C) Acquisition D) Assignment Answer: C Difficulty: 1 Easy Topic: Types of mergers and acquisitions Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 20-01 Differentiate among types of and address motives for mergers and acquisitions.

3) Which of the following is a type of merger in which an entirely new firm is created? A) Composition B) Synergy C) Consolidation D) Assignment Answer: C Difficulty: 1 Easy Topic: Types of mergers and acquisitions Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 20-01 Differentiate among types of and address motives for mergers and acquisitions. 4) Which of the following is a type of merger in which two firms that sell the same products in different market areas are combined? A) Vertical B) Conglomerate C) Product extension D) Market extension Answer: D Difficulty: 1 Easy Topic: Types of mergers and acquisitions Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 20-01 Differentiate among types of and address motives for mergers and acquisitions. 5) Which of the following is a combination of a firm with a supplier or distributor? A) Vertical merger B) Conglomerate merger C) Product extension merger D) Market extension merger Answer: A Difficulty: 1 Easy Topic: Types of mergers and acquisitions Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 20-01 Differentiate among types of and address motives for mergers and acquisitions.

6) Which of the following combines two companies that have no related products or markets? A) Vertical merger B) Conglomerate merger C) Product extension merger D) Market extension merger Answer: B Difficulty: 1 Easy Topic: Types of mergers and acquisitions Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 20-01 Differentiate among types of and address motives for mergers and acquisitions. 7) Which of the following is a combination of firms that sell different, but somewhat related, products? A) Vertical merger B) Conglomerate merger C) Product extension merger D) Market extension merger Answer: C Difficulty: 1 Easy Topic: Types of mergers and acquisitions Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 20-01 Differentiate among types of and address motives for mergers and acquisitions. 8) A merger of two companies within the same industry is a A) Horizontal merger B) Market extension merger C) Vertical merger D) Conglomerate merger

Answer: A Difficulty: 1 Easy Topic: Types of mergers and acquisitions Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 20-01 Differentiate among types of and address motives for mergers and acquisitions.

9) A type of horizontal merger that combines two firms that sell the same products in different market areas is a . A) Product extension merger B) Market extension merger C) Vertical merger D) Conglomerate merger Answer: B Difficulty: 1 Easy Topic: Types of mergers and acquisitions Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 20-01 Differentiate among types of and address motives for mergers and acquisitions. 10) Which of these terms is defined as the value of the combined firms being greater than the sum of the value of the two firms individually? A) Composition B) Synergy C) Consolidation D) Conglomerate Answer: B Difficulty: 1 Easy Topic: Motives for mergers and acquisitions Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 20-01 Differentiate among types of and address motives for mergers and acquisitions. 11) Which of the following is NOT one of the sources of value enhancing synergy in a merger? A) Revenue enhancement B) Cost reduction C) Tax considerations D) Higher cost of capital Answer: D Difficulty: 2 Medium Topic: Motives for mergers and acquisitions Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 20-01 Differentiate among types of and address motives for mergers and acquisitions. 4

12) Which of the following is defined as a merged firm's ability to generate synergistic cost savings through the joint use of inputs in producing multiple products? A) Economies of scale B) Economies of scope C) Economies of synergy D) X-efficiencies Answer: B Difficulty: 2 Medium Topic: Motives for mergers and acquisitions Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 20-01 Differentiate among types of and address motives for mergers and acquisitions. 13) Which of the following is defined as a merged firm's advantage over smaller firms if cuts associated with the merger lower the firm's operating costs of production? A) Economies of scale B) Economies of scope C) Economies of synergy D) X-efficiencies Answer: A Difficulty: 2 Medium Topic: Motives for mergers and acquisitions Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 20-01 Differentiate among types of and address motives for mergers and acquisitions.

14) The cost advantage when fixed costs are spread over a large number of units is A) Long-term effect B) Economies of scope C) Economies of synergy D) Economies of scale

Answer: D Difficulty: 2 Medium Topic: Motives for mergers and acquisitions Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 20-01 Differentiate among types of and address motives for mergers and acquisitions. 15) Which of the following is cost savings usually attributed to superior management skills and other difficult-to-measure managerial factors? A) Economies of scale B) Economies of scope C) Economies of synergy D) X-efficiencies Answer: D Difficulty: 2 Medium Topic: Motives for mergers and acquisitions Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 20-01 Differentiate among types of and address motives for mergers and acquisitions. 16) Which of the following is NOT a tax consideration motive for a merger? A) Tax gains from net operating losses B) Tax gains from unused debt capacity C) Tax gains from unused equity capacity D) Tax gains from surplus funds Answer: C Difficulty: 2 Medium Topic: Motives for mergers and acquisitions Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 20-01 Differentiate among types of and address motives for mergers and acquisitions.

17) Which of these makes the following a true statement? Diversification resulting from a merger can: A) make the debt of the merged firm more risky, thus lowering the cost of capital. B) make the debt of the merged firm less risky, thus lowering the cost of capital. C) make the debt of the merged firm less risky, thus raising the cost of capital. D) None of the options make the statement true. Answer: B Difficulty: 2 Medium Topic: Motives for mergers and acquisitions Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 20-01 Differentiate among types of and address motives for mergers and acquisitions. 18) Which of the following is the most extreme type of financial distress for a business? A) Business failure B) Economic failure C) Technical insolvency D) Business extension Answer: A Difficulty: 1 Easy Topic: Financial distress Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 20-03 Suggest methods by which a firm can informally resolve severe financial distress. 19) Which of the following is the type of financial distress in which the return on a firm's assets is less than the firm's cost of capital? A) Business failure B) Economic failure C) Technical insolvency D) Business extension Answer: B Difficulty: 1 Easy Topic: Financial distress Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 20-03 Suggest methods by which a firm can informally resolve severe financial distress. 7

20) Which of the following is the type of financial distress in which a firm's operating cash flows are not sufficient to pay its liabilities as they come due? A) Business failure B) Economic failure C) Technical insolvency D) Business extension Answer: C Difficulty: 1 Easy Topic: Financial distress Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 20-03 Suggest methods by which a firm can informally resolve severe financial distress. 21) Which of the following is the termination of the firm as a going concern in which assets are sold and any proceeds go to pay off the firm's creditors? A) Liquidation B) Assignment C) Composition D) Consolidation Answer: A Difficulty: 1 Easy Topic: Private workout Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 20-03 Suggest methods by which a firm can informally resolve severe financial distress.

22) Which of the following is a voluntary liquidation proceeding that passes the liquidation of the firm's assets to a third party that is designated as the assignee or trustee? A) Liquidation B) Assignment C) Composition D) Consolidation Answer: B Difficulty: 1 Easy Topic: Private workout Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 20-03 Suggest methods by which a firm can informally resolve severe financial distress. 23) A voluntary settlement in which a firm's creditors will arrange with the firm to help it recover and re-establish itself as a viable entity is a . A) Extension B) Composition C) Workout D) none of the above Answer: C Difficulty: 1 Easy Topic: Private workout Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 20-03 Suggest methods by which a firm can informally resolve severe financial distress.

24) An agreement in which creditors voluntarily reduce their claims on the firm, receiving only a partial payment for their claims, by reducing the principal amount or the interest rate on the debt or by taking equity in exchange for debt is a . A) Extension B) Composition C) Workout D) none of the above Answer: B Difficulty: 1 Easy Topic: Private workout Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 20-03 Suggest methods by which a firm can informally resolve severe financial distress. 25) Which of these is the person who liquidates the firm's assets through a private sale or public auction and then distributes any proceeds from the sale to the firms' creditors and stockholders? A) Assignor B) Grantor C) Trustor D) Trustee Answer: D Difficulty: 1 Easy Topic: Private workout Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 20-03 Suggest methods by which a firm can informally resolve severe financial distress.

26) Which of the following is a formal bankruptcy proceeding which outlines the process to be followed for liquidating a failed firm? A) Chapter 7 B) Chapter 11 C) Chapter 13 D) Chapter 17 Answer: A Difficulty: 1 Easy Topic: Bankruptcy Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 20-04 Differentiate between Chapter 7 and Chapter 11 bankruptcy. 27) Which of the following is a formal bankruptcy proceeding involving the reorganization of the corporation with some provision for repayment to the firm's creditors? A) Chapter 7 B) Chapter 11 C) Chapter 13 D) Chapter 17 Answer: B Difficulty: 1 Easy Topic: Bankruptcy Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 20-04 Differentiate between Chapter 7 and Chapter 11 bankruptcy. 28) Which of the following involves a firm and its creditors agreeing to a private reorganization outside the formal bankruptcy process? A) Consolidation bankruptcy B) Prepackaged bankruptcy C) Chapter 13 D) Chapter 7 Answer: B Difficulty: 1 Easy Topic: Bankruptcy Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 20-04 Differentiate between Chapter 7 and Chapter 11 bankruptcy.

29) Jan's Bakery is considering a merger with Tina's Cookies. Jan's total operating costs of producing services are $300,000 for a sales volume of $2 million. Tina's total operating costs of producing services are $75,000 for a sales volume of $600,000. If the two firms merge, calculate the total average cost for the merged firm assuming no synergies. A) 12.5 percent B) 11.54 percent C) 14.42 percent D) 13.75 percent Answer: C Explanation: AC =

$375,000 $2,600,000

= 0.1442 = 14.42%

Difficulty: 1 Easy Topic: Merger and acquisition analysis Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 20-02 Mathematically value mergers. 30) Flowers Galore is considering a merger with Balloons N More. Flowers Galore's total operating costs of producing services are $400,000 for a sales volume of $4 million. Balloons' total operating costs of producing services are $30,000 for a sales volume of $700,000. If the two firms merge, calculate the total average cost for the merged firm assuming no synergies. A) 4.29 percent B) 9.15 percent C) 10.00 percent D) 7.14 percent Answer: B Explanation: AC =

$430,000 $4,700,000

= 0.0915 = 9.15%

Difficulty: 1 Easy Topic: Merger and acquisition analysis Bloom's: Apply; Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 20-02 Mathematically value mergers.

31) Building Supplies is considering a merger with Tools and More. Building's total operating costs of producing services are $4 million for a sales volume of $20 million. Tools' total operating costs of producing services are $1 million for a sales volume of $5 million. Suppose that synergies in the production process result in a cost of production for the merged firms totalling $4.8 million with total sales remaining unchanged. Calculate the total average cost for the merged firm. A) 9.6 percent B) 40.0 percent C) 19.2 percent D) 20.0 percent Answer: C Explanation: AC =

$4,800,000 $25,000,000

= 0.192 = 19.2%

Difficulty: 1 Easy Topic: Merger and acquisition analysis Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 20-02 Mathematically value mergers.

14) Consider a market that has three firms with the following market shares: Firm A 25 percent Firm B 55 percent Firm C 20 percent Suppose Firm A wants to acquire Firm C so that the post-acquisition market would exhibit the following shares: A + C = 45 percent B = 55 percent What is the change in the HHI resulting from the merger? A) 1,000 B) 4,050 C) 5,050 D) No change Answer: A Explanation: The premerger HHI for the market is: HHI = (25)2 + (55)2 + (20)2 = 625 + 3,025 + 400 = 4,050 The postmerger HHI would be: HHI = (45)2 + (55)2 = 2,025 + 3,025 = 5,050 Thus, the increase or change in the HHI (ΔHHI) postmerger is: ΔHHI = 5,050 − 4,050 = 1,000 Difficulty: 1 Easy Topic: Merger and acquisition analysis Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 20-02 Mathematically value mergers.

15) Consider a market that has three firms with the following market shares: Firm A 15 percent Firm B 25 percent Firm C 60 percent Suppose Firm B wants to acquire Firm A so that the post-acquisition market would exhibit the following shares: B + A = 40 percent C = 60 percent What is the change in the HHI resulting from the merger? A) 750 B) 4,450 C) 5,200 D) No change Answer: A Explanation: The premerger HHI for the market is: HHI = (15)2 + (25)2 + (60)2 = 225 + 625 + 3,600 = 4,450 The postmerger HHI would be: HHI = (40)2 + (60)2 = 1,600 + 3,600 = 5,200 Thus, the increase or change in the HHI (ΔHHI) postmerger is: ΔHHI = 5,200 − 4,450 = 750 Difficulty: 1 Easy Topic: Merger and acquisition analysis Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 20-02 Mathematically value mergers.

34) Suppose that the financial ratios of a potential borrowing firm took the following values: X1 = Net working capital/Total assets = 0.15, X2 = Retained earnings/Total assets = 0.10, X3 = Earnings before interest and taxes/Total assets = 0.15, X4 = Market value of equity/Book value of long-term debt = 0.40, X5 = Sales/Total assets ratio = 0.8. Calculate the Altman's Z-score for this firm. A) 9.10 B) 1.60 C) 0.371 D) 1.855 Answer: D Explanation: Z = 1.2(0.15) + 1.4(0.10) + 3.3(0.15) + 0.6(0.40) + 1.0(0.8) = 1.855 Difficulty: 1 Easy Topic: Bankruptcy prediction Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 20-02 Mathematically value mergers. 35) Suppose that the financial ratios of a potential borrowing firm took the following values: X1 = Net working capital/Total assets = 0.25, X2 = Retained earnings/Total assets = 0.30, X3 = Earnings before interest and taxes/Total assets = 0.35, X4 = Market value of equity/Book value of long-term debt = 0.50, X5 = Sales/Total assets ratio = 0.9. Calculate the Altman's Z-score for this firm. A) 2.30 B) 3.075 C) 9.8 D) 1.96 Answer: B Explanation: Z = 1.2(0.25) + 1.4(0.30) + 3.3(0.35) + 0.6(0.50) + 1.0(0.9) = 3.075 Difficulty: 1 Easy Topic: Bankruptcy prediction Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 20-02 Mathematically value mergers.

36) Suppose that the financial ratios of a potential borrowing firm took the following values: X1 = Net working capital/Total assets = 0.30, X2 = Retained earnings/Total assets = 0.40, X3 = Earnings before interest and taxes/Total assets = 0.43, X4 = Market value of equity/Book value of long-term debt = 0.65, X5 = Sales/Total assets ratio = 0.95. Calculate the Altman's Z-score for this firm. A) 3.679 B) 2.73 C) 10.23 D) 2.046 Answer: A Explanation: Z = 1.2(0.30) + 1.4(0.40) + 3.3(0.43) + 0.6(0.65) + 1.0(0.95) = 3.679 Difficulty: 1 Easy Topic: Bankruptcy prediction Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 20-02 Mathematically value mergers. 37) Suppose that the financial ratios of a potential borrowing firm took the following values: X1 = Net working capital/Total assets = 0.35, X2 = Retained earnings/Total assets = 0.50, X3 = Earnings before interest and taxes/Total assets = 0.60, X4 = Market value of equity/Book value of long-term debt = 1.50, X5 = Sales/Total assets ratio = 3.65. Calculate the Altman's Z-score for this firm. A) 7.65 B) 1.54 C) 6.60 D) 1.32 Answer: A Explanation: Z = 1.2(0.35) + 1.4(0.50) + 3.3(0.60) + 0.6(1.50) + 1.0(3.65) = 7.65 Difficulty: 1 Easy Topic: Bankruptcy prediction Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 20-02 Mathematically value mergers.

38) Suppose a linear probability model you have developed finds there are two factors influencing the past bankruptcy behavior of firms: the debt ratio and the profit margin. Based on past bankruptcy experience, the linear probability model is estimated as: PDi = 0.20 (debt ratio) + 0.15 (profit margin) A firm you are thinking of lending to has a debt ratio of 55 percent and a profit margin of 10 percent. Calculate the firm's expected probability of default, or bankruptcy. A) 12.5 percent B) 10.0 percent C) 1.65 percent D) 10.25 percent Answer: A Explanation: PDi = 0.20 (0.55) + 0.15 (0.10) = 0.125 or 12.5 percent Difficulty: 1 Easy Topic: Bankruptcy prediction Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 20-05 Build and use statistical models to predict bankruptcy. 39) Suppose a linear probability model you have developed finds there are two factors influencing the past bankruptcy behavior of firms: the debt ratio and the profit margin. Based on past bankruptcy experience, the linear probability model is estimated as: PDi = 0.15 (debt ratio) + 0.05 (profit margin) A firm you are thinking of lending to has a debt ratio of 50 percent and a profit margin of 8 percent. Calculate the firm's expected probability of default, or bankruptcy. A) 7.90 percent B) 11.6 percent C) 30.00 percent D) 7.80 percent Answer: A Explanation: PDi = 0.15 (0.50) + 0.05 (0.08) = 0.079 or 7.9 percent Difficulty: 1 Easy Topic: Bankruptcy prediction Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 20-05 Build and use statistical models to predict bankruptcy.

40) Suppose a linear probability model you have developed finds there are two factors influencing the past bankruptcy behavior of firms: the debt ratio and the profit margin. Based on past bankruptcy experience, the linear probability model is estimated as: PDi = 0.23 (debt ratio) + 0.08 (profit margin) A firm you are thinking of lending to has a debt ratio of 60 percent and a profit margin of 12 percent. Calculate the firm's expected probability of default, or bankruptcy. A) 14.76 percent B) 22.32 percent C) 10.30 percent D) 13.25 percent Answer: A Explanation: PDi = 0.23 (0.60) + 0.08 (0.12) = 0.1476 or 14.76 percent Difficulty: 1 Easy Topic: Bankruptcy prediction Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 20-05 Build and use statistical models to predict bankruptcy. 41) Suppose a linear probability model you have developed finds there are two factors influencing the past bankruptcy behavior of firms: the debt ratio and the profit margin. Based on past bankruptcy experience, the linear probability model is estimated as: PDi = 0.25 (debt ratio) + 0.12 (profit margin) A firm you are thinking of lending to has a debt ratio of 62 percent and a profit margin of 14 percent. Calculate the firm's expected probability of default, or bankruptcy. A) 17.18 percent B) 2.604 percent C) 14.99 percent D) 19.09 percent Answer: A Explanation: PDi = 0.25 (0.62) + 0.12 (0.14) = 0.1718 or 17.18 percent Difficulty: 1 Easy Topic: Bankruptcy prediction Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 20-05 Build and use statistical models to predict bankruptcy.

20) Dee's Dry Cleaning is considering a merger with Larry's Laundry Supply Stores. Dee's total operating costs of producing services are $600,000 for sales volume of $4 million. Larry's total operating costs of producing services are $200,000 for a sales volume (JP) of $1 million. Calculate the average cost of production for Dee's and Larry's firms, respectively. A) 15 percent, 20 percent B) 20 percent, 15 percent C) 16 percent, 16 percent D) 60 percent, 5 percent Answer: A Explanation: ACDee

$600,000

= 0.15 = 15%

ACLarry =

$4,000,000

$200,000 $1,000,000

Difficulty: 2 Medium Topic: Merger and acquisition analysis Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 20-02 Mathematically value mergers.

= 0.20 = 20.00%

21) Dee's Dry Cleaning is considering a merger with Larry's Laundry Supply Stores. Dee's total operating costs of producing services are $600,000 for sales volume of $4 million. Larry's total operating costs of producing services are $200,000 for a sales volume (JP) of $1 million. For a sales volume of $5 million, calculate the reduction in production costs the merged firms need to experience such that the total average cost (TAC) for the merged firms is equal to 10 percent. A) Decrease of $500,000 B) Decrease of $300,000 C) Decrease of $100,000 D) Decrease of $200,000 Answer: B Explanation: ACcombined

TC1

= 0.10 = 10%

$5,000,000 => TC1 = 0.1 ($5,000,000) = $500,000 $600,000 + $200,000 − $500,000 = $300,000 Difficulty: 2 Medium Topic: Merger and acquisition analysis Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 20-02 Mathematically value mergers. 44) Blinds N Such is considering a merger with Window Supply Stores. Blinds' total operating costs of producing services are $750,000 for sales volume of $6 million. Window's total operating costs of producing services are $100,000 for a sales volume (JP) of $1 million. Calculate the average cost of production for the Blinds and Window firms, respectively. A) 10 percent, 12.5 percent B) 12.5 percent, 10 percent C) 75 percent, 1.67 percent D) 13.93 percent, 13.93 percent Answer: B Explanation: ACBlinds

$750,000

= 0.125 = 12.5%

ACWindow =

$6,000,000

$100,000 $1,000,000

Difficulty: 2 Medium Topic: Merger and acquisition analysis Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 20-02 Mathematically value mergers. 21

= 0.10 = 10.00%

45) Blinds N Such is considering a merger with Window Supply Stores. Blinds' total operating costs of producing services are $750,000 for sales volume of $6 million. Window's total operating costs of producing services are $100,000 for a sales volume (JP) of $1 million. For a sales volume of $7 million, calculate the reduction in production costs the merged firms need to experience such that the total average cost (TAC) for the merged firms is equal to 12 percent. A) Decrease of $840,000 B) Decrease of $10,000 C) Decrease of $40,000 D) Decrease of $90,000 Answer: B Explanation: ACcombined

TC1

= 0.12 = 12%

$7,000,000

=> TC1 = 0.12 ($7,000,000) = $840,000 $750,000 + $100,000 − $840,000 = $10,000 Difficulty: 2 Medium Topic: Merger and acquisition analysis Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 20-02 Mathematically value mergers.

46) Jewelry Designs is considering a merger with Beads Supply Stores. Jewelry's total operating costs of producing services are $300,000 for sales volume of $2 million. Beads' total operating costs of producing services are $125,000 for a sales volume (JP) of $2.25 million. Calculate the average cost of production for the Jewelry and Beads firms, respectively. A) 15 percent, 5.56 percent B) 5.56 percent, 15 percent C) 15 percent, 55.56 percent D) 13.33 percent, 6.25 percent Answer: A Explanation: ACJewelry

$300,000

= 0.15 = 15%

ACBeads

$2,000,000

$125,000

= 0.055556 = 5.56%

$2,250,000

Difficulty: 2 Medium Topic: Merger and acquisition analysis Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 20-02 Mathematically value mergers. 47) Jewelry Designs is considering a merger with Beads Supply Stores. Jewelry's total operating costs of producing services are $300,000 for sales volume of $2 million. Beads' total operating costs of producing services are $125,000 for a sales volume (JP) of $2.25 million. For a sales volume of $4.25 million, calculate the reduction in production costs the merged firms need to experience such that the total average cost (TAC) for the merged firms is equal to 8 percent. A) Decrease of $340,000 B) Decrease of $85,000 C) Decrease of $40,000 D) Decrease of $25,000 Answer: B Explanation: ACcombined

TC1

= 0.08 = 8%

$4,250,000 => TC1 = 0.08 ($4,250,000) = $340,000 $300,000 + $125,000 − $340,000 = $85,000 Difficulty: 2 Medium Topic: Merger and acquisition analysis Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 20-02 Mathematically value mergers. 23

48) Crib World is considering a merger with Tots Supply Stores. Crib's total operating costs of producing services are $250,000 for sales volume of $1.25 million. Tots' total operating costs of producing services are $210,000 for a sales volume (JP) of $900,000. Calculate the average cost of production for the Crib and Tots firms, respectively. A) 20 percent, 23.33 percent B) 23.33 percent, 20 percent C) 27.78 percent, 16.8 percent D) 21.4 percent, 21.4 percent Answer: A Explanation: ACCrib

$250,000

= 0.20 = 20%

ACTots =

$1,250,000

$210,000 $900,000

Difficulty: 2 Medium Topic: Merger and acquisition analysis Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 20-02 Mathematically value mergers.

= 0.2333 = 23.33%

49) Crib World is considering a merger with Tots Supply Stores. Crib's total operating costs of producing services are $250,000 for sales volume of $1.25 million. Tots' total operating costs of producing services are $210,000 for a sales volume (JP) of $900,000. For a sales volume of $2.15 million, calculate the reduction in production costs the merged firms need to experience such that the total average cost (TAC) for the merged firms is equal to 17.5 percent. A) Decrease of $376,250 B) Decrease of $83,750 C) Decrease of $127,500 D) Decrease of $87,500 Answer: B Explanation: ACcombined =

TC1

= 0.175 = 17.5%

$2,150,000 => TC1 = 0.175 ($2,150,000) = $376,250 $250,000 + $210,000 − $376,250 = $83,750 Difficulty: 2 Medium Topic: Merger and acquisition analysis Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 20-02 Mathematically value mergers. 50) Baby Supplies is considering a merger with Tot Toy Stores. Baby's total operating costs of producing services are $450,000 for sales volume of $2.15 million. Tot's total operating costs of producing services are $250,000 for a sales volume (JP) of $975,000. Calculate the average cost of production for the Baby and Tot Toy firms, respectively. A) 11.63 percent, 20.93 percent B) 20.93 percent, 25.64 percent C) 46.15 percent, 11.63 percent D) 22.4 percent, 22.4 percent Answer: B Explanation: AC Baby

$450,000

= 0.2093 = 20.93%

AC = Tot

$2,150,000

$250,000

25.64% $975,000

Difficulty: 2 Medium Topic: Merger and acquisition analysis Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 20-02 Mathematically value mergers. 25

= 0.2564 =

51) Baby Supplies is considering a merger with Tot Toy Stores. Baby's total operating costs of producing services are $450,000 for sales volume of $2.15 million. Tot's total operating costs of producing services are $250,000 for a sales volume (JP) of $975,000. For a sales volume of $3.125 million, calculate the reduction in production costs the merged firms need to experience such that the total average cost (TAC) for the merged firms is equal to 19.5 percent. A) Decrease of $609,375 B) Decrease of $90,625 C) Decrease of $9,375 D) Decrease of $159,375 Answer: B Explanation: ACcombined

TC1

= 0.195 = 19.5%

$3,125,000

=> TC1 = 0.195 ($3,125,000) = $609,375 $450,000 + $250,000 − $609,375 = $90,625 Difficulty: 2 Medium Topic: Merger and acquisition analysis Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 20-02 Mathematically value mergers.

27) The Justice Department has been asked to review a merger request for a market with the following four firms. Firm A B C D

Assets 10 million 20 million 100 million 30 million

If Firm A acquires Firm D, what is the HHI for the new market? A) 100 B) 625 C) 3,906.25 D) 4,687.50 Answer: D Explanation: Firm A B C

Assets 40m 20m 100m

Market Share 25.00% 12.50 62.50 100.00%

The HHI = (25)2 + (12.5)2 + (62.50)2 = 625 + 156.25 + 3,906.25 = 4,687.50 Difficulty: 1 Easy Topic: Merger and acquisition analysis Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 20-02 Mathematically value mergers.

28) The Justice Department has been asked to review a merger request for a market with the following four firms. Firm A B C D

Assets 10 million 20 million 100 million 30 million

If Firm C acquires Firm D, what is the HHI for the new market? A) 100 B) 160 C) 6,796.875 D) 17,400.00 Answer: C Explanation: Firm A B C

Assets 10m 20m 130m

Market Share 6.25% 12.50 81.25 100.00%

The HHI = (6.25)2 + (12.50)2 + (81.25)2 = 39.0625 + 156.25 + 6,601.5625 = 6,796.875 Difficulty: 1 Easy Topic: Merger and acquisition analysis Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 20-02 Mathematically value mergers.

54) Tim's Fix It Shop, Inc., is asking a price of $50 million to be purchased by Taylor's Tire Hut Corp. The two firms currently have cumulative total cash flows of $4 million which are growing at 2 percent annually. Managers estimate that because of synergies the merged firm's cash flows will increase to 5 percent for the first four years following the merger. After the first four years cash flows will grow at a rate of 3 percent. The WACC for the merged firms is 12 percent. Calculate the NPV of the merger. Should Taylor's Tire Hut Corporation agree to acquire Tim's Fix It Shop, Inc., for the asking price of $50 million?

A. B. C. D.

Yes, the NPV is ≥ $0 Yes, the NPV is ≤ $0 No, the NPV is ≥ $0 No, the NPV is ≤ $0

A) Option A B) Option B C) Option C D) Option D

Answer: D Explanation: The cash flows for the first four years after the merger are: Year after merger Cash flow

$4.0m.(1.05) 4.0m.(1.05)2 4.0m.(1.05)3 4.0m.(1.05)4 = = $4.20m. = $4.41m. = $4.6305m. $4.862025m.

The value of cash flows after year 4 is: Value of cash flows received after year 4

4.862m.(1+ = Cash flow in year 5 =

0.03) = $55.6429m.

$55.6429m. at end of year 4

WACC − growth rate in cash flows after year 4

(0.12 − 0.03)

To find the present value of the merged firm's cash flows, managers next discount the projected cash flows by the WACC as follows: Present value of cash flows from the merger

$4.20m.

(1.12)1

$4.41m.

(1.12)2

$4.6305m.

(1.12)3

$4.862m.

(1.12)4

+ $55.6429m.

= $49.01348m.

(1.12)4

Finally, the NPV of the merger is calculated by subtracting the price of the target firm from the present value of the cash flows from the merger. NPV = $49.01348m − $50m = −$0.98652m This merger would not be beneficial for the stockholders of the bidder firm. Their wealth would decrease by $0.98652 million as a result of the merger. Difficulty: 2 Medium Topic: Merger and acquisition analysis Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 20-02 Mathematically value mergers. 30

55) Windows N Such, Inc., is asking a price of $195 million to be purchased by Curtain Rods Corp. The two firms currently have cumulative total cash flows of $15 million which are growing at 1 percent annually. Managers estimate that because of synergies the merged firm's cash flows will increase to 3 percent for the first four years following the merger. After the first four years cash flows will grow at a rate of 2 percent. The WACC for the merged firms is 10 percent. Calculate the NPV of the merger. Should Curtain Rods Corporation agree to acquire Windows N Such, Inc., for the asking price of $195 million? A. B. C. D.

Yes, the NPV is ≥ $0 Yes, the NPV is ≤ $0 No, the NPV is ≥ $0 No, the NPV is ≤ $0

A) Option A B) Option B C) Option C D) Option D

Answer: A Explanation: The cash flows for the first four years after the merger are: Year after merger Cash flow

$15.0m.(1.03) 15.0m.(1.03)2 15.0m.(1.03)3 15.0m.(1.03)4 = $15.45m.

= $15.9135m.

= = $16.88263215m $16.390905m. .

The value of cash flows after year 4 is: Value of cash Cash flow in 16.8826m.(1 = flows received = = year 5 + 0.02) $215.2535599m. after year 4 at end of year 4 WACC − growth rate in (0.10 − 0.02) cash flows after year 4 To find the present value of the merged firm's cash flows, managers next discount the projected cash flows by the WACC as follows: Present value of $16.88263215m + cash flows = $15.45m. + $15.9135m. + $16.390905m. + . from the merger (1.10)1 (1.10)2 (1.10)3 (1.10)4

= $215.2535599 $198.06m m. . (1.10)4

Finally, the NPV of the merger is calculated by subtracting the price of the target firm from the present value of the cash flows from the merger. NPV = $198.06m − $195m = $3.06m This merger would be beneficial for the stockholders of the bidder firm. Their wealth would increase by $3.06 million as a result of the merger. Difficulty: 2 Medium Topic: Merger and acquisition analysis Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 20-02 Mathematically value mergers. 32

56) Department Stores, Inc., is asking a price of $25 million to be purchased by Discount Stores Corp. The two firms currently have cumulative total cash flows of $2 million which are growing at 2.5 percent annually. Managers estimate that because of synergies the merged firm's cash flows will increase to 5 percent for the first four years following the merger. After the first four years cash flows will grow at a rate of 4.5 percent. The WACC for the merged firms is 13 percent. Calculate the NPV of the merger. Should Discount Stores Corporation agree to acquire Department Stores, Inc., for the asking price of $25 million? A. B. C. D.

Yes, the NPV is ≥ $0 Yes, the NPV is ≤ $0 No, the NPV is ≥ $0 No, the NPV is ≤ $0

A) Option A B) Option B C) Option C D) Option D

Answer: A Explanation: The cash flows for the first four years after the merger are: Year after merger Cash flow

$2.0m.(1.05) 2.0m.(1.05)2 2.0m.(1.05)3 2.0m.(1.05)4 = = $2.10m. = $2.205m. = $2.31525m. $2.4310125m.

The value of cash flows after year 4 is: Value of cash flows Cash flow in year 2.4310m.(1 = = received after year 4 at = 5 + 0.045) $29.887m. end of year 4 WACC − growth (0.13 − rate in cash flows 0.045) after year 4 To find the present value of the merged firm's cash flows, managers next discount the projected cash flows by the WACC as follows: Present value of = cash = $2.10m. + $2.205m. + $2.31525m. + $2.4310125m + $29.887 $25.01107 m. flows . m. from the merger (1.13)1 (1.13)2 (1.13)3 (1.13)4 (1.13)4

Finally, the NPV of the merger is calculated by subtracting the price of the target firm from the present value of the cash flows from the merger. NPV = $25.01107m − $25m = $0.01107m This merger would be beneficial for the stockholders of the bidder firm. Their wealth would increase by $0.01107 million as a result of the merger. Difficulty: 2 Medium Topic: Merger and acquisition analysis Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 20-02 Mathematically value mergers.

57) You own stock in Carpet City, Inc., which has just made a bid of $165 million to purchase Tile Corporation. The two firms currently have cumulative total cash flows of $25 million which are growing at 2 percent annually. Managers estimate that because of synergies the merged firm's cash flows will increase to 4 percent for the first three years following the merger. After the first three years cash flows will grow at a rate of 3 percent. The merged firms are expected to have a beta = 1.75, the risk-free rate is 5.5 percent, and the market risk premium is currently 7.5 percent. Calculate the NPV of the merger. Will you vote in favor of the merger? A. B. C. D.

Yes, the NPV is ≥ $0 Yes, the NPV is ≤ $0 No, the NPV is ≥ $0 No, the NPV is ≤ $0

A) Option A B) Option B C) Option C D) Option D

Answer: A Explanation: The cash flows for the first three years after the merger are: Year after merger Cash flow

1 $25m.(1.04) = $26m.

2 25m.(1.04)2 = $27.04m.

3 25m.(1.04)3 = $28.1216m.

WACC = 5.5% + 1.75(7.5%) = 18.625% => the value of cash flows after year 3 is: Value of cash Cash flow in 28.1216m.(1 = flows received = = year 4 + .03) $185.3775872m. after year 5 at end of year 5 WACC − growth rate in (0.18625 − cash flows 0.03) after year 3

To find the present value of the merged firm's cash flows, managers next discount the projected cash flows by the WACC as follows: Present value of cash = flows from the merger

$26m.

$27.04m.

+ $28.1216m. + $185.3775872m.

= $169.0325389m.

(1.18625)1

(1.18625)2

(1.18625)3

Finally, the NPV of the merger is calculated by subtracting the price of the target firm from the present value of the cash flows from the merger. NPV = $169.03m − $165m = $4.03m This merger would be beneficial for the stockholders of the bidder firm. Their wealth would increase by $4.03 million as a result of the merger. Difficulty: 2 Medium Topic: Merger and acquisition analysis Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 20-02 Mathematically value mergers.

58) Suppose a linear probability model you have developed finds there are two factors influencing the past bankruptcy behavior of firms: the debt ratio and the profit margin. Based on past bankruptcy experience, the linear probability model is estimated as: PDi = 0.18 (debt ratio) + 0.35 (profit margin) You know a particular firm has a debt ratio of 35 percent and a probability of default of 8 percent. Calculate the firm's profit margin. A) 4.857 percent B) 8.163 percent C) 6.53 percent D) 8.00 percent Answer: A Explanation: 0.08 = 0.18 (0.35) + 0.35 (profit margin) => profit margin = (0.08 − 0.18(0.35))/0.35 = 0.04857 = 4.857 percent Difficulty: 2 Medium Topic: Bankruptcy prediction Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 20-05 Build and use statistical models to predict bankruptcy. 59) Suppose a linear probability model you have developed finds there are two factors influencing the past bankruptcy behavior of firms: the debt ratio and the profit margin. Based on past bankruptcy experience, the linear probability model is estimated as: PDi = 0.20 (debt ratio) + 0.50 (profit margin) You know a particular firm has a debt ratio of 60 percent and a probability of default of 15 percent. Calculate the firm's profit margin. A) 6.00 percent B) 12.00 percent C) 19.50 percent D) 15.00 percent Answer: A Explanation: 0.15 = 0.20 (0.60) + 0.50 (profit margin) => profit margin = (0.15 − 0.20(0.60))/0.50 = 0.06 = 6 percent Difficulty: 2 Medium Topic: Bankruptcy prediction Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 20-05 Build and use statistical models to predict bankruptcy. 37

60) A linear probability model you have developed finds there are two factors influencing the past bankruptcy behavior of firms: the equity multiplier and the total asset turnover ratio. Based on past bankruptcy experience, the linear probability model is estimated as: PDi = 0.04 (equity multiplier) + 0.01 (total asset turnover) A firm has an equity multiplier of 1.5 times and a probability of default of 7 percent. Calculate the firm's total asset turnover ratio. A) 1.0 B) 4.5 C) 0.01 D) 2.0 Answer: A Explanation: 0.07 = 0.04 (1.5) + 0.01 (total asset turnover) => total asset turnover = (0.07 − 0.04(1.5))/0.01 = 1 time Difficulty: 2 Medium Topic: Bankruptcy prediction Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 20-05 Build and use statistical models to predict bankruptcy. 61) A linear probability model you have developed finds there are two factors influencing the past bankruptcy behavior of firms: the equity multiplier and the total asset turnover ratio. Based on past bankruptcy experience, the linear probability model is estimated as: PDi = 0.05 (equity multiplier) + 0.02 (total asset turnover) A firm has an equity multiplier of 1.9 times and a probability of default of 10 percent. Calculate the firm's total asset turnover ratio. A) 0.25 B) 25 C) 2.5 D) 0.75 Answer: A Explanation: 0.10 = 0.05 (1.9) + 0.02 (total asset turnover) => total asset turnover = (0.10 − 0.05(1.9))/0.02 = 0.25 times Difficulty: 2 Medium Topic: Bankruptcy prediction Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 20-05 Build and use statistical models to predict bankruptcy. 38

39) A survey of a local market provided the following average cost data: Johnson Construction Corp. (JCC) has assets of $4 million and an average cost of 10 percent; Anderson Architects (AA) has assets of $5 million and an average cost of 20 percent; Cole Home Builders (CHB) has assets of $5 million and an average cost of 15 percent. For each firm, average costs are measured as a proportion of assets. JCC is planning to acquire AA and CHB with the expectation of reducing overall average costs by eliminating the duplication of services. What should be the average cost after the acquisition for JCC to justify this merger? A) 15.357 percent or lower B) 15.357 percent or higher C) 15.000 percent or lower D) 10.000 percent or lower Answer: A Explanation: Average cost: Johnson Construction Anderson Architects Cole Home Builders Total costs

= 0.10 × = 0.20 × = 0.15 ×

$ 4,000,000 = $ 5,000,000 = $ 5,000,000 =

400,000 1,000,000 750,000 $ 2,150,000

The average cost after merger = $2,150,000/$14,000,000 = 15.357 percent. If Johnson Construction can lower its average costs to less than 15.357 percent, it should go ahead with the merger. Difficulty: 3 Hard Topic: Merger and acquisition analysis Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 20-02 Mathematically value mergers.

40) A survey of a local market provided the following average cost data: Johnson Construction Corp. (JCC) has assets of $5 million and an average cost of 15 percent; Anderson Architects (AA) has assets of $8 million and an average cost of 20 percent; Cole Home Builders (CHB) has assets of $8 million and an average cost of 17 percent. For each firm, average costs are measured as a proportion of assets. JCC is planning to acquire AA and CHB with the expectation of reducing overall average costs by eliminating the duplication of services. What should be the average cost after the acquisition for JCC to justify this merger? A) 17.667 percent or lower B) 17.667 percent or higher C) 17.333 percent or lower D) 15.00 percent or lower Answer: A Explanation: Average cost: Johnson Construction Anderson Architects Cole Home Builders Total costs

= 0.15 × = 0.20 × = 0.17 ×

$ 5,000,000 = $ 8,000,000 = $ 8,000,000 =

750,000 1,600,000 1,360,000 $ 3,710,000

The average cost after merger = $3,710,000/$21,000,000 = 17.667 percent. If Johnson Construction can lower its average costs to less than 17.667 percent, it should go ahead with the merger. Difficulty: 3 Hard Topic: Merger and acquisition analysis Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 20-02 Mathematically value mergers.

41) A survey of a local market provided the following average cost data: Johnson Construction Corp. (JCC) has assets of $5 million and an average cost of 15 percent; Anderson Architects (AA) has assets of $8 million and an average cost of 20 percent; Cole Home Builders (CHB) has assets of $8 million and an average cost of 17 percent. For each firm, average costs are measured as a proportion of assets. JCC is planning to acquire AA and CHB with the expectation of reducing overall average costs by eliminating the duplication of services. If JCC plans to reduce operating costs by $300,000 after the merger, what will the average cost be for the new firm? A) 16.238 percent B) 15.00 percent C) 17.33 percent D) 17.667 percent Answer: A Explanation: Average cost: Johnson Construction Anderson Architects Cole Home Builders Total costs

0.15 ×

5,000,000 − $ 300,000 =

0.20 ×

8,000,000

1,600,000

0.17 ×

8,000,000

1,360,000

450,000

$ 3,410,000

The average cost after merger = $3,410,000/$21,000,000 = 16.238 percent Difficulty: 3 Hard Topic: Merger and acquisition analysis Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 20-02 Mathematically value mergers.

65) A survey of a national market provided the following average cost data: Jackson County Construction (JCC) has assets of $2 million and an average cost of 30 percent; Arkansas Architects (AA) has assets of $1.5 million and an average cost of 20 percent; Colorado Home Builders (CHB) has assets of $500,000 and an average cost of 10 percent. For each firm, average costs are measured as a proportion of assets. JCC is planning to acquire AA and CHB with the expectation of reducing overall average costs by eliminating the duplication of services. If JCC plans to reduce operating costs by $200,000 after the merger, what will the average cost be for the new firm? A) 18.75 percent B) 19.74 percent C) 20.00 percent D) 16.67 percent Answer: A Explanation: Average cost: Jackson County = Construction Arkansas = Architects Colorado = Home Builders Total costs

0.30 ×

2,000,000 −

0.20 ×

0.10 ×

200,000 =

$ 400,000

1,500,000

300,000

500,000

50,000 $ 750,000

The average cost after merger = $750,000/$4,000,000 = 18.75 percent Difficulty: 3 Hard Topic: Merger and acquisition analysis Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 20-02 Mathematically value mergers.

66) The managers of BSW Inc. have been approached by EAG Corp. for a possible merger. EAG Corp. is asking a price of $20.5 million to be purchased by BSW Inc. The two firms currently have cumulative total cash flows of $1 million that are growing at 3 percent annually. Managers of EAG estimate that because of synergies the merged firm's cash flows will increase to 4 percent for the first three years following the merger. After the first three years, managers of EAG have estimated that cash flows will grow at a rate of 2 percent. The WACC for the merged firms is 8 percent. Managers of BSW Inc. agree that cash flows should grow at an additional 4 percent for the first three years, but are unsure of the long-term growth rate in cash flows estimated by EAG. Calculate the minimum growth rate needed after the first three years such that BSW Inc. would see this merger as a positive NPV project. A) 3.00 percent B) 2.82 percent C) 4.05 percent D) 8.00 percent Answer: B Explanation: The cash flows for the first four years after the merger are: Year after merger Cash flow

1 $1m.(1.04) = $1.04m.

2 1m.(1.04)2 = $1.0816m.

3 1m.(1.04)3 = $1.124864m.

Value of cash flows received after year 3 at end = Cash flow in year 4 = of year 3 WACC − growth rate in cash flows after year 3

$1.124864m.

The value of cash flows after year 3 is:

(1 + g) (0.08 − g)

To find the present value of the merged firm's cash flows, managers next discount the projected cash flows by the WACC as follows:

Present value of cash flows = from the merger

$1.04m.

(1.08)1

= $0.962962963m.

$1.0816m.

(1.08)2

+ $0.927297668m

$1.124864m.

($1.124864m.(1 + g))/(0.08 − g)

(1.08)3

+ $0.89295331m

= $20.5m.

(1.08)3

($1.124864m.(1

= + g))/(0.08 − g) $20.5m. (1.08)3

=> ($20.5m − $2.783213941m) × (1.08)3 = $22.318048m = ($1.124864m(1 + g))/(0.08 − g) => $22.318048m × (0.08 − g) = $1.78544384m − $22.318048m(g) = ($1.124864m × 1 + $1.124864m(g)) => $1.78544384m − $1.124864m = $0.66057984m = ($1.124864m + $22.318048m)(g) = $23.442912m(g) => g = $0.66057984m/$23.442912m = 2.8178 percent This merger would be beneficial for the stockholders of the bidder firm if the growth rate after the first three years was at least 2.82 percent. Difficulty: 3 Hard Topic: Merger and acquisition analysis Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 20-02 Mathematically value mergers.

67) The managers of BSW Inc. have been approached by EAG Corp. for a possible merger. EAG Corp. is asking a price of $50 million to be purchased by BSW Inc. The two firms currently have cumulative total cash flows of $2.5 million that are growing at 2 percent annually. Managers of EAG estimate that because of synergies the merged firm's cash flows will increase to 5 percent for the first three years following the merger. After the first three years, managers of EAG have estimated that cash flows will grow at a rate of 2 percent. The WACC for the merged firms is 12 percent. Managers of BSW Inc. agree that cash flows should grow at an additional 5 percent for the first three years, but are unsure of the long-term growth rate in cash flows estimated by EAG. Calculate the minimum growth rate needed after the first three years such that BSW Inc. would see this merger as a positive NPV project. A) 5.00 percent B) 6.925 percent C) 1.728 percent D) 12.00 percent Answer: B Explanation: The cash flows for the first four years after the merger are: Year after merger Cash flow

1 $2.5m.(1.05) = $2.625m.

2 3 2.5m.(1.05)2 2.5m.(1.05)3 = $2.75625m. = $2.8940625m.

The value of cash flows after year 3 is:

Value of cash flows received after year 3 at end of year 3

= Cash flow in year 4 =

$2.8940625. (1 + g)

WACC − growth rate in cash flows after year 3

(0.12 − g)

To find the present value of the merged firm's cash flows, managers next discount the projected cash flows by the WACC as follows: Present value of cash flows = $2.625m. + $2.75625m. + from the merger (1.12)1 (1.12)2

= $2.34375m.

+ $2.197265625m

$2.8940625m.

(1.12)3

+ $2.059936523m

($2.8940625m.

= (1 + g))/(0.12 − g) $50m. (1.12)3

($2.8940625m. (1 + g))/(0.12 − g) (1.12)3

= $50m.

=> ($50m − $6.600952148m) × (1.12)3 = $60.9725375m = ($2.8940625m(1 + g))/(0.12 − g) => $60.9725375m × (0.12 − g) = $7.3167045m − $60.9725375m(g) = ($2.8940625m × 1 + $2.8940625m(g)) => $7.3167045m − $2.8940625m = $4.422642m = ($2.8940625m + $60.9725375m)(g) = $63.8666m(g) => g = $4.422642m/$63.8666m = 6.92481203 percent This merger would be beneficial for the stockholders of the bidder firm if the growth rate after the first three years was at least 6.925 percent. Difficulty: 3 Hard Topic: Merger and acquisition analysis Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 20-02 Mathematically value mergers.

68) A linear probability model you have developed finds there are two factors influencing the past bankruptcy behavior of firms: the debt-to-equity ratio and the sales-to-total assets ratio. Based on past bankruptcy experience, the linear probability model is estimated as: PDi = 0.45 (debt/equity) + 0.01 (sales/total assets) A firm you are thinking of lending to has a sales-to-assets ratio of 1.9 and its expected probability of default, or bankruptcy, is estimated to be 7 percent. Calculate the firm's debt-toassets ratio. A) 11.33 percent B) 10.18 percent C) 89.82 percent D) 7.00 percent Answer: B Explanation: 0.07 = 0.45 (debt/equity) + 0.01(1.9) => debt/equity = (0.07 − 0.01(1.9))/0.45 = 0.1133 times => debt/equity = (total assets − equity)/equity = (total assets/equity) − 1 = 0.1133 => total assets/equity = 1.1133 => equity/total assets = 1/1.1133 = 0.8982 => debt/total assets = 1 − 0.8982 = 0.1018 = 10.18 percent Difficulty: 3 Hard Topic: Bankruptcy prediction Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 20-05 Build and use statistical models to predict bankruptcy.

48) A linear probability model you have developed finds there are two factors influencing the past bankruptcy behavior of firms: the debt-to-equity ratio and the sales-to-total assets ratio. Based on past bankruptcy experience, the linear probability model is estimated as: PDi = 0.60 (debt/equity) + 0.02 (sales/total assets) A firm you are thinking of lending to has a sales-to-assets ratio of 1.75 and its expected probability of default, or bankruptcy, is estimated to be 8.1 percent. Calculate the firm's debt-toassets ratio. A) 7.667 percent B) 7.12 percent C) 92.88 percent D) 8.1 percent Answer: B Explanation: 0.081 = 0.60 (debt/equity) + 0.02 (1.75) => debt/equity = (0.081 − 0.02(1.75))/0.60 = 0.076667 times => debt/equity = (total assets − equity)/equity = (total assets/equity) − 1 = 0.07667 => total assets/equity = 1.07667 => equity/total assets = 1/1.07667 = 0.928789 => debt/total assets = 1 − 0.928789 = 0.0712 = 7.12 percent Difficulty: 3 Hard Topic: Bankruptcy prediction Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 20-05 Build and use statistical models to predict bankruptcy.

49) A linear probability model you have developed finds there are two factors influencing the past bankruptcy behavior of firms: the debt-to-equity ratio and the profit margin. Based on past bankruptcy experience, the linear probability model is estimated as: PDi = 0.02 (debt/equity) + 0.80 (profit margin) A firm you are thinking of lending to has a debt-to-equity ratio of 110 percent and its expected probability of default, or bankruptcy, is estimated to be 8 percent. If sales are $2 million, calculate the firm's net income. A) $145,000 B) $165,000 C) $160,000 D) $200,000 Answer: A Explanation: 0.08 = 0.02(1.10) + 0.80 (profit margin) => profit margin = (0.08 − 0.02(1.10))/0.80 = 0.0725 => profit margin = 0.0725 = net income/sales = net income/$2,000,000 => net income = 0.0725 × $2,000,000 = $145,000 Difficulty: 3 Hard Topic: Bankruptcy prediction Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 20-05 Build and use statistical models to predict bankruptcy.

50) A linear probability model you have developed finds there are two factors influencing the past bankruptcy behavior of firms: the debt-to-equity ratio and the profit margin. Based on past bankruptcy experience, the linear probability model is estimated as: PDi = 0.03 (debt/equity) + 0.65 (profit margin) A firm you are thinking of lending to has a debt-to-equity ratio of 105 percent and its expected probability of default, or bankruptcy, is estimated to be 7 percent. If sales are $3 million, calculate the firm's net income. A) $177,692 B) $210,000 C) $193,846 D) $300,000 Answer: A Explanation: 0.07 = 0.03 (1.05) + 0.65 (profit margin) => profit margin = (0.07 − 0.03(1.05))/0.65 = 0.0592307692 => profit margin = 0.0592307692 = net income/sales = net income/$3,000,000 => net income = 0.0592307692 × $3,000,000 = $177,692.3076 Difficulty: 3 Hard Topic: Bankruptcy prediction Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 20-05 Build and use statistical models to predict bankruptcy. 72) Peter's TV Supplies is considering a merger with Jan's Radio Supply Stores. Peter's total operating costs of producing services are $330,000 for a sales volume (SP) of $4.5 million. Jan's total operating costs of producing services are $60,000 for a sales volume (SJ) of $550,000. Suppose that synergies in the production process result in a cost of production for the merged firms totalling $360,000 for a sales volume of $5,050,000. Calculate the total average cost (TAC) for the merged firm. A) 7.61 percent B) 7.43 percent C) 7.13 percent D) 7.52 percent Answer: C Explanation: TAC = 360K/5,050K = 7.13 percent Difficulty: 1 Easy Topic: Merger and acquisition analysis Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 20-02 Mathematically value mergers. 50

73) Cindy's Computer Corp. is considering a merger with Bobby's Computer, Inc. Cindy's total operating costs of producing services are $2.1 million for a sales volume (SC) of $13 million. Bobby's total operating costs of producing services are $2.5 million for a sales volume (SB) of $7 million. If the two firms merge, calculate the total average cost (TAC) for the merged firm assuming no synergies. A) 23 percent B) 17 percent C) 19 percent D) 21 percent Answer: A Explanation: TAC = [2.1 + 2.5]/[13 + 7] = 23.00 percent Difficulty: 1 Easy Topic: Merger and acquisition analysis Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 20-02 Mathematically value mergers. 74) Suppose that the financial ratios of a potential borrowing firm took the following values: X1 = Net working capital/Total assets = 0.15, X2 = Retained earnings/Total assets = 0.27, X3 = Earnings before interest and taxes/Total assets = 0.28, X4 = Market value of equity/Book value of long-term debt = 0.68, X5 = Sales/Total assets ratio = 0.9. Calculate and interpret the Altman's Z-score for this firm. A) 1.92; Low risk B) 2.01; Indeterminate C) 2.79; Low risk D) 2.79; Indeterminate Answer: D Explanation: Z = 1.2(0.15) + 1.4(0.27) + 3.3(0.28) + 0.6(0.68) + 1.0(0.9) = 2.79. According to the Altman's Z-score, this firm should be placed in the indeterminate bankruptcy risk class. Difficulty: 1 Easy Topic: Bankruptcy prediction Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 20-05 Build and use statistical models to predict bankruptcy.

75) Suppose that the financial ratios of a potential borrowing firm took the following values: X1 = Net working capital/Total assets = 0.05, X2 = Retained earnings/Total assets = 0.12, X3 = Earnings before interest and taxes/Total assets = 0.17, X4 = Market value of equity/Book value of long-term debt = 0.42, X5 = Sales/Total assets ratio = 0.6. Calculate and interpret the Altman's Z-score for this firm. A) 1.64; High risk B) 1.64; Indeterminate C) 1.99; Low risk D) 2.79; Indeterminate Answer: A Explanation: Z = 1.2(0.05) + 1.4(0.12) + 3.3(0.17) + 0.6(0.42) + 1.0(0.6) = 1.64. According to the Altman's Z-score, this firm should be placed in the high bankruptcy risk class. Difficulty: 1 Easy Topic: Bankruptcy prediction Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 20-05 Build and use statistical models to predict bankruptcy. 76) Suppose a linear probability model you have developed finds there are two factors influencing the past bankruptcy behavior of firms: the debt ratio and the profit margin. Based on past bankruptcy experience, the linear probability model is estimated as: PDi = 0.15 (debt ratio) + 0.1 (profit margin) A firm you are thinking of lending to has a debt ratio of 57 percent and a profit margin of 7.15 percent. Calculate the firm's expected probability of default, or bankruptcy. A) 9.27 percent B) 8.49 percent C) 7.83 percent D) 6.91 percent Answer: A Explanation: PDi = 0.15 (0.57) + 0.1 (0.0715) = 0.0927 or 9.27 percent Difficulty: 1 Easy Topic: Bankruptcy prediction Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 20-05 Build and use statistical models to predict bankruptcy.

77) A linear probability model you have developed finds there are two factors influencing the past bankruptcy behavior of firms: the equity multiplier and the total asset turnover ratio. Based on past bankruptcy experience, the linear probability model is estimated as: PDi = 0.02 (equity multiplier) + 0.01 (total asset turnover) A firm you are thinking of lending to has an equity multiplier of 3.2 times and a total asset turnover ratio of 1.95. Calculate the firm's expected probability of default, or bankruptcy. A) 7.06 percent B) 7.92 percent C) 8.35 percent D) 9.12 percent Answer: C Explanation: PDi = 0.02 (3.2) + 0.01 (1.95) = 0.0835 or 8.35 percent Difficulty: 1 Easy Topic: Bankruptcy prediction Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 20-05 Build and use statistical models to predict bankruptcy. 78) George's Dry Cleaning is considering a merger with Weezzie's Laundry Supply Stores. George's total operating costs of producing services are $790,000 for sales volume (SG) of $4.7 million. Weezzie's total operating costs of producing services are $202,000 for a sales volume (SW) of $2.3 million. For a sales volume of $7 million, calculate the reduction in production costs the merged firms need to experience such that the total average cost (TAC) for the merged firms is equal to 12 percent. A) $840,000 B) $710,000 C) $175,000 D) $152,000 Answer: D Explanation: 0.12 = Total operating costs/7M; Total operating costs = $840,000; Reduction = 840,000 − 790,000 − 202,000 = $152,000 Difficulty: 2 Medium Topic: Merger and acquisition analysis Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 20-02 Mathematically value mergers.

79) George's Dry Cleaning is considering a merger with Weezzie's Laundry Supply Stores. George's total operating costs of producing services are $590,000 for sales volume (SG) of $4.7 million. Weezzie's total operating costs of producing services are $152,000 for a sales volume (SW) of $2.3 million. For a sales volume of $7 million, calculate the reduction in production costs the merged firms need to experience such that the total average cost (TAC) for the merged firms is equal to 9 percent. A) $97,000 B) $101,000 C) $112,000 D) $128,000 Answer: C Explanation: 0.09 = Total operating costs/7M; Total operating costs = $630,000; Reduction = 630,000 − 590,000 − 152,000 = $112,000 Difficulty: 2 Medium Topic: Merger and acquisition analysis Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 20-02 Mathematically value mergers. 80) Jenny's Day Care is considering a merger with Lionel's Diaper Manufacturers. Jenny's total operating costs of producing services are $350,000 for sales volume of $1.4 million. Lionel's total operating costs of producing services are $300,000 for a sales volume of $1.3 million. For a sales volume of $2.7 million, calculate the reduction in production costs the merged firms need to experience such that the total average cost (TAC) for the merged firms is equal to 20 percent. A) $129,000 B) $110,000 C) $540,000 D) $103,000 Answer: B Explanation: 0.2 = Total operating costs/2.7 million; Total operating costs = 540,000; Reduction = 540,000 − 350,000 − 300,000 = $110,000 Difficulty: 2 Medium Topic: Merger and acquisition analysis Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 20-02 Mathematically value mergers.

81) Stubborn Motors, Inc., is asking a price of $10.5 million to be purchased by Rubber Tire Motor Corp. Rubber Tire currently has total cash flows of $6 million which are growing at 1 percent annually. Managers estimate that because of synergies the merged firm's cash flows will increase by 4 percent for the first four years following the merger. After the first four years, incremental cash flows will grow at a rate of 3 percent annually. The WACC for the merged firms is 9.75 percent. Calculate the NPV of the merger. Should Rubber Tire Motor Corporation agree to acquire Stubborn Motors for the asking price of $10.5 million? A) Agree to the merger because the NPV = −$2.32 million. B) Agree to the merger because the NPV = $1.03 million. C) Disagree to the merger because the NPV = −$0.96 million. D) Agree to the merger because the NPV = $2.48 million. Answer: D Explanation: Year after merger Cash flow with merger Cash flow w/no merger Incremental cash flow from merger

$6.0(1.05)

$6.0(1.05)2

$6.0(1.05)3

$6.0(1.05)4

= $6.30

= $6.62

= $6.95

= $7.29

$6.0(1.01)

$6.0(1.01)2

$6.0(1.01)3

$6.0(1.01)4

= $6.06

= $6.12

= $6.18

= $6.24

= $0.24

= $0.50

= $0.77

= $1.05

Step 1: Find the incremental cash flows (in millions) for the first four years after the merger: Step 2: Find the value of incremental cash flows (in millions) after yr 4: $1.05(1.03)/[0.0975 − 0.03] = $16.02 Step 3: Use Financial Calculator to find NPV of cash flows discounted at 9.75 percent: NPV = $2.48m This merger would be beneficial for the stockholders of the bidder firm. Their wealth would increase by $2.48 million as a result of the merger. Difficulty: 2 Medium Topic: Merger and acquisition analysis Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 20-02 Mathematically value mergers.

82) Suppose a linear probability model you have developed finds there are two factors influencing the past bankruptcy behavior of firms: the debt ratio and the profit margin. Based on past bankruptcy experience, the linear probability model is estimated as: PDi = 0.28 (debt ratio) + 0.51 (profit margin) You know a particular firm has a debt ratio of 46 percent and a probability of default of 18 percent. Calculate the firm's profit margin. A) 11.93 percent B) 13.27 percent C) 10.04 percent D) 12.81 percent Answer: C Explanation: 0.28(0.46) + 0.51(profit margin) = 0.18 => profit margin = 0.1004 or 10.04 percent Difficulty: 2 Medium Topic: Bankruptcy prediction Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 20-05 Build and use statistical models to predict bankruptcy. 83) A linear probability model you have developed finds there are two factors influencing the past bankruptcy behavior of firms: the equity multiplier and the total asset turnover ratio. Based on past bankruptcy experience, the linear probability model is estimated as: PDi = 0.02 (equity multiplier) + 0.06 (total asset turnover) A firm has an equity multiplier of 1.1 times and a probability of default of 6.2 percent. Calculate the firm's total asset turnover ratio.

A) 0.53 times B) 0.67 times C) 1.2 times D) 0.84 times Answer: B Explanation: 0.062 = 0.02(1.1) + 0.06 (total asset turnover) => total asset turnover = 0.67 Difficulty: 2 Medium Topic: Bankruptcy prediction Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 20-05 Build and use statistical models to predict bankruptcy. 56

84) A survey of a local market has provided the following average cost data: Johnson Construction Corp. (JCC) has assets of $3 million and an average cost of 22 percent. Anderson Architects (AA) has assets of $4 million and an average cost of 31 percent. Cole Home Builders (CHB) has assets of $5 million and an average cost of 28 percent. For each firm, average costs are measured as a proportion of assets. JCC is planning to acquire AA and CHB with the expectation of reducing overall average costs by eliminating the duplication of services. If JCC plans to reduce operating costs by $500,000 after the merger, what will the average cost be for the new firm? A) 23.33 percent B) 23.87 percent C) 24.12 percent D) 22.50 percent Answer: A Explanation: Calculate the average cost for the three firms: {[0.22 × 3 − 0.5] + 0.31 × 4 + 0.28 × 5}/[3 + 4 + 5] = 23.33 percent Difficulty: 3 Hard Topic: Merger and acquisition analysis Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 20-01 Differentiate among types of and address motives for mergers and acquisitions.

85) The managers of State Bank have been approached by City Bank about a possible merger. State Bank is asking a price of $171.78 million to be purchased by City Bank. City Bank currently has total cash flows of $30 million that are growing at 2 percent annually. Managers of State Bank estimate that because of synergies the merged firm's cash flows will increase by 6 percent for the first four years following the merger. After the first four years, managers of State Bank have estimated that incremental cash flows will grow at a rate of 3 percent. The WACC for the merged firms is 11 percent. Managers of City Bank agree that cash flows should grow at an additional 6 percent for the first four years, but are unsure of the long-term growth rate in incremental cash flows estimated by City Bank. Calculate the minimum growth rate needed after the first four years such that City Bank would see this merger as a positive NPV project. A) 7.26 percent B) 7.73 percent C) 8.01 percent D) 8.29 percent Answer: A Explanation: Step 1: Find the incremental cash flows (in millions) for the first four years after the merger: Year after merger Cash flow with merger Cash flow w/no merger Incremental cash flow from merger

$30(1.08)

$30(1.08)2

$30(1.08)3

$30(1.08)4

= $32.4

= $34.99

= $37.79

= $40.81

$30(1.02)

$30(1.02)2

$30(1.02)3

$30(1.02)4

= $30.60 = $1.8

= $31.21 = $3.78

= $31.84 = $5.95

= $32.47 = $8.34

Step 2: Find the value of incremental cash flows (in millions) after year 4: $8.34(1 + g)/[0.11 − g] = $8.34(1.03)/(0.11 − 0.03) = $8.5902/.08 = $107.3775 Step 3: Use financial calculator to find NPV of cash flows found in step 1 discounted at 11 percent: NPV = $14.53m Step 4: Set NPV of project = 0 = −171.78 + 14.53 + PV of cash flows in Step 2; => PV of cash flows in Step 2 = 157.25 Step 5: $8.34(1 + g)/[0.11 − g]/(1.11)4 = 157.25; => g = 7.26 percent; This is the minimum growth rate necessary after the first four years for this project to be beneficial to shareholders. Difficulty: 3 Hard Topic: Merger and acquisition analysis Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 20-02 Mathematically value mergers. 58

59) A linear probability model you have developed finds there are two factors influencing the past bankruptcy behavior of firms: the debt-to-equity ratio and the sales-to-total assets ratio. Based on past bankruptcy experience, the linear probability model is estimated as: PDi = 0.52 (debt/equity) + 0.01 (sales/total assets) A firm you are thinking of lending to has a sales-to-assets ratio of 2.0 and its expected probability of default, or bankruptcy, is estimated to be 12 percent. Calculate the firm's debt ratio. A) 14.03 percent B) 14.92 percent C) 15.49 percent D) 15.97 percent Answer: D Explanation: 0.12 = 0.52 (debt/equity) + 0.01 (2.0) => debt/equity = 0.19 times => TA = debt + equity = 1.19; and debt ratio = 0.19/1.19 = 0.1597 = 15.97 percent Difficulty: 3 Hard Topic: Bankruptcy prediction Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 20-05 Build and use statistical models to predict bankruptcy.

60) A linear probability model you have developed finds there are two factors influencing the past bankruptcy behavior of firms: the debt-to-equity ratio and the profit margin. Based on past bankruptcy experience, the linear probability model is estimated as: PDi = 0.01 (debt/equity) + 0.76 (profit margin) A firm you are thinking of lending to has a debt-to-equity ratio of 121 percent and its expected probability of default, or bankruptcy, is estimated to be 8.125 percent. If sales are $1 million, calculate the firm's net income. A) $81,600 B) $87,700 C) $91,000 D) $97,400 Answer: C Explanation: 0.08125 = 0.01 (1.21) + 0.76 (profit margin) => profit margin = 0.0910; NI = 0.0910 × 1m = $91,000 Difficulty: 3 Hard Topic: Bankruptcy prediction Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 20-05 Build and use statistical models to predict bankruptcy.

61) A linear probability model you have developed finds there are two factors influencing the past bankruptcy behavior of firms: the debt-to-equity ratio and the profit margin. Based on past bankruptcy experience, the linear probability model is estimated as: PDi = 0.013 (debt/equity) + 0.78 (profit margin) A firm you are thinking of lending to has a debt-to-equity ratio of 112 percent and its expected probability of default, or bankruptcy, is estimated to be 15.35 percent. If sales are $1.55 million, calculate the firm's net income. A) $276,100 B) $290,700 C) $196,200 D) $299,400 Answer: A Explanation: 0.1535 = 0.013 (1.12) + 0.78 (profit margin) => profit margin = 0.1781; NI = 0.1781 × 1.55m = $276,100 Difficulty: 3 Hard Topic: Bankruptcy prediction Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 20-05 Build and use statistical models to predict bankruptcy. 89) A merger between Bank of America and JP Morgan Chase is an example of a: A) vertical merger. B) horizontal merger. C) conglomerate merger. D) none of the options. Answer: B Difficulty: 1 Easy Topic: Types of mergers and acquisitions Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 20-01 Differentiate among types of and address motives for mergers and acquisitions.

90) The main motive for a merger is: A) product extension. B) manager's personal incentives. C) synergies. D) none of the options. Answer: C Difficulty: 1 Easy Topic: Motives for mergers and acquisitions Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 20-01 Differentiate among types of and address motives for mergers and acquisitions. 91) Which of the following is NOT a source of value-enhancing synergy in a merger? A) Cost reduction B) Revenue enhancement C) Increased marketing presence D) Tax considerations Answer: C Difficulty: 2 Medium Topic: Motives for mergers and acquisitions Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 20-01 Differentiate among types of and address motives for mergers and acquisitions. 92) If Walt Disney and American Airlines merged, it would be an example of a: A) consolidation merger. B) conglomerate merger. C) vertical merger. D) horizontal merger. Answer: B Difficulty: 1 Easy Topic: Types of mergers and acquisitions Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 20-01 Differentiate among types of and address motives for mergers and acquisitions.

93) Which of the following is NOT an example of a revenue enhancement that is a result of a merger? A) The revenue stream of the acquired firm becomes more stable because the target firm has different risk characteristics. B) The merger may expand the target firm's operations into areas that are not fully competitive. C) The merger may create cost synergies. D) All of the options are examples of a revenue enhancement that is a result of a merger. Answer: C Difficulty: 2 Medium Topic: Motives for mergers and acquisitions Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 20-01 Differentiate among types of and address motives for mergers and acquisitions. 94) The merged firm's ability to generate synergistic cost savings through the joint use of inputs in producing multiple products is referred to as: A) economies of scale. B) economies of scope. C) x-efficiencies. D) none of the options. Answer: B Difficulty: 2 Medium Topic: Motives for mergers and acquisitions Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 20-01 Differentiate among types of and address motives for mergers and acquisitions.

95) Cost savings not directly due to economies of scope or economies of scale are referred to as: A) economies of scale. B) economies of scope. C) x-efficiencies. D) none of the options. Answer: C Difficulty: 1 Easy Topic: Motives for mergers and acquisitions Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 20-01 Differentiate among types of and address motives for mergers and acquisitions. 96) Which of the following refers to a firm that is still allowed to continue to operate while the creditors' claims are settled using a collective procedure? A) Chapter 7 bankruptcy B) Chapter 11 bankruptcy C) Technical insolvency D) Prepackaged bankruptcy Answer: B Difficulty: 2 Medium Topic: Bankruptcy Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 20-04 Differentiate between Chapter 7 and Chapter 11 bankruptcy. 97) Which of the following is an incorrect priority of claims in the event of liquidation? (Note: The first item would be paid first.) A) Secured creditors, wages due employees, unsecured creditor claims, common shareholders B) Secured creditors, unsecured creditor claims, preferred shareholders, common shareholders C) Secured creditors, administration expenses, common shareholders, preferred shareholders D) Secured creditors, wages due employees, taxes due federal government, preferred shareholders Answer: C Difficulty: 2 Medium Topic: Bankruptcy Bloom's: Evaluate AACSB: Reflective Thinking Accessibility: Keyboard Navigation Learning Goal: 20-04 Differentiate between Chapter 7 and Chapter 11 bankruptcy.

98) All of the following are an advantage of prepackaged bankruptcy EXCEPT: A) there is less disruption to the firm's business and less damage to its goodwill. B) reduced legal expenses and other fees, which leave more funds available for the creditors. C) it is a shorter and simpler bankruptcy process. D) All of the options are advantages. Answer: D Difficulty: 1 Easy Topic: Bankruptcy Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 20-04 Differentiate between Chapter 7 and Chapter 11 bankruptcy. 99) All of the following are problems associated with using the Z-score model to make credit risk evaluations EXCEPT: A) the model does not benchmark firms to the average in the industry. B) the model does not use important data that is difficult to quantify such as the phase of the business cycle. C) the model categorizes firms as either high risk or low risk. D) All of the options are problems associated with using the Z-score model. Answer: A Difficulty: 2 Medium Topic: Bankruptcy prediction Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 20-05 Build and use statistical models to predict bankruptcy.

100) Which of the following statements is incorrect? A) While linear probability models divide firms into high or low bankruptcy risk classes, logit models and linear discriminant models produce a value for the expected probability of bankruptcy. B) The logit model overcomes a weakness of the linear probability model by restricting the estimated range of bankruptcy probabilities to lie between 0 and 1. C) All three credit scoring models use past data, such as financial ratios, as inputs to explain repayment experiences on old debt. D) All of the statements are correct. Answer: A Difficulty: 2 Medium Topic: Bankruptcy prediction Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 20-05 Build and use statistical models to predict bankruptcy. 101) If Walmart acquires Target, this would be an example of a: A) horizontal merger. B) vertical merger. C) market extension merger. D) conglomerate merger. Answer: A Difficulty: 1 Easy Topic: Types of mergers and acquisitions Bloom's: Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 20-01 Differentiate among types of and address motives for mergers and acquisitions.

102) If Verizon buys the Green Bay Packers, this would be an example of a: A) horizontal merger. B) vertical merger. C) market extension merger. D) conglomerate merger. Answer: D Difficulty: 1 Easy Topic: Types of mergers and acquisitions Bloom's: Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 20-01 Differentiate among types of and address motives for mergers and acquisitions. 103) If Whole Foods grocery store buys Whole Wheat Bread, this would be an example of a: A) horizontal merger. B) vertical merger. C) market extension merger. D) conglomerate merger. Answer: B Difficulty: 1 Easy Topic: Types of mergers and acquisitions Bloom's: Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 20-01 Differentiate among types of and address motives for mergers and acquisitions. 104) Which of the following is a poor justification for a merger? A) Tax considerations B) Lowering cost of capital C) Reducing costs D) Increasing the size of the firm Answer: D Difficulty: 1 Easy Topic: Motives for mergers and acquisitions Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 20-01 Differentiate among types of and address motives for mergers and acquisitions.

68) LD Inc. declared bankruptcy through a Chapter 7 filing. Consider the following data in millions of dollars and determine the funds available for secured creditors. • • • • • • •

Proceeds from the liquidation of assets = $395 First mortgage = $100 Administration expenses associated with the bankruptcy = $2 Notes payable to the banks = $205 Subordinated debentures = $350 Taxes due to federal, state, and other governmental agencies = $12 Wages due employees (1,000 employees) = $3

A) $379 B) $378 C) $278 D) $279 Answer: A Explanation: 395 − [2 + 12 + 2] = $379; note that the wages due are capped at $2,000 per employee Difficulty: 2 Medium Topic: Bankruptcy Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 20-05 Build and use statistical models to predict bankruptcy.

69) LD Inc. declared bankruptcy through a Chapter 7 filing. Consider the following data in millions of dollars and determine the funds available for secured creditors. • • • • • • •

Proceeds from the liquidation of assets = $395 First mortgage = $102 Administration expenses associated with the bankruptcy = $5 Notes payable to the banks = $205 Subordinated debentures = $350 Taxes due to federal, state, and other governmental agencies = $17 Wages due employees (2,000 employees) = $6

A) $265 B) $367 C) $267 D) $369 Answer: D Explanation: 395 − [5 + 17 + 4] = $369; note that the wages due are capped at $2,000 per employee Difficulty: 2 Medium Topic: Bankruptcy Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 20-05 Build and use statistical models to predict bankruptcy.

107) LD Inc. declared bankruptcy through a Chapter 7 filing. Consider the following data in millions of dollars and determine the funds available for secured creditors. • • • • • • •

Proceeds from the liquidation of assets = $225 First mortgage = $50 Administration expenses associated with the bankruptcy = $5 Notes payable to the banks = $205 Subordinated debentures = $350 Taxes due to federal, state, and other governmental agencies = $17 Wages due employees (2,000 employees) = $6

A) $197 B) $147 C) $199 D) $149 Answer: C Explanation: 225 − [5 + 17 + 4] = $199; note that the wages due are capped at $2,000 per employee Difficulty: 2 Medium Topic: Bankruptcy Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 20-05 Build and use statistical models to predict bankruptcy. 108) The main reason for a vertical merger is: A) avoidance of fixed costs. B) elimination of costs of searching for input prices. C) control over input prices. D) All of the options. Answer: C Difficulty: 2 Medium Topic: Types of mergers and acquisitions Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 20-01 Differentiate among types of and address motives for mergers and acquisitions.

109) Firm-specific reasons for financial distress include all of the following EXCEPT: A) large amounts of financial leverage. B) poor management. C) economic recession. D) volatility in earnings. Answer: C Difficulty: 2 Medium Topic: Financial distress Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 20-03 Suggest methods by which a firm can informally resolve severe financial distress. 110) Market-specific reasons for financial distress include all of the following EXCEPT: A) high interest rates. B) high unemployment. C) economic recession. D) volatility in earnings. Answer: D Difficulty: 2 Medium Topic: Financial distress Bloom's: Remember AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 20-03 Suggest methods by which a firm can informally resolve severe financial distress.

111) HiHo Inc. is evaluating a merger with the following cash flows: • • •

Years 1 and 2 Incremental Cash Flows: $10 million each year Year 3 incremental cash flow: $40 million Discount rate = 10 percent

What is the most HiHo should pay for this merger? A) $38.53 million B) $41.09 million C) $47.41 million D) $51.27 million Answer: C Explanation: Find NPV of cash flows using financial calculator at 10 percent. NPV = $47.41 million Difficulty: 2 Medium Topic: Merger and acquisition analysis Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 20-02 Mathematically value mergers. 112) Kasha Inc. is evaluating a merger with the following cash flows: • • •

Years 1 and 2 Incremental Cash Flows: $60 million each year Year 3 incremental cash flow: $70 million Discount rate = 9 percent

What is the most Kasha should pay for this merger? A) $113.96 million B) $158.96 million C) $159.60 million D) $190.00 million Answer: C Explanation: Find NPV of cash flows using financial calculator at 9 percent. NPV = $159.5995 million Difficulty: 2 Medium Topic: Merger and acquisition analysis Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 20-02 Mathematically value mergers.

113) J&J Inc. declared bankruptcy through a Chapter 7 filing. Consider the following data in millions of dollars and determine the funds available for secured creditors. • • • • • • •

Proceeds from the liquidation of assets = $130 First mortgage = $100 Administration expenses associated with the bankruptcy = $3 Notes payable to the banks = $25 Subordinated debentures = $5 Taxes due to federal, state, and other governmental agencies = $1 Wages due employees (8,500 employees) = $18

A) $79 B) $84 C) $109 D) $0 Answer: C Explanation: 130 − [3 + 17 + 1] = $109; note that the wages due are capped at $2,000 per employee Difficulty: 2 Medium Topic: Bankruptcy Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 20-05 Build and use statistical models to predict bankruptcy.

114) A linear probability model you have developed finds there are two factors influencing the past bankruptcy behavior of firms: the debt-to-equity ratio and the sales-to-total assets ratio. Based on past bankruptcy experience, the linear probability model is estimated as: PDi = 0.65 (debt/equity) + 0.10 (sales/total assets) A firm you are thinking of lending to has a sales-to-assets ratio of 0.9 and its expected probability of default, or bankruptcy, is estimated to be 11 percent. Calculate the firm's debt ratio. A) 1.03 percent B) 2.99 percent C) 3.08 percent D) 9.70 percent Answer: B Explanation: 0.11 = 0.65 (debt/equity) + 0.10(0.9) => debt/equity = (0.11 − 0.10(0.9))/0.65 = 0.0308 times => debt/equity = (total assets − equity)/equity = (total assets/equity) − 1 = 0.0308 => total assets/equity = 1.0308 => equity/total assets = 1/1.0308 = 0.9701 => debt/total assets = 1 − 0.9701 = 0.0299 = 2.99 percent Difficulty: 3 Hard Topic: Bankruptcy prediction Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 20-05 Build and use statistical models to predict bankruptcy.

115) One Day Dry Cleaning is considering a merger with Speedy's Laundry Supply Stores. One Day's total operating costs of producing services are $450,000 for sales volume (SG) of $3.75 million. Speedy's total operating costs of producing services are $200,000 for a sales volume (SW) of $1.70 million. For a sales volume of $5 million, calculate the reduction in production costs the merged firms need to experience such that the total average cost (TAC) for the merged firms is equal to 11 percent. A) $100,000 B) $200,000 C) $450,000 D) $550,000 Answer: A Explanation: 0.11 = Total operating costs/5M; Total operating costs = $550,000; Reduction = 550,000 − 450,000 − 200,000 = $100,000 Difficulty: 2 Medium Topic: Merger and acquisition analysis Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 20-02 Mathematically value mergers. 116) Cathy Corp. is considering a merger with Russell, Inc. Cathy's total operating costs of producing services are $200,000 for a sales volume (SC) of $700,000. Russell's total operating costs of producing services are $400,000 for a sales volume (SB) of $1 million. If the two firms merge, calculate the total average cost (TAC) for the merged firm assuming no synergies. A) 28.57 percent B) 35.29 percent C) 40.00 percent D) 68.57 percent Answer: B Explanation: TAC = [200,000 + 400,000]/[700,000 + 1,000,000] = 35.29 percent Difficulty: 1 Easy Topic: Merger and acquisition analysis Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 20-02 Mathematically value mergers.

117) Suppose that the financial ratios of a potential borrowing firm took the following values: X1 = Net working capital/Total assets = 0.36, X2 = Retained earnings/Total assets = 0.08, X3 = Earnings before interest and taxes/Total assets = 0.25, X4 = Market value of equity/Book value of long-term debt = 0.80, X5 = Sales/Total assets ratio = 0.75. Calculate and interpret the Altman's Z-score for this firm. A) 2.24; High risk B) 2.24; Indeterminate C) 2.60; Low risk D) 2.60; Indeterminate Answer: D Explanation: Z = 1.2(0.36) + 1.4(0.08) + 3.3(0.25) + 0.6(0.80) + 1.0(0.75) = 2.599. According to the Altman's Z-score, this firm should be placed in the indeterminate bankruptcy risk class. Difficulty: 1 Easy Topic: Bankruptcy prediction Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 20-05 Build and use statistical models to predict bankruptcy. 118) Suppose that the financial ratios of a potential borrowing firm took the following values: X1 = Net working capital/Total assets = 0.65, X2 = Retained earnings/Total assets = 1.10, X3 = Earnings before interest and taxes/Total assets = 0.10, X4 = Market value of equity/Book value of long-term debt = 2.05, X5 = Sales/Total assets ratio = 0.45. Calculate the Altman's Z-score for this firm. A) 8.70 B) 4.35 C) 4.33 D) 2.33 Answer: C Explanation: Z = 1.2(0.65) + 1.4(1.1) + 3.3(0.10) + 0.6(2.05) + 1.0(0.45) = 4.33 Difficulty: 1 Easy Topic: Bankruptcy prediction Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 20-02 Mathematically value mergers.

119) Suppose a linear probability model you have developed finds there are two factors influencing the past bankruptcy behavior of firms: the debt ratio and the profit margin. Based on past bankruptcy experience, the linear probability model is estimated as: PDi = 0.20 (debt ratio) + 0.15 (profit margin) A firm you are thinking of lending to has a debt ratio of 75 percent and a profit margin of 6 percent. Calculate the firm's expected probability of default, or bankruptcy. A) 15.0 percent B) 15.9 percent C) 20.3 percent D) 40.5 percent Answer: B Explanation: PDi = 0.20 (0.75) + 0.15 (0.06) = 0.159 or 15.9 percent Difficulty: 1 Easy Topic: Bankruptcy prediction Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 20-05 Build and use statistical models to predict bankruptcy. 120) Jan's Bakery is considering a merger with Tina's Cookies. Jan's total operating costs of producing services are $100,000 for a sales volume of $250,000. Tina's total operating costs of producing services are $75,000 for a sales volume of $300,000. If the two firms merge, calculate the total average cost for the merged firm assuming no synergies. A) 25.0 percent B) 31.8 percent C) 32.5 percent D) 40.0 percent Answer: B Explanation: AC = $175,000/$550,000 = 31.82% Difficulty: 1 Easy Topic: Merger and acquisition analysis Bloom's: Apply AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 20-02 Mathematically value mergers.

121) Flowers Galore is considering a merger with Balloons N More. Flowers Galore's total operating costs of producing services are $800,000 for a sales volume of $3 million. Balloons' total operating costs of producing services are $60,000 for a sales volume of $100,000. If the two firms merge, calculate the total average cost for the merged firm assuming no synergies. A) 26.67 percent B) 27.74 percent C) 43.34 percent D) 60.00 percent Answer: B Explanation: AC = $860,000/$3,100,000 = 27.74% Difficulty: 1 Easy Topic: Merger and acquisition analysis Bloom's: Apply; Analyze AACSB: Analytical Thinking Accessibility: Keyboard Navigation Learning Goal: 20-02 Mathematically value mergers.